Shaw Muddles Along While It Awaits Resolution of Its Proposed Merger With Rogers

Equity Analyst

Matthew Dolgin

Shaw has agreed to be acquired by Rogers, but the proposed deal has seen pushback from regulators. The merger’s fate now rests with the Competition Tribunal, and we expect a resolution by early 2023. We think the agreement to sell Freedom Mobile to Quebecor makes the deal good for competition overall and therefore makes approval more likely.

Shaw re-entered the Canadian wireless market in 2016, and it made good progress until growth slowed following the merger announcement. Shaw has significantly improved its wireless network and is now bundling wireless with wireline service to customers in its cable footprint, enabling it offer even better value and enhancing service when offloaded onto its Wi-Fi network. Between the ends of fiscal years 2016 and 2020, Shaw more than doubled its postpaid wireless subscriber base, increased average billings per user by 20%, and expanded its wireless EBITDA margin by 900 basis points. Gains slowed after March 2021, when the merger was announced, but we think renewed focus in the business, especially in the hands of Quebecor, can make it a legitimate competitor to the big three carriers.

We are less optimistic about Shaw's wireline business, which still makes up over three quarters of total revenue. Shaw’s cable network, built with fiber and coaxial cable, had historically been superior to its primary geographic competitor, Telus. However, Telus has replaced most of its legacy copper network with fiber and can now offer broadband service at a quality as good or better than Shaw in many places. The stronger competition has caused Shaw to lose customers and market share over the last several years. Shaw ended fiscal 2022 with under 5 million wireline revenue generating units, or RGUs, down from 6.4 million RGUs in 2012. The losses are attributable to television and voice customers, which face secular challenges for all competitors, but even internet customer growth has been anemic (up 2% since 2017, including customer losses in 2021). Shaw has materially underperformed Telus across all types of RGUs. Telus has grown its internet customer base by 22% since 2017 while also adding television customers.

Business Strategy & Outlook

Our narrow moat rating for Shaw is based on efficient scale and cost advantages in its wireline business, which accounted for more than 75% of total revenue in fiscal 2022. Shaw's primary competitor in offering the "triple-play" services (internet, television, and landline phone) is Telus, with which Shaw competes in the western Canadian provinces of British Columbia and Alberta. Shaw also has a presence in the much more sparsely populated geographies of Saskatchewan, Manitoba, and northern Ontario, where it competes mostly with regional providers and, in Manitoba, with BCE. Shaw's return on invested capital averaged about 11% between 2008 and 2015, a period when wireline provided the bulk of Shaw's sales but the company also had a media segment and was in and out of multiple smaller businesses. ROIC fell below the firm's 8% WACC in 2016 when Shaw re-entered the wireless space with its acquisition of Wind Mobile (subsequently renamed "Freedom Mobile"), a smaller carrier with an inferior network relative to national wireless providers Rogers, Telus, and BCE. Very high costs associated with building a high-quality wireless network will weigh on Shaw's returns for the next few years, but we expect a growing subscriber base to result in wireless capital spending gradually coming down relative to wireless sales, and we forecast margins expanding as Freedom Mobile raises prices. Shaw’s ROICs have stayed between 7.0% and 7.5% for the last five years, and we expect them to slowly trend upwards and reach return to the 8% level in 2024.

Shaw's efficient scale stems from the very high capital costs required to build and maintain a wireline communications network. Shaw's capital spending in its wireline segment has been between CAD 800 million and CAD 1 billion each year since at least 2012, and during that time, the company's adjusted ROIC never exceeded 12%. While the return eclipsed Shaw's 8% WACC by a comfortable margin, it is a return that would likely dissuade smaller competitors with higher capital costs and no existing customer base from wading into Shaw's territories. According to the most recent government data, there were fewer than 5 million households in Shaw's geographic footprint in 2019. Shaw and Telus collectively provided internet service to about 4 million of them (although some of Telus' subscriber base is in eastern Quebec). With such a high proportion of the potential market already being served by the largest players who earn only modest excess returns on capital, we don't see opportunities for regional players to expand or new entrants to profitably build networks. 

Shaw also has cost advantages in its wireline business over current and potential competitors besides Telus. Versus small or upstart competitors, Shaw's large scale enables it to spread overhead and marketing costs over a larger customer base. Relative to Telus, we don’t expect a significant shift in the competitive dynamic that has allowed a long-standing western Canadian duopoly under which both companies have been able to earn excess economic profits. While Telus is now a much stronger competitor after having installed fiber over most of its network, the very high capital expenditures that were required to build out the fiber should help to support industry pricing and margins, as Telus needs to recoup its investment. Shaw, on the other hand, is simply maintaining its hybrid fiber-coax network that is already competitive with Telus’ fiber from a performance standpoint. This older network has required less than CAD 1 billion in capital spending, on average, over the last five years, versus CAD 2 billion annually for Telus. Shaw’s wireline margins have stayed above 45% for most of the past decade, while Telus’ wireline margins have generally been below 30%.

We do not see a moat in Shaw's wireless segment, which is still young, relatively small and on an inferior network to its national competitors. In the near-term, Shaw is spending outsize levels of capital to bring its wireless network up to par and attempting to lure customers with unmaintainably low subscription offers. We estimate Shaw has only about 5% of the Canadian wireless subscribers as of 2020, and the economics of its wireless segment pale in comparison to competitors. However, we think Shaw has a good strategy and the financial wherewithal to build a competitive network; and, as a smaller player, it is given favored status by the government over larger players. While we don't project a moat in the near future for this business, we think it will be sufficiently successful to cease weighing on the company's overall returns after the near-term network spending is complete.

The biggest factor keeping us from labeling Shaw a wide-moat company is the ever-present threat of regulation in the telecom industry, which could weigh on Shaw's wireline business (85% of EBITDA in fiscal 2020). Telecom services are sometimes viewed as public utilities (a classification that the U.S. government used regarding broadband internet when it was defending net neutrality), and the government tends to keep a watchful eye over service offerings, competition, and network requirements. While current Canadian regulations and oversight are not so prohibitive that they diminish Shaw's moat, the possibility that the government could deem it necessary to compel greater levels of network sharing, price controls, or other means of competition tempers our confidence in long-term projections and keeps us from assuming Shaw will operate in an environment that would allow excess returns on capital over a 20-year time frame.

Narrow

Economic Moat

Shaw Communications

Shaw Communications, Inc. engages in the provision of cable telecommunications and satellite video services. The company was founded by James Robert Shaw on December 9, 1966 and is headquartered in Calgary, Canada.

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Shaw Communications is a telecommunications company that provides connectivity solutions to business customers of all sizes from home offices to medium- and large-scale enterprises. It leverages business-grade Fibre+ and fiber-to-the-premise (“FTTP”) networks. The company was founded in 1966 and is headquartered in Calgary, Alberta.

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