Telco 2.0 apac arete

November 2011 - 1Richard Kramer

Taming the Tech Hydra?

Richard Kramer, Managing Partner

[email protected]


About Arete

Left in disgust at ethics of investment bank world after four yrs. as #1 ranked Tech analyst,

Founded Arete in early 2000 on three principles:� No conflicts of interest � No money from companies

� Select list of investors trust us to help them und. investment ideas

� No First Call, quotes, etc.

ExclusivityExcellence

� All analysts w/ tech industry + financial market experience

� 200+ company visits/month

Since inception: profitable, low staff turnover;Looking at global trends with total freedom to tell the truth.Unlike banks/industry analysts, we are entrepreneurs.

Integrity

Frequent presentations to companies’ strategy teams…


Tech vs. Rationality

� Huge disparities in regional importance, valuations of TMT

� Investors dangerously susceptible to hype in tech, far less so in telco

Tech’s premium over telco is not rational: ROIC not above other sectors, more prone to losses

$6bnAMZN

$38bnGOOG

$8bnINTC

$17bnQCOM

$28bnCSCO

$45bnMSFT

$82bnAAPL

Net Cash

Key lessons of past 15+ yrs.: Tech cos. cannot grow while restructuringTelcos should not diversify just to show growth, are seen as utilities

GOOG $192bn 16x

YHOO $19bn 19x

EBAY $42bn 16x

AMZN $98bn 173x

WALM $198bn 13x

BAIDU $39bn 48x

TCNT $43bn 26x

ORCL $164bn 14x

MSFT $221bn 10x

VMW $42bn 47x

AAPL $372bn 12xSSUNG $118bn 12xRIM $8bn 4xHTC $12bn 8x NOK $25bn 18xIBM $220bn 14xHPQ $54bn 6xTSMC $64bn 14xINTC $125bn 10xQCOM $95bn 16xCSCO $97bn 11xJNPR $13bn 19x

ERIC $35bn 12x

NLFX $5bn 21x

TWC $20bn 14x

CCST $62bn 15x

There is little logic to tech hardware vs. software v. telcosvaluations, most cos. are already hybrids

Current M&A spree will aim to create illusion of growth, paper over failing strategies


Devices: Demolition Derby, Fight Club…Now Purgatory?

Clear message from Android to OEMs: Profit is your problem!

9M11 Sales/profits for vendors

HTC sold 35m smartphone in 9M11 = more than LGE (14m), Motorola (13m), and SonyEricsson (9m);

HTC = 15% margins vs. losses at all the Android vendors (ex Samsung)

PC model of std. HW + platform SW coming to handsets:

Largest end market in CE:

$230bn+ in mobile devices

$150bn+ in smartphones

Samsung 4Q11 Android volumes (~25m+) more than Nokia (<2M WP7), LG (<5m), SonyEric. (<5m) and Motorola (<6m).

$5.2bn$33.7bnSSUNG

Loss$7.0bnMOT

B/E$5.2bnSEMC

Loss$8.2bnLGE

$800m$11.3bnRIM

$1.9bn$12.5bnHTC

$0.8bn$22.9bnNOK

$14.2bn$36.6bnAPPL

Profit9M11 Sales

Huge differentiation problem for Mobile Device vendors

New entrants have 15% gross margin template


Standing On Its HeadGetting to 1bn Smartphones

Low-end will embrace $100 smartphones

Squeezing mid-range featurephones

Smartphones SustainingIndustry ASPs vs. Mix

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YoY ASP Variation (RHS) ASP in US$ (LHS)

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YoY ASP Variation (RHS) ASP in US$ (LHS)

ASPs actually rising

Consumers see higher marginal utility in device…

Getting to an $80 BoMSmartphone?(US$) Specifications Details

Value

'10

Value

'11

Value

'12

Commodity Tech

Touchscreen Display Size [inch] 2.8

Resolution [pixels] 240x320

Price per inch squared [$] 2

Touch Module Price per inch squared [$] 1 7.8 5.9 4.4

NAND Amount [GB] 1

Price per GB [$] 1.5

DRAM Amount [GB] 0.25

Price per GB [$] 15

Other Chassis, etc. 3.0 2.7 2.4

Total 31.8 21.9 17.5

Semiconductors

Connectivity Bluetooth, GPS, WiFi 3.5 2.8 2.2

Baseband Quad Band, HSPA

Application Processor Integrated ARM11 AP/Baseband

MEMs Compass, Mic, etc. 4.3 3.6 3.1

RF/PA e.g. IFX, ST, SWKS, RFMD, etc. 2.6 2.3 2.0

Other 4.0 3.6 3.2

Total 31.4 26.3 21.5

Hardware

Board Number of PCB Layers 4 3.5 3.0 2.5

Components Other Components (Filters, Bus, Conn.) 10.0 8.5 7.2

Camera module Resolution [MP] 3.2

Front facing Camera No

Li-Ion Battery Capacity [mAh] 1100 3.0 2.6 2.3

Charger, box, literature Price [$] 4.0 3.4 2.9

Total 24.0 20.3 17.2

Total component cost 87.1 68.4 56.3

Assembly cost Cost [$] 5.0 4.3 3.6

Total construction cost 92.1 72.7 59.9

Royalties (% of ASP) Qualcomm, Nokia, Dolby 7% 9.1 7.2 6.0

Total Direct Cost 101.2 79.9 65.9

Shipping/distribution Cost [$] 10.0 9.5 9.0

Provision Warranty [% of ASP] 2% 2.6 2.1 1.7

Total gross costs (ex D&A) per phone 113.8 91.4 76.6

Gross margin Implied (%) 12% 11% 10%

ASP [$] 130.0 103.0 85.0

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BoM cost <$100, going to $80, $60

Forget it!

“Segmentation”

~58% of smartphoneunits in ‘13

Emerging Markets

Too much focus on US/EU now; EMs grow to ‘15

By value, high-end 50%+ of total –Apple iPhone = $60bn, Samsung $25bn, HTC $16bn

Consumers will demand local brands


Example from Tele2 Sweden

Smartphone now half of market, and rising…

Low-end creeping into the mix

Key questions we put to low-end smartphone vendors:

� How to make money? We don’t think ZTE/HW do!

� How to differentiate longer-term for any premium?

Where is WP7 in this world? Tango not cheap enough, OS not familiar enough

Mobile devices are NOT commodities!

Industry-wide fear over device vendors losing scope for differentiation…being told they are commoditizing!

Would also be bad for operators!


Hooked on Tablets

UX not from PCs, but smartphones: SSD, touch, 3G, all-day battery, cloud storage

Tablet Forecast

� Apple’s low iPad gross margins are #1 issue for Android OEMs.

� Who can match Apple’s tech specs AND ecosystem AND retail channel?

July ’10 = ~53m in 2011…

Jan. ’11 = ~55m, more iPad

Media consumption device, like TV or game consoles; further pressures PCs until Win8 comes

40% of BoM = display and touch, not AP or modem! $200 by mid-’12

Kindle Fire: $180 BoM cost?

No 3G. Subsidy to Prime users ($80/yr.)

Puts virtual shop window in consumer’s hands 24/7. =

India = 54 languages, 8 major ones200m+ tablets in next 5 yrs.

Tablets will be the low cost computing platform in emerging markets.

OS = means to an end,

Apps a.k.a. Content

No need to subsidise (netbooks failed)


Apple: Secrets of the Temple

Vs.

Table 2: Apple's Gross Profit Boost From NAND Flash

Price Cost/GB Extra Memory

Cost

Add'l Margin

per Unit

Margin on

Extra Memory

Assumed/

Increm. GP

Gross

Profit/Unit

iPod Touch 8GB $199 $1.0 20% $40

iPod Touch 32GB $249 $1.0 $24 $26 52% 26% $66

iPod Touch 64GB $349 $1.0 $32 $68 68% 38% $134

iPhone 3GS 8GB $499 $1.0 38% $190

iPhone4 16GB $599 $1.0 $8 $92 92% 43% $257

iPhone4 32GB $699 $1.0 $16 $84 84% 49% $341

Source: Arete Research estimates, Company accounts.

$81bn cash+80% growth iOS notebooks TVs, next….

iTunes’ 220m+ billing accounts makes Apple a Top 15 telco w/ wealthier customers

A4/A5 processor = superior cost structureComplete SoC strategy –they own chipset platform

Scale = could be 400m APs sold in 2015

� Vulnerabilities?

� Relies on operator SAC

�Rivals narrowing gaps

� Lagging on displays

Apple makes up to a third of its operating profit by marking up NAND flash -$100 for 16GB

Apple avoids paying chipmaker gross margin, and higher foundry GMs

� Less suited for EMs

Now recognising risks on IPR…

$30 profit x 11m units = $300m!


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Smartphone

Margins

Samsung and HTC: Brute Force

$1.5bn$1.3bn$1.1bnMotorola

$1.2bn$1.2bn$1.5bnSony Ericsson

$1.7bn$0.9bn$0.4bnHTC

$1.8bn$1.4bn$1.2bnRIM

$2.3bn$2.4bn$2.1bnLGE

$3.5bn$3.6bn$3.9bnNokia

$6.4bn$5.0bn$4.1bnSamsung

$3.5bn$1.7bn$1.4bnApple

'11E'10'09

Source: Arete Research estimates.

� Samsung sold c. 29m smartphones in 3Q11, up 40% seq., now #1 by volume

� Koreans obsessed with league tables, share ; ‘12 aim to pass Nokia as #1 player

� Tablets lack content/cloud services

� Industry’s biggest marketing budget

Samsung Telecom unit is a distribution channel for memory, display, logic semis; Profits from leverage of commodity dominance

Fight Apple on Samsung’s home turf….

Taiwanese (ex-ODM)

doing $500m of M&A in US/EU

Table 2: SG&A by Vendor, '09-'11E ($bn)

Only other profitable Android

OEM; $16bn+ sales, up from <$5bn in ’09!


Nokia and RIM: Troubled Twins

RIM: Doors of Perception,June ‘11

Sharp Turn for the Titanic,May ‘10

Blind Man’s Bluff, Feb. ‘11

Leap

#1

(YE’11)

Make current

portfolio & initial

WP7 competitive;

parity unrealistic

Leap

#2

(1H12)

Leap

#3

(YE12)

Make current

portfolio & initial

WP7 competitive;

parity unrealistic

Aim for parity, or

leapfrog next iterations

of Android, iPhone5;

“unique experience?”

Make current

portfolio & initial

WP7 competitive;

parity unrealistic

Address lower-

tier WP7

segment w/

Apollo release;

Hold Your Horses, Nov. ‘11RIM: Lost in Transition, Sept. ‘11

Key Issue: execution

Nokia and RIM both still profitable, w/ resources, and

desperate … but v. hard to reverse market perceptionand make up for lack of Internet innovation.


Vampire Squids?

� Quasi-monopoly share in search, brings regulatory risk (AdMob)

� Challenged to monetise Android, …� Beyond IPR,

“boys w/ toys?”� CEO “just don’t =

lose money”� Home = GoogleTV

50 cos. since ’10, 18 already in ’11

Looks inevitable FaceBook will expand more into ads, connectivity, own “brand” apps

Mult. failures: Gears, Wave, Chrome, TV+ internal conflicts

Yet to develop a systematic cross-platform “Google” UX

10m UK users/day + 4m/week Expect more devices – FB’s#1 priority is mobile


Building Global Brains…

Internet brands will create significant niche device categories; Kindle Fire just the start, very culture-specific…

=

=

=

Vertical model? Or external reach of search?

Expect more devices – FB’s #1 priority is mobile

Does any of this link up or resonate with consumers?

You can see 4-5 clear product + services ecosystemsforming up; each one trying to absorb data on connected consumer behaviour


Telcos in 2011:Stop Bullying the Fat Kid

US Phone Bill Analysis of Data

Clear action vs. bandwidth hogs, rebalancing pricing

Telcos must get data pricing, activation, provisioning, right: its boring, but essential.

US Mobile Service Revenue Growth

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4Q10 1Q11

Source: Arete Research.

� VODA now 40% declining voice revenues, 60% growing data and emerging markets

Investors sceptical about RoIs at telcosBUT encouraged by data growth, telcosstable performance after 3 bad yrs.

� After 5-10 yrs overcapacity post 3G licenses, no pricing power

� Now Smartphones = profit from mobile data (unlike dongles); marginal pricing re-set; EU penetration still <30%

APRU Uplift from S’phone

Figure 3: Weighted Average European Mobile Revenue Growth

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Service Revenue Data (Inc. Messaging) Revenue

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Service Revenue Data (Inc. Messaging) Revenue

Source: Arete Research.

20%+ Non-SMS Data Growth

Mobile Data Growth in Vanguard Markets


Laying Out the Challenge

Challenge from Web players goes beyond “hot”

names like FB, Google, Apple, AMZN… but best thing since sliced bread in driving traffic.. Or would you prefer MMS and mobisodes?

Best thing about telcos is that the delusionary days are well and truly over!


Back to School: The 3 R’s

KPN’s 1Q profit warning -cannibalisation of high margin SMS by IP messaging on free data plans

Re-Price Mobile data is 90% of network traffic/cost but only 10% of revenue. All operators know where industry is headed…more data usage, until voice becomes an app

Re-Org (Again!)

Unintentional slip?

Re-Duce CostsGoogle 31K staffn(!) FB 2,000…

FT = 100,000!

Digital divisions aside, we still see 2-sided business models as mostly fantasy

Nasty transition in data/SMS usage

Gone from 0% to 88% in 8mos

Customer innovation has to mean letting your customers innovate!

NOT specialised customer care…


Two Definitions of LTE

LTE: Late, Tempting, Elusive Jun. '09

Testing

The laTEr

the better!

LaTE!LTE Outside US & Japan, LTE best

remains a niche, still several yrs. off, marred foremost by inconsistent spectrum, rel. few devices

Optimisation� Still attractive capacity additions via HSPA+ to 42Mbps….

� Lot to do w/ 2G infra. (M2M)

This is not RoI on LTE per se, but RoI on unstoppable data demand in a (and artificially) supply-constrained industry – and inevitablity of moving to single RAN

Nokia Ultra-Site 2G+ 3G started

the ball rolling…

Less Transforming than Expected

We said in ’09 LTE faces (sensible) delays; better right than early – 2.5 years later, the first 100s of 1000s of customers are now appearing

� LTE/4G not going to change usage per se..

� Initially adds costs to devices, power issues, etc.; will bring another hype cycle from vendors

� Will help improve UX … but only eventually!

Business Model


Mobile Ads, Mobile Money

‘06 ‘07 ‘08 ‘09 ‘10‘08 ‘09 ‘10 ‘11 ‘12‘10 ‘11 ‘12 ‘13 ‘14‘12 ‘13 ‘14 ‘15 ‘16

Mobile Ad Forecasts

� Operators want NFC to be SIM based to manage authentication, security

� Credit card companies do not want SIM and say telcos can’t manage risk.

IssuerBank<2%

Visa, MCInterLink<1%

AcquirerBank<1%

MerchantHas to Pay Some…

� Who makes money?

Not yet clear who monetises mobile advertising, under which model:

� Telcos? ISPs? Web Brands?

� Trad. agencies going digital?

Then mobile advertising Behaviour change?

PoS?Use case?

Regulatory issues


Please, Get Me Excited!

Are T-Mobile or Verizon doing something really different? Still the same old confusing tariff packages, offering same devices as competition

Price!

Device!


Get Me Excited, Part II!

Can Vodafone or Tele2 be like Apple – premium brand, connect consumers

to platform, content, retail, billing? Then show me what I can do!

Price! Device!


Maybe T-Mobile Slovakia is on to Something Here?

At least I know T-Mobile is about chicks (and guys) at the beach, pool,

Still no “use case” “demos” or “new services”!


How About Asian Operators?

Lots of promising end

markets for multi-SIM offerings


Some Other Approaches?

Like Google, start with Search….

Weiβer Spargel, Surstromming, Chili Crab?

What’s unique customer experience on any operator?

What can any telco offer that its competitors won’t or can’t?

� A few hit apps branded by operator

that work on any platform: based on customer insight - location, contacts, usage, etc.

Create “radical chic” buzz around high-end tech: TelcoNext?Build communities!

Lots of clutter…

and one device!


OK, How’s ‘Bout Some Forecasts?

� A Billion Smartphone in 2013, dominated by emerging markets

By 2013, every smartphoneco-branded with Internet brand based on likely usage…

“Best for…” Twitter, Facebook, WeiBo, Yandex, LinkedIn, ESPN, etc.

� Tablets to follow…

By the time industry gets “third platform” scaling up, native apps will be in decline

� Device OS means zero w/o content ecosystem behind it;it’s a means to an end…the end is content consumption/creation/communities

Tech’s future in emerging markets, tremendous capacity for innovation and consumer demand.

� Tech hardware in period of “scorched earth” competition; but risk of perception like PC.

Google, Apple, Facebook, Amazon (+ Microsoft?) are tech’s Hydras;as they get cut off or fail in one segment, they acquire or grow back in two others; next incanation as services providers….


Q&A

Richard Kramer, Managing [email protected]