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Awe Blue Atlantic 10162003

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Research Report on ATT Wireless prior to acquisition by Cingular

Research Report on ATT Wireless prior to acquisition by Cingular


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  • 1. US Mobile Telecom Industry: AT&T Wireless (AWE) Research Report October 16, 2003 B LUE A TLANTIC
  • 2. Executive Summary US Mobile Telecom Outlook AT&T Wireless Valuation Appendix 1 2 3 4
  • 3. We see AWE as attractive for long term appreciation driven by solid earnings and free cash flow growth over the 2002-07 timeframe.
    • Industry Outlook
    • We see subscriber growth at 8.5%p.a. over the next 5 years, with penetration reaching 70% by 2007
    • Revenue growth is forecast at 9.5%p.a. in the same period, as data adoption and wireline substitution offset lower prices and lower quality net adds to drive avg. revenue per user (ARPU) marginally higher
    • Near term catalysts:
      • Net adds at 16-16.5M in 2003, up from 12.3 in 2002 is helping carriers post strong results
      • Data adoption is starting to have a positive impact, with carriers reporting strong ARPU numbers
      • Wireless number portability (WNP) may increase churn near term (we see LT impact to be neutral)
    • Investment Opinion
    • AWE is attractive on valuation, trading at 20% discount to book value and 30% discount to our DCF based intrinsic value, the company is well positioned for strong growth in earnings and free cash flow:
      • Third largest US carrier with strong brand name recognition well positioned to grow subscribers and revenues at 8%p.a. in the forecast horizon
      • EBITDA margins seen expanding from 30% to 39%, as company transitions to GSM platform and focuses on improving operating metrics
      • Capital expenditure seen dropping to 17-19% of revenues in 2003-07 from 37% in 2002 as GSM build-out is largely over
      • Expanding margins and improving capital efficiency seen driving solid earnings (48%p.a.) and free cash flow (25%p.a.) growth
    • Near term catalysts:
      • Strong 3Q report expected
      • GoPhone offer seen driving market share gains
      • NWP overhang
    Price history Summary Forecast
  • 4. AWE is undervalued relative to industry comparables on an EV/EBITDA basis. ATT Wireless AWE $8.40 $2,791 $29,823 6.6X
    • Third largest US carrier
    • Conservatively financed
    • Well positioned for margin expansion
    • May benefit from number portability
    Buy Sprint PCS PCS $5.75 $5,948 $22,968 7.0X
    • High operating leverage and capital efficiency going forward
    • High churn/low customer satisfaction make PCS vulnerable to WNP
    • Tracking stock (like fantasy football)
    Buy Nextel NXTL $22.12 $22,906 $33,978 8.5X
    • Outstanding recent performance
    • Vulnerable to PTT competition
    • No path to 3G
    • Overvalued given risks
    Sell US Cellular USM $34.64 $2,984 $4,374 6.7X
    • Regional player with limited float (80% owned by TDS)
    N/R Western Wireless WWCA $20.25 $1,606 $3,956 9.9X
    • Turnaround play
    N/R Dobson DCEL $9.03 $814 $2,322 8.3X
    • Regional player
    N/R Nextel Partners NXTP $9.12 $2,290 $3,826 28.1X
    • Nextel affiliate
    Sell Triton TPC $4.89 $333 $1,661 6.2X
    • Regional player
    N/R Selected US Mobile Telecom Pure Plays – Oct. 15th 2003 Sources: Company reports, BlueAtlantic Analysis. Company Market Value Comments Rating Name Ticker Price Mkt Cap (m) Enterpr. Value EV/EBITDA
  • 5. Executive Summary US Mobile Telecom Outlook AT&T Wireless Valuation Appendix 1 2 3 4
  • 6. Over the 2003-07 period we see opportunity for the mobile telecom industry to make the transition from high growth phase to solid free cash generation.
    • Subscriber base seen growing 8.5% to 212M in 2007 from 141M in 2002, with penetration reaching 70%
    • Service revenue seen growing at 9.5% p.a. to $132B in 2007 driven by increase in subscribers and higher average revenue per user (ARPU)
    • EBITDA margins to expand from 30% in 2002 to 40% by 2007 driven by economies of scale and benefits from next generation networks (3G)
    • Capital expenditure requirements should fall from 30% of revenues in 2002 to 14% of revenues by 2007 as carriers complete their migration to 3G networks
    • The absence of future consolidation however, poses a long term threat to industry profitability, as the market remains too fragmented.
  • 7. Subscriber base seen growing 8.5% to 212M in 2007from 141M in 2002, with penetration reaching 70%. Sources: CTIA, Bureau of Census, BlueAtlantic Analysis.
    • Offer designs targeted at under-penetrated segments of population such as youth and credit challenged (e.g. AT&T’s GO Phone, family plans, etc)
    • Introduction of compelling data applications (picture messaging, music downloads, games, location based information services) and snazzy handsets (color screen, MP3 player, digital camera, PDA) will drive incorporation of mobility “anywhere/anytime” into life-styles, increasing usage and reinforcing wireless/ wireline substitution
    • Introduction of data only terminals/service offers targeted at enterprise applications, including high speed internet access
    Key Drivers US Mobile Telecom Subscribers – (EOP) Sources: CTIA, Bureau of Census, CIA Factbook, BlueAtlantic Analysis. 19.4% CAGR 8.5% CAGR Forecast 278.1 280.9 283.7 286.8 289.9 292.4 294.8 297.4 299.9 302.4 13.9 16.8 24.0 18.4 12.3 16.5 13.7 13.3 13.6 13.8 Pops Net Adds - 5% 10% 6% 4% 5% 4% 4% 4% 4% Increm Penetr Penetration (%) Subscribers (millions) Benchmark: Penetration Vs. Income Level Note: Bubble proportionate to subscriber base. Hong Kong Mobile Penetration (%) Per Capita GDP (000s of US$) US Portugal France Switzerland U.K. Sweden Spain Italy S. Korea Germany Netherlands Avg:$30k Avg:60% Japan
  • 8. Service revenue to grow at 9.5% p.a. to $132B in 2007 driven by increase in subscribers and marginally higher average revenue per user (ARPU).
    • Increase in number of subscribers to 212M by 2007, up from 141M in 2002
    • Monthly ARPU rises from $51 to $54 driven by increase in usage of both voice and data services offsetting lower prices and lower quality users:
      • We estimate data services to easily account for 12% of ARPU by 2007 driven by adoption of new offerings, including:
        • Multimedia messaging
        • Interactive games
        • MP3 and video downloads
        • Location based services
        • Video calls
        • Internet access, etc.
    Key Drivers Benchmark: Data as % of ARPU Mobile Telecom Service Revenue – $ billions Sources: FCC, CTIA, Company Reports, BlueAtlantic Analysis. 27.5% CAGR 9.9% CAGR Forecast - 25% 39% 29% 17% 12% 43.0 43.0 47.0 49.5 51.0 51.5 Rev. Growth ARPU - - - 0.5% 1.0% 1.5% %Data 11% 52.0 2.5% 9% 52.5 9% 53.0 10% 8% 53.6 12% 5.0%
  • 9. EBITDA margins to expand from 30% in 2002 to 40% by 2007 driven by economies of scale and benefits from next generation networks (3G). Sources: CTIA, Company reports, BlueAtlantic analysis. Key Drivers
    • Consolidation of network infrastructures acquired as a result of consolidation (T-Mobile) or migration to GSM (ATT, Cingular) will contribute to lower costs: one network technology, one billing system, one CRM platform should reduce complexity and improve efficiency across the organization.
    • Transition from a period of fast growth and accelerated network rollout to a phase of slower, albeit healthy, growth will allow management to focus on operating efficiency metrics (learning curve benefits)
    • Additionally, 3G networks are expected to provide higher capacity at reduced operating costs.
    Benchmark: Selected EBITDA Margin 35.2% CAGR 15.6% CAGR Forecast - 20% 48% 42% 33% 19% 18% 16% 15% 14% - -1.0% 1.0% 3.0% 3.0% 2.0% 2.0% 2.0% 2.0% 2.0% EBITDA Growth Margin Exp. Mobile Telecom EBITDA EBITDA Margin (%) EBITDA ($ billion)
  • 10. Capital expenditure requirements should fall from 30% of revenues in 2002 to 14% of revenues by 2007 as carriers complete their migration to 3G networks. Key Drivers
    • The bulk of the investment for migrating networks to the 3G standard have been completed, allowing carriers to limit future network capital expenditures to capacity expansion, maintenance and software upgrades.
    • Two of the top three operators in the US representing 30% market share have chosen to migrate to GSM, a move expected to improve their capital efficiency by 10-15%.
    • Additionally, recent network sharing, collocation and roaming agreements should improve capital efficiency at the industry level.
    Benchmark: Capex/Revenue (2002/03) Sources: CTIA, Company reports, BlueAtlantic analysis. Forecast 65.9 81.7 104.3 127.5 139.3 158.2 177.6 194.5 213.1 231.2 1.05 1.05 1.05 1.01 1.01 0.99 0.96 0.95 0.93 0.92 Cellsites (‘000) Mobile Telecom Capex Capex as % of revenue Capex ($ billion) Subs/Cel(million)
  • 11. The absence of future consolidation however, poses a long term threat to industry profitability, as the market remains too fragmented. Mobile telecom market share - 2002 Sources: FCC, Company reports, BlueAtlantic Analysis.
    • The US market is the most fragmented in the world with over 15 facility based operators while most other developed countries have 3 to 4.
    • Over the past 2-3 years the US mobile market experienced periods of intense price competition which stimulated subscriber growth and higher usage, with limited negative impact on revenue growth and ARPU stability.
    • In the absence of consolidation however, predatory pricing remains a long term threat to industry profitability/ attractiveness.
    Comments Markets with 3 or more operators % of covered pops 2000 2002
  • 12. Mobile data impact on revenue growth may lead to an upside surprise whereas excessive price competition poses the biggest threat to the downside.
    • Downside:
    • Slower subscriber growth with penetration falling short of 70% by 2007
    • Wireless number portability (WNP) may lead to higher churn, increased price competition and lower industry ARPU.
    • Technology disruption (e.g. potential impact of WiFi on data revenues)
    • Regulatory disruption (e.g. will the FCC allow the industry to earn a return on capital?)
    • Upside:
    • Mobile data adoption has the potential to lift industry ARPU and drive revenue growth above current expectations as new and compelling applications are launched, including:
      • Picture messaging
      • Games
      • Video calling
      • Music downloads
      • Location based services, etc
    • Consolidation may improve industry profitability and capital efficiency
    Forecast Risks
  • 13. Executive Summary US Mobile Telecom Outlook AT&T Wireless Valuation Appendix 1 2 3 4
  • 14. We see AWE benefiting from favorable industry fundamentals to grow EBITDA at 17%p.a. and free cash flow at 25% in the 2003-2007 period.
    • Subscriber growth at AWE is estimated at 8.0%p.a. in the forecast horizon based on market share at around 14.5% and churn at 2.1% per month.
    • Revenue growth is estimated at 7.9%p.a. driven by growth in subscriber base and stable ARPU at around $61 per month.
    • EBITDA growth is seen at 16.9%p.a. driven by rising revenues and margins as AWE reduces its cash cost per user (CCPU) in line with its key competitors.
    • Capital expenditure requirements should come down significantly from 37% in 2002 to 15% in 2007, spurring 25%p.a. growth in free cashflow.
    • Our DCF model indicates a value of $11.70 per AWE share which would still leave it trading at a discount to Nextel’s current EV/EBITDA ratio.
    AWE is well positioned to leverage its brand name and GSM network to earn its cost of capital, but pricing pressures due to industry fragmentation and unpredictable regulatory environment remain a notable threat to our forecast.
  • 15. Subscriber growth at AWE is estimated at 8.0%p.a. in the forecast horizon based on market share at around 14.5% and churn at 2.1% per month.
    • WIP
    AWE Subscribers - EOP Sources: CTIA, Bureau of Census, CIA Factbook, BlueAtlantic Analysis. 17.3% CAGR 8.0% CAGR Forecast - - Growth Net Add (m)* - Net Add Share* Key Drivers 19.0% 2.9 15.3% 15.6% 2.8 22.7% 8.0% 1.7 10.1% 9.0% 2.0 14.7% 8.2% 2.0 15.0% 7.7% 2.0 15.0% 7.2% 2.1 15.0%
    • We expect AWE subscriber base to grow in line with the overall industry, slowing down to an annual rate of 7.9% over the next 5 years, from 17.3% over the last 3 years, as the US market approaches saturation (i.e. which we expect to happen at the 70% penetration level in the US).
    • We see AWE leveraging its competitive strengths to sustain its overall market share at current levels, in particular:
      • Solid brand name recognition and reputation for superior quality of service
      • GSM network
        • Handset availability at lower prices and faster product cycles (faster, cheaper, better models) due to global scale
        • Worldwide roaming capability
      • Leading position in the implementation of compelling data offer designs (e.g. first to introduce txt messaging interoperability in the US, partnership with NTT-DoCoMo)
    • We see churn at AWE maintaining its recent downward trend despite Wireless Number Portability (WNP) as network quality improves and underlying causes of churn are addressed through increased retention efforts.
    * Includes acquisitions (e.g.Telecorp, etc.) 2.9% Churn 2.9% 2.6% 2.2% 2.3% 2.1% 2.1% 2.1% Market Share (%) Subscribers (millions)
  • 16. Revenue growth is estimated at 7.9%p.a. driven by growth in subscriber base and stable ARPU at around $61 per month.
    • WIP
    AWE Service Revenues Sources: CTIA, Bureau of Census, CIA Factbook, BlueAtlantic Analysis. 24.2% CAGR 7.9% CAGR Forecast - 63.2 Rev Growth ARPU Key Drivers 33.7% 62.9 15.6% 62.0 8.6% 59.4 5.9% 61.6 8.7% 60.9 8.4% 61.1 8.0% 60.4
    • We see service revenue growth averaging 7.9% in the 2003-07 period driven by underlying subscriber growth and stable ARPU.
    • We expect ARPU to remain stable at current levels as increased overall usage (MOU) and ramp up of data revenues offsets lower prices and penetration into lower value segments (i.e. youth and credit challenged)
      • Data is forecasted to account for 10% of revenues by 2007, up from less than 1% in 2002
      • MOU is expected to maintain current trend line growth driven by wireless/wireline substitution.
    * Includes acquisitions (e.g.Telecorp, etc.) - MOU 382 477 539 582 594 606 617 Benchmark: ARPU 2002 Data Share (%) Service Revenues - $B
  • 17. EBITDA growth is seen at 16.9%p.a. driven by rising revenues and margins as AWE reduces its cash cost per user (CCPU) in line with its key competitors.
    • WIP
    AWE EBITDA Sources: CTIA, Bureau of Census, CIA Factbook, BlueAtlantic Analysis. 41.4% CAGR 16.9% CAGR Forecast Key Drivers 65% 32.73 23% 32.03 24% 31.04 14% 29.14 18% 28.05 15% 27.02 14% 26.02
    • We see EBITDA growth averaging 16.9% in the forecast horizon driven by revenue growth and expanding margins.
    • We expect EBITDA margins to reach 39% by 2007 driven by lower cash cost per user (CCPU) and marginally lower cash cost per gross add (CPGA)
      • Lower CCPU will result from:
        • transition to the 3GSM (WCDMA) standard and consequent rationalization of operations around one (lower cost) network platform (AWE today operates two).
        • Lower roaming costs
        • Management focus shifting from growth to cash generation mode (learning curve)
    * Includes acquisitions (e.g.Telecorp, etc.) $334 $377 $365 $338 $347 $350 $354 Benchmark: CCPU 2002 EBITDA Margin (%) EBITDA - $B EBITDA Growth CCPU $/m CPGA
  • 18. Capital expenditure requirements should come down significantly from 37% in 2002 to 15% in 2007, spurring 25%p.a. growth in free cashflow.
    • WIP
    AWE Capital Expenditure Requirements Forecast Key Drivers
    • We see capex requirements falling to 15% of revenues by 2007 from an average of close to 40% in the recent past, following completion of most of the GSM/GPRS network overlay in 2002.
    • Going forward most of the capex requirements will be associated with capacity expansion to accommodate increase in traffic, maintenance and software upgrades to enhance data speeds (e.g. EDGE).
    $1,805 $0.20 $1,886 $0.14 $1,796 $0.11 $1,402 $0.12 $1,447 $ 0.16 $1,448 $0.16 $1,539 $0.17 76 113 140 164 182 200 219 AWE Free Cash Flow % of Revenue Capex - $B Capex/ Net Add Capex/ Ad Minute Minutes (bn) 25%p.a.
  • 19. Our DCF model indicates a value of $11.70 per AWE share which would still leave it trading at a discount to Nextel’s current EV/EBITDA ratio. AWE Target Price Recent Price - - DCF Valuation DCF Rationale
    • We have performed a discounted cash flow (DCF) analysis of AWE’s mobile telephony business based on a detailed forecast of key operating metrics in the 2003-07horizon and using a 5% perpetual growth rate of free cash flow thereafter discounted at a rate of 10% to arrive at the operating value for the business of $39.2 billion.
    • We have added cash and financial investments and deducted debt, preferred stock and minority interests to arrive at the equity value which divided by number of shares yield 11.78 per share.
    • Our DCF based value of $11.70 per share would leave AWE trading at a slight discount to Nextel's 7.6x Enterprise Value to 2004 EBITDA ratio.
    Comparable EV/EBITDA* Multiples Share Price: $8.3 $12 $5.7 $21.5 *2004 EBITDA
  • 20. AWE is well positioned to leverage its brand name and GSM network to earn its cost of capital, but pricing pressures due to industry fragmentation and unpredictable regulatory environment remain a notable threat to our forecast.
    • Weaknesses:
    • Higher cash cost per user than most competitors makes AWE vulnerable to increase in competitive pressures
    • Transition from TDMA to GSM leaves AWE vulnerable to network coverage/quality issues in the short term
    • Strengths:
    • Brand name recognition and reputation for quality
    • Solid market share of high value segments
    • GoPhone offer may allow profitable penetration of low value segments with potential upside impact on market share.
    • Adoption of dominant GSM network standard create opportunity to reduce operating costs and capital expenditure requirements and handset procurement costs
    • Conservative balance sheet
    • Threats:
    • Wireless number portability (WNP) could potentially increase internal industry rivalry and lead to higher churn and lower ARPU
    • Long term technology disruption (e.g. impact of WiFi on data revenue)
    • Regulatory environment may prevent AWE from earning an adequate return on capital (e.g. spectrum availability, mandatory requirements such as E911 and WNP, etc.)
    • Opportunities:
    • US subscriber penetration has room to grow as youth, credit challenged and old age
    • Mobile data adoption and associated revenue stream could exceed expectations by a very wide margin
    • Potential consolidation may improve overall industry profitability/attractiveness
  • 21. Executive Summary US Mobile Telecom Outlook AT&T Wireless Valuation Appendix 1 2 3 4
  • 22. Pro-forma Income Statement forecast.
  • 23. Pro-forma Balance Sheet forecast.
  • 24. Pro-forma Free Cash Flow forecast.

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