We took Millicom through the East Coast at the end of last week and, in addition to significant interest in this rather unique situation, we also detected rising interest in the LatAm cable “cohort” more broadly i.e. including Megacable and Televisa (both reporting late last week) and Liberty Latin America. We tend to find interest here correlates somewhat with US cable, so a strong print from Charter provides a positive sentiment in the space and encourages investors to look for the LatAm equivalent. In this sense, it’s helpful that Millicom’s CEO, Mauricio Ramos, is on the Board of Charter.
We’ve never bought into the idea that 5G is a magic wand for competitiveness and prosperity, or that being first out of the 5G starting blocks held any particular merit.
However, we are not dismissive of the idea that the early stages of 5G can illuminate important features of the telecoms landscape, or that 5G concerns will continue to energise politicians and regulators. Both of these aspects of 5G should be of concern to investors.
The landscape feature that we want to focus on here is the relative scale of the telecoms sectors in Asia, the USA and Europe – the three poles of the global industry. Our observation is that many investors have a false sense of the relative scale and importance of these three poles – partly because Asian EVs are relatively modest, but mostly the effect of investors’ proximity to their local telecoms markets in the US and Europe. This false sense of relative scale is reinforced by the confident projection by western operators of their own importance in the global pecking orderIn the US there is also a persistent ‘don’t worry, we’re doing great!’ line from some in government and the FCC (see here for example). Although this is balanced by ‘no we are not‘ from other quarters (e.g. here), it succeeds in muddying the waters..
The early picture of emergent global 5G may help to puncture this misperception –
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.
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.
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).
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.
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.
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.
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.
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:
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.