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It’s all about Growth- Mobile Telecommunications -

LS telcom Summit, June 12th 2002

2Mobile TelecommunicationsPresentation

Telecoms TeamTelecoms Team

Robert Vinall (Team Leader)Mobile Operators

Phone: +49 69 7447-6245Fax: +49 69 7447-2201

e-mail:[email protected]

Wolfgang SpechtIncumbents

Phone: +49 69 7447-1582Fax: +49 69 7447-2201


Vidar KalvoyTelecoms Equipment

Phone: +49 69 7447-9260Fax: +49 69 7447-2201


DZ BankAm Platz der Republik

60265 FrankfurtGermany


AgendaAgenda

1. Key Investment Points

2. Mobile Operators

3. Mobile Phone Manufacturers

4. Mobile Equipment Manufacturers

5. Coverage


1. Key investment points1. Key investment points

We take a parallel look at the three sub-sectors of the mobile market: operators, and equipment and handset manufacturers. Due to their interdependence, analysing them together makes more sense than the traditional approach of analysing them separately.

Our central argument is that the growth and hence valuation of all players in the mobile market hangs on the mass market acceptance of m-services. It will determine to a large extent growth rates in ARPU, handset sales and investment in new network capacity.

We are pessimistic about the likelihood of mass market acceptance of m-services in our detailed forecast period up to 2004. Teething problems with new technologies, lack of killer applications and absence of viable business models are a few reasons for our pessimism.

What does this mean for the individual sub-sectors?


1. Key investment points1. Key investment points

Mobile operators will have lower revenue growth than currently priced into their share prices.ARPUs will continue to stagnate as m-services fail to penetrate the mass market until after 2004. Consolidation and cost savings could, however, drive earnings growth in the short term.

Handset manufacturers will not meet revenue targets, mainly as replacement times are longer than expected. In the absence of attractive m-services, people will be less inclined to replace their mobile phones.

Wireless equipment manufacturers will achieve lower revenues than expected due to slower growth in data traffic following from the delayed take-up of m-services. In response, the operators are reducing capacity upgrades in their 2G networks and delaying investments in 3G networks.

Given the alternative growth opportunities for the operators, we take a more positive view of the operators than the manufacturers. We prefer equipment to handsets due to the greater margin pressure we expect in the handset segment.


2. Mobile OperatorsRevenues - growth set to slow down2. Mobile Operators

Revenues - growth set to slow down

We expect revenue growth to be below market expectations.

We expect growth to be 7% in 2002, 6% in 2003 and 5% in 2004.

Our medium term growth forecast (used in all our operator DCF models) is 5%.

The main reasons for our pessimism are negative net new user growth and stagnating ARPUs.

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Fra n c e G e rm a n y Ita ly S p a in U K

Mobile Services Revenues (Euro bn)

Source: DZ Bank estimates


2. Mobile OperatorsRevenues - subscriber growth falling2. Mobile Operators

Revenues - subscriber growth falling

Subscriber growth, the growth engine in the past, is stagnating.

Average penetration in Europe now exceeds 70%.

Assuming 20% of the population is elderly, infirm, or puerile, saturation is close at hand.

Lowest penetration is in France, whereas in Italy and UK it is very high.

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Penetration in Western Europe

Users in Western Europe (m)


2. Mobile OperatorsRevenues - Voice ARPUs falling

2. Mobile OperatorsRevenues - Voice ARPUs falling

Voice ARPU is falling.

Average minutes are falling as as the proportion of prepaid customers increases.

ARPU is falling even faster despite the rise in SMS revenues, indicating falling prices.

Operators are forced to cut prices to acquire customers who then telephone less!

This trend will continue until operators introduce tariffs to drive fixed to mobile integration.

Average minutes per user are 500 in the US compared to 150 in Europe, indicating medium term potential for traffic growth.

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H1 2000 H2 2000 H1 2001 H2 2002

Orange France Orange UK

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H1 2000 H2 2000 H1 2001 H2 2002Orange France Orange UK

Average minutes per user per moth

Annual ARPU (Euro)

Source: Company report

Source: Company report


2. Mobile OperatorsRevenues - data ARPUs growing

2. Mobile OperatorsRevenues - data ARPUs growing

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Voice Data

Data ARPU is growing due to SMS traffic growth.

We are pessimistic about m-services in the short and medium term. It took SMS 8 years to reach 5% of mobile revenues.

Lack of handsets.

No compelling range of services or a single killer application.

Teething problems with new data technologies.

Unresolved billing issues.

Nevertheless some early signs of long term potential.

SMS is very popular.

European spent USD 521 m on mobile content in 2001 compared to 221 m on the PC.

ARPU

Data vs. Voice




2. Mobile OperatorsEBITDA - Margin development is positive

2. Mobile OperatorsEBITDA - Margin development is positive

EBITDA margins are increasing rapidly.

Combination of lower net adds and reduced handset subsidies is leading to significantly lower opex.

Long term we believe margins of 40-50% are sustainable.

Competition is limited by the scarcity of licences.

Operators cannot be aggressive on price. Tier 2 operators are weakened by the UMTS auctions. Tier 1 operators fear a regulatory backlash.

Users are not sensitive to price for calls.

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EBITDA margin development at T-Mobile Germany

Source: T-Mobile Germany


2. Mobile OperatorsCapex - set to be lower than expected2. Mobile Operators

Capex - set to be lower than expected

Most operators are showing falling capex in the short term as they have lower volume requirements and enjoy pricing power over manufacturers, who have massive over-capacity.

Further 2G capacity is not required as data and voice traffic is not growing as rapidly as expected.

UMTS build-out will only happen where a certain geographical coverage is necessary to meet licence conditions. A build-out of 3G capacity is unlikely until after 2004 due to handset delays and lack of demand from users for m-services.

In the long run, consolidation could further reduce capex requirements.

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Annual capital expenditure (Euro bn)



2. Mobile OperatorsConsolidation - difficult to achieve2. Mobile OperatorsConsolidation - difficult to achieve

Expectations of consolidation are high, particularly in Germany and Italy, the two six player markets.

Consolidation is difficult to achieve in Germany as it is not permitted to merge spectrum. Most likely scenario is that Group 3G exits the market. Merging MobilCom with a 2G operator is tough as it would breach its service provider agreements.

Consolidation should be easier to achieve in Italy as spectrum trading is now permitted.

Operators Operator 1 Operator 2 Operator 3 Operator 4 Operator 5 Operator 6

France Orange SFR Bouygues (GSM) - - -

Germany T-Mobile Vodafone E-Plus mmO2 Mobilcom TEM

Italy TIM Vodafone Wind Blu (GSM) IPSE Hutchison

Spain TEM Vodafone Amena Xfera - -

UK Vodafone mmO2 Orange T-Mobile TIW -


2. Mobile OperatorsDebt - not a major issue

2. Mobile OperatorsDebt - not a major issue

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DeutscheTelekom

FranceTelecom

KPN BT Group(GBP)

TelecomItalia

Telefonica

Market Cap Euro bn Net debt Euro bnSource: DZ Bank forecasts

Market cap and net debt (Euro bn)Debt is not a major issue for the mobile operators as they are all under-leveraged.

The key risk is that the mobile subsidiaries are plundered by heavily indebted holding companies.

Orange is most at risk. Take-over of MobilComis likely to directly involve Orange.

TIM is a small risk due to the group’s complex ownership structure.

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mmO2 Orange vodafone TIM TelefonicaMoviles

Market Cap Euro bn Net debt Euro bnSource: DZ Bank forecasts

Market cap and net debt (Euro bn)


3. Mobile Phone ManufacturersNot a high growth market anymore

3. Mobile Phone ManufacturersNot a high growth market anymore

We expect mobile phones sales growth to be lower than the market expects.

We estimate that the global handset market revenues will grow by a CAGR 2001-2006 of only 2-4% compared to consensus expectations in the range of 5-12%.

Annual average volume growth of only 7% in 2001 to 2006 and average selling price will continue to decline 3-5% annually.

The main reason for our pessimism is the lack of a new driver to replace growth in net adds.


Total sales - Net adds and replacement

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Replacement salesNet adds% total grow th


3. Mobile Phone ManufacturersNew driver needed in the handset market


New subscribers or Net adds has historically been the main driver for the handset market.

Net adds has historically accounted for about 60-70% of total sales.

There is still growth in the subscriber base, but the years with 50% growth are history.

Last year the subscriber base grew by 30% to 940m subscribers and this year we expect 20% growth and 1125m subscribers at the end of the year.

In 2006 we expect it to be 1125m subscribers, i.e. CAGR 2001-2006 of 12%.

Our subscribers estimates are in line withNokia and Ericsson’s and the general industry consensus.



Net adds vs replacement sales

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Growth in the subscriber base is not enough, what is important for total sales is growth in net adds.

Net adds has until 2000 grown by about 50% annually, i.e. slightly less than total sales.

In 2000 net adds peaked with 250m new subscribers and the decline started.

Last year only 220m new subscribers signed up and this year we expect only 185m new subscribers.

We estimate CAGR 2001- 2006 of -11% - will total sales decline correspondingly?


Yearly net adds and growth y/y

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3. Mobile Phone ManufacturersReplacement rates holds the key

3. Mobile Phone ManufacturersReplacement rates holds the key

With declining net adds, the future growth of the handset market is entirely dependent on the replacement market - the industry has not a good track record of calculating this market.

We believe average replacement time will increase in the future due to:

slow uptake of m-services in the developed markets.

a larger proportion of low-end users in developing countries with longer replacement time.

Replacement market will grow at a CAGR 2001-2006 of 19%, but this is only sufficient for 7% volume growth on average going forward.


Replacement time in months

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3. Mobile Phone ManufacturersPrice pressure expected

3. Mobile Phone ManufacturersPrice pressure expected

Historically the decline in average selling price (ASP) has been between 5-15%.

There will be great differences between companies also in the future, but on average we believe the prices will continue to decline:

Competition increases; Japanese players entering the GSM track and consumer electronic companies will start licensing technology from Motorola and Ericsson.

Globalisation of operators shifts the bargaining power in their favour.

Data enabled phones will have to come down in price order to attract the mass market and the manufacturers will have to compensate consumers for the reduced subsidies.

Commoditisation of mobile phones - consumer electronic pricing in the long run.

The emerging markets are likely to have higher price elasticity, and in order to achieve the expected growth in subscribers, there is no room for price increases.

We expect the prices in the high-end to increase the coming years, but due to the growing share of low-end users following from increased penetration in emerging markets, the global average selling price will continue to slide.

We assume an annual price decline of 3-5% for the industry going forward.


3. Mobile Phone ManufacturersMediocre growth and margin pressure

3. Mobile Phone ManufacturersMediocre growth and margin pressure

The growth in the replacement market is partly offsetting the decline in the net adds, but it is only sufficient for 7% volume growth on average going forward.

With 3-5% price decline, we arrive at market CAGR 2001-2006 of only 2-4%.

Lower growth, intensified competition, price pressure, commoditisation and common sense (law of economics) imply that margins will come under pressure.

We believe margins greater than 4-8% will be hard to achieve in the long run.


Total sales - Net adds and replacement

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Replacement salesNet adds% total grow th


4. Mobile Equipment ManufacturersLower growth than generally expected

4. Mobile Equipment ManufacturersLower growth than generally expected

We expect the wireless equipment market to grow slower than the industry expects.

We estimate a CAGR 2001-2006 of only 4% which is well below the long term growth levels indicated by market leader Ericsson.

Wireless equipment market has been growing in step with growth in net adds, i.e. about 50% annual growth.

The main reason for our pessimism is the lack of a new driver to replace growth in net adds.



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4. Mobile Equipment ManufacturersGrowth in data traffic is the new key driver

4. Mobile Equipment ManufacturersGrowth in data traffic is the new key driver

The total capacity needed in mobile systems network is a function of the total traffic, i.e. both voice and data.

Total amount of voice data is still growing, but annual investments needed to support this growth are declining with the declining number of net adds.

Average minutes of use per subscriber (MOU) and improved quality of service (QoS) will not equalise the negative growth in net adds.

The vendors hope that growth in data traffic will replace growth in net adds as the main driver.



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4. Mobile Equipment Manufacturers3G is not going to save the day

4. Mobile Equipment Manufacturers3G is not going to save the day

The equipment vendors are putting their faith in the success of m-services to increase the data traffic in the networks and to necessitate substantial investments in existing 2G networks and the expansion of new 3 networks.

We believe their expectations are too optimistic.

Take up of m-services will take more time than generally expected.

3G is cannibalising 2G investments - the biggest worry short term.

3G capacity investments will be held back - the current coverage investments is only a minor part of the expected total investments - the biggest worry long term.

Consolidation among operators will at best only delay 3G revenues.

Network sharing will reduce the coverage investments and delay capacity investments.

Globalisation of operators shifts the bargaining power in their favour - 70% of total subscriber base is indirectly controlled by the ten largest operators.

The current over-capacity in the equipment industry is resulting in further price pressure.

Operators plan to reduce capex going forward.


4. Mobile Equipment ManufacturersMediocre growth going forward

4. Mobile Equipment ManufacturersMediocre growth going forward

The interconnected nature of the operators and equipment vendors means that it is impossible for one to grow revenues significantly more than the other in the long run.

We expect operators’ revenues growth to be 5% at best. Moreover, the operators are planning a reduction in their capex/sales ratios from current levels of 20-30% to 10-15%.

This indicates market contraction rather than market growth going forward.

Our estimate of CAGR 2001-2006 of 4% is therefore quite optimistic.


USDbn 1999 2000 2001 2002E 2003E 2004E 2005E 2006E CAGR 01-062G 42.3 51.7 47.6 37.9 33.4 30.2 27.6 25.2 -12%y/y growth 22% -8% -20% -12% -10% -9% -9%

2.5G 0.0 1.9 2.1 2.3 2.3 2.2 2.1 2.0 -1%y/y growth 11% 10% 0% -4% -5% -5%

3G 0.0 0.0 1.3 3.7 11.0 18.0 25.0 34.0 92%y/y growth 185% 197% 64% 39% 36%

Total 42.3 53.6 51.0 43.9 46.7 50.4 54.7 61.2 4%y/y growth 27% -5% -14% 6% 8% 9% 12%


4. Mobile Equipment ManufacturersMargin pressure as the growth slows down

4. Mobile Equipment ManufacturersMargin pressure as the growth slows down

When an industry matures and the growth slows down the margins come under pressure.

In the short-term the margins are under double pressure from sliding prices on 2G equipment and weak initial margins on 3G equipment.

It will probably take 2-3 years to ramp up production and go down the learning curve before healthy 3G margins are achieved.

We are not expecting the long-term 3G margins to be on the level of the 2G margins.

We believe sustainable margins for the industry will be in the mid double digits at best.


USDbn 1999 2000 2001 2002E 2003E 2004E 2005E 2006E CAGR 01-062G 42.3 51.7 47.6 37.9 33.4 30.2 27.6 25.2 -12%y/y growth 22% -8% -20% -12% -10% -9% -9%

2.5G 0.0 1.9 2.1 2.3 2.3 2.2 2.1 2.0 -1%y/y growth 11% 10% 0% -4% -5% -5%

3G 0.0 0.0 1.3 3.7 11.0 18.0 25.0 34.0 92%y/y growth 185% 197% 64% 39% 36%

Total 42.3 53.6 51.0 43.9 46.7 50.4 54.7 61.2 4%y/y growth 27% -5% -14% 6% 8% 9% 12%

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