Global Weekly Reviews

Getting bullish on Asian 5G – Global Weekly Review

This week we published on our evolving and more upbeat thesis on Asian consumer 5G (HERE), having visited the telcos in China (see HERE for feedback), Korea (HERE) and Japan (HERE) as well as Huawei (HERE).

Despite downbeat expectations we now see the potential for 5G to drive meaningful revenue growth improvements in those countries in Asia that are able to monetise as they have the capacity in place. The 5G handset price premium is dropping rapidly suggesting limited barriers to uptake. Operators are expected to see a  c. 20% 5G ARPU uplift in the region, and we think the core use cases (including interactive TV and cloud gaming) could lead to a step up in high end data volumes from c. 20GB/month to potentially 50-100GB/month or even higher.

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Hop, skip, jump….the triple jump to value creation

It’s the World Athletics Championships at the moment so a few shameless athletics metaphors. Watching the telecoms sector in Europe over the past 20 years has been similar to watching the flight of the javelin….soaring returns from 1998-2008, followed by a steady crash back to earth in the following 10 years from 2008-2018. However, with the sector now trying to haul itself out of the proverbial sandpit, we see three easy steps for the sector to start to regain its past glories and head to the top step on the medal podium. We wrote an updated view on our optimism on the European telecoms sector this week (see HERE), and see three easy steps for the sector to offer really attractive returns for investors and be positioned to outperform.

Read on to follow our European triple jump to gold.

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Learnings from the first large scale 5G deployments in Asia

We hosted a client tour visiting all the telcos in the early 5G markets in Asia: Japan (feedback HERE), South Korea (HERE) and China (HERE), and finished the trip with a day at Hauwei’s HQ in Shenzhen (HERE). Our key takeaway is that we may have been too cautious on the likely revenue impact 5G & IoT is set to have on revenues in these markets. Thus our view shifts from seeing 5G as largely neutral to revenue and overall a negative because of the impact on capex, to potentially a meaningful positive driver of shareholder returns through higher growth. Running the math on this and it seems plausible for the winning companies in these markets (which we would see as Softbank, LG U+, China Telecom) to see mobile service revenue growth head towards high single digit, or even low double digit as the 5G wave impacts their business models, with potentially significant impacts on equity valuations.  However, we would hesitate to read across from what is happening in these markets to a more positive view on 5G globally especially in markets which don’t have the site density and capacity to satisfy very high levels of traffic as high end packages shift from 20-30GB/month to 100-200GB/month (and to ‘properly unlimited’ services).

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What to buy and sell if it all falls apart

We were worried about a recession at the beginning of the year, and published a report quantifying the exposure of our companies in the event of a recession.  It was all for naught.  The economy soldiered on, despite worries and warning signs.  Well, we are still worried, and so we updated our recession exposure framework for the US and republished it this weekend (see report HERE).  We summarize our findings on exposure in the US in this edition of the Global Weekly review.  We also gathered thoughts from the team on what to buy and sell in Europe, Asia and Latin America.  We are sorry to ruin your Sunday with gloomy thoughts, but we thought you should at least have our list of what to avoid if it all goes “pete-tong”, and our list of what to buy at the bottom.

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Cable’s wireless ambitions…one step closer

We have been arguing for a couple of years that investors have the 5G threat backwards.  The opportunity for wireless carriers in the fixed broadband market is small and the threat to Cable often exaggerated.  However, the opportunity for Cable companies entering wireless is much greater, and it is largely ignored by investors as an opportunity for Cable or as a threat to the Wireless carriers (we touched on it in our tome on Cable’s wireless economics HERE (now a little dated), and in a past global weekly review HERE, and Blair has commented on it HERE).

We have focused on this theme less in the last year because wireless subscriber growth had been slower than we expected for Cable, and the thesis wasn’t likely to get much traction until they picked up the pace.  We even pulled the value of the wireless opportunity out of our price targets for Comcast (worth $5) and Charter (worth $98).  We had never included it in our valuation for Altice because they hadn’t announced a strategy when we were focused on the issue, but a successful Wireless MVNO would be worth at least $3 for them (we have a detailed wireless model for each of them; let us know if you need them).

We noticed something in the new iPhone that renewed our excitement.  It could pave the way for Cable to move beyond the MVNO, with a much better wireless product, and much better wireless economics.

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Quick thoughts on Elliott’s plan for AT&T

Like Elliott, we see an opportunity to unlock value in AT&T’s wireless business.  We highlighted early signs that this business may already be improving in our recent Wireless trends report (LINK).  If AT&T can capitalize on their asset advantage in wireless, they ought to be able to recapture much of the share they have lost over the last few years.  We see two challenges to Elliott’s plan.  The first, is getting AT&T’s management team and board to shift its course.  The second, is that outside of wireless the problems are more structural.  It is not clear that these can be easily fixed with better management.  Nevertheless, we see opportunities for value creation here too.

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Four Things You Missed Over the Summer

This week’s review focused on a few important reports that we are worried you may have missed (mostly published during the late-summer doldrums).  We highlight the three or four reports that we have written for each region that touch upon the biggest controversies that will impact our sector in the months ahead.  The list includes riveting accounts of the coming disruption in US wireless, the drivers of falling churn in US broadband, a new focus on infrastructure assets in Europe, and failing firms, new entrants and the impact of 5G in Asia.

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What does Rakuten’s launch delay mean for Japanese mobile?

Perhaps the worst kept secret in global telcos in recent months has been that Rakuten was planning to delay commercial launch. Now that the Japanese challenger has opened up to the problems it is facing building out its network we addressed the likely implications for the incumbents. The note we published (HERE) also set out our overall thinking on the market, explaining how we & why we think the analogy with how new entrants trashed cash flows in other markets is a poor one.

On the face of it our position seems hard to justify: we are both constructive on Rakuten and on the incumbents Rakuten is set on disrupting. This reflects our view that Rakuten will gain customers (and therefore create value for itself), but that the incumbents will be able to off-set this pressure through their own actions.

For Rakuten the logic behind our case is simple: the company is investing c. $5bn to enter a market with an EV of c. $250bn. As long as the technology works (which it does) and the company can hit modest subscriber targets, it ought to be able to at least recoup its investment. Yet trading 40% below its level prior to the announcement of mobile entry, the share price is still discounting that the venture will destroy substantial value. Since we think this is unlikely we are positive on the stock.

The situation for the incumbents is less simple, as here we see two conflicting trends: on the one hand revenues are set to come under pressure, as a result of Rakuten’s entry. Offsetting this though we see a number of levers available to the incumbents to maintain cash flow and returns. Ultimately therefore the likely share price outcome depends on the extent to which revenue pressure can be offset through these levers.

Bears believe that revenue pressure will be intense, and quickly overwhelm the ability of the incumbents to offset. But we think this ignores the fact that the Japanese telco market is a good one to defend. Churn is low (well below 1% per month). Price sensitivity is low (HERE). Network quality is high and consumers rate network quality as important (HERE). There is no sharing so as Rakuten is experiencing (HERE) the challenge for a new entrant is more severe than elsewhere. Regulatory support for the new entrant is questionable which explains why the roaming deal is relatively unattractive. Furthermore, Rakuten is likely to target only customers within its own coverage area which is c. 11% of Japanese pops initially. All these things suggest to us that Rakuten’s impact on incumbent revenues will be relatively modest, reducing growth by 2-3% per year we think.

Just as importantly though we note a number of levers that the incumbents have to offset this pressure:

1. Capex cuts (HERE)
2. Opex cuts
3. Reduced handset subsidies (HERE)
4. Share buybacks
5. M&A (HERE)
7. Payout ratio increases

As a result, we are confident that cash flow will not get squeezed in the medium term and that the companies can continue to grow shareholder remuneration. Returns are high, which suggests the Japanese should trade on a widening premium to the rest of the world. On this basis, we remain constructive.

Furthermore, if one considers the incumbents ability to weather a storm you also understand why we are less concerned about Softbank vs the other incumbents. SB has some discrete advantages, such as lower exposure to Rakuten’s customer base (HERE) and fewer MVNO customers, but ultimately weathering the storm is going to be as much about flexibility as anything else. SB we think has a greater ability to flex its business model, as we are already seeing for instance in the YJ acquisition. As a result, we are constructive on all the Japanese mobile operators, but see Softbank as a particularly poor short. KDDI remains our top pick.

European Towers: Is it too good to be true?

European tower stocks have undoubtedly been the global telecom companies to own this year with Cellnex up 70% YTD and Inwit up 58%. Asset scarcity, falling bond yields, increasing M&A optionality and favourable accounting changes have all helped. The trend is your friend isn’t it? The upwards momentum should continue? We are now only selectively convinced. This week we did a deep dive review on the European tower names (see HERE), and came away with the conclusion that there should still be more momentum in Inwit, but that Cellnex’s giddy rise is harder to justify. Other names like Vodafone or Orange also look like alternative ways to play this theme.

The tower model is a simple one. Rent space from landlord. Build tower. Get anchor tenant. Add incremental tenants at high margin. Increase contract value each year. Job done. An arbitrage on owning the infrastructure. While the tower model is indeed extremely attractive, there is a price for everything, even as bond yields fall, and there are arguably a few warning signs on the horizon, that we think aren’t necessarily being fully factored in, especially when a company such as Cellnex is trading on a multiple as high as 25x EBITDA.

Longer-term growth for the tower companies will be driven by tenancy growth, but MNOs are desperately keen to save money themselves and finally realising that tower location sites aren’t necessarily the differentiator they once were. Hence the existing MNOs are looking to consolidate their existing tenancy locations to save on ground rent and tenancy costs. Vodafone is leading the charge on this through pooling resources with Orange in Spain and Telecom Italia in Italy. For Cellnex, they stand to lose tenancies in both markets, and Wind’s tie-up with Fastweb curtails what could have been future demand in Italy. Although political pressure will still remain to build out in rural areas, we believe the MNOs are likely to use new spectrum bands above 3GHz and small cells as the most likely routes to increase capacity, rather than continued macro-site buildout.

Lower bond yields have arguably the biggest support for these stocks, but that isn’t a one-way bet in Europe as tower contracts are almost all linked to inflation which means that real growth for these companies is actually little changed.

The big unknown that could support the tower thesis is continued consolidation and newsflow around M&A as the European tower market remains very fragmented. So far, this has been seen as a sure-fire way for tower companies to create value, as TowerCos have been able to arbitrage rising multiples, but sellers are increasingly likely to demand a higher multiple, as we saw with Vodafone’s disposal at 24x EBITDA in Italy. Increasing scale in the tower market raises the spectre of potential future regulation, and the proposed Inwit-Vodafone transaction will be an interesting test case. This could well force the tower companies to open up to more third party tenancies as an extra source of growth, but it could also lead to greater regulatory intrusion if TowerCo gains too much scale. The EC to date has generally been supportive of network sharing, but the recent Czech ruling shows that it won’t tolerate practices that ultimately curtail consumer choice. Just offering space to independent third parties might not be enough in the longer-term. Just ask the electricity grids – monopolies of infrastructure can ultimately lead to RAB-based pricing.

Cellnex is likely to be the leading consolidator in Europe, and if we were investment bankers, we would be encouraging them to issue as much equity as possible at these elevated levels to build a warchest for future deals, especially as the market is willing to award them such a low cost of equity right now.

For Cellnex specifically, we also believe the stock has been supported by the move to IFRS16, as we address this in more detail in our recent note. It remains the only developed market tower company to report EBITDA excluding leases and we do not believe this optical shift, but with no change to underlying cashflow, has yet been fully understood in by the market. We find most people tell us they think Cellnex is trading closer to 18x EBITDA, rather than our calculation of 25x – a sizeable difference. Inwit though which includes leases in guidance EBITDA looks more appealing to us at 20x EBITDA with higher tenancy growth. More details on our Inwit thesis are HERE.

Looking across the rest of the Europe, we believe Vodafone could also offer an attractive way to play the tower theme (see HERE for more details on this idea), and of the other MNOs in Europe with tower value still to be unlocked, Orange might well be the other way to play this (see HERE). Orange is still resolutely committed to its view that its tower assets are strategic, but that is what Vodafone was saying a year ago….The tower business model still has some way to play out, but with increasing valuation disparities now emerging, we believe Vodafone or Orange or Inwit represent better ways to play this as an investor rather than through Cellnex which has been the star name to date.

Regulators and investors are making a mistake in their analysis of Dish

We published a report this week showing that if Dish deploys a network, they will have the capacity to take at least 15% of the market’s traffic, and an incentive to price aggressively to do so (LINK).  We argue that their unit cost would be so low that they could sell capacity in the wholesale market well below current wholesale rates (below even the existing carriers’ unit costs).  This could open the market to competition that would dwarf anything we have seen from Sprint in a decade.

A neutral-host wholesale capacity platform does more than just drive competition in the retail wireless market though; it paves the way for innovation in new business models that wouldn’t otherwise be possible.   Companies across industries will be able to purchase wireless network capacity, either as an input to, or bundled with, a product or service they sell to consumers or enterprises.

It would also drive investment: the existing carriers would have to accelerate investments in fiber, spectrum and 5G equipment, and they would have to innovate, in order to remain competitive with a new network with a big cost advantage.

Consumers would benefit directly from faster, better networks, more choices, and lower wireless prices.  Companies with products or services that are delivered over a network benefit for the same reasons; the value of their businesses should rise as connectivity costs fall.

So, what is the problem with the T-Mobile / Sprint deal?

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