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March 2012

Telecom Operators
Let's face it

Core telco revenues the decline is here to stay: -1.8% p.a. until 2015e
Over-the-top services: a major threat for mobile but an opportunity for fixed-line
Diversification into adjacent markets can add significant revenues, but not enough to
stabilise the top-line
Big opportunities to transform costs
Mega-operator, local hero or infrastructure play: different telcos will make different
strategic choices

Telecom Operators

Contacts

Exane BNP Paribas

Antoine Pradayrol
antoine.pradayrol@exanebnpparibas.com
Exane BNP Paribas, London: +44 207 039 9489

ARTHUR D. LITTLE

Didier Levy
levy.didier@adlittle.com
Arthur D. Little, Paris: +33 1 55 74 29 62

www.exanebnpparibas-equities.com
Please refer to important disclosures
at the end of this report.

Telecom Operators

Executive Summary
This 11th edition of the joint annual report by Exane BNP Paribas-Arthur D. Little
focuses on the consequences of the move to all IP for European telecom operators. Is
the opportunity linked to innovative services larger than the risk to legacy revenues?
What are the key strategic choices available to telcos across Europe? In preparing the
report, we have met with 105 organisations in the telecom-media-technology arena and
beyond, across 15 countries.
All in all, we see core telco revenues continuing to decline by 1.8% p.a. until 2015e.
The move to all-IP enables anyone to propose IP-based services over any network.
This is the over the top (OTT) concept.
In fixed-line, OTT TV is more an opportunity for telcos than a threat an opportunity
to gain market share in TV and to accelerate super-fast broadband adoption.
In mobile, OTT is a direct threat to legacy voice and SMS revenues. SMS can be
displaced rapidly by independent and embedded messaging applications. Operators
are taking defensive steps, but the downside risk remains significant.
In an all-IP world, everything will be connected. This creates opportunities for telcos
in adjacent markets such as automotive, energy and utilities, financial services, etc. We
estimate potential revenues at 4-9% of large telcos revenues by 2015e, significant but
not enough to reverse the overall negative trend.
In this context of prolonged revenue pressure, telcos must accelerate their cost
transformation. We identify large cost saving opportunities both in opex (online-centric
business model) and in capex (network consolidation/sharing).
Operators will increasingly make different strategic choices: 1) mega-operators,
competing (and collaborating) with OTT providers which will require both scale and a
range of new capabilities likely to lead large incumbents to make acquisitions;
2) local heroes, with limited geographic footprint and a presence in some vertical
businesses; 3) infrastructure plays, focusing on the network while developing a range
of partner agreements in services and distribution.
Figure 1: Contributions to the sector growth core telco revenues
6%
5%
4%
3%
2%
1%
0%
(1%)
(2%)
(3%)
(4%)
(5%)
(6%)
(7%)
2010
MTR

Mobile data

2011

2012e

Voice & text

Source: Arthur D. Little, Exane BNP Paribas estimates

2013e
Fixed telephony

2014e
Fixed broadband

2015e
Pay-TV

Telecom Operators

Lets face it, the decline in core telco revenues is here to stay
We expect core revenues from European telecom services to continue decreasing until
2015e, by 1.8% per year on average, including a CAGR of -2.4% in mobile and -3.4%
in fixed-line, partially offset by +5.8% in pay-TV.
The expectation of a decline is consensual among industry participants, but even
though we expect strong growth in mobile data (the single most important growth driver
in the sector), our overall forecast is more bearish than consensus.
In a nutshell, we expect the 2011 trend (-2%) to continue in the coming years, for three
key reasons: 1) the risk of cannibalisation of voice and text revenues has significantly
increased, with over-the-top services developing fast; 2) in fixed-line, broadband and
pay-TV are far from being big enough to offset the decline in traditional telephony;
3) the tough economic context is here to stay, with a direct impact on usage and
indirect impacts on competition and consumer behaviour.
For incumbents in their domestic markets, we model core revenues down 3.6% p.a.,
given their higher than average exposure to fixed telephony, despite our expectations
of improving broadband market share and increasing pay-TV market shares.
The largest uncertainty in the sector is mobile data monetisation: even a small tweak to
our 2015e assumptions regarding traffic per smartphone and revenue per GByte could
lead the whole sector to return to growth. On the other hand, stronger cannibalisation of
voice and text could lead to an even faster decline (-3.8% CAGR).
However, our analysis of mobile operators return on capital employed shows that a
return to growth is too optimistic, as it would imply operators increasing their returns
despite the tough environment (economy, competition, regulation, network capex)
while the bear case would imply returns of challenger mobile operators falling
significantly below their cost of capital, hence driving massive consolidation.

OTT: risks in mobile larger than opportunities in TV


The over the top concept is well know for TV but actually it applies to all telecom
services, including mobile.
As smartphone adoption increases, new applications enable users to save on their bills
by using mobile voice over IP instead of traditional voice, and messaging instead of
traditional SMS. This risk is not new but it is accelerating, as: 1) smartphone
penetration has grown strongly; 2) WhatsApp is one of the three most downloaded paid
iPhone applications in nine European countries; 3) Google, Microsoft, Apple, etc. all
have an interest in upping their game in communication services and the growing
integration of hardware and software gives them more firepower.
In a bear case scenario, our 2015e mobile revenue estimate which is already 9%
lower than the 2011e figure would be cut by another 8%.
In terms of fixed-line, over-the-top TV offers are evolving very quickly, for both
hardware and services all made possible by ever faster broadband. Viewing habits
are changing fast, with a massive generational effect. From the perspective of
incumbent pay-TV providers, OTT TV is a threat but from telcos perspective, OTT TV
is in our view a positive, on balance: 1) telcos have limited exposure to downside in the
traditional pay-TV market; 2) for them, playing the OTT game is an opportunity to
differentiate from established pay-TV players; 3) OTT TV should have a positive impact
on fixed broadband, pushing towards faster speeds, provided that operators are able to
link speeds with higher ARPU.

Telecom Operators

To make the best of this new world and avoid cannibalisation, the most effective moves
expected from telcos are: 1) price bundling which we think can basically halve the risk of
cannibalisation of mobile operators legacy revenues; 2) tiered pricing, in mobile but also in
fixed to make sure that revenues increase in line with traffic growth; 3) leveraging the
box, in fixed-line; and 4) developing wholesale revenues from OTT providers, although this
is difficult to quantify except for Content Delivery Network (CDN) activity.

Diversification opportunities: working hard for the long term


When not only everyone, but also everything is connected, surely telcos should benefit.
How big is the internet of things opportunity overall? How can telcos best position
themselves? Will this new world restore growth to the sector?
Thanks to IP technology, a multiplicity of devices will be connected, beyond mobile
phones, computers and tablets: cars and other moving objects, utility meters
(electricity, gas, water), but also other home appliances or vending machines, as well
as medical devices. Mobile phones will become electronic wallets (m-payment). Finally,
the increasing power of IT infrastructure, combined with broadband everywhere, is a
key driver for remote provision of IT services this is the cloud opportunity.
Each of these device types relates to specific vertical markets; e.g. automotive, energy
and utilities, healthcare, financial services, etc. Each of these is a large market in itself
compared to the telecom market, and each can benefit from the smartisation of devices,
which can bring cost savings as well as enable innovative services to customers.
Most of these are very long term opportunities and opinions on the probability of
telcos success are divided. We estimate the total potential for incumbent telcos to be
4-9% of their revenues by 2015e significant but not enough to reverse the revenue
pressure elsewhere.
The largest operators are already positioning themselves and we believe that payment,
cloud services, moving objects (including connected cars and fleet telematics) and building
surveillance and automation are all interesting areas to explore. Nevertheless, if they are to
capitalise on these opportunities, operators will need to be more proactive about extending
their value chain positions, potentially by acquiring early movers in the market.
Figure 2: Revenue opportunities from diversification into verticals
Total telco revenues, EURbn in 2015e, believers case
CDN, 1.2

Cloud, 2.0

Outlook for incumbents revenues


110

Building
automation,
0.8
Smart
metering, 0.5

100

90

Vending
machines &
payment
terminals, 0.4

3
3

7
3

43

43

43

39

39

2011

2015e - Sceptics

2015e - Believers

EURbn

80

Others, 0.5

70

53

60
50

m-payment,
1.4

40

Connected
cars, 1.7

Fleet and
freight
telematics,
2.0

30
20

Mobile

Source: Arthur D. Little, Exane BNP Paribas estimates

Fixed-line

Pay-TV

Verticals

Telecom Operators

Increasingly divergent strategic routes and no silver bullet


Telcos have different visions of the industrys outlook (more or less negative), different
views on key assets to leverage (the infrastructure or the customer), but also very
different starting positions (leaders versus challengers, local versus global).
Figure 3: Three potential strategic choices for telcos

Geographic footprint

Ambition in the value chain

Local

Infrastructure

Services

Infrastructure play

Local hero

Mega-operator

Global

Source: Arthur D. Little, Exane BNP Paribas estimates

It is therefore no surprise that they consider a wide range of strategies, with varying
levels of emphasis on the retail side (this is the bit pipe versus full service operator
debate) and varying ambitions in terms of geographic footprint (with most European
telcos focused on one or a few countries, but a handful looking at a global footprint).
Combining these two axes, we find three key strategic routes: 1) the mega-operator;
2) the local hero, i.e. the full service telco focused on a limited geographic footprint; and
3) the local infrastructure play. We believe that:
The mega-operator approach can in theory create the most value in the long term,
but is the most difficult to execute (need for capital and multi-faceted competitive
challenges), so the most risky. In any case only a handful of European telcos can play;
The local hero could lead to a slightly better top-line than the infrastructure play,
but it comes with additional opex and capex in the next few years along with execution
risks. Due to its focus on one or a few countries, competitive structure in its home
market will have a material impact on its success;
The infrastructure play is the least risky but also brings the lowest returns in the
long term. In any case, it cannot be implemented by operators lacking opex flexibility
due to the requirement to be the low cost producer.

Telecom Operators

Accelerating the pace of change


We look at the key prerequisites for telcos to succeed:
1) leaner cost base, with notably a large opportunity from the online transformation of
the business model, which we estimate could reduce a typical integrated operators
total opex by 9% by 2015e;
2) strong infrastructure. This requires continued capex notably on FTTx and 4G
hence local scale will matter more and more. Different types of network consolidation
can enable typical mobile operators to save 10-30% of network costs (opex+capex) in
the coming years.
Combining these two transformation opportunities could theoretically enable an
operator with revenues declining by 2.4% p.a. until 2015e (in line with our industry
scenario) to limit the decline in its EBITDA and OpFCF to less than -3% p.a., versus an
OpFCF CAGR of -12% in a theoretical scenario with flat opex and capex.
Figure 4: Potential opex and capex transformation to alleviate revenue pressure
28
24
2
20
EURbn

6
16
12

24

14

4
0
2011

EBITDA-Capex

2015e

Online centric savings

Network consolidation savings

Source: Arthur D. Little, Exane BNP Paribas estimates

Importance of global stature


Finally, we conclude that global scale will become more significant in the long run, both
in terms of cost (global purchasing, global pooling of IT infrastructure) and as a
commercial differentiator (in a few market segments).
Since each operator has room to optimise its strategic footprint and pressures on the
top-line will not ease quickly, we predict a flurry of M&A: at the local level (fixed-fixed,
mobile-mobile, fixed-mobile), vertical (acquisition of incremental capabilities to serve
adjacent markets), but also cross-border (most probably small moves rather than big
jumps, even though large deals cannot be entirely ruled out in the medium term).

Telecom Operators

Contributors
Arthur D. Little

Exane BNP Paribas

Team
Didier Levy

Antoine Pradayrol

Author

Richard Swinford

Laurent Barbezieux

Angel Lam

Arnaud Schoenmakers

Karim Taga

Other contributors

Telecom Operators team

Austria: Karim Taga, Andreas Tiefengraber,

Mathieu Robilliard

Clemens Schwaiger, Nicolai Schttgen, Lars


Riegel

Michael Williams

Belgium: Ignacio Garcia Alves, Jean Fisch,


Gregory Pankert

Michael Zorko
Maxime Rey
William Beavington, marketing analyst

Central Europe : Marcel Hominda, Michal


Sladek, Radek Swoboda, Stipe Maric

France: Ignacio Garcia Alves, Franck Herbaux,


Bertrand Grau, Paul Desjonqures
Germany: Klaus von den Hoff, Hans-Peter Erl,
Michael Opitz, Ansgar Schlautmann, Christian
Niegel, Simon Best, Carsten Kahner

Italy: Giancarlo Agresti, Andrea Faggiano,


Vincenzo Basile
Japan: Shinichi Akayama
Netherlands: Martijn Eikelenboom
Spain: Jess Portal, Carlos Abad, David
Borras, Pedro Ugarte, Pedro Fernandez
Sweden/Finland: Erik Almqvist, Bjorn
Thunstrom, Martin Glaumann, Michael Arnr,
Niklas Sondell, Agron Lasku

Switzerland: Klaus von den Hoff, Uli Prommer


UK: Stuart Keeping, Richard Swinford

Telecom Operators

Acknowledgments
We want to thank everyone from outside Exane BNP Paribas and Arthur D. Little who
contributed to this project. We would particularly like to thank all those that we
interviewed at the companies listed below, including fixed, mobile, cable and satellite
operators, internet companies and software developers, media groups, equipment
manufacturers and regulators.

Telecom operators / Cable / Satellite


1&1, Abertis Telecom, A1 Telekom Austria, Base, Belgacom, Bouygues Telecom, BT,
BT Germany, Colt, Deutsche Telekom, Easynet, ecotel, e-plus, Everything Everywhere,
GTS Novera, H3G, Halebop, Iliad Free, Invitel, KBW, KCOM Group, KDG, KPN, Mnet,
Mobistar, Numricable, O2 UK, O2 Czech Republic, ONO, Orange Business Services,
Orange Austria, Orange Slovakia, Orange Spain, SFR, Swisscom, TalkTalk, TDF,
Tele2, Telecom Italia, Telecom Italia Wholesale, Telefnica, Telefnica Germany,
Telenet, TeliaSonera, T-Mobile Austria, T-Mobile Czech Republic, UPC Austria, UPC
Netherlands, Versatel, Vipnet, Virgin Media Business, Virgin Mobile, Vodafone Czech
Republic, Vodafone Germany, Vodafone Spain, Wind

Equipment, infrastructure and IT


Alcatel-Lucent, Alcatel-Lucent Spain, Arqiva, Cisco, Ericsson Germany, Ericsson
Sweden, Ericsson UK, InterXion, Logica, Nokia Siemens Networks Austria, Nokia
Siemens Networks Germany, Qualcomm, Reggefiber

Media, software, internet and vertical sectors


Agfa Healthcare, BBVA, BMW, Canal+, Cegeka, Corporacin Cooperativa Mondragn,
Endesa, Google, Iberdola, Mediaset, Microsoft, MSD (Merck), Pages Jaunes, Sky,
Sogecable, Vivendi, Wien Energie, undisclosed retail bank

Regulators and others


AGCOM, CMT, ETNO, GSMA, RTR, Swedish Post and Telecom Authority, vatm

Telecom Operators

Contents

Core revenue decline is here to stay __________________________ 9


A decade of no revenue growth __________________________________________ 9
Core market scenario: -1.8% p.a. until 2015 _______________________________ 15
Sensitivity analysis: mobile data the largest uncertainty_______________________ 28
Mobile ROCE sanity check _____________________________________________ 31

Towards an all-IP world: risks larger than opportunities? _________ 33


OTT risk on mobile voice and text: coming of age ___________________________ 34
Content OTT: more opportunity than risk, for most __________________________ 40
Key tactics to avoid the bear case _______________________________________ 50

Diversification: work hardfor the long term ___________________ 60


m-payment, NFC About to take off _____________________________________ 67
Smart metering/grid Hundreds of millions of devices _______________________ 72
Smart home Room for automation and assistance _________________________ 76
Fleet and freight management Further growth ahead _______________________ 80
Connected cars Telcos search for traction _______________________________ 81
e-Health, m-Health Fitter in the long term ________________________________ 85
Cloud Attractive but substantial investment needed ________________________ 89

Increasingly diverging routes and no silver bullet ______________ 95


The prerequisites: strong infrastructure and lean opex _______________________ 96
Local scale is more and more important ___________________________________ 99
Global scale: growing benefits, in the long term ____________________________ 105
Increasingly diverging strategies Anybody wins? _________________________ 107
Outcome: a flurry of deals?____________________________________________ 112

Arthur D. Little presentation _______________________________ 115


Exane presentation _____________________________________ 115

Telecom Operators

ICore revenue decline is here to stay


We expect core revenues from European telecom services to continue decreasing until
2015e, by 1.8% per year on average, including a CAGR of -2.4% in mobile and -3.4%
in fixed-line, partially offset by +5.8% in pay-TV.
Expectation of a decline is consensual among industry participants but even though we
expect strong growth in mobile data, the single most important growth driver in the
sector, our overall forecast is more bearish than average. Indeed, we expect the 2011
trend (-2%) to continue in the coming years, for three key reasons: 1) the risk of
cannibalisation of voice and text revenues has increased; 2) in fixed-line, broadband
and pay-TV are still far from big enough to offset the decline in traditional telephony;
3) the tough economic context is here to stay, with direct and indirect impacts.
For incumbents in their domestic markets, we model core revenues down 3.6% p.a.,
due to higher exposure to fixed telephony and despite their opportunity to gain market
share in pay-TV.
The largest uncertainty in the sector is mobile data monetisation: assuming 2015e data
traffic per smartphone of 2.5GBytes/month instead of 1.9GB in our core scenario, and
average revenue per GB of EUR7 versus EUR6 in our core scenario, would enable the
whole sector to return to growth (+0.8% CAGR). On the other hand, stronger
cannibalisation of voice and text could lead to an even faster decline (-3.8% CAGR).
However, our analysis of mobile operators return on capital employed shows that the
bull case is too optimistic as it would imply operators increasing their returns despite
the tough environment (economy, competition, regulation, network capex) conversely
our bear case is probably too negative as it would see challengers ROCE significantly
below their cost of capital, thereby driving massive consolidation in our view (ultimately
this would prove positive in terms of market structure).

A decade of no revenue growth


Telecom spending in Europe has remained stable as a percentage of consumer
expenditure since 2002, at around 2.8%.
Figure 5: Telco spending stable as a % of consumer spending since 2003
4.0%

8%

3.5%

7%

3.0%

6%

2.5%

5%

2.0%

4%

1.5%

3%

1.0%

2%

0.5%

1%

0.0%

0%

(0.5%)

(1%)

(1.0%)

(2%)

(1.5%)

(3%)
1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010
% of consumer spending - LHS

Source: Euromonitor, Arthur D. Little, Exane BNP Paribas estimates

Telecom spending, yoy - RHS

Telecom Operators

This apparent stability has masked 1) divergent trends in different sub-sectors, with
good growth in mobile until 2008, offset by a progressive decline in fixed-line; and
2) strong volume growth, in mobile but also in broadband, offset by significant pricing
pressures driven by competition and regulation.

Mobile: strong usage growth continues


With mobile SIM card penetration having surpassed 100% since 2005 in Western
Europe, customer growth has slowed to 2% per year since 2009. However volume
growth has continued in European mobile in terms of: 1) voice traffic (+4% in 2011),
2) SMS usage, although this is now declining in some markets, and 3) data, driven now
primarily by smartphone adoption.
We estimate that at the end of 2011, smartphone penetration in Europe stood just
above 28% of mobile customers (corresponding to up to 38% of the population, given
the 133% mobile penetration of the population), up from 20% in 2010 and 14% in 2009.
The European countries with the highest smartphone penetration are the Netherlands,
the UK and the Nordics (penetration >33% as a percentage of mobile customers), but
the US remains more advanced (46% of customers at AT&T and Verizon Wireless).
Figure 6: Smartphone penetration has doubled in the last two years
Smartphone penetration in Europe

Smartphone penetration by country (% of mobile users)

40%

50%
38%

45%

35%

35%

40%
31%

30%
28%

30%

26%

25%

35%

25%

22%
21%

20%

20%

19%
17%

15%

15%

10%
10%

5%
0%

5%

BE PT DE

Q4 09 Q1 10 Q2 10 Q3 10 Q4 10 Q1 11 Q2 11 Q3 11 Q4 11
% of mobile customers

% of population

Q4 10

IT

SP

FI

FR DK NO UK SE NL US
Q4 11

Source: Arthur D. Little, Exane BNP Paribas estimates

Smartphone penetration has continued to grow by 2 percentage points (of the mobile
customer base) per quarter throughout 2011, despite the economic crisis in Europe.
The majority of handsets sold in Europe are now smartphones (figures publicly quoted
by operators vary between 30% and 90% in regards to Q4 11; for reference, this stood
at 70-80% at Verizon Wireless and AT&T in Q4).
The growth in mobile data traffic has slowed, to an estimated 35% yoy, but this is
largely because of traffic generated by dongles, which had represented up to 90% of
total data traffic in 2009-2010 depending on the countries and which is now declining
for several operators (notably Vodafone and Mobistar).
Data traffic from smartphones is growing by more than 100% yoy, a result of growth in
the smartphone base (almost +50% yoy in Q4 11) combined with growth in the average
traffic per smartphone.

10

Telecom Operators

Traffic per smartphone currently stands in a range of 200-400MByte per month in


Europe but the newest/most advanced smartphones, such as the iPhone4S,
generate much higher traffic (>700MByte/month), due to the faster speeds of the
hardware, the wider range of applications and the richer content (e.g. video).
Figure 7: Mobile data traffic growth
TeliaSonera
Bouygues Telecom
O2 Europe
O2 Germany
Vodafone Europe
Mobistar

Q4 10

Q1 11

Q2 11

Q3 11

Q4 11

57%
15%

85%
65%
48%
34%
-

79%
21%
-

69%
19%
-

57%
57%
46%
32%
20%
15%

Source: Company reports, Arthur D. Little, Exane BNP Paribas estimates

but the decline in voice revenues largely outpaces the growth in data
Despite this continued strong growth in mobile usage, European mobile service
revenues have been declining by 1.8% per year over 2008-2011, ending the period on
a very negative note: -4.2% yoy estimated in Q4 11.
The chart on the left hand side of Figure 8 below shows the contributions of voice, data
and SMS to the sectors top-line trend, reflecting the massive negative impact of the
decline in voice revenues, compared to the positive contribution of data. Mobile
revenues represented EUR25.2/month per capita in 2011, including:
EUR14.6 from outgoing voice, down 7% yoy despite the 4% yoy growth in traffic
pointing to a yoy decline in the average price per outgoing minute of more than 10%;
EUR2.0 from incoming voice, estimated down more than 25% yoy given the steep
cuts in mobile termination rates (see below);
EUR4.2 from SMS: SMS revenues still grew in the first nine months of the year but
stalled in Q4, according to our estimates although the picture varies significantly
between markets and operators;
EUR4.4 from data, with data revenues up 23% in the year, a relatively steady pace
of growth despite the base effect.
Figure 8: European mobile service revenue trends
Voice, SMS and data contributions

Data revenue, yoy growth


40%

6%

35%
3%
30%
0%

25%
20%

(3%)

15%
(6%)
10%
(9%)
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
Q4 10
Q1 11
Q2 11
Q3 11
Q4 11

5%

SMS

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
Q4 10
Q1 11
Q2 11
Q3 11
Q4 11

Voice

0%

Non-SMS data

Source: Arthur D. Little, Exane BNP Paribas estimates

11

Telecom Operators

Figure 9: Mobile voice revenue drivers: volumes and prices, impact of regulation
Volume versus price

MTR impact
4%

15%
3%
10%

2%
1%

5%

0%
0%

(1%)

(5%)

(2%)
(3%)

(10%)

(4%)
(5%)
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
Q4 10
Q1 11
Q2 11
Q3 11
Q4 11

(15%)

Voice revenues

Traffic

Q1
09

Price

Q2
09

Q3
09

Q4
09

Q1
10

Q2
10

Q3
10

Q4
10

Service revenue growth

Q1
11

Q2
11

Q3
11

Q4
11

Adjusted for MTR

Source: Arthur D. Little, Exane BNP Paribas estimates

The decline in voice revenues is notably driven by regulation, in particular mobile


termination rates (MTR). In 2011, MTRs stood on average at EUR0.041/min, down
31% yoy. This represented an estimated drag of -4% on the European mobile top-line,
i.e. excluding these MTR cuts the sectors revenue would have been flat in Q4 11.
Based on glide paths published by national regulators for the next few years, this
impact will continue in 2012 and 2013, albeit at a slightly milder rate.

Increasing penetration in fixed broadband


On the fixed-line side, growth in broadband has been continuously driven by PC
adoption, more widespread availability of broadband and the development in triple-play
and new TV services: better quality (HD) and more features (e.g. catch-up TV).
Figure 10: Fixed broadband penetration in Europe
Fixed broadband penetration (% of households)

Fixed broadband penetration by market, 2011


(% of households)

75%

100%

70%

90%
80%

65%

70%

60%

60%
55%
50%
50%
40%
45%

30%

40%

20%

35%

10%

30%

0%
2007

2008

2009

2010

NL

2011

Source: Arthur D. Little, Exane BNP Paribas estimates

12

FR

UK

BE

EU

DE

SE

SP

AT

IT

PT

Telecom Operators

At the end of 2011, fixed broadband penetration reached 69% in Western Europe, up
2.9 percentage points over the period, and the number of broadband customers in
Europe was still up almost 5% yoy. The most advanced markets show penetration of
more than 80% while many are still below 70%, so there is still growth potential as the
lower-penetration countries catch up in the coming years.

but total fixed-line revenues are declining


Excluding pay-TV, which is mainly provided by satellite and cable operators, fixed-line
revenues have been declining by 2% per year over 2009-2011, with growth in
broadband revenues (up 4.5% pa.) not offsetting the decline in traditional telephony
(down 7% pa.). On a per household basis, fixed-line (excluding pay-TV) represented an
expenditure of EUR49.6/month in 2011e, of which EUR26.3 is for traditional telephony
(including line rental) and EUR23.3 is for broadband (ARPU is higher on broadband
than on fixed telephony, but penetration of fixed telephony remains higher).
Traditional telephony remains the main negative revenue driver in the sector as
volumes have constantly decreased due to the migration of fixed telephony over the
internet (voice over IP) and increasingly social networking has replaced traditional
voice calls, on the back of broadband adoption. In addition, the transition from
traditional telephony to broadband comes with a more competitive market, i.e.
incumbents have been losing market share to alternative carriers and cable operators
(average incumbent market share on broadband of 42% currently versus 45% in 2007).

Pay-TV a growth market but small compared to telecom services


Pay-TV penetration has also been growing, albeit more slowly than broadband.
Aggregating the total number of subscribers of cable companies, satellite operators and
telcos providing IPTV, we calculate that pay-TV penetration of European households
reached almost 52% at the end of 2011, up 1.5 percentage point yoy.
Figure 11: Pay-TV* penetration in Europe
Pay-TV penetration (% of households)

Pay-TV penetration by market, 2011 (% of households)


100%

54%

90%
52%

80%
70%

50%

60%
48%

50%
40%

46%

30%
20%

44%

10%
42%

0%
2008

2009

2010

NL

2011

BE

FR

PT

DE

UK

EU

SE

SP

IT

* In this chart, we include all customers with pay-TV services, i.e. satellite, cable and IPTV which leads to some double counting, particularly in
markets where IPTV is most advanced such as France, as many IPTV customers also subscribe to a premium pay-TV bouquet (hence are counted
as customers of the satellite operator).
Source: Arthur D. Little, Exane BNP Paribas estimates

13

Telecom Operators

Penetration discrepancies remain large between markets: e.g. Italy and Spain are still
below 25% while the UK, Germany and France are above 50%, and Belgium and the
Netherlands are above 95% (cable markets). Pay-TV penetration in the US is 85%.
These penetration figures reflect different situations in different countries. For instance
pay-TV in Italy mainly reflects the premium pay-TV services offered by Sky Italia, while
in France our pay-TV penetration figure includes not only cable and satellite but also all
broadband customers using IPTV.
Although each market must be analysed on a local basis (e.g. penetration in Germany
is likely to remain below average given the attractiveness of free-to-air satellite TV), we
believe that there is further penetration potential in pay-TV in Europe.
In addition, unlike telecom service revenues, pay-TV revenues have been growing by
an average of almost 5% p.a. over 2009-2011, driven by a 4% CAGR in customer
numbers combined with increasing ARPU. Average spend per household on pay-TV
has reached EUR12.7/month in 2011 (penetration of 52%, ARPU of EUR24.5/month).
Given the rise in triple-play (pushed by telcos and cable operators across Europe, and
in one particular case by a satellite operator, BSkyB in the UK), it makes sense in our
view to aggregate the fixed-line and pay-TV markets (see pages 45-47 for our analysis
on the importance of TV for telcos).
As shown in Figure 12 on the left hand side, the total spend per household on fixed-line
and pay-TV reached EUR62.3/month in 2011, down c1.5% yoy, as the growth in payTV revenues was not sufficient to offset the decline in fixed-line telecom revenues.
Figure 12: Fixed-line, broadband and pay-TV trends
Fixed-line, broadband and pay-TV revenues
70

EUR/month per household

60

Broadband market shares


15.5%

45%

11.7

12.0

12.7

15.0%

44%

50
40

14.5%

21.5

43%

22.5

23.4

14.0%
42%

30

13.5%

20
30.4

41%

28.6

13.0%

26.3

10
40%

12.5%
2007

2009
Fixed telephony

2010
Fixed broadband

2011

2008

Incumbents (lhs)
Cable (rhs)

Pay-TV

Source: Arthur D. Little, Exane BNP Paribas estimates

14

2009

2010

2011

Altnets (lhs)

Telecom Operators

Core market scenario: -1.8% p.a. until 2015


We expect overall revenues of European telecom operators core services to keep
declining in the coming years, by c.2.4% in 2012e and 2013e, by c.1.5% in 2014e and
by c.1% in 2015e hence a CAGR of -1.8%.
The two reasons for the progressive improvement are 1) the end of large MTR cuts in
2014e, and 2) our forecast of persisting growth in mobile data revenue over the whole
period, as detailed below.
Our overall sector forecasts reflect:
on mobile, revenue CAGR of -2.4%, with -13% on voice, -8% on SMS and +23% on
mobile data;
on fixed-line, revenue CAGR of -3.4%, with telephony down 10% per year and
broadband up 3%;
pay-TV revenues CAGR of +5.8%.
Figure 13: Central scenario Estimates for the core services of European telecom operators*
EURbn

2010

2011e

2012e

2013e

2014e

2015e

2011-2015e CAGR

Mobile service revenues


Mobile voice
Interconnect
Outgoing
Mobile data
SMS
New data
Fixed-line revenues
Fixed telephony
Fixed broadband
Pay-TV
Total revenue incl pay-TV

110.8
78.3
11.8
66.6
32.4
17.2
15.2
95.3
53.3
42.0
22.5
228.6

107.1
70.4
8.5
61.9
36.7
17.8
18.9
92.9
49.1
43.7
23.7
223.7

103.8
62.7
5.8
56.9
41.1
17.8
23.3
89.7
44.9
44.8
25.1
218.6

99.8
54.2
3.1
51.1
45.6
16.9
28.7
86.7
40.5
46.2
26.6
213.2

97.9
47.2
2.4
44.9
50.6
15.2
35.4
83.7
36.2
47.6
28.1
209.7

97.1
40.8
2.0
38.8
56.4
12.9
43.4
80.8
31.9
48.9
29.7
207.7

(2.4%)
(12.8%)
(30.1%)
(11.1%)
11.4%
(7.7%)
23.2%
(3.4%)
(10.2%)
2.8%
5.8%
(1.8%)

* Excluding revenues from verticals and including mobile termination rate cuts
Source: Arthur D. Little, Exane BNP Paribas estimates

The industry is cautious, we are even more so


Compared to a few years ago, the consensus regarding the sector outlook among the
companies interviewed has deteriorated significantly.
This year, the overwhelming majority expect revenues to decline between 2011 and
2015: only 20% expect revenues to remain stable over the period, and 9% expect them
to grow (those expecting growth fall into three categories: challengers gaining market
share, operators focusing on a specific sub-segment with better fundamentals, and
operators in specific markets such as the Nordics or Austria, reflecting local conditions).
The weighted average expectation of the 79 interviewees that provided an estimate
stands at -0.8% (2011-2015 CAGR).

15

Telecom Operators

Figure 13: Interview feedback 71% expect the industry revenues to decline
% of respondents split by their expectations for the sectors top-line over the next few years
35%
30%
25%
20%

15%
10%
5%
0%
<-2%

-2% / -1%

-1% / 0%

Flat

1%+

Source: Arthur D. Little, Exane BNP Paribas estimates

Our -1.8% CAGR forecast is more cautious than this industry consensus. The key
drivers of our scenario are: 1) our view that pressure on legacy mobile revenues i.e.
voice and SMS can increase further, driven by regulation, competition but also
cannibalisation by data; 2) our expectation that the fixed market will continue to decline,
with growth drivers such as broadband and pay-TV not big enough to offset the decline
in traditional telephony; and 3) an expectation that the difficult macroeconomic
environment in Europe is here to stay i.e. limited hopes of underlying improvement in
consumer confidence or business trends in the coming years.
As another point of reference, Telecom Italia recently published its 2011-2014 plan
which is based on the groups expectation that the overall Italian telecom services
market (fixed + mobile, excluding pay-TV) would decline by 2.1% pa. over the period.

The tough macro context is here to stay: direct and indirect impacts
The European economy has deteriorated in recent quarters, as the compound effect of
austerity measures (lower spending, higher taxes) increasingly impacts consumer
spending. In the Eurozone, consumer spending declined by 0.8% in Q4 11 and is
expected to decline by 1.2% in Q1 12. Given the long term nature of the ongoing
deleveraging process in Europe, Exane BNP Paribas economists expect the economic
environment to remain difficult not only for a few quarters but for several years. As
shown in the charts below, consumer spending in the Eurozone is expected to decline
by 0.3% in 2012e, and merely to stabilise in 2013e.

16

Telecom Operators

Figure 14: The tough macro-environment is here to stay


GDP and consumer spending growth in the Eurozone

GDP growth in selected European countries

5%

8%

4%

6%

3%
2%

4%

1%

2%

0%
0%

(1%)
(2%)

(2%)

(3%)

(4%)

(4%)
(6%)
SE

2013e

2012e

2010

2011e

2009

2008

2007

2006

2005

2004

2003

2002

2001

2000

1999

1998

1997

1996

(5%)

DE

UK

2010
GDP

* European Union average

NL

EU*

2011e

BE

FR

SP

2012e

IT

PT

2013e

Consumer spending

Source: Exane BNP Paribas Economics Team

We believe that this economic context will have both a direct impact on telecom
revenues, in particular on mobile (lower traffic, in particular less international travel,
consumers more budget-conscious, corporate customers getting tougher at
renegotiations), as well as two types of indirect impact: low-cost challengers should be
more successful than they would have been in a growing economy; and consumers are
likely to optimise their bills, increasing the risk of voice and SMS substitution by data.
1) Direct impact: In 2009, as European GDP dipped from +0.7% in 2008 to -4.1% in
2009, the European mobile service revenue trend (restated for MTR cuts) slowed from
+2.7% to +0.2%. In the following year, as GDP returned to growth (+1.8%), the ex-MTR
service revenue trend returned to +2.1%.
In particular, a weak economic environment has a direct impact on B2B revenues the
area most impacted in 2009. Corporate customers are themselves less active (less
lines and less traffic) and focus on efficiency in all domains, including telecoms. Such
macro-pressures on the sector are likely to continue in the coming years.
Figure 15: European mobile trends have shown they are not immune to the economy
YoY service revenue trends versus GDP

The North vs. South divide (yoy service revenue, ex-MTR)


7%

4%

6%

3%

5%
2%

4%
3%

1%

2%

0%

1%
(1%)

0%

(2%)

(1%)
(2%)

(3%)

(3%)
(4%)

(4%)
Q1
09

(5%)
2008
Service revenue

2009

2010
Ex-MTR

2011

Q2
09

Q3
09

Q4
09

Q1
10

Q2
10

Q3
10

Q4
10

Q1
11

Q2
11

France, UK, Germany, Belgium, Nordics


Italy, Spain, Portugal

GDP

Source: Arthur D. Little, Exane BNP Paribas estimates

17

Q3
11

Q4
11

Telecom Operators

As shown by the right-hand chart above, the difference between Northern and Southern
Europe in terms of mobile service revenue evolution is telling, highlighting how
contrasting macro-economic environments lead to contrasting mobile revenue trends.
2) Competitive impact: As the economic backdrop worsens, customers are getting
more sensitive to price. Spain is a good example of this: since the end of 2008,
Spanish challengers have seized the opportunity with growing success, both on the
fixed broadband side and on the mobile side.
Figure 16: Market share trends in the Spanish fixed broadband and mobile markets
Leading operators market shares

Challengers market shares

62%
82%

12%

26%

11%

25%

10%

24%

60%
80%
58%

23%

9%
78%

22%

8%

56%

21%

7%

20%

76%

54%

6%

72%

50%
48%

18%

4%

17%

3%

16%

2%

70%

15%
Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
08 08 08 08 09 09 09 09 10 10 10 10 11 11 11 11
Telefonica, fixed broadband - Left

19%

5%

74%

52%

Jazztel

Mobile leaders* - Right

Orange + Yoigo - Right

* Mobile leaders: Telefnica and Vodafone


Source: Arthur D. Little, Exane BNP Paribas estimates

The chart above shows that:


between Q4 08 and Q4 11, Telefnicas broadband market share has shrunk from
over 58% to 51% (Telefnica has lost customers in absolute terms since Q2 11), while
Jazztel has more than doubled its share from 4% to almost 10%;
in mobile, the combined market share of Orange and Yoigo went up from 19% to 25%
during the same period, at the expense of mobile leaders Telefnica and Vodafone.
Even though it is early days, the Free Mobile launch in France is also interesting. The
companys aggressive SIM-only offers, combined with the controversial claim that
French customers have been paying too much for their mobile services for years, has
generated a huge buzz effect and massive customer intake.
We expect challengers to continue to benefit from such a favourable backdrop in the
coming years driving continued price pressure and market share redistribution in
telecom markets in Europe.
3) Consumer behaviour impact: Finally, the tough macro-environment can accelerate
shifts in consumer behaviour. The most striking example is that of the Dutch mobile
market, where KPN has suffered from an unprecedented cannibalisation of SMS usage
by data. In Q4 11, the number of SMS per customer was down 19% yoy at KPNs
Consumer division, while the outgoing voice minutes per customer were down 4% yoy
both reversing from growth less than a year ago.

18

Telecom Operators

Figure 17: KPN mobile consumer usage trends


Voice minutes per customer

SMS traffic per customer

120

35%

70

35%

30%

30%
60

25%

115

20%

25%
20%

50

15%

15%

110

40

10%
5%
105

10%
5%

30

0%

0%
20

(5%)
100

(10%)

-5%
-10%

10

-15%

(15%)
95

(20%)

Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
08 08 09 09 09 09 10 10 10 10 11 11 11 11

Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
08 08 09 09 09 09 10 10 10 10 11 11 11 11
MoU per month

-20%

YoY

Outgoing SMS per customer per month

YoY

Source: KPN, Arthur D. Little, Exane BNP Paribas estimates

Where is growth going to come from?


Mobile data is currently the key growth driver in the sector, while fixed-broadband and
pay-TV are also incrementally positive. As shown in Figure 19 below, this is fully
consistent with the industry view. We detail our assumptions for these key growth
drivers in the following pages. The chart below highlights the key role expected from
mobile data as well as the positive contributions also expected from fixed broadband
and pay-TV.
Figure 18: Contributions to sector growth
6%
5%
4%
3%
2%
1%
0%
(1%)
(2%)
(3%)
(4%)
(5%)
(6%)
(7%)
2010
MTR

Mobile data

2011

2012e

Voice & text

2013e
Fixed telephony

2014e
Fixed broadband

2015e
Pay-TV

Source: Arthur D. Little, Exane BNP Paribas estimates

Interviewees have also pointed to other growth drivers for telecom operators much
more emphatically than in previous years in particular: ICT (including cloud services)
and new/adjacent services such as m-payment, and generally machine-to-machine
applications (M2M). This corresponds to the use of wireless technology to enable all
kinds of machines to communicate including cars, utility meters, etc. We focus on
these new growth opportunities in pages 60-94.

19

Telecom Operators

Figure 19: Interview feedback Mobile data to remain the key growth driver
Number of interviewees having quoted different potential growth drivers for telecom operators
Mobile data
Fixed broadband
ICT, B2B, Cloud
New TV services
New/adjacent services
Pay-TV
M2M
mpayment, NFC
CDN
Wholesale
Gaming
0

10

15

20

25

30

35

40

45

50

Source: Arthur D. Little, Exane BNP Paribas estimates

Mobile revenues expected to decline despite strong growth in data


Our estimates point to mobile data revenues more than doubling from EUR4.4/month
per inhabitant in 2011 to EUR10.1/month in 2015e but over the same period, we
model mobile voice revenue per inhabitant falling from EUR16.5 to EUR9.5 (including
the impact of MTR), and SMS revenue dropping from EUR4.2 to EUR3.0. Overall, we
therefore model mobile revenue per inhabitant dropping by 2.7% per year, from
EUR25.2/month in 2011e to EUR22.5 in 2015e.
Figure 20: Forecasts for mobile service revenue per inhabitant in Europe

EUR per month per pop.

30

25

3.6

20

4.1

4.4
5.5
6.7

8.2

4.2
4.2
15

10.1

3.9
3.5

10

3.0

15.7
14.6

13.3

11.9

10.4

9.0

2.8

2.0

1.3

0.7

0.5

0.5

2010

2011

2012e

2013e

2014e

2015e

Mobile termination

Voice outgoing

Source: Arthur D. Little, Exane BNP Paribas estimates

20

SMS

Mobile data

Telecom Operators

There is little doubt that mobile data traffic has a bright future:
smartphone penetration has grown faster than we anticipated in 2010, providing
room to increase long term penetration estimates. We now model 95% population
penetration by 2015e, corresponding to a pace of 14 percentage points per year, only a
mild acceleration compared to the increase observed during 2011 (+12ppt).
the average traffic per smartphone currently stands in the 200-400MByte/month
range, and under our core scenario we estimate this will grow to 1.9GByte/month.
How will this huge usage increase translate at the revenue level for telcos? This is
arguably the largest unknown in the sector.
The growth in data revenues is key not only for the whole sector revenue outlook (the
single biggest contributor in the next five years) but also for its profitability. The growth
in data traffic impacts network capacity requirements hence capex, and operators need
to establish a link between consumption and revenue generation.
Based on the current data revenues and estimated traffic, we calculate that the
average revenue per GByte in the European mobile industry was EUR40-50 in 2011
(versus more than EUR80 in 2010), and under our core scenario we estimate that this
will drop to EUR6 by 2015e i.e. CAGR of -40% until then. We discuss this assumption
in page 53.
This leads to mobile data revenue CAGR of 23% over 2011-2015e, basically in line
with the 24% CAGR observed over 2009-2011. However, we must emphasise that
visibility is very low regarding the balance between the expected growth in traffic and
the expected decline in prices. As discussed below, any small move in either of the
variables can have a massive impact on trends for the whole sector.
Figure 21: Key assumptions on smartphone penetration, usage and revenue

80%
6
70%
5

60%

50%
40%

30%
2
20%
1

10%
0%

GB/month per smartphone

90%

Data traffic (millions of TB/month)

100%
Smartphone penetration (% of pop)

Traffic per smartphone versus price per GByte

90

1.8

80

1.6

70

1.4

60

1.2
50
1.0
40
0.8
30

0.6
0.4

20

0.2

10

0.0

2009 2010 2011 2012e 2013e 2014e 2015e


Smartphones % of pop.

2.0

0
2009

Total traffic

2010

2011 2012e 2013e 2014e 2015e

Traffic per smartphone (GB)

Source: Arthur D. Little, Exane BNP Paribas estimates

21

EUR/GB

EUR per GByte

Smartphone penetration and data traffic growth

Telecom Operators

Regarding voice, our core scenario largely reflects continuity compared to current trends:
we model +1.4% voice traffic CAGR until 2015e, slowing down only modestly
compared to the latest trend (+2.3% in Q4 11). This does not include a large
cannibalisation of traditional mobile voice traffic by mVOIP or by messaging which
represents a risk to our scenario;
we expect the average price per outgoing minute to decrease by 12% per year,
from the current EUR0.09/min to EUR0.05/min by 2015e. This is a sharp decline, but
again in line with the latest trend and the long term level of EUR0.05/min could prove
optimistic, i.e. it has already been reached in many offers across many markets.
On SMS however, we take a more aggressive stance: we expect this revenue stream
to decrease by 8% per year in the period 2011-2015e, an important change of trend
compared to the last few years (SMS revenues were up 3% in 2011). We expect SMS
revenues to be cannibalised over time by messaging applications, both independent
services (such as WhatsApp or equivalent) and smartphone-native applications (such
as RIM Blackberry Messenger, or iMessenger in Apples devices) see details in
page 34. Such cannibalisation has started notably in the Netherlands (see Figure 17).
Figure 22: Core scenario Revenue outlook for mobile voice and SMS
Mobile voice & SMS drivers

Total traffic (million minutes)


Average revenue per min. (EUR)
Voice interconnect (EUR)
Voice outgoing (EUR)
Voice revenue per pop. (EUR/mth)
SMS revenue per pop.
Voice & text per pop.
Voice & text per pop, ex regulation

2010

2011

2012e

2013e

2014e

2015e

2011-2015e CAGR

882,329
0.089
0.059
0.097

919,386
0.077
0.041
0.087

937,774
0.067
0.028
0.078

951,841
0.057
0.015
0.069

961,359
0.049
0.011
0.060

970,973
0.042
0.009
0.052

1.4%
(13.9%)
(31.1%)
(12.3%)

18.5
4.1
22.5
19.8

16.5
4.2
20.7
18.7

14.7
4.2
18.8
17.5

12.7
3.9
16.6
15.9

11.0
3.5
14.5
14.0

9.5
3.0
12.4
12.0

(13.1%)
(8.0%)
(12.0%)
(10.6%)

Source: Arthur D. Little, Exane BNP Paribas estimates

Regulation to remain a significant drag until 2014


2011 was the year with the biggest impact from MTR cuts ever. In 2011, the average
mobile termination rate in Europe stood at EUR0.041/min, down from EUR0.059/min in
2010. We estimate that this corresponded to a drag of 4% on the European mobile topline in the year.
Visibility on MTRs in the coming years is good. They are expected to reach
EUR0.01/min by 2014, in line with European Commission recommendations. On
average, the rate of decline should be slightly milder from 2012e as shown in the
table below but the MTR impact will not stop being significant before 2014e.
Figure 23: Mobile termination rates in Europe*
EURcents per minute

2009

2010

2011

2012e

2013e

2014e

2015e

CAGR 09-15e

France
Netherlands
UK (GBpence)
Italy
Germany
Spain
Portugal
Sweden (SEK)
Denmark DKK
Norway (NOK)
Finland
Belgium
Average big 8
YoY in EURc

5.8
8.3
5.2
8.6
7.1
7.0
6.8
38
57
58
4.9
8.5
7.3
(1.4)

3.9
6.8
4.2
7.4
6.5
5.5
5.3
29
48
50
4.8
6.8
5.9
(1.4)

2.5
3.7
3.3
6.5
3.6
4.5
3.6
23
37
30
4.4
4.3
4.1
(1.8)

1.3
2.6
1.3
4.2
3.4
3.5
2.2
13
28
25
3.7
2.6
2.7
(1.4)

0.8
2.1
0.7
1.3
1.8
2.3
1.3
10
23
15
2.8
1.1
1.4
(1.2)

0.8
1.5
0.7
1.0
1.3
1.1
1.2
10
21
12
2.8
1.0
1.1
(0.4)

0.7
1.0
0.7
1.0
0.8
1.0
1.0
10
19
10
2.2
0.9
0.9
(0.2)

(29%)
(30%)
(28%)
(30%)
(31%)
(27%)
(27%)
(20%)
(17%)
(25%)
(12%)
(31%)
(29%)
(1.1)

* Average over the full year, per country, with MTRs of different operators weighted by market shares.
Source: Arthur D. Little, Exane BNP Paribas estimates

22

Telecom Operators

Further risk on roaming - The European Parliament is pushing for steeper reduction
in retail roaming fees than proposed by the European Commissioner Nelly Kroes in
2011, proposing: EUR0.15/min for voice calls (versus Kroes proposal of EUR0.24),
data capped at EUR0.20/MB (versus EUR0.50) and SMS capped at EUR0.05 (versus
EUR0.10). Under the Parliament's proposal, the caps proposed by Ms. Kroes would
come into force in July 2012, but the steeper cuts would be implemented from 2013.
Discussions are ongoing to reconcile the two sets of proposals.
The Commission is also willing to introduce structural measures to boost competition in
the roaming market, e.g. allowing customers to sign up (from 1 July 2014) for a
cheaper mobile roaming contract, separate from their contract for national mobile
services, whilst using the same phone number.
Roaming rate reductions are therefore likely to end-up being more aggressive than
anticipated. Roaming still represents 5-8% of European mobile operators' revenues and
a slightly greater share of EBITDA. This is a potential additional negative for the sector.

Still growth in broadband


We model broadband revenue growth of 2.8% per year until 2015e, driven by +4.7%
CAGR in customers and -1.8% CAGR in ARPU. We expect broadband penetration to
reach 82% of households by 2015e compared to 69% in 2011 i.e. a continued pace
of penetration of three percentage points per year.
Even though our penetration estimate may look optimistic, we believe that such growth
can be sustained in the coming years because fixed broadband will become
indispensable for more and more households: 1) it is becoming an increasingly popular
way to convey TV/video services see page 40, 2) the explosive growth of connected
devices within homes (smartphones and tablets) will require faster and faster
broadband (most tablets are connected to the internet thanks to fixed broadband
connections, via WiFi, rather than 3G), and 3) an internet connection is becoming
increasingly necessary in the every day life (e-administration, e-commerce, etc.).
We model super-fast broadband penetration growing from 3% of households at the end
of 2011e to 16% in 2015e (i.e. 20% of broadband customers by 2015e), with an
incremental ARPU of EUR10/month i.e. EUR40 versus EUR30 in the long run (NB:
these figures refer to broadband only ARPU, not double-play or triple-play ARPU).
Figure 24: Key drivers of our fixed-broadband and pay-TV revenue estimates
Penetration (% of households)

ARPU (EUR/month)

80%

18%

50

70%

16%

45

14%

60%

12%

50%

40
35
30

10%
25

40%
8%
30%

20

6%

15

4%

10

10%

2%

0%

0%

20%

2009

2010

2011

2009

2012e 2013e 2014e 2015e

Normal broadband

2010

2011

Normal broadband

Pay-TV

Pay-TV

Super-fast bband - RHS

Source: Arthur D. Little, Exane BNP Paribas estimates

23

2012e

2013e

2014e

2015e

Super-fast bband

Telecom Operators

Figure 25: Core scenario Revenue outlook for fixed broadband and pay-TV
Fixed-line drivers

2010

2011e

2012e

2013e

2014e

2015e

2011-2015e CAGR

Fixed telephony rev. per HH


Fixed broadband rev. per HH
Pay-TV rev. per HH

28.6
22.5
12.0

26.3
23.4
12.7

23.9
23.9
13.4

21.5
24.5
14.1

19.1
25.2
14.9

16.8
25.8
15.7

-10.5%
2.5%
5.4%

42,007
1,434
40,572

43,736
1,965
41,771

44,842
3,515
41,327

46,211
5,935
40,276

47,559
8,460
39,100

48,891
11,080
37,811

2.8%
54.1%
-2.5%

102,969
2,986
99,983

107,775
4,419
103,356

113,183
9,140
104,043

118,626
14,294
104,332

124,105
19,888
104,217

129,619
25,924
103,695

4.7%
55.6%
0.1%

66.2%
1.9%
64.3%
2.9%

69.1%
2.8%
66.3%
4.1%

72.3%
5.8%
66.5%
8.1%

75.6%
9.1%
66.4%
12.1%

78.8%
12.6%
66.2%
16.0%

82.0%
16.4%
65.6%
20.0%

35.1
46.8
34.8
12.0

34.6
44.2
34.2
10.0

33.8
43.2
33.2
10.0

33.2
42.2
32.2
10.0

32.7
41.2
31.2
10.0

32.1
40.3
30.3
10.0

-1.8%
-2.3%
-3.0%
0.0%

78,109
50.2%
24.0

80,615
51.7%
24.5

83,355
53.3%
25.1

86,113
54.8%
25.8

88,888
56.4%
26.4

91,682
58.0%
27.0

3.3%

Broadband revenues (EURm)


of which super-fast
of which normal
Broadband customers (000)
of which super-fast
of which normal

Broadband penetration (% of HH)


of which super-fast
of which normal
Super-fast in broadband customers
Broadband ARPU (EUR/month)
of which super-fast
of which normal
Super-fast premium
Pay-TV customers (000)
Pay-TV penetration (% of HH)
Pay-TV ARPU (EUR/month)

2.4%

Source: Arthur D. Little, Exane BNP Paribas estimates

Pay-TV: customer growth and ARPU growth


In pay-TV, we include the activities of satellite, cable and IPTV providers. Our core
scenario points to European pay-TV revenue CAGR of +5.8% until 2015e, in line with
the trend observed in 2011 (our estimate), driven both by penetration and ARPU:
penetration expected to increase by six percentage points i.e. to 58% in 2015e
versus 52% in 2011e;
ARPU expected to continue growing by 2% pa., from the current blended average
of EUR24.5/month to EUR27 in 2015e (NB: the ARPU of pure-play pay-TV operators
such as satellite players is much higher, in the region of EUR40/month, while cable
operators TV ARPU is around EUR20/month, and telcos TV ARPU around EUR10).
Figure 26: European Pay-TV KPIs
Split of customers between legacy providers (cable and
satellite) and incumbents IPTV services

2011 TV ARPU of selected players*

90

50

80

45
40

70
EUR/month

Customers (m)

35

60
50
40

30
25
20

30

15

20

10
5

10

Legacy pay-TV

DTH (satellite)

Incumbents IPTV

Cable

PT

Orange F

DTE

KPN

BGCM

Ziggo

Zon

TNET

VMED

Sky DE

Sky IT

Sky UK

Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4 Q1 Q2 Q3 Q4
09 09 09 09 10 10 10 10 11 11 11 11

Canal+

IPTV

* Belgacoms IPTV ARPU is stated as reported, i.e. with the discount offered to pack customers applied proportionately to telephony, broadband and
TV ARPU rather than only applied to TV ARPU.
Source: Arthur D. Little, Exane BNP Paribas estimates

24

Telecom Operators

For telcos in particular, we expect a stronger growth in pay-TV as we model continued


share gains both in terms of customers and revenues.

Focus on incumbents: core revenues to decline by 3.6% pa.


Incumbent operators experience tougher revenue trends than the overall telecom
market, for two key reasons: 1) they have the largest exposure to the decline in fixed
telephony revenues with an estimated market share of c70% - hence the migration
from traditional telephony towards broadband is a negative for them; 2) they have been
losing market share in both mobile and broadband. In contrast, the incumbents have
been gaining market share in pay-TV, but given the smaller market size this is far from
sufficient to offset the decline in other revenue lines.
In our core scenario, we model incumbents revenue CAGR of -3.6% over 2011-2015e
(versus -1.8% for the sector), based on the following drivers.
Mobile revenues expected to decline by 3.0% pa, i.e. a minor underperformance
versus the market (-2.4%), reflecting a revenue market share drop from 40.5% in
2011e to 39.4% in 2015e. This implies a future pace of market share loss at half the
rate observed in the past two years. The main uncertainty here is not incumbents
market share, but the evolution of the mobile market overall.
A stabilising broadband share. Incumbents share of net additions dropped to
22% in 2011, due to the combined push from low-cost alternative carriers in Southern
Europe (e.g. Italy, Spain but also France) and from cable operators promoting superfast broadband in the North of Europe (e.g. Germany, the Netherlands, Belgium).
We stick to the view developed in our 2011 report focusing on super-fast broadband
i.e. that incumbents will increase FTTx investment to improve their competitive
positions in fixed broadband hence we model better market shares of net additions in
the coming years. This implies incumbents capturing 32% of fixed broadband revenue
growth between 2011 and 2015e. This is also consistent with our view that the move
towards super-fast broadband will lead to a consolidation of broadband markets around
two or three leaders per country, including the incumbent and, in most markets, the
cable operator(s).
Figure 27: Key drivers, incumbents core scenario
Broadband market share

Triple-play penetration and pay-TV share


45%

60%

40%
50%

35%
30%

40%

25%
30%

20%
15%

20%

10%
10%

5%
0%

0%

2009
2010

2011

2012e

2013e

2014e

2010

2011

Triple-play penetration
Revenue share

2012e

2013e

2014e

2015e

2015e

Net adds market share

Pay-TV revenue share

Source: Arthur D. Little, Exane BNP Paribas estimates

25

Pay-TV customer share

Telecom Operators

A continued strong push into pay-TV. The penetration of triple-play in incumbents


customer bases stood at 24% at the end of 2011, up from 21% a year before, and we
model this increasing to 40% by 2015e. We note that several incumbents are already
far more advanced than this, e.g. Portugal Telecom (91% penetration by the end of
2011), Belgacom (64% penetration of TV in the consumer broadband customer base)
and KPN (52%) as shown in the left hand side chart, Figure 28 while several large
telcos are far below average, notably Telecom Italia (4%), BT (12%), Deutsche
Telekom (13%) and Telefnica (15%).
Incumbents pay-TV ARPU stands in the EUR10-15/month range, much lower than that
of satellite and cable operators, for three reasons: 1) as challengers in pay-TV, telcos
logically have more aggressive pricing; 2) the quality of TV over DSL is lower than with
cable and satellite (however this should be solved with FTTx); and 3) telcos do not
compete in the premium/exclusive content market, i.e. they target a lower-end segment
than BSkyB or Canal+. In the coming years, we expect incumbents pay-TV ARPU to
increase, but not to catch-up with that of leading players: we model EUR13 by 2015e.
Figure 28: Penetration of IPTV in incumbents broadband customer base
IPTV % of incumbents broadband customers**

IPTV penetration versus price point

100%

Telcos price delta 3-play vs. 2-play (EUR)

16

90%
80%
70%
60%
50%
40%
30%
20%
10%
0%

14

SP

12
10
PT
8

DE
BE

6
IT

UK

4
NL
2
FR*

0
PT
2009

BE

NL

FR
2010

SP

DE

UK

IT

0%

20%

40%

60%

80%

Incumbents' IPTV penetration

2011

*In France, double-play is not offered separately from triple-play, hence an inferred price premium of zero
**Belgacom penetration based on unique TV customers (excluding multi-boxes equipment) as a % of consumer broadband customers; KPN
penetration based on TV customers as a % of consumer broadband customers.
Source: Arthur D. Little, Exane BNP Paribas estimates

26

100%

Telecom Operators

Figure 29: Core scenario Incumbents revenue outlook


Reminder - market

Mobile service revenues


Fixed telephony
Fixed broadband
Pay-TV
Total revenue incl pay-TV
Incumbents' market shares
Mobile service revenues
Fixed telephony
Fixed broadband
Pay-TV
Sector revenue share
Incumbent revenues
Mobile service revenues
Fixed telephony
Fixed broadband
Pay-TV
Total
Capture share of growth
Mobile service revenues
Fixed telephony
Fixed broadband
Pay-TV

Overall broadband customers


Incumbents broadband customers
Share
Share of net additions
Overall pay-TV customers
IPTV customers
Share
Share of net additions
Triple-play penetration
IPTV ARPU

2010

2011e

2012e

2013e

2014e

2015e

CAGR

110,778
53,327
42,007
22,450
228,561

107,069
49,131
43,736
23,722
223,658

103,771
44,860
44,842
25,148
218,621

99,847
40,510
46,211
26,620
213,188

97,855
36,175
47,559
28,139
209,728

97,144
31,941
48,891
29,705
207,681

(2.4%)
(10.2%)
2.8%
5.8%
(1.8%)

41.2%
70.0%
42.8%
4.4%
44.6%

40.5%
70.0%
41.8%
5.1%
43.5%

40.2%
70.0%
41.4%
6.5%
42.7%

39.9%
70.0%
41.1%
7.7%
41.9%

39.6%
70.0%
41.1%
9.0%
41.1%

39.4%
70.0%
41.3%
10.5%
40.4%

45,599
37,329
17,970
988
101,885

43,335
34,392
18,300
1,301
97,328

41,671
31,402
18,576
1,647
93,296

39,829
28,357
18,987
2,055
89,228

38,785
25,323
19,526
2,534
86,168

38,304
22,359
20,192
3,105
83,960

162%
70%
23%
34%

61%
70%
19%
25%

50%
70%
25%
24%

47%
70%
30%
28%

52%
70%
40%
32%

68%
70%
50%
37%

102,969
44,630
43%
27%

107,775
45,698
42%
22%

113,183
47,050
42%
25%

118,626
48,683
41%
30%

124,105
50,875
41%
40%

129,619
53,632
41%
50%

4.7%
4.1%

78,109
9,235
12%
55%

80,615
11,134
14%
76%

83,355
13,302
16%
79%

86,113
15,667
18%
86%

88,888
18,361
21%
97%

91,682
21,453
23%
111%

3.3%
18%
41%

21%
9.9

24%
10.6

28%
11.2

32%
11.8

36%
12.4

40%
13.0

Capture share of growth


54%
70%
32%
29%

(3.0%)
(10.2%)
2.5%
24.3%
(3.6%)

5.1%

Source: Arthur D. Little, Exane BNP Paribas estimates

Overall, our estimates point to incumbents increasing their pay-TV revenue market
share from 5% in 2011 to more than 10% in 2015e i.e. incumbents capturing c.30%
of the markets revenue growth in the coming years.
This positive view on telcos opportunity in pay-TV is backed by companies surveyed
for this report: 32 of the 74 respondents see pay-TV as a key growth driver (more than
for fixed broadband), reflecting 1) the growth potential into traditional pay-TV (via IPTV)
but also 2) new TV services, including web-based TV, time-shifting, VOD, etc.
We discuss the potential impact of over-the-top TV services on the telcos pay-TV
opportunity in page 53.

27

Telecom Operators

Sensitivity analysis: mobile data the largest uncertainty


The sensitivity of the sector revenue outlook in the next five years to a few key
parameters is large this is consistent with the lack of visibility acknowledged by many
industry participants.
Based on a range of scenarios for mobile data monetisation, mobile voice and text
cannibalisation, fixed broadband developments and pay-TV pressure from OTT, the
sector top-line CAGR could theoretically vary between -4.9% and +1.4%, versus our
core scenario of -1.8%. The total revenue per inhabitant, which currently stands at
EUR52.5/month, would vary between EUR43 in 2015e in the bear case and EUR55 in
the bull case, with our core scenario pointing at EUR48: see Figures 30 and 31 below.
Figure 30: Sector yoy revenue trends in key scenarios*
6%
4%
2%
0%
(2%)
(4%)
(6%)
(8%)
2011
Core scenario

2012e
Bear x2

2013e

2014e
Bull x2

2015e
Bull and bear combined

* Bear x2 refers to a scenario combining our bear case n1 (on mobile voice and text) and our bear case n2
(on pay-TV), and Bull x2 refers to a scenario combining our bull case n1 (on mobile data) and our bull case
n2 (on broadband). Bull and bear combined refers to a scenario combining all alternative scenarios.
Source: Arthur D. Little, Exane BNP Paribas estimates

Bull case N1: better mobile data monetisation


The main positive driver for the sector would be better than expected monetisation of
mobile data, driven by a combination of 1) stronger volume growth and 2) pricing
discipline and innovation (i.e. tiered pricing, etc.) the two aspects may go hand in
hand as strong volume growth would mean less capacity available in the networks and
scarcer mobile frequencies.
Our core scenario points to average spend per person of EUR10.1/month on mobile
data in 2015e (excluding SMS) based on 1.9GBytes/month per smartphone and a data
price of EUR6/GByte. A modest change to these assumptions can shift the whole
sector outlook. We have built a bull case assuming 2.5GBytes per month and average
revenue of EUR7/GByte (basically in line with the current average data pricing for large
smartphone users), which would lead to data revenue of EUR15.5/month per pop.
In such a scenario the mobile service revenue trend would turn positive (+3% CAGR)
and so would the whole sector: +0.8% (versus -1.8%).
However, this scenario seems unlikely as it would imply accelerating traffic combined
with no decrease in the price per gigabyte for high-end users between now and 2015e.
There is already evidence that such stability in the price per GB in high-end bundles will
be difficult to maintain between now and 2015e (e.g., current increase in data
allowances observed in several markets such as France or Denmark).

28

Telecom Operators

In addition, the rollout of LTE/4G will bring more capacity into the market and lower unit
costs to operators thereby constituting a potential trigger for mobile data price
deflation, depending on competitive intensity in each market.
Figure 31: Core scenario Incumbents core revenue outlook

Mobile data
Traffic per smartphone in 2015e (GB/month)
Average revenue per GByte in 2015e (EUR)
Mobile data revenue CAGR 2011-2015e
Data revenue per pop 2015e (EUR/month
Mobile voice & text
Voice traffic growth in 2014-2015e
Voice revenue CAGR
SMS revenue trend in 2014e
SMS revenue CAGR
Voice & text revenue per pop 2015e (EUR/month)

Core

Bull
mobile data

1.9
6.0
23.2%
10.1

2.5
7.0
37.1%
15.5

1.0%
(12.8%)
(10.0%)
(7.7%)
12.4

Fixed broadband
2015e super-fast broadband % of broadband
2015e super-fast broadband incremental ARPU
Broadband revenue per pop 2015e (EUR/month)

20%
10
11.3

Pay-TV
2015e pay-TV penetration
2015e pay-TV ARPU
Pay-TV revenue per pop 2015e (EUR/month)

58%
27
6.9

2011-2015e CAGR
Mobile service revenue
Fixed-line & broadband
Pay-TV
Total sector
Total revenue per pop 2015e (EUR/month)

Bear
voice & text

Bull fixed
broadband

Bear Pay-TV

(10.0%)
(18.8%)
(26%)
(20.8%)
8.7
40%
15
12.6
52%
22
5.0

(2.4%)
(3.4%)
5.8%
(1.8%)

3.0%
(3.4%)
5.8%
0.8%

(6.7%)
(3.4%)
5.8%
(3.8%)

(2.4%)
(1.8%)
5.8%
(1.2%)

(2.4%)
(3.4%)
(2.2%)
(2.8%)

48.1

53.5

44.4

49.4

46.3

Source: Arthur D. Little, Exane BNP Paribas estimates

Bear case N1: strong cannibalisation of mobile voice & text


The flipside of mobile data growth is the risk of cannibalisation for voice and
text. In our core scenario we have assumed that voice traffic would grow by 1% p.a.
even in the medium term, and that SMS revenues would fall only progressively (stable
in 2012e, down 5% in 2013e, then down 10% in 2014e) pointing to revenue per
inhabitant of EUR12.4/month generated by voice and text by 2015e, versus EUR20.7 in
2011.
In our bear case (see page 38) we assume rapid cannibalisation of voice and SMS
revenues by over-the-top applications, leading to the revenue per inhabitant from voice
and text falling to EUR8.7/month in 2015e and pointing to total mobile service
revenue down -6.7% per year in 201115e, and the whole sector would see revenues
decline by 3.8% pa.
However we believe that operators have understood the risk of such a scenario and are
already starting to implement defensive tactics to avoid this bear case. In particular
they are increasingly bundling voice, SMS and data into integrated tariffs, which in
effect renders the total revenue stream insensitive to the usage mix, i.e. insensitive to a
potential drop in voice and/or SMS traffic. We think that implementing this strategy
could at least halve the impact of this bear case cannibalisation scenario on the
sectors revenue (see page 52).
As always, the main risk to this tactic is competition, as challengers may choose to
continue gaining market share via aggressive pricing rather than let leaders stabilise
their core revenues.

29

Telecom Operators

Bull case N2: super-fast broadband explosion


What would happen if broadband revenues developed more rapidly, for instance driven
by a faster adoption and higher willingness to pay for super-fast broadband? This could
be triggered by massive adoption of over-the-top TV services, as customers willing to
watch movies or video over the internet would rapidly become very sensitive to the
speed and quality of their broadband connection (see pages 45-47).
This bull case is based on 40% of broadband customers having migrated to super-fast
offers by 2015e versus 20% in our core scenario and an ARPU uplift of
EUR15/month versus EUR10 in our core scenario. This combination of optimistic
assumptions would point to fixed broadband revenues of EUR28.6/month per
household by 2015e versus EUR25.8 in our core scenario.
Fixed-line revenues would decline by only 1.8% pa versus -3.4% in the core scenario,
and sector top-line would reach -1.2% versus -1.8%. This scenario clearly shows that
fixed broadband is not as material a parameter for the sector as mobile data.

Bear case N2: pay-TV cannibalisation by OTT


Finally, the rise of over-the-top-players could end-up derailing growth in the pay-TV
market, either by capping pay-TV penetration or by putting pressure on the high ARPU
levels derived by premium pay-TV providers, in particular satellite players but also, by
extension, cable and, to a lesser extent, telcos (see page 40).
In our bear case around this theme we have assumed that pay-TV penetration would
not grow between 2011 and 2015e i.e. remain at 52% (versus 58% in 2015e in our core
scenario) and that pay-TV ARPU would decline from the current EUR24.5 to EUR22
(versus slight growth to EUR27 in our core scenario).
This scenario would entail a declining pay-TV market (CAGR -2.2% versus +5.8% in
our core scenario), which would put the overall sector CAGR at -2.8% (versus -1.8% in
the core scenario).
Given the relatively small size of pay-TV revenues compared to the pure telecom
services it is logical that the impact of such a scenario on telcos would be minimal.
It would, however, be much more important for incumbent pay-TV players such as
satellite players and, to some extent, cable operators.

30

Telecom Operators

Mobile ROCE sanity check


The European mobile sector has historically been very profitable. We estimate that in
2011, the sectors return on capital employed (ROCE) still reached almost 18% (posttax), lower than in 2009 (21%) but still high compared to the sectors cost of capital of
c8% - indicating that the sector continues to create value.
Importantly, given the scale factor in this industry (see page 99), we estimate that
mobile leaders still enjoy a ROCE of more than 20%, on average, while challengers
ROCE stand at 9% - a difference driven to some extent by EBITDA margins (36% for
leaders in 2011 versus 33% for challengers), but more significantly by the weight of the
fixed assets (capex/sales of 16% at challengers versus 10% for leaders).
Figure 32: Mobile ROCE analysis, core scenario
EBITDA margin and capex/sales, 2011
40%

Mobile ROCE estimates, 2009-2015e


30%

35.8%
33.2%

35%

25%

30%
20%
25%
15%

20%
15.9%
15%

10%
10.1%

10%
5%
5%
0%
0%

2009
EBITDA margin
Leaders

2010

2011

2012e

2013e

2014e

2015e

Capex/sales
ROCE

Challengers

Mobile leaders

Mobile challengers

Source: Arthur D. Little, Exane BNP Paribas estimates

In our core scenario, the sectors ROCE should fall to 15% by 2015e, including 18% for
the leaders, still a healthy return, but with challengers continuing to struggle, on
average, at 8%.
Importantly, this outlook is based on our view that operators will be able 1) to reduce
costs by 2% p.a., because a significant portion are variable costs but also because they
have opportunities to transform their business model; and 2) to control capex despite
the large growth expected in traffic, thanks notably to network sharing opportunities
(see analysis on opex and capex, page 101-104).
In our bull case on mobile (Bull case N1), the long term ROCE of the sector would
return to 20%, i.e. the 2010 level, with leaders at 22% and challengers at 12%. In our
view, such a scenario is unlikely as it would mean that all players, large and small,
would create much more value than today i.e. it would indicate a significant return of
pricing power, which looks unlikely given competitive pressure and regulation.

31

Telecom Operators

Conversely, in our bear case (Bear case N1), the long term returns would fall to 12%
on average, with 15% for leaders (still fine) but only 6% for challengers, i.e. significantly
below their cost of capital. This would be an unsustainable level, similar to that
achieved by T-Mobile USA in 2011 and the key reason why Deutsche Telekom has
decided to seek a structural solution for the business. In other words, we believe that
should this bear case unfold, smaller operators would seek consolidation in a majority
of European markets.
Figure 33: Impact of scenario analysis on the sectors ROCE
30%
26%
24%

25%

22%
21%

21%

20%

20%

20%
18%

17%
15%

15%

15%

12% 12%
10%

8%

9%

8%

8%
6%

5%

0%
2009

2010

2011

ROCE

Mobile leaders

Source: Arthur D. Little, Exane BNP Paribas estimates

32

2015e - Core 2015e - Bull 2015e - Bear


Mobile challengers

Telecom Operators

Towards an all-IP world: risks larger than


opportunities?
For mobiles, as smartphone adoption increases, new applications enable users to save
on their bills by using mVOIP instead of traditional voice and messaging instead of
SMS. This risk has been around for at least a year, but it is accelerating, as:

smartphone penetration has increased faster than expected;

WhatsApp, which already carried 5% of the worlds SMS traffic in November 2011, is
one of the three most downloaded paid iPhone applications in nine European countries;
Google, Microsoft, Apple, etc. all have an interest in upping their game in
communication services and the growing integration of hardware and software
(Google/Motorola, Nokia/Microsoft/Skype, Apple) gives them new firepower.
In a bear case scenario, our 2015e mobile revenue estimate which is already 9%
lower than the 2011 figure would be cut by another 8%.
For fixed-line, over-the-top TV propositions are evolving very quickly in terms of both
hardware and services all made possible by ever faster broadband. Viewing habits
are changing fast, with a massive generational effect.
From the telcos perspective we believe that OTT TV is not risk free, but it is overall
more a positive than a negative: 1) whatever the impact on pay-TV, telcos have limited
exposure to downside in this market; 2) playing the OTT game is an opportunity for
telcos to differentiate from legacy pay-TV players; 3) last but not least, OTT TV should
have a positive impact on fixed broadband, pushing towards faster speeds.
Operators are generally concerned by the OTT risk on mobile and see OTT content as
an opportunity. They are not standing on the sidelines in this respect. The most
effective moves expected from telcos are: 1) price bundling which we think can
basically halve the risk of cannibalisation of mobile operators legacy revenues;
2) tiered pricing, in mobile but also in fixed to make sure that revenues increase in
line with traffic growth; 3) leveraging the box, in fixed-line; and 4) developing wholesale
revenues from OTT providers, although this is difficult to quantify except for the CDN
activity, a relatively small opportunity.

The risk for telcos of becoming dumb pipes


Voice (fixed and mobile) revenues are declining while data is growing on both fixed
and mobile. This current rapid migration towards an all-IP world is not only driving
accelerated traffic growth but also enables new forms of competition to traditional
players, called the over-the-top competition.
The Over-the-top (OTT) acronym initially applied to TV and was related to
customers ability to stream or download movies or TV shows directly from the internet via
a broadband connection, bypassing the traditional pay-TV business model. Over-the-top
TV has large implications for both the pay-TV operators, cable operators and telcos. In
particular, OTT TV can cannibalise pay-TV revenues as customers can choose content
from new, less costly sources and it can drive huge internet traffic growth.
This OTT concept also applies to communication services. Thanks to web-based
service providers, customers can make voice calls over IP rather than with their legacy
operator (Skype being the historical example on fixed telephony) and/or send
emails/messages via WhatsApp, RIMs Blackberry Messenger or Apples iMessenger
rather than SMS. Transporting a minute of voice or an SMS over IP is much less costly
for the customer so as mobile data adoption grows, so does the risk of
cannibalisation of voice and SMS revenues.

33

Telecom Operators

As shown in the chart above, three quarters of companies surveyed consider over-thetop services as a risk to mobile operators voice and SMS revenues (NB: The 11%
responding that OTT voice is an opportunity are mainly new entrants/challengers i.e.
operators that have the opportunity to gain market share from a change in consumer
habits these are the disruptive players in the market). On the other hand, more than
half consider OTT content services as an opportunity, versus 26% a risk.
Figure 34: Interview feedback OTT a risk or an opportunity?
Voice

Messaging

Opportunity
11%

Neutral
26%

Neutral
15%

Content

Opportunity
0%

Risk
74%

Neutral
21%

Risk
74%

Risk
26%

Opportunity
53%

Source: Arthur D. Little, Exane BNP Paribas estimates

OTT risk on mobile voice and text: coming of age


The number of OTT communication applications available for smartphones has
increased exponentially in the past two years. These include:
pure service players i.e. over-the-top applications such as Skype, WhatsApp, Google
Voice, Viber or Tango, which can be downloaded by users onto their smartphones;
applications integrated by device manufacturers and/or OS developers into all their
devices such as Apples Facetime and iMessenger, or Blackberry Messenger.
Such applications bring free voice and/or free SMS. For customers, this is
particularly appealing for international and roaming calls, but also potentially for
national calls and SMS, depending on each operators retail tariffs. This arbitrage
opportunity stems from the difference between the price of voice calls and SMS on one
side, and that of data on the other side. When transformed into data, voice
(transformed into voice over IP) and SMS (transformed into IP messaging) usually cost
much less than what operators charge for them on a standalone basis: an SMS
transformed into data is virtually free, and an hour of voice is equivalent to 5MBytes of
data so even assuming a high price of data at EUR40 per GByte, one hour on voice
over IP would cost only EUR0.20.
However, beyond the appeal of free voice or SMS, these OTT applications also bring
a richer user experience/interface. For instance Skype and Facetime enable video
calling, many enable conferencing (a feature which is usually available only to B2B
customers), Skype and Google Voice enable transferring files in parallel to the
conversation, etc. (see Figure 35 below).
This is all made possible by the computing power of smartphones (i.e. their ability to
run applications), the faster speed of mobile data networks (in particular to ensure a
reasonable quality of voice over IP services) and improvements in VOIP technology
(e.g., adaptive codec).

34

Telecom Operators

Figure 35: OTT players are strong innovators, continuously adding services
ClassicTelco
services*

9
9
9
9
9
9
9

9
9
9
9
9
9
9
9
9
9
9
9

Video conference

9
9
9
9
9

Advanced
management
Integration with
social networks

9
9

mVoIP

Voice

Voice chat
Call out
Phone No.
Redirection
Voicemail
Conferencing

Other

Video/Data

Block callers

IM
SMS
File
transfer
Voice
chat
Video call

9
9
9
9

9 (normal call)

9 (B2B)

9
9
9
9

9
9 (B2B)
9
9

Least cost routing


Video conference

Source: Arthur D. Little, Exane BNP Paribas estimates

Mobile OTT penetration remains low but is likely to accelerate


As shown in the chart below, the number of users of OTT platforms globally can be
counted in tens of millions for most applications, and hundreds of thousands in the
case of Skype, Facebook and Google (if one includes Gmail).
Figure 36: Number of global users of leading OTT service platforms
Number of registered users per voice OTT company
Telcos

In m
680
663

Industrial players (HW, SW)

Comments
Independent OTT

~20% of worldwide
international calls

660
Messaging only (no Skype
integration on mobile)

The user base among OTT


communication suite
companies is increasing
rapidly
- Skype is the leader with
~0,7bn users

440

The speed of user base build


is accelerating:
- Tango grew twice as fast as
Skype

425
420

US accounts have access


to Google voice service,
services planned for H1
2012 in Europe

400
380

17m users in
9 months

5% of world SMS

360

350

50

50

50

Only major
OTT service
belonging to
telco

35

40

23

20
13

20
0
Skype

facebook Gmail
(mobile)

BBM

Whats
app

NimBuzz mig33

ooVoo

Tango

JaJah

Convenience, price, and


brand awareness determine
active usage
Nevertheless, switching
barriers are extremely low
Users use several
applications

RebTel

Source: Arthur D. Little, Exane BNP Paribas estimates

The number of active users is much lower, and switching barriers are low so users
often use several applications. We estimate that the penetration of mVOIP applications
in the European mobile customer base currently stands at less than 2% (c.5%
penetration within smartphone customers).

35

Telecom Operators

Skype has been a feature on the fixed-line for years but has failed to take off on
mobile devices because of a combination of 1) operators initiatives to block mVOIP on
their networks, 2) quality issues, and 3) high mobile termination rates, meaning that
Skype-Out calls have remained relatively expensive.
However, the penetration of OTT applications on mobile phones is likely to rise strongly
in the coming years due to a combination of factors:
1) the rising penetration of smartphones,
2) the progressive rollout of 4G/LTE networks, which will dramatically improve the
quality of voice over IP on mobile,
3) the reinforcement of net neutrality rules in Europe (see page 51),
4) the competition from mobile challengers, which are often first-movers in promoting or
allowing VOIP with their customers (e.g. 3 UK with Skype several years ago),
5) the likely viral effects which will take place when the OTT customer base will
increase (e.g. WhatsApp experience in the Netherlands).
Voice and messaging applications are likely to develop, but we believe that the largest
risk lies with SMS. Indeed:
regarding voice, mVOIP can be very appealing because it promises to cut the
customers main expense in mobile, namely voice (voice still represents 63% of bills in
Europe). However, quality of the service remains an issue. Except for specific calls like
international calls to friends and family, customers are not ready for lower voice quality
or dropped calls. While the quality of mVOIP has improved greatly, carrier class quality
is not expected before 4G is rolled out.
regarding SMS, handling a short data message such as a SMS is very easy and does
not suffer from quality issues. As well as being free, messaging applications propose a
superior user experience compared to basic SMS. Finally, in addition to rapidly spreading
applications such as WhatsApp, new messaging systems are embedded into handset
(e.g. Apples iMessenger). We therefore believe that unless operators take decisive
action (see page 50), SMS revenues could be rapidly cannibalised.

WhatsApp: example of a fast-spreading threat


WhatsApp was brought to the worlds attention by KPN, which justified part of its profit
warning at its Q1 11 results by a change in consumer behaviour on mobile notably
due to the rise of OTT applications such as WhatsApp. By Q2 11, WhatsApp had
already been adopted by 85% of its Hi brand customers (these are typically young, tech
savvy customers). In H2 11, the average SMS traffic per KPN mobile customer started
to fall significantly: it was down 19% yoy in Q4 11.
WhatsApp is a multi-platform unlimited messaging service on iPhone, Android,
Blackberry and Nokia. The application is generally not free although the price is low
(EUR0.99) and enables free usage for a year (then the price is USD1.99 per year).
WhatsApp is spreading fast not only in the Netherlands:
In Q3 11, WhatsApp was the top-selling iPhone application in 61 countries. By
November 2011, there have been more than 10m downloads on Android, and overall
the application was used in 250 countries on 750 mobile networks. WhatsApp
announced that it was delivering 1bn messages a day worldwide, which is equivalent to
c5% of the global SMS volume.
In early 2012, WhatsApp was still the most downloaded paid application on the
Apple iTunes store in the Netherlands but also in Spain, Austria, Switzerland and
Ireland. It was in the top-3 in Germany, Italy, Belgium and Greece. On the other hand, it
was not in the top-10 in France, Finland, Denmark and Norway.

36

Telecom Operators

Figure 37: WhatsApp one of the most downloaded paid applications on the Appstore (rank)
Country
27 Jan 12
28 Feb 12

NL

SP

AT

CH

IR

BE

GR

DE

IT

PT

UK

SE

FI

FR

DK

NO

1
1

1
1

1
1

1
2

1
2

2
1

2
2

3
3

3
3

4
4

6
6

6
6

>10
>10

>10
>10

>10
>10

>10
>10

Source: Apple, Arthur D. Little, Exane BNP Paribas estimates

The charts below, which compare the number of searches in Google for WhatsApp to
the well established Skype reference (and also to Viber), show the strong take-off of
WhatsApp throughout 2011 in particular in the Netherlands and Spain, and to a lesser
extent in the UK, and the lack of take-off in France. They also show that the interest for
Viber remains far smaller.
Figure 38: The growing popularity of WhatsApp according to Google Trends, depending on countries
Netherlands

Spain

UK

France

* Yellow lines = Skype, blue lines = WhatsApp, red lines = Viber


Source: Google, Arthur D. Little, Exane BNP Paribas estimates

The current difficult economic environment is certainly a factor in customers interest in


downloading applications such as WhatsApp onto their smartphone, if they find that they
can optimise their bill by using the application instead of their operators SMS service so
the markets where it is taking off are a mix of 1) countries where the economy is under
strong pressure, e.g. Spain, Ireland, Greece and Italy; and 2) countries where operators
SMS pricing offers an arbitrage opportunity to customers, in particular the Netherlands,
Spain, Germany and Italy as opposed to countries where the heavy SMS users have
already migrated to unlimited SMS bundles (e.g. France, the UK or Denmark).

Global internet leaders all have an interest in OTT


Whatever the success of specific applications such as WhatsApp, we believe that OTT
is here to stay. Indeed it is an area of strong interest for the worlds internet and tech
giants such as Apple, Google, Facebook, Microsoft and Amazon.
Google: the group sees communication services as a key way to attract users to its
websites, and to gather data hence to generate more advertising revenues. It has
recently integrated all its services (search, email, messaging, social network, etc.).
Google is the leading force behind Android, which can be leveraged for new
applications such as Google Voice, etc.
Facebook: communication between users is the social networks core proposition,
so expanding its services to pure messaging and telephony would be a logical step.
Skype voice and video calls are already integrated in Facebook.

37

Telecom Operators

Microsoft has been established in messaging services for a long time (Microsoft
Messenger) and has more recently acquired Skype. Skype could be fully integrated into
Windows (on fixed-line and smartphones) and into the Xbox environment.
Apple: the groups core business is to sell hardware (iPhone, iPad, etc.) but it also
develops services (in particular iTunes and the AppStore) as an additional revenue
stream and as a side benefit to its hardware activity. Unlike Google and Facebook,
Apple has a billing relationship with customers via iTunes so it is a bigger threat
regarding paying services. Facetime is an example of the power of Apples platform.
Amazons core activity is e-commerce, in particular selling content (originally
books), but the group sees any means to boost its content business as an opportunity
to develop new revenues. For instance, it is leveraging its powerful IT infrastructure
with its cloud offering (Amazon Web Services), and pushing into the mobile device
arena (Kindle, Fire). Like Apple, Amazon has a billing relationship with customers.
Figure 39: Positioning of key internet leaders in communication services
Original business &
main revenue driver
Business: Web search
Revenues: Ads

Business: Social
network

Overall strategy

Revenues: SW licences

Revenues from HW
(c.30-40% margin per
device)
Business: eCommerce,
cloud
Revenues: low margin
in all businesses

Web
search

Customer
identity
Google
account

Billing
relationship

Free services to
attract users and
gather data

Put users life


on FB

Core activity is to
make users
communicate with
other users

Facebook
website
(c.800m)

Facebook
account

Development of
virtual money
( Facebook
credits )

Try to sustain
position in PC
ecosystem

Skype buy-out
probably to
integrate to Office
& Xbox
environment

Windows,
Xbox Live,
Hotmail
(330m)

United
profile with
Windows 8

For business,
monthly fees
(Office 365) ; not
regular revenue
for non-corporate

Integrated HW
ecosystem ;
Extension of
services
through SW

HW opportunities :
iPhone , iPad

HW
devices

iTunes
account

Credit-card
number for iTunes

Still limited in
services

Apple
stores

Selling content,
getting in the
cloud

Leverage
infrastructure for
cloud services

HW
devices

Amazon
account

Credi-card number
of eCommerce,
One-clic shop

Grow new
revenue fields
Business: HW & OS

Customer
gateways

Digitalization
of the world to
gather and
monetize data

Revenues: Ads
leveraging user data
Business: OS &
productivity

Communication
services

Gmail
(c.200m)

Website,
Kindle
service

Limited
monetization of
users
Android market

Source: Arthur D. Little, Exane BNP Paribas estimates

How big is the revenue risk for telcos?


In fixed-line, Skype has become the largest operator in the world for international traffic,
with an estimated global market share having grown from c3% in 2005 to 20% in 2010
(in number of minutes). The impact on telcos fixed international voice revenues has
been significant. Indeed, we estimate that more than 85% of the growth in international
voice traffic has been captured by Skype in 2010.

Could cannibalisation affect mobile operators, for voice and/or for SMS?
The voice and SMS revenues most at risk of cannibalisation are the out-of-bundle and
prepaid parts which are directly driven by usage, unlike the in-bundle voice and SMS
usage which could be impacted over time, but a bundling strategy with data can
protect them. Consumer out-of-bundle and prepaid revenues represented respectively
12% and 26% of Vodafone Europe service revenues in Q4 11 (see chart below).

38

Telecom Operators

In our core scenario, mobile service revenues are expected to decline by 2.4% per year
until 2015e but in a bear case with a strong cannibalisation of voice and text
revenues by OTT applications, we estimate that the mobile service revenue decline
could more than double, to -6.7% per annum until 2015e.
Figure 40: Assessing operators revenue exposure to voice and text cannibalisation
Split of Vodafone Europe service revenues, Q4 11
Other
5%

Qualitative assessment of the risk of SMS revenue


cannibalisation by country
5

Enterprise
30%

Consumer
prepaid
26%

Consumer
contract,
incoming
5%
Consumer
contract, out
of bundle
12%

Consumer
contract, in
bundle
22%

0
SP

NL

IT

DE

PT

BE

FR

UK

DK

Source: Vodafone, Arthur D. Little, Exane BNP Paribas estimates

Figure 41: Assessing the cannibalisation risk Bear case scenario


EUR/month

2011e

2012e

2013e

2014e

2015e

25.2
16.5
2.0
14.6
8.6
4.2
4.4

24.3
14.7
1.4
13.3
9.6
4.2
5.5

23.3
12.7
0.7
11.9
10.6
3.9
6.7

22.8
11.0
0.5
10.4
11.8
3.5
8.2

22.5
9.5
0.5
9.0
13.1
3.0
10.1

(9%)
(11%)
(11%)
(11%)
0%
(25%)
0%
(25%)
(6%)
(13%)
0%
(25%)
0%

(12%)
(15%)
(15%)
(15%)
0%
(31%)
0%
(44%)
(9%)
(20%)
0%
(39%)
0%

(15%)
(19%)
(19%)
(19%)
0%
(38%)
0%
(63%)
(10%)
(27%)
0%
(54%)
0%

(17%)
(23%)
(23%)
(23%)
0%
(44%)
0%
(81%)
(10%)
(34%)
0%
(68%)
0%

(17%)
(28%)
(28%)
(28%)
0%
(50%)
0%
(100%)
(9%)
(41%)
0%
(83%)
0%

Bear case Mobile service revenue per pop.


Mobile voice
Interconnect
Outgoing
Mobile data
SMS
New data

22.9
14.8
1.8
13.0
8.1
3.7
4.4

21.3
12.5
1.2
11.3
8.8
3.3
5.5

19.8
10.2
0.6
9.6
9.6
2.9
6.7

19.0
8.4
0.4
8.0
10.6
2.3
8.2

18.7
6.8
0.3
6.5
11.8
1.8
10.1

% of pop. with smartphone


% of smartphone customers using MVOIP & IM
% of pop using MVOIP & IM

38%
5%
2%

51%
16%
8%

67%
28%
18%

82%
39%
32%

95%
50%
48%

150%

140%

130%

120%

110%

(0.2%)

(0.9%)

(2.6%)

(5.0%)

(7.5%)

Core scenario Mobile service revenues per pop.


Mobile voice
Interconnect
Outgoing
Mobile data
SMS
New data
ARPU impact of using MVOIP & IM
Mobile voice
Interconnect
Outgoing
Enterprise
Prepaid
Postpaid in bundle
Postpaid out of bundle
Mobile data
SMS
In bundle
Out of bundle
New data

ARPU of MVOIP customers versus average


Impact on mobile service revenue
Source: Arthur D. Little, Exane BNP Paribas estimates

39

Telecom Operators

This is based on a scenario whereby 50% of smartphone users i.e. 48% of the
population by 2015e would use such OTT services, and these would:
reduce the out-of-bundle usage of voice and text to zero for contract customers
(hence including international and roaming revenues, but also a large part of the
national out-of-bundle revenues). We have used the above-mentioned data published
by Vodafone;

cut prepaid voice and text revenues by 50%;

have no impact on either the postpaid in-bundle revenues, non-SMS data, or


enterprise revenues.
Interconnect revenues are assumed to be cut proportionally to voice and text.
Compared to our core scenario, this bear case would reduce the total voice and text
revenue per inhabitant by 31% (from EUR12.4/month in our core scenario in 2015e to
EUR8.6), cutting total European mobile service revenues by 7.5% compared to the
core scenario.

Content OTT: more opportunity than risk, for most


Over-the-top television propositions are evolving very quickly, both on the hardware
side (from the PC to boxes to smart TV sets) and on the services side (from the
Youtube of the early days to TV stations catch-up TV propositions and Netflix) all
made possible by ever faster broadband. For OTT providers, content is an issue but
not one which will block them from launching appealing offers to at least a significant
part of the market, if not to the premium football fans. Viewing habits are changing fast,
with a massive generational shift occurring.
The impact of OTT on pay-TV has yet to be proven a significant negative, even in the
US and from the telcos perspective we believe that OTT TV is not risk free, but it is
overall more positive than negative: 1) whatever the impact on pay-TV, telcos have
limited exposure to downside in this market; 2) for them, playing the OTT game is an
opportunity to differentiate from legacy pay-TV players; 3) last but not least, OTT TV
should have a positive impact on fixed broadband, pushing towards faster speeds.
We have not changed our view that fixed-line operators need to invest more in FTTH
networks. However this capex will not be driven by OTT TV, but rather by the need for
telcos to keep up with super-fast broadband competition from cable operators.

What does OTT TV offer to customers?


OTT video services provide a non-linear TV experience (i.e. in theory, any programme
or film at any time, anywhere, on any device in practice this depends on access to
content see below) combined with the ability for the customer to save on their payTV bill. Fundamentally, OTT service unbundles pay-TV content: the customer can
watch (pay to watch) specific programmes rather than having to subscribe to a bundle
of traditional pay-TV channels the likes of BSkyB, Canal+ and cable operators.
Initially, OTT video started on the PC, with the rise of Youtube which was initially
quite limited in terms of quality and type of content (mainly user generated).
OTT video then evolved to boxes, including dedicated hardware such as TiVo in the US
or the Apple TV (re-launched in 2010; price USD99; sold 2m units as of Nov 2011), but
also gaming consoles (Xbox 360, PS3, Wii). These boxes compete with operators own
boxes (e.g. Oranges Livebox, Freebox Revolution, BT Vision, etc.). The hardware
players developing these boxes have signed content deals, enabling an alternative lineup essentially focused on video on demand.

40

Telecom Operators

Figure 42: Evolution of over-the-top video content services and key figures for
the German market
1st Generation

2nd Generation

PC

Set-top box

3rd Generation
Multiscreen

Streams or downloads of videos


directly from the web onto the PC

Video access through set-top boxes


and consoles connected to the TV

Internet connectivity directly


embedded into TV sets

Strongest focus on short-form


videos

Pre-installed services to watch free


and paid for video

Innovative interface: 2nd screen


apps, voice, gesture

Mainly user-generated content and


other small clips

Increasing focus on long-form


videos

Short- & long-form videos directly


consumed on several screens

In Germany, 79% of households


have got at least one PC (Internet
access 69%)

In Germany, 20% of households


have got gaming consoles

68% of Germans access online video

40% of German households have got


a laptop

There will be a boost in the sales of


set-top boxes by the termination of
analogue satellite TV in Germany in
2012

3m tablets sold in 2010 and 2011


20% penetration for smart TVs
expected in 2012

Source: Arthur D. Little, Exane BNP Paribas estimates

The latest trend is the rise of connected TVs, with consumer electronics manufacturers
such as LG or Samsung now launching a second generation of such TVs. Once
connected to a broadband line (with no need for a box), smart TV sets aggregate
content from a variety of sources, including OTT video services such as Netflix or
Youtube, but also integrate communication services such as Facebook. These players,
in particular Samsung, also forge local content partnerships and have widgets of local
content producers and broadcasters in their app stores.
The next key steps could involve: 1) a launch by Apple of its own TV set, iTV as
reported by the press, and 2) a further push by Google on the Google TV concept
with the strategic aim of lodging its OS and services in connected TV sets (similar to
the Android push into smartphones) with for instance Sony having signed a
partnership to launch Google TV in the UK in 2012. Another sign that Google is
seriously looking at the TV market is the report that the company is seeking permission
to establish a satellite dish station in the US, able to receive satellite-based content
feeds from TV stations.
In terms of services, beyond Youtube (which is getting content of its own, and evolving
towards HD etc.), the most successful services are:
A few independent services such as Netflix (24m customers in the US at end
2011), just launched in the UK and other countries in Europe should follow. Netflix is
hardware agnostic i.e. it is available on the PC but also on the TV if connected to the
PC or via the leading game consoles (Wii, PS3, Xbox360, Vita). In the UK, competitors
include notably Lovefilm (owned by Amazon) and Blinkbox (owned by Tesco).
Services launched by content owners and TV stations such as Hulu in the USA,
BBC iPlayer and ITV Player in the UK, M6 Replay in France, maxdome by
ProSiebenSat1 and Mediathek by ZDF in Germany, or ipla in Poland.

Viewing habits are definitely changing


Viewing habits are changing in Europe and we believe that this change is likely to
accelerate rather than slow in the coming years fostered by 1) the expansion of the
number of screens per person, 2) technological evolution in particular faster
broadband speeds, and 3) a strong generation effect.

41

Telecom Operators

In Western Europe, the number of screens available per person has grown from 1.7 in
2000 to 3.6 in 2011e. This has mainly been driven by PCs, mobile phones and other
mobile devices (such as tablets) while the number of TV sets grew only slightly.
These additional screens are a key driver for new ways to access video content:
TV viewing continues to increase in Western Europe, but Internet delivery is capturing
most of the growth in terms of time spent.
This is made possible by the digitalisation of content and the all-IP nature of networks
and devices, combined with the increases in broadband speeds (in particular with the
advent of super-fast broadband on cable, and progressively on telcos).
For example, a UK Ofcom report in 2011 showed that customers who migrated from
classic broadband to super-fast broadband increased their usage of OTT content
services: +63% for streaming of HDTV programmes or films, +54% for streaming of
SDTV programmes or films, +35% for watching short video clips (e.g. on Youtube).
Figure 43: Key trends in content consumption
Hours spent per media per week (Western Europe)

Number of screens
per person

In hours per week


+1%
50,6
46,1

CAGR
48,2

48,0

12.0

12.3

+5.74%

3.9

3.8

-2.78%

4.9

4.7

-1.98%

13.2

12.4

1.7

2.6

3.3

3.6
1,477

11.3
8.8
4.0

4.5

5.2

5.3

13.0

14.8

Installed screens
(in millions)

1,335
1,021
158

-0.78%

144

583

541

678
405

151
14.5

2004

15.3

2006

14.2

2008

Internet

Radio*

Magazines

Television*

14.8

313

258

320

0.34%

63
2000

2010
Newspapers

352

363

123

184

218

2005

2010

2011

335

Other mobile devices

Mobile phones

TVs

PCs

* Excluding TV and radio via the internet


Source: IEAA Mediascope 2010, Arthur D. Little, Exane BNP Paribas estimates

Finally, there is a strong generation effect at play: 1) in the US, consumers aged 18-34
watch twice as much video on the internet than those aged 50-64, on average, and
they spend 30-40% less time watching TV, according to Nielsen; 2) in Germany, 90%
of the 14-29 years old access online video, versus only 24% of the 50+ years old. As
under-25s grow older, they are likely to keep some key consumption habits.
Overall, we believe that Europe is progressively getting ready for the rise of OTT TV,
with a few countries at the forefront.
This is notably the case of the UK, where customers have been accustomed to OTT
content thanks to the BBC iPlayer, and the first country where Netflix has launched in
Europe. The company has recently described its UK launch as very successful
(Were seeing faster member growth than we did when we launched [in] Canada). In
Central and Eastern Europe, OTT video has also seen significant success, with
multiple independent and broadcaster-backed platforms competing for audience (e.g. in
Poland alone there are at least five platforms such as ipla, and Romania also has
multiple OTT platforms, amongst others dolce.tv).

42

Telecom Operators

Can the content challenge block the rise of OTT?


When OTT services try to move beyond the market fringes and become significant
players, they face a dual challenge: 1) they need to build a content line-up which is
attractive to the mainstream audience this will trigger an increase in content costs,
and 2) they arrive on the radar screens of content production companies such as
Hollywood majors an industry which is more organised than many in terms of
protecting and maximising the value of its intellectual property.
In 2011, Netflix, which has in excess of 20m customers in the US, has faced
renegotiation of its content rights with several majors. It has ended up paying
significantly more than in the past for some of its key content. According to industry
sources, Netflix was able to renew its agreement with NBC Universal only by agreeing
to increase its payments tenfold (to USD300m/year). Also, negotiations with Starz
Entertainment failed, and the company decided not to renew its agreement with Netflix
in order to protect the premium nature of our brand by preserving the appropriate
pricing and packaging of our exclusive and highly valuable content (Starz CEO).
In Q2 11, Netflix changed its pricing policy, proposing separate offers for streaming and
DVD rental, each for USD7.99/m, versus USD9.99/month for both previously, causing a
customer backlash. This generated significant churn in Q3 11 (see Figure 44, right
chart) and accelerated the transformation of Netflix into a streaming-only company.
OTT players realise that they must strengthen their content portfolio:
In the short term, they will probably not invest in sport/mass media entertainment
but rather invest in different types of content, e.g. more niche/viral/long-tail content.
Major OTT players like Netflix and Hulu not only acquire rights but also finance
exclusive content, e.g. Hulu plans to invest USD500m in new content initiatives in 2012
and air web-only premium content (e.g. Battleground), and Netflix financed
Lilyhammer. Not many OTT players will be able to do the same.
In Europe, Netflix CEO recently admitted that competition would be tough in the
UK, particularly against BSkyB, but he warned that Netflix would attempt to steal valueadded content such as Hollywood studio rights from this key competitor when such
rights come up. As our membership in the UK and Ireland grows, well be able to
invest more and more in content.
Will content providers move to sign deals with OTT players? Generally, companies we
have surveyed have underlined that content owners have existing, long-lasting
relationships with established pay-TV operators so for them, deciding to deal with a
new entrant OTT provider rather than with the incumbent pay-TV company represents
a risk. For a content provider, putting pressure on ones main client (the established
pay-TV player) by signing with a new entrant is not a logical move, at least initially.
However, longer term, content producers may find it increasingly difficult to favour the
traditional pay-TV operators over global OTT players, especially in small-size markets
where the local pay-TV operators may be small compared to global OTT players.
In addition, the situation in Europe is made complex by the fact that content rights
legislation varies by country forcing players into country-by-country negotiations. This
makes the process much slower, and reduces the advantage of global or panEuropean players versus local ones.
Overall, we conclude that:
size will be a key factor in the OTT game, as only the biggest players on a local
and/or global basis can maintain power in content negotiations over the long run;

43

Telecom Operators

in any case, OTT players are likely to focus their offers on cheaper content rather
than premium content including free-to-air TV and relatively inexpensive channels,
catalogues of older movies and shows, and a few high profile content propositions.
This means that OTT services should position themselves in a similar way as telcos on
IPTV. Despite early challenges and hiccups, most telcos have been able to grow into
successful triple-play providers. They do not compete head-on with the very high-end
of premium content satellite players, but they do a good job versus the basic-TV
offerings of cable operators.

Impact on pay-TV has yet to be proven


As an alternative way of accessing video content, the rise of OTT TV could trim the
value of the pay-TV market overall either via a lower penetration of pay-TV (e.g.,
customers sticking with double-play and watching OTT content via their broadband line
rather than moving to a fully-fledged triple-play bundle) or via a lower pay-TV ARPU
(i.e., pressure on providers ability to charge a premium for content or ad-hoc VOD
usage) or both.
The US market is both very mature in terms of pay-TV penetration (85%) and very
advanced in terms of OTT development (Netflix has more than 24m subscribers). But
at this stage, the rise of OTT has not led to significant cord-cutting (i.e., customers
cutting their pay-TV subscription).
Figure 44: Limited evidence of cord-cutting in the US
Pay-TV customers in the US (m)

Netflix subscribers and quarterly net additions (000)


30,000

90

4,000
3,500

80

25,000

3,000

70

2,500
60

20,000

2,000

50

1,500

15,000

1,000

40
30

500

10,000

20

(500)

5,000
10

(1,000)

Cable (big 4)

Satellite

IPTV

Subscribers

Q3 2011

Q1 2011

Q3 2010

Q1 2010

Q3 2009

Q1 2009

Q3 2008

Q1 2008

Q3 2007

(1,500)
Q1 2007

Q3 2011

Q2 2011

Q1 2011

Q4 2010

Q3 2010

Q2 2010

Q1 2010

Q4 2009

Q3 2009

Q2 2009

Q1 2009

Q4 2008

Q3 2008

Q2 2008

Q1 2008

Net adds

Source: IEAA Mediascope 2010, Arthur D. Little, Exane BNP Paribas estimates

As shown on the left above, customer numbers at the traditional US pay-TV players
(the four big cable operators plus satellite players) have dipped since Q4 10. However,
including IPTV customers, the total number of pay-TV customers in the US has
continued to rise by c.1%. This is slightly down from +2% in 2009 and H1 10, but given
the economic environment it is hard to attribute the slowdown to the OTT factor alone.
The situation is not so advanced in Europe with pay-TV penetration at 52% so the
risk of cannibalisation should be milder. We have nevertheless modelled the sensitivity
of the overall sector top-line to alternative scenarios on pay-TV. A bear case assuming
no increase in pay-TV penetration between 2011 and 2015e (stalling at 52%) and
ARPU decreasing to EUR22/month in 2015e (compared to EUR27 in our core
scenario) would deflate the total sector revenue CAGR (including fixed+mobile+payTV) by 1% (-2.8% versus -1.8%).

44

Telecom Operators

Figure 45: Sensitivity of incumbents top-line to the triple-play outlook

2015e pay-TV ARPU (EUR/month)

-1.8%

52%

22
27
32

-2.8%
-2.2%
-1.6%

2015e pay-TV penetration


55%
58%
61%

-2.6%
-2.0%
-1.4%

-2.5%
-1.8%
-1.2%

-2.3%
-1.7%
-1.0%

64%

-2.2%
-1.5%
-0.8%

Source: Arthur D. Little, Exane BNP Paribas estimates

Pay-TV players have identified the risk and are developing initiatives to fend off the
OTT risk on their core business. For instance:
in France, Canal+ has launched an SVOD service (subscription video-on-demand)
called Infinity, which is available to SFR and Free broadband customers (soon on
Bouygues Telecoms Bbox) for EUR9.99/month with no commitment. This pre-empts
potential moves from OTT players and widens the potential customer base of Canal+ to
all French broadband households;
in the UK, as of now, BSkyBs online streaming service Sky Go is only open to Sky
customers, but the company plans to launch a standalone OTT service in H1 12,
available to non-Sky customers, with no minimum commitment. Sky announced
accessibility for a wide range of devices (PCs, tablets, mobile phones, game consoles,
connected TVs), a flexible pricing scheme (choice between unlimited access, pay
monthly or pay-for-use) and selective access to Skys content portfolio. Separately,
BSkyB is also letting catch-up TV services from the BBC (iPlayer) and ITV onto its box,
with less control over the user interface and editorial control of front pages.

An opportunity rather than a risk for telcos


For telcos, the downside risk associated with potential pay-TV cannibalisation by OTT
TV services is limited, given their low starting point in terms of revenues while in our
view OTT represents two attractive opportunities for them:
teaming up with OTT, telcos could propose innovative triple-play offers compared to
legacy pay-TV providers, and hence accelerate their penetration of the pay-TV market;
the rise in OTT could accelerate the take-up of super-fast broadband by customers,
potentially boosting telcos broadband revenues.
Telcos have limited exposure to downside on pay-TV - As shown in the table below,
incumbents top-line shows relatively limited exposure to bear case scenarios on the
broader pay-TV market. If triple-play penetration remained flat at 24% rather than
increasing to 40% by 2015e, the total incumbent revenue CAGR would reach -4.0%
versus -3.6% in the core scenario. Also, the sensitivity is relatively low to a bear case in
which IPTV ARPU would be declining rather than growing in the long run.
Figure 46: Sensitivity of incumbents top-line to the triple-play outlook

2015e IPTV ARPU (EUR/month)

0%

13
18
8

-4.5%
-4.5%
-4.4%

Source: Arthur D. Little, Exane BNP Paribas estimates

45

2015e triple-play penetration


20%
40%
60%

-4.2%
-4.0%
-3.9%

-4.0%
-3.6%
-3.3%

-3.7%
-3.2%
-2.7%

80%

-3.5%
-2.8%
-2.2%

Telecom Operators

OTT as an opportunity to differentiate Telcos could use the new OTT trend to be
more disruptive in the pay-TV market i.e. to differentiate themselves from legacy payTV players. Opportunities include:
striking partnerships with OTT providers and bundling their services into their tripleplay packages. For instance, this is what TeliaSonera, Orange France, KPN or SFR
(France) are doing on the music side with Spotify or what Orange could do in France
via its partnership with Dailymotion (in which it has acquired a 49% stake);
pushing the multi-platform angle i.e. making content available on any device,
anywhere, in a seamless way. For instance this is the type of service proposed by
Mobistars Starpack offer in Belgium (not successful so far due to activation issues and
its reliance on satellite), or by the latest Bouygues Telecom Bbox in France.
These opportunities to differentiate could be especially relevant: 1) in markets where
telcos have failed so far to grow in triple-play and where existing TV providers are well
entrenched (e.g. Italy, the UK or Germany). For instance, in the UK, the Youview JV
could help BT and TalkTalk to expand further into triple-play; 2) more generally, for
mobile-only operators which have yet to significantly enter the triple-play market.
In any case, the sensitivity of incumbents revenues to a bull case is relatively limited.
For instance, if we assumed that they would be able to seize their fair share of the
pay-TV market i.e. that their customer market share of pay-TV would in the long run
equate their customer market share in broadband (42%e), this would point to revenue
CAGR of -3.0% versus -3.6% in the core scenario.
Indirect positive impact on broadband - A positive impact from the development of
OTT for the sector (including both telecom and cable operators) could be to drive
broadband revenues by:
1) expanding fixed broadband penetration potentially enabling a stabilisation or even
a return to growth in the number of fixed lines in the markets which have suffered most
from fixed-mobile substitution (e.g. Telekom Austria growing its number of fixed lines by
21k in 2011, admittedly from a low base);
2) pushing towards faster speeds and hence potentially driving broadband ARPU up,
even if no direct pay-TV revenue is captured by telcos.
As one interviewee put it, OTT content is pulling broadband, which is good. This is a
similar phenomenon as that observed on mobile, with the Apple iPhone and AppStore
driving mobile data traffic: even though mobile operators are not getting any revenue
from applications, they are getting a benefit from increased mobile data usage and
customers moving from higher speed services.
Indeed, OTT video services require up to 3.8Mbit/s of actual streaming speed for HD
quality video, as shown in the table below.
Figure 47: Broadband speeds required by different OTT video services
Service

Broadband speed (Mbit/s)

Netflix HD
Netflix SD
BBC iPlayer
Hulu
M6 Replay HD
SeeSaw
Blinkbox

2.6-3.8
0.375-1.5
0.8-3.2
0.48-0.7
>1
Up to 0.5
0.27-1.1

Source: Exane BNP Paribas estimates

46

Telecom Operators

According to Akamai, the average speed of broadband access in Europe has increased
by 26% yoy, to 5Mbit/s, but there are still only 29% of customers getting an average
speed in excess of 5Mbit/s and this percentage is below 20% in France, Italy and
Spain. This clearly highlights the need for faster broadband speeds for customers
willing to use OTT services providing a competitive edge to operators able to provide
faster speeds. This is currently mainly cable operators (e.g. in the Netherlands,
Belgium and Portugal), but as detailed in our 2011 report, we believe that telecom
operators also need to accelerate the rollout of super-fast broadband services.
Figure 48: Broadband speeds in Europe, according to Akamai
Country

% >5Mbit/s

Average speed (Mbit/s)


Q3 11
Q3 10

YoY

IT
FR
SP
AT
UK
SE
DE
FI
PT
NO
CZ
DK
CH
BE
NL

14%
15%
18%
30%
31%
31%
33%
36%
40%
40%
50%
51%
51%
54%
68%

4.0
3.8
4.0
5.4
5.1
5.3
5.3
5.7
5.1
6.2
7.3
6.3
7.5
6.2
8.5

3.3
3.3
2.8
3.7
4.0
4.9
4.3
4.4
4.0
4.9
5.5
5.0
5.4
4.8
6.3

22%
15%
45%
47%
26%
7%
24%
29%
29%
26%
33%
25%
40%
28%
34%

Weighted average

29%

5.0

3.9

26%

Source: Akamai, Arthur D. Little, Exane BNP Paribas estimates

The table below shows the sensitivity of the overall sector revenue CAGR to
assumptions regarding super-fast broadband penetration and ARPU in the long run.
Our core assumptions are 20% penetration of the broadband base by 2015e (versus
4% today) and an incremental ARPU of EUR10. Massively increasing the penetration
to 40% of the broadband base and assuming an incremental ARPU of EUR15 would
lead to a bull case scenario whereby the sectors revenue would decrease by a milder
1.2% versus -1.8% in the core scenario.
Figure 49: Sensitivity of the sectors revenue CAGR to super-fast broadband
2015e penetration, % of broadband customer base
10%
20%
30%
40%
2015e incremental
ARPU (EUR/month)

-2.1%
-2.0%
-1.9%

5
10
15

-2.0%
-1.8%
-1.7%

-1.9%
-1.7%
-1.4%

-1.8%
-1.5%
-1.2%

50%
-1.8%
-1.4%
-1.0%

Source: Arthur D. Little, Exane BNP Paribas estimates

Another opportunity for telcos associated with OTT could be to generate wholesale
revenues by charging them either for bandwidth or for additional services (e.g. CDN,
billing, etc.): we discuss these in page 57.

47

Telecom Operators

Are OTT services Trojan horses about to capture the customer?


OTT service providers will develop their own customer base over time either on a
paying basis (e.g. Netflix) or on a free, advertising-based model (Youtube). Telcos
would continue charging for access but OTT players would increasingly charge for
services (or get advertising revenues to support these services). The value chain would
evolve with the risk that the telcos get disintermediated over time and end up being
purely commodity dumb pipes.
The risk could be significant for mobile: customers could increasingly see Skype,
WhatsApp, Apple or Google as their main service provider, not just for some marginal
services but also for core communication services such as voice and messaging.
Customers would continue paying mobile operators for an access bundle, of which the
core component would be data traffic. This shift in customer ownership from operators
towards OTT players is not only theoretical: there is a growing trend among customers
to use OTT platforms (e.g. Google, Facebook, etc.) to manage their primary contact
databases and diaries as opposed to storing and managing these data in the handset.
The extent to which such a scenario would be negative for operators depends on the
split of value between access and services. Since the real value will increasingly be in
data while voice and SMS will increasingly be commoditised, operators relationship
with customers as a data provider will remain important.
However, large OTT players do not necessarily worry about direct revenues and profits
from these OTT communication services, but rather aim at boosting their core business
in a different field, such as hardware sales (Apple) or advertising (Google, Facebook).
Indeed, regarding pure OTT players, we believe in a winner takes all situation, e.g.
Spotify in music (already profitable), WhatsApp, in messaging, etc. (albeit with room for
smaller OTT players if they manage to differentiate and provide services adapted to the
local context e.g. Deezer or Dailymotion in France).
The risk for telcos would be much more significant if OTT players were to become
operators or even just MVNOs i.e. were able to capture the whole customer
relationship. At this stage, this risk has remained contained.
In the UK, Amazon is selling Kindle e-reader devices with embedded 3G
connectivity and no monthly fee for GBP149. This remains small in the scheme of
things, and this is an additional device rather than the core device/handset.
Google is rolling out a 1Gbps fibre network in Kansas City (USA), but this remains a
very local case. The official goal is to foster innovation and new usages through ultrahigh-speed networks.
A few years ago, Apple considered introducing soft SIM cards in its iPhone
handsets (as opposed to classic SIM cards which are controlled by the operator), a
move which could have led telcos to lose their control of the customer. However,
considering that telcos are the main distributors of iPhone, it would have been
dangerous to confront them so directly. Nevertheless, its recent assault on SMS
revenues (making iMessenger a native application in its mobile devices) was viewed as
a painful precedent by some mobile operators.

48

Telecom Operators

In any case, this risk of disintermediation should not be ignored, notably when
operators make strategic decisions about distribution or SIM-only.
Given the importance of devices for customers (the device is king), the player in
control of the distribution of devices has a stranglehold over the value chain. The
balance of power, previously in favour of telcos, could change further if they were to
significantly reduce their retail footprint and/or device subsidies to cut costs, while
players like Apple develop their own retail networks.
SIM-only leads to separating the handset from the service provider and could also
be a strategic risk for telcos. At this stage, we estimate that SIM-only represents less
than 5% of the customer base in Europe, and less than 15% of gross additions. But
there are two types of exceptions: 1) some markets have had no subsidies historically
(Italy, Belgium), and 2) a few others are currently moving away at least partially from
subsidies (Denmark and France).

Capex risk on the fixed-line side, for super-fast broadband


OTT data is the main driver of the exponential growth in global IP volumes, which are
expected to quadruple by 2015, according to Cisco. Will this exponential traffic growth
force telcos to increase capex massively? We stick to the views developed in our 2010
and 2011 reports on mobile and fixed-line capex, i.e. we believe that telcos need to
increase capex in fixed-line to catch up in super-fast broadband, but not massively so
in mobile.
Regarding fixed-line, we reiterate the view we expressed last year, that telcos need to
upgrade to super-fast broadband and that this will require higher capex. This mainly
relates to the access part of the network, which is also the most costly. The core
networks are scalable: capacity in the core network has always and will continue to be
increased as traffic grows.
Figure 50: Evolution of the global consumer* IP traffic, 20102015

CAGR

PB per Month
35.000
Internet video

+48%

File sharing

+23%

Web, email, and data

+29%

Video calling

+41%

Online gaming

+43%

30.000

25.000

20.000

15.000

10.000

5.000

Voice over IP (VoIP)


Others
0
2010 2011 2012 2013 2014 2015
* Consumer traffic accounts for ~80% of world traffic in 2010 and ~87% in 2015F
Source: Cisco

49

+4%
+132%

Telecom Operators

As for mobile, we see no real concern, for several reasons:


Traffic is much more modest and sometimes not growing as fast as could be
expected a few years ago, because operators have managed to control/reduce traffic
from mobile dongles. For instance, Vodafone Europes data traffic growth has slowed
to around +20% yoy since Q2 11, with dongle traffic reported flat in Q4 11;
Technologies provide more and more capacity for the same cost the next move
being LTE. Operators are already preparing the LTE rollout by swapping their networks
to a single-RAN technology which is 4G ready;
There is potential to offload a large part of the traffic on fixed-line via WiFi.
According to Cisco, 10% of Western Europe's mobile data traffic was offloaded in 2011;
this proportion should grow to 25% by 2016. Focusing specifically on mobile data traffic
originating from handsets and tablets, the figures are 30% in 2011 and 34% by 2016.
At this stage, tablets are largely connected via WiFi rather than 3G (according to GFK
only 23% of tablets sold in France in 2011 were 3G-enabled, while according to Park
Associates, only 29% of the 16.5m tablets sold worldwide in 2010 were 3G-enabled).

Key tactics to avoid the bear case


Operators attitude towards OTT-related risks has changed significantly in the past few
years. As shown in the chart below, the negative approach (i.e. try to block them) was
only quoted by a handful of those surveyed, and most companies articulated responses
revolving around two key themes:
Telcos should compete with OTT on the customer front by leveraging existing
customer relationships in their local markets (leveraging customer trust, the billing
relationship, the local hero status versus the global OTT, the local language, and, on
the fixed broadband side, the box). They should at the same time protect their existing
revenue streams through more aggressive bundling by bundling services that can be
cannibalised (voice and SMS) with services that can cannibalise them (data), so that
ARPU becomes insensitive to the actual usage mix;
Recreating a clear link between traffic/usage and revenues, either on the customer
front (tiered pricing) and/or on the OTT provider front. Many telcos envisage developing
partnerships with OTT providers, to whom they can offer a better quality of service,
guaranteed bandwidth, etc., for a fee. The most advanced example of this would be
Verizons Digital Media Services initiative (see below).
Figure 51: Interview feedback Operators in constructive mode with OTT?
Number of responses regarding Telcos levers to face competition from over-the-top players
Leverage customer contact, trust & billing
Control and monetise QoS and bandwidth
Develop partnerships with them
Offer them wholesale services such as CDN
Leverage brand, 'local hero', language
Launch own OTT services
Leverage customer data
More price/service bundling
It will be difficult
Leverage STB (better than OTT)
Block them and ask for money
This is only a minor subject
Push for regulatory changes
0

Source: Arthur D. Little, Exane BNP Paribas estimates

50

10

15

20

25

30

35

40

45

50

Telecom Operators

In our view the most effective responses are: 1) price bundling, which we think can
basically halve the risk of cannibalisation of mobile operators legacy revenues;
2) tiered pricing, not just in mobile but also in fixed, to ensure revenues increase in line
with traffic growth; 3) leveraging the box, in fixed-line; and 4) developing wholesale
revenues from OTT providers, although this is difficult to quantify except for the CDN
activity, which is a relatively small opportunity.

Blocking OTT: not a long-term option


The initial response of many mobile operators has been to block VOIP on their networks.
This is particularly the case with many leaders. However we believe that blocking OTTs
will not be a long-lasting solution. Interestingly, among those surveyed, only four (from 93
responses) mentioned blocking OTT as a possible long-term solution.
Indeed, competitive pressure is likely to make this tactic unsustainable. In most
markets, the challenger(s) are not blocking VOIP, so leaders may have to follow. For
instance, in the UK, Everything Everywhere is blocking Skype, Vodafone is allowing
Skype on its relatively high-end contracts but charging GBP15/month to use Skype with
lower-end contracts, while 3 and O2 are allowing Skype. Similarly, in Germany, e-plus
and O2 both allow VOIP, but only on higher tier data plans.
Figure 52: Operators attitudes towards mobile voice over IP

Market position (shares)

Leader

Challenger
Partner with
VoIP provider

Allow use with


data plan

Impose a
surcharge

Prohibit use
of VoIP

Action towards mobile VoIP


Source: Arthur D. Little, Exane BNP Paribas estimates

In any case, European regulators have said that they are opposed to such blocking,
citing net neutrality rules. In the UK Ofcom has recently put pressure on operators
banning Skype.
The European parliament passed a Net Neutrality Resolution in November 2011,
which points to the potential of anti-competitive and discriminatory behaviour in traffic
management, in particular by vertically integrated companies and underlines that
ensuring quality in time-critical service traffic shall not be an argument for abandoning
the best effort principle.
On the other hand, the resolution states that as of now, there is no clear need for additional
European-level regulatory intervention on net neutrality. It also said it will wait for the
publication of new guidelines by BEREC (the body comprises all European national
regulators) in Q2 12 before deciding whether further regulatory measures are needed.

51

Telecom Operators

Pricing response #1 = Bundling


Bundling services is a great way to avoid cannibalisation of one service by another, and
to enrich an operator customer proposition, hence better defending pricing.
Bundling the new and the old revenue streams
This approach has been very successfully implemented by fixed-line operators when
they were attacked by fixed VOIP players like Skype a few years ago. For instance, in
France, telcos have included unlimited fixed VOIP calling in their broadband offers
(alternative carriers have included unlimited calls not only to France but also to more
than 100 international destinations), to the extent that 65% of fixed telephony traffic in
France was carried via operators broadband boxes in Q3 11 and only 35% over the
PSTN. This has neutralised the appeal of Skype to French consumers.
In mobile, operators core response to averting voice and SMS cannibalisation by data
is to bundle voice and SMS with data, i.e. to make sure that customers cannot access a
large data bundle without also paying for voice and SMS. Countries where operators
have rearranged their tariffs this way include France (unlimited SMS in all monthly
plans giving access to data), the UK (unlimited SMS from relatively low price points of
GBP1520 for most operators) and Denmark (unlimited SMS in all bundles).
However, there are still many monthly plans for smartphones which offer data usage
but do not include unlimited SMS in Spain (this is the case in particular at Telefnica
and Orange) and, to a lesser extent, in Germany (unlimited SMS offered in most
smartphone plans at Vodafone and E-Plus, but only progressive SMS allowances
offered by O2, and no SMS included at T-Mobile) and Belgium (Mobistar has been
offering customers the choice between unlimited SMS and data, rather than bundling
SMS with data).
Vodafone is pushing this bundling strategy throughout its European footprint. It has
reported that these efforts are particularly well advanced in the UK (68% of consumer
contract revenues from integrated bundles in Q4 11) and the NL (49% in Q1 11). At the
Vodafone Europe level, 37% of consumer contract revenues are generated from
integrated bundles a commendable achievement since the penetration of
smartphones in the contract customer base is 42%, and these two figures have been
climbing in parallel, as shown in the chart below.
Figure 53: Revenue contribution from integrated bundles (as a % of consumer contract revenues),
compared to smartphone penetration, in the Vodafone Europe contract customer base
Vodafone Europe, evolution over time

Vodafone Europe and Vodafone UK Q4 11

45%

80%

40%

70%

35%

60%

30%

50%

25%
40%
20%
30%

15%

20%

10%

10%

5%
0%

0%
Q4 10

Q1 11

Smartphone penetration

Q2 11

Q3 11

Q4 11

Europe

Revenues from integrated bundles

Smartphone penetration

Source: Vodafone, Arthur D. Little, Exane BNP Paribas estimates

52

UK
Revenues from integrated bundles

Telecom Operators

Such an approach should in our view keep the risk of revenue cannibalisation in check.
For instance, assuming that operators would be able to reduce the share of out-ofbundle revenues from roughly a third of consumer contract revenues to less than 10%
by 2015e, and assuming that prepaid tariffs would also be increasingly integrated
(i.e. selling voice, SMS and data top-ups together), the sensitivity of operators revenue
to cannibalisation would be drastically reduced. The impact of our bear case
cannibalisation scenario on operators revenue would be at least halved.
Adding OTT services into the bundles to add value
To defend against the threat of becoming dumb pipes, another pricing response from
operators is to bundle core services with specific OTT services with which they have
partnered. This would increase the perceived value of the whole bundle, to better
defend the operators core revenues.
This approach is popular among industry participants: of 93 interviewees, 27 talked
about the opportunity of developing partnerships with OTT players. And there are
already many examples of such an approach, both in fixed broadband and in mobile:
in mobile, the bundling of music services, for instance Deezer with Orange France
and Orange UK, and Spotify with 3UK or SFR in France;
in fixed-line, the bundling of video content services such as BBC iPlayer and TiVO
by Virgin Media, and also music services such as Deezer with Orange France, and
Spotify with TeliaSonera in Sweden and KPN in the Netherlands.
The value added here, notably on the fixed-line front, is that the offer can include
enhanced service quality relative to that available from an independent OTT offer,
because the operator can integrate the specific content in its core proposition (see
specific point on the box strategy below). The risk here is that operators could fail to
convince the consumer of the value added of such service bundles.

Pricing response #2 = Tiered pricing an absolute necessity


Data has become the main source of traffic (and of traffic growth) both in fixed-line and
mobile, so monetising data is essential. This is especially so given that the growth in
data traffic is driven mainly by OTT applications, from which operators do not get
additional revenues, the best examples being Youtube and Facebook.
In fixed-line, unlimited data usage is the norm (with caps in some markets), but in most
countries, prices differ by broadband speed a simple form of tiered pricing. The move
towards super-fast broadband, both on cable (with DOCSIS3.0 technology) and on
telecom networks (VDSL, FTTH) is an opportunity to increase ARPU.
Furthermore, telcos develop fixed broadband tiered-pricing through extra options. For
instance: in the UK, BTs discount brand plusnet proposes a Pro option for gamers
and home workers for GBP5/month (lower latency and ping, prioritized traffic, etc.) and
Virgin Media has tiered broadband pricing; in Italy, Telecom Italia proposes a Super
Internet Offer starting from EUR4/month enabling speed increase (up to 1Mbit/s in
upload, 1020Mbit/s in download).
In mobile, the incremental cost of a GB of data is significant and spectrum is a scarce
resource, so most operators have moved away from unlimited data pricing. The first
step has been to introduce fair usage policies, followed by the design of a price ladder
depending on traffic.
Using a wide sample of offers in six countries, and putting them in categories
depending on the size of the data allowance (see chart below) we have calculated
approximate average prices: EUR24 per GByte for entry-level users
(0.2-0.5GByte/month), EUR13 per GByte for mid-tier users (0.5-1GByte/month), and
EUR8.4 per GByte for the heaviest users (more than 1GByte), including VAT.

53

Telecom Operators

Figure 54 below shows how we have calculated the implied price of mobile data on a
subset of mobile contract pricing examples in France, the UK and the Netherlands, by
comparing the price of bundles with equivalent voice and text allowances but different
data allowances.
Figure 54: Mobile data pricing examples from six European markets
EUR per GByte, including VAT
70
65
60
55
50
45
40
35
EUR24

30
25

EUR13
EUR8

20
15
10
5
0
0.25-0.5GB

>0.5-1GB

>1GB

Source: Arthur D. Little, Exane BNP Paribas estimates

Figure 55: Mobile data does not come for free


Examples of mobile offers with different amounts of data, and calculation of implied price of data
Operator

Offer 1

Price

Data

Orange France

Style 120*
Star 120
Star 180
Star 300

29
37
45
55

0.5
2
2
2

SFR (France)

Web 120
Web 180

37
43

1
2

Bouygues (France)

Relax 120
Smartphone 120
Smartphone 120
Smartphone 180
Smartphone UL
B&You
B&You

22
35
35
39
69
38
38

Orange UK

Panther 100
Panther 400
Panther 600

Vodafone UK

Offer 2

Price

Data

EUR/GB

Zen 120
Style 120
Zen 180
Zen 300

21
29
29
37

0
0.5
0
0

16.0
5.3
8.0
9.0

Connect 120
Connect 180

24
34

0.25
0.5

17.3
6.0

0.35
1
1
1
1
1
1

Classic 120
Classic 120
Relax 120
Relax 180
Relax UL
B&You
B&You

18
18
22
31
64
25
33

0
0
0.35
0.5
0.5
0.1
0.5

11.4
17.0
20.0
16.0
10.0
14.4
10.0

20.5
31
36

0.5
0.75
1

Dolphin 100
Dolphin 400
Dolphin 600

15.5
26
31

0.1
0.25
0.25

12.5
10.0
6.7

300 min
600 min
900 min
900 min

20.5
26
31
36

0.25
0.5
0.5
0.75

300 min
600 min
900 min
900 min

15.5
20.5
26
26

0
0
0
0

20.0
11.0
10.0
13.3

T-Mobile UK

300 min
600 min
900 min

25.5
30.6
35.8

0.5
0.5
0.5

300 min
600 min
900 min

15.3
20.4
30.6

0
0
0

20.4
20.4
10.2

KPN NL

100 min/SMS
200 min/SMS
350 min/SMS
450 min/SMS

30
37.5
47.5
57.5

0.1
0.25
0.75
1

100 min/SMS
200 min/SMS
350 min/SMS
450 min/SMS

20
28.5
40
50

0
0
0
0

100.0
36.0
10.0
7.5

Vodafone NL

125 min/SMS
225 min/SMS
325 min/SMS

28.5
36.5
44.5

0.3
0.5
0.7

125 min/SMS
225 min/SMS
325 min/SMS

20.0
29.3
39.0

0
0
0

28.3
16.1
8.5

* Origami Style 120 includes unlimited access to Deezer Premium (EUR4.99/month), which generates data consumption.
Source: Arthur D. Little, Exane BNP Paribas estimates

54

Telecom Operators

In our industry revenue model, we have used an average revenue per GByte of EUR26
for 2012e, with the figure falling to EUR6 for 2015e. In the long run, average traffic per
smartphone is expected to reach 1.9GB/month, so the revenue per GByte of EUR6 that
we have used actually assumes only a limited price decline compared to todays offers
for the heaviest users (EUR8.4 per GByte).
However, the adoption of fully tiered data pricing is not a given, given the competitive
pressures in many mobile markets. For instance, the well structured tiers launched by
UK and French operators could be disrupted by the respective push on unlimited data
pricing from 3 and T-Mobile in the UK (e.g. T-Mobiles Full Monty bundle including
unlimited texts and unlimited internet with no fair usage policy), and from Free Mobile in
France (EUR19.99/month for unlimited voice, unlimited SMS and 3GBytes of data).

Product response #1 = The box


On the fixed broadband side, a number of operators are trying to leverage the box to
offer a superior service compared to those available directly from OTT players.
Examples include Iliad in France with the Freebox Revolution, Virgin Media in the UK
with its BBC iPlayer partnership and the successful launch of the TiVo box.
Compared to OTT, the advantages of integrating services into the box are:
the ability to provide a superior quality of service. IPTV or cable TV is superior to
internet TV and is likely to remain so, because the TV stream is provided via a
dedicated channel (or set of channels). Unlike TV signals carried over the broader
internet, the quality of the delivery can be ensured;
the ability to bring a wide variety of services together on the customers screen, i.e.
the power of aggregation. While with OTT the customer may (at least initially) have to
go to different websites/service providers (and potentially to subscribe to multiple
services) to get all the content desired (e.g. in the UK, one needs to go on the BBC
iPlayer website to get BBC content, use the ITV Player to get ITV content and
subscribe to Netflix for specific drama series or movies, etc.);
the ability to get specific local content that OTT players do not have. A significant
part of what TV users want to watch is local or regional, including news, sports
(football), series, etc.
the ability to bundle all this with the management of the users personal content i.e.
the role of the box as a multi-media storage device. Operators can exploit the users
trust in its local provider for the storing of personal pictures, movies, etc., and make it
possible to watch them on several devices, e.g. the Freebox Revolution or the
Bouygues new Telecom Bbox Sensation.
Importantly, such a box strategy is very specific to the fixed-line: mobile operators do
not control the device, especially now that the key element has become the operating
system, dominated by Apple (iOS), Google (Android) and potentially Microsoft (notably
supported by Nokia).
However, the long-term sustainability of such a box strategy in fixed-line can be
questioned. Content is moving into the cloud anyway, and TV sets are becoming
increasingly smart i.e. able to directly connect to OTT services. As such, some
interviewees believe that the box will soon become an irrelevant piece of hardware.
In our view: 1) the box will still act as the gatekeeper in the next few years, mainly
because it is provided by a trusted operator and enables a simple and rich experience,
and, 2) in the longer term, operators can prolong the life of the box by ensuring that the
hardware and OS remain up-to-date and by enriching the content offering via
partnerships with OTT players.

55

Telecom Operators

Product response #2 = Own OTT services?


A few operators have mentioned launching their own OTT services as a way to counter
the threat from the OTT pure plays. Examples of such a strategy follow.
On the mobile side, Telefnicas acquisition of the mVOIP player Jajah is the
boldest example. The company paid EUR145m in 2009, with the intention of using
Jajahs communication platform and R&D expertise, and leveraging it to create new
services and attract innovative developers. Since then new products and partnerships
have indeed been created, consistent with Telefnicas broader strategy.
Figure 56: Jajahs new developments with Telefnica

New products & partnerships

Integration to social networks

Further development of Jajah


platform (web, PC, mobile, set top)

Facebook calling on Android


platform

Cooperation with Microsoft for Lync /


Office (for SMEs)

Twitter calling(@call@)

New products launched: Phone a


Friend (DE), Calling cards (UK)
Product launch follows TEF footprint:
Europe: SP, GE, UK
Latin America: 6 countries planned

Importance of social network


integration:
Re-integrated social network
communications in Telefonica
network
These communications are not
free: drive revenues

Source: Arthur D. Little, Exane BNP Paribas estimates

In an attempt to emulate the success of SMS, Telefnica, Vodafone, Orange,


Deutsche Telekom and Telecom Italia recently announced the launch of an initiative to
create a new standard for advanced communication services, based on the existing
RCS (Rich Communication Suite) technology. Services will include enhanced contact
management, messaging, video calls and file sharing. Orange has announced that it
targets 20m RCS handsets in its customer base by 2015. It highlighted that the main
benefit of RCS would be that, unlike OTT services, RCS services would be
interoperable between different handsets.
On the fixed broadband/content side, the TV Everywhere concept launched by US
cable operators and by BSkyB in the UK (see page 45)
Even though such a strategy could be interesting, it will be difficult for telecom operators
to execute. Indeed, OTT services are fundamentally services developed to be rolled out
globally on all networks whereas telcos target is to grow or defend revenues from
their existing customer base, in the specific regions they cover. These are two very
different approaches. In addition, as can be seen from many past examples:
for telcos, it would be a daunting task to develop their own successful OTT offers
from scratch. In this field, they would be competing against both web giants, which
employ thousands of software developers worldwide, and against start-up companies
i.e. small groups of very motivated and innovative people. Most interviewees have
highlighted the cultural differences between these software specialists and large telcos;
it is also very difficult to acquire start-ups as the start-up spirit and culture can easily
and rapidly get diluted by big organisations like the large telcos. Moreover, as
highlighted by several interviewees, the risk for a large telco is to acquire an also ran
start-up company rather than the leader in its field, when the world of OTT is very much
a winner takes all market.

56

Telecom Operators

Wholesale response = double-sided business model opportunity


Apart from maximising revenues from customers, operators are increasingly looking at
generating revenues from service providers utilising their networks, in particular the
OTT TV players.
At this stage, the most common situation is that the Youtubes and Netflixes of the world
are sending traffic through telecom networks on the basis of symmetrical peering
agreements that have governed relationships between players since the inception of
the internet. They do pay content delivery services (CDN) as well as for quality of
service, in some cases, but operators see their contribution as largely insufficient.
Operators view the traditional peering system as unfair because, with video services,
internet traffic is not symmetrical at all: OTT TV players send huge amounts of traffic in
the direction of customers connected to the local telcos networks. This traffic is
generating no incremental revenue for telcos, but they still need to invest in their
networks to keep up with this traffic increase.
The first business opportunity for telcos is to propose differentiated levels of quality at
different prices. For instance, they could create a new guaranteed quality delivery
service, enabling video streaming companies to choose between two options: 1) basic,
free delivery, as currently and 2) premium delivery with a guaranteed quality, for a fee.
BT Wholesale introduced such a service in 2011.
A second opportunity is to provide more value-added wholesale services to the OTT
players, including notably 1) hosting, content storage and delivery (i.e. Content Delivery
Network or CDN), and 2) services monetising operators knowledge of their customers.
For instance operators can track customers usage and sell this information to
advertisers; they can provide dynamic advertising insertion i.e. insert advertising
tailored to each customers profile (localisation, preferences, etc.). These different
types of approaches have been mentioned by a large number of respondents: 39 of 93
talked about telcos monetising the quality of service and bandwidth of their networks,
and 17 about offering wholesale services such as CDN services to OTT players.
One of the most advanced initiatives combining these different approaches is Verizons
launch of a Digital Media Services division. The aim is to provide a platform to content
providers, retailers and advertisers to deliver any content on any device with
guaranteed QoS. It will soon include value-added services such as local ad insertion.
This platform positions Verizon to be able to cater to OTT players willing to move
towards unicast i.e. personalized direct-to-consumer content delivery offers.

57

Telecom Operators

Figure 57: Verizon Digital Media Services initiative 1/2

Source: Verizon, Arthur D. Little, Exane BNP Paribas estimates

Figure 58: Verizon Digital Media Services initiative 2/2

Source: Verizon, Arthur D. Little, Exane BNP Paribas estimates

The CDN opportunity - All large operators have made moves in this direction: AT&T
launched its own CDN in 2008, Deutsche Telekom has been partnering with Edgecast
for IPTV since 2009, BT has a CDN offer through BT Wholesale, KPN launched its own
CDN in 2009 with JetStream, Telecom Italia has a partnership with CDNetworks and
Telefnica launched its own CDN in 2010.
Telcos have two reasons to play the CDN market: 1) the monetisation of content
delivery, i.e. being paid by content providers to cache content closer to the customer,
and 2) the reduction of network costs: replicating the most heavily demanded content at
the edge of the network reduces the need for network capacity. Telcos have a
competitive advantage compared to global pure CDN players: they can cache content
in many more places, and are hence closer to the customers.

58

Telecom Operators

Telcos could build a winning proposition by combining the following.


The strength of their local presence: each local telco can build CDN servers closer
to the customer in each country, hence maximising the benefit of caching and storing
content to reduce traffic flows and improve latency;
A potential proposal of a global CDN offer to global content providers. Indeed most
content providers expect a global footprint from their CDN operators to avoid dealing
with several counterparts (although there is a national CDN market, for national TV
channel websites for instance). A possible solution for telcos is to federate their
national CDNs, enabling global content providers to put their content into all the local
CDNs of different telcos, via a single contract and, technically, a single entry point.
Standardization initiatives have started (e.g. IETF CDNi) but the technical and
economic aspects of such a federation are still to be specified. Another solution is to
sell a national CDN service to global CDN players like Akamai, which are providing
global coverage to their clients through a combination of their own network and
agreements with local telcos.
However, the size of the global CDN market is estimated at only USD2bn3bn in 2011,
and it is unlikely to exceed USD10bn by 2015 even in a bullish scenario, where
demand from CDN would be driven by the development of more attractive CDN offers
by telcos. The market is currently dominated by Akamai (see chart below), which is a
global player.
In Europe, the opportunity for telcos can be estimated at EUR800m, but it depends
very much on operators level of commitment, and their ability to coordinate to provide
a federated CDN. Our estimates thus range from EUR400m by 2015, in a scenario of
moderate market development and a 25% market share, to EUR1.2bn if telcos capture
50% of the market (which also means that they would make a stronger push in this
market and thus fuel overall growth). In any case, CDN revenues most probably will not
represent more than 0.5% of total telecom sector revenues by 2015.
Figure 59: The CDN market is a small one, compared to telcos
Revenues of the main CDN players

In m$ (2010)

Akamai

Total CDN market revenue forecasts

1.023

In bn$

CAGR

12

12

+46%
183

Limelight

10
8

115

Internap

6
Highwinds

+27%

100

4
Amazon Cloudfront

75

Level 3

60

Cotendo

2
0
2006

20

2008

2010

2012

2014

"Status quo" scenario


"Push from Telcos" scenario

Source: Arthur D. Little, Exane BNP Paribas estimates

59

2016

Telecom Operators

Diversification: work hardfor the long term


When not only everyone, but also everything will be connected, surely telcos will
benefit. How big is the internet of things opportunity overall? How can telcos best
position themselves? Will this new world bring the sector back to growth?
Thanks to IP technology, a multiplicity of devices will be connected, beyond mobile
phones, computers and tablets: cars and other moving objects, utility meters
(electricity, gas, water), other home appliances and vending machines, as well as
medical devices. Mobile phones will become electronic wallets (m-payment). Finally,
the increasing power of IT infrastructure, combined with broadband everywhere, is a
key driver for remote provision of IT services this is the cloud opportunity.
Each of these types of devices relate to specific vertical markets e.g. automotive, energy
and utilities, healthcare, financial services, etc. Each of those is a large market in itself
compared to the telecom market and can benefit from the smartisation of devices, which
can bring cost savings as well as enable innovative services to customers.
All these are very long-term opportunities, and opinions on the probability of telcos
success are divided. We estimate the total potential for incumbent telcos to be 4-9% of
their revenues by 2015e potentially significant even though this will not reverse the
sectors revenue decline before 2015e. The largest operators are already positioning
themselves and we believe that cloud services, moving objects (including connected
cars and fleet telematics) and building surveillance and automation are all interesting
areas to explore.
Figure 60: Seven areas offer business potential for players along the value chain
Includes:
- Smartphones
- Table PCs
- Mobile Computers
-

Energy
Smart Metering & Smart Grid

Mobile
Devices

Medical & Health

Includes:
- Medical Equipment
- Assisted Living
- eHospital
- Sports/Training

Smart
Home

Smartization
Smartization
Areas
Areas

Industrial Retail
Vending MachiProcesses nes & POS

Source: Arthur D. Little, Exane BNP Paribas estimates

60

Includes:
- Appliance Automation
- Security/Surveillance
- Consumer electronics
- Media
- Infrastructure

Moving Objects

Includes:
- Connected cars
- Commercial fleets
- Freight / Containers
- Logistics & Tracking

Telecom Operators

How big is the opportunity overall?


These vertical opportunities relate to large markets: energy and health each
represents around 4% of consumer spending versus 2.8% for telcos, while
transportation represents as much as 13% (of which the purchase of cars is 4%).
The telecom-based services that can be provided in these vertical markets are mainly
based on machine-to-machine (M2M) applications, i.e. SIM cards embedded in
machines (cars, utility meters, etc.) that send and receive data to and from servers.
Figure 61: Consumer spending in telecoms compared with key verticals areas
Share of household expenditure
Telecommunications: 2.7%
Financial services: 2.4%

Telecom. Equipment
0.2%

Household appliances: 0.9%

0.9%

2.4%
2.5%

Telecom. Services

Energy: 3.8%
Solid Fuels
Liquid Fuels

Health: 4.0%

Heat Energy

Hospital Service
0.7%

0.1%
0.2%

0.5%

1.7%

1.8%

Electricity
Pharmaceutical Products,
Medical Appliances & Equipment

1.3%
Gas

1.5%
Outpatient Service

Purchase of cars & other vehicles


Operation of personal transport equip.
Others
2.4%
4.2%

Transportation: 13.4%

6.7%

Source: Arthur D. Little, Exane BNP Paribas estimates

In terms of volumes of SIM cards, these M2M applications represent hundreds of


millions or even billions of SIM cards. For instance, Ericsson touts a potential market of
about 50bn connected devices globally (see chart below) while the GSMA forecasts
24bn connected devices globally by 2020. In Western Europe, Cisco forecasts that the
total number of M2M modules will grow from 67m in 2011 (already up 71% from 2010)
to 381m by 2016. Orange targets to have sold 10m M2M SIM cards by 2015.

61

Telecom Operators

Figure 62: Vision statement by Ericsson

Source: Ericsson, Arthur D. Little, Exane BNP Paribas estimates

However, these are SIM cards with very low ARPU (for instance, Mobistar, which is in
charge of M2M for the Orange group, has released figures showing that in 2011, it
generated revenues of EUR13m with an end-of-year SIM card base of 417k, up from
193k a year earlier, pointing to ARPU of EUR34/month in 2011).
Our analysis of the largest verticals, as detailed in the following pages, point to
verticals altogether bringing revenues equivalent to between 2% and 5% of the telecom
sectors revenues by 2015e (more by 2020e) see table below.
Assuming a reasonably successful strategy built upon existing connectivity capabilities
and other strengths, and by partnering with existing service providers, large incumbents
would capture 75% of the verticals revenues, which would represent incremental
revenue of c.4% by 2015e. However, if these incumbents are more aggressive,
particularly if they move quickly, catch up and dominate the value chain, potentially by
acquiring other providers, they might achieve a higher proportion of revenue (up to 9%).
Figure 63: Overall view of telcos diversification opportunities
Sceptics case
EURm

Believers case

2010

2015e

20102015e CAGR

2015e

20102015e CAGR

97
254
58
111
84
150
114
20-40
898

664
800
177
343
258
847
989
409
225
4,713

47%
26%
25%
25%
25%
41%
54%
69%
39%

1,685
2,017
496
754
447
1,395
1,978
1,203
480
10,454

77%
51%
54%
47%
40%
56%
77%
109%
63%

Core sector revenues


Core + Verticals
Verticals % of core

228,561
229,460
0.4%

207,661
212,374
2.3%

-1.9%
-1.5%
-

207,661
218,115
5.0%

-1.9%
-1.0%
-

Core incumbent revenues


Incumbents share of verticals
Verticals revenues captured
Core + Verticals
Verticals % of core

101,885
75%
674
102,559
0.7%

84,767
75%
3,535
88,302
4.2%

-3.6%
-2.9%
-

84,767
75%
7,840
92,608
9.2%

-3.6%
-2.0%
-

Connected cars
Fleet and freight telematics
Smart metering
Building automation
Vending machines
m-payment
Cloud
CDN
Others (including e/m-health)
Total

Source: Arthur D. Little, Exane BNP Paribas estimates

62

Telecom Operators

Operators official targets


Large incumbents have publicly announced the following objectives:
Telefnica targets EUR5bn7bn revenues in 2013 in Services beyond
connectivity, i.e. video, applications, financial services, eHealth, security, machine to
machine and cloud, up from EUR3bn in 2010.
Deutsche Telekom targets EUR1bn new revenues in 2015 from intelligent networks,
i.e., energy, health, media distribution and connected cars, and EUR8bn revenues in
2015 from T-Systems which includes cloud services (up from EUR6.5bn in 2011).
Orange targets around EUR13bn revenues from Data & new services, up from
around EUR7bn in 2010 (mobile & fixed data for B2C and B2B). Although Orange has
not given a breakdown of this figure per vertical market, it stated that EUR500m of
revenues were expected from cloud services in 2015, and targets new markets such as
e-Heath, m-payment/NFC (EUR20bn addressable market by 2015), smart network
wholesale (EUR5bn), and utilities and transportation (EUR10bn).
Vodafone has not given a target for its own revenues but said that the addressable
market for new services will reach EUR10bn by 2020, including financial services
(among which near field communication technology i.e. NFC), third-party billing,
machine-to-machine and advertising.
Figure 64: Examples of diversification projects by large European telcos
Telefonica
Growth
area
focus in
verticals

M2M

Cloud

Security

eHealth

Fin. Serv.

Apps & video

Orange

Energy

Deutsche Telekom

eHealth

Cloud

Connected cars Smart cities

Energy

Cloud

eHealth

Connected cars Connected home

Vodafone

Fin. Serv. &


billing

M2M

NFC

Advertising

New services

Data & New services

Verticals

VF "new services"

BB connectivity

Internet Access

Online Consumer Services

Addressable market

Others (incl. voice)

Others

T-Systems (incl. Cloud)


Mobile Internet

Group
growth
objectives

Revenues (bn)
61
3
11

63
5
15

CAGR
47 other business
43
2010-13: -2.9%

Connected Home
Revenues (bn)

Revenues (bn)
46
8
6

50

CAGR other business


32
2010-15: -2.5%
28

Addressable
market (bn)
10,00

62
6

13

Revenues
(bn)

1
4

2 1

8
10
7

No indication for total


45 CAGR 2011-15
group
37
0,25

2010

2013F

2010

2015F

2011

Source: Operators, Arthur D. Little, Exane BNP Paribas estimates

63

2015F

2010

2020

Telecom Operators

The chart below shows which verticals are seen as most promising by interviewees,
compared to OTT content delivery (see pages 40-50) i.e. financial services (mpayment), smart metering and moving objects.
Figure 65: Interview feedback Index reflecting the perceived size of the revenue
opportunities of different verticals
Average scores based on 86 responses, using: 0 for <1% of revenues by 2015, 1 for 1-4%, and 2
for 5%+.
OTT content delivery*

Financial services

Smart metering

Moving objects

Health

Home automation

mCommerce/mAdvertising
0.0

0.1

0.2

0.3

0.4

0.5

0.6

0.7

0.8

0.9

* OTT content delivery is not a vertical as per this section, but is included in this chart as a reference in terms of
revenue expectations.
Source: Arthur D. Little, Exane BNP Paribas estimates

It is important to keep in mind that these verticals are at different levels of maturity:
smart meters and cloud services are already at the commercial level; connected cars
are just moving to commercial, as are m-payment services based on NFC technology;
e-health is at the stage of pilot projects as are electric cars; smart home and smart
city are more in the concept/initial consultation phase.

Can telcos get more than mere connectivity revenues?


Which share of the value created in these verticals will telcos manage to capture in the
coming years? They should certainly capture revenues from connectivity/pure
communication services but can they hope to get more? Doing so would require
telcos to invest to claim a longer portion of the value chain of each vertical basically
to build a diversification strategy.
Unsurprisingly, the debate is very open in the industry. As shown in the chart below,
40% of interviewees believe that telcos should diversify into verticals, while a majority
either believe that they should not diversify or that it will be difficult to do so.
By type of operator, incumbents are logically the more hopeful because they need it
most (by contrast, altnets and cable operators still have growth ahead from market
share gains) and because they have more means to actually execute such a strategy.

64

Telecom Operators

Figure 66: Interview feedback Should telcos try to diversify?


% of respondents, out of a total of 67
45%
40%
35%
30%
25%
20%
15%
10%
5%
0%
They should

They should try, but difficult

They should not

Source: Arthur D. Little, Exane BNP Paribas estimates

What do telcos bring to the table? Beyond the core network capabilities, key
areas include:
their customer relationships including their access to a large customer base, billing
capabilities and trust from customers. However vertical partners such as utilities also
have access to large customer bases, so this may or may not be an asset that telcos
can monetise, depending on the specific vertical market;
their ICT capabilities, datacenters and more generally their ability to handle big
data. Here again, some telcos are well positioned but some verticals are dominated by
large IT services companies such as IBM.
In any case, telcos need to enter into JVs with other players in the ecosystem of each
vertical, i.e. potentially both the industry specialists (car manufacturers for connected
cars, banks for financial services, etc.) and other partners able to offer specific skills
(e.g. tech/equipment specialists bringing specific medical equipment in the eHealth
space, IT services/software companies/datacenter specialists in the big data field).
Based on our interviews with both telcos and their potential partners and competitors in
these verticals, we believe that the main challenges for telcos are: 1) their ability (or
lack thereof) to innovate and execute in new markets, 2) the uncertainty over the
willingness of different players in each ecosystem to collaborate with telcos (many see
them as potential competitors and would prefer telcos to only provide connectivity on a
wholesale basis), 3) the uncertain ability to expand their brand beyond the core telecom
business and 4) their willingness/ability (or lack thereof) to invest in areas that are less
profitable than their core business.
Key success factors for telecom operators in this area include in our view:
A significant adaptation of organisational structures, necessary to foster disruptive
innovation within large groups such as telcos. Operators need to create dedicated
business units with dedicated responsibilities for verticals, with appropriate
specialisation by vertical (matching the size of the organisation to the size of the target
market). The benefits of creating such dedicated business units include the ability to
attract talent and capital, and avoid interference from regulated areas.
Appropriate capital commitment. This is for instance the case when setting-up a
specific JV, as for instance the m2o city JV by Orange and Veolia to develop smart
metering in water distribution (said to aim at equipping 5m meters within 10 years).
Another example is the Telefnica Digital partnership with the cloud services company
Jovent, with Telefnica contributing to its latest USD85m fund raising.

65

Telecom Operators

Strong partnering. Telcos need to develop partnerships with the vertical industry
players driving the IP-isation of the sector.
A strong effort to build machine-to-machine platforms that can be leveraged across
verticals and across national borders.
The most advanced example of such an organisational move is that of Telefnica,
which regrouped all its OTT activities under one business unit called Telefnica Digital,
based in London, encompassing notably Jajah, Terra, Tuenti and O2 Media.
Figure 67: Telefnica Digital case study

Pooling of activities

in a dedicated
structure
Avoiding conflicts of
interest with other
businesses

Apps

Social
network

TV

VoIP

with appropriate
capital commitment
Manage investments in
new digital business

Own corporate culture,


innovation-driven

Coordination with
internal capital fund
Amerigo, Wayra and VCs

Own valuation &


financing channels

London: proximity with


financial markets

Avoid some regulatory


constraints

2,500 staff

in an attractive
location
HQ London:
Cosmopolitan workplace,
proximity with start-ups
Local government support
(Silicon Roundabout)
2012 Olympic games: trial
of new technologies &
services
Regional offices: Madrid,
Sao Paulo, Silicon Valley,
Asia

+ smart metering , M2M,


cloud
Objective of this reorganization is to play the OTT game to attract talent
and create an innovative business unit
Source: Telefnica public releases, Arthur D. Little, Exane BNP Paribas estimates

As discussed in pages 106-107, size matters in the verticals game and large
incumbents are best placed.
First, they have greater financial and personnel capabilities. While some verticals are
local and specific (e.g. healthcare and smart metering), others offer direct cross-border
scale synergies (e.g. smart vehicles). In addition, the ability to leverage platforms
across several countries and/or several verticals can be an advantage, as seen with
the worldwide M2M competence centre by Mobistar in the Orange group;
Second, incumbents core businesses are facing greater challenges than other industry
players (such as altnets and cable, which are still growing through market share gains).
They are hence more interested in exploring potential additional growth avenues.
Industry participants share the view that the best placed are the largest telcos such as
Vodafone, Telefnica, Deutsche Telekom, France Telecom, and their US counterparts.

66

Telecom Operators

Case study NTT DoCoMo


The global operator with the biggest announced ambitions in verticals is NTT DoCoMo
in Japan. NTT DoCoMo targets generating 20% of its revenues from new services by
2015, basically planning to transform itself from a telecom operator to an integrated
services company focused on mobile services but expanding into adjacent markets.
The largest opportunities targeted by DoCoMo are in finance and m-payment, media
and content (websites, more users, etc.), and m-commerce see Figure 68.
In total, DoCoMos target is for all new services to generate revenues of EUR10bn by
2015, versus EUR4bn in 2010. The EUR10bn target represents c.20% of the groups
total revenue.
Figure 68: DoCoMo strategy, 20102020
New services growth objectives
Revenues (bn)

2011

M2M
Aggregation
platform
Enverionment
Safety

2015F

70

Media/Content
Finance/
Payment
Commerce
e/m-Health

Partnerships for mobile business

210
180
60

270

180

4
28
10

70

10

70

3
30
15

2011: 352bn

45

2015: 903bn

Source: Arthur D. Little, Exane BNP Paribas estimates

m-payment, NFC About to take off


M-payment relates to payment services over mobile phones, an opportunity which has
been touted for many years but has not really taken off yet. It suffers from a chicken
and egg problem: customers are not adopting the technology as there is no
application, and retailers are not adopting it since no customers are equipped.
This time round, the technical infrastructure is getting in place, both on the consumer
(NFC-enabled phones) and on the retailer front. We believe that 2012 will see very
strong acceleration in m-payment. According to many people, m-payment looks like the
most mature of the vertical opportunities that we have identified.
The mitigating factor in our view is that the revenue opportunity for telcos should not be
overestimated. We model potential revenues of EUR1.4bn at the European level by
2015e, equivalent to 0.7% of the sectors revenues then, i.e. similar in size to the other
verticals that we discuss. This includes a slow growing legacy m-payment business, the
fast-growing emerging NFC-based payment activity, and additional revenues to be
generated by telcos as an add-on to m-payment e.g. loyalty services.

67

Telecom Operators

What are we talking about?


We define m-payment as relating to electronic payments (for goods or services) which
are initiated via a mobile phone. This includes:
1) Remote payments: buying either virtual goods such as ring tones, etc., and also
real goods or services e.g. a parking slot, a transport ticket, etc. This is already well
developed although it remains a relatively small niche excluding ring tones.
2) Proximity payments i.e. using the mobile handset basically as a replacement for a
debit or credit card when buying something in a shop. This has yet to develop, and will
be driven by the adoption of NFC technology.
As such, m-payment is neither mobile money transfer nor mobile banking:
mobile money transfer mostly corresponds to fund movements initiated via a mobile
phone e.g. domestic person-to-person money transfer, or international remittances.
We believe that money transfer is a feature for emerging markets but not for developed
markets, given the very high banking penetration in developed markets.
mobile banking corresponds to the mobile access to selected internet banking
functions e.g. balance inquiries, account-to-account transfers, etc.
Remote mobile payment has existed for many years. Some applications are well
developed e.g. SMS-based payment for parking slots in many Central European
countries (e.g. >50% of parking tickets are bought via mobile phones in Austria).
This elimination of the need for cash would be more convenient for the customer and
also more cost effective for the merchant. However this remains a small market. For
instance: 1) Paybox, which provides the service as a partner to the local government in
Vienna, generates EUR120m of transactions, on which it keeps a small fraction in fees;
2) overall m-payment transactions are estimated around EUR1bn in Germany today.
Outside Europe, examples of well developed m-payment applications include Octopus
in Hong Kong, and FeliCa by NTT Docomo in Japan, which was launched in 2005.
Docomo has built an NFC ecosystem based on Sonys FeliCa NFC technology; today,
37.5m Docomo clients (65% of the customer base) own an NFC-enabled handset and
can use it in 1.4m shops.
Figure 69: NTT DoCoMos NFC offering
NTT DoCoMo NFC offering
Ticketing

Landmarks

Parking
Remote
&
Proximity

Remittances

2004: FeliCa Networks is founded by


Sony, NTT DoCoMo and East Japan
Railway Co
Shopping

Vending

Travel

2005: Softbank licenses Felica/


Osaifu-Keitai (wallet phone)
2008: More than 50 % of all handsets
support mobile Felica; Mobile Felica is
integrated into every new handset
2008: McDonalds start e-couponing
using Osaifu Keitai

Member cards

Key ID

Source: Arthur D. Little, Exane BNP Paribas estimates

68

2011: 65% of Docomo customers


(37.5m) own NFC-enabled phone ;
1.4m shops accept Osaifu-Keitai
system

Telecom Operators

What is NFC and why is it attractive?


NFC stands for Near Field Communication. The technology allows a chip (e.g. in a
card) to communicate with a nearby reader/terminal. What is needed are:
An NFC antenna in the phone this would mean the customer needs a new
smartphone. This is expected to take off quickly, starting in earnest in H2 12. Samsung,
HTC, LG and many others already offer smartphones that are NFC-enabled, using in
particular the Google Wallet system (see below), as do Nokia and RIM (Blackberry). In
addition, the press reports that Apples iPhone5, due to launch in H2 12, will be NFCenabled. Given the pace of renewal of handsets in Europe, it is absolutely possible that
more than half of the customer base could have an NFC-enabled smartphone by
2015e. At the end of 2010, Orange announced that it targeted to sell 500k NFCenabled mobile phones by the end of 2011.
A secure module to store the highly sensitive data/code/etc. in the handset. There
are solutions using a specific SD card or embedding the module directly in the handset,
but the most common solution for now is for the secure module to be embedded in the
SIM card. This implies one has to change SIM cards, but new SIM cards launched
today in key European markets already have the secure element capability included.
On the other side of the transaction, the merchant requires an NFC-enabled pointof-sale equipment. These are renewed every three to four years by the large retailers,
so the ramp-up could be quick. Some big retailers already have NFC-enabled point-ofsale. For instance, Ingenico said that 21% of its terminal sales in 2010 were already
NFC-enabled.
A clear rationale for NFC-based m-payment is to reduce the cost of transactions by
obviating the use of cash. Indeed, in Europe, credit cards are very developed for midsize to large transactions, but 87% of transactions of less than EUR20 at the point of
sale remains cash-based.
Beyond this important cost advantage versus cash, m-payment needs to bring
additional benefits to the customer and the merchant to be well received by both, and
we believe this to be indeed the case with NFC-based m-payment:
From the customers point of view, in addition to the convenience of not having to
carry cash, it will promote new applications such as targeted couponing, the
integration of loyalty cards into the handset phone, etc, as notably proposed by Google
Wallet technology;
From the merchants point of view, an NFC solution brings two major benefits: 1) a
better communication channel, especially for services such as loyalty and couponing,
for which mail can be replaced by a direct push to the customers smartphone; and 2)
the data collected on the customers purchases can lead to highly value-added
customised propositions, using profiling information on what the customer likes to buy,
his/her location, the types of coupons redeemed, etc., all potentially in real time.
Obviously, such potential applications raise the key issues of customer acceptance for
such tracking of purchasing behaviour, and of the evolution of data protection
legislation. This should not be disregarded and the players involved must earn the
trust of customers but we note that in the past, such issues have not blocked the
development of applications collecting large amounts of data from customers such as
credit cards, Facebook, etc.

69

Telecom Operators

Whos doing what?


A large number of experiments of NFC-based m-payment solutions are ongoing
globally, involving many different types of companies along the value chain. We believe
that a number of wide-scale launches are approaching.
Global internet giants and handsets/OS leaders are active in m-payment.
In particular, Google is developing its Google Mobile Wallet in the US in cooperation
with not just Mastercard Paypass, First Data and Citi, but also Macys, Subway,
Walgreens, Toys R Us, and more. The Google Wallet uses the NFC chip embedded in
the handset for enabling proximity payments at the point of sale. Worldwide, there are
already 300k merchants technically equipped and ready for the solution. Customers
can get discounts at the point of sale based on saving offers they find on their
smartphones. We believe that such a solution could be rolled out in Europe in the next
two years. Other handset/OS makers such as Apple, RIM and Microsoft are likely to
offer competing payment solutions.
Figure 70: Visa and Google mobile wallet initiatives
VISA

Google

The Visa Mobile Wallet

The Google Mobile Wallet

mWallet to handle multiple cards, payment solutions through


multiple financial networks
mWallet will run on most smart devices and supports NFC
Partnerships with 14 banks and financial service providers

Google wallet uses embedded (in the phone) NFC chips for
enabling proximity payments at PoS
Existing credit cards can easily be added
Multi level Security is provided
Phone lock and Google pin

Features: Click2buy, cross-channel payment solution,


preference management, merchant offers

Encryption of credit card information, credit card number


never fully displayed

Source: Arthur D. Little, Exane BNP Paribas estimates

VISA and MasterCard are also strongly involved in competition on m-payment,


which is for them both a key expansion area (ability to capture transactions which are
predominantly done in cash today) and a way to secure their existing positions against
initiatives from other players in the value chain. For instance, VISA is investing at least
EUR100m per year to support and promote NFC developments in Europe (both mpayment and contactless card-based).
Telcos have clearly understood that there is an opportunity for them and are
participating in many industry initiatives. For instance, Deutsche Telekom is furthering
its global NFC ambitions with several initiatives: 1) a mobile wallet service, to be
launched in more than five countries; 2) the group is part of the m-pass cross-operator
initiative in Germany offering NFC services; 3) in the US, it is participating in the Isis
cross-operator initiative alongside AT&T and Verizon in offering NFC payment. A
similar participation in Netherlands was recently halted by T-Mobile on concern over
potential regulatory constraints.

70

Telecom Operators

Banks see telcos mainly as partners, but some do also see them as potential future
competitors. Even though they do not see this as an immediate concern, banks
obviously want to maintain their customer relationships. Although payment services are
a core function of banks, this is not a key profit driver for them (e.g. there is pressure
from regulators on commissions between banks) so they see payment more as a tool to
enable the securing of clients.
The attraction of the payment data is indeed what drives global internet giants such as
Google into this field, and it is also an opportunity for telcos so competition for these
data is likely to be fierce.

What role and what revenues for telcos?


Telcos will obviously operate the network and distribute a large part of the NFCenabled handsets and/or SIM cards. But they can also leverage their billing capabilities
and billing relationship with millions of customers, and they could expand into the IT
side of the m-payment business, providing the servers enabling the applications.
The strengths of telcos in this market relate to 1) their control of the SIM card, 2) their
billing competence and billing relationship with customers, and 3) the trust that
customers put in them (e.g. they are viewed as more trustworthy than global internet
giants regarding customers private data). In addition, payment is a local market
(banking is fragmented) so telcos have an advantage versus global internet giants.
In terms of potential revenues, the first revenue stream is potentially a share of the
transaction fee paid by the merchant. Merchant fees typically range from 0.3% for debit
cards to 2.5% for credit cards and as much as 78% for credit cards on the web
pointing to a rough average of 2%. In this context, in m-payment, we would expect
telcos to get a fee in the range of 0.20.3% of the transaction value. Given
expectations for m-payment transactions in Europe, expected to increase to potentially
EUR50bn120bn by 2015e, this could lead to telcos share in transaction fees reaching
EUR150m400m by then.
Additional revenues could come from operators providing services to merchants
interested in a better communication channel and big data capabilities, e.g.
couponing, advertising, loyalty schemes etc. This will be a contested arena between
different types of players, including web giants, and it is difficult to value at this stage.
However, it is probably also where the most value can be extracted because retailers
can benefit from partnering with telcos and web giants. The fact that Google plans to
exchange revenues from transaction fees for revenues from advertising/customer data
indicates that significant revenues can be expected. We have taken this opportunity
into account by assuming that loyalty programmes could yield c.EUR700m in addition
to the above-mentioned fees.
Furthermore, telcos will continue to drive revenues from SMS-based payment
solutions, where single-digit growth can be expected. We assumed that revenues
would reach EUR200m in 2015e, up from EUR150m in 2010. Finally, other remote
payment solutions are also likely to be further developed, but we did not include this
upside here since 1) virtual goods, e.g. ring tones, would rather fit in the OTT section,
and 2) for physical goods, the development of non-NFC mobile wallet solutions based
on PIN codes (e.g. M-Pass in Germany) is uncertain.
In total, we estimate a range of potential revenues for telcos of EUR850m1,400m by
2015e, equivalent to 0.40.7% of the sectors revenues then. Local incumbents are
those most likely to seize this opportunity: our mid-range estimate equates to 1.3% of
their revenues by 2015e.

71

Telecom Operators

Vending machines and other payment terminals Still value to play for
Besides the development of NFC and m-payment, another area related to payment will
generate revenues for telcos: vending machines and payment terminals.
In this B2B market, telcos provide M2M connectivity to retail/vending machine
operators, hotels and banks. The market can be segmented according to the different
types of services provided: alarm systems, online authentication/payment, performance
measurement, re-fill and repair notification.
For instance, embedded M2M modules in unmanned gas stations, vending machines
or parking meters can improve maintenance and repair with remote diagnosis, and also
ensure that vending machines are appropriately stocked with enough supplies to meet
demand. Connectivity can be made in unexpected places: Orange Business Services
will provide M2M connectivity for Nespresso. The companys B2B revenues heavily
depend on the adequate supply and reliability of its coffee machines.
Potential revenues for telcos - We have made an estimate of the opportunity for
telcos in vending machines based on the revenues they can drive from network access
revenues, which typically represent 20% of the value chain, as well as the potential
upside in online authentication/payment enabling, system integration and service
provision. Telcos development in m-payment (NFC) would give them an incentive to
also target this B2B market, and synergies here could allow them to capture half of it by
2015. We estimate the opportunity at c.EUR450m by 2015e.

Smart metering/grid Hundreds of millions of devices


Smart metering is viewed by many interviewees as the biggest vertical opportunity and
indeed our estimate for 2015e revenues is consistent with this view.
Benefits expected from smart metering are: 1) from the utilities point of view, an
opportunity to lower operational costs and 2) from the point of view of all parties
involved (utilities, customers and also other potential players such as telcos), an
opportunity to offer value-added services to customers. Smart metering is a way to
improve the management of energy consumption in a context where the cost/price of
energy is increasing. This is already true for electricity and gas and could be as well for
water at some point.
In addition, smart systems can play a key role to balance demand and supply across
the power grid which is then called a smart grid in a world where energy
production can be better distributed across regions. The expected growth in renewable
energies means strong growth in distributed generation i.e. power generation from an
increasing number of locations across a country, with less predictable production
patterns (e.g. wind, solar), rather than from a few power generation stations (hence the
need for utilities grids to become 'smart').
As such, communications will become increasingly essential for the utility business.

Smart meters are due to be rolled out widely in Europe


The smart meter market has been off to a slow start. Most projects are still in their early
stages (except in Italy and Sweden) and nothing major is expected to emerge early in
2012. However, the number of smart meters is expected to double in Europe by 2015
(to 100m smart meters), and further strong growth is due after 2015, to reach the
European objective of 80% of households being connected with smart meters by 2020.

72

Telecom Operators

Indeed, according to European law (Directives 2009/72/EC and 2009/73/EC), member


states must produce cost-benefit assessments for the rollout of smart metering for
electricity and gas by September 2012. As part of the business case, a timetable for the
implementation with a window of up to 10 years must be prepared. When the business
case is assessed positively, at least 80% of households shall be equipped with
intelligent electricity metering systems by 2020. There are no implementation targets
for gas smart metering.
Figure 71: Smart meter installed base forecast, Europe, based on public
Million meters

CAGR
+118%

250
200

229

235

2019f

2020f

197
150

169

CAGR
+109%

135

100

108
Mass take-off
Germany

88
50
51

74

65

57

Start UK

Start France

0
2010

Italy:
Spain:
Sweden:
Others:

2011f

2012f

2013f

2014f

2015f

2016f

2017f

2018f

Upgrade+ Replacement

34.6 m
7.8 m
5.5 m
4m

Source: Arthur D. Little, Exane BNP Paribas estimates

Figure 72: Smart meter installed base estimates in key countries, based on
public announcements
Country

2010

2015e

2020e

CAGR
1015e

CAGR
1020e

Germany
France
UK
Italy
Spain
Sweden
Total

0.3
0.3
0.1
34.2
7.8
5.5
48.2

7.9
7.3
10.2
46.8
18.2
5.5
95.9

35.2
35.0
53.0
50.4
26.0
5.5
205.1

92%
89%
164%
6%
18%
0%
15%

61%
61%
91%
4%
13%
0%
16%

Comment

Electricity
Electricity
Electricity & Gas
Electricity & Gas
Electricity
Electricity

Source: Arthur D. Little, Exane BNP Paribas estimates

Compared to the number of households in each market, many of these figures point to
penetration rates of more than 100% because they include 1) both electricity and gas
meters in the UK and Italy and 2) both residential and professional premises.

Telcos role and potential revenues


Overall, using an ARPU of EUR0.260.38/month per meter (of which a third is pure
connectivity revenues and the remainder ancillary services) and an estimated
penetration of smart meters of 6570% of households by 2015e (very high in Italy and
Spain, but significantly lower in Germany, France and the UK), we derive a potential
revenue opportunity of up to EUR500m for telcos at the European level by 2015e. This
is equivalent to 0.2% of the sectors mobile revenues then.
Connectivity: telcos have the network and spectrum, unique assets compared to others
in the value chain. Connectivity is therefore their home turf, though there are three buts:
1) The network part of the smart metering business does not require broadband. It can
be done via GPRS (although operators may actually decide to provide this service over
3G because these are very long-term contracts, and using 2G may lead to the inability
to refarm the 2G spectrum in the medium term).

73

Telecom Operators

2) Telcos and their wireless modules (2G, 3G) are not the only possible connectivity
solution and sometimes lack coverage to reach in-building meter locations in cellars
and stair cupboards. Alternatives include the International Scientific and Medical
technology (but risk of interference with ISM equipment) and WiFi (although this would
need the customer to have a fixed broadband connection nearby), and last but not least
Powerline Communication (sending data along the electricity cable).
3) Telcos need to adapt their networks to the quality requirements of utilities networks,
notably to be able to provide guaranteed data collection from smart meters to ensure
the appropriate billing of customers.
Customer care capabilities, billing and customer trust. Payment services would
be the main value proposition (e.g. operators could propose a package of network
connectivity and billing), but the revenue opportunity on billing is very small: estimated
at only EUR1 per year per meter, and so not a meaningful addition.
Ability to develop and run the platform. Possible role of enabler of smart
solutions/smart grid. In addition to transport and billing, they could position themselves
on the design of the platform, data collection and aggregation, and could even support
utilities with "dynamic pricing". However, telcos are not the only ones able to do that.
The revenue opportunity is difficult to assess and more project-based than recurring.
Figure 73: The evolving smart metering/smart grid value chain

Source: Arthur D. Little, Exane BNP Paribas estimates

The debate in the industry regarding the potential role of telcos in the value chain is
quite open, and solutions will vary across markets given their different organisation.
B2B or B2C model? Both look possible in theory, but it is difficult to imagine many
utilities letting telcos operate their core business, so the B2B model looks more likely.
Many interviewees are very sceptical about telcos ability to get beyond the mere
connectivity layer, i.e. they would have a limited role in the value chain. Indeed the
smart metering business is seen as too distant from their core business, and they are
often seen as not having the competency.
A few interviewees, mostly large incumbents, highlight the need for telcos to fight to
provide "complete solutions" rather than just SIM cards and connectivity and try to
become the key enablers of smart grids. In any case, telcos need to collaborate with
utilities on the system integration and service enabler roles.

Market organisation varies by country


Each countrys market is organised differently, offering different opportunities (or lack
thereof) for telcos.

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Telecom Operators

Sweden: the utilities control the rollout but often adopt turnkey solutions, and telcos
are active in this field, e.g., the Telenor-Fortum JV, competing with Telvent-Vattenfall
and Telven-E.On. The law requires only monthly readings of meters, but many utilities
have enabled hourly reading, creating an opportunity for value-added services.
Italy: Enel basically controls the whole value chain, on both the utility and ICT
fronts. It developed its own smart meters using a hybrid system including the Echelon
Power Line Communications technology but also machine-to-machine on 2G. The total
investment has reached EUR2.1bn. The focus is mainly on efficiency benefits for Enel
rather than on developing VAS for consumers.
France: ERDF controls all elements in the value chain, including the smart meters
(Linky, developed by ERDF). These will be connected to low-voltage posts through
Power Line Communications technology, then data will be carried over the air to the
control centre, via a M2M MVNO agreement (GPRS). Telcos will therefore get only
connectivity revenues, although the system design is open i.e., third party services can
interact with the smart meters, potentially opening longer term service opportunities.
Germany: the utility market is very fragmented (although with some major regional
players such as RWE, e-on, EnBW) and there are attempts at launching independent
metering operators. The meter rollout is based on customer demand rather than a
centralised push, resulting in a very limited rollout at this stage. The utility provides a
smart meter but the customer can choose any player on the market to offer metering
services instead of the utility. This offers opportunities for telcos. For instance,
Deutsche Telekom plans to offer Energy Box for metering management and services.
Figure 74: Examples of smart metering market organisation
Sweden Competitive market for DSOs and connectivity
and service providers

Italy DSO Enel controls market

Germany Competitive market for DSOs and Meter Operators

UK Government controls market via DCC

DSO = Distribution System Operator; DECC = Department of Energy & Climate Change; Ofgem = Office of Gas and electricity Markets
(UK regulator); DCC = Central Data and Communications Company
Source: Arthur D. Little, Exane BNP Paribas estimates

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Telecom Operators

UK: a Central Data and Communications company (DCC) is due to oversee access
to the data (privacy issues). There will be tenders to build wide area network and data
services to support smart meters, with service fees over the duration of the contracts
worth a total of GBP4.59bn (over 920 years). DCC controls the network operators and
service providers. Companies that win the tender will have to partner along the value
chain to offer a turnkey solution, so the role of telcos may be to provide only the
connectivity. Each large mobile operator hopes to get its fair share of this market.
Spain: Endesa is implementing a proprietary solution based on Enel technology. The
rollout of the system, which includes power line communication (PLC) combined with
GPRS machine-to-machine communication is being performed by the company itself
with little cooperation from telcos. Iberdrola is also developing its own PLC technology
in collaboration with technology firms. Both companies are developing their networks,
which should be fully rolled out by 2016, with a focus on grid and operations efficiency
at this stage. Customer services will be rolled out gradually.

Smart home Room for automation and assistance


Beyond smart metering for electricity, gas and water, some companies expect telcos to
have a role in all household oriented applications i.e. home control, energy, security
with the view that the "smart home" can be a natural opportunity for telcos.
In particular, home surveillance is viewed as an application with good revenue potential
as surveillance is based on emotions (fear) and therefore customers willingness to pay
can be high. In addition, in surveillance applications, connectivity is mission critical
and requires relatively high bandwidth, so this is quite attractive and quite close to
telcos core network business.
Finally, the growing number of connected devices and the lack of a consistent
ecosystem in consumer electronics have created a growing market space for technical
assistance in households, in which telcos are already active.

Home automation
Home automation refers to the process of turning conventional products and
appliances into smart, networked, IT-empowered devices, potentially enabling solutions
in security, lighting, air conditioning, home energy and home appliances. Of the various
fields, security and home energy management appear as the most interesting for
customers, according to recent surveys.
The development of this market is driven by the growing penetration of fixed and
mobile connectivity, the decreasing prices for connectivity components, the increasing
appetite of customers (multi-screen households, digital natives) and the ability to meet
existing and growing needs in energy efficiency and safety solutions.
Still, demand has not fully matured, and is thus difficult to forecast. The market size for
Home automation in Europe is estimated at USD1.4bn (USD5bn worldwide), and could
reach USD3.5bn in 2015 and USD8.4bn in 2020 (ABI Research, Facit Research).
As shown in the chart below, many different types of players are involved in this
market. Smart home solutions require products and technologies from a wide range of
areas and players: electrical power distribution, automation and controls, humanmachine interface, wireless and fixed-line communications, etc.
Large equipment players including LG, Honeywell and Johnson Controls have
developed smart home concepts, often focusing on energy efficiency. The smart home
controls company Philips Dynalite offers solution to control all domains of a smart
home, with a focus on ambient living and lighting control. LG has developed HomNet,
a comprehensive solution encompassing entertainment, communications, online portal,
utilities and appliances control.

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All these devices and services use various communication protocols, which can be IPbased (WiFi, Ethernet, Powerline) or non-IP based (ZigBee, DECT, Z-Wave, etc.).
Figure 75: Main groups of players in the smart home market
Electrical Power
Distribution/ Building Automation
& Application Players

Smart Building
Specialists

Service Providers
(Telecom Operators,
Utilities)

Smart Home /
Home Automation
Market
SW, IT, Communication
Equipment Players

Household Appliances
Players

Source: Arthur D. Little, Exane BNP Paribas estimates

In this complex communication ecosystem, telcos have a natural potential role as home
area network manager, but they also aim to develop the platform managing the
services and selling it as a bundle or as an extra to connectivity.
Several European telcos have launched home automation services, though often
limited to security, e.g. Telekom Austria (aonAlarmServices: alarm system), SFR
(HomeScope: home remote monitoring with camera) and Telecom Italia
(Energy@Home with Electrolux, Enel, Indesit). Energy management solutions are also
being proposed by some telcos, e.g. Bouygues Telecom (Bbox Energie in partnership
with Ijenko).
Telcos are now launching more ambitious and integrated home automation solutions.
For instance, Deutsche Telekom is developing its Smart Connect platform (launch
expected by mid-2012), in partnership with two of the four main energy providers in
Germany (e.on and EnBW), as well as Miele and eQ-3. This move is part of the groups
commitment to develop into four Intelligent Network fields (smart energy,
telemedicine, media distribution and connected car see page 63).

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Telecom Operators

Figure 76: Examples of telcos smart home concepts and offers


Deutsche Telekom Smart Connect architecture

Verizon home monitoring and control offers

Source: Deutsche Telekom, Verizon

The system, which should provide home energy management and device automation
functionalities, is based on a box (Smart Connect Box) which supports various types of
connectivity (ZigBee, Z-Wave, KNX, etc.) and is linked to a cloud services platform via
ADSL. Deutsche Telekom expects 50% of German households to have at least one
smart application in 2020 and says that its home automation solution can provide
energy savings of up to 20%.
US telcos are already active in this field. AT&T recently set up a separate organisation
(AT&T Digital Life Services) and acquired Xanboo, a home system specialist. Verizon
launched a home monitoring and control service offering different packages.
To secure revenues beyond the provision of mere connectivity into the home (which telcos
already provide anyway), some operators are participating in the shaping of the home
automation platforms. For instance, Telefnica is a member of the Beywatch project, a
European funded project on home energy management involving eight partners, including
EDF, Fagor and Gorenje. Telcos ability to monetise this market will depend on their level of
commitment in the ecosystem. They could play the role of integrator of the smart home
solution and provide assistance to customers. This could involve designing a dedicated box
or an extension of the functionalities of their current boxes.
Telcos also have activities in B2B markets, where they provide M2M for security firms,
government or facility management companies. M2M modules can enable various
services such as the remote management of machines, surveillance, alarm sensors,
access control and asset tracking.
For instance, BT established a dedicated business unit, BT RedCare, to provide
complete security solutions to local authorities, police and public transport companies.
Vodafone is proposing M2M connectivity to facility management firms and services
companies, with for instance remote diagnosis and preventive maintenance for
elevators and printers.
Potential revenues for telcos All these services ultimately need network access, but
the extent to which telcos can drive significant revenues from these services depend on
their involvement as enabler, service integrator and provider. Managed network access
could represent c.20% of the addressable market, but if some operators decide to
provide extended solutions, they could tap other parts of the value chain. Most telcos
are operating in this market in partnership or conjunction with other parties, given the
extent of on-site presence involved in installation, emergency attendance, support, etc.
We model revenues from this segment rising to up to EUR750m by 2015e if telecom
operators can achieve significant expansion beyond their current role. There is
uncertainty on the pace of this market development, not least because security service
retail (above and beyond the M2M component) has in the past proved sensitive to
economic growth as it is linked to the housing market.

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Telecom Operators

Technical assistance
The development of smart home networks and appliances generates increasing
complexity for households. This could lead to increased demand for technical
assistance services provided to the home. This area is increasingly considered by
telecom operators as well as other players (e.g. distributors, other services companies)
as a way to generate additional revenues and also increase client stickiness.
Technical assistance refers to services aiming at facilitating the installation, repair and
use of communication and electronic devices and services, including
telecommunications products (internet access, IPTV, smartphone/PDA, etc.), home
networking (domestic network configuration, WiFi networking, etc.), IT assistance (PC
configuration, virus removal, etc.), digital home integration (PC-TV, media centre-TV,
gaming console-internet, TV-internet, etc.). It also includes training as well as insurance
and warranties (hardware repair, theft insurance, substitution, first aid assistance, etc.).
The size of the potential market is difficult to estimate since it is heavily linked to the
hardware, software and connectivity markets, and is thus hard to reconstruct. Some
sources expect the US market for premium assistance to reach USD3bn in 2012.
For many market players (e.g. distributors or independent service providers), the
decision to enter the technical assistance market is driven by customer demand for this
type of services. For hardware vendors and for telcos, such a decision is also driven by
the need to ensure a satisfactory total consumer experience. In particular, telcos can
expect to drive some revenues and also use the opportunity to differentiate itself from
the competition, improve customer satisfaction, reduce churn, and ensure the take-up
of new services.
Figure 77: Main groups of players in the assistance market
Telecom operator

Distributor

Independent Service Provider

Marketplace

Vendor Ecosystem

Source: Arthur D. Little, Exane BNP Paribas estimates

Examples of telcos offerings in this space include:


BT Home IT Support (UK): 1) general IT support service which may include set up
and configuration of a customers PC, including networking peripherals, equipment or
software, or networking fault diagnosis and rectification; 2) broadband accelerator
service (assess the set-up of your current BT Total Broadband service and try to
improve the speed available for you) and 3) broadband repair service.
DT Technical Services (Germany): IT Sofort-Service Basic (EUR4.95/month):
phone help for OS and software problem and installation, virus and spywares,
installation of new devices (router, printer); IT Sofort-Service Comfort (EUR9.95/month):
phone help (same as Basic) + up to four interventions per year.
Virgin Media Digital Home Support (UK): PC Healthcheck (a free application), and
Live Expert Help (online/phone assistance) for a price of GBP6/month for one computer
or GBP10 for three computers and all devices: printers, routers, game consoles.

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Fleet and freight management Further growth ahead


What are we talking about?
The fleet and freight management segment emerged in the 1980s with early on-board
vehicle computers in transport vehicles, which were then connected to satellites and
mobile networks. Fleet management services (FMS) are vehicle-based systems
incorporating data logging, satellite positioning (GPS) and data communication to a
back-office application. These solutions are integral parts of much larger information
systems such as supply chain optimisation programmes for logistics services.
Fleet management services can help avoid congestion (ensuring timely product delivery),
enable automated road charging, protection against theft and hijacking, and ensure that
work time directives are respected by drivers but the main benefit of such systems is
direct savings, through better route planning (increased productivity), vehicle
management (fuel cost reduction) and better customer service (time management).
This aspect drove market adoption, especially due to the short pay-back period for high
value loads. For instance, a basic fleet management system for trucks, typically costing
EUR2,000 upfront (hardware cost per truck) with service costs from EUR40/month (per
heavy truck) can often still be paid back within a year thanks to the savings generated.
Whilst these systems are clearly of large value for important vehicles and high value
loads, they are increasingly also deployed in lighter vehicles. There is a broad
opportunity for systems to be deployed to support fleets of other types for example
monitoring and managing fleets of hire vehicles (which vastly outnumber HGV i.e.
heavy goods vehicles).

Potential revenues for telcos


Although the fleet management market is already bigger than other verticals and even
though fleet sizes are roughly stable (anti-HGV legislation and economic downturn), it
still has growth potential due to the current low penetration level. Indeed the
commercial vehicle installed base in Europe stands at c.29m vehicles, including 6.2m
medium and heavy trucks (of which 3.6m are heavy trucks/trailers). The penetration
rate of fleet management services is estimated at less than 5% today, and third parties
expect it to reach at least 17% of heavy trucks and trailers by 2015e. Telecoms
operators already tap this market today but could increase their exposure:
Provision of connectivity services, which can be provided directly to the fleet owner
but also through vehicle manufacturers (for new vehicles) and third party vendors (of
services or hardware, for retrofit FMS installations).
Partnering with third party companies. An increasing number of telecom operators
partner with telematics and fleet management service providers. For example
Telefnica recently announced a partnership with the major European fleet
management solution provider Masternaut, which will provide fleet management
services, applications, platforms and technical support, while Telefnica will contribute
with its commercial network, including pre- and post-sales support, and customer care.
The products will be distributed under the Telefnica brand.
Extended end-to-end involvement. Beyond the value chain roles that they already
control, telcos can try expanding into provisioning, enablement and system integration
roles. This is a competitive market but competitors are often small and could be bought
out and integrated (indeed some have recently been acquired).

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Telecom Operators

Fleet management and supply chain services are already worth hundreds of millions of
Euros in revenue to telcos, one of the largest contributors to M2M divisions today.
We estimate that connectivity revenues could reach EUR800m by 2015e the base
case of what telcos can capture while in a more assertive case, in which telcos also
capture a 35% share of the enabler, system integration and solution providing roles
from established players, revenues may exceed EUR2bn by 2015e (through deep
partnerships with a lead telco role, or M&A).
Given the trans-national nature of transport fleets in Europe, large incumbents with
wide geographic footprints appear best positioned in this market.

Connected cars Telcos search for traction


What are we talking about?
As one interviewee put it, there will be SIMs in all cars. The market for connected cars
is expected to grow strongly, pushed by many different parties: 1) car manufacturers:
cars are increasingly complex, with electronic components a key driver of failures; need
to manage repairs efficiently for customers & service stations; extending customer
relationship; gaining behavioural data and building brand loyalty; growing integration of
multimedia in cars; 2) customers, reflecting the growing penetration of mobile data and
applications in the consumer market, and the need for efficiency in the B2B segment
e.g. logistics, 3) mobile operators: mobile broadband infrastructure is in place and they
want to leverage it; but also 4) regulators and governments, with objectives in terms of
security, environmental benefits and tolling.
Connected car systems can provide a very wide range of services:
Safety: crash-management, airbag control, tracking and e-Call a system currently
being designed to enable emergency calls to the 112 number in case of car accident,
either automatically via the activation of in-vehicle sensors or manually. The system is
expected to communicate a standardised minimum set of data and also to open a voice
communication channel between the vehicle occupants and the emergency responders. It
is expected to cut emergency response times by 40-50%. However, it faces some privacy
issues, notably because the system includes an in-vehicle blackbox.
Traffic management: car-to-car communication, monitoring of street conditions,
tolling, automatic driver license check, speeding alert.

Remote vehicle services: remote diagnosis, remote management, etc.

Navigation and information: navigation, parking space finder and other location
based services, advertising, environmental information, etc.
Communication and entertainment: voice communication, personal messaging,
address book, calendar, music, video & games, voice control, access to cloud storage,
applications, internet radio, etc.

Financial services: pay-as-you-use, financing, insurance, etc.

Professional services such as fleet management (data logging, fleet tracking,


navigation, maintenance, dynamic routing, field management) and logistics (tracking,
environmental scanning, performance management, etc.).
Three models are typically envisaged for connected car services:
Embedded SIM: the car is fitted with a closed communication system with
integrated controls and a dedicated SIM card. External CPEs (e.g. MP3 player, hard
disk drive, etc.) can be integrated.
Smartphone-based model: connectivity is provided by the customers smartphone,
which enables entertainment and navigation applications. The system cannot be used
for car-related remote services due to security concerns and e-Call implementation is
problematic. No specific mobile plan is required.

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Telecom Operators

Hybrid model: includes both an embedded SIM for the car-related services and the
integration of the customers smartphone for multi-media services and apps. Both
platforms are secured by firewalls to ensure security.
Figure 78: Connected car installed base estimates, Western Europe
30

25

million

20

15

10

0
2010

2011

2012e

2013e

2014e

2015e

Source: Berg Insight, iSupply, Arthur D. Little, Exane BNP Paribas estimates

Market forecasts and potential revenues for telcos


Sales of car-related telemetric systems by the main car manufacturers in Europe are
expected to grow from 5.8m in 2011 to 13.3m in 2015e including both the embedded
systems and those based on external mobile devices. The active user base is expected
to grow from 7.8m at the end of 2011 (up from 4.1m at the end of 2010) to 25m in
2015e equivalent to 10% penetration of the EU27 vehicles (and higher if we consider
only Western Europe and only passenger cars).
In terms of potential revenues for operators, we have built two scenarios reflecting
widely different views on the share of the market value that telcos can capture:
In the sceptics case, we have assumed revenues of EUR3-5 per unit per month for
SIMs, connectivity and supply of basic services including e-Call and recovery
assistance pointing to revenue of c.EUR600-700m by 2015e. This assumes that the
telcos fulfil significant roles beyond the pure provision of embedded SIMs (a fraction of
the above), but do not secure the client relationship or move into direct provision of
advanced services, and that the base of vehicles taking at least this level of service
would be c.17m within the EU-8 countries by 2015e;
In the believers case, we have assumed that telcos capture the above but also
succeed in deepening their service set (into entertainment, communications,
speed/radar warning, etc.) and their involvement in the value chain (into system
integration, platform management, provisioning and the customer care relationship).
This would move telcos closer to services that car manufacturers and third parties (like
OnStar) currently retail at EUR20+/month in pioneer markets. In this scenario we
assume that telcos capture (on average) at least 50% of this across a base of c.12m
vehicles by 2015e. To achieve this, telcos would need to take a leading partnership role
with existing providers (and secure the entire market volume) or eliminate/absorb
existing providers (e.g. through M&A). Revenues could reach EUR1.7bn by 2015e. In
both cases we exclude hardware revenues, since the value added by telcos here is
minimal relative to other suppliers.

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Telecom Operators

This range of outcomes highlights that if operators can successfully play the
aggregation, service provision, integration and middleware roles for a car manufacturer
and displace (or acquire) the existing suppliers there is very significant value to be
created, but if telcos are relegated to a SIM supplier role for telematics solutions
(positioning, simple e-Call, maintenance info), then the opportunity is smaller. At this
stage, there are moves in both directions hence visibility is low.
Figure 79: Major European telcos are already active in connected cars
Entity in
charge

Activities

M2M competence
center

Orange Business
Services

International Global M2M competence center with over 100 employees


Own Connected Car Initiative, cooperation with SEAT on eCar integration of eCall,
navigation (Google Maps) & Infotainment
Network Provider in Connected Car field

M2M City with focus on telematics in passenger cars and fleet & process management

Network Provider for TomTom and Digicore (European wide connectivity management)

Partnership with Gemalto for emergency call services

Installed base: 200,000 BMW cars with M2M solutions (e.g. BMW Connected Drive)

Global M2M

M2M City

Connected Car
business unit

M2M- competence center with focus on Connected Car & Digital Home
Sales of Fleet Management products through Kuantic (FR) und Aeromark (UK) with a focus
on Tracking & Tracing and Navigation
Network Provider in Connected-Car field

Source: Arthur D. Little, Exane BNP Paribas estimates

Figure 80: Potential positioning of telcos in the value chain


Hardware

Content

Network

Service
enabler

System
integrator

Service
provider

Sales

OEM

OEM

OEM

Telcos managed

HW Partnership

Ext. Provider

Ext. Provider

Embedded
services

Embedded SIM

Provider of
Smartphones

Standard HW
Integration
Smartphone
Telco

OEM

Partner
Management &
Integration
Smartphone

Management of
Providers

Centralized
Connected Car
Platform

Interfaces &
Vehicle integration

White Label
Service
provisioning

Sales Support (e.g.


cross- & Upselling)

Telco with ext. Partners

Source: Arthur D. Little, Exane BNP Paribas estimates

Given the cross-border nature of these services, we think most of the value will go to
the largest global telcos (e.g. covering a third of the world population or more) who can
offer the best deals for global car manufacturers, and can minimise the roaming
element of service costs if bandwidth usage from vehicles rises rapidly in the future.
Examples of operators participating in industry alliances aimed at developing the
connected car market include:
Ertico a global development platform founded by the European Commission in
1991, which is notably working on the definition of eCall (due in 2014). Members
include Allianz, BMW, Cobra, Continental, Efkon, Ericsson, Fiat, Honda, Logica,
Mitsubishi, NEC, Nissan, NXP, TomTom, Vialis, VW, Volvo, and among operators:
Telecom Italia and Vodafone.

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Telecom Operators

Connected Car Forum created by the GSMA in 2011, a platform between telcos
and car manufacturers. Members include Orange, NTT DoCoMo, KPN, Telenor,
Telefnica, Vodafone, AT&T, Telecom Italia, Bell Canada, and, on the manufacturers
side: Jaguar/Land Rover, Toyota, Nissan, Audi, Hyundai, BMW China and Fiat.

Electric cars & urban mobility


Electric cars will require specific technologies to manage the new constraints brought
by the batteries and integrate the car to the grid infrastructure. Electric vehicle
initiatives are gaining significant traction in many European cities, driven by converging
interests of OEMs, utilities and municipalities.
Figure 81: Integration of electric car to infrastructure

Source: Arthur D. Little, Exane BNP Paribas estimates

Figure 82: Electric cars demonstration projects in Europe


Non-exhaustive
London (Polar): charging
infrastructure (M2M by
O2 with Chargemaster)

Denmark: battery swopping,


cross-border integration

Ireland: Advanced
integration studies, smart
grid integration

Berlin: largest integratd


project testing business
models and consumer
behaviour

Paris (Autolib): carsharing system (100


vehicles, 30+ stations)

Ireland
Dublin

Denmark

Cork

Copenhagen
/ Bornholm

UK
London

Berlin

Poland

Germany

Barcelona: electric
mobility service citizen
office, e-motorbike
demonstration

Paris

Karlsruhe
Strasbourg

France

Budapest
Hungary
Pisa

Madrid

Malaga: embedment in
smart city concept,
vehicle-to-grid, buildingto-grid, charging stations

Karlsruhe/Stuttgart: smart
grid features, bi-directional
charing, corss-border
connection with Strasbourg

Barcelona
Rome

Spain

Strasbourg:
Plug-in hybrid vehicles, crossborder connection with
Karlsruhe/Stuttgart

Italy

Malaga
Greece
Kozani

Italy: innovative services &


user interfaces, kWh billing
system, business model
testing

Source: Arthur D. Little, Exane BNP Paribas estimates

However this is a very long term project and the government objectives point to still
very low penetration by 2020. For instance, at the EU level, the objective is that electric
cars represent 3-10% of sales by 2025, and aggregating the targets published by
different countries for different timeframes, we estimate that the installed base of
electric cars could remain below 5m in Europe by 2015e, below 10m by 2020e and
below 20m by 2025e. The contribution of this segment to telcos revenues should
therefore be negligible by 2015e.

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Telecom Operators

Figure 83: Government targets regarding hybrid and electric cars (installed base)
Targets (m)

2014e

2015e

2020e

2030e

2040e

France
Germany
Netherlands
Spain
Sweden
UK

1.0
-

0.01
-

2.0
1.0

3.3

0.2
-

0.6
1.55

Source: Arthur D. Little, Exane BNP Paribas estimates

e-Health, m-Health Fitter in the long term


Healthcare is a huge and growing market, especially in aging developed countries like
those in Europe. Communication technology enables many e-Health and m-Health
solutions, which could both make peoples lives easier (e.g. by saving time and
avoiding visits to hospitals) and save large amounts of money.
Telcos can provide fixed and mobile connectivity, handle mobile devices and in theory
could help manage the growing flows of medical data. However, given the complexity
of the healthcare ecosystem and the sensitive nature of the services, we believe the
opportunity for telcos to find incremental revenue streams in this field remains remote.

What are we talking about?


e-Health refers to the implementation of electronic processes and communication in
healthcare practices. Electronic health records or telemedicine are particular e-Health
applications. m-Health is a particular field of e-health, which refers to the use of mobile
communication technologies, for instance to remotely monitor patients health and
provide care.
e-Health solutions can be theoretically implemented in any healthcare field and for any
disease, but the current experiments in Europe generally reflect the priorities of the
different healthcare systems. For instance, several experiments are related to chronic
diseases with high treatment costs (e.g. diabetes, heart failures, etc.)
Figure 84: m-Health Four examples of use cases
Aging Independently
An adult child helping
their elderly parents age
gracefully in their own
home
Basic life monitoring as
appropriate

Health and Wellness

Disease Management

Weight loss

Vital sign monitoring

Fitness

Medication reminders and


compliance

Email / chat / video


Appointment scheduling
Personal Health Records

Trend analysis and alerts


Connect with family care
givers

Young Families
Allergy tracking and
analysis
Managing pediatrician
appointments
Vaccination management
Holistic management of
family health issues

Source: Arthur D. Little, Exane BNP Paribas estimates

Examples of e-Health solutions include: 1) the secure exchange and management of


medical data, including interacting with consumers via mobile apps, and enabling digital
processing of medical data; 2) websites where patients can store their medical data, as
well as small devices at home (blood pressure, etc.) which can be connected to remote
servers; and 3) the rollout of unified networks in hospitals.

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Telecom Operators

The main benefits expected from e-health and m-health are:


better care: the real-time tracking of health indicators can improve the diagnosis
and improve the handling of patients;
better quality of life: a tele-consultation at home gives patients access to qualified
medical staff; the time spent in hospitals can be reduced thanks to mobile medical
devices and health data remote reporting;
savings: remote care is more cost-effective (shorter stays in hospitals, less transport
and patient handling); costs are also reduced thanks to better treatment (e.g.
personalised treatment based on electronic health record). Generally, e-Health is believed
to lead to stronger patient input, hence to a lower and better use of medical help.
The implementation of e-health solutions is challenging due to: 1) the stringent
requirements on the security of medical data; 2) the scattered nature of medical data
sometimes not digitalised; 3) the financing constraints; and 4) the sector being strongly
driven by regulation.

Large potential market reflecting large potential savings


There are few consistent data points regarding the size of the e-Health and m-Health
market opportunities. The global telemedicine market is estimated at USD50bn60bn in
2010 and the European e-Health market at around EUR15bn, with growth of c.3% per
year (Business Insights). The global market for mobile healthcare applications is
estimated at USD718m in 2011 and is expected to grow to USD1.3bn in 2012
(research2guidance). In the US, the m-Health app market is expected to reach
USD392m in 2015 (Frost & Sullivan).
Beyond convenience, a key benefit expected from e- and m-health solutions is the
amount of potential savings, in a context where healthcare expenses are growing faster
than the economy (+4/+5% per year), notably driven by the fact that populations are
ageing. In developed countries, healthcare is a very large market, representing 911%
of GDP in European countries, the equivalent of USD2,8003,700 per year per capita.
As such, the potential savings are very large.
Examples of such savings include: 1) potential savings of EUR7.7bn in Germany
relating to four telemedicine applications (cerebro-vascular diseases, chronic ischemic
heart disease, diabetes type two, cardiac insufficiency); 2) in the UK, potential savings
for the National Health Service estimated at EUR760m per year from m-Health
applications; and 3) in France, potential savings relating to four chronic diseases
(diabete, hypertension, cardiac insufficiency, renal insufficiency) estimated at
EUR2.6bn based on recent trials, according to Syntec.
The European Union has been funding eHealth R&D since 1989, and has put e-Health
on the Digital Agenda. Between 2002 and 2006, it spent EUR200m on eHealth
projects. The 20072013 Framework Programme for Research has already focused
EUR335m on e-Health in 20072011, in particular on e-Health solutions providing
personalised healthcare and mobility. Finally, industry and healthcare professional
groups are also working on standardization. For instance, the IHE (Integrating the
Healthcare Enterprise) initiative aims at defining common IT and communication
standards (e.g. DICOM, HL7) to help implement electronic health records.

What are telcos doing?


The European healthcare environment is dominated by three types of players: 1) the
service providers (healthcare practitioners, pharmacies, and also medical technology
and devices providers), 2) the paying authority and 3) the patient (and informal
caregivers e.g. families).

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Telecom Operators

The development of eHealth implies adding new players to the ecosystem that are
specialised in telecommunication and integration. Integrated eHealth solutions, conceived
in partnership with healthcare professionals, will cover a larger part of the value chain and
provide customized turn-key solutions to healthcare practitioners (e.g. hospitals).
Figure 85: Value chain example in e-Health Medical imaging solutions

Source: Arthur D. Little, Exane BNP Paribas estimtes

As for the other verticals, telcos primary role can be to provide connectivity, as they
already do, and to expand connectivity services from fixed-line to mobile. Beyond that,
opportunities include: 1) managing the devices, particularly new mobile connected
devices; 2) managing medical data (a cloud-related opportunity); and 3) possibly
becoming full service providers, jointly with partners (mentioned in a few interviews; this
opportunity was estimated in one interview at EUR200m+ in Germany by 2015e); this
view was however not shared by most, who see the healthcare market as very distant
from telcos core business.
According to some sources, telcos providing only connectivity could access up to 20%
of the value of the m-Health market, a proportion that could rise up to 45% if they were
able to provide end-to-end solutions (Business Insights).
Figure 86: Possible business models for telcos in eHealth

Source: Arthur D. Little, Exane BNP Paribas estimates

87

Telecom Operators

Orange established a line of business dedicated to healthcare in 2007. The goal of


Orange Healthcare is to become the trusted partner for medical data transport and
storage in three segments: healthcare professionals, patient at home, and prevention &
wellness. The operator is also active in health insurance services (e.g. third party
payment, billing). Orange is working with various technology and medical specialists:
Sorin, a medical technology provider, in providing remote monitoring solutions to
cardiac patients; Tribvn, a medical imaging specialist, in providing remote medical
expertise solutions; Toshiba, for telemedicine solutions in France (Dmter project).
Figure 87: Orange Healthcare
Oranges market segment focus

Orange-Sorin remote monitoring solution for cardiac patients

Source: Orange

Deutsche Telekom: eHealth is one of the four growth areas identified by the group.
Several products are already available: digital patient file on tablets (Checkpad MED)
medical conferences on the internet (in T-City), CardioMessenger (remote reporting for
ill health patients).
Telefnica created a global e-Health unit in 2010, with 80 projects in nine countries.
It focuses on three areas: 1) ICT for hospitals, 2) remote medicine (chronic patients
monitoring, remote rehabilitation, collaborative tools for health practitioners) and 3)
remote care (Mobile Telecare: location and emergency alerts for dependent people).
Vodafone consolidated its health activities in 2010 into Vodafone mHealth
Solutions. It provides solutions for remote care, living assistance (Alzheimer and elderly
people), and is working with Baxter on a remote infusion monitoring service
(immunoglobulin treatment).
Swisscom proposes several Connected Health products e.g. Medgate (24/7 doctor
consultation via phone or internet, chronic care management), Evita (electronic health
dossier), Emporia (emergency call function on specific mobile phone), TeleAlarmS12
(wireless alarm system to call emergency assistants).
In the US, Verizon launched a cloud-based Health Information Exchange in 2010,
and AT&T has set up a healthcare unit focusing on m-Health and cloud-based services.
Overall, we believe that the opportunity for telcos is a long-term one. Indeed, the value
chain is complex, with players coming from different backgrounds (healthcare, IT,
governmental bodies, etc.). Due to the sensitive nature of these activities, regulation
plays an important role, and is mostly national-based. It can also be challenging to get
a strong commitment from the various types of caregivers. Furthermore, the economic
equation is complex, since the paying authorities are often distinct from the players
benefiting directly from e-Health projects (i.e. patients and caregivers). Thus, a strong
impetus at the national level is necessary for successful implementation.

88

Telecom Operators

Cloud Attractive but substantial investment needed


Many operators see B2B as a growth area and are driven by ambitious plans to capture
market share and develop their offerings in managed services. Unlike in B2C, many
telcos think usage growth can offset price pressure in B2B. This growth is being fuelled
by a number of key trends, notably 1) the rising demand for enterprise mobility; 2) the
convergence of network platforms, reducing costs and improving interoperability; 3) the
accelerating adoption of IT virtualisation and cloud services; and 4) a continuing trend
towards managed services and selective outsourcing.
Telecom operators are well placed in this domain as they have connectivity, datacenter
and operational systems important elements of increasingly network-centric ICT
services. A number of emerging businesses present opportunities for telcos to capture
additional value including machine-to-machine (see above) and cloud services.
Figure 88: Whats the Cloud?

Source: Arthur D. Little, Exane BNP Paribas estimates

The cloud concept is to provide services remotely, based on a centralised IT


infrastructure. A basic example is the original web mail services such as Yahoo Mail,
whereby the customers emails are stored on Yahoos servers and accessible from any
device anywhere, rather than lodged in specific software in a specific PC. This concept
can be extended to any software or any piece of data or even any IT infrastructure,
which can be rented by a cloud provider to a customer.
The cloud market is already large and expected to grow to around EUR40bn in Europe
in 2015e. It is however a crowded one, with many credible contenders, from web giants
to global B2B tech companies. Operators, particularly mobile operators, generally lack
the credibility of large IT players in directly offering IT services. They typically lack the
sales and operational capability to provide IT solutions without partners. We
nevertheless believe that telcos have legitimate claims on this market: they control the
network, ensuring end-to-end quality of services, and they have existing relationships
with customers.
We estimate that all in all the cloud opportunity could add EUR1.0bn1.5bn to
revenues for telcos by 2015e. If one assumes that this would be mainly captured by
incumbents, this could add 1.52.0% to their overall top line by 2015e which is far
from negligible.
Such revenues could come with fair margins, i.e. EBITDA margin potentially in the 30%
range. This would however only be achieved after a period of substantial investments,
notably in datacenters (although the several billion euros expected at the European
level should be put in perspective by comparing against telcos capex).
A risk for telcos would be that in racing against one another, they create fragmentation
at a time when OTT players are building products on a global scale. Telcos should in
our view instead consider a federation in the cloud market and ensure interoperability
between different services, to get the advantages of a global solution whilst enjoying
the benefits of a local cloud provider.

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Telecom Operators

What is the cloud?


Ingredients for cloud based services are not new, but are becoming more available and
affordable, in particular broadband access, smart (high power) devices, and an ever
increasing efficiency of central IT systems.
Clouds are virtualized, scalable, dynamically configurable IT resources (hardware,
platforms and/or services), providing on-demand services, accessible from anywhere
(through fixed and/or mobile broadband connections). In a nutshell, cloud computing is
IT-as-a-service, with various versions:
infrastructure as a service (IaaS): computing, storage (e.g. Amazon, IBM, Oracle);
platform as a service (PaaS): software framework (e.g. Amazon, Microsoft, Google);
software as a service (SaaS): business applications, web services, multimedia (e.g.
salesforce.com, Google, Hulu).
The four different types of clouds are: 1) Public clouds: many users share a common
base, there is no restriction on applications; 2) Private clouds: for companies, public
administrations, etc. (this can be implemented in-house or with a service provider);
3) Community clouds: a private cloud accessible to and standardised for a defined
group (e.g. value-added networks in the automotive industry); and 4) Hybrid clouds,
corresponding to combinations of public and private cloud.
Key common characteristics of cloud services: on-demand self service (the user can
independently order resources), broad network access (access via different kinds of
devices), resource pooling (the user has no control over IT resources employed), rapid
elasticity (down/up-scaling of resources in reaction to usage), and billing per use
(based on the monitoring of the customers exact usage).

Benefits of the cloud architecture: lower cost and new services


The Cloud architecture potentially offers two fundamental value propositions: (i) more
effective ways to deliver IT in larger businesses, and (ii) new cloud service
opportunities for ICT providers see examples in the charts above and below.
Figure 89: The huge cost benefits enabled by cloud architecture
IT Consumers

ICT suppliers

Source: Arthur D. Little, Exane BNP Paribas estimates

90

Telecom Operators

Figure 90: Beyond the cost, what are the benefits of adopting a cloud architecture?
Enabling mobility is the top reason for adopting SaaS

Backup/recovery and storage are the top cloud use cases

In %

In %

Backup/recovery

Allows distributed/remote employees to stay connected


Lower maintenance and support costs than
premises-based alternatives

Storage

More scalable than premises-based alternatives

Production-ready application
deployment

Better functionality than premises-based alternatives

Accessing extra computing power on


demand

Lower software costs than premises-based alternatives


IT staff is too busy or understaffed with current projects

Data mining/analysis

Reduced challenges associated with upgrades,


updates and security patches

Application development and


testing

More user-friendly interface for end-users


Lower risk can switch vendor if service not adequate

Database provisioning

IT staff are generalists and cannot support


complex business applications

2010
2011

Other

2010
2011

Batch processing

Source: Yankee Group, Arthur D. Little, Exane BNP Paribas estimates

European cloud market expected to reach EUR40bn by 2015e


Adoption of cloud-based solutions in enterprises worldwide is expected to more than
double over the next three years: PaaS and SaaS penetration from 7% to 15%,
Managed Hosting from 11% to 14%, and IaaS from 3% to 7%.
Gartner estimates the cloud market worldwide grew from USD46bn in 2008 to
USD89bn in 2011e (including roughly half in cloud-based advertising i.e. the market
developed by Google) and expects this to increase further to USD150bn in 2013e
(of which still half in advertising). In Europe, the market is expected to grow from
c.EUR17bn in 2011e to almost EUR40bn in 2015e see chart below.
Figure 91: European cloud market forecasts
80
70
60

EURbn

50
40
30
20
10
0
2009

2010

2011

2012e

2013e

2014e

2015e

2016e

2017e

2018e

Source: Gartner, Business Insights (analysts consensus), Arthur D. Little, Exane BNP Paribas estimates

Telcos moves and ambitions in the cloud


The rationale for telcos to move into cloud services is fivefold in our view:
preventing the risk of disintermediation of telcos by IT players, as IT players are
increasingly prescribing telco services to their corporate customers. This is about
ensuring telcos business resilience by expanding their value chain positioning;
gaining exposure to the IT services market, which is both large (3-4 times larger
than the telco market) and fast-growing (much faster than the telco market);
creating synergies, by leveraging network assets and customer relationships;

91

Telecom Operators

maximizing customer stickiness, by increasing their share of the clients wallet.


reducing cost for their internal IT.
Important moves by large telcos in the past few years include:
Verizon: In January 2011 Verizon acquired Terremark, one of the largest IaaS
providers in the US (public cloud offering) for USD1.4bn more than three times
Terremarks annual revenues (in the last nine months prior to the acquisition Terramark
had revenues of USD258m and an EBITDA margin of 27%).
Telstra: In 2011 Telstra announced its plans to invest more than USD850m in cloud
computing over the next five years. Sales of Telstras T-Suite SaaS have grown
threefold for the past year. The use of its cloud service surged by 50 percent in 2011.
Deutsche Telekom: In 2009, it acquired the web-hosting provider Strato for
EUR275m, the second-largest web hosting provider (online storage, hosting, virtual
servers) in Europe after United Internet. Strato was present in the UK, Germany,
France, Spain, Netherlands and Italy, focusing mainly on consumers. This fits into the
groups target of boosting revenues from on-demand download services, web hosting
and mobile applications from EUR800m in 2009 to EUR2-3bn in 2015.
Orange has recently reiterated its target to reach EUR500m of revenues from cloud
services by 2015e, starting from EUR50m in 2010. The addressable market, which was
EUR6bn in 2010, is expected to grow to almost EUR15bn by 2015e, representing a
target market share of 3.3% for OBS by 2015. Orange Business Services announced
that it achieved strong revenue growth in 2011, in line with its targets, and that it has
3,600 clients, of which 110 had chosen the IT infrastructure outsourcing solution IaaS,
launched in October 2011, and 2500 professional clients had chosen the Le Cloud Pro
offer. Furthermore, Orange is part of the French government-funded national cloud
project Andromede, in partnership with Thales, an electronic systems company. The
consortium will compete with SFR which has joined up with Dassault Systemes.
Investments by European telcos in cloud services remain small compared to those of
global telcos, estimated by analysts at less than USD1bn of a total of USD13.5bn.
European investments have mainly been coming from Deutsche Telekom, Orange,
Telefnica and Portugal Telecom, while the top six telco investors in the cloud
worldwide are AT&T, CenturyLink, NTT, Telstra, Verizon and Windstream.
Figure 92: Telcos have developed IaaS cloud services, leveraging their network, and SaaS, but still have
limited offers in PaaS

Examples
IaaS

PaaS

SaaS

AT&T Synaptic Storage and


Compute storage and computing
infrastructure

Custom-built platform as a service:


Previsto

Communication, collaboration,
messaging and e-mail

Verizon Computing as a Service:


cloud computing solution on Demand

Communication, collaboration,
messaging and e-mail

BT Virtual Data Center: Virtual


infrastructure with self service portal

Several CRM solutions in partnership


with Salesfore.com and Netsuite

Orange Flexible Computing: Virtual


infrastructure solution
Deutsche Telekom (Zimory): Cloud
computing infrastructure

Communication, collaboration,
messaging and e-mail
T-Systems Database and
Middleware Environments

SAP service through the cloud

TeliaSonera Business Class Cloud


Services: Infrastructure for managed
voice and virtual meeting services
On-the-fly IT services: Storage and
computing infrastructure

CRM solution with Microsoft Dynamics

Storage and computing infrastructure

Telefnica Aplicateca: Platform for


business applications (accounting, order,
billing, e-learning, help desk, CRM, RH)

Source: Arthur D. Little, Exane BNP Paribas estimates

92

Telecom Operators

Telcos positioning: network centric and focus on SMEs


Telcos are new entrants in this market, but they are not the only ones, and competition
is likely to be very tough, coming from different types of players. Leaders in the cloud
Software as a Service area are large IT companies such as Amazon, IBM, Microsoft,
Google, Salesforce.com, etc.
Telcos are logically starting from their network position, and trying to expand into other
parts of the value chain.
Recent client surveys seem to indicate that telcos could be preferred for cloud-based
communications services such as telephony, web conferencing and unified
communications; while hosting firms and datacenter operators (such as Salesforce.com
or Amazon) would be the preferred vendors for IaaS services including storage, backup
and recovery; and technology integrators (such as IBM, Cisco or HP) show strength in
desktop as a service/virtual desktop infrastructure/VDI and contact centre applications.
The argument used by telcos (notably Orange, Telecom Italia, BT and Colt) is that
since they control the network, telcos can ensure end-to-end quality of service,
integrating both the connectivity (network) and the IT platforms.

Figure 93: Telcos trying to expand their presence in the cloud value chain

Source: Arthur D. Little, Exane BNP Paribas estimates

Finally, in terms of market segment, the sweet spot for telcos should be SMEs. Indeed:

consumers are seduced by powerful OTT players such as Google, Apple, Yahoo;

large corporate clients have existing relationships and value the dedicated service
provided by major IT players;
SMEs often value their trusted telco/local partner and are somewhat wary of global
ICT players. Overall, the SME segment is expected to represent more than half of
telcos cloud revenues in the next few years.

93

Telecom Operators

Figure 94: Many telcos have concluded that the SME segment is a key focus area

Source: Arthur D. Little, Exane BNP Paribas estimates

Potential revenue and profitability for telcos


Using Oranges ambition in terms of market share as a benchmark i.e. growing from
0.8% of its addressable market in 2010 to 3.3% in 2015e we derive a potential
revenue contribution from cloud services to the telco sector of EUR2.0bn in 2015e in a
believers case (assuming that within revenues captured by telcos, incumbents like
Orange will get two thirds and other telcos the remaining third). This is overall
equivalent to 1% of telecom sector revenues by 2015e.
The initial profitability of telcos moves into the cloud should be limited, given the
relatively large upfront investment and high fixed costs associated with building, owning
and operating datacenters but as utilization of a facility rises, operating leverage
should allow for attractive incremental margins. Scale is a really important factor to
unlock value from cloud investments.
The table below shows examples of current EBITDA margins at a selection of (mainly
US) cloud players, both in the infrastructure hosting space and in the service space
showing a range of 4-45%, and the majority of companies in the 18-35% range.

Figure 95: Examples of EBITDA margins of cloud players


Company

Current year EBITDA margin

Equinix (US)
Rackspace Hosting (US)
Strato (DE)
TerreMark Worldwide (US)
Concur Technologies (US)
Taleo Corp. (US)
Salesforce.com (US)
Rightnow Tech (US)
United Internet (DE)
Amazon Cloud Services (US)

45%
34%
33%
29%
24%
22%
18%
17%
16%
4%

Source: Bloomberg, Arthur D. Little, Exane BNP Paribas estimates

Such margins could prove slightly dilutive to telcos margins initially, but the cloud
should in the long run be accretive to absolute EBITDA, and telcos should get other
benefits from such initiatives, in particular stronger customer relationships (churn
reduction) which could improve profitability in other activities.

94

Telecom Operators

Increasingly diverging routes and no silver


bullet
Telcos have different visions on the industrys outlook (more or less negative), different
views on key assets to leverage (the infrastructure or the customer), but also very
different starting positions (leaders versus challengers, local versus global). It is
therefore no surprise that they consider strategies which are increasingly different:
with varying levels of emphasis on the retail side. This is the bit pipe versus full
service operator debate;
and varying ambitions in terms of geographic footprint, with most European telcos
focused on one or a few countries, but a handful looking at a global footprint.
Combining these two axes, we find three key strategic routes: 1) the mega-operator,
2) the local hero, i.e., the full service telco focused on a limited geographic footprint,
and 3) the local infrastructure play.

Figure 96: Three potential strategic choices for telcos

Geographic footprint

Ambition in the value chain

Local

Infrastructure

Services

Infrastructure play

Local hero

Mega-operator

Global

Source: Arthur D. Little, Exane BNP Paribas estimates

We believe that:
the mega-operator approach can in theory create the most value in the long term,
but it is the most difficult to execute (need for capital and multi-faceted competitive
challenges), so the most risky. In any case only a handful of European telcos can play;
the local hero could lead to a slightly better top-line than the infrastructure play,
but it comes with additional opex and capex in the next few years, and execution risks.
the infrastructure play is the least risky but also brings the lowest returns in the
long term. In any case, it cannot be implemented by operators lacking opex flexibility.
We look at the key prerequisites for telcos to succeed, in our view:
1) a leaner cost base, with notably a substantial opportunity from the online
transformation of the business model, which we estimate could reduce a typical mobile
operators total opex by 9% by 2015e;
2) a strong infrastructure. This requires continued capex, notably on FTTx and 4G
hence local scale will be of increasing importance. Different types of network
consolidation can enable typical mobile operators to save 10-30% on network opex and
capex in the coming years.

95

Telecom Operators

As shown in Figure 97, combining these two opportunities could theoretically enable an
operator with revenues declining by 2.4% pa until 2015e (in line with our industry
scenario) to limit the decline in its EBITDA and OpFCF to less than 3% pa.

Figure 97: Mobile opex and capex opportunities, comparing to a flat opex and capex scenario
Theoretical scenario
with flat opex & capex
EURm

Opex & capex


opportunities

2011e

2015e

CAGR

Mobile revenues

107,069

97,124

(2.4%)

Online centric opportunity on opex


Opex
EBITDA
EBITDA margin

(69,272)
37,796
35.3%

(69,272)
27,852
28.7%

0.0%
(7.3%)

(9%)

Network consolidation opportunity


Network opex & capex
% of revenue

(11,778)
(11.0%)

(11,778)
(12.1%)

0.0%

(15%)

24,115
22.5%

14,171
14.6%

(12.4%)

EBITDA-Capex
EBITDA-Capex / revenue

% reduction

Potential scenario

EURm

2015e

CAGR

97,124

(2.4%)

6,211
6,211

(63,061)
34,063
35.1%

(2.3%)
(2.6%)

1,767

(10,011)
(10.3%)

(4.0%)

7,978

22,148
22.8%

(2.1%)

Source: Arthur D. Little, Exane BNP Paribas estimates

Finally, we conclude that global scale will become more significant in the long run, both
in terms of cost (global purchasing, global pooling of IT infrastructure) and as a
commercial differentiator (in a few market segments).
Since each operator has room to optimise its strategic footprint and pressures on the
top-line will not ease quickly, we predict a flurry of M&A: at the local level (fixed-fixed,
mobile-mobile, fixed-mobile), vertical (acquisition of incremental capabilities to serve
adjacent markets), but also cross-border (most probably small moves rather than big
jumps, even though large moves cannot be entirely ruled out in the medium term).

Figure 98: Interview feedback What are the characteristics of potential longterm winners?
Strong infrastructure
Large global footprint
Large local market share
Depends on execution
Integrated (F+M)
Full service
OTT players
The leanest
Strong brands
Deep pockets
0

10

12

14

16

Source: Arthur D. Little, Exane BNP Paribas estimates

The prerequisites: strong infrastructure and lean opex


The revenue outlook for the industry is gloomy, particularly for incumbents and mobile
operators, putting pressure on profitability and free cash-flow generation.
Given the strong growth in data traffic and the expected move to super-fast broadband,
infrastructure will be a key differentiator. Under-investing compared to the competition
is a key risk. Capex cannot be the adjusting factor so to preserve their strategic
position, telcos increasingly need to work on their opex base.

96

Telecom Operators

In 2011, European telecom operators average EBITDA margin was c.34%, with most large
telcos in the 30-40% range, depending on their revenue mix, geographic footprint and scale.
Given the revenue pressure expected at the sector level (-2% CAGR):
if opex were to be flat over the same period, EBITDA would fall by 23% between
2011 and 2015e;
at the other end of the spectrum, to maintain EBITDA in absolute terms between
2011 and 2015e would require telcos to cut their total opex by 12% in four years.
Can operators achieve such massive opex reductions in a four-year timeframe?
We believe that beyond the classic benchmarking exercise that all operators do
regularly on key cost elements, telcos have not fully exploited two fundamental
improvement opportunities which could bring radical upside:
1) Front-end: leveraging the rise of online applications and the virtualisation of
interactions with customers;
2) Back-end consolidation, including network sharing on a country-by-country basis and
optimisation of IT resources on a cross-border basis.

Figure 99: Opex analysis


Flat opex or flat EBITDA? Two extreme scenarios

Key categories of opex as a % of revenues

100

70%

90

60%
Opex % of revenue

80
70
0%

Index

60

-12%

50
40
30

50%
40%
30%
20%

0%

20

10%

-23%

10

0%

Mobile
2011

EBITDA

2015e
with flat
opex

Integrated

2015e
with flat
EBITDA

Interconnect

Other direct costs

SARC

Other customer costs

Opex

Other opex

Source: Arthur D. Little, Exane BNP Paribas estimates

Telcos cost structure: where are the opportunities?


Not many operators report their detailed cost structures, but based on a significant
sample (including notably Vodafone, Mobistar, France Telecom, Telecom Italia and
Portugal Telecom) and our own analysis, we find that the key opex areas are:
Interconnect costs represent 10-20% of mobile operators revenues and 5-15% for
incumbents. This is not an area over which operators have significant control, but we
expect these costs to decrease faster than revenues, thanks to the lower MTRs and the
evolving revenue mix (growth in mobile data with no interconnect costs).
Other direct costs notably include leased lines for mobile backhaul, content costs
and bad debt. Mobile operators have relatively large other direct costs (c.10% of
revenues) while integrated incumbents spend less (c.5% of revenues) reflecting that
mobile businesses of integrated players are using elements of the fixed-line network
such as fibre links (capex), while independent mobile operators rely more on leased
lines (opex). All operators are moving towards having their own backhaul links (own
fibre or point-to-point wireless) instead of leased ones, so other direct costs should
decrease faster than revenues, although this comes at a cost in terms of capex.
Network sharing can be a source of large saving regarding backhaul and can also
impact network maintenance opex (included in other opex) see our analysis below.

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Telecom Operators

Commercial costs, including in particular subscriber acquisition and retention


costs (handset subsidies, commissions). This opex item varies sharply by market
depending on the competitive pressure and the subsidisation (or lack thereof) of
handsets. We estimate that commercial costs represent 8-21% of mobile operators
revenues, and 5-16% of integrated incumbents. Commercial costs cannot be an area
of deliberate cost cutting for any operator, as 1) these are a key determinant of market
shares hence are driven primarily by competition and 2) in some markets, a move to
SIM-only may lead to a substantial cut in handset subsidies (e.g. in Q3 11, TDC saw a
50% y/y decline in its unit SARC in Denmark) although we believe that this could be
dangerous for operators in the long run (see page 48). However, operators can
optimise commercial costs via a move to an online centric business model see below.
Other customer costs, in particular distribution networks (own shops) and call
centres. These are personnel-heavy areas. We estimate that they represent 6-9% of
mobile operators revenues and 15-20% of integrated incumbents. These are key
areas which can be made more efficient thanks to the development of online tools.
Other opex include network maintenance, IT opex, general & administrative costs,
etc. and they represent 12-15% of mobile operators revenues and 9-13% of integrated
incumbents. These also include a more or less significant share of personnel costs
depending on the operators reliance on outsourcing. In pages 101-106, we look at
consolidation opportunities both at the national level (network sharing) and the crossborder level (IT, datacenter).

Online transformation: potential to cut total opex by 9%


The move to online has the potential to improve all aspects of telcos customer-related
functions, in particular the selling, after-sale, billing and customer service processes
via the development of transactions performed by the customer itself on a website
rather than by on the phone with a call centre or with a sales representative in a shop.
We estimate that in total, the different transformations which can be implemented at a
typical telco could lead to a reduction of the whole opex base by as much as 9%, the
equivalent of an EBITDA margin uplift of 580bp, all other things being equal.
This online transformation is demanded by customers (asking to get in control, and
calling for flexibility), but also pushed by the development of OTT players (online is their
core way of interacting with customers). Telcos already have online processes, but
areas of improvement include: 1) making sure that their online and offline activities are
in sync, 2) improving their time to market, 3) enhancing the customer experience, with
ultimately the opportunity to reduce costs (lower opex per transaction online).

Online sales channels have already been developed by operators, but we see large
potential to boost them by: 1) improving the convenience/ease of use of portals, 2)
providing a more personalised/real-time approach to each customer, and 3) integrating esales with other sales channels to provide a seamless cross-channel experience. Some
cable and mobile operators already do three quarters or more of their sales online.
Cost items that can be reduced thanks to online include 1) commercial costs (reduction
in indirect sales commissions), and 2) customer sales functions including retail shops
(number of shops and/or headcount in shops). As online progresses, the structure of
operators distribution channels could change, with a reduction in the number of shops,
notably franchises, potentially moving to a model with fewer but larger, flagship, stores.

Self-care can be expanded by 1) increasing the number and types of tasks that can be
performed by the customer itself, online rather than offline; 2) increasing the number
and types of channels that the customer can use e.g. websites but also smartphone
apps, social media, etc.

98

Telecom Operators

These moves can significantly reduce the cost of call centres both in their customer
service function (i.e. enabling customers to change their offer, to add or remove
options, etc.) and in their after sale function (i.e. help for customers facing problems,
fault handling, etc.).

Marketing costs can also be reduced by online initiatives, for example by 1) simplifying
the product portfolio, 2) enhancing up- and cross-selling opportunities, but also 3)
shifting marketing and campaigns to online tools, which are more cost effective.
In particular, engaging with users via social media (e.g. by creating digital communities)
is a great way to learn directly from users (product feedback etc.), to enlarge the reach
of the brand and even to have clients work for the operator (for instance they can
provide help for other users in forums). Online can reduce time-to-market for new
offers, and reduce market research costs and advertising spend.
Finally, billing can be moved online even more extensively with potential to save
costs in bill processing (printing, sending, etc.) and payment (move to direct debit).
For instance: 1) Telefnica has publicly committed to increase the proportion of online
transactions with customers from 16% in 2010 to 29% in 2013e, at the group level; 2)
in France, existing mobile operators created new sub-brand offers available only on the
web (Orange Sosh, SFR Red, Bouygues Telecom B&You) in anticipation of the launch
of Free Mobile.
Depending on the operator and the context, we estimate that the savings could reach
1025% on relevant cost categories, notably customer sales, customer service, aftersales call centres, acquisition and retention costs, marketing and billing. Overall, in this
example, total savings are equivalent to a 9% cut in the operators total opex, i.e. an
EBITDA margin uplift of 580bp, all other things being equal.

Figure 100: Assessing the potential savings from online centric move
Index

Before

Potential savings

After

Revenue

100.0

0%

100.0

Interconnect
Other direct costs
SARC
Marketing
Customer sales & customer service
After sale call centres
Billing
Access installation & repair
Network operations
IT service
G&A
Total opex

-7.7
-4.4
-6.1
-3.3
-15.5
-1.3
-2.6
-6.9
-9.5
-3.9
-3.9
-65.0

0%
0%
-12%
-11%
-26%
-25%
-15%
0%
0%
0%
0%
-9%

-7.7
-4.4
-5.4
-2.9
-11.4
-1.0
-2.2
-6.9
-9.5
-3.9
-3.9
-59.2

EBITDA
Margin

35.0
35%

17%
5.8%

40.8
41%

Source: Arthur D. Little, Exane BNP Paribas estimates

Local scale is more and more important


Telecom is a fixed-cost business so scale has always mattered on a local basis:
leading operators with larger market shares have historically commanded higher
margins and returns than challengers with lower market shares on a like-for-like
basis. If a telco required 1m customers to be profitable in the past it will need 2m in the
future, as one interviewee has put it.
We believe that local scale is increasingly important on the infrastructure side i.e.
spectrum, mobile networks and fixed/fibre networks but it is not as obvious on the
services side. This would suggest a future landscape of very highly concentrated
networks, but a more fragmented service market.

99

Telecom Operators

The strong growth in data traffic volumes gives an advantage to the stronger
infrastructure players, i.e. operators boasting networks with the fastest speed and
largest capacity. These will be able to provide a better quality of service to customers,
and to be the lowest unit cost operators.
This is true on the fixed-line side (need to invest in FTTx and upgrade capacity) but
also on the mobile side (need to boost 3G+ capacity, buy spectrum and roll out 4G).
For instance, O2 Germany had to face customer complaints on its network quality, and
T-Mobile Germany used these concerns on O2s network quality in one of its
advertising campaigns. In the USA, network quality has also been a strong commercial
argument for Verizon for several years.

Market share matters for spectrum


The chart below compares the results of recent spectrum auctions in Europe (in 20102011) with operators revenues, showing that spectrum acquisition has represented a
much larger part of revenues for challengers than for leaders: average of 22% of
revenues spent versus 15% for leaders.
In addition, many challengers did not secure any part of the most valuable spectrum
(800MHz). Neither e-plus in Germany, nor Iliad in France, nor Yoigo in Spain nor 3 in
Italy got any sub-1GHz spectrum although this does not mean that these operators
will not continue to be aggressive contenders:
e-plus stepped out once the price for 800MHz got too high. However, in total it
secured more spectrum than any other bidder and now deploys a hybrid high-speed
network using 1.8GHz and 2.6GHz spectrum;
Iliad (Free Mobile) acquired the right to roam nationwide on the future 4G network
to be rolled out by SFR in 800MHz, as per SFR's license obligations;
Yoigo got 1.8GHz spectrum and some 2.6GHz in the first stage of auctions, while in
a second stage the three largest operators bid for 800MHz;
3 Italy, deploys UMTS900 for rural outdoor and urban indoor data coverage, and
may deploy a hybrid LTE network using 1.8GHz and 2.6GHz.

Figure 101: Amounts spent on spectrum in 2010-2011 as % of 2011e mobile


service revenues
50%
45%
40%
35%
30%
25%
20%
15%
10%
5%

Source: Arthur D. Little, Exane BNP Paribas estimates

100

Total

Number 3+4

Number 1+2

Base

Belgium

Mobistar

Belgacom

Spain

Yoigo

Vod Sp

Orange Sp

Telefonica

3 IT

Italy

Wind

TIM

Vod IT

O2 G

Germany

Vod G

E-Plus

T-Mo G

France

SFR

Bouygues

Orange F

0%

Telecom Operators

Scale synergies on networks


The examples of the UK, US and Swiss merger synergies show the extent of potential
savings linked to scale: looking at opex and capex together, companies have pointed to
potential run-rate savings in the range of 4-9% of the total combined base of the
merged operators, and focusing on opex only (in the case of the UK and Switzerland)
the savings were expected to reach 4-8% of the combined base driven mainly by
network, IT and commercial costs.
Savings on the network side were a key feature of the UK and Swiss deals, with the
target to save and at the same time to create a better network. The merged network
was expected to have fewer base stations compared to two separate networks, but
more than each stand-alone operator.

Figure 102: Synergies announced in three local consolidation deals


UK
Orange-T-Mobile
GBPm

Switzerland
Orange-Sunrise
CHFm

US
AT&T-Mobile
USDm

445
5
8.3%

200
5
3.7%

145
12.3%

47
na

300
8.4%

153
na

Cumulative capex saving


Over x years
% of combined base

620
5
19.7%

570
6
12.2%

Run-rate capex saving


% of combined base

100
13.3%

65
7.8%

545
8.9%

265
4.2%

>3,000
4.6%

600-800
11.5%

140
11.2%

9,000
13.9%

3,500

3,200

>40,000

Run-rate opex saving


By year
% of combined base
of which commercial opex
% of combined base
of which network & other opex
% of combined base

Run-rate opex + capex saving


% of combined base
Cumulative integration costs
% of combined base
NPV of synergies

Source: Companies, Arthur D. Little, Exane BNP Paribas estimates

Figure 103: Network rationalisation Example of proposed Orange-Sunrise


merger in Switzerland

Source: Orange, TDC, Arthur D. Little, Exane BNP Paribas estimates

Such merger benefits on the radio access network side can also be achieved via
network sharing agreements.
We expect the rollout of 4G networks to be a key driver of a new wave of network
sharing in Europe, given the need for additional capex in a context of tougher pressure
at the revenue level. As seen above, there are many examples of challenger mobile
operators which have not secured 800MHz spectrum, while some others have secured
such spectrum but at a high cost compared to their size creating a natural incentive
for network sharing.

101

Telecom Operators

The table below includes a sample of network sharing agreements struck in Europe over
the past years. Sweden is, in our view, one of the most advanced countries in terms of
network sharing, with currently three out of four mobile operators in the country engaged
in network sharing in three joint ventures: Net4Mobility (Tele2 & Telenor) for 2G and 4G,
SUNAB (TeliaSonera & Tele2) for 3G, and 3GIS (Telenor & 3) for 3G.

Figure 104: Mobile network sharing examples


Country

Sweden
Sweden
Spain
UK
Spain
Sweden

Operators

Tele2 / TeliaSonera
Telenor / 3Sweden
Vodafone / Orange
T-Mobile / 3UK
Telefnica / Yoigo
Tele2 / Telenor
Orange/SFR/
France
Bouygues
Czech Rep. T-Mobile / O2
Austria
T-Mobile / Orange
Denmark
TeliaSonera / Telenor
Poland
TPSA / PTC
Germany
T-Mobile/Vodafone/O2
Austria
T-Mobile / H3G

Announced

Status

Extent of
sharing

Depth of
sharing

Reach of
sharing

# of sites

Which sites?

Structure

Savings target
per partner

2001
2001
Oct. 2007
Dec. 2007
June 2008
2009

Operational
Operational
Operational
Operational
n/a
In deployment

3G
3G
3G
3G
2G/3G
2G/4G

Active RAN
Active RAN
Active RAN
Active RAN
Passive RAN
Active RAN

Nationwide
Ex big cities
Rural
Nationwide
Rural & urban
Nationwide

n/a
n/a
5,000
13,000
4,000
n/a

New
New
New
All 3G
Existing
New

JV
JV
no JV
50-50 JV
no JV
50-50 JV

n/a
n/a
EUR0.2bn / 5Y
GBP2bn / 10Y
n/a
n/a

Feb. 2010
Feb. 2011
April 2011
June 2011
July 2011
Dec. 2011
Jan. 2012

In deployment
In deployment
Operational
Announced
In deployment
In discussion
Announced

3G
3G
3G
2G/3G/4G
2G/3G
Backhaul
3G

Active RAN
Active RAN
Active RAN
Full RAN
Active RAN
Backhaul
Active RAN

Rural
Rural
Rural
Nationwide
Nationwide
Nationwide
Rural

2,500
1,000
Hundreds
n/a
10,000
n/a
n/a

New
New
Existing
All
Existing & new
All
Existing

Roaming
n/a
no JV
n/a
50-50 JV
n/a
no JV

n/a
n/a
EUR30m
n/a
Opex -29% / 3Y
n/a
n/a

Source: Operators, Arthur D. Little, Exane BNP Paribas estimates

There are many different possible options as regards sharing of infrastructure between
mobile operators, and these are summarised in the chart below. In particular, the
depth of sharing is a key factor ranging from the full sharing of the whole mobile
network in a region or even in a whole country for a specific technology (e.g. the
Tele2/TeliaSonera JV on 3G in Sweden), to a limited sharing focused only on masts
(passive infrastructure sharing). In the case of full network sharing, this enables
operators to save not only on the masts and base stations but also on backhaul and
the JV structure can also enable the pooling of spectrum assets, if regulation allows it.

Figure 105: Network sharing deals can vary greatly in scope and ambition

Source: Arthur D. Little, Exane BNP Paribas estimates

102

Telecom Operators

The depth of sharing is a key determining factor of the potential savings that can be
achieved but also of the complexity of the sharing process (depending on operators
legacy assets) and also of the remaining ability of the sharing operators to continue to
differentiate at the network level.
At one end of the spectrum, the national roaming option means that there is only
one network overall, enabling full synergies but basically annihilating the operators
ability to differentiate on the network side;
At the other end of the spectrum, passive RAN sharing involves sharing only the
passive infrastructure i.e. the tower/mast, shelter and power. The savings that can be
achieved here are small.

Figure 106: Different options regarding depth of sharing

Source: Arthur D. Little, Exane BNP Paribas estimates

Based on information publicly communicated by operators to investors in the past and


other sources, we estimate that potential savings from network sharing range from 10%
to 30% on network capex and opex depending on the type of sharing, the starting
position of operators and the potential costs related to decommissioning of sites, JV
setup, and backhaul upgrades, etc.

Network sharing brings retail benefits: Network sharing essentially is a consolidation


of two telcos limited to the back-end. Whilst this cannot be expected to bring full merger
benefits, notably in terms of potential easing of the competitive intensity in the retail
side, we believe that it does bring some element of rationalisation to the overall market.
A key rationale for this is that network sharing reduces the risk of overcapacity in the
network and hence diminishes the risk of a price war driven by the need for one
competitor to fill its network.
The example of the Swedish mobile market is in our view quite telling in this respect, as
it has the most advanced network sharing as well as the best top-line trends in Europe
(+7% y/y in 2011 versus the European average of -3%). However, it should be noted
that larger operators face the typical question of providing network sharing benefits to
smaller competitors.

103

Telecom Operators

Fibre rollout: In fixed-line, we detailed in our 2011 report (Super-fast broadband:


catch up if you can) that we expect FTTx rollout to accelerate in the coming years
and we have found that the economics are tough for all operators, and in particular for
those with lower market shares.
Regarding FTTH, we reiterate our view that we expect network sharing to take place.
Many deals have already been announced, for instance in France (SFR/Bouygues
Telecom JV, and deals between Orange and other parties in medium-density areas)
and in Germany (Deutsche Telekom/NetCologne deal).
However, for the time being, in many markets, incumbents are favouring a technology
approach focused on FTTC/VDSL, with the aim to leverage their existing copper lines
as much as possible by aiming at deploying advanced DSL technologies such as
vectoring (e.g. Belgacom, Telecom Italia).

What about the commercial side?


Beyond the infrastructure, is local size also an advantage in customer-interfacing
activities such as retail distribution or service provision? Operators have talked about
the ability to reduce general and administrative costs, to optimise the workforce and to
save on commercial spending but how big is the potential and can these savings be
achieved without reducing the commercial impact of the operator?
In both the above-mentioned mergers in the UK and Switzerland, commercial costs
were expected to be a key area of synergies but: 1) in the UK, these have not yet
been significantly realised, and 2) in Switzerland, the deal never took place so it is
difficult to assess the actual consequences of the proposed synergies.
Optimising commercial costs potentially involves the rationalisation of advertising
spend, of the brand strategy (towards a single brand?) and of the retail network. Indeed
providing services generates substantial fixed costs (e.g. a retail network of shops
throughout a country) and having a mega service organisation can bring scale benefits
in terms of distribution.
However many examples in the past have demonstrated the benefits of having a
multitude of brands and service propositions as shown by the success of the multibrand strategy implemented by KPN in Germany, the success of MVNOs in many
markets and the development of web-only offers in France (Orange Sosh, SFR Red,
Bouygues B&You).
As distribution increasingly moves online, one can wonder whether the advantage of
owning an extensive distribution network may have passed its peak. We nevertheless
expect that there will be more and more value in larger flagships where telcos will be
able to demonstrate the breadth of their product portfolios and provide assistance.
In the case of the Orange-T-Mobile merger in the UK, Everything Everywhere is
strongly focusing on executing the promised synergies on the network/infrastructure
side, but the company has been hesitating longer than anticipated on the strategy on
the services side keeping at this stage two separate brands, positioning, and largely
two retail networks.

104

Telecom Operators

Global scale: growing benefits, in the long term


It has never been proven that operators with large footprints have an advantage over
operators with smaller footprints notably margins of smaller operators are not, on
average, lower than those of global players, and neither has global scale helped market
share trends. However, we see three areas in which global scale will bring increasing
benefits in the future.
First, operators are setting up global purchasing power houses to strengthen their
bargaining power versus equipment and technology providers and publishing
quantifiable targets: the France Telecom-Deutsche Telekom initiative aims at savings
of EUR1.3bn per year from 2014, i.e. -11% on the relevant capex+opex base.
Second, as cloud infrastructure expands in the future, the proportion of IT infrastructure
will grow as a percentage of telcos total assets and this infrastructure can be
centralised across borders, generating efficiencies which will be specific to larger groups.
Third, on the commercial side, large operators will be in a better position regarding a
small part of the product portfolio, namely some specific verticals like connected cars,
and OTT services which are cross-border by nature.
These are not sufficient to justify cross-border deals, but can lead to a growing number
of partnerships in terms of purchasing as well as in terms of innovative services.

Bargaining power versus equipment and technology providers


As a result of consolidation in the equipment industry, a substantial share of the
operators core purchases is now done with global suppliers (network equipment and
customer equipment, including handsets). Operators seek to increase their bargaining
power versus these global equipment and technology vendors.
This could be achieved through huge M&A deals, but also - at least partly - by setting
up purchasing JVs as done by France Telecom and Deutsche Telekom recently.

Figure 107: BUYIN, the France Telecom-Deutsche Telekom procurement JV

Source: France Telecom, Deutsche Telekom

105

Telecom Operators

The purpose of setting up this JV (called BUYIN) is for the partners to achieve a more
competitive cost position by aggregating demand to vendors. Areas covered by the JV
are purchases in network, equipment and services (including service platforms),
customer equipment (including terminals) and IT. The addressable spend
(capex+opex) is EUR12bn and the target is to save EUR1.3bn annually from 2014
(three years after the start of operations in Q4 11), i.e. a savings rate of almost 11%, of
which >EUR400m for Deutsche Telekom and <EUR900m for France Telecom.
Other examples include: 1) Vodafone Procurement Company formed in 2008, open to
both Vodafone affiliates and external telecom operators; 2) Telefnica Global Sourcing
formed in 2009 as a German company located in Munich. Telefnica and China
Unicom announced an extension of their cooperation in procurement in January 2011.

Global scale effect in some parts of the infrastructure


Local infrastructure represents a much larger part of telcos assets than backbones and
IT infrastructure and there is no global scale effect on local network elements, beyond
the above-mentioned purchasing power benefits.
However, as trans-border fibre backbones enable companies to carry huge amounts of
data virtually instantly over the globe, servers do not need to be situated in the same
country as the end customer. Many operators have been consolidating their
datacenters across their footprint for several years already, but more can be done in
this respect.
Many interviewees have highlighted the remaining opportunities in this field e.g. one
data warehouse for the whole group, sited in a low-cost country.
Importantly, not all data can be stored or used in such a way, notably this is not the
case of 1) personal data (e.g. some personal data is subject to national or regional law,
notably in Europe, potentially forbidding operators from storing it outside of the
European Union) and 2) specific content which is subject to exclusive or specific rights,
as these rights are often granted on a country-by-country basis.
However, we believe that as cloud services grow, the ability to run an operators core IT
infrastructure from a smaller number of locations, even though the operator has
customers in many countries, will become an ever-greater cost advantage. For
instance, Vodafone rationalised its European IT operations in 2006, with regionalized
Northern and Southern Europe datacenters, and has said that it achieved annual
savings of 30% in 2008.

Commercial side: global scale to bring small but growing benefits


Even though a growing proportion of customer interactions will be performed online,
operators cannot and should not abandon their local presence with customers. We
nevertheless believe that the operators with a larger international footprint will have
some advantages in the future over national or regional ones in particular in some
verticals, and in new/OTT services.

Verticals: operators with large international footprints will be at an advantage


compared to smaller ones, at least for some verticals. This is the case for instance for
the connected cars opportunity car manufacturers are global companies, and have
launched pan-European RFPs.

106

Telecom Operators

Another example is the way the Orange group has organised its whole machine-tomachine activity, with a global centre of expertise run by its Belgian subsidiary
Mobistar. In 2011, Mobistar signed more than ten contracts in the US and Europe for a
total commitment of 1.5m SIM cards and interestingly, Mobistar has a 70% market
share on M2M in its home market, Belgium, far ahead of the local incumbent
Belgacom. This illustrates how being part of the Orange gives Mobistar a crucial
advantage. Recently, France Telecom has announced a partnership in M2M with the
US operator Sprint, leading to an expanded global footprint in this market.

OTT services: It will not be easy for operators to compete versus global OTT players
such as Google, Facebook, Apple or even Netflix on new services but we believe that
telcos with a broader footprint should have an advantage, for two reasons:
1) As networks and services become all IP-centric, telcos, like web giants, have the
opportunity to develop services once and then to roll them out across their whole global
footprint. This enables savings, but also faster time to market e.g. France Telecom can
hope to be first to roll out new services in African countries, while if these local operators
were to run locally, they would not have the means to roll out such services as quickly;
2) Forging partnerships with the most advanced start-ups in each specific OTT field is a
challenge, but it will be essential for operators with ambitions to remain ahead of the
game in terms of innovative services. A broad-based operator with substantial means
should have the edge on more local players in terms of finding the right potential
partners (size matters for knowledge), and it will be a more attractive partner than a
small operator as it will offer a larger business opportunity for most OTT innovators.

Increasingly diverging strategies Anybody wins?


Combining different visions on the industrys outlook (more or less negative) and
different views on key assets to leverage (essentially the infrastructure or the customer
base), but also very different starting positions (leaders versus challengers, local
versus global footprint), telcos management teams are in our view considering
strategies which are increasingly different, notably along two axes:
vertical integration, with different levels of emphasis on developing a full portfolio of
retail services. This is the bit pipe versus full service operator debate;
geographic footprint, with most European telcos focused on one or a few countries,
and a small group looking at a much larger footprint.
Combining these two axes, telcos strategies can broadly be categorised in three
groups: 1) the mega-operator, 2) the local hero, i.e. the full service telco focused on a
limited geographic footprint, and 3) the local infrastructure play.

107

Telecom Operators

We conclude that:
the mega-operator approach can in theory create the most value in the long term,
but it is the most difficult to execute given the need for capital and the multi-faceted
competitive challenges and in any case only a handful of European telcos can play;
the local hero could lead to a slightly better top-line but this does not come without
opex and capex in the next few years as well as execution risks.
the infrastructure play approach is the least risky but also brings the lowest returns in
the long run, and in any case cannot be implemented by operators lacking opex flexibility.

Option 1 The mega-operator Doing everything well is not easy


This is a very large operator present in many European countries as well as other
global regions, with strong infrastructure across its geographic footprint, and with the
ambition to capture revenues from the whole spectrum of services with both B2C and
B2B customers. The mega-operator has the ambition to compete (but also collaborate)
with OTT providers, and also targets the key vertical market opportunities (since some
are best served on a global basis with clear cross-border synergies).
In our view, this strategy is difficult to execute, as it needs to combine the strength of a
large utility with a strong delivery on opex/transformation projects, as well as the
nimbleness of a leading tech company. Indeed:
a mega-operator is a very large group with a large scale and footprint, hence a
large number of employees, a large number of partners to find and nurture, a large
number of competitors to keep ahead of, a large number of regulators to deal with etc.
This requires impressive organisational and management skills.
a mega-operator will inevitably be an incumbent in some markets and a challenger
in others, requiring different strategic skill sets;
a mega-operator needs a large range of capabilities to address the different types
of customers and offer all kinds of services from entertainment services to
professional ones in the vertical areas.
at the same time, like all other telcos, the mega-operator faces strong headwinds on
legacy revenues, hence, like others it needs to restructure costs and transform into a
leaner company.
finally, since it aims at playing a leading role in tech (OTT services, cloud, verticals,
etc.), it needs to be as nimble and innovative as players in these fields.
In Europe, the groups pursuing this strategy are, in our view, Telefnica, Vodafone,
Deutsche Telekom and France Telecom. All are currently reshuffling their operational
footprints while seeking to maintain scale advantages across multiple regions.
In terms of financial profile, this strategic choice is the one offering the most theoretical
long-term upside. Indeed the mega-operator: 1) pursues the widest possible market
opportunities hence potentially it will get the highest share of revenues in the value
chain; 2) aims at keeping the high value retail customer relationship with as many types
of customers as possible; and 3) at the same time it targets the best possible cost
structure via optimisation at the local and global levels.
However, this is also the strategy with the biggest investment (in terms of opex and
capex) and given its willingness to compete with everyone everywhere, the chances of
success appear lower than in the case of the two other, more focused strategies.

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Option 2 The local hero Challenge of striking the right balance


We call local hero an operator with a limited geographic footprint, aiming to keep and
develop services across the value chain, on different market segments (B2C, B2B, etc.)
with a strong focus on defending its revenues and, if possible, return to growth.
Given global scale advantages that we have identified above, the local hero should
in theory:
be less competitive than mega-operators on some specific market segments, such
as some verticals (e.g. connected cars) or on multi-national clients but it will compete
very efficiently in the market of more local customers (SMEs, pros and consumers) as
well as on some key verticals to support the emergence of local internet of things
(e.g. smart metering, partnering with local utilities, and potentially financial services,
partnering with local banks);
leave more space than mega-operators to global OTT players (e.g. on TV or cloud
services), although it will be able to compete on local content and services (news,
football, etc.), and will potentially extend the share of wallet it addresses through one
stop shop approaches (retailing of products from other sectors adjacent to the telecom
and media sectors).
This local hero strategy appears to be the most common approach among incumbent
telcos we have talked to. Most interviewees have highlighted the important role of a
telco as service integrator, not bit-pipe, and their willingness to diversify into valueadded services and verticals. This is notably the strategy of KPN (in the Netherlands),
Telecom Italia, Belgacom, Swisscom and TDC.
Key difficulties in such a strategy include in our view:
the need for small-sized players to make the investments and acquire the skills
necessary to develop a credible presence on many different fronts, such as B2C, B2B,
verticals, etc. Size is a weakness versus mega-operators if they are present in their
market. In addition, regarding the cost efficiency of service platforms (e.g. for machineto-machine) or datacenters (for cloud services), the local hero will probably lag larger
telcos but also global competitors in the value chain such as web and tech leaders.
the local hero will probably not be as efficient and lean as operators choosing the
local infrastructure play strategy, because management will focus on efforts to return
to revenue growth rather than just on restructuring.
In terms of financial profile, this strategic choice leads to a period of transition with
limited short-term visibility. Indeed, new activities such as ICT/cloud, verticals and
content services should be dilutive to margins and bring limited revenues at least for
the next few years.
However, assuming that the local hero strikes the right balance between opex
restructuring, infrastructure investments and efforts to maintain a high market share,
this strategy can, in our view, lead to a better-than-average top line, although at the
cost of limited dilution to margins.

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Telecom Operators

Option 3 Local infrastructure play More solid but less profitable?


A significant minority of players see network infrastructure as telcos core differentiated
asset and consequently they plan to refocus around the role of providing connectivity.
Most companies focusing on this approach start from the core views that 1) telcos
cannot be successful if they do not drastically cut costs (so integrated telcos will be
gone) and that 2) the customer relationship will increasingly become the battleground
for more powerful players, both in B2C (Apple, Google, etc.) and in B2B (IT services
and tech giants, mega-operators).
The infrastructure player makes a conscious choice of focusing on the network, while
developing a range of partner agreements on the service side to expand its (indirect)
reach to as many end-clients as possible. Partners potentially include MVNOs, other
operators, distributors, companies in other sectors (for verticals), OTT players, etc. This
is a scale game so maximising wholesale opportunities is necessary to maximise the
return on network assets.
Others describe this approach negatively by talking about a bit pipe but the notion of
infrastructure should be understood in a broad sense, including the access network in
fixed and mobile, but also service platforms (e.g. MVNE), billing systems, datacenters,
machine-to-machine platforms, etc.
To be successful this strategy requires that:
the operator has a high (wholesale) market share in its local market. This is usually
already the case for most incumbents, but can be enhanced via consolidation or
network sharing;
the operator can effectively become as lean as possible requiring flexibility in
terms of cost cutting, notably on personnel costs (not necessarily a given for all
incumbents);
the operator should not abandon the retail market: it can have its own retail client
base, in competition with its wholesale partners. This makes sense as long as this is
done in a very lean way, for instance via an online distribution approach. A good
example of this approach is E-Plus in Germany.
A fundamental strength of this business model is the visibility it offers given the utilitylike profile (high barriers to entry on infrastructure).
On the other hand, the fundamental weakness of such a strategy is that it comes with
lower profitability. The EBITDA margin is generally higher for operators with such a
profile, thanks to the leaner structure (commercial costs, etc.). However, the capex/sales
is also higher (because the revenue per minute or per GByte is lower on wholesale than
on retail) and so the actual return on capital employed of such a utility type business
model appears lower than that of retail oriented organisations. Fundamentally, a telco
extracts less value from being a wholesale player (squeezed by OTT players /
professional buyers) than from being close to the customer (especially in B2C).

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Telecom Operators

For now, infrastructure is less profitable than retail


To illustrate our point on EBITDA margins, capex and returns, we show in the chart
below (left hand side) the average EBITDA margins and capex/sales of different groups
of players. The conclusion of our analysis is that the capital intensity of the business
model is actually more important than the EBITDA margin to determine the return on
capital employed.
Players with relatively light asset bases generate the highest returns even though
they may not have the best margins. These include what we have called light asset
players (BT Global Services, United Internet, TalkTalk and KPNs iBasis unit) with an
average EBITDA margin of 11% and capex/sales of 6%, but also pure B2C and pure
B2B operators (respectively BT Retail, Belgacom Consumer, KPN NL Consumer; and
Belgacom Enterprise division, KPN NL Enterprise division, C&W Worldwide).
At the other end of the spectrum, in the wholesale players we have included BT
Openreach, BT Wholesale and KPNs Wholesale & Operations division in the
Netherlands with an average EBITDA margin of 47% and capex to sales of 25%. This
leads to an estimated post-tax ROCE of 11%. Other operators with high EBITDA
margins are lean B2C players (Iliad, E-Plus) and cable operators (Telenet, Kabel
Deutschland, Virgin Media) however both groups also have high capex/sales (in
excess of 20%, on average) and generate relatively lower returns.

Figure 108: Financial profiles of different types of telcos


EBITDA margin versus capex/sales

Return on gross assets, post-tax


70%

25%
Lean B2C

60%

Cable ops.

20%

Capex/sales

Wholesale

50%
40%

15%

30%

Integrated
10%

20%

Pure B2C
Pure B2B

5%

10%

Light assets

50%

Pure B2C

40%

Pure B2B

30%

Light assets

20%

EBITDA margin

Integrated

10%

Lean B2C

0%

Cable ops.

Wholesale

0%

0%

Source: Arthur D. Little, Exane BNP Paribas estimates

However, such a conclusion in favour of retail versus wholesale providers may be true
for now, but the situation may change in the future given the potential for consolidation
among infrastructure players, to be compared to the risk of increased competition
between retail service providers.
The profitability of the wholesale model strongly depends on the competitive intensity,
in particular on the number of infrastructure players in a given market. In fixed-line,
many markets have only two viable local infrastructure players (incumbent and cable).
This is a more favourable situation than in mobile, where there are three to four players
in each market. Full-fledged consolidation or network sharing could ease competitive
intensity, and hence enhance profitability.
On the other hand, playing on the retail side may currently lead to higher profitability
but this is the part of the telecom market which is the most challenged by new entrants
and OTT players so the profitability level may not be sustainable.

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Telecom Operators

Outcome: a flurry of deals?


No telco is exactly where it wants to be neither in terms of geographic footprint (some
want to expand, some want to shrink, some want both), nor in terms of market share
(most are looking for local consolidation opportunities), nor in terms of capabilities
(many are interested in developing new services requiring different skills or assets).
As shown in the chart below, most companies surveyed anticipate local consolidation in
their domestic markets in Europe although significant minorities rather expect network
sharing arrangements (or deals at the network level but not at the service level), or see
room for new entrants (generally at the service level). In addition, many foresee panEuropean deals, although very few foresee large M&A between large telcos.
We expect 1) local consolidation attempts in virtually all key European markets, either
fixed-fixed, mobile-mobile or fixed-mobile deals and at the very least a multiplication
of network sharing agreements; 2) integrated operators are also likely to continue
acquiring capabilities in adjacent markets such as cloud services; 3) finally, in terms of
cross-border moves, we expect many small steps, starting with partnerships or bolt-on
M&A, but one should not entirely rule out bigger deals, in our view.

Figure 109: Interview feedback Do you expect more consolidation?


Yes local
Yes pan-Europe
Network sharing and
alliances
Yes at the network level but
not the service level
Yes but place for new
entrants/small players
Uncertain due to regulation
Yes but longer term
Horizontal or vertical
0%

10%

20%

30%

40%

50%

60%

70%

Source: Arthur D. Little, Exane BNP Paribas estimates

Local consolidation Moves likely in all key markets


In the context of mounting pressure on revenues combined with the need to keep
spending (or increase spending) on network infrastructure, it is very likely that further
consolidation moves will take place in many European markets.
Regulation may block such attempts, but we do not believe that the recent antitrust issues
encountered by the official merger project in Switzerland (Orange/Sunrise) and the
tentative one in Greece (Vodafone/Wind Hellas) are necessarily signs that regulators will
block all deals. Indeed, in both cases, these deals were transforming three player mobile
markets into duopolies, while in most cases consolidation will be about reducing the
number of mobile operators from four to three. This is notably the case of the recently
announced Austrian merger, which is in our view a more important test case.
Beyond mobile-mobile deals, we also continue to expect fixed-fixed consolidation (as
small alternative carriers lack the scale to compete in super-fast broadband) and fixedmobile integration (e.g. potential Vodafone UK/Cable & Wireless Worldwide deal, a few
years after the SFR/Neuf Cegetel acquisition in France) or mobile-cable deals (e.g. VIP
in Croatia with Telekom Austria).

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Telecom Operators

At the very least, we anticipate more network sharing agreements, both in mobile (as
seen on page 101, there is at least one mobile operator without 800MHz spectrum in
most large markets, calling for network JVs on 4G/LTE) and in fixed-line (sharing
required for FTTH rollout).
Spain: the current pressure on FCF generation is a strong catalyst for
consolidation. Potential targets are MVNOs, Yoigo and Jazztel, and potential acquirers
are Vodafone and Orange pointing notably to mobile-mobile and fixed-mobile deals.
Italy: some interviewees see consolidation as almost sure, as several operators
are seen as borderline, hence logical targets for consolidation. Market participants
expect a three operator mobile market in the long run.
Germany: many players continue to talk about local consolidation in mobile. An eplus/O2 merger, the only possible combination, has been rumoured many times in the
past and never happened and the potential regulatory response remains uncertain. In
our view, a more likely outcome is network sharing (e-plus does not have 800MHz
spectrum, while O2 has spare spectrum). On fixed-line, we expect only the most
focused players to succeed (e.g. some city carriers) while the remaining pure play fixed
altnets are repositioning themselves (e.g. Versatel focusing on B2B & wholesale,
shifting away from B2C).
UK: we expect the market structure to evolve towards two (or potentially three)
operators on the fixed-line side (the move to fibre should drive consolidation) and two
operators on the mobile network side in the mid-to-long term. However, we expect
continued fragmentation at the service/retail level (many different service providers),
even though some consolidation is expected amongst B2B service providers. In
addition, a few players expect fixed-mobile integration to occur in the UK in the next
few years and the UK landscape to be affected by asset reshuffles by operators
following the mega-operator path: corporate activity around both Cable & Wireless
Worldwide and Deutsche Telekoms holding in Everything Everywhere support this line
of thought.
France: in the past, the French market has already experienced significant
consolidation in fixed broadband, and then fixed-mobile (SFR-NeufCegetel). Due to the
recent entry of Free in the mobile market, we do not expect consolidation in the short
term but fierce price competition will generate more incentives for network sharing.
Austria: the acquisition of Orange by Hutchison has recently been announced, with
Telekom Austria also acquiring part of the Orange customers (Yess brand). The
regulatory process is expected to be long.
Belgium: in the long run, we see fixed-mobile consolidation finally happening in
Belgium.
Sweden: in the Nordics, we expect further network sharing in mobile, along the lines
of the Telenor-Tele2 joint venture Net4Mobility announced in 2009 (the worlds first 2G
and 4G RAN sharing); three out of four mobile operators in Sweden are engaged in
network sharing. On the retail side, we expect a rapid customer take-up for OTT services
and the development of more partnerships between OTT players and telcos.

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Telecom Operators

Trans-border deals Many small steps rather than one big jump
Even though some believe in the virtue of mega-operators, we do not believe that
mega-deals (along the lines of the failed France Telecom/TeliaSonera acquisition)
should be expected any time soon. However, it is likely that, progressively, smaller
groups will get absorbed into larger ones.
In the meantime (and potentially in parallel), we expect more partnerships and JVs to
be announced between large telcos along the lines of: 1) the France
Telecom/Deutsche Telekom purchasing JV, 2) Telefnicas partnerships with Telecom
Italia (Telefnica owns 46% of Telco, the holding company which in turn owns 22.4% of
Telecom Italia ordinary shares), China Unicom, Bouygues Telecom or Sunrise; 3)
Vodafones partnership with Verizon. Ultimately, some of these partnerships may (or
may not) evolve into the smaller partner being acquired by the larger group.

Vertical deals Integrated players looking for more bolt-on deals


Many operators have already made M&A moves into adjacent industries, notably ICT
and cloud services, acquiring capabilities to grow into verticals. This is notably the case
of Belgacom (Telindus), KPN (Getronics), France Telecom (Dailymotion, Diwan, Data &
Mobiles), BT (Basilica, Lynx Technology, Wire One Communications, Ribbit), Deutsche
Telekom (Strato), Telefnica (JaJah), etc. while partnerships with all different types of
tech companies are countless.
Nevertheless, other actors in the value chain appear more aggressive in vertical M&A,
given their similar needs to diversify (into the service layer from the hardware space).
For example, in smart metering and controls alone, there have been multiple billion
dollar deals in recent years: Schneider-Telvent (USD2bn), Toshiba-Landis&Gyr
(USD2.3bn), ABB-ventyx (USD1bn), etc. The same is true of many other verticals,
where small independents are rapidly being acquired by hardware players and/or
private equity.
Among the mega operators and the local heros, the view is that telcos need to
acquire innovative companies, make more partnerships and participate in more
consortia so as to continue climbing up the value chain. In the coming years, we
would not rule out some telcos making bold moves and acquiring established service
providers, in different vertical areas, notably cloud services.

114

Telecom Operators

Arthur D. Little presentation


Founded in 1886 in Boston by a pioneer chemist and MIT professor, Arthur D. Little was the worlds first professional management
consulting firm. Ever since its creation, it has proved able to evolve and adapt with a constant focus on answering our clients
needs and challenges and creating true partnerships with business leaders.
Arthur D Little is a global leader in management consultancy, linking strategy, innovation and technology with deep industry
knowledge. We offer our clients sustainable solutions to their most complex business problems.
The firm has over 30 offices worldwide. Arthur D. Littles global leadership in management consulting is demonstrated by
numerous standard-setting publications.
Arthur D. Little completes over 2000 projects every year serving the worlds leading companies. This rate of activity has enabled
Arthur D. Little to gain strong experience and a well established know-how which is highly valued by our clients.
The pioneer spirit of its founder is still a strong feature of Arthur D. Little today. Arthur D Little has indeed a collaborative client
engagement style, exceptional people and a firm-wide commitment to quality and integrity. Arthur D. Little people bring curiosity,
creativity, integrity and analytical rigor to every job, which means fast and dramatic performance improvements. Our constant
objective is to create value for our clients, placing innovation at the heart of our recommendations and fostering the use of new
technologies and next generation processes.
Arthur D. Little teams work both with major multinational groups and smaller growth driven companies. The firm has conducted
projects with many of Fortune 100 companies. The quality of our work is rewarded by our clients loyalty: approximately 70% of our
worldwide revenue is generated by projects for companies that have been our clients for over three years.
With more than 500 professionals, the TIME practice (Telecommunications, Information, Media and Electronics) has unrivalled expertise
in strategic and technological assistance of leading telecom and media players. Arthur D. Little helps major telecom operators,
government agencies, equipment suppliers, Pay Television operators, Free to air channels and major internet players in the completion of
their most sensitive projects. The practice has gained a true and precise knowledge of the sector and of its main players.
During the last few months, Arthur D. Little has assisted several major telecom, media and internet players in the world with their
strategic plan, new technologies and innovative services.
For further information consult the Arthur D. Little website at www.adl.com.

Exane presentation
Founded in 1990, Exane is an investment company specialising in three businesses:
Cash Equities: Under the brand name Exane BNP Paribas, Exane provides institutional investors with a range of services, such
as research, sale and execution on European equities;
Equity Derivatives: Exane Derivatives has built a robust structured products franchise, based on its longstanding leadership in
European convertible bonds and options;
Asset Management: Exane Asset Management is a leading long/short equity fund manager in France.
The agreement between Exane and BNP Paribas, signed in 2004 and strengthened in 2010 and 2011, revolves around
three core elements:
An operational partnership in European cash equities where BNP Paribas conferred exclusivity on secondary equity brokerage
and the distribution of primary market activity to Exane under the Exane BNP Paribas brand;
A balance sheet partnership providing financing and support for our rating;
A capital partnership uniting the strength of BNP Paribas with the independence of Exane.
Exane works primarily with institutional clients worldwide (pension funds, fund managers for banks and insurers and hedge funds),
and markets its derivatives products to a broader pool of clients comprising private asset managers and investment advisors.
Exanes 860-strong workforce operates from offices in Paris, London, Brussels, Frankfurt, Geneva, Madrid, Milan, New York,
Stockholm and Singapore.
Exane BNP Paribas equity research team covers more than 600 European companies. UK companies represent the biggest part
of our coverage universe (29% of covered market cap), followed by France (15%) and Germany (13%).
Our research receives regular acclaim in leading industry surveys. Exane BNP Paribas was voted No.7 for Equity Sectors
Research in the 2011 Pan-European Extel survey and No.10 in the 2012 Institutional Investor All Europe Research Team survey.
For further information, log on to our website at www.exane.com

115

Telecom Operators

Analyst location
As per contact details, analysts are based in the following locations: London, UK for telephone numbers commencing +44; Paris, France +33; Brussels, Belgium +32;
Frankfurt, Germany +49; Geneva, Switzerland +41; Madrid, Spain +34; Milan, Italy +39; New York, USA +1; Singapore +65; Stockholm, Sweden +46

Rating definitions
Stock Rating (vs Sector)
Outperform: The stock is expected to outperform the industry large-cap coverage universe over a 12-month investment horizon.
Neutral: The stock is expected to perform in line with the industry large-cap coverage universe over a 12-month investment horizon.
Underperform: The stock is expected to underperform the industry large-cap coverage universe over a 12-month investment horizon.
Under review: The rating of the stock has been placed under review for following important news. Any possible change will be confirmed as soon as possible.
Sector Rating (vs Market)
Outperform: The sector is expected to outperform the DJ STOXX50 over a 12-month investment horizon.
Neutral: The sector is expected to perform in line with the DJ STOXX50 over a 12-month investment horizon.
Underperform: The sector is expected to underperform the DJ STOXX50 over a 12-month investment horizon.
Key ideas
BUY: The stock is expected to deliver an absolute return in excess of 30% over the next two years. Exane BNP Paribas Key Ideas Buy List comprises selected stocks that
meet this criterion.

Distribution of Exane BNP Paribas equity recommendations


As at 09/01/2012 Exane BNP Paribas covered 597 stocks. The stocks that, for regulatory reasons, are not accorded a rating by Exane BNP Paribas are excluded
from these statistics. For regulatory reasons, our ratings of Outperform, Neutral and Underperform correspond respectively to Buy, Hold and Sell; the underlying
signification is, however, different as our ratings are relative to the sector.
38% of stocks covered by Exane BNP Paribas were rated Outperform. During the last 12 months, Exane acted as distributor for BNP Paribas on the 1% of stocks with
this rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 7% of the companies
accorded this rating*.
40% of stocks covered by Exane BNP Paribas were rated Neutral. During the last 12 months, Exane acted as distributor for BNP Paribas on the 0% of stocks with this
rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 3% of the companies
accorded this rating*.
23% of stocks covered by Exane BNP Paribas were rated Underperform. During the last 12 months, Exane acted as distributor for BNP Paribas on the 1% of stocks
with this rating for which BNP Paribas acted as manager or co-manager on a public offering. BNP Paribas provided investment banking services to 7% of the
companies accorded this rating*.
* Exane is independent from BNP Paribas. Nevertheless, in order to maintain absolute transparency, we include in this category transactions carried out by BNP
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Commitment of transparency on potential conflicts of interest


Complete disclosures, please see www.exane.com/compliance

Exane
Pursuant to Directive 2003/125/CE and NASD Rule 2711(h)
Unless specified, Exane is unaware of significant conflicts of interest with companies mentioned in this report.
Company

Investment
banking

Distributor

Liquidity
provider

Corporate
links

Analyst's
personal
interest

Equity stake
US Law

Equity stake
French Law

Amended
after
disclosure to
company

Additional
material
conflicts

Eutelsat

NO

NO

YES

NO

NO

NO

NO

NO

NO

Iliad

NO

NO

YES

NO

NO

NO

NO

NO

NO

SES SA

NO

NO

YES

NO

NO

NO

NO

NO

NO

Source: Exane
See www.exane.com/disclosureequitiesuk for details

BNP Paribas
Exane is independent of BNP Paribas (BNPP) and the agreement between the two companies is structured to guarantee the independence of Exane's research,
published under the brand name Exane BNP Paribas. Nevertheless, to respect a principle of transparency, we separately identify potential conflicts of interest with
BNPP regarding the company/(ies) covered by this research document.
Potential conflicts of interest:
Bouygues: As of 29/02/2012 BNPP owns 1,36% of BOUYGUES SA
France Telecom: As of 29/02/2012 BNPP owns 1,25% of FRANCE TELECOM SA
Telefnica: BNP Paribas was selected as Joint Bookrunner for the Atento Inversiones y Teleservicios IPO.
Vodafone Group: BNP acted as BNPP is advisor for Vodafone for sale of Vodafone's stake in SFR to Vivendi (04/2011)

Source: BNP Paribas

116

Telecom Operators

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146-1 Susong-dong Chongro-ku
Seoul, Korea 110-755
Tel: (+82) 2 720 2040
Fax: (+82) 2 720 2100

Arthur D. Little Netherlands


Strawinskylaan 10
1077 XZ Amsterdam
The Netherlands
Tel: (+31) 20 30 16 500
Fax: (+31) 02 33 16 13

Arthur D. Little Spain


Ortega y Gasset 20 Planta 3a
2806 Madrid
Spain
Tel: (+34) 91 702 7400
Fax: (+34) 91 702 7499

Arthur D. Little Sweden


Kungsgatan 12-14
S-107 25 Stockholm
Sweden
Tel: (+46) 8 50 30 65 00
Fax: (+46) 8 50 30 65 02

Arthur D. Little Malaysia


Office Suite 19-13-2
Level 13, UOA Centre
19 Jalan Pinang
50450 Kuala Lumpur
Malaysia
Tel: (+60) 3 2164 6063
Fax: (+60) 3 2164 6067

Arthur D. Little Middle East

Office 606, 6th floor, Arjaan Tower


Al Sufouh Complex, Al Sufouh Road
Dubai Media City
PO Box 112687
Dubai, United Arab Emirates
Tel: (+971) 4 433 5401
Fax: (+971) 4 429 0679

Arthur D. Little India


A-1 First Floor,
Sector 10, Noida,
UP 201301
India
Tel: (+91) 98105 60652
www.adlittle.com

LONDON
Exane Ltd
1 Hanover Street
London W1S 1YZ
UK
Tel: (+44) 207 039 9400
Fax: (+44) 207 039 9440
PARIS
Exane S.A.
16 Avenue Matignon
75008 Paris
France
Tel: (+33) 1 44 95 40 00
Fax: (+33) 1 44 95 40 01
BRUSSELS
Branch of Exane S.A.
Ravenstein 29
1000 Brussels
Belgium
Tel: (+32) 2 400 3750
Fax: (+32) 2 400 3751
FRANKFURT
Branch of Exane S.A.
Europa-Allee 12, 3rd floor
60327 Frankfurt am Main
Germany
Tel: (+49) 69 42 72 97 300
Fax: (+49) 69 42 72 97 301
GENEVA
Branch of Exane S.A.
Rue du Rhne 80
1204 Geneva
Switzerland
Tel: (+41) 22 718 65 65
Fax: (+41) 22 718 65 00
MADRID
Branch of Exane S.A.
Calle Serrano 73
28006 Madrid
Spain
Tel: (+34) 91 114 83 00
Fax: (+34) 91 114 83 01
MILAN
Branch of Exane S.A.
Via dei Bossi 4
20121 Milan
Italy
Tel: (+39) 02 89 63 17 13
Fax: (+39) 02 89 63 17 01
NEW YORK
Exane Inc.
640 Fifth Avenue
15th Floor
New York, NY 10019
USA
Tel: (+1) 212 634 4990
Fax: (+1) 212 634 5171
SINGAPORE
Branch of Exane Ltd
20 Collyer Quay
#07-02 Tung Centre
Singapore 049319
Tel: (+65) 6212 9059
Fax: (+65) 6212 9082
STOCKHOLM
Representative office of Exane SA
Nybrokajen 5
111 48 Stockholm
Sweden
Tel: +46 8 5629 3500
Fax: +46 8 611 1802

Front cover image copyright:


Collection: Vetta
Photographer: Chris Price
Supplied by Getty Images