The UK’s broadband market is getting more competitive, and Talktalk Telecom (LSE: TALK) is starting to get worried.
As sector giants BT (LSE: BT-A) and SKY (LSE: SKY) use their size and financial firepower to undercut each other on price and offer customers deals they can’t refuse, smaller players like Talktalk are at risk of falling behind.
Indeed, alongside its trading update for the 3 months to 30 June 2015, Talktalk warned today that recent demand for its broadband services “was softer than we have seen in recent quarters, with higher promotional activity in the sector“.
And it seems as if BT’s war with pay-tv giant Sky can be blamed for this market weakness.
Turf war
Over the past year or two, BT and Sky have started to encroach on each other’s turf. For example, BT has ploughed money into its pay-tv offering, a market Sky has dominated for some time. On the other hand, Sky has pushed into the broadband market, using its presence in households across the UK to cross-sell its offering.
This battle for customers has reached fever pitch within the past few months.
In an attempt to attract customers, BT is now offering its sports channels to broadband customers for free. Meanwhile, Sky has announced that it will now offer its basic fibre-optic broadband package, which typically costs £120 for 12 months, for free.
In addition to cutting prices, the two companies have been calling for Ofcom to investigate each other’s dominance over respective areas of the market. BT claims that Sky is overcharging customers to the tune of £500m per year, while Sky claims that BT has a dominant position in the UK telecommunications market and has called for the company to broken up.
Unfortunately, the turf war between Sky and BT is bad news for Talktalk and the company’s shareholders.
Bad news
Talktalk’s growth over the past five years has been nothing short of impressive. The company’s shares have risen by 206% excluding dividends since the end of June 2010.
What’s more, if the company hits its targets for growth during the next two years, by 2017 pre-tax profit will have jumped 370% in just seven years. However, the company is currently trading at a forward P/E of 26.5, which does not leave much room for error if Talktalk fails to hit its targets.
And the company is already struggling. In today’s trading update, Talktalk announced that revenue for the period expanded by 3.5% year-on-year, below analysts’ forecasts, which were calling for growth of 6.5%. Still, the company remains confident that it can deliver full-year revenue growth of 5%.
Nevertheless, City analysts are now starting to express concern that with competition increasing, and margins coming under pressure across the broadband market, Talktalk will struggle to meet its long-term growth targets.
Management expects revenue to grow at 5% per annum from 2017 onwards. The group is also targeting an EBITDA margin of 25% by 2017.
Foolish summary
So overall, as competition in the broadband market increases Talktalk could struggle going forward. However, before you make a trading decision, I strongly recommend that you do your own research — you may come to a different conclusion.