BoAML: Virgin is facing a daunting combination of structural issues

According to Bank of America Merrill Lynch (BoAML), the Virgin Media ‘story’ is characterised by a two-way pull between management trying to tweak the model to generate cash (to drive share buybacks) and the operational issues facing the company.

The bank retains its ‘Underperform’ recommendation and has lowered its price objective from $25 to $24. BoAML believes that Virgin Media is “facing a daunting combination of structural issues (affecting all three main core products) as well as UK consumer exposure”.

“These combine, and are magnified by, operational and financial gearing. The net result is cashflow risk.”

BoAML’s view is that recent developments validate its previous concerns on Virgin’s business model –

• Phone: Virgin Media’s £1 billion “cash cow” is under threat with subs leaving every quarter
• TV: New platforms (such as YouView, Netflix etc) allow consumers to go direct to content providers. Faced with a fundamental change, Pay TV providers must adapt (a significant problem)
• Broadband: Virgin’s 40% market share is threatened by BT’s fibre deployment, which appears to be incentivising Sky (and other operators) to act as a Trojan Horse to take share
• Strategy: Virgin Media appears be trying to pull off a balancing act. It is under pressure to raise revenues and has pushed through a price rise (hoping that its customers are more digitally savvy than rate sensitive). However it faces a problem with churn, which averaged 16.7% in 2011 (vs c.10% for Sky homes)

Looking ahead it is also facing the launch of YouView, which should accelerate churn from mid and lower tier customers (with ARPUs of £460/year and churn rates of c.23% already).