Issue 8 (Q2 2010-Q3 2010)

Project Contributors:

London Business School
Cambridge University
New Economic School (Moscow)

December 16 2010

INTRODUCTION

Altimo is pleased to release the Eighth edition of the Altimo Index, prepared on the basis of mobile industry data for Q2 2010 – Q3 2010.

The Altimo Index was launched in March 2007 and was developed by contributing professors from three leading academic institutions: Cambridge University, London Business School, and the New Economic School (Moscow). Its objective is to produce a regular, practical review of the international mobile telecoms market’s attractiveness to investors.

It is updated every six months and combines relevant data from the Wireless Intelligence database, companies’ reports and websites, proprietary Altimo market sources and from the contributing academic institutions.

ALTIMO INDEX, ISSUE 8 (Q2-Q3, 2010): DATA DRIVES MOBILE INDUSTRY

The 8th edition of the Altimo Index is devoted to mobile data market development and its growing and imminent influence on global telecommunications market trends. After a successful ‘test-drive’ on developed markets such as the US and Western Europe, 3G networks and data-based business models have been successfully launched into emerging markets. As a result we see an increase in average mobile spend per capita and penetration growth, driven by data services. We are confident that the data market will change the whole telecoms industry in 3-5 years and replace the current voice-based business model, a process that has already begun.

KEY RESULTS

• Data-based services will increasingly drive greater penetration and growth in the operators’ competitive power rather than the traditional voice model.
  Mobile voice penetration growth is slowing down on a global basis. In some markets its level has been even decreased. Meanwhile mobile data penetration is growing year–on-year and is expected to hit 1bn subscriptions in the first half 2012. This will constitute around 15% of global mobile data penetration.  The global trend has begun to shift towards a new business model based on data services.
   
• The 2010 ratio of data/voice traffic in developed countries is estimated to be around 80% to 20%.
  In emerging markets this average proportion is currently 40% to 60% and will gain developed countries level in 2012.
   
• Mobile data revenue growth in Q3 2009-Q3 2010 is around 35% worldwide.
  It has become the main driver of revenue growth in 2010. Data represents 11% of revenues on average and is expected to grow up to 20% of revenues in 2011.
   
• Mobile industry in developed countries will face lower RoI and EBITDA margins in 2011-2013.
  Data traffic has being rapidly outrun data services revenue in 2010. Further erosion of return on investment is expected because unlimited flat data rates require additional massive CAPEX and OPEX on network capacity.
   
• Telecoms operators’ success will be determined by gaining control of the mobile network traffic growth.
  Operators should revise their tariff plans and offload traffic to fixed networks by fixed-mobile convergent offers. In the next 2-3 years we expect further fixed plus mobile M&A activities in emerging markets because in new data world it will extremely hard to compete without own fixed infrastructure. The operators possessing it will invest heavily in further network capacity development.
   
• Telecoms operators should decide on the strategic direction of their businesses: whether to become pure commodity cash cows or change the TMT sector by purchasing various content TV/Internet producers.

Mobile data is changing mobile world and breaks current business models
The influence of mobile data on the global telecoms market has increased significantly during 2009-2010. Mobile data traffic surpassed voice traffic on a global basis in December 2009.

The data-traffic to voice-traffic ratio in developed countries with operating 3G networks is currently estimated to be 80% to 20%.

The main reasons for such a move are unlimited flat rates for data usage, the unexpected effect of the introduction of the iPhone and the follow-up effect from smartphones and laptops.

Further penetration growth will be significantly influenced by data-only SIM-cards, especially in developed markets with a penetration of more than 100%.

Data revenue growth is the main driver of total revenue growth of mobile operators: mobile data’s share of total revenue is growing at an average rate of 35% in Q3 2010 compared to Q3 2009.

Reverse side of data growth
Despite being the main driver of revenue growth, mobile data revenues represent on average 11% of total revenues. Given that this 11% creates 80 to 90% of total traffic in the network, the profitability of the current pricing model for mobile broadband should be reconsidered. A marginal increase in revenue from mobile data significantly reduces investment efficiency, as flat rates for mobile data lead to the situation where further traffic growth will demand huge capital investment and operational expense, with insignificant increase in revenues. In other words, the efficiency and investment return of telecoms operators will be essentially diluted. At the same time the marginally strong voice model is at risk of dilution from the VoIP usage over mobile broadband. The data channel could cannibalise the traditional voice model in mobile networks leading to further margin erosion.

Operators should rethink their data market policies to prevent return erosion
The first data tariffs were introduced at the turn of the millenium along with the construction of 3G networks that were not designed for unlimited data usage. Mobile operators had invested huge sums of money in 3G networks, and due to low data usage were finding it difficult to recover their investments. Data networks were highly under-utilised before the introduction of the iPhone. In order to encourage data usage, they started to offer flat data plans, while some (such as AT&T, Verizon Wireless, T-Mobile USA, Vodafone, Orange UK, and O2) went a step further by providing unlimited data plans. Mobile operators did not realise that in the long-term the unlimited data model would be unsustainable, and that it would be hard to reshape customers' traffic habits. During recent quarters operators have started to adopt usage-based pricing schemes to address the increase in traffic usage.

Along with restrictions on unlimited data usage telecoms operators with both fixed and mobile infrastructure could offload traffic from mobile to fixed broadband; Wi-Fi hot-spots and femtocells offers within households could also help to solve this problem.

Future of TMT sector
With the mobile data traffic boom telecoms operators are getting more of a clear commodity; they are just passing the traffic, providing infrastructure for new business models. In this case companies like Apple are transforming the mobile industry for its own goals.

While all operators are just a transport for the services, subscribers will choose the operator that will offer a unique set of intranet resources and opportunities. This could lead telecoms operators to acquire internet resources to secure free access for their own subscribers (and take the ‘one-cent fee’ for the subscribers from other networks) as it was the case previously with retail networks. Telecoms cash cows hunting for content sources could dramatically change the current landscape of the TMT sector.

In coming 2-3 years we will see whether telecom operators are able to invent and adopt new business models based on data services production and provision or just piping new data oil.

TRENDS BY REGIONS AND COUNTRIES

Asia: most attractive market overall for investors
Asian companies top the Altimo Index showing the attractiveness of the region for investors. High EBITDA margins and strong balance sheet positions along with comparatively low penetration of data services make the regional companies extremely attractive investments from both a short- and long-term perspective. Further fixed-mobile mergers and consolidation activities will keep the attention of potential investors.

Active penetration growth in the Asian markets is slowing down after reaching the 90% mark in the key Asian markets. During 2011/12 we will see increased competition among operators and consolidation in these markets along with a fast slowdown in penetration. The main competitive advantages will be brand positioning, mobile data offers and strong networks. Strong macroeconomics, EBITDA margins above 50%, low penetration levels with growing demand and a young population, in addition to a reasonable regulatory policy make China the most attractive investment proposition (1.1 points in the Altimo Index).

Cambodia dropped in Index more than ten positions on significantly increased penetration on the market while mobile spend per capita is on very low level. Malaysia lost ten positions on better attractiveness performance of other developing countries, high penetration and GDP development pressure on country index weighting.

Russia and CIS: strong growth of data revenues expected
In Russia we see the rise of a new trend – the strong growth of the data market. This growth attracts new capital expenditures and creates new opportunities that significantly increase the attractiveness of the Russian market. Driven by data revenue, the market is expected to grow by around 10-15% next year.

The recovery of the economy in the CIS and a clearer vision of the future have a positive influence on the attractiveness of the main mobile markets of Kazakhstan and the Ukraine, so they have improved their positions in the overall ratings. The ongoing rollout of 3G networks in Kazakhstan and the potential issue of 3G licences in Ukraine will have a positive effect on the overall market’s attractiveness. Kazakhstan moved to 6^th position in index driven by economy recovery and active rollout of 3G networks. CIS leader of previous indexes Uzbekistan moved down on better attractiveness of other emerging markets.

Africa: potential for long-term rewards
Africa still has room for further development and we will see further penetration growth in this continent in the coming years. This continent is clearly for strategic investors with a long-term investment horizon as the return on investment can be enormous (as is the risk). The penetration growth opportunities along with economic growth in the coming 5 to 10 years could significantly change the investments landscape of Africa.

North America and Europe: data market playing a key role in cash generation
Germany is traditionally ranked as the most attractive European market, scoring a similar level to the middle-ranking Asian markets. This is mainly due to its leading role in the EU and substantial network potential due to huge capex investments in 3G networks at the beginning of the millenium.

The data market is playing an increasingly important role in cash generation by mobile operators, with the increasing penetration of smartphones, netbooks and other devices being the main driver of this growth.

Middle East: continues to remain closed to outside investors
Middle East markets continue to keep strong positions in the Index mainly because the region has oil-based cash flows that lead to high ARPU with no need for controlling shareholders to take all their cash from telecoms companies. This in turn leads to increased investment in network infrastructure and M&A activity. But Middle East markets in general remain closed to outside investors. The high premiums in the region are supported by oil-based conglomerates that use telecoms as a hedge for their money.

Latin America: moderate investment opportunities
Mexico remains in the top ten due to its having the highest profit margin in the region, despite weak penetration growth. With many markets close to saturation, the investment opportunities are moderate except for countries that continue to attract new mobile customers and earn stable profits, such as Peru, Ecuador, and Chile.

Graph 1. ALTIMO Index 8 by country

Graph 2. ALTIMO Index 8, trends by region

TECHNICAL DESCRIPTION OF THE ALTIMO INDEX

The index aggregates six country-specific factors (see Table 1) that determine the future profitability of a mobile company.

Table 1. Determinants of the ALTIMO Index

The average revenue per capita (ARPC) is measured as the total spending on mobile communication divided by the country’s population. Alternatively, it can be computed as the product of ARPU and penetration rate. ARPC growth is derived from the cross-country regression of log ARPC on log GDP, which is re-estimated every time using the latest annual data.

The six variables that define a market’s attractiveness are then combined into a single index using user-defined weights. The aggregate index is computed as a simple linear combination of the standardized variables taken in logs (marked by underlining) using the weights described in the last column of Table 1:

INDEXi = 0.3*ARPCgrowthi + 0.3*EBITDAmi + 0.1*PENgrowthi + 0.1*CAPEX/REVi + 0.1*POPULATIONi + 0.1*GDPi

The variables (in logs) are standardized by subtracting the sample average and dividing by the sample standard deviation, e.g.:

GDPi = [log(GDPi) – mean(log(GDP))] / std(log(GDP))

By construction, the standardized variables are on average zero and have unit standard deviation.

This implies that each standardized variable and the aggregate index may be negative. Therefore, to make sure that the mobile development index takes only positive values, we compute ALTIMO Index as a linear function of Index:

ALTIMO INDEXi = 0.5*(1 + INDEXi)

The quarterly data on mobile companies are provided by Wireless Intelligence and mobile companies’ websites. The annual measures are calculated as the average over the last four quarters with available data. The country-specific mobile industry measures such as ARPC and EBITDA margin are computed as weighted averages of the corresponding company data, with weights proportional to the company’s number of SIM-cards. The annual data on the country’s GDP per capita and population are taken from the World Bank.

The index is computed for countries that have no missing data on the five factors. If the country has no data on CAPEX/REV in the current year, we substitute the last-year value. In addition, we winsorized the most extreme values of CAPEX/REV and EBITDAm. If the observed CAPEX/REV was below 0 (above 0.8), it was replaced with 0 (0.8). Similarly, if the observed EBITDAm was negative, it was replaced with 0.

The index is calculated for eleven geographical regions: Africa, CIS, Eastern Europe, Eastern Asia, Latin America, Mideast, North America, Oceania, South Asia, South-Eastern Asia, and Western Europe. The regional index is computed as a weighted average of the respective country indices, with weights proportional to the number of SIM-cards in a given country.

The annual values of the index are available for individual countries as well as regions from 2002.