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Mobile Data Wave 13 june 2012


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Mobile Data Wave 13 june 2012

  1. 1. June 13, 2012MORGAN STANLEY BLUE PAPER MORGAN ST ANLEY RESEARCH Global 1 Nick Delfas 1 Francois Meunier 2 Simon Flannery 3 Tetsuro Tsusaka 2 Ehud Gelblum 2 Stanley Kovler Morgan Stanley Telecommunications, Morgan Stanley Technology *See page 2 for all contributors to this reportMobile Data Wave 1 Morgan Stanley & Co. International plc+Who Dares to Invest, Wins 2 Morgan Stanley & Co. LLC 3. Morgan Stanley MUFG Securities Co., Ltd.+Exponential growth in data usage could challenge network capacity by 2014. Tabletand smartphone penetration is driving up data usage with rising demand for video. Ournew capacity utilisation model suggests that base case European usage growth (9x 2011usage by 2015) can be met at current capex levels, but that quality will continue to suffer.Capacity is challenged in our bull case where usage reaches 23x 2011 levels by 2015.Scale operators have the opportunity to improve pricing power and take share:1) by investing to improve the quality of the user experience; and 2) by actively stimulatingdata demand, resulting in tighter capacity utilisation and pricing power, as in the US.The risk-reward is attractive for scale players – a 20% capex increase could drivean 80% uplift in equity value. Identical frequencies in use, easy access to capital, andexcess marginal capacity have suppressed the natural scale benefits of mobile in Europe.But, scale is back: differentials are opening up between larger and smaller players inspectrum holdings and access to capital. We estimate the upgrade cost per majorcountry network ex spectrum at €1.4bn, or €10-12bn pan-Europe. Over three years, thisis a 20% uplift to capex for major operators; for second tier operators, it is a costly 40%.Starting line position and execution are key. We see Vodafone as a winner by virtueof its good market and spectrum positions and low leverage, while levered or subscale Morgan Stanley Blue Papers focus on criticaloperators will struggle. Ericsson and Huawei should continue to take share given their investment themes that require coordinatedexpertise in multi-standard base stations, though price competition remains intense. perspectives across industry sectors, regions, or asset classes.Morgan Stanley does and seeks to do business with companies covered in Morgan Stanley Research. As a result, investors should be aware that the firm mayhave a conflict of interest that could affect the objectivity of Morgan Stanley Research. Investors should consider Morgan Stanley Research as only a single factorin making their investment decision.For analyst certification and other important disclosures, refer to the Disclosure Section, located at the end of this report.* = This Research Report has been partially prepared by analysts employed by non-U.S. affiliates of the member. Please see page 2 for the name of each non-U.S.affiliate contributing to this Research Report and the names of the analysts employed by each contributing affiliate.+= Analysts employed by non-U.S. affiliates are not registered with FINRA, may not be associated persons of the member and may not be subject to NASD/NYSErestrictions on communications with a subject company, public appearances and trading securities held by a research analyst account.
  2. 2. MORGAN STANLEYMORGAN STANLEY RESEARCH June 13, 2012 Mobile Data Wave: Who Dares to Invest, Wins Global Technology and Telecoms ResearchMORGAN STANLEY BLUE PAPER Contributors to this Report Europe Telecoms Nick Delfas1 +44 20 7425-6611 Luis Prota1 +34 9141-81217 Saroop Purewal3 +81 3 5424-5326 Terence Tsui1 +44 20 7425-3095 Ryan Fox1 +44 20 7425-5413 Europe Technology Francois Meunier1 +44 20 7425-6603 Andrew Humphrey1 +44 20 7425-2630 US Telecoms Simon Flannery2 +1 212 761-6432 John Mark Warren2 +1 212 761-0430 Michel Morin2 +1 212 761-0328 Daniel Rodriguez2 +1 212 761-6648 US Technology Ehud Gelblum2 +1 212 761-8564 Stanley Kovler2 +1 212 761-3501 Asia, Japan and Latam Telecoms Navin Killa4 +852 2848-5422 Vinay Jaising5 +91 22 6118-2252 Tetsuro Tsusaka3 +81 3 5424-5901 US Media Benjamin Swinburne2 +1 212 761-7527 Ryan Fiftal2 +1 212 761-3005 1 Morgan Stanley & Co. International plc++ 3 Morgan Stanley MUFG Securities Co., Ltd.+ 5 Morgan Stanley India Company Private 2 Morgan Stanley & Co. LLC 4 Morgan Stanley Asia Limited+ Limited+ See page 57 for recent Blue Paper reports. 2
  3. 3. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsContents PageExecutive Summary 4This Blue Paper’s Key Findings 6The Data Wave: Mapping the Rise in Capacity Utilisation 7Usage Growth Scenarios: 5x or 23x by 2015? 17Pricing a Quality Network 21Quality Is a Strategy Whose Time Has Come 29US versus Europe: More Capex, but More Cash Flow and Value 35LTE Devices: Driving the Uptake 38Focus Stocks: Equipment Vendors 40Focus Stocks: Network Operators 42Appendix 1: 4G / LTE Primer 44Appendix 2: Global Data Consumption Model 49Appendix 3: Global Spectrum Holdings 50Appendix 4: Glossary 53 3
  4. 4. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsExecutive Summary Exhibit 1Who Dares to Invest, Wins In Our Bull Case, Capacity is Insufficient from 2014In this Blue Paper we present a simplified model of mobile network 600capacity and usage. This lays bare the key variables on the network side: Total system capacity (Gbps) 500spectrum in use, spectral efficiency and busy hour concentration. It also Busy hour demand (Gbps) - Base casemakes clear the wide range of possible usage outcomes, looking at 400 Busy hour demand (Gbps) - Bear casesmartphone and tablet penetration, and the intensity of data usage per 300 Busy hour demand (Gbps) - Bull casedevice, in particular due to video. 200We estimate the cost of network upgrades – including radio,transmission and core investments – at $1.7bn/€1.4bn per operator. 100This excludes the cost of spectrum, more of which will be required in 02014/15 on our bull case demand estimates. 2010 2011 2012 2013 2014 2015We conclude that the time is right in Europe for scale operators to Source: Morgan Stanley Research estimatesmove towards a demand fulfillment and network quality strategy. Exhibit 2The risk reward on such a strategy is attractive: we estimate an 80%+ upliftto equity value if successful for an annual cost of around 4% of current Estimated Cost of a Network Quality Strategy € m pa Average % equip- Equipment Upgrade Years to Capexequity value. per 60m pop capex ment capex cost upgrade uplift Large operator 652 55% 359 1,429 3 18% Small operator 482 55% 265 1,429 3 44%The growing use of data will create a new set of Note: Average capex 2007-11 for big 3 UK operators, largest 2 in Germany, Spain, and Vodchallenges and opportunities for network operators. The IT and Ora FT (Large Operators); O2 DE, E+ DE and ORA ES (Small Operators) . All resized proportionally to 60m population country. Source: Company Data, Morgan Stanley Researchnumber of smartphones and tablets is rising, but moresignificantly the quantity of video use is also increasing, and We estimate it costs $1.7bn/€1.4bn to upgrade a network,could challenge networks as soon as 2014/2015. The or €10-12bn pan-Europe (ex spectrum). Future networksoperators who invest early – not only to prepare for this growth will have to be based on Long Term Evolution (LTE), i.e. thebut also to provide a quality service – are the most likely to next, faster generation of mobile technology, and will need toshow a greater return on capital. be more complex, with small cells and better transmission. How quickly we get there will define the capex path, which isOur mobile usage forecasts have a strong upside skew. highly sensitive to the length of time to upgrade. In the bullEuropean data usage could grow to anything from 5x to 23x case, the capex uplift would be at least 20% for a scale2011 levels by 2015, we estimate, with our base case at 9x. operator and 40% for a challenger.Video and related uses such as gaming are the key variables.Our 2015 base case is for 11 minutes of low quality video per Scale operators are best positioned for networkday on a smartphone over 3G/4G (only 3% of total “screen investment. Sunk costs, undifferentiated spectrum and lowtime” on TV and internet currently) and 6 minutes of high capacity utilisation have given operators few incentives toquality video on a tablet. Our bull case doubles these figures. invest in network upgrades in recent years. However, scale operators now have two key advantages: (i) low frequencyIn the bull case, mobile capacity is insufficient. We spectrum is generally owned by only three operators perestimate capacity growth will be ~5x, taking into account gains market and is usually awarded to the highest bidder; and (ii)in spectral efficiency, additional spectrum deployed and slight capital is more scarce.growth in base stations. On our base case, utilisation in thebusy hour rises from 32% to 57%, but in our bull case capacity We see an 80%+ value uplift opportunity for scale playersis insufficient for demand. We calculate US operators already from a network quality strategy. Network quality is not justhave higher capacity utilisation, suggesting recent price rises about download speed or capacity utilization. It is also about– such as AT&T’s $5 increase in data plan tariffs – have an in-building and geographical coverage, time to attach for aeconomic underpinning. data session and latency / jitter. Better network quality should also mean that an operator encourages and fulfills demand rather than tries to discourage it with small data allowances, 4
  5. 5. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, Winsas better network utilisation should lead to better pricing but the read-across from the US is not encouraging: marketpower in the longer term. The transition to a quality shares for discount players continue to fall and pricing powerinvestment strategy is risky, as initially FCF must fall, but we is poor.estimate an 80% equity value uplift from a network qualitystrategy and from better pricing and market positioning Scale operators and well-positioned equipment providersrelative to laggards. In other words, the risk reward on are set to benefit. We see Vodafone as a key winnerincremental investment (and good execution) is extremely amongst operators. DT has already suffered from poor scaleattractive, in our view. in the US, and could rebound. Among equipment providers, we see the transition to multi-frequency base stations asUS network quality strategy provides a blueprint. favouring Ericsson and Huawei, while more complex networksCompared with Europe, capex has been significantly higher in favour Ericsson’s strength in network services. However,the US in absolute terms and as a percentage of sales over price competition in the vendor space remains intense.the last five years. Lower population density, less Chinese Exhibit 3supplier presence and the need to build more backhaul allplay a part. However, operators have also been marketing Financial Flexibility Is Becoming a Differentiator fornetwork quality more aggressively, and have been more Operators Least flexibilityeffective in monetising data growth. We expect to see 120European operators follow a similar path in the next phase of TEF 100 DT KPNnetwork investment. The leading US players trade at a % Payout of Net Income 2012e VOD FTsignificant premium to Europe (an average of 6.3x 2012e 80 AT&T Verizon TelenorEBITDA versus 4.8x), reflecting their success in using their TeliaSonerascale advantages to create network quality and gain pricing 60 SCMNpower. BT TI 40‘Unmarried’ challengers most disadvantaged. Smaller 20 AMXoperators who cannot find partners with whom to network Most flexibilityshare or those with high debt levels can be expected to 0 0.0x 0.5x 1.0x 1.5x 2.0x 2.5x 3.0xstruggle the most, as upgrade costs and investments in Proportionate net debt / EBITDA 2012espectrum or quality will likely be prohibitive in the absence of Source: Morgan Stanley Research estimatesany consolidation. There will be a place for discount players, 5
  6. 6. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsThis Blue Paper’s Key FindingsWhen Will There Be a Capacity Crunch? not an obvious partnership between 3rd and 4th operators owing to differentials in market share and1. Capacity will grow 5x, but usage 5-23x over spectrum ownership. 2011-2015, with 9x in our base case. The key usage driver is video over better (LTE) networks/ handsets/ 8. Vendor consolidation will increase. Deployment of tablets. single RAN base stations saves costs for operators and leads to market share consolidation in Europe for2. Capacity at the busy hour is sufficient for the base Ericsson and Huawei at the expense of NSN and case, but quality can still suffer. We estimate Alcatel-Lucent, though price pressure remains intense. capacity utilisation at the busy hour will rise from 32% today to 57% at the mid point, with a range of 49-118%. 9. Network Services will be an increasingly important Even at the base case, this is likely to create additional equipment vendor sub-segment. “Network quality” difficulties for the busiest sites (5-20% of base stations encompasses capacity, speed, security, coverage, account for 20-80% of traffic). However, in the bull case latency and downtime, across time and space. Our capacity is insufficient for demand from 2014. conversations with equipment vendors suggest geographic traffic concentration is becoming a greater3. Our usage forecasts have upside risk. Tablet attach issue than “busy hour” concentration, as data use is rates to 3G/4G versus WiFi and the amount of video on beginning to look relatively flat through the day. both smartphones and tablets are key uncertainties. We Managing this complexity supports vendor network see our mid-point 9x usage uplift as conservative. Our services businesses. bull case foresees 20 minutes per day of low quality video per smartphone, which is still only 6% of total TV 10. Spectrum values could increase in 2012/2013; and internet “screen time”. regulators should maintain a light touch. Post 2015 network congestion looks likely. Spectrum owners –4. In the US, capacity is already pressured from 2013. including governments, some satellite players such as A higher proportion of high usage iPhones, with fewer DISH, and even smaller players with still underutilised sites per pop and less spectrum, quickly fills the networks – should benefit. Spectrum regulation requires network: This should be positive for pricing power. care, however. Awarding low frequency spectrum atWho Wins? below-market rates to challengers could undercut large operators’ willingness to compete on quality.5. Scale is back. Spectrum is the key driver of capacity growth, and is awarded in an open market in most What is the Risk Reward on Investment? countries. Despite vendor discounting, LTE and related 11. We estimate it costs $1.7bn / €1.4bn to upgrade a investments further accentuate scale operators’ wireless network from voice to quality data, split advantages. 54% between base stations/antennae/radio and 46%6. Scale operators should choose a “quality” over backhaul/core network – both equally important. This is “best efforts” strategy, and prepare for the bull based on a 3-year network modernisation plan, and case. More spectrum, more sites, more small cells, excludes spectrum costs. We estimate that this implies better advertising: these build reputation, market share a 20% capex uplift for a large operator, 40% for a small, and pricing power, and improve asset turnover. or €10-12bn across EU operators. Operators should not try to limit usage today with small 12. Operating leverage could drive 80% equity value data tiers, in our view: higher use could bring high upside for scale operators. Current European equity capacity utilisation closer, which should be beneficial for prices discount an EBITDA decline. A modest change in pricing. market share and pricing power prospects towards US7. Sub-scale operators must search for network norms could drive an 80% equity value uplift for e.g. partners. Three UK has led the way with a highly Vodafone Europe (from -5% to +3% EBITDA CAGR successful partnership with T-Mobile and now implied). Everything Everywhere, and Vodafone has followed with Telefonica in the UK. However, in most markets there is 6
  7. 7. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsThe Data Wave: Mapping the Rise in Capacity Utilisation coverage (especially within aluminium-laminated concrete and• We estimate that capacity will grow 5x to 2015/16, but that usage glass office blocks), which cannot be modelled. will grow 5-23x – 9x in our base case. Network utilisation rises from 32% to 57% in the busy hour. Our approach is therefore necessarily very broad brush, but we think this is nevertheless a worthwhile exercise as it illustrates• Capacity growth is relatively certain, driven mainly by better the order of magnitude of the capacity and quality challenges spectral efficiency and additional spectrum being lit. Lighting new spectrum is key, and relies largely upon installing new the industry is facing. multi-frequency radio equipment. Key data usage drivers• Usage is much harder to forecast. Video is already >35% of usage We have used key disclosures principally from Vodafone on Three UK and Vodafone, and will be the key future driver of Europe as the basis for our data usage model. In particular: consumer usage growth, in our view. Our base case implies ~11 minutes of low quality or ~3 minutes of high quality video per day by  Smartphone penetration. We forecast 60% 2015. penetration in 2015 in our base case. Vodafone Europe smartphone penetration was 21.7% at H1• Our model shows why AT&T, with significantly greater iPhone FY12, 24.4% at Q3 and 26.9% at Q4. However, these penetration and usage per phone than European operators, has numbers would be higher if we were to exclude suffered capacity issues, and why LTE has become necessary in Eastern Europe and Turkey – we estimate a ~35% the US sooner than in Europe – capacity utilisation is around 20pp smartphone penetration for Western Europe at end higher than in Europe. 2011.• All these “whole network” statistics require care: network use is  Smartphone utilisation. We forecast 1.2GB by concentrated in different places at different times, and there is 2015 in our base case. Vodafone Europe disclosed significant variation between networks/countries. usage per smartphone of 0.1GB per month at March 2011, rising to 0.13GB by September. This is theModelling Usage Growth and Capacity Utilisation in average of all smartphones including Blackberry,Europe which have low usage of around 50-60MB per month.Network capacity and utilisation are very complex and Usage for Android is around 0.25GB and for iPhonetechnical topics. There is no single measure of network 0.300GB. Other operators report higher smartphoneutilisation. A network can be 30% utilised on average, but this usage – e.g. 0.8GB at Three UK, up from 0.2MB onlycan mask variations across two key dimensions: a year ago.  Number of dongles/tablets. We forecast a  Geography. Base stations in large, wealthy urban population penetration of 15% for attached tablets centres tend to be very heavily utilised. and dongles by 2015. We estimate 15% of  Time. The “busy hour” can account for 10-15% of households have dongles, with a 33% market share total daily usage, instead of 1/24th where utilisation is for a large operator; tablets are becoming a more completely flat (4%). The busy hour for data is not the important part of the base, but attach rates to 3G same as the busy hour for voice, occurring later in the remain low (under 30%). evening for a peak often around 9pm. Furthermore,  Dongle utilisation. We forecast a rise to 3.0GB per data tends to have a smoother overall profile than month by 2015 in our base case in tablet and dongle voice. utilisation. Vodafone Europe disclosed 1.6GB at March 2011, a fall to 1.4GB by September andPut these together and a “30% utilised network” can be 100% 1.25GB by March 2012. Tablets are less utilised, atutilised in the busy hour in the major urban centres, where the around 0.45GB.majority of the high ARPU users live, making “whole network”statistics unrepresentative of the real world.  Network still dongle-heavy. On our forecasts, dongle/tablet traffic falls to 40% by 2015. VodafoneThere are also other network performance issues that affect Europe disclosed at Q4 FY11 that 88% of its trafficnetwork capacity and utilisation, in particular in-building was on dongles, falling to 79% at September 2011. 7
  8. 8. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, Wins Exhibit 4Note that we focus exclusively on data in this report as datausage already outstrips voice by a large margin globally (see Data Already Outstrips Voice on a Global BasisExhibit 4) and by an even wider margin in Europe. The chief 800 Total (uplink + downlink) monthly traffic (PetaByte/month) Voice Dataimportance of voice in our calculations is because spectrum 700previously allocated to voice will be re-purposed for data in the 600coming years (e.g. re-farming of 900 MHz). 500Exhibit 5 below is our base case forecast, with a 74% CAGR 4002011-2015 in total usage of the mobile network, giving a 9xincrease in total traffic. 300 200 100 0 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 07 07 07 07 08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11 12 Source: Ericsson Traffic and Market Report, June 2012Exhibit 5Usage Growth Model – Large European Operator 2010 2011 2012 2013 2014 2015 CAGR 11-15Customers (mm):Smartphone handsets 3.6 6.4 8.8 10.0 11.2 12.0 17%Non smartphone handsets 16.4 13.6 11.2 10.0 8.8 8.0 -12%Dongles / tablets 1.1 1.3 1.7 2.2 2.8 3.3 26%Total 21.1 21.3 21.7 22.2 22.8 23.3 2%Smartphone penetration of handset base 18% 32% 44% 50% 56% 60%Dongle / tablet attach rate to 3G/4G 80% 45% 30% 25% 25% 25%Dongle / tablet penetration of population - incl WiFi 7% 15% 29% 45% 56% 68%Usage per customer per month (GB):Smartphone handsets 0.1 0.2 0.4 0.6 0.9 1.2 57%Non smartphone handsets 0.0 0.0 0.0 0.0 0.0 0.0 5%Dongles / tablets 1.6 1.2 1.4 1.8 2.5 3.0 26%Annual total usage (GB mm):Smartphone handsets 3 12 36 68 114 167 93%Non smartphone handsets 1 1 1 1 1 1 -9%Dongles / tablets 21 17 26 43 75 110 59%Total 25 30 63 111 190 278 74%% growth total 6% 22% 107% 77% 72% 46%% growth smartphone handsets usage 40% 257% 204% 86% 69% 46%% growth non smartphone handsets usage -4% -8% -13% -10% -7% -6%% growth total handsets usage 26% 195% 188% 83% 68% 46%% growth dongles/tablets usage 3% -15% 46% 67% 77% 47%% of usage on dongles/tablets and non-smartphones 87% 60% 42% 39% 40% 40%Source: Morgan Stanley Research 8
  9. 9. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsExhibit 6Flexing Data Usage Growth Rate and Duration Gives a 5-23x Increase vs 2011 Traffic CAGR 30% 40% 50% 75% 120% 130% Years 3 2 3 3 5 11 12 4 3 4 5 9 23 28 5 4 5 8 16 52 64 6 5 8 11 29 113 148Source: Morgan Stanley Research Exhibit 8Clearly, however, this is only one of a range of possibleoutcomes. In Exhibit 6, we show the multiple of 2011 traffic Share of Data Volume by Application 15%resulting not only from a variety of CAGRs, but also from avariety of durations of this growth – there is a very bigdifference between the quantity of traffic generated by a 5% 35%four-year CAGR of 95% and a five-year CAGR of the same 3%magnitude – nearly double. We highlight a range of 5-23xthe 2011 traffic by 2015. We explore this range in our bear,base and bull case usage scenarios. 13%The wide range of these results serves to remind us thatnetwork planning at a four- to five-year horizon is extremely 29%difficult, partly because the duration of growth is so hard to Streaming Web File / Software updates VoIP Peer to Peer Otherpredict. To what extent will adoption of video on smartphones Source: Vodafoneor tablets take off, and is an average usage on smartphones of1.2GB in the long term an under-estimate of demand? We note Network Capacity Assumptionsthat Three UK smartphone users are already using 800MB, up In building our network capacity model, we have used4x in 12 months, compared to around 250MB at Vodafone disclosures from a variety of sources, together with some keyEurope. What will be the impact of LTE adoption on demand? simplifying assumptions:We show in Exhibit 7 below how much data different types of  Base station growth. We assume 2% annualusage require. growth; the CTIA in the US has measured 7% compound growth for the last five years, but weExhibit 7 believe growth is lower in the more densely populatedKB, MB, GB: What They Mean European continent.Volume Content10 KB A single page of text  Spectral efficiency. Spectral efficiency of 2bps/Hz4 MB A song download1.5 GB A two hour film (10Mbps/5MHz carrier) is often quoted for LTE, butSource: Ofcom, Morgan Stanley Research further from the base station this is lower. Three UK gives a figure of 0.6bps/Hz (3Mbps/5MHz) for 3G, andBoth Three UK and Vodafone report a significant volume 33% better for LTE, as a sensible “real world” figure,overhead from software updates of around 15-20% (see and we use this.Exhibit 8 “Other”) – this is particularly pronounced in thesoftware updates required by the iPhone – and volume from  System efficiency: important simplifyingstreaming of around 35%. So taking 35% of Three UK’s assumption. A cellular system is of course far from800MB usage is already equivalent to 22 minutes per month 100% efficient. We have already adjusted for(45 seconds a day) of video, taking the video data requirement lower-than-headline spectral efficiency – this has toimplied by Ofcom in Exhibit 7 above (which equates to do with distance from the base station and physical1.7Mbps); most users will probably experience this as ~90 obstacles, such as concrete. However, and equallyminutes per month (3 minutes per day) at a lower quality small importantly, users do not arrange themselvesscreen speed of 400kbps. (As a useful aide memoire, a optimally around a base station, which means that400kbps video clip translates into usage of 180MB per hour.) some sectors are overloaded while others are empty. 9
  10. 10. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, Wins Equally, users do not distribute themselves evenly in our bull case. While actual utilisation figures are not around the country, with different numbers trying to disclosed by operators, AT&T has talked about splitting cells access a base station in Cumbria than are doing so in and building distributed antenna systems, but also raising Camden Town. We estimate a 20% “real world” prices without access to new spectrum – indeed AT&T recently efficiency. increased their data bucket prices by $5 per month.  Busy hour. Data traffic is less “peaky” than voice, but Sense check (3) – VZW disclosure. In its application for this could change depending on whether events such approval to buy the SpectrumCo spectrum, Verizon disclosed as sports or music concerts or simply greater usage of that it has experienced a 94% CAGR from Q4 2006 to Q4 2011 video increases peak usage. For the purposes of our and that “our LTE usage projections suggest that this trend of modeling, we adopt a steady busy hour percentage of doubled data usage every year will continue, and that traffic on 12% of traffic. our LTE network will surpass data usage on our EV-DO network in early 2013”. (FCC disclosure, March 8 2012).Sense check (1) – utilisation. Vodafone Europe disclosed inJuly 2011 an average busy hour utilisation of 38% of the “real Note on conversion from GB per month to” network – similar to our figure for 2011 as a whole of In accordance with the usual practice, we forecast usage per32% in Exhibit 9. Vodafone also disclosed that 47% of second month in Gigabytes, or GB, and measure total utilisation incarriers are not lit, compared to our average of 2.5 carriers, but millions of GB (technically “Petabytes”). We show utilisation inwe note that in densely populated areas three carriers will have Gigabits per second, or Gbps. To reach Gbps we multiply by 8been lit, while in rural areas only one will have been – (there are 8 bits in a byte), and divide by 365 and by 3,600 tosuggesting a Vodafone average of around 2.0 carriers. reach a per second figure.Sense check (2) – FCC report. The FCC published a report Our model suggests that bringing new spectrum into use willin 2010 quantifying the need for additional spectrum, in support enable mobile network capacity to remain just ahead ofof the president’s National Broadband Plan (see here). The demand, though overall capacity utilisation remainsreport uses a higher growth in spectral efficiency than our significantly more elevated – reaching 57% in 2015 from 32%estimate (0.625bps/Hz rising to 1.25bps/Hz by 2014 versus our today in the busy hour. However, our bull case usage forecasts0.6bps/Hz rising to 0.8bps/Hz by 2015) but also a higher mean capacity would be insufficient for demand.growth rate in demand (93% CAGR 2010-14 versus our 74%CAGR 2011-15). Interestingly, however, the report predicts ashortage in licensed spectrum in 2013, versus 2014 in EuropeExhibit 9Capacity Utilisation Model – Large European Operator 2010 2011 2012 2013 2014 2015 CAGR 11-15Number of sites 15,000 15,300 15,606 15,918 16,236 16,561 2%Number of sectors 3.0 3.0 3.0 3.0 3.0 3.0Number of 5 MHz carriers 2.5 2.5 3.0 5.0 7.0 9.0 38%Mbps per carrier per sector 3.0 3.0 3.0 3.3 3.6 4.0 7%Total system capacity (Gbps) 338 344 421 788 1,227 1,789 51%Total system capacity at 20% efficiency (Gbps)(Gbps) 68 69 84 158 245 358Percent of daily use in the busy hour 12.0% 12.0% 12.0% 12.0% 12.0% 12.0%Total busy hour use (Gbps) 18 22 46 81 139 203 74%% utilisation at busy hour 27% 32% 54% 51% 57% 57%Source: Morgan Stanley Research 10
  11. 11. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsExhibit 10 Exhibit 11Bringing New Spectrum into Use Keeps Capacity Spectrum Is the Key Driver of Capacity GrowthAhead of Demand – Just 100% 400 Total system capacity (Gbps) Spectral efficiency Busy hour use (Gbps) - Base case 80% 300 60% Quantity of spectrum 40% 200 20% 100 Number of base stations 0% Contribution to Capacity Growth 0 2010 2011 2012 2013 2014 2015 Source: Morgan Stanley ResearchSource: Morgan Stanley Research If spectrum is so key, who has enough of it?Spectrum Holdings – Mobile Network Scale is  In Appendix 3 we show spectrum holdings worldwide.Gaining Importance What is immediately apparent from the European table is that the allocation of lower frequency 800MHzOur capacity utilisation model suggests the following about the and 900MHz spectrum is skewed to the top 2-3future of mobile networks: players in each market. 1. Unlike usage, the likely growth of mobile capacity  As shown in Exhibit 12 and Exhibit 13, the price of low can be calculated within a tighter range. The key frequency spectrum in recent auctions is on average variables are the number of base stations; the 11x that of high frequency, owing to its superior efficiency of the spectrum; and the quantity of propagation geographically and into buildings. This spectrum available. includes some cases where the 2.6GHz spectrum was sold for a fixed fee – in Germany where the 2. Spectrum is the major driver of capacity growth, auction was open, the multiple was 32x! based on our knowledge of the likely increase in site numbers or spectral efficiency (Exhibit 11).  Fourth players also tend to have a lower absolute allocation of spectrum. 3. Sectorisation (re-using spectrum more than three times per base station) could form further upside We believe the rising importance of spectrum to mobile – some base stations are sectorised 6x – but this is networks will reinforce the importance of scale in mobile technically complex and expensive to implement. networks, which has been in abeyance since the end of the telco/tech bubble.If spectrum is the key driver of capacity growth, it means thatbase station swap-outs to new multi-frequency base stations Note that currently, virtually all data traffic in Europe is carriedbecome a key step in the modernisation of the network. at 2.1 GHZ, leading to low differentiation between networks.Vodafone has said that it has already swapped out 33% of the Newly licensed 800MHz (generally available 2013 postbase stations in its European network (including Turkey and analogue TV switch-off) and 2.6GHz spectrum will be used inEastern Europe), a figure which is around 20pp higher than a general for LTE. Operators will also be able to re-farm some ofyear ago. their existing 2G spectrum (900MHz and/or 1800MHz) for LTE, leaving a smaller amount for residual 2G voice. In the US, AT&T currently uses both 850MHz and 1900 MHz for 3G, and 700 MHz for LTE. After the transfer of AWS (split spectrum in 1.7GHz / 2.1GHz ranges) licences to TMO-USA, AT&T also has 5 MHz of AWS (1,700/2,100 MHz) spectrum on average in the top 100 markets, on our estimates. 11
  12. 12. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsThe US has some significant non-telco spectrum owners, in WiFi: Never a Substituteparticular DISH’s 2GHz holding, which, while not prime low WiFi is often talked about as a substitute for macro 3G or LTEfrequency “real-estate”, will play a role in easing congestion in (i.e. a replacement for the fastest mobile data networksurban areas. As capacity becomes more constrained, currently available or being introduced). The theory is thatspectrum values should be well supported. most data usage is stationary, and either at home or in theExhibit 12 workplace, where free WiFi service is usually available.European Auction Results 2010-2012€c/MHz/pop 800 MHz 1800 MHz 2600 MHz We do not doubt that WiFi will take significant additional trafficGermany 74.5 2.6 2.3 over the coming years, with most smartphones able to switchFrance 73.3 na 11.1 seamlessly to WiFi where it is available. It is also true that in aItaly 82.3 26.5 6.0 home environment, WiFi is likely to provide a much better userSpain 47.3 na 2.7 experience, with speeds of 6Mbps+ to be expected today inDenmark na na 12.3 most European markets as ADSL2+ and VDSL penetrationSweden 35.6 26.9 11.3 deepens.Netherlands na na 0.1Austria na na 2.5 However, we believe that 3G/LTE will retain premiumBelgium na na 4.6 positioning, for several reasons:Portugal 42.5 3.7 2.8AverageSource: Company Data, Morgan Stanley Research 59.2 14.9 5.6  Ubiquity. 3G/LTE is available when WiFi is not, i.e. in 30-40% of cases when the consumer is not at homeExhibit 13 or work. The argument for WiFi is a little reminiscentAuction Results: Sub 1 GHz Worth 10x 2.6 GHz of the argument against mobile phones in France in 70 the mid-1990s: penetration in France was supposed 60 to remain structurally lower because of the excellent network of payphones. In reality, it is the ability to use 50 the phone even where no payphone or WiFi is €c per MHz per pop 40 available that has the highest value. Indeed, this is a 30 further argument for investing in a quality 3G/LTE network, as it is the full geographical and in-building 20 coverage, and consistently high speeds, that makes 10 this a product worth paying for when compared to a 0 patchy WiFi service. 800 MHz 1800 MHz 2600 MHzSource: Company Data, Morgan Stanley Research  Licensed spectrum. In addition, WiFi usesExhibit 14 unlicensed spectrum, making it harder for the qualitySome Significant US Non-Telco Spectrum Owners of the network to be controlled or expanded. 1700/Frequency 850 1900 2100  Backhaul constraints. Any network is only as good 700 MHz MHz MHz 2 GHz 2.5(top 100 markets) MHz Cellular PCS AWS AWS-4 GHz Total as its backhaul capacity – backhaul is the line takingAT&T¹ 30 25 34 5 0 0 93 data back from the base station to the core network –Verizon 32 25 21 13 0 0 91 and WiFi hotspots with just a DSL backhaul will beT-Mobile¹ 0 0 27 34 0 0 61 particularly constrained at busy periods.Sprint² 0 14 36 0 0 0 50Dish³ 0 0 0 0 40 0 40 DT has given some useful data on consumers’ propensity toSpectrum Co 0 0 0 19 0 0 19 concentrate their usage in a small number of locations –Clearwire 0 0 0 0 0 160 160 something that can lead people to believe WiFi will substituteVZ (pro-forma) 4 32 25 21 52 0 0 130 for cellular coverage. In particular:(1) AT&T and T-Mobile are pro-forma for the 7 MHz AWS transfer(2) Sprint 850 MHz: holds 800 MHz spectrum (SMR or specialised mobile radio)(3) NPRM pending(4) Verizon is pro-forma for Spectrum Co (19 MHz in the AWS band) and Cox Communications  80% of all traffic for the typical use is generated in only(20MHz, AWS)Source: Company Data, Morgan Stanley Research 3 cells. 12
  13. 13. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, Wins  The remaining 20% of traffic is carried over 28 cells. Vodafone Europe gives regular updates on the percent of base stations that are “hot” (>90% utilised) in the busy hour – usuallyHowever, to take this to mean all value is in WiFi is misleading 5-10%. This relatively low number is intended to be taken as afor two reasons, in our view: sign of network resilience and strength, but we believe it holds the key to poor quality user experiences.  Even in the 3 high use cells, WiFi may not be available or the consumer may not turn on the WiFi functionality We believe that networks are seeing an 80/20 rule in usage (e.g. not all workplaces have public WiFi); concentration; in other words, 20% of the base stations are carrying around 80% of the data traffic. DT, for example, has  The 28 cells where 20% of traffic is carried will be said that 20% of 3G cells carry 60% of traffic, and 50% of cells particularly valued by the customer. carry 95% of traffic.Exhibit 15 Seen from this perspective, it becomes clear that if 5-10% ofA Typical User Is “Mobile” for 20% of Their Usage base stations are getting “hot” in the busy hour, it is likely that Number of sites utilised 35 80% of traffic this means that 20-50% of traffic is suffering poor service and 30 100% of traffic delays at the busy hour. 25 20 The solution is splitting macro cell sites (expensive), or 28 sites installing small cell technology (cheaper), or else encouraging 15 account for 20% of usage; WiFi offloading. 10 3 sites for 80% 5 4 2 3 3 3 2 2 2 1 1 1 What is concerning is that these “hot” sites today tend to be 1 0 found in the major metros, where the greatest proportion of B B B B B B B B B B B B M M 0M M 0M 0M G tech-savvy early adopters are to be found. Over time, 1G 2G 5G 0G 0G 10 <1 10 00 0- 1- 2- -2 >2 -5 20 50 5- 1- -1 50 10 10 0- 0- 50 however, we would expect the utilisation of data services to 10 20Source: Deutsche Telekom spread into secondary metros, and at this point the number ofAs an example of an operator building WiFi offload capability, “problem” sites could start to become a significantly biggerAT&T has 30,000 AT&T WiFi Hot Spots, up 60% from 2008. network management and capex issue.Usage of the AT&T WiFi network was up nearly 3x in 2011 Exhibit 16versus 2010. AT&T WiFi Services offers indoor coverage Networks Exhibit Strong Skew to the Top 20% ofsolutions in particular to large venues and enterprises in order Base Stations 100to supplement the macro network. However AT&T has said % of Trafficthat its 30,000 hotspots account for only 1% of all mobile traffic 80it carries. 60“Whole Network” Statistics Don’t Reveal HowQuality Is Already Suffering During Busy Periods 40Given that the statistics on network usage suggest there is 20ample spare capacity, even in the case of AT&T, whataccounts for the poor user experience of data in so many 0 0 10 20 30 40 50 60 70 80 90 100countries and networks? Base stations Source: Morgan Stanley ResearchWe believe the answer lies in the concentration of data usagein key metros and at key hours of the day. 13
  14. 14. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsAT&T Faces Greater Network Strain than European This is a significantly greater strain on the network than in ourOperators Due to Fast Adoption of iPhone European model, particularly when the impact is considered on very dense metropolises, such as New York City in the busyOur usage and capacity models can be flexed to understand hour, combined with in general more expensive backhaul in thebetter the specific strains facing operators in other markets, US than in Europe, owing to the lack of unbundling regulation.which also helps to put Europe in context. In particular, AT&Thas had well-publicised network difficulties following the fast We could summarise the reasons for AT&T’s greater difficultiesadoption of the iPhone, which was exclusively available on its as:network for three years – in contrast to Europe, which currentlyhas fewer high-usage mobile devices and more base stations  20% more smartphones on a “per pop” basis thanthan the US. We expect usage in Europe to pick up, creating Vodafone Europe;some of the same issues as in the US but with a time lag.  2-4x the usage per smartphone, owing to theIn Exhibit 17, we set out a model for AT&T, based on 100m prevalence of the high usage iPhone within the mix;subscribers, of whom 40 million are smartphones utilising600MB per month, compared to ~200MB for Vodafone Europe.  30% fewer base stations on a per pop basis than European operators – see Exhibit 20;Our model suggests higher capacity utilisation for AT&T.We estimate just over 55,000 base stations, with three carriers  A more expensive backhaul 2010 rising to five now, and ultimately to eight carriersincluding LTE. The resulting capacity utilisation at the busyhour is 56% in 2011, rising to 78% in 2012, even though morecarriers are lit than in the European example inExhibit 9.Exhibit 17Usage Growth Model – Large US Operator 2010 2011 2012 2013 2014 2015 CAGR 11-15Customers (mm):Smartphone handsets 30.0 40.0 55.0 65.0 70.0 72.0 16%Non smartphone handsets 70.0 60.0 45.0 35.0 30.0 28.0 -17%Dongles / tablets (mobile connected) 1.1 4.0 4.8 5.8 6.9 8.3 20%Total 101.1 104.0 104.8 105.8 106.9 108.3 1%Smartphone penetration of handset base 30% 40% 55% 65% 70% 72%Usage per customer per month (GB):Smartphone handsets 0.3 0.6 0.8 1.0 1.5 2.0 35%Non smartphone handsets 0.0 0.0 0.0 0.0 0.0 0.0 5%Dongles / tablets 1.6 1.5 1.8 2.7 3.2 3.5 24%Annual total usage (GB mm):Smartphone handsets 90 252 456 720 1,215 1,704 61%Non smartphone handsets 5 4 3 3 2 2 -14%Dongles / tablets 21 46 95 171 243 319 62%Total 115 302 555 894 1,461 2,026 61%% growth total 97% 162% 84% 61% 63% 39%% growth smartphone handsets usage 170% 180% 81% 58% 69% 40%% growth non smartphone handsets usage -9% -12% -15% -20% -15% -6%% growth total handsets usage 146% 171% 79% 57% 68% 40%% growth dongles/tablets usage 3% 123% 107% 80% 42% 31%% of usage on dongles/tablets and non-smartphones 22% 17% 18% 19% 17% 16%Source: Morgan Stanley Research 14
  15. 15. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, WinsExhibit 18Capacity Utilisation Model – Large US Operator 2010 2011 2012 2013 2014 2015 CAGR 11-15Number of sites 50,000 55,000 57,750 60,638 63,669 66,853Number of sectors 3.0 3.0 3.0 3.0 3.0 3.0Number of 5 MHz carriers 3.0 4.0 5.0 6.0 8.0 8.0Mbps per carrier per sector 3.0 3.0 3.0 3.3 3.6 4.0Total system capacity (Gbps) 1,350 1,980 2,599 3,602 5,501 6,418 34%Total system capacity at 20% efficiency (Gbps)(Gbps) 270 396 520 720 1,100 1,284Percent of daily use in the busy hour 12.0% 12.0% 12.0% 12.0% 12.0% 12.0%Total busy hour use (Gbps) 84 221 405 653 1,067 1,480 61%% utilisation at busy hour 31% 56% 78% 91% 97% 115%Note: Capacity utilisation >100% is shown only as a mathematical output, not a real world possibility.Source: Morgan Stanley ResearchExhibit 19 Exhibit 20Europe Has Been Spending 15-40% Less Than US Cell Site Numbers Do Not Explain Higher US Capex(€ m) Average 2007-2011 % discount 000s Number of base stations Per 60m popCountry level AT&T 57 11USA ($ m) 19,834 VZW 43 8per 60 m pop (€ m) 3,071 S 67 13 TMO 50 10Germany per 60 m pop 1,955 -36% Others 33 6Italy 2,356 -23% Total 250 48France 1,866 -39%UK 2,631 -14% UK average per operator 15 Source: Ofcom and CTIA for UK and US totals; company data for TMO-USA, Morgan StanleyOperator level ResearchVerizon Wireless ($ m) 7,515AT&T Wireless ($ m) 6,856 The additional capital investment is unlikely to be entirelyVZW per 60 m pop (€ m) 1,164 explained by higher investment in network quality. Indeed, theAT&T per 60 m pop (€ m) 1,062 number of cell sites does not explain higher US capex (ExhibitAverage 1,113 20). Other factors are also important, such as the weight of Chinese competition (significantly greater in Europe) andVodafone Germany (inc fixed) per 60 m 665 -40% population density (US is a third the population density of theTelefonica Spain 609 -45% EU at 34 people/km², and even states like Illinois or CaliforniaWind Italy (inc fixed) 901 -19%Note: European country data is estimated. Telefonica Spain data is estimated for recent have a population density similar only to Spain).periods as disclosure now includes fixed capex.Source: Company Data, Morgan Stanley Research Nonetheless, the differential is very large, and indicative of aHigher capacity utilisation plays a role in higher US capex. different approach to developing networks and network qualityEuropean capex has been 15-40% below the US level in reputations, and enabling customer demand.absolute terms since 2007. European capex disclosure is notas uniform as in the US – operators often disclose a single A word on opFCF margins: similar, but with very differentfigure across fixed and mobile businesses, and some smaller ratings. There are two important differences in revenueoperators do not give consistent disclosure as they are not structure between the US and Europe: in Europe, revenues arelisted. In Exhibit 19 we show estimated country level average inflated by Mobile Termination Rates, which for the most partcapex and compare it to the US figure on a “per 60m pop” basis cancel out in costs but raise the overall ARPU, while they are– i.e. scaled to the size of a large European country, such as deflated by the strong presence of prepaid plans, which reducethe UK, France or Italy – as this is more informative, in our ARPU as there is no repayment for the handset subsidyview, than a “per capita” figure. We also show selected included.examples of European operator disclosure for operators in keymarkets such as Germany, Spain and Italy. Nonetheless, it is worth noting that opFCF margins for the US industry were 21% in 2011, with Verizon Wireless at 30% and AT&T at 21%. Vodafone Europe recorded an opFCF margin of 21% in FY12 (22% ex Turkey). We conclude therefore that the 15
  16. 16. MORGAN STANLEY RESEARCHJune 13, 2012Mobile Data Wave: Who Dares to Invest, Winshigher absolute capex is accompanied (whether causally or while the European telco sector as a whole trades at 4.8x. Wenot) by better profitability in the US. Importantly, although the estimate that Vodafone Europe trades at under 4.0x if weopFCF margin is not dissimilar, the perceived sustainability of assign a higher trading multiple to its stake in Verizon Wireless.that margin is significantly greater, as seen in the widerdifference in trading multiples: AT&T and Verizon (including AT&T is covered by Simon Flannerytheir respective fixed line arms) trade at 6.3x 2012e EBITDA, 16