Telco 2.0 apac arete

Taming the Tech Hydra?

Richard Kramer, Managing Partner
richard.kramer@arete.net

Richard Kramer November 2011 - 1

About Arete
Left in disgust at ethics of investment bank world after four yrs.
as #1 ranked Tech analyst,
Founded Arete in early 2000 on three principles:
No conflicts of interest
Integrity No money from
companies
Exclusivity
Excellence
Select list of investors
trust us to help them All analysts w/ tech industry +
und. investment ideas financial market experience
No First Call, quotes, etc. 200+ company visits/month
Frequent presentations to companies’ strategy teams…
Since inception: profitable, low staff turnover;
Looking at global trends with total freedom to tell the truth.
Unlike banks/industry analysts, we are entrepreneurs.

Tech vs. Rationality
Huge disparities in regional Tech’s premium over telco is not
importance, valuations of TMT rational: ROIC not above other
Investors dangerously susceptible to sectors, more prone to losses
hype in tech, far less so in telco There is little Net Cash
AAPL $372bn 12x logic to tech
GOOG $192bn 16x SSUNG $118bn 12x hardware vs. AAPL $82bn
YHOO $19bn 19x RIM $8bn 4x
EBAY $42bn 16x HTC $12bn 8x software v. MSFT $45bn
NOK $25bn 18x telcos
AMZN $98bn 173x CSCO $28bn
IBM $220bn 14x valuations,
WALM $198bn 13x HPQ $54bn 6x most cos. are
BAIDU $39bn 48x TSMC $64bn 14x QCOM $17bn
already
TCNT $43bn 26x INTC $125bn 10x
ORCL $164bn 14xQCOM $95bn 16x hybrids INTC $8bn
MSFT $221bn 10x CSCO $97bn 11x
JNPR $13bn 19x GOOG $38bn
VMW $42bn 47x
ERIC $35bn 12x
AMZN $6bn
NLFX $5bn 21x
TWC $20bn 14x Current M&A spree will aim to create illusion
CCST $62bn 15x of growth, paper over failing strategies
Key lessons of past 15+ yrs.: Tech cos. cannot grow while restructuring
Telcos should not diversify just to show growth, are seen as utilities

Devices: Demolition Derby,
Fight Club…Now Purgatory?
9M11 Sales/profits for vendors Largest end market in CE:
9M11 Sales Profit $230bn+ in mobile devices

APPL $36.6bn $14.2bn $150bn+ in smartphones
SSUNG $33.7bn $5.2bn
HTC sold 35m smartphone in 9M11
NOK $22.9bn $0.8bn
= more than LGE (14m), Motorola
HTC $12.5bn $1.9bn
(13m), and SonyEricsson (9m);
RIM $11.3bn $800m
LGE $8.2bn Loss
HTC = 15% margins vs. losses at all
the Android vendors (ex Samsung)
MOT $7.0bn Loss
Clear message from Android to
SEMC $5.2bn B/E
OEMs: Profit is your problem!
Huge differentiation New entrants PC model of std. HW
problem for Mobile have 15% gross + platform SW
Device vendors margin template coming to handsets:
Samsung 4Q11 Android volumes (~25m+) more than
Nokia (<2M WP7), LG (<5m), SonyEric. (<5m) and Motorola (<6m).


Standing On Its Head
Getting to 1bn Smartphones
“Segmentation” By value, high-end 50%+ of total –
Apple iPhone = $60bn, Samsung
Forget it! Consumers see $25bn, HTC $16bn
higher marginal
utility in device…

Smartphones Sustaining
Industry ASPs vs. Mix Squeezing mid-range featurephones
350 15%
Getting to an $80 BoM
300 10%
Smartphone?
250
5%
0%
(US$)
Commodity Tech
Specifications
Emerging
Details
Value
'10
Value
'11
Value
'12

Markets
Touchscreen Display Size [inch] 2.8
200 Resolution [pixels] 240x320 15.7 9.1 7.3

-5% Touch Module
Price per inch squared [$]
Price per inch squared [$]
2
1 7.8 5.9 4.4
150 NAND Amount [GB]
Price per GB [$]
1
1.5
1.5 1.2 1.0
-10% DRAM Amount [GB] 0.25
3.8 3.0 2.4
Price per GB [$] 15
100 -15%
Other
Total
Chassis, etc. 3.0
31.8
2.7
21.9
2.4
17.5
Semiconductors

~58% of
Connectivity Bluetooth, GPS, WiFi 3.5 2.8 2.2
50 -20% Baseband Quad Band, HSPA
17.0 14.0 11.0

ASPs actually rising -25%
Application Processor Integrated ARM11 AP/Baseband
MEMs Compass, Mic, etc. 4.3 3.6 3.1

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

smartphone
Other 4.0 3.6 3.2
Total 31.4 26.3 21.5
'1 1 E
'1 2 E
'1 3 E
'1 4 E
'1 5 E

Hardware
'9 6
'9 7
'9 8
'9 9

'0 1

'0 4

'0 7

'1 0
'0 0

'0 2
'0 3

'0 5
'0 6

'0 8
'0 9
'9 5

Board Number of PCB Layers 4 3.5 3.0 2.5
Components Other Components (Filters, Bus, Conn.) 10.0 8.5 7.2

Low-end will embrace $100 smartphones
YoY ASP Variation (RHS) ASP in US$ (LHS)
Camera module

Li-Ion Battery units in ‘13
Resolution [MP]
Front facing Camera
Capacity [mAh]
Charger, box, literature
Price [$]
3.2
No
1100
3.5
3.0
4.0
2.8
2.6
3.4
2.3
2.3
2.9
Total 24.0 20.3 17.2
Total component cost 87.1 68.4 56.3
Assembly cost Cost [$] 5.0 4.3 3.6
Total construction cost 92.1 72.7 59.9

Too much focus Consumers Royalties (% of ASP)
Total Direct Cost
Shipping/distribution
Provision
Qualcomm, Nokia, Dolby

Cost [$]
Warranty [% of ASP]
7%

2%
9.1
101.2
10.0
2.6
7.2
79.9
9.5
2.1
6.0
65.9
9.0
1.7
Total gross costs (ex D&A) per phone 113.8 91.4 76.6

on US/EU now; will demand Gross margin Implied (%)
ASP [$]
12%
130.0
11%
103.0
10%
85.0

BoM cost <$100,
EMs grow to ‘15 local brands
going to $80, $60

Example from Tele2 Sweden

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

Would also be bad
for operators!
Smartphone now half
of market, and rising…

Low-end creeping
into the mix

Key questions we put to low-end smartphone vendors:
How to make money? We don’t think ZTE/HW do!
How to differentiate longer-term for any premium? Mobile devices
Industry-wide fear over device vendors losing scope are NOT
for differentiation…being told they are commoditizing! commodities!

Hooked on Tablets
Tablet Forecast
Apple’s low iPad gross margins are
July ’10 = ~53m in 2011… #1 issue for Android OEMs.
Jan. ’11 = ~55m, more iPad Who can match Apple’s tech specs
UX not from PCs, but smartphones: SSD, AND ecosystem AND retail channel?
touch, 3G, all-day battery, cloud storage
40% of BoM = display and touch,
Media consumption device, not AP or modem! $200 by mid-’12
like TV or game consoles; further India = 54 languages, 8 major ones
pressures PCs until Win8 comes 200m+ tablets in next 5 yrs.
Puts virtual shop
window in
consumer’s
= hands 24/7.
OS = means to an end,
Apps a.k.a. Content Tablets will be the low
cost computing platform
Kindle Fire: $180 BoM cost? in emerging markets.
No 3G. Subsidy to Prime users No need to subsidise (netbooks failed)
($80/yr.)

Apple: Secrets of the Temple
Vulnerabilities?
$81bn cash
+80% growth Rivals narrowing gaps
iOS notebooks TVs, next….
Vs.
iTunes’ 220m+ billing accounts
makes Apple a Top 15 telco w/
wealthier customers
A4/A5 processor = superior Lagging on displays
cost structure Now
Complete SoC strategy – recognising
risks on Relies on operator SAC
they own chipset platform
IPR…
Scale = could be 400m Less suited for EMs
APs sold in 2015
Table 2: Apple 's Gross Profit Boost From NAND Flash
Apple avoids Apple Price Cost/GB Extra Memory Add'l Margin
makes up to a third
paying Margin on Assumed/ Gross

chipmaker of its operating profit by per Unit
Cost Extra Memory Increm. GP Profit/Unit

gross margin, marking
iPod Touch 8GB
iPod Touch 32GB
$199 up $1.0
$249
NAND flash - $26
$1.0 $24
$30 profit x
52 %
2 0%
2 6%
$40
$66
and higher $100 for 16GB
iPod Touch 64GB $349 $1.0 $32 $68 11m units =
68 % 3 8% $134
foundry GMs iPhone 3GS 8GB $499 $1.0
$300m!3 8% $190
iPhone4 16GB $599 $1.0 $8 $92 92 % 4 3% $257
iPhone4 32GB $699 $1.0 $16 $84 84 % 4 9% $341
Source: Arete Research esti mates, Company accounts.


Samsung and HTC: Brute Force
40.0 18%
Samsung sold c. 29m smartphones in 35.0 Smartphone 16%

30.0 Margins 14%
3Q11, up 40% seq., now #1 by volume 25.0
12%
10%
20.0
Koreans obsessed with league tables, 15.0
8%
6%
share ; ‘12 aim to pass Nokia as #1 player 10.0 4%
5.0 2%

Tablets lack content/cloud services 0.0
1Q11 2Q10 3Q10 4Q10 1Q11 2Q11 3Q11 4Q11E
0%

'09 '10 '11E
Table 2: SG&A by Vendor, '09-'11E ($bn) Industry’s biggest marketing budget
Apple $1.4bn $1.7bn $3.5bn

Samsung $4.1bn $5.0bn $6.4bn
Fight Apple on
Nokia $3.9bn $3.6bn $3.5bn
Samsung’s home turf….
LGE $2.1bn $2.4bn $2.3bn
Samsung Telecom unit$1.8bn a
RIM $1.2bn $1.4bn is distribution
channel for memory, display, logic semis;
HTC $0.4bn $0.9bn $1.7bn

Sony Ericsson $1.5bn $1.2bn $1.2bn
Profits from leverage $1.5bn commodity dominance
Motorola $1.1bn $1.3bn
of
Source: Arete Research estimates. Taiwanese
Only other (ex-ODM)
profitable Android
doing $500m
OEM; $16bn+ of M&A in US/EU
sales, up from
<$5bn in ’09!

Nokia and RIM: Troubled Twins
Key Issue: execution Blind Man’s Bluff, Feb. ‘11

RIM: Doors of
Sharp Turn for
Perception,
June ‘11 the Titanic,
May ‘10
RIM: Lost in Hold Your Horses, Nov. ‘11
Transition,
Sept. ‘11
Nokia and RIM both still profitable, w/ resources, and
desperate … but v. hard to reverse market perception
and make up for lack of Internet innovation.

Leap Leap Leap
#1 #2 #3
(YE’11) (1H12) (YE12)

Make current Address lower- Aim for parity, or
portfolio & initial tier WP7 leapfrog next iterations
WP7 competitive; segment w/ of Android, iPhone5;
parity unrealistic Apollo release; “ nique experience?
u ”


Vampire Squids?
Quasi-monopoly share in search,
brings regulatory risk (AdMob) Beyond IPR,
Challenged to monetise Android, … “boys w/ toys?”
CEO “just don’t =
50 cos. since ’10, 18 already in ’11 lose money”
Home = GoogleTV

Mult. failures: Gears, Wave, Chrome, TV+ internal conflicts
Yet to develop a systematic cross-platform “Google” UX

Looks inevitable FaceBook will
expand more into ads,
connectivity, own “brand” apps
Expect more devices – FB’s
10m UK users/day + 4m/week #1 priority is mobile

Building Global Brains…

Vertical model?
= Or external reach
of search?

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

Does any of this link
= up or resonate with
consumers?
Internet brands will create significant
niche device categories; Kindle Fire just
the start, very culture-specific…
You can see 4-5 clear product + services ecosystems
forming up; each one trying to absorb data on connected
consumer behaviour

Telcos in 2011:
Stop Bullying the Fat Kid
Figure 3: Weighted Average European
Mobile Revenue Growth
14%
12%
10%
8%
6%
4%
20%+ Non-SMS Data Growth
2%
0%
-2%
-4%
-6%
Mobile Data Growth in
4Q09

1Q10

2Q10

Vanguard Markets
2Q09

3Q09

3Q10

4Q10

1Q11
Service Revenue Data (Inc. Messaging) Revenue
APRU Uplift from S’phone
Source: Arete Research.
Telcos must get data pricing, activation, VODA now 40% declining
provisioning, right: its boring, but essential. voice revenues, 60%
US Phone Bill Analysis of Data
US Mobile Service growing data and
Revenue Growth
25%
20%
emerging markets
15%

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

Now Smartphones = profit from mobile data (unlike 0%
-5%

dongles); marginal pricing re-set; EU penetration still <30%
-10%

Cincinnati
TMO US

nTelos
Sprint
Metro

AT&T
Leap

VZW

Bell
Investors sceptical about RoIs at telcos
4Q10 1Q11
Clear action vs. bandwidth
hogs, rebalancing pricing
BUT encouraged by data growth, telcos
Source: Arete Research.

stable performance after 3 bad yrs.

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

Challenge from Web players goes beyond “hot”
names like FB, Google, Apple, AMZN… but best
thing since sliced bread in driving traffic..
Or would you prefer MMS and mobisodes?

Back to School: The 3 R’s

Re-Price Mobile data is 90% of network
KPN’s 1Q profit warning - traffic/cost but only 10% of
cannibalisation of high revenue. All operators know where
margin SMS by IP messaging industry is headed…more data
on free data plans
usage, until voice becomes an app
Gone from 0% to Nasty transition in
88% in 8mos data/SMS usage
Unintentional slip?

Re-Org (Again!) Customer innovation has to mean
letting your customers innovate!
Digital divisions aside, NOT specialised customer care…
we still see 2-sided
business models as
mostly fantasy
Google 31K staffn(!) FB 2,000…
Re-Duce Costs FT = 100,000!


Two Definitions of LTE
LTE: Late, Tempting, We said in ’09 LTE faces (sensible) delays; better
right than early – 2.5 years later, the first 100s of
Elusive Jun. '09
1000s of customers are now appearing

LTE Outside US & Japan, LTE best
LaTE! remains a niche, still several yrs. off,
marred foremost by inconsistent
The laTEr
spectrum, rel. few devices
the better!
Business Model Testing Optimisation
Still attractive capacity additions
via HSPA+ to 42Mbps…. Less Transforming than Expected
Lot to do w/ 2G infra. (M2M)

Nokia Ultra-Site LTE/4G not going to change usage per se..
2G+ 3G started Initially adds costs to devices, power issues, etc.; will
the ball rolling… bring another hype cycle from vendors
Will help improve UX … but only eventually!
This is not RoI on LTE per se, but RoI on unstoppable
data demand in a (and artificially) supply-constrained
industry – and inevitablity of moving to single RAN

Mobile Ads, Mobile Money
Who makes money? PoS?
Use
case?
Issuer Visa, MC Acquirer Merchant
Bank InterLink Bank Has to Pay
<2% <1% <1% Some…

Operators want NFC to be SIM based to manage authentication, security
Credit card companies do not want SIM and say telcos can’t manage risk.

Then mobile advertising Behaviour
Regulatory
change?
issues

Not yet clear who monetises mobile
advertising, under which model:
‘06
‘12
‘08
‘10 ‘07
‘13
‘09
‘11 ‘08
‘14
‘10
‘12 ‘09
‘15
‘11
‘13 ‘10
‘16
‘12
‘14 Telcos? ISPs? Web Brands?
Trad. agencies going digital?
Mobile Ad Forecasts

Please, Get Me Excited!

Price!

Device!

Are T-Mobile or Verizon doing something really different? Still the same
old confusing tariff packages, offering same devices as competition2011 - 18
Richard Kramer November

Get Me Excited, Part II!

Price! Device!

Can Vodafone or Tele2 be like Apple – premium brand, connect consumers
to platform, content, retail, billing? Then show me what I can do!

Maybe T-Mobile Slovakia is on
to Something Here?

At least I know T-Mobile is about chicks (and guys) at the beach, pool,
Still no “use case” “demos” or “new services”!

How About Asian Operators?

Lots of promising end
markets for multi-
SIM offerings


Some Other Approaches?
What can any telco offer that
Lots of clutter…
its competitors won’t or can’t?
and one device!
A few hit apps branded by operator
that work on any platform: based on
customer insight - location,
contacts, usage, etc. Like Google, start
with Search….

Weiβer Spargel, Surstromming, Chili Crab?

What’s unique Create “radical
customer chic” buzz around
experience on high-end tech:
Build communities! TelcoNext?
any operator?

OK, How’s ‘Bout Some Forecasts?
A Billion Smartphone in By 2013, every smartphone
2013, dominated by co-branded with Internet
emerging markets brand based on likely usage…
“Best for…” Twitter, Facebook,
WeiBo, Yandex, LinkedIn, ESPN, etc.
By the time industry gets
“third platform” scaling up,
native apps will be in decline
Tablets to follow…

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

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

Tech hardware in Google, Apple, Facebook, Amazon
period of “scorched (+ Microsoft?) are tech’s Hydras;
earth” competition; but as they get cut off or fail in one segment,
risk of perception like PC. they acquire or grow back in two others; next
incanation as services providers….

Q&A

Richard Kramer, Managing Partner
richard.kramer@arete.net


Telco 2.0 apac arete

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