On Thursday, Sky (SKY) announced it will launch a wireless service in 2016. It will operate as a mobile virtual network operator using Telefonica's network. Since BT Group announced it was in exclusive negotiations to acquire EE and Hutchison Whampoa announced it was in exclusive negotiations to acquire Telefonica's U.K. network, O2, we had thought Sky would eventually offer a wireless service. However, as these other acquisitions are unlikely to close until 2016, we didn't expect it to be announced this early.
Previously, Sky suggested there was no need to offer a wireless service, as U.K. consumers weren't demanding a quad-play offer of fixed-line and wireless telephony along with broadband and pay television. Clearly the market is changing, and Sky is changing with it. We view this more of a defensive manoeuvre for Sky rather than a source of much future revenue growth, so we are maintaining our fair value estimate and moat rating.
We also think Telefonica wanted to announce the deal now in order to help its merger prospects with Hutch. We expect Telefonica will use this news to demonstrate to regulators that competition will still exist if the U.K. market moves from four to three operators.
Sky is the U.K.'s largest pay TV operator, with 10.7 million subscribers versus only 3.7 million cable customers. It is also Italy's largest pay television provider, and one of the largest in Germany and Austria. However, at 28% in Italy and 19% in Germany and Austria, pay television has much lower penetration rates in these countries than the European average of almost 50%. While this reduces the country scale that Sky possesses in these countries, it also provides more growth opportunities. As a satellite broadcaster, the firm doesn't have the costs of laying cables throughout the country in order to reach the populace. This means it can be profitable with a much lower penetration rate than a cable or telephone operator can. By adding these new countries, Sky has the ability to sell its own generated product across larger audience.
The firm has already been providing set top boxes to Italy, and it should find other ways of cross-selling services in order to reduce costs. Additionally, if content rights ever move to a pan-European basis, Sky is well-positioned. Similar to the U.K., its new operations in Italy and Germany control much of the best content. Better content drives viewership, which in turn produces additional funds to acquire even more content, leading to a virtuous circle. We anticipate pay television's penetration rate will increase in these countries and, as in the U.K., the quality of Sky's content will drive its growth. We think the firm's strong positioning provides it with a narrow economic moat.
