Why have telecom operators performed so badly over the last decade and what strategy do they need to adopt in order to remain relevant in the Digital World? Telcos’ have consistently underperformed analyst and market expectations … their stock market recoveries after the 2000 crash and the 2007 crash were weak relative to the rest of TMT. Their core revenues – voice, messaging and internet access – are now in terminal decline (or at least moving towards terminal decline). Their future is tied to over-the-top services such as internet TV, mobile payments and cloud services. Telcos remain the most over-regulated part of the internet value chain, so any super-normal profits they attempt to make from new technology cycles risk being capped by the regulator. In order to survive, Telcos need to latch on to one of the many emerging technology cycles mentioned on page 19. But they also need to change their business models: - By moving towards software services - By restructuring their businesses such that their new products are not regulated - By consolidating to eliminate excess competition SK Telecom is an example of how the move to software can raise shareholder returns. BT’s ring-fencing of its regulated activity into Openreach is an example of the type of internal restructuring that can raise shareholder returns AT&T and Verizon are living proof that industry consolidation will raise shareholder returns.

1. Telecoms
Media
Technology
Where do telecom operators go from here?
10 October 2013
Cyrus Mewawalla, Partner
+44 (0) 20 3393 3866
cyrus@cmresearch.co.uk
www.cmresearch.co.uk
Authorised and regulated by the Financial Conduct Authority
CM Research
22 Upper Grosvenor Street
London W1K 7PE

2. Contents
1. How have Telco valuations changed since the last two stock market crashes?
2. Why have Telcos performed so badly?
(a) Debt
(b) Technology
(c) Regulation
3. How can Telcos grow earnings in the future?
5. What kind of technology cycles should Telcos latch on to?
‐ Example 1: Big Data
‐ Example 2: Software Defined Networks
6. Conclusions
Analysing Trends in Technology, Media and Telecoms
2

3. How have Telco valuations changed post the dotcom crash?




Technology analysts were blamed for the stock market crash of 2000 for publishing over‐inflated valuations.
But they were right about many internet valuations; it was Telco valuations they got dramatically wrong.
Amazon and eBay – symbols of the dotcom era – are worth more today than at the peak of the 2000 bubble.
By contrast, Vodafone and AT&T – like most Telcos – are significantly down on their 2000 valuations.
Share price performance since the 2000 internet crash
Amazon
eBay
Vods
AT&T
Source: FT.com
Analysing Trends in Technology, Media and Telecoms
3

4. How have Telco valuations changed post the credit crunch?



Since the 2007/8 financial crisis, Telcos have been the worst performing sector across 13 TMT industries,
bar one, down 14% on January 2008 levels.
By contrast the internet sector (e.g. Google, Amazon, eBay, Priceline) is up 250%.
And the software sector (e.g. SAP, Oracle and Salesforce) is up 120%.
TMT sector performance since the 2007/8 financial crash
Source: FT.com, CM Research. Bar chart shows cumulative sector performance from 1 January 2008 to the periods ending 31 December 2008, 2009, 2010, 2011, 2012 and 30 September 2013 of a selection of stocks that we believe are bellwethers for each sector aggregated on an equal weighting basis.
Analysing Trends in Technology, Media and Telecoms
4

5. Why have Telcos performed so badly?



The message from both the 2000 crash and the 2007 crash is that the market overvalued Telcos.
Why?
There were three big problems:
1.
Debt: They had too much of it
2.
Technology: They were unable to monetise the big
technology cycles of the day
3.
Regulation: They were over‐regulated
Analysing Trends in Technology, Media and Telecoms
5

6. Why have Telcos performed so badly?



Problem 1: Debt
You don’t want to be holding debt in the middle of a debt crisis.
Telcos were highly indebted in 2000 and 2007.
Telecoms remains the most debt laden sector in the global TMT space.
Telcos Rest of TMT
Source: Company data, Bloomberg, CM Research
Analysing Trends in Technology, Media and Telecoms
6

7. Why have Telcos performed so badly?





Problem 2: Technology
The chart below can be applied to almost any technology growth cycle.
The steep curve is where the technology is going. The shallow curve is where the Telco is going.
For some reason, Telcos are unable to latch on to technology cycles and profit from them the way their
peers in the TMT sector are doing.
Another way to look at this chart is to pretend that the steep curve is the cost base of a Telco and the
shallow curve is the revenue base: an income gap is developing.
Some industry commentators forecast this income gap will bankrupt several high‐profile operators within
five years.
Source: Cisco, ITU, CM Research
Analysing Trends in Technology, Media and Telecoms
7

8. Why have Telcos performed so badly?




Problem 3: Regulation
In the schematic of the internet value chain below, the shaded areas represent regulated activity.
Regulators cap super‐normal profits, reducing the incentive to invest in new technologies.
So the unregulated parts of the internet value chain have grown by 25%, compared to 2‐6% for the rest
The trick for Telcos is to re‐engineer their businesses so that the profitable bits are outside the remit of
the regulator.
Source: Company data, CM Research
Analysing Trends in Technology, Media and Telecoms
8

9. So how can telecom operators grow earnings in future?






Telco's are in dangerous position now.
They need to do something drastic, because their core revenue streams are all falling simultaneously.
A seminal paper by Chetan Sharma called “The Fourth Wave” best sums up the state of telecoms today.
Voice, Messaging and Internet Access revenues are already – or close to – terminal decline.
Over‐the‐Top (OTT) services represent the fourth wave of revenues that is just starting to take off now.
But which technology cycles do Telcos need to latch on to in order to build these OTT services?
The Fourth Wave
Source: Chetan Sharma Technology and Strategy Consulting
Analysing Trends in Technology, Media and Telecoms
9

10. What are the big technology cycles that will create OTT opportunities?



Telcos need to latch on to one of these technology themes and create OTT services out of them.
Many of these technologies require Telcos to make a heavy investment in software.
Let’s examine two of them in more detail: Big Data and Software Defined Networks.
Social
‐ games, music, video
‐ location shopping
‐ Google Glass
‐ new advertising models
Mobile
‐ wearable devices
‐ location services
‐ mobile payments
‐ mobile ads
Cyber security
‐ Telecom equipment focus
‐ national security issues
‐ software defined network
‐ open standards
Cloud
‐ everything everywhere
‐ cyber security
‐ IT cost reduction
‐ age of software
Big data
‐ Re‐imagination
‐ privacy issues
‐ wearable devices
‐ age of software analytics
Software defined
networks
‐ Cost reduction
‐ service enhancement
‐ Network function virtualis
TV
‐ Internet TV
‐ Second/third screens
‐ 16k / flexible screens
‐ Social networks
Copying Apple
‐ Ecosystem lock‐in
‐ Walled gardens
‐ Hardware/software
integration
Regulation
‐ Net neutrality
‐ Data privacy
‐ Internet regulation
‐ Anti‐competition cases
Source: CM Research
Analysing Trends in Technology, Media and Telecoms
10

11. The Big Data Technology Cycle: What is it?








Big Data is one technology cycle Telcos can
latch on to.
Big Data refers to data that cannot be analysed
on a traditional database.
Its scale is mind boggling.
90% of the stored data in the world today was
created in the last 2 years.
This data is created from hundreds of sources,
including emails, documents, apps, pictures,
videos, tweets, and credit card data.
Much of this data is unstructured which means
it cannot be easily compartmentalised by field.
Unstructured data – such as video – is difficult
to analyse because it depends on a machine
interpreting nuances that only humans can
truly understand.
For investors, the big money lies in developing
a Big Data Analytics Engines that can reliably
interpret these nuances in real time.
Categorising Big Data
Ease of use
Easy and cheap to analyse
Difficult or expensive to analyse
Requires extensive infrastructure
Classification
Structured data
Unstructured
data
Sensor data
(machine‐to‐machine)
Data type
Databases
XML data
Data warehouses
Enterprise systems
Social media
Voice, music & video
Documents
Email
RFID
GPS
QR
Temperature
Source: CM Research
Analysing Trends in Technology, Media and Telecoms
11

12. The Big Data Technology Cycle: Behind the value chain
What does the Big Data value chain look like?
Big Data Management
Big Data Production
Big Data Consumption
Storage
Data Mining
Social media
Documents
Databases
Web crawlers
Web robots (bots)
Sensors
Voice
Music & video
Email
RFID
Call records
Payment details
GPS
Volume
Security
Search
Velocity
Big Data
quality
Digital Marketing
Variety
Gather raw data on industrial scale
Analytics
Re‐selling
Databases
Improve Big Data quality
Commercialise Big Data
Source: CM Research
Analysing Trends in Technology, Media and Telecoms
12

13. The Big Data Technology Cycle: Where do Telcos sit in the value chain?




How do the main players
interact in the Big Data
value chain?
The big internet champions
like Facebook and Google
straddle the entire value
chain: they control how the
data is produced, managed
and sold.
By contrast Telcos are
instrumental in Big Data
production, but are not so
good at managing or
commercialising the data.
Perhaps, like many
technology companies,
Telcos need to invest more
in software.
Regulatory oversight
Privacy, piracy, security
Big Data
Production
Big Data
Consumption
Big Data
Management
Operating system and browser software developers
Social media
Documents
Databases
Web crawlers
Web robots
Sensors
Voice
Music & video
Email
RFID
Call records
Payment details
GPS
Search engines
Social networks
Cloud services providers
Marketing
agencies
Telecom operators
Data centres
Analytical engines
Third party
resellers
Hardware makers
Cybersecurity
Data
scientists
Apps developers
Source: CM Research
Analysing Trends in Technology, Media and Telecoms
13

14. The Big Data Technology Cycle: Winners and losers
Internet companies
The big Internet companies control where the data comes from and where it goes to. Amazon, Baidu,
Facebook and Google may soon sell lucrative, proprietary Big Data Analytics services to end users.
Data storage, networking and hardware companies
Hardware makers like Cisco, Dell, Lenovo and HP are investing heavily in Big Data appliances. Data storage
companies like EMC and NetApp could benefit from the explosion in data.
Enterprise software companies
Open‐source database platforms like Hadoop threaten Oracle, IBM and SAP. Cloud database services like
Salesforce.com are likely to be the fastest growth sector this year within the enterprise software space.
Cyber security companies
Cyber‐attacks remain the biggest investment risk faced by players in the Big Data space. When the CEO of a
FTSE 100 company is fired for failing to prevent a big cyber attack, cyber security share prices will take off.
Telecom operators
As more business‐critical data flows through the cloud, Telcos should – in theory – gain more pricing power
when carrying that data. But machine‐to‐machine (M2M) revenues are likely to be regulated. The trick for
Telcos is to create a Big Data Analytics product that is unregulated and can provide a growing revenue
stream. That requires heavy investment in software.
Analysing Trends in Technology, Media and Telecoms
14

15. The SDN technology cycle: What is it?



Software Defined Networks (SDN) is another technology cycle Telcos can latch on to.
SDN is a new architecture for telecom networks in which the emphasis shifts from hardware to software.
It will be hugely disruptive because it fundamentally changes who controls the telecom network.
Source: CM Research
Analysing Trends in Technology, Media and Telecoms
15

16. The SDN Technology Cycle: Timing


We are early in the SDN investment cycle.
In 2012, the SDN equipment sector was worth less than $400m.
SDN Commercialisation
SDN Research & Development
Stanford Univ
Research Project
into SDN
2005
Open Flow
Switching
specification
released
2006
2007
2008
MIT Technology
Review coins
the phrase,
"software defined
networking"
2009
Open Networking
Foundation founded
by Google, Facebook,
Microsoft, Yahoo
Deutsche Telekom and
Verizon
2010
2011
2012
Several SDN
start‐ups
acquired by
equipment
makers
2013
SDN technology
begins to go
mainstream
2014
2015
Source: CM Research



Telcos are evaluating SDN technology carefully: it could enhance network services whilst simultaneously
lowering costs.
But the key question is whether regulators will allow Telcos to keep the gains from their SDN investment.
The smart Telcos will develop SDN products that are outside the regulator’s remit.
Analysing Trends in Technology, Media and Telecoms
16

17. The SDN Technology Cycle: Market size forecasts


The network equipment sector is worth $68bn this year, with SDN accounting for less than 1%.
But by 2020, SDN could account for a third of global networking equipment sales.
Source: IDC, Gartner, CM Research
Analysing Trends in Technology, Media and Telecoms
17

18. The SDN Technology Cycle: Winners and losers
Telecom equipment
SDN’s open hardware standards threaten to commoditise the telecom equipment sector, most of which still
promotes closed, proprietary systems. Cisco has the most to lose: it supplies 59% of the world’s switches,
53% of its routers and 52% of its data centre equipment. To survive, Cisco will have to transform from a
hardware company into a software company. But, as with most such transitions, revenues and earnings may
dip in the process. In mobile equipment, Ericsson and Nokia are also under threat.
Servers and network storage
SDN technology could reduce high‐value servers to generic white boxes. This threatens the big server
makers IBM, HP and Dell. The proprietary network storage systems of EMC and NetApp could be made
obsolete by open software‐defined‐storage standards.
Software
The software sector will be the biggest beneficiary of SDN. Cloud software companies like Facebook,
Google, Netflix and Salesforce will be able to programme networks to enhance their web services. Cyber‐
security companies like Check Point, Verint and Fortinet will see ballooning demand for their products.
Telecom operators
If SDN technologies allow Telcos to transform into a network version of Apple’s App Store where third party
developers create new network applications, Telcos may profit from an innovation boom. But if regulators
cap the returns Telcos can make from their infrastructure investment, the bulk of the profits will flow to the
Internet companies who will be able to programme the network in a way that enhances their own services.
Analysing Trends in Technology, Media and Telecoms
18

19. If operators do not latch onto these technology cycles they risk becoming irrelevant
As voice, messaging and internet access revenues decline, Telcos need to make a success of the
technologies that are developing around them and sell them via OTT services.
Social
‐ games, music, video
‐ location shopping
‐ Google Glass
‐ new advertising models
Mobile
‐ wearable devices
‐ location services
‐ mobile payments
‐ mobile ads
Cyber security
‐ Telecom equipment focus
‐ national security issues
‐ software defined network
‐ open standards
Cloud
‐ everything everywhere
‐ cyber security
‐ IT cost reduction
‐ age of software
Big data
‐ Re‐imagination
‐ privacy issues
‐ wearable devices
‐ age of software analytics
Software defined
networks
‐ Cost reduction
‐ service enhancement
‐ Network function virtualis
Analysing Trends in Technology, Media and Telecoms
TV
‐ Internet TV
‐ Second/third screens
‐ 16k / flexible screens
‐ Social networks
Copying Apple
‐ Ecosystem lock‐in
‐ Walled gardens
‐ Hardware/software
integration
Regulation
‐ Net neutrality
‐ Data privacy
‐ Internet regulation
‐ Anti‐competition cases
19

20. Conclusions









Telcos’ have consistently underperformed analyst and market expectations … their stock market
recoveries after the 2000 crash and the 2007 crash were weak relative to the rest of TMT.
Their core revenues – voice, messaging and internet access – are now in terminal decline (or at least
moving towards terminal decline).
Their future is tied to over‐the‐top services such as internet TV, mobile payments and cloud services.
Telcos remain the most over‐regulated part of the internet value chain, so any super‐normal profits they
attempt to make from new technology cycles risk being capped by the regulator.
In order to survive, Telcos need to latch on to one of the many emerging technology cycles mentioned on
page 19.
But they also need to change their business models:
i.
By moving towards software services
ii.
By restructuring their businesses such that their new products are not regulated
iii.
By consolidating to eliminate excess competition
SK Telecom is an example of how the move to software can raise shareholder returns.
BT’s ring‐fencing of its regulated activity into Openreach is an example of the type of internal
restructuring that can raise shareholder returns
AT&T and Verizon are living proof that industry consolidation will raise shareholder returns.
Analysing Trends in Technology, Media and Telecoms
20

21. About CM Research




Independent research house
Global coverage
TMT focus
Thematic research approach
 Clients: institutional investors,
governments, family offices,
consultancies, corporations
 Business model: Research
available by direct subscription as
well as through global platforms
such as S&P Capital IQ,
Bloomberg and Factset
 Regulation: Authorised and
regulated by the UK’s Financial
Conduct Authority
Analysing Trends in Technology, Media and Telecoms
21

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Analysing Trends in Technology, Media and Telecoms
22