The End Of Mobile Telecom?

Includes: S, SKM, VOD, VZ
by: Shareholders Unite

At first sight, the spectacular growth of mobile communication seems like a bonanza for mobile telecom providers. Mobile traffic is expected to increase 100-fold between now and 2020, from the current 1 exabyte to more than 127 exabytes [The Delta Perspective].

While we're not yet there, but we're nearing a future in which mobile connection will be ubiquitous, not only for smartphones and other devices we use, but for many other devices as well that simply 'talk' (that is, exchange information) with other devices (M2M, or machine to machine traffic).

We're rapidly moving from an old world in which

telecom was based on one service per device (e.g. cellphone, laptop data card, TV) and services were based on what access network was required to deliver the service (e.g. DSL, 3G, PSTN voice). Additionally, services were classified as either business or consumer contracts and the rates varied. The future of telecom must look different. With the potential to connect over 50 billion devices by 2020, services will be multi-device and multi-network. [Forbes]

The rise of ever-faster mobile broadband will give rise to whole new services like mobile payments, smart (connected) meters and sensors, tele-healthcare, education, cloud services and much more which few of us can imagine, let alone predict, right now. One might keep in mind that with Moore's Law continuing unabated, high-performance computing will be almost free by 2020.

According to Intel microprocessors will shift from 22nm to 5nm by the end of 2020. To grasp the consequences:

In very simple terms, if you shrink a computer chip from today's 22nm tech down to 5nm, adding nor removing any transistors, you end up with something roughly six per cent the size of the original.

You should also realize that energy needs and cost will improve roughly along the same lines:

Thus, the individual chip cost is directly proportional to how many you can cram into a wafer. And if you're cramming in 15 times more chips, well...

Since we've achieved similar orders of magnitude improvements on these metrics, we only have to look back to see how revolutionary such change can be. It is said (by Michael J. Saylor, CEO of MicroStrategy) that the iPhone contains more processing power than the Apollo 11 that took the first man on the moon. By 2020 we can expect

The cost of putting meaningful compute power into an object will be so low, they'll be sticking compute into almost everything. A quad-core Core i5 in your loaf of bread by 2025? It sounds ridiculous. It sounds pointless. But I think you'll be surprised by just how close reality comes.

Add ubiquitous high-speed mobile broadband with near free high-performance computing and one gets into science fiction stuff pretty fast. Considering the following:

From telling us when our train is coming, helping us when we're lost and letting us watch our favorite TV shows, there seems no limit to how involved our smartphone is with our day-to-day life. Now the gadget promises something so advanced it verges on the supernatural: it will know exactly what we're doing tomorrow. Scientists have found a way of predicting an individual's future movements by analyzing information their mobile phone. A team of computer scientists at the University of Birmingham successfully predicted future locations with an error margin of just 60ft, which has fuelled fears of privacy invasions. [Dailymail]

This is today, and all fun and games (or perhaps not), but we can be sure about one thing. Mobile data will explode and unleash a whole new universe of services.

Telecom's bright future?
If you think that this is necessarily good news for mobile telecom operators, think again. Data traffic, for all the exuberant growth, will become a commodity. It already generates considerably lower margins than the traditional services (voice and SMS messages).

That means that telecoms are increasingly buffeted by a shift from present cash-cows voice (40% margin) and text (70% margin) towards data traffic, which requires large investments and generates considerably lower margins.

Mobile data in particular often has only an average margin of 20%. In fact, margins can range from -10% on heavy-user dongles to 40% on smartphones. [The Delta Perspective]

There are many ways for bypassing high voice rates on mobile networks:

consumers can keep their voice-minutes needs to a minimum by taking advantage of the many so-called over-the-top services, which provide voice, video, messaging, and more by way of your device's Internet data connection, typically for free or for notably lower fees than the standard voice-minute plans charge. The savings can be even higher when you use an OTT service through your device's Wi-Fi connection [pcworld]

The more well-known OTT services are Skype, Google Voice and Apple's FaceTime. Here is Arthur D. Little's take on Skype:

Skype, for instance, already represents over 25 percent of cross-border international call minutes. The company, which has been disruptive since its launch, is now focusing on business users, in addition to mobile users and HD voice. Microsoft's acquisition of Skype can lead to voice becoming just another application on your smart device. Microsoft is expected to integrate Skype more deeply into Lync, Outlook, Xbox Live, Hotmail and Messenger.

There are a raft of new services like Bobsled, a T-Mobile (DT) service which originally launched as a way to initiate a call from a Facebook page. Unlike with Skype, all Bobsled calls are free. It isn't surprising then that:

Apparently the service is very popular among people who wish to contact folks in other countries, since according to T-Mobile 80 percent of all Bobsled calls so far are to a number outside the United States.

But there are still others, like Tango, Oovoo, Fring, Tru, and Mig33. Depending on the scenario, Arthur D. Little expects mobile voice OTT market size to range between $14-100 billion in 2016, accounting for between 2 - 20 percent of total voice revenues

Possibly even a bigger threat is the development of soft SIM, that is, moving away from the traditional SIM card towards a more flexible SIM in software in the cloud. This is a clear threat to mobile operators, according to Arthur D. Little:

with the development of soft SIMs, traditional players may, in the long run, lose the direct customer relationship altogether to the advantage of OTT players or third parties.

Since mobile data is essentially a commodity, competition is setting in:

Currently Sprint uses WiMAX in most of its 4G areas, but as it rolls out LTE networks moving forward, it plans to offer rate plans with up to 20% more data than competitors for the same price. [dailytech]

While at present, many operators limit bandwidth use in order to recoup the large investment in new networks (licenses and technology), it's difficult to imagine this is going to be the normal state of affairs forever. Many consumers shy away from using mobile data networks altogether out of sheer fear of ending up with big bills as a result of overrunning their data allowances.

Data limits are simply not a practical way to improve the returns on mobile data use. Once there is enough bandwidth, expect these limits to disappear and replaced by an all-you-can-eat flat fee structure. The advent of tablets with mobile data connections is likely to speed up this development. Just to see how limiting today's networks, even the newest are, here is the UK's first 4G (LTE) network from EE:

the entry tariff of £36 per month includes 500MB of data, beyond which an add-on cost must be paid if the user wishes to carry on using the internet on their mobile. An hour of streaming a programme using, for example, the BBC iPlayer mobile app, can use up to 225MB - almost half the entry level tariff's data allowance limit. [BBC]

The impact of some of these developments can be seen in the Netherlands, one of the most advanced markets for mobile telecom. The market itself is more or less saturated, with most adults (and many kids) having some form of mobile device.

  • Large investments in new 4G infrastructure and frequency licenses
  • Saturated markets
  • Significant cannibalism of high-margin core services like voice and text

The market leader is KPN (OTC:KKPNF). Here is Bloomberg's verdict from the latest earnings figures:

KPN is struggling with changing consumer behavior as smartphone customers communicate more via messaging technology such as WhatsApp or with calling software such as Skype. The company may also face new entrants to the Dutch mobile market after the government starts a spectrum auction on Oct. 31.

And it's not only in the Netherlands, but in Germany too, where they have a presence (the E-Plus subsidiary):

third-quarter profit fell 32 percent amid increasing German price competition and declining mobile subscription revenue.

Holland and to a slightly lesser extent Germany are quite advanced in terms of smartphone penetration. However, other markets also feel the pinch from increased commoditization. In France, France Telecom had to cut dividend and renege on a share buy-back program in order to restore finances (more especially its debt position):

France Telecom said its operating cash flow would only grow again in 2014, once pricing pressure stabilizes in France. Meanwhile, operating cash flow will be more than 7 billion euros next year, from a target of close to 8 billion euros in 2012.

It's dividend, at a whopping 15% still looks pretty good to us though! But telecoms are cutting generous dividends left, right, and center:

Competitors in the telecommunications business, an industry which has paid generous dividends historically, have also curbed payouts. Spain's Telefonica suspended its dividend in July, and Dutch carrier Royal KPN NV cut its payout forecast the same month. Telekom Austria AG last month reduced its dividend projection for the second time in less than 10 months, citing increased competition.

Earlier in the year, it was Belgian's second biggest mobile operator Mobistar (actually part of France Telecom):

The guidance is substantially below consensus, which increases risk of further dividend cuts," Emmanuel Carlier, an analyst at ING Groep NV in Brussels, wrote in an investor note. "The weaker-than-expected service revenues potentially indicate the impact of mobile voice cannibalization. [Bloomberg]

These trends haven't yet started to impact US mobile carriers like Verizon (NYSE:VZ), AT&T , Sprint Nextel (NYSE:S) and T-Mobile (DT). However, despite still seeing some growth in basic services, they are buffeted by high investment needs in new networks, like Sprint:

Sprint's wireless service revenue witnessed a growth of 14%, and this was primarily driven by the increasing subscriber base and postpaid ARPU, which increased by $3.01. However, as the company has been heavily investing in its Network Vision and working towards the Nextel platform shutdown, its related costs put Sprint into the red as it posted a net loss of $767 million. The carrier is in the second phase of the Network Vision, which involves a huge amount of investment. The company's capital expenditure was as high as $1.49 billion in the quarter. [Motley Fool]

So first we get the hit of heavy investment, then the slow grind of commoditization of data networks and cannibalization of traditional services. Is there a way out?

Additional services
Doing nothing isn't an option:

Sitting on the fence is not an option as 'wait-and see' operators will see costs explode and revenues start to stagnate. [Delta Perspective]

This is hardly surprising, of course, doing nothing is rarely an option in a wide swath of industries. Companies could chose to embrace the competition and compete on efficiency and cost, or they could try to create some new high value added services. What things do we have to envision? Well, stuff like:

Vodafone Group Plc (NASDAQ:VOD) has reached a deal to use smart-chip maker Gemalto NV (NYSEARCA:GTO)'s technology to manage a new mobile-phone payment product set for release next year, two people familiar with the plan said. [Bloomberg]

Verizon takes another route:

A big, expected shift in the phone-billing arena finally arrived last month, when Verizon unveiled its first attempt at so-called family plans, which allow users to bundle multiple devices together under a single data-services contract. [pcworld]

More imaginative is SKTelecom (NYSE:SKM):

SK Telecom has transformed more than 2,000 homes to incorporate them with interconnected devices like smart meters and such appliances as televisions, refrigerators, washing machines, and air-conditioning units, allowing residents to monitor and adjust household energy consumption according to peak demand or outside temperatures. [Delta Perspectives]

Or SingTel, which has its own apps store and an e-book service. But with the "walled garden" model gone and mobile users having the full internet at their fingertips, it will be difficult to develop those services.

With their cash-cows slowly eroding and mobile data connections requiring huge investments and a future of commoditization which is difficult to escape, it's difficult to see a bright future for mobile telecom providers despite the spectacular mobile data use growth. It's difficult to see a new killer service emerging, but that doesn't mean it can't be done.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.