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Jamie Mariani

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[email protected]

Rodney Sherrington

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Marketing Analyst

Simon Carrington

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[email protected]

October 2002Pan-European Telecoms

3G Tsunami: the revolution begins

� The 3G growth opportunity

exists - in voice, not data,

services

� Network capacity could grow

five-fold

� 58% price cuts may deliver

30% ARPU growth by 2006

� Wireless stocks to rerate,

after initial period of

readjustment

� mmO2 and Orange offer

greatest long-term upside

potential

Pan

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pean

Tele

co

ms

3G

Tsu

nam

i: the r

evo

lutio

n b

eg

ins

Octo

ber 2

00

2

3G-tsnunami-cov 15/10/02, 12:03 pm1

Please refer to terms relating to the provision of this research at the end of the document.

http://www.abnamroresearch.com

ABN AMRO UK250 BishopsgateLondonEC2M 4AAUnited Kingdom

IndustryMobile Networks - W. Europe

3G Tsunami: The revolution beginsLonger-term flat rate access plans and pre-to-post-paid migration

will drive structurally higher ARPUs and increased cash flow per sub.

In the interim price reductions will put pressure on margins. We

maintain a neutral stance and highlight mmo2 (Buy from Add) and

Orange (Buy) as preferred plays.

Summary of recommendations

New Recomm. Old Recomm. Price Target

Mmo2 Buy Add 60p

Orange Buy Buy €7.0

TIM Hold Hold €4.1

TEM Hold Hold €6.0

Vodafone Add Add 105pSource: ABN AMRO

The European cellular equity story has changed. While stale bulls

continue to cling to the 'blue sky' mobile data service vision, mobile voice

communication is the killer application. We believe wireless networks will

account for 30%-40% of originated traffic (from 10%-15% today),

structurally shifting ARPU by up to 30% by end 2006.

New entrant competition: We anticipate that H3G will adopt bucket

pricing plans throughout its operations in Europe (similar to VoiceStream in

the US). Aggressively priced bundles charged at a flat rate fee could result

in a structural shift in European cellular's share of GDP.

In Europe, 3G capacity enables voice substitution. We believe 3G

will increase available capacity by up to 5x in some markets. As wireless

voice prices decline towards a 50% premium to underlying fixed line prices,

we expect a material displacement of volume from fixed to mobile.

Ahead of rising ARPU, lower prices will hit profitablity, due to

declining gross telephony margins. Ironically, operators with

disproportionate exposure to the corporate market could suffer most, as

they cannabalise higher-value customers.

Prior to CYQ3 results we continue to prefer Orange (Buy) and mm02

(Buy from Add). We have reduced our price targets for TIM (€4.1 from €4.4)

and TEM (€6 from €6.7).

16 October 2002

Jamie Mariani

[email protected]+44 207 678 0243

Rodney Sherrington

[email protected]+44 207 678 1610

Telecom Networks

W. Europe

Europe-Ds Telecom Services

605.74

Sector Performance

435

935

1435

1935

2435

Aug-99 Aug-00 Aug-01

I N D US TR Y D E V E LO P M E N TS > CO R P O R A T E S TR A TEG Y

(1M) (3M) (12M)

Absolute -4.9% -6.6% -21.0%

Source: Datastream

M O B I L E N E T W O R K S - W . E U R O P E 1 6 O C T O B E R 2 0 0 2 2

In Brief…

What's ChangedPerformance. European wireless stocks have outperformed strongly since we last

looked in detail at the subsector (European Cellular Bear Trap dated 9 July 2002).

Industry restructuring, strong Q202 results and scope for even better numbers at the

Q3s have underpinned this achievement. Our preference for beta has been partially

validated with strong relative performance from Orange (Buy), Vodafone (Add) and

mmo2 (Buy from Add). To the end of the Q302 results season, we expect continued

strong share price movements. Beyond November the key management challenge will

be to turn volume into value.

Chart 1 : Relative share price performance (09/07/02 to date)

-20%-15%

4% 6% 7%10%

19%

-6%

-25%

-15%

-5%

5%

15%

25%

35%

FTSE EURO100

DJ Stoxx 50 FTSE GlobalTelco Services

TEM TIM mmo2 Vodafone Orange

Percentage change

Top picks

Source: ABN AMRO

Capacity and competition. The deployment of 3G networks throughout Europe will

increase capacity by up to 5x (with Italy most affected). Contrary to consensus

expectations (which focus on the long-promised data wave), we suspect that H3G

could introduce “bucket” pricing plans. It is our core belief that as cellular prices move

to a 50% premium to underlying fixed line prices, mass substitution could occur. We

believe that wireless networks will account for 30%-40% of originated traffic (from

10%-15% today), structurally shifting ARPUs by up to 30% by end 2006.

Unfortunately changing business model is unlikely to frictionless. We expect a

minimum 300-500bp contraction in margin.

Recommendations. We have upgraded mmo2 to Buy (from Add) and increased our

fair value estimate to 60p, reflecting recent consolidation in the German market and

the prosect of further restructuring. The Buy recommendation on Orange is

maintained, with a price target of €7. Price targets for the southern European

operators have been lowered to €4.1 and €6.0 for TIM and TEM respectively. We areleaving our view on Vodafone unchanged (Add, 105p price target).

E X E C U T I V E S U M M A R Y


A C T I O N P O I N T S

■ Ahead of CYQ302 results we prefer Orange and mmo2. This is framed

with reference to our core belief that in the event of (1) industry

restructuring, (2) strong Q3 (over Q2) ARPU expansion higher-risk stocks

will outperform.

■ During the medium term (into 2003), we would consider a change in

stance, reflecting our core belief that a change in business model (to

bucket pricing from tariff plans) could dramatically contract margins

(300-500bp). Operators with corporate exposure (eg Vodafone) look

particularly exposed. Longer term we continue to prefer the higher-beta

plays, recognising the potential of F2M substitution.

Issues to Consider

The mobile data services vision is increasingly bankrupt. The core problem

facing Europe’s wireless operators is simple, identifying opportunities large enough to

drive top-line growth today’s absolute level. In our view, data services should be

viewed as an incremental bonus. Disciplined capital investment should require focuson revenue streams, where sufficient demand exists to validate investment.

Fixed to mobile substitution offers a compelling second leg of growth. In the

short term, pre-to-post-paid migration is the most important driver of the top line.

Our forecasts imply 4%-8% blended ARPU growth from this dynamic over the next

four years. During the medium term we expect wireless networks to grab 30%-40%

share of outgoing total traffic by year-end 2006, driven by price cuts of about 50%-

60%. This could structurally shift ARPU upwards by around 30% by year-end 2006.

Bucket pricing plans facilitate displacement and are superior. US operators

have maintained high ARPUs by not targeting lower value prepaid subs, and through

the introduction of bucket plans. The US model generates higher EBITDA per

subscriber. Similar to the impact VoiceStream had on the US, H3G could be thecatalyst in Europe for driving voice substitution through flat rate access.

3G provides capacity to drive wireline volume displacement. European 2G

capacity constraints have prohibited the introduction of bucket pricing plans. We do

not buy into the “3G is data” proposition (3G is capacity). We estimate that W-CDMA,

using a conservative 20% increase in spectral efficiency, results in a 1.7x-2.8xincrease in capacity. In densely populated areas, capacity could increase by up to 5x.

Switching between business models will cause friction. In our view (should

bucket pricing plans emerge), a margin contraction is inevitable. Dramatically falling

prices will drive structurally lower gross telephony margins. Ironically, operators with

exposure to the corporate market could be the worst affected. Notwithstanding this

uncertainty, longer-term investors should view fixed to mobile substitution as a

potentially unique opportunity. We cannot think of any other sector in the wider

economy that offers such easily identifiable growth.


Contents

I N D U S T R Y D Y N A M I C S

Data services dream 7

The mobile data services vision appears increasingly bankrupt. Global SMSrevenue amounted to about US$13bn (approximately £8.7bn) in 2001,contributing a mere 4% to total global mobile revenue of nearly US$300bn(approx...

Introduction 7

M A C R O D Y N A M I C S

Fixed to mobile substitution 21

In the short term, pre-to-post-paid migration is the most important driver ofrevenue growth. We believe high prepaid call charges have stunted usage. Ourforecasts imply about 4% annual growth in blended ARPU over the n...

Introduction 21

I N V E S T M E N T V I E W

Bucket pricing plans 45

Despite intense competition, US operators have maintained high ARPU levels bynot targeting lower-value prepay subscribers, and through the introduction of“bucket plans.” US operators have increased the number of free m...

Introduction 45

Bucket plans generate higher ARPU and usage 47

Average yield based on actual minutes used 51

S E C T O R D Y N A M I C S

3G as the facilitator 59

In our view, European 2G capacity constraints have prohibited the introduction ofbucket pricing plans (and by association fixed-to-mobile substitution). While 3Gmay facilitate the use of high-speed applications, the re...

Introduction 59

N E W S H I G H L I G H T

Fixed-line tariff rebalancing 71

Fixed-line tariff rebalancing is a significant topic that merits more space than wehave in this note (hence our intention to revisit it at a later date). However, wemust recognise that fixed line tariff rebalancing pro...

Background 71

R I S K A N A L Y S I S

Economic impact 73

We see between 10% and 25% upside from our existing fair value estimates forthe European wireless community as a result of (1) our pre-to-post-paidmigration thesis and (2) our central case fixed-to-mobile substitution...

Timing 73

T A B L E O F C O N T E N T S


A P P E N D I X

European 3G licensing conditions 81

In this section we have presented regulatory requirements for rollout by majorEuropean market. License duration ranges between 12 and 20 years, with sharplydivergent coverage requirements by country. In Korea, we note...

Technical glossary 82

Erlang 82

T E A M

Acknowledgements 83


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Data services dream

The mobile data services vision appears increasingly bankrupt. Global SMS revenue

amounted to about US$13bn (approximately £8.7bn) in 2001, contributing a mere

4% to total global mobile revenue of nearly US$300bn (approximately £200bn). In

the E5 (France, Germany, Italy, Spain and the UK), we estimate mobile revenue of

€75bn was generated during 2001. The core problem facing Europe’s wireless

operators is simple, identifying opportunities large enough to drive top-line growth

from this absolute level. Contrary to some commentators’ expectations, we do not

believe that MMS will materially affect European operators’ top line during the next

24 months. Disciplined capital investment should require operators to focus on

identifiable revenue streams. In our view data should be viewed as an incremental

“bonus.”

Introduction

In this section of the note we present:

■ the size of the E5 voice and data market (€75bn and €6bn, respectively);

■ the absolute revenue required to generate a material upside surprise (€9bn);

■ the validity of operator-articulated targets for data as a percentage of revenue;

■ our view on the sustainability of the low volume/high prices of SMS;

■ the problem of scale – why MMS will struggle to drive growth;

■ the potential cannibalisation of voice/SMS by MMS; and

■ a preliminary assessment of the margin/capex impact of take-up.

Data services lookincreasingly like the ‘bettermousetrap’ nobody wants



European revenue

In the E5, we estimate that mobile revenue of €75bn was generated during 2001,

accounting for about 1.1% of GDP. The problem facing Europe’s major operators is

clear – identifying opportunities large enough to generate material growth from thisabsolute number.

Table 1 : E5 total revenue (€m) calendarised

1999E 2000E 2001E

France 8,863 12,343 15,046

% Change 39% 22%

Germany 10,729 15,057 16,480

% Change 40% 9%

Italy 11,671 13,808 15,534

% Change 18% 12%

Spain 6,523 8,107 9,615

% Change 24% 19%

UK 11,975 16,384 18,582

% Change 37% 13%

Total E5 49,761 65,699 75,257

% Change 32% 15%

Source: ABN AMRO estimate

Data revenue

Relative to the absolute size of the European cellular market, data pales by

comparison. We calculate that data revenue of €6.3bn was posted in 2001,

corresponding to a small 8.3% of the total top line, or nearly 10% of service

revenue.

Major operator revenue outlook

As the absolute size of operators’ revenue line grows further, future growth

becomes more difficult. We calculate that to deliver 5%-10% upside surprise at the

top line, Europe’s major operators would need to generate an additional €4.5bn-

9.0bn to December 2002/March 2003 (see following table), corresponding to thetotal top line of the UK IT Hardware sector.

Table 2 : Revenue by major operator

Unit Revenue2002/03F

5% Upside 10% upside

mmo2 £m 4,815 241 481

Orange €m 16,877 844 1,688

TIM €m 10,648 532 1,065

TEM €m 9,096 455 910

Vodafone £m 29,480 1,474 2,948

Total Revenue €m 88,063 4,403 8,806

Source: ABN AMRO

Wireless revenue of €75bnwas generated during 2001in the E5

Scale creates growthdifficulties

Revenue upside would needto register scale in line withthe top line of the UK IThardware sector



Data as a percentage of revenue

Every major European operator has articulated a target “data as a percentage of

revenue” by year-end 2004/05 (see following table). We have asked the operator

community to clarify the methodology it has employed in deriving these targets (in

terms of GDP or disposable income). The absence of any meaningful response has

led us to openly question the validity and reliability of these targets.

Table 3: Data as a percentage of revenue

% of revenue from data (lastreported) Data as a % of target 2004/05

mmo2 Group 14.6% 24%

Orange UK 13.9% 25%

TIM Spa 8.5% 16%-20%

TEM Esp 14.6% 25%-30%

Vodafone Group 12.1% 20%

Orange France 8.6% 25%

Source: ABN AMRO

SMS: A lead indicator?SMS is often cited as the positive lead indicator validating mobile data success. We

acknowledge that SMS has been a genuine smash hit for the European cellular

community. The vast proportion of existing data revenue is SMS-related (see

preceding table 3). Looking forward, there are few reasons why operators towards

the lower end of the usage range should not be able to close the gap with higherSMS generating operators.

High SMS price hides low volume

However, before rushing to the conclusion that SMS validates the longer-term data

services story, it is worth putting this revenue stream in perspective. Incredibly

high tariff rates hide low network volume. We estimate that an average SMS is

priced up to 450 times higher than an average two-minute voice call, which in our

view is unsustainable (see following table). If in a 3G environment there is no

distinction between a voice or data bit, then tariffs per bit should converge,

suggesting SMS pricing pressure is inevitable.

Table 4 : SMS in perspective

SMS no of characters 160

Data capacity employed (kb/s) 1.28

Ave. price per SMS (€) 0.10

Implied price per kb (€) 0.08

2 minute voice call (length seconds) 120

Data capacity employed (kb/s) 9.6

Total capacity employed (Mb) 1.15

Ave. price for 2 minute voice call (€) 0.20

Implied price per kb (€) 0.0002

SMS per bit pricing multiple (x) 450

Source: ABN AMRO

Data targets guilty offinger-in-the-airmethodology?

SMS high price hides lownetwork volume

SMS cost/unit volumepriced at a 450x premium



Actual capacity used close to 0%

We estimate that SMS traffic is close to 0% of total traffic carried. Even in the

youth segment (the keenest users of SMS), we understand that SMS traffic

represents less than 0.5% of total traffic. We can demonstrate this with reference

to TIM, the leading Italian operator. To June 2002, TIM generated 17.8bn voice

minutes and 3.8bn messages (see following table).

Table 5 : SMS capacity in perspective

Jun-02

Voice minutes (m) 17,842

Average length (seconds) 60

Capacity employed per second (kb/s) 9.6

Capacity employed per minute (kb/s) 576.0

Total capacity employed (Mb) 10,277

SMS volume (m) 3,826

Ave. no of characters per SMS 160

Capacity employed per SMS (kb/s) 1.28

Capacity employed (Mb) 4.9

SMS as a % of total traffic 0.05%

Source: ABN AMRO

We calculate that SMS as a percentage of total traffic accounts for about 0.05% of

usage. While Italy does not “lead the curve” in terms of SMS usage, our example

underlines an important point, namely, the tiny volume contribution of SMS.

Regulator interest in SMS

We also note that OFTEL, the UK regulator, is examining UK SMS termination rates,

following a complaint by an unnamed operator. At present, SMS termination rates

are unregulated, leaving operators free to set rates. The four UK operators

currently charge a termination rate of 3p per message. This is approximately 3x the

rate of fixed-line termination charges in the UK, and 30% of voice cellular

termination fees. A risk to forecasts is that the “cost price” of SMS becomes an

important determinant of retail prices as a result of regulatory intervention. We

also highlight the role OFTEL plays as an opinion leader in European regulation.

MMS: The silver bullet?Multimedia Messaging Service (MMS) allows users to send and receive messages

with colour photos, voice, sound and text. Data bulls have suggested that the MMS

has immense potential (see following chart). According to Mobile Streams by 2008,MMS volume globally is expected to be double that of SMS.

SMS capacity used minimal

TIM SMS less than 1% oftotal traffic

SMS termination rates maycome under increasingscrutiny

Data bulls continue tobelieve in the ‘power’ ofMMS



Chart 2 : Monthly mobile messaging volume at year-end, 2002-2008

0

10,00

20,000

30,000

40,000

50,000

60,000

70,000

80,000

90,000

100,00

Monthly total global Monthly total global

Monthly total global

Source: Mobile streams

Our discussions with investors suggest to us that MMS is still perceived as the silver

bullet for European cellular. Following the somewhat unexpected success of SMS,

the market appears to believe that MMS provides the next step on the long path to

build a credible mobile data equity story.

2002/03: An important year for messaging?MMS was widely launched across Europe during 1H02. Historically, we (incorrectly)

viewed the potential of MMS as the largest potential upside risk to our short-term

forecasts. Today we do not expect a material impact on group revenue for any ofEurope’s major cellular operators this year (or next year) from MMS.

The problem of scale – Sha-mail lead indicator?

The J-Phone service Sha-mail is often cited as an example of the success of MMS,

although Vodafone (J-Phone’s owner) does not disclose the top-line contribution.

We understand the following.

■ Historically, J-Phone has charged between €0.12 and €0.33 per message (about

£0.21, at the top end).

■ At year-end (March 2002), J-Phone had 4 million camera phone customers

(about one-third of the subscriber base).

■ At the end of August 2002, J-Phone had 6m Sha-mail enabled handsets (at theend of August 2001, J-Phone had approximately 1.8m Sha-mail handsets sold).

■ To August, J-Phone had a 12-month period-average number of Sha-mailsubscribers of 3.9m.

■ In early 2002 (at the time of the J-Phone presentation to analysts, 28 February

2002), Vodafone management indicated that the J-Phone picture messagingservice was being used about twice a week.

For simplicity, we have factored in a constant “two messages sent a week” scenarioto calculate the revenue generated from MMS.

MMS silver bullet statusprovides some hope ...

... but ignores theimportance of handsetreplacement and top-lineabsolute scale

Sha-mail is often cited asexample of MMS success



Table 6 : Sha-mail example

J-Phone subscribers (June 2002) 12.189

J-Phone MMS subscribers (period average) 3.900

Avg MMS usage per week 2.0

Avg MMS usage pa 104

Avg price per MMS (£) 0.21

Avg MMS revenue per user (£) pa 22.1

Avg MMS revenue per user (£) per month 1.8

Total MMS revenue (£m) 86.4

Total J-Phone revenue (£bn) – end of March 2002 7.5

MMS revenue as a percentage of total sales 1.1%

Source: ABN AMRO

We estimate that MMS, on a 12-month run rate, would generate approximately

£86m of revenue per annum using an average price of £0.21 per message. To put

this into context, it is important to recognise the absolute size of J-Phone’s top line

– around £7.5bn at the end of March 2002. In other words on a 12-month run rate,

Sha-mail’s contribution appears to be about 1% of J-Phone’s mobile revenue.

Despite the “success” of Sha-mail, J-Phone posted a 6% decline in ARPU yoy toJune 2002.

Networking effects – the importance of critical mass

A networking effect refers to the self-fulfilling cycle of penetration and usage

beyond a point of “critical mass” of adoption of a new technology. European cellular

telephony has followed the classic “S” curve of adoption. SMS is a good example of

a product that has also followed an “S” curve. MMS is likely to follow a similar

growth pattern, displaying slow penetration/revenue growth followed by a rapid

increase, as users become more familiar with the new technology.

Critical mass: 30% penetration of base

In our view, Europe’s operators must embed MMS handsets into 30% of subscriber

bases to achieve the critical mass required to “kick off” a networking effect of

penetration and usage. This is a crucial point and has profound implications interms of timing of P&L impact.

Handset replacement cycles

We estimate that by year-end 2002, Western Europe will have 307m subscribers.

Of this base, 30% equates to 92m MMS-enabled subscribers. Our IT Hardware

team currently estimates the natural handset replacement cycle to be around 39

months on a global basis. This is skewed by Latin America (Latam), among other

developing continents (see following table). We understand that the Western

Europe replacement cycle is about 34 months (or slightly less than three years).

... but MMS revenue is inthe noise (1.1%)

We expect MMS to follow an‘S’ curve of penetration

In our view, 30%penetration will be requiredto drive a networking effect

Current Western Europeanhandset replacement cycleis running at 34 months



Table 7: Replacement cycle (months)

2000 2001 2002E 2003E

Europe (W & E) 24 31 35 35

- W Europe 24 30 34 34

- E Europe 34 39 48 40

Middle East & Africa 33 32 44 45

Asia/Pacific 34 37 46 47

North America 27 31 33 32

South America 30 37 50 48

Total 28 33 39 39

Source: ABN AMRO IT Hardware equity research team

A three-year handset replacement cycle suggests an annual rate of handset churn

of nearly 33%. Even if 50% of the replacement handsets sold during 2003 were

MMS-enabled this corresponds to only 17% of Western Europe’s existing subscriber

base owning an MMS-enabled handset by calendar year-end 2003, some distance

below the critical mass level we estimate is required to drive usage/revenue.

Using the 34-month handset replacement cycle, Western Europe would need to

wait until year-end 2004 to reach the point of critical mass in terms of MMS

penetration. This suggests that a material revenue boost will not occur until

CY2005. Bulls of MMS beware!

What about guidance of 18 months?

We have heard some operators talking handset replacement cycles of 18 months

today, ie every one and a half years. We can sanity-check the “reasonableness” of

this claim with reference to total global handset sales. Holding “new” European

sales and ROW handset sales constant, we can identify the implied replacement

handsets sold in Europe and the impact this has on total global handset sales. For

example, if we believe that 2002 and 2003 will both have an 18-month

replacement cycle, we can imply global handset sales of 474m and 559m

respectively (see following table), somewhat ahead of our IT Hardware team’s

forecasts.

Table 8 : Scenario analysis: 18-month handset replacement cycle

2002E 2003E

Suggested replacement cycle (months) 18 18

Replacement cycle implied replacement handsetsales 153 187

Add new sales 18 13

Implied total handset WE sales 171 200

ROW handset sales 303 359

Implied total handset sales 474 559

IT Hardware forecast 402 471

Variance 72 88

Source: ABN AMRO

Nevertheless we do not rule out a shortening of the handset replacement cycle in

Western Europe, should operators choose to aggresively subsidise growth.

Even if 50% of all WesternEuropean handsets sold in2003 were MMS, only 17%of Western Europe’s basewould be MMS-enabled

MMS critical mass isreached CY2005

18-month replacementcycle would lead to materialupgrades of global handsetsale forecasts



Vodafone – a worked example

Using Vodafone group as a benchmark, we can quickly emphasise the importance

of absolute scale. To the end of March 2003, we forecast Vodafone to generate

£29.3bn of revenue (consolidated – see following table). To deliver a 10% upside

surprise at the top line, Vodafone would need to generate another £2.9bn in

revenue.

MMS pricing structures vary on a case-by-case basis. The average price appears to

be around €0.40-0.60 per message (about 25p-40p; outliers such as Telenor in

Norway have recently dramatically reduced their price from as much as €1.33 permessage to €0.65).

Table 9 : Vodafone – the problem of scale (£)

Mar-03 Mar-04

Vodafone consolidated revenue 29,480 31,922

Vodafone average subscribers 91.7 95.8

Vodafone consolidated ARPU 321.5 333.4

Vodafone consolidated ARPU (Monthly) 26.8 27.8

10% upside surprise (revenue) 2,948 3,192

MMS Enalbed Handsets 11% 26%

MMS Subscribers (period end) 10.4 25.2

MMS Subscribers (beginning period) 4.0 10.4

Ave. MMS Subscribers 7.2 17.8

MMS ARPU (Monthly) 34.2 15.0

Ave. price per MMS 0.25 0.25

Implied MMS volume per subscriber (Monthly) 136.9 59.9

Implied MMS volume per subscriber (Weekly) 31.6 13.8

Implied total MMS volume 11,792 12,769

Source: ABN AMRO

In our example we have factored in 11% and 26% of Vodafone’s subscriber base to

buy MMS-enabled handsets by the end of March 2003 and March 2004,

respectively, and an average price of £0.25 per message. Our basic analysis shows

that to deliver a 10% upside surprise to our existing revenue forecast, Vodafone

would need to encourage its initial MMS-enabled subscribers to pay for 31.6

messages a week to the end of March 2003 (or 13.8 messages per week to the end

of March 2004). We believe this level of volume is too challenging.

Best case: 1.5% impact

To fiscal 2004, we suspect that MMS provides at most 1.5% upside to our existing

forecasts. This view is based on three simple drivers:

■ factoring in a generous 26% of Vodafone’s base will buy (and use) MMS-enabled

handsets (implying 25.6m MMS subscribers at the end of March 2004 from10.4m at the end of March 2003);

■ usage of 2x a week (resulting in 104 messages a year);.and

■ an average price of £0.25,

Vodafone would need togenerate about £3bn ofrevenue to generate a 10%upside revenue surprise.

Using an average price of 25pper message ...

... implied volume appearschallenging: 32 messages aweek could provedemanding



Pulling these drivers together suggests potential incremental revenue of nearly £2.2

per month per subscriber, corresponding to £26 per year. In total, this offers

£469m of additional revenue to the end of March 2004 (about 1.5% of consolidated

revenue). This realistic upside is in the noise (see following table).

Table 10 : Vodafone impact of MMS

Mar-04

Avg MMS subs (m) 18.0

Usage pa per sub 104.0

Total usage (m) 1,875.6

Price per MMS 0.25

MMS ARPU pa 26.0

MMS ARPU (monthly) 2.2

MMS revenue (£m) 468.9

Implied % of revenue 1.5%

Source: ABN AMRO

Voice cannibalisation

We also note the potential cannibalisation of existing SMS revenue by MMS, and the

potential of MMS to substitute for voice usage. Arguably MMS can be viewed as the

classic “technology” push innovation, for which little or insufficient demand exists.

Should customers not perceive they have a real "new” need for the technology,

they could either:

■ not buy the innovation; or

■ substitute MMS for existing cellular usage.

Arguably evidence to date suggests that data has been generated at the expense of

existing voice revenue streams. In the charts that follow we show that NTT

DoCoMo,1 the widely accepted leader in data service deployment, has not yet

registered an increase in ARPU, and data ARPU appear to have been generated

largely at the expense of voice ARPU. Similarly, Vodafone’s voice ARPU in its key

European territories has continued to decline at a faster rate than blended ARPU

(assuming constant spending patterns across time), suggesting data service

cannibalisation.

1Our analysis of NTT DoCoMo ignores the impact of marginal investment costs for 2G. In Japan, a

high number of subscribers for available spectrum has led to higher capital costs (increased cost ofcell splitting), hence discouraging aggressive volume expansion. Nevertheless, data’s initial failure to

drive expanding ARPUs for DoCoMo provides a negative benchmark for European investors.

Realistic upside in the noise

Evidence to date suggeststhat messaging hascannibalised existing voicerevenue streams



Chart 3 : NTT DoCoMo ARPU trend (yen) Chart 4 : Voice/Data ARPU trends CY Q2 02/Q2 01

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

1997

1998

1999

2000

2001

Q1 0

2

Q2 0

2

Q3 0

2

Q4 0

2

Q1 0

3

Q2 0

3F

Q3 0

3F

Q4 0

3F

ARPU (12m, contract) VARPU DARPU

-14%

-12%

-10%

-8%

-6%

-4%

-2%

0%

2%

4%

VOD - UK VOD -Germany

VOD - Italy DoCoMo

ARPU VARPU

CY Q2 02/Q2 01

Source: Company reports Source: Company reports

Notwithstanding this axiom, we do acknowledge that the higher pricing of MMS

relative to existing voice and SMS usage could reduce the risk of cannibalisation.

Table 11 : Relative price, voice, SMS and MMS (€)

Price Premium/Discount to voice

Avg price 2 minute voice call 0.20 0%

Avg price per SMS 0.10 -50%

Avg price per MMS 0.40 100%

Source: ABN AMRO

Margin impact of MMS

So far we have considered the revenue impact of MMS. It is also important to

consider the margin implications. As we have noted historically (see Floating at the

edge, dated 14 January 2002) the process of embedding MMS-enabled handsets

into an operator’s subscriber base requires a substantial investment in opex

(handset subsidies, dealer commissions and marketing expenses).

Subscriber acquisition costs/subscriber retention costs (SAC/SRC) historically have

represented 7.0%-45% of an operator’s top line. The top end of this range has

been provided by the least mature new entrants throughout Europe. Typically, for a

more mature operator, we see SAC/SRC running at 7.0%-20.0% of sales. A major

risk to margins is the cost of (1) acceleration in the handset replacement cycle (ie

volume) and/or (2) increasing handset subsidies (ie unit cost).

(1) Volume

Our views on the prospect of acceleration in the European handset replacement

cycle are well known. We have long argued that an increase in churn is inevitable,

if the European operator community is to achieve material data-related revenue

growth in the medium term. Our margin thesis has revolved around the concept of

technology migration (stimulating the migration of exiting 2G subscriber to next-

generation terminals).

DoCoMo has failed to drivean ARPU upgrade from data

In our view, embeddinghandsets requires amaterial investment in opex

SAC/SRC could increasebetween 100-300bp as apercentage of sales

We suspect an increase inchurn is inevitable



We recognise that the speed of migration will vary on a country-by-country basis,reflecting:

■ the level of market share concentration;

■ the balance sheet strength of the smaller players; and

■ the arrival (or absence) of new entrants.

We continue to believe that Spain and France will be the most benign markets in

terms of competition, with the UK confirming its reputation as the most competitive

market in Europe. Italy, currently a benign market, is a wild card that could seemuch fiercer price-based competition looking forward.

In our view, the key metric on which investors should focus to assess our volume

thesis is gross additions. For the purpose of simplicity, our modelling of costs

includes “internal migrations” as external churn. While this is technically incorrect,

it does enable us to capture the volume driver of costs. Should the number of the

gross adds accelerate (all other factors held equal), operating costs will increase as

a percentage of sales. We highlight the structural shift in growth that Europe has

(and will) continue to undergo away from “new” growth, to the size and share ofthe disconnection pool, driven by churn and SOGA (see following chart).

Chart 5 : German gross adds example

2.0 2.5 5.79.3

34.4

7.33.7 4.7 4.0

1.4 1.4

2.1

3.5

5.9

12.014.2

15.2 15.7

29%

14% 15%

19%

16%

23%25% 25% 24%

0

5

10

15

20

25

30

35

40

45

1996 1997 1998 1999 2000 2001 2002 2003 2004

0%

5%

10%

15%

20%

25%

30%

35%

Net Adds (m) Disconnections (m) Churn %

Source: RegTP/Group3G

Our modelling incorporates full detail on the trend in gross adds across Europe. A

copy of this model is available upon request. Investors requiring further detail of

our views on technology migration should refer to Vodafone – The cost of capitalchallenge, dated 8 April 2002.

(2) Unit cost

We note recent comment from the Carphone Warehouse that by late January 2003,

MMS-enabled handsets will be priced for the mass market. The Nokia 7650 is

currently priced at €450-500. In 2003, Carphone is seeking to sell camera-enabled

handsets for €72-80 to contract customers. Similarly, first estimates of the unit

cost of the dual-mode 3G Nokia handset were €700-800 (about £500).

Speed of migration will varyon a country-by-countrybasis

Churn becomes a key driverof margin

Tracking gross adds crucial

Handset retailers havesuggested that handsetswill need to be retailedbelow €100



Our IT Hardware team has suggested an initial unit cost range of €600-700 per 3G

handset. To put this in some context, existing unit costs for 2G handsets in Europe

range between €250 and €300. (Globally, costs range between €100 and €110,

reflecting the low-end 2G handsets sold into markets such as China). While we

would expect this cost to fall as scale production commences, it could result in a

sharp short-term spike to subsidies.

Average subsidies at the last reported date have been running €24-350 per

addition. At the (all-important) post-paid level, SACs have been €156-350

(excluding the Italian experience; see following table). Post-paid subsidies over the

past year have diverged between (1) falling subsidisation of lower-end handsets

and (2) accelerating subsidisation of higher-end handsets (eg the Ericsson T68i).

Table 12 : Major operator SAC trends FY2002/1H02

Vodafone mmO2 Orange

(€) ContractSAC

PrepaidSAC

BlendedSAC

SAC as% ofSales

ContractSAC

PrepaidSAC

BlendedSAC

SAC as% ofSales

ContractSAC

PrepaidSAC

BlendedSAC

SAC as% ofSales

UK 184 41 110 7.5% 286 84 156 13.1% 350 32 158 9.0%

Germany 156 24 81 6.6% 254 70 157 17.1% na na na na

Italy 35 35 35 3.0% na na na na na na na na

France na na na na na na na na 206 83 140 10.2%

Source: ABN AMRO

Using a unit cost of (say) €650 would result in a material spike in subsidies if the

operator’s objective is to retail the product below €300 (about £200). This could

have a profound impact on margin. The implied subsidy would grow to about €350

per handset. This is significantly ahead of existing average post-paid handset

subsidies, although we note that it is more in line with existing high-end handset

subsidies. The actual margin impact would be driven by the number of gross adds

(volume) connecting to 3G. Our central case is for a 100-300bp reduction in

profitability (purely from an increase in SG&A as a percentage of sales).

A key risk to a positive outlook is that aggressive subsidisation does not result in

significant increases in ARPU (ie value destruction occurs). This risk is most

pronounced in markets such as the UK and Germany (in Europe) given the lower

level of industry concentration and the scope for the present equilibrium to be

destabilised by aggressive new entrants.

Capex impact of MMS

Investors should also be aware of the capex implications of successful MMS

deployment. GSM networks operate with eight time slots. A typical MMS can take

up to three time slots, cannibalising existing time slots allocated to voice

communication.

While the operator community claim this “success-driven” capex is already built

into its models, we are sceptical given the lack of visibility on (1) MMS subscriber

targets and (2) existing network capacity utilisation in major urban areas. Hence

the successful deployment of MMS could lead to upward momentum in capex

guidance from the major operators, although we note that this spend would besuccess-driven.

Our IT Hardware teamsuggests that 3G handsetswill cost €600-700

Post-paid subsidiescurrently sit at €156-300

Average subsidies couldmaterially increase to make3G handset prices attractiveto the end user

Successful deployment ofMMS could shift capexexpectations upwards ...

... although capex would besuccess-driven …



Strategic investor choices

Hence we encourage investors to sanity-check claims that MMS (or data) is the

silver bullet for the European wireless community. In our view, a fresh

management approach is required. We suspect that operator business models (and,

for that matter, analyst forecasts) based on material contributions from mobile data

in the short term could be fundamentally flawed.

We are not writing off the medium- to longer-term prospects of mobile data. On the

contrary, we recognise the potential for data (as a longer-term driver) to surprise

on the upside. In our view the risk look finely balanced. We can use a basicportfolio analysis tool to consider the risks.

In our view, mobile data is a highly attractive market, but in an area of low

business strength (see chart below, top right quadrant). Bulls of mobile data could

categorise it as part of “developments,” recently developed services that may have

some future, but require greater investment to achieve that future. More bearish

commentators (like ourselves) could categorise data as part of “ego trips,” or

services that have strong product champions among influential managers, but for

which there is little proven demand in the marketplace. The company, because of

the involvement of powerful managers, continues to pour resources into these new

services in the hope that they eventually come good. Hence the risks, today,

appear finely balanced between data following the “Death cycle,” down to becoming

a failure or moving across and then downwards via “Tomorrow’s breadwinners” into

“Today’s breadwinners.”

Figure 1 : The product portfolio

Business strengthLowHigh

Tomorrow’s breadwinners

Developments SleepersEgo trips

Today’s breadwinners

Failures Yesterday’sbreadwinners

Marketattractiveness

Low

High

Lifecycle

Deathcycle

Source: ABN AMRO/Drucker (1973)

Given this outlook, we believe that investors should demand a more disciplined

approach to capital investment, until there is greater visibility that data is not a

classic “better mousetraps nobody wants” but actually offers scope to create value

where none existed before.

... but we remain sceptical

Investors should demand amore disciplined approachto capital investment

Mobile porn, sport andgambling could still drive‘niche’ usage

The biggest risk (alreadymostly discounted in prices)is that mobile data turnsout to be an ego trip

Investors should demand amore disciplined approachto capital investment



Fixed to mobile substitution

In the short term, pre-to-post-paid migration is the most important driver of

revenue growth. We believe high prepaid call charges have stunted usage. Our

forecasts imply about 4% annual growth in blended ARPU over the next five years

from this dynamic. During the medium term, we suspect that consensus models of

revenue growth are fundamentally flawed, assuming 2G economics (lower volume,

low ARPU, low EBITDA per subscriber) will underpin European 3G. It is our core

belief that at a 50% premium to underlying fixed-line prices, mass displacement of

voice minutes and revenue will occur from fixed to mobile networks. In our view,

3G will be characterised by higher-volume, higher-ARPU, higher-EBITDA per

subscriber voice services, similar to the model that prevails in the US. Our central

case assumes mobile grabbing 30%-40% share of outgoing total traffic by year-end

2006, from 10%-15% today, driven by price cuts of about 50%-60%. This view has

a profound implication for European ARPU growth, which could structurally shift

upwards by about 30% by year-end 2006. The key is flawless execution to turn

volume into value.

Introduction


■ the ARPU impact of pre-to-post-paid migration;

■ US volume as a lead indicator for Europe;

■ the defining characteristics of 3G over 2G economics;

■ the relative price of mobile vs fixed;

■ the cross-elasticity of demand of mobile to fixed-line;

■ a sensitivity analysis on the scope for voice substitution by call type and the

impact on ARPU; and finally

■ the risk/opportunity presented by declining termination rates.

Fixed to mobile substitutionoffers a compelling secondleg of growth



Background

The average European wireless subscribers still only use their handset for about 3.0

outgoing minutes a day, or 4.5 minutes including incoming minutes of use (MOU).

Across Europe, mobile calls represent 10%-15% of total outgoing call volume. In

the UK there are seven times as many minutes carried on fixed-line networks than

on the UK’s wireless networks (see following chart).

Chart 6 : UK call volume by type (bn minutes)

0

50

100

150

200

250

300

1999 2000 2001

Fixed local calls Fixed Internet calls Fixed long distance calls

Mobile outgoing calls Fixed international calls Fixed to mobile calls

Source: ABN AMRO/OFTEL

At the top line, we believe that Europe’s wireless landscape will be characterised bythree major phases during the next four years, namely:

■ Phase one: prepaid to post-paid subscriber migration (2002-2006);

■ Phase two: material fixed-to-mobile call volume substitution (2004-2006); and

■ Phase three: dramatically declining termination rates (2002-2006).

Phase One: Pre-to-post-paid migration

It is our core belief that European cellular usage has been stunted by high prepaid

call charges. Including the handset subsidy offered on post-paid products, we

estimate prepaid prices are 40%-110% higher than “equivalent usage” post-paid

offers across Europe. In our view, lower call charges have played a key role indriving materially higher volume in the US market.

Prepaid subscribers as a percentage of the total European base appear to have

already peaked. Looking forward, we expect four key drivers to cajole Europe’s pre-

paid subscribers into migrating: (1) handset subsidies, (2) dealer incentives, (3)

product exclusivity and (4) bucket pricing plans (value for money).

Phase One drives higher usage/blended ARPUs

We retain a firm belief that increasing pre-to-post-paid migration offers a

compelling macro driver of volume and blended ARPU. The impact of migration can

be identified with reference to a “generic” model.

European wireless usersstill only use 3 minutes aday

At the top line, the wirelesslandscape will becharacterised by threemajor phases

Prepaid usage has beenstunted by high call charges

In Europe, prepaidsubscribers have peaked asa percentage of totalsubscribers

Prepaid subscribermigration offers a strongmacro driver of blendedARPU



Our generic model is built on Country X. In Country X we have considered OperatorY.

■ To capture the impact of pre-to-post-paid migration, we have moved operator

Y’s post-paid share of overall gross adds from 38% at x+0 (today), to 60% inx+1 (today + one year).

■ Each new year’s post-paid subscriber connections are assumed to connect to a

lower-priced post-paid plan, reflecting incremental subscriber dilution (we have

factored in a 20% decline pa).

■ In terms of current period (x+0) post-and prepaid ARPU, we have used £40 and£9, respectively.

In the following chart we show the evolution of subscribers by post-paid plan type

(post-paid subscribers joining high-value, Phase One, Phase Two and Phase Three

plans).

Figure 2 : Generic subscriber evolution by plan type

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

10.0

X+0 X+1 X+2 X+3 X+4 X+5 X+6 X+7 X+8 X+9 X+10 X+11

Time (Yrs)

Subsc

riber

s (m

)

High Value Contract Phase 1 Contract Phase 2 Contract Phase 3 Contract

Source: ABN AMRO

The chart shows the highest value post-paid subscribers (the bottom area) falling in

absolute numbers over time. Each year’s connections are assumed to connect to a

new type of plan (Phase One in x+1, Phase Two in x+2 and Phase Three in x+3).

In aggregate, total post-paid subscribers grow to nearly 60% of the total base from

31%. We have then factored in the different (declining) incremental post-paidARPUs for new connections (see following chart).

We have built a genericmodel to show theimportance of planmigration

We have grouped eachyears connections by a plantype, to model migration

Incrementally we expectpost-paid ARPU to fall



Figure 3 : Generic ARPU evolution by plan type

0.0

10.0

20.0

30.0

40.0

50.0

60.0

X+0 X+1 X+2 X+3 X+4 X+5 X+6 X+7 X+8 X+9 X+10 X+11

Time (yrs)

ARPU

(G

BP£)

High Value Contract Phase 1 Contract Phase 2 Contract

Phase 3 Contract Total Contract Total Blended

Source: ABN AMRO

Together these two charts provide an expected blended ARPU growth rate. Our

analysis shows blended ARPU improving by between 4%-8% on an annual

basis to year-end 2005 (see chart above). In the short term, this is the most

important driver of growth.

Given the sensitivity of the analysis to the rate of churn, the percentage of gross

adds connecting to post-paid tariff plans and post-paid ARPU decline, a full copy ofgeneric model is available to investors in the appendix of the note.

Call volume per pop

Our view on the potential for strong growth in wireless volume driven by lower

prices is lent some credence by existing US wireless/wireline volume. US telecom

volume is significantly higher than existing European volume. We attribute the gap

to the difference subscriber mix and the pricing structures offered (US local calls

are bundled with line rental). For example, in the US fixed local call volume per popis 3.5x higher than the UK fixed local volume (see table below).

Table 13 : Major market local call volume per pop pa

Local calls Volumes bn Population min/per pop min/pop/mon

UK 80 60 1,331 111

France 77 59 1,309 109

Germany 125 82 1,516 126

Italy 60 58 1,040 87

Spain 42 39 1,065 89

Netherlands 25 16 1,583 132

Finland 10 5 1,863 155

US 1,353 288 4,698 391

Japan 215 126 1,706 142

Source: ABN AMRO/IDC

We have then modelledARPU by plan type, tounderstand the impact onblended ARPU ...

Together these driversprovide blended ARPUgrowth of 4% on an annualbasis

US call volume, driven bylower prices, lendscredence to our view



Call volume per line

If we re-run our analysis using a per line metric, we can remove the distortion of

differences in penetration (see following table). On average we estimate US telco

volume is about 6x higher per line than the European average. For example, in the

US, fixed local call volume is 6.5x higher than the UK fixed local volumes per line,

or 6.9x the European average. Mobile traffic per line is about 3x European average

volume.

Table 14 : Major market wireline local call volume per line

Volume bnNo of Lines

(m) Minutes/Line Min/Line/Mon

UK 80 84 951 79

France 77 73 1060 88

Germany 125 157 794 66

Italy 60 52 1,157 96

Spain 42 33 1,267 106

Netherlands 25 27 950 79

Finland 10 11 849 71

US 1,345 219 6,133 511

Source: ABN AMRO/Country regulators

In the following table we have summarised the multiple of US minutes per line by

call type relative to the European average by call type per line. The evidence makes

stark reading. For the wireless industry we do not believe that the difference in

usage is primarily attributable to differences in penetration.

Table 15 : US vs European telco volume (2000)

Euro ave. MOU perline per line

US ave. MOU perline per month

European averagemultiple

Local - Euro average 84 511 6.1

National - Euro average 35 315 8.9

International - Euro average 5 11 2.1

Mobile - Euro average 107 284 2.7

Source: ABN AMRO

Our thesis is simple – in the event of subscribers moving from pre-to-post-paid

plans (with large bundles), usage should increase. Evidence to date supports a

positive view. We highlight TEM’s Q202 results, which indicated that average usage

from migrated subscribers jumped more than 2x. Applying the US propensity to call

to each of Europe’s major markets results in a significant shift in European wireless

outgoing volume.

US local call volume per line6x higher than in Europe

In aggregate call volume inthe US is between 2x and6x the European average

Should pre-to-post paidmigration occur blendedspend should increase



Table 16 : Mobile minutes 2001: applying a US multiplier

Annual mobilevolume 2001 (bn)

US multiplier (x) New annual mobilevolume (bn)

UK 69.4 2.7 187.3

France 65.6 2.7 177.1

Germany 74.1 2.7 200.1

Italy 49.1 2.7 132.6

Spain 27.6 2.7 74.6

European major market total 285.8 2.7 771.7

Source: ABN AMRO

Readers should recognise that we have not incorporated this volume increase into

our bottom-up models for each operator. We merely present the data as a further

perspective. This is important from a wireline perspective, given the scope for the

wireless subsector to gain (in terms of volume) from pre-to-post-paid subscribermigration, but not entirely at the revenue expense of the wireline operators.

Phase Two: fixed to mobile substitution

While local access fees may be largely retained by wireline telephony operators, we

expect a large percentage of fixed-line voice calls to migrate to Europe’s cellular

networks. This view has a profound implication for European ARPU growth and

fundamental valuation.

2G vs 3G economics

Increasingly, we suspect that consensus models of revenue growth are

fundamentally flawed, assuming 2G economics will underpin European 3G. We

reject the view that blended ARPU will gently tick along at 3-5% growth pa, coupled

with margin progression and capex/sales falling to sub-10%. In our view, European

cellular models that follow this trend ignore the potential capacity for 3G to enablethe mass substitution of fixed-line voice minutes to the wireless network.

Material wireless growthmay not necessarilyterminally damage wirelinevolume but ...

... As 3G is deployed acrossEurope, we anticipate largeF2M volume displacement

The assumption that 2Gmobile economics willprevail in 3G could befundamentally flawed



Chart 7 : 2G vs 3G economics

European 2GEconomics

Growth via shift in capacity 3G Economics

Low MOU/low volumegrowth

Low ARPU/declining voiceARPU

Higher MOU/high volumegrowth

Higher ARPU/lower yield

High level of marketconcentration

High margins Lower margins

Lower EBITDA persubscriber

Higher EBITDA persubscriber

Capex: Capacity andmaintenance

Capex: coverage focused

Low NOPAT/IC: goodreturns

Higher NOPAT/Similar IC:higher returns

Lower level of marketconcentration

Shift in Capacity

2 x - 5 x

Source: ABN AMRO

Elasticity of demandHistorically, a great deal of telco equity research has been dedicated to the

discussion of elasticity of demand, the percentage change in quantity demanded for

a percentage change in price. Analysis of elasticity of demand is obscured by

penetration growth. The authors of this study have seen estimates ranging from

negative 0.6 to negative 0.9, suggesting a high degree of elasticity at historical

price levels (implying volume growth somewhat compensates for price declines).

Cross-elasticity of demandFrom a theoretical perspective, the key determinant of elasticity of demand is the

availability of substitutes, which is a key point missed by many industry experts. Adiscussion of elasticity of demand for one good in isolation is flawed.

Elasticity of demand rangesfrom negative 0.6 tonegative 0.9

... but the key is crosselasticity of demand



In our view, the key factor to focus in on is the cross-elasticity of demand

between European wireless and European wireline (ie At what price will wireless be

preferred to fixed-line communication?). Cross-elasticity of demand refers to the

responsiveness of demand in one product to the change in price of another product.

Substitute goods have positive cross-elasticities. To better understand cross-

elasticity, we have focused our attention on the relative price of cellular to fixed

line.

Fixed vs mobile: A comparative analysis

The average price of a cellular minute of use vs a fixed-line minute of use has fallen

to nearly 3x today from about 6x in 1995 (excluding fixed-line access and

connection fees; see following chart).

Chart 8 : Comparative price of mobile vs fixed

-

1.0

2.0

3.0

4.0

5.0

6.0

7.0

1996 1997 1998 1999 2000 2001

Euro average

Source: ABN AMRO estimates/IDC

France

In determining revenue, we can either include or exclude access and connection

charges. Choice of methodology has a significant impact on the implied multiple of

cellular prices to fixed line. For example, in the French market, including access

fees, we calculate a multiple of around 2x vs a relative call price of nearer 3x

excluding access fees. In terms of the relative price of fixed voice calls to a mobile

voice calls, the French market offers a decent proxy for Europe in aggregate (seefollowing chart, including fixed-line access).

We estimate wireless as amultiple of wireline hasfallen to about 3x from 6x

In France, the multiple hasfallen to nearly 3x



Chart 9 : France: mobile. price per minute relative to fixed line price per

minute (inc. fixed line access)

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

1999 2000 2001E

Local National International F2M Ave multiple

Source: ABN AMRO/IDC

The implied multiple of fixed to mobile calls and mobile international calls are close

to parity. Should the cellular handset become the primary point of local access for

the customer, we would view both of these segments as having a very highpropensity to migrate towards mobile.

The revolution begins

Intuitively a 10% reduction in price, when cellular is priced at (say) a 6x premiumto equivalent wireline prices, is not a compelling reason to substitute usage.However, it is our core belief that as cellular outgoing voice prices move to 1.5xaverage fixed call prices (ie a 50% premium), mass substitution of minutes andrevenue could occur. Of course the actual premium customers will be willing to paywill vary on a type-by-type basis (eg local, national etc).

Convenience

We believe that a 50% premium for the convenience of mobility will be accepted. In

our view, the overwhelming convenience and privacy of the mobile phone (relative

to fixed) should not be underestimated as a driver of growth. We view this driver as

further justification for increased migration from fixed to mobile usage. Remember

a 50% difference at (say) 1p increases the spend to 1.5p, for the convenience of

mobility, so for a two-minute call 1p more is spent.

The UK – a proxy for Europe; elasticity in focus

Of Europe’s regulators, OFTEL provides the most detail on volume and revenue by

call type. To assess the potential impact on outgoing voice ARPU throughout

Europe, we have used the UK as a proxy.

At 1Q02, UK mobile prices were around 3.6x the corresponding fixed line price (see

following table, average fixed line price per minute £0.04, average cellular price per

minute £0.15). To the end of Q102, the UK mobile market generated £1.8bn in

outgoing call revenue, corresponding to a monthly ARPU of £13.2. This includes

connection, access and call charge revenue.

If cellular becomes theprimary point of localaccess, we see significantscope for displacement

At a 1.5x multiple webelieve a mass substitutionof volume will occur

We think customers will beprepared to pay a 50%premium for theconvenience of mobility

OFTEL data enables toassess the scope forsubstitution by call type



To get the implied multiple of cellular to fixed line down to 1.5x (a 50% premium to

the underlying fixed line price), we calculate cellular prices must fall by about 60%

(1.5 x £0.04 = £0.06, which is a 50% premium to the fixed price, and a discount to

the current cellular price per minute of about 60%). Excluding any positive revenue

impact from increased volume, we calculate a revised ARPU of £5.6 per subscriber

(see following table).

Table 17 : UK mobile market ARPU (pre- and post-price decline)

Unit Q102

Total UK mobile minutes (all calls, exc termination) bn minutes 12330

Average UK mobile subscribers m 45.6

Minutes of use (MOU) minutes 90.2

Total UK outgoing mobile revenue £bn 1.8

Actual price per minute £ 0.15

% change in price % -58%

ARPU (pre-price change) £ 13.2

ARPU (post-price decline) £ 5.6

Source: ABN AMRO

Central case outlook

Our central case is for large-scale substitution of call volume to occur between the

wireline and wireless networks. We believe the future will see most wireless

subscribers paying a flat rate fee for a large bundle of voice minutes. A high flat

rate entry point provides a marketing tool. Customers may never fully consume

their allocated minutes, but the large volume should create the impression of valuein their mind.

To assess the potential impact of fixed to mobile substitution on UK industry

monthly ARPU on a bottom-up basis, we have disaggregated UK call

volume/revenue by type, and taken a view on the scope for substitution. In the

following example we have used OFTEL data for Q102. Our substitution analysis

excludes any revenue for connection or access, which we assume remains

with the wireline operator.

OFTEL tells us that in Q102, total UK non-call revenue was about £1.1bn. Again we

have assumed none of this revenue migrates to the wireless network. However,

methodologically we believe it would be incorrect to ignore the access fee for

comparison of fixed line prices with cellular prices. Hence at a theoretical level we

have to allocate this non-call cost to the fixed line, to get a feel for the price per

fixed-line minute the customer actually pays, when comparing the average fixedline price per minute with the average cellular price per minute.

The reason we must include the access fee for price comparison is that the fee paid

by the customer is regular in nature, and is not a sunk cost for the customer.

Additionally, as the number of minutes originated on wireline networks diminishes,

the implied price per minute rises, and the value for money proposition

deteriorates. While we have ignored the subject of fixed-line disconnection, we do

recognise the risk displacement of originated minutes presents to the existing

number of fixed lines without DSL emerging.

58% price reductionreduces blended ARPU to£5.6 from £13.2

When assessing relativeprices, we must considerconnection and access fees



Including access fees, we estimate that the implied multiple (of cellular price per

minute vs fixed price per minute) is about 1.5x (ie cellular at a 50% premium to

the underlying fixed line price). Excluding access fees from the relative price

comparison, the price multiple between the two platform grows from 1.5x to 2.6x.

We can calculate this from total fixed call revenue post-substitution excluding

access of £1.5bn, divided by the number of minutes equals an average price per

minute of £0.02, which is 2.6x less than the implied price per mobile minute of

£0.06 post price decline.

Including access fees, total fixed line quarterly revenue equalled £2.5bn in Q102,

divided by the number of minutes equals an average price per minute of £0.04.

This is 1.5x less than the implied price per mobile minute of £0.06 post pricedecline.

Our central case for volume migration is based on the following assumptions:

■ 30% of all local call volumes substituting to wireless;

■ 60% of all F2M calls substituting to wireless;

■ 50% of all national calls substituting to wireless;

■ 30% of all international calls substituting to wireless; and

■ 15% of “other” calls, including NTS and “free call numbers.”

This equates to 35% of UK call volume orignated by wireless networks from 13%.

Total call volume in Q102 equalled 97.3bn minutes, of which 13% were mobile-

originated. Our central case grabs an additional 22.2bn minutes, giving total

mobile minutes post price decline of 34.5bn minutes, or 35% of the total marketminutes for the quarter.

We are not suggesting that call volume at Q102 offers a good proxy for call volume

in the absence of fixed-to-mobile substitution looking forward. But given the

transparency of Q102 numbers, we have used the data to get a feel for the scope

for an ARPU shift.

Similarly we don’t want to become too bogged down by the question, What’s the

correct percentage for displacement by call type? The future is by definition

unknown, and hence the question is clearly open to debate at a bottom-up level.

In our view it is more important to focus on the bigger picture – What percentage

of total volume will migrate?, and What price reduction is required to drive this

displacement?

Factoring in a willingness to pay a 50% premium to the underlying fixed line price

in aggregate, we estimate conservatively outgoing voice ARPU growth of 18%

(outgoing voice ARPU £5.6 post price decline, from £13.2, adding incremental ARPU

uplift from volume growth of £10.0, resulting in post price decline ARPU of £15.60,

which is 18% ahead of £13.2). Outgoing growth of 18% corresponds to 11%

change in overall ARPU. This would represent a significant upside surprise to

consensus expectations. We note comment from British Telecom that to date about

4% of existing volume pa has been cannibalised by mobile.

Our central case assumesmobile grabbing around35% of total originated callvolume (from 13%)

This corresponds tooutgoing ARPU growth of18% (using a price cut of58%).

MOBILE NETWORKS - W. EUROPE16 OCTOBER 200232

MACRO DYNAMICS

Tab

le 1

8 : U

K M

ark

et O

utg

oin

g D

rivers

Q1

20

02

OFT

EL S

tatistics

Lo

cal ca

lls F

2M

calls

Natio

nal

calls

Inte

rnatio

na

lca

lls O

ther ca

lls T

ota

l Fix

ed

calls

Mo

bile

To

tal A

ll Calls

Sta

rting

Po

int

Call vo

lum

e bn m

ins

18.8

3.5

13.6

2.0

47.1

85.0

12.3

97.3

Call reven

ue (exc. access) £

bn

0.4

0.5

0.4

0.3

0.7

2.3

1.8

4.1

Implied

revenue p

er min

ute

0.0

2 0

.14

0.0

3 0

.14

0.0

1 0

.03

0.1

5 0

.04

Impact o

f Subsitu

tion

Mobile p

rice per m

inute red

uctio

n-5

8%

New

mobile p

rice 0

.06

Sco

pe fo

r local su

bstitu

tion

30%

60%

50%

30%

15%

26%

Averag

e mobile su

bscrib

ers 4

5.6

45.6

45.6

45.6

45.6

45.6

45.6

MO

U su

bstitu

ted to

mobile (b

n m

ins)

5.6

2.1

6.8

0.6

7.1

22.2

22.2

Implied

additio

nal M

OU

per su

b 4

1.3

15.2

49.9

4.3

51.7

162.4

162.4

Reven

ue lo

st to Fixed

Line

0.1

0.3

0.2

0.1

0.1

0.8

Reven

ue su

bstitu

ted to

mobile

0.3

0.1

0.4

0.0

4 0

.4 1

.4 1

.4M

obile R

evenue lo

st due to

price cu

t 1

.0In

cremen

tal ARPU

uplift

2.5

0.9

3.1

0.3

3.2

10.0

10.0

En

d G

am

eCall vo

lum

e bn m

ins

13.2

1.4

6.8

1.4

40.0

62.8

34.5

97.3

Call reven

ue (exc. access) £

bn

0.3

0.2

0.2

0.2

0.6

1.5

2.1

3.6

Implied

revenue p

er min

ute

0.0

2 0

.14

0.0

3 0

.14

0.0

1 0

.02

0.0

6 0

.04

Pre-p

rice declin

e P

ost p

rice declin

eA

RP

U 1

3.2

5.6

Increm

ental A

RPU

uplift (fro

m su

bstitu

tion)

10.0

New

ARPU

(post p

rice declin

e inc. vo

lum

e uplift)

15.6

% C

han

ge

18%

Differen

ce T

otal fixed

line call vo

lum

e 8

5.0

62.8

22.2

Total m

obile call vo

lum

e 1

2.3

34.5

22.2

97.3

97.3

-

Total fixed

line call vo

lum

e87%

65%

Total m

obile call vo

lum

e13%

35%

Differen

ce T

otal fixed

line call rev

enue

2.3

1.5

0.8

Total m

obile call rev

enue

1.8

2.1

0.3

Total telco

call revenue

4.1

3.6

0.5

Total fixed

line access reven

ue

1.1

1.1

- T

otal telco

revenue

5.1

4.7

0.5

Total fixed

line call rev

enue (%

)56%

41%

Total m

obile call rev

enue (%

)44%

59%

Total telco

call revenue (%

)100%

100%

Total fixed

line call rev

enue

44%

32%

Total m

obile call rev

enue

35%

46%

Total fixed

line access reven

ue

21%

23%

Total telco

revenue

100%

100%

Source

: ABN

AM

RO



UK local calls

Factoring 30% volume substitution at an average cellular price of £0.06 results in

revenue for the quarter of £0.3bn substituting to mobile from fixed line. This

corresponds to 5.6bn minutes of fixed-line local voice calls substituting to the

mobile network, or an additional 41 monthly MOU per wireless subscriber per

month (see following table).

Table 19 : UK local call market (quarter only £bn)

End-Q102

Fixed local call volume (bn mins) 18.8

Fixed local call revenue (exc. access) (£bn) 0.4

Implied revenue per minute 0.02

Scope for local substitution 30%

Local MOU substituted to mobile (bn mins) 5.6

Implied additional MOU per sub 41.3

Local revenue substituted to mobile 0.3


Using an average price per cellular minute of £0.06 implies a premium of 2.8x the

average price per fixed-line minute (fixed-line price per minute of £0.022). This

massively overstates the actual premium the wireless user is paying because it

ignores the wireline access and connection fee that the customer pays.

UK F2M calls

Using an average revenue per cellular minute of £0.06, and assuming the

displacement of 60% of fixed to mobile volume to mobile, we see about £0.1bn of

fixed calls to mobile moving to mobile. This amounts to about 2.1bn of additional

minutes, or 15 monthly MOU per wireless subscriber. It is important for readers to

recognise that as the wireless handset becomes the “accepted” point of access, we

believe that a significant networking effect could occur (in terms of mobile to

mobile communication). Hence we believe that our 60% migration assumptioncould prove too conservative.

Table 20 : UK F2M call market (quarter only £bn)

End-Q102

F2M call volume (bn mins) 3.5

F2M call revenue (exc. access) (£bn) 0.5

F2M Implied revenue per minute 0.14

Scope for F2M substitution 60%

MOU substituted to mobile (bn mins) 2.1


F2M revenue substituted to mobile 0.1


30% local call volumesubstitution equates to anadditional 41 MOU permonth

30% local call volumesubstitution drives £0.3bnto mobile

60% F2M substitutioncorresponds to 15 MOU persub per month

60% substitution results in£0.1bn moving to mobile



UK national calls

Our central case uses 50% substitution of national calls to the wireless network. We

view the national call market as a core opportunity for Europe’s wireless operators.

On this basis, we see 6.8bn minutes substituting to the UK’s wireless operators (50monthly MOU per subscriber), or about £0.4bn in revenue terms.

Table 21 : UK national call market (quarter only £bn)

End-Q102

Fixed call volume (national calls) (bn mins) 13.6

Fixed call revenue (National calls) (£bn) 0.4


Scope for national substitution 50%



National revenue substituted to mobile 0.4


UK international calls

In our central case outlook, we see a less material opportunity from the

international call segment. We acknowledge that this could be overly conservative.

Our central case assumes 30% substitution of international call volume, or about

0.6bn minutes migrating to the UK wireless network operators (4 monthly MOU per

subscriber).

Table 22 : UK international call market (quarter only £bn)

End-Q102

Fixed call volume (international calls) (bn mins) 2.0

Fixed call revenue (International calls) (£bn) 0.3


Scope for international substitution 30%



International revenue substituted to mobile 0.0


UK other calls

Other calls include Internet dial-up, pay phones, calls to premium services, calls

through the operator, calls to the speaking clock, calls to paging operators and free

phone numbers. While we view this market as “fair game” for the wireless operator

community, we have included only 15% of this traffic displacing to the wireless

operators, recognising that Internet traffic is a key driver. This corresponds to

about 7.1bn minutes (52 monthly MOU per subscriber).

50% substitution ofnational calls results in£0.4bn moving to mobile

30% substitution ofnational calls results in£35m moving to mobile



Table 23 : UK other call market (quarter only £bn)

End-Q102

Fixed call volume (other calls) (bn mins) 47.1

Fixed call revenue (Other calls) (£bn) 0.7


Scope for 'other calls' substitution 15%



Other call' revenue substituted to mobile 0.4


UK market in aggregate

In aggregate, our central case estimates show mobile traffic growing to 35% of

total telco volume from 13%, or to 46% of total revenue (from 35%). This equates

to 162 monthly MOU per subscriber substituting from the UK wireline operators to

the UK wireless community. This corresponds to an additional 5.3 MOU per day

being substituted, or about 8.3 minutes a day in outgoing cellular usage in total

(5.3 MOU plus the original 3.0 MOU). In revenue terms this equals £1.4bn of

additional revenue, or a monthly ARPU uplift of £10 per subscriber. This is 18%

growth on the “pre” price decline monthly ARPU scenario of £13.2 per

subscriber.

Table 24 : Total UK call market (quarter only £bn)

End-Q102

Total MOU substituted to mobile (bn mins) 22.2

Period average UK mobile subscribers (Q4/Q3) 45.6

Total MOU per sub substituted to mobile 162.4

Total revenue substituted to mobile (£bn) 1.4

Total ARPU uplift (£) 10.0

Source: ABN AMRO estimates/OFTEL

We can also think of this substitution in terms of ARPU contribution by call type

(see following table). Our analysis clearly shows outgoing voice ARPU increasing

to £15.6 from £13.2 (+18%).

Table 25 : Central case: UK market ARPU by call type

Unit End Q102

Total ARPU (outgoing, exc. SMS) pre-decline £ 13.2

Total ARPU (outgoing, exc. SMS) post-decline (excelasticity) £ 5.6

Add: local call ARPU £ 2.5

Add: fixed to mobile call ARPU £ 0.9

Add: national call ARPU £ 3.1

Add: international call ARPU £ 0.3

Add: “other call” ARPU £ 3.2

Total outgoing ARPU post decline £ 15.6

% growth in ARPU % 18%


15% substitution of othercalls drives £0.4bn tomobile

Together we see up to 18%growth in outgoing voiceARPU

In total, substitutionincreases ARPU by £10

ARPU post migration is18% higher ...



Industry impact

We can also think about the potential of fixed to mobile substitution in terms of the

total industry, recognising the importance of the 50% premium to the underlying

fixed-line price per minute. Our central case for mobile (holding all other factors

equal) suggests that UK mobile revenue grows to £2.1bn (for Q102 factoring in the

indicated substitution), and UK wireline revenue declines by 24% to £2.5bn from

£3.3bn. For the wireline operators this does not include any compensating benefit

from DSL. In aggregate, this results in total outgoing telecoms revenue in the UK

declining by about 9% (from about £5.1bn to £4.7bn).

Table 26 : UK fixed and mobile market post 58% cellular price decline

Fixed: post-price decline End-Q102

Fixed local call revenue (exc. access) (£bn) 0.3

F2M call revenue (exc. access) (£bn) 0.2

Fixed call revenue (national calls) (£bn) 0.2

Fixed call revenue (international calls) (£bn) 0.2

Fixed call revenue (Other calls) (£bn) 0.6

Total fixed call revenue (£bn) 1.5

Fixed access revenue (£bn) 1.1

Total fixed revenue (post-decline) £bn 2.5

% change -24.3%

Total fixed minutes bn 62.8

Actual price per minute (£) 0.04

% change 3%

Mobile revenue £bn 2.1

% change 18%

Mobile volume bn 34.5

% change 180%

Actual price per minute (£) 0.06

Implied multiple 1.5


We can present this impact more clearly using the following pie chart.

Figure 4 : UK telecoms quarterly revenue (£bn): central case

Pre-Decline Post-Decline

£5.1bn £4.7bn

Wireline revenue(pre-decline)% total 64%

Mobile revenue(pre-decline)% total 35%

Wireline revenue(post-decline)% total 54%

Mobile revenue(post-decline)% total 46%

Source: ABN AMRO

... but migration (withoutDSL growth) damages thewireline industry



A word of warning

Intuitively, some readers of this study may ask why total revenue is shrinking. If

UK wireline loses more than 22bn minutes to wireless, and UK wireless customers

are prepared to pay a 50% premium to the underlying fixed line price, then

(surely) the industry should grow (not contract). This is (of course) correct,

excluding the original UK wireless revenue (see following chart). Total fixed falls to

£2.5bn from £3.3bn, mobile adds £1.4bn, resulting in total revenue of £3.8bn(from £3.3bn). But mobile also loses £1bn from its historical revenue stream.

Figure 5 : Q102 UK telco market revenue evolution (£bn)3.3 0.8

2.5

1.8 1

0.8

1.4 2.2

0

0.5

1

1.5

2

2.5

3

3.5

Total F.L..R (Pre-Decline)

Total F.L R (Lost)

Total F.L.R(Post-Decline)

Mobile (Pre-Decline)

Mobile (Lost) Mobile (Post Decline)

Mobile Rev. Added Mobile Rev(Post-Decline)

£.b

n

Source: ABN AMRO

Sensitivity analysis

In the following table we have presented a range of scenarios for outgoing voice

ARPU based on our analysis of the UK market at Q102. This enables investors to

take their own view of the scope for traffic substitution, for a given price reduction

and identify potential outgoing voice ARPU. For example, assuming a (say) 55%

share of traffic and 58% price reduction suggests outgoing voice ARPU shifts to

£24.4 (+84%).

Table 27 : Absolute ARPU (£) scenario analysis

Price reduction

-78% -68% -58% -48% -38% -28% -18%

Volume share 15% 4.1 5.5 6.8 8.1 9.4 10.8 12.1

25% 8.5 9.9 11.2 12.5 13.8 15.2 16.5

35% 12.9 14.3 15.6 16.9 18.2 19.5 20.9

45% 17.3 18.6 20.0 21.3 22.6 23.9 25.3

55% 21.7 23.0 24.4 25.7 27.0 28.3 29.7

65% 26.1 27.4 28.7 30.1 31.4 32.7 34.0

75% 30.5 31.8 33.1 34.5 35.8 37.1 38.4

Source: ABN AMRO

Without DSL growth,telecoms shrinks

We have also run asensitivity analysis on theprice change required todrive migration

For example, assuming a58% price cut results in55% of originated callsmigrating to mobile, movingARPU to £24



Table 28 : Percentage change ARPU: scenario analysis

Price reduction

0.2 -78% -68% -58% -48% -38% -28% -18%

Volume share 15% -69% -59% -49% -39% -29% -19% -9%

25% -36% -26% -16% -6% 4% 14% 24%

35% -2% 8% 18% 28% 38% 48% 58%

45% 31% 41% 51% 61% 71% 81% 91%

55% 64% 74% 84% 94% 104% 114% 124%

65% 97% 107% 117% 127% 137% 147% 157%

75% 130% 140% 150% 160% 170% 180% 190%

Source: ABN AMRO

What about the power of the network?

A key risk is presented by the management of this process. We recognise that

running volume into value will be a challenging task. To quote a famous Greek

proverb, “What’s small, dark and knocking at the door? The future.” People are

rightly cynical about forecasting, but forecasting is at the heart of the planning

process and competitive positioning. However, it is our core belief that the low case

scenario is unlikely to emerge, because it ignores the scope for a networking effecton usage.

In our view, an analysis of existing call volume does not fully capture the potentialof the volume opportunity for the European wireless operator community. Why?

■ Mobiles are not generally shared and are most usually carried on the person,which provides an opportunity for a networking effect of increasing usage.

■ Our core thesis is that high prepaid charges have stunted European cellular

usage.

Hence our earlier assessment of the percentage of fixed-line call volume that could

displace to mobile could fundamentally underestimate the overall size of the

wireline telephony opportunity. In other words, the total size of the voicetelephony/broadband data market could explode (see following chart).

Chart 10 : Hypothetical volume forecast

-

5,000

10,000

15,000

20,000

25,000

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008T

hou

sands

of G

igab

ytes

per

yea

r

Total Fixed Narrowband Data Total Fixed Narrowband Voice Total Fixed Narrowband

Total Broadband Data Total Broadband Voice Total Broadband

Total Mobile

Source: ABN AMRO

Using the same example,we can observe 84%growth on the pre-declineARPU

Should the wireless handsetbecome the primary accesspoint, large scale growth inthe size of the pie couldoccur

A classic bull market chart,or maybe realistic upside?



F2M additive to pre-to-post paid migration

It is crucial to note that this fixed-to-mobile substitution growth is in addition to

underlying volume growth and the benefit we expect from pre-to-post-paid

migration (see above). In other words, there are two distinct drivers of ARPU:

■ Phase One: 4%-8% annual growth in blended ARPU from pre-to-post-paid

migration for the next four years’ and

■ Phase Two: an 18% structural shift in outgoing voice ARPU by 2006 (holding all

other factors equal 11% overall ARPU growth)

This results in up to 30% overall ARPU growth in total by year-end 2006.

Phase Three: Termination rate declines

Slowing subscriber growth at a time of sharply falling mobile termination prices

could further expose the cellular operators to a revenue crunch. Where regulated

reductions in mobile termination rates are exercised, they must be passed onto the

consumer. Termination rates typically account for 15%-35% of operators’ revenue.

Termination rates in Europe remain substantially higher than is observable in other

major markets, including the US and Korea (see following chart).

Chart 11 : European termination rates (€)

0

5

10

15

20

25

30

35

Aust

ria

Bel

giu

m

Den

mar

k

Ger

man

y

Finla

nd

Fran

ce

Gre

ece

Irel

and

Ital

y

Luxe

mbou

rge

Net

her

lands

Nor

way

Port

ugal

Sw

eden

Sw

itze

rlan

d

Spai

n

UK

Kor

ea US

Source: ABN AMRO/country regulators

In Regulation – Friend or Foe? dated 16 August 2002 we ran a detailed sensitivity

of various operators’ revenue to reductions in termination rates. Simply put, all

operators have material exposure – but new entrant operators have

disproportionately higher exposure. Ironically, as many regulators aim to promote

competition, they cannot cut rates too aggressively. We can assess the impact of

cuts to termination rates with reference to the UK.

A UK example

In the UK, OFTEL has suggested that RPI negative 12% should be applied to all UK

operators’ termination fees. Historically, UK operators have been subject to RPI

negative 9% for fixed line calls to wireless only. The extension of the mandate will

encompass about 48% of total incoming volume from 21% under the previousregulation (see following tables).

We have to balanceimproving outgoing voiceARPUs with potential fortermination rate cuts

European termination ratesremain at a signifiacntpremium to other majormarkets

Lower quality (primarily)new entrant businesses aremost exposed

The UK (again) offers anexcellent benchmark forunderstanding theeconomic impact of cuts



We can work through the impact of RPI-12% using OFTEL data. First, we know

from OFTEL that mobile outgoing calls amounted to 12.3bn minutes in Q102 (for

the quarter, see following table).

Table 29 : UK mobile volume (m mins) Q102

(m mins) %

UK calls 11,931 97%

Outgoing international 166 1%

Roaming 233 2%

All calls (outgoing) 12,330 100%

Source: OFTEL

Of these minutes we know the percentage split between fixed calls, and on-and off-

net mobile minutes (see following table).

Table 30 : UK mobile volume call split % (excluding SMS)

FY Dec 01 Jan - Mar 2002

UK fixed calls 49% 6,042

On-Net mobile 26% 3,206

Off-Net mobile 13% 1,603

Outgoing international 1% 123

Roaming abroad 2% 247

Other 9% 1,110

100% 12,330

Source: ABN AMRO

We know that total interconnection volume amounted to 6.1bn minutes. Using the

data above we can imply about 1.3bn minutes attributable from the fixed line (see

following table).

Table 31 : UK interconnection volume

Jan - Mar 2002 % split

Portion from on network mobiles 3,206 52.4%

Portion from off network mobiles 1,603 26.2%

Total Portion from other mobiles 4,809 78.6%

Portion from fixed line 1,309 21.4%

Interconnection total 6,118 100.0%

Source: ABN AMRO

We also know that quarterly interconnect revenue of £672m was generated during

1Q02, and that £361m was attributable to off-net mobile. Hence factoring in a

2.0% RPI rate (ie a 10% price cut), suggests a 2.4% reduction in total quarterly

revenue (24% of revenue attributable to interconnect, multiplied by the percentage

subject to regulation [100%], multiplied by the percentage fall in regulated

interconnection [10%]). Hence double-digit declines in termination rate (all otherfactors held equal) results in minor negative revenue growth for the industry.

Using OFTEL data we canwork through the proposedRPI-12% cut

OFTEL tells us the splitbetween fixed, on- and off-net mobile minutes

We know that totalinterconnection minutesamounted to 6.1bn minutes(Q102), implying 1.3bnminutes attributable fromthe fixed line

Using an inflation rate of2%, and RPI-12% suggestsa 2.4% reduction inquarterly revenue, which isin the noise



Table 32 : UK interconnection calculations

Volume Revenue ppm

On-net mobiles 3,206 0 0.00

Off-net mobiles 1,603 361 0.22

Mobile-to-mobile 4,809 361 0.07

Fixed-line 1,309 311 0.24

Total 6,118 672 0.11

Source: ABN AMRO

Given much of the doom and gloom surrounding the issue of termination rates, it is

important not to lose sight of the minor impact at the top line of RPI-12%. We put

a 60% probability on the RPI-12% cut being endorsed by the UK’s competition

commission. If this were confirmed, we would view it as an upside surprise to the

market’s current expectation.

We recognise that in a worst-case scenario, the competition commission could

introduce a draconian one-off price cut. Using a 20% price cut (for the purpose of

scenario analysis) we would expect revenue to decline between 4% and 5%, and

EBITDA by 8%-10%. Either way, we do not expect any announcements before

Q103.

Increasingly we think investors should question this analysis that excludes volume

uplift. Focusing on the impact to the profitability of a reduction in termination rates

without any compensating volume increase is appealing (due to simplicity), but it

ignores the possibility that growth in volume could occur, potentially compensating

operators for the loss in price.

Impediment to substitution

We recognise that the one of biggest impediments to potential substitution is the

high rate of mobile termination fees throughout Europe. We expect termination

rates will continue to decline at a double-digit rate for the foreseeable future.

Ironically, cuts in termination rates could refocus management on the fixed-to-

mobile substitution opportunity. Hence we believe falling termination rates are key

to enabling growth in outgoing voice ARPU.

The US experience

While there is a weight of evidence showing that cuts to terminations rates do

materially affect short-term profitability in markets with relatively high levels of

termination (see Portugal as an example), we believe there could be a silver lining

to the cloud. In our view, the US cellular market provides a benchmark that could

provide an indicator of Europe’s future. US blended ARPUs are more than 50%

higher than UK ARPUs (see following chart).

We put 60% probability onthe RPI-12% ruling beingconfirmed

We put a 40% probabilityon a draconian price cut ...

… but remind investors ofthe potential for increasingvolume to at least partiallyoffset losses

Ironically, cuts intermination rates could r-focus management onfixed-to-mobile substitution

The US model suggeststhere could be a silverlining to the cloud ...



Chart 12 : UK vs US – blended ARPU and penetration

20%25%

31%

39%45%

50%

14%

23%

40%

67%

78% 81%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1997 1998 1999 2000 2001 Q1 02

Year

Pen

etr

ati

on

(%

)

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

AR

PU

(£

)

Penetration US Penetration UK US Monthly ARPU UK Industry ARPU

Source: ABN AMRO & company reports

We estimate that approximately 60% of all US traffic is outgoing. New entrant

players, such as VoiceStream, generally have a greater reliance on incoming

volumes (about55% of traffic is outgoing). On a per minute basis, US termination

rates average about €0.005. The key driver of US incoming ARPUs is higher

volumes (see following table). Our thesis is that European incoming ARPUs

(and usage) have been stunted by excessive charges.

Table 33 : US wireless trends

1999 2000 2001

Call volume (bn) 221.5 372.6 561.2

% Change 68% 51%

Call revenue (bn) 40.6 49.4 64.0

Implied revenue per minute 0.18 0.13 0.11

% Change -28% -14%

Mobile subscribers 86.0 109.5 129.2

Ave. lines 77.6 97.8 119.3

MOU per line 285.4 381.1 470.3

Outgoing MOU (ABN AMRO estimate) 171.2 228.7 282.2

Incoming MOU (ABN AMRO estimate) 114.1 152.5 188.1

Source: ABN AMRO/CTIA

The problem Europe’s operators face is to manage the decline in rates without

significantly damaging returns. The danger is that in the event of relatively small

cuts to termination rates, demand fails to materialise. This is akin to the firm that

gets caught in the middle of the road (between excessively high termination rates

and rates similar to the fixed line operator community) – getting run over!

While declining termination rates will create a “tough” top-line growth environment,

given the US experience, it is plausible to argue that a significant decline could be

proportionately offset by an increase in volume.

US incoming volumes arematerially higher than inEurope, as a result of lowerprices

The key challenge in Europeis to manage decliningtermination rates withoutdamaging returns

Using the US as abenchmark suggests upsideto bearish marketperception



Top down: share of GDP

While getting into the detail is useful, it is important not to forget the implied share

of GDP that we are suggesting is attainable for Europe’s wireless operators.

According to our estimates, wireless’s share of GDP ranges between 0.7% and1.3% in Europe’s major markets.

Wireline spend ranges between 1.2x and 2.3x wireless spend as a percentage of

GDP. Hence in aggregate, telecoms spend accounts for 2.2%- 3.3% of GDP. In the

UK, telco spend accounted for around 2.4% at year-end 2001 (see following table).

Table 34 : UK telco spend

(£) 1998 1999 2000 2001

Wireline revenue (£) 13.4 14.2 14.9 15.0

Wireless revenue (£) 3.9 5.3 6.9 8.2

Nominal GDP (£) 859 902 950 988

Telecom spend as %GDP 2.0% 2.2% 2.3% 2.4%

Wireline spend as %GDP 1.6% 1.6% 1.6% 1.5%

Wireless spend as % GDP 0.5% 0.6% 0.7% 0.8%

Source: ABN AMRO

This can be compared with the higher share of GDP that is observable in the US.

Wireless share of GDP is particularly impressive given the materially lower rate ofpenetration (c.50% vs Europe c.81%).

Table 35 : US telco spend as a % of GDP

1998 1999 2000 2001

Wireless 0.4% 0.5% 0.6% 0.8%

LD 1.1% 1.1% 1.0% 0.9%

Local 1.3% 1.3% 1.3% 1.3%

Total 2.8% 2.9% 3.0% 3.0%

Source: ABN AMRO/FCC

We have sanity-checked ourbottom-up work to share ofGDP

Wireline spend rangesbetween 1.2x and 2.3xwireless spend

US wireless share of GDP isparticularly impressivegiven the lower rate ofpenetration



Bucket pricing plans

Despite intense competition, US operators have maintained high ARPU levels by not

targeting lower-value prepay subscribers, and through the introduction of “bucket

plans.” US operators have increased the number of free minutes of service, rather

than reduce the monthly access fee. In Europe, “tariff plans” have resulted in

significant ARPU dilution, and higher margins but lower pre-capex cash flow per

subscriber. In our view, the bucket pricing plan offers superior long-term returns to

Europe’s tariff plan model. As a result, we believe that Europe will move towards

flat rate access fees. We highlight that success can breed failure as the historical

success model becomes the major obstacle to a firm’s adoption of the new reality.

The introduction of the “your plan” flat rate fee by Orange in the UK provides early-

stage validation of our view. In addition we flag that an analysis of VoiceStream,

the aggressive US new entrant, provides a benchmark for understanding the

potential impact of Hutchison in Europe, and the domino effect we forecast

throughout the European wireless landscape.

Introduction


■ the difference in subscriber mix by major market;

■ US vs European ARPUs;

■ bucket plan volume;

■ capacity/capex as a driver of pricing; and

■ US bucket plan yields vs Europe’s major markets.

Flat rate access plansenable fixed-to-mobilesubstitution



The US experience

US operators, while reporting falling historic ARPU, have consistently reported

higher and more stable ARPUs than their European counterparts. We attribute this

to two key drivers, post-paid focus and bucket plans.

Post-paid focus

US operators have not aggressively targeted lower-value prepay subscribers. This

is easily identifiable from a comparative analysis of subscriber mix by geography

(see following chart). In the US, this product is unattractive because prepaidcustomers would also have to pay for incoming calls.

Chart 13 : Worldwide subscriber bases

85%

15%

72%

28%

65%

35%

67%

33%

52%

48%

3%

97%

9%

91%

Italy UK Spain Germany France Japan US

Pre-Pay Post-Pay

Total 50 48 29 58 37 62 130Subs (m)

89%

53%

60%

69%

79%75%

46%

Source: ABN AMRO and Deutsche Telekom

Flat rate fees/increasing volume

The US cellular business model has increased the number of free minutes of service

included in access plans (bucket plans), rather than reducing the cost of access

plans. By comparison, European operators have traditionally structured mobile

plans with cheaper access fees, but with much fewer free minutes included and

charging per minute for calls made (tariff plans). The US model is based onincreasing volume offsetting declining prices to maintain ARPU.

US vs UK blended ARPUs

Blended ARPUs in the US are materially higher than in Europe. To December 2001,

in the US monthly ARPU stood at £29.7, compared with £19.6 in the UK, ie over

50% higher (see following chart). At 2Q02, Vodafone was the highest ARPU

operator in the UK (£23 per month) vs monthly ARPU at Nextel [NXTL-US$9.20,

N/R] of £48 and AT&T Wireless [AWE-US$4.94, N/R] of £43 per month. This is a

direct function of the higher-volume/lower-margin business model that has been

adopted (in marked contrast to the established European model).

US operators haveconsistently reportedhigher and more stableARPUs than their Europeanpeers

The US model is volumebased

US monthly industry ARPUover 50% higher than theUK industry average



Chart 14 : UK vs US - Blended ARPU and penetration

20%25%

31%

39%45%

50%

14%

23%

40%

67%

78% 81%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

1997 1998 1999 2000 2001 Q1 02

Year

Pen

etr

ati

on

(%

)

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

40.0

AR

PU

(£

)

Penetration US Penetration UK US Monthly ARPU UK Industry ARPU

Source: ABN AMRO & Company reports

Our time series analysis clearly shows that the US market increased penetration by

over 30% between 1997 and 2Q02, without material dilution to ARPU. This can be

contrasted to the UK’s performance. The difference in ARPU between the two

markets is not entirely attributable to differences in penetration. This can be quickly

demonstrated by looking at US monthly ARPU at year-end 2000, relative to UK

monthly ARPU at year-end 1999, with similar levels of penetration. Hence our

thesis is that average European cellular MOUs/ARPUs have been stunted by tariff

plan pricing. Looking forward, we believe the introduction of higher flat rate access

fees, with a higher level of “free” minutes (bucket pricing plans) should have a

profound impact on ARPU.

Bucket plans generate higher ARPU and usage

As noted in our recent study VoiceStream – The American Dream dated 2 August

2002, the structure and pricing of bucket plans encourages mobile subscribers to

use their wireless phone for all their voice calls. The average US subscriber uses

three times as many minutes per year as a UK subscriber (see following chart).

VoiceStream subscribers (who are more geared toward bucket plans) use 1.5 times

the US average. UK industry volume has remained static during the past nine

quarters. In our view, the introduction of bucket-style pricing plans should

dramatically shift UK (and European) cellular usage.

Differences in ARPUbetween the US and the UKare not primarilyattributable to penetration

Evidence that bucket planssignificantly increasemobile usage



Chart 15 : Monthly MOU (incoming and outgoing)

0

100

200

300

400

500

600

700

Q1 00A Q2 00A Q3 00A Q4 00A Q1 01A Q2 01A Q3 01A Q4 01A Q1 02A

Period

Min

ute

s

VoiceStream US Industry Average UK Industry Average

Source: ABN AMRO, company reports and OFTEL data

Following AT&T Wireless, VoiceStream introduced more aggressive bucket pricing

plans into the US market, creating a domino effect. US national operators offer two

main types of bucket plans, which generally provide more minutes than most

subscribers can consume. This is a marketing ploy used particularly well by

VoiceStream to make the subscribers feel they are receiving greater value for

money.

■ National one-rate plans eliminate long distance charges. These plans consist

of a monthly fee that includes an allocation of “anytime minutes,” off-peak

minutes and one standard overage rate. It is difficult to compare plans across

operators because some, like VoiceStream, charge extra for off-network

roaming, while others include it in the price.

■ Regional plans offer users free minutes in their region (multi-state, not

national) but typically charge for roaming out of one’s region and for long

distance minutes. This is the plan that has given VoiceStream the most publicity

– ie 3,000 “anytime” minutes for $59.99 – but accounts for less than 20% of

new customers.

Recent pricing plans announced by the big six operators are very similar as each

fights for market share. VoiceStream has been the most aggressive US operator,

setting industry-low price points for both national one-rate and regional plans.

The evidence available from the US market model to date suggests that new

subscribers are choosing national instead of regional plans. Customers are using

these national plans to replace their landline phones for long distance calls, but still

using wireline for untimed local calls.

Two main types of bucketplans

VoiceStream the mostaggressive US operator

80% of new subscribers arechoosing national plans



US operator national rate plans

When discussing bucket pricing plans we are often asked, “What distinguishes the

US model from what we already have in Europe?” The answer is simple – the scale

of the buckets and the high flat rate entry fee differentiates the US. Europe is

charecterised by low flat rate entry fees and relatively high overage rates. To

provide investors with a feel for the magnitude of the typical US offering and

minimum price entry point, we have taken a sample of various plans offered at theend of July 2002.

Table 36 : National one-rate plans – roaming included

Entry pointYield/

minute MonthlyAnytime

min. OverageOff-peakminutes

Weeknightminutes

AT&T Wireless $0.13 $59.99 450 $0.35 NAIncluded in any

time minutes

Cingular $0.10 $29.99 300 $0.40 1,000 Included in off-peak

Sprint PCS* $0.17 $34.99 200 $0.40 3,300 Included in off-peak

Verizon Wireless $0.23 $35.00 150 $0.40 NA Included in off-peak

High usageYield/



Weeknightminutes

AT&T Wireless $0.10 $199.99 2,000 $0.25 NAIncluded in any

time minutes

Sprint PCS* $0.07 $74.99 1,000 $0.40 6,500 Included in off-peak

Cingular $0.06 $199.99 3,500 $0.25 3,500 Included in off-peak

Verizon Wireless $0.10 $300.00 3,000 $0.20 NA Included in off-peak

* ABN AMRO does not cover this stock.

Source: ABN AMRO

Table 37 : National one-rate plans - roaming NOT included

Entry pointYield/



Weeknightminutes

VoiceStream $0.07 $39.99 600 $0.35 Unlimited None

Nextel* $0.25 $49.99 200 $0.35 2,000 Included in off-peak

Verizon Wireless $0.12 $35.00 300 $0.40 4,000 Included in off-peak

High usageYield/



Weeknightminutes

VoiceStream $0.07 $99.99 1400 $0.30 Unlimited None

Nextel* $0.10 $99.99 1000 $0.35 3,000 Included in off-peak

Verizon Wireless $0.07 $200.00 3000 $0.20 4,000 Included in off-peak


Source: ABN AMRO

Most of the national operators have a national rate plan “anytime” yield per minute

of USD $0.07 (off-network roaming extra), following VoiceStream’s aggressive

pricing. Similarly, the established operators have increased their number of free

off-peak minutes (following VoiceStream), but none have matched VoiceStream’s

unlimited weekend minutes. As the US operators have experienced increasing

capacity constraints (a function of rising usage and penetration), operators have

introduced a slight shift in off-peak times for new customers ie pushing back the

start time for off-peak to 9pm from 8pm, to manage network congestion.

Scale of the number of freeminutes and high flat rateentry prices differentiatethe US model

US national rate plans havean ‘anytime’ yield ofUS$0.07



US operator regional plans

Table 38 : Regional (Northeast neighbourhood) rate plans

Entry pointYield/


min. OverageOff-peakminutes Roaming

Longdistance

VoiceStream $0.02 $59.99 3,000 $0.35 NA $0.49 $0.20

AT&T Wireless $0.30 $29.99 100 $0.40 2,000 $0.69 NA

Nextel* $0.10 $49.99 500 $0.35 NA NA $0.15

Sprint PCS* $0.14 $34.99 250 $0.40 3,250 NA $0.20

Verizon Wireless $0.10 $35.00 350 $0.45 4,000 $0.69 $0.20

High usageYield/


min. OverageOff-peakminutes Roaming

Longdistance

VoiceStream $0.02 $59.99 3,000 $0.35 NA $0.49 $0.20

AT&T Wireless $0.08 $199.99 2,500 $0.25 Unlimited $0.69 NA

Nextel* $0.10 $99.99 1,000 $0.35 NA NA $0.15

Sprint PCS* $0.09 $69.99 800 $0.40 6200 NA $0.20

Verizon Wireless $0.07 $100.00 1,500 $0.30 4000 $0.69 $0.20


Source: ABN AMRO

Many investors flag the low yield per minute ($0.02) generated by VoiceStream’s

controversial 3,000 “anytime” minute regional plan as being an unsustainablebusiness model; however, the following points must be considered.

■ This plan was introduced in 3Q01 primarily as a marketing tool by VoiceStream

to reinforce its image as being the best value wireless provider in the US. The

actual effect on VoiceStream’s network capacity and margins is limited as less

than 20% of new net adds choose this plan.

■ On average, only 1,000 (16.6 hours per month) of the 3,000 minutes (50 hours

per month) are actually used, implying a real yield of $0.06 per minute, which is

almost in line with the competition and not dissimilar to the $0.07 yieldgenerated by national call plans.

We believe that national operators will continue to promote this offer as a

marketing tool while they have spare capacity. However, as penetration and usage

increase, operators will need to either increase prices and/or reduce the number of

bundled minutes. The speed of this process will be an individual consideration foreach operator based on spare network capacity available.

Spare network capacity in each market is a function of spectrum and the number

of subscribers on the network. In the US, VoiceStream is by far the smallest

national operator in terms of subscribers, but has a similar amount of spectrum in

the top 50 markets as its competitors, and therefore has greater spare capacity tocarry additional minutes on its network (see following chart).

Points to consider about the3,000 ‘anytime’ minuteregional plan

Little impact on margins –only 20% of customerschoosing this plan

Only one-third of minutesused, generating sameactual yield as national callplans

VoiceStream is the smallestnational operator, but has asimilar amount of spectrumin the top 50 markets



Chart 16 : MHZ per subscriber (average top 50 markets)

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

Verizon Wireless CingularWireless

AT&T Wireless Sprint PCS NextelCommunications

Voicestream

ABN AMRO does not cover Sprint PCS or Nextel Communications.

Source: ABN AMRO

Additionally, all of VoiceStream’s network is based on GSM technology, while some

operators such as AWE and Cingular are still partially using less capacity-efficient

TDMA. Cingular’s chief technology officer has stated that upgrading to GSM/GPRS

by 2004 will increase voice capacity on Cingular’s existing network by 120%, while

at the same time requiring 18% less spectrum.

Average yield based on actual minutes used

To calculate the average actual yield per minute being generated by the various

plan options, we have divided average ARPU by the actual number of minutes used

(rather than offered) for the past nine quarters. In the US market VoiceStream,

with its lower-priced bucket plans, is the cheapest US wireless provider per minute.

The effect of competition and bucket plans has led to the US market pricing per

minute (yield) being relatively cheaper.

Chart 17 : Yield per MOU

0.00

0.05

0.10

0.15

0.20

0.25

0.30

Q1 00A Q2 00A Q3 00A Q4 00A Q1 01A Q2 01A Q3 01A Q4 01A Q1 02A

Period

Yie

ld (

USD

)

VoiceStream US Industry Average UK Industry Average

Source: ABN AMRO, company reports and OFTEL data

VoiceStream’s networktechnology is morecapacity-efficient

VoiceStream the cheapestUS wireless provider perminute



Linking yield to ARPU

It is important for investors to recognise that yield is the actual average revenue

per minute achieved and is not a proxy for ARPU. In fact (as we have already

observed), US ARPUs are substantially higher than in the UK. Hence lower yield in

the US does not result in lower ARPU. This is particularly pronounced at the

VoiceStream level. The key difference is volume.

US invested capital

The reason VoiceStream has been able to price so aggressively relative to its

competition is its lower cumulative capex spend per covered pop (see following

chart). This is a very important point. Intuitively, a more “capital-light” network

requires a lower absolute level of net operating profit after tax to generate a cost of

capital return.

Chart 18 : Cumulative capex spend per covered population

0

20

40

60

80

100

120

Voicestream T-Mobile Nextel Com. Orange Vodafone MMo2 AT&TWireless

Sprint PCS

US

$ m

ABN AMRO does not cover Sprint PCS or Nextel Communications.

Source: ABN AMRO and company reports

Our analysis also highlights the lower cost proposition of T-Mobile and Orange in

the UK relative to (say) both Vodafone UK and mmo2 UK. This is intuitive, given

that the UK’s established operators (Vodafone and mmo2) have deployed their

networks over 20 years, relative to about eight years for the new entrants. Hence

the new entrants have benefited from falling kit costs. The same relationship is

observable between AT&T Wireless (established operator) and VoiceStream (new

entrant) in the US.

US operators generate lower margins ...

It has often been pointed out to us that US operators generate lower EBITDA

margins than their leading European counter-parts. This is true, but percentage

profitability only tells us half the story.

... but generate higher EBITDA per subscriber

Compared with Europe, more mature US operators generate significantly higher

absolute EBITDA per subscriber. US operators report lower margins because they

also generate much higher revenue/ARPUs from bucket plans. This makes it almost

meaningless to compare EBITDA margins from Europe with the US.

Yield is not a proxy forARPU

A more capital-lightnetwork enables a lowerunit operating costproposition

In terms of cumulativecapex per covered pop,there is no discernibledifference between the USand European model. Thekey driver is length ofservice

The US model appears toresult in lower EBITDAmargins

But higher EBITDA persubscriber



Chart 19 : EBITDA per subscriber

-80.0

-60.0

-40.0

-20.0

-

20.0

40.0

60.0

80.0

Via

g

Voi

ceStr

eam

/Pow

erte

l

Eplu

s

T-M

obile

- U

K

Ora

nge

- U

K

MM

o2

Vod

afon

e -

Ger

man

y

T-M

obile

Ger

man

y

Vod

afon

e -

UK

AT&

T W

irel

ess

Sprint

PCS

Ver

izon

Wirel

ess

Cin

gula

r

(Euro

)

ABN AMRO does not cover Sprint PCS.

Source: ABN AMRO & Company reports

Higher pre-capex cash flow per subscriber supports our thesis that the US model

could be superior to the existing European model. Unfortunately, it is difficult to

compare absolute cash flow per subscriber between the US and Europe. This is a

function of three key factors.

■ Differences in penetration. If the numerator is reasonably similar, differences

in the denominator distort comparison. As US penetration moves towards

maturity (c.75%), comparison would be more meaningful.

■ Differences in capex phase. US operators are completing network coverage

relative to more mature European network operators that are primarily investing

in capacity and maintenance. Coverage remains the most capital-intensivephase of the cellular business model.

■ Technology migration. US operators such as AT&T Wireless and Cingular have

(and will continue) to be affected by the commitment of capital to migrate their

existing networks from TDMA to GSM.

Notwithstanding the difficulty of comparison, we suspect that the US model

(technology migration issues aside) is not proportionately more capital-intensive

than the European model. When coverage has been completed, capacity and

maintenance is success-driven and represents a very small percentage of

incremental revenue generated. In other words, higher pre-capex cash flow per

subscriber should feed down to higher absolute cash flow per subscriber.

If our thesis is correct, we must address why US cellular assets trade at such a

material discount to their European peers. We attribute this to four easily

identifiable factors.

■ Uncertainty over incremental penetration growth remaining (driving

significant forecast downgrades to top-line growth)

■ A structurally more competitive market. We note nearly 50% of the US

population has access to over six wireless operators (over 75% have access to

over five). The US Herfindahl index at year-end 2001 sat at 1700, suggesting

fierce competition, much lower than its European peers (eg Italy at 3729,

suggesting a high degree of pricing power).

Higher pre-capex cash flowper sub supports ourpositive thesis

Cellular capex is primarilycoverage (not capacity)driven

Weak US cellular valuationsdo not affect our positive on‘bucket pricing’ thesis



■ Coverage and technology migration capex. As capital markets have closed

to wireless operators across the world, US operators have had to complete

network coverage and migrate technology platforms, which have damaged

returns.

■ Minimal spectrum on the horizon. US wireless operators have no clear path

to 3G, given the scarcity of spectrum (there is little new wireless spectrum set

to become available). Arguably this removes a second leg of growth (from massF2M substitution).

European outlook: H3G – the catalyst

In our view, reviewing VoiceStream and the US market provides a valuable insight

into H3G’s strategic options as it enters the European market. In the absence of

meaningful data revenue streams, we believe H3G will refocus on the fixed line

voice opportunity via the provision of bucket pricing plans. We believe that Europe’s

operators will be forced to mimic H3G’s pricing plans, similar to the behaviour of

the established US operators in response to VoiceStream. This is a function of

available capacity. In our view, investors should think of H3G in terms of (1) spare

network capacity and (2) technology.

Spare network capacity. Our analysis of Mhz per subscriber in the US market

offers an insight into potential pricing in Europe. Similar to VoiceStream, we expect

H3G to enjoy an abundance of capacity relative to its competitors. For example in

the UK, investors can replace Verizon Wireless, Cingular and VoiceStream with

(say) mmo2, Vodafone and H3G (see chart below).

Chart 20 : UK MHz per subscriber

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

BTCel

lnet

Vodaf

one

One2

one

Ora

nge

MHz per subscriber 2G MHz per subscriber

Source: ABN AMRO

Technology

H3G will enter Europe using W-CDMA, relative to its competition currently

employing GSM. Similar to VoiceStream, H3G should enjoy a more capacity-

efficient technology. We very conservatively estimate capacity increases of 2x-3x

(for a more detailed discussion of capacity we refer investors to the “3G as the

facilitator” section of this report).

VoiceStream’s role in theUS market provides abenchmark forunderstanding H3G inEurope

High capacity (MHz per sub)provides scope foraggressively priced flat rateaccess plans

W-CDMA provides a morecapacity efficienttechnology



European yield

As part of the preparation for this note, we analysed the yield observable in the UK,

France and Italy (see following chart). The markets with the highest level of

concentration ie less competition have enjoyed the highest yield (France and Italy).

This is in line with our core belief that industry structure determines longer-term

sustainable returns.

Chart 21 : Key European market yields: the impact of competition

0.15

0.20

0.25

0.30

1999 Q100 Q200 Q300 Q400 Q101 Q201 Q301 Q401

Period

Yie

ld (

USD

)

France Italy UK

Source: ABN AMRO

European yield outlook

The trend in yield per minute observable in the US provides an excellent lead

indicator of potential yields throughout Europe as a result of the entrance of

Hutchison 3G. In the US, VoiceStream has been able to prosper with a lower yield

as a result of its lower invested capital base. In Europe, we believe that H3G will be

able to play the same game.

Chart 22 : US % change in yield Q200A to Q102A

-20%

-15%

-10%

-5%

0%

5%

10%

Q2 00A Q3 00A Q4 00A Q1 01A Q2 01A Q3 01A Q4 01A Q1 02A

Voicestream % change US industry % change

Source: ABN AMRO

Other European marketsstill have very high yieldlevels

The trend observable in theUS provides a lead indicatorof Europe’s potential future



Over the past two years, US industry yields have fallen by a CAGR of 20%, relative

to VoiceStream posting an annual decline of about 15%. However, we note that US

yields have stabilised in recent quarters, reflecting capacity constraints.

Cumulative capex

We understand that HWL’s original business plan budgeted for about US$10bn of

cumulative capex to year-end 2005 for its European wireless operations. We

believe that approximately 55% of this spend will be dedicated to the UK operation

(US$5.5bn), 35% to Italy (US$3.5bn) and what remains to HWL’s more minor

operations (eg Denmark, Sweden, Ireland, Austria etc). More recently, HWL has

indicated that the operations in Italy and the UK will benefit from infrastructure

sharing, reducing capital expenditure by around 20%, implying new cumulative

capex of €4.4bn for the UK and €2.8bn for Italy.

Cumulative capex per covered pop

Using this data as a starting point we can pinpoint H3G’s position in the UK relative

to the existing competition.

■ Using Companies House data, we can identify cumulative capex for each of the

UK’s major operators to year-end 2001 (with the exception of Vodafone and T-

Mobile, for which we have used an estimate of 10% of their top lines for theperiod to December 2001).

■ We then assume a maintenance level of capex at 6% of each operator’s forecast

top line per annum to year-end 2005.

■ Finally, we take a common view on the cost of deploying a 3G network in the UK

for the established operators, conservatively assuming 50% of existing 2G sitescan be re-used (see following table).

Table 39 : UK established operator 3G capex to year-end 2005

(€m) Cost

H3G capex 4,400

70% of capex “real estate build” 3,080

Existing operator (50% re-use of existing sites) 1,540

Other kit capex 1,320

Total existing operator 3G capex 2,860

As a % of total 65%

Source: ABN AMRO

While this analysis is “quick and dirty,” it enables us to identify the cumulative

capex per covered pop by operator (see following chart). Reflecting its newer

operator status, H3G enjoys a significantly lower cumulative capex per coveredpop.

In the US, industry yieldshave fallen by a CAGR of20% over the past twoyears

H3G could enjoy a similarlowest-cost operatorposition

We have presented apotential cumulative capexper covered pop analysis forthe UK operators

While this is ‘quick anddirty,’ it enables us tobetter understand thepotential pricingenvironment



Chart 23 : Forecast cumulative capex per covered pop by UK operator

-

20

40

60

80

100

120

140

160

180

mmo2 Vodafone Orange T-Mobile H3G

Source: ABN AMRO estimates

As demonstrated by the pricing of VoiceStream in the US market, an operator’s

returns are a function of its balance sheet invested capital (of which a large

proportion is capex); historical cost plays an important role in framing reported

returns. To 2005, we would expect H3G to have a “lighter” balance sheet than its

established peers. Over the longer term, as the UK’s established operators replace

the capital in their balance sheet, we would expect a movement towards

convergence.

Over the longer term wewould expect a movementtowards convergence



3G as the facilitator

In our view, European 2G capacity constraints have prohibited the introduction of

bucket pricing plans (and by association fixed-to-mobile substitution). While 3G

may facilitate the use of high-speed applications, the real untold story of 3G is

capacity. 3G will enable Europe’s cellular operators to increase volume

aggressively. We estimate that employing W-CDMA with just one transceiver, 3G

will increase existing operator capacity between 1.7x and 2.8x, employing a

conservative 20% improvement in spectral efficiency. In densely populated areas,

capacity could increase by up to 5.0x employing only one transceiver. It is our core

belief that this will drive substantial displacement. In the medium term we do not

rule out the possibility that EDGE could be deployed in Europe to unlock existing 3G

spectrum allocation.

Introduction

In this section of this note we present:

■ existing operator capacity constraints;

■ modulation comparisons;

■ cell sites as a driver of capacity;

■ W-CDMA vs GSM capacity analysis;

■ frequency allocations by operator;

■ the potential capacity uplift from W-CDMA and additional spectrum; and

■ the scope for EDGE as an interim solution.

3G provides the capacity todrive fixed-linedisplacement



Existing operator capacity constraints

A method of assessing the capacity of existing operators is to look at the number of

cell sites per subscriber vs covered pops per cell site.

■ Covered POPS per base station. This calculation provides a rough proxy to

compare the amount of capacity each operator has built into its footprint.

Operators with high covered POPs per base station can spend additional capex

on base stations to increase capacity, while operators with low covered POPs per

base station are closer to reaching maximum capacity.

■ Subscribers per base station. This calculation provides a rough proxy to the

current capacity each operator has available to service its existing subscriber

base.

Whilst our matrix does not gives us absolute capacity, in our view it provides a

good feel for relative capacity constraints across Europe (see chart below).

Figure 6 : Capacity matrix (1H02 2002)

Vodafone (Germany)

T-Mobile (Germany)

E-Plus

mmo2 (Germany)

TEM Esp

TIM Spa

mmo2 (UK)

T-Mobile (UK)

Orange (UK)

Vodafone (UK)

Bouygues

Orange (France)

-

200

400

600

800

1,000

1,200

1,400

1,600

1,800

2,000

2,500 3,500 4,500 5,500 6,500 7,500 8,500 9,500

1H02 CPOP/Cell

1H

02 S

ub/C

ell

Quadrant Two:High capacity built into footprintLow capacity per subscriber

Quadrant Three:Low capacity built into footprintLow capacity per subscriber

Quadrant One:High capacity built into footprintHigh capacity per subscriber

Quadrant Four:Low capacity built into footprintHigh capacity per subscriber

Source: ABN AMRO

The graph can be interpreted by looking at the four quadrants.

■ Quadrant One. Operators in this quadrant have the most flexibility with regard

to medium-term capex spend because they have the greatest available capacity

per subscriber. They offer the best network access because they have already

built a lot of capacity into their footprint and have low market share. As these

operators obtain greater subscribers and market share, they will move towards

Quadrant Two, and therefore report significantly higher-than-average returns onnew invested capital.

■ Quadrant Two. Operators in this quadrant are normally in highly penetrated

markets and are relatively capacity-constrained, requiring additional spectrum

or improved technology. They have already built a lot of capacity into their

footprint (fewer covered POPs per cell site) but because of their high market

share have less available capacity for each subscriber (greater number of

subscribers per cell site). Subscribers will experience network congestion during

peak periods. TIM Spa fits into this category.

We have presented a simplerelative capacity matrix foreach major Europeanoperator

Quadrant One. Excesscapacity enables operatorsto generate high returns asthey add new subscribers

Quadrant Two. Operatorsare generating high returnsbut are relatively capacity-constrained



■ Quadrant Three. Operators in this quadrant have not yet built a lot of capacity

into their footprint and have low capacity per each subscriber. Subscribers will

experience network congestion during peak periods; however, by spending

additional capex on new cell sites, these operators can improve their network

capacity. This quadrant is an indicator of high future capex. Most of Europe’smajor operators fit in this quadrant.

■ Quadrant Four. Operators in this quadrant have not yet built a lot of capacity

into their footprint, but have high capacity for each subscriber. If these

operators are not experiencing rapid growth, they can delay capex. Mmo2

Germany fits in this category.

These quadrants show that Hutchison3G could be relatively well placed compared

with its European peers, admittedly recognising its lower intended population

coverage (around 80%). When it is established, H3G’s network/footprint should be

able to handle many more subscribers without needing substantial additional capex.

It is also important to note that it is not all rosy for the remaining European

operators with regard to capex spend and, in particular, capacity when compared

with the H3G’s potential. We can clearly observe the relative capacity

constraints of Europe’s most established operators, such as TIM Spa,

Vodafone Germany, Vodafone UK and Orange UK. In our view this is majorincentive for these operators to accelerate the deployment of 3G.

Enabling volume growth

To have confidence in our fixed to mobile substitution thesis, investors must believe

in the prospect of an imminent material increase in available voice capacity. Thecapacity of a cellular system is dependent upon several factors, including:

■ the signal (analog or digital);

■ the coding and modulation method used in air interface;

■ the total number of cells in the network system; and

■ the amount of frequency,

(1) The signal – analog - AMPS (1G) to digital

Signals are either digital or analog. Analog signal transmission is a form of

electronic transmission accomplished by adding signals of varying frequency or

amplitude to carrier waves of a given frequency of alternating electromagnetic

current. This compares with a digital signal, which consists of a discrete set of data

points that can take on only fixed values of one or zero. The ones and zeroes arecalled bits, which comes from the phrase binary digits.

In all segments of communication, a migration to digital from analog has been

occurring for several reasons: (1) Increased capacity on digital networks is possible

because data compression allows multiple digital channels and more economic

benefits; (2) signal quality is better and is nearly independent of distance and

network topology; (3) there is better resistance to interference; and (4) frequency

is more easily shared with other signals and is more flexible. Depending on the

digital technology (the coding and modulation), digital cellular has three to

15 times greater capacity than analog service. Both GSM and W-CDMA are

digital.

Quadrant Three. Operatorsface imminent future capexspend to meet existingsubscribers’ needs

Quadrant Four. Operatorscan delay capex ifexperiencing slowsubscriber growth

We can clearly observeemerging capacityconstraints for Europe’smajor operators

We have considered fourpotential drivers ofincreased capacity



(2) Coding and modulation

Three major cellular digital technologies are currently in use: TDMA, CDMA and

GSM. A fourth technology used to a lesser extent is iDEN. Each has own their own

advantages and disadvantages. For a more detailed “bottom-up” discussion of each

of these technology platforms, we refer investors to the detailed descriptions within

VoiceStream – The American Dream.

Table 40 : Comparison of the various mobile systems

System Advantages Disadvantages

TDMA Capacity advantage of 3X over analog Average sound quality, more digitised, than normal human

voice

More operators on GSM and CDMA

Does not have the capacity of GSM or CDMA

CDMA Has a nationwide footprint in the US

Has the most significant capacity gains over analog systems, of

approximately at least 6x. Therefore, cost per minute of service

and capital expenditures could fall to low levels

Newest digital technology. Less experience about what could

happen with regard to the potential technology glitches or in

overcapacity situations.

Initial costs to build CDMA are significantly higher, expensive

handsets

Fewer equipment manufacturers for CDMA than for GSM.

Hence, less economies of scale and therefore higher

Not widely used in Asia or Europe

GSM Most widely used in the world

Proven technology

Cheaper handsets, cheaper equipment

Has capacity gains of 3-5x over analog systems

Footprint still not comparable with CDMA or TDMA in the US

Present system not entirely suited for wireless data

IDEN Only technology that can currently support 3-1 function of

dispatch, cellular and paging

Packet-switched based network should work well with wireless

data

Limited use and support from equipment providers, handsets

Less spectrum that other players

Source: Company reports and ABN AMRO

Because radio spectrum is a limited resource shared by all users, a method must be

devised to divide up the bandwidth among as many users as possible. The method

used by GSM is a combination of TDMA and frequency division multiple access

(FDMA). The FDMA part involves the division by frequency of the (maximum) 25

MHz bandwidth into 124 carrier frequencies spaced 200 kHz apart. One or more

carrier frequencies are assigned to each base station.

The introduction of 3G should lead to a structural shift in spectral efficiency (see

following discussion, “The total number of cells”), enables scalability and provides

additional spectrum (see frequency allocation discussion above). 3G provides the

additional capacity to deploy bucket pricing plans and drive mass fixed-to-mobile

substitution.

(3) The total number of cells

Network systems are generally designed with a sufficient number of cells, and radio

frequencies assigned to each cell, to serve the estimated number of subscribers

and network traffic in each service area. As the capacity requirements in each cell

increase, additional radio frequencies may be used to cover the same area.

Three major cellulartechnologies co-exist

The introduction of 3Gshould lead to a structuralshift in capacity



Coverage and capacity trade-off

There is clear trade-off between coverage, capacity and quality of service in the 3G

wireless business model. 3G operates at a higher frequency than GSM and as a

result requires a greater density of cell sites. GSM 900 normally has a maximum

cell radius if about 35km due to its frame structure. GSM 1800 has at least 8-10dB

weaker link budget, resulting in a typical cell radius of about 3-5km.

The authors of this study do not profess to have a doctrate in physics. We

acknowledge the work of Claes Beckman from the the Royal Institute of Technology

in Stockholm that has given us the scope to calculate the capacity benefit of W-CDMA over GSM based on different coverage scenarios.

GSM capacity (static channel allocation)

If we look at a very simple GSM network with static channel allocation and 5Mhz of

spectrum, we find that:

■ 5MHz divided over 200KHz per radio channel gives us 25 carriers;

■ 12 of those are control channels;

■ the other 13 traffic channels can be allocated in a 1/3 re-use; and

■ in total we get five carriers per sector,

We can then derive total capacity:

■ maximum 5 carriers per sector; and

■ 5*8-1 = 39 voice channels, with 2% blocking equates to 28 Erlangs/sector

W-CDMA capacity

We understand that the soft capacity of W-CDMA gives flexibility between

coverage, capacity and quality. As a cell sites coverage area increases, capacity

drops dramatically. We can calculate the capacity of a simple W-CDMA network

with 5MHz of spectrum assuming a cell site radius of 3.5km and one transciever,

which implies 42 voice channels per sector, with 2% blocking giving 33

Erlangs/sector.

W-CDMA vs GSM 1800

Therefore, in a network with a cell site radius of 3-5km, 5 MHz of spectrum and one

transceiver, we get only a marginal improvement in capacity of about 20% from

employing W-CDMA from GSM. This immediately raises the question, Why bother

with W-CDMA? The key is that in smaller cells, W-CDMA capacity increases

substantially. For example, in a cell site of about 2.6km, W-CDMA could provide up

to 86 voice channels per sector and about 75 Erlang (ie an improvement of nearly

170%). And this is based on one transceiver, which is scalable. It has been pointed

out to us that GSM could deliver similar capacity using modern techniques such as

AMR, frequency hopping and 1/1 re-use, but would require 11 radios per sector.

Hence W-CDMA can offer material capacity improvements. The secret is the

wideband 5MHz radio channel. We flag that should European operators deploy more

than one transceiver per cell site, available capacity could explode (ie an operator

could double a cell’s existing capacity from about US$50,000 of incremental capex

on an additional transceiver).

There is a clear trade-offbetween coverage, capacityand QoS in the W-CMDAmodel

We have calculated thecapacity benefit offered byW-CDMA over 2G

In a large cell site (3-5km)W-CDMA offers a 20%improvement to capacity

In a smaller cell site W-CDMA offers a 127%improvement in capacity



(4) The amount of frequency

Before Europe began the process of 3G licensing, total 2G spectrum available in

Europe was similar to the 170MHz allocated in the US. However, most European

countries have now allocated on average an additional 130MHz of spectrum for 3Guse, bringing the total amount of spectrum available to an average of 220-330MHz.

Chart 24 : Allocated unpaired spectrum per country - pre and post 3G auctions

0

50

100

150

200

250

300

350

United States France Spain Germany Italy United Kingdom

Spect

rum

(M

hz)

2G Spectrum 3G Spectrum

Source: ABN AMRO

Existing frequency

A simplistic approach to assessing an operator’s capacity is to look at Mhz per

subscriber. This approach clearly favours operators with a smaller subscriber base

(eg VoiceStream in the US, T-Mobile in the UK). It is our view that the smaller

operators have greater ability to service their existing subscriber base and

therefore dictate pricing. It also shows the magnitude of 3G spectrum waiting on-

line in Europe (total MHz per subscriber shows 2G and 3G specturm, vs. 2G only

MHz per subscriber). We can contrast Europe’s relative capacity depth toconstraints in the US.

Chart 25 : France MHz per subscriber Chart 26 : Germany MHz per subscriber

0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

Itineris SFR Bouyges


0.00

1.00

2.00

3.00

4.00

5.00

6.00

7.00

8.00

9.00

DeT

e M

obil

Man

nes

man

n

E-P

lus

E2


Source: ABN AMRO estimates Source: ABN AMRO estimates

Spectrum and capacityissues for larger USoperators in each market

In our view, smalleroperators have a greaterability to dictate pricing



Chart 27 : Italy MHz per subscriber Chart 28 : Spain MHz per subscriber

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

TIM OPI Wind


0.00

10.00

20.00

30.00

40.00

50.00

60.00

Telefonica AirTel Amena


Source: ABN AMRO estimates Source: ABN AMRO estimates

Chart 29 : UK MHz per subscriber Chart 30 : US MHz per subscriber

0.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

4.50

BTCel

lnet

Vod

afon

e

One2

one

Ora

nge


0.00

1.00

2.00

3.00

4.00Verizo

n W

irele

ss

Cin

gula

rW

irele

ss

AT&

T W

irele

ss

Sprint

PCS

Next

el

Com

munic

ations

Voic

est

ream

Source: ABN AMRO estimates ABN AMRO does not cover Sprint PCS or Nextel Communications.

Source: ABN AMRO estimates, average top 50 markets

On average, there are 6-8 competitors in each US market compared with individual

European countries of 3-4 for 2G and 4-6 including 3G licences. While the average

European operator has 40-50MHz, US operators make do with 10-30MHz.

Frequency outlook

Clearly this leads to spectrum and capacity issues for the larger US operators in

each market. In Europe, the 1900-2100 spectrum secured is currently

“locked up” and is useable only over IMT-2000 compliant infrastructure. A

term of the license awards prohibits the use of this spectrum over existing 2G

infrastructure. The International Telecommunications Union (ITU) has defined

384kbps as the data rate limit required for a service to fulfil the IMT-2000 standard

in a pedestrian environment. The 384 kbps data rate corresponds to 48 kbps per

time slot, assuming an eight time slot terminal. The key point is that when

unlocked, this spectrum should provide significant additional capacity (see following

section on modulation for discussion of potential capacity increase).

The average European has40-50MHz, US operatorshave 10-30 MHz

When unlocked, 3Gspectrum should providesignificant additionalcapacity



3G – 1.7x-2.8x increase in capacity

Having identified two key drivers of additional capacity (spectral efficiency and

additional spectrum) we can put them together to get a feel for the potential

increase in capacity from the introduction of W-CDMA across Europe. For example,

even in the event of W-CDMA (3G) only operating 20% ahead of existing GSM

infrastructure and one transceiver we calculate a capacity increase of between 1.7x

(France) and 2.8x (Italy) to existing capacity (see following tables).

Table 41 : France: potential capacity increase

2Gspectrum

Totalpaired

spectrum

Capacityincrease

(1:1)

Newspectrum

(1.2:1)

Capacityincrease

(1.2:1)

Orange 24 39 1.6 42.0 1.8

SFR 24 39 1.6 42.0 1.8

Bouyges 26 41 1.6 44.4 1.7

Sub-total 74.4 119.4 1.6 128.4 1.7

Source: ABN AMRO

Table 42 : Germany: potential capacity increase

2Gspectrum

Totalpaired

spectrum

Capacityincrease

(1:1)

Newspectrum

(1.2:1)

Capacityincrease

(1.2:1)

T-Mobil 17.4 27.4 1.6 29.4 1.7

Vodafone D2 17.6 27.6 1.6 29.6 1.7

E-Plus 22.4 32.4 1.4 34.4 1.5

mmo2 (Viag) 22.4 32.4 1.4 34.4 1.5

Mobilcom 0.0 10.0 na 12.0 na

Quam 0.0 10.0 na 12.0 na

Sub-total 79.8 139.8 1.8 151.8 1.9

Source: ABN AMRO

Table 43 : Italy: potential capacity increase

2Gspectrum

Totalpaired

spectrum

Capacityincrease

(1:1)

Newspectrum

(1.2:1)

Capacityincrease

(1.2:1)

TIM 31.2 46.2 1.5 49.2 1.6

Vodafone-Omnitel 15.2 30.2 2.0 33.2 2.2

Wind 14.6 29.6 2.0 32.6 2.2

Andala 0.0 20.0 na 24.0 na

IPSE 0.0 20.0 na 24.0 na

Sub-total 61.0 146.0 2.4 163.0 2.7

Source: ABN AMRO

We have considered thepotential capacity increaseusing a 20% improvementin spectral efficiency

Capacity is increased by uybetween 1.7x-2.8x



Table 44 : Spain: potential capacity increase

2Gspectrum

Totalpaired

spectrum

Capacityincrease

(1:1)

Newspectrum

(1.2:1)

Capacityincrease

(1.2:1)

Telefonica Moviles (Esp) 13.4 28.4 2.1 31.4 2.3

Vodafone Airtel 13.4 28.4 2.1 31.4 2.3

Amena 13.4 28.4 2.1 31.4 2.3

xfera 0.0 15.0 na 18.0 na

Sub-total 40.2 100.2 2.5 112.2 2.8

Source: ABN AMRO

Table 45 : UK: potential capacity increase

2Gspectrum

Totalpaired

spectrum

Capacityincrease

(1:1)

Newspectrum

(1.2:1)

Capacityincrease

(1.2:1)

mmo2 (Cellnet) 5.8 15.8 2.7 17.8 3.1

Vodafone 5.8 20.8 3.6 23.8 4.1

T-Mobil 30.0 40.0 1.3 42.0 1.4

Orange 30.0 40.0 1.3 42.0 1.4

3 (Hutchison 3G) 0.0 15.0 na 18.0 na

Sub-total 71.5 131.5 1.8 143.5 2.0

Source: ABN AMRO

Of course, this dramatically understates the spectral efficiency of W-CDMA relative

to GSM, in the event of more dense cell site coverage in major urban areas. For

example, using the top end of expectations (75 Erlang), W-CDMA offers nearly

170% more capacity than existing 2G infrastructure (in other words, a ratio of

2.7:1.0) using only one transceiver.

Using a 2.7x we estimate that capacity is increased by between 2.6x and 5.0x.

Even at this conservative level this is a material increase in capacity. Looking

forward, as operators add further transceivers to each cell site, an explosion in

capacity could occur at a very low incremental capital expenditure (i. real estate

costs, and civil engineering costs have already been met). We also note that

eventually existing spectrum allocated to 2G will be re-farmed for use with W-

CDMA technology. This would drive a minimal 20% increase in the 2G spectrum to

which in the analysis above we apply a 1x multiple. Hence our capacity increase

estimates appear very conservative.

Capacity increase varies market by market

We also note the sharp difference observable between countries. Italy clearly

stands out as the market with the greatest increase in available capacity. This has

implications for the timing of the introduction of bucket pricing plans and the speed

of fixed to mobile substitution. At the other end of the spectrum, France will see a

less significant increase in supply, suggesting a slower emergence of fixed-to-

mobile substitution.

Capacity is increasedbetween 2.6x and 5.0xusing more aggressiveestimate of spectralefficiency

Italy stands out as having aparticularly stark increasein capacity



The scope for EDGE (2.5G) as an interim solution?

EDGE is the final network-upgrade-stage technology for GSM operators. The

objective of the new technology is simple – to increase data transmission rates and

spectrum efficiency and to facilitate new applications and increased capacity formobile use.

EDGE uses a new modulation technique and improvements in radio protocol that

allows existing operators to use existing frequencies more efficiently (800, 900,

1800 and 1900 MHz). Software upgrades in the base station system enable use of

the new protocol facilitating packets over the radio interface in both the base

station and base station controller; new transceiver units in the base station enable

use of the new modulation technique. The core network does not require any

adaptations. EDGE increases theoretical end-user data rates up to 384Kbps (3

times speed of GPRS); however, realistic data rates range between 80Kbps and

150Kbps.

Compatibility of existing infrastructure

We note many commentators suggest that only GSM base stations deployed during

the past two years are capable of being upgraded to EDGE. This is in fact incorrect.

For example, the Ericsson RBS 2000 macro products (produced since 1995) can be

easily upgraded to EDGE.

EDGE: Capacity implications

EDGE also enables each transceiver to carry more voice and/or data traffic (see

following chart). In a typical TDMA system, like GSM, a single frequency is shared

by eight time slots. The capacity increase with EDGE means that a single

subscriber, or a number of subscribers using, (say) three time slots with GPRS,

could be handled with just one time slot. Consequently, capacity is freed up for

other uses (data or voice)., although we note coverage is lost.

Chart 31 : EDGE capacity benefits

Voice Voice

Voice

Voice Voice Voice Data Data Data

Voice Voice

Voice

Voice Voice Voice FreeTS

Data

Standard GSM Transceiver

EDGE Transceiver

Freed up capacity!

FreeTS

Source: ABN AMRO/Nokia

Should scepticism grow further among investors and operators over the potential

for revenue from 3G wireless services in the foreseeable future (2-3 years), some

operators may question if they need to incur the substantial costs of upgradingtheir networks beyond EDGE to 3G.

EDGE increases datatransmission rates andfrees up voice capacity

The core network does notrequire any adaptations

EDGE enables operators tocarry more voice

Should scepticism growamong investors over 3G,EDGE may be exploredfurther



US perspective

Operators see little need for higher data rates within the current suite of products

being developed. Supporting this view for US GSM operators (AWE, Cingular and

VoiceStream) is that fact that timing of availability of sufficient additional spectrum

is very unclear. Cingular, the second-largest US wireless operator, has announced

that it had no plans after EDGE to roll out W-CDMA.

European options

European operators that have no such spectrum issues following the recent 3G

auctions have long been expected to bypass EDGE in their rush to deploy third-

generation WCDMA. However, there stands a greater chance now that European

operators also concerned with returns on additional capex may decide to delay

investing in 3G infrastructure. Obviously, this would require changes in

laws/regulations regarding scheduled build-out licence requirements and use of

new 3G spectrum. However, it is important that investors are aware of this issueand its implications for free cash flow.

What about the regulators?

A fly in the ointment is the specified technology that each operator has nominated

for deploying additional spectrum. For example, in the UK, each of the existing

operators specified UMTS as the technology platform they intended to deploy to

fulfil the IMT 2000 standard. To unlock the spectrum granted, each of the UK

operators would have to approach OFCOM (the UK telco regulator) to request a

change in their license conditions (ie to enable the use of the 3G spectrum, withEDGE). Our conversations with the UK operators suggest that this is a possibility.

What about handsets?

To date, no EDGE handsets are available. This represents a major impediment to

EDGE deployment. In theory, the development of an EDGE handset should be

easier than dual mode (3G and 2G) handset technology. Starhub, the No. 2

Singapore operator, had indicated it is working with Nokia to develop an EDGE

handset for deployment in its market. We anticipate similar operator pressure fromthe US.

Should more operators consider EDGE as a capacity-enhancing solution, the vendor

community would come under greater pressure to deliver an appropriate handset.

This would be similar to the process behind the development of the GAIT handset

(TDMA/GSM) in the US, when the vendor community was cajoled into developing

the terminal by AT&T Wireless and Cingular. While the widespread deployment of

EDGE throughout Europe remains a wildcard, it is important to be aware of its

implications.

Arguably US operatorsprovide a sanity check

Regulatory changes wouldbe required and ...

... new handsets wouldneed to developed



Fixed-line tariff rebalancing

Fixed-line tariff rebalancing is a significant topic that merits more space than we

have in this note (hence our intention to revisit it at a later date). However, we

must recognise that fixed line tariff rebalancing provides a potential third driver of

material fixed-to-mobile call substitution. Should fixed line players be forced to

rebalance their tariffs (ie increase the price of access and drop the price of calls),

we suspect the wireless handset could become the primary telephony access point

for many customers. Political pressure on regulators to maintain universal access

provides a barrier to rebalancing. Notwithstanding this issue, we suspect operators

could overcome the obstacle via the provision of a bundled wireless alternative.

Background

Long distance fixed-line voice calls in Europe typically do not reflect underlying

network cost structure (for example, a fixed-line long distance call may cost

approximately €0.04, compared with as little as €0.02 for local traffic, without any

underlying cost difference). The difference in cost is an incumbent telephony

legacy, in which distance was a key driver of cost. The importance of distance as a

driver of cost has diminished (reflecting lower backhaul cost, driven by technology

innovation and the removal of physical operators connecting calls).

Arguably Europe’s wireline operator community are overcharging customers for

long distance and international call charges, and subsidising the provision of local

access, fulfilling political pressure for universal access. We suspect there is an

opportunity for Europe’s wireless operators to lobby country regulators to force

incumbent operators to rebalance their tariffs to reflect underlying network cost

structure.

Wireless opportunity

In our central case analysis of the fixed-to-mobile call market, we conservatively

assumed the migration of only about 30% of all local call volume from the wireline

to the wireless network. We further assumed that no fixed-line access fees would

be displaced to wireless. We suspect that in the event of tariff rebalancing, thiscould be overly conservative.

In our view, a core opportunity for Europe’s cellular operators pursuing fixed-to-

mobile substitution is provided by the local access/local call volume portion of voice

fixed-line calls and fixed to mobile calls. As we noted earlier in this research study,

as fixed-line voice call volume falls the implied price of each incremental unit of use

increases, thus encouraging savvy customers to re-assess their need for a wireline

connection to the home/office.

Fixed-line telephony pricesdo not reflect underlyingnetwork cost structures

Arguably wireline operatorsare overcharging for longdistance and internationalcalls, and subsidising localaccess

In the event of fixed-linetariff rebalancing, our localaccess substitution scenario(30%) could proveconservative



Easing of regulatory stance

Across Europe, the prices for cellular are dropping more quickly than fixed call

prices. Going forward we expect this to continue, with increasing prospect that the

fixed call prices may be increased. It is noteworthy that cellular prices are even

decreasing in countries like Germany and France, where mobile prices are not

regulated. This implies that cellular markets can be competitive in their own right.

Lobbying opportunity

Looking forward, this environment may help the cellular operators to lobby

regulators to rebalance local call charges to reflect the underlying network cost

structure. It is possible that if tariffs were rebalanced (to reflect underlying cost

structure), local calls could move towards the price of long distance calls.

Dramatically reduced European cellular tariffs, coupled with rebalancing of fixed-line voice tariffs, could be a powerful stimulant of the next phase of cellular growth.

US perspective

We note that in the US in 1993, President Clinton mandated that auctions be held

for frequencies within the PCS airwaves. The primary motive was to open up

competition in the cellular market, drive down the cost of wireless driving

individuals to use their cellular phone for local calls.

We suspect that more proactive lobbying of National Regulatory Authorities (NRAs)

by Europe’s cellular operator community could result in a more favourable

regulatory environment during the medium term. At a recent lecture given by Dave

Edmonds (head of OFTEL) and Gregory Sidack (ex-deputy counsel of the FCC),

both commentators indicated a belief in one wireline network and up to three

wireless networks contesting telephony markets longer term. Recognition of this

dynamic is important if Europe’s wireline operators are to rip a more material chunk

of the local market away from the wireline incumbent.

Reduced cellular tariffs andwireline tariff re-balancingcould be powerfulstimulants of growth

The future: one wirelineand three wirelessnetworks?



Economic impact

We see between 10% and 25% upside from our existing fair value estimates for the

European wireless community as a result of (1) our pre-to-post-paid migration

thesis and (2) our central case fixed-to-mobile substitution belief. Our published

price targets do not factor in the upside from a structural shift in fixed-to-mobile

substitution. As evidence builds supporting our thesis we will re-visit our published

fair value estimates. Full bottom-up detail by major European wireless operator is

detailed in the sister publication, Wireless Model Builder: Edition 1. Current cellular

share prices bet against the emergence of mass fixed-to-mobile substitution. We

recognise that margins could contract in the event of a change in business model.

Investors will need to be nimble, timing will be crucial.

Timing

As already noted we see two distinct positive drivers of ARPU looking forward:

■ Phase One (2002-2006): 4%-8% annual growth in blended ARPU from pre-

to-post-paid migration for the next four years; and

■ Phase Two (2004-2006): an 18% structural shift in outgoing voice ARPU by

2006 (holding all other factors equal 11% overall ARPU growth)

Holding incoming ARPU constant, this results in up to 30% overall ARPU growth in

by year-end 2006. This would be a material upside surprise to consensus

expectations.

Valuation: Published case

Reflecting our core views on the outlook for ARPU, we have re-set our fair value

estimates by operator. Given the profound impact of Phase Two (fixed-to-mobile

substitution), we have run our models excluding the structural shift in outgoing

voice ARPU. In the following table we detail out fair estimates by major operator.

Full bottom-up detail by major European wireless operator is detailed in the sister

publication accompanying this study, Wireless Model Builder: Edition 1.

Table 46 : ABN AMRO fair value

New price target Old price target Newrecommendation

Oldrecommendation

mmo2 0.60 0.52 Buy Add

Orange 7.0 7.5 Buy Buy

TIM 4.1 4.4 Hold Hold

TEM 6.0 6.7 Hold Hold

Vodafone 1.05 1.05 Add Add

Source: ABN AMRO

Two distinct positive driversof ARPU growth

1) Pre-to-post migration,and

2) F2M substitution

Our published price targetsexclude the upside from astructural shift in ARPU



Market-by-market positioning

With the help of David Wright from our wireline telecoms team, we have developed

a schema to better understand the impact of the fixed-to-mobile substitution

opportunity/threat by major European market. This schema highlights two keydrivers of a market’s attractiveness:

■ its level of market share concentration (the Herfindahl index); and

■ the difference in price per minute between an average fixed and cellular call.

We have then disaggregated schema into four quadrants to enable easier

interpretation (see following chart). The location of an individual operator on theschema determines the relative attractions of the asset from a wireline perspective.

Figure 7 : European market matrix: relalative resilience

2500

3000

3500

4000

4500

5000

5500

6000

6500

7000

7500

1.2 1.4 1.6 1.8 2 2.2 2.4 2.6

mob/fix price factor

Spain Italy Portugal Germany Uk Holland France

Inte

rmod

al H

H,

outg

oing v

oice

min

ute

s

Source: ABN AMRO

Quadrant One (top left): Bad long term, bad short term, is the worst possible

place for an incumbent wireline operator to occupy on the schema. Operators in

this quadrant have a high level of concentration (indicated by the monopoly style

HHI score on the y-axis) suggesting negative regulatory intervention and mobile

pricing has fallen below the crucial substitution level of 1.5x (see earlier discussion

on fixed to mobile for rationale).

Quadrant Two (bottom left): Good long term, bad short term, is marginally

better in terms of the level of concentration, suggesting adverse regulatory

intervention is unlikely. Against mobile enjoys large-scale substitution in markets in

this schema, as a result of the decline in relative price. Portugal Telecom sits in

this quadrant. As we noted in European Cellular Bear Trap, Portugal has been

charecterised by the emergence of fixed call volume substitution to mobile. Minutes

of domestic calls have fallen by 8% pa, and 10% of households use mobile only,

compared with the UK at an estimated 4%.



Quadrant Three (top right): Bad long term, good short term, is a sweet spot

for existing returns for incumbent wireline operators, as they enjoy high levels of

market concentration (ie low competition) and mobile is still priced at a high

premium to fixed, suggesting little imminent impact from fixed to mobile

substitution. Spain and the Netherlands fit into this category. Longer term, the

prospect of fixed-line tariff rebalancing (increasing competition, lowering the HHI)

and aggressive 3G-driven price cuts suggest that a downward and “left” trajectorywill be established.

Quadrant Four (bottom right): Good long term, good short term, arguably is

the sweet spot for both existing and future returns for incumbent wireline

operators, as they have relatively minimal regulatory risk, and continue to display a

high premium for wireless prices over wireline (delaying the impact of substitution).BT and DT sit within this quadrant.

Fixed to mobile case

While local access fees may be largely retained by wireline telephony operators, we

are expecting a large percentage of fixed-line voice calls to migrate to Europe’s

cellular networks. This view has a profound implication for European ARPU growth

and fundamental valuation. Including our central case outlook for outgoing voice

ARPU (based on our work in the UK market) suggests upside of between 10%

and 25% from our fair value calculations. As more evidence emerges during

the medium term, supporting our thesis, we will be looking to revisit our published

price targets in anticipation of crystalisation of upside.

... but look out for margins

We are bullish regarding the outlook for fixed-to-mobile substitution to provide the

“next leg of growth” for Europe’s wireless operators. Notwithstanding this view,

ahead of the improvement in returns, lower prices will hit profitability, due to

declining gross telephony margins.

In the following table we have presented a framework for identifying the risk to

margins. In the left-hand column we have the potential volume increase from fixed

to mobile substitution; in the top row we detail the expected price decline per

minute. For example, using an initial price per minute decline of 30%, a volume

increase of 10% results in a margin decline of 13%. We can envisage a run-rate of

decline moving diagonally upwards towards the top right of the table. The exact

margin contraction will be determined by the volume increase that follows the price

cuts.

A structural shift in ARPUoffers between 10%-25%upside from our publishedvaluations

We have considered theimpact on margin



Table 47 : Generic example of margin impact (for given price and volume)

Price per minute fall

0% -30% -35% -40% -45% -50% -55% -58%

Volume increase 180% 22% 20% 18% 15% 13% 9% 7%

150% 19% 17% 15% 12% 9% 5% 2%

120% 15% 13% 11% 8% 4% 0% -4%

80% 9% 6% 3% 0% -5% -10% -14%

50% 2% -1% -5% -9% -15% -21% -26%

20% -8% -12% -17% -23% -29% -38% -43%

10% -13% -18% -23% -29% -36% -45% -51%

Source: ABN AMRO

Managing this transition could prove challenging. Ironically, operators with

exposure to the corporate market (eg Vodafone), could suffer most, as they

cannabilise higher value customers. This is the primary reason we have not

upgraded our recommendations for Europe’s wireless operators in aggregate.



Tab

le 4

8:

Gen

eri

c ad

op

tio

n m

od

el

Year

en

d D

ece

mb

er

Un

its

X+

0X

+1

X+

2X

+3

X+

4X

+5

X+

6X

+7

X+

8X

+9

X+

10

X+

11

Countr

y X P

opula

tion

m65.7

66.3

67.0

67.6

68.3

69.0

69.7

70.4

71.1

71.8

72.5

73.2

Pen

etra

tion r

ate

%75.0

76.0

77.0

78.0

79.0

80.0

81.0

82.0

83.0

84.0

85.0

85.0

All

subsc

riber

s (p

erio

d e

nd)

m49.2

50.4

51.6

52.8

54.0

55.2

56.4

57.7

59.0

60.3

61.6

62.3

Countr

y X N

et A

dds

per

per

iod

m1.1

41.1

61.1

71.1

91.2

11.2

31.2

51.2

71.2

91.3

11.3

30.6

2

Mar

ket

Churn

% p

er m

onth

%2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

Countr

y X C

hurn

per

per

iod

m11.5

11.8

12.1

12.4

12.7

13.0

13.2

13.5

13.9

14.2

14.5

14.8

Countr

y X G

ross

Adds

m12.7

13.0

13.3

13.6

13.9

14.2

14.5

14.8

15.1

15.5

15.8

15.4

Oper

ator

Y S

ubsc

riber

s (p

erio

d e

nd)

m13.0

13.2

13.3

13.5

13.7

14.0

14.3

14.5

14.8

15.1

15.5

15.6

Net

Adds

per

per

iod

m0.0

50.1

10.1

60.2

00.2

30.2

50.2

70.2

80.3

00.3

10.3

20.1

4

Churn

% p

er m

onth

%2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

Churn

per

per

iod

m3.1

3.1

3.2

3.2

3.2

3.3

3.4

3.4

3.5

3.6

3.6

3.7

Gro

ss A

dds

m3.1

73.2

43.3

23.3

93.4

73.5

53.6

23.7

03.7

83.8

73.9

53.8

5

Shar

e of G

ross

Adds

%25.0

%25.0

%25.0

%25.0

%25.0

%25.0

%25.0

%25.0

%25.0

%25.0

%25.0

%25.0

%

Shar

e of

Net

Adds

%4.7

%9.8

%13.6

%16.5

%18.6

%20.2

%21.4

%22.3

%23.0

%23.5

%23.9

%23.2

%

Ove

rall

Mar

ket

Shar

e%

26.5

%26.1

%25.8

%25.6

%25.5

%25.3

%25.2

%25.2

%25.1

%25.1

%25.1

%25.1

%

Contr

act

Subsc

riber

s (p

erio

d e

nd)

m4.1

75.1

15.8

86.5

07.0

27.4

67.8

58.1

98.4

98.7

79.0

49.1

8

Contr

act

Net

Adds

per

per

iod

m0.2

70.9

50.7

60.6

30.5

20.4

40.3

80.3

40.3

10.2

80.2

60.1

4

Contr

act

Churn

% p

er m

onth

%2.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

0

Contr

act

Churn

per

per

iod

m0.9

1.0

1.2

1.4

1.6

1.7

1.8

1.9

2.0

2.0

2.1

2.2

Contr

act

Gro

ss A

dds

m1.2

1.9

2.0

2.0

2.1

2.1

2.2

2.2

2.3

2.3

2.4

2.3

Contr

act

Share

of ove

rall

net

adds

%504%

834%

477%

318%

231%

178%

143%

120%

103%

92%

83%

100%

Contr

act

Share

of ove

rall

gro

ss a

dds

%38%

60%

60%

60%

60%

60%

60%

60%

60%

60%

60%

60%

Contr

act

% o

f Tota

l Subs

%32%

39%

44%

48%

51%

53%

55%

56%

57%

58%

58%

59%



Tab

le 4

9:

Gen

eri

c ad

op

tio

n m

od

el (c

on

t’)

Year

en

d D

ece

mb

er

Un

its

X+

0X

+1

X+

2X

+3

X+

4X

+5

X+

6X

+7

X+

8X

+9

X+

10

X+

11

Pre

pai

d S

ubsc

riber

s (p

erio

d e

nd)

m8.8

78.0

47.4

47.0

16.7

26.5

26.4

16.3

56.3

46.3

76.4

26.4

2

Pre

pai

d N

et A

dds

per

per

iod

m-0

.22

-0.8

3-0

.60

-0.4

3-0

.30

-0.1

9-0

.12

-0.0

6-0

.01

0.0

30.0

50.0

0

Pre

pai

d C

hurn

% p

er m

onth

%2.0

2.1

2.1

2.1

2.0

2.0

2.0

2.0

2.0

2.0

2.0

2.0

Pre

pai

d C

hurn

per

per

iod

m2.2

2.1

1.9

1.8

1.7

1.6

1.6

1.5

1.5

1.5

1.5

1.5

Pre

pai

d G

ross

Adds

m1.9

71.3

01.3

31.3

61.3

91.4

21.4

51.4

81.5

11.5

51.5

81.5

4

Pre

pai

d S

har

e of ove

rall

net

adds

%-4

04%

-734%

-377%

-218%

-131%

-78%

-43%

-20%

-3%

8%

17%

0%

Pre

pai

d S

har

e of ove

rall

gro

ss a

dds

%62%

40%

40%

40%

40%

40%

40%

40%

40%

40%

40%

40%

Pre

pai

d %

of Tota

l Subs

%68%

61%

56%

52%

49%

47%

45%

44%

43%

42%

42%

41%

Hig

h V

alue

Contr

act

Subsc

riber

s (p

erio

d e

nd)

m4.1

73.7

53.2

52.7

72.4

22.1

61.9

71.8

31.7

31.6

61.6

21.2

3

Hig

h V

alue

Net

Adds

per

per

iod

m0.2

7-0

.42

-0.5

0-0

.47

-0.3

5-0

.26

-0.1

9-0

.14

-0.1

0-0

.07

-0.0

4-0

.39

Hig

h V

alue

Churn

% p

er m

onth

%2.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

0

Hig

h V

alue

Churn

per

per

iod

m0.9

1.0

0.9

0.8

0.7

0.6

0.5

0.5

0.4

0.4

0.4

0.4

Hig

h V

alue

Gro

ss A

dds

m1.2

0.6

0.4

0.3

0.3

0.3

0.3

0.3

0.3

0.3

0.4

0.0

Hig

h V

alue

Shar

e of ove

rall

contr

act

net

adds

%100%

-44%

-66%

-76%

-68%

-59%

-50%

-41%

-32%

-24%

-16%

-273%

Hig

h V

alue

Shar

e of ove

rall

contr

act

gro

ss a

dds

%100%

30%

20%

15%

15%

15%

15%

15%

15%

15%

15%

0%

Hig

h V

alue

% o

f Tota

l Contr

act

Subs

100%

73%

55%

43%

34%

29%

25%

22%

20%

19%

18%

13%

Phas

e 1 C

ontr

act

Subsc

riber

s (p

erio

d e

nd)

m1.3

61.8

31.9

01.9

62.0

22.0

82.1

42.1

92.2

52.3

02.3

3

Phas

e 1 N

et

Adds

per

per

iod

m1.3

60.4

70.0

70.0

60.0

60.0

60.0

60.0

50.0

50.0

50.0

3

Phas

e 1 C

hurn

% p

er m

onth

%2.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

0

Phas

e 1 C

hurn

per

per

iod

m0.0

0.3

0.4

0.5

0.5

0.5

0.5

0.5

0.5

0.5

0.6

Phas

e 1 G

ross

Adds

m1.4

0.8

0.5

0.5

0.5

0.5

0.6

0.6

0.6

0.6

0.6

Phas

e 1 S

har

e of ove

rall

contr

act

net

adds

%144%

61%

11%

12%

14%

15%

16%

18%

19%

20%

18%

Phas

e 1 S

har

e of ove

rall

contr

act

gro

ss a

dds

%70%

40%

25%

25%

25%

25%

25%

25%

25%

25%

25%

Phas

e 1 %

of Tota

l Contr

act

Subs

%27%

31%

29%

28%

27%

27%

26%

26%

26%

25%

25%



Tab

le 5

0:

Gen

eri

c ad

op

tio

n m

od

el (c

on

t’)

Year

en

d D

ece

mb

er

Un

its

X+

0X

+1

X+

2X

+3

X+

4X

+5

X+

6X

+7

X+

8X

+9

X+

10

X+

11

Phas

e 2 C

ontr

act

Subsc

riber

s (p

erio

d e

nd)

m0.8

01.1

11.3

71.5

71.7

41.8

81.9

92.1

02.1

82.2

4

Phas

e 2 N

et

Adds

per

per

iod

m0.8

00.3

20.2

50.2

00.1

70.1

40.1

20.1

00.0

90.0

5

Phas

e 2 C

hurn

% p

er m

onth

%2.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

0

Phas

e 2 C

hurn

per

per

iod

m0.0

0.2

0.3

0.3

0.4

0.4

0.5

0.5

0.5

0.5

Phas

e 2 G

ross

Adds

m0.8

0.5

0.5

0.5

0.5

0.6

0.6

0.6

0.6

0.6

Phas

e 2 S

har

e of ove

rall

contr

act

net

adds

%104%

51%

49%

46%

43%

41%

38%

36%

34%

38%

Phas

e 2 S

har

e of ove

rall

contr

act

gro

ss a

dds

%40%

25%

25%

25%

25%

25%

25%

25%

25%

25%

Phas

e 2 %

of Tota

l Contr

act

Subs

%14%

17%

19%

21%

22%

23%

23%

24%

24%

24%

Phas

e 3 C

ontr

act

Subsc

riber

s (p

erio

d e

nd)

m0.7

11.2

71.7

12.0

62.3

42.5

82.7

72.9

33.3

9

Phas

e 3 N

et

Adds

per

per

iod

m0.7

10.5

60.4

40.3

50.2

80.2

30.1

90.1

60.4

5

Phas

e 3 C

hurn

% p

er m

onth

%2.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

02.0

0

Phas

e 3 C

hurn

per

per

iod

m0.0

0.2

0.3

0.4

0.5

0.6

0.6

0.7

0.7

Phas

e 3 G

ross

Adds

m0.7

0.7

0.7

0.8

0.8

0.8

0.8

0.8

1.2

Phas

e 3 S

har

e of ove

rall

contr

act

net

adds

%114%

107%

99%

92%

84%

76%

69%

62%

318%

Phas

e 3 S

har

e of ove

rall

contr

act

gro

ss a

dds

%35%

35%

35%

35%

35%

35%

35%

35%

50%

Phas

e 3 %

of Tota

l Contr

act

Subs

%11%

18%

23%

26%

29%

30%

32%

32%

37%

Op

era

tor

Y_

Co

un

try X

Su

bsc

rib

er

Su

mm

ary

Hig

h V

alue

Per

iod E

nd C

ontr

act

Subsc

riber

sm

4.2

3.7

3.2

2.8

2.4

2.2

2.0

1.8

1.7

1.7

1.6

1.2

Phas

e 1 P

erio

d E

nd C

ontr

act

Subsc

riber

sm

-1.4

1.8

1.9

2.0

2.0

2.1

2.1

2.2

2.2

2.3

2.3

Phas

e 2 P

erio

d E

nd C

ontr

act

Subsc

riber

sm

--

0.8

1.1

1.4

1.6

1.7

1.9

2.0

2.1

2.2

2.2

Phas

e 3 P

erio

d E

nd C

ontr

act

Subsc

riber

sm

--

-0.7

1.3

1.7

2.1

2.3

2.6

2.8

2.9

3.4

Tota

l Per

iod E

nd C

ontr

act

Subsc

riber

sm

4.2

5.1

5.9

6.5

7.0

7.5

7.8

8.2

8.5

8.8

9.0

9.2

Tota

l Per

iod E

nd P

repai

d S

ubsc

riber

sm

8.9

8.0

7.4

7.0

6.7

6.5

6.4

6.4

6.3

6.4

6.4

6.4

Tota

l Per

iod E

nd S

ubsc

riber

sm

13.0

13.2

13.3

13.5

13.7

14.0

14.3

14.5

14.8

15.1

15.5

15.6

Hig

h V

alue

Ave

rage

Contr

act

Subsc

riber

sm

4.0

4.0

3.5

3.0

2.6

2.3

2.1

1.9

1.8

1.7

1.6

1.4

Phas

e 1 A

vera

ge

Contr

act

Subsc

riber

sm

-0.7

1.6

1.9

1.9

2.0

2.1

2.1

2.2

2.2

2.3

2.3

Phas

e 2 A

vera

ge

Contr

act

Subsc

riber

sm

--

0.4

1.0

1.2

1.5

1.7

1.8

1.9

2.0

2.1

2.2

Phas

e 3 A

vera

ge

Contr

act

Subsc

riber

sm

--

-0.4

1.0

1.5

1.9

2.2

2.5

2.7

2.9

3.2

Tota

l Ave

rage

Contr

act

Subsc

riber

sm

4.0

4.6

5.5

6.2

6.8

7.2

7.7

8.0

8.3

8.6

8.9

9.1

Ave

rage

Pre

pai

d S

ubsc

riber

sm

9.0

8.5

7.7

7.2

6.9

6.6

6.5

6.4

6.3

6.4

6.4

6.4

Ave

rage

Tota

l Subsc

riber

sm

13.0

13.1

13.2

13.4

13.6

13.9

14.1

14.4

14.7

15.0

15.3

15.5



Tab

le 5

1:

Gen

eri

c ad

op

tio

n m

od

el (c

on

t’)

Year

en

d D

ece

mb

er

Un

its

X+

0X

+1

X+

2X

+3

X+

4X

+5

X+

6X

+7

X+

8X

+9

X+

10

X+

11

KP

I d

ata

& A

ssu

mp

tio

ns

Hig

h V

alue

Contr

act

ARPU

£40.0

41.2

42.4

43.7

45.0

46.4

47.8

49.2

50.7

52.2

53.8

55.4

% c

hange

PoP

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%

Phas

e 1 C

ontr

act

ARPU

£32.0

33.0

33.9

35.0

36.0

37.1

38.2

39.4

40.5

41.8

43.0

% c

hange

PoP

%-2

0.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%

Phas

e 2 C

ontr

act

ARPU

£25.6

26.4

27.2

28.0

28.8

29.7

30.6

31.5

32.4

33.4

% c

hange

PoP

%-2

0.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%

Phas

e 3 C

ontr

act

ARPU

£20.5

21.1

21.7

22.4

23.1

23.7

24.5

25.2

25.9

% c

hange

PoP

%-2

0.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%3.0

%

Tota

l Ble

nded

Contr

act

ARPU

(Cal

cula

ted)

£40.0

39.8

38.5

36.8

35.4

34.7

34.6

34.7

35.1

35.7

36.4

36.7

% c

hange

PoP

%-0

.4%

-3.5

%-4

.4%

-3.8

%-1

.8%

-0.5

%0.5

%1.2

%1.6

%2.0

%0.7

%

Pre

pai

d A

RPU

£9.0

9.2

9.4

9.6

9.7

9.9

10.1

10.3

10.5

10.8

11.0

11.2

% c

hange

PoP

%2.0

%2.0

%2.0

%2.0

%2.0

%2.0

%2.0

%2.0

%2.0

%2.0

%2.0

%

Ble

nded

ARPU

(su

bsc

riber

rev

enue

only

)£

18.6

20.0

21.4

22.1

22.5

22.9

23.4

23.9

24.5

25.1

25.8

26.1

% c

hange

PoP

%7.7

%7.0

%3.1

%1.6

%1.9

%2.1

%2.3

%2.4

%2.5

%2.6

%1.4

%

Reven

ues:

Tota

l Contr

act

reve

nues

£m

1,9

35

2,2

18

2,5

36

2,7

29

2,8

69

3,0

17

3,1

74

3,3

40

3,5

15

3,6

99

3,8

93

4,0

11

% c

hange

PoP

%14.6

%14.3

%7.6

%5.1

%5.2

%5.2

%5.2

%5.2

%5.2

%5.2

%3.0

%

Pre

pai

d r

even

ues

£m

970

932

870

828

802

789

786

791

803

820

841

862

% c

hange

PoP

%-4

.0%

-6.7

%-4

.8%

-3.1

%-1

.6%

-0.4

%0.6

%1.5

%2.1

%2.6

%2.4

%

Tota

l se

rvic

e re

venues

2,9

05

3,1

50

3,4

05

3,5

57

3,6

71

3,8

07

3,9

61

4,1

31

4,3

18

4,5

19

4,7

34

4,8

73

Sourc

e:

ABN

AM

RO


A P P E N D I X

European 3G licensing conditions

In this section we have presented regulatory requirements for rollout by major

European market. License duration ranges between 12 and 20 years, with sharply

divergent coverage requirements by country. In Korea, we note that SK Telecom

must launch service by 2003 (with KT Freetel following in 2004 and LG Telecom by

2005). In Singapore, 80% coverage is required by 2004.

Table 52 : European 3G license summary by country

Country Duration (years) Requirements

UK 20 80% pop by 1.12.07

Germany 20 25% of pop by 31.12.03. 50% by 31.12.05

France 20 80% of pop by T1+8 years.

Italy 20 Regional capitals <30 months. Provincial capitals within next 30 months

Netherlands 15 60% of population by 2007

Switzerland 15 50% population coverage by end of 2004

Austria 20 25% by 31.12.03. 50% by 31.12.05

Spain 20 (Originally all cities with a population greater than 250,000 by August 2001 and total investment byfour operators of €16.29bn into 3g networks by 2010)

Government now saying that it is largely free of investment obligations and push back launch date tosometime in 2003

Sweden 15 In licence application. Generally 99.98% population coverage by 31.12.03

Portugal 15 20% of the national population at the end of the first year of the validity period of the license; 40% atthe end of the third year; 60% at end of the fifth year

Finland 20 No coverage obligation

Norway

1290% of the population of Greater Oslo, Bergen, Stavanger/Sandnes, Trondheim,

Fredrikstad/Sarpsborg, Porsgrunn/Skien, Drammen, Kristiansand, Tromsø, Tønsberg/ Åsgårdstrand,Sandefjord, and Bodø within five years

Denmark 15 End-04 30% population coverage, end 08-80%

Belgium 20 Start service, Sep-02. 30% coverage after 3 years

Ireland 20 A license- 53% of the national population (equivalent to the five major cities) by the end of 2005 andwith the fulfilment of the minimum 80% population requirement by the end of 2007

Source: ABN AMRO/Cellular News.com

A P P E N D I X


Technical glossary

Erlang

An Erlang is a unit of telecommunications traffic measurement. Strictly speaking,

an Erlang represents the continuous use of one voice path. In practice, it is used to

describe the total traffic volume of one hour. For example, if a group of users made

30 calls in one hour, and each call had an average call duration of 5 minutes, then

the number of Erlangs this represents is worked out as follows:

■ minutes of traffic in the hour = number of calls x duration;

■ minutes of traffic in the hour = 30 x 5 = 150;

■ in the hour = 150/60 = 2.5; which gives

■ a traffic figure of 2.5 Erlangs

Trunking

Erlang traffic measurements are made to help telecommunications network

designers understand traffic patterns within their voice networks. This is essential if

they are to establish the necessary trunk group sizes. The more efficient the

existing lines are used, the higher the trunking efficiency is of the network.

Erlang B

Several traffic models exist that share their name with the Erlang unit of traffic.

They are formulae that can be used to estimate the number of lines required in a

network, or to a central office (PSTN exchange lines).

Erlang B is the most commonly used traffic model, and is used to work out how

many lines are required if the traffic figure (in Erlangs) during the busiest hour and

the number of blocked calls are known. The model assumes that all unlocked callsare immediately cleared.


T E A M

Acknowledgements

We would like to thank Nimeshh Patel, from ABN AMRO’s wireline telecom equity

research team, for his invaluable insights and resource in researching global telcovolume and revenue trends by market and being a generally good bloke.


Companies mentioned: 0013.HK, ORA.PA, VOD.L

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