First off, an outline of my brief presentation on a financial markets perspective on the smartphone ecosystems. We will look at four different topics or aspects in the following couple of slides: A quick overview of mobile operators’ business case evolution – in particular, how they are adapting to the new all-data-driven world, how they cope with the regulatory and market pressure on their traditional voice/SMS-centric revenue model. Then we will turn to the “core” issue of smartphone wars – we will observe how the pecking order has been turned upside down by the arrival of, let’s call it “modern smartphone”, some call it “superphone”. We will look at the “next frontier” for smartphones – lower-cost, likely highly commoditised devices for emerging markets. We will try to gauge the “survival potential” of the various protagonists in ongoing smartphone wars and have a look how that correlates to their stock price performance. And finally, a little peek into how the markets perceive the NFC opportunity.
First check: how are operators doing in the brave new world of smartphones? Service revenue trends are mixed to negative at the moment. There is substantial pressure on operators’ voice/SMS revenues from regulation in the form of MTR-related tariff cuts. The traditional voice has a -8% contribution in Q2 for the aggregate of European operator revenue and the Q3 number is in a similar ball-park, actually probably a bit worse. This is essentially down to price pressure (competition and MTR-related), but volumes of minutes are also slowing from +4% in Q2 to +3% in Q3. Data, on the other hand, compensates partially the voice decline, to the tune of +3% in revenue growth contribution terms. SMS still contributes a slight positive to overall growth. Excluding the regulatory pressure from MTR, service revenue is positive, but even here growth is slowing to below 2%. Given the current macro environment, it is important to highlight the correlation to GDP growth for operator revenue. The 08-09 period showed a revenue to GDP correlation of cca 0.5%. This means that all else equal, the 1.6%pt cut to European GDP may translate into a 0.8%pt cut for service revenue. In all, the underlying trends at operators are thus mixed: negative given the headline revenue contraction, but positive with data now being the major revenue growth driver for operators. A healthy operator base is essential for the smartphone industry, as ultimately operators’ solidity warrants healthy capex trends, with encouraging data revenue trends encouraging upgrades to newer, more data-capable networks alongside more substantial subsidies, essential for an accelerated smartphone adoption.
Now, let us have a look at how the mobile device industry changed with the arrival of the “modern smartphone” – naturally, we are here referring to the iPhone, that first made its appearance in 2007. This chart depicts mobile phone (including smart and non smart devices) profit shares at the operating (EBIT) level. Until the emergence of the iPhone, Nokia reigned supreme in the “old-school” smartphone arena, with a unit market share of 50-60% in smartphones and an overall market share of 40%. Nokia’s overall mobile phone industry profit share (in EBIT terms) peaked at 60-65%, last seen for that vendor in Q2 08. I think it is only fair to say that Nokia’s smartphone domination was achieved with a very different class of devices, epitomised by its legendary N95 smartphone. The device boasted best-in-class features, including all forms of connectivities, a then-very-high-end camera and screen, significant on-board storage – essentially a glorified featurephone. There was no application or content ecosystem to speak of, and the “touch paradigm” that revolutionised the smartphone user interface was nonexistent. With Apple’s launch of iPhone 3G, the incumbent’s landslide, headed by Nokia, started as of Q3 2008. Fast-forward three years later to today – and you see that Apple and Nokia traded places, with now Apple dominating 2/3 of industry profits while Nokia is crushed to negligible entity. Note that Nokia is not the first casualty in mobile phones: Motorola was a very strong number two with its RAZR, but almost vanished in 07 and never made it back to the top of the charts. The same can be said for the more marginal Sony Ericsson, off the charts in 2008, or LG, embattled since early 2010. It will be very interesting to observe whether Nokia can be the first manufacturer to truly make it “back from the dead” in the mobile phone arena. Note also that, interestingly, apart from the consistently good performer Samsung and the relatively new kid on the block HTC, the Android camp is far from dominant in profit share terms – although Samsung’s clout is clearly growing. Finally, RIM is not really dead from the profit perspective, supported by highly lucrative subscription services. RIM’s real underlying profit share of the device industry probably looks much worse, if we attempt to strip out only blackberry device EBIT (not disclosed by Co but likely negative).
Now, since I have the pleasure (or the uncomfortable position, given current times) of being the “voice of the stock market” on this panel, here goes my first (and last!) stock price chart of my presentation. With this chart, I hope you will be able to understand why equity markets monitor very closely smartphone competitors’ operating profit share – it is an excellent measure of how an individual vendor stacks against the rest of the world in this fiercely competitive market. With higher profitability, a vendor can secure more ambitious R&D and marketing roadmaps, invest into its ecosystem and its operating system, secure large quantities of critical components at the best possible price… And so, you can probably understand why Nokia’s share price tracked so closely the vendor’s share in the overall industry profits over the past ten years. The peak in 2007 coincides with the last moments when Nokia commanded a collosal 2/3 of industry profits. Fast forward four years later to today, and Nokia’s market capitalisation shrunk by a factor of 6 as its industry profit share almost vanished. You can probably also clearly guess why Nokia shares can only recover if the vendor manages to prop up its global industry share to something decent, but even in the best of events, a return to former glory seems near-impossible – Nokia’s new CEO Stephen Elop targets a 10% Device EBIT margin longer-term –by 2013– which is less than half the margins of Nokia Devices’ glory days (20-25% range), with a global unit market share also about half what it used to be – therefore Nokia can perhaps recover to a 15-20% industry profit share at best – and this assumes Apple’s collosal EBIT margins normalise a little bit, which in itself is also quite a daring assumption.
And now for a quick look of where the smarpthone market is going at present. As you can see in the left-hand chart, smartphones as a proportion of overall phone sales have surpassed the 50% threshold by end-2010/early 11 in mature economies (WEUR, NAM), currently closer to 60%. As these are saturated markets with overall handset sales barely growing, it is only natural to now assume these markets have seen the best of their smartphone growth years. All eyes should now turn to emerging markets – only 20% of devices sold there are smart, with strong regional discrepancies (LatAm and China have higher adoption rates, India and Africa much lower, for example). And this is clearly perceptible if you look at the distribution of smartphone market growth by geography. In 09, mature economies represented 2/3 of total growth. Emerging rose to ½ of total market growth in 2010, and this year it is dominating by capturing 2/3 of world smartphone growth. For example, WEuropean smartphone growth stalled to flat/slightly down yoy in Q3, from 50% growth earlier in the year, while NAM slowed to 20% in Q3 from 70% yoy growth in Q1. meanwhile, APAC smartphone market growth powers ahead at an unperturbed 130% - 150% every quarter this year. In order for smartphone growth to accelerate in emerging economies, we need to get price/demand elasticity to do its job over time – a common pattern in consumer electronics. In this specific case, smartphones at an unsubsidised price of less than USD100 are needed – indeed, most emerging markets are largely unsubsidised due to low ARPUs (although this is changing a bit in some markets such as China). We hear from Chinese suppliers and from Samsung, that these price points will be reached in the course of next year with mass volumes of Androids. Nokia is not ready for these price points with its new (WP) platform yet, and has stop-gap measures in place (“smarter” featurephones with on-board FB / Angry Birds). This is of course NOT the future for this market – a commoditised full smartphone is the only way to go in the long run, in our opinion.
And now, on to the more difficult question – how many operating systems will survive? Let’s first contemplate one simple fact: the smartphone market is getting towards an annual run-rate of half a billion units. This is therefore a very large market indeed, bigger than the PC market, with very entrenched and sticky ecosystems. Unlike the plain mobile phone market where vendors compete on perceived brand equity, design and feature set, a smartphone vendor must convince the incremental new buyer of the quality of its ecosystem above all – and this is getting harder and harder as more consumers chose and start investing hard currency in established ecosystems. This is why, at least when it comes to North America and Western Europe, we believe that smartphone ecosystem wars have been fought and won by Apple and Google – there is no question whether these two guys are here to stay – the question is rather, is there a good reason for any other ecosystem to survive longer-term. As Symbian is wound down to zero by 2013 from absolute domination in 2008, it will be interesting to watch whether Nokia can convert a meaningful portion of its historical user base to the Windows platform. This will be very interesting to watch, because the share of Windows actually shrunk very substantially since the launch of WP7 to currently an almost negligible entity (1.5%) from 5-6% in H1 2010 just before the WP7 launch. In our estimates, we give Nokia credit for its brand equity in emerging economies, which yields the recovery of the WP platform share from 2013 on, but Nokia’s ability to drive costs down on WP8 will be absolutely key here for the platform’s longer-term viability. Finally, the jury is out on RIM. There is clearly a loyal and extremely sticky customer base with in Entreprise users, and perhaps in some emerging markets (although the longer-term stickiness of such commodity, simple applications as BBM remains to be seen). I would just say that after Symbian, WebOS and LiMo/MeeGo and, let’s face it, WP7 fiascos, RIM is the last player to attempt the impossible: total makeover with BBX. To-date its execution with QNX (present on its PlayBook tablet) has been patchy, to say the least, despite a seemingly promising UI effort. We shall see but chances are RIM’s recovery centred on BBX is a very, very long shot. Just a final word on this matter, that I leave to your appreciation. In my view, selling an OS with the associated ecosystem is much, much harder than selling a branded product. In order to succeed, a new platform needs to ADD COLLOSAL VALUE to the consumer, either with features (iOS) or price point / accessibility (Android). A vendor that only imitates the best-in-class without adding this collosal and unmissable value to the end-user will, in my view, invariably fail in the long run. If I push this line of thought to the extreme, by 2015 only iOS and Android will coexist with non-negligible (>5%) market shares – all others will either perish or accumulate ever-increasing losses (this is something that large monopolists such as Microsoft can effectively afford to do for quite a long time).
Now, back to what we do best – talk about stock prices! Of course we only talked about one tiny aspect of global technology – smartphone strategies. But I think we can say success or failure in this particular niche is of paramount importance for the equity market’s valuation of individual protagonists’ overall potential. We compiled here a list of smartphone giants (in many cases significantly diversified outside of the smartphone arena and some of them even don’t make smartphones at all). So let’s have a look at the correlation between these smartphone leaders’ share prices, and what we can qualitatively say about the success of their smartphone strategy with the amount of smileys (or non-smileys) that they “earned” so far this year, in our view. You can clearly see that the equity market rewards a successful smartphone strategy deployed by winners Apple, Samsung, to a lesser extent Google on which the jury is out whether they are actually making any money or just preserving their core business by investing heavily, then giving away for free, their Android OS and ecosystem. At the other end of the spectrum, Nokia, LG and RIM, clearly the failures of the year, have been punished by 40-70% drop in their market value year-to-date. HTC is perhaps on its way, shifting from winners into losers, as its share gains stall in the current quarter. Can HTC really put up a solid fight with an increasingly dominant Samsung at the high end, and low-cost Chinese at the commoditised end, in the increasingly bloody Android arena?
And finally, a quick peek into how markets see the NFC opportunity. First of all, we are seeing a huge amount of interest from investors, very few question the long-term potential of the technology and those who trialled it on trade shows or elsewhere actually do love it. However, the biggest question we are getting at this point is “how to play it?” from an equity investment perspective. Investors are reluctant to buy into big semi names such as NXP or STM for which NFC will always only represent a tiny bit of earnings. Same goes for likes of First Data or Google for instance. This leaves investors with smaller listed companies such as Gemalto, Ingenico, or VeriFone; but on these names, a general lack of understanding of the technology/business model actually leads to somewhat unpredictable share price reactions. For instance, as illustrated below in the case of Gemalto, the stock was up “only” 1.5% vs the sector when GTO was first rumoured to have won the TSM contract for Isis. Conversely and weirdly enough, the stock was up 4.3% vs the sector when Google launched its NXP-based First Data-serviced Nexus S. These erratic and poorly-founded moves find their explanation in the typical questions we get from investors which only illustrate that a lot of education remains to be done in this field. Amongst the most common misconceptions, we would highlight that most investors still believe that MNOs are eager to share interchange fees with payment networks, that Apple will be able to use iTunes as a payment platform in the real brick-and-mortar world, regardless of obvious processing/acquiring issues, that Google plans to make money out of its Wallet by taking a cut on transactions…and so on. In short, it seems that on NFC, financial markets are largely driven by general sentiment: depending on the mood of the day, NFC-related stocks move on any piece of news, with little understanding of how such newsflow will actually impact the different stakeholders in the industry.
Mr Peterc Exane Smartphones
Smartphones: a commodity in the Future of the Mobile Internet? A financial market perspective Alexander Peterc Head of IT Hardware research, Exane BNP Paribas [email_address] +44 207 039 9413 IDATE DigiWorld Summit November 2011
Smartphone wars enter a new phase A financial markets perspective <ul><li>Operators’ revenue now almost exclusively driven by mobile data </li></ul><ul><ul><li>Smartphones set mobile data consumption on fire </li></ul></ul><ul><ul><li>SMS and voice revenue in terminal decline – Operators need to adapt their offer </li></ul></ul><ul><li>“ Modern” smartphones turned the mobile phone market upside down </li></ul><ul><ul><li>New leaders emerge; incumbents turned into challengers almost overnight </li></ul></ul><ul><ul><li>The next few years will be dominated by low-cost smartphones, squeezing feature phones out of the market </li></ul></ul><ul><ul><li>Smartphones for emerging markets are the next “New Frontier” </li></ul></ul><ul><li>How many OS will survive? </li></ul><ul><ul><li>iOS and Android’s lead continues to expand, supported by strong ecosystems </li></ul></ul><ul><ul><li>Microsoft is here to stay (thanks to Nokia), RIM in question </li></ul></ul><ul><ul><li>The equity market rewards only success, and punishes severely underperformers </li></ul></ul><ul><li>NFC opportunity: significant investor interest; lack of understanding </li></ul><ul><ul><li>Large caps (Google, STM FirstData) exposure too small to matter on their scale </li></ul></ul><ul><ul><li>All eyes on a limited number of smaller players, but with many misconceptions and fairly unpredictable related share price reactions </li></ul></ul>
Operator revenue now exclusively driven by mobile data <ul><li>Current service revenue trends are not great </li></ul><ul><ul><li>Q2 -2.9% vs. Q1 -1.8% </li></ul></ul><ul><ul><li>MTR a driver, but also slowing ex-MTR </li></ul></ul><ul><ul><li>Data stronger, but voice pricing weaker </li></ul></ul><ul><li>Mobile service revenue is not immune to the macro </li></ul><ul><ul><li>2008-2009 showed elasticity of ~0.5 </li></ul></ul><ul><ul><li>Since end of July, 2012 European GDP estimates cut by 1.6% </li></ul></ul><ul><li>Healthy operator revenues are essential </li></ul><ul><ul><li>Profitable growth at operators means solid capex plans for networks </li></ul></ul><ul><ul><li>Solid service revenues from high-end devices lead to higher subsidies </li></ul></ul>European mobile revenue trends vs. GDP European operators: data stronger than ever but voice weakening further
Smartphones turned the mobile phone market hierarchy upside down... <ul><li>The arrival of the “modern” smartphone radically transformed the distribution of profits among mobile device vendors </li></ul><ul><ul><li>The share of profits of mobile industry pioneers (Motorola, Sony-Ericsson, Nokia) has been squeezed into negligible quantities – to-date, no vendor returned “from the dead” (MOT, SE, LG, NOK) </li></ul></ul><ul><ul><li>Apple and to a lesser extent Samsung are the new leading forces in today’s industry, together commanding a staggering 80% of industry profits </li></ul></ul>Mobile phone market – Share of industry profits, 2002-2011 Source: Exane BNP Paribas estimates and historical data
The “new order” in profit distribution dictates the vendors’ share prices – Example of Nokia Mobile phone market – Share of industry profits and Nokia share price (RHS) 2002-2011 Source: Exane BNP Paribas estimates; Datastream share price data <ul><li>Nokia’s share price is directly correlated to its share of industry profits </li></ul><ul><ul><li>Leading the industry in volume is nearly worthless – While still being the volume leader, Nokia is today worth 6X less than at the peak of its glory (end-2007) </li></ul></ul>Share of industry profits (%) Nokia share price (EUR) 3 5 10 15 20 25 30
Smartphone growth will be increasingly limited to emerging markets Smartphones - % of total market Distribution channels NA / EU / APAC Smartphone market growth contribution by geography <ul><li>The geographic distribution of growth is shifting </li></ul><ul><ul><li>NAM/EU supercharged smartphone growth is about to finish as smartphones reach >60% of total sales (2013/14). EU already slowing substantially (Q2 11). </li></ul></ul><ul><ul><li>Emerging markets are set to become by far the largest growth area for smartphones (already 2/3 of growth and 50% of the market in 2011) </li></ul></ul><ul><li>A necessary commoditisation </li></ul><ul><ul><li>Sub-USD100 price points in unsubsidised markets (APAC, MEA) will be key to industry growth over the next 3-5 years </li></ul></ul><ul><ul><li>The “smarter featurephone” (Nokia’s strategy vs low-cost Chinese Androids) is merely a stop-gap measure ahead of low-cost WP in 2013 </li></ul></ul>Source: Exane BNP Paribas estimates Source: Exane BNP Paribas estimates Source: Exane BNP Paribas estimates
How many operating systems will survive? Android Linux Windows Symbian RIM iOS <ul><li>To an extent, OS wars have been fought, and Android / iOS already won </li></ul><ul><ul><li>iOS dominates the mindshare and the wallet share </li></ul></ul><ul><ul><li>Android dominates the sheer numbers </li></ul></ul><ul><ul><li>Windows probably lost out in mature markets, but the Nokia wild-card may warrant an emerging markets second life for MSFT’s OS </li></ul></ul><ul><li>RIM’s survival in doubt with its BBX transition </li></ul><ul><ul><li>The success rate in total makeovers in mobile OS is zero thus far (Symbian, WebOS, LiMo/MeeGo) </li></ul></ul><ul><ul><li>RIM’s execution (QNX) thus far does not inspire confidence </li></ul></ul><ul><ul><li>Only (fragile) support in emerging markets (LatAm, MEA) cannot compensate for the US share meltdown </li></ul></ul>Smartphone operating system market share (units) 2008-2013 Source: Exane BNP Paribas estimates
The equity market seems to appreciate (only) a successful smartphone/OS strategy Key smartphone share price performance year-to-date (%, rebased in EUR) Source: FactSet Smartphone strategy success/failure Accelerating share loss, too little & too late BB OS 7, bungled tablet launch… can BBX save RIM in 2012? Started with Windows and failed, badly executed in the switch to Android – is this the end of LG’s smartphones? Failed with Symbian, chose the non-obvious Windows over Android. 2012 = make-or-break for Elop’s strategy. Successful but stalling – can HTC withstand the pressure from Samsung? Catching up with WP OS – but beating the best-in-class is the only option for long-term success Best open-source OS strategy Best-in-class execution with a wise (essentially agnostic) platform strategy Best-in-class software/hardware/content integration across multiple platforms (tablet/phone/computer)
NFC for investors: huge amount of interest, but lack of general understanding <ul><li>Positive view in general from investors, very few question the potential of NFC. Two major issues for investors however: </li></ul><ul><li>Issue 1: most listed companies involved in NFC are too big to be good “pure NFC plays” (i.e. STM, NXP, First Data, Google…) </li></ul>Gemalto share performance vs. MSCI Europe Technology index <ul><li>Issue 2: a general lack of education re a still young and changing ecosystem. Most common misconceptions include: </li></ul><ul><ul><li>Telcos eager to own the SE to force payment networks to share interchange fees </li></ul></ul><ul><ul><li>Google will take a cut on transactions initiated via Google Wallet </li></ul></ul><ul><ul><li>NFC payment will substitute 100% of chip card transactions </li></ul></ul><ul><ul><li>Mobile payment application = TSM services = Mobile Wallet </li></ul></ul><ul><ul><li>Should Apple launch an NFC-iPhone, iTunes could work as a closed payment network </li></ul></ul>all eyes on a very limited number of stocks such as Gemalto, Ingenico, Verifone as somewhat unpredictable share price reaction to major NFC-related newsflow, as illustrated below in the case of Gemalto Source: Exane BNPP, DataStream
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