6 December 2006
Industry and technology
primer
Guy Peddy
Research Analyst (44) 20 754 58490 [email protected]
Matthew Bloxham, CFA
Research Analyst (44) 20 754 58163 [email protected] Gareth Jenkins Research Analyst (44) 20 754 75849 [email protected]
A real mixed bag: confusing simplicity!
The telecom sector can appear confusing: the stakeholders are many and often have contradictory objectives. Balancing government/political designs, huge employee numbers, an increasing competition without limiting investment in an environment of technological evolution and substitution, can appear overwhelming. However, fundamentally the drivers of telecom business models are simple: penetration, customers and ARPU whilst balancing investment levels.
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Telecom for beginners 2007
Primer
Pan-European Telecoms Team
Guy Peddy [email protected]
+44 20 754 58490
Carola Bardelli [email protected] +39 0286379-708
Matthew Bloxham [email protected] +44 20 754 58163
Gareth Jenkins [email protected] +44 20 754 75849
Vivek Khanna [email protected]
+44 20 754 72905
Sales Contact
Audrey Wiggin [email protected] +44 20 754 50707
Jonathan Smith [email protected] +44 20 754 74383 Company Research
In
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Second edition: Revised and updated for 2007 and beyond
This is the second edition of our Telecom for Beginners report, first published in January 2004. This comprehensive report aims to show how the telecom sector has developed over time. We focus on the influences on returns, and we examine some of the key issues for the future and we have consciously avoided drawing any company specific conclusions.
Structured into discreet parts: Environmental/Technological/Reference
There are three distinct sections to this report. In section 1 we examine the telecom business model, highlighting the relationship between penetration, ARPU and revenue, explain the history of telecoms over the past three decades and how the sector had ended up where it is, and assessed the wider telecoms environment showing how operators, equipment manufacturers and content providers interrelate. We study the evolution of the regulatory model, probably the single most important driver of pricing and competition industry, and finally we put telecoms into a wider industry context with some macro comparisons. We have, where relevant, attempted to use standard business analysis tools (such as the BCG matrix and Porters’ 5 forces) to highlight themes.
In section 2 we look at some of the key technologies in the industry, starting with a basic explanation of the electro-magnetic wave (i.e. the signal), followed by an assessment of voice technologies (switching, PTSN and VoIP), mobile technologies 1G to 3G, HSDPA and Bluetooth) and broadband technologies DSL, fibre, WIMAX/WiFi and satellite). We also review trends in convergence (TV, IPTV, mobile TV, gaming and music).
Finally, in section 3 we summarise basic statistical facts about each European country and a basic SWOT analysis of the industry. We also include those databases that are often forgotten: licence payments and types, European telecom IPOs, key events for large capitalized operators over the past few years, a breakdown of government ownership and a list of recent M&A transactions and finally we end the note with an ever-expanding glossary.
Something for everyone
This primer is aimed at everyone - those that have been involved in the sector for years and those who are new, and to generalists who like to occasionally dip in and out of the sector. It has been fun to write, but is by no means exhaustive, and we are always open to suggestions on how we improve it going forwards.
Table of Contents
Section 1: Environmental... 5
The telecoms business model ... 6
History of European telecoms ... 31
The telecoms environment ... 47
Regulation ... 57
Telecoms in a macro context... 77
Section 2: Technological ... 82
Basics of Electronic Communication ... 83
Technology: Traditional voice ... 86
Technology: Mobility... 93
Technology: Bandwidth ... 105
Technology: Convergence ... 116
Section 3: Reference... 129
Country: Austria... 130
Country: Belgium... 131
Country: Denmark ... 132
Country: Finland ... 133
Country: France ... 134
Country: Germany ... 135
Country: Greece... 136
Country: Ireland ... 137
Country: Italy ... 138
Country: Japan... 139
Country: Netherlands ... 140
Country: Norway ... 141
Country: Portugal ... 142
Country: Spain ... 143
Country: Sweden... 144
Country: Switzerland ... 145
Country: US... 146
Appendix A: European telecoms SWOT ... 148
Appendix B: European UMTS licenses ... 149
Appendix C: AWS auctions... 152
Appendix D: License lives ... 162
Appendix E: European IPOs... 166
Appendix F: European operator key dates ... 168
Appendix G: Government ownership ... 183
Appendix H: European M&A... 184
The telecoms business model
Penetration and ARPU
Telecommunications is a very simple business complicated by regulation and politics. The standard business model relies on a trade off between pricing, penetration and capital intensity. Almost all elements of the telecoms industry follow the standard “S” growth curve in penetration as depicted in Figure 1.
Figure 1: Penetration “S” curves in UK telephony
0% 20% 40% 60% 80% 100% 120% 140% 199 4 199 5 199 6 199 7 199 8 199 9 200 0 200 1 200 2 200 3 200 4 200 5 200 6E Wireless Broadand Wireless penetration inflexion - mass market
Penetration slows - start of a market share battle
Premium product - business focus
Source: Deutsche Bank
Four key drivers
In Figure 2 we have attempted to describe, simplistically, the effects on what we believe are the four key drivers (business model clarity, competitive environment, pricing and capex) of telecoms profitability at different stages in the product life cycle. Although there are clearly some business models that do not conform to these characteristics, we believe most of them do.
As we show later in our BCG matrix analysis (Figure 76) and as we also show in Figure 6, much of the European telecoms sector is approaching the maturity stage in the product life cycle, with broadband penetration offering a hope of growth, but with significant price deflation and an increasing risk of substitution with the technologies that it has enabled (VoIP, IPTV etc).
Figure 2: Key drivers of the product life cycle
Phase of the life cycle Business model clarity Competitive environment Pricing Capex
Early stage Uncertain Limited Premium product Capital intensive
Growth Certain Focused on growth Aggressive deflation to drive
penetration Customer/demand driven
Telecom cycles
The telecom industry work in cycles (earning, revenue growth etc) and they tend to range from 3 to 7 years. In Europe over the past 15 years there have been several cycles, such as:
Market related:
Mobile penetration and revenue growth: 1998 to 2004 Broadband penetration growth: 2004 to ?
EU regulatory focus on unbundling, mobile termination and mobile roaming tariffs:
2004 to ?
Financial related
TMT bubble: 1998 to 2000
European earnings downgrades: 2004 to ? European deleveraging: 2001 to 2004
The most important consideration currently is where is the growth driver for the European industry? Historically the telecom industry has found ways to invent growth drivers but currently the outlook is void. As such, rather than the industry growing at its historical rate (at greater than nominal GDP) expectations are that it grows at rates below nominal GDP in the coming years. This is shown in Figure 3 and in Figure 4 we proffer a view on where European and US telecom industries are in their current cycle. The outlook for the US operators appears to be more positive as the regulatory cycle has subsided and operators are more aggressively roll-out fibre and IPTV services.
Figure 3: Re-inventing growth Figure 4: Cycles in telecom trends
Today
Fixed Mobile What is the next technology?
Historic growth Future growth + ve -ve Time 3-7 years? US telecoms ? EU telecoms ?
Source: Deutsche Bank Source: Deutsche Bank
Evolving value chain
One of the major drivers of the current change in the cycle is the revolution in the structure of the European telecom value chain. In the past, operators focused on networks, where there was an exclusivity of supply, and outsourced industry R&D to equipment manufacturers (i.e. Nokia, Ericsson etc), and distribution to third parties (such as Carphone Warehouse in the UK) and this meant that the consumer relationship was minimal.
In the modern world network exclusivity is disappearing as the equipment manufactures increasingly look to manage, and even own infrastructure, and other media operators and upstarts, such as Google, are entering the distribution place. In order to respond telecom operators are investing more in R&D to deliver new products and are seeking to take control of distribution channels, both on-line and on the high street, and finally are investing in brand and market segmentation to more appropriately target the consumer.
Figure 5: The evolving telecom value chain
Networks
Equipment
Distribution
Consumer
BSkyB
R&D
New focus ofoperator services
Source: Deutsche Bank
Usage drivers: New product innovation
Average revenue per user (ARPU) is one of the most common measures of customer value in the telecoms world, especially in the mobile environment. It is most often driven by usage, either with an incremental pricing-based model (i.e. a charge is incurred for every call made) or through a bundle (i.e. a flat rate package with specified or unlimited usage).
With growth slowing and many markets in the maturity phase of development new product innovations, which could be additional services and products that either exploit existing infrastructure or open up new market environments, are required. In Figure 6 we flag where we believe different products/services currently are in the product life cycle and we highlight the maturity of the leading revenue streams (mobile voice and traditional wireline). There are however new services and products that offer hope for the future, such as telecoms operators offering TV services.
Figure 6: European telecoms product life cycle
Introduction Growth Maturity Decline
Traditional wireline – voice
ATM, X25, leased lines Mobile voice Mobile SMS Broadband Instant messaging Mobile data VoIP Mobile TV, IPTV, video telephony
Introduction Growth Maturity Decline
Traditional wireline – voice
ATM, X25, leased lines Mobile voice Mobile SMS Broadband Instant messaging Mobile data VoIP Mobile TV, IPTV, video telephony
which products and services are substitutionary to existing offers and which are revolutionary products. For those that are substitutionary, we have listed which other business areas have they affected.
Figure 7: Classifying new products and services
Product/Service Categorization Affected business
Mobile voice Revolutionary
Mobile SMS Revolutionary
Mobile data ?
Broadband Substitutionary Traditional wireline access (PTSN and ISDN)
VoIP Substitutionary Wireline and mobile voice
Instant messaging Substitutionary Email, SMS, voice
Mobile TV Revolutionary
IPTV Substitutionary Traditional TV (terrestrial, cable, satellite)
Video telephony Substitutionary Wireline and mobile voice
Source: Deutsche Bank
Wireline – all about access and traffic
Access – growth and then substitution
A wireline business model (either incumbent or new entrant) is fundamentally about securing the consumer access and then charging for incremental services. Unfortunately, in most cases the premium charged for incremental services trends to be zero and as such the wireline business model is increasingly focused on access revenues. As can be seen in Figure 8, access line growth in OECD countries was consistent throughout the 1990s but more recently has started to decline as wireless competes as another form of access technology and broadband has reduced the demand for multiple access to single premises -- broadband has replaced ISDN and increasingly the convergence with media is such that consumers require only a single TV/telephony access pipe rather than one for each service.
Figure 8: Access lines (m) and growth (%) in OECD countries 0 100 200 300 400 500 600 700 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 -2.0% -1.0% 0.0% 1.0% 2.0% 3.0% 4.0% 5.0% 6.0% 7.0%
Access channels* Growth
Source: OECD
In many counties access line penetration has stalled at around 50% to 60% of the population reflecting the fact that the average house has over 2 residents that can share and access. In certain countries, such as Mexico, access penetration remains lower and we doubt there will be huge long-term growth, as wireless is picking up the incremental demand for access technologies, and is considerably more cost effective to deploy – the civil works in constructing wireline infrastructure can be excessive. There may, however, be incremental demand if broadband penetration picks up, but again there is an affordability issue in many of these under-developed countries.
Figure 9: Access lines penetration in OECD – 2004 0 10 20 30 40 50 60 70 80 90 100 L u xem bou rg S w ed en Sw it ze rl a n d No rw ay Ger m a n y De n m a rk Icela n d U n ited S ta tes C a na da Net h er lan d s Finla n d Ko re a Gr ee ce U n it ed K ingdo m Jap an A u str a lia OE C D aver a g e Ita ly Ir ela n d Fr an ce Au st ri a Be lg iu m N e w Zeala n d Sp a in Por tug a l Hu n g a ry C ze c h R e pub li c Pol a n d Tur k ey S lov ak R e pub li c M exi co 0 10 20 30 40 50 60 70 80 90 100
% of population OECD average
Source: OECD
In Europe, the pressure on access lines is explicit. Using Deutsche Telekom as an example below (Figure 11), the company grew ISDN access volumes in the 1990s as if offered higher basic internet dial-up speeds and was not regulated (only PSTN access fees and traffic tariff were regulated). This ISDN growth replaced existing PSTN accesses, which were also starting to suffer the effects of the growth in mobile penetration. However, with the launch of broadband, ISDN has become more redundant and since 2005 DT has experienced access line erosion due to unbundling.
Figure 10: Deutsche Telekom PSTN and ISDN access lines (000)
Figure 11: Deutsche Telekom PSTN and ISDN access lines changes (000) -5,000 10,000 15,000 20,000 25,000 30,000 35,000 40,000 45,000 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 PSTN ISDN -3,000 -2,000 -1,000 0 1,000 2,000 3,000 4,000 5,000 199 3 199 4 199 5 199 6 199 7 199 8 199 9 200 0 200 1 200 2 200 3 200 4 200 5 PSTN ISDN
Traffic – up, down and down
Over the past decade it is has been difficult to construct a view on the underlying trends in tariff as there have been many material one-off events. Liberalization of the European telecoms markets and consequential tariff deflation led to increased volumes, but this was combined with huge growth in ISP dial-up accesses, which stimulated a dramatic increase in local call volumes. This has subsequently been impacted by the growth in broadband which has reduced dial-up ISP minutes and increased mobile substitution, especially in markets where mobile is the dominant traffic device (such as Portugal and Finland as shown in Figure 12). Increasingly VoIP substitution is also depressing traditional traffic volumes.
Figure 12: Share of outgoing mobile minutes (%) – 2005
16.2 19.9 21.7 25.6 29.4 30.3 31.4 40.0 40.6 42.3 48.8 49.2 55.7 10 15 20 25 30 35 40 45 50 55 60 Germany Sweden Netherlands Greece Italy Denmark UK Ireland Spain France Austria Finland Portugal Source: Analysys
In Figure 13 we show how the German fixed-line voice market grew between 1997 and 2002 due to liberalization and the growth in dial-up ISP traffic. But due to mobile, broadband VoIP, volumes in the industry have rolled over. Figure 13 also highlights how Deutsche Telekom has lost 50% market share in wireline traffic (since liberalisation in 1998).
Figure 13: German market traffic growth (bn of minutes) 0 50 100 150 200 250 300 350 400 1997 1998 1999 2000 2001 2002 2003 2004 2005 Other DT AG Liberalisation and ISP growth
Broadband, VoIP and mobile substitution and ISP growth
Source: Bundesnetzagentur
This shift in traffic revenue has led to a substantial cut in the importance of wireless traffic revenue in an operators revenue mix. Indeed at Deutsche Telekom, access revenue, due to price increases and DSL growth, has increased by 32% but traffic revenue has declined by 71% since 1998. This also reflects a huge rebalancing of tariff that has been undertaken in Europe over the past decade. Historically, and for philanthropic reasons, access fees were kept to a minimum in order to stimulate penetration, but traffic fees were high. In this scenario, heavy users (i.e. corporates) subsidised domestic telephony. However, with the charges in EV model to more accurately reflect the cost of provision, access charges have increased and traffic fees have declined.
Figure 14: Access and traffic revenue at Deutsche Telekom’s domestic wireline business (Euro m) -5,000 10,000 15,000 20,000 25,000 1997 1998 1999 2000 2001 2002 2003 2004 2005
Access revenue Traffic revenue
Mobile – penetration is the king
Universally the mobile technology has been accepted by the consumer, once the price point of entry has been lowered (with advances in handset development, infrastructure costs have declined for the benefit of the consumer) and in many emerging markets the wireless device has become the pre-eminent access technology (i.e., stimulating wireline penetration). Key to this business model is penetration (access or SIM), and the industry growth becomes challenging when penetration growth slows down (as we depicted in Figure 1) and a market share battle materialises.
The scale of industry growth since the turn of the century across the globe has been outstanding. The technology has grown such that penetration is now over 40%, up from low single digits a decade ago. This growth has predominantly been driven by the near universal acceptance of GSM technology (other than in Korea and Japan) which has led to a consequential reduction in both capex and handset costs as shown in Figure 16.
The combination of competition in the infrastructure market, (especially with the entrance of Chinese vendors such as Huawei) and the belief that 2G technology will soon be replaced by 3G, has led to infrastructure price deflation. This has allowed mobile technology to be rolled out into emerging markets where ARPUs are low, and advances in handset technology are such that ASPs (average selling prices) have declined as the cost of low-end handsets has reduced to $30 and below. This has materially enhanced the attractiveness of the emerging market mobile business model (hence the huge growth in markets such as China and India)
Figure 15: Global digital mobile customers (m) Figure 16: Technology spread of mobile customers
0 500 1,000 1,500 2,000 2,500 3,000 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 H1 2006 GSM 81% 3 GSM 3% CDMA 2% CDMA 1x 9% TDMA 1% CDMA 1x EV-DO 1% PDC 2% iDEN 1% Analog 0%
Source: EMC and Wireless Intelligence Source: Wireless Intelligence
Europe was the main driver of GSM growth (as the EV adopted it as a single technology in the early 1990s) as penetration is over 100%. The US has grown on a more steady trajectory, helped by consolidation, and growth in GSM technology over the past three years (the USA also has CDMA technology), but the growth in LatAm has been the most marked, due to handset price deflation and severe competition in Brazil as the market has consolidated. In total volume terms, the Chinese market is driving the huge absolute, even if relative growth is less discernable.
Figure 17: Penetration of mobile by continent Figure 18: Geographic spread of digital mobile customers (2006E) 0% 20% 40% 60% 80% 100% 120% 2003 2004 2005 2006E 2007E Europe Middle East + Africa China Asia Pacific North America LatAm
Africa 9% Asia Pacific 41% Europe: Eastern 17% Europe: Western 22% Middle East 6% USA/Canada 5%
Source: Deutsche Bank estimates and company data Source: Wireless Intelligence
However, across continents the mobile business model varies significantly, primarily due to stages in competition, development and regulatory pressures. In Figure 19 we attempt to show how the European mobile business model is changing and the importance of the current wave of regulatory pressure which is driving down roaming, SMS, data (potentially) and mobile termination revenue.
Figure 19: Changes in the European mobile business model (% of revenue)
0 10 20 30 40 50 60 70 80 90 100 2006E 2010E
Roaming SMS data Mobile Termination Non SMS data Outgoing voice
Assuming elasticity 1x
3.2x increase
Reduction of 2/3rds
Source: Deutsche Bank estimates
Putting these trends into context, in Figure 20 we have attempted to assess the drivers of the mobile business model in each region.
Figure 20: Comparing mobile markets (2006E)
Europe USA Japan Asia Middle East Africa Latam
Stage in product life cycle Maturity Growth Maturity Mixed (but mostly
growth) Growth Growth
Competition Severe Controlled Controlled Light Light Severe
Regulatory threat Significant Negligible Limited Limited Limited Significant
Over the past 20 quarters, growth in the European mobile market has slowed down dramatically due to a combination of penetration peaking, price declines and regulation. To compensate for this slowdown and in order to support returns and cash flow generation, capex levels have been volatile but essentially flat, as there are spurts of 3G investment and then a slowdown to reflect, in many countries, a lack of usage and demand.
Figure 21: Western European wireless operators: Aggregated revenue and EBITDA growth (YoY)
Figure 22: Western European wireless operators: Aggregated capex growth (YoY)
-10% -5% 0% 5% 10% 15% 20% 25% 30% 35% 40% 1Q02 2Q02 3Q02 4Q02 1Q03 2Q03 3Q03 4Q03 1Q04 2Q04 3Q04 4Q04 1Q05 2Q05 3Q05 4Q05 1Q06 Revenue EBITDA -40% -30% -20% -10% 0% 10% 20% 30% 1Q 02 2Q 0 2 3Q 0 2 4Q 0 2 1Q 03 2Q 0 3 3Q 0 3 4Q 0 3 1Q 0 4 2Q 04 3Q 0 4 4Q 0 4 1Q 0 5 2Q 0 5 3Q 0 5 4Q 0 5 1Q 0 6
Source: Deutsche Bank Source: Deutsche Bank
Whilst penetration is king to the mobile business model it is also important to stress ARPU, elasticity and pricing. Due to a combination of penetration-mix effects, price cuts and regulatory pressure, ARPU in Europe has contracted in recent years (we show the trends in the UK since 1993 in Figure 23), whereas it has been more stable in the US. This may also reflect different usage patterns and price points.
Figure 23: ARPU per month for UK operators (£)
0 20 40 60 80 100 120 140 160 180 Q 1 1994 Q 1 1995 Q 1 1996 Q 1 1997 Q 1 1998 Q 1 1999 Q 1 2000 Q 1 2001 Q 1 2002 Q 1 2003 Q 1 2004 Q 1 2005 Q1 2006E
Vodafone O2 T-Mobile Orange
Source: Deutsche Bank estimates and company data
Figure 24: Comparative UK fixed and mobile pricing (GBp) 0.00 0.10 0.20 0.30 0.40 0.50 0.60 0.70 Q1 1993 Q1 1994 Q1 1995 Q1 1996 Q1 1997 Q1 1998 Q1 1999 Q1 2000 Q1 2001 Q1 2002 Q1 2003 Q1 2004 Q1 2005 Q1 2 0 06E 0.0 2.0 4.0 6.0 8.0 10.0 12.0
Mobile Fixed Fixed/mobile ratio
Source: Deutsche Bank estimates, OFCOM and company data
Broadband and regulation
Broadband is a generic term describing the consumer demand for greater internet access speeds, and is predominantly a battle between two technologies; cable and DSL. Other technologies, such as WiFi, WIMAX and satellite are either infant or are merely used to infill footprint where cable and DSL are uneconomic.
Generally, North America and Korea have a strong cable broadband presence and the EU is led by DSL. There are, of course, exceptions such as the Netherlands, but strength of cable in any market is driven by the legacy position of the technology and TV distribution (cable dominant in TV distribution in most of these countries) and the cable operators’ historical ability to fund a network upgrade from narrowband to broadband in the early part of the century. In Figure 25, we show the relative penetration of broadband at the end of 2005 in most OECD countries and the split by technology. The lack of cable broadband in France, Germany and Italy is as stark as is the scale of cable in the USA and Canada.
Figure 25: OECD broadband penetration (as % of population by technology) 2005 0.0 5.0 10.0 15.0 20.0 25.0 30.0 Icela n d Ko re a Net h er lan d s De n m a rk Sw it ze rl a n d Finla n d No rw ay C a na da S w ed en Be lg iu m Jap an U n ited S ta tes U n it ed K ingdo m Fr an ce L u xem bou rg Au st ri a A u str a lia Ger m a n y Ita ly Sp a in Por tug a l N e w Zeala n d Ir ela n d C ze c h R e pub li c Hu n g a ry S lov ak R e pub li c Pol a n d M exi co Tur k ey Gr ee ce
DSL Cable Modem Other
Source: OECD
In Figure 26, we show the scale of relative cable and DSL broadband in the OECD, where DSL is 2x the size of cable and in Figure 27, we reinforce the fact that the EU is dominated by DSL.
From a regulatory perspective, the strength of cable has huge implications. In the US, and increasingly so in the Netherlands, technology-based competition is removing the need for regulatory body to set wholesale DSL tariffs, as effectively two competitive networks control access pipes into homes and businesses. Where DSL is dominant, regulators are forced to maintain wholesale access in order to compensate for the fact that there may only be a single access pipe connected to a home or business.
Figure 26: Broadband access technology (2005) - OECD Figure 27: Broadband access technology (2005) – EU 15
DSL 62% Cable Modem 31% Other 7% Cable Modem 16% Other 2%
Assessing the long-term penetration of broadband is difficult, but as shown in Figure 28 there remains growth if only to fully penetrate current internet (PC) demand. Thereafter, broadband growth will depend upon the success of non-PC access technologies (such as television and mobile). However, as we showed earlier, to date broadband is following the “S” curve trends of other technologies.
Figure 28: Internet subscribers in total OECD (m)
0 50 100 150 200 250 300
1999 2000 2001 2002 2003 2004 2005E 2006E 2007E
Total Internet subscribers (including broadband) Broadband subscribers
Source: OECD
As we show in Figure 29, email communication remains the most popular use on the internet (both in a broadband and narrowband world). However, broadband has also opened up new markets, such as gaming, music and film downloading, and is also a substitute for traditional voice telephony. In particular, we would highlight the growth in business models, such as Google and Party Gaming, which have been spawned by broadband growth.
Figure 29: Applications used by broadband versus dial-up
91% 82% 72% 57% 46% 38% 40% 16% 84% 67% 60% 38% 22% 21% 17% 7% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% e-mail General surfing Making purchases Banking Music or film downloads Gaming Chat & voice calls Real time gambling/trading
Broadband Narrowband
Figure 30: Value transfer to new media: Aggregated market cap of Time Warner and Disney compared with Google ($m)
Figure 31: Growth in internet gaming (revenue ($bn))
-50,000 100,000 150,000 200,000 Q1 2002 Q3 2002 Q1 2003 Q3 2003 Q1 2004 Q3 2004 Q1 2005 Q3 2005 Q1 2006 Q3 2006
Time Warner/Disney Google
-2.0 4.0 6.0 8.0 10.0 12.0 14.0 16.0 1 998 1 999 2 000 2 001 2 002 2 003 2 004 20 05E 20 06E
Source: Datastream Source: Deutsche Bank
Telecoms and PayTV: Converging through fear
What is convergence? Convergence is an overly used generic term, which is hiding an underlying rationale: “fear” – the opportunity cost of inactivity and business model evaporation.
Telecoms and PayTV operators are increasingly fearful of their existing business models, which are historically technology dependent, and are therefore executing the “prisoner’s dilemma” – entering each others markets with a marginal cost pricing model. This expansion of strategy is being driven by:
Expectation of declining returns;
Increasingly technology agnostic consumers; Technology evolution dissolving barriers to entry; Historic returns driven by network differentiation.
In turn this is leading to a charge to “own the consumer” and the operators are seeing other business areas, preferably where they are unregulated (as they would be new entrants), to increase consumer stickiness. As a consequence telecoms and PayTV operators are chasing the residential consumer’s wallet and both industries are therefore being consumerised.
Figure 32: Current landscape of communications technology and the consumer
Figure 33: Future landscape of communications technology and the consumer
Pay TV Free to air TV Broadband Mobile Fixed voice Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Pay TV Free to air TV Broadband Mobile Fixed voice Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Pay TV Free to air TV Broadband Fixed voice Mobile Consumer Consumer Consumer Consumer Consumer Consumer Consumer Consumer Pay TV Free to air TV Broadband Fixed voice Mobile Consumer Consumer Consumer Consumer
Source: Deutsche Bank Source: Deutsche Bank
This convergence of distribution channels for voice and data (content) is dramatically increasing the consumer choice as we highlight in Figure 34. For example television in the UK has three existing distribution channels – terrestrial free to air, satellite and cable, but all three have coexisted for the last one decade as there was sufficient differentiation.
With telecoms operators entering the media sector, this framework is changing dramatically:
Pricing for premium services reduces dramatically, as telecoms operators price at a more
marginal cost and exploit the imbalance between traditional and IPTV content rights – triple pay offerings are now priced at Euro35;
Offer integrated services with mobility, currently not offered by cable operators.
Offer simplicity – a single provider for services in the home. The major decision maker in
the home, invariably an adult, has shown a willingness to accept single electricity and gas providers in the UK, such that around 60% of all customers are dual bill.
The move to digital TV will require every European television consumer to acquire some
kind of digital receiver (DTT box, satellite, cable or IP TV), which means telecoms operators could benefit from this transition.
Figure 34: Broadband fixed connections into the home – The UK example Cable Operator Satellite Operator INTERNET CONTENT TELCOS DSLAM Cable Modem 2-way wireline/ wireless link
2-way internet + voice telephony Up to 10 Mbit/s downstream
Up to 0.5 Mbit/s upstream
Low capacity phone line return 120-200 digital channels U pl ink of TV br oad ca st s ig na ls 400-500 chan nels Downlink (1-w ay) Dow nlin k (1 -way )
ULL “Unbundled local loop” Telephone Exchange Digital Terrestrial TV (DTT) 50-70 channels(1-way) Broadband (ADSL) Up to 8 Mbit/s (downstream) Up to 0.5 Mbit/s + voice telephony
Set Top Box D S L M O D E M Cable Operator Satellite Operator INTERNET CONTENT TELCOS DSLAM Cable Modem 2-way wireline/ wireless link
2-way internet + voice telephony Up to 10 Mbit/s downstream
Up to 0.5 Mbit/s upstream
Low capacity phone line return 120-200 digital channels U pl ink of TV br oad ca st s ig na ls 400-500 chan nels Downlink (1-w ay) Dow nlin k (1 -way )
ULL “Unbundled local loop” Telephone Exchange Digital Terrestrial TV (DTT) 50-70 channels(1-way) Broadband (ADSL) Up to 8 Mbit/s (downstream) Up to 0.5 Mbit/s + voice telephony
Set Top Box D S L M O D E M D S L M O D E M
Source: Deutsche Bank NB. With ADSL 2+ the downstream capacity will increase to “up to 18 Mbit/s” in the UK
A measure of convergence will be the pricing of terrestrial TV and IPTV football rights. In a converged world where the technology differential is non-existent there should be limited difference. For example on the 1995 sale of Bundesliga rights the winning consortium paid Euro420m per annum for the traditional terrestrial TV rights whereas we estimate Deutsche Telekom paid around Euro40m for the IPTV rights per annum. We would expect this imbalance to narrow at the next auction in 2008.
Is broadband really different?
We have identified five key drivers of the change in consumer activity that is affecting the way media operators think about the internet. This was aimed at showing why current moves are different from the “super-highway” nonsense of the late 1990s. In Figure 35 we summarise these drivers, offer examples and also relate them to the telecoms space.
Figure 35: Drivers of increased economic scale of online activity
Driver Examples Implications for telecoms operators
Investment in network
expenditure BSkyB's entrance into ULL and DT's FTTC roll-out This is the primary focus of operators, as it protects existing revenue but also breaks into unregulated business areas Online applications Google and its roll out of music downloads, web-hosting, VoIP
etc Less relevant to operators, but given network advantages are diminishing, operators will focus increasingly on services as they try to circumvent "independent" gateway providers
Consumer demand 10pp growth in EU penetration in 2005 The key driver of existing market expansion and is being
stimulated by declining access prices as competition increases. Operators sense a demand for integrated services and so are diversifying their technology exposure – clearly the integrated operators have an existing competitive advantage
Piracy Content owners seeking direct customer relationships Not relevant to telecoms operators but Vodafone and Google
are now cooperating to limit exposure Robust on-line business
models Google is not a "dot.com" era business model Not relevant currently, but may stimulate operators to acquire business in this space in the longer term as they may offer increased access to both services and customers
Source: Deutsche Bank
PayTV: Moving offline to online?
The rollout of broadband networks by telecoms operators is radically changing the European media distribution landscape, stimulated by the EU’s aggressive deregulatory policy agenda. The moves by telecoms operators into broadband access and rollout of IPTV will create higher capacity networks. These, coupled with new applications being released by portal operators and other Internet service providers, will bring about a steep change in online functionality.
The media sector is pricing in a massive shift to online media operators, suggesting that historic distribution franchises are being eroded and value is being generated by businesses that provide gateways (i.e. facilitate access rather than infrastructure access).
This is leading to a scenario where value lies in monetizing customer traffic rather than content exploitation or connection. Value will remain in content ownership as a driver of generating consumer interest (i.e. traffic) rather than in content aggregation.
Portals will increasingly become conduits for information and services currently provided by media owners. Historical silo-based oligopoly competition will slowly break down and with it the high margin characteristics of the sector will be threatened. This in turn will lower pricing power as media companies have smaller direct audiences.
Furthermore, as a longer-term threat to medium distributors, telecoms operators are increasingly purchasing content either on fixed or on mobile platforms. As an example of the devaluation of content aggregation in early 2006 France Telecom signed an agreement to access Viacom content directly, by passing TPS and Canal+; this has since stimulated their merger in order to improve their competitive strength.
To compensate for this threat media companies are increasingly looking to expend their service offerings and distribution platforms. For example in the UK an unbundling strategy opens media companies to a c.£6bn market with limited capital investment and limited only by consumer’s willingness to churn and a desire for a strong marketing push.
Figure 36: Relative market size of telecoms and media in the UK (annualized 2005E) (£m)
Figure 37: Relative market size of telecoms and media in the Germany (annualized 2005E) (Euro m)
-2,000 4,000 6,000 8,000 10,000 12,000 14,000 M obile -Co ns u m e r T e le phon y -Re s ide nt ia l TV -S u bs c ipt io n TV -Ad s p en d Li c e n c e f e e -2,000 4,000 6,000 8,000 10,000 12,000 14,000 Mo bil e -Co nsum e r Te le pho ny -Re s ide n tia l TV -Sub s cipt ion TV -Ads p en d Lice nce f e e
Source: Deutsche Bank, OfCOM, Company data Source: Deutsche Bank, FNA, Company data
Figure 38: Relative market size of telecoms and media in France (annualized 2005E) (Euro m)
Figure 39: Relative market size of telecoms and media in Italy (annualized 2005E) (Euro m)
-2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 M obi le -C ons u m er Tel e pho ny -Re s id e n ti a l TV -S u b scipt io n TV -Ad spe n d Licence fee -2,000 4,000 6,000 8,000 10,000 12,000 14,000 16,000 M obi le -C ons u m er Tel e pho ny -Re s id e n ti a l TV -S u b scipt io n TV -Ad spe n d Licence fee
Source: Deutsche Bank estimates Source: Deutsche Bank estimates
Figure 40: Relative market size of telecoms and media in Spain (annualized 2005E) (Euro m)
Figure 41: Relative market size of telecoms and media in big five European markets (annualized 2005E) (Euro m)
-2,000 4,000 6,000 8,000 10,000 12,000 M obi le -C ons u m er Tel e pho ny -Re s id e n ti a l TV -S u b scipt io n TV -Ad spe n d Licence fee -10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000 M obi le -C ons u m er Tel e pho ny -Re s id e n ti a l TV -S u b scipt io n TV -Ad spe n d Licence fee
Source: Deutsche Bank estimates Source: Deutsche Bank estimates
Figure 42: Winners and losers in a media world
Winners Why?
Content developers The expansion of competing distribution technologies will increase the value of quality content (i.e. content that secures the consumer eye and wallet. It will lead to a reduction in the power of content aggregators and potentially reduce developer distribution costs). Examples: Sports rights licensors; film studios (such as DreamWorks which has recently been bought for $1.6bn by Paramount who intends to sell off its rights library which could fetch $850m to $1.0bn); TV content producers such as ITV, BBC; potentially music labels. Content gateways Cross media platforms that act as bucket shops to all types of media - music, print, film and video.
Examples: Increasingly this is Google's domain, but strong internet brand such as Amazon.com could benefit.
IPTV platforms Entry costs are minimal as the network capability is a core element of any telecoms network and the access to content is cheap as there is limited current demand. Deutsche Telekom acquired the IPTV rights to the Bundesliga for 1/10th of the traditional rights costs although the offering will be comparable. This represents a very cheap option in our view.
Examples: Dominant IP network and IPTV operators, such as European integrated operators. Note, in their area football is a killer application in Europe and is something that US telecoms operators will struggle to replicate.
Advertising agencies With the proliferation of new business models (IPTV for example) and the increase of the cost of “must have content”, we would anticipate significant increases in advertising and promotional spend. Where this spend is targeted is difficult to judge (i.e. high street billboards or TV or press advertising) but there may be an increase in the total budget. The consumerisation of media and telecoms will result in a greater level of marketing activity.
Examples: The German cable operators will aggressively publicise their Bundesliga offerings as DT will publicize its IPTV offerings. Similarly Premiere will have to reposition its business model and this will require continued brand investment.
Losers
Content aggregators Network providers will increasingly circumvent the telecoms aggregators and source content directly from the developers. Also aggregators that previously monetized an exclusivity of content through a specific distribution platform or with premium channels are at risk.
Examples: Premiere's business model is requiring immediate surgery, but others such as Sogecable and BSkyB are at risk through potentially losing rights or significant price inflation as other distributors (cable, telecoms) seek to compete.
Traditional high street
media retailers In a converged world with the ability to download content and with mass market video-on-demand, there is further risk to high street volume contraction and price declines. Also with operators such as Orange turning their retail distribution into communication centres, we would expect them to offer on-site access to content that is downloadable into CDs and DVDs (replicating the home environment for those that do not have a PC).
Source: Deutsche Bank
Small mobility premium; diversification of service; distribution and brand strength key
With the value of networks diminishing it will be increasingly difficult for operators to sustain superior returns through network advantages. It will also lead to the abandonment of the generic mobile strategies (all operators currently target all segments of the market with similar networks and services) and technological differentials.
Industry analysts have long talked about the integration of media and telecoms (“infotainment”) and increasingly telecoms operators across Europe are launching TV over broadband strategies (entitled IPTV or TV over DSL).
Capital intensity
Most of the other areas of telecoms we have discussed so far are macro revenue growth drivers. Therefore, it is important not to forget the importance of capital expenditure, in what has historically been a capital intensive business. Admittedly, there are cycles in capex, as shown in Figure 43, which highlight the growth in telecoms infrastructure during the 1990s, and the slowdown since 2000. In particular, this reflects the growth in European mobile penetration and the subsequent focus on balance sheet recovery post 2000.
Figure 43: Telecommunications infrastructure investment for OECD ($bn) and growth rates 0 50 100 150 200 250 300 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004E -40% -30% -20% -10% 0% 10% 20% 30% 40%
OECD Total Growth
Source: OECD
Capex/sales is often assessed as the best measure of capital intensity, but it works best in a steady state environment and fails to reflect the marginal return on capex. As such, we prefer EBITDA/capex multiples. In Figure 44 we show the capex/sales ratios of US, European and Japanese operators over the past 15 years, and in Figure 45 the implied EBITDA/capex multiples, which highlight the range (from past to current levels) in the European capex cycle relative to the US.
Figure 44: Comparative capex/sales ratios
0% 10% 20% 30% 40% 50% 60% 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06E 20 07E 20 08E US EU BT Vodafone DoCoMo NTT
Figure 45: Comparative EBITDA/capex multiples -0.5 1.0 1.5 2.0 2.5 3.0 3.5 19 90 19 91 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 200 6E 200 7E 200 8E US EU BT Vodafone DoCoMo NTT
Source: Deutsche Bank estimates and company data
Indeed the greater consistency of the US relative Europe can be interpreted as offering greater certainty, we believe. The volatility in Europe was also driven by the faster mobile penetration in the late 1990s and the requirement for the year 2001 to 2003.
How operators spend capex lacks clarity but Vodafone has offered details of its capex spend for its March 2006 financial year as shown in Figure 46. Interestingly only 48% was actual network investment and a further 19% was backbone transmission-related. Indeed the key determinant of capex is peak capacity, which often leaves networks underutilized (breeding marginal cost business model). In Figure 47 we show our best estimate of the usage profile of T-Mobile UK and O2 UK, highlighting the fact that networks are built for two peak hours in the day, have much residual capacity. Usage patterns differ depending on customer and tariff profiles.
Figure 46: Vodafone capex analysis for FY05/06 (£5bn) Figure 47: T-Mobile UK and O2 UK – comparison of
usage patterns 3G network 36% Transmission 19% 2G network 12% Other mobile 31% Other operations 2% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 O2 TMO
Earnings and P/E trends
In Figure 48 we highlight the trends in earnings and P/E ratios in Figure 48, which broadly show the trend of declining multiples as the sector has converged with general market multiples.
Figure 48: Cyclicality of earnings and market enthusiasm
-40.0 -20.0 0.0 20.0 40.0 60.0 80.0 100.0 19 92 19 93 19 94 19 95 19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 200 6 E 200 7 E 200 8 E
P/E ratio Headline (x) Total Headline Earnings Growth (%)
UK liberalisation and move to digital mobile technology
EU liberalisation
Technology bubble
Focus on cost control and deleveraging
EU earnings downgarde cycle
Source: Deutsche Bank
In order to contextualize the environment, we have shown in Figure 50 the performance of the European telecoms sector over the past 14 years and categorized the sector into three periods: utilities, bubble and uncertainty (we explain these definitions in more detail in Figure 51).
Figure 49: Key characteristics of each period
Utilities Monopolies in fixed line, mobile in infancy, retail regulation
Bubble M&A expansion, mobile growth, broadband in infancy
Uncertainty Mobile maturity, fixed line declines, broadband explosion, commoditization of pricing, substitution, regulatory convergence
Source: Deutsche Bank
Figure 50: Telecoms sector (.SXKP) over the past 14 years
0 200 400 600 800 1,000 1,200 05 Jan u a ry 1992 05 Ju ly 1992 05 Jan u a ry 1993 05 Ju ly 1993 05 Jan u a ry 1994 05 Ju ly 1994 05 Jan u a ry 1995 05 Ju ly 1995 05 Jan u a ry 1996 05 Ju ly 1996 05 Jan u a ry 1997 05 Ju ly 1997 05 Jan u a ry 1998 05 Ju ly 1998 05 Jan u a ry 1999 05 Ju ly 1999 05 Jan u a ry 2000 05 Ju ly 2000 05 Jan u a ry 2001 05 Ju ly 2001 05 Jan u a ry 2002 05 Ju ly 2002 05 Jan u a ry 2003 05 Ju ly 2003 05 Jan u a ry 2004 05 Ju ly 2004 05 Jan u a ry 2005 05 Ju ly 2005 05 Jan u a ry 2006 05 Ju ly 2006 "UTILITIES" "BUBBLE" "UNCERTAINTY"
Source: Deutsche Bank and Reuters
Telecoms: Financials relative to the total market
In the following charts (Figure 51 to Figure 56), we attempt to compare the overall telecoms sector with other sectors, in order to put the sector into context. The messages are clear however; margins are high, as are operating cash flow margins. EBITDA/capex ratios for the sector as a whole are comparable with other sectors and the wider market, but the relative capital intensity (capex/sales) has declined significantly over the past few years following the end of the wireless boom.
Over time telecoms earnings multiples have converged but indebtedness has increased significantly, suggesting a greater “financial risk” to the telecoms sector.
Figure 51: High relative EBITDA margins Figure 52: High relative operating cash flow margins 0% 10% 20% 30% 40% 50% 60%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005E 2006E 2007E
Telecommunications ALL SECTORS EUROPE
0% 5% 10% 15% 20% 25% 30%
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005E 2006E 2007E
Telecommunications ALL SECTORS EUROPE
Source: Deutsche Bank estimates and company data Source Deutsche Bank estimates and company data
Figure 53: Comparable EBITDA/capex ratios Figure 54: But declining capital intensity
0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x 3.5x 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
2005E 2006E 2007E 2008E
Telecommunications ALL SECTORS EUROPE
0% 10% 20% 30% 40% 50% 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
2005E 2006E 2007E
Telecommunications ALL SECTORS EUROPE
Source: Deutsche Bank estimates and company data Source Deutsche Bank estimates and company data
Figure 55: Converged P/E multiples Figure 56: Shift in relative indebtedness
0.0 5.0 10.0 15.0 20.0 25.0 30.0 35.0 40.0
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006E 2007E 2008E
Telecommunications ALL SECTORS EUROPE
0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0x 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2 005E 2 006E 2 007E
Telecommunications ALL SECTORS EUROPE
History of European telecoms
Telecoms over the ages: Pre-1980
Before Alexander Graham Bell, the Scotland born scientist and inventor, widely considered to be the father of the telephone, communication was a haphazard affair, and was carried out using basic tools such as paper, couriers, noise, carrier pigeons, beacons, semaphore and flags.
With developments in electronic communications and with advances in cable technology, networks were developed. Initially these were local area networks, but then national and international connections were made that facilitated long distance communication. Originally, most national calls were switched manually by operators but in the 1960s there was the first international direct-dial call between the UK and USA.
Transatlantic services started in 1927 using two-way radio, but the first trans-Atlantic telephone cable was laid in 1956, with TAT-1, providing 36 telephone circuits. The first experimental satellite was commissioned in 1962 (Telstar 1). With the laying of TAT-8 in 1988, the 1990s saw the widespread adoption of systems based around optic fibres, which introduced a 10-fold increase in capacity, which has since been expanded by many multiples again.
Figure 57: A history of transatlantic cable
Cable Name Date(s) Initial No. of channels Final No. of channels Western end Eastern end
TAT-1 1956-1978 36 48 Newfoundland Scotland
TAT-2 1959-1982 48 72 Newfoundland France
TAT-3 1963-1986 138 276 New Jersey England
TAT-4 1965-1987 138 345 New Jersey France
TAT-5 1970-1993 845 2112 Rhode Island Spain
TAT-6 1976-1994 4,000 10,000 Rhode Island France
TAT-7 1978-1994 4,000 10,500 New Jersey England
TAT-8* 1988-2002 40,000 - USA France
TAT-9 1992-2004 80,000 - USA Spain
TAT-10 1992-2003 2 x 565 Mbit/s - USA Germany
TAT-11 1993-2003 2 x 565 Mbit/s - USA France
TAT-12/13 1996 12 x 2.5 Gbit/s Transatlantic - USA x 2 GB, FR
TAT-14 2000 64 x 10 Gbit/s Transatlantic - USA x 2 GB, FR, NL, D, DK
CANTAT-1 1961-1986 80 - Newfoundland Scotland
CANTAT-2 1974-1992 1,840 - Nova Scotia England
CANTAT-3 1994 2 x 2.5 Gbit/s Canada Europe
PTAT-1 1989 3 x 140 Mbit/s US-Bermuda Ireland-UK
Source: Deutsche Bank and Wikipedia,
In Europe, telecoms was deemed a “philanthropic” investment predominately lead by governments and often combined with the national postal operators (therefore building a complete communication monopoly). Indeed, before the privatisation wave of European telecoms in the 1990s most governments had to separate out into different legal entities the telecommunications business from the post office. Indeed in some countries such as Austria, the post office still owns most of the property that houses the telecoms operators’ switches.
In the USA, AT&T was formed through the amalgam of different geographically diverse US telecoms companies and it was not until the 1920s that the concept of universal services was developed.
In Figure 58 we use the Boston Consulting Group matrix to highlight the relative development of European and US telecoms. In 1980, with penetration growth slowing, the industry was deemed “utility like” and, as can be seen, was a relatively simple. Indeed, the fax machine was deemed a revolution in the industry in the mid-1970s as it stimulated demand for incremental lines and volumes. It was also the first mover of the telecoms industry outside voice, and it started to challenge the postal services as a distributor of hard copy information. It was also the first move to immediacy.
Figure 58: European telecoms in context: Application of BCG matrix – 1980
STAR ?
CASH COW DOG
High
Low
High
Low
Relative position (market share)
Busi
n
ess gro
w
th
rate
European traditional wireline
US traditional wireline
STAR ?
CASH COW DOG
STAR ?
CASH COW DOG
High
Low
High
Low
Relative position (market share)
Busi
n
ess gro
w
th
rate
European traditional wireline
US traditional wireline
Source: Deutsche Bank
The 1980s: Embryonic
This decade was the start of the telecommunications evolution. As the PC and the video-recorder were growing in importance dramatically, the structure of the telecoms industry changed forever. In the US, AT&T’s monopoly was broken up, BT was privatized in the UK and mobile technology, as we know it today, was born.
Systems. Effective 1 January 1984, AT&T's local operations were split into seven independent Regional Bell Operating Companies (RBOCs) known as "Baby Bells". AT&T, reduced in value by about 70%, continued to run all its long distance services, although it lost some market share in the ensuing years to competitors such as MCI and Sprint.
BT privatization
In 1981 BT became a state-owned corporation independent of the Post Office. In 1982 BT's monopoly on telecommunications was broken, with the grant of a license to Mercury Communications, part of Cable and Wireless. BT’s privatisation occurred in 1984, with the sale of more than 50% of its shares.
Cable and Wireless privatization and Mercury Communications
Cable and Wireless was one of the early privatisations by the Thatcher government in the UK. It was announced in 1980, with Cable and Wireless privatised in November 1981. Mercury Communications was Cable and Wireless’ UK national telephony business (formed in 1981). Mercury proved only moderately successful at challenging BT's dominance as in 1997 the Mercury brand was abandoned and it was amalgamated into Cable and Wireless Communications (the UK cable division of the group), which in turn was eventually acquired by NTL.
First generation (cellular) mobile telephony
The Motorola DynaTAC 8000X, which received approval in 1983, was the first mobile telephone “brick”. Mobile phones began to proliferate through the 1980s with the introduction of "cellular" phones based on cellular networks. Networks were constructed by multiple base stations located relatively close to each other, and protocols established for the automated "handover" between two cells when a phone moved from one cell to the other. At this time analogue transmission was the technology in all systems. The weakness with analogue mobile technology was (and still is in many markets) easy to eavesdrop, and as such, was not particularly private.
Mobile phones were large with a battery pack the size of a briefcase and were designed for permanent installation in cars (hence the term carphone). In Switzerland, the name of the big car-based phone models was "Nationales Autotelefon", and the abbreviation of it ("Natel") persists as Swisscom Mobile’s brand today. Towards the end of the decade the handsets were becoming “transportable" but still briefcase size.
In the early days, there were multiple differences in analogue technologies (NMT, AMPS, TACS, RTMI, C-Netz, and Radiocom 2000) which later became known as first generation (1G) mobile. In September 1981 the first cell phone network with automatic roaming was started in Saudi Arabia; it was an NMT system manufactured by Svenska Radio Aktiebolaget (SRA). In late 1982 the Nordic countries started an NMT network with automatic roaming between countries and became pioneers of the technology (hence Nokia and Ericsson’s dominance today).
Returning to the BCG matrix in Figure 59 we note that by 1990 the telecoms environment is becoming busier and a new growth driver has arrived with mobile technology; although at this stage there were question marks over the long-term penetration rate the technology would achieve. Indeed mobile was expected to be a premium product aimed at the corporate market, achieving a maximum of 10% penetration.
Figure 59: European telecoms in context: Application of BCG matrix – 1990
STAR ?
CASH COW DOG
High
Low
High
Low
Relative position (market share)
European traditional wireline
European mobile
US mobile
US traditional wireline
STAR ?
CASH COW DOG
STAR ?
CASH COW DOG
High
Low
High
Low
Relative position (market share)
European traditional wireline
European mobile
US mobile
US traditional wireline
Source: Deutsche Bank
The 1990s: Revolution
At the beginning of the 1990s the telecoms sector was slowly evolving from its utility-like reputation, but no one envisaged the growth in the industry towards the end of the decade. In the US there was the Telecommunications Act in 1996, which introduced local loop infrastructure competition. In Europe the later years of the decade were dominated by IPOs (national incumbents and new entrants) and liberalization. However, the most significant events in the decade were the dramatic pick-up in mobile penetration growth rates and the equity market bubble. In particular, the bubble-fuelled large scale M&A as operators chased scale, footprint and in some cases anything that had either “com” or “data” in its description.
US Telecommunications Act of 1996
The Telecommunications Act of 1996 was the first major overhaul of United States telecommunications law in nearly 62 years, amending the Communications Act of 1934. The general intention of the Act was deregulation and promotion of competition. The Act removed barriers which had previously prevented telecoms from competing head-to-head. A new group of telephone companies, "Competitive Local Exchange Carriers" (CLECs), grew to compete with the incumbents (also known as "ILECs" or “Incumbent Local Exchange
AT&T: SBC acquired AT&T in 2005 and adopted the name AT&T. AT&T previously
acquired TCI, Media One Cable, and Teleport Communications. SBC was created when, as Southwestern Bell, it acquired Pacific Telesys, Ameritech and SNET;
Verizon: Verizon acquired MCI in 2005. In 2000, Bell Atlantic and GTE merged to form
Verizon. Bell Atlantic previously merged with NYNEX (1998) and MFS. Verizon Wireless was the analogue of Bell Atlanta mobile and Vodafone’s Air Torch business.
BellSouth: AT&T and BellSouth are in the process of merging. AT&T and BellSouth are
already connected through their wireless joint venture, Cingular.
Qwest: Qwest was founded in 1996 and merged with US West in 2000.
European liberalization
Most European markets were liberalized en masse on 1 January 1998, but there were a few exceptions as shown in Figure 60. In some cases delays were generally awarded to allow the incumbents to complete the tariff rebalancing processes, but effectively the delay merely just deferred the introduction of competitive pressures. Indeed, the Southern European operators still benefit in 2006 from these early liberalization delays we believe.
Figure 60: European market full liberalization dates
Austria Jan-98 Belgium Jan-98 Denmark Jan-96 Finland Jan-98 France Jan-98 Germany Jan-98 Greece Jan-01 Ireland Jan-00 Italy Jan-98 Netherlands Jan-98 Norway Jan-98 Portugal Jan-00 Spain Oct-98 Sweden Jan-93 Switzerland Jan-98 UK Mar-91
Source: Company data
A wave of European IPOs
As the equity markets motored in the late 1990s and offered a glut of capital, there was a wave of telecoms IPOs. The trend was kicked-off with incumbent privatizations, but in 1999 and 2000, start-up or early stage new entrants dominated the list. This also reflected the liberalization of European telecoms in 1998 and the launch of many smaller start-up businesses. Since Orange (for the second time) was IPOd in 2001, the number of telecoms-related IPOs have been small, limited primarily to eircom (also for the second time) and Belgacom, both of which were IPOd in 2004, and Iliad and Telenet, which are both focused on the growth in broadband.
Figure 61: IPOs per annum 0 2 4 6 8 10 12 14 16 1994 1995 1996 1997 1998 1999 2000 2001 2003 2004 2005 Privatisation of incumbents
New entrant IPOs
Privatisations/ broadband
Source: Deutsche Bank estimates and Bloomberg
European mobile licenses
There was a proliferation of 2G operator launches in the 1990s with the auction/beauty contest of many third and fourth licenses; especially in 1992 to 1995 when the first generation analogue operators converted into digital, and GSM 1800 spectrum became available.
Figure 62: An explosion in European mobile operators (service launched per annum)
0 2 4 6 8 10 12 14 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006E 2007E
Source: Deutsche Bank estimates, Company data and GSM Worlds Associations
The start of the M&A frenzy
Worldcom bid for MCI – the M&A catalyst: In June 1994, BT and MCI launched
would have given BT an entry into the US market and MCI a global reach. The merger proposition gained approval from the European Commission, the US Department of Justice and the US Federal Communications Commission and looked set to proceed. However, on 1 October 1997 Worldcom made a rival bid for MCI which was followed by a counter bid from GTE. MCI accepted the Worldcom bid and BT pulled out of its deal with a generous severance fee of $465m. BT made even more money when it sold its stake in MCI to Worldcom in 1998 for £4,159m on which it made an exceptional pre-tax profit of £1,133m. It also avoided being mired in the later Worldcom scandal. BT also bought from MCI its 24.9% interest in Concert Communications making Concert a wholly-owned part of BT.
Vodafone’s moves to increase footprint. In January 1999, AirTouch agreed to be
acquired by Vodafone, in a cash-stock transaction valued at $62bn (to be rebranded as Vodafone AirTouch) and after AirTouch had received a bid from Bell Atlantic. Then in September 1999, Bell Atlantic and Vodafone Airtouch agreed to merge their U.S. wireless operations (Bell Atlantic Mobile, AirTouch Cellular, PrimeCo Communications, and AirTouch Paging) to form Verizon Wireless.
In April 2000 after a long battle, Vodafone bought German conglomerate Mannesmann
AG to get control over the mobile network operator Mannesmann Mobilfunk GmbH & Co KG, operating the "D2" network in Germany and control of Omnitel, the number 2 in Italy. The deal is one of the largest in European history and is Germany's first hostile takeover by a foreign firm and valued Mannesmann’s equity at Euro181.4bn. The conglomerate was subsequently broken up and all manufacturing-related operations sold off.
Deutsche Telekom and Telecom Italia – a deal that got away: In 1999 Deutsche
Telekom and Telecom Italia tried to merge. The proposed transaction broke-up Deutsche Telekom’s partnership with France Télécom , where there were cross shareholdings, but was trumped in a wave of nationalistic frenzy by a bid by the Italian conglomerate, Olivetti.
Telefónica and KPN – squashed by political meddling: In early 2000 Telefónica and
KPN were discussing a merger, which would have, with hindsight, saved billions of Euros in the UMTS license auction process of 2000 and 2001, but was squashed by political interference.
The globalisation trend
NTT DoCoMo invested heavily outside Japan, but was consistently unsuccessful.
DoCoMo had significant sums invested in KPN, Hutchison Telecom (including 3 UK, Hutch in India), KTF and AT&T Wireless, and unfortunately had to write-off or sell-off all of these investments.
Concert with MCI, AT&T and then implosion: As mentioned above, in June 1994, BT
and MCI launched Concert Communications Services. Its aim was to build a network which would provide easy global connectivity to multinational corporations. With the purchase of MCI by Worldcom, BT switched to AT&T as its global partner, but in late 2000 the two Boards eventually fell-out due to both BT and AT&T’s excess debt levels and management changes. Concert was split into two: North America and Eastern Asia went to AT&T, the rest of the world to BT. BT's remaining Concert assets were merged into Global Solutions group and Concert disappeared.
Global One and implosion: Global One was an international voice and data
telecommunications carrier, formed in 1996 as a joint venture between France Télécom, Deutsche Telekom and Sprint Corporation (each owned 1/3rd) and France Télécom and
Deutsche Telekom both owned 10% in Sprint. DT invested Euro367m and both DT and France Télécom invested $1.8bn in Sprint at the same time. Although Global One built an extensive international network, it was never a financial success. In 2000, France Télécom bought out the other partners, and in 2001 it was taken over by Equant, who themselves have since been bought by France Télécom.
