Telecom Industry

NTNU
April 13, 2007
CONTENT

• Overview of industry

• Trends/basic beliefs within Telecom

• Digital Content Services

1
Telecom operators by far outweigh the equipment manufacturers and
internet service providers
Market capitalization*, USD billions
Telecom operators Telecom equipment manufacturers

AT&T Inc 246 Cisco Systems 156

China Mobile Ltd 180 Nokia 92
Vodafone Group Plc 140
Qualcomm 70
Verizon Comm 110
107 Ericsson 57
Telefonica Sa
NTT DoCoMo Inc 82 Motorola 42
Nippon T&t 73 Corning 37
Deutsche Telekom 72 Abovenet 34
France Telecom 69 Alcatel Lucent 29
America Movil Sa De Cv 61 27
55 Research In Motion
Sprint Nextel Corp
Telecom Italia Spa 53 Foxconn Intl 23
BT Group Plc 50 American Tower 17
Telstra Corp Ltd 47 Juniper Networks 12
TeliaSonera Ab 39 Nortel Networks 10
Saudi Telecom Co 35 9
Crown Castle Intl.
KDDI Corp 35
Singapore Telecom 34 Harris 7
Bharti Airtel Ltd 33
Telenor Asa 30
Internet service providers
KPN 30
Softbank Corp 27
Bouygues Sa 26 Google 107
BCE Inc 24 42
23 Yahoo
Telmex
Mtn Group Ltd 23 Yahoo Japan 20
Alltel Corp 23 Akamai Techs. 8
Telekomunikasi Indonesia 22 Nhn 7
Rogers Comm 21 Tencent Holdings 6
Chunghwa Telecom Ltd 19
Iliad 6
Swisscom Ag 19
China Unicom Ltd 18 United Internet 5
Telus Corp 18 Getin Holding 3
China Netcom Group Corp 17 Freenet 3
Telefonica De Argentina Sa 17 Digital River 2
Qwest Communication 17 Access 2
American Tower Corp 17
Tiscali 2
Carso Global Telecom 16
China United Telecomm 15 Telecom Italia Media 1
Vimpel Communications 15 Mixi 1
* As of March 31, 2007
Source: McKinsey CPAT 2
IN THE LAST DECADE, THE TELECOM INDUSTRY HAS BEEN TRS CAGR
OUTPERFORMED BY THE GLOBAL MARKET In percent
Total Return to Shareholders. Base: January 1997 Telecom

Market

1 2 3
1997 - 1999 2000 - 2002 2003 - 2007

300

-16.1 Global market* 9.3

22.0
200 Global telecom
46.6 industry** 7.7

100 20.3
22.3 -32.2

0
1997 1999 2001 2003 2005 2007

* DS Global Market Index in USD

** DS World Telecom Index in USD
Source: Datastream, McKinsey analysis 3
CONTENT

• Overview of industry

• Trends/basic beliefs within Telecom

• Digital Content Services

4
TRENDS/BASIC BELIEFS

1. Huge demand growth and substantial revenue growth within

communication services driven by
• Emerging markets
• Mobile data/internet
• Fixed data (e.g., Broadband and ICT services to SME/Business)

2. More M&A expansion and consolidation to be expected

3. Regulatory development most important value lever for most telcos –

termination rates, llub, licensing and mvnos

4. Media convergence and devices/CPE innovation most important

technology development

5. Closing performance gaps short-term huge lever for most operators

5
1. DEMAND IS EXPLODING MEA Asia Pacific*

China-India Eastern Europe

Western Europe Latin America

North America

Voice traffic International used Internet bandwidth

Billion minutes, worldwide per region Worldwide**, Terabyte

18.000 45

16.000 40
CAGR
14.000 2006-10: 35
+8%
CAGR CAGR
12.000 30 2006-12:
2000-06:
+7% +26%
10.000 25

8.000 20

6.000 15 CAGR
2002-06:
4.000 10 +53%

2.000 5

0 0
2000 2005 2006 2007 2008 2009 2010 2015 2002 03 04 05 06 07 08 09 10 11 2012

*Asia Pacific excluding China and India *** 69 countries

Source:Ovum 2006; Telegeography 2007 6
1. TELECOM REVENUES GROWTH EXPECTED TO CONTINUE
Total revenues, USD billions in nominal terms (constant USD**); CAGRs in percent

The telecom industry is still growing, but revenue growth Key assumptions behind
is slowing down growth expectations

Nominal GDP
growth (%) • No major technology
disruptions, rather
CAGR (%) evolutionary steps
02-05 05-10
• No major changes in
1.558 7.9 6,8 6.2 6,4 regulation policies
compared to today
543 11.6 9,5 12.2 8,9 • No major changes in
1.163
industry structure
935 306
Emerging compared to today
220
Markets*

1.015 6.2 4,9 3.4 4,8

Developed 857
715
Countries*

2002 2005 2010

* Developed markets defined as WE , NA, Japan, Hong Kong, Singapore, Korea, Australia, Israel, South Africa and U.A.E. Emerging as rest of the world
** Currency exchange assumed constant at projection date
Source: IDC Blackbook 2006; Global Insight; McKinsey analysis 7
2. THERE COULD BE UP TO € 400 - 670B CASH AVAILABLE FOR ESTIMATE

ACQUISITIONS IN THE INDUSTRY OVER THE NEXT 3 YEARS

Estimate of available cash for M&A*. EUR billion

400-670

250-300
100-300
300-370
500-600

50-70

Excess cash 2006-2008 Committed Cash Additional Total available

in 2005 Free cash flow interest and available to debt cash for M&A
generation dividend shareholders capacity**
payments

* Extrapolation of free cash flows and committed interest and dividend payments based on a sample of 39 international players representing 64% of
world telecom revenues in 2005.
** Additional debt capacity less excess cash, assuming net debt/ EBITDA ratio range of [2.0 to 3.6] for all companies with above BBB+ rating
Source: CF&T database 8
2. TOP 5 PLAYERS CONCENTRATE 40-50% OF “M&A FIRE
POWER”
M&A firepower*. EUR billion

45 - 55
45 - 55

400 - 670
35 - 40

215 - 265
60 - 80 30 - 35

185 - 405

Decisions taken by
these players will
largely influence the
Total "M&A Top 5 Rest of fate of the industry
fire power" players players

* Based on current excess cash, accumulated cash generated between 2006 and 2008 plus additional new debt from leveraging up to target net
debt/EBITDA of [2.,0-3.6], and deducting committed dividend and interest payments
Source: CF&T database 9
2. M&A LEVELS ARE AT HIGH LEVELS FUELED BY TELCOS LOOKING
FOR GROWTH, EXCESS CASH FLOWS AND PRIVATE EQUITY
PLAYERS ENTERING THE INDUSTRY
Total equity deal value*. US$ billion

• Incumbents experiencing limited

Telcos organic growth in their home markets
searching for • Window for entry into new/emerging
growth markets seems to be closing
122,8
+85%
• Strong cash-flow generation,
especially for largest players
82,4 Cash-flow • Already improved debt ratings
72,8 generation providing for renewed financial
flexibility

• Telecom and Media increasingly

targeted by PE firms and among
Private Equity
19,3 largest deals
players
entering the • ~$50bn in 2005 in Telecom equity
industry deals with participation of PE firms

2003 04 05 2006

* Includes all completed transactions (majority interest or outright purchase) where acquirer in a Telco with equity value greater than US$ 25 million
Source: Dealogic; McKinsey analysis 10
3. REGULATORY – HUGE VALUE LEVER

Early 90-ties: Regulatory bodies „creating“ the industry

(Digitilaztion, GSM)

Late 90-ties/ Regulatory bodies „destroying“ huge value

Early 2000: (LLUB, 3G licences)

Recent years: „Friendly“ regulation past 3G and LLUB

Future: Tougher regulation – more cash than ever

generated by telcos. From telecom regulation to
industry regulation

Spectrum, Termination,
rates, MVNO, Network
separation

11
4. DEVICE/CPE ENHANCEMENTS

From … … to … … to

?
• Already more music-enabled Nokia and Sony Ericsson phones
than iPods
• More Nokia camera-phones than cameras from any other
camera manufacturer
• Higher growth potential estimated for the phone-based GPS
products than for stand alone ones

12
4. MEDIA CONVERGENCE IS HAPPENING, BUT VALUE STAYS WITH
TELCOS
5 Advertisers

1 Content 2 Aggregation 3 Connectivity/ 4 Consumer

generation transport devices

6 Enablers (e.g., DRM, payment, authorization)

Content crea- Device makers expand

MNOs move into into networks and services
tors move down
content
value chain

Mobile Telcos Device

Content creators Traditional
manufacturers Revenue/value shift
aggregators

Key questions

• What is most likely

Fixed Telcos/Cable/ to materially impact
<_____> <___> DBS providers consumers?

Portals • Who will extract

value from DCS?

• Who will enter the

connectivity space?

• Where are new pools

Attackers of revenues and
value to be created?

Portals develop Portals expand • MSOs and satellite Attackers deliver-

content/user into networks/WiFi/ providers provide telephony ing content via new
generated content telephony • ILECs enter content wireless networks
distribution (IPTV)

Source: McKinsey 13
5. LARGE POTENTIAL FOR PERFORMANCE IMPROVEMENT
IN THE INDUSTRY
2006E. Industry ROIC margin distribution. Percentage
There are large differences in While some of these differences are explained by market
performance amongst players in the conduct, there some levers that players can pull to
industry… improve performance
Key margin improvement levers
• “Lean” telco concept
Top Cost-base
Cost-base
39.2 – Procurement and offshoring
quartile and
and capex
capex – Network sharing/ outsourcing
management
management
– Call center operations

Financial
Financial • Excess cash-flow management
discipline
discipline • Financial leverage
Average
27.5
players
• Pricing
Frontline
Frontline • Channels efficiency
management
management • Customer retention
• Innovation & Product development
Low
quartile
14.4 • Access regulation
Regulatory
Regulatory
management
• Spectrum regulation for new services
management
• Interconnection costs

Source: CF&S Database; McKinsey analysis 14

CONTENT

• Overview of industry

• Trends/basic beliefs within Telecom

• Digital Content Services

15
Currently, telecom players get more than their fair share ESTIMATE
of the EBITDA and FCF pool Content
GLOBAL 2006 Connectivity
Percent, EUR billions Devices

100% = 2,014 515 343

Others 5 1 3 1
Device 4
6 5 3
makers Handsets
4
Others
Fixed 21 31 30
Connectivity
43% 61% 55%
providers
Mobile 18
22
25
Internet 2
1
Print 16 2 10
Aggregators Radio 2 10 3
TV 10 3 9
9
Content
16 13 16
generators

Revenues EBITDA* Operating FCF*

(EBITDA-CAPEX)
* Calculated from the average EBITDA margin and CAPEX of major players in 2005
Source: PricewaterhouseCoopers LLP, IDC, Gartner, ITU, Credit Swiss, Data stream, Yankee, Data monitor, Jupiter

16
A relatively small share of revenues accrues to internet players, and most of
them are from access
Global, 2006E
Advertisement market Communication market Breakdown of the
breakdown breakdown internet market
Percent, EUR billions Percent, EUR billions Percent

100% = 335 128 100 1,548 584 477

5 4 100% 100% = EUR 147 billion
Other 7

Other 49 Paid-contents
Print* 42 48 49 52
48 and services
7
Adverti-
16
sement
Print* 21 19
Broad- 24
46 38
casting** 39 Broad-
21 25 77
casting** 16
Internet 7 10 6 Internet 10 7 8 Internet access
Glo- US WE Glo- US WE
bal bal

* Magazines, books, and newspapers Source: PricewaterhouseCoopers LLP, IDC, ITU, Yankee, Data monitor, Jupiter
** TV and Radio
*** Includes access fees, paid content, and advertising 17
The market is betting on the internet killer brands EXAMPLES

EUR BILLIONS, 2005, BY PLAYER GROUP

Category Sub category Company Revenues EBITDA Net enterprise value* Multiples**
1 Content Disney (Walt) Co, 27.1 4.3 52 12
Film 87 7
generators Time Warner Inc, 37.0 12.1

ITV Plc. 3.2 0.6 8 12

TV
B Sky B Grp. 5.9 1.3 14 11

NRJ group 0.5 0.2 2 10

Radio/Print New York Times 2.9 0.5 5 11
2 Aggregators Washington Post 3.0 0.6 6 9

Google Inc. 5.2 2.1 96 47

Yahoo Inc. 4.5 1.3 46 36
Internet 16 33
Amazon.com 7.2 0.5
eBay.com 3.9 1.5 49 32

Telia Sonera Mobile 9.3 3.2 23 7

Telenor 8.6 2.7 18 7
Mobile operators 8
Vodafone 42.7 16.3 139
China Mobile 25.5 14.0 72 5
3 Connectivity
providers British telecom group 28.4 8.0 39 5
Fixed operators AT&T 37.2 11.9 104 9
Verizon 63.7 24.2 122 5

Cable companies Comcast 18.9 6.2 67 11

Nokia 34.2 5.1 60 12

Handset vendors 41 10
Motorola 31.2 4.1
4 Device
makers Other intelligent 8 12
Nintendo Co, Ltd. 3.7 0.7
devices HP 73.5 6.2 64 10

18
Time spent communicating is growing and shifting towards US EXAMPLE

time-/place-shifted formats, one-to-many, and free

Minutes per day
138
Blog/
16
118 Communities

107 5 11 IM
99 1 11
91 0 11 24 E-mail
0 11 21
8 Mobile
78 19 3
17 3 messaging
0 15
7 3
3 20 25 Mobile voice
13 4 17
51 14
0 13
3 0 9
7
0 4

53 55 58 58 Fixed voice
48 51
37

1995 2000 2001 2002 2003 2004 2005

Source: CTIA, Pyramid Research, Strategy Analytic, Pew Internet, Comscore Media Metrix, Team

19
Looking at the young generation, media is used differently
US EXAMPLE

Daily time spent with media/ Comparison of media usage by age group
communication of 18-34 yrs old group (18~34 yrs old vs. +34)

Percent, 2005 Minutes per day per person, 2005 +34 yrs old
18~34 yrs old

100% = 650 minutes* 283

TV 193
Wireline Mobile 87
Internet 95
Print
3 51
Game Console 3 3 Music 88
4 TV
Video 30 66
7 Software 83
93
Radio 64
Radio 10
23
Video 47
6
Game Console 25
13 15
Software 47
Internet Print 19
14
35
Music Wireline 18
7
Mobile 18

* Does not include other media usage

Source: Ball state University report 2005, Team

20
If Telcos decide to play the question is how and where

3rd party
Telco as Mobile Operator Controlled Community controlled
Community ? communities

Telco as Content Horizontal News & Vertical

Multi- Friend M-
Provider ? player finder/ Com- … …
search traffic search
gaming dating merce

Identity and Advertising engine

Payments engine
Telco as a Presence engine
Platform ?
Location engine

….

21
The relaunch of IPTV 2.0 also coincides with the rise of over the top
digital video services
Owned and supported
by IPTV operator

IPTV delivery model

Service providers Users
Example Description
Network
centric model • Telecom carrier provides service end-to-end Content Network Last mile
1 • On-demand video is streamed from local
servers onto carrier-owned set-top-boxes Set
Current
• Customer service and provisioning same as top TV set
IPTV model box
in DSL

Device-based
model • The portable device (e.g., iPod) is sold to
2a the user
Portable
• The device downloads or streams content
from the Web onto the device (directly or
through PC)
• No provisioning needed; no customer Content Network Last mile
service is provided
STB Dumb
2b device
• Similar to above, but based on fixed device Smart
(TV)
STB-based device
mostly STB (set-top boxes) instead
of a portable device that connects to TV
• Content downloaded or streamed
2c • PC and browser are used
PC-based • No dedicated customer device
• Content can be downloaded or streamed
(caching and best-effort)
• No provisioning, basic customer service
* Does not include cost of last mile and cost of content
Source: PD Over-The-Top – Impact of new applications, team analysis 22
CONFIDENTIAL

Perspective on WiMax

Presentation NTNU

April 2007

This report is solely for the use of client personnel. No part of it may be
circulated, quoted, or reproduced for distribution outside the client
organization without prior written approval from McKinsey & Company.
This material was used by McKinsey & Company during an oral
presentation; it is not a complete record of the discussion.
KEY MESSAGES

• WiMax is a recently standardized family of technologies, whose performance can

Latest compare with 3G or low-end DSL performance.
Latest on
on the
the
technology
technology • WiMax enjoys strong industry support driven by Intel. For fixed WiMax, end-user
equipment is now available and deployed widely.

• Since first WiMax d certifications in early 2006 we are starting to see a growing number
of WiMax deployments, especially in Europe driven by new entrants
Recent
Recent WiMax
WiMax
deployments
deployments • In the US, the leading player is Clearwire, which is already present in many tier-2 cities
using proprietary pre-Wimax technology and Sprint which announced a nationwide
WiMax deployment.
• Many traditional mobile operators are currently upgrading their 3G networks to higher
speeds through HSDPA/EVDO, partially to capture part of the fixed and nomadic
WiMax
WiMax versus
versus broadband markets. In developed countries, this limits the WiMax opportunity.
HSDPA/EVDO
HSDPA/EVDO
• In theory, WiMax can offer more throughput than 3G+, mainly due to the broader
channel spacing (5Mhz) and spectrum availability. However, there is not “one WiMax”
making global comparison difficult. Limited experiments show that real-life performance is
comparable, however WiMax d is constrained to fixed usage.

• WiMax deployment opportunities depends on several local parameters, primarily current

fixed infrastructure, competitive intensity, current assets owned by the player
Economics
Economics and
and (spectrum, towers, sites…), spectrum available
opportunities
opportunities
• WiMax can offer an economically competitive model for a brownfield player aiming at
fixed broadband replacement at moderate speeds (<4 Mbps).