HSBC - Abundant Scarcity

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

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The capital intensity of fibre is now improving fixed-line competitive dynamics and pricing conditions

Mobile capacity constraints are starting to make their effect felt, both in terms of capex and better tariffs

European cable operators, mobile players (Vodafone) and some vendors (Ericsson) are best placed

Disclosures and Disclaimer This report must be read with the disclosures and analyst

certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

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Abundant ScarcityPricing power is returning to telecoms

Global Telecoms, Media & Technology – Equity

February 2011

Main Contributors

Luis A Hilado*Analyst, Global Telecoms, Media & Technology ResearchThe Hongkong and Shanghai Banking Corporation Limited, Singapore+65 6239 [email protected]

Luis Hilado joined HSBC in 2010 from a US investment bank, where he covered the SE Asia telecom sector. He has over 15 years of equity research experience primarily covering SE Asia telecoms. Luis held a number of positions on the sell-side including Head of Research, Philippines for a European stock brokerage. He holds a BA in Economics and a BS in Commerce and BusinessManagement from De La Salle University.

Dominik Klarmann*, CFAAnalyst, Global Telecoms, Media & Technology ResearchHSBC Trinkaus & Burkhardt AG, Dusseldorf+49 211 910 2769 [email protected]

Dominik Klarmann has worked as a telecoms analyst since 2007. He obtained a degree in management at Bamberg and Madrid Universityin 2004. He has been with HSBC since 2007, having previously worked in management consulting and investor relations at Deutsche TelekomAG. Dominik is a CFA charterholder.

Richard DineenAnalyst, Global Telecoms, Media & Technology ResearchHSBC Securities (USA) Inc, New York+1 212 525 [email protected]

Richard joined HSBC in 2004 to work on the Global Telecoms Research team, with a particular emphasis on technology strategy. Prior tothis, he was research director for Mobile Telecoms at Ovum, a highly respected industry analyst firm, where he spent seven years.

Hervé Drouet*Analyst, Global Telecoms, Media & Technology ResearchHSBC Bank plc+44 20 7991 [email protected]

Hervé has been covering GEMs/CEEMEA Telecoms research for more than 9 years and has been ranked highly and regularly acrossnumerous external surveys. Prior to this, he worked as a senior management consultant in the TMT practice at Deloitte Consulting. He has15 years experience in the Media, Telecoms and Technology sectors, having worked previously as a project manager for SchlumbergerTechnologies. He holds a Full time MBA from London Business School and graduated from Ecole Supérieure d'Ingénieurs enElectrotechnique et Electronique in France.

Tucker Grinnan*Analyst, Global Telecoms, Media & Technology ResearchThe Hongkong and Shanghai Banking Corporation Limited, Hong Kong+852 2822 [email protected]

Tucker joined HSBC in November 2005 and has 15 years of experience as an analyst in the telecommunications, media and technologyindustries. Prior to joining HSBC, he spent five years as a head of regional telecoms for Asia and Latin America. Tucker also spent five yearswith a management consulting firm servicing clients in telecommunications and media. He holds degrees from the University of Virginiaand George Washington University.

Neale Anderson*Analyst, Global Telecoms, Media & Technology ResearchThe Hongkong and Shanghai Banking Corporation Limited, Hong Kong+852 2996 [email protected]

Neale Anderson joined HSBC in March 2007. Previously he spent seven years at the specialist consultancy Ovum, where he was ResearchDirector for Asia-Pacific telecommunications markets. He holds a BA from Oxford University and an MA in Advanced Japanese Studiesfrom Sheffield University.

Nicolas Cote-Colisson*Head of European Telecoms, Media & Technology ResearchHSBC Bank plc+44 20 7991 [email protected]

Nicolas joined HSBC in 2000 as a telecoms analyst in the Global Telecoms research team. Prior to that, he worked as an economist with CCFin Paris for five years and also with the French Ministry of Finance. Nicolas holds a DEA in Econometrics from Paris la Sorbonne.

Kunal Bajaj*Analyst, Global Telecoms, Media & Technology ResearchHSBC Bank Middle East Limited, Dubai+9714 507 [email protected]

Kunal joined HSBC in 2005. Before covering Middle Eastern telecoms, he was a member of HSBC’s EMEA telcos team, working on Eastern European and South African telecoms companies. Kunal is a Chartered Accountant and has an MBA in Finance.

Stephen Howard*Head, Global Telecoms, Media & Technology ResearchHSBC Bank plc+44 20 7991 [email protected]

Stephen Howard is Head of the Global Telecoms, Media & Technology Research team. He has covered the telecoms sector since joiningHSBC in 1996. He also brings experience in the technology industry, having worked previously with IBM.

Luigi Minerva*Analyst, Global Telecoms, Media & Technology ResearchHSBC Bank plc+44 20 7991 [email protected]

Luigi joined HSBC in 2005 as a telecoms analyst in the Global Telecoms Research team. Before this, he was a buy-side analyst at a fundmanager, having previously worked in the Telecoms Practice of McKinsey & Co based in Milan. Luigi holds a Masters in Finance from theLondon Business School and an M.Sc. in Economics and Econometrics from the University of Southampton.

Steve Scruton*Head of Equity Research, CEEMEAHSBC Bank plc+44 20 7992 [email protected]

Steve Scruton is the Head of Equity Research, CEEMEA. He has been with HSBC since 1997, and was previously the co-head of Global TMTin London and Head of Research, Bangalore, a team that provides support to Global Research across countries, sectors, products andservices. Prior to joining HSBC, Steve worked with British Petroleum, Cable & Wireless and a banking house in London.

110214_28253 Telecoms thematic - Stephen Howard_R3:Layout 1 2/16/2011 1:09 AM

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Telecoms, Media & Technology – Equity 16 February 2011

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Abundant scarcity One way to think about the telecoms sector’s complexities is to break it down into its constituent portions.

A popular division is frequently made between the fixed-line (wireline) and mobile (wireless) portions of

the industry. We would overlay this with a second distinction: between the provision of connectivity (ie

raw bandwidth or capacity) and applications (ie the services that exploit the underlying connectivity).

Combined, this approach yields a two-by-two grid that acts as a convenient means of analysing the sector.

Focusing first on the connectivity layer, our argument is that there is much to play for. The key quality to

bear in mind is scarcity. We believe that this vital ingredient has been largely missing in both the fixed-

line and mobile elements of the sector over the last decade, but is now making a reappearance; as a

consequence, we think that telecoms should – at long last – begin to enjoy a measure of pricing power.

This is of tremendous importance: volumes in telecoms traditionally look after themselves; the problem is

that price deflation is commonly still more powerful, with the result that revenues decline. But if prices

fall less rapidly, the growth in volumes actually has the chance to translate into growth in revenues.

Mobile connectivity

Take the mobile subsector. Although this part of the industry enjoyed heady growth in the late 1990s,

since then the relentless deflationary nature of pricing has taken its toll. However, in a series of research

Summary

A degree of pricing power is (at long last) becoming apparent in the telecoms sector, thanks to scarcity emerging as a factor on both the fixed-line and the mobile sides of the industry. In fixed line, the capital required in the shift from copper-based infrastructure to fibre platforms is re-asserting the importance of scale at the expense of the unbundlers, and resulting in a more benign pricing environment. Meanwhile, in mobile, the intrinsically finite nature of cellular resource has already led operators to begin rationing capacity on price. In view of this new-found ‘abundant scarcity’, we believe that the prospects for monetising connectivity services look very encouraging. Alas, we are much less sanguine about the operators’ ability to monetise the applications that run over this connectivity (such as IPTV or mobile ‘apps’). In our opinion, the connectivity opportunity will have to suffice – but it is enough.

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reports from late 2009 through 2010 (The Capacity Crunch, Frequonomics, The Cell Side,

SuperFrequonomics), we have argued that scarcity is at long last making an appearance. The physics of

mobile telecommunications (specifically Shannon’s Law) mean that the amount of capacity available is

finite. Even new technologies like 4G/LTE, while offering some efficiency gains versus their

predecessors, are not sufficient an answer to the explosive demand seen from mobile data capacity. As a

result, we have argued that capex is likely to trend upwards, but also that operators will need to ration

their scarce capacity by means of price – in other words, operators will enjoy a measure of pricing power.

Although this view remains very controversial, supporting evidence continues to accumulate. For

example, at its interim results, market bellwether Vodafone indicated the need for a modest increase in

capex, but at the same time not only raised its revenue guidance but also announced it was on-track to

introduce tiered tariffs in all its European markets by the end of calendar Q1 2011. And while, admittedly,

plenty of questions remain about the profitability of data services, we would highlight the excellent

margins achieved by eMobile (one of the world’s very few data-only wireless operators).

Fixed-line connectivity

Although much of our 2010 thematic research focused on the mobile subsector, a parallel set of points

could be made about the fixed-line side of the industry: here too, the power of scarcity is finally making

itself felt, even if its origins are very different. To be clear, the scarcity involved is certainly not related to

the bandwidth available down superfast pipes: instead, it is associated with the prodigious capex required

to deploy such technologies, which limits the number of such competing platforms in any one market.

Clearly, in one sense, the scarcity of access infrastructure platforms is nothing new. But, over the last

decade, regulators have undermined this barrier to entry by enabling entrants to unbundle the incumbent’s

infrastructure at a price related to the incumbent’s own unit costs. Not only has this meant competitors

have had no need to secure billions in funding to roll out infrastructure of their own, but it also ensured

that they could behave, in terms of pricing, as if they had the same scale as the incumbent. With network

reach and economies of scale no longer points of differentiation, the competitive battleground moved on

to areas like marketing, where nimble entrants have tended to get the better of the incumbents.

But now the shift towards next generation access (NGA) platforms providing superfast broadband gives

an opportunity to redress the balance, and reassert the importance of scale. In the present-day, copper-

based ADSL broadband world, unbundling has required little capital. By contrast, in networks that mix

fibre and copper (like FTTN/VDSL), unbundling is intrinsically expensive (as a result of the need to

install electronics not at a handful of local exchanges but instead at tens of thousands of street cabinets);

while in those networks that consist entirely of fibre, it is currently practically impossible. We therefore

Breaking down the telecoms sector into its component platforms and services, with examples of each category

Applications layer Eg IPTV Eg mobile ‘apps’

Eg superfast broadband Eg tiered data plansConnectivity layer

Fixed-line network Mobile network

Source: HSBC

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believe that the landscape of competition is set to change, moving away from an unbundled framework

and towards being based around wholesale offerings. Crucially, the economics of the latter are radically

better than those of the former, so far as incumbents are concerned. Indeed, there are already indications

that this transition is underway, as well as that pricing conditions are improving as a result.

Naturally, there is the risk that regulators turn tough on the wholesale pricing of fibre-based connectivity.

However, to do so would be to jeopardise the roll-out of this infrastructure in less economically attractive

areas, thereby creating a ‘digital divide’. Our survey of recent regulatory developments points to an

environment much improved by comparison with that pertaining to copper infrastructure, though still

disappointing in some respects. On the closely related issue of net neutrality, a trans-Atlantic divide is

evident, with European bodies adopting a more pragmatic and telecoms-sympathetic stance.

We therefore believe that there is, for the first time in recent history, ‘abundant scarcity’ evident in the

telecoms connectivity layer, on both the fixed-line and mobile sides. Unfortunately, though, we think that

prospects in the industry’s other layer – applications – are rather less rosy.

Mobile applications

Almost wherever one looks, the telecoms players have failed in their ambitions to become providers of

applications. Perhaps the most high profile instance of this has been in the mobile space, where the very

term ‘application’ is now synonymous with Apple and its iPhone. And while Apple does face competition

in this area, the most conspicuous source of rivalry is from Google’s Android platform, rather than from

telecoms companies. The risk here is that, by losing control of the applications layer, the operators will

find themselves disintermediated from some of their most traditional activities.

For example, consider the rise of social networking sites, and the way that they might very well become

the obvious address book intermediary for users looking to contact one of their social circle. Any

software like Facebook, which effectively organises an individual’s contacts, is in a strong position to

help guide how communications between those individuals takes place – and could readily direct a call to

take place via a VoIP application, like Skype. Efforts by telecoms operators in the mobile space to meet

this threat, and bring address book management out of the era of the telephone directory and into the

modern age (via platforms like RCS, the Rich Communications Suite) look to be too little too late. The

dangers here will be self-evident, although it should be emphasised that even service such as VoIP still

rely on underlying connectivity. This remains the preserve of the telecoms operators, and is not territory

that we see players in the applications layer as having either the skills or the appetite to pursue. Even

modest or oblique encroachments in this area by the vendors or technology companies (such as by setting

up as a MVNO or introducing soft SIM functionality) would likely be dilutive and/or counter-productive.

Fixed-line applications

Companies like Skype and Facebook are generally termed ‘over-the-top’ (OTT) providers, since they

offer an application that runs over the top of the connectivity that the telecoms operators deliver. In the

mobile subsector, it is already difficult to avoid the conclusion that this is the natural arrangement of

things. However, OTT is also becoming increasingly relevant in the fixed-line market, especially with

reference to payTV services – a topic closely examined in our thematic report, DisContent (September,

2009). Since this publication, ever more parties have entered the fray, with recent initiatives from players

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as diverse as Google and Tesco. We suspect that even established media players will struggle in this

environment, let alone telecoms operators. Arguably the incumbents, by investing in what are termed

content delivery networks (CDNs), are themselves tacitly acknowledging this state of affairs, by looking

to provide the hosting services required by OTT providers of video content.

In this confusing environment, we would argue that there remain only two fixed poles: firstly, customers

want the best content; and, secondly, this content is in need of delivery (with ‘content’ here referring to

any application, whether IPTV, VoIP offerings like Skype, iPhone apps, etc). So, content is king, but it

cannot be ‘teleported’ to the customer: it requires delivery – and hence connectivity.

We would argue that, at the very least in the developed world, it is time the telecoms operators embraced

the realities – positive and negative – of the market’s structure. The industry is well placed to be able to

monetise connectivity; it is much less clear what it can really add in the applications layer. Admittedly,

there is an argument for a degree of continued activity in this latter space, if only to retain bargaining

power with the other market participants and to stimulate the uptake of the connectivity services upon

which applications depend. But it is perhaps time that operators embraced the fact that one of the fastest

and most efficient means of encouraging the uptake of new forms of connectivity (such as superfast

broadband and mobile data packages) is to adopt open platforms, as it is these that best foster innovation.

Ironically, the appeal – from a profitability perspective – of applications like IPTV has long been dubious.

Although this service might generate healthy revenues, the bulk of these would need to be passed onto the

content owners. As a result, whether or not a telecoms company owns an IPTV revenue stream matters

less, in our view, than the fact that this service is likely to promote adoption of superfast broadband

connectivity – a field where the operator is much more clearly poised to benefit. Moreover, third parties

might be less anxious of the need to push net neutrality regulation if they could be confident that

prioritisation would not be used to favour the incumbents’ own retail services in the applications layer.

Winners and losers Clearly, the emergence of pricing power in telecoms should be a powerful positive right across the sector –

especially after so long an absence. However, because this positive is concentrated in the connectivity

layer, the benefits are by no means evenly distributed. In terms of the fixed-line subsector, we believe that

the best-placed operators are those with NGA infrastructure. Incumbents furthest ahead deploying this

network will be the first to benefit (Swisscom, KPN, Bezeq and Verizon being good examples), but we

think that the greatest benefits will actually accrue to the cable operators (KDG, Liberty Global, Telenet,

Virgin Media and ZON; as well as, in a sense, TDC), as their upgrade path via DOCSIS3.0 is relatively

inexpensive as well as rapid to deploy. In terms of the mobile industry, we favour larger operators with the

necessary scale to out-invest their smaller rivals (and thereby provide superior a quality of service with

their data offerings), as well as those equipment manufacturers that will supply them. As a consequence,

we prefer networks like Vodafone, Telenor , NTT DoCoMo and KT, plus Ericsson among the vendors.

In the emerging markets, the dynamics are somewhat different. There should still be the opportunity to

monetise scarcity in terms of connectivity, and hence we would suggest stocks like TIM Brazil. However,

additionally, there may still be some scope for operators to capture a portion of the applications layer: we

would advocate STC and MTN on this basis. We see the losers on this theme as being those companies

that have been slow to invest in their core connectivity capabilities, like TI and TPSA.

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Global Telecoms: Coverage universe

_______________________Overweight________________________ ___________________ Neutral _____________________ _________________Underweight __________________ Company Currency TP Price Company Currency TP Price Company Currency TP Price

Axiata MYR 5.8 5.0 China Mob HKD 81.0 73.1 FET TWD 39.0 42.2CCS HKD 4.6 5.0 KDDI JPY 525000 527000 China Uni HKD 6.7 13.5China Tel HKD 5.1 4.4 M1 SGD 2.5 2.4 GTL Infrastructure* INR 39.0 36.7DiGi.com MYR 29.0 25.6 NTT JPY 4000 3925 MTNL* INR 59.0 42.5Indosat IDR 5800 5000 SingTel SGD 3.3 3.0 Tata Com* INR 225.0 210.1NTT DoCoMo JPY 172000 151100 SKT KRW 177000 162500 Tata Tele* INR 15.0 15.4PT Telkom IDR 9600 7600 RCOM INR 152.0 97.2 KT KRW 60000 41200 SKB KRW 6200 5010 LGT U+ KRW 8900 5970 CHT TWD 91.2 86.7 SmarTone HKD 26.0 24.8 SoftBank JPY 3200 2997 Telstra AUD 3.4 2.9 TWM TWD 69.0 66.7 Tulip Tel INR 235.0 164.6 Maxis MYR 5.8 5.4 Baidu.com* USD 158.0 129.6 PCCW HKD 4.0 3.7 CITIC* HKD 2.7 2.6 StarHub SGD 2.9 2.6 Comba T. Sys* HKD 11.1 8.1 Tel Malaysia MYR 3.9 3.9 eAccess* JPY 79000 51400 Bharti* INR 370.0 318.9 Netease.com* USD 54 44 Idea* INR 75.0 63.7 Tencent* HKD 240 197 J:COM* JPY 97000 86900 XL Axiata* IDR 7700 5200 Perfect World* USD 33.0 21.4 Shanda* USD 43.0 44.8

Asia

ZTE* HKD 32.0 30.3

Bezeq ILS 11.60 10.11 Comstar USD 7.5 6.7 TPSA PLN 15.3 16.6Cellcom ILS 135.0 117.5 Etisalat AED 12.0 11.1 Turk Tel TRY 6.8 7.1EE (Mobily) SAR 71.0 54.8 Qtel QAR 192 171.5 Zain Group* KWD 1.2 1.4Millicom USD 110.0 92.8 Magyar T. HUF 575 537.0 MTN ZAR 148.0 126.0 MarocTel MAD 160 154.2 MTS USD 29.0 19.8 Mobinil EGP 185 133.2 Oman Tel OMR 1.5 1.2 Safaricom KES 5.3 4.4 Partner ILS 90.0 70.6 Zain KSA SAR 8.5 7.9 Sonatel XOF 175000 160000 Telkom SA ZAR 40.0 34.0 STC SAR 48.0 40.3 Turkcell USD 20.6 16.0 TefO2 CZ CZK 450.0 400.0 Vodacom ZAR 83.0 75.3 Tel Egypt EGP 21.0 16.0 Rostelecom* USD 29.6 33.1 Wataniya KWD 2.2 1.8 VimpelCom* USD 18.0 14.4 Orascom T.* USD 6.2 3.3

CEEM

EA

Sistema* USD 33.0 25.0

Aegis Group GBP 1.7 1.5 Belgacom EUR 30.0 27.0 BSkyB GBP 4.8 7.5Atos-Origin EUR 43.0 41.4 BT GBP 2.0 1.9 DT EUR 9.5 9.9Bouygues EUR 41.0 33.7 JC Decaux EUR 23.0 24.3 Elisa EUR 15.0 16.8Capgemini EUR 43.0 39.6 OTE EUR 6.0 7.6 ITV GBP 0.6 0.9Ericsson SEK 95.0 82.1 PagesJaunes EUR 9.0 6.9 Mediaset EUR 4.3 4.9Eutelsat EUR 33.0 28.8 Portugal T. EUR 9.0 8.6 Mobistar EUR 42.0 45.6Freenet EUR 10.0 8.6 Publicis EUR 40 40.9 Nokia EUR 6.5 7.0FT EUR 21.0 16.2 SAP EUR 40 44.4 Fastweb EUR 18.0 18.0Havas EUR 4.9 4.2 Tele2 SEK 160 148.7 Pearson GBP 9.3 10.6Iliad EUR 103.0 77.2 TeliaSonera SEK 58 54.5 TI EUR 1.1 1.1Inmarsat GBP 8.8 7.2 Tel. Austria EUR 11.0 10.5 COLT* GBP 0.8 1.5KPN EUR 15.0 11.8 Informa Group* GBP 4.6 4.6 QSC* EUR 1.4 3.0Lagardere EUR 37.0 33.1 Forthnet* EUR 0.8 0.6 Meetic EUR 22.5 16.8 Telecinco* EUR 9.2 9.9 Reed Elsevier GBP 6.6 5.9 Versatel* EUR 5.5 5.8 Ses Sa EUR 23.0 18.5 Swisscom CHF 470.0 430.9 TDC DKK 58.0 46.3 Telefonica EUR 22.0 18.3 Telenet EUR 34.0 31.2 Telenor NOK 111.0 91.5 Virgin Media USD 33.0 27.4 Vivendi EUR 28.0 20.8 Vodafone GBP 2.3 1.8 WPP Group GBP 8.4 8.3 ZON EUR 4.4 3.8 C&W* GBP 0.8 0.5 Drillisch* EUR 6.0 7.0 Jazztel* EUR 4.0 3.9 Kabel Deutschland* EUR 44.0 38.1 United Bueiness Media* GBP 7.5 7.2 United Internet* EUR 14.0 12.6

Euro

pe

XING* EUR 36.0 39.3

Liberty Global USD 44.0 42.3 AMX USD 64.0 56.8 Net Serv BRL 19.0 18.5Tim Part BRL 7.5 6.0 AT&T Inc. USD 30.0 28.5 Telmex USD 16.0 17.4Verizon USD 41.0 36.4 Tele Norte BRL 31.0 26.1 Vivo Part BRL 69.0 54.1 Telesp BRL 41.0 39.5

US &

Lat

am

Sprint Nextel* USD 5.0 4.6

Source: HSBC estimates, priced as at 11 February 2011

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Fixed-line connectivity 7

Mobile connectivity 28

Fixed-line applications 54

Mobile applications 67

Winners and Losers 74

Company profiles 97 America Movil (Neutral, TP USD64) 98

AT&T (Neutral, TP USD30) 100

Belgacom (Neutral, TP EUR30) 102

BT Group (Neutral, TP 200p) 104

Bezeq (Overweight, TP ILS11.6) 106

Deutsche Telekom (Underweight, TP EUR9.5) 108

eAccess (Overweight (V), TP 79,000) 110

France Telecom (Overweight, TP EUR21 112

KPN (OW, TP EUR15) 114

KT Corp (Overweight, TP KRW60,000) 116

Mobily (Overweight, TP SAR71) 118

MTN (Overweight, TP ZAR148) 120

Mobile Telesystems (Overweight, TP USD29) 122

NTT DoCoMo (Overweight, TP JPY172,000) 124

Portugal Telecom (Neutral, TP EUR9) 126

Saudi Telecom Company (Overweight, TP SAR48) 128

Sprint Nextel (Neutral (V), TP USD5) 130

Swisscom (Overweight, TP CHF470) 132

TDC (Overweight, TP DKK58) 134

Tele2 (Neutral, TP SEK160) 136

Telecom Italia (Underweight, TP EUR1.05) 138

Telefonica (Overweight, TP EUR22) 140

Telekom Austria (Neutral, TP EUR11) 142

Telenor (Overweight, TP NOK111) 144

TeliaSonera (Neutral, TP SEK58) 146

Telstra (Overweight, TP AUD3.40) 148

TIM Participações (Overweight, TP BRL7.50) 150

TPSA (Underweight, TP PLN15.3) 152

Turk Telekom (Underweight, TP TRY6.80) 154

Verizon (Overweight, TP USD41) 156

Vodafone (Overweight, TP 230p) 158

Disclosure appendix 161

Disclaimer 164

Contents

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Introduction There are now the first clear signs emerging that

the transition to next generation access (NGA)

superfast broadband is shifting the competitive

landscape away from unbundling and towards

wholesale. This should provide incumbents (as

well as their cable rivals) with a considerably

better operating environment than has been the

case during the last decade, when the highly

corrosive regulatory intervention that is the

unbundling of the local loop (ULL) dominated the

picture.

Generally, it is only fair to acknowledge that

European regulation is becoming more

sympathetic to those deploying fibre upgrades,

although some of the detailed terms still fall far

short of what the Federal Communications

Commission (FCC) offered to supercharge NGA

roll outs in the US. However, the situation is

reversed on the topic of net neutrality, where it is

the Europeans, in our opinion, who have adopted

the more rational policy – accepting that there are

actually benefits to being able to prioritise certain

types of data traffic, provided the process is

transparent and non-discriminatory.

Such a pragmatic approach seems entirely

appropriate for a wide variety of reasons. One

worth mentioning is the operators’ increasing

interest in entering the content delivery network

(CDN) space, which effectively signals their

interest in hosting providers of over-the-top

(OTT) services. Hence, far from using their

network ownership to discriminate against third-

party suppliers of services utilising their

infrastructure, they are now specifically setting

out to sell to such players.

Age of enlightenment It is obviously ironic to even be discussing

scarcity in the context of the tremendous

bandwidths that NGA access network upgrades

deliver. But the speeds involved do come at a

price, particularly for incumbent operators that

must generally replace all or part of their existing

twisted-copper pair infrastructure with fibre.

Historically, regulators have undermined the

incumbents’ traditional barrier to entry (the

enormous expense of replicating their access

infrastructure) by making it available to third

parties at a unit-cost based price. With the

infrastructure (and its price) effectively common

ground, the terms of competition have migrated

elsewhere – into areas like marketing and

customer service. In such territory, it has all too

often been the entrants rather than the incumbents

that have held the upper ground.

However, the shift towards NGA platforms looks

set to redress the balance, and highlight once more

the importance of scale in the telecoms industry.


NGA already resulting in competitive landscape shifting to wholesale

EC regulation more sympathetic to NGA, but concerns remain

Net neutrality threat receding in Europe; CDN opportunity emerging

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Today’s unbundling platforms require relatively

little by way of capital commitment, with altnets’

infrastructure deployment needing to be no more

diffuse than encompassing the local exchange.

But, in a FTTN/VDSL platform, their equipment

must be installed in street cabinets – of which

there are commonly 20-40 for each local

exchange. This implies vastly greater costs for the

altnet – to the extent that it is very difficult to see

it being economically viable. For more

information, see our own detailed report on NGA

and its consequences, Age of Enlightenment,

September, 2008; note that independent reports

commissioned by a variety of regulators have

reached similar conclusions in both Ireland and

the Netherlands. Moreover, in the case of fibre-to-

the-premises (FTTP), unbundling is presently

practically unfeasible.

Hence we conclude that the landscape of

competition is likely to fundamentally change,

shifting away from the unbundling of copper.

Altnets that wish to continue to compete in the

world of NGA-delivered superfast broadband will

most likely need to purchase the connectivity

wholesale from the incumbent. Wholesale pricing

is naturally much more attractive to an incumbent

than that associated with unbundling (as, with

wholesale, the incumbent is doing all the real

work).

Naturally, regulators could turn tough on

wholesale pricing, but to do this would jeopardise

the build out of fibre in less economically

attractive regions. Once these projects are

complete, the intensification of regulation does

therefore represent a real risk, but – given the

duration of fibre deployments – we believe that

this is many years away.

The process of migrating toward fibre has been a

slow and painful one (we originally discussed it in

our thematic report Phoenix – rising from the

ashes, all the way back in September, 2004).

Operators have been wary of investing in

upgrading their infrastructure, given the very poor

reputation that capex in the telecoms sector

acquired post the internet bubble – or, more

specifically, its burst. Moreover, with regulators

aggressively pushing interventions like

unbundling, management teams have

understandably questioned the merits of investing

in a platform that they might then be forced to sell

at, or even beneath, cost.

Then came the credit crunch, and arguably the

worst global economic slowdown in three-

Future NGA and DOCSIS coverage plans (as % of total households) ( Incumbent vs cable)

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

Belgium Germany Netherlands Portugal Spain Sw itzerland UK France Italy

Incumbent Cable (key competitor)

Mid 2011

2009 2012e

2012e

20092012e

2009

2015e

2015e

2009

2009

2012e 2010e

2010e

FT plans: Fibre in all 96 homeland and in 3 overseas administrative districts by 2015

Numericable : No future coverage plans available

2015e

No cable operator in Italy

Source: company data, HSBC estimates

9


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quarters of a century. Although the free cash flow

yields currently seen in the telecoms sector might

give the impression that the industry is

particularly fragile (given these valuation levels,

the markets would certainly seem to perceive it as

such), in fact the sector displayed a quite

remarkable degree of resilience during the

downturn. Admittedly, revenues were negatively

impacted by the troubled macro environment;

however, operators were able to offset this

pressure by making cost savings – with capex

being a primary focus in this regard.

Inevitably, such cuts had an impact on the pace at

which operators invested in NGA upgrades, which

are intrinsically expensive. In Europe, even those

incumbents that were among the more

enthusiastic (like KPN) adopted cautious roll-out

schedules. Meanwhile, in the US, although

Verizon pushed ahead with its highly ambitious

FiOS project, AT&T extended its U-verse

programme over a longer period, effectively

slowing the pace of deployment.

As we argued at the time (in our thematic Déjà vu,

February, 2009), the extent of the cuts possible in

discretionary capex on a short-term view meant

that the sector’s cash flow generation could

remain robust. The key phrase here, though, is

‘short-term’. Operators can indeed cut back on

capex over brief timescales – a process that is

made even easier if their primary rivals are

engaged in the same behaviour. But it is

dangerous to overly prolong this hiatus – and,

indeed, undesirable to do so if there is an

appealing opportunity in the offing. We believe

that NGA upgrades fall into this category.

Despite the macro difficulties, these investments

are now broadly underway, and some of the

benefits that they bring to the competitive

landscape are becoming apparent. The most

important aspect of NGA builds, so far as we are

concerned, are not that they will enable operators

to drive retail ARPUs higher (though, of course,

this is a distinct possibility), but rather that they

encourage a shift away from unbundled-based

competition towards that based on wholesale

products. The latter are typically priced on terms

far more attractive to the incumbent than the

former.

Unbundled to wholesale

We have already seen several altnet competitors

accepting the logic of this transition. For example,

in an event of – we would argue – seismic

significance (but one that went largely

unrecognised by the financial press), UK

broadband provider Orange (better known for its

mobile network) decided to abandon its

German broadband market in 2007… …and 2010: NGA drives consolidation

DT44%

Arcor13%

UTDI14%

Vodafone1%

others1%

TEF O21%

Cable4%

Alice12%

freenet7%

Versatel3%

DT46%

UTDI13%

Cable13%

TEF O28%

Vodafone14%

others4%

Versatel2%

Source: company data, HSBC Source: company data, HSBC

10


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unbundled ADSL offering and move onto BT’s

wholesale platform. Admittedly, Orange is now a

relatively small player in the UK broadband

market (though once having been far stronger). Its

DSLAM equipment may have been somewhat

antiquated, and so may well have required

significant investment even to maintain an

unbundled ADSL service. The prospect of having

to invest capex in an ADSL offering at just the

time BT is beginning to deploy fibre was clearly

an unattractive one – given that any new assets

Orange put in place would have a fairly limited

lifespan (in the face of the incumbent’s faster

NGA technology).

Hence, even if Orange had invested in upgrading

its unbundled ADSL platform, it would still have

faced the dilemma of whether or not to invest a

great deal more in a few years time. Maintaining

its presence as an unbundler with ADSL would

have been relatively inexpensive, but becoming an

unbundler of BT’s FTTN/VDSL platform would

involve an immense outlay. And if this capital

commitment was too large to contemplate, what

would be the point in remaining an unbundler in

the meantime? In the end, Orange presumably

decided that, given it could not afford to unbundle

the FTTN/VDSL platform, there was little point

in continuing to invest in unbundling ADSL, and

the company moved directly into taking a

wholesale service.

The example provided by Orange proved to be an

early warning of a broader trend. The choice

confronting Orange arrived sooner than for most

of its peers, owing to the age of some of its

existing infrastructure, and therefore its need to

make an investment to maintain even its existing,

unbundled ADSL capability. However, the same

issue would sooner or later confront every

unbundler. TalkTalk remains an enthusiastic

unbundler of BT’s copper at the local exchange,

but (although it is conducting a small-scale fibre

trial) looks set to wholesale the incumbent’s NGA

product rather than unbundle at the street cabinet

level. Indeed, although Ofcom is insisting that BT

make available unbundled FTTN/VDSL reference

products, the regulator acknowledges that these

have not attracted a great deal of attention.

TalkTalk has made the point in its strategy

presentation that it can still obtain the same,

healthy margin reselling BT’s wholesale NGA

offerings that it achieves today with unbundled

ADSL. BT’s Openreach division, which has the

task of deploying the NGA platform, needs to

tread a difficult line in setting its prices. On the

one hand, obviously, these must be sufficient to

justify the investment made (and the not

inconsiderable risk involved); on the other, these

must not be so high as to deter take up. On

TalkTalk’s suggested numbers, it can indeed

maintain its gross margin, but the really standout

aspect is surely rather the fact that its payment to

NGA builds encourage shift from unbundled products to wholesale

Status quoStatus quo NGA buildsNGA builds

Copper linesLower cost

Credit crunch lower capex NGA upgrade delayed copper still important

US-FCC: unbundling abandoned on networks bringing fibre within 1,000 feet of customer homes

Copper lines

Lower costCredit crunch lower capex NGA upgrade

delayed copper still importantUS-FCC: unbundling abandoned on networks

bringing fibre within 1,000 feet of customer homes

Replace twisted copper with fibreFTTN/VDSL rollout to street cabinet

Higher cost, but superfast broadbandManagement wary

Regulatory risk, but LTScale importanceEncourage shift from unbundled to wholesale

Replace twisted copper with fibre

FTTN/VDSL rollout to street cabinetHigher cost, but superfast broadband

Management waryRegulatory risk, but LTScale importance

Encourage shift from unbundled to wholesale

Status quoStatus quo NGA buildsNGA builds

Copper linesLower cost

Credit crunch lower capex NGA upgrade delayed copper still important

US-FCC: unbundling abandoned on networks bringing fibre within 1,000 feet of customer homes

Copper lines

Lower costCredit crunch lower capex NGA upgrade

delayed copper still importantUS-FCC: unbundling abandoned on networks

bringing fibre within 1,000 feet of customer homes

Replace twisted copper with fibreFTTN/VDSL rollout to street cabinet

Higher cost, but superfast broadbandManagement wary

Regulatory risk, but LTScale importanceEncourage shift from unbundled to wholesale

Replace twisted copper with fibre

FTTN/VDSL rollout to street cabinetHigher cost, but superfast broadband

Management waryRegulatory risk, but LTScale importance

Encourage shift from unbundled to wholesale

Source: HSBC

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BT approximately doubles when comparing

wholesale NGA to unbundled copper.

The utility of NGA upgrades to the incumbent

should therefore be perfectly clear. The

incumbents are the only operators with the

necessary scale, capital and experience to

undertake nationwide fibre upgrades; even

unbundling such a platform becomes prohibitively

expensive, and this should leave unbundled

copper competitors shifting towards a wholesale

NGA service, for which they will have to pay

(quite properly) considerably more.

Incipient fixed-line pricing power

What is important to emphasise here is that the

prerequisite for a more orderly pricing

environment is the upgrade to NGA infrastructure

(to fibre in the case of incumbents, or to

DOCSIS3.0 on cable platforms). Unfortunately,

because the process of migrating towards fibre

platforms is so expensive and time-consuming,

progress here has often been frustratingly slow.

It is for this reason that the evidence for incipient

pricing power emerging on the fixed-line side of

the industry is much less clear cut than that seen

in the mobile subsector.

Nevertheless, we feel that the anecdotal evidence

is increasingly convincing. The slow pace of

incumbent NGA upgrades also explains why the

clearest examples of pricing power in the fixed-

line market are often to be found among the cable

operators, since their upgrade path to NGA status

via DOCSIS3.0 technology is relatively swift.

Those cable operators already using DOCSIS3.0

in significant portions of their footprint have been

able to show a remarkably resilient top line, even

during the difficult macro environment of the past

few years.

ZON Multimedia (ZON.LS, EUR3.78, OW) in

Portugal provides an example of a cable operator

that has been able to command a certain degree of

pricing power – having found itself able to

increase the pricing on its services for each of the

last three years. In the course of 2010, ZON was

able to raise its tariffs in the region of 3-4% across

the board. This move was then followed by the

incumbent, Portugal Telecom. PT was able to lift

its prices because it has itself conducted a

substantial NGA network upgrade. ZON expects

to be able to increase its prices by about 1% in

2011, despite the austerity measures that have

been implemented in Portugal and the 2ppt

increase in VAT effective from January 2011.

Turning to the UK, cable operator Virgin Media

(VMED.O, USD27.38, OW) has been a

frontrunner among its European peers in

upgrading to DOCSIS3.0, which enabled it to

offer a service that is clearly differentiated from

that of the incumbent, BT. But BT is now also

rolling out a NGA deployment of its own – which

seems to be persuading present-day unbundlers

(like Orange) that a move towards wholesale-

based services is inevitable. Note that despite the

difficult macro conditions in the UK, Virgin

Media announced in February 2011 a set of tariff

increases in its TV packages: the price of its ‘L’

package is to rise by GBP1.25 per month, while

that of its ‘XL’ package is to step up by GBP1.0

per month. In addition, its broadband packages are

to cost an extra GBP0.75 per month. Conversely,

though, the price of the 30Mbps package has been

reduced from GBP20 to GBP18.5 per month.

The above examples therefore suggest that

investing in network upgrades creates the

conditions necessary for the exercise of pricing

power. In our view, failure to invest tends

inevitably to condemn operators to pure price-

based competition. Arguably, one good example

of this is Telecom Italia. On the plus side, the lack

of a cable infrastructure in Italy has limited the

damage that the company’s decision to repeatedly

postpone its NGA roll-out plans would otherwise

12


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have caused. However, the resulting lack of

service differentiation has exposed TI to the

aggressive pricing of altnets exploiting

unbundling. For instance, in Q4 2010

Wind/Infostrada, Tele2 and Tiscali started

offering double-play broadband products for a

two year (sic) promotional price of EUR19.95 per

month. TI has opted not to follow this move, but

this decision is likely to have hit the performance

of its domestic fixed-line business in Q4 2010.

The same risk potentially applies to other

operators that have elected to postpone NGA

capex during the recent recession – and so may

also apply to the likes of Telefonica de Espana,

for example.

There is also the hint in some of those (rare)

markets where the deployment of NGA could be

relatively broad based that the elevated levels of

capital involved (a particular step change so far as

the incumbent’s competitors are concerned) will

trigger more responsible pricing policies. This

would seem to be the case in France, a market that

has been the cheapest in Europe in terms of triple-

play services effectively ever since Iliad launched

its EUR29.99 per month offer back in 2003. Its

competitors were forced to align their pricing to

Iliad’s, with only FT managing to retain some sort

of premium to this. (Even this premium has been

eroding, following FT’s price cuts in summer

2010.)

However, in Q4 2010, retail prices were raised by

all the major operators, in response to a hike in the

VAT rate. What is significant, though, is that the

price rises were in excess of what the higher VAT

charge alone would have justified, and therefore

also represents an increase in the underlying

pricing at Iliad and SFR. These operators can

legitimately claim that they now incorporate

additional features in their offerings, such as

unlimited calls to mobile phones or a new set-top

box – but the fact remains that triple-play

packages now cost more on a headline basis than

previously. For example, Iliad's new customers

will be paying EUR37.97 per month (for its triple-

play, fully unbundled, unlimited calls to mobile

package), compared with EUR29.99 previously.

Of the total price increase, only a third can be

attributed to the higher VAT rate. Similarly, at

SFR, the new triple-play offer now costs EUR36.9

per month compared with EUR29.9 previously.

The equivalent bundles would cost EUR39.9 per

month at Bouygues (including three hours of calls

to mobile, rather than unlimited calls) and EUR37

at Orange (but with only one hour of calls to

mobile phones included, and excluding EUR3 for

set-top box rental).

Note that fibre is currently priced at the same

level as ADSL in France, although it has not yet

received any mass-market push. Hence, there

remains the possibility that the operators will also

attach a price premium to the superior bandwidth

services that fibre can support.

Finally, there is the example of the US. In this

market, traditional fixed-line revenues have been

under sustained pressure, driven in particular by

line losses in the region of 8-10% per annum.

An additional headwind arises from the weak

economy. Nevertheless, the absence of regulator-

mandated wholesale or unbundled fibre products,

as well as the growing popularity of services that

exploit superfast broadband connectivity, do

together have the potential to lead to some form of

pricing power.

Of course, because of the very different

bandwidths available over fibre compared with

copper, life-for-like price comparisons are

somewhat spurious. Nonetheless, it is worth

drawing attention to the positive nature of the

‘share of wallet’ effects as seen at the RBOCs.

The ARPU from Verizon’s FiOS customers in Q4

increased by 4% year-on-year, reaching USD146.

Similarly, AT&T’s fixed-line revenues are

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benefiting from growth generated by its U-Verse

connectivity offerings and related services. Fixed-

line consumer revenues per household have now

been growing for the last 12 quarters in

succession. Additionally, the evidence suggests

that fibre offerings are helping to mitigate the

traditional process of line loss.

Ray of light One concern about any scenario in which the

incumbent’s scale and ability to deploy capital

work to its advantage must inevitably be that the

regulator will intervene to the detriment of the

incumbent. To an extent, this is inevitable.

However, incumbents still have some powerful

bargaining chips that should ensure they are more

equitably treated than in the present, copper-

dominated world.

The first point to make is simply to repeat that it

will be very difficult – at any conceivable price –

to make activities like unbundling at the street

cabinet very financially attractive, because of the

capital outlay involved (not to mention the

logistical challenges). Most unbundled players

have relatively limited experience with

infrastructure, given that they are presently tasked

with installing their DSLAMs in perhaps a few

hundred local exchanges. They are not generally

geared up for deployments that would involve

visiting literally thousands of street cabinets. So,

even though regulators will undoubtedly define

products and pricing on unbundled FTTN/VDSL

platforms, this does not imply that they will

actually be used.

There have been efforts in some countries by

governments, notably in Australia, to wrest

responsibility for upgrading the infrastructure to

fibre away from the incumbent, namely Telstra.

However, this has proven hugely controversial,

time-consuming and complex. Most governments

would likely prefer to see the work done by the

local expert (ie the incumbent), using the latter’s

access to capital (rather than potentially impacting

an already over-extended state).

Incumbents, in our view, should be enthusiastic to

build NGA platforms, provided the regulation is

supportive. In practice, they likely will look to

receive sympathetic treatment, via (for instance)

flexibility on pricing, or – if it must be dictated –

tariffs established with the use of generous cost of

capital assumptions.

Ultimately, once capital has been irrevocably

committed, regulators have generally shown a

tendency to turn more aggressive. But, in the

meantime, while they are looking to see

substantial quantities of capital deployed, they

have an incentive to remain more generous. And

this ‘meantime’ could represent a considerable

period – fibre networks can take years to deploy,

particularly if there are to be upgrades beyond

FTTN/VDSL towards FTTP.

Hence the incumbents should possess a

bargaining tool that they can make use of for

years to come. If regulators were to turn unduly

harsh mid-build, this could potentially jeopardise

further deployment of fibre. And because

operators are likely to begin their roll out in the

more affluent, densely populated areas, and only

Fibre to the node vs fibre to the premises

FTTN

FTTP

Fibre optic Copper

En

d u

ser

bui

ldin

gE

nd u

ser

bui

ldin

g

Telco office

Telco office

FTTN

FTTP

Fibre optic Copper

En

d u

ser

bui

ldin

gE

nd u

ser

bui

ldin

g

Telco office

Telco office

FTTN

FTTP

Fibre optic Copper

FTTN

FTTP

Fibre optic Copper

En

d u

ser

bui

ldin

gE

nd u

ser

bui

ldin

g

Telco office

Telco office

Source: HSBC

14


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then move onto less financially compelling

regions, it becomes particularly important that

regulatory decisions do not impair the profitability

of earlier build – which, in a sense, must cross-

subsidise that which follows.

In our view, the most enlightened approach (pun

intended) is that adopted by the FCC in the US,

which decided to abandon unbundling altogether

on networks bringing fibre within 1,000 feet of

the customer premises. This has encouraged the

very rapid deployment of fibre NGA platforms in

the US. European regulators have not taken this

approach, and consequently have not triggered

anything like the same speed of build out.

However, regulators like Ofcom have at least

conferred pricing flexibility on BT – in other

words, the incumbent has the freedom to set its

own prices for both retail and wholesale NGA

products.

Commission regulation

It will be interesting to see how this particular

arrangement can co-exist with the line coming out

of the European Commission. The Commission’s

earlier documents on the subject of NGA

regulation were very worrying from the

perspective of those hoping to see a supportive

regime put in place to encourage fibre investment.

For instance, the Commission has previously

suggested that the use of fibre between local

exchange and street cabinet was to be considered

a conventional upgrade, and therefore not one that

should attract any cost of capital premium. This

despite the fact that there would be no

conceivable to reason to make such an upgrade

other than to offer superfast broadband services –

services that the Commission itself recognises

entail taking on board a good deal of risk.

The latest documents from the Commission show

some relaxation of its attitude, although arguably

still leave much to be desired from the perspective

of a prospective investor. The Commission’s

argument for its adopting an active role in this

process is that regulation in Europe might

otherwise become fractured, given the wide

variety of approaches national regulators have

already adopted towards NGA. We would be

tempted to see this as something of an advantage

– providing an opportunity to test out a variety of

techniques, and then evolve regulation across the

region towards the most successful variants.

The Commission is adamant that the principle of

the so-called ‘ladder of investment’ must be

maintained, despite the fact that it has been of

only limited success to date. The idea here is to

attract players into the market via products that

require relatively little capital to exploit (ie

wholesale offerings, where the incumbent service

is simply resold), and then have them graduate

towards taking on a greater degree of

responsibility in terms of infrastructure as they

gain in terms of size and experience (ie towards

unbundled offerings, where the altnet provides the

electronics and relies on the incumbent only for

passive network components). The same concept

was applied to ADSL broadband services, and –

indeed – many altnets began with wholesale and

later migrated to unbundling. However, there was

no obvious next stage, given the enormous capital

involved in access infrastructure. Arguably this is

still very much the case.

With respect to NGA, the regulatory mandated

products cover everything from the basic passive

infrastructure (eg trenches and poles) for those

wishing to deploy their own fibre connections, up

through unbundling (eg of the copper loop

between the street cabinet and customer) for those

looking to launch unbundled FTTN/VDSL, and

culminating in wholesale offerings (ie where the

reseller simply resells the incumbent’s service).

But it will be a very tall order, in our view, for an

altnet successful with a wholesale product (given

the relatively thin margins that a relatively

15


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undifferentiated product such as this implies) to

make sufficient profit to justify committing the

capital required for unbundling, let alone laying

fibre of its own.

More positively, the Commission does seem clear

that part of its role is to encourage investment in

network:

The [EC] Recommendation… does emphasize the

need for NRAs [national regulatory authorities]

to reflect investment risk in terms of risk premia

and, importantly, in terms of price flexibility

We feel it is a pity, though, that this approach is

not more clearly reflected in its comments on

FTTP unbundling. Clearly, all forms of NGA are

risky, but the degree of capital required for FTTP

puts it in a different league to even FTTN. Hence,

while we see it as regrettable that European

regulators have not followed the FCC in ruling

out unbundling even on FTTN, we would concede

that this form of regulatory intervention does

make more sense applied to FTTN rather than to

FTTP. Given the costs of FTTP, it might have

been hoped that unbundling would have been

ruled out. In fact, with today’s technology,

unbundling FTTP is not really technically

practically feasible, but the Commission still

seems determined that it ought to be introduced as

soon as it becomes so.

Cost orientation

Another weakness, in our opinion, of the

Commission's approach is the focus (for both

unbundling and wholesale, as well as for FTTN

and FTTP) on cost-orientated pricing. The

problem here is that the regulator is referring to

the costs of the incumbent – the largest player in

the market and therefore that with the lowest unit

cost. This tends to penalise those competitors that

have gone to the expense and trouble to deploy

infrastructure of their own, the most prominent

example of which are the cable operators. But

cable companies typically lack the market share

and geographic reach of the incumbents, and

hence also their scale efficiencies. In our view, if

the regulator really wants to encourage

infrastructure-based competition, it ought to be

pricing unbundled infrastructure at a unit cost

price determined not from the incumbent, but

rather from its smaller rivals. The smaller the rival

selected, the greater the incentive for competitors

to commit to investing in infrastructure. (It is also

worth pointing out that the cable operators

themselves might be tempted to extend their

footprints were the potential returns adequately

attractive).

It is worth highlighting the potential injustice

here. An altnet could theoretically simply resell a

wholesale superfast broadband service at a price

offering it a higher return than a cable operator

could generate from its own infrastructure (which

would be smaller scale and, thus, higher unit cost

than the network of the incumbent that the reseller

was wholesaling). This is hardly a circumstance

likely to incentivise future investment.

Ultimately, though, despite the discouraging

nature of the Commission’s philosophical

approach, a great deal rests simply on the cost of

capital that regulators apply to NGA investments.

Here the Commission is clear (without prescribing

actual figures) that the incumbent is entitled to a

premium:

In cases where investment into NGAs depends for

its profitability on uncertain factors such as

assumptions of significantly higher ARPUs or

increased market shares, NRAs should assesss

whether the cost of capital reflects the higher risk

of investment relative to investment into current

networks based on copper.

We have long argued that the immense cost of the

upgrade to NGA platforms could be in part paid

for out of the elimination of the artificial and

16


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transient arbitrage that is local loop unbundling.

However, one alternative would admittedly be for

regulators to choose to permit a greater share of

the returns to accrue to the provider of the NGA

infrastructure. The problem with this is simply

that it is likely to translate into higher retail prices,

which is likely to deter uptake – thereby

potentially damaging the economics of the entire

programme.

Like Ofcom, the Commission is also prepared to

countenance a degree of pricing flexibility. This

seems to boil down to permitting the incumbent a

limited degree of flexibility in terms of pricing

use of its FTTx infrastructure at a discount to

those prepared to purchase it either on a longer-

term basis or in higher volumes (since both reduce

the risk of the NGA investment). However, it does

not seem very apparent that the regulator is

permitting the type of price differentiation that is

commonly seen in other industries.

In the scenario where a scarcity of capital on the

scale required for superfast broadband platforms

results in a diminishing number of infrastructure

competitors, it is – in theory – possible to see the

operators being able to introduce a broader range

of price differentiation techniques. The most

obvious mechanism available is to price

differentiate according to the bandwidth provided,

selling faster services at a premium. It is possible

this could meet with regulatory approval, if only

by virtue of the fact that the faster bandwidths

possible over a FTTP platform as compared to

FTTN/VDSL cost greatly more to provide,

because of the need to take the fibre all the way to

the customer’s premises.

In a more conventional market, though, other

forms of price differentiation would likely appear.

For example, operators might sell tiers of data

capacity, just as they are starting to do in the

mobile side of the industry. The size of the tiers

would be considerably greater for fixed-line

broadband than for mobile, but this might

nonetheless be a good way of differentiating

between casual users of broadband (who would

tend to value the service less) and those reliant

upon it satisfy all their entertainment needs,

thereby consuming a great deal of capacity-

hungry video (who would tend to value the

service more highly).

However, it remains to be seen whether the

wholesale pricing structures to be imposed by the

regulators will support this type of price

differentiation. This is despite the fact that it

would perform a useful function: enabling

operators to charge intensive users a figure more

closely representative of the utility they derive

from the service, and therefore helping to pay for

the deployment of this controversial technology

sooner than would be the case had the build out

depended exclusively on the price that less

committed users would be prepared to pay.

The specific issue here is that there is not

necessarily a substantial differential between the

cost to supply a modest and a large quantity of

data over a broadband network (given the

essentially fixed-cost structure of the industry). A

regulatory-imposed, cost-orientated wholesale

pricing regime would therefore tend to undermine

any attempt to price differentiate based on

volumes, because a reseller could always undercut

any materially premium-priced high-usage

offering. While such a pricing regime might be

justified, were the only goal to eliminate

‘distortions’ relating to the misalignment of costs

and pricing, it would also prevent useful price

differentiation aimed at charging customers more

closely in relation to their derived utility – and

thereby securing an improved revenue outlook of

just the type that might encourage a faster

deployment of NGA infrastructure.

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Could try harder

Overall, we would argue that the regulatory regime

does show some limited signs of being more

sympathetic, with the motive being to encourage

incumbents to deploy NGA platforms. At the same

time, we would continue to emphasise that there

are aspects of the transition to NGA that are

intrinsically unfavourable to unbundling (ie the

expense of visiting the street cabinet). It is evident

that regulators themselves do seem nervous that

they might be perceived as becoming overly

tolerant towards the incumbents, even though the

‘concessions’ involved (as discussed above) would

be solely aimed at encouraging an expensive, risky

investment programme (ie NGA) while

acknowledging the realities imposed by physics (ie

the fact that unbundling is unlikely to be economic

at the street cabinet level).

It is this anxiety that is perhaps the best way to

interpret innovations like the rebranding of

Ofcom’s Active Line Access (ALA) wholesale

product as ‘virtual unbundling’. These labels refer

to a sophisticated wholesale product that Ofcom

intends to impose upon BT – one which will

enable the wholesaler to exert a good deal more

control over its service than would be possible via

equivalent ADSL products. This makes perfect

sense, but the decision to rechristen this service

‘virtual unbundling’ – when what is on offer is

quite obviously a wholesale product – looks

decidedly odd. It is almost as if Ofcom felt the

desire to retain the ‘unbundling’ moniker in order

to emphasise the fact that it is not relaxing its

stance towards BT (a fact that no one would likely

dispute in any case). Note that the European

Commission has accepted Ofcom’s proposal, but

indicated that the virtual unbundling product will

not be sufficient in itself. The Commission wants

Ofcom to secure the unbundling of BT’s NGA

infrastructure as soon as this is practicable.

Net neutrality However, there is one further area of activity

where European regulators – if not their US

counterparts – seem to be leaning towards a

stance that really should be supportive of

investment: on the fraught topic of net neutrality.

The question here boils down to the degree of

freedom that operators should have in how they

manage and tariff their networks, and could have

wide ranging implications in terms of the structure

of the overall market and the degree of incentive

operators are provided to invest in NGA platforms

(and hence the likely speed of their deployment).

Operators can use deep packet inspection (DPI) technology to implement traffic management policies, such as prioritisation according to the requirements of the underlying service (e.g. delay-intolerant voice and video prioritised over email and browsing)

Payload

Hea

der

Policy Engine (PE)

- Prioritize premium users

- Prioritize by service need

- Block objectionable content

Node

Deep packet inspection

Fixed/mobile Internet

Users

Payload

Hea

der

Policy Engine (PE)

- Prioritize premium users

- Prioritize by service need

- Block objectionable content

Node

Deep packet inspection

Fixed/mobile Internet

Users

Source: HSBC

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We have never found the arguments for net

neutrality to be in the least convincing (see Net

Neutrality, April 2006). Unfortunately, this has not

prevented the concept from gaining widespread

acceptance in certain quarters, and with certain

regulators – especially the FCC in the US.

The scope for conflicts of interest in this area will

be readily apparent. Operators, faced with the

colossally expensive challenge of rolling out

superfast broadband networks would like

maximum flexibility in terms of managing, and

charging for, the use of their infrastructure. This

boils down to two key areas:

First, telecoms companies would like to

manage their resources as efficiently as

possible with the use of traffic management

techniques. This would involve, for example,

prioritising the packets of a time-sensitive

video stream (time-sensitive because the

viewer will be immediately conscious of any

delays or interruptions) over that of an email

(where the recipient is likely to be less

sensitive to a modest delay); see the

accompanying diagram.

Second, the operators would like flexibility in

charging for this prioritisation. This would

involve not only applying a premium for the

delivery of prioritised traffic, but also

potentially billing not only the recipient but

also the party sending the packets.

Naturally, the internet players are concerned that

their services might be de-prioritised in favour of

services sponsored by the telecoms operator (rival

video streaming services, for instance); and/or that

they would start having to foot more of the bill for

the ongoing explosion in data traffic volumes

(rather than this being borne by the end-user).

The FCC has been largely sympathetic to these

worries - one of the reasons that we have become

progressively less positive on the US RBOCs as

investments and more upbeat about prospects for

the incumbents in Europe, where the regulation on

net neutrality is looking more reasonable. It will

not have escaped the FCC’s attention that the US

has produced a set of enormous internet

powerhouses, such as Google and Amazon. Such

companies can export their services across the

globe in a way that domestic telecoms providers

cannot. In terms of US industrial policy, therefore,

it arguably makes sense to privilege the internet

names over their telecoms peers. This is

particularly the case given that much of the NGA

fibre upgrade has already been completed in the

US. In other words, the capital has already been

committed, and hence the regulator no longer

needs to create a more attractive returns

environment in order to stimulate the relevant

capex.

One flashpoint has been the legal case embroiling

the FCC and Comcast, the US cable giant.

Comcast had been de-prioritising peer-to-peer

traffic on its network from services like

BitTorrent. The FCC objected to this, and

intervened; in response, Comcast changed its

approach but nonetheless introduced a 250GB

usage cap on its customers. This move did not

please the regulator, which then decided to

sanction Comcast. The latter took the matter to

court, winning the case on the grounds that the

FCC lacked the necessary authority to intervene.

The longer-term implications of this tussle,

however, remain unclear. One risk is that it

incentivises the FCC to secure the necessary

authority via the statute book. However, the

regulator has also been pursuing a more informal

approach, with the aim of keeping regulation of

the internet to a minimum (which seems to be

something that most sides can at least agree is

desirable).

Nonetheless, the fact that this dispute entered the

courts in the first place is surely somewhat

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alarming. Comcast acted to ensure that it could

preserve a good quality of service on its

contended cable network despite the excessive

burdens placed on its platform by a small minority

of its customers using peer-to-peer applications.

Cable networks are intrinsically contended, as all

customers on a given street share the same coaxial

cable; hence capacity taken by one user is no

longer available for another. In such

circumstances, individual customers can degrade

the service of their neighbours, and Comcast’s

actions were taken to prevent this. It is surely an

added irony that probably the most popular use of

the application in question – peer-to-peering – is

video piracy.

Atlantic divide

In Europe, circumstances are somewhat different

to those across the Atlantic. Most of the

investment in NGA upgrades has yet to be made,

and incumbents are cautious about the economic

case for fibre. Given this environment, it makes

sense to give telecoms players as much freedom

as possible to create business models that will

support NGA deployment. Europe’s politicians

have made it perfectly plain that fibre is a priority,

out of fear that the continent’s economy might fall

behind; supporting NGA investment will arguably

be more important (in their eyes) than ensuring

that existing internet giants – largely foreign in

origin – enjoy the benefits of connecting to their

end users at the minimum price.

Ultimately, we remain of the view that hard-line

net neutrality is simply unworkable. Even in the

fixed-line network, there will always be

bottlenecks where capacity is scarce. It is simply

not possible to build a network that at all times

and in all places will be free of constraints. Given

this reality, it will always be necessary to apply

some traffic management policies. Packets

belonging to services that are particularly time-

sensitive to delay (with that most traditional of

offerings, voice, being the clearest example) need

to be conveyed with priority over and above data

traffic relating to, for example, an overnight

routine system backup. Indeed, services that are

really demanding in terms of bandwidth – such as

high-definition video – will arguably never be

able to mature successfully unless supported by

techniques such as prioritisation. It is thus,

ironically, actually in the internet players own

interests’ that prioritisation be permitted, because

otherwise they will likely find themselves

practically constrained in terms of what they are

able to offer customers with an adequate quality

of service.

Although net neutrality advocates often suggest to

the contrary, the presence of prioritisation is

actually the status quo. For example, to take a

case reduction ad absurdum, a corporate taking a

leased line is purchasing dedicated capacity

between two points, in other words, full

prioritisation. Note that traditional switched voice

services are also, in effect prioritised, given that

the circuit conveying the communications is held

open between the callers for the duration of the

call, with no other traffic being permitted over

that portion of the pipe.

It is further worth highlighting that the presence

of net neutrality should not be thought of as

necessarily helping the ‘little guy’. Net neutrality

advocates often suggest that prioritisation charges

would hamper the development of the next

generation of internet entrepreneurs, but it is

revealing that the current giants of this space

invest prodigious quantities of capital in

optimising their response times. For instance, the

likes of Google have constructed numerous data

centres at optimally located points on the global

telecoms network in order to ensure their sites’

services are as responsive as possible. In other

words, even in today’s, supposedly ‘net neutral’

world, the advantage lies with the scale players.

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Admittedly, to agree that there ought to be some

form of traffic management does not necessarily

imply that a charging structure should be

employed. It might be conceptually possible to

introduce a hierarchy, where all video enjoyed

priority over voice, voice over emails, and emails

over backups (for example). But there are obvious

problems with this arrangement. For instance, a

corporate’s voice communications might be held

to be more important than a schoolchild streaming

YouTube videos. Of course, the conventional

method employed to allocate scarce resources (at

least in capitalist societies) is to use a pricing

mechanism. This gives customers the ability to

ascribe a value to the timeliness of the delivery of

their data. Without such a pricing mechanism

acting as a deterrent, the likelihood is that all

traffic would soon become flagged as highest

priority video, rendering the whole system otiose.

There is also the broader point, well made by

Ofcom in its recent report Traffic Management

and ‘net neutrality’ (24 June 2009), that it is

hardly desirable that regulators determine from

the very outset what business model an industry

should pursue. Ofcom cites the example of

newspapers, which charge not only their readers

(ie the purchase price) but also businesses wanting

to reach those readers (ie for advertising). In

effect, the advertising cross-subsidises the

purchase price of the newspaper.

To apply a similar template to, say, an IPTV

service, the cost might be borne partially by the

viewer (via a subscription charge) and partly by

the corporate owning the content (via

prioritisation fees). This is not so very different

from the way in which traditional broadcasters

work today, since they already pay fees to those

operating the broadcast platform (whether

terrestrial or in geosynchronous orbit).

Non-discrimination and transparency

European NRAs seem to be gravitating towards a

relatively hands-off approach, while at the same

time making it clear that they will be imposing

demands in terms of non-discrimination and

transparency. On the former issue, ARCEP (the

French regulator) has made use of a powerful

analogy, comparing the situation to that of a toll

road. ARCEP observes that toll roads price

differentiate price between cars and trucks, on the

grounds that the latter are more demanding than

the former (since trucks will cause more wear to

the road, and thus require higher maintenance to

support). However, toll roads are not able to

discriminate between, say, a red truck and a blue

truck.

Translating this into the world of telecoms, this

suggests that a network should be able to price

delivery of packets that are part of a high-priority,

time-sensitive video stream over and above those

that comprise an email. However, it would not be

permitted to discriminate between a video packet

originating from an incumbent retail division’s

IPTV product over one originating with the

equivalent service of a rival (assuming, of course,

that the two were paying for the same level of

video prioritisation). This is, in our opinion, the

real risk that regulators are entitled to address,

rather than the excitable warnings about the

emergence of a new form of ‘censorship’ that are

heard from some quarters. (For instance, certain

of the shriller voices on the net neutrality side

have even claimed that, were net neutrality

ignored, Republican-leaning political blogs would

be quicker to access than Democrat-leaning sites;

such claims seem far fetched).

It will be observed that the debate over non-

discrimination is therefore in essence merely

another repeat of the time-worn ‘infrastructure

dominance leads to downstream market

advantage’ concern, which has been frequently

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dealt with in the regulation of incumbents. (A

good example being the fact that many

incumbents’ retail arms are obliged to purchase

ADSL services from their associated wholesale

divisions on precisely the same terms as third-

party resellers).

European regulators like Ofcom do, however, flag

the fact that the pricing of prioritisation could in

future become a concern to them. For instance, if

access to the end consumer was controlled by a

relatively small number of parties (quite possible

in a NGA world), this might facilitate over-

charging for prioritisation – which would, in turn,

necessitate regulatory action. But, as Ofcom

acknowledges, this is certainly not an issue at

present.

The above said, being permitted by the regulator

to charge for prioritisation and actually being able

to successfully push through such tariffs are two

entirely different things. So, while the regulator

might be happy for an incumbent to charge for

prioritisation, this is not to say that the latter

would actually be able to persuade, say, Google to

pay such a fee for streaming HD video. And if an

operator was unable to make Google pay, then (on

grounds of non-discrimination) it would find it

difficult to force others with HD video content to

do so. Any broadband provider that refused to

provide prioritised connectivity to Google (since

the latter would not pay the relevant premium)

would obviously risk losing many of its customers

– who might well churn to any competitor that

was prepared to deliver the necessary prioritised

bandwidth without the incremental tariff

(presumably with the goal of taking market

share).

This could prove a stiff test, though the

concentration of the infrastructure market that we

envisage with the evolution towards NGA

platforms should help. The capital intensity

involved in this transition should concentrate the

market, and with fewer participants (each of

which will have committed very substantial

capital to its access network), it is easier to

envisage how an element of prioritised tariffing

might be introduced. It would likely be easiest to

charge incrementally for the prioritisation

required to support newer services, such as the

streaming of HD video. It is also worth

highlighting recent developments in the mobile

market, where the adoption of tiered pricing plans

has been near-uniform – despite the temptation

that would have presented itself to some networks

to decline to follow, and instead to look to capture

market share.

The other vital requirement is that operators be

transparent with their customers about their traffic

management. In other words, customers must be

made aware of the way in which their traffic may

be ‘shaped’. Although this objective is simple

enough to set down on paper, it could prove a real

challenge to implement in practice – after all, the

topic is a complex one with many variables, and it

would be difficult to convey to consumers the

day-to-day implications of the differing

prioritisation offerings. Nonetheless, according to

EC Commissioner, Neelie Kroes, transparent

traffic management is ‘non-negotiable’. This

could become a thorny issue, but the generally

well-considered tone of most European regulators

on the whole net neutrality subject is surely a

positive for telecoms investors. To quote Ofcom:

At the current time we do not think there is

compelling evidence of anti-competitive

behaviour. Therefore, we do not think that there is

a strong rationale for preventing ex ante all forms

of traffic management. Indeed, given the potential

for network congestion, some forms of traffic

management are likely to lead to consumer

benefits.

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Rise of the CDN Net neutrality is an important topic already, but is

set to become still more so as over-the-top (OTT)

services develop (where OTT denotes any third-

party service delivered over the top of a

broadband platform). Historically, the telecoms

space has been dominated by vertical integration –

that is to say, those operating the infrastructure

have typically also been those selling services

utilising that infrastructure (ie voice, and so on).

However, regulators have intervened in order to

ensure that dominance ‘upstream’ in the network

does not bestow dominance ‘downstream’ in the

services.

As the arguments above (hopefully) outline, it is

perfectly feasible to introduce priority charging

without doing so in a discriminatory fashion that

advantages the incumbent’s own retail services.

And, with access to superfast bandwidth

consequently equally accessible to all, it becomes

all the more important to ask the question whether

or not those providing the network connectivity

are necessarily best placed to deliver the services

that utilise them. After all, to employ an analogy,

most road construction companies do not

manufacture motor vehicles, or run coach

services.

In a regulatory environment where operators are

able to use techniques like bundling to leverage

their network platform advantage (for instance, by

offering packages combining telephony,

broadband and IPTV), it makes sense to do so

(see our thematic report, Quadrophonia, February

2006). But where this type of cross-leverage is

inhibited, the best course of action becomes much

less apparent.

Naturally, there remain some persuasive

arguments in favour of telecoms operators

persisting with the bundling of products that are

outside their traditional sphere of expertise, but

that may nevertheless help them sell connectivity.

So we would continue to advocate operators

pushing IPTV as a part of their service suite.

Persuading customers to take broad bundles also

has a proven track record in terms of lowering

rates of churn. However, we would caution that it

is generally (though with some notable

exceptions) difficult to see how the typical

telecoms operator – at least in developed, western

markets – is really likely to add value in its

capacity as, for example, a media player.

Unless the operator is prepared to invest in

content of its own (a prospect that would probably

terrify the majority of investors), it would simply

be reselling others’ product – with likely thin

margins. Hence, even if a telecoms company

achieved reasonable market share and thereby

captured incremental revenues, the additional

profitability associated with this activity would

likely be relatively minor.

Media content distribution through long-haul vs CDN

Media company

using CDN

Regional server

Regional server

Media company

using long-haul

Media company

using CDN

Regional server

Regional server

Media company

using long-haul

Source: HSBC

But another powerful justification for operators

getting involved in this space is to stimulate the

market in general, knowing that they will receive

their reward, if not necessarily from selling the

service itself, then through providing the

underlying connectivity. And, whereas the gross

margin involved in reselling others’ content is

often negligible, the gross margin from providing

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superfast broadband connectivity ought to

approach 100%.

In other words, operators need not make a

colossal success of their own retail IPTV efforts

to nonetheless benefit from IPTV services. After

all, whoever owns the content still needs a

distribution mechanism to get it to the viewer –

and the most flexible and powerful of these is the

telecoms (or cable) pipe. The quicker new

applications dependent on superfast bandwidth

develop, the quicker and more compelling end

customers will find the NGA proposition. In other

words, the best way for an operator to spur fibre

adoption may be to ensure that a wide range of

applications are available over its platform – and

are certainly not restricted to those provided via

its retail arm.

Hence, regulatory and commercial interests may

converge with the practical business reality that

telecoms operators are not identified by

consumers as the most natural providers of

services beyond telecoms. And there are signs that

some operators are beginning to acknowledge

this, for instance through their investment in

content delivery networks (CDNs). Capex in this

field is effectively providing third-party providers

of OTT services with the infrastructure they

require to ply their trade. Hence we might say that

CDNs deployed by telecoms incumbents are, in

effect, the infrastructure and connectivity face of

OTT services.

What is a CDN?

The principle behind a CDN is simple enough.

Instead of, say, a media company streaming its

video content from a single bank of servers in one

location to customers wherever they are in the

world, the idea is to distribute the content to

regional servers, closer to the end user. This

obviously significantly cuts down on the quantity

of ‘long-haul’ international data traffic generated,

thereby saving the content owner on traffic

carriage fees.

So telecoms operators could be forgiven for

regarding CDNs with some suspicion, since they

effectively undermine certain revenue streams.

But in practice, operators have often been keen to

have CDNs attached to their network because the

resulting additional traffic enables them to

negotiate better interconnection terms with rival

telecoms networks. Moreover, if time-sensitive

services like video streaming are to achieve the

high degree of quality of service required before

they are to take off, it is clearly advantageous that

the content be as close as reasonably possible to

the consumer (as a shorter distance, requiring

fewer hops between servers, naturally facilitates

quicker delivery and means there is less to go

wrong).

The CDN arena has been dominated by specialists

in this field, often deploying their own proprietary

technologies so as to optimise their service. The

largest and best known of these companies is

Akamai, although it has numerous smaller

competitors. These ranks are now being joined by

the telecoms operators themselves.

The challenge

The CDN represents an interesting revenue

opportunity in its own right so far as the telecoms

operators are concerned. But this field is not

without its challenges: not only does it already

contain a set of entrenched players, but many of

the potential clients could be OTT competitors of

the incumbents. Nevertheless, CDNs are the type

of ‘connectivity’ service in which telecoms

operators ought to have some natural advantages.

One notable aspect of this market is that, because

it has evolved on an ad hoc basis, there has been

little by way of standardisation – quite a contrast

from the telecoms world, where everything

depends on the network effect. Therefore, one

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opportunity open to the telecoms operators is

effectively to leverage the benefits of

standardisation by bringing this to the CDN

industry, perhaps by forming an international

alliance (although such arrangements admittedly

have a poor track record in telecoms).

One of the benefits to the client of this approach

would be that it could rely upon having its content

distributed from multiple locations across the

globe while only having to manage one, unified

set of technology protocols (even if the various

participants were to use different flavours of

technology underneath). This would also address

an obvious weakness of existing operator CDN

capabilities: although incumbent networks have

unparalleled depth in their home markets, they

typically lack the global reach of the larger CDNs

(meaning that content owners could be put to the

inconvenience of securing deals with several

different companies if they were to cover different

regions).

But can the telecoms operators persuade content

owners to come to their CDNs? Some of the

internet giants that have invested heavily in their

own hosting facilities are in direct competition

with the operators in many market segments; the

likes of Google and Apple fall into this category.

Another prominent class of CDN customer are

those engaged in OTT IPTV services. To cite an

example, the BBC uses Akamai’s platform to host

its popular on-demand iPlayer service.

Parties such as the BBC, that regard themselves

essentially as content producers, and which have

no ambitions in the area of connectivity, might

well be prepared to consider a telecoms-run CDN,

were the price/service level advantageous.

However, other OTT players will have conflicts

of interest: for instance, BSkyB competes with BT

in both television services and ADSL. This rivalry

would likely make it difficult for BSkyB to rely

upon BT’s CDN service.

Nonetheless, it is interesting that BT’s Wholesale

division has recently established a UK CDN

capability (known as ‘Content Connect’) with the

specific objective of hosting video content –

suggesting that it sees OTT IPTV of one sort or

another as an appealing market segment.

Doubtless BT Retail will become a customer,

given the latter’s ambitions for its Vision payTV

product. And Orange – assuming it moves into the

IPTV arena – would also seem a likely customer,

given that it has already decided to take a BT

wholesale product for its retail broadband

offering.

The other potential differentiation that operator

CDNs might offer relates to their ability to

leverage their control of the underlying network to

provide quality of service (QoS) functionality and

guarantees. It is fair to say that content providers

at present remain unconvinced about the merits of

this proposition. This may largely be as a result of

uncertainties over the business model, and in

particular the controversial question of which

party should pay the premium that a prioritised

QoS streaming service would entail. But, at least

in those markets where regulators adopt an

enlightened approach to net neutrality (ie permit

scarce network resource to be rationed on price –

as looks likely in Europe), it would appear

probable that telecoms CDNs could monetise this

capability. This should particularly be the case as

video becomes ever higher definition, so imposing

a greater burden in terms of the sheer volume of

data packets requiring prompt delivery.

Furthermore, it may become harder for existing

CDNs to continue to provide their present level of

quality of service. In the past, CDNs have often

been able to install their servers at key points on

the telecoms operators’ networks. The operators

have consented to this because having the data

cached locally cuts down on the cost of transiting

it in from elsewhere. But the telecoms players

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might now start charging properly for this

privilege; if this leads to third party CDNs hosting

their content at more distant locations, it could

impair the QoS provided. In turn, this would

increase the appeal of operator-controlled CDNs,

given their ability to provide QoS guarantees.

We therefore conclude that CDNs should provide

some potential upside for the telecoms operators.

Based on the company’s own estimates, Akamai

delivers around 15-30% of all web traffic. In

2011, Bloomberg consensus anticipates revenues

of USD1.2bn and EBITDA of USD544m; as of 11

February, the company had a market capitalisation

of USD7.5bn. If we make the simplistic

assumption that all web traffic is handled by

CDNs (which is not as unrealistic as it might

sound given the particularly heavy bandwidth that

video consumes), then we can gross up to an

estimated market size of about USD4-8bn.

Of course, given the likely increasing importance

of this service, these numbers are doubtless set to

grow strongly. Nonetheless, the size of the market

– while material – is still relatively modest by

comparison with that for connectivity in the

access layer, which NGA upgrades address.

Hence the importance of CDN for telecoms

incumbents is arguably as much in their

recognition of the need for CDNs to drive OTT

services in order to spur NGA penetration rates as

in their intrinsic profitability.

Fixed-line technology The view that a degree of pricing power should

return to the fixed-line telecoms subsector is

clearly predicated on the idea that an element of

scarcity is returning to the sector, given the

tremendous expense of the fibre upgrades that are

now underway. What, though, if alternative

technologies emerge that would permit operators

to upgrade to superfast broadband speeds without

the capital commitment demanded by fibre-based

systems? Recently, a set of upgrades to copper-

based DSL technologies have led to the

suggestion that fibre investment may be

premature. Were this the case, it would obviously

call into question the presence of scarcity in fixed-

line telecoms, and thus the sustainability of any

pricing power that the incumbents might have

begun to enjoy here.

Phantom of the copper-a

Although fibre clearly represents the future of

telecoms access networks, as an infrastructure it is

plainly both expensive and time consuming to

deploy. (Indeed, this is one of the reasons we like

the technology: since it is intrinsically expensive

even to unbundle, let alone to replicate – and the

capital involved should therefore also elicit more

supportive regulation).

However, the above said, a number of vendors

notably including Alcatel Lucent, ECI Telecom

and Ericsson are actively pushing two innovations

that could potentially squeeze more life out of

copper-based DSL systems: namely vectoring and

what is (rather cryptically) termed ‘phantom

mode’.

Alcatel Lucent announced in 2010 the results of a

laboratory test in which two bonded VDSL2

copper pairs delivered 300Mbps over 400 metres

and 100Mbps over 1km. By comparison, a single

VDSL2 copper pair line would have a maximum

bandwidth of around 100Mbps.

These enhanced speeds were, in part, the result of

implementing dynamic spectrum management

level 3 (DSM L3) commonly known as

‘vectoring’. This exploits similar techniques to

those used in noise cancelling headphones to

mitigate far-end cross-talk (FEXT), which acts as a

substantial impairment to the bandwidth and range

that can be provided over bonded DSL pairs.

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A further boost to the available bandwidth is

generated through the creation of a third, virtual pair.

DSL pairs consist of a ground wire and a signal wire.

When two pairs are bonded together, one of the

ground wires is effectively surplus, and can be

converted into a signal wire, a technique known as

‘phantom mode’. Again, vectoring is applied to

reduce the negative effects of cross-talk from the

phantom mode circuit. Bonded together, these

techniques together can – in the laboratory at least –

create a 300Mbps pipe.

Naturally, these speeds sound exciting. Moreover,

superficially, these technologies might seem to be a

real positive for the industry, since they could

materially reduce its capex requirements. However,

for the reasons outlined above, it turns out that the

amount of capital required for fibre upgrades

(affordable to incumbents but inaccessible to most

altnets) is in fact an important positive for the sector.

But, leaving such points aside, the new technologies

are in fact less practical than they might at first

appear. Firstly Alcatel Lucent’s test relied upon

high-quality 0.6mm-gauge copper. While this might

be standard issue for new copper pairs installed in

the last twenty years or so, the vast majority of the

world’s installed copper plant consists of poorer

quality, thinner, less conductive 0.4mm or 0.5mm

lines.

Secondly, to take advantage of the new technologies,

a home requires not one but two copper pairs. This is

unusual in most markets: lines were doubled up in

the narrowband internet era, when households would

have a second line dedicated to their internet

connection, but this was rendered redundant by the

shift to broadband.

It is also worth noting two additional handicaps.

Firstly, new customer premises equipment (CPE) is

required, as well as upgraded line cards

(incorporating dedicated chips capable of coping

with the greater signal processing demands of real-

time noise cancellation). Secondly, in order to derive

the full benefit from vectoring, an operator really

needs to control all of the pairs connected to the

DSLAM; clearly, this is typically not the case in

markets where local loop unbundling has gained

traction. Hence, our conclusion remains that fibre-

based systems (whether FTTN/VDLS or FTTP) are

required to deliver superfast broadband services, and

given the capital that these roll-outs require, we

continue to be of the view that they will reassert the

importance of capital and scale within the industry.

Techniques such as vectoring and “phantom mode” have produced greater speeds from bonded VDSL2 over copper in lab tests

Ground wire

Signal wire

Ground wire

Signal wire

Signal wire

Ground wire Signal wire “Phantom circuit”

Signal wire

Ground wire

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cto

ring

miti

gate

s FE

XT

b

etw

een

sig

nal w

ires

Vec

tori

ng m

itiga

tes

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Ground wire

Signal wire

Ground wire

Signal wire

Signal wire

Ground wire Signal wire “Phantom circuit”

Signal wire

Ground wire

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cto

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Source: HSBC

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NGA roll-out status

Country Technology Coverage achieved by the incumbent

Incumbent's coverage target Cable network status Cable vs incumbent Broadband market shares

Belgacom VDSL 76% population coverage by end-Q3 10

80% by mid-2011 TNET has upgraded 100% of its network with DOCSIS3.0

Battle of equals 61% incumbent and altnets, 39% for Cable

British Telecom

VDSL/FTTH Ramping up the coverage, aim to reach 4m HH by Dec 2010, adding 70k HH/week

10m (c40%) premises by 2012 (o/w 2.5m FTTH)

50% UK coverage , but100% of its network is DOCSIS3.0

VMED at an advantage in the medium term

21% for Virgin Media Vs 28% for incumbent

Deutsche Telekom

VDSL/FTTH VDSL coverage 25% of German homes

Plans to increase VDSL coverage to 31% HH (c12.4m HH) by 2012, 10% FTTH coverage (c4m HH) by 2012

UnityMedia and KabelBW have upgraded 95% of footprint, Kabel Deutschland 30%; by March 2012 65% of all German homes will have DOCSIS3.0

Cable at advantage even in 2012 1/3 of German homes covered by DOCSIS3.0 but no telco NGA infrastructure

DT 45%, Cable 13%, rest altnets

France Telecom

FTTH c650k HH passed by FTTH at end Q3 10

Fibre in all 96 homeland and in 3 overseas administrative districts by 2015

Numericable covers 9m homes out of 26m, no clear indication of DOCSIS3.0 coverge, we assume c2.7m homes

Cable at a disasdvantage (weak financials + FT Ilad and SFR inveting in FTTH)

Cable is 6% of the BB market

KPN VDSL/FTTH KPN is rolling out FTTH through its JV Reggefiber and has already passed 658k homes. Has 80 % IPTV coverage with VDSL/ADSL+

Targeting 1000-1300k homes passed by FTTH by 2012e and has ambition of 30-60% coverage in Netherlands

UPC (Liberty Global) is nearly fully DOCSIS3.0 upgraded and Ziggo is fully DOCSIS3.0

Battle of equals KPN 41%, all other cables 40% (as of Q4)

Portugal Telecom

FTTH 1m homes passed by Dec 2010

Reach 1.6m households with FTTH

DOCSIS3.0 100% upgraded completed with 3.2m homes passed

Battle of equals (ZON covers more households with DOCSIS3.0, but PT's FTTH is superior to DOCSIS3.0)

PT: 46% ZON: 33% (as of Q3 10)

Swisscom VDSL/FTTH 78% VDSL coverage FTTH coverage of 1m (33%) households by 2015

DOCSIS available to 75% of home passed by Cablecom (Liberty Global)

Battle of equals Cablecom 18% vs incumbent 55%

Telecom Italia

VDSL Upgrading Milan and to start Rome, no significant progress yet.

Target to reach 10-12% HHs by 2012. And 50% HHs by 2018

No cable in Italy TI 55.7% (as of Q3 10)

Telefonica VDSL Awating for regulatory clarity. No material progress as such

Previously guiding to spend EUR 1bn in the period 2008-2012. Update expected in April 2011 (Investors day)

ONO covers 7m homes (44% of total), out of which 4.7m upgraded to DOCSIS3.0 (as on Nov 10)

Battle of equals TEF: 54%, all cable 18.5% (Q2 10 CMT data)

Telekom Austria

VDSL/ FTTEx/ FTTC/FTTH

42% of HHs have access to Giganet network through comination of FTTEx (38%), FTTB,FTTC & FTTH (4%)

Giganet Access (combination of FTTEx, FTTC, FTTB, FTTH) for 50% of Austrian Households by 2011

UPC Austria (LGI) has DOCSIS3.0 covering 40% of Austrian homes

Battle of equals, TKA covers cable footprint with VDSL or FTTH; TKA only incumbent guiding for net line growth

30% TKA, 16% cable, 35% mobile bb only, rest altnets

TeliaSonera VDSL/FTTH Fiber to 430k households (10% of total households)

Fiber to 50% of households by 2014

ComHam covers 40% of Swedish homes and has mostly upgraded to DOCSIS3.0

Battle of equals but with Telia clear commitment to invest in NGA

Telia 35%, ComHem 19%, Bredbandsbolaget 15%, rest altnets

Source: Companies, HSBC

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Introduction The idea that mobile data capacity is intrinsically

scarce and that this will result in pricing power for

the operators has proven highly contentious. For a

variety of entirely understandable reasons,

operators are nervous about broaching the subject.

Even the suggestion that a company’s network is

under strain and might require remedial

investment might scare off investors and

customers alike. But, that said, there is now an

increasing body of evidence in support of the

arguments originally outlined in our thematic

reports The Capacity Crunch (8 December, 2009)

and Frequonomics (March, 2010). For those

unfamiliar with the technological arguments

underpinning our view on the intrinsic scarcity of

mobile data capacity, we have summarised our

thesis in the final part of the present section.

A few operators such as AT&T and America

Movil now have the confidence to guide for

higher capex, and, in the meantime, there has been

a profusion of networks introducing tiered data

plans to ration their scarce bandwidth resource.

We believe that tiered tariffs will enable operators

to properly monetise the data opportunity. The

potential profitability of this area remains subject

to intense scepticism, although we would

highlight the fact that the track record of eMobile

in Japan – a mobile operator that only provides

data services – is extremely encouraging (moving

from service launch to operating profit break-even

in just under three years).

SuperFrequonomics In our view, the mobile telecoms market stands at

an important juncture. In the past, capacity has

been relatively abundant, thanks in no small part

to the fact that each new generation of technology

has enabled operators to squeeze significantly

greater volumes of traffic over a given portion of

radio spectrum. In tandem with steady increases

in the quantity of radio frequencies devoted to

mobile services, and rapid growth in the number

of base stations deployed by the operators, this

has enabled the industry to move from niche

status to supplying the communications needs of

billions globally.

However, existing technologies are already highly

efficient, and, indeed, are approaching the

physical constraint that is the Shannon limit. This

caps the quantity of data that can be conveyed

over a Hertz of radio frequency in a second.

Given the interference levels that we can expect in

most environments, the Shannon Limit stands at

around 2 bits per second per Hertz. Current

technology already manages around 1, implying

that a doubling in efficiency is the theoretical

maximum; in practice, the next generation of

4G/LTE equipment is likely to be around 30%

more efficient than today’s systems.

Mobile connectivity

Pricing power evident in widespread shift to tiered data tariffs

Certain operators now prepared to indicate capex is set to rise

eMobile shows data-only services can generate healthy profits

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Of course, operators can also purchase more

spectrum (although this can be very expensive)

and build more base stations (also costly). We

would expect them to do both, and with vigour.

We also anticipate use of alternative strategies –

everything from MIMO (multiple input multiple

output antennae) to base station caching to

wireline offload (of which more later). Yet,

despite all of this, we still think that capacity will

be intrinsically scarce and hence require rationing

by means of price.

Given the unpopular and contentious nature of

capex in telecoms, we would expect operators to

delay as long as possible before investing more.

Certainly, they will need to demonstrate the

attractiveness of the opportunity before they will

be able to confidently justify the additional

expenditure. Hence, the first evidence that we are

on the right track with this thesis is unlikely to

emerge in the capex line. Instead, we would argue

that investors should look to operators’ approach

to tariffs as a leading indicator. Because, by

adopting the appropriate pricing strategy, and

rationing their scarce capacity resource, operators

should be able to manage their capex line while

demonstrating to the market the appeal of data

services. Once this has been accomplished, they

can subsequently announce their intention to

invest more without the same risk of pillory.

The AT&T narrative

AT&T is arguably the best example of a corporate

establishing this narrative. On the company’s Q3

2009 conference call in October, management

were adamant that the network was up to the job,

despite the numerous complaints from iPhone

customers that the AT&T platform was

Shannon Limit sets a ceiling on mobile spectrum efficiency

1

2

3

4

5

6

0

-15 -10 -5 0 5 10 15 20

Typica l loaded mobile n etw ork (outdoors)

Inaccessible

Region

Lower interference environmen ts e .g. isolated hotspots, femtocells

Shannon li mit

Shannon li mit with 3dB offset

OFDMA

CDMA (HSPA)

Required SN R (dB)

Ach

ieva

ble

rate

(bps

/Hz)

1

2

3

4

5

6

0

-15 -10 -5 0 5 10 15 20

Typica l loaded mobile n etw ork (outdoors)

Inaccessible

Region

Lower interference environmen ts e .g. isolated hotspots, femtocells

Shannon li mit

Shannon li mit with 3dB offset

OFDMA

CDMA (HSPA)

Required SN R (dB)

Ach

ieva

ble

rate

(bps

/Hz)

Source: Alcatel Lucent, HSBC

Capex/sales for various operators with wireless operations

0%

2%

4%

6%

8%

10%

12%

14%

16%

18%

Vodafone AM X AT&TWireless

Sprint NextelWireless

VerizonWireless

2009 2010 2011e

Source: Company reports and HSBCe

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struggling. Then, at the Q4 2009 results

conference call in January 2010, the company

unveiled a significant network investment

programme. But with service revenue growth in

the mobile division of nearly 10%, there were few

complaints. And, in fact, capex growth in the

wireless division for the full year 2010 eventually

came in at around 50%, considerably higher than

implied in the original guidance (a USD2bn or

c30% increase) Investors, though, can plainly see

that the capital is being invested in what is a very

attractive business.

AT&T was also among the first operators to shift

to tiered pricing structures for its iPhone4

smartphones. Such plans have the advantage of

linking consumption with revenues, encouraging

customers to consume capacity responsibly (rather

than utilising their connectivity for peer-to-peer

activities, for example) and, very likely, to

ultimately spend more to obtain additional

bandwidth (in the same way that many customers

have migrated over a period of time to larger

minute plans commanding a higher ARPU).

Remarkable uniformity

Operators right across the developed world have

followed suit in a remarkably short period of time

(while most in the emerging markets had refrained

from offering unlimited data plans in the first

place). In a fractious, highly competitive market

like mobile, where operators are quick to pounce

on any opportunity to take market share, a shift

displaying such uniformity demands a coherent

explanation. The ‘control experiment’ provided

by the voice market (where unit prices continue to

decline rapidly) indicates that, whatever is taking

place, it is unique and specific to the data arena –

rather than being a function of the broader

competitive environment, for instance.

In our minds, the only plausible driver of this

rapid transition is the emergence of capacity

constraints among the operators. An operator

contemplating the otherwise risky introduction of

caps to its data plans can move with greater

confidence because it understands that its rivals

are in a very similar situation, facing similar

challenges. In other words, any operator leading

the way by introducing tiered pricing plans will

likely find its chief competitors following, rather

than attempting to seize market share by

exploiting the lead operator’s introduction of a

more complex and inflationary tariff.

So it was perhaps not so surprising that, at its H1

2010/11 results presentation, Vodafone

management indicated that in almost all of its

European markets, its introduction of tiered data

plans had been followed – rather than undermined

– by its chief competitors. We would infer that the

one exception that Vodafone alluded to was the

Dutch market. And even here, according to KPN’s

Q4 2010 results presentation, the market has now

moved in the direction of tiers.

This is not to suggest that the pricing moves have

been entirely in one direction. Nevertheless, the

degree of uniformity witnessed is remarkable by

telecoms standards. But what of the dissenting

voices? As discussed in our SuperFrequonomics

report (September 2010), some of these are

relatively small operators that are perhaps not

greatly significant in terms of the overall market

(such as Virgin Mobile USA, part of Sprint

Nextel). Others result from local market

circumstances (for instance, South Korean

operators have an unusual abundance of capacity

due to years of government-sponsored, industrial

policy-driven, over-investment in network). Still

others have indicated that their current all-you-

can-eat offers are unsustainable in the longer-term

(for example, Telenor Sweden). However, one

prominent European operator is keen on flat-rate

data tariffs, namely Three.

The view at Three is that the operator has

sufficient capacity not to need to ration it tightly

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by means of price. What is particularly interesting

about this is that its network sharing partners in

the UK (originally T-Mobile, but now also

Orange, as a result of the ongoing merger between

these two) seem to take a very different view,

despite the fact that all effectively operate off the

same infrastructure. So it is notable that, despite

Everything Everywhere (the name of the

combined Orange/T-Mobile UK entity)

highlighting at its inaugural presentation its

advantage in terms of numbers of base stations

over its rivals O2 and Vodafone, it nonetheless

has the tightest caps among its peers restricting

the usage of its iPhone4 customers.

Who is right? Is capacity abundant, implying that

Three UK can afford to maintain its generous

offers on mobile data? Or is Orange/T-Mobile

UK’s characterisation more accurate, implying

that Three will – in time – be forced to more

tightly limit the bandwidth its customers

consume? At this stage it is too early to tell

directly, although it must have been one fear at

France Telecom and Deutsche Telekom that

merging their UK mobile assets would effectively

permit Three (which had established a prior

network sharing arrangement with T-Mobile UK)

to ‘piggyback’ on the capacity advantage that the

merger was in part designed to create. Everything

Everywhere has therefore been at pains to

emphasise that, if Three generates the requirement

for additional network capacity, then it must bear

the relevant costs.

The real challenge for Three will be what an

economist would term ‘adverse selection’. What

type of customer would consider churning from

their existing network to Three because the former

introduced tiered pricing structures, thereby

effectively capping usage? The answer, plainly, is

that the customers most prone to jump ship are

those who consume the greatest bandwidth. Given

the capex required to support such customers, the

network losing them may consider itself to have

enjoyed the better side of the bargain.

Network failure

Furthermore, recent events in Australia at another

of Three’s networks do raise questions about

operators’ ability to meet the rapidly intensifying

demands of today’s mobile customers. Three’s

Australian business has merged with that of

Vodafone, and competes against Telstra, the

incumbent, and Optus, part of SingTel. In an

effort to gain market share, Vodafone/Hutchison3

positioned itself with a set of generous plans

encouraging heavy voice and data usage.

Unfortunately, even the operators’ combined

network does not seem to have been fully up to

the challenge of meeting the resulting demand.

Customer dissatisfaction has culminated in the

appearance of a local website dedicated to

charting the network’s failings, and even to the

potential launch of a class action lawsuit, with

disgruntled customers looking to sue over the

allegedly poor nature of the service. In response,

the CEO has issued a public apology, and pointed

to the company’s AUD550m network upgrade

programme. With respect to Vodafone

specifically, it should be stressed at this point that

the group’s Australian activities are not a

substantial proportion of the company (and thus

do not derail our investment thesis); as well as

that Vodafone has typically considerably out-

invested its rivals, and so should actually enjoy a

competitive advantage versus the competition in

most of its markets of operation. Nevertheless,

this example is useful in terms of highlighting the

problems that can rapidly emerge when pricing

plans encourage usage that the underlying

network is unable to support.

To summarise, in view of the type of experience

seen in markets like Australia (as well as the

previously mentioned example of Telenor

Sweden), it remains our view that unlimited plans

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are counter productive. If network service quality

is impaired, the resulting damage to an operator’s

brand could prove enduring. The risks therefore

involved with flat-rate pricing perhaps go a long

way towards explaining its increasing rarity.

Note, though, that while operators would (in our

opinion) be well advised to avoid selling data

tariffs on the basis of a flat rate, all-you-can-eat

approach, nevertheless this concept remains

highly attractive from a marketing perspective.

Hence operators’ marketing may well continue to

suggest that their plans provide a ‘flat-rate’

approach, even while they are in actuality merely

selling a finite chunk of data. So, for example,

certain of E-Plus’s data plans in Germany are

described by the operator as ‘flat-rate’ but in fact

have caps varying between 50MB and 5GB.

Recent pricing trends positive

As discussed above, starting from Q2 2010, tiered

data pricing has been spreading rapidly across the

industry. In the months following the publication

of SuperFrequonomics report (September 2010),

there have been many further announcements

confirming this shift as a consolidated trend. A

selection of the most interesting examples are

detailed below.

Vodafone (Europe)

Vodafone announced in its fiscal Q3 2010/11

(calendar Q4 2010) results release that the

company had completed the migration to tiered

data plans in eight western European markets. The

remainder will follow in Q4 2010/11, so that by

the end of March 2011 all the European

operations should have moved to tiered data

tariffs.

Taking tiering one step further is the practice of

‘smart notification’, which has been tested with

success in the UK over the last quarter. As users

approach their allocations, they are contacted and

offered either a block of additional data or the

option of upgrading to a bigger plan. Such

solutions reinforce the inflationary potential of

tiered data plans. Vodafone will extend the

service to other Western European markets this

quarter, starting with Germany and the

Netherlands.

A further sign of Vodafone’s determination to

ration data capacity comes with the news that

allowances in Italy are being reduced from

2GB/month to 1GB/month, although this move

has so far not been followed by the main

competitor, Telecom Italia.

Everything Everywhere (UK)

The new joint venture between Orange and T-

Mobile in the UK unveiled its strategy in

September last year. The new entity will have the

densest network in the country and enjoy the

largest spectrum allocation. Despite this, it has

decided to opt for tiered data plans: it is currently

offering data in similarly sized blocks as

Vodafone and O2 (500MB or 1GB per month).

Hence, all large operators in the UK have now

introduced what appear to be sensible usage caps.

However, Hutchison 3G has instead decided to

head in the opposite direction and revert to a flat-

rate ‘all-you-can-eat’ approach for the 16GB

version of the iPhone4 (for the 32GB model

500MB and 1GB per month plans are offered in

addition to all-you-can-eat). This is likely to

encourage very heavy users (eg those partial to

peer-to-peer download activity) to churn towards

Three. Arguably, these are the least desirable type

of customers: heavy users with no willingness to

pay.

It is also worth introducing our usual market share

analysis at this point. We would describe Three as

an ‘infant’ player, as it has not yet achieved a

percentage market share in the teens (so as to

qualify as a ‘teenage’ operator). Just like their

teenage rivals, infant networks certainly have the

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incentive to disrupt the market; however, unlike

teenage operators, they typically lack sufficient

weight to really rock the boat. When teenagers

introduce aggressive price plans, the ‘adults’

(companies with 20%+ market share) generally

must counter; but infants generally the lack the

brand, network and high-street penetration to

force a response.

KPN (Netherlands)

Management has now delivered on the

undertaking made at the Q2 2010 results, namely

that KPN would migrate to tiered data plans in the

Netherlands by the end of 2010. All iPhone plans

come with a data bundle of either 500MB or 1GB

per month. The 1GB per month data plans cost

between EUR45 and EUR110, depending on the

chosen allocation of voice minutes (from 250 to

1,000 per month) and texts (500 to 2,000 per

month).

Meanwhile, KPN’s German operation E-Plus

announced in October a new range of

smartphones to be sold in conjunction with ‘a flat-

fee data package’. Though, at first sight this

would appear to be the very opposite of a tiered

tariff, the plans in fact seem sensibly designed.

Initial caps are as low as 200MB, and beyond this

point customers then have the option of either

accepting a reduced speed or topping up.

It is particularly encouraging to witness a

‘teenage’ operator like E-Plus displaying such a

rational stance with tiered pricing structures.

Firstly – as a teenager – E-Plus has real scope to

damage the overall German market. If it were to

introduce aggressive pricing arrangements – even

if these were of the all-you-can-eat variety - then

the two leading operators (T-Mobile and

Vodafone) might be forced to follow suit. It has

certainly been the case in the past that E-Plus has

adopted aggressive pricing policies in order to

take share, and this has been one of the major

drivers behind the heavy price pressure seen in

Germany over the past half decade. It is also

worth mentioning that O2, the other teenager in

the market, has also been circumspect with its

data tariffs. Its iPhone plan has a monthly data

usage cap of 300MB per month.

Sweden

Sweden is currently one of the most attractive

mobile markets in Europe, with all the major

operators here reporting high single-digit service

revenue growth in Q4 2010. On its results call,

Tele2 management expressed the view that the

market remains only at the bottom of the data

adoption curve. Tele2 was sufficiently confident

about the strength of mobile data demand to be

able to guide for high single-digit service revenue

growth to continue in 2011.

In our view, the key drivers here are rational

pricing in data, together with relatively benign

price competition in voice (and note that MTRs

are already relatively low in Sweden). With the

exception of Telenor, all the major operators have

introduced tiered data pricing. TeliaSonera’s

offering starts with a 2GB block of capacity for

SEK99 (EUR12.7) per month; while its largest

KPN Base Germany: New flat rate data tariffs promotions are actually capped and throttled

Internet Flat S Internet Flat Internet Flat L Internet Flat XL

Offer for… ...people who only occasionally browse the web

…people who access the internet with a smartphone

…smartphone users regularly access the internet

…people who need mobile internet access for their

laptop Data Volume unlimited unlimited unlimited unlimited speed throttled to GPRS (56kbps) at …

50MB 200MB 1GB 5GB

Monthly fee (EUR) 5.00 10.00 15.00 20.00

Source: KPN Base Germany

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package is a 4G offer of 30GB for SEK599

(EUR77) per month.

Currently TeliaSonera imposes speed restrictions

of 120kbps once a user exhausts their data cap.

Telenor, on the other hand, has continued to sell

unlimited data plans, although it does restrain

consumption by capping the speed it provides

once users exceed their allotted usage. Its

cheapest plan is priced at SEK199 (EUR26) per

month, while its high-end offering weighs in at a

hefty SEK549 (EUR71). The relatively expensive

nature of these plans, in combination with the use

of speed throttling, suggest that the risk to Telenor

Sweden from selling flat-rate plans is, at the

moment, modest. Nonetheless, it was interesting

on the company’s Q4 2010 results conference call

to hear management express the view that

unlimited plans are not sustainable in the long

term.

Telecom Italia

With regards to data pricing, Telecom Italia (TI)

remains an exception among the large European

operators, in that it continues to offer what are

essentially flat-rate plans (albeit with a fair-usage

cap of 2GB per month). This state of affairs is

probably explained by the very specific situation

in which TI finds itself. Following an ill-

conceived price increase introduced in September

2009, the domestic mobile operation has been

underperforming its peers. In addition, its 2010

tariff rebalancing in favour of flat-rate plans (in

voice and data) has caused both revenue

cannibalisation and ARPU dilution. We expect the

mobile business will continue to show significant

weakness in Q4 2010 (results to be reported on 24

February 2011), and most likely also throughout

H1 2011.

However, we do not think that Telecom Italia is in

a different position to its European peers with

respect to the intrinsic scarcity of mobile capacity,

and the pressure that will result from increasing

data usage. So while TI has not yet followed

Vodafone Italy’s move to reduce the cap on its

data tariffs from 2GB to 1GB per month, we

would not be surprised if an announcement in this

direction was made in due course.

SKT and KT (South Korea)

The South Korean mobile market was showing

real promise last year, with KT’s introduction of

tiered data pricing plans. However, in July 2010,

SK Telecom (SKT) announced the introduction of

flat-rate data tariffs for customers spending in

excess of KRW55,000 (cUSD50) per month, as

well as free VoIP minutes over its 3G network –

presumably in a bid to take back market share.

Initially, KT insisted that it would not retreat, but

subsequently, in September, the company

capitulated, indicating that it would match SKT’s

flat-rate offers.

While SKT’s move and KT’s decision to follow

were disappointing, there are some important

mitigating factors to consider. First, note that both

operators’ ‘flat-rate’ offerings come with

constraints: usage is restricted in peak hours, as

well as on a dynamic basis in busy cell sites – thus

limiting the potential for debilitating congestion.

Second, although this is hardly the popular

perception of the market in Korea, smartphone

penetration is currently relatively low, at around

15% of total accounts as at the end of 2010. But,

by the end of 2011, we project this figure could

reach as high as 45%. Hence the operators

probably will be able – in the very short-term – to

absorb the additional volumes that their new tariff

plans will doubtless stimulate. The acid test will

only come as usage grows: will the Korean

operators then be able to retain their present

stance? This pressure is likely to fall

disproportionately on SKT, as it lacks KT’s

extensive WiFi presence (and thus the ability to

offload traffic onto the fixed-line network). As at

September 2010, an impressive 67% of KT’s total

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mobile data traffic (2,500TB per month) was

being offloaded onto WiFi.

Thirdly, it is important to recognise that the price

points associated with these tariffs represent a

clear step-up as compared to overall ARPU levels.

For example, SKT’s ‘All-in-One’ flat-rate tariffs

begin at KRW55,000, a considerable premium

over its network ARPU of KRW36,000.

Arguably, the situation is analogous to the

Japanese mobile market back in 2003, when

KDDI first introduced its flat-rate data plans, and

initially achieved very strong growth. The risk is

really that the Korean operators – like their

Japanese counterparts – subsequently find

themselves unable to move away from flat-rate

pricing, because of the sheer number of customers

for whom this has become the norm. However,

this does not constitute a near-term risk.

Verizon Wireless (US)

AT&T’s original introduction of tiered data plans

has arguably been the highest profile to date. This

move was necessitated by the immense loads that

the iPhone (which was exclusive to AT&T until

very recently) imposed on the company’s

network. However, the biggest new development

in the US is very clearly that Verizon Wireless has

now finally also been able to launch a version of

the iPhone compatible with its 3G platform.

At least in the initial stages, Verizon Wireless is

not being aggressive as AT&T in charging its

customers for data usage on a tiered basis. The

minimum requirement for its iPhone customers is

that they should take up an ‘unlimited data

package of USD29.99 or higher’. However, in

order to combat the potential for network

congestion, Verizon Wireless has stated that it

may throttle data rates (ie slow the bandwidth) to

those customers falling within the top 5% of

users. For such customers, Verizon Wireless has

further warned that it “may reduce data

throughput speeds periodically for the remainder

of the then current and immediately following

billing cycle”.

Verizon Wireless has further clarified that data

throttling will be applied in those areas where a

user’s data consumption is impacting surrounding

users. This clearly indicates that the company is

very much mindful of capacity and quality of

service issues, and so we suspect that its approach

is ultimately unlikely to be very different from

that of AT&T. We see its initial tariffs as a

tactical move to maximise the appeal of its variant

of the iPhone and poach customers on the AT&T

network who are frustrated with the quality of its

network. In due course, we would anticipate

Verizon Wireless transitioning to tiered plans.

Smaller operators Sprint Nextel and T-Mobile

USA for now are also sticking with unlimited

plans. However, Sprint commented on its Q3

2010 results conference call that it was continuing

to evaluate tiered pricing plans.

Latin America

The situation in Latin America is rather different

from that in the US, given that most operators

here never sold unlimited data packages in the

first place. Admittedly, the Brazilian mobile

networks did initially offer unlimited access to

email and Facebook-type applications, but

distinguished such usage from that of more

bandwith intensive iPhone customers, who faced

‘fair usage’ caps from the outset. But, by 2010,

the operators had switched to some form of

limited tiered price plan in conjunction with most

handset models.

Vivo and Claro, which cater to higher-end

consumers and have a better mix of contract

subscribers (c20%), have largely withdrawn

unlimited data plans altogether. That said, Claro

has been offering an unlimited data plan with the

iPhone, provided the customer pays the full price

(cUSD500) for the 16GB iPhone4. Meanwhile,

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value player Oi offers tiered pricing, with up to

10GB per month of usage. TIM, which caters to

the large C-class of middle income users (roughly

60% of the population) has taken a different

approach to pricing, by charging on the basis of

time rather than on data volumes. It has also

introduced an unlimited offering for pre-pay

customers, but with speeds that are reduced once a

daily threshold has been reached.

In Mexico, America Movil’s Telcel unit (the clear

market leader) offers a so-called unlimited mobile

data plan, but with speeds that are throttled to a

maximum of 64kbps for the remainder of the

month once a user has reached a 500MB ‘fair use’

threshold. Telcel can afford to be tougher on

pricing than most operators in the Americas given

its dominant market share, and the fact that it is

the only sizeable operator with a 3G service in the

key region of Mexico City.

Capacity crunch We believe that the transformation in data tariff

structure is the most conspicuous ‘smoking gun’

indicating the veracity of our thesis that mobile

data capacity is scarce. The introduction of tiered

pricing is also clearly helpful in providing

evidence that operators should be able to charge

more for the extra capacity that they must supply

if they are to meet demand.

However, there are also indications from other

quarters that mobile data network capacity is

showing signs of being scarce – and even the

admission from certain telecoms companies that

mobile capex is likely to be on the rise, albeit in a

controlled fashion. Given its pan-regional

presence, Vodafone is often regarded as a useful

proxy for the European mobile sector as a whole.

It was therefore particularly interesting to hear

management’s implicit guidance at its H1 2010/11

results that capex was likely to rise somewhat.

The company guided for revenue growth of

between 1% and 4% (as compared to a consensus

of around 1%), as well as for stabilising margins.

However, it did not lift free cash flow guidance on

the basis that it felt it would be advantageous to

invest more in the business. Clearly, additional

subsidies may be required as ever more customers

choose smartphones; but this type of expenditure

is registered above EBITDA. The additional

investment mentioned therefore implies higher

capex. Management remains adamant that the

Vodafone network in Europe does not face

capacity constraints; nonetheless it does now

seem sufficiently confident in the prospects for

data services to implicitly guide to modestly rising

levels of capex.

Again, a crucial point to make here is that

Vodafone has historically out-invested most of its

mobile rivals. In other words, a need (or desire) to

invest more in capex does not indicate (in Europe

at least) that its network is somehow deficient. In

fact, Vodafone cut its capex during the credit

crunch rather less aggressively than most, and so

has been outspending its competitors even

recently. Vodafone’s guidance does not therefore

represent ‘catch-up’ spending. We suspect that if

a consistent, relatively heavy investor like

Vodafone is contemplating rising capex, some of

its rivals may have to up the pace of their

spending by rather more.

We would also point to the track record of AT&T,

which initially guided to a rather modest rise in

capex, but in the end increased its expenditure by

considerably more. While AT&T’s network issues

are somewhat unusual (relating in part to its

somewhat tortuous technology upgrade path), we

would nonetheless argue that there remains scope

for operators to revise upwards their guidance for

capex, as the extent of the opportunity in mobile

data becomes more apparent.

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There are also more subtle indicators that mobile

data services will be subject to capacity

constraints. An interesting and surprising example

is in the détente reached between two long-term

adversaries, Google and Verizon. The former is,

needless to say, the loudest of activists on the

subject of net neutrality; while the latter has

lobbied hard against such regulatory intrusions.

But, in the aftermath of the Comcast court victory

over the FCC on net neutrality, there have been

efforts by industry participants to broker a

solution that would avoid the FCC taking a more

active role in internet regulation.

One result of this was Google and Verizon

reaching a compromise, in which Verizon agreed

that net neutrality was a viable proposition on its

fixed-line network (which, in Verizon’s FiOS

regions, is all-fibre, and hence has enormous

capacity), but in which Google conceded that net

neutrality should not be applied to the wireless

industry. Implicit in this agreement is the idea that

fixed-line capacity is limitless, but that mobile

capacity is intrinsically limited, and thus does

require rationing.

Further to this, the FCC in December 2010

adopted a modified net neutrality policy along

similar lines: applying strict net neutrality

principles to fixed-line networks but conceding

that due to the inherent scarcity of wireless

capacity, that it was only practical to allow

operators to perform legitimate traffic

management, provided that the reasons for doing

so were transparent.

WiFi provides further evidence

Another interesting recent development has been

the announcement by O2 UK that it is to move

more aggressively into the WiFi hotspot market.

With modest additional investment, the operator is

seeking to deploy its hotspots in areas like retail

outlets and hotels, but will then offer the resulting

connectivity to everyone, not just users of its own

cellular network. Ostensibly, the idea here is to

build the O2 brand and win new customers,

attracted by the operator’s innovation and

generosity. The WiFi coverage should also be

useful in going after the fast-developing mobile

advertising market: for example, customers could

receive an advert for a shop conveyed by a WiFi

hotspot located there. Given WiFi’s very limited

range, the advert would reach only customers who

found themselves in close proximity, and could

therefore pop in to the premises in question.

But we suspect that there is more to the move than

the pursuit of potential new revenue streams. O2

UK has enjoyed good success with its (initial)

iPhone exclusivity, but this has resulted in some

well-publicised strains to its network. Although

remedial capex has been invested in particularly

congested areas like London (O2’s Network

Performance Improvement Plan earmarked an

additional GBP100m in 2010 primarily focused

on adding 3G cell sites in major towns and cities),

it would hardly be a surprise – given the ongoing

explosion in data traffic – if the network was still

feeling under strain.

One way to alleviate this would be to use

‘wireline offload’, in which traffic that would

otherwise hit the (contended) cellular base station

is instead routed via WiFi (or, for that matter, a

femtocell) to the fixed-line network (where

capacity is far greater).

Arguably there is a useful parallel here with

Softbank in Japan – which, just like O2, has had

both iPhone exclusivity and its fair share of

network problems. In an effort to alleviate the

burden being placed upon its cellular network,

Softbank has actually been giving out WiFi units

free – though note it is also engaging in an

ambitious capex upgrade programme at the same

time. In our view, Softbank’s twin-pronged

approach really underlines the severity of the

capacity issues facing the industry: management

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guidance for 2010 suggested an increase in capex

of over 80%, and yet the company still felt the

need to embark on a parallel and very ambitious

WiFi hotspot strategy.

Naturally, the approach being taken by both O2

UK and Softbank also raises questions about the

respective roles of WiFi and cellular, and whether

there is a risk that the former cannibalises the

latter. There are certainly some vocal bears of the

mobile space who would argue that WiFi amounts

to a powerful competitive challenge to cellular

systems. But, were this really the case, it is

somewhat difficult to explain why there should be

two cellular networks among those that are

leading the WiFi charge. In fact, both operators

would seem to feel that there is more than enough

capacity demand to justify the deployment of both

types of network.

We covered this topic in some detail in our

thematic report The Cell Side last year (April,

2010). A key conclusion was that WiFi

infrastructure is simply not scalable: in other

words, it is fundamentally incapable of providing

any kind of ubiquitous service. As a result, WiFi

will remain a ‘nice-to-have’ rather than a

necessity. Customers valuing ubiquitous service

(which has been a common feature of all

successful mobile services) will continue to need

to take a service from a cellular operator. See

illustration at bottom of page. As such, it is the

mobile operator that owns the intrinsically scarce

element in the value chain, and thus stands the

best chance of being able to charge for it.

Moreover, if mobile data growth comes anywhere

near forecasts suggesting it will double every year

for a decade (implying something like a thousand-

fold increase over the course of a decade), then

networks will need to perform all the wireline

offload of which they are capable (and more tricks

besides) in order to cope.

So, far from signalling that mobile is set to be

displaced, we see moves into WiFi from the likes

of O2 UK and Softbank as providing further

corroboration for our view that cellular capacity is

intrinsically scarce, implying rising capex but also

price-based rationing – or, to put it another way,

pricing power.

Note, though, that O2 UK has not been the only

British company to recently push into the WiFi

space. BSkyB (hitherto primarily a payTV

operator with an extensive presence in the

unbundled ADSL market) has announced its

purchase of The Cloud, a WiFi hotspot startup.

This move implies that BSkyB are concerned

about the mobile operators’ ability to deliver Sky

Player’s streamed video content to its customers.

The deal might also indicate that BSkyB is

concerned about the type of charging structure

that the mobile operators could choose to impose

WiFi: although handover has improved the barrier remains a practical one: patchy coverage

Cellular: hierarchical cell structures support cost-effective ubiquitous service

WiFiNo service WiFiNo service

GPRS/EDGE WCDMA HSPAGPRS/EDGE WCDMA HSPA

Source: HSBC Source: HSBC

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in order to provide the necessary prioritisation to

ensure adequate quality of service for Sky’s video

streams. However, for the reasons touched on

above, even an acquisition such as this barely

scratches the surface in terms of providing

coverage. BSkyB’s customers will still need to

rely on cellular network transmission if they are to

be able to access their video content in the

majority of locations – although perhaps BSkyB’s

latest acquisition might plausibly improve its

bargaining position.

Note that BSkyB has shown an excellent track

record in terms of being prepared to invest in

order to head off future potential challenges. For

instance, well in advance of BT being able to

bundle IPTV content with its offerings, BSkyB

had entered the broadband market by unbundling

ADSL through its Easynet acquisition. Such a

move need not indicate long-term commitment to

the network market in question – after all, with

the transition to NGA, BSkyB may well return to

wholesaling connectivity from BT, rather than

unbundling the service (although it is participating

in a small fibre trial).

SuperEconomics The commercial appeal of data services remains

subject to widespread scepticism. One part of the

anxiety on this topic relates to the capex that is

required in support. We have argued that levels of

capital intensity are likely to rise, and return to

their (pre-credit crunch) longer-term norms (in

Europe, around 12-13% of sales seems plausible).

Unrestrained, the tremendous growth in demand

for data bandwidth would, in our view, far

outstrip the ability of operators to keep pace (even

allowing for innovations like fixed-line offload

and MIMO (multiple-input multiple-output)

antennas. However, we think that they will be

able to keep the growth to within bounds that they

are capable of satisfying through the use of tiered

plans. But even leaving to one side the question of

capital intensity, there remains the nagging

suspicion in the market that data services are

simply intrinsically unprofitable by comparison

with their voice antecedents. Indeed, it is

frequently said that data is intrinsically dilutive to

returns – perhaps one reason why the prospect of

higher capex in order to deliver it has cast such an

oppressive shadow over the sector.

Judged from first principles, though, there is no

reason to suppose this must intrinsically be the

case. Consider the question through the lens of the

gross margin, for instance. Voice calls often

terminate off-network, necessitating interconnect

payments that remain substantial (despite

regulators’ ongoing efforts). Hence, the gross

margin on voice services must reflect this –

resulting in margins often around the 65% level.

By contrast, with respect to data services,

interconnect is not a factor – hence gross margins

are closer to 100%.

But perhaps the most compelling argument that

mobile data can generate attractive profitability is

of the simple empirical variety. What is needed is

a mobile player that is devoted exclusively to

providing data services. Fortunately, such an

operator does exist, and provides an enticing

insight into the profitability of data, even at a

modest (but not irrelevant) level of market share.

The network in question is eMobile in Japan (the

mobile subsidiary of eAccess): and what should

be truly impressive is that, with market share

standing at a modest 2.4% as at end-2010, we

nonetheless anticipate a full year EBITDA margin

of 27% for the mobile division (for the year to

March 2011).

The eMobile business

eMobile is a wireless broadband operation in

Japan, a country where wireless competition is

intense, while fixed-line broadband services are

the fastest and cheapest in the world (according to

the OECD). Yet, in an environment that looks

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exceptionally tough (at least on paper), eMobile

has flourished. The company has had a number of

factors in its favour; some are market specific, but

others are more broadly applicable:

Competition specifically for mobile data is

actually limited. Direct wireless broadband

competitors (Willcom, UQ Communications)

are currently ineffective competitors because

of financial and operating difficulties, and –

crucially – the established cellular operators

(NTT DoCoMo, SoftBank, KDDI) are

capacity constrained.

New network equipment. eMobile launched

services in March 2007, benefiting from a

Huawei/Ericsson 3G network of an entirely

different order to that deployed by NTT

DoCoMo in its ground-breaking launch of

non-standard WCDMA back in 2001.

Business model designed for wireless

broadband. eMobile intended from the outset

to focus exclusively on wireless broadband.

Strong demand from younger users. Despite

Japanese wireline broadband being both

cheap and fast, eMobile services have tapped

a need among younger Japanese users (many

of whom live with their parents due to high

rental/housing costs) for a private/personal

broadband service.

eMobile launched services in March 2007, using

equipment from Huawei and Ericsson. From the

outset it has seen solid demand for its wireless

services (which were delivered almost entirely via

datacards for the first three years after launch).

Key milestones have included:

eMobile reached 1.6m subscribers (market

share of 1.5%) and break-even on an

EBITDA basis in the quarter ending June

2009.

In the quarter ending December 2009,

eMobile achieved break-even on an operating

profit basis, and moved to operating free

cashflow break-even in the quarter ending

June 2010.

By end-2010, eMobile had 2.924m wireless

data subscribers, equivalent to market share

of 2.4%. We forecast its EBITDA margin in

the year to March 2011 at 27%.

eMobile CEO Eric Gan has controversially

observed that the job of eMobile was ‘merely’ to

provide access – to be the ‘bit-pipe guys’ (in an

interview in Ericsson magazine, December 2008).

eMobile EBITDA (JPYbn) and EBITDA margin trends

-15

-10

-5

0

5

10

15

Mar-08 Jun-08 Sep-08 Dec-08 Mar-09 Jun-09 Sep-09 Dec-09 Mar-10 Jun-10 Sep-10

0%

5%

10%

15%

20%

25%

30%

EBITDA Margin, %

Source: Company data, HSBC

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Given mobile operators’ largely ineffectual

attempts to prevent the surrender of value in the

wireless application layer to companies such as

Apple, his focus on building a profitable business

based on data transport now seems prescient.

eMobile’s pricing mechanisms have been both

sensible and consistent, in our view:

Data pricing has been tiered, with recent

declines in ARPU due to the increased take-

up of plans with a lower minimum monthly

fee (but with more expensive overage

charges).

Netbook subsidies are repaid over a two-year

contract. This is as compared to operators in

Taiwan, which have run several heavily

subsidised, value-destructive offers on

netbook and wireless broadband

combinations. eMobile customers are

required to pay an additional amount over the

monthly fee on a 24-month contract that

cumulatively equates to the value of the

netbook.

Unlike operators seeing substantially higher

marketing costs for smartphones (such as in Taiwan

and Korea), eMobile has seen average subscriber

acquisition costs (SACs) fall due to the sharp

declines in the cost of procuring wireless broadband

modems. Previous company guidance had been for

SACs of JPY30,000, to be split equally between

device subsidy, commission and advertising. Recent

price declines should see the subsidy portion decline

substantially – we project SACs falling to

JPY24,000 in the year to March 2013.

Obviously, with respect to SACs, eMobile’s

experience may prove less relevant to more

conventional operators that will be subsidising

smartphones rather than datacards. Nonetheless,

the operation’s profitability (whether considering

its market share or its time since launch) is

impressive given mobile data’s reputation for

dilution.

The power of pricing power The example of eMobile, then, augurs well for the

mobile industry’s profitability as data services

grow in significance. The outlook should be even

better if operators are able to enjoy a degree of

pricing power in this area. Arguably, eMobile

represents an early instance of this phenomenon

as well. It owes part of its success, in terms of its

degree of pricing power, to the capacity

constraints of its chief rivals – for example,

DoCoMo (which has been saddled with a pre-

standardised WCDMA platform that has

hampered its upgrade path) and Softbank (the

network of which is struggling to cope with the

volumes generated as a result of the company’s

iPhone exclusivity).

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Whatever its precise source, though, there is little

to rival the scale of the impact that the arrival of

pricing power can have on an industry. In order to

drive home this point, it may be useful to consider

a handful of examples. The purpose of this

exercise is not to inspect the mechanisms

conferring pricing power (which are different in

each instance – even within the telecoms sector,

between fixed-line and mobile) so much as to

examine the extent of its impact – most

particularly in terms of valuation.

Perhaps the best known example of the sudden

appearance of pricing power originates from the

oil sector. Lately, OPEC’s ability to control the oil

price has been somewhat diminished as a result of

the development of new reserves in Russia,

Alaska and the Gulf of Mexico. But its members

still own around 79% of the planet’s crude oil

reserves and account for 44% of current

production. It might be supposed that higher oil

prices would translate into greater profitability for

the western oil companies, and thus also, more

generous valuations. However, there are a number

of other factors in the mix – for instance, the

heavy taxation that oil tends to attract. Recently,

strong demand from emerging markets like China

and political tensions in the Middle East have

contributed to a significant appreciation in the

price of both oil itself and the stocks of the

companies that extract it.

There have been two periods of pronounced

scarcity in the oil sector. The first period, 1973 to

1980, was triggered by the actions of OPEC.

Firstly, it decided to raise the price of oil by 70%,

to USD5.11 per barrel. Secondly, it announced its

intention to cut production in 5% instalments over

time until OPEC’s members’ economic and

political objectives were met.

Oil demand is relatively inflexible in the short

term (ie inelastic), and so demand does not tend to

fall dramatically in response to a price increase.

Therefore, the price increase had to be still more

dramatic if it was to curb demand to a level that

the new, lower levels of supply could satisfy. In

anticipation of this, the market price for oil in fact

quadrupled, moving from USD3 per barrel to

USD12 in the space of less than a year.

However, the read-across into oil company

valuations was not straightforward. Of course,

these corporations did not derive as much benefit

from the price rise as those countries actually

owning the oil reserves. Moreover, the sudden

nature of the oil price increase led to a recession,

which impacted demand in the medium term. So,

for example, the share price of Exxon Mobile

OPEC had a dramatic impact on the oil price in the 1970s Oil sector valuations move in tandem with the oil price

0

20

40

60

80

100

120

1965 1969 1973 1977 1981 1985 1989 1993 1997 2001 2005 2009

Crude O il (USD/bbl) (at nominal prices)

0

20

40

60

80

100

120

140

160

1995 1997 1999 2 001 2003 2005 2007 2009 2011

100

200

300400

500

600

700

800

900

1000

Bren t crud e (USD/bbl) (LHS)

FTSE Europe O&G Prod Index (RHS)

Source: BP Source: Thomson Reuters Datastream

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actually decreased from USD2.95 at the start of

1973 to USD2 at the end of 1974. Looking

slightly further out, though, Exxon Mobile’s

shares almost doubled to reach USD5 in 1980 (by

which time the oil price had reached a peak of

USD40 per barrel).

The second period of oil scarcity has been more

recent, driven in large part by the fact that demand

from emerging markets has increased sharply

during a period when production has stagnated.

Political tensions and conflict in the Gulf region

have further exacerbated the situation. From 2003

to its peak in July 2008, the oil price increased by

a factor of 4.7x, from USD25 to USD143 per

barrel. But on this occasion, because the

appreciation was determined more by basic

economics (ie the demand/supply equation) rather

than exogenous political factors, companies in the

oil and gas sector have directly benefited. The

industry’s valuation (as measured by the FTSE

Europe Oil and Gas production index) rose by

1.6x over this timescale.

So, at least in this latter period, the arrival of

pricing power in the oil industry had a significant

impact on its valuation. We would also argue that

a similar phenomenon has been seen in the steel

sector.

The steel industry has a relatively finite

production capacity (at least over shorter time

durations) and, in addition, has been undergoing a

Steel industry valuations vs steel price increases Steel price relative to world Iron & Steel EV/EBITDA

200

400

600

800

1000

1200

2002 2003 2004 2 005 2006 2007 2008 2009 2010 2011

0

500

1000

1500

2000

2500

3000

Ste el HRC price global av g (USD/tonne) (LHS)Datastream World Iron & Steel index (RHS)

200

300

400

500

600

700

800

900

1000

1100

1200

2002 2003 2004 2005 2006 2007 2008 2009 2010 2011

0

2

4

6

8

10

12

14

Steel HRC price global av g (USD/tonne) (LHS) World Iron & Steel EV/EBITDA

Source: HSBC, Thomson Reuters Datastream Source: HSBC, Thomson Reuters Datastream

Steel prices driven by consolidation and increased demand Sharp rise in steel demand powered by emerging markets

200

300

400

500

600

700

800

900

1000

1100

1200

1980 1984 1988 1992 1996 2000 2004 2008

Steel HRC price global av g (USD/tonne)

600

700

800

900

1000

1100

1200

1300

1400

1980 1984 1988 1992 1996 2000 2004 2008

World apparent crude steel consumption (mt)

Source: Bloomberg Source: World Steel

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process of consolidation (eg Arcelor/Mittal).

Meanwhile, in recent years, demand from

emerging markets has exploded. The impact on

the steel price of this combination of relatively

tight supply vs exponential growth has been very

marked. Once world apparent crude steel

consumption rose above the 900mt per annum

mark in 2002, the industry became capacity

constrained, and the price began to shoot upwards.

By 2008, apparent crude steel consumption had

reached around 1,300mt, an increase of 45% from

its 2002 level. Over this period, the steel HRC

average global price rose 3.8x, from USD223 per

tonne to a peak of USD1,079 per tonne. This

translated into a massive appreciation in the value

of the industry: the world Iron and Steel index

rose about seven-fold, from 316 in Jan 2002 to

2,202 in August 2008.

Exponential demand, linear supply Our December 2009 report, The Capacity Crunch,

set out our belief that the mobile industry faces a

major imbalance in the demand and supply of

network capacity. Mobile traffic (demand) has

doubled each year for the past couple of years and

is set to continue growing at an exponential rate

for the foreseeable future, perhaps even for the

next ten years. Cisco, for example, forecasts that

mobile network traffic will grow at a 100%

compound rate to 2014. Note also that the firm’s

current forecast (published in February 2011)

increases projected volumes from the year-earlier

analysis, as shown in the chart below.

Cisco has increased its global mobile traffic (Terabytes per month) forecast over the past year

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

2010 2011 2012 2013 2014

Feb-10 Feb-11

100% CAGR

Source: Cisco Visual Networking Index

Exponential mobile traffic growth is the product

of three compounding factors:

Rising penetration of smart devices such as

smartphones, tablets and connected laptops.

These devices feature full web browsing and

rich media capabilities that in turn spur

massive increases in individual bandwidth

consumption: as customers migrate from

simple voice/text usage to mobile broadband,

use of network resource increases typically

twenty-fold or more. See illustration.

Smart devices consume orders-of-magnitude more bandwidth than basic voice/text mobile phones

=

=

=

X 24*

X 122*

X 515*

=

=

=

X 24*

X 122*

X 515*

Cisco, HSBC. Note: multiples based on Cisco’s VNI Mobile 2011

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As the utility of connected smart devices increases and as the range of mobile applications grows, more and more activities can be executed over the mobile web; hence there will be a propensity for people to use these devices more frequently and for longer periods over time

Consumption will also increase indirectly, as mobile applications become ever more sophisticated and web media ever richer. For example, most web video today is quarter video graphics array (QVGA) format offering approximately half the resolution of a standard-definition (SD) television picture. As mobile video cameras become more ubiquitous and as the quality of video capture on these devices increases, the bandwidth required to upload and download this content wirelessly rises significantly too. A standard definition video file is roughly twice the size of a QVGA format file, while a high definition (HD) file is roughly twice the size again. Bandwidth consumption could thus quadruple – purely due to higher quality video formats – without the user watching another minute of content

Admittedly, though, this is not the first time that the mobile industry has faced skyrocketing demand for capacity – indeed, it has periodically faced capacity crunches a number of times before. This is intuitive when one considers how the mobile market has grown from a handful of developed-market business users in the late 1980s to five billion accounts globally (including 500m mobile broadband users) in a period of a little over twenty years.

It has been possible to add sufficient capacity to support this explosive growth in large measure because of the improved efficiency of mobile network technology. It is this innovation that has massively leveraged the comparatively modest increases in spectrum allocated to mobile services over the period, and thus permitted the mobile market to grow to its current size and scope. Successive generations of infrastructure have enabled operators to squeeze 10-20 times more capacity from a given slice of mobile spectrum than did their predecessors. For example:

2G microcellular architectures and antenna sectorisation enabled much more intensive frequency re-use than was possible in first-generation (1G) analog networks. Replacing,

Global mobile data traffic 2010–2015 (TB per month)

0

1,000,000

2,000,000

3,000,000

4,000,000

5,000,000

6,000,000

7,000,000

2010 2011 2012 2013 2014 2015Nonsmartphones Smartphones Laptops and Netbooks TabletsHome Gateways M2M Other portable devices

Source: Cisco

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say, a four-mile radius analog macrocell with

four one-mile radius microcells increases

channel capacity four-fold, while splitting

each cell into three 120° sectors (known as

tri-sectorisation) increases it a further three-

fold – in this example a total capacity gain of

1,200%, purely as a result of these 2G

innovations

3G code division multiplexing (CDMA)

enabled universal frequency re-use. 2G

systems used frequency division multiplexing

(FDMA), whereby adjacent cells are required

to use discrete frequencies. This had the

implication that operators were only able to

use a fraction (at best, one-seventh) of their

total spectrum in each 2G cell. By contrast 3G

CDMA ensures separation between

communications by means of a unique code

(pseudorandom noise or PN code). This

enables every cell to make use of all the

frequencies allocated to a given operator.

Increasing utilisation of spectrum from one-

seventh to seven-sevenths represents a 600%

uplift in capacity. In parallel, improved 3G

modulation techniques like QPSK (2 bits per

symbol) and 16QAM (4 bits per symbol)

enable more data to be inserted into each

carrier wave cycle than the GMSK (1 bit per

symbol) modulation used by 2G GPRS data

services – thus doubling or quadrupling data

capacity. Bringing all these techniques

together, it can be seen that the aggregate

capacity gain achieved by moving from 2G to

3G is well over 1,000% on a like-for-like

basis

Innovations such as these have massively

improved mobile network efficiency. In turn, this

has delivered huge increases in capacity over the

past two decades – enough to support the

compounding demands of mass market adoption

of mobile services and the migration from basic

voice and text offerings to mobile broadband.

Habituated to this trend of ever-increasing

efficiency, it is not surprising that – in the face of

the current wall of demand created by mass

market adoption of mobile broadband – there is a

widely-held assumption that the latest generation

of network technology, 4G/LTE, will perform the

same tricks and thereby save the industry from yet

another impending capacity crunch. However, we

are firmly of the opinion that things will not be so

simple this time.

Hitting the Shannon Limit

The problem is that the efficiency of mobile

networks is starting to peak. The practical

implication of this is that we believe new 4G/LTE

technology is barely any more efficient than

today’s 3G platforms – perhaps as little as 30%

more efficient on a strict like-for-like basis. This

gain is trivial by comparison to previous

generational upgrades that have comfortably

yielded 1,000-2,000% like-for-like efficiency

benefits.

The sharply flattening efficiency curve is due to

the technology approaching what is known as the

Shannon Limit. This is a law of radio physics that

governs the maximum amount of error-free data

that can be transmitted over-the-air for a given

level of noise (or interference). Noise is an

unavoidable feature of the mobile environment,

with interference created by buildings and other

obstructions, signals from other users, and simply

due to attenuation of the signal as radio waves

travel through the air. The higher the level of

noise, the more the network has to compensate –

by reverting to less data-intensive but more robust

modulation techniques as well as dedicating a

greater portion of the channel resources to error

correction (and thus leaving less for the end-user’s

data). From a customer’s perspective, the higher

the noise level, the lower the data rate that they

47


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will receive. For a typically noisy outdoor urban

cell, the Shannon Limit is around

2bits/second/Hz. Standard 3G (WCDMA)

technology has an optimal performance of around

1bit/Hz, while HSPA-enabled 3G and 4G LTE

can increase this to between 1-2bits/Hz. See the

grey shaded area in the accompanying illustration.

In lower noise environments (for example, where

the user is both close and has line-of-sight to the

base station, or if the cell is relatively uncrowded,

or if it is indoors) then a speed of greater than

2bits/Hz may be achieved. In this type of

scenario, the lowering of the noise allows the user

to move further up the Shannon curve (up-and-to-

the-right in the accompanying illustration).

Some reduction in outdoor cell noise may be

achieved in the future through implementation of

‘smart’ beam-forming antennae that can reduce

co-channel interference (residual noise from other

users). These smart antennas are able to pinpoint a

specific mobile device with a narrow beam; this is

in contrast to the vast majority of antennas today

that blast signals out to a large portion of the

sector in an attempt to find the specific user.

However, note that smart antennas will only

improve one aspect of cell noise (co-channel

interference), and hence significant improvements

in bits/second/Hz as a result of implementing

beam-forming antennas seem unlikely.

The building blocks of efficiency

The spectral efficiency of a radio technology is

largely the product of three different areas:

Multiplexing – whereby radio spectrum is

divided up in order to support multiple

simultaneous connections

Modulation – the process of inserting

information into a radio carrier wave

Coding – or more properly, forward error

correction coding (FEC). This is the process

of transmitting redundant information in the

knowledge that some original data will be lost

or corrupted along the way

Comparing 3G and 4G across these three

fundamental building blocks of spectral

Shannon Limit sets a ceiling on mobile spectral efficiency

1

2

3

4

5

6

0

-15 -10 -5 0 5 10 15 20

Typical loaded mobile network (outdoors)

Inaccessible

Region

Lower interference environments e.g. isolated hotspots, femtocells

Shannon limit

Shannon limit with 3dB offset

OFDMA

CDMA (HSPA)

Required SNR (dB)

Achi

evab

le ra

te (b

ps/H

z)

1

2

3

4

5

6

0

-15 -10 -5 0 5 10 15 20

Typical loaded mobile network (outdoors)

Inaccessible

Region

Lower interference environments e.g. isolated hotspots, femtocells

Shannon limit

Shannon limit with 3dB offset

OFDMA

CDMA (HSPA)

Required SNR (dB)

Achi

evab

le ra

te (b

ps/H

z)

Source: Alcatel Lucent, HSBC

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efficiency, the first observation to highlight is

simply the degree of similarity seen between the

two platforms:

Modulation options for each are identical

(standard 16QAM with the option to use more

data-intensive 64QAM if conditions permit).

Indeed, underlining the relevance of the

Shannon Limit is the fact that 64QAM (6 bits

per symbol) will likely only function in

around 5-10% of the cell area, where radio

conditions are at their most benign

Similarly, forward error-correction techniques

for 3G and 4G are near-identical, each based

on turbo coding (albeit with 4G/LTE

featuring a minor ‘tail biting’ improvement)

The fundamental similarities between 3G and 4G

in terms of modulation and coding mean that – by

a simple process of elimination – any

improvement in spectral efficiency that exists

between the two generations must be principally

derived from differences in multiplexing.

3G WCDMA employs code division multiplexing

(systemised as CDMA) while 4G LTE uses

orthogonal frequency division multiplexing

(systemised as OFDMA). Both techniques

achieve universal frequency re-use, meaning that

all frequencies may be utilised in all cells. The

only major difference between the two is that

while CDMA is a single-carrier transmission

technology, LTE uses multi-carrier transmission

on the downlink (though note that LTE also uses

single-carrier on the uplink).

By splitting the signal into multiple sub-carriers,

4G/LTE is able to assign groups of sub-carriers to

users based on their bandwidth needs: if the user

requires a higher data rate, then a larger group of

sub-carriers is assigned; if the user requires a

lower data rate, then fewer sub-carriers are

allocated.

This more granular approach of 4G/LTE versus

3G enables the better matching of mobile network

resources to demand – with the flexibility of the

multi-carrier structure able to fill bandwidth

requests more precisely. However, this advantage

is generally only available with certain traffic

patterns when the network is relatively unloaded.

As more users fill the cell, though, radio resource

allocations will, ceteris paribus, be governed by a

policy that supports users more equitably – even if

3G HSPA (WCDMA) assigns resources in relatively large blocks (different colours signify different users)

4G LTE (OFDMA) is more granular enabling better matching of radio resources to demand (different colours signify different users)

Time

T2 T3 T4 T5

Codes

T1

Time

T2 T3 T4 T5

Codes

T1

Tim

e

Sub-carriers

T2

T1

T3

T4

T5

= 23 sub-carriers

1 1589

Tim

e

Sub-carriers

T2

T1

T3

T4

T5

= 23 sub-carriers

1 1589

Tim

e

Sub-carriers

T2

T1

T3

T4

T5

= 23 sub-carriers

1 1589

Source: HSBC Source: HSBC

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this means that some customers experience

download speeds that fall short of the peak

capabilities of their device (or that are inadequate

to the application or service that they are trying to

access). Hence, as cells become more crowded,

the greater flexibility of OFDMA is negated,

diminishing its relative efficiency gain versus 3G.

MIMO theory undermined in practice

This is not to suggest that all innovation will grind

to a halt – and capacity/efficiency gains with it.

However, in our view, it does seem likely that

future gains will tend to be rather more marginal

than those achieved in the past.

Among the most promising new technological

developments is the use of MIMO (multiple input

multiple output) antenna arrays, which are

supported by both 3G/HSPA+ and 4G/LTE. Most

antennas today are single input single output

(SISO), and incorporate just a single antenna on

the device that communicates with a

corresponding antenna at the base station. By

contrast, MIMO systems use multiple sets of

antennas on both the device and at the base

station. There are two (mutually exclusive)

benefits to this:

By transmitting duplicate information, MIMO

can improve the reliability of connections in a

process known as ‘transmit diversity’. This is

typically of greatest benefit to users at the

edge of the cell, as it is they who experience

the highest levels of interference

Alternatively, the MIMO antennas can

transmit different information from one

another, with specialised algorithms at the

receiver able to constructively combine

signals from the different paths taken by these

signals into one, integrated information

stream. This creates an additional, ‘spatial’

multiplexing efficiency gain

MIMO can improve link reliability or increase spectral efficiency via a spatial multiplexing gain

Tra

nsm

itter

Rec

eive

r

n n

2 2

1 1

Tra

nsm

itter

Rec

eive

r

n n

2 2

1 1

Tra

nsm

itter

Rec

eive

r

n n

2 2

1 1

Source: HSBC

In theory, moving from today’s single input single

output (SISO) antennas to 2 x 2 or 3 x 3 MIMO

arrays should double or treble the efficiency (and

thus the data capacity) of the system. However,

achieving these gains in the real world is more

difficult, if for no other reason than the

complexity of differentiating between the separate

transmission streams.

MIMO’s spatial multiplexing techniques rely on

differences in the timing or incidence (angle of

arrival) of the received signals. When antennas

are spaced too closely together, there is

insufficient difference between the signals for the

system to work – a problem known as ‘spatial

correlation’. In order to mitigate spatial

correlation issues, MIMO antennas need to be

spaced multiple wavelengths apart on the device.

This creates major issues for smaller devices such

as smartphones, which may not have the

dimensions to accommodate anything more than

the most basic 2 x 2 arrays, where the relative

gains versus SISO are smaller.

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WiFi is friend, not foe to cellular

We see WiFi as a useful complement to cellular

infrastructure, as a means of offloading traffic

from increasingly overburdened cellular networks.

We do not believe that WiFi can supplant cellular

services, due to a number of technical factors that

compromise its appeal as a commercial first-line

public access service. These issues include:

Range limitations: WiFi’s lack of scalability

will always imply patchy coverage

Limited capacity: spectrum assigned to WiFi

at suitable frequencies is scarce and

unlicensed, so it is contended by a wide range

of other devices with equal priority.

Moreover, note that WiFi is no more

spectrally efficient than leading cellular

technologies

Limited functionality: WiFi compares poorly

to cellular services not only in terms of

mobility but also in terms of service quality

and security. And because it cannot provide

ubiquity, it likewise lacks the secondary

added value of capabilities like location

awareness, which is an important component

in many mobile data applications

Around 30% of traffic (both voice and data)

typically originates in the home, while a further

20% is typically generated in offices and other

places sufficiently close to fixed-line points of

presence to use WiFi instead of cellular. Given the

prospect of spiralling mobile network traffic, any

role that WiFi can play in offloading a portion of

this growing burden will surely be welcome.

Cisco’s VNI index forecasts that (depending on

the country in question) roughly 20-40% of traffic

from smartphones and tablets will be offloaded to

WiFi or femtocells (the former’s cellular

equivalent technology) – see table above.

However, we believe that it is unlikely that WiFi

can fulfil a more ambitious role, for a series of

reasons:

Firstly, there is actually precious little suitable

WiFi spectrum available. Most WiFi systems

exploit the 2.4GHz Industrial Scientific Medical

(ISM) band, which is comprised of 100MHz of

unlicensed public spectrum. WiFi itself works in

broad 22MHz channels; with the inclusion of

guard bands, this implies that only three non-

overlapping channels can be accommodated

within the ISM spectrum. The practical

ramification of this is that no more than three

different service providers can efficiently operate

WiFi hotspots in the same approximate location.

Only three broad 22MHz WiFi channels can be established in the all-important 2.4GHz band

1

2.412

2

2.417

3

2.422

4

2.427

5

2.432

6

2. 437

7

2.442

8

2.447

9

2.452

10

2. 457

11

2.462

12

2.467

13

2.472

14

2.484

22 MHz

Channel

Center Freque ncy

(GHz)

1

2.412

2

2.417

3

2.422

4

2.427

5

2.432

6

2. 437

7

2.442

8

2.447

9

2.452

10

2. 457

11

2.462

12

2.467

13

2.472

14

2.484

22 MHz

Channel

Center Freque ncy

(GHz)

Source: Wikimedia Commons

WiFi and femtocell percentage offload of smartphone and tablet traffic

2010 2015

China 20% 23% U.S. 21% 30% Brazil 23% 22% France 31% 38% Japan 32% 28% Russia 35% 42% Germany 38% 37% U.K. 40% 42%

Source: Cisco VNI Feb 2011

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Moreover, it is important to stress that the ISM

band is unlicensed. This does confer the benefit

that it is free for operators to use (in contrast to

dedicated cellular spectrum which is typically

auctioned at very high prices). The drawback,

though, is that public spectrum is also shared with

a host of other devices and services that rely on

short-range radio connections. These include

Bluetooth-equipped electronics, microwave

ovens, remote controlled toys, baby monitors and

wireless CCTV links (to name but a few). No one

user or device has precedence above any other.

So, while operators can opportunistically utilise

WiFi to offload cellular traffic, they cannot rely

on it.

WiFi’s short-range is a further major barrier to its

assuming a more ambitious role. The widely-

deployed 802.11g standard is capable of covering

a maximum range of around 30m, while the newer

802.11n standard merely doubles this, to around

70m.

The ability of network technology to

accommodate growth (whether in terms of

expansion of coverage, user growth or demand for

higher bandwidths) is known as scalability; and it

is precisely scalability that WiFi lacks, in our

view. A few hundred square feet can be covered

with a relatively inexpensive WiFi access point. A

few hundred square miles, however, requires a

literally geometric increase in investment. For

example, it would take 522 x 70m-radius WiFi

hotspots to cover the same geographic area as a

one-mile radius cellular microcell (see illustration

opposite). Even at a modest cost of USD500 per

access point, this would total USD261,000 for

access electronics alone, compared with perhaps

USD15,000 for a 3G cellular base station.

As far as the technology itself is concerned, WiFi

is no more (nor less) spectrally efficient than

cellular technologies like 3G (WCDMA/HSPA)

or 4G (LTE) or even WiMAX (IEEE 802.16). All

of these draw from broadly the same pool of

constituent techniques: spread spectrum (code

division multiplexing) or orthogonal frequency

division multiplexing, similar modulation options

(QPSK, 16QAM and 64QAM, the latter only in

benign radio conditions) and coding (low density

parity check, LDPC, or turbo codes).

With WiFi no more (nor less) efficient than 3G, it

therefore largely comes down to a question of

how much additional radio resource does WiFi

bring to the table? The answer: a further 60MHz

globally, shared by all WiFi operators and users

(and a host of other devices too) – which is hardly

in and of itself a game-changer. 60MHz would

represent a fraction of the total spectrum that is

otherwise allocated to cellular services – typically

several hundred MHz in total in most developed

markets, for example.

So while cellular spectrum globally supports 5bn

accounts, including 500m mobile broadband users

(a figure expected to double to 1bn by the end of

2011, according to Ericsson forecasts), WiFi

spectrum currently supports perhaps only a couple

of hundred million users at most.

WiFi’s inherent range limitations means poor scalability 1 microcell= 522 WiFi hotspots (802.11n)1 microcell= 522 WiFi hotspots (802.11n)

Source: HSBC

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So when considering the question of WiFi as a

potential substitute for cellular, it is useful to think

from first principles. Does WiFi bring

significantly more spectrum to the table? No –

only around a further 60MHz (net of overhead).

Does WiFi squeeze any more out of this spectrum

than cellular technologies? No – WiFi uses

broadly the same techniques as cellular; it is

generally no more (nor less) spectrally efficient.

So is it likely that WiFi could handle the

wholesale migration of the world’s cellular users

(even just cellular broadband users) onto a thin

sliver of unlicensed public spectrum? Clearly not,

in our view.

Importance of capex re-emerges

So, to re-cap: mobile traffic is set to continue

doubling each year for the next several years,

driven by rapid smart device adoption, growing

usage patterns and indirect increases in

consumption as applications become more

sophisticated. At the same time, however, the

industry’s ability to supply significant amounts of

additional capacity is starting to be constrained by

the hard laws of radio physics (specifically the

Shannon Limit). This is what underlies the fact

that 4G technology is barely any more efficient

(perhaps only by 30% or so) than today’s 3G

networks, on a strict like-for-like basis.

Some small efficiency improvements may be

possible going forward, thanks to innovations like

MIMO and smart, beam-forming antennas.

However, we expect these gains to be relatively

modest – and particularly so when set against

historic gains from previous generational

upgrades (ie 2G succeeding 1G, and 3G

succeeding 2G – each of which transitions

delivered orders-of-magnitude improvements in

capacity).

With the idea of any quick fix from innovative

technology breakthroughs likely off the table, we

believe the industry will have to take a ‘back-to-

basics’ approach to adding more mobile capacity.

This will involve offloading traffic to WiFi and

femtocells wherever possible, but it will also

mean increasing substantially the density of

cellular networks, through techniques like cell

splitting. This latter term refers to the shrinkage of

cell sizes, in order to reduce demand on each base

station’s radio resources. While it is a relatively

expensive, time-consuming and complex process,

it does have the advantage of being a tried-and-

tested method of adding substantial capacity.

We believe that WiFi can play an important

supporting role in offloading traffic from

overburdened cell towers – Cisco for example

forecasts that between 20-40% of total

smartphone and tablet traffic can be diverted to

fixed line via WiFi and femtocells. However, we

are highly sceptical that it can play any more than

a supporting role to cellular, due to its manifest

constraints (its use of public spectrum that is itself

in limited supply; the fact that, with only three

channels available, co-location becomes a major

challenge; the shared nature of its radio

frequencies; and its intrinsically short range).

It is therefore our view that, facing the threat of a

capacity crunch and without the prospect of new

technologies to save the day, operators will need

to deploy more cellular infrastructure. This will

necessitate an increase in capex, and hence our

conviction Overweight call on mobile equipment

market leader, Ericsson.

However, in our opinion, investment in cellular

infrastructure is about considerably more than

merely avoiding an imminent network collapse.

We believe that capex is likely to emerge as a

powerful source of competitive advantage – in a

way that has not, frankly, been the case in the 2G

voice-centric world. The reason for this lies in the

difference between circuit-switched voice and

adaptive IP data services.

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2G voice is a circuit-switched service. Circuit

switching creates a dedicated channel which runs

at a constant bit rate (9.6-14.4kbps depending on

the voice codec), which in turn means that – as

long as the user is within range of the base station

– they will receive a broadly uniform quality of

service. (Poor call quality is typically the result of

being out of range, while call dropping is typically

due to either moving out of range, or the cell

being over-crowded). The key point to note here,

though, is that voice users close to the base station

experience broadly the same level of service as

those who are much farther away (but still within

range). But, while this is the case with 2G voice, it

is emphatically not true of a 3G or 4G data-centric

world.

3G and 4G are adaptive systems. Adaptive

networks change their method of operation based

on prevailing radio conditions. In this sense, 3G

and 4G base stations might be thought of as tool

boxes, offering an array of tools ranging from

sophisticated precision engineering devices at one

end to basic hammers and chisels at the other. The

choice of tool depends on the conduciveness of

the radio environment. When radio conditions are

benign, with low levels of noise (such as when a

user is close to the base station and has line-of-

sight), the network can utilise the most

sophisticated techniques to cram more data into

the radio waves (and simultaneously allocate less

of the radio resource to error-correction). But if

the user is far from the base station and is subject

to high levels of interference (for example, from

intervening buildings and other users in the cell),

then the base station must revert to the most basic

(but robust) of tools. These are less adept at

cramming 1s and 0s into the radio wave, and must

also incur a greater overhead in terms of error

connection.

So while distance matters little in providing a

voice service, it matters greatly in the world of

mobile data. The closer a user is to a base station,

the faster the data speeds that they will receive;

and vice versa. This fact should benefit the larger

networks. Because they will have more base

stations than their rivals, their users will on

average be closer to a base station, and – being

such – should enjoy superior bandwidth. Note that

two operators might have the same capex/sales

ratio, and even the same ratio of customers to base

stations – but if one operator is twice the size of

the other, with twice the number of base stations,

then despite the parity in capital intensity, the fact

that the average distance of its customers to a base

station is shorter implies it should be able to

provide a materially superior data service. Of

course, a final point to make is that, thanks to

their scale, the larger operators should in any case

be able to purchase infrastructure at a per unit

discount to their smaller rivals – which should

compound the scale-friendly nature of the effect

described above.

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Introduction In one sense the most popular service running

over fixed-line connectivity remains voice.

However, thanks to years of aggressive price

competition (often stimulated by regulatory

intervention) and the arrival of VoIP, voice

revenues represent an ever-diminishing portion of

the total. Operators everywhere have taken

strenuous efforts to rebalance into contracted

revenues, in particular line rental and broadband.

Given this context, what are the fixed-line

applications of the future? One especially stands

out: IPTV – the provision of a payTV service over

a broadband line.

However, this is also an area that arouses

profound suspicions. Investors are (quite rightly,

in our opinion) acutely nervous about the prospect

of any telecoms operator moving out of its natural

comfort zone and into the unknown territory that

is the media sector. Can telecoms operators make

any kind of success of this field? The answer, in

our opinion, simply depends on what they are

trying to achieve. We would argue that most

operators would be best served seeing IPTV in

modest terms: as a way of improving customer

loyalty, as well as a means of stimulating the

market for underlying connectivity by

demonstrating the power of video delivered over a

superfast broadband infrastructure. In developed

markets, it seems unlikely that telecoms operators

will have the right competencies to match existing

media players – or the technology/internet

companies that are also eyeing this territory

(although arguably there is still everything to play

for in some of the emerging markets).

The problem for the telecoms operators is that

they are not merely going into battle against

powerful existing media brands. Indeed, both

traditional telecoms and media companies face a

potential barrage of new entrants in the form of

so-called over-the-top (OTT) competitors piping

payTV over broadband connections. Previously,

entry into the payTV market has been difficult,

due to the very limited number of conduits

available to take payTV content into the home (eg

digital satellite or digital terrestrial broadcast

platforms). But the arrival of superfast broadband

infrastructure means that suddenly any entrant has

access to a conduit able to convey programming

to viewers. As a result, a host of new rivals will

appear – very likely led by some of the biggest

and most innovative companies in the world: the

likes of Apple, Google and Amazon.

Telecoms IPTV: a brave effort Previously, if a customer wanted to receive a

video service, they generally had a choice

between a cable provider and/or a set of

satellite/terrestrial broadcasters. As we argued in

our DisContent thematic report (September,


Operator IPTV has mixed track record; often a response to cable

OTT eliminates barriers to entry, ushering in a new wave of rivals

Set-top boxes fast becoming a ‘Trojan horse’ for OTT services

55


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2009), the defining feature of this system is that

the number of conduits into the home (ie

broadcast channels, whether over satellite, cable,

or terrestrial multiplex) is very limited. This has

understandably made those conduits (such as

digital terrestrial broadcast spectrum) very

expensive.

An ‘entrant’ with video content wanting to break

into the market and distribute its programming

therefore faces a real challenge in this

environment. But, with the arrival of broadband

(and particularly superfast broadband), suddenly

any player with content has access to a

distribution mechanism. Broadband is, in essence,

a conduit available to anyone with content – and,

with the removal of such a massive barrier to

entry, it is hardly surprising that there should be

such a large number of players looking to take

advantage of the new opportunities on offer. One

of the challenges for the telecoms operators is that

many of the potential entrants are high-profile and

popular brands from the worlds of the internet,

technology and retail, as well as well-established

media entities.

However, the first entrants into the payTV space

using broadband telecoms pipes have typically

been the incumbent themselves. Most have now

launched a payTV service to augment their more

conventional voice and broadband service

proposition. Incumbent video offerings typically

make use of IPTV – an acronym denoting any

television service that is provided over a

broadband connection using internet protocols. (It

generally also indicates that the service is a

managed one, rather than a best-effort video

stream such as that provided by YouTube).

45m IPTV users globally

In terms of sheer customer numbers, IPTV might

not rival the penetration of mobile, but it has

nonetheless grown to a material size over a

comparatively short period of time. We estimate

that there were more than 45m IPTV users in the

world in January 2011, a 40% year-on-year

increase. IPTV subscriptions represented 8.2% of

total broadband lines in Q3 2010, as compared to

6.2% in Q3 2009 (as shown in the graph below).

If we exclude cable and mobile broadband

accounts, we estimate that IPTV penetration of

broadband lines would be closer to 12%.

Measured by absolute IPTV customer numbers,

Europe is the most significant region, accounting for

46% of global IPTV connections in Q3 2010,

followed by Asia (with 35%) and the Americas

(with 18%). The Middle East and Africa contributed

less than 1% of the total. France is the world leader,

with nearly 10m IPTV connections, followed by

China (9m including HK) and the US (7m).

Global broadband users (million) and IPTV penetration as a percentage of broadband lines

Top 10 IPTV countries, Q3 2010 (IPTV connections, millions)

0

100

200

300

400

500

600

Q1

07

Q2

07

Q3

07

Q4

07

Q1

08

Q2

08

Q3

08

Q4

08

Q1

09

Q2

09

Q3

09

Q4

09

Q1

10

Q2

10

Q3

10

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

Global BB users IPTV penetration

0

2

4

6

8

10

Fra Chi USA SKor Jap Ger Bel Spa Ita

Source: Point topic, HSBC Source: Point Topic

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One clear driver of IPTV is simply the

deployment of incumbent NGA platforms. As

operators roll out fibre-based infrastructure

capable of supporting superfast broadband speeds,

it becomes much more straightforward to

accommodate the bandwidth demands of HDTV

streams. Note that Akamai suggest a good quality

HDTV picture requires at least 5Mbps; the

company estimates that, currently, only around

22% of global internet connections achieve this

type of throughput. This would seem to indicate

that there is plenty of potential future upside for

IPTV services, as the reach of NGA services

extends further.

But however appealing the prospect of revenues

from an entirely new market area, we suspect that

the most compelling case for operators to provide

IPTV services is defensive. Cable operators are a

particular threat to the incumbents, and make

extensive use of bundled propositions, combining

all the various services a customer might take via

a physical communications connection.

Furthermore, the cable companies have become a

particular threat now that relatively inexpensive

DOCSIS3.0 upgrades (which take very little time

to deploy) enable them to deliver fibre-type

broadband speeds. Where cable operators are

pitching a triple-play including payTV and

(superfast) broadband, incumbent operators have

little choice but to follow.

It is therefore perhaps not surprising that there

does seem to be a clear statistical relationship

between the degree of IPTV penetration in a given

country and the magnitude of cable broadband

market share there. The accompanying graph plots

IPTV subscribers as a percentage of incumbent

broadband lines against cable market share of

broadband for European operators. The positive

relationship indicates that the stronger the cable

operator in a market, the harder the incumbent has

pushed IPTV.

Incumbent IPTV service penetration of incumbent broadband lines (x-axis) vs cable market share of broadband (y-axis)

PT

SWI

BELKPNBT

TI

TEF

DT

FT

0%

10%

20%

30%

40%

50%

0% 20% 40% 60% 80% 100%

Source: Companies, HSBC

We would therefore identify four different groups

of countries:

Firstly, markets like Belgium, Switzerland,

Portugal and the US, where the push into

IPTV has likely been driven by the need to

compete effectively against upgraded cable

networks

Secondly, markets where IPTV has not been

much of a focus because the local cable

competition is lacklustre, such as Italy and

Spain

Thirdly, a number of (sizeable) anomalies:

countries where telecoms operators have been

aggressive with IPTV, despite the fact that

cable is weak – examples being France and

Hong Kong

Fourthly, countries where cable competition

might well have spurred on IPTV services,

had factors like regulation permitted it

Spurred by cable: Bel, Swi, Ger, UK, US, Japan

In a series of markets it seems likely that the

presence of powerful cable competitors has been a

substantial factor in spurring the incumbents into

action with IPTV service offerings. Belgium

provides a good example of this, with the

incumbent Belgacom doubtless keenly aware of

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the threat potentially posed by cable rival Telenet

(now part of Liberty Global).

Belgacom was among the earliest to launch IPTV

services in Europe, and now has around 20%

market share of the national TV market as at the

end of Q3 2010 – with the rest belonging to cable

operators (predominantly Telenet). Satellite and

DTTV are very small in Belgium (respectively

2% and 4% of the market). IPTV penetration

reached 60% of Belgacom’s broadband

connections by Q3 2010. Indeed, IPTV has

become a relatively material item for the

incumbent, and now provides 16% of its

consumer revenues (growing at 43% year-on-year

in Q3 2010). The company’s triple-play package,

which includes fixed-line voice and broadband

(12Mbps with a 50GB cap) as well as more than

70 TV channels, starts at EUR52 per month.

Telenet’s equivalent triple-play packages start

from EUR45 per month (for 15Mbps broadband

with a 15GB cap and 70 digital TV channels).

Swisscom is another European incumbent that

faces competition from one of Liberty Global’s

cable operations. The Swiss incumbent started

providing IPTV services in 2007 and had secured

around 10% of the TV market by the end of Q3

2010 – by which point, 23% of its broadband lines

were taking an IPTV service. Swisscom’s triple

play package starts at CHF99 per month and

includes line rental, free voice calls to the

Swisscom fixed-line and mobile networks,

10Mbps broadband and a TV service with over

160 channels. The incumbent is competing against

cable operator Cablecom’s triple-play package

(CHF75 per month for fixed-line calls, 20Mbps

broadband and more than 120 TV channels).

Turning to Portugal, incumbent Portugal Telecom

(PT) has made a good measure of progress with

its IPTV offering. The company has secured

control of 28% of the payTV market in a period of

only three years (although payTV in total only

represents about 47.5% of total TV households).

Nearly 80% of PT’s broadband lines take an IPTV

service. The company’s triple-play offering

includes 70 channels as well as video-on-demand,

12Mbps broadband and unlimited voice, all from

EUR42 per month. Zon, the larger of the cable

operators, has a 34% market share in broadband

and 60% in TV. Important content such as

football is available to both PT and ZON on the

same basis.

The two major operators presently offering an

IPTV service in Germany are Deutsche Telekom

(DT) and Hansenet (which is part of Telefonica),

under the Alice brand. Meanwhile, Vodafone is

presently re-launching its IPTV offering. DT is

the largest IPTV provider, though, with 1.4m

subscribers (a circa 3.5% share of the TV market),

which represents only 11.8% of the company’s

broadband lines. DT offers IPTV packages both

on a stand-alone basis and bundled together with

broadband. The price of its stand-alone packages

European incumbents: IPTV performance and market environment

IPTV subs % total BB subscribers TV channels Exclusive content IPTV competitors Cable competitors

FT 3.2m 35.8% 130+ Football rights + cinema Iliad, SFR NumericableDT 1.4m 11.8% 120+ Football rights Hansenet KDG, UnityMedia, KBWTEF 0.8m 13.6% 30+ None Orange, Jazztel OnoTI 0.4m 5.4% 100+ None Fastweb, Vodafone No cable in ItalyBT 545K 9.9% 70+ None Talk Talk, BSkyB Virgin MediaKPN 1.2m 46.5% 50+ None Tele2 Ziggo, UPCBEL 920k 59.2% 70+ Football rights+exclusive content none Telenet, Woo, NumericableSWI 358k 23.1% 160+ none CablecomPT 0.8m 79.8% 70+ None Sonaecom, Vodafone ZonTLSN 450K 39.9% 40+ none Telenor ComHemTDC 128k 9.9% 38+ none Dansk Bredbånd StofaSource: Companies, HSBC

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range from EUR27.95 to EUR39.95 per month

over a 16Mbps DSL connection. The bundled

packages’ prices range from EUR44.95 to

EUR49.95 per month over a 16Mbps DSL

connection. The TV packages provide 120

channels, although DT also offers 10,000 movies

and soaps on an on-demand basis. DT’s offering

needs to be compelling, because it faces stiff

competition from the cable segment, which has

been in the process of a major network upgrade to

enable it to provide superfast broadband services.

Moving across the Atlantic, IPTV has been a

major focus for the US RBOCs, Verizon and

AT&T. Both have invested heavily in upgrading

their access infrastructure to high capacity fibre

systems since 2004. Although not strictly an IPTV

service (as it is actually broadcast over fibre on

dedicated wavelengths), Verizon’s FiOS TV now

has 3.5m customers, equivalent to 28%

penetration in the areas where it is available for

sale. AT&T uses more economical IPTV switched

video over FTTN/VDSL, and now has 3m U-

verse video customers.

The RBOCs’ motivation for shifting into the

payTV world was in large measure provided by

the increasing threat posed by the cable operators

with their triple-play bundles. And while Verizon

and AT&T have made some solid progress, their

IPTV subscriber bases remain small by

comparison to the 100m payTV households in the

US – the bulk of which continue to be serviced by

cable and satellite providers (see accompanying

chart).

In Japan, NTT has developed its IPTV platform

both to maintain competitiveness with cable

operators as they upgrade broadband capabilities,

and to provide an additional 'hook' for households

to upgrade from DSL. This service is now

demonstrating good momentum, with 1.8m

households were subscribing to NTT's optical

broadcast service at end 2010, equivalent to a

penetration rate of 12.6% of its fibre accounts.

This total includes both the FLETs TV service,

where NTT rebroadcasts SKY Perfect content,

and the Hikari TV IPTV service, which is

operated by NTT Communications. FLETs TV

prices begin low (at JPY700, cUSD9 per month),

and so have succeeded in attracting some of those

cable customers looking to save on their costs, as

well as winning viewers new to payTV services.

After a period during which NTT’s IPTV service

lacked appealing content relative to its cable

peers, NTT has now been able to redress the

balance. In addition to rebroadcasting terrestrial

TV, NTT offers more than 70 IPTV channels,

including around 40 in HD. Half of current users

take the unlimited service, which allows access to

about 13,000 video-on-demand programmes;

recently released movies are available for JPY820

(cUSD10) each.

By contrast, KDDI has focused on broadband and

VoIP rather than IPTV. As at the end of

September 2010, only circa 10% of its fibre

customers took its IPTV service, doubtless

reflecting the fact that it has a weaker channel and

content line-up relative to that provided by NTT.

IPTV not a focus: Italy, Spain

Cable’s presence, though, is patchy even in

developed markets. Several European countries

are notable for having either an, at best, limited

US payTV market share end 2010

Cable

60%

Satellite

33%

Telco

7%

Source: Companies, HSBC estimates

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cable segment, or none at all – with Spain a case

of the former and Italy of the latter.

Telecom Italia (TI) and Fastweb are the two main

IPTV providers in Italy, although this service is

still minor as compared to satellite – representing

only 20% of the payTV market and 5% of the

total TV market. Telecom Italia’s IPTV customers

are equivalent to only 5% of its broadband lines.

TI’s chief rival, Fastweb, offers a basic triple-play

service with more than 30 TV channels, 10Mbps

broadband and fixed-line voice all starting from

EUR27.45 per month. In addition, Fastweb and

Sky Italia (the largest digital satellite player) have

entered into a commercial agreement whereby

customers can choose services from either within

a joint plan, and then receive a unified bill with

dedicated call centre support. This could provide

TI with a serious challenge, as it combines strong

content from Sky with the high-speed broadband

capability of Fastweb.

Meanwhile, in Spain, IPTV is now being offered

not only by the incumbent Telefonica, but also by

the likes of Orange and Jazztel. However, in total,

IPTV represents around 20% of the payTV market

(with payTV in turn accounting for around 25%

of total TV households). Telefonica is the largest

player, with a market share in IPTV of more than

90%. But this still only represents 14% of the

company’s broadband connections in Spain.

Telefonica’s IPTV package consists of 30

channels and access to a video-on-demand

catalogue, and is available for a monthly price

starting at EUR10.

IPTV not response to cable: France, Hong Kong

In contrast, certain other markets have embraced

IPTV services even without the presence of a

convincing cable threat. France arguably provides

the best example of this, given the relatively

limited nature of cable deployment in this market.

By Q3 2010, France had close to 10m IPTV

subscribers, out of 26m homes and 21m

broadband lines. The French market has been

offering IPTV since 2003, when Iliad launched its

triple-play offers over ADSL. Subsequently, not

only France Telecom (FT) but also other

alternative operators have launched similar

bundles: hundreds of channels, video-on-demand,

payTV and also catch-up TV. The success of

these services has been facilitated by the fact that

FT’s local loops are shorter in length than in most

countries (and also employ thicker wires), which

means that the service can work well with even

basic ADSL technology. Another factor, though,

was the fact that the local loop was made

available on an unbundled basis both relatively

swiftly and at attractive tariffs (at least so far as

FT’s competitors are concerned).

So France is rather atypical in the sense that

IPTV’s success was not triggered by a perceived

need on the part of the incumbent to address

troublesome cable competition (indeed, cable’s

market share of broadband in France is only 6%).

Instead, it was Iliad’s early and innovative move

into IPTV that forced competitors to replicate its

offer.

The above said, it is worth pointing out that most

households in France (unlike those in Belgium or

Switzerland) still rely on digital terrestrial TV

(DTTV) for the bulk of their TV consumption.

We estimate that analogue TV and DTTV still

provide the main mode of access to television for

about 45% of French households. This compares

to about 24% for satellite and 22% for IPTV. But

IPTV is nevertheless a very popular complement

to DTTV services in France.

However, while IPTV services might have

achieved a good measure of uptake, this is not to

suggest that they are necessarily lucrative –

especially so far as the incumbent is concerned.

FT has bought exclusive content, whereas its

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competitors have preferred to focus on reselling

standard channels and video-on-demand

catalogues. In particular, FT spent EUR625m to

purchase key football rights for the period 2010-

12, and also acquired movie content for the

Orange cinema series of channels (at a cost of

EUR249m). Orange’s payTV offering attracted

1.7m clients as at the end of Q3 2010, a figure

equivalent to 53% of its standard broadband IPTV

users, but seems unlikely to have delivered

attractive returns. As a result, FT has announced

that it will not be bidding for the next round of

football rights, as well as that it now intends to

merge its Orange channels with those of Canal+.

Turning to Hong Kong, incumbent PCCW does

face a cable competitor, but its enthusiasm for

IPTV services has had a long track record, dating

all the way back to the turn of the last decade.

PCCW now runs the market’s largest payTV

service based on an IPTV platform. The offering

is bundled with the company’s market leading

broadband service. Indeed, PCCW is the only

quad-play (fixed-line voice, broadband and IPTV

together with mobile) operator in Hong Kong

(with market shares of 57%, 55%, 46% and 14%,

respectively). As noted above, PCCW does face

cable competition, but it has generally been

ineffectual – although the company was also

doubtless encouraged to push IPTV thanks to the

supportive topology of its network (short loop

lengths serving dense urban neighbourhoods).

IPTV but for regulation: Brazil, Mexico

There are good grounds for doubting developed

world telecoms operators’ expertise with media

content, and hence for scrutinising their IPTV

plans with due caution. However, there is

arguably a very genuine opportunity in the

emerging markets. Here, operators are often able

to more fully leverage their scale and network

advantages. Meanwhile, local content may make

it more difficult for the US technology giants to

gain superiority. Infrastructure permitting, then,

IPTV offered by the telcos would seem to make

most sense in some of the emerging markets. But,

as it happens, the necessary regulation has not

always been forthcoming.

For example, the development of IPTV in Brazil

has hitherto been stymied by the country’s media

laws, which prohibit the offering of IPTV over

terrestrial telecoms networks. This has resulted in

the Brazilian payTV market up to this point

comprising a virtual duopoly between a dominant

cable operator, NET Serviços, and a dominant

satellite player, Sky Brasil.

However, there are signs that this may be about to

change. The telecoms and media regulator Anatel

has been keen to foster greater competition in

payTV, and so has supported proposed changes to

the media law (PLC116) – currently awaiting

review by the Brazilian senate – that would allow

telecoms operators to offer IPTV. Although

precise timing remains unclear, we believe the

necessary changes to legislation will take place in

H1 2011. In fact, Anatel has already removed

language prohibiting IPTV over telecoms

networks in its licence renewals for 2011.

From a practical point of view, though, further

growth in IPTV will still depend on the roll out of

superfast fibre-based broadband platforms. The

Brazilian government is keen to improve

broadband availability, although the focus here is

more on bridging the so-called ‘digital divide’ for

basic broadband rather than on the higher-speed

technologies (FTTP or FTTN/VDSL) that are

needed for good quality IPTV.

The success of alternative operators like GVT

might also stimulate further activity. GVT (part of

Vivendi) has been offering superfast broadband

(ADSL2+, VDSL and FTTP) services in lucrative

areas of its home region II; additionally, it now

has plans to expand into Rio de Janeiro (region I)

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as well as Sao Paulo. This should help spur the

telecoms operators into fibre investments of their

own that are suitable for IPTV services.

The IPTV market in Mexico has a similar story to

that in Brazil, with current legislation prohibiting

the dominant telecoms player (Telmex) from

entering the market. What is different, however, is

that – unlike Brazil – the prospect of imminent

changes to the legislation seems less likely.

Telmex had struck a deal with the government in

which it agreed to allow cable operators to

interconnect with its fixed-line infrastructure,

thereby enabling these companies to enter the

voice telephony market. In exchange, Telmex was

to be permitted to enter the pay-TV market.

However, although cable companies are now

permitted to offer telephony, Telmex has yet to

receive permission to offer TV (of any kind –

IPTV, satellite or otherwise). The disagreement

between the government and Telmex on this issue

has rumbled on for several years, and shows little

sign of resolution (although we would add that

visibility on this issue is entirely absent – and

hence there is also the potential for a positive

surprise).

IPTV vs OTT

As outlined above, the response to operators IPTV

services has been mixed – and in only very few

countries could the service be described as an

unqualified success. However, the incumbents are

not the only potential providers of IPTV offerings.

Indeed, one of the startling features of superfast

broadband in particular is that it opens up a

conduit to the home capable of carrying HDTV

streams that is potentially available to anyone

with content to distribute.

Because of their knowledge of the underlying

connectivity, it is only natural that the incumbents

should want to exploit this opportunity. But they

will not be alone. And given that regulators

increasingly insist that the connectivity be offered

to all-comers on equal terms, it is no longer very

apparent that expertise in NGA platforms (such as

possessed by the incumbents) is much of a

relevant consideration. The ability to bundle IPTV

with other associated products (particularly

broadband itself) obviously still holds appeal, but

– again – regulation now often permits the

incumbents’ competitors to readily replicate this

proposition.

Over-the-top (OTT) providers are so-called

because their offering runs on top of the

connectivity provided by a telecoms operator’s

infrastructure. It is very plausible that certain OTT

players will not only give the incumbents’ own

IPTV services some stiff competition, but could

also challenge existing media brands that are

today well-established in the payTV market. Most

high-profile among the OTT new entrants are the

likes of Google, Apple and Amazon.

Indeed, if the challenge confronting telecoms

operators looks tough, spare a thought for the

payTV stalwarts. For telecoms’ operators, what is

at stake are potentially attractive additional

revenues, but likely at low margins (as operators

would always have to pay out much of the retail

revenue captured in fees to the content owner).

For payTV players, what is at stake is their

existing livelihood.

Admittedly, due to factors such as the

complexities of rights arrangements and the

power of their existing brands in the entertainment

space, it seems likely that today’s payTV

providers will remain a powerful force in the OTT

world, and their sites a popular destination for

those seeking video content. But there remains the

simple problem that, with the barriers to entry

now much reduced, there are likely many

companies besides the existing payTV players

that will suppose this market holds promise.

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However, OTT services have a very long way to

go before they can hope to challenge the viewing

figures of mainstream broadcasters. That said,

though, those wishing to downplay OTT’s

significance should beware the deceptive s-curve

displayed by so many new technologies:

penetration rates should not be extrapolated in a

linear fashion from the early adoption phase, as

there is usually a point at which uptake rapidly

accelerates.

In summary, then, the number of market

participants is likely to swell significantly, and

among the new arrivals will probably be some of

the largest, most powerful companies on earth. It

is hard to see how this could be an incremental

positive for today’s payTV companies, even if

they are able to retain a significant position in the

new OTT order. In order to give an impression of

just how many players are involved in the contest

for a share of payTV revenues, the section below

surveys the way in which this struggle has already

manifested itself in the consumer electronics

space.

The fight for your living room In living rooms right across the world, a fierce

contest is now underway – indeed, dear reader, it

is more than likely taking place in your very own

home. The weapons of choice are the otherwise

anonymous plastic boxes that typically house

consumer electronics equipment. Sitting beneath

the world’s television sets are an ever expanding

array of devices, ostensibly devoted to enabling

their owners to variously access content provided

via conventional means, such as DTTV, satellite,

DVD and so on. But almost all of these units

today also include what could be regarded as a

‘Trojan horse’ element, intended for use with

OTT video services.

Consoles such as the Microsoft Xbox 360 or

Sony PS3 might superficially appear to be

dedicated to the (increasingly important)

business of video gaming. But both of these

devices are also capable of streaming video

content from OTT suppliers.

Many DTTV and satellite boxes, while

primarily intended to enable their owners to

watch broadcast content, also contain an

Ethernet interface enabling them to handle

certain video streams. In many cases, these

boxes are produced to work in conjunction

with a specific payTV company’s broadcast

output, but there are also generic standards

emerging that work on an open basis, and will

thus facilitate access to OTT content from a

wide variety of sources.

Dedicated streaming devices have also begun

to make their appearance, an example being

the Roku box in the US, a USD99 device that

enables its owners to view content streamed

from the likes of Netflix and Amazon.

Another example would be the AppleTV set-

top box, which has recently been re-vamped

and re-launched. The GoogleTV platform is

also making its entrance, and will be available

in set-top boxes initially manufactured by

Logitech, in addition to some TVs.

Televisions themselves are also getting in on

the act. The latest premium models are often

internet enabled, meaning that they can

directly access streamed video content from

OTT sites such as Google’s YouTube. Similar

functionality is also appearing in supporting

devices, such as Blue-ray players.

Just to further complicate matters, many

participants have their fingers in more than one

pie. For example, Sony has its own suite of

products such as internet TVs and the PS3, but is

also collaborating with the GoogleTV project.

Additionally, there are a number of conscious

efforts on the part of various participants to

establish some common standards. For instance,

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in Europe, the Hybrid broadcast broadband TV

(HbbTV) consortium has achieved a good

measure of traction, with a double digit number of

German broadcasters now utilising the format to

provide services like catch-up TV. Sony,

mentioned just a moment ago, is again a

participant. (Note Project Canvas, now renamed

YouView, is approximately a UK equivalent of

HbbTV, and two may converge in future).

There are two asides to make at this stage. The

first is that, amid all the intense rivalry on display

here, there is clearly the risk that an undue degree

of fragmentation takes place, potentially both

confusing the consumer and introducing excessive

costs for those that own content rights but must

port them between numerous different standards

and electronic programme guides (EPGs). By way

of example, note that platforms often use different

DRM (digital rights management) technology:

that appropriate for streaming to a games console

is not necessarily compatible with that working on

an internet TV – even if both units share the same

manufacturer.

The second is that, despite the panoply of

acronyms, there remains one practical issue within

the home that still lacks a good uniform solution:

most houses are simply not wired so as to enable

the television set in the living room to take a

service from a data feed. A variety of technologies

are in contention to address this need, although

none would currently seem to provide all the

answers.

There are new wireless technologies like wireless

HD (WiHD) and wireless home digital interface

(WHDI) but – of course – these are not

incorporated into the majority of pre-existing

consumer equipment, and WiHD is restricted to

line-of-sight implementations. WiFi remains the

most widely deployed domestic wireless data

technology, but does not generally have the

bandwidth to support IPTV streaming,

particularly if in HD. Another alternative is

powerline technology, which enables data to be

streamed over the one form of existing wiring

seen in almost all homes, ie that providing

electricity. Earlier implementations lacked the

bandwidth to cope with HDTV, but there are now

faster upgrades available.

The name of the game

Why all this potential duplication of effort? The

players in this field would naturally each like to

control the customer’s gateway into the world of

streamed video services, hence the desire to see

their software interface alongside (or inside!)

consumers’ televisions. A great deal of jockeying

for position, as well as hedging of risks, is

therefore to be expected.

The problem for telecoms operators in this context

is the sheer number of players (often with

powerful brands) that are eying this space. And

while the telecoms network may be an absolutely

vital component in the overall service (after all,

OTT content can only reach the consumer over

telecoms pipes), the problem is that this element is

somewhat invisible (indeed, this is the usual

dilemma for any service company). In contrast to

telecoms players, electronics and technology

companies will not have to deploy substantial

capital to reach the home; but if it is their EPG

that the customer consults to select content, then –

however ‘unjustly’ – the chances are that it is with

them that the consumer will primarily associate

the service.

Some customers may come to OTT via an orderly

decision process, having selected their optimum

supplier. However, many others (particularly

those less interested in technology) will likely

stray into this territory, rather than making a

definite plan from the outset. There is a good

chance that whichever company is first able to

entice them into experimenting with a service may

secure them as a customer for its platform.

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Several telecoms operators have therefore made

efforts to get their own set-top boxes into the

home, to ensure that their streamed video services

are competing for the eyeballs of any customers

curious to see what sort of video streaming

service their living room equipment can provide.

Plainly, if the telecoms operator can exert some

form of control over the electronic programme

guide in particular, it would be in the powerful

position of being able to steer customers towards

one video service over another. Even was its own

IPTV service to wither, a telecoms operator able

to act as a gatekeeper in this fashion would

doubtless find it very lucrative. But the problem

here is simply getting heard amidst all the activity

– from so many players – in this space.

Orange/FT, for example, has made a clear effort

to get its own-branded equipment into customers’

homes, via its Livebox. However, the results have

been mixed. In an admirably forward looking

move, Orange gave access to the box’s

application programming interfaces (APIs), with a

view to encouraging the emergence of innovative

applications (rather like Apple has successfully

achieved with its iPhone). However, this has

failed to stimulate the appearance of any kind of

developer ecosystem, although this is not to

detract from the fact that the device’s presence in

many living rooms will have made Orange’s

services an easy upgrade path for its customers.

Telecoms operators interested in a set-top box

presence are not confined to those with a fixed-

line focus. Vodafone has recently announced

boxes for the German and Spanish markets that

are capable of receiving broadcast TV (from a

variety of conventional platforms) alongside OTT

video via broadband.

A particular concern to all market participants

(whatever their origins) will be AppleTV. It

should almost go without saying that Apple has a

formidable reputation in terms of designing and

manufacturing highly desirable consumer

electronics. Rivals will be concerned that the

AppleTV device itself will lure in customers,

particularly those that are already enthusiastic

devotees of the brand. Previous iterations of the

AppleTV product were arguably underpowered

(the device would not support 1080p HDTV) and

overpriced (both in terms of the unit itself and the

HD movies offered over it).

Many competitors may have been relieved that

Steve Jobs’s second iteration of the AppleTV

product was not more radical. The first version

sold in (by Apple’s standards) disappointing

quantities, not even shifting 1m units. Its

replacement offers a greater range of VoD and is

also cheaper, yet it hardly looks like a game

changer. For this paradigm shift, we would argue

that it is necessary to look elsewhere –

specifically to the iPad. In future, these devices

may provide the most immediate viewing

platform, with consumers opting to send a

streamed signal to a more conventional TV only

when they know that several companions are

interested in seeing the same programme.

Furthermore, the iPad and its tablet equivalents

look like the best interface by which to navigate

through the likely bewildering array of content

available from OTT sources. In future, the

purchase of a programme via an OTT video-on-

demand service might involve a transaction via an

iPad, rather like the purchase today of an app. So,

even on the assumption that customers continue

viewing their programming on television screens

(rather than on the tablets themselves), Apple –

through its iPad – has control of the platform that

could effectively become the equivalent of the

remote control in countless households. Hence

Jobs may have concluded that – with or without

AppleTV – his company already owns the most

obvious gateway into the OTT world for many

future viewers.

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Where Apple goes, Google is usually not too far

behind, and OTT video services are no exception.

The GoogleTV offering seeks to meld together

internet and TV content, capitalising on some of

the company’s traditional strengths in search.

Following the conventional web model, the

platform is fully open. As usual, Google will be

looking to monetise the opportunity via

advertising (clearly it has its eyes on the

enormous television advertising market).

Interestingly, though, Google has chosen to

include some relatively traditional partners: for

instance, Sony and DirecTV (indeed, working

alongside a conventional US satellite broadcaster

will undoubtedly raise some eyebrows). But

Google’s most powerful weapons remain its brand

and core search competence (giving users an easy

way to find programming amid the otherwise

confusing landscape of OTT).

But, lest it be supposed that the greatest threats to

media and telecoms companies seeking to

monetise the OTT opportunity originate entirely

out of technology companies based on the west

coast of the US, the intentions of various

supermarkets also merit mention. In the US,

Walmart has already entered the OTT field, while

in the UK, Tesco also has its eyes on this area.

Indeed, Tesco is actually looking to sell its own

internet connected set-top boxes, which will have

video-on-demand functionality. Any ambitions

held by Tesco in the OTT field are highly relevant

to the UK market because of the enormous power

and clout of its brand and retail presence.

What operators can do What should operators do to confront the

challenges that beset their IPTV businesses? Most

lack a brand that would naturally be associated

with entertainment; nor do they own exclusive

content, or enjoy the benefits of having (say) a

powerful internet brand.

Indeed, many telecoms operators do seem to be

retreating from the idea that they can muscle in on

the traditional broadcast space. For instance,

PCCW in Hong Kong decided that it was simply

too expensive to renew its English Premier

League rights exclusivity. Meanwhile, the

intervention of the regulator has persuaded FT

that it should re-evaluate how to go forward with

its Orange Cinema and Sport channels (following

complaints from Vivendi concerning their

exclusivity). It made sense to acquire exclusive

rights when it was possible to use these as a

mechanism to attract customers to a given

distribution platform. But with regulators

increasingly intolerant of such exclusive

arrangements (and not just with respect to the

telecoms operators), this is no longer such an

appealing strategic option. The content rights

business model is, instead, moving in the more

open direction implied by OTT.

But at least the regulators are looking at

exclusivity arrangements established by all parties

(and not just at those put in place by telecoms

players). This should limit the ability of dominant

payTV players to draw viewers onto their

proprietary distribution platforms (eg DTTV or

satellite) via exclusive content. In turn, this should

leave telecoms networks (including cable) as the

most natural and flexible content delivery solution

– a fact that operators should benefit from through

their connectivity revenues. As an example of this

process, note that Ofcom has referred BSkyB to

the UK Competition Commission on the grounds

that it might be necessary “to reduce Sky’s ability

to act on incentives to exploit market power, by

requiring it to provide wholesale access to linear

and S[ubscription] VoD premium movie content

on regulated terms.”

What makes this so important is that the

availability of a wide range of video content via

OTT platforms is very likely to prove one of the

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most powerful drivers of uptake for telecoms

NGA fibre services. Regulators will be aware of

this, and given that the deployment of such

platforms is in many places regarded as a priority

for national competitiveness, may view

sympathetically the need for there to be attractive

video content available over NGA connections, in

order to improve the economics of the roll out.

Alas, the matter of winning payTV customers

involves more than just assembling the right

programming. For example, BT had long been

looking to obtain access to some of BSkyB’s

sports content in order to boost the appeal of its

Vision service. Having at long last (thanks to

regulatory intervention) secured this

programming, it undertook a substantial

advertising campaign, highlighting the cheap

availability via its offering of Sky Sports 1 at just

GBP6.99 per month. Admittedly, the new content

did enable BT to improve its Vision net adds for

the quarter (to 24k from 14k in the previous three

months), but this is hardly an impressive

acceleration, especially given the marketing

undertaken.

Perhaps, then, the issue is really one of brand:

operators are simply not seen as credible suppliers

of video entertainment. Another alternative for the

telecoms companies would be to extend their

remit into elements of the applications layer other

than IPTV that are perceived as being more

functional in nature (and thus closer to the

operator’s core competency of providing

connectivity).

DT is among those that have developed services

of this type. For instance, customers are offered a

network-based address book that can be used via

PCs as well as mobile phones, on-line storage

accessible by a variety of means, including

through TVs equipped with DT’s set-top box,

control of IPTV programme recording via PCs

and mobile handsets, and so on. But, while a

useful feature set, it will be apparent that many (if

not quite all) of these capabilities are available

from the big internet and technology brands, and

customers may well gravitate towards using these

providers rather than their telecoms supplier.

Another alternative would be to exploit one

unique selling point that telecoms operators do

possess – in the form of their extensive call centre

resources. Operators are often heard complaining

that they are generally on the receiving end of the

telephone call when something goes wrong with a

consumer’s set up, even if the problem is more

likely to be with a supplier of the electronics or

software. Since the technology companies

responsible for the latter components of the

service are usually much harder to reach, the

customer’s first port of call is to ring their

telecoms supplier.

While it might be frustrating for operators to have

to take a call about a problem that is not

necessarily in any way their responsibility, it is

perhaps worth considering whether – if this is

going to happen in any case – it is worth making a

virtue of the situation? Operators’ support

capabilities are an advantage that could be

leveraged with the suppliers of consumer

electronics to persuade them to enter into

partnership, and (at the very least) incorporate

pathways guiding users to the telecoms

companies’ OTT services.

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Introduction The mobile applications layer is now firmly in the

possession of companies from the technology

industry. Indeed, even the term ‘application’ has

effectively become synonymous with Apple and

its ‘app store’. Even established device vendors

are struggling, and Apple’s most powerful rival in

this space looks set to be Google, with its Android

platform. The investment markets have – not

unreasonably – long since written off the

operators chances in this arena, and hence the rise

of the likes of Apple and Google in this field has

not come at the expense of telecoms valuations.

But there is a risk that the operators find

themselves not only cut out of the upside from

applications, but also dis-intermediated from

services that have traditionally been their

preserve. For instance, applications may become

the gateway to communications services and

make no acknowledgement of the underlying

connectivity upon which they depend. In this

context it is disappointing not to see the operators

showing more commitment to platforms like the

Rich Communications Suite (RCS) initiative,

which might at least have helped them to contain

certain threats.

That said, though, the operators do continue to

need the applications ecosystem to drive

innovation and thus the take-up of data services

that will exploit the connectivity they provide. In

a country such as China, where there is a risk that

the ecosystem could become stunted (because the

like of Apple and Google are unlikely to have any

hands-on control), this might – in turn – actually

hamper the take off of the entire mobile data

market segment.

The operators, then, do need the applications

ecosystem; but the reverse is also true: the

technology players need the operators, which foot

most of the bill for the mobile device upgrade

cycle. Consequently, we think it unlikely that

vendors such as Apple will either launch as

mobile virtual network operators (MVNOs) or

introduce soft SIM functionality (which makes

phones re-configurable to other networks) as such

moves would risk jeopardising their relationship

with the very companies that provide the bulk of

their revenues.

RCS: Relegated to Connectivity Service? We have long warned of the potential danger to

the operators of leaving the technology sector in

control of the smartphone software and

applications layer (for instance, see Avoid

Android, 9 November 2007). However, it is now

abundantly clear that the operators have almost

entirely ceded this space – and, as a result, it will

Mobile applications

Operators may regret failure to push RCS as a defensive measure

Connectivity revenues at risk in markets lacking app ecosystem

Soft SIM threat overstated, as not in vendors’ own best interests

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be technology companies like Apple and Google

that harvest the potentially rich pickings here.

The financial markets have essentially accepted

this state of affairs as a fait accompli, and there

has been little noticeable effect on operators'

valuations as a result – chiefly because investors

had long-since given up on their ability to

monetise the more sophisticated elements of the

data opportunity (anything much, that is, beyond

connectivity). However, it is worth asking

whether the markets currently fully appreciate the

extent of the territory sacrificed to the technology

sector.

The point here is that, once the applications layer

is outside of the operators’ control, everything

other than connectivity potentially becomes a

service that is delivered OTT, rather than by the

network operator. This applies not only to new

services like IPTV, but also to the most traditional

of telecoms fare, such as voice telephony.

Not surprisingly, the operators are making some

(late) attempts to at least regain a measure of

influence – given that to retake control looks well-

nigh impossible at this stage. One such initiative

is the Wholesale Applications Community, an

effort by a broad swathe of operators to provide a

common platform for developers (over both

different handsets and networks), potentially

streamlining development processes and

multiplying the addressable market. However,

such initiatives are almost certainly a case of too

little, too late, in our view – particularly given the

long-standing hostility felt between the developer

community and the telecoms industry due to the

latter’s historic inflexibility as regards the design

and revenue-sharing models for mobile

applications.

Another telecoms initiative is the GSM

Association’s (GSMA) Rich Communications

Suite (RCS), an effort to produce a set of

standards enabling mobile networks to provide the

type of functionality otherwise associated with

software-led platforms. For example, RCS has a

‘presence’ capability, able to inform users

whether their contacts are available for

communication, in the same type of way that

instant messaging systems work today. This is

plainly a very useful capability if users are to be

persuaded to continue to rely on switched mobile

Number of applications available by platform

150,000

20,0006,000 4,500

300,000

130,000

25,000 18,0005,000

0

50,000

100,000

150,000

200,000

250,000

300,000

350,000

Apple Android Nokia Ov i BlackBerry Window s 7

0%

100%

200%

300%

400%

500%

600%

end-2009 end-2010 Grow th y -o-y

Source: Distimo, HSBC estimates

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calls for their voice communications needs, rather

than electing instead to use OTT VoIP

applications.

However, RCS has attracted limited support from

the industry, with most operators non-committal.

There have been initial trials, for instance in the

South Korean market, but a typical complaint

relates to the fact that it has proven difficult to

monetise the services in question. The situation

bears comparison with the lack of enthusiasm

shown for the IP multimedia subsystem (IMS) or

the GSMA’s OneAPI initiative: two other

platforms that have inspired little enthusiasm,

likely as a result of the opaque nature of the

perceived business case. Naturally, this state of

affairs has a knock-on effect with the handset

vendors, creating something of a ‘chicken and

egg’ problem (ie without RCS-enabled handsets,

why push the services, but without the services,

why produce RCS-enabled handsets?).

Alas, a clear revenue upside opportunity may

prove to be a luxury: the battle is arguably rather

to retain ownership of the customer in relation to

their communications needs – in particular, given

the way in which social networking sites like

Facebook could become their users’ embarkation

point for all their communications needs. For the

telecoms operator to be dis-intermediated in this

way might not actually cost much revenue in the

short-term (as the customer’s communications

still rely on its connectivity), but very likely

entails longer-term risks.

The API wars

Facebook already provides a series of APIs for

third-party applications to hook into, and most

developers (given their IT background) are more

at home co-operating with another technology

player rather than a telecoms operator. Moreover,

the greater the popularity of social networking

sites (and their associated applications), the more

likely it becomes that mobile users will look to

them for innovative new services. Indeed, it is

difficult to see how mobile operators can keep up,

given that telecoms is an industry composed of

large (and therefore generally slower moving)

organisations where standardisation is regarded as

fundamental. Hence their very nature means that

they lack the flexibility of technology companies

to invest in new services without any clear picture

of how the revenue model will develop.

APIs offer web developers access to key operator network functions to add greater value to applications

Source: HSBC

The above said, operators do retain certain

advantages. They are likely more trusted than

internet names in terms of security, have

extensive customer support facilities (an area

where many technology players have almost no

capability whatever), and should – if the

necessary resources are committed to the relevant

development work – be able to leverage their

control of the underlying connectivity (for

instance, by providing QoS-related functionality).

Note that much of the effort with RCS is to

provide developers with APIs (essentially

software interfaces) enabling developers to access

and leverage the capabilities of the mobile

network, for instance to initiate a call or a text

message. Arguably, there are now just too many

APIs competing for the attention of developers –

and (as mentioned above) this will likely leave

developers graduating by default towards those

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provided by fellow technology companies, rather

than to those provided by the telecoms industry.

But even if developers can be attracted to exploit

this platform, given the operators are no longer in

control of the applications layer, there is no

guarantee that the application will in any way

signal to the user that they are utilising the

telecoms network’s connectivity – in just the same

way that Skype draws no attention to the fact that

it relies on telecoms bandwidth. So, from a

branding perspective, even were RCS to be

readily adopted, the operator may still lose out as

a result of its having ceded control of the

applications layer.

It is worth pointing out at this stage, though, that

we do not regard VoIP as a practical technology

for mass market voice communications over

mobile at present. As detailed in greater depth in

our thematic reports Frequonomics and

SuperFrequonomics (March and September 2010

respectively), 3G platforms are intrinsically

unsuited to the quality of service that is demanded

by VoIP. However, VoIP should work better with

4G/LTE, where it is the only means of carrying

voice (given the new technology’s lack of circuit

switched capability). It will, though, in our view,

take a number of years for 4G/LTE platforms to

mature, and for handsets using this technology to

become mass market. Moreover, most operators

have every incentive to retain lucrative voice

traffic on their circuit-switched, metered 3G (and

2G) infrastructure, which will also tend to limit

the pace of transition towards VoIP.

Hence, over the next few years, the threat looks

limited from either VoIP or the fact that the

operators may no longer exercise control over

how users initiate their voice calls. But, looking

out rather longer term (which, admittedly, could

mean 5 years plus), losing control of this

important interface could spell real problems with

regard to branding. After all, even if the reality of

the situation is that operators are best advised to

stick to what they know – that is, essentially,

providing the proverbial ‘dumb pipe’ – it would

perhaps be best if they could retain greater

engagement with the customer, so as to limit

churn and avoid being perceived merely as a

commodity supplier (albeit one owning and

operating an intrinsically scarce resource).

Flourishing ecosystems best Had the operators displayed real aptitude and

enthusiasm for the applications layer, then the

capture of this segment by players from the

technology sector might have been perceived as

more of a distinct negative. However, the reality

of the situation has been that, although some

extravagant claims were made for the scope of the

operators’ opportunity during the internet bubble,

most investors have long-since written this off.

So, while we might decry the mobile players’

failure in the application space, in a scenario

where there is no associated value being ascribed

to them, arguably the most important

consideration is that someone pursues the

opportunity – whatever their identity. In other

words, if there are no good reasons to suppose the

telecoms companies will get applications right,

then it is better that the challenge be taken up by

those fit for the task (ie the likes of Apple and

Google) rather than the whole field be neglected.

Provided the applications layer is properly served,

customers are likely to want to take advantage of

the exciting services on offer, and therefore to

take out data plans – and thus the operators

benefit via the resulting connectivity revenues. If,

on the other hand, the applications layer remains

rudimentary, the incentive for customers to adopt

data connectivity services will simply not be

present. To summarise: if operators have not the

aptitude to take the whole pie (ie applications +

connectivity), better that a rival provide the

applications so that the operator can take the

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connectivity half of the pie, rather than the

absence of applications mean there is no

associated demand for connectivity (ie no pie at

all!).

The global nature of brands like Apple and

Google might lead one initially to suppose that

their involvement in the applications layer would

ensure that this field could develop rapidly in

every important market. However, there may well

be at least one substantial exception to this: China.

It seems most unlikely that Apple or Google will

be left in charge of running the applications layer

in China, a responsibility that is more likely to be

given to the telecoms operators. However – as

elsewhere on the planet – there is little reason to

suppose that these companies have the right skill

set to make a success of this enterprise. This

might not dim the appeal of iconic devices such as

the iPhone, which possess clear status appeal, but

sales of high-status devices need not translate

through into data connectivity revenues. The risk

is, therefore, that without the proven track record

of innovation of the global technology leaders,

data connectivity could be a damp squib in China.

Softly softly on Soft SIMs Given the tremendous success that technology

players like Apple have had in terms of building

their presence in the mobile applications layer, it

is hardly surprising that concerns have been raised

as to the possibility of their attempting to extend

this power base further. For instance, consider the

scenario where they decided to push into the

connectivity space itself – the mobile operators'

heartland – or, alternatively, where they chose to

disrupt this space by introducing innovations such

as 'soft SIMs' (of which more below).

How might technology players like Apple (or

Google) go about making a move into the

connectivity layer? One route would be for them

to launch as MVNOs, leveraging their powerful

branding and reputation to attract customers.

Operators would know from experience the power

of these brands, and the stronger operators would

also be aware that their weaker rivals might find it

difficult to resist such an opportunity. Although

the technology player in question would own the

retail customer, they would still be paying the

mobile network operator a wholesale fee. This

could be perceived by smaller network operators

as a short cut to gain market share; and the

knowledge that the smaller players would find

such a proposition compelling might force the

hand of a larger operator into itself accepting the

proposal (with the justification that, if it were to

refuse, one of its rivals would get the business

instead).

But, in our view, there are good reasons to

suppose that the technology players will not in

fact take this route. The first of these revolves

around returns. We certainly believe that telecoms

in general (including mobile) generates an

attractive return profile, but we would not claim

the ROIs are as high as those seen from successful

technology companies. So the first question is,

why would the technology players want to dilute

their returns by becoming, in effect, mobile

operators?

This is arguably particularly the case given that,

as a MVNO, they would be perceived as

responsible for something that would not actually

be under their direct control: the quality of the

mobile network that they were reselling. Mobile

coverage will always be patchy, given issues of

interference, in-building penetration difficulties,

and so on. At present, it is the telecoms operators'

brands that take the hit for the inevitable problems

of mobile reception. It seems unlikely, in our

view, that the technology players would want to

be on the receiving end of the blame for this type

of issue, especially when they do not directly

control the infrastructure in question.

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There is also the problem that any move into the

MVNO space by the technology players would

effectively involve competing against their own

customers. It might – wrongly – be supposed that

the customers of a company like Apple are the

people who emerge from shops having purchased

an iPhone. But this would be a simplification,

because most of those 'buying' an iPhone pay

nothing like its full list price, instead taking a

handset subsidised by a mobile operator. So, if the

identity of the 'customer' is defined as the party

paying the largest element of the list price, then

this is usually likely to be a mobile network.

Clearly, if (for example) Apple was to decide to

launch as a MVNO, it would thus become a direct

competitor at a retail level to all the mobile

networks in the country in question. This would

doubtless leave the operators much less keen to

subsidise Apple's devices. Thus Apple might lose

out to its handset rivals, in particular to those

producing equipment powered by Google's

Android platform. Apple might (not

unreasonably) argue that its devices have such a

hold on the popular imagination, that operators

would simply have to continue subsidising its

devices; but, nonetheless, they would surely

become more wary of doing so, as well as keener

to find alternatives. It seems unlikely that this risk

is worth running simply in order to gain the

relatively thin margins of a wholesale operator,

particularly given the associated risks around

brand/network quality outlined above.

Soft SIMs counter-productive

What, then, of the risk of technology players

introducing so-called soft SIMs? (News reports in

November 2010, for example, suggested that

Apple was planning to integrate a soft SIM into

the iPhone, before the firm beat a hasty retreat

following the vocal concerns of several mobile

operators). At this stage, the phrase “soft SIM”

may require some explanation. Traditionally, a

mobile customer deciding to churn between two

networks would have to remove the SIM card of

their previous operator, and replace it with one

provided by their new operator. Not only is this

process fiddly, but there is also the strong

possibility that the original operator will have

'locked' the mobile phone such that it will only

work with one of that operator's SIM cards.

Mobile networks do this in order to ensure that,

once they have subsidised a handset's retail price,

the customer does not simply churn to a

competitor (after all, they need to earn a return on

the handset subsidy). Note that handsets can be

unlocked by those with the requisite know-how,

and while this is a service that is widely available,

it is also somewhat disreputable.

Soft SIMs make the process of switching mobile

operator much simpler by enabling the user via

on-screen software to re-configure the device to

work on different mobile operators’ specific

frequency bands as well to be recognized by their

AAA (authentication, authorization and

accounting) servers. For instance, there need be

no fiddling around removing casings and

manipulating diminutive slivers of plastic. But,

from a business model perspective, there is a

clearly a major potential headache here. Just as

with regard to the risk vis-a-vis technology

players becoming MVNOs, the problem is that to

introduce soft SIMs would be to work very clearly

against the operators' interests. And, in a business

model where the operator (via the subsidy) is, in

effect, the real customer (since it is responsible for

paying the bulk of the handset list price), this is

plainly highly risky.

Operators subsidise handsets in the hope that they

will attract customers to their network. If customers

are able to churn as soon as they have their handset

(courtesy of soft SIM functionality), then there is

little incentive for the operator to subsidise the

device at all. This would leave the customer having

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to pay up front the full list price for the handset. In

such circumstances, there is little doubt but that

customers would upgrade their handsets much less

frequently, and thus that the handset vendor would

take a considerable revenue hit.

It would therefore be surprising, in our view, if the

technology companies were prepared to risk the

arrangement in which they currently find

themselves. It is perhaps worth reviewing again in

outline the present business model. A handset

vendor like Apple develops expensive, premium

devices with a very substantial list price that, were it

to be reflected in the retail price, would surely deter

many would-be users. But the retail price is then

substantially reduced through the subsidy of the

operator, enabling the likes of Apple to sell far more

devices than they would otherwise do – and yet

Apple still receives the full list price. This is clearly

an advantageous state of affairs for the vendor:

Apple in effect gets to sell far more of its devices

than it would if its retail price was its list price.

Why jeopardise such a beneficial business model?

One set of circumstances in which this might be

justified would be in the scenario where the

operators looked intent on moving into Apple's

territory. Given the operators' poor showing in

terms of developing the applications layer, and the

tremendously successful entry into this space of

the Apple App Store in particular, the technology

players could be forgiven for thinking that this

now represents their own home territory. As such,

belated efforts by the operators to get involved,

such as the Wholesale Application Community

(WAC), would likely appear threatening

(notwithstanding the low chances of success that

we would ascribe to this particular initiative). So,

one possible explanation for the sudden interest in

soft SIMs is that Apple was well aware of the

counterproductive nature of this functionality, but

wanted to send a warning shot across the

operators' bows in view of developments such as

WAC.

In summary, therefore, we are sceptical about the

concept of technology companies either becoming

MVNOs or introducing soft SIMs. Neither

innovation would seem to make sense from a

business model perspective, although both might

make for useful threats in order to persuade the

operators that the mobile applications layer is no

longer a suitable goal for them.

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Introduction The emergence of pricing power in both fixed-line

and mobile telecoms should be a powerful positive

right across the industry, particularly after having

been absent for so long. We would stress,

however, that because pricing power is being

driven by the connectivity layer, the benefits are

by no means evenly distributed. In terms of the

fixed-line subsector, we believe that the best-

placed operators are those who are investing in

fibre-based next generation access (NGA)

infrastructure, which – by dint of the high capital

intensity of such projects – is ensuring scarcity in

the market for super-fast broadband provision.

Incumbents furthest ahead deploying NGA will be

the first to benefit; among the Europeans this

includes smaller incumbents like Swisscom and

KPN of the Netherlands, which are generally

further ahead than their peers in larger markets. In

the CEEMEA region, Israeli incumbent Bezeq

looks best-placed, while in the US, Verizon, which

has deployed FTTP to nearly 16m homes, stands

to benefit most, we believe. However, even ahead

of the best-placed telecoms operators, we think

that the greatest benefits will actually accrue to the

cable companies (Germany’s KDG, multinational

Liberty Global, Belgium’s Telenet, Virgin

Media in the UK and ZON in Portugal, as well as

recently re-floated Danish incumbent TDC which

also has cable assets). This is because digital cable

platforms can take advantage of a rapid and

relatively low cost upgrade to NGA via

DOCSIS3.0 modem technology.

In the mobile subsector, we favour larger operators

with the necessary scale to out-invest their smaller

rivals. Here again the application of capital should

be a positive differentiator, enabling operators with

deep resources to deploy a more densely-built

mobile network. This should mean shorter average

distances between their customers and their base

stations, which in turn should result in a faster and

more robust data connection – clearly a significant

source of competitive advantage. As a

consequence, we prefer the mobile exposure of

scale players like Vodafone, Telenor, NTT

DoCoMo and KT.

We believe that the tremendous growth in mobile

data volumes will mean that operators will need

(and want) to invest more in capex. The mobile

equipment vendors ought to benefit from this, with

our favourite being market-leader Ericsson, which

has the highest exposure to the mobile sector.

In the emerging markets, the dynamics are

somewhat different. There should still be the

opportunity to monetise scarcity in terms of

connectivity, and hence we would suggest stocks

like TIM Part in Brazil. However, additionally,

there may still be some scope for operators to

Winners and Losers

The scarcity is in the connectivity, so network investment vital

Fixed-line winners: cable plus telecoms operators investing in fibre

Mobile winners: scale players to enjoy quality of service advantage

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capture a portion of the applications layer: we

would advocate STC and MTN on this basis.

We see the losers on the themes discussed in this

report as being those companies that have been slow

to invest in their core connectivity capabilities, like

Telecom Italia and TPSA in Poland.

Developed world: winners and losers on all themes The specific theme examined in this report – the

emergence of scarcity and its ramifications in

terms of bestowing a measure of pricing power

upon the operators – is certainly topical, and

merits special focus, in our view. However, this

theme is only one of many that are relevant to our

overall evaluation of the companies in the

telecoms sector. The accompanying chart

therefore summarises our assessment of

developed telecoms stocks on all the various

themes considered in this and previous

documents, set against a basket of valuation

measures.

We highlight stocks that screen well on the topics

discussed in the current report, but which also do

well on our broader analysis of thematic issues. In

Europe, this applies to Vodafone (obviously a key

beneficiary of this particular report’s central

theme too) as well as to KPN and Telefonica.

CEEMEA: winners and losers on this theme We believe that there is an opportunity for

telecoms operators in the connectivity layer in

both developed and emerging markets. However,

emerging markets are somewhat distinct from

their developed counterparts, in that there may

still also be some scope for operators to monetise

the applications layer as well. In view of the

Stocks assessed in terms of full range of strategic themes (x-axis) vs valuation on a basket of measures (y-axis)

AT&T

Belga

Bouy

BT

CT

DT

Elisa

FWB

FTKDDI

KPN

MOBI

NTT

OTE

PT

SNX

Swiss

Tele2

TI

Tef

TA

Tnet

Tnor

TLSN

VZ

Vod

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

5.00

1.00 1.50 2.00 2.50 3.00 3.50 4.00 4.50 5.00

Thematic relative

Valu

atio

n re

lativ

e

Key:O/W =N/W =U/W =(size = mkt cap)

Source: HSBC

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different scope of their opportunities, below we

set out winners and losers in the CEEMEA region

as an example of emerging market operators’

prospects.


In the CEEMEA region, there has been a

relatively slow transition to next generation access

(NGA) superfast broadband at the fixed-line

operators. Ultimately, this shift could potentially

move the competitive landscape away from

unbundling and towards wholesale in the most

mature telecom markets in CEEMEA, like in

CE3. The slow speed of deployment is mostly due

to the desire on the part of the telecoms

incumbents to negotiate first with the regulator

some guarantee for a minimum return or a more

accommodating regulatory environment. Typical

examples of this approach have been seen at

TPSA in Poland and Bezeq in Israel. In 2009,

TPSA entered into an agreement with the

regulator that requires the company to provide

1.2m high-speed broadband lines. This will

require an investment of cPLN3bn over three

years, but has helped to ease regulatory pressure

somewhat.

Due to the delays in NGA roll-outs, we have not

yet seen signs of a migration from unbundling to

wholesale. And note that in some countries, like

Russia and in Africa, ULL has not even been

implemented. However, increased investment in

NGA has precipitated a degree of consolidation

between small cable operators in CE3, as well as

triggering the acquisition of smaller cable TV

operators by CEE incumbents. Recent

acquisitions of regional cable operators by

Magyar Telekom in Hungary and by MTS in

Russia are examples.

In most CEEMEA telecoms markets, regulation is

not particularly stringent as regards net neutrality.

In fact, this issue has only really become a topic

of discussion for countries like CE3 that are

converging towards European telecoms

regulation. The absence of net neutrality

regulation is clearly a positive for emerging

market telecom operators, since it will enable

them to manage their resource (and available

capacity) more efficiently, and even to charge a

premium for prioritisation. Another recent

positive regulatory trend is for the media and

cable companies tends to be increasingly

compared with the telecoms operators, and

included within the remit of new regulation.

Hence, the regulatory advantage previously

enjoyed by cable operators is gradually eroding.

A similar conclusion could be drawn vis-à-vis

taxation: for example, the new communications

tax in Hungary applied to both telecoms and cable

operators.

The monetisation of fixed-line connectivity varies

greatly between countries in CEEMEA. Key

factors to consider are affordability, levels of

income disparity within the population and also

the level of availability of substitutes. For instance,

Polish subscribers spend a relatively modest

amount on broadband compared with customers in

Czech or Saudi. In 2010, TPSA reduced fixed-line

broadband pricing, through which it intends to re-

engage with the core market. However, broadband

competition is fierce in Poland, mainly thanks to

the cable operators, which are upgrading their

networks to DOCSIS3.0. Overall, we therefore

believe that TPSA should be seen as vulnerable to

the cable threat.

The Saudi environment is much more supportive

when it comes to the monetisation of broadband

connectivity. There are cable or altnets

competitors offering fixed-line broadband; mobile

broadband (via dongles) are the only alternative.

Currently VoIP is banned in Saudi Arabia, with

the consequence that broadband is not a direct

substitute for voice services. There is also likely

to be a healthy demand for broadband in the long

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term, given Saudi’s attractive demographics,

favourable regulatory environment, lack of

entertainment options and the absence of

alternative technologies.

In Turkey, the main inhibitor of fixed-line

broadband growth in Turkey is PC penetration.

Note that there is only a small difference between

PC penetration and broadband penetration (ie

households with a PC but no broadband). The

attempt to increase prices for unlimited packages

in 2011 to adjust for sharply rising inflation and to

impose fair usage quotas could negatively impact

subscriber and ARPL growth in the near term.

Furthermore, the nominal price increase does not

represent pricing power in real terms, given the

c7% inflation in Turkey that is expected by HSBC

economists in 2011. However, positives for Turk

Telekom include the absence of regulation

promoting net neutrality and the fact that local

loop unbundling remains unattractive for altnets.

Mobile connectivity

As discussed in our SuperFrequonomics report

(September 2010), data is not a story confined to

the developed world – indeed, in many ways, it is

actually operators in emerging markets that are

better placed on this theme. Emerging markets

are, naturally enough, further behind in data

adoption, but as a result should have more of the

growth ahead of them. Affordability issues will do

much to dictate the speed at which data services

penetrate the customer base, but the pace at which

smartphones and PCs are falling in price is

remarkable: it should not be long before USD100

smartphones make their appearance.

The provision of mobile broadband services in

many emerging markets is also inherently less

competitive, by simple virtue of the fact that

fixed-line platforms (the obvious alternative

supplier of broadband) are often limited in their

geographic reach. And there is arguably some

prospect that emerging market players may be

able to learn from developed-world operators’

missteps. For instance, it is interesting that

comparatively few have launched all-you-can-eat

data tariffs, with most instead (very sensibly)

opting for plans with usage caps. Another mistake

(in our view) committed by the developed-world

players was to cede the phenomenally important

applications layer to the technology sector.

In the CEEMEA region, MTS and some of the

African operators like MTN look well positioned.

All have introduced capped data tariffs, face

relatively little competition from fixed-line

broadband and have upside via content and/or

VAS. MTN is well placed in terms of pricing

power on mobile data. All the mobile operators in

Africa currently offer tiered data plans – there is

no ‘all you can eat’ data plan currently. Data

usage in South Africa has increased 49% since

December 2009, with MTN’s data revenues

growing 42% year-on-year in H1 2010.

Even more impressive is the 58% year-on-year

growth seen in non-SMS data revenues, which

accounted for 11% of MTN’s South African

service revenue. Among its larger operations,

Nigeria currently has the lowest proportion of

revenue (4.2%) coming from data services, the

key reason for this being simply a lack of required

bandwidth. However, with the landing of various

submarine cables in Africa, we expect the

capacity bottleneck issues to be removed soon.

This should, in our view, allow MTN to capture

the vast growth potential for data usage in

Nigeria. However, there are risks relating to the

entry of a credible new entrant (Bharti).

In Russia, growing demand for data is providing

mobile connectivity with momentum. 3G USB

modem numbers have now overtaken fixed-line

broadband subscribers. In Q3 2010, VAS (SMS

included) amounted to 20.5% of revenue in

Russia (a 2.1 ppt year-on-year increase), boosted

by the expansion of the 3G network and the fast

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growth seen in data traffic. We believe that

pricing power is unlikely to be undermined

significantly in the medium term, as the

competitive environment has remained quite

rational in Russia. However, there have been also

cases of private reselling of connectivity and the

illegal sharing of capacity. While the impact of

this could potentially be significant, it should be

mitigated as long as data tariffs remain tiered. We

would also expect the potential issues with illegal

sharing of capacity to gradually fade, as the

demand for higher speeds takes hold.


There has been limited success in the

monetisation of fixed-line data applications by

operators in emerging markets. IPTV is one of the

most obvious potential services, but is chiefly

considered as a bolt-on tool for retaining

subscribers and competing at par against cable

operators. For example, in Poland, where cable

penetration is high, users are reluctant to pay for

IPTV unless real premium content is provided –

something that the incumbent is now making

progress in. TPSA signed a 10-year content

agreement with TVN group to cross-sell each

other’s services, with a special focus on multi-

play bundles.

Telecoms operators have had a degree of success

with their portals. TPSA’s Wirtualna Polska is

one of the most frequently visited websites in

Poland, but monetisation remains elusive. The

hope is that TPSA will be able to venture into

adjacent sectors like payment and e-commerce.

Meanwhile, competition in terms of content is

already pronounced – UPC has been providing

cable services in CE3 since the late 1990s. OTT is

not yet a threat, but inevitably is a looming risk for

the future.

As for the other CEEMEA countries, especially

Russia and MENA, factors like the complexities of

rights arrangements, power of existing brands and

absence of net neutrality regulation should provide

significant pricing power and advantage to the

incumbents. In Saudi, STC formally launched IPTV

services in August 2010 under the ‘InVision’ brand

– and is bundling its services through triple-play

offerings of voice, broadband and IPTV. This should

now leave them well-placed to monetise the fixed-

line applications layer.

Mobile applications

By contrast with their developed peers, emerging

market operators should enjoy several advantages

when it comes to leveraging the application layer.

For example, they will benefit from a degree of

familiarity with their local culture and language

that global technology brands will find it difficult

to replicate. They should also have less cause for

concern over one application in particular that will

likely cause headaches for their developed-world

peers: VoIP. This service is blocked in many

emerging markets – and, not infrequently, with

the government’s approval.

Hence, we believe that Africa and MENA should

display good growth in the medium term. We

expect low-cost smartphones based on the

Android platform to drive internet usage in

Africa. However, language will present a barrier

to would-be developed world competitors. So, for

instance, we believe players like MTN should be

able to avoid the fate of being dis-intermediated

from the applications layer.

Some successful non-voice mobile applications

are already evident in the emerging markets. For

example, mobile payment could become a

significant revenue generator (and now provides

around 14% of revenues for SafariCom). The fact

that most countries in Africa have a large

unbanked population creates an appealing

opportunity in these countries especially. MTN’s

mobile payment service, Mobile Money, is

showing a good take-up. For instance, MTN

Uganda already has almost 16% of its subscriber

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base using the service. In total, MTN has c2.2m

mobile payment subscribers across its various

operations. We reiterate our view that, over the

medium term, mobile payments will contribute

approximately 6% of revenues at a margin of

around 20% for the African mobile operators.

In Saudi Arabia, services based on news,

entertainment and religious content offer good

growth prospects. The increase in network

coverage and online Arabic content should also

drive strong mobile broadband uptake over comin

years, in our view. Data volumes conveyed over

Mobily’s network have increased by 70% year-

on-year, reaching 85 terabytes per day. Mobily

remains the market leader in the mobile

broadband segment, with 60% market share, and

has been able to command a pricing premium,

reflected in its high data ARPU of cUSD55.

Pricing has remained stable in Saudi Arabia for

broadband services, unlike other – more

competitive – markets, such as Egypt.

Turning to CE3, we expect low-cost smartphones

based on the Android platform to drive mobile

data usage. However, language will likely

continue to present a modest barrier to would-be

developed world competitors eyeing these

markets. Hence operators like TPSA may not yet

be completely dis-intermediated from the mobile

applications layer.

Ratings, target price & risks Below we summarise our target prices, valuation

methodologies and highlight the main risks for

each of the incumbents analysed in this report.

Note that our ratings on these operators reflect our

work on numerous themes, and not only the issues

on which the present report focuses on.

America Movil: Maintain Neutral rating and USD64 target price

We have tweaked our estimates following the Q4

2010 results conference call. Most of the changes

stem from a slight increase in Brazil mobile

ARPU after adjusting for Q4 2010 equipment

sales. We summarise the main changes in the

table below.

America Movil: Change in estimates

(USDm) 2011e 2012e 2013e

Revenue 52,893 54,769 56,224

Previous 52,617 54,346 55,698 Difference % 0.5% 0.8% 0.9% EBITDA 21,844 22,948 23,928 Previous 21,755 22,805 23,744 Difference % 0.4% 0.6% 0.8% Net profit 9,171 9,793 10,415 Previous 9,124 9,710 10,301 Difference % 0.5% 0.9% 1.1%

Note: All figures on an adjusted basis. Source: HSBC estimates

We value America Movil using a DCF approach

employing a WACC of 8.2% with a risk-free rate

of 3.5%, equity risk premium of 5.0%, country

risk premium of 1.0%, beta of 1.0, and debt-to-

total capital ratio of 30%. Our AMX.N ADR

target price is USD64.

Under our research model, for stocks without a

volatility indicator, the Neutral band is 5ppts

above and below our hurdle rate for Mexican

stocks of 9.5%, or 4.5-14.5% around the current

share price. Our target price of USD64 per ADR

implies a potential return of 12.7% which is

within the Neutral band; thus, we maintain our

Neutral rating.

Key upside risks to our Neutral ratings, in our

view, include synergy delivery above our

expectations and greater success of converged

fixed-mobile service offerings than we anticipate.

Key downside risks, we believe, include merger

synergies falling below those of the market, and

deteriorating trends at Telmex, which represents

around one-fifth of group sales.

AT&T: Maintain Neutral rating and USD30 target price

We reduce our forecasts for AT&T following the

loss of iPhone exclusivity and its fourth quarter

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results. We summarise the main changes in the

table below.

AT&T: Change in estimates

(USDm) 2011e 2012e 2013e

Revenue 124,847 126,302 128,943 Previous 127,041 129,076 132,243 Difference % -1.7% -2.1% -2.5% EBITDA 43,676 44,817 46,297 Previous 45,164 46,151 47,643 Difference % -3.3% -2.9% -2.8% Net profit 13,983 14,987 15,654 Previous 14,843 15,812 16,575 Difference % -5.8% -5.2% -5.6%


We value AT&T using a DCF approach

employing a WACC of 6.3% (from 6.7%

previously) with a risk-free rate of 3.5% (4%

previously), equity risk premium of 3.5%, beta of

1.1, and debt-to-total capital ratio of 30%.

The impact of the decrease in our forecasts on our

DCF-based valuation is broadly offset by a

reduction in the WACC, and hence we maintain

our target price for AT&T at USD30.



above and below our hurdle rate for US stocks of

7.0% or 2.0-12.0% around the current share price.

Our USD30 target price implies a potential return

of 5.4%, which is within the Neutral band; thus,

we reiterate our Neutral rating on AT&T shares.

Key downside risks, in our view, include

continued weakness in wireline revenues, and

AT&T taking longer than anticipated or being

unable to expand its wireless service margins

from current levels in absence of iPhone

exclusivity. Key upside risks, we believe, include

continued high share of net additions despite

Verizon’s iPhone launch and wireless ARPU

growth.

Belgacom: Maintain Neutral rating and EUR30 target price

We have a Neutral rating on Belgacom with a

DCF-based target price of EUR30. In our DCF-

based valuation, we use a risk-free rate of 3.5%

(from 4.0% earlier), a market risk premium of

5.0% (from 4.5% earlier) and a beta of 1.1 to

derive our target price. Under our research model,

for stocks without a volatility indicator, the

Neutral band is five percentage points above and

below our hurdle rate for Europe-ex-UK stocks of

8.5%, or 3.5-13.5% above the current share price.

Our 12-month target price implies a potential

return of 11%, which is within the Neutral band

and hence we reiterate our Neutral rating.

The key upside risk, in our view, is rapid

macroeconomic recovery leading to higher-than-

expected revenue and EBITDA growth; the key

downside risk is a price war in mobile triggered

by the introduction of handset subsidies, leading

to a higher-than-expected deterioration in

margins.

BT: Maintain Neutral rating, raise target price to 200p (from 153p)

We lift our target price to 200p (from 153p), driven

partly by the changes in our estimates post Q3

results and partly by the reduction in our contingent

liability assumption for pension deficit – an

intrinsically volatile number – to GBP3.0bn (from

GBP5.7bn earlier) to reflect the changes in the

pension indexation to CPI from RPI. The

accompanying table summarises the changes to our

forecasts. Our WACC assumption of 8.0% is

unchanged (cost of equity of 8.7%, cost of debt of

8.4% and a debt-to-capital ratio of 25%).

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BT: Change in estimates

GBPm FY 2011e FY 2012e FY 2013e

Revenue Old 20,284 20,090 20,112 New 20,173 20,067 20,083 % change -0.5% -0.1% -0.1% EBITDA reported

Old 5,433 5,645 5,791 New 5,620 5,813 5,974 % change 3.4% 3.0% 3.2% EPS reported (p) Old 14.7 17.9 20.2 New 18.2 20.6 23.1 % change 23.9% 15.2% 14.2%

Source: HSBC estimates


volatility indicator, the Neutral band is five

percentage points above and below our hurdle rate

for UK stocks of 7.5%, or 2.5-12.5% around the

current share price. Our target price of 200p

implies a potential return of 7.9%, which is within

the Neutral band; therefore, we reiterate our

Neutral rating on the stock.

A primary risk – both upside and downside – to

our Neutral stance relates to the triennial pension

fund review. BT has agreed to payments of

GBP525m into the pension fund for the next three

years and committed to further payments

increasing at 3% CAGR for the next 17 years.

However, the Pensions Regulator has expressed

its disquiet at this approach, and is presumably

concerned that this time frame is simply overlong.

Additional risks to the upside include the potential

for BT to beat expectations on its cost savings.

Additional risks to the downside include any fresh

problems emerging within Global Services as a

result of the UK government’s austerity measures.

Bezeq: Maintain Overweight rating and target price of ILS11.6

We maintain our Overweight rating on Bezeq

with a target price of ILS 11.6 per share. Our DCF

valuation and target price are based on a cost of

equity of 11%, incorporating a risk-free rate of

5.5% (based on long-term bond yield) and equity

risk premium of 5.5% and a beta of 0.8.

Downside risks, in our view, include negative

regulation that will support alternative operators

but not provide similar relief to Bezeq; launch of a

new MNO with regulatory protection (ie sub

pricing for national roaming); IEC moving to

install fibre network in selected regions within

Israel, offering third parties an alternative to

Bezeq’s transmission services.

DT: Maintain Underweight rating and EUR9.5 target price

We use a DCF methodology to arrive at our one-

year forward target price of EUR9.5. We have

assumed a risk-free rate of 3.5%, an equity-risk

premium of 5.0%, a beta of 1.1 and terminal growth

rate of -1%). We have adjusted our numbers to

reflect the Q4 currency movements and rolled

forward the valuation to year-end 2011e, leading

overall to an unchanged target price of EUR9.5.

Our target price implies a potential return of

-4.4%, which falls below the HSBC Neutral band

of 3.5% to 13.5% for European non-volatile

stocks. Thus, we reiterate our Underweight rating

on the stock.

DT: Change in estimates

EURm Dec-10 Dec-11 Dec-12

New Revenue HSBC 62,317 60,787 60,630 EBITDA company 19,555 19,059 19,098 EBITDA HSBC 18,550 18,054 18,093 EPS HSBC (EUR) 0.69 0.68 0.75 Old Revenue HSBC 62,677 60,747 60,241 EBITDA company 19,892 19,429 19,388 EBITDA HSBC 18,887 18,424 18,383 EPS HSBC (EUR) 0.73 0.73 0.79 Change Revenue HSBC -0.6% 0.1% 0.6% EBITDA company -1.7% -1.9% -1.5% EBITDA HSBC -1.8% -2.0% -1.6% EPS HSBC -5.5% -7.0% -5.8%


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Key upside risks include a quick and sustainable

turnaround of T-Mobile US, a strong USD and

macro recovery in Eastern Europe.

eAccess: Maintain Overweight (V) rating, cut target price to JPY79,000 (from JPY88,000)

We continue to apply a multiple of 9x to March

2012e EPS to derive our target price for eAccess,

based on average trading history. Applied to our

new March 2012 EPS estimate of JPY8,732, this

yields a new target price of JPY79,000, down

10% from JPY88,000 previously.

Under our research model, the Neutral band for

volatile Japanese stocks is defined as the hurdle

rate of 7% for Japan, plus or minus 10ppt, which

translates into -3% to 17% relative to the current

share price. Our new target price of JPY79,000

for eAccess shares implies a potential return of

54.9% (including prospective dividend yield of

1.2%). We therefore maintain our Overweight (V)

rating on eAccess stock.

The principal downside risks to our rating are as

follows:

Lower profitability than expected in the

wireless broadband business, driven by an

increase in SACs (we believe the company’s

current SAC guidance of JPY30,000 is

conservative)

Greater-than-expected churn in the ADSL

business, possibly caused by increased

discounting by fibre broadband suppliers

Increased competition in the wireless

broadband business – from UQ

Communications, in particular – causing

erosion of margins from cheaper pricing

Forecast changes

We reduce our FY March 2011 estimates

substantially, reflecting lower profitability in the

quarters ending September and December 2010.

This is a result of eMobile handsets and the

network upgrade to 42Mbps being delayed – we

expect strong sales in the final quarter, and in 2011

generally. Our estimates vs consensus and our

previous forecasts are outlined in the table below.

eAccess: Change to estimates

JPYbn Mar-11 Mar-12 Mar-13

Consensus Sales 189.8 228.4 252.0 EBITDA 57.4 76.8 88.4 EBIT 24.8 36.7 46.8 Net Income 9.5 20.7 27.4 EPS 2,949 5,880 8,227 HSBC new estimates Sales 183.5 219.0 253.5 EBITDA 57.4 83.2 91.2 EBIT 24.1 45.4 55.9 Net Income 8.5 30.2 41.0 EPS 2,856 8,732 11,846 HSBC old estimates Sales 186.1 228.6 252.0 EBITDA 58.5 83.7 99.7 EBIT 26.9 45.7 62.4 Net Income 11.1 33.8 51.0 EPS 3,756 9,757 14,743 HSBC vs Consensus Sales -3.3% -4.1% 0.6% EBITDA -0.1% 8.3% 3.2% EBIT -2.7% 23.7% 19.4% Net Income -10.6% 46.0% 49.6% HSBC vs previous estimates Sales -1.4% -4.2% 0.6% EBITDA -1.9% -0.6% -8.5% EBIT -10.4% -0.6% -10.4% Net Income -23.9% -10.5% -19.7% EPS -23.9% -10.5% -19.7%

Source: HSBC estimates Ericsson: Maintain Overweight rating and SEK95 target price

We value Ericsson using a DCF approach. We

employ a WACC of 9.1% based on a risk-free rate

of 3.5%, equity risk premium of 5.5%, beta of

1.25 and debt to capital ratio of 20%. Our target

price is SEK95, implying a 15.7% potential return

based on the SEK82.1 closing price of 11

February; we have an Overweight rating on the

stock. Ericsson’s current PE is 12.5x 2011

(HSBCe), which compares with a historical range

(2005-10) of 8.5-17.5x; our target price of SEK95

implies a PE of 14.5x.

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Downside risks to our Overweight rating in the

shorter term include continued softness in

network orders as these tend to lag the economic

cycle. Price pressure from Chinese rivals Huawei

and ZTE and a trend toward network sharing

among mobile operators may both adversely

affect Ericsson’s revenues.

France Telecom: Maintain Overweight rating and EUR21 target price

We have cut 2010 net profit forecasts by 16%

mainly due to the reclassification to net income of

the Orange JV in the UK. Other changes in our

estimates are immaterial.

France Telecom: Change in estimates

EURm 2010e 2011e 2012e

Revenue New 45341 45439 45165 Old 44839 44920 44585 difference % 1.1% 1.2% 1.3% EBITDA New 15608 15504 15460 Old 15524 15682 15392 difference % 0.5% -1.1% 0.4% Net profit New 4604 4725 4842 Old 5478 4696 4693 difference % -16.0% 0.6% 3.2%


We value France Telecom using a DCF-based sum-

of-the-parts (SOTP) methodology to arrive at our

target price of EUR21. For our SOTP DCF, we

assume a discount rate of 8.5% for France, the UK,

Spain and the Enterprise business, 11% for Poland

and 9.2% for the Rest of the World division.

Under our research model, for French stocks

without a volatility indicator, the Neutral band is

five percentage points above and below our hurdle

rate of 8.5%, or 3.5-13.5% above the current share

price. Our France Telecom target price of EUR21

implies a potential return of 29.3%, which is

above the Neutral band; therefore, we reiterate our

Overweight rating on the stock.

Key downside risks in our view include:

Higher competition in the French market,

although Iliad’s entry into the mobile market

has been impacting the share price already, in

our view

A significant M&A transaction would

probably weigh on FT shares as investors

would fear dividend cuts and execution risks,

although this is not our view and the company

has not stated that it has any such plans

Execution risks in the UK during the

integration process

KPN: Maintain Overweight rating and target price of EUR15

After the Q4 2010 results, we have fine-tuned our

forecasts, cutting revenue forecasts by 2% to 3%

and EBITDA forecasts by 1% to 2% in the

medium term (see table below).

We have used a DCF valuation to derive our 12-

month forward target price of EUR15, which

implies a potential return of c27%. We have

assumed a risk-free rate of 3.5%, a market risk

premium of 5.0%, and asset beta of 1.1. Under our

research model, for stocks without a volatility

indicator, the Neutral band is five percentage

points above and below the hurdle rate for Europe

ex-UK stocks of 8.5% (3.5-13.5%). We reiterate

our Overweight rating.

KPN: Change in estimates

EURm 2011e 2012e 2013e

Revenues Old 13,633 13,938 14,254 New 13,423 13,579 13,782 % change -2% -3% -3% EBITDA Old 5,460 5,561 5,669 New 5,472 5,519 5,557 % change 0% -1% -2%


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Key risks to our Overweight rating include:

E-Plus delivering lower EBITDA margin than

we expect or losing market share to competition

More aggressive price-based competition by

Dutch cable that could hit KPN’s broadband

recovery

KT Corp: Maintain Overweight rating and KRW60,000 target price

We maintain our Overweight rating on KT Corp

with a PE-based one-year forward target price of

KRW60,000. We continue to apply a multiple of

8x forward earnings, based on average trading

history.

Under our research model, for Korean stocks


five percentage points above and below the hurdle

rate of 10% (ie 5-15%). Applying a multiple of 8x

to our 2011 EPS estimate of KRW7,441 yields an

unchanged target price of KRW60,000. This

implies a 52% potential return including the 6.3%

dividend yield in 2011e. We therefore maintain

our Overweight rating on KT stock.

The key downside risks include:

Action by the KCC that mandates the

provision of free voice minutes in smartphone

tariffs

More competition than anticipated in wireline

from LG U+ and SK Broadband and in the

wireless business from SKT

Mobily (Etihad Etisalat): Maintain Overweight rating, raise target price to SAR71 from SAR69

We continue to use a three-stage DCF model to

value Mobily. We have adjusted our WACC to

10.1% compared with 10% earlier. Our revised

WACC is a function of cost of equity of 13%

(risk-free rate of 3.5%, market risk premium of

9.5%, including inflation differential of 3.5% in

Saudi Arabia, equity beta of 1.0) and cost of debt

of 3.3% pre tax, using a debt-to-asset ratio of 30%

We have revised our earnings estimates upwards

by 11.9% in 2011 and 11.6% in 2012 to

incorporate strong pricing power for mobile

operators in Saudi Arabia in the lucrative

broadband business. Our base case estimates

suggest data as a percentage of total revenues

would go up from 18% in 2010 to around 29% by

2012, driven by strong subscriber growth along

with pricing power for telecom companies in

Saudi Arabia. Our capex estimates also go up to

incorporate increased network expenses on

account of high data usage.

Based on our revised WACC assumptions and

changes in estimates, our target price rises to

SAR71 from SAR69. Under our research model,

for Saudi Arabia stocks without a volatility

indicator, the Neutral band is 5ppt above/below

the hurdle rate of 9.5%. Our new target price

implies a potential return of 29.7% from the

current price. As this is above the Neutral band

for non-volatile Saudi stocks of 4.5-14.5% under

the HSBC research model, we maintain our


The key downside risks to our rating include:

(1) an aggressive price war with Zain KSA that

erodes the profitability of mobile operators in

Saudi Arabia; (2) STC’s aggressive build-up of

fixed network negatively affecting mobile

broadband growth in the Kingdom; and (3) a

deterioration in the broader Saudi market with an

adverse impact on the stock price, as Mobily is a

growth story.

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Mobily: Change to estimates

SARm 2011e 2012e 2013e

Old estimates Revenues 17,021 17,896 18,377 EBITDA 6,595 6,851 7,071 EBITDA margin 38.7% 38.3% 38.5% Capex -3,278 -3,221 -3,014 Net Profit 4,262 4,402 4,544 New estimates Revenues 17,930 18,645 19,116 EBITDA 7,148 7,420 7,599 EBITDA margin 39.9% 39.8% 39.7% Capex -3,454 -3,580 -3,319 Net Profit 4,768 4,912 4,986 Change Revenues 5.3% 4.2% 4.0% EBITDA 8.4% 8.3% 7.5% EBITDA Margin (bp) 112 151 127 Capex 5.4% 11.1% 10.1% Net Profit 11.9% 11.6% 9.7%


MTN: Maintain Overweight rating and target price of ZAR148

We value MTN on a SOTP basis using country-

specific cost of capitals ranging from 14.2% to

20.2%. Our SOTP valuation and target price are

based on a cost of equity of 14.7%, incorporating

a risk-free rate of 9.2%, equity risk premium of

5.5% and a beta of 1.0.

Under our research model, for South African

stocks without a volatility indicator, the Neutral

band is 5ppt above/below the hurdle rate of 10%.

This translates into a Neutral band of 5-15%

around the current share price. Our target price

implies a potential return of c18%, which is above

the Neutral band; hence, we reiterate our

Overweight rating.

M&A activity is a significant risk to MTN’s

valuation, in our opinion. Other key potential

downside risks include political and economic

instability in MTN’s areas of operation,

particularly Iran, Syria and Sudan, and operational

and regulatory risks across its operations. A

recession in global commodity prices could

weaken demand from the economies where it

operates, most of which are commodity-driven.

The entry of new operators in many markets could

potentially threaten its ARPU and margins in

these markets, which can significantly affect its

valuation. Fluctuations in ZAR and local

currencies against USD and relative movements

against each other could have a significant impact

on the valuation.

MTS: Maintain Overweight rating and target price of USD29

Our DCF valuation and target price are based on

an unchanged cost of equity of 11.5%. We use the

one-year average US 10-year treasury bond yield

(currently 3.5%) as the risk-free rate (we

previously used 6.0%). We arrive at a market risk

premium of 8% (was 5.5%), calculated using the

relative USD volatility of the local equity market

to the US equity market (time-weighted average

over the past 10 years). We use a beta of 1.0

(unchanged). Currently we assume no goodwill

write-off and no synergies from the Comstar

merger in our estimates.


volatility indicator, the Neutral band is 5% above

and below the hurdle rate for Russian stocks of

11.5%. This translates into a Neutral band of 6.5-

16.5% around the current share price. Our target

price implies a potential return of c47%, which is

above the Neutral band; hence, we reiterate our

Overweight rating.

Downside risks, in our view, are execution risks

with potential difficulties in the integration of

Comstar with MTS and an unsuccessful bid for a

3G licence in Ukraine. RUB fluctuation versus the

USD continues to have an impact on the ADR

price and is, in our view, a significant risk. A

collapse in crude oil prices would have a negative

impact on the Russian currency and

unemployment level as well as private

consumption demand.

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NTT DoCoMo: Maintain our Overweight rating, raise target price to JPY172,000 (from JPY165,000)

Our primary valuation methodology for NTT

DoCoMo is PE-based, as we believe this better

reflects the way investors view the stock relative

to domestic peers and sectors. We continue to

apply a multiple of 13x to our March 2012 EPS

estimate of JPY13,197. This yields a new target

price of JPY172,000, up 4.2% from JPY165,000

previously. Under our research model, the Neutral

band for non-volatile stocks is 5ppt above and below

the hurdle rate of 7% for Japan. This translates into

2-12% around the current share price. Given the

potential return (including prospective dividend

yield) of 17% implied by our JPY172,000 target

price, we maintain our Overweight rating.

The primary downside risks to our rating are:

Greater than expected tariff competition in

mobile data: We expect DoCoMo to match

SoftBank’s smartphone plan at cJPY4,000.

Prices lower than this would be a negative for

the sector. As we explain in this report, we

base our revenue forecasts on this

assumption, but recognise that announcement

of a price cut could be negative for sentiment.

Faster than expected voice revenue declines:

We assume that DoCoMo’s voice ARPU

decline bottoms out in 2-3 years as a result of

migration to the Value Plan concluding.

Higher than expected investment in India: We

expect further investment in the Tata-DoCoMo

joint venture in India, to fund 3G network

deployment, but believe this should be both

relatively small and expected by investors.

We increase our revenue and profit estimates for

NTT DoCoMo after faster than expected smartphone

growth in the quarter ending December 2010.

Changes to our estimates, and our forecasts vs

consensus, are outlined in the table below.

NTT DoCoMo: Change to estimates

JPYbn Mar-11 Mar-12 Mar-13

Consensus Sales 4,253 4,329 4,395 EBITDA 1,559 1,569 1,598 OP 844 864 902 Net Income 499 514 538 EPS 11,940 12,348 12,990 HSBC Sales 4,251 4,356 4,597 EBITDA 1,616 1,653 1,731 OP 885 937 1,024 Net Income 518 548 598 EPS 12,460 13,208 14,391 HSBC new estimates Sales 4,197 4,296 4,451 EBITDA 1,561 1,593 1,602 OP 842 899 917 Net Income 493 526 535 EPS 11,849 12,683 12,892 HSBC vs Consensus Sales 0.0% 0.6% 4.6% EBITDA 3.7% 5.4% 8.3% OP 4.8% 8.5% 13.5% Net Income 3.9% 6.7% 11.1% HSBC vs previous estimates Sales 1.3% 1.4% 3.3% EBITDA 3.5% 3.8% 8.0% OP 5.1% 4.3% 11.7% Net Income 5.2% 4.3% 11.8% EPS 5.2% 4.1% 11.6%


Portugal Telecom: Maintain Neutral rating and EUR9 target price

We value PT’s domestic business on a DCF basis

(risk-free rate 3.5%, market risk premium 5.0%

and asset beta of 1.1). We value PT’s stake in the

Oi Group/Telemar by applying a 25% discount (to

take into account the complex governance) to the

fair market value of Telemar. Under our research

model, for stocks without a volatility indicator,

the Neutral band is five percentage points above

and below the hurdle rate for Europe ex-UK

stocks of 8.5% (ie 3.5-13.5%). Our 12-month

target price of EUR9 implies a potential return of

5%, which is within the Neutral band; hence, we

maintain our Neutral rating. Key risks to our

Neutral rating include.

The key upside risk, in our view, is if PT were

to acquire a stake of more than 22.38% in the

Oi Group for the same consideration of

BRL8.4bn .This could occur if the existing

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shareholders of TNL and TMAR do not fully

subscribe to the rights issues

The key downside risk, in our view, is if the

macroeconomic condition were to become

tougher, affecting the domestic business more

than expected

Saudi Telecom Company (STC): Maintain Overweight rating, cut target price to SAR48 (from SAR49)

We continue to use a three-stage DCF model to

value STC. We now use a WACC of 10.7%

compared with 10.5% earlier. We use the long-

term EBITDA contribution of 60% from domestic

operations to calculate the weighted average cost

of equity for STC. International COE is taken to

be 15%. For domestic operations, we use a risk

free rate of 3.5%, market risk premium of 9.5%

including inflation differential of 3.5% in Saudi

Arabia and equity beta of 1.0. Our weighted cost

of equity for STC is 13.8%. Using a long-term

debt-to-equity ratio of 30%:70%, we obtain a

WACC of 10.7%. Cost of debt is unchanged at

3.8% for the group.

We have revised our earnings estimates upwards

by 5% in 2011 and 8.2% in 2012 to incorporate

strong pricing power for mobile operators in

Saudi Arabia in the lucrative broadband business.

Our capex estimates also go up by 13.9% in 2011

and 16.7% in 2012 to incorporate increased

network expenses on account of high data usage

as the migration to NGN continues for STC.

Based on our revised WACC assumptions along

with changes in estimates, our target price falls to

SAR48 from SAR49. Under our research model,

for Saudi Arabia stocks without a volatility

indicator, the Neutral band is 5ppt above/below

the hurdle rate of 9.5%. Our new target price

implies a potential return of 19% from the current

price. As this is above the Neutral band for non-

volatile Saudi stocks of 4.5-14.5% under the

HSBC research model, we maintain our


The key downside risks to our rating include: 1)

increased FX losses from international operations;

2) Zain KSA getting into a price war in Saudi,

leading to erosion of ARPUs for all mobile

operators; 3) overpayment for international

acquisitions; 4) delay in NGN implementation,

and 5) higher-than-expected capex in international

operations such as those in India and Indonesia. Sprint Nextel: Maintain Neutral (V) rating and USD5 target price

We reduce our profit estimates for Sprint Nextel

following its fourth quarter results. We summarise

the main changes in the table below.

We value Sprint Nextel using a DCF approach

employing a WACC of 8.1% (down from 8.4%

previously) with a risk-free rate of 3.5% (4%

previously), equity risk premium of 3.5%, beta of

1.5, and debt-to-total capital ratio of 30%.

STC: Change in estimates

SARm 2011e 2012e 2013e

Old estimates Total Revenue 52,026 52,582 53,700 EBITDA 19,872 20,099 20,530 EBITDA margin 38.2% 38.2% 38.2% Capex -9,478 -8,607 -8,124 Net Profit 8,723 8,767 9,154

New Estimates

Total Revenue 54,477 54,975 55,796 EBITDA 20,631 21,104 21,479 EBITDA margin 37.9% 38.4% 38.5% Capex -10,791 -10,043 -9,178 Net Profit 9,157 9,484 9,626

Variation

Total Revenue 4.7% 4.6% 3.9% EBITDA 3.8% 5.0% 4.6% EBITDA margin (bp) -33 16 26 Capex 13.9% 16.7% 13.0% Net Profit 5.0% 8.2% 5.1%


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Sprint Nextel: Change in estimates

USDm 2011e 2012e 2013e

Revenue 32,348 32,822 33,553 Previous 32,250 32,363 32,725 Difference % 0.3% 1.4% 2.5% EBITDA 5,917 6,188 6,367 Previous 6,140 6,327 6,482 Difference % -3.6% -2.2% -1.8% Net profit -1,069 -14 492 Previous -335 572 1,180 Difference % NM NM -58.3%

Note: All figures on an adjusted basis. Source: HSBC estimates The impact of a decrease in our profit forecasts on

our DCF valuation of Sprint Nextel is broadly

offset by a reduction in the WACC. Accordingly,

we maintain our target price for Sprint Nextel at

USD5.

Under our research model, for stocks with a


above and below our hurdle rate for US stocks

of7.0% or -3% to 17.0% around the current share

price. Our target price of USD5 indicates a

potential return of 8.7%, which is within the

Neutral band; thus, we reiterate our Neutral (V)

rating on Sprint Nextel shares.

Downside risks, we believe, include operational

performance below consensus expectations.

Upside risks that we see include potential

consolidation the US wireless sub-sector.

Swisscom: Maintain Overweight rating and CHF470 target price

We have marginally revised our forecasts,

although this has no material impact on valuation.

We have an Overweight rating on Swisscom with

a DCF-based target price of CHF470. In our DCF,

we assume a risk-free rate of 3.5% (from 4.0%

earlier), a market risk premium of 4.0% (from

4.5% earlier) and beta of 1.1.

Swisscom: Change to estimates

CHFm 2010e 2011e 2012e

Revenue New 12,008 11,951 12,243 Old 11,994 11,987 12,254 change 0% 0% 0% EBITDA New 4,696 4,741 4,840 Old 4,692 4,771 4,858 change 0% -1% 0% Net profit New 1,898 2,018 2,093 Old 1,897 2,044 2,116 change 0% -1% -1%


The key downside risks to our Overweight rating

on Swisscom are: a worsening in competition

conditions in Switzerland for both fixed line and

mobile owing to lower tariffs in either retail or

wholesale (ULL pricing); Swisscom continuing to

be conservative with its dividend payout in FY

2010; and a worse-than-expected tax investigation

outcome for Fastweb.

TDC: Maintain Overweight rating and DKK58 target price TDC: Change to estimates

FY 2011e FY2012e FY2013e

New DKKm DKKm DKKm Revenue reported 26,143 26,200 26,307EBITDA reported 9,794 9,873 9,945Operating profit reported 4,572 4,796 5,000Old Revenue reported 26,220 26,393 26,594EBITDA reported 9,925 10,082 10,184Operating profit reported 4,624 4,923 5,152Change Revenue reported -0.3% -0.7% -1.1%EBITDA reported -1.3% -2.1% -2.3%Operating profit reported -1.1% -2.6% -2.9%


We have slightly revised down our estimates to

reflect Q4 2010 reported numbers. We use two

separate methods to calculate an equity valuation

range for TDC: first, a DCF approach; and

second, a comparison to peer group EV/EBITDA

multiples and dividend yields. Our target is the

mid point of both approaches. We believe long-

term a pure DCF-based approach is legitimate.

However, as TDC just recently returned to the

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market, it will take time for investors to

reacquaint themselves with the stock. During that

process, a balanced approach of DCF and peer

multiple valuation seems appropriate to us.

We calculate a target price of DKK58 as the mid

point of our DCF and peer multiple valuations.

Our DCF assumes a WACC of 7.2% (RFR 3.5%,

MRP 4.5%, beta 1.1) and a (cautious) 0% terminal

growth rate.

Under our research model, for Danish stocks



rate of 8.0% (3.0-13.0%). Our target price implies

a potential return of 25%; we maintain our

Overweight rating.

As for all incumbents, regulation is a significant

source of downside risk for TDC, and there is

specific concern that the introduction of a

wholesale bitstream broadband product over

TDC’s cable network could undermine the

incumbent’s access network advantage. The

utility companies’ fibre ambitions also represent a

continued threat. Price erosion in traditional

products could more than offset growth from

newer areas such as quad-play.

Tele2: Maintain Neutral rating, raise target price to SEK160 (from SEK155)

We value Tele2 based on HSBC’s DCF

methodology (assumptions: risk-free rate 3.5%,

market premium 5.5%, debt-to-capital ratio 25%

and a beta of 1). The upward revision of our target

price to SEK160 from SEK155 reflects a slight

increase to our revenue estimates (primarily due

to higher growth expectations for Swedish mobile

and a small increase to subscriber numbers for

Russian mobile) and a reduction to our WACC

assumption to 8.3% from 8.6%. On a DCF basis

we arrive at one-year forward target price of

SEK160.

In our current valuation methodology we assume

a debt-to-capital ratio of about 25%. Please note

our target price of SEK160 includes the

extraordinary dividend of SEK27 proposed by

Tele2 for FY 2010e; post adjusting for this, our

implied target price would be SEK137.

The potential return from the current price of

SEK148.7 implied by our SEK160 target price is

8%, which is within the 4% to 14% Neutral range

for non-volatile Swedish (ex-UK) stocks under

HSBC’s research model; thus we retain our

Neutral rating on Tele2.

Better than expected margin performance from

the Swedish mobile division, where Tele2 has

been focusing on gaining higher share of post paid

subscribers could be a potential positive driver for

the stock. Key downside risks include a failure to

maintain the Russian growth momentum given the

lack of 3G spectrum and a collapse of cash

generation of its arbitrage businesses, in our view.

Telecom Italia: Maintain Underweight rating and EUR1.05 target price

We are consolidating Telecom Argentina from Q4

2010 following the approvals by the Argentine

regulators that have resulted in some significant

changes in our forecasts. Considering that the

competition has worsened in the domestic fixed

and domestic mobile continues to underperform

the market, we are cutting our domestic forecasts

Tele2: Change to estimates

SEKm FY 2011e FY2012e FY2013e

New Revenue reported 40,769 42,043 42,700 EBITDA reported 10,672 11,653 12,321 Operating profit reported 7,054 7,799 8,263 Old Revenue reported 39,774 40,246 40,687 EBITDA reported 11,046 11,725 12,401 Operating profit reported 7,662 7,906 8,358 Change Revenue reported 3% 4% 5% EBITDA reported -3% -1% -1% Operating profit reported -8% -1% -1%


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downwards and this is also reflected in the cutting

of our EPS forecasts.

We have used a DCF valuation to derive our one-

year forward target price. We assume a risk-free

rate of 3.5%, a market risk premium of 5.0% and

asset beta of 1.1 to arrive at an unchanged

EUR1.05 per share.



percentage points above and below the hurdle rate

for Europe ex-UK stocks of 8.5% (3.5-13.5%).

The potential return implied in our valuation of

0% is below the Neutral band; we therefore

reiterate our Underweight rating .

Telecom Italia: Change to estimates

EURm 2011e 2012e 2013e

Revenues Old 26,803 26,732 26,690 New 29,695 29,927 30,067 % change 11% 12% 13% EBITDA Old 11,335 11,233 11,180 New 12,221 12,159 12,142 % change 8% 8% 9% EBIT Old 5,934 6,132 6,367 New 6,371 6,661 6,921 % change 7% 9% 9% EPS Old 0.12 0.13 0.14 New 0.11 0.13 0.14 % change -4% -1% 0%

Source: HSBC estimates The key upside risk to our rating is a rebound in the

economy, which could lead to lower revenue

pressure in Italy. We estimate a 1-3% domestic

revenue decline in 2011 and 2012 after a 7%

revenue decline in 2010; an improvement in the top

line would also be an upside risk to our rating.

We are factoring in aggressive MTR cuts beyond

2011 to reach EUR4c in 2012e and EUR2c in

2013e. More benign MTR cuts would represent

upside to our rating.

Telefonica: Maintain Overweight rating and target price of EUR22

We maintain our Overweight rating on TEF and

our DCF-based one-year forward target price of

EUR22. We have assumed a risk-free rate of

3.5%, an equity risk premium of 5.0% and asset

beta of 1.1. Under our research model, for stocks



rate for Europe ex-UK stocks of 8.5% (ie 3.5-

13.5%). Our 12-month target price of EUR22

implies a potential return of 20%, which is above

the Neutral band; hence we maintain our

Overweight rating. Key risks to our Overweight

rating include:

A delayed recovery of the Spanish economy

(HSBC economist Madhur Jha forecasts GDP

growth of -0.4% in 2010 and +0.6% in 2011)

A currency crisis in LatAm that would hurt

the growth momentum

Telefonica or competitors introducing

irrational mobile data pricing in Spain, UK or

Germany, limiting the potential for restoring

revenue growth in Telefonica’s developed

markets

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Telekom Austria: Maintain Neutral rating, raise target price to EUR11 (from EUR10) Telekom Austria: Change to estimates

EURm FY 2010e FY 2011e FY 2012e

New Revenue reported 4,618 4,570 4,600EBITDA Reported 1,641 1,586 1,598Operating profit 573 569 649Old Revenue reported 4,588 4,540 4,466EBITDA Reported 1,614 1,591 1,543Operating profit 575 563 580Change Revenue reported 1% 1% 3%EBITDA Reported 2% 0% 4%Operating profit 0% 1% 12%


We value Telekom Austria based on a simple

DCF. Our valuation assumes a risk-free rate of

3.5%, market risk premium 5.0% and beta of 1.1.

Our target price upgrade to EUR11 from EUR10

reflects rolling forward our valuation to FY 2011e

and a slight increase in our estimates.

Our EUR11 target price implies a potential return

of 4.6%, which is above the 3.5% to 13.5%

Neutral range for non-volatile Austrian stocks

under HSBC’s research model; thus, we maintain

our Neutral rating on the stock.

Key upside risks include a quicker macro

recovery, consolidation of the Austrian mobile

market and a share-buyback announcement as

originally envisaged in January 2009 (though we

do not foresee any announcements in the

immediate future). Key downside risks include

prolonged revenue decline across the CEE and

TKA failing to stabilise the fixed-line business.

Telenor: Maintain Overweight rating, cut target price to NOK111 (from NOK115) Telenor: Change to estimates

NOKm FY 2011e FY 2012e FY 2013e

New Revenue reported 100,544 105,789 109,174 EBITDA reported 30,510 33,580 35,526 Operating profit reported 14,493 17,811 20,368 Old Revenue reported 100,957 105,905 110,151 EBITDA reported 31,481 34,055 36,127 Operating profit reported 16,151 19,354 21,990 Change Revenue reported 0% 0% -1% EBITDA reported -3% -1% -2% Operating profit reported -10% -8% -7%


We value Telenor based on a sum-of-the parts

valuation, in which we ascribe 4.5x EV/EBITDA

for Nordic business (Fixed+ Mobile), 5x

EV/EBITDA for CEE operations and 6x

EV/EBITDA for emerging Asian market

subsidiaries (except DiGi, which we now value

based on HSBC’s target price of MYR29/share;

DSOM.KL, MYR25.9, OW). We value Vimpelcom

based on our target price for Vimpelcom of USD18

(revised down from USD22, in our last report dated

18 January; VIP.N, USD14.3, N(V)).

Our NOK111 target price implies a potential

return of 21%, which is above the 5.5% to 15.5%

Neutral range for non-volatile Norwegian stocks

under HSBC’s research model; thus, we maintain

our Overweight rating on the stock.

Our target price revision to NOK111 (from

NOK115) primarily reflects the downward revision

to our target price on Vimpelcom, slightly offset by

a higher valuation for DiGi, which we now value

based on HSBC’s target price of MYR29, from

6.0x EV/EBITDA previously, and a slightly

increased valuation for the Nordic business driven

by margin improvements.

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The key downside risks to our valuation and

estimates, in our view, are: 1) higher than

expected cash outflow in the Indian operations

following the 2G licence debate; 2) failure to

maintain competitive shareholder remuneration;

and 3) loss of influence in Vimpelcom.

TeliaSonera: Maintain Neutral rating and SEK58 target price TeliaSonera: Change to estimates

SEKm FY 2011e FY 2012e FY 2013e

New Revenue reported 106,041 109,481 110,850 EBITDA reported 37,242 38,409 38,941 Operating profit reported 24,644 25,766 25,873 Old Revenue reported 107,473 108,740 109,814 EBITDA reported 37,625 38,604 39,120 Operating profit reported 25,443 26,111 26,396 Change Revenue reported -1% 1% 1% EBITDA reported -1% -1% 0% Operating profit reported -3% -1% -2%


We use HSBC’s standard three-stage DCF to

value the core business and a peer multiples

approach to value the associates and minorities

not under our coverage. We assume a risk-free

rate of 3.5%, market risk premium of 5.5%, debt-

to-capital ratio of 25% and beta of 1.1. Our

valuation methodology yields an unchanged target

price of SEK58.

We have slightly revised our estimates to reflect

the currency movements. The potential return

from the current price of SEK54.5 implied by our

SEK58 target price is 6.4%, which is within the

4% to 14% Neutral range for non-volatile

Swedish stocks under HSBC’s research model;

thus, we retain our Neutral rating on TeliaSonera.

The key downside risks would be a significant fall

in domestic business margins or any obstacles to

an agreement with Alfa group to combine their

Telenor: Sum-of-the-parts valuation (NOKm)

Business Stake 2011e Sales

2011e EBITDA

Multiple(x)

Valuation method and ratio Valuation Val / share

% of EV OLD Val/share

Telenor Norway (fixed+mobile) 100.0% 25,816 10,311 4.5 EV/EBITDA 46,399 28 23% 28Telenor Denmark (fixed + mobile) 100.0% 7,268 1,840 4.5 EV/EBITDA 8,279 5 4% 5Telenor Sweden (fixed + mobile) 100.0% 9,978 2,534 4.5 EV/EBITDA 11,404 7 6% 7Nordic Operations 66,082 41 32% 39Pannon GSM - Hungary 100.0% 4,565 1,650 5.0 EV/EBITDA 8,249 5 4% 7ProMonte - Montenegro 100.0% 631 275 5.0 EV/EBITDA 1,373 1 1% 1Telenor Mobile-Serbia 100.0% 2,678 1,068 5.0 EV/EBITDA 5,341 3 3% 4Eastern European Operations 14,963 9 7% 12Telenor Pakistan 100.0% 4,946 1,519 6.0 EV/EBITDA 9,117 6 4% 6DTAC - Thailand 65.5% 14,852 5,173 6.0 EV/EBITDA 31,037 19 15% 19GrameenPhone 55.8% 7,027 3,432 6.0 EV/EBITDA 20,590 13 10% 13DiGi.Com - Malaysia 49.0% 10,808 4,744 9.1 HSBC TP of MYR29 42,981 26 21% 17Asian Operations 103,724 64 51% 50Broadcast 100.0% 9,083 2,322 7.2 EV/EBITDA 16,720 10 8% 10Value of core businesses 201,489 124 99% 117EDB-Ergo 27.2% Market Cap 765 0 0% 0Vimpelcom 39.6% 70,003 33,396 4.2 HSBC TP of USD18 54,127 33 26% 40Others Book value 844 1 0% 1Value of associates 55,735 34 27% 41Indian venture market value Cash burn until breakeven in 2014 -10,279 -6 -5% -6Value of minorities -42,656 -26 -21% -21Appraised EV 204,289 125 100% 131Net debt -19,276 -12 -13Pension deficit ( 2010a) -1,381 -1 -1Contingent liabilities (anticipated licences in Bangladesh and Thailand)

-3,000 -2 -2

Appraised equity value 180,632 111 115Number of shares 1,631 Appraised share price 111.0


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holdings in Turkcell and MegaFon, and value

destructive acquisitions.

The main upside risks would be a decision that

could lead to higher shareholder returns,

stabilisation of the Swedish fixed business and

dividends from Megafon (which we believe has

limited visibility in the short term).

Telstra: Maintain Overweight rating and AUD3.40 target price

Given depressed earnings in FY 2011 and a lack

of medium-term visibility, we continue to use a

dividend discount methodology (DDM) to value

Telstra stock. We apply a cost of equity of 8.5%,

a beta of 1.1, and a terminal growth rate of 0%.

This yields our unchanged target price of

AUD3.40.

For stocks without a volatility indicator, the

Neutral band is five percentage points above and

below the hurdle rate for Australian stocks of

8.5%, or 3.5-13.5% around the current share

price. Our target price of AUD3.40 implies a

potential return of 16.8%. Therefore we maintain

our Overweight rating for Telstra stock.

The key downside risks to our rating are

NBN risk. With the passage of the June 2010

Heads of Agreement deal not finalised and

subject to change, regulatory risk remains.

A more hostile attitude to Telstra (including

more threats of break-up) would result in a

likely rejection of a deal by Telstra

shareholders, and further regulatory

uncertainty.

Operational risk. Our forecasts are in line

with consensus for FY June 2011, but

substantially ahead of consensus for FY June

2012 – based on our view of Telstra’s

sustainable competitive advantage in both its

wireline and wireless networks. A further

deterioration in the Australian competitive

environment may put this recovery at risk.

TIM Participações: Maintain Overweight rating and BRL7.50 target price

We value TIM Participações using a DCF

approach, employing a WACC of 10.1% with a

risk free rate of 3.5%, equity risk premium of 5.0%,

country risk premium of 3.0%, beta of 1.0, and

debt-to-total capital ratio of 30%. Our DCF-based

target price for TIM common shares (TCSL3.SA)

is BRL10.00.

To value the preference shares (TCSL4.SA), we

apply a 25% discount to our core valuation of TIM

common shares based on the historical trading

relationship. This results in a target price of

BRL7.50 for the preference shares.

We attain our TSU.N ADR target price of USD45

by converting our TCSL4.SA target price to USD

using HSBC’s 2011 average BRL/USD forecast of

1.67 at the time we last updated our target price on

16 November 2010. Under our research model, for stocks without a


above and below our hurdle rate for Brazilian

stocks of 11.5%, or 6.5-16.5% around the share

price.

Since our target prices imply potential returns

above the Neutral band (TCSL4.SA 24.6%,

TCSL3.SA 37.0%, TSU.N 22.0%), we rate all

TIM share classes Overweight.

Downside risks, we believe, include execution risks

surrounding the company’s turnaround plan.

Competition in the Brazilian mobile market remains

high, and although we believe that it has moderated

somewhat, an uptick remains a risk to TIM.

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TPSA: Maintain Underweight rating and PLN15.3 target price TIM Participações: Ratings and target prices (BRL except TSU ADR)

Ticker

New rating

Previous rating

Target price

Current price

Upside

TSU (USD) OW OW 45.00 34.38 30.9% TCSL4 OW OW 7.50 5.76 30.2% TCSL3 OW OW 10.00 7.05 41.8%

Source: HSBC estimates. Prices at close 10 January 2011

Our DCF valuation and target price are based on a

cost of equity of 11.8%. We use the one-year

average US 10-year treasury bond yield (currently

3.5%) as the risk-free rate. We arrive at the

market risk premium of 7.5%, calculated using the

relative USD volatility of the local equity market

to the US equity market (time-weighted average

over the past 10 years). We use an unchanged beta

of 1.1 to reflect the earnings and price uncertainty

arising out of the DPTG dispute.


volatility indicator, the Neutral band is 5ppt above

and below the hurdle rate of 11% for Poland. This

translates into a Neutral band of 6-16% around the

current share price. Our 12-month target price

implies a potential return of only 1.4%, despite

including the dividend yield of c9%. That is

below the Neutral band, so we maintain our

Underweight rating.

A quick resolution of the DPTG claim in favour

of TPSA would be a significant upside risk. Other

upside risks include rational competition in the

mobile segment, less competition than expected

from cable operators, and a better-than-expected

macro and regulatory environment.

Turk Telekom: Maintain Underweight rating and TRY6.8 target price

We value Turk Telekom using the average of our

SOTP and DCF valuations. Our DCF valuation

gives a fair value of TRY6.7, while our SOTP fair

value is now TRY6.9.

The DCF valuation is based on a cost of equity of

13.5%. We use the one-year average US 10-year

treasury bond yield (currently 3.5%) as the risk-

free rate. We arrive at a market risk premium of

10%, calculated using the relative USD volatility

of the local equity market to the US equity market

(time-weighted average over the past 10 years).

We use a beta of 1.0. The SOTP uses WACCs of

13.5% for the fixed-line business and 13.2% for

the mobile business.


volatility indicator, the Neutral band is 5ppt above

and below the hurdle rate of 13.5% for Turkey.

This translates into a Neutral band of 8.5-18.5%

around the current share price. Our 12-month

target price implies a negative potential return of

4.5%, including a dividend yield of 9%. As this is

below the Neutral band, we maintain our

Underweight rating.

Main upside risks, in our view, include lower-

than-expected inflation, higher-than-expected

dividends, high growth in Turk Telekom’s

subscriber acquisitions, higher-than-expected

mobile ARPU and broadband ARPL, brisk IPTV

off-take, and a delay in the entry of competition in

the fixed-line mass market.

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Verizon: Maintain Overweight rating, raise target price to USD41 (from USD37) Vodafone: Change in estimates

GBPm 2011e 2012e 2013e

Sales New 45,555 46,476 47,648 Old 44,790 45,232 45,840 %change 1.7% 2.8% 3.9% EBITDA New 14,659 14,825 15,168 Old 14,611 14,833 15,081 %change 0.3% -0.1% 0.6% EPS* (p) New 17.1 17.5 18.6 Old 16.2 16.4 16.7 %change 5.6% 6.3% 11.4%

Note: *Company definition of adjusted earnings. Source: HSBC estimates

We increase our forecasts following Verizon’s

fourth quarter results and the firm’s launch of the

iPhone. We summarise the main changes in the

table below.

Verizon: Change in estimates

(USDm) 2011e 2012e 2013e

Revenue 110,599 118,385 123,006 Previous 107,446 110,593 114,394 Difference % 2.9% 7.0% 7.5% EBITDA 36,697 39,640 41,235 Previous 36,533 38,031 39,651 Difference % 0.4% 4.2% 4.0% Net profit 6,539 7,791 8,662 Previous 6,529 7,468 8,392 Difference % 0.2% 4.3% 3.2%


We value Verizon using a DCF approach

employing a WACC of 6.3% (adjusted down from

6.7% previously) with a risk-free rate of 3.5%

(4% previously), equity risk premium of 3.5%,

beta of 1.1, and debt-to-total capital ratio of 30%.

Reflecting the increase in our forecasts and

reduction in the WACC, our target price rises to

USD41 from USD37 previously.



above and below our hurdle rate for US stocks of

7.0% or 2.0-12.0% around the current share price.

Our new USD41 target price implies a potential

return of 12.7%, which is above the Neutral band;

thus, we maintain our Overweight rating on

Verizon shares.

Key downside risks, in our view, include weaker

than anticipated sales response to the launch of

the Verizon iPhone, longer than anticipated

weakness in the wireline business, and moves by

Verizon and Vodafone Group to restructure their

ownership of their Verizon Wireless partnership.

Vodafone: Maintain Overweight rating, raise target price to 230p (from 190p)

We value Vodafone via a DCF methodology, and

have arrived at a new target price of 230p, up

from 190p previously benefiting partly from

change in our forecasts post the company’s Q3

results and partly from the GBP2.8bn share buy-

back programme (of which Vodafone has already

completed GBP1.1bn to 31 December 2010). Our

WACC assumption of 8.0% (cost of equity of

9.1%, cost of debt of 6.3% and debt-to-capital

ratio of 25%) is unchanged. The accompanying

table summarises the changes to our forecasts.



percentage points above and below our hurdle rate

for UK stocks of 7.5%, or 2.5-12.5% around the

current share price. Our Vodafone target price of

230p implies a potential total return of 27.8%,

which is above the Neutral band; therefore, we

maintain our Overweight rating on the stock.

Key downside risks, in our view, include: an

intensification of competition and adverse

regulatory impact in the already challenging

Indian market; the improvements seen in the

European operations faltering; or the upcoming

spectrum auctions proving more expensive than

anticipated.

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Company profiles

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America Movil (Neutral, TP USD64) Fixed line connectivity

America Movil (AMX) is now a diversified player

having merged its mobile assets with the Mexican

incumbent Telmex as well as Telmex Internacional’s

roster of South American cable and altnet properties.

To the benefit of fixed incumbents (although less so

altnets), unbundling of the local loop either does not

exist or is not actively supported by the region’s

regulators. Generally speaking, regulators in Latin

America often lack the necessary experience,

resources or political clout to pursue radical agendas

like unbundling or net neutrality. The only exception

so far in is Chile where a law upholding net

neutrality principles was passed in July 2010.

Mobile connectivity

Smartphone penetration is low in Latin America

(excluding QWERTY devices like BlackBerrys, we

estimate penetration of true smartphones across the

region is in the low single digits). America Movil

however has a strong focus on data which is paying

dividends with Q4 2010 group mobile data revenues

growing c37% year-on-year in constant currency

terms. Mobile data now represents typically c20-

25% of service revenues in most countries. We

expect continued steep price erosion of Android-

based smartphones, primarily from Asian

manufacturers to continue expanding the addressable

market for mobile data in Latin America.

Towards the end of Q4 2009, America Movil’s

Brazilian unit, Claro, experienced some isolated

pressure from data users on its 3G network before

it was comprehensively built out. Having watched

the difficulties created by unlimited mobile data

plans in developed markets, operators in the region

have adopted sensible tariff structures: tiered

pricing, data caps with overage or speed throttling

are normal practises in the region. Additionally,

America Movil, and most of its competitors are

careful to differentiate between pure smartphone

use and tethering (using a smartphone as a laptop

modem) which attracts a 20% premium in markets

like Mexico for example. In Mexico, America

Movil’s c73% market share and 3G leadership

afford it a certain degree of pricing power in data.

In Brazil, although voice price competition

remains fierce (America Movil has noted the price

of a voice minute fell by 20% in 2010), there is

greater price discipline in data between the data

market leaders, Claro and Telefonica’s Vivo.

Fixed line applications

In Mexico, regulatory challenges continue to prevent

Telmex from offering pay TV. Meanwhile, in Brazil,

America Movil’s has cable (NET Serviços, Brazil’s

leading cable player) as well as rapidly growing

satellite operations (Embratel’s satellite TV

customer base quintupled in 2010). It is widely

expected that Brazil’s media law which currently

prohibits telcos from offering IPTV will be changed

this year; the regulator Anatel has already started

removing this restriction from telco licence renewals

as it seeks to foster more payTV competition.

Mobile applications

Although operators in emerging markets with local

knowledge and powerful domestic content allies

(America Movil joint-owns Net Serviços with

powerful Brazilian media group Globo), we still

believe it will be difficult for mobile operators to

capture a significant portion of the applications value

chain (ie above any revenue share under the Android

Market model).

Investment thesis

We rate America Movil Neutral. Although well-

positioned to benefit from mobile capacity scarcity,

we expect consolidation of Mexican fixed-line

(Telmex) to drag significantly on group growth. In

fixed line, the scarcity opportunity is not being fully

exploited with little NGA investment and little or no

unbundling to flush out anyway.

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Financials & valuation: America Movil Neutral Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (USDm)

Revenue 48,130 52,893 54,769 56,224EBITDA 19,553 21,844 22,948 23,928Depreciation & amortisation -7,216 -7,286 -7,438 -7,622Operating profit/EBIT 12,337 14,558 15,510 16,306Net interest -989 -1,077 -1,026 -973PBT 10,982 13,823 14,740 15,619HSBC PBT 12,200 13,823 14,740 15,619Taxation -3,179 -4,147 -4,422 -4,686Net profit 7,195 9,171 9,793 10,415HSBC net profit 7,853 9,171 9,793 10,415

Cash flow summary (USDm)

Cash flow from operations 14,832 17,216 17,633 18,413Capex -6,508 -8,573 -8,793 -8,683Cash flow from investment -11,757 -8,573 -8,793 -8,683Dividends -1,034 -1,275 -1,431 -1,609Change in net debt 100 -5,092 -4,925 -5,645FCF equity 8,747 8,003 8,565 9,467

Balance sheet summary (USDm)

Intangible fixed assets 9,150 9,150 9,150 9,150Tangible fixed assets 33,319 34,606 35,961 37,022Current assets 20,595 16,379 20,484 23,356Cash & others 9,229 4,863 8,687 11,341Total assets 72,188 69,602 75,317 79,537Operating liabilities 15,976 16,721 17,135 17,497Gross debt 25,981 16,522 15,421 12,430Net debt 16,752 11,659 6,734 1,089Shareholders funds 26,787 32,599 38,477 44,807Invested capital 37,860 38,552 39,774 40,691

Ratio, growth and per share analysis

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue 14.3 9.9 3.5 2.7EBITDA 13.5 11.7 5.1 4.3Operating profit 9.9 18.0 6.5 5.1PBT 1.5 25.9 6.6 6.0HSBC EPS -3.9 18.7 9.2 8.8

Ratios (%)

Revenue/IC (x) 1.3 1.4 1.4 1.4ROIC 23.5 26.7 27.7 28.4ROE 31.1 30.9 27.6 25.0ROA 12.9 14.9 15.5 15.2EBITDA margin 40.6 41.3 41.9 42.6Operating profit margin 25.6 27.5 28.3 29.0EBITDA/net interest (x) 19.8 20.3 22.4 24.6Net debt/equity 62.5 35.2 17.0 2.3Net debt/EBITDA (x) 0.9 0.5 0.3 0.0CF from operations/net debt 88.5 147.7 261.8 1690.5

Per share data (USD)

EPS Rep (fully diluted) 3.34 4.59 5.01 5.46HSBC EPS (fully diluted) 3.87 4.59 5.01 5.46DPS 0.51 0.64 0.73 0.84Book value 13.34 16.33 19.70 23.47

Key forecast drivers

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Mexico Revenues 19,865 21,489 21,760 22,114Brazil Revenues 11,939 13,172 13,461 13,499Group Revenues 48,130 52,893 54,769 56,224Group EBITDA 19,553 21,844 22,948 23,928Group mobile subscribers (000) 225,025 239,801 251,741 261,340

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e

EV/sales 2.6 2.3 2.1 2.0EV/EBITDA 6.5 5.6 5.1 4.6EV/IC 3.3 3.2 2.9 2.7PE* 14.7 12.4 11.3 10.4P/Book value 4.3 3.5 2.9 2.4FCF yield (%) 8.0 7.3 7.8 8.6Dividend yield (%) 0.9 1.1 1.3 1.5

Note: * = Based on HSBC EPS (fully diluted)

Issuer information

Share price (USD) 56.78 Target price (USD) 64.00 Potent'l return (%) 12.7

Reuters (Equity) AMX.N Bloomberg (Equity) AMX USMarket cap (USDm) 114,501 Market cap (USDm) 114,501Free float (%) 59 Enterprise value (USDm) 121,468Country Mexico Sector Wireless TelecomsAnalyst Richard Dineen Contact 1 212 525 6707

Price relative

19242934394449545964

2009 2010 2011 2012

19242934394449545964

America Movil Rel to MEXICAN I.P.C. IDX

Source: HSBC Note: price at close of 11 Feb 2011

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AT&T (Neutral, TP USD30) Fixed line connectivity

The FCC’s 2003 Triennial Review effectively

withdrew support for unbundling (known in the US

as UNE-P, Unbundled Network Elements –

Platform) of incumbent local access fibre. The shift

in regulation encouraged incumbents like AT&T and

Verizon to then embark on extensive fiber

investments. Unbundled access providers in fibred

areas of the US have since all but disappeared.

While unbundling regulation has favored

incumbents, the FCC has taken a hard line on net

neutrality. This is understandable given the

strategic importance of US Internet companies

(whose products and services may be exported,

unlike those of domestic-focused telcos). In a

December 2010 decision, the FCC passed a new

policy that maintains strict net neutrality rules for

fixed-line networks while acknowledging the

unique scarcity of wireless capacity by permitting

some shaping of mobile traffic by operators based

on reasonable network management criteria.

Mobile connectivity

The US mobile data market is highly developed.

Over 60% of AT&T’s postpaid base has an

integrated device (including QWERTY devices

such as BlackBerrys); we estimate 35-40% of its

base has a “true” smartphone. Following the rapid

adoption of smartphones due mainly to the firm’s

exclusive carriage of the Apple iPhone June 2007-

February 2011, AT&T’s mobile network came

under intense pressure with widely publicized

network problems in San Francisco and New

York from mid-2009. This prompted a substantial

increase in AT&T’s wireless capex with 2010

spend increasing over 50% versus the prior year.

A major focus was the addition of a further c2,000

3G base stations during 2010 as well as boosting

backhaul capacity.

AT&T was among the first operators globally to

shift from flat-rate unlimited plans to tiered data

bundles – either USD15 for 200MB or USD25 for

2GB (overage charges apply above these limits).

Although other US operators are for the moment

sticking with unlimited plans, we believe there is

longer-term consensus that tiered plans represent

the future. AT&T and Verizon are the price-

setters in the US market, having several

advantages that their rivals lack (iPhone carriage

and broader and/or higher quality network

coverage, larger marketing budgets and so forth).

Given the pressure on its network it is

unsurprising that AT&T has been among the first

to exploit public WiFi to offload traffic where

possible. AT&T has 23,000 hotspots in the US,

including expanded hotzones in places like New

York City’s Times Square. The firm is also

offering femtocell products under the “Microcell”

brand which retail for cUSD150.


AT&T’s U-verse IPTV service had nearly 3m

customers by end-2010, penetration of around

14% in areas available for sale. As with Verizon,

AT&T competes directly against cable and

selectively against satellite (AT&T also re-sells

DirecTV satellite payTV outside U-verse markets).

Mobile applications

In our view AT&T, like Verizon, has been

decisively outflanked by Apple and Google in the

mobile applications space. We see little prospect

that any US carrier can successfully re-take this

ground from arguably the two most powerful

technology companies in the world.

Investment thesis

We are Neutral on AT&T. Although it should

benefit from growing mobile scarcity, trends in

wireless may weaken, we believe, following loss of

iPhone exclusivity which ended February 2011.

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Financials & valuation: AT&T Neutral Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e


Revenue 124,399 124,847 126,302 128,943EBITDA 40,080 43,676 44,817 46,297Depreciation & amortisation -19,462 -19,454 -19,153 -19,505Operating profit/EBIT 20,618 24,223 25,664 26,792Net interest -2,996 -3,175 -3,087 -3,214PBT 18,384 21,848 23,417 24,460HSBC PBT 20,905 21,848 23,417 24,460Taxation 1,123 -7,865 -8,430 -8,806Net profit 19,507 13,983 14,987 15,654HSBC net profit 13,379 13,983 14,987 15,654


Cash flow from operations 32,010 32,653 32,936 33,617Capex -20,302 -19,257 -19,204 -19,101Cash flow from investment -21,449 -21,607 -19,204 -19,101Dividends -9,916 -10,120 -10,580 -10,897Change in net debt -3,549 -2,050 -3,152 -3,618FCF equity 17,779 13,396 13,732 14,515




Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue 1.1 0.4 1.2 2.1EBITDA -2.7 9.0 2.6 3.3Operating profit -4.1 17.5 5.9 4.4PBT -1.6 18.8 7.2 4.5HSBC EPS 10.7 3.8 7.2 4.5

Ratios (%)





Year to 12/2010a 12/2011e 12/2012e 12/2013e

AT&T revenues 124,399 124,847 126,302 128,943AT&T EBITDA adjusted 41,659 43,676 44,817 46,297AT&T EBIT adjusted 22,959 25,023 26,504 27,674AT&T PBT adjusted 19,963 21,848 23,417 24,460AT&T EPS adjusted 2.25 2.34 2.51 2.62

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information


Reuters (Equity) T.N Bloomberg (Equity) T USMarket cap (USDm) 168,286 Market cap (USDm) 168,286Free float (%) 100 Enterprise value (USDm) 219787Country United States Sector Diversified TelecomsAnalyst Richard Dineen Contact 1 212 525 6707

Price relative

18

20

22

24

26

28

30

32

2009 2010 2011 2012

18

20

22

24

26

28

30

32

AT&T Rel to S&P 500


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Belgacom (Neutral, TP EUR30) Fixed line connectivity

Belgacom has one of the most advanced NGA

roll-outs in Europe, with 76% VDSL coverage at

end Q3 2010. As a result, we expect Belgacom to

close 10% to 15% of its local exchanges by 2013,

switching off around 40% of the unbundled lines.

This will force alternative operators such as

Mobistar to replace cheap ADSL (EUR7.5 per

month) with expensive VDSL bistream wholesale

offers (EUR13.9 per month). In determining the

VDSL wholesale price, the regulator has applied a

15% mark-up to the cost incurred by Belgacom.

Hence, though regulated, we believe the move of

competitors to wholesale VDSL from unbundling

will be beneficial for Belgacom.

There is no active discussion on net neutrality in

Belgium. We believe the Belgian regulation on

net neutrality is likely to be in line with EU

recommendations, which currently appear

pragmatic (authorising prioritisation in the event

of congestion).

Mobile connectivity

Mobile data demand is picking up in Belgium,

with Belgacom’s advanced data services revenues

growing by 11% y-o-y in 9M 2010. Given there

are no handset subsidies in Belgium, smartphone

penetration here is behind most of Europe, but,

with smartphone prices falling, we expect

penetration to increase rapidly. The mobile

networks in Belgium do not seem to be under any

strain as yet. Belgacom commented in its Q3 2010

conference call that it still had a huge amount of

capacity to fill on its 3G networks.

Belgacom has adopted tiered data plans. It has

four mobile data plans catering to various

categories of users, starting with a package of

50MB for EUR5 and with a high-end package of

1GB for EUR25. Additional usage is charged at

EUR0.03 per MB. We see pricing power as

Belgacom’s main competitor, Mobistar, is also

experiencing strong demand for data (+117%

volume and 63% revenue growth in 2010) and

also has (low) caps of 50MB and 100MB.


Belgacom was among the earliest to launch IPTV

services in Europe, and now has around 20%

market share of the national TV market as at the

end of Q3 2010 – with the rest belonging to cable

operators (predominantly Telenet). IPTV

penetration had reached 60% of Belgacom’s

broadband connections by Q3 2010. Indeed, IPTV

has become a relatively material item for the

incumbent, and now provides 16% of its

consumer revenues (growing at 43% y-o-y year-

to-date Q3 2010).

Mobile applications

Belgacom has joined the Rich communication

suite initiative to help develop more data services

which we see as a positive. But, although we see

the soft SIM threat as overstated in most

European countries, the situation may be different

in Belgium. There are no handset subsidies (apart

from Telenet’s MVNO) and a vendor such as

Apple would not take a big risk by taking the soft

SIM route. But Belgium is more an exception in

Europe and it may not be worth vendors adopting

a very different strategy in a small market.

Investment thesis

We believe the company has the right network

assets (fixed and mobile) and strategy (quad-play

offers) to monetise fixed connectivity, but it still

faces stiff competition from cables Telenet and

VOO. On the mobile data front, Mobistar, which

has exclusivity for iPhone, has been ahead of

Belgacom in monetising the opportunity so far,

but we see a good potential here for Belgacom

too. We maintain our Neutral rating and EUR30

target price on Belgacom.

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Financials & valuation: Belgacom Neutral Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e

Profit & loss summary (EURm)

Revenue 5,990 6,589 6,622 6,693EBITDA 1,967 2,398 1,933 1,951Depreciation & amortisation -706 -802 -776 -728Operating profit/EBIT 1,261 1,596 1,157 1,223Net interest -117 -106 -102 -98PBT 1,144 1,489 1,055 1,125HSBC PBT 1,134 1,052 1,055 1,125Taxation -241 -256 -264 -337Net profit 904 1,218 768 762HSBC net profit 749 679 673 717

Cash flow summary (EURm)

Cash flow from operations 1,406 1,578 1,546 1,549Capex -597 -730 -671 -678Cash flow from investment -631 -683 -683 -690Dividends -684 -702 -701 -714Change in net debt -119 -180 -162 -145FCF equity 1,037 1,413 896 827

Balance sheet summary (EURm)

Intangible fixed assets 2,711 3,548 3,560 3,571Tangible fixed assets 2,420 2,351 2,246 2,196Current assets 1,945 2,135 2,277 2,432Cash & others 471 500 637 782Total assets 7,450 8,334 8,382 8,500Operating liabilities 1,771 2,481 2,507 2,579Gross debt 2,187 2,036 2,011 2,011Net debt 1,716 1,536 1,374 1,229Shareholders funds 2,521 2,679 2,733 2,784Invested capital 4,834 5,053 4,938 4,839


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue 0.1 10.0 0.5 1.1EBITDA 3.3 21.9 -19.4 0.9Operating profit 8.5 26.5 -27.5 5.7PBT 8.5 30.2 -29.2 6.6HSBC EPS 0.3 -9.6 -0.9 6.6

Ratios (%)


Per share data (EUR)



Year to 12/2009a 12/2010e 12/2011e 12/2012e

Belgacom Revenues 5,990 6,589 6,622 6,693Belgacom EBITDA adjusted 1,957 1,961 1,933 1,951Belgacom EBIT adjusted 1,261 1,596 1,157 1,223Belgacom Net income adjusted 904 1,218 768 762Belgacom FCF definition 798 900 893 889

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information

Share price (EUR) 27.02 Target price (EUR) 30.00 Potent'l return (%) 11.0

Reuters (Equity) BCOM.BR Bloomberg (Equity) BELG BBMarket cap (USDm) 12,380 Market cap (EURm) 9,135Free float (%) 42 Enterprise value (EURm) 11211Country Belgium Sector Diversified TelecomsAnalyst Nicolas Cote-Colisson Contact 44 20 7991 6826

Price relative

171921232527293133

2009 2010 2011 2012

171921232527293133

Belgacom Rel to BEL-20


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BT Group (Neutral, TP 200p) Fixed line connectivity

BT is now well underway with its NGA upgrade

deployment, and ultimately targets passing two-

thirds of the country’s premises with either

FTTN/VDSL or FTTP. In our view, Ofcom’s

regulation is not as sympathetic as is warranted by

a project of this scale, but BT has nonetheless

been given a good degree of flexibility on setting

its pricing. And although the regulator’s armoury

will include techniques like unbundling of the

sub-loop, we believe this is uneconomic in the

majority of the country (although it will doubtless

be in the interests of BT’s retail competitors to

express continuing interest in this approach).

There is already good evidence that the prospect

of fibre-based, superfast broadband is causing

some BT competitors to rethink their strategies.

For instance, Orange (thought of primarily as a

mobile operator, but also a provider of ADSL

services) has chosen not to invest in upgrading its

platform, and is shifting instead to taking a

wholesale product from BT. Presumably it

reasoned there was little point in lavishing

expenditure on ADSL ULL infrastructure, just as

fibre is becoming widely available.

Since BT’s Openreach division must make

available its fibre product to all-comers on equal

terms, there is every possibility that BT’s retail

market share will come under ongoing pressure:

some of its competitors may prove more adept at

selling the connectivity than BT itself. But the key

point is that, whereas the company is paid only

GBP7.4 per month for an unbundled copper line,

it could receive double this for wholesale fibre.

Moreover, what constitute additional revenues for

BT are extra costs for those rivals that rely on the

incumbent’s access infrastructure. Their need to

be able to digest these cost hikes should result in a

more price-disciplined market in general.

Ofcom’s views on net neutrality look sensible and

pragmatic. While insisting on due transparency,

the regulator argues that business models

incorporating charges for prioritisation could in

fact bring certain benefits. Meanwhile, BT is

moving to address the opportunities available in

the OTT video market by launching its own CDN

specifically targeting those with video content. BT

Vision, the incumbent’s IPTV service, will

doubtless be an early customer, but the CDN’s

capabilities will be sold to third parties as well.


To date, BT Vision has struggled. This is perhaps

not surprising given the intense competition from

BSkyB in particular. Ofcom has recently

intervened to give BT and others access to

BSkyB’s sports content, and this has now been

incorporated into the Vision line-up. However,

despite heavy advertising, customer net adds have

responded only slowly. We think the YouView

OTT platform (previously Project Canvas) should

provide a boost to the whole concept of IPTV, but

its set-top boxes are now delayed until early next

year. Even then, we are more confident of BT’s

ability to monetise this type of service through

selling the underlying connectivity rather than by

acting as a payTV retailer.

Investment thesis

BT has made progress in tackling its various

operational challenges (for instance, in its Global

Services division), and management has now been

able to move on to address m strategic issues – in

particular with regard to the upgrade to a fibre

access platform. However, that said, the pension

overhang remains an issue and the key factor that

underpins our Neutral stance. While the financial

markets have improved since the time of the

triennial review, we would caution that the

Pensions Regulator will want reassurance that the

scheme’s obligations can be met if economic

conditions deteriorate once more.

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Financials & valuation: British Telecom Neutral Financial statements

Year to 03/2010a 03/2011e 03/2012e 03/2013e

Profit & loss summary (GBPm)

Revenue 20,859 20,173 20,067 20,083EBITDA 5,162 5,620 5,813 5,974Depreciation & amortisation -3,039 -3,027 -2,963 -2,938Operating profit/EBIT 2,123 2,593 2,850 3,036Net interest -1,158 -942 -811 -732PBT 1,007 1,705 2,054 2,321HSBC PBT 1,445 1,868 2,122 2,382Taxation 22 -294 -455 -530Net profit 1,028 1,410 1,598 1,789HSBC net profit 1,046 1,349 1,531 1,718

Cash flow summary (GBPm)

Cash flow from operations 3,888 4,235 4,142 4,164Capex -2,509 -2,737 -2,696 -2,710Cash flow from investment -2,794 -3,235 -2,696 -2,710Dividends -265 -543 -568 -624Change in net debt -1,977 -1,355 -878 -830FCF equity 1,347 1,643 1,801 1,952

Balance sheet summary (GBPm)

Intangible fixed assets 3,672 3,465 3,465 3,465Tangible fixed assets 14,856 14,598 14,331 14,104Current assets 6,285 4,489 5,417 4,556Cash & others 2,482 1,033 1,911 1,000Total assets 28,680 24,831 25,502 24,423Operating liabilities 7,151 6,759 6,979 7,120Gross debt 12,791 9,987 9,987 8,246Net debt 10,309 8,954 8,076 7,246Shareholders funds -2,650 547 1,589 2,753Invested capital 15,180 14,761 14,323 14,004


Year to 03/2010a 03/2011e 03/2012e 03/2013e

Y-o-y % change

Revenue -2.5 -3.3 -0.5 0.1EBITDA 61.8 8.9 3.4 2.8Operating profit 605.3 22.2 9.9 6.5PBT 69.3 20.5 13.0HSBC EPS 6.0 28.7 13.5 12.2

Ratios (%)

Revenue/IC (x) 1.3 1.3 1.4 1.4ROIC 9.9 12.5 14.2 15.5ROE -83.4 -128.3 143.3 79.1ROA 5.8 7.6 8.5 9.1EBITDA margin 24.7 27.9 29.0 29.7Operating profit margin 10.2 12.9 14.2 15.1EBITDA/net interest (x) 4.5 6.0 7.2 8.2Net debt/equity 0.0 1567.5 500.3 260.7Net debt/EBITDA (x) 2.0 1.6 1.4 1.2CF from operations/net debt 37.7 47.3 51.3 57.5

Per share data (GBPp)

EPS Rep (fully diluted) 13.28 18.19 20.62 23.09HSBC EPS (fully diluted) 13.52 17.40 19.75 22.17DPS 6.90 7.32 8.05 8.86Book value -34.24 7.06 20.51 35.52


Year to 03/2010a 03/2011e 03/2012e 03/2013e

BT Adjusted revenues 20,911 20,173 20,067 20,083BT Adjusted EBITDA 5,639 5,847 5,913 5,974BT Adjusted PBT 1,735 2,016 2,222 2,382BT Adjusted EPS (GBp) 18.0 20.4 22.3 23.7 BT FCF 2,106 2,061 2,183 2,143

Valuation data

Year to 03/2010a 03/2011e 03/2012e 03/2013e

EV/sales 1.3 1.3 1.3 1.2EV/EBITDA 5.4 4.7 4.4 4.1EV/IC 1.8 1.8 1.8 1.8PE* 13.7 10.6 9.4 8.4P/Book value 26.2 9.0 5.2FCF yield (%) 7.6 9.4 10.3 11.3Dividend yield (%) 3.7 4.0 4.3 4.8


Issuer information

Share price (GBPp) 185 Target price (GBPp) 200 Potent'l return (%) 7.9

Reuters (Equity) BT.L Bloomberg (Equity) BT/A LNMarket cap (USDm) 23,013 Market cap (GBPm) 14,381Free float (%) 100 Enterprise value (GBPm) 26478Country United Kingdom Sector Diversified TelecomsAnalyst Stephen Howard Contact 44 20 7991 6820

Price relative

56

76

96

116

136

156

176

196

2009 2010 2011 2012

56

76

96

116

136

156

176

196

British Telecom Rel to FTSE ALL-SHARE


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Bezeq (Overweight, TP ILS11.6) Fixed line connectivity

Fixed line business in Israel remains a duopoly

with HOT (cable operator, NR) being the only

other alternative to the incumbent Bezeq with

c70%+ market share. Bezeq’s roll-out of NGN

means an unmatched broadband offering that could

possibly arrest the rate of fixed line erosion. HOT’s

broadband offering is hampered by service and last

mile connectivity reach. Bezeq’s 100% last mile

connectivity means that competitors use the “naked

ADSL” pipes to offer services to their customers.

Absence of regulations on net neutrality is positive

for incumbents. Local loop unbundling by altnets is

yet to be allowed in Israel.

Bezeq’s market share in the commercial market has

fallen below the 80% threshold (regulatory

requirement), meaning that it is eligible for

regulatory relief measures such as allowing Bezeq

to bundle services; these measures should provide

Bezeq with better tools to cope with the expected

competition.

Mobile connectivity

Bezeq (via Pelephone) launched its HSPA

network (previously CDMA) in January 2009,

giving a major push to data applications. Its 3G

subscriber base increased from 46% of the total

subscriber base in Q1 2009 to 63% of the total

subscriber base in Q3 2010. Data revenues as a

percentage of total service revenues for Pelephone

reached 25%. There are no signs of capacity

constraints on the network (given the late

introduction of the iPhone in Israel), despite the

ongoing move from “walled garden” to “open

garden”. Israel is fast moving from “all you can

eat” plans to tiered data pricing; which pushes the

capacity crunch thesis further away for the

present. Cellcom has recently launched speed

tiered pricing (rather than capacity related).

We expect Pelephone to follow with a similar data

pricing structure. Given the rational pricing

environment in Israel, with these tiered-data

pricing systems, risks of capacity constraints seem

low to us.


OTT players are less likely to pose a threat to the

incumbent given the firm access control of Bezeq.

Naked DSL pricing (regulated) ensures that Bezeq

collects its toll, in the case of alternative VoB

operators, taking voice minutes share from Bezeq.

Its strong brand name in Israel as the “preferred

operator at home” should help Bezeq offer

advanced NGN based services to its large

subscriber base in the future.

Mobile applications

Pelephone has been able to maintain a good grip

on content, data applications and VAS thanks to a

relatively close garden approach, presented by all

mobile operators. The ability of Pelephone to

successfully charge for VAS/application offerings

should be supported by its domestic customisation

offering. Still we expect data revenues in the

future to gradually move towards tiered pricing

for mobile connectivity, maximising data network

resources.

Investment thesis

We are bullish on the ability of Bezeq to grow its

cash flow by implementing further efficiencies

post ownership change (ie new retirement

agreement with its union); material cost savings

on the back of NGN implementation (ie reducing

national switches from c140 to only 30); capex

drop following NGN project completion; mobile

HSPA network grabbing all new roaming

revenues and corporate clients to better handle

MTR cut/MVNO threats. A strong macro outlook

for Israel should also help Bezeq maximise its

ongoing real estate asset sales.

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Financials & valuation: Bezeq Overweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e

Profit & loss summary (ILSm)

Revenue 11,519 11,605 11,663 11,808EBITDA 4,457 4,722 4,741 4,844Depreciation & amortisation -1,485 -1,414 -1,357 -1,303Operating profit/EBIT 2,972 3,308 3,384 3,541Net interest 31 -94 -62 -41PBT 2,969 3,127 3,265 3,468HSBC PBT 2,969 3,127 3,265 3,468Taxation -807 -795 -783 -798Net profit 2,162 2,332 2,481 2,670HSBC net profit 2,162 2,332 2,481 2,670

Cash flow summary (ILSm)

Cash flow from operations 3,622 3,806 3,916 3,997Capex -1,622 -1,398 -1,082 -928Cash flow from investment -1,663 -1,183 -1,012 -858Dividends -1,941 -3,646 -2,407 -2,576Change in net debt -1,704 832 -498 -563FCF equity 1,789 2,345 2,834 3,069

Balance sheet summary (ILSm)

Intangible fixed assets 1,885 1,856 1,851 1,855Tangible fixed assets 5,303 5,374 5,034 4,584Current assets 3,659 3,567 3,676 4,223Cash & others 580 660 768 1,279Total assets 13,941 13,516 13,222 13,291Operating liabilities 3,196 3,149 3,170 3,197Gross debt 4,136 5,048 4,658 4,606Net debt 3,556 4,388 3,890 3,327Shareholders funds 6,544 5,252 5,326 5,421Invested capital 8,361 8,134 6,622 6,186


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue 4.6 0.8 0.5 1.2EBITDA 8.7 5.9 0.4 2.2Operating profit 12.6 11.3 2.3 4.6PBT 18.5 5.3 4.4 6.2HSBC EPS 27.4 8.9 5.6 6.9

Ratios (%)

Revenue/IC (x) 1.3 1.4 1.6 1.8ROIC 24.3 29.9 34.9 42.6ROE 38.4 39.5 46.9 49.7ROA 17.4 18.0 19.8 21.5EBITDA margin 38.7 40.7 40.7 41.0Operating profit margin 25.8 28.5 29.0 30.0EBITDA/net interest (x) 50.5 76.3 118.3Net debt/equity 54.4 83.6 73.1 61.4Net debt/EBITDA (x) 0.8 0.9 0.8 0.7CF from operations/net debt 101.9 86.7 100.7 120.1

Per share data (ILS)



Year to 12/2009a 12/2010e 12/2011e 12/2012e

Wireline revenues 5,303 5,175 4,983 4,903Pelephone revenues 5,376 5,638 5,804 6,076Bezeq International Revenues 1,316 1,355 1,382 1,401Wireline EBITDA margin 44 47 46 46Pelephone EBITDA margin 33 35 36 36

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information

Share price (ILS) 10.03 Target price (ILS) 11.60 Potent'l return (%) 16

Reuters (Equity) BEZQ.TA Bloomberg (Equity) BEZQ ITMarket cap (USDm) 7,360 Market cap (ILSm) 26,958Country Israel Sector Diversified TelecomsAnalyst Avshalom Shimei Contact 972 3 710 1197

Price relative

3456789

101112

2009 2010 2011 2012

3456789101112

Bezeq Rel to TA-100 INDEX


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Deutsche Telekom (Underweight, TP EUR9.5) Fixed line connectivity

Deutsche Telekom (DT) announced its NGA

programme as early as 2006, initially deploying

solely VDSL/FTTC. At its 2010 capital markets

day, DT announced a further roll-out of NGA,

targeting 31% of German homes to be passed with

VDSL/FTTC and up to another 10% with FTTH by

the end of 2012. Altnets have either been

consolidated or are struggling to keep their

subscriber bases stable. Even big pocket players like

Vodafone and Telefonica are not growing their

fixed businesses in Germany and are hesitant about

building their own NGA networks. Cable operators,

having upgraded faster than DT, are gaining share

strongly in an increasingly saturated market.

BNetzA, the German regulator, has obliged DT to

open its NGA network on a wholesale as well as

on an unbundling basis, but conditions are such

that even Telefonica and Vodafone find it

uneconomical to unbundle at the street cabinet

level. Wholesale price points for NGA are at least

double the copper ULL fee. On net neutrality in

Germany, BNetzA are committed to net neutrality

principles but leave themselves a big backdoor by

accepting that differentiation of service can be

beneficial to society and economically sensible as

long as it does not discriminate and limit

competition. We view the political climate around

net neutrality as sensible overall.

Deutsche Telekom entered the CDN market in

early 2009, partnering with California-based

Edgecast.

Mobile connectivity

Historically DT has not had tiered data pricing,

but has had fairly generous usage policies. With

the new tariff scheme introduced before the 2010

Christmas sales season, DT changed its small

print, capping the data at a volume as low as

300MB for cheaper smartphone tariffs; only price

points from around EUR60 include 1GB of data

volume and more. In February 2011, DT

announced a new initiative with France Telecom

to explore areas of cooperation, including radio

access network sharing in Europe and improving

WiFi user experience while roaming.


DT Triple Play product is slowly gaining traction.

With 1m subscribers, DT’s market share remains

well below 4% of the German TV market, despite

featuring Bundesliga and an increasingly wide

VideoOnDemand library. OTT platforms have yet

to gain traction in Germany and cable operators

are just about to introduce VideoOnDemand. It’s

very early days for OTT in Germany, but DT is

sensibly positioning itself in this market.

Mobile applications

DT has attempted to develop a broad service set,

going well beyond connectivity into the

applications layer. Capabilities include a network-

based address book. But, while a useful feature

set, many (though not all) of these capabilities are

available via the big internet and technology

brands, and customers may well gravitate towards

using these providers rather than their telecoms

supplier. DT is part of WAC, the Wholesale

Application community, but to date little tangible

results have come out of this alliance.

Investment thesis

We believe Deutsche Telekom is at risk of

continuing to underinvest in what is an above-

average competitive domestic fixed and mobile

market. We also see no easy solution to the

subscale issues of its former growth engine T-

Mobile US. We, thus, remain Underweight on

Deutsche Telekom given its unattractive organic

growth profile versus peers.

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Financials & valuation: Deutsche Telekom Underweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e


Revenue 64,639 62,317 60,787 60,630EBITDA 19,906 18,162 18,054 18,093Depreciation & amortisation -13,894 -11,015 -10,773 -10,801Operating profit/EBIT 6,012 7,147 7,280 7,292Net interest -2,555 -2,489 -2,560 -2,344PBT 2,655 4,506 5,011 5,334HSBC PBT 5,723 4,920 5,011 5,334Taxation -1,782 -1,415 -1,416 -1,484Net profit 353 2,676 2,945 3,194HSBC net profit 3,493 2,991 2,945 3,194


Cash flow from operations 14,982 14,220 14,486 14,626Capex -9,202 -8,927 -9,151 -9,124Cash flow from investment -8,649 -10,929 -8,751 -8,724Dividends -3,474 -3,402 -3,025 -2,998Change in net debt 2,717 1,801 -2,309 -2,503FCF equity 6,174 5,438 4,965 5,138




Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue 4.8 -3.6 -2.5 -0.3EBITDA 10.5 -8.8 -0.6 0.2Operating profit -14.6 18.9 1.9 0.2PBT -23.1 69.7 11.2 6.4HSBC EPS 22.1 -14.2 -0.6 9.4

Ratios (%)





Year to 12/2009a 12/2010e 12/2011e 12/2012e

DT Revenues 64,639 62,317 60,787 60,630DT EBITDA adjusted 20,668 19,555 19,059 19,098DT EBIT adjusted 9,143 8,414 8,576 8,683DT Net income adjusted 5,140 4,425 4,279 4,553DT FCF definition 6,969 6,245 6,321 6,414

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information

Share price (EUR) 9.90 Target price (EUR) 9.50 Potent'l return (%) -4.0

Reuters (Equity) DTEGn.DE Bloomberg (Equity) DTE GRMarket cap (USDm) 57,976 Market cap (EURm) 42,781Free float (%) 63 Enterprise value (EURm) 94126Country Germany Sector Diversified TelecomsAnalyst Dominik Klarmann Contact +49 211 910 2769

Price relative

6789

1011121314

2009 2010 2011 2012

67891011121314

Deutsche Telekom Rel to DAX-100


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eAccess (Overweight (V), TP 79,000) Fixed line connectivity

Following the ‘business combination’ of July

2010, the fixed-assets of eAccess were

incorporated into eMobile in a reverse acquisition.

The DSL business comprises 42% of overall

revenues, but mobile is the growth driver. eAccess

primarily provides DSL connectivity on a

wholesale basis to ISPs, but also offers bundled

wireline products with eMobile wireless

broadband packages. We expect DSL revenues

and subscribers to decline gradually, as a result of

increasing competition (and lower prices) from

fibre providers.

Mobile connectivity

eMobile has been at the vanguard of wireless

broadband service provision in Japan. Launched

in March 2007, it took advantage of capacity

constraints at the larger operators, and slower

speeds at PHS operator Willcom, to corner the

market in wireless broadband. It reached

operating profitability after just 2.5yrs in June

2009, and reached 3m accounts in January 2011.

eMobile ARPU has declined as a result of

increased competition (from WiMAX operator UQ

Communications) and an increasing proportion of

MVNO sales (at lower ARPU and acquisition

costs). However, we expect it to benefit from the

growth in demand for Android smartphones (it

offers models from HTC and Huawei) and also

mobile WiFi: its Pocket WiFi product remains

very popular at c50% of gross additions, fuelled by

growing demand for tablet PCs.

With its late launch of HSPA services, it was able

to take advantage of lower-priced equipment from

Ericsson and Huawei, and built out a high-speed

network at a fraction of the cost of NTT

DoCoMo, which launched services six years

earlier. In December 2010, it launched the first

42Mbps service in Japan, enabling it to compete

with DoCoMo’s ‘Xi’ LTE service.


eAccess, as a mostly wholesale DSL supplier, is

less involved in fixed line applications. This is

largely the preserve of its ISP clients – its primary

focus is on maintaining EBITDA trends given

higher levels of customer churn.

Mobile applications

eMobile has refocused its smartphone strategy,

which was initially based around Windows

Mobile. It launched HTC’s Aria Android

smartphone on 17 December 2010, and the Pocket

WiFi S from Huawei in January 2011 – both

feature Android 2.2, and allow full ‘tethering’, or

portable WiFi service. In conjunction with a flat-

rate voice promotion, we believe these initiatives

will help restore sales that suffered in the second

quarter from a lack of new products.

Investment thesis

We believe eMobile’s competitiveness has

improved considerably as a result of the product

launches in the quarter ending December 2010.

The upgrade to 42Mbps, and the launch of both

high and low-end Android smartphones (Aria and

Pocket WiFi S) should enable it to capitalise on

growing consumer demand. We also see upside

for the company as a result of the growth in

demand for tablet PCs: it is the only provider

currently to offer ‘tethering’ or mobile WiFi

services without restriction.

For the eMobile business on a stand-alone basis,

we forecast an EBITDA margin of 28% in FY

March 2011 and 30% in March 2012. In our view,

this business is a case study in the potential

profitability of the stand-alone mobile data

business model.

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Financials & valuation: eAccess Ltd Overweight (V) Financial statements

Year to 03/2010a 03/2011e 03/2012e 03/2013e

Profit & loss summary (JPYbn)

Revenue 83 184 219 254EBITDA 27 57 83 91Depreciation & amortisation -7 -34 -38 -35Operating profit/EBIT 19 24 45 56Net interest -2 -8 -7 -5PBT 11 13 36 49HSBC PBT 11 16 39 51Taxation -7 -6 -6 -8Net profit 4 7 30 41HSBC net profit 6 9 23 30

Cash flow summary (JPYbn)

Cash flow from operations 15 53 71 78Capex -3 -53 -51 -42Cash flow from investment -4 -53 -51 -42Dividends -4 -4 -3 -3Change in net debt -5 150 -17 -33FCF equity 14 -9 19 36

Balance sheet summary (JPYbn)

Intangible fixed assets 3 10 9 9Tangible fixed assets 16 200 214 221Current assets 46 178 179 181Cash & others 26 100 100 100Total assets 87 409 423 432Operating liabilities 17 43 46 51Gross debt 55 279 262 229Net debt 29 179 162 129Shareholders funds 13 75 103 141Invested capital 21 245 255 260


Year to 03/2010a 03/2011e 03/2012e 03/2013e

Y-o-y % change

Revenue -12.1 120.9 19.4 15.7EBITDA 10.6 116.0 45.0 9.7Operating profit 14.1 21.0 96.9 23.0PBT 19.8 176.5 36.2HSBC EPS -47.9 186.6 29.6

Ratios (%)


Per share data (JPY)

EPS Rep (fully diluted) 2,864 2,343 8,732 11,846HSBC EPS (fully diluted) 4,496 2,343 6,714 8,704DPS 2,400 600 800 800Book value 8,929 25,428 29,702 40,748


Year to 03/2010a 03/2011e 03/2012e 03/2013e

ADSL Revenue (JPY bn) 71 61 56 55Mobile Revenue (JPY bn) 113 144 172 211ADSL EBITDA (JPY bn) 26 23 21 20Mobile EBITDA (JPY bn) 18 44 63 71Total Operating Profit (JPY bn 19 24 45 56Total Capex (JPY bn) 3 39 51 42

Valuation data

Year to 03/2010a 03/2011e 03/2012e 03/2013e

EV/sales 2.5 1.9 1.5 1.2EV/EBITDA 7.7 6.2 4.1 3.3EV/IC 9.6 1.4 1.3 1.2PE* 11.4 21.9 7.7 5.9P/Book value 5.8 2.0 1.7 1.3FCF yield (%) 8.1 -5.2 10.6 20.6Dividend yield (%) 4.7 1.2 1.6 1.6


Issuer information

Share price (JPY) 51400 Target price (JPY) 79000 Potent'l return (%) 54.9

Reuters (Equity) 9427.T Bloomberg (Equity) 9427 JPMarket cap (USDm) 2,135 Market cap (JPYbn) 178Free float (%) 54 Enterprise value (JPYbn) 355Country Japan Sector Diversified TelecomsAnalyst Neale Anderson Contact +852 2996 6716

Price relative

406344563450634556346063465634706347563480634

2009 2010 2011 2012

406344563450634556346063465634706347563480634

eAccess Ltd Rel to TOPIX INDEX


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France Telecom (Overweight, TP EUR21 Fixed line connectivity

France is the exception rather than the rule in

Europe. Regulation has been effective from the

beginning of 2000: unbundling of the local loop,

together with an ADSL bistream provided by FT

gave Iliad and SFR (after consolidating the

market) enough scale to afford to build their own

access network (FTTH). As a consequence, FT

cannot force altnets to migrate from cheap ULL to

expensive wholesale offers and regain EBITDA

market share as we see in other European

countries. On the other hand, FT does not face a

strong cable (6% broadband market share). We

expect operators to start pushing mass market

distribution of FTTH this year. FT plans to pass

10m homes in 2015 and 15m by 2020 (out of

28m) for a total cost of EUR2.5bn.

On the positive side for FT, the French regulator

(ARCEP) published a list of recommendations to

preserve the neutrality of the net, in September

2010. ARCEP insists on granting operators the

ability to market managed services due to scarcity

alongside internet access, which may create some

revenue opportunities with OTTs in particular. FT

CEO Stephane Richard has been calling for a fair

split of value (and costs) between content

providers and telcos (Les Echos, 18 November

2010). This can be achieved by forcing traffic

generators to pay for the use of the networks. It is

too early to see tangible signs of pricing power in

the business to business area, but we are seeing

some on the retail side: In Q1, Iliad and SFR

increased their pricing for triple play by more than

the VAT increase (we estimate that two-thirds

was not tax related) thanks to new set-top boxes

and new services (unlimited calls to mobile now

included). FT still commands a small premium,

but we think the trend has been favourable for FT.

Mobile connectivity

FT has been introducing caps in France and in

other European countries (UK, Spain) “to

preserve the quality of the network”. Stephane

Richard already warned that FT will move

towards yield management (pricing depending on

the load on the network). We do not believe

Iliad’s entry in the mobile market in 2012 should

disrupt this data pricing trend: Iliad still has to

secure a data roaming agreement first (time to

build its 3G network) and the available wholesale

pricing may reflect the congestion issues.


36% of FT’s broadband customer base takes IPTV

services. IPTV’s success was not triggered by

troublesome cable competition but by Iliad’s early

and innovative move into IPTV. FT controls its

box and offer premium content (Orange own TV

channel, but also proposes Canal+ packs). FT

bought 49% of the OTT Dailymotion (second

largest video sharing site behind YouTube) to

build its franchise in aggregation and content

broadcasting.

Mobile applications

Orange is promoting its own mobile applications

such as Orange TV, map services or music

streaming through its partnership with Deezer.

These services are part of the largest contracts but

can also be added as paid options for smaller packs.

Investment thesis

Despite strong domestic competitors, we think FT

has the right network and application strategy. We

think FT may benefit from its large scale (43%

broadband market share in France) to monetise its

network against OTT traffic, but also in mobile,

with the strong data growth across its geography.

FT is also offering a high level of applications in

fixed and mobile. We are Overweight FT, target

price EUR21.

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Financials & valuation: France Telecom Overweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e


Revenue 45,944 45,341 45,439 45,165EBITDA 14,794 15,608 15,504 15,460Depreciation & amortisation -6,935 -7,132 -6,807 -6,736Operating profit/EBIT 7,859 8,476 8,697 8,724Net interest -2,299 -1,828 -1,681 -1,518PBT 5,560 6,903 7,475 7,789HSBC PBT 7,161 7,640 7,945 8,159Taxation -2,295 -1,858 -2,242 -2,337Net profit 2,997 5,659 4,634 4,828HSBC net profit 4,537 4,604 4,725 4,842






Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue -14.1 -1.3 0.2 -0.6EBITDA -19.3 5.5 -0.7 -0.3Operating profit -23.5 7.8 2.6 0.3PBT -23.7 24.2 8.3 4.2HSBC EPS -2.5 1.4 2.6 2.5

Ratios (%)





Year to 12/2009a 12/2010e 12/2011e 12/2012e

FT revenue 45,944 45,341 45,439 45,165FT EBITDA 14,794 14,867 14,968 14,867FT EBIT 7,859 8,476 8,697 8,724FT Net Income 2,997 5,659 4,634 4,828FT FCF 8,443 8,055 7,734 6,889

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information


Reuters (Equity) FTE.PA Bloomberg (Equity) FTE FPMarket cap (USDm) 58,293 Market cap (EURm) 43,015Free float (%) 73 Enterprise value (EURm) 71521Country France Sector Diversified TelecomsAnalyst Nicolas Cote-Colisson Contact 44 20 7991 6826

Price relative

11

13

15

17

19

21

23

25

2009 2010 2011 2012

11

13

15

17

19

21

23

25

France Telecom Rel to SBF-120


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KPN (OW, TP EUR15) Fixed line connectivity

KPN‘s current fibre households coverage stands at

c15%; it is targeting c60% in the medium term. In

the meantime, KPN is relying on VDSL2 (currently

80% IPTV coverage and 70% HDTV coverage) as

an interim solution to compete with the cable

DOCSIS3.0 alternative. NGA regulation is

favourable in the Netherlands: the Dutch regulator

OPTA is of the view that NGA investments entail an

element of risk and hence regulation should provide

room for the incumbent to earn a return adequate to

the risk inherent in such investment. OPTA has

issued detailed regulation on NGA and laid down

clear tariffs regulation for unbundled fibre access,

therefore removing most of the regulatory risk on

such investment. On the net neutrality side, OPTA

has not expressed any views in public, but we

generally expect it to follow the European

Commission recommendations, which so far have

been pragmatic and in general positive for operators.

Mobile connectivity

KPN has been investing in its networks (fixed and

mobile) with domestic capex/sales ratio of c15% in

the past two years. Even with rapid growth in data

traffic at +130% y-o-y (non-voice revenue as a % of

ARPU was c35% in Q4 2010 and 45% of post-paid

customers have a data product), KPN’s network has

not shown sign of congestion. KPN has proactively

invested in upgrading the network to HSDPA (speed

up to 14.4 Mb/sec), also conducting trials on high

speed LTE (up to 100Mbps). Anticipating the

pressure on the mobile networks, KPN has already

connected close to 60% of its UMTS base station

with fibre.

On mobile data pricing, management has now

delivered on the undertaking that it would migrate to

tiered data plans in the Netherlands by the end of

2010. All iPhone plans come with a data bundle of

either 500MB or 1GB per month. The 1GB per

month data plans cost between EUR45 to EUR110,

depending on the chosen allocation of voice minutes

and texts. KPN’s German operation, E-Plus, has also

announced data plans, with initial caps as low as

50MB; beyond this point, customers have the option

of either accepting a reduced speed or topping up. It

is particularly encouraging to witness a ‘teenager’

(market share in the teens) operator like E-Plus

displaying such a rational stance with tiered pricing

plans.


KPN has rapidly expanded its market share to c15%

in cable dominated TV market from 10% two years

ago. KPN provides TV services through a mix of

DVB-T and an IPTV based platform. FTTH, in

combination with the VDSL2 upgrade, have enabled

KPN to make its IPTV offer a real success, which

can be gauged from the fact that IPTV net adds in

2010 have been +155k vs only 17k Digitenne net

adds; now IPTV subs constitute one-quarter of TV

subscribers, up from 10% a year ago.

Mobile applications

KPN has introduced a few mobile applications

and also formed collaboration with some of the

key M2M service providers (machine to machine

communication) to provide a cost effective

comprehensive machine to machine solution.

KPN has also reached an agreement with some

Dutch banks (Rabobank, ING and ABN Amro) to

launch mobile payment services by 2012e.

Investment thesis

Our Overweight rating on KPN is primarily

driven by its strong FCF generation as well as its

policy of 100% distribution of FCF. KPN’s FTTH

strategy with VDSL as an a interim solution and

its transition to tiered data plans from flat rate

plans are steps in the right direction, in our view,

to command pricing power and monetise scarcity.

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Financials & valuation: KPN Overweight Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e


Revenue 13,398 13,423 13,579 13,782EBITDA 5,476 5,472 5,519 5,557Depreciation & amortisation -2,226 -2,229 -2,245 -2,253Operating profit/EBIT 3,250 3,244 3,274 3,304Net interest -903 -763 -726 -726PBT 2,316 2,457 2,531 2,567HSBC PBT 2,299 2,457 2,531 2,567Taxation -516 -595 -612 -619Net profit 1,799 1,861 1,920 1,948HSBC net profit 1,703 1,824 1,882 1,909


Cash flow from operations 3,808 3,902 4,077 4,133Capex -1,809 -1,846 -1,887 -1,932Cash flow from investment -2,149 -1,746 -1,787 -1,882Dividends -1,152 -1,277 -1,322 -1,363Change in net debt 722 121 0 0FCF equity 2,470 2,256 2,290 2,276


Intangible fixed assets 9,755 9,332 8,949 8,570Tangible fixed assets 7,514 7,454 7,379 7,388Current assets 2,870 3,047 3,071 3,101Cash & others 823 1,000 1,000 1,000Total assets 22,737 22,407 21,956 21,604Operating liabilities 4,240 4,302 4,362 4,408Gross debt 12,788 13,086 13,086 13,086Net debt 11,965 12,086 12,086 12,086Shareholders funds 3,500 3,010 2,599 2,276Invested capital 15,076 14,531 14,036 13,650


Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue -0.8 0.2 1.2 1.5EBITDA 5.5 -0.1 0.9 0.7Operating profit 14.0 -0.2 0.9 0.9PBT 13.8 6.1 3.0 1.4HSBC EPS 10.3 13.2 12.2 7.3

Ratios (%)





Year to 12/2010a 12/2011e 12/2012e 12/2013e

Netherland 9,274 9,275 9,339 9,436International mobile 4,181 4,265 4,358 4,467Others -120 -117 -119 -120Group revenues 13,335 13,423 13,579 13,782KPN FCF definition 2,428 2,446 2,635 2,501

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information


Reuters (Equity) KPN.AS Bloomberg (Equity) KPN NAMarket cap (USDm) 25,233 Market cap (EURm) 18,620Free float (%) 100 Enterprise value (EURm) 30568Country Netherlands Sector Diversified TelecomsAnalyst Luigi Minerva Contact 44 20 7991 6928

Price relative

6789

1011121314

2009 2010 2011 2012

67891011121314

KPN Rel to AEX


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KT Corp (Overweight, TP KRW60,000) Fixed line connectivity

KT Corp is unusual in that regulatory risk to its

wireline business is relatively low. The

government has no stake in KT (having sold its

final 28% holding in May 2008), and facilities-

based competition is very strong. Total broadband

penetration is approaching 100%, and KT has

c43% of this market. The prevalence of high-

speed broadband infrastructure from the three

main operators means there is little need for KT to

offer unbundled services.

Each operator has deployed a blend of FTTH and

FTTx technology, with KT tending towards fibre

to the home. A blend of FTTx and LAN/VDSL

within the user premises is also common.

Mobile connectivity

Like SoftBank in Japan, KT was the first operator

in Korea to tap into nascent demand for

smartphones when it launched the iPhone in late

November 2009. Since then, 2.7m subscribers, or

17.5% of its subscriber base, have migrated to a

smartphone.

In July 2010, it announced it would replicate the

‘All-in-One’ tariffs offering unlimited data from

SK Telecom. KT has done this reluctantly, but

ultimately could not afford not to match this tariff

from the largest operator in the market. Despite our

preference for tiered data plans that link usage to

revenue, we see substantial upside in the migration

of users from cKRW36,000 ARPU levels to

smartphone tariffs of KRW50,000 and above.

KT continues to leverage the strength of its

network: we see greater upside in 2011 from its

under-utilised WiBro network, which can be used

to create mobile WiFi hotspots for tablet PC users.

The size and location of KT’s WiFi accesspoints

means that it is very advanced in ‘off-loading’

data from the wireless to the wireline network: in

September 2010, 67% of the its mobile data traffic

– around 2,500 Terabytes per month – was

offloaded on to WiFi.


KT has been the most aggressive telco operator

developing an IPTV product. It saw subscriptions

increase sharply after adding with satellite content

in 2010, and targets 3m subscribers by end 2011

(from 2m at end 2010). It currently offers 120,000

channels and 90,000 VoD files, and is in

negotiations with key content companies to

further improve its content.

Mobile applications

As for the other Korean and Japanese operators,

KT has focused mainly on creating a local app

store that offers users a familiar, Korean-language

portal to download mobile content. It is not as

aggressive as SK Telecom in sourcing or

developing its own in-house content.

Investment thesis

We believe KT Corp has one of the best mobile

networks in Asia. It is an integrated operator with

an extensive fibre deployment. It has both a

CDMA and WCDMA 3G network, and a largely

unused wireless broadband network (using

WiBro, the Korean variant of WiMAX).

Crucially, compared with SK Telecom, it has a

massive network of WiFi hotspots – KT targets

100,000 by end 2010. This is a legacy of its heavy

deployment in 2000-05, and means that it is able

to offload wireless network traffic in many public

places, relieving the capacity on its wide-area

cellular network.

Management has been active in seeking to

leverage this network, which has helped it gain

revenue market share with the iPhone. It targets

25-30 smartphone launches in 2011.

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Financials & valuation: KT Corp Overweight Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (KRWb)


Cash flow summary (KRWb)

Cash flow from operations 3,870 4,606 5,200 5,629Capex -3,057 -2,992 -3,068 -3,121Cash flow from investment -3,082 -3,092 -3,178 -3,121Dividends -298 -569 -613 -845Change in net debt 310 -946 -1,409 -1,663FCF equity 813 1,615 2,132 2,508

Balance sheet summary (KRWb)



Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change


Ratios (%)


Per share data (KRW)

EPS Rep (fully diluted) 4,966 7,441 9,692 11,768HSBC EPS (fully diluted) 5,918 7,611 9,776 11,852DPS 2,410 2,600 3,580 4,580Book value 46,795 51,636 57,747 64,935

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information

Share price (KRW) 41,200 Target price (KRW) 60,000 Potent'l return (%) 52

Reuters (Equity) 030200.KS Bloomberg (Equity) 030200 KSMarket cap (USDm) 9,545 Market cap (KRWb) 10,758Free float (%) 78 Enterprise value (KRWb) 16374Country Korea Sector Diversified TelecomsAnalyst Neale Anderson Contact +852 2996 6716

Price relative

18945

23945

28945

33945

38945

43945

48945

53945

2009 2010 2011 2012

18945

23945

28945

33945

38945

43945

48945

53945

KT Corp Rel to KOSPI INDEX


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Mobily (Overweight, TP SAR71) Mobile connectivity

We view Mobily as the best placed operator in the

MENA region in terms of pricing power for

mobile data. Mobily offers a range of tiered data

plans and an unlimited plan. Fixed line broadband

coverage in Saudi Arabia is limited to a few areas

in big cities like Riyadh, Jeddah and Makkah.

There are no cable operators in Saudi Arabia;

hence, we believe mobile operators will continue

to benefit from the uptake of broadband services.

There is not much price differentiation within

fixed and mobile broadband services, which

should continue to drive the demand for mobile

broadband services in the kingdom. Mobily is the

market leader in the mobile broadband segment

with 60% market share. Hence, it has been able to

command a pricing premium, which is reflected in

its high data ARPU of cUSD55. Pricing has

remained stable in Saudi Arabia for broadband

services unlike other markets like Egypt. Mobily’s

unlimited plan sells at SAR350 per month

(USD96); the 5GB plan sells at SAR 200 per

month (USD55), while 1GB plan sells at SAR100

per month (USD 27). This hasn’t changed since

late 2007 when broadband was introduced in

Saudi Arabia.

We expect the contribution of data to Mobily’s

revenue to grow from 18.3% in 2010 to c29% by

2012e, driven by strong subscriber growth along

with limited ARPU dilution due to its strong

pricing power. Net neutrality or any other form of

intrusive regulation is not a concern for Saudi

telcos. This situation is unlikely to change

significantly in the medium term, in our opinion.

Mobile applications

Services based on news, entertainment and

religious content offer good growth prospects in

Saudi Arabia if mobile operators can develop the

right products at the right price. Also, with the

increase in network coverage and online Arabic

content, wealthier nations like Saudi Arabia

should demonstrate strong broadband uptake in

the coming years, in our view. This has resulted in

high data transmitted over Mobily’s network,

which has increased by 70% y-o-y, registering 85

terabytes/day in 2010 (50TB in 2009 and 19TB in

2008). The growing sales of smart phones and

tablets along with falling PC prices and high

disposable income should play a significant role

in boosting data revenue. Mobily owns Bayanat

Al Oula, which has a licence to offer data services

in the kingdom over fixed line. We see this as an

important platform to offload some network

capacity in dense and high usage area like Riyadh.

Investment thesis

Mobily is a growth story and a good way to gain

exposure to MENA telcos’ growth profile, in our

view. We like Mobily for its broadband-focused

strategy: it is the market leader in this segment,

with a market share of 60% in 2010, despite a

market share of only 39% of overall subs.

Management’s focus is on growth via increases in

broadband utilisation rates and the achievement of

operational efficiency through infrastructure

sharing. We believe Mobily is best positioned to

capture the growing demand for broadband

services, given its growing 3.5G coverage

(currently at 92%). We believe there is a demand

supply gap in Saudi Arabia, which is being served

by Mobily with mobile data card offerings. We

expect the data contribution to revenue to increase

by 1100bp to 29% of revenue by 2012 as it

already has 2.3m broadband subscribers, a figure

we expect to grow to 4.1m by 2012e.

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Financials & valuation: Etihad Etisalat(Mobily) Overweight Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (SARm)


Cash flow summary (SARm)

Cash flow from operations 5,470 6,839 7,122 7,371Capex -3,288 -3,454 -3,580 -3,319Cash flow from investment -3,227 -3,454 -3,580 -3,319Dividends -875 -1,400 -1,750 -2,100Change in net debt -1,802 -1,985 -1,792 -1,952FCF equity 2,115 3,362 3,538 4,052

Balance sheet summary (SARm)

Intangible fixed assets 11,558 11,032 10,506 9,981Tangible fixed assets 12,457 14,388 16,273 17,732Current assets 9,415 9,519 9,512 10,394Cash & others 2,111 2,190 2,075 2,886Total assets 33,430 34,939 36,291 38,106Operating liabilities 9,814 10,212 10,658 11,078Gross debt 7,972 6,065 4,158 3,017Net debt 5,860 3,875 2,083 131Shareholders funds 15,580 18,597 21,409 23,945Invested capital 21,505 22,538 23,558 24,142


Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change


Ratios (%)


Per share data (SAR)


Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information

Share price (SAR) 54.75 Target price (SAR) 71.00 Potent'l return (%) 29.7

Reuters (Equity) 7020.SE Bloomberg (Equity) EEC ABMarket cap (USDm) 10,234 Market cap (SARm) 38,325Free float (%) 40 Enterprise value (SARm) 42200Country Saudi Arabia Sector Wireless TelecomsAnalyst Kunal Bajaj Contact 9714 5077200

Price relative

25

30

35

40

45

50

55

60

2009 2010 2011 2012

25

30

35

40

45

50

55

60

Etihad Etisalat(Mobily) Rel to TADAWUL ALL SHARE INDEX


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MTN (Overweight, TP ZAR148) Mobile connectivity

MTN is well placed in terms of pricing power on

mobile data. All the mobile operators in Africa

currently offer tiered data plans. Even if a data

plan is marketed as an “unlimited” plan, in reality

the plan is not truly unlimited. There is no “all

you can eat” data plan currently, which gives

significant pricing power to the mobile operators.

The lack of fixed line alternatives necessitates the

use of mobile phones and USB modems to access

data. Satellite-based broadband is very expensive

and is unlikely to be a threat in the African

markets. Competition from fixed line operators is

limited as these suffer from a lack of network

coverage and proper distribution systems.

MTN is making attempts to monetise the data

growth potential in Africa. Data usage in South

Africa has increased 49% since December 2009,

with its data revenue increasing 42% y-o-y in H1

2010. Even more impressive is the 58% y-o-y

growth in non-SMS data revenue, which accounted

for 11% of its South African service revenue.

Data usage is increasing across most of its

operations and has started contributing to top-line

growth. Among its larger operations, Nigeria

currently has the lowest proportion of revenue

(4.2%) coming from data services, because of a

lack of required bandwidth. With the landing of

various submarine cables in Africa, we expect the

capacity bottleneck to be removed soon. This

should, in our view, allow MTN to begin to capture

the vast growth potential for data usage in Nigeria.

We believe the risks to MTN’s pricing power are

quite limited and unlikely to be significant in the

near to medium term. However, the risks from the

entry of a credible new entrant (particularly

Bharti) cannot be ignored. As we have witnessed

in the Kenyan voice market, Bharti can be quite

aggressive in pricing. If a similar sort of risk

materialises in the data services, it would hurt

MTN. This is, however, unlikely in the near term,

particularly in data segment, as Bharti will need

large capex to build sufficient capacity to meet the

growing demand.

Mobile applications

So far, MTN has been able to maintain a relatively

good grip on content, data applications and VAS

thanks to its advantages in terms of familiarity with

the local culture. We expect low-cost smartphones

based on the Android platform to drive internet

usage in Africa. However, language could present a

barrier to would-be developed world competitors.

Hence, we believe MTN would not be dis-

intermediated from the applications layer.

Mobile payment services have achieved

considerable success in Africa as most of the

countries here have a large unbanked population.

MTN’s mobile payment service, Mobile Money,

is showing a good take-up in countries where it

has been launched. For instance, MTN Uganda

has almost 16% of its subscriber base already

using the service. MTN has c2.2m mobile

payment subs across its operations. We reiterate

our thematic view (Assessing new growth

opportunities, 25 January 2010) that, over the

medium term, mobile payments will contribute

approximately 6% of revenue at a margin of

around 20% for African mobile operators.

Investment thesis

MTN’s is a strong growth story in the CEEMEA

telecoms universe, as one of the fastest-growing

telcos in the region, in our view. We are also

bullish on the data usage growth potential in Africa

as the affordability barrier and capacity bottlenecks

are removed. Despite the increasing competition

across its markets, we find it well positioned to

compete within the changing competitive

environment with a focus on cost management.

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Financials & valuation: MTN Overweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e

Profit & loss summary (ZARm)


Cash flow summary (ZARm)


Balance sheet summary (ZARm)

Intangible fixed assets 37,526 35,100 32,715 30,330Tangible fixed assets 67,541 73,784 79,015 82,988Current assets 46,024 51,258 66,167 82,137Cash & others 23,999 34,062 47,221 61,822Total assets 156,237 167,432 185,304 202,980Operating liabilities 39,094 38,522 41,379 44,861Gross debt 36,917 36,434 36,434 36,434Net debt 12,918 2,372 -10,787 -25,388Shareholders funds 67,866 75,228 87,479 98,675Invested capital 87,998 87,558 89,297 88,772


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue 9.2 1.9 10.2 7.3EBITDA 6.7 4.7 10.9 7.8Operating profit 3.9 4.1 10.8 7.3PBT -9.5 16.0 16.6 9.2HSBC EPS 8.8 -3.2 8.9 8.5

Ratios (%)

Revenue/IC (x) 1.2 1.3 1.4 1.5ROIC 28.7 28.6 30.6 32.5ROE 30.7 29.8 28.5 27.1ROA 12.6 13.4 14.4 14.2EBITDA margin 41.1 42.3 42.5 42.7Operating profit margin 28.2 28.8 29.0 29.0EBITDA/net interest (x) 20.9 24.2 31.4 49.6Net debt/equity 17.7 2.8 -11.0 -22.5Net debt/EBITDA (x) 0.3 0.0 -0.2 -0.4CF from operations/net debt 307.0 1550.5

Per share data (ZAR)



Year to 12/2009a 12/2010e 12/2011e 12/2012e

Nigeria EBITDA (ZARm) 19,746 19,889 21,838 23,055South Africa EBITDA (ZARm) 10,410 12,063 12,921 13,688Ghana EBITDA (ZARm) 2,566 2,359 2,433 2,464Iran EBITDA (ZARm) 2,664 3,829 4,426 4,754

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information

Share price (ZAR) 125.99 Target price (ZAR) 148.00 Potent'l return (%) 17.5

Reuters (Equity) MTNJ.J Bloomberg (Equity) MTN SJMarket cap (USDm) 32,520 Market cap (ZARm) 237,432Free float (%) 75 Enterprise value (ZARm) 258603Country South Africa Sector Wireless TelecomsAnalyst Herve Drouet Contact 44 20 7991 6827

Price relative

73

83

93

103

113

123

133

143

2009 2010 2011 2012

73

83

93

103

113

123

133

143

MTN Rel to JSE ALL SHARE


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Mobile Telesystems (Overweight, TP USD29) Fixed line connectivity

MTS’ recent acquisition of a controlling stake in

Comstar has opened up new horizons in the fixed

line space. Comstar has been seen historically as a

local player in Moscow, but MTS’s nationwide

presence gives access to the regions of Russia. We

expect Comstar to benefit from rolling out its

broadband offering to existing MTS mobile

subscribers. It is well positioned in terms of pricing

power on data services as tariffs are data tiered.

There are no “all you can eat” data packages.

There are some substitutes to deliver broadband but

those are relatively limited. There are some small

regional cable operators but these have limited scale

and financial power to upgrade their cable network.

Substitution from fixed regional operators is also

limited at the moment. Absence of regulations on

net neutrality is positive for incumbents. Local loop

unbundling by altnets is yet to be allowed in Russia.

There have also been cases of private reselling of

connectivity and illegal sharing. The impact, while

potentially significant, would be mitigated as long

as data tariffs remain tiered. Here we would expect

the potential issues with illegal sharing to gradually

fade as the demand for higher speed takes hold.

Mobile connectivity

Growing data demand is pushing mobile

connectivity with the number of 3G USB modems

having now overtaken fixed line broadband

subscribers. MTS is well positioned in terms of

pricing power on mobile data services. In Russia

and CIS countries, tariffs are data tiered. Some

packages are marketed as “unlimited” but in

reality are capacity-limited.

In local currency terms, data traffic revenue

jumped 69% y-o-y in 9M 2010, while total VAS

revenue increased c26% y-o-y (in local currency).

In Q3, VAS (SMS included) amounted to 20.5%

of revenue in Russia (increased 2.1ppt y-o-y),

helped by the expansion of its 3G network and

fast growing data traffic.

We believe pricing power is unlikely to be altered

significantly in the medium term as the

competitive environment has remained quite

rational in Russia.


It is plausible that certain OTT competitors will

pose a threat to incumbent IPTV services and

could also challenge well-established brands in

the pay-TV market. However, factors like the

complexities of rights arrangements, power of its

existing brands and absence of net neutrality

regulations would provide significant pricing

power and advantage to incumbents like MTS.

Mobile applications

MTS has been able to maintain a relatively good

grip on content, data applications and VAS thanks

to its advantages in terms of familiarity with the

local culture. Data content already represents c5%

of mobile revenue in Russia, almost matching the

revenue from data traffic excluding SMS. We

expect low-cost smartphones based on the

Android platform to drive internet usage in

Africa. However, language could present a barrier

to would-be developed world competitors. Hence,

we believe MTS would not be dis-intermediated

from the applications layer.

Investment thesis

We are bullish on the data usage growth potential

in Russia. Usage trends are reassuring, with

ARPU growth in local currency terms, driven by

higher voice and data usage. The mobile operators

in Ukraine have shifted their focus to profitability,

while making upward adjustments to tariffs. The

recent trends indicate an improving

macroeconomic outlook in Russia and CIS,

increased usage and recovery in Ukraine.

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Financials & valuation: Mobile Telesystems Overweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e




Cash flow from operations 3,596 3,697 4,269 4,644Capex -1,942 -1,989 -2,674 -2,687Cash flow from investment -3,718 -2,042 -2,841 -2,687Dividends -1,262 -496 -958 -1,188Change in net debt 1,739 -622 -469 -768FCF equity 1,578 1,698 1,486 1,864


Intangible fixed assets 2,236 2,401 2,401 2,401Tangible fixed assets 7,749 8,441 9,172 9,658Current assets 4,390 3,055 3,243 3,386Cash & others 2,728 960 1,000 1,000Total assets 15,749 14,390 15,309 15,938Operating liabilities 2,256 3,011 3,452 3,833Gross debt 8,349 5,959 5,530 4,762Net debt 5,621 4,999 4,530 3,762Shareholders funds 3,330 3,601 4,394 5,318Invested capital 9,391 9,926 10,363 10,611


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue -17.1 13.2 8.8 7.8EBITDA -23.5 10.3 9.5 8.3Operating profit -30.3 16.7 10.9 10.9PBT -49.3 55.6 17.6 14.8HSBC EPS -32.2 -7.7 25.4 16.7

Ratios (%)





Year to 12/2009a 12/2010e 12/2011e 12/2012e

Russia subscribers (000s) 69,342 70,192 72,214 73,982Russia ARPU (USD) 7.8 8.4 8.9 9.4Ukraine subscribers (000s) 17,564 18,313 19,206 19,979Ukraine ARPU (USD) 4.7 4.9 5.2 5.5

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information


Reuters (Equity) MBT.N Bloomberg (Equity) MBT USMarket cap (USDm) 19,704 Market cap (USDm) 19,704Free float (%) 44 Enterprise value (USDm) 24327Country Russian Federation Sector Diversified TelecomsAnalyst Herve Drouet Contact 44 20 7991 6827

Price relative

4

9

14

19

24

29

2009 2010 2011 2012

4

9

14

19

24

29

Mobile Telesystems Rel to RTS INDEX


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NTT DoCoMo (Overweight, TP JPY172,000) Mobile connectivity

We forecast smartphones as a proportion of

DoCoMo handset users to grow from 2.3% at end

2010 to 14% by end 2011, with these users

tending to spend more as they begin to measure

data usage in megabytes, rather than kilobytes.

A DoCoMo study of Sony Ericsson Xperia users

found they spent JPY2,100 more per month after

upgrading – while this amount will decline, the

trend is indicative.

A further positive for DoCoMo is its network

strength. It has invested consistently in its

network, and its strength here is in strong contrast

to SoftBank, which is struggling to manage strong

data demand from its iPhone users.

Expectations regarding data tariff levels are

ingrained: unlike in the US and Europe, c40% of

Japanese users already subscribe to some form of

tiered data plan. This makes it difficult for the

Japanese operators to shift to a pay-per-usage

model at the high-end – at least for 3G.

However, all operators have flagged the migration

to LTE as a chance to change this. Subscribers to

DoCoMo’s ‘Xi’ (pronounced ‘Crossy’) LTE

service launched in December 2010 will pay

JPY2,500 (USD30) for each 2GB of usage

beyond the 5GB tier (which costs a hefty

JPY8,700, or USD104).

Mobile applications

Each of the Japanese operators is focusing on

building a local suite of applications and services

that ensure continuity in the smartphone era with

services their customers were using before, on

more proprietary platforms such as DoCoMo’s

iMode. Within the ‘DoCoMo market’ subscribers

can choose between an app store, a music store

(with c1m titles) and a book store (which had

recorded 1.5m downloads by December 2010).

Part of the delay in launching Android-based

phones for both DoCoMo and KDDI has been a

result of their desire to integrate native Japanese

applications (such as e-wallet) services, with the

Android platform as shipped by the vendor.

Investment thesis

In our view, NTT DoCoMo is well-placed to

benefit from surging demand for smartphones in

Japan. This is coming from a very low base: just

c2.3% of DoCoMo users had smartphones at end

December 2010 – a result of the dominance of

domestic vendors, who (as in Korea) have been

late to produce smartphones. As a result,

DoCoMo performed poorly relative to SoftBank

in 2009 and 2010: as the sole supplier of the

iPhone this operator had c80% of market

smartphone subscribers at September 2010.

With the launch of Android-based smartphones in

the last quarter of 2010, NTT DoCoMo has seen

strong sales. It raised its smartphone sales target

to 2.5m for FY March 2011 (originally set at

1.3m), and saw ‘strong demand’ in December and

January. We see its network strength as a strong

positive: users are increasingly aware of the

disparity between different networks, a strong

benefit to DoCoMo as the breadth and depth of its

smartphone portfolio improves.

While we see little strategic benefit from

DoCoMo’s early launch of LTE, we see minimal

downside: unlike its early move to 3G, DoCoMo

will spend a relatively low proportion of its capex

on LTE. We project capex as a proportion of sales

to remain constant at c15%. NTT is our top pick

in the Japanese telecoms sector.

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Financials & valuation: NTT DoCoMo Inc. Overweight Financial statements

Year to 03/2010a 03/2011e 03/2012e 03/2013e

Profit & loss summary (JPYb)

Revenue 4,284 4,249 4,354 4,595EBITDA 1,573 1,614 1,652 1,730Depreciation & amortisation -735 -731 -716 -707Operating profit/EBIT 838 883 937 1,023Net interest -4 -4 -4 -3PBT 839 874 929 1,016HSBC PBT 863 931 969 1,056Taxation -338 -355 -379 -416Net profit 499 517 548 597HSBC net profit 507 548 570 621

Cash flow summary (JPYb)

Cash flow from operations 1,183 990 1,251 1,295Capex -726 -715 -665 -700Cash flow from investment -1,164 -722 -665 -700Dividends -209 -216 -220 -224Change in net debt -36 45 -354 -372FCF equity 488 539 601 598

Balance sheet summary (JPYb)

Intangible fixed assets 198 209 209 209Tangible fixed assets 3,236 3,214 3,204 3,237Current assets 2,061 2,220 2,597 3,005Cash & others 761 773 1,142 1,514Total assets 6,757 6,895 7,258 7,694Operating liabilities 1,007 944 969 1,036Gross debt 762 820 836 836Net debt 1 47 -307 -679Shareholders funds 4,636 4,801 5,113 5,477Invested capital 3,728 3,926 3,899 3,900


Year to 03/2010a 03/2011e 03/2012e 03/2013e

Y-o-y % change

Revenue -3.7 -0.8 2.5 5.5EBITDA -6.3 2.6 2.4 4.7Operating profit 0.9 5.4 6.1 9.2PBT 7.6 4.1 6.3 9.4HSBC EPS 7.2 4.0 6.2 9.0

Ratios (%)

Revenue/IC (x) 1.2 1.1 1.1 1.2ROIC 14.2 14.4 14.7 16.1ROE 11.3 11.6 11.5 11.7ROA 7.6 7.6 7.8 8.1EBITDA margin 36.7 38.0 38.0 37.7Operating profit margin 19.6 20.8 21.5 22.3EBITDA/net interest (x) 417.0 438.6 429.3 507.4Net debt/equity 0.0 1.0 -6.0 -12.3Net debt/EBITDA (x) 0.0 0.0 -0.2 -0.4CF from operations/net debt 94625.4 2121.9

Per share data (JPY)

EPS Rep (fully diluted) 11,947 12,422 13,197 14,383HSBC EPS (fully diluted) 11,947 12,422 13,197 14,383DPS 5,200 5,200 5,400 5,600Book value 111,063 115,404 123,118 131,902

Valuation data

Year to 03/2010a 03/2011e 03/2012e 03/2013e



Issuer information

Share price (JPY) 151100 Target price (JPY) 172000 Potent'l return (%) 17.2

Reuters (Equity) 9437.T Bloomberg (Equity) 9437 JPMarket cap (USDm) 79,358 Market cap (JPYb) 6,617Free float (%) 35 Enterprise value (JPYb) 6121Country Japan Sector Wireless TelecomsAnalyst Neale Anderson Contact +852 2996 6716

Price relative

111668

121668

131668

141668

151668

161668

171668

181668

2009 2010 2011 2012

111668

121668

131668

141668

151668

161668

171668

181668

NTT DoCoMo Inc. Rel to TOPIX INDEX


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Portugal Telecom (Neutral, TP EUR9) Fixed line connectivity

PT currently covers 1m homes (c20%) with its

FTTH and has plans to raise this to 1.6m homes in

the medium term. In our view, the regulator’s

stance on fibre is beneficial for PT as it aims to

ensure transparent legislation that promotes

investment in NGA, while at the same time

safeguarding a return for operators and conditions

for sustainable competition. On the net neutrality

side, regulator Anacom has not expressed any

views in public, but we believe it is likely to

follow the European Union framework;

considering the EU’s pragmatic stance this should

be favourable for PT.

Mobile connectivity

PT has been investing in its networks with a

mobile capex/sales ratio of c12% over the past

four years and has the best 3G coverage of 93% in

Portugal vs 92% and 86% for the second and third

operators, respectively. TMN experienced a

relatively rapid take-up of data services, which can

be gauged from the fact that TMN’s mobile

broadband now has 3x the number of broadband

customers it had two years back. Anticipating the

rise of data traffic, PT is conducting trials on high

speed LTE and has connected 85% of its cell sites

with fibre.

On mobile data pricing, management has migrated

to tiered data plans. TMN has some basic data

plans with data cap at 600MB per month but it has

continued with its unlimited data plans priced at

EUR100/month (it comes with a voice and text

bundle with a fair usage policy of 5,000 voice

minutes, 5,000 text message, unlimited WiFi and

5GB internet). On the iPad it has an unlimited data

plan for a price of EUR29.9.


PT has rapidly expanded its market share to

currently c27% of the Portuguese pay-TV market

from a greenfield operation started in H2 2007. PT

provides TV services through a mix of IPTV and

DTH based platforms. PT’s TV customers

constitute almost 80% of its broadband subscriber

base, which is one of the highest among the

European incumbents. Success of its TV strategy

is also reflected in the top-line performance of its

fixed division; which is likely to post positive

revenue growth two years in a row.

Mobile applications

PT has made some attempts to enter the

application space. First, TMN has launched Meo

mobile, which makes available 40 TV channels

with innovative features such as wireless remote

recording and sms alerts. Second, TMN has

launched its own application store with sports,

news, entertainment, games, books and utility

applications available to its customers. This

application store leverages on PT’s portal Sapo,

the most popular portal in Portugal. Third, PT has

introduced an aggregation service that enables

access to multiple personal accounts, aggregation

of social network accounts in a single place,

simultaneous posts in multiple accounts and

sharing of photos and videos.

Investment thesis

PT’s investment in FTTH, investment in fibre

backhaul to support mobile traffic and its

successful IPTV strategy remain the key positives,

but, in our opinion, are fully priced in at the

current trading price. PT is currently trading at a

10% premium to the 2011e sector EV/EBITDA

multiple. Hence, we are Neutral on Portugal

Telecom with a EUR9 price target (including

EUR0.65 of expected special dividend).

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Financials & valuation: Portugal Telecom Neutral Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e


Revenue 6,785 5,585 5,933 6,766EBITDA 2,502 2,051 2,275 2,559Depreciation & amortisation -1,527 -1,254 -1,071 -1,128Operating profit/EBIT 975 797 1,204 1,431Net interest -302 -245 -186 -244PBT 1,021 5,993 1,175 1,353HSBC PBT 951 797 1,267 1,431Taxation -233 -148 -299 -343Net profit 685 5,699 750 865HSBC net profit 624 480 842 942


Cash flow from operations 1,612 1,548 1,719 1,678Capex -1,268 -967 -989 -1,051Cash flow from investment -871 4,462 -2,664 -1,051Dividends -504 -1,380 -1,139 -569Change in net debt -25 -5,157 4,132 -58FCF equity 706 700 801 797


Intangible fixed assets 4,047 1,080 4,436 4,436Tangible fixed assets 4,862 3,635 5,641 5,624Current assets 3,699 4,896 4,043 4,168Cash & others 1,500 1,500 1,500 1,500Total assets 14,831 11,103 16,393 16,556Operating liabilities 2,904 2,237 2,751 2,812Gross debt 7,046 1,890 6,022 5,964Net debt 5,547 390 4,522 4,464Shareholders funds 1,318 3,594 3,775 4,053Invested capital 8,204 5,874 9,869 9,916


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue 1.0 -17.7 6.2 14.0EBITDA 0.9 -18.0 10.9 12.5Operating profit -16.5 -18.2 51.0 18.8PBT 10.0 487.2 -80.4 15.2HSBC EPS -7.3 -23.1 75.5 11.9

Ratios (%)





Year to 12/2009a 12/2010e 12/2011e 12/2012e

Domestic fixed 1,948 1,949 1,969 1,979Domestic mobile 1,518 1,399 1,337 1,316Vivo 3,138 1,885 0 0Telemar 0 0 2,234 3,067Others 181 352 392 404Group revenues 6,785 5,585 5,933 6,766

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information


Reuters (Equity) PTC.LS Bloomberg (Equity) PTC PLMarket cap (USDm) 10,423 Market cap (EURm) 7,691Free float (%) 90 Enterprise value (EURm) 10464Country Portugal Sector Diversified TelecomsAnalyst Luigi Minerva Contact 44 20 7991 6928

Price relative

4

5

6

7

8

9

10

11

2009 2010 2011 2012

4

5

6

7

8

9

10

11

Portugal Telecom Rel to PSI 20


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Saudi Telecom Company (Overweight, TP SAR48) Fixed line connectivity

STC is the incumbent telecom service provider in

Saudi Arabia, currently operating in a duopoly

environment in the fixed line space. However,

while the second fixed line operator, Etihad

Etheeb, has recently started operations, it has not

invested in its network because of balance sheet

constraints, giving STC still 98% market share in

fixed voice. There are no substitutes to deliver

broadband in Saudi Arabia on fixed line ( no cable,

altnets etc) and mobile broadband (dongles, USBs)

are the only alternative to fixed line broadband for

the customers. VOIP is banned in Saudi Arabia,

meaning internet is not a direct substitute for voice

services. Absence of regulations on net neutrality is

positive for incumbents. Local loop unbundling by

altnets is yet to be allowed in Saudi Arabia. STC

currently has around 85,000 km of fibre cable in the

country and the DSL penetration is only 32% of

households. Pricing is not a differentiating factor,

with a 2Mbps fixed broadband for unlimited data

plan cost of around SAR221, which is 10% higher

than mobile broadband for 2GB usage cap.

Mobile connectivity

There are around 4m mobile broadband users in

Saudi Arabia compared with 1.5m fixed

broadband users. STC is well positioned in terms

of pricing power on mobile data services, as is

Mobily. Pricing has remained stable in Saudi

Arabia for broadband services, unlike other

markets like Egypt.


The Saudi Arabian media market is unregulated

and the mass medium of content distribution is

satellite. Around 52% of households in Saudi with

a television are on the satellite platform, with the

rest on terrestrial DTT. STC formally launched

IPTV in August 2010 as “InVision” and has

already started to bundle its services through triple

play offerings of landline, DSL and IPTV.

Mobile applications

STC has been able to maintain a relatively good

grip on content, data applications and VAS thanks

to its advantages in terms of familiarity with the

local culture .While there has been no separate

disclosures from Saudi companies on data content

revenues, STC has started to invest in contents

and applications for its 3.5G services on mobile.

In October 2008, STC, in association with Astro

All Asia Networks of Malaysia and Saudi

Research and Marketing Group (SRMG), set up a

new mobile content services company with capital

of USD74.8m, with 51% ownership by STC.

Investment thesis

We are bullish on broadband prospects in Saudi

Arabia as long-term healthy demand for

broadband services is be supported by Saudi’s

attractive demographics, favourable regulatory

environment, lack of entertainment options and

absence of alternative technologies (like cable).

We expect STC’s data revenue as a percentage of

domestic revenues to grow from 14.8% currently

to 19.4% within the next 5 years. We have little

doubt that the NGN will create new growth

opportunities for STC from about 2011 onwards.

Fixed-line technology is much better suited than

mobile technology for the transmission of data at

very high speeds, and hence it will always be

superior to mobile for high-bandwidth

applications such as video streaming and

television. STC is the only integrated operator in

Saudi Arabia and thus should be able to offer such

applications in bulk; this is one reason why STC

should remain the telecoms provider of choice for

large business and public-sector customers and for

very high end consumers.

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Financials & valuation: Saudi Telecom Company Overweight Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (SARm)

Revenue 51,787 54,477 54,975 55,796EBITDA 19,625 20,631 21,104 21,479Depreciation & amortisation -8,645 -9,137 -9,239 -9,510Operating profit/EBIT 10,981 11,494 11,865 11,969Net interest -1,789 -1,009 -954 -892PBT 10,983 10,486 10,911 11,077HSBC PBT 9,708 10,486 10,911 11,077Taxation -884 -844 -941 -966Net profit 9,496 9,157 9,484 9,626HSBC net profit 8,323 9,157 9,484 9,626

Cash flow summary (SARm)

Cash flow from operations 18,780 18,757 19,260 19,630Capex -10,674 -10,791 -10,043 -9,178Cash flow from investment -13,046 -10,791 -10,043 -9,178Dividends -6,109 -6,000 -7,587 -7,701Change in net debt 704 -1,966 -1,629 -2,752FCF equity 6,185 7,976 9,119 10,427

Balance sheet summary (SARm)



Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue 2.0 5.2 0.9 1.5EBITDA -4.8 5.1 2.3 1.8Operating profit -14.3 4.7 3.2 0.9PBT -10.2 -4.5 4.1 1.5HSBC EPS -20.6 10.0 3.6 1.5

Ratios (%)


Per share data (SAR)


Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information

Share price (SAR) 40.30 Target price (SAR) 48.00 Potent'l return (%) 19.1

Reuters (Equity) 7010.SE Bloomberg (Equity) STC ABMarket cap (USDm) 21,523 Market cap (SARm) 80,600Free float (%) 30 Enterprise value (SARm) 106771Country Saudi Arabia Sector DIVERSIFIED TELECOMSAnalyst Kunal Bajaj Contact 9714 5077200

Price relative

26

31

36

41

46

51

56

61

2009 2010 2011 2012

26

31

36

41

46

51

56

61

Saudi Telecom Company Rel to TADAWUL ALL SHARE INDEX


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Sprint Nextel (Neutral (V), TP USD5) Fixed-line connectivity

Sprint Nextel’s only fixed-line asset is its long-

distance network, having spun off its local access

division in 2006 (as “Embarq”) which is now

owned by CenturyLink. Understandably therefore

Sprint Nextel has not been particularly vocal on

the issue of net neutrality, releasing only a brief

statement regarding the FCC’s new policy agreed

in December 2010 which maintained strict net

neutrality principles for fixed networks while

permitting “reasonable traffic management” on

mobile networks. Sprint Nextel commented that

the FCC had recognized “the differences between

fixed and mobile networks” and had resolved “a

fair and balanced approach to a difficult issue”.

Mobile connectivity

Sprint Nextel’s network is under considerably less

pressure than that of AT&T, and potentially that

of Verizon Wireless too (as the latter expects to

roughly double its smartphone base this year on

the back of new CDMA iPhone sales). The reason

for Sprint’s greater breathing room is hardly

positive though as the company has been losing

mobile subscribers consistently for more than four

years now: Q4 2010 saw the first positive direct

postpaid net additions (+58,000) since Q2 2006.

A dwindling subscriber base has enabled the

company to reduce mobile capex to very low

levels – this averaged 5% of divisional sales

2008-2010. Part of the company’s problems may

be ascribed, we believe, to its running multiple

network technologies – CDMA, iDEN and (via

Clearwire) WiMAX in parallel. Although

questions still remain on further funding of

Clearwire, Sprint Nextel has announced Network

Vision, a network modernization frame agreement

with Alcatel-Lucent, Ericsson and Samsung to

rationalise the company’s technology roadmap.

We expect the 3GPP’s LTE technology to form

the core of Network Vision.

As a challenger for market share and with few

capacity pressures on a series of relatively under-

occupied networks, Sprint Nextel does not have the

same imperative as AT&T to ration consumption

through tiered data pricing although periodically the

firm notes that it does not rule out this option in

future. Sprint Nextel does not have a public WiFi

network (indeed some might quip this is one of the

few network technologies it doesn’t operate),

although via its 54% stake in Clearwire, Sprint does

have substantial amounts of spare WiMAX

capacity: Clearwire has nearly 100MHz of spectrum

in its major markets and only around one million

customers. Such abundance of capacity does not

encourage pricing power, we believe. Indeed, Sprint

Nextel, having ample capacity as well as a desire to

regain market share lost over the past four years,

makes for a potentially disruptive combination,

which detracts from the appeal of the US wireless

market, in our view.


As Sprint Nextel lacks a fixed-line local access

presence the firm does not have plans for IPTV.

Mobile applications

We see little prospect of Sprint Nextel forcing

change to the status quo in the mobile applications

value chain (given we believe even its greatly

more powerful rivals, Verizon Wireless and

AT&T, are equally unable to resist the dominance

in this space from Apple and Google).

Investment thesis

We have a Neutral (V) rating on Sprint Nextel.

Although the company has reported improving

metrics over the past couple of quarters, we

believe it still remains vulnerable to increased

competitive intensity from larger rivals, which

underpins our cautious stance on the stock.

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Financials & valuation: Sprint Nextel Corp Neutral (V) Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e


Revenue 32,563 32,348 32,822 33,553EBITDA 5,633 5,917 6,188 6,367Depreciation & amortisation -6,537 -5,548 -4,842 -4,365Operating profit/EBIT -904 370 1,347 2,002Net interest -1,367 -1,439 -1,360 -1,209PBT -2,271 -1,069 -14 793HSBC PBT -2,276 -1,069 -14 793Taxation -166 99 5 -301Net profit -2,437 -970 -8 492HSBC net profit -2,276 -1,069 -14 492


Cash flow from operations 4,815 5,035 4,781 5,064Capex -1,935 -2,927 -3,221 -3,332Cash flow from investment -2,556 -2,927 -3,221 -3,332Dividends 0 0 0 0Change in net debt 2,237 -2,157 -1,559 -1,732FCF equity 2,145 1,591 1,465 1,426




Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue 0.9 -0.7 1.5 2.2EBITDA -6.4 5.0 4.6 2.9Operating profit NA NA 264.2 48.7PBT NA NA NA NAHSBC EPS NA NA NA NA

Ratios (%)

Revenue/IC (x) 0.8 0.8 0.9 0.9ROIC 1.4 2.0 4.3 3.8ROE -13.9 -7.4 -0.1 3.4ROA -1.7 1.0 2.9 2.6EBITDA margin 17.3 18.3 18.9 19.0Operating profit margin -2.8 1.1 4.1 6.0EBITDA/net interest (x) 4.1 4.1 4.5 5.3Net debt/equity 133.2 119.7 108.9 93.7Net debt/EBITDA (x) 3.4 2.9 2.5 2.2CF from operations/net debt 24.9 29.2 30.5 36.4


EPS Rep (fully diluted) -0.85 -0.34 0.00 0.17HSBC EPS (fully diluted) -0.80 -0.37 0.00 0.17DPS 0.00 0.00 0.00 0.00Book value 5.10 5.04 5.04 5.21


Year to 12/2010a 12/2011e 12/2012e 12/2013e

Reported revenues 32,563 32,348 32,822 33,553Reported EBITDA 5,633 5,917 6,188 6,367Reported EBIT -821 370 1,347 2,002Reported PBT -2,188 -1,069 -14 793Reported EPS -1 0 0 0

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e

EV/sales 1.0 0.9 0.9 0.8EV/EBITDA 5.8 5.2 4.7 4.3EV/IC 0.8 0.8 0.8 0.8PE* NA NA NA 26.7P/Book value 0.9 0.9 0.9 0.9FCF yield (%) 16.0 11.8 10.9 10.6Dividend yield (%) 0.0 0.0 0.0 0.0


Issuer information


Reuters (Equity) S.N Bloomberg (Equity) S USMarket cap (USDm) 13,579 Market cap (USDm) 13,579Free float (%) 100 Enterprise value (USDm) 30661Country United States Sector Diversified TelecomsAnalyst Richard Dineen Contact 1 212 525 6707

Price relative

1

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7

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1

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Sprint Nextel Corp Rel to S&P 500


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Swisscom (Overweight, TP CHF470) Fixed line connectivity

Swissscom, with VDSL coverage of 78% and

ongoing investments in FTTH, has a strong

domestic position in fixed-line services. That

means alternative operators competing on ULL

are at a disadvantage. The regulatory environment

in Switzerland is favourable to Swisscom, because

fibre networks (VDSL or FTTH) are not included

in the current regulatory network and are not

expected to be regulated anytime soon. In 2009,

the Swiss Parliament asked the Federal Council to

assess the level of competition in the telecom

market. In a report published on 17 September

2010, the Council answered that there was no

urgent need to change the current telecoms law as

it would discourage ongoing investments. Also,

Swisscom is laying multi-fibre rather than single

fibre, which reduces the chances of regulation.

Mobile connectivity

Swisscom has been continually investing in its

networks (fixed and mobile) with average

domestic capex/sales ratio of 14% over 2006-10e.

Hence, even with rapid growth in data revenues in

2010 (in 9M 2010 non-messaging data revenues

grew by 36% y-o-y), Swisscom’s networks do not

face congestion. Swisscom has proactively

upgraded its network to HSDPA and has

complementary WiFi coverage that helps to

offload traffic in high-density areas. In its Q2

2010 conference call, the company said it would

ensure that all Apple devices log in automatically

to wireless hotspots when in they’re in a WiFi

zone. Swisscom has three sets of data plans

catering to the different class of data users – its

basic plan is 250MB for CHF35, then it has a

1GB plan for CHF55 and an unlimited voice and

data plan (speeds reduced after 2GB of usage) for

CHF169.


Swisscom started providing IPTV services in

2007 to fight back against Cablecom. It had

secured around 10% of the TV market by the end

of Q3 2010 – by which point, 23% of its

broadband lines were taking an IPTV service.

Swisscom’s triple-play package starts at CHF99

per month and includes line rental, free voice calls

to the Swisscom fixed-line and mobile networks,

10Mbps broadband and a TV service with over

160 channels. The incumbent is competing against

cable operator Cablecom’s triple-play package

(CHF75 per month for fixed-line calls, 20Mbps

broadband and more than 120 TV channels).

Swisscom has an agreement with OTT provider

Zattoo that lets subscribers of Swisscom VDSL

watch some extra channels in the player. Those

channels have a high-quality signal that shows a

sharp picture even if one enlarges the player

window. The benefit to Swisscom is that it

encourages people to upgrade to fibre-based

broadband.

Mobile applications

Swisscom promotes the use of apps with its

Swiscom Appvisor to help clients select

applications. Swisscom also offers live TV

(Swisscom TV air), news (Swisscom’s own

portal) and location services. As the application

layer is properly served, clients are encouraged to

use their mobile more, enabling Swisscom to

monetise it.

Investment thesis

Our Overweight rating on Swisscom is primarily

driven by its strong domestic position in both

fixed and mobile services, which we believe the

company can maintain over the long term as it is

continually investing in its networks. The

regulatory environment is also favourable for

Swisscom. On the mobile side, Swisscom has the

right connectivity and application strategy to

monetise the capacity scarcity.

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Financials & valuation: Swisscom Overweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e

Profit & loss summary (CHFm)


Cash flow summary (CHFm)

Cash flow from operations 4,195 3,737 3,935 4,034Capex -1,987 -1,876 -1,834 -1,849Cash flow from investment -1,189 -2,148 -1,834 -1,849Dividends -984 -1,036 -1,243 -1,347Change in net debt -928 -230 -857 -838FCF equity 1,892 1,946 2,110 2,183

Balance sheet summary (CHFm)

Intangible fixed assets 8,979 8,581 8,429 8,277Tangible fixed assets 8,044 8,035 8,072 8,101Current assets 4,154 4,361 5,216 4,057Cash & others 1,078 1,116 1,974 800Total assets 21,960 21,856 22,578 21,279Operating liabilities 3,371 4,587 4,698 4,830Gross debt 10,010 9,818 9,818 7,807Net debt 8,932 8,702 7,844 7,007Shareholders funds 6,409 5,270 5,945 6,588Invested capital 16,728 15,274 15,045 14,804


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue -1.6 0.1 -0.5 2.4EBITDA -2.6 0.7 1.0 2.1Operating profit 1.4 1.5 2.7 2.7PBT 8.5 0.9 6.1 3.7HSBC EPS -1.3 5.4 1.1 3.5

Ratios (%)


Per share data (CHF)



Year to 12/2009a 12/2010e 12/2011e 12/2012e

Swisscom Revenues 12,001 12,008 11,951 12,243Swisscom EBITDA adjusted 4,666 4,696 4,741 4,840Swisscom EBIT adjusted 2,678 2,719 2,792 2,867Swisscom Net income adjusted 1,928 1,898 2,022 2,093Swisscom FCF definition (OpFCF) 2,669 2,611 2,844 2,919

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information

Share price (CHF) 430.90 Target price (CHF) 470.00 Potent'l return (%) 9.1

Reuters (Equity) SCMN.VX Bloomberg (Equity) SCMN VXMarket cap (USDm) 22,966 Market cap (CHFm) 22,321Free float (%) 42 Enterprise value (CHFm) 30837Country Switzerland Sector Diversified TelecomsAnalyst Nicolas Cote-Colisson Contact 44 20 7991 6826

Price relative

276296316336356376396416436

2009 2010 2011 2012

276296316336356376396416436

Swisscom Rel to SMI


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TDC (Overweight, TP DKK58) Fixed line connectivity

TDC owns Denmark’s biggest cable network,

covering about 57% of Danish homes under the

YouSee brand. It has invested substantially in

recent years in NGA infrastructure (14%

capex/sales on average in 2007-10) both on the

cable as well as on the telecom side. It also

acquired fibre network operator DONG in the

Copenhagen area.

Its main competition arises from utilities building

fibre networks, which currently cover almost a

quarter of Danish homes. Those utility fibre

networks are technologically competitive but

typically lack scale and knowhow in increasingly

complex multi-play telco products.

The Danish regulator’s key line of action at the

moment is to force TDC to open its YouSee cable

network on a wholesale bitstream basis to

competitors.

Mobile connectivity

We see TDC as well-positioned in data pricing

strategy with tiered data tariffs in place, albeit in

an especially challenging market with contract

periods limited to six months, which stimulates

churn, and aggressive MVNO activity.

TDC is well-advanced in rolling out HSPA+

covering 15% of its network. After securing

2.5GHz of spectrum, TDC in April 2010 started to

roll out LTE, with Ericsson as primary vendor.

TDC offers mobile data in tiered tariffs with 1GB

priced at DKK99 (EUR14) and 1GB at DKK199

(EUR28).


Given its cable ownership, TDC is the leading

pay-TV operator in Denmark. Sales of triple-play

to its telecom subscriber base have been modest.

It is primarily used as a retention tool under the

pre-requisite not to cannibalise its YouSee cable

subscriber base. Video on demand is offered on

both platforms, and only towards the end of 2010

started to gain momentum, with VoD sessions

doubling in Q4 sequentially.

Mobile applications

TDC is not part of WAC, the Wholesale

Application Community. Given the small size if

the Danish market, it appears sensible not to try

and compete in the application market with global

internet giants, but rather to focus on providing

and monetising quality connectivity.

Investment thesis

We like TDC as a pure play on the stable Danish

market with no M&A risk, high visibility on cash

generation and use. We believe TDC has invested

sensibly in past years. TDC also enjoys the

advantage of owning an upgraded cable network.

TDC compares favourably to its peers in

diversifying its brand portfolio, having acquired

and established several no-frill, discount and

premium brands around its core TDC brand. TDC

has also reorganised into segments grouped by

customers rather than products.

We have an Overweight rating on TDC, with a

target price of DKK58. A policy of 80% to 85%

payout of FCFE leaves little room for value-

destructive use of cash and the historically high

capex/sales ratio provides flexibility to protect

short-term FCF should the economy slow.

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Financials & valuation: TDC Overweight Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (DKKm)

Revenue 26,167 26,143 26,200 26,307EBITDA 9,425 9,794 9,873 9,945Depreciation & amortisation -5,356 -5,222 -5,077 -4,945Operating profit/EBIT 4,069 4,572 4,796 5,000Net interest -1,591 -1,040 -1,035 -1,033PBT 2,586 3,539 3,767 3,973HSBC PBT 2,759 3,632 3,860 4,066Taxation -782 -885 -942 -993Net profit 1,804 2,654 2,825 2,980HSBC net profit 2,069 2,724 2,895 3,049

Cash flow summary (DKKm)

Cash flow from operations 7,265 7,408 7,445 7,475Capex -3,646 -3,464 -3,485 -3,509Cash flow from investment -3,923 -3,464 -3,485 -3,509Dividends -70 -1,882 -3,771 -3,786Change in net debt -10,822 -2,063 -189 -183FCF equity 3,977 4,500 4,486 4,410

Balance sheet summary (DKKm)

Intangible fixed assets 34,799 33,239 31,808 30,501Tangible fixed assets 15,531 15,426 15,358 15,322Current assets 6,248 8,316 8,531 5,996Cash & others 831 2,894 3,083 500Total assets 64,786 65,195 63,917 60,045Operating liabilities 11,783 9,383 8,904 8,449Gross debt 23,644 23,644 23,644 20,879Net debt 22,813 20,750 20,561 20,379Shareholders funds 20,855 23,509 22,555 21,748Invested capital 43,964 44,704 43,710 42,870


Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue 0.3 -0.1 0.2 0.4EBITDA 0.1 3.9 0.8 0.7Operating profit -14.5 12.4 4.9 4.2PBT -6.6 36.8 6.5 5.5HSBC EPS -21.6 31.6 6.3 5.3

Ratios (%)


Per share data (DKK)



Year to 12/2010a 12/2011e 12/2012e 12/2013e

EBITDA company 10,772 10,966 11,045 11,117EBITDA HSBC 9,600 9,794 9,873 9,945EBITDA reported 9,425 9,794 9,873 9,945FCF HSBC TMT 2,897 3,787 4,389 4,386FCFE HSBC 3,977 4,500 4,486 4,462FCFE company 4,515 4,562 4,581 4,590

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information

Share price (DKK) 46.31 Target price (DKK) 58.00 Potent'l return (%) 25.2

Reuters (Equity) TDC.CO Bloomberg (Equity) TDC DCMarket cap (USDm) 6,851 Market cap (DKKm) 37,698Free float (%) 33 Enterprise value (DKKm) 52850Country Denmark Sector Diversified TelecomsAnalyst Stephen Howard Contact 44 20 7991 6820

Price relative

202530354045505560

2009 2010 2011 2012

202530354045505560

TDC Rel to KFX


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Tele2 (Neutral, TP SEK160) Fixed line connectivity

Tele2’s focus is its mobile business; it has limited

fixed-line presence. Tele2’s cable TV network in

Sweden passes through about 210k households, or

c5% of total Swedish households. Although Tele2 is

currently building out a fibre backhaul network in

Sweden to support its mobile broadband business, it

has not disclosed its coverage plans.

Mobile connectivity

Tele2 has predominantly been a price challenger in

the Swedish market and has continued to be

aggressive in its offering. But with the rapid growth

in smartphone penetration, the company has been

increasing its focus on the post-paid segment of the

market to take advantage of data growth. Tele2

launched 4G services in five cities in Sweden late

last year. It plans to cover 100 cities by the end of

FY 2011e and 99% of the population by the end of

FY 2012e.

The Swedish market still has high end flat-fee offers.

Telenor, Tele2 and Three continue to have some of

their plans under flat-fee offers. Telenor, which has

about 18% market share, falls under our ‘teenage

operator’ definition and could disrupt the market in

its effort to gain share and scale. Encouragingly,

Telenor’s management recently commented that it

sees flat-rate data tariffs as unsustainable. We note

that even though flat-rate tariffs still exist in Sweden,

the market already enjoys high single-digit mobile

revenue growth rates.

On net neutrality, the current thinking of the

Swedish telecom regulator, PTS, is that: “Traffic

prioritisation does not need to be socio-economically

inefficient as long as it takes place on a market

where there is competition; rather it may often

promote consumer benefits instead. Charging for

better performance or access to desirable content

services is a completely natural phenomenon in a

market subject to competition.” In other words, the

regulator seems to feel charging for packet

prioritisation is perfectly reasonable. The regulatory

view on net neutrality certainly is more relaxed at an

EU level than is the case in the US. But it is plainly

helpful that the national regulator has clear and

sensible views on the subject as well.


Tele2 serves about 5% of Swedish homes with its

cable TV network, competing against ComHem

(cable), ViaSat (satellite) and other TV players.

Mobile applications

Tele2 is not part of WAC (Wholesale Application

Community) or OMA (Open Mobile Alliance).

Investment thesis

Tele2’s focus continues to be infrastructure-led

mobile businesses in Sweden, Russia, the Baltic

countries and Kazakhstan. Tele2’s operations in

Russia and Sweden have continued to deliver good

results and we expect positive growth momentum to

continue.

However, we have been sceptical on Tele2 arbitrage

(ULL/MVNO) businesses, which contribute c25%

to revenues. We expect these businesses to face

significant pressure as incumbents (through fibre)

and cable operators (through DOCSIS) upgrade their

network capabilities, which in our view will put

them in a strong position to take away market share

from ULL operators. We also believe Tele2’s lack of

3G spectrum could impede its growth prospects in

Russia.

We have a Neutral rating on the stock with a target

price of SEK160 (increased from SEK155, post

change to our WACC assumption) and believe

Tele2’s low debt levels (1.1x FY 2011e net

debt/EBITDA post accounting for FY 2010e

dividends) should continue to provide support for

competitive yields.

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Financials & valuation: Tele2 Neutral Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (SEKm)

Revenue 40,197 40,769 42,043 42,700EBITDA 10,284 10,672 11,653 12,321Depreciation & amortisation -3,596 -3,618 -3,855 -4,058Operating profit/EBIT 6,688 7,054 7,799 8,263Net interest -497 -439 -536 -500PBT 6,412 6,693 7,340 7,840HSBC PBT 6,268 6,693 7,340 7,840Taxation -283 -1,720 -1,888 -2,018Net profit 6,574 4,965 5,444 5,822HSBC net profit 4,656 4,965 5,444 5,814

Cash flow summary (SEKm)

Cash flow from operations 9,610 9,178 9,286 9,863Capex -3,603 -5,247 -4,816 -4,202Cash flow from investment -5,260 -5,247 -4,816 -4,294Dividends -2,580 -11,944 -3,760 -4,123Change in net debt -203 8,013 -710 -1,446FCF equity 5,801 3,211 4,302 5,531

Balance sheet summary (SEKm)

Intangible fixed assets 13,201 13,201 13,201 13,293Tangible fixed assets 15,130 16,760 17,721 17,865Current assets 7,697 7,837 8,028 8,126Cash & others 946 1,000 1,000 1,000Total assets 40,369 42,216 43,445 43,857Operating liabilities 7,695 262 873 1,312Gross debt 2,948 11,015 10,305 8,859Net debt 2,002 10,015 9,305 7,859Shareholders funds 28,872 30,077 31,398 32,808Invested capital 27,387 36,535 37,077 36,973


Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change


Ratios (%)


Per share data (SEK)



Year to 12/2010a 12/2011e 12/2012e 12/2013e

Tele2 Revenues 40,197 40,769 42,043 42,700Tele2 EBITDA adjusted 10,284 10,672 11,653 12,321Tele2 PBT reported 6,735 6,693 7,340 7,840Tele2 Net income reported 6,926 4,965 5,444 5,814

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information

Share price (SEK) 148.70 Target price (SEK) 160.00 Potent'l return (%) 7.6

Reuters (Equity) TEL2b.ST Bloomberg (Equity) TEL2B SSMarket cap (USDm) 9,638 Market cap (SEKm) 62,449Free float (%) 72 Enterprise value (SEKm) 69438Country Sweden Sector Diversified TelecomsAnalyst Dominik Klarmann Contact +49 211 910 2769

Price relative

50

70

90

110

130

150

170

2009 2010 2011 2012

50

70

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Tele2 Rel to OMX


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Telecom Italia (Underweight, TP EUR1.05) Fixed line connectivity

Telecom Italia is lagging behind other European

incumbents in terms of NGA deployment,

currently running trials in Milan and Rome. The

company has a target of reaching 1.3m

households (about 5.5% of total) covered with

FTTN/VDSL by the end of 2012 and a longer-

term goal of 10m households (about 42% of total).

Despite such unambitious plans, the lack of a

cable infrastructure in Italy has in part preserved

TI’s position. However, it has not protected it

from pricing pressure from altnets on an

undifferentiated voice and broadband product.

The national regulator AGCOM has granted TI an

increase in ULL copper fees, which will gradually

rise from EUR8.49 in early 2010 to EUR9.28 in

2012. While this has brought TI’s ULL fees closer

to the EU average, it is in counter trend with the

other European markets. This, together with

wholesale broadband access fees that most likely

will be determined on a LRIC basis, does not

create strong regulatory incentives for TI to

accelerate its NGA deployment. AGCOM’s

position on net neutrality is no different from the

other European regulators and is likely, in our

view, to follow the EU recommendations, which

currently appear pragmatic.

Mobile connectivity

TI’s approach to tiered data pricing continues to

make it quite an exception among peers. While

most peers have shifted to tiered data plans, TI

continues to stick to flat rate tariffs up to 2GB per

month. As a comparison, Vodafone Italy has

reduced its cap to 1GB per month. However, we

do not think TI’s case is any different from other

operators: mobile capacity is an intrinsically

scarce resource also for the company. We would

not be surprised if TI decided to adopt tiered data

plans during the course of 2011.


Given the limited NGA deployment and the

inferior contents available compared with the

satellite alternative Sky Italia, IPTV has not so far

had a significant impact: as of 2010, TI’s IPTV

customers are equivalent to only 5% of its

broadband lines. Moreover, Fastweb and Sky

have recently strengthened their commercial

relationship: customers can now choose services

from either within a joint plan and then receive a

unified bill with dedicated call centre support.

This represents an additional challenge to TI.

Mobile applications

TI’s efforts in the applications space have so far

had a limited impact: Tim store has around 1,000

applications available, grouped in categories such

as social network, sport, games, travels and

others. TI has reached an agreement with the main

Italian publishers to offer a virtual bookshop;

however, this is available on TI’s dedicated

device (the biblet) rather than as an app available

on iPads or Android tablets. Although we see the

soft SIM threat as overstated in most European

markets, in Italy, given the history of traditionally

low or no subsidies, a vendor like Apple would

take a lower risk by taking the soft SIM route.

Investment thesis

We expect domestic mobile to continue its

underperformance in Q4 2010 (results due on 24

February 2011) with double-digit service revenue

decline. Increasingly tough competition in fixed

line is a source of concern and may put additional

pressure on the Q4 results. However, Brazil

should outperform and dividend growth should

resume. We are Underweight Telecom Italia with

a target price of EUR1.05.

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Financials & valuation: Telecom Italia Underweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e




Cash flow from operations 6,094 6,326 7,596 7,960Capex -4,543 -4,593 -4,751 -4,988Cash flow from investment -5,188 -4,411 -4,751 -4,988Dividends -1,050 -1,033 -1,134 -1,231Change in net debt -90 -2,020 -1,712 -1,741FCF equity 2,535 2,417 3,725 3,369




Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue -7.3 2.1 8.1 0.8EBITDA 0.2 2.5 7.3 -0.5Operating profit 1.1 8.4 11.7 4.5PBT -4.7 48.5 16.9 9.0HSBC EPS 12.4 4.9 -6.0 9.3

Ratios (%)





Year to 12/2009a 12/2010e 12/2011e 12/2012e

Domestic business 21,663 20,073 19,494 19,213Brazilian mobile 4,753 6,181 6,824 7,223TI Media 230 246 251 256Olivetti 350 377 377 377Others/Elimination -102 585 2,748 2,857Group Revenues 26,894 27,462 29,695 29,927

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information

Share price (EUR) 1.05 Target price (EUR) 1.05 Potent'l return (%) -0.1

Reuters (Equity) TLIT.MI Bloomberg (Equity) TIT IMMarket cap (USDm) 26,218 Market cap (EURm) 19,347Free float (%) 81 Enterprise value (EURm) 53344Country Italy Sector Diversified TelecomsAnalyst Luigi Minerva Contact 44 20 7991 6928

Price relative

0

0.5

1

1.5

2

2.5

2009 2010 2011 2012

0

0.5

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2

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Telecom Italia Rel to BCI ALL-SHARE INDEX


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Telefonica (Overweight, TP EUR22) Fixed line connectivity

The economic recession and the consequent

slowdown of the broadband market have led

Telefonica to shelve its NGA plans announced in

October 2007 (aim of achieving 25% FTTH

coverage). Now TEF targets a more focused VDSL

in those areas where cable operator ONO is already

present with a DOCSIS3.0 offer.

The regulatory environment remains benign in Spain

and this is likely to benefit Telefonica. First, national

regulator CMT in October 2008 said that Telefonica

would have to share its infrastructure as well as

provide a wholesale service – but only up to speeds

of 30Mbps. Clearly, if this regulation were

implemented, TEF would have an upper edge in

competition considering that most of the fibre

products would have speed greater than 30Mbps.

Second, the CMT has indicated that in-building fibre

should be shared, but the terms should be established

by commercial negotiations (based on “reasonable

requests”).

On the net neutrality side, we believe that in Europe

the regulators (both at the EC and national level) are

likely to adopt a pragmatic approach that is unlikely

to hurt operators. CMT has stated that traffic

prioritisation could be allowed as long as it does not

have a negative impact on competition.

Mobile connectivity

TEF has good 3G coverage of +90% in Europe and

has proactively invested in HSDPA and currently

has almost 80% coverage. TEF has faced some

network outrage due to the exponential data traffic

growth. For instance, O2 UK has faced some well-

publicised strains to its network in London and

Bristol. TEF has consequently deployed additional

3G cell sites in major towns and cities, has moved to

tiered data plans, has been conducting LTE trials in

all of its key markets, promoting WiFi usage and has

been deploying selective femtocells.

Telefonica has already departed from unsustainable

‘all-you-can-eat’ tariffs by introducing tiering

pricing. O2 UK is offering a maximum monthly

allowance of 1GB and customers exceeding this are

required to purchase an additional allowance, at

GBP5 for 500MB and GBP10 for 1GB. In Spain,

TEF has introduced a milder form of tiering plans. A

data package of 1GB is 2.5x more expensive than a

data package of 100MB; however, customers

exceeding their data limit would see the download

speed reduced significantly to 128Kbps.


Telefonica launched its IPTV service in Spain under

the brand name Imagenio in 2004 and has now 773k

customers with 18% market share of the pay-TV

market. Telefonica’s current IPTV offer is based on

ADSL2+, which provides limited options. Despite

the relatively early launch; Spain has an IPTV

household penetration of only 5% (as of Q3 2010).

Mobile applications

Telefonica is one of the key promoters of the

Wholesale Application Community (WAC)

initiative, which in our view comes as too little, too

late given the strong position that Apple and Google

have built in this space. In February 2011,

Telefonica announced a new multi-platform service

(to be launched by Q3 2011 in among others Brazil,

Mexico, Spain, UK and Germany) that allows

customers to use applications on mobile, tablets,

netbooks, and set-top-box TV.

Investment thesis

Telefonica offers a strong combination of value

(with growing DPS visibility until 2012 and a

very attractive 2010e yield of 7.6%) and growth

(thanks to LatAm exposure and a strong mobile

performance in the UK, which should offset a

slower than we expected recovery in Spain.

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Financials & valuation: Telefonica Overweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e




Cash flow from operations 15,897 16,325 16,240 17,542Capex -7,592 -8,208 -9,053 -9,589Cash flow from investment -8,770 -15,009 -10,559 -9,589Dividends -4,557 -5,877 -6,326 -7,074Change in net debt 778 12,236 2,449 -879FCF equity 8,873 11,871 8,550 8,689




Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue -2.1 8.3 6.4 1.9EBITDA -1.4 18.4 -9.0 2.8Operating profit -1.6 28.1 -18.8 7.1PBT -4.8 42.8 -24.5 7.9HSBC EPS -3.9 16.7 -0.1 7.5

Ratios (%)





Year to 12/2009a 12/2010e 12/2011e 12/2012e

Spain 19,432 18,775 18,539 18,368LatAm 22,984 26,336 30,357 31,715O2 13,532 15,320 15,327 15,219Others 783 994 1,118 1,273Group revenues 56,731 61,425 65,342 66,575TEF FCF definition 9,098 7,283 7,984 8,750

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information


Reuters (Equity) TEF.MC Bloomberg (Equity) TEF SMMarket cap (USDm) 113,341 Market cap (EURm) 83,635Free float (%) 100 Enterprise value (EURm) 148181Country Spain Sector Diversified TelecomsAnalyst Luigi Minerva Contact 44 20 7991 6928

Price relative

12131415161718192021

2009 2010 2011 2012

12131415161718192021

Telefonica Rel to MADRID SE


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Telekom Austria (Neutral, TP EUR11) Fixed line connectivity

Telekom Austria’s update on its NGA strategy at its

capital markets day on 17 December 2010 is

encouraging. At the end of December 2010 the

company’s VDSL/ Fibre to the Exchange network

reached 38% of households, and it plans to have

45% of Austrian households by the end of 2011.

Additionally, 5% of homes will be covered with

either FTTB/FTTC or FTTH by end of 2011. While

TA has long been the laggard in Europe in terms of

NGA roll-out, the new management team seems to

be much more aware of the fixed line opportunity;

the fibre to the exchange technology combined with

relatively short local loop length should allow TA a

relatively cheap and fast NGA roll-out and TA’s

guidance of fixed access line growth is both

exceptional in Europe and encouraging.

Mobile connectivity

The Austrian market remains highly competitive in

mobile broadband and the migration from fixed to

mobile broadband has been quite high. Telekom

Austria has been continually upgrading its mobile

network, and now more than 1,000 base stations

have been connected via fibre backbone. The

company is also adopting dual cell roll-out, where in

a second carrier per cell is installed. 25% of base

stations were dual-cell by the end of 2010. Telekom

Austria also became the first Austrian mobile

operator to launch LTE services and has already

upgraded 50 base stations.

The Austrian market has largely moved away

from all-you-can-use offers. Telekom Austria,

T-mobile and Orange all offer data packages with

download caps, except Three Austria, which

continues to offer flat fee packages albeit at a

higher monthly commitment.

There is no active discussion about net neutrality

in Austria at the moment, which we generally

consider a positive for the incumbent.

Historically, the Austrian regulator has closely

followed EU recommendations, which appear

much more relaxed on the issue than the US. We

therefore consider this aspect as neutral to slightly

positive for TA.


Telekom Austria offers IPTV service with 90-plus

channels. It had 134,000 subscribers at the end of Q3

2010. It also offers 1,000 video-on-demand films

and series.

Mobile applications

Telekom Austria is a member of the Open Mobile

alliance and Wholesale Applications Community but

to date little tangible results have come out of this

initiative.

Investment thesis

Recent improvements in fixed-line trends and the

progress in NGA roll-out have been encouraging, in

our view, but we believe it is too early to call an

economic recovery in the CEE markets (37% of

group EBITDA). The company has set a floor of

EUR0.76 dividend per share over 2011-12, which

translates into a yield of 7% currently. During the

capital markets day in December 2010, the company

revised its payout ratio to 55% of free cash flow

from 65% of net income earlier and increased its

leverage target from 1.8-2.0x to 2.0-2.5x also

flagging general interest in inorganic expansion

within its region.

We have a Neutral rating on the stock with a target

price of EUR11 (increased from EUR10; we have

raised slightly our revenue and EBITDA estimates to

reflect stabilisation in fixed-line losses and

stabilisation in CEE. Our target-price revision

reflects the positive revision to our estimates and

rolling forward of our valuation to year-end 2011.

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Financials & valuation: Telekom Austria Neutral Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e


Revenue 4,802 4,618 4,570 4,600EBITDA 1,794 1,641 1,586 1,598Depreciation & amortisation -1,450 -1,068 -1,016 -949Operating profit/EBIT 344 573 569 649Net interest -220 -205 -223 -226PBT 106 365 346 424HSBC PBT 530 408 346 424Taxation -11 -82 -87 -106Net profit 95 283 260 318HSBC net profit 398 307 260 318


Cash flow from operations 1,385 1,355 1,279 1,244Capex -711 -699 -784 -770Cash flow from investment -930 -728 -784 -835Dividends -332 -332 -332 -336Change in net debt -378 -81 -163 -72FCF equity 667 557 488 474


Intangible fixed assets 3,393 3,185 3,069 2,979Tangible fixed assets 2,675 2,501 2,385 2,296Current assets 2,024 1,522 1,574 1,340Cash & others 1,122 622 676 431Total assets 8,499 7,836 7,656 7,309Operating liabilities 1,178 1,484 1,489 1,479Gross debt 4,736 4,155 4,047 3,729Net debt 3,615 3,534 3,371 3,298Shareholders funds 1,611 1,209 1,132 1,113Invested capital 5,793 5,102 4,863 4,706


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue -7.1 -3.8 -1.0 0.7EBITDA 38.5 -8.5 -3.4 0.8Operating profit 153.8 66.6 -0.6 14.1PBT 243.5 -5.2 22.4HSBC EPS -9.1 -23.0 -15.3 22.4

Ratios (%)





Year to 12/2009a 12/2010e 12/2011e 12/2012e

TA Revenues (EURm) 4,802 4,618 4,570 4,600TA EBITDA Adj.(EURm) 1,794 1,680 1,586 1,598TA EBIT Adj.(EURm) 696 611 569 649TA Net Income Adj.(EURm) 358 307 260 318TA FCF Definition (EURm) 674 655 495 474

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information


Reuters (Equity) TELA.VI Bloomberg (Equity) TKA AVMarket cap (USDm) 6,316 Market cap (EURm) 4,660Free float (%) 73 Enterprise value (EURm) 8273Country Austria Sector Diversified TelecomsAnalyst Dominik Klarmann Contact +49 211 910 2769

Price relative

56789

101112131415

2009 2010 2011 2012

56789101112131415

Telekom Austria Rel to ATX


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Telenor (Overweight, TP NOK111) Fixed line connectivity

Telenor enjoys the advantage of owning the cable

network covering about a third of Norwegian

homes. Its main competition arises from utilities

building fibre networks that are technologically

competitive but typically lack scale and knowhow

in increasingly complex multi-play telco products.

The Norwegian regulator laid out its position on

net neutrality in consultation with operators in

February 2009. On the issue of traffic

management, the view is that “internet users are

entitled to an internet connection that is free of

discrimination with regard to type of application,

service or content or based on the sender or

receiver address”. However, it does not prohibit

traffic management measures on an operator’s

network if they are intended to ensure the quality

of service for specific applications that require

this, or to deal with situations of temporary

network overload. We believe this could leave the

door open to prioritising data streams of time-

sensitive material, such as voice and video. It

would appear that Norway is at the tougher end of

the spectrum in Europe.

Telenor has some low-profile CDN activities in

Norway competing with independent CDN players.

Mobile connectivity

We see Telenor as well-positioned in its data-plan

structure; the company has introduced speed caps

beyond a usage limit of 5GB per month and in its

offer states that this policy is to ensure good

service to all customers.

Telenor management, during its capital-markets

day presentation held in September 2010,

highlighted that flat-rate data plans are not

sustainable. Telenor is working on a new pricing

structure for individual customer segments by

tiering volumes, speeds and time. In Norway, all

the operators across the various subscription plans

have usage caps, which range from 200MB to

6GB. In Sweden, Telenor maintains unlimited

volume tariffs but rationalises usage by speed

caps rather than volume caps. That has not

harmed the Swedish mobile market, which is

growing in high single digits.


Given its cable and satellite ownership, Telenor

only introduced IPTV in 2010 and it has yet to

gain traction. Overall, including satellite, cable

and IPTV, Telenor enjoys a TV market share of

48%. Video on demand is in its infancy in

Norway, a function of the small size of the market

and potentially the monopolistic market structure.

Mobile applications

Telenor is especially active in financial services

and mobile banking in emerging markets.

Easypais in Pakistan aims for 7m active users and

PKR10bn (USD120m) revenues in 2013. Telenor

is also part of WAC, the Wholesale Application

Community, but so far few tangible results have

come out of this alliance.

Investment thesis

We believe Telenor has an attractive portfolio of

assets that offer some of the best and most

sustainable growth potential among Western

European incumbents. In addition to the exposure

to high-growth, low-penetration emerging

economies, we believe Telenor’s multiple

platform holdings in Norway (mobile, cable,

satellite and DSL) make it well-placed as the

industries converge and limit competitive

pressures. We have an Overweight rating on

Telenor, with a target price of NOK111. Telenor

in our view is an attractive combination of

sustainable growth and a competitive and growing

distribution.

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Financials & valuation: Telenor Overweight Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (NOKm)

Revenue 98,083 100,544 105,789 109,174EBITDA 28,687 30,510 33,580 35,526Depreciation & amortisation -16,349 -16,017 -15,769 -15,158Operating profit/EBIT 12,338 14,493 17,811 20,368Net interest -1,140 -1,077 -1,050 -836PBT 19,960 17,851 22,723 26,487HSBC PBT 15,111 17,851 22,723 26,487Taxation -4,975 -5,058 -5,365 -5,830Net profit 14,332 11,952 16,113 18,988HSBC net profit 9,974 11,952 16,113 18,988

Cash flow summary (NOKm)


Balance sheet summary (NOKm)

Intangible fixed assets 51,479 47,198 43,174 39,808Tangible fixed assets 52,963 53,087 53,481 53,815Current assets 32,209 29,596 43,999 53,951Cash & others 14,552 11,794 25,410 34,854Total assets 172,731 168,012 181,766 192,066Operating liabilities 34,212 34,811 42,154 44,324Gross debt 35,577 28,751 28,751 28,751Net debt 21,025 16,957 3,341 -6,103Shareholders funds 87,867 90,617 97,868 106,413Invested capital 87,887 83,276 73,088 68,395


Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue 0.3 2.5 5.2 3.2EBITDA -7.1 6.4 10.1 5.8Operating profit -7.0 17.5 22.9 14.4PBT 31.5 -10.6 27.3 16.6HSBC EPS -31.2 21.8 36.2 17.8

Ratios (%)

Revenue/IC (x) 1.1 1.2 1.4 1.5ROIC 9.2 12.1 17.4 22.5ROE 12.2 13.4 17.1 18.6ROA 9.6 8.1 10.5 11.6EBITDA margin 29.2 30.3 31.7 32.5Operating profit margin 12.6 14.4 16.8 18.7EBITDA/net interest (x) 25.2 28.3 32.0 42.5Net debt/equity 21.9 17.4 3.2 -5.4Net debt/EBITDA (x) 0.7 0.6 0.1 -0.2CF from operations/net debt 116.0 145.2 834.2

Per share data (NOK)



Year to 12/2010a 12/2011e 12/2012e 12/2013e

Telenor revenue 98,083 100,544 105,789 109,174Telenor EBITDA adjusted 29,262 30,510 33,580 35,526Telenor PBT adjusted 15,111 17,851 22,723 26,487Telenor Net income adjusted 10,475 11,952 16,113 18,988Telenor OCF definition 17,732 18,650 21,441 23,400

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information

Share price (NOK) 91.45 Target price (NOK) 111.00 Potent'l return (%) 21.4

Reuters (Equity) TEL.OL Bloomberg (Equity) TEL NOMarket cap (USDm) 25,924 Market cap (NOKm) 151,614Free float (%) 46 Enterprise value (NOKm) 168311Country Norway Sector Diversified TelecomsAnalyst Dominik Klarmann Contact +49 211 910 2769

Price relative

2535455565758595

105

2009 2010 2011 2012

2535455565758595105

Telenor Rel to OBX INDEX


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TeliaSonera (Neutral, TP SEK58) Fixed line connectivity

In March 2008, TLSN announced it would upgrade

1.5m to 2.0m households, out of 4.4m Swedish

homes and enterprises, with a combination of FTTH

and VDSL technology over a period of five years.

Key competitors are Com Hem, the Swedish cable

operator covering roughly 40% of Swedish homes,

and fibre operator Bredbandbolaget. At the end of

2010, TeliaSonera covered 10% of Swedish homes

with NGA, with a take-up rate of c32%.

Uncertainty about regulation remains. The Swedish

regulator, PTS, has proposed forcing TLSN to

unbundle its fibre-optic broadband access network

and offer a full range of wholesale fibre services to

competitors, including fibre and ducts. PTS is

expected to announce its decision on fibre wholesale

prices sometime in Q2 2011.

Mobile connectivity

We see TeliaSonera’s management as frontrunners

in developing sophisticated pricing plans to monetise

the data growth opportunity. TeliaSonera introduced

tiered data pricing plans in mid 2009.

The Swedish market still has high flat-fee offers.

Telenor, Tele2 and Three provide some of their

plans under flat-fee offers. Telenor, which has about

18% market share, falls under our ‘teenage operator’

definition and could disrupt the market in its quest to

increase share and scale. Encouragingly, even

Telenor’s management recently commented that it

sees flat-rate data tariffs as unsustainable. We would

note that although flat-rate tariffs still exist in

Sweden, mobile revenue is already growing at

healthy high-single-digit rates.

On net neutrality, the current thinking of PTS is that

“Traffic prioritisation does not need to be socio-

economically inefficient as long as it takes place on a

market where there is competition; rather it may

often promote consumer benefits instead. Charging

for better performance or access to desirable content

services is a completely natural phenomenon in a

market subject to competition”. In other words, the

regulator seems to understand that charging for

packet prioritisation is perfectly reasonable. The

regulatory view on net neutrality certainly is more

relaxed at an EU level than it is in the US. But it is

plainly helpful that the national regulator has clear

and sensible views on the subject as well.


TeliaSonera serves about 15% of Swedish homes

with IPTV, including video on demand, competing

against ComHem (cable), ViaSat (satellite),

Tele2Vision (IPTV) and other TV players.

TeliaSonera has about 450,000 IPTV subscribers or

roughly 10% of Swedish homes.

Mobile applications

TeliaSonera’s management is a firm believer in

telecoms’ core strength being connectivity and

providing super-fast broadband rather than in

services and applications. Hence, TeliaSonera is not

part of WAC (Wholesale Application Community)

or OMA (Open Mobile Alliance).

Investment thesis

Our view is that TeliaSonera has been taking the

right steps by investing in mobile and fixed business

infrastructure and its reasonable exposure to

Eurasian markets should help to drive top-line

growth. However, uncertainty over its Russian and

Turkey assets, along with increased M&A risk and

competition expected in Kazakhstan, make us prefer

Telenor. We have a Neutral rating on the stock

with a target price of SEK58. TeliaSonera’s low

debt levels should provide support for competitive

dividend yields.

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Financials & valuation: TeliaSonera Neutral Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (SEKm)


Cash flow summary (SEKm)

Cash flow from operations 27,434 31,767 32,388 33,263Capex -14,934 -14,450 -14,666 -14,574Cash flow from investment -16,476 -14,450 -14,666 -14,574Dividends -10,104 -12,349 -12,828 -13,470Change in net debt -1,726 5,031 -4,894 -5,220FCF equity 14,570 14,634 15,187 15,871

Balance sheet summary (SEKm)



Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue -2.4 -0.5 3.2 1.3EBITDA 7.1 -1.3 3.1 1.4Operating profit 8.8 1.6 4.6 0.4PBT 8.6 2.9 5.3 1.8HSBC EPS 3.7 1.3 7.4 2.1

Ratios (%)


Per share data (SEK)



Year to 12/2010a 12/2011e 12/2012e 12/2013e

TLSN Revenues 106,582 106,041 109,481 110,850TLSN EBITDA adjusted 36,977 37,242 38,409 38,941TLSN PBT adjusted 30,217 30,900 32,499 33,097TLSN Net income adjusted 21,538 21,877 22,980 23,461TLSN FCF definition 12,901 17,331 17,890 18,705

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information

Share price (SEK) 54.50 Target price (SEK) 58.00 Potent'l return (%) 6.4

Reuters (Equity) TLSN.ST Bloomberg (Equity) TLSN SSMarket cap (USDm) 37,772 Market cap (SEKm) 244,730Free float (%) 36 Enterprise value (SEKm) 224545Country Sweden Sector Diversified TelecomsAnalyst Dominik Klarmann Contact +49 211 910 2769

Price relative

28

33

38

43

48

53

58

2009 2010 2011 2012

28

33

38

43

48

53

58

TeliaSonera Rel to OMX


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Telstra (Overweight, TP AUD3.40) Fixed line connectivity

Telstra’s wireline outlook is dominated by the

current negotiations over the National Broadband

Network (NBN). If its deal with the government

and the NBN Co (with a post-tax NPV to Telstra

of AUD11bn) is approved, it will lease its fixed

network assets to the NBN Co, which will become

the sole wholesale supplier of high-speed

broadband to businesses and consumers in

Australia. The government-funded venture aims

to provide high-speed broadband to households

and businesses nationwide (using FTTH and

wireless), with a price tag of up to cAUD43bn.

Our scenario analysis indicates margin

compression over time as a result of Telstra’s

move away from vertical integration, but we

expect it to be able to port many of its existing

client relationships into the new structure.

Mobile connectivity

Telstra results for the half ending December 2010

indicated that its investment in opex (cAUD1bn

this FY) to rebuild market share is paying off. It

added over 1m accounts in the half (a record),

including 917,000 mobile accounts. The company

is benefiting from strong organic demand for

smartphones, in addition to network problems at

no.3 operator Vodafone Hutchison Australia

(VHA). We believe the company is growing

revenue market share as a result.

Telstra is increasing subsidy levels (particularly in

smartphones) to rebuild market share, rather than

cut prices. However, its shift to capped plans

(allowing larger amounts of usage for a specific

‘cap’) is limiting ARPU gains – postpaid handset

ARPU in the half ending Dec 2010 was down

0.9% y-o-y.

Telstra continues to leverage its Next G wireless

network. This has the best coverage in Australia,

but Telstra erred in allowing tariff premiums to

escalate as competitors cut prices in 2009 and

early 2010. It has now revised its tariffs and

allowances, increasing the appeal to users

frustrated by coverage and capacity shortcomings

at VHA. This operator faces a class action as a

result of a series of network problems over the

past year – the result of issues subsequent to the

Vodafone and Three Australia merger, as well as

network overloading.

The basic pricing model for mobile data is a tiered

structure, with Telstra more aggressive than peers

in charging for usage outside these caps.


Telstra’s recent fixed line application strategy has

centred on its T-Hub (VoIP) and T-Box (IPTV)

products – which had 128,000 and 107,000 users at

end December 2010, from launch in early 2010. It is

focused on adding bundled service customers (804k

at end 2010) to reduce customer churn. These are

powered by its Next IP backbone network.

Mobile applications

Telstra’s mobile application strategy remains a

mix: after a period of focusing on vendors such as

HTC for smartphones, it fully embraced the

iPhone 4. It is also working to integrate closer

with Sensis, its advertising business, as more

traffic and activity moves towards mobile.

Investment thesis

Our Overweight rating for Telstra is predicated on

its high dividend yield (c9.6%) and operational

improvement as a result of this year’s “strategic

investment” in EBITDA. We expect Telstra’s

NPV of AUD11bn from the NBN negotiations to

remain secure, and believe its early investment in

the Next G wireless and Next IP wireline

networks has created a durable competitive

advantage relative to its peers.

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Financials & valuation: Telstra Corp Overweight Financial statements

Year to 06/2010a 06/2011e 06/2012e 06/2013e

Profit & loss summary (AUDm)

Revenue 25,029 25,284 25,176 25,120EBITDA 10,847 10,093 10,532 10,584Depreciation & amortisation -4,346 -4,388 -4,232 -4,111Operating profit/EBIT 6,501 5,705 6,300 6,474Net interest -963 -938 -922 -842PBT 5,538 4,767 5,378 5,631HSBC PBT 5,538 4,193 5,378 5,631Taxation -1,598 -1,290 -1,645 -1,721Net profit 3,883 3,441 3,694 3,869HSBC net profit 3,877 2,935 3,765 3,942

Cash flow summary (AUDm)

Cash flow from operations 8,629 6,801 8,158 8,069Capex -3,595 -3,762 -3,450 -3,507Cash flow from investment -3,466 -3,643 -3,450 -3,507Dividends -3,474 -3,484 -3,484 -3,519Change in net debt -2,820 28 -1,224 -1,043FCF equity 5,434 4,186 4,352 4,486

Balance sheet summary (AUDm)



Year to 06/2010a 06/2011e 06/2012e 06/2013e

Y-o-y % change

Revenue -2.0 1.0 -0.4 -0.2EBITDA -0.1 -6.9 4.3 0.5Operating profit 0.5 -12.2 10.4 2.8PBT -0.6 -13.9 12.8 4.7HSBC EPS 0.1 -24.3 28.3 4.7

Ratios (%)


Per share data (AUD)


Valuation data

Year to 06/2010a 06/2011e 06/2012e 06/2013e



Issuer information

Share price (AUD) 2.91 Target price (AUD) 3.40 Potent'l return (%) 16.8

Reuters (Equity) TLS.AX Bloomberg (Equity) TLS AUMarket cap (USDm) 36,284 Market cap (AUDm) 36,209Free float (%) 50 Enterprise value (AUDm) 50007Country Australia Sector Diversified TelecomsAnalyst Neale Anderson Contact +852 2996 6716

Price relative

11.5

22.5

33.5

44.5

55.5

2009 2010 2011 2012

11.522.533.544.555.5

Telstra Corp Rel to AUSTRALIAN ALL ORDINARIES


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TIM Participações (Overweight, TP BRL7.50) Fixed line connectivity

TIM Participações is effectively a mobile pure-play,

having relatively little revenue exposure to fixed line

via its 2009 acquisition of Brazilian long-distance

altnet Intelig. Unbundling is not a major problem for

fixed-line players in Brazil as most local access

competition is facilities-based (although players like

fibre-based altnet GVT and dominant cable player

NET Serviços offer enough competition for the

incumbents, we would argue). Neither is net

neutrality a hot issue for the Brazilian regulator

Anatel at the moment it seems, generating little

public comment on the matter thus far.

Mobile connectivity

Although smartphone penetration in Brazil is low –

excluding QWERTY devices like the BlackBerry,

we estimate penetration of true smartphones is in the

low single digits – we expect it to rise steadily in

coming years, driven by continued steep price

erosion of Android-based smartphones, primarily

produced by Asian vendors. TIM has thus far not

fully exploited the mobile data opportunity in Brazil

we would argue, having instead focused up to this

point mainly on voice services. This is changing

though as the firm re-vamped its data offering in H2

and placed greater emphasis on selling smartphones

in the fourth quarter, we believe. Data as a

percentage of mobile service revenues is in the low-

teens we estimate, which compares with more than

20% at data leader Vivo, highlighting the potential

growth upside.

Given relatively low levels of data traffic on its

network, TIM has not experienced capacity issues,

and continues to invest primarily in increasing its 3G

footprint, which is now around 60% of the urban

population. Although the data pricing environment

in Brazil is less aggressive than the voice market,

TIM is offering some of the more competitive tariffs

in the market at the moment, including a BRL0.50

per day flat rate for a 300kbps service (but crucially

with bandwidth throttled to a maximum of 50kbps

after a threshold of 10MB per day or 300MB per

month has been reached). Unlike Vivo and America

Movil’s Claro unit, which focus primarily on the

corporate and high-end consumer segments of the

mobile data market, TIM is focused firmly on the

large, but lower-income C-class (c60% of Brazil’s

population), targeting users who typically require

only email, instant messaging and social networking

rather than video or other high-bandwidth services.

We believe that lacking the massive capital

resources of its rivals (which are controlled by the

two dominant Latin American telecoms groups,

America Movil and Telefonica), it is sensible for

TIM to pursue a differentiated strategy rather than

try to compete head-to-head.


With no local access wireline presence TIM does not

have plans to enter the pay-TV market.

Mobile applications

TIM lacks the scale of regional giants America

Movil and Telefonica. As we do not expect these

players to stand much chance of securing a more

central role in the applications value chain, we see

even less chance for TIM. Note that unlike the

revenue share model for the Apple App Store

(whereby operators generally receive nothing),

Google’s Android Market often has provisions for

revenue shares with operators (with Google instead

taking little or no revenue itself).

Investment thesis

We rate TIM Participações Overweight. Following

the fixed-mobile merger of America Movil and

Telmex Internacional and the pending fixed-mobile

merger of Vivo and Telesp (the Sao Paulo wireline

incumbent), we believe TIM is the clearest way to

play the mobile data scarcity theme in Latin

America.

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Financials & valuation: TIM Participações Overweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e

Profit & loss summary (BRLm)

Revenue 13,744 14,404 15,907 16,836EBITDA 3,469 4,164 4,668 5,032Depreciation & amortisation -2,693 -2,701 -2,765 -2,882Operating profit/EBIT 776 1,464 1,903 2,150Net interest 253 -258 -174 -117PBT 1,030 1,205 1,729 2,033HSBC PBT 1,094 1,205 1,729 2,033Taxation -6 -255 -415 -488Net profit 1,024 951 1,314 1,545HSBC net profit 710 795 1,141 1,342

Cash flow summary (BRLm)

Cash flow from operations 2,331 3,400 4,075 4,402Capex -2,690 -2,935 -2,964 -3,620Cash flow from investment -2,690 -2,935 -2,964 -3,620Dividends 0 -201 -225 -409Change in net debt -394 -279 -886 -374FCF equity 1,015 712 1,110 783

Balance sheet summary (BRLm)

Intangible fixed assets 4,494 3,930 2,977 2,251Tangible fixed assets 5,323 5,866 7,018 8,482Current assets 6,767 5,621 6,538 7,005Cash & others 2,559 1,404 2,290 2,664Total assets 17,450 16,402 17,519 18,723Operating liabilities 4,320 3,307 3,519 3,931Gross debt 4,160 2,726 2,726 2,726Net debt 1,601 1,322 436 62Shareholders funds 8,323 8,678 9,583 10,376Invested capital 9,705 10,705 10,725 11,144


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change


Ratios (%)


Per share data (BRL)



Year to 12/2009a 12/2010e 12/2011e 12/2012e

Subscribers 41,102 51,028 56,066 59,899ARPU 27 24 22 22Service revenues 12,806 13,652 15,117 16,098Handset revenue 938 752 789 739Total revenues 13,744 14,404 15,907 16,836

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information

Share price (BRL) 6.02 Target price (BRL) 7.50 Potent'l return (%) 24.6

Reuters (Equity) TCSL4.SA Bloomberg (Equity) TCSL4 BZMarket cap (USDm) 9,568 Market cap (BRLm) 15,983Free float (%) 30 Enterprise value (BRLm) 17,305Country Brazil Sector Wireless TelecomsAnalyst Richard Dineen Contact 1 212 525 6707

Price relative

1

2

3

4

5

6

7

8

2009 2010 2011 2012

1

2

3

4

5

6

7

8

TIM Participacoes Rel to BOVESPA INDEX


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TPSA (Underweight, TP PLN15.3) Fixed line connectivity

TPSA has an ADSL-based network to provide

high-speed broadband. In 2009, it entered into an

agreement with the regulator that requires TPSA

to provide high-speed broadband to 1.2m lines,

which will need an investment of cPLN3bn over

three years. That has helped to ease the regulatory

pressure somewhat. We expect the regulator to

intervene less as the network improvement

continues. However, convergence with European

regulations may increase net neutrality threat.

Polish subscribers spend relatively little on

broadband. TPSA is working to increase its

market share using triple-play services. In 2010, it

reduced fixed-line broadband pricing, through

which it intends to re-engage with the core

market. TPSA also continues to roll out TV

services to its broadband subscribers.

Competing offerings, however, are strong in

Poland, mainly from cable operators, which are

upgrading their networks to DOCSIS3.0. Overall,

we consider TPSA vulnerable to the cable threat.

Mobile connectivity

In Poland, tariffs are data tiered. Some packages

are marketed as unlimited, but in fact are

capacity-limited. There is no all-you-can-eat data

plan currently, which gives pricing power to the

mobile operators. However, new entrants like P4

look to undercut the larger operators on pricing,

thereby providing tough competition.

TPSA’s mobile broadband subscribers make up

less than 4% of its mobile subscribers, which

seems to reflect weaker demand for broadband

services and increased competition in mobile data

from P4. Non-voice revenue has not increased

significantly over the past two years, remaining

around 24% of revenue for TPSA. We believe

pricing power may change significantly if data

pricing becomes irrational, like the reductions in

voice tariffs after MTR cuts in 2009.


IPTV is considered an add-on in Poland, with

users reluctant to pay unless real premium content

is provided. In October 2010, TPSA signed a 10-

year content agreement with TVN group to cross-

sell each other’s services, with a special focus on

multi-play bundles. TPSA’s own portal,

Wirtualna Polska, is one of the most frequently

visited websites in Poland. TPSA is also trying to

leverage its subsidiaries to venture into adjacent

sectors like payment and e-commerce.

Competing offerings on content are strong. UPC has

had experience providing media content in CE3 with

cable since the late 1990s. It is plausible that certain

OTT competitors may challenge IPTV services and

well-established brands in the pay-TV market.

Mobile applications

TPSA has no substantial advantage over global

players in content and data applications, despite

its familiarity with the local culture. We expect

low-cost smartphones based on the Android

platform to drive internet usage in Poland.

However, language may present a barrier to

would-be developed-world competitors, so TPSA

may not be completely dis-intermediated from the

applications layer.

Investment thesis

TPSA is trading at the top end of its five-year PE

band of 10x to 16x. We believe TPSA does not

warrant a premium over its CE3 peers, because of

the uncertainties involving DPTG claims. If the

recent claim by DPTG is taken into account, it

could almost halve EPS for 2011. Furthermore, its

dividend yield offers a much smaller spread over

the sovereign bond yield compared with

TelefonicaO2 CZ.

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Financials & valuation: TPSA Underweight Financial statements

Year to 12/2009a 12/2010e 12/2011e 12/2012e

Profit & loss summary (PLNm)

Revenue 16,560 15,631 15,375 15,095EBITDA 6,280 4,742 5,786 5,712Depreciation & amortisation -4,183 -3,801 -3,564 -3,364Operating profit/EBIT 2,097 941 2,222 2,348Net interest -363 -389 -327 -336PBT 1,598 508 1,895 2,012HSBC PBT 1,823 1,639 1,895 2,012Taxation -315 -321 -379 -402Net profit 1,281 184 1,514 1,608HSBC net profit 1,456 1,309 1,514 1,608

Cash flow summary (PLNm)

Cash flow from operations 5,541 4,720 5,070 4,931Capex -2,207 -2,516 -2,760 -2,717Cash flow from investment -2,281 -2,632 -2,760 -2,717Dividends -2,004 -2,004 -2,003 -2,003Change in net debt -1,268 -229 -307 -211FCF equity 3,337 1,508 2,299 2,191

Balance sheet summary (PLNm)

Intangible fixed assets 7,298 7,236 7,236 7,236Tangible fixed assets 17,743 16,456 15,652 15,005Current assets 4,189 3,610 3,902 4,057Cash & others 2,218 1,539 1,846 2,057Total assets 29,365 27,416 26,903 26,411Operating liabilities -4,756 -7,505 -7,480 -7,381Gross debt 6,499 5,591 5,591 5,591Net debt 4,281 4,052 3,745 3,534Shareholders funds 16,539 12,694 12,205 11,809Invested capital 31,768 33,268 32,424 31,622


Year to 12/2009a 12/2010e 12/2011e 12/2012e

Y-o-y % change

Revenue -8.8 -5.6 -1.6 -1.8EBITDA -16.5 -24.5 22.0 -1.3Operating profit -36.7 -55.1 136.1 5.7PBT -38.4 -68.2 273.5 6.2HSBC EPS -33.1 -10.1 15.7 6.2

Ratios (%)


Per share data (PLN)



Year to 12/2009a 12/2010e 12/2011e 12/2012e

Reported revenue (PLNm) 16,560 15,631 15,375 15,095Reported EBITDA (PLNm) 6,280 4,742 5,786 5,712Reported EBIT (PLNm) 1,961 896 2,222 2,348Reported PBT (PLNm) 1,598 508 1,895 2,012Reported EPS (PLN) 0.96 0.14 1.13 1.20

Valuation data

Year to 12/2009a 12/2010e 12/2011e 12/2012e



Issuer information

Share price (PLN) 16.57 Target price (PLN) 15.30 Potent'l return (%) -7.7

Reuters (Equity) TPSA.WA Bloomberg (Equity) TPS PWMarket cap (USDm) 7,657 Market cap (PLNm) 22,132Free float (%) 50 Enterprise value (PLNm) 26086Country Poland Sector Diversified TelecomsAnalyst Herve Drouet Contact 44 20 7991 6827

Price relative

8101214161820222426

2009 2010 2011 2012

8101214161820222426

TPSA Rel to WIG 20

Source: HSBC Note: price at close of 11 Feb 2011 Stated accounts as of 31 Dec 2005 are IFRS compliant

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Turk Telekom (Underweight, TP TRY6.80) Fixed line connectivity

Broadband is the growth driver for the Turkish

telecom market, but fixed broadband growth in

Turkey is hampered by low PC penetration.

Subscriber growth will be hard to come by in the

near future, and we are sceptical about the short-term

growth potential of fixed broadband. We believe it

will be constrained by the small gap between PC

penetration and broadband penetration (households

with PC but no broadband), as well as Turkcell’s

aggressive promotion of 3G.

Average revenue per line (ARPL) is increasing,

however, mainly owing to the company’s focus on

up-selling/upgrading services to existing clients.

With more than 70% of its users already subscribed

to its highest-speed package (up to 8Mbps), and

more than 50% using unlimited packages, the scope

for further increase in ARPL looks quite limited.

We believe that Turk Telekom’s attempt to increase

prices for unlimited packages in 2011 and impose

fair usage quotas could adversely affect its

subscriber and ARPL growth in the near term.

Furthermore, the nominal price increase would not

translate into pricing power, in real terms, owing to

the c7% inflation in Turkey in 2011 forecast by

HSBC economists. Positives for Turk Telekom

include the absence of regulations on net neutrality,

and the fact that local loop unbundling remains

unattractive for altnets.

Mobile connectivity

3G services, heavily promoted by Turkcell, are

driving broadband growth in Turkey. Tariffs in

Turkey are data tiered and there is currently no “all

you can eat” data plan, which gives mobile operators

the pricing power. Turkcell has recently launched

competitive tariff plans in the post-paid segment,

while Vodafone Turkey is increasingly pushing

wireless data with increased 3G coverage. We

believe pricing power may diminish significantly if

data pricing becomes irrational – similar to the

competition seen in the voice segment post

introduction of mobile number portability in

November 2008.


It is plausible that certain OTT competitors could

pose a threat to the established brands in the pay-TV

market in Turkey. However, factors such as the

complexities of rights arrangements, the power of

existing brands and the absence of net neutrality

regulations could give incumbents significant pricing

power and advantages.

Mobile applications

Mobile operators in Turkey – particularly Turkcell –

have focused on capturing the applications layer.

Even Avea (TurkTelekom mobile subsidiary) has

attempted to develop innovative applications aimed

at certain segments. We expect Turkish mobile

operators to keep their edge over the global players

on data content as they have the advantage of being

familiar with the local culture. We expect low-cost

smartphones based on the Android platform to drive

internet usage. However, language may present a

barrier to would-be developed world competitors. As

a result, Avea may not be completely

disintermediated from the applications layer.

Investment thesis

We forecast 2011 pro forma revenue growth of 4.8%

and an EBITDA margin of 45.3%. HSBC

economists expect 7% inflation in Turkey in 2011,

implying a revenue decline, in real terms, for Turk

Telekom. In our view, wage inflation could be a

serious threat to its EBITDA margin as personnel

costs still account for c20% of its fixed-line revenue.

There is also not much scope for a significant

reduction in the employee headcount. It is trading at

a premium to its peer group, which we believe is

unwarranted. Its dividend yield implies a negative

spread to the country’s long-term bond yield.

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Financials & valuation: Turk Telekom Underweight Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e

Profit & loss summary (TRYm)


Cash flow summary (TRYm)

Cash flow from operations 3,844 4,266 4,630 4,677Capex -1,733 -1,998 -1,931 -1,951Cash flow from investment -1,523 -1,998 -2,949 -1,951Dividends -1,590 -2,244 -2,459 -2,780Change in net debt -382 -24 778 55FCF equity 2,165 2,289 2,641 2,713

Balance sheet summary (TRYm)

Intangible fixed assets 3,570 3,570 4,071 4,071Tangible fixed assets 7,161 7,539 7,830 8,130Current assets 3,712 2,712 3,466 3,559Cash & others 1,875 847 1,500 1,500Total assets 15,100 14,478 16,023 16,416Operating liabilities -2,957 -3,153 -3,639 -3,828Gross debt 4,164 3,112 4,542 4,597Net debt 2,289 2,265 3,042 3,097Shareholders funds 6,175 6,418 6,564 6,713Invested capital 15,525 16,127 17,505 18,087


Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change


Ratios (%)


Per share data (TRY)



Year to 12/2010a 12/2011e 12/2012e 12/2013e

Mobile penetration (%) 85.6 91.8 97.6 102.9Mobile revenue (TRYm) 2,646 2,958 3,453 3,949Mobile EBITDA (TRYm) 332 629 898 1,058Broadband HH penetration (%) 38.0 40.9 43.6 46.2Fixed line revenue (TRYm) 8,511 8,938 9,091 9,192Fixed line EBITDA (TRYm) 4,507 4,616 4,644 4,649

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information

Share price (TRY) 7.12 Target price (TRY) 6.80 Potent'l return (%) -4.5

Reuters (Equity) TTKOM.IS Bloomberg (Equity) TTKOM TIMarket cap (USDm) 15,702 Market cap (TRYm) 24,920Free float (%) 13 Enterprise value (TRYm) 27545Country Turkey Sector Diversified TelecomsAnalyst Herve Drouet Contact 44 20 7991 6827

Price relative

123456789

2009 2010 2011 2012

123456789

Turk Telekom Rel to ISTANBUL COMP

Source: HSBC Note: price at close of 11 Feb 2011 Stated accounts as of 31 Dec 2006 are IFRS compliant

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Verizon (Overweight, TP USD41) Fixed line connectivity

The FCC’s Triennial Review in 2003 largely

withdrew support for unbundling (known in the US

as UNE-P, Unbundled Network Elements –

Platform) of incumbent local access fibre

investments. This shift almost immediately

prompted Verizon and AT&T to initiate extensive

fibre projects: FiOS and U-verse respectively. Over

the past five years unbundled providers in fibred

areas in the US have all but disappeared.

While unbundling regulation has favoured the

incumbents, the FCC has taken a hard line on net

neutrality. This is understandable given the

strategic importance of US Internet companies

(whose products and services may be exported,

unlike those of the domestically-focused RBOCs).

In a December 2010 decision, the FCC agreed a

new policy that preserves strict net neutrality

principles for fixed-line services while permitting

some “traffic management” on mobile networks.

Mobile connectivity

The US is among the most advanced mobile data

markets in the world. Verizon reports that around

26% of its base currently has a smartphone – a

figure which it expects to double to around 50%

by end-2011, driven primarily by sales of the first

CDMA iPhone4, available since early February.

We expect a significant portion of Verizon’s

existing base to migrate to the iPhone and for it to

gain an increasing share of postpaid net additions

over the next two years as customers on other

networks switch as their contracts expire, attracted

by Verizon’s reputation for superior network

coverage and quality. Until this point Verizon has

not experienced any major network outages as a

result of smartphone demand, although this could

clearly change as smartphone penetration is

expected to double this year.

Verizon Wireless has resisted following AT&T in

moving to tiered data plans and still offers

smartphone customers a single USD30 flat-rate plan,

although it has not ruled out moving to tiers longer-

term. We believe that sticking with unlimited for the

time being is primarily a tactical move designed to

maximise initial sales of the iPhone. Verizon

Wireless generally enjoys stronger pricing power

than rivals, which stems from the broad customer

perception that it leads the market in terms of

network quality. Unlike AT&T, Verizon Wireless

does not currently or plan to use public WiFi as a

means of offloading traffic. However, we expect

Verizon’s attitude here to be flexible, particularly as

the impact of doubling its smartphone base on the

network is unknown at this stage.


Verizon’s FiOS TV competes head-to-head with

cable in areas where FiOS is deployed and

selectively against satellite players, as the firm

also re-sells DirecTV satellite services for

customers outside the FiOS footprint. FiOS TV

has garnered 3.5m customers thus far averaging

28% penetration in areas available for sale.

Mobile applications

Being the home of Apple and Google, the RBOCs

are strongly challenged in the mobile applications

space. Initial attempts by operators to promote the

LIMO Foundation (Linux Mobile) as a more

equitable partnership with application developers

have largely failed, crushed by the momentum of the

Apple App Store and Google’s Android Market. We

see little chance of operators re-gaining lost ground.

Investment thesis

We rate Verizon Overweight and increase our

target price to USD41 (from USD37). The firm is

well-placed to exploit mobile capacity scarcity,

we believe, and we expect particularly strong data

revenue momentum this year driven by the

iPhone.

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Financials & valuation: Verizon Communications Overweight Financial statements

Year to 12/2010a 12/2011e 12/2012e 12/2013e








Year to 12/2010a 12/2011e 12/2012e 12/2013e

Y-o-y % change

Revenue -1.2 3.8 7.0 3.9EBITDA 8.5 9.9 8.8 4.0Operating profit 16.8 18.5 16.2 6.3PBT 24.3 20.1 19.3 9.1HSBC EPS -4.4 0.9 19.1 11.2

Ratios (%)





Year to 12/2010a 12/2011e 12/2012e 12/2013e

Verizon revenues 106,565 110,599 118,385 123,006Verizon EBITDA adjusted 35,911 36,697 39,640 41,235Verizon EBIT adjusted 19,866 20,716 23,692 25,156Verizon PBT adjusted 17,343 18,034 21,185 23,105Verizon EPS adjusted 2.28 2.30 3.05 3.32

Valuation data

Year to 12/2010a 12/2011e 12/2012e 12/2013e



Issuer information


Reuters (Equity) VZ.N Bloomberg (Equity) VZ USMarket cap (USDm) 101,892 Market cap (USDm) 101,892Free float (%) 100 Enterprise value (USDm) 174671Country United States Sector Diversified TelecomsAnalyst Richard Dineen Contact 1 212 525 6707

Price relative

18

23

28

33

38

43

2009 2010 2011 2012

18

23

28

33

38

43

Verizon Communications Rel to S&P 500


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Vodafone (Overweight, TP 230p) Mobile connectivity

Vodafone was one of the first operators globally to

push for more sophisticated data charging structures.

At the company’s Q3 2010/11 results, management

highlighted that tiered data tariffs had now been

introduced in eight of its European markets, and that

the remainder were to follow during the course of

the present quarter. Additionally, the UK network

had undertaken a successful experiment with what it

has termed, ‘smart notification’. This involves

contacting those customers whose data consumption

is approaching the top end of their data cap, and

either offering to sell them an incremental block of

usage or suggesting that they take a plan with a

greater allocation. This approach is shortly to be

extended to the Dutch and German markets, and

then rolled out across the rest of the company’s

European footprint.

However, we also remain of the view that the

tremendous growth in data volumes will require

capex to support. Indeed, it has always been one of

Vodafone’s strengths that it has generally out-

invested its rivals to maintain network quality

leadership. At Vodafone’s interim 2010/11 results in

November, management said that capex was likely

to rise, albeit modestly. We think that it will become

easier to justify the incremental investment to the

markets as the appeal of the data growth story

becomes progressively clearer. Meanwhile, though,

the experience of Vodafone’s Australian JV with

Three exposes the danger of running an

infrastructure inadequate to users’ demands. There is

even talk (see ABC News, 27 December 2010)

about the potential of a class action lawsuit from

disgruntled customers frustrated with the inadequate

coverage and bandwidth. (We should stress at this

point that the operation here is too small a part of the

overall group to undermine our positive stance on

the stock).

Mobile applications

Vodafone has made some efforts in the mobile

applications layer to counter the strides taken by

Apple and Google, but initiatives like its 360

platform and participation in the Wholesale

Application Community (WAC) look – at best –

more like bargaining chips aimed primarily at

keeping the technology giants as co-operative as

possible. Nor does Vodafone (in common with most

other operators) seem to have much enthusiasm for

the GSMA’s RCS initiative. It is therefore difficult

to avoid the conclusion that the applications layer is

moving beyond the company’s reach. Clearly,

though, it is in Vodafone’s interest to ensure that the

smartphone platform arena is as competitive as

possible. This may mean supporting players that

have lagged in this space, such as Nokia/Microsoft

and RIM. We remain of the view that operators’

provision of handset subsidies is actually a strategic

strength, as it makes it hazardous for vendors to

pursue wholesale or soft SIM strategies.

Investment thesis

We believe that Vodafone should be a substantial

beneficiary as capacity constraints bestow pricing

power on the operators. However, much of the

recent appreciation in the share price is simply due to

signs of a more pragmatic approach from

management on the group’s portfolio of assets.

Vodafone’s stake in China Mobile has now been

sold, and funds used to buy back shares. Following

statements from Verizon’s management, a

resumption of the dividend from the US now looks

very likely. In line with the company comments,

there is also the prospect that Vivendi may buy full

ownership of SFR. Potential triggers such as these in

combination with our strategic view relating to

mobile data pricing power underpin our Overweight

stance. We note that consensus revenue forecasts

remain well short of company guidance for growth

of up to 4%.

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Financials & valuation: Vodafone Group Overweight Financial statements

Year to 03/2010a 03/2011e 03/2012e 03/2013e

Profit & loss summary (GBPm)

Revenue 44,472 45,555 46,476 47,648EBITDA 14,735 14,659 14,825 15,168Depreciation & amortisation -9,997 -8,870 -8,118 -8,060Operating profit/EBIT 4,738 5,789 6,707 7,108Net interest -796 138 -929 -944PBT 8,674 13,776 11,531 12,348HSBC PBT 10,564 11,165 11,531 12,348Taxation -56 -1,962 -2,398 -2,632Net profit 8,645 11,858 8,954 9,513HSBC net profit 7,836 8,293 8,341 8,913

Cash flow summary (GBPm)

Cash flow from operations 13,179 12,212 12,483 15,456Capex -4,841 -4,684 -5,391 -5,956Cash flow from investment -9,209 -2,826 -8,391 -5,456Dividends -4,139 -4,476 -4,647 -4,894Change in net debt -1,511 -4,016 490 -5,781FCF equity 9,042 8,176 6,098 5,576

Balance sheet summary (GBPm)



Year to 03/2010a 03/2011e 03/2012e 03/2013e

Y-o-y % change

Revenue 8.4 2.4 2.0 2.5EBITDA 1.7 -0.5 1.1 2.3Operating profit 168.3 22.2 15.9 6.0PBT 107.1 58.8 -16.3 7.1HSBC EPS 2.3 6.5 2.6 6.9

Ratios (%)


Per share data (GBPp)



Year to 03/2010a 03/2011e 03/2012e 03/2013e

Europe 32,833 31,693 31,555 31,871AMAP 11,089 13,331 14,380 15,221Other 550 531 542 555Revenue HSBC 44,472 45,555 46,476 47,648Adjusted operating profit 11,466 12,105 12,460 13,292

Valuation data

Year to 03/2010a 03/2011e 03/2012e 03/2013e



Issuer information

Share price (GBPp) 180 Target price (GBPp) 230 Potent'l return (%) 27.8

Reuters (Equity) VOD.L Bloomberg (Equity) VOD LNMarket cap (USDm) 149,443 Market cap (GBPm) 93,390Free float (%) 100 Enterprise value (GBPm) 85413Country United Kingdom Sector Wireless TelecomsAnalyst Stephen Howard Contact 44 20 7991 6820

Price relative

97107117127137147157167177187

2009 2010 2011 2012

97107117127137147157167177187

Vodafone Group Rel to FTSE ALL-SHARE


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Notes

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Disclosure appendix Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Stephen Howard, Nicolas Cote-Colisson, Richard Dineen, Luigi Minerva, Herve Drouet, Dominik Klarmann, Neale Anderson, Tucker Grinnan, Kunal Bajaj, Luis Hilado and Steve Scruton.

Important disclosures

Stock ratings and basis for financial analysis HSBC believes that investors utilise various disciplines and investment horizons when making investment decisions, which depend largely on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations. Given these differences, HSBC has two principal aims in its equity research: 1) to identify long-term investment opportunities based on particular themes or ideas that may affect the future earnings or cash flows of companies on a 12 month time horizon; and 2) from time to time to identify short-term investment opportunities that are derived from fundamental, quantitative, technical or event-driven techniques on a 0-3 month time horizon and which may differ from our long-term investment rating. HSBC has assigned ratings for its long-term investment opportunities as described below.

This report addresses only the long-term investment opportunities of the companies referred to in the report. As and when HSBC publishes a short-term trading idea the stocks to which these relate are identified on the website at www.hsbcnet.com/research. Details of these short-term investment opportunities can be found under the Reports section of this website.

HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings and other considerations. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations. Investors should carefully read the definitions of the ratings used in each research report. In addition, because research reports contain more complete information concerning the analysts' views, investors should carefully read the entire research report and should not infer its contents from the rating. In any case, ratings should not be used or relied on in isolation as investment advice.

Rating definitions for long-term investment opportunities

Stock ratings HSBC assigns ratings to its stocks in this sector on the following basis:

For each stock we set a required rate of return calculated from the risk free rate for that stock's domestic, or as appropriate, regional market and the relevant equity risk premium established by our strategy team. The price target for a stock represents the value the analyst expects the stock to reach over our performance horizon. The performance horizon is 12 months. For a stock to be classified as Overweight, the implied return must exceed the required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). For a stock to be classified as Underweight, the stock must be expected to underperform its required return by at least 5 percentage points over the next 12 months (or 10 percentage points for a stock classified as Volatile*). Stocks between these bands are classified as Neutral.

Our ratings are re-calibrated against these bands at the time of any 'material change' (initiation of coverage, change of volatility status or change in price target). Notwithstanding this, and although ratings are subject to ongoing management review, expected returns will be permitted to move outside the bands as a result of normal share price fluctuations without necessarily triggering a rating change.

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*A stock will be classified as volatile if its historical volatility has exceeded 40%, if the stock has been listed for less than 12 months (unless it is in an industry or sector where volatility is low) or if the analyst expects significant volatility. However, stocks which we do not consider volatile may in fact also behave in such a way. Historical volatility is defined as the past month's average of the daily 365-day moving average volatilities. In order to avoid misleadingly frequent changes in rating, however, volatility has to move 2.5 percentage points past the 40% benchmark in either direction for a stock's status to change.

Rating distribution for long-term investment opportunities

As of 15 February 2011, the distribution of all ratings published is as follows: Overweight (Buy) 49% (23% of these provided with Investment Banking Services)

Neutral (Hold) 36% (20% of these provided with Investment Banking Services)

Underweight (Sell) 15% (21% of these provided with Investment Banking Services)

HSBC & Analyst disclosures Disclosure checklist

Company Ticker Recent price Price Date Disclosure

AMERICA MOVIL AMX.N 56.44 15-Feb-2011 1, 2, 5, 6, 7, 11AT&T T.N 28.46 15-Feb-2011 7, 11BELGACOM BCOM.BR 27.14 15-Feb-2011 7, 11BRITISH TELECOM BT.L 1.84 15-Feb-2011 2, 4, 6, 7, 11DEUTSCHE TELEKOM DTEGn.DE 9.89 15-Feb-2011 6, 7, 11ERICSSON ERICb.ST 81.55 15-Feb-2011 2, 7, 11ETIHAD ETISALAT (MOBILY) 7020.SE 54.00 15-Feb-2011 2, 5, 7FRANCE TELECOM FTE.PA 16.16 15-Feb-2011 1, 2, 4, 5, 6, 7, 11KPN KPN.AS 11.74 15-Feb-2011 6KT CORP 030200.KS 40750.00 15-Feb-2011 6, 7, 11MOBILE TELESYSTEMS MBT.N 19.90 15-Feb-2011 2, 5, 7, 11MTN GROUP MTNJ.J 127.10 15-Feb-2011 6, 7NTT DOCOMO INC. 9437.T 154200.00 15-Feb-2011 6PORTUGAL TELECOM PTC.LS 8.48 15-Feb-2011 6, 11SAUDI TELECOM COMPANY 7010.SE 40.20 15-Feb-2011 2, 6, 7SPRINT NEXTEL CORP S.N 4.55 15-Feb-2011 6SWISSCOM SCMN.VX 427.90 15-Feb-2011 6, 7TDC TDC.CO 46.25 15-Feb-2011 1, 5, 6, 11TELECOM ITALIA TLIT.MI 1.04 15-Feb-2011 6, 7, 11TELEFONICA TEF.MC 18.28 15-Feb-2011 1, 2, 4, 5, 6, 7, 11TELENOR TEL.OL 91.30 15-Feb-2011 6, 7, 11TELIASONERA TLSN.ST 54.40 15-Feb-2011 6, 11TELSTRA CORP TLS.AX 2.92 15-Feb-2011 1, 2, 5, 7VERIZON COMMUNICATIONS VZ.N 35.90 15-Feb-2011 6, 11VODAFONE GROUP VOD.L 1.80 15-Feb-2011 1, 2, 4, 5, 6, 7, 11

Source: HSBC

1 HSBC* has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next

3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 31 January 2011 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 31 December 2010, this company was a client of HSBC or had during the preceding 12 month period been a client

of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 31 December 2010, this company was a client of HSBC or had during the preceding 12 month period been a client

of and/or paid compensation to HSBC in respect of non-investment banking-securities related services. 7 As of 31 December 2010, this company was a client of HSBC or had during the preceding 12 month period been a client

of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as

detailed below.

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10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below.

11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company

Analysts, economists, and strategists are paid in part by reference to the profitability of HSBC which includes investment banking revenues.

For disclosures in respect of any company mentioned in this report, please see the most recently published report on that company available at www.hsbcnet.com/research.

* HSBC Legal Entities are listed in the Disclaimer below.

Additional disclosures 1 This report is dated as at 16 February 2011. 2 All market data included in this report are dated as at close 14 February 2011, unless otherwise indicated in the report. 3 HSBC has procedures in place to identify and manage any potential conflicts of interest that arise in connection with its

Research business. HSBC's analysts and its other staff who are involved in the preparation and dissemination of Research operate and have a management reporting line independent of HSBC's Investment Banking business. Information Barrier procedures are in place between the Investment Banking and Research businesses to ensure that any confidential and/or price sensitive information is handled in an appropriate manner.

4 As of 31 January 2011, HSBC and/or its affiliates (including the funds, portfolios and investment clubs in securities managed by such entities) either, directly or indirectly, own or are involved in the acquisition, sale or intermediation of, 1% or more of the total capital of the subject companies securities in the market for the following Company(ies): FRANCE TELECOM , BRITISH TELECOM , TELEFONICA , VODAFONE GROUP

5 As of 21 January 2011, HSBC owned a significant interest in the debt securities of the following company(ies): FRANCE TELECOM , TELEFONICA , KT CORP , TELECOM ITALIA , DEUTSCHE TELEKOM

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Disclaimer * Legal entities as at 31 January 2010 'UAE' HSBC Bank Middle East Limited, Dubai; 'HK' The Hongkong and Shanghai Banking Corporation Limited, Hong Kong; 'TW' HSBC Securities (Taiwan) Corporation Limited; 'CA' HSBC Securities (Canada) Inc, Toronto; HSBC Bank, Paris branch; HSBC France; 'DE' HSBC Trinkaus & Burkhardt AG, Dusseldorf; 000 HSBC Bank (RR), Moscow; 'IN' HSBC Securities and Capital Markets (India) Private Limited, Mumbai; 'JP' HSBC Securities (Japan) Limited, Tokyo; 'EG' HSBC Securities Egypt S.A.E., Cairo; 'CN' HSBC Investment Bank Asia Limited, Beijing Representative Office; The Hongkong and Shanghai Banking Corporation Limited, Singapore branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch; The Hongkong and Shanghai Banking Corporation Limited, Seoul Branch; HSBC Securities (South Africa) (Pty) Ltd, Johannesburg; 'GR' HSBC Pantelakis Securities S.A., Athens; HSBC Bank plc, London, Madrid, Milan, Stockholm, Tel Aviv, 'US' HSBC Securities (USA) Inc, New York; HSBC Yatirim Menkul Degerler A.S., Istanbul; HSBC México, S.A., Institución de Banca Múltiple, Grupo Financiero HSBC, HSBC Bank Brasil S.A. - Banco Múltiplo, HSBC Bank Australia Limited, HSBC Bank Argentina S.A., HSBC Saudi Arabia Limited., The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch.

Issuer of report HSBC Bank plc 8 Canada Square London, E14 5HQ, United Kingdom Telephone: +44 20 7991 8888 Fax: +44 20 7992 4880 Website: www.research.hsbc.com

In the UK this document has been issued and approved by HSBC Bank plc (“HSBC”) for the information of its Clients (as defined in the Rules of FSA) and those of its affiliates only. It is not intended for Retail Clients in the UK. If this research is received by a customer of an affiliate of HSBC, its provision to the recipient is subject to the terms of business in place between the recipient and such affiliate. HSBC Securities (USA) Inc. accepts responsibility for the content of this research report prepared by its non-US foreign affiliate. All U.S. persons receiving and/or accessing this report and wishing to effect transactions in any security discussed herein should do so with HSBC Securities (USA) Inc. in the United States and not with its non-US foreign affiliate, the issuer of this report. In Singapore, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Singapore Branch for the general information of institutional investors or other persons specified in Sections 274 and 304 of the Securities and Futures Act (Chapter 289) (“SFA”) and accredited investors and other persons in accordance with the conditions specified in Sections 275 and 305 of the SFA. This publication is not a prospectus as defined in the SFA. It may not be further distributed in whole or in part for any purpose. The Hongkong and Shanghai Banking Corporation Limited Singapore Branch is regulated by the Monetary Authority of Singapore. Recipients in Singapore should contact a "Hongkong and Shanghai Banking Corporation Limited, Singapore Branch" representative in respect of any matters arising from, or in connection with this report. In Australia, this publication has been distributed by The Hongkong and Shanghai Banking Corporation Limited (ABN 65 117 925 970, AFSL 301737) for the general information of its “wholesale” customers (as defined in the Corporations Act 2001). Where distributed to retail customers, this research is distributed by HSBC Bank Australia Limited (AFSL No. 232595). These respective entities make no representations that the products or services mentioned in this document are available to persons in Australia or are necessarily suitable for any particular person or appropriate in accordance with local law. No consideration has been given to the particular investment objectives, financial situation or particular needs of any recipient. This publication has been distributed in Japan by HSBC Securities (Japan) Limited. It may not be further distributed, in whole or in part, for any purpose. In Hong Kong, this document has been distributed by The Hongkong and Shanghai Banking Corporation Limited in the conduct of its Hong Kong regulated business for the information of its institutional and professional customers; it is not intended for and should not be distributed to retail customers in Hong Kong. The Hongkong and Shanghai Banking Corporation Limited makes no representations that the products or services mentioned in this document are available to persons in Hong Kong or are necessarily suitable for any particular person or appropriate in accordance with local law. All inquiries by such recipients must be directed to The Hongkong and Shanghai Banking Corporation Limited. In Korea, this publication is distributed by The Hongkong and Shanghai Banking Corporation Limited, Seoul Securities Branch ("HBAP SLS") for the general information of professional investors specified in Article 9 of the Financial Investment Services and Capital Markets Act (“FSCMA”). This publication is not a prospectus as defined in the FSCMA. It may not be further distributed in whole or in part for any purpose. HBAP SLS is regulated by the Financial Services Commission and the Financial Supervisory Service of Korea. This publication is distributed in New Zealand by The Hongkong and Shanghai Banking Corporation Limited, New Zealand Branch. This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. HSBC has based this document on information obtained from sources it believes to be reliable but which it has not independently verified; HSBC makes no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. The opinions contained within the report are based upon publicly available information at the time of publication and are subject to change without notice. Nothing herein excludes or restricts any duty or liability to a customer which HSBC has under the Financial Services and Markets Act 2000 or under the Rules of FSA. A recipient who chooses to deal with any person who is not a representative of HSBC in the UK will not enjoy the protections afforded by the UK regulatory regime. Past performance is not necessarily a guide to future performance. The value of any investment or income may go down as well as up and you may not get back the full amount invested. Where an investment is denominated in a currency other than the local currency of the recipient of the research report, changes in the exchange rates may have an adverse effect on the value, price or income of that investment. In case of investments for which there is no recognised market it may be difficult for investors to sell their investments or to obtain reliable information about its value or the extent of the risk to which it is exposed. HSBC Bank plc is registered in England No 14259, is authorised and regulated by the Financial Services Authority and is a member of the London Stock Exchange. © Copyright. HSBC Bank plc 2011, ALL RIGHTS RESERVED. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, on any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior written permission of HSBC Bank plc. MICA (P) 142/06/2010 and MICA (P) 193/04/2010

290898

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations.

Ab

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The capital intensity of fibre is now improving fixed-line competitive dynamics and pricing conditions

Mobile capacity constraints are starting to make their effect felt, both in terms of capex and better tariffs

European cable operators, mobile players (Vodafone) and some vendors (Ericsson) are best placed

Disclosures and Disclaimer This report must be read with the disclosures and analyst

certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it

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Abundant ScarcityPricing power is returning to telecoms

Global Telecoms, Media & Technology – Equity

February 2011

Main Contributors

Luis A Hilado*Analyst, Global Telecoms, Media & Technology ResearchThe Hongkong and Shanghai Banking Corporation Limited, Singapore+65 6239 [email protected]

Luis Hilado joined HSBC in 2010 from a US investment bank, where he covered the SE Asia telecom sector. He has over 15 years of equity research experience primarily covering SE Asia telecoms. Luis held a number of positions on the sell-side including Head of Research, Philippines for a European stock brokerage. He holds a BA in Economics and a BS in Commerce and BusinessManagement from De La Salle University.

Dominik Klarmann*, CFAAnalyst, Global Telecoms, Media & Technology ResearchHSBC Trinkaus & Burkhardt AG, Dusseldorf+49 211 910 2769 [email protected]

Dominik Klarmann has worked as a telecoms analyst since 2007. He obtained a degree in management at Bamberg and Madrid Universityin 2004. He has been with HSBC since 2007, having previously worked in management consulting and investor relations at Deutsche TelekomAG. Dominik is a CFA charterholder.

Richard DineenAnalyst, Global Telecoms, Media & Technology ResearchHSBC Securities (USA) Inc, New York+1 212 525 [email protected]

Richard joined HSBC in 2004 to work on the Global Telecoms Research team, with a particular emphasis on technology strategy. Prior tothis, he was research director for Mobile Telecoms at Ovum, a highly respected industry analyst firm, where he spent seven years.

Hervé Drouet*Analyst, Global Telecoms, Media & Technology ResearchHSBC Bank plc+44 20 7991 [email protected]

Hervé has been covering GEMs/CEEMEA Telecoms research for more than 9 years and has been ranked highly and regularly acrossnumerous external surveys. Prior to this, he worked as a senior management consultant in the TMT practice at Deloitte Consulting. He has15 years experience in the Media, Telecoms and Technology sectors, having worked previously as a project manager for SchlumbergerTechnologies. He holds a Full time MBA from London Business School and graduated from Ecole Supérieure d'Ingénieurs enElectrotechnique et Electronique in France.

Tucker Grinnan*Analyst, Global Telecoms, Media & Technology ResearchThe Hongkong and Shanghai Banking Corporation Limited, Hong Kong+852 2822 [email protected]

Tucker joined HSBC in November 2005 and has 15 years of experience as an analyst in the telecommunications, media and technologyindustries. Prior to joining HSBC, he spent five years as a head of regional telecoms for Asia and Latin America. Tucker also spent five yearswith a management consulting firm servicing clients in telecommunications and media. He holds degrees from the University of Virginiaand George Washington University.

Neale Anderson*Analyst, Global Telecoms, Media & Technology ResearchThe Hongkong and Shanghai Banking Corporation Limited, Hong Kong+852 2996 [email protected]

Neale Anderson joined HSBC in March 2007. Previously he spent seven years at the specialist consultancy Ovum, where he was ResearchDirector for Asia-Pacific telecommunications markets. He holds a BA from Oxford University and an MA in Advanced Japanese Studiesfrom Sheffield University.

Nicolas Cote-Colisson*Head of European Telecoms, Media & Technology ResearchHSBC Bank plc+44 20 7991 [email protected]

Nicolas joined HSBC in 2000 as a telecoms analyst in the Global Telecoms research team. Prior to that, he worked as an economist with CCFin Paris for five years and also with the French Ministry of Finance. Nicolas holds a DEA in Econometrics from Paris la Sorbonne.

Kunal Bajaj*Analyst, Global Telecoms, Media & Technology ResearchHSBC Bank Middle East Limited, Dubai+9714 507 [email protected]

Kunal joined HSBC in 2005. Before covering Middle Eastern telecoms, he was a member of HSBC’s EMEA telcos team, working on Eastern European and South African telecoms companies. Kunal is a Chartered Accountant and has an MBA in Finance.

Stephen Howard*Head, Global Telecoms, Media & Technology ResearchHSBC Bank plc+44 20 7991 [email protected]

Stephen Howard is Head of the Global Telecoms, Media & Technology Research team. He has covered the telecoms sector since joiningHSBC in 1996. He also brings experience in the technology industry, having worked previously with IBM.

Luigi Minerva*Analyst, Global Telecoms, Media & Technology ResearchHSBC Bank plc+44 20 7991 [email protected]

Luigi joined HSBC in 2005 as a telecoms analyst in the Global Telecoms Research team. Before this, he was a buy-side analyst at a fundmanager, having previously worked in the Telecoms Practice of McKinsey & Co based in Milan. Luigi holds a Masters in Finance from theLondon Business School and an M.Sc. in Economics and Econometrics from the University of Southampton.

Steve Scruton*Head of Equity Research, CEEMEAHSBC Bank plc+44 20 7992 [email protected]

Steve Scruton is the Head of Equity Research, CEEMEA. He has been with HSBC since 1997, and was previously the co-head of Global TMTin London and Head of Research, Bangalore, a team that provides support to Global Research across countries, sectors, products andservices. Prior to joining HSBC, Steve worked with British Petroleum, Cable & Wireless and a banking house in London.

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