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DBS Group Research • January 2017DBS Asian Insights35n

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SECTOR BRIEFING

The Push for 5G Shaking Up the Landscape

DBS Asian Insights SECTOR BRIEFING 3502

The Push for 5G Shaking Up the Landscape

Produced by:Asian Insights Office • DBS Group Research

go.dbs.com/research @dbsinsights [email protected]

Chien Yen Goh Editor-in-ChiefJean Chua Managing EditorGeraldine Tan EditorMartin Tacchi Art Director

Sachin MITTAL Telecom, Media and Technology Analyst DBS Group [email protected]

Daniel FOOAnalystDBS Group [email protected]


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Investment SummaryIntroduction to 5G

Why Develop 5G

5G Timeline: Asian Telcos Leading the Pack

What Can 5G Do? High Costs a Hurdle

5G Single Network Implementation Model Benefits of a Single Network

Shared Networks: Tried and Tested

Forms of Network Sharing

Regulatory Response a Key Determinant

5G’s Financial Implications Leasing 5G network

Sharing 5G Network

Owning 5G Network

Strategic Responses to 5G Telco Equipment Vendors Well Positioned

Telcos at a Critical Crossroad

Now Till 2020: 5G Implementation Roadmap Asia: Ahead of the Pack

Europe Will Be Next

Interim Technologies

gainst the backdrop of rapidly growing data consumption and telecommunication companies or telcos’ inexorable pursuit of network entrenchment opportunities, Asian telcos are leading the charge in implementing Fifth-Generation (5G) networks. Japan and South Korea’s KT have plans to launch trial 5G networks

by 2017; hot on their heels would be China Mobile, which intends to roll out a massive scale network by end-2020.

The allure of 5G’s enhanced capabilities and wide range of applications is, however, accompanied by an unprecedented slew of highly demanding technical standards and specifications. We believe the sheer intensity of 5G-related operational and capital requirements would set forth a paradigm shift in telcos’ business models and financial returns.

While telcos might be drawn to retain network advantages by owning and individually implementing 5G networks, they would be presented with major challenges and discover that they would not be able to replicate the success of previous generations of networks under this similar model. This beckons the consideration of alternative implementation models of sharing or leasing access to a single 5G network as discussed below.

Telcos which perpetuate the network ownership model would be presented with two main challenges. Firstly, they would be laden with gargantuan capital outlays – required to enhance current telecommunication infrastructure – estimated to be 2.5x of current levels over the next five years. Their diminished cash flows might also hamper their ability to obtain financing for these capital expenditures at a feasible cost. Secondly, additional expenditure from operating the 5G equipment would cause a drag on their earnings. As a result, these telcos would experience a reduced return on invested capital (ROIC) of 12%.

Investment Summary

A

Intensive capital outlay

Paradigm shift

Asian telcos’ ROIC projections under various 5G implementation models in 2020

Source: DBS Bank


Comparatively, under the 5G network-sharing model, where telcos would collectively contribute towards the 5G infrastructure roll-out, there would be less additional capital outlay and savings on operation costs from industry-wide economies of scale. This would improve the ROIC to 15% from 12%.

Under the leasing model, telcos would access 5G networks from a single network provider, and achieve a ROIC of 15%, comparable to that under the 5G network sharing model. This occurs as the absence of additional capital outlays is mitigated by lease payments to the single network provider. Under this structure, the single network provider – likely to be a telco equipment provider – would take on the 5G infrastructure assets under favourable financing conditions due to the stability of cash flows generated. The value from the lower costs of financing of the single network provider underpins the difference between the 5G network leasing and sharing models. Notably, even with the carve-out of 5G infrastructure assets, telcos under the leasing model are capable of achieving comparable earnings as telcos which possess their own 5G networks.

Leasing or sharing the 5G network will lead to the telcos’ loss of network differentiation. However, we believe that this is a fair trade-off as they could then transform their business models to differentiate themselves in the domain of digital services.

We recommend that telcos under the 5G network-sharing and leasing models judiciously manage their 5G-related capital expenditure (capex) savings by investing in fast-growing and established digital businesses. This is preferred to small investments scattered across a wide range of digital services, which tend to yield less favourable results. We also believe that digital business should be the focus, as it represents approximately 7x the market size of providing incremental connectivity services. This transformation toward digital businesses as a diversified source of earnings could potentially elevate telcos’ ROIC further.

Leasing – the preferred model

Opportunity to transform

Asset-light telcos under the leasing model to differentiate themselves in digital services

Source: DBS Bank


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Loss of network advantages with 5G roll-out to prompt differentiation through digital services

Source: DBS Bank


5G-related operational and capital requirements would set forth a paradigm shift

he Next Generation Mobile Networks (NGMN) Alliance defines 5G1 as “an end-to-end ecosystem to enable a fully mobile and connected society. (5G) empowers value creation towards customers and partners, through existing and emerging use cases, delivered with consistent experience, and enabled by sustainable

business models”.

The futuristic vision of 5G is expected to fulfil a number of requirements including the following2:

• 1 - 10 gigabit per second (Gbps) connections to end points in the field (i.e. not theoretical maximum)

• 1 millisecond (ms) end-to-end round trip delay (measure of latency)

• 1000x bandwidth per unit area

• 10 - 100x number of connected devices

• (Perception of) 99.999% availability

• (Perception of) 100% coverage

• 90% reduction in network energy usage

• Up to ten-year battery life for low power, machine-type devices

How has 5G evolved from 4GFourth-generation (4G) telecommunications technology was implemented to enhance data transfer speed and capacity by improving spectral efficiency. The focus of 5G, however, will be to provide pervasive, low-latency connectivity that is reliable and available, regardless of the user’s or the device’s location. Through which, 5G would be able to support new applications that are incompatible with existing 4G networks.

Why Develop 5G

Global mobile data traffic will grow over 8x (or at a five-year compound annual growth rate or CAGR of 53%)3 from just 3.7 Exabytes (EB)* per month in 2015 to 30.6EB per month by 2020. This is driven by i) the rising average data consumption (as more people use smartphones) from 929MB to 4.4GB per month, and ii) the proliferation of connected devices to 11.6 billion4, exceeding the world’s population forecast of 7.8 billion people in 2020.

Explosion of data consumption

Introduction to 5G

T


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1 Exabyte = 1,024 Petabytes = 1,000,000 Gigabytes


Telco network providers would have to scale up their network capacities by several times through the use of newer technology to ride on this rapidly rising wave of mobile consumption. Those who do not will risk losing market share.

5G Timeline: Asian Telcos Leading the Pack

Research firm Ovum estimates 5G will be commercially available worldwide by 20205, with global subscriptions to reach over 24 million by 2021. In anticipation of this, telcos worldwide are already conducting experiments on 5G, with Asian telcos leading the pack.

Rapid rise of global mobile data consumption

5G implementation timeline in Asia

Source: CISCO, DBS Bank

Source: Companies

5G standards are expected to be finalised only by 2020, making it difficult for telcos to

pursue an earlier commercial launch


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South Korea’s KT intends to launch 5G services at the 2018 Winter Olympics in PyeongChang6. Additionally, the company has plans to launch its commercial 5G network by 2019, a year earlier than previously planned. Japanese telco, NTT DoCoMo, has similar plans to launch a trial network in Japan. The telco is also looking to meet the Japanese government’s prescribed timeline for 5G’s commercial launch in 2020. In China, China Mobile has unveiled plans for its commercial 5G network, encompassing a mass-scale network roll-out by end-2020 and a subsequent commercial launch.

However, one stumbling block to the earlier launch of 5G is the timeframe for the finalisation of its standards. 5G standards are expected to be finalised only by 2020, making it difficult for telcos to pursue an earlier commercial launch. Currently, only South Korea’s KT is likely to launch a commercially viable network prior to the finalisation of 5G standards.

Standards not yet finalised

he functional attributes of 5G allow it to serve as the enabling infrastructure for many upcoming technologies, such as the Internet of Things (IoT), connected wearables, augmented and virtual reality, autonomous vehicles, etc. Unlike 4G, 5G would be capable of handling a significantly larger number of devices and array of traffic types.

For example, 5G could provide extremely fast connectivity for applications, such as virtual reality or ultra-high-definition video streaming, and simultaneously handle low-data transfer speeds from numerous IoT sensors with high reliability. Hence, 5G would be the first network with a focus on enabling commercial applications, while also catering to the incremental need of better connectivity among consumers.


From wearables to VR

What Can 5G Do?

TMore applications require lower latency and higher capacity (bandwidth throughput) of 5G

Source: www.gsmaintelligence.com


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Lower latency criticalOf the many characteristics that are considered to be unique to 5G, one of the most critical, and in some ways, one of the most challenging to fulfil, is its lower latency. Lower latency is an essential component in a wide variety of applications, which require almost immediate feedback for safe operations.

Autonomous vehiclesAutonomous cars, considered to be the next evolution of personal transportation, promise improved safety levels, reduced travelling time, and higher traffic throughput. Intelligent traffic management systems, coupled with embedded sensors in autonomous cars, enable better coordination and eliminate human error. This allows vehicles to travel at higher speeds and increased proximity. However, these traffic conditions demand a lower connection latency between the traffic management system and cars than what is currently possible under the current Long-Term Evolution (LTE) network.

With 4G’s latency at 50ms7, a car cruising at 100km/h would still move 1.4 metres from between the time when it identifies an obstacle to that when it executes the braking command. While 4G’s latency is already superior to the average human reaction time of 180ms8, this is still insufficient in the context of high travelling speeds and proximity. In comparison, with 5G’s lower latency of 1ms, that same car would only move forward by just slightly over an inch.

Remote medical procedures Virtual reality technology could potentially enable surgeons to perform medical procedures remotely in the future. However, for remote medical procedures to be a safe and effective substitute for in-person procedures, 5G’s attributes of ultra-high reliability, connectivity, and

Lower latency could be the difference between a timely halt and a fatal collision

Source: DBS Bank


low latency will be vital. This is a crucial requirement of 5G when looking to support mission critical and life-dependant applications. A connection disruption during a critical juncture of a medical procedure would be the difference between the patient’s life and death.

High Costs a Hurdle

Proponents of 5G have advocated small cells, and closely located content servers, as the solution to fulfil 5G requirements of high speed and throughput, low latency, full coverage, and high reliability. Small cells are standalone base stations, which are capable of serving a relatively small area and a few users simultaneously. To achieve gigabyte-level and low latency connectivity for all base stations, the implementation of 5G will likely result in a stepped increase in capex and operating costs (opex) for telcos.

Telco network providers would incur significantly higher capex and opex as they need to deploy:

1. Thousands of small cells densely located in a given area;2. Link up with high bandwidth connections and keep them powered throughout the day;

and3. The integrated fail safe mechanisms

required to achieve 5G’s higher data transfer speed, greater fidelity, and wider coverage.

Lower latency crucial for time-sensitive medical and surgical procedures

Source: DBS Bank

Despite the ongoing advances in equipment and hardware, there remains a delay in signal processing and transfer, as well as delays related to administrative functions, such as authentication and security. Furthermore, transfer speeds on air and cable cannot be improved further due to physical limitations.

To achieve 5G’s prescribed latency targets, telco network providers need to significantly reduce the distance between the content servers and the end users’ devices to as low as 1km according to GSMA. As a result, content servers would be closer to and possibly integrated with the base stations. Correspondingly, there would be the proliferation of content servers as the ancillary infrastructure to the thousands of small cell base stations deployed, thus chalking up an ever greater amount of capex.

Data transfers between different telco network providers would have to occur at a similarly low latency of 1ms. Unprecedented levels of connectivity between network providers at the base station level would be another crucial piece to realising the 1ms low latency requirement. Compared to the few limited trunk connections present in current networks, having such levels of connectivity would only exacerbate the capex requirements of having individual networks.

5G aims to achieve data transfer rates of 1Gbps, which is usually associated with fibre and other high capacity wired connections. However, unlike fibre connections, data throughput in wireless networks are substantially limited by available spectral resources. Competing uses of the available spectrum such as broadcasting, satellite, etc., result in mobile networks occupying only a fraction of that available to isolated fixed line or fibre connections.

Reducing distance

Enabling connectivity and collaboration

Expanding spectral range


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Significantly higher capex due to high concentration of 5G cells

Source: DBS Bank

To achieve higher data speeds, industry participants have therefore considered implementing high density small cell networks (leading to more base station level units) and potentially expanding the spectral range beyond 6 GHz. However, the higher frequency bands offer limited cell radiuses and hence rely on a technique known as “beam-forming”. This occurs by focusing radio waves to form a beam for transfer across greater distances, and achieve wider coverage.

This technique is particularly challenging in forming sustained connections with mobile devices as the beam would have to be directed at and track the end user’s device amid interferences and distortions in the air. Hence, the small cells would be equipped with the technology to emit hundreds, if not thousands, of beams to simultaneously connect and track the end users’ devices. Integrating this intensive technology would only augment the already high capex from the large scale deployment of small cells.

High data speeds above 1Gbps and throughput rates of 5G are achieved by linking base transreceiver station (BTS) level cells, with a high capacity core fibre-based network. Fibre connectivity is extremely capital intensive, involving high installation costs, and has only been used recently by telcos to support their heaviest data transfer needs. Inevitably, the deployment of a 5G network that connects thousands of small cells would be a substantial capex burden.

Differing expectations on the cost of investment in 5G

Representatives from carriers such as Verizon and NTT DoCoMo, for over the past year or so, have indicated that 5G will not result in a massive capital burden for telcos. Fran Shammo, Verizon’s executive vice president and chief financial officer, noted that Verizon is looking to maintain its capital expenses at relatively consistent levels between US$17.2-17.7 billion. Similarly, Seizo Onoe, the Chief Technology Officer of NTT DoCoMo, has indicated that 5G’s deployment is unlikely to require massive investment, and that capex for telcos had actually decreased over the last 15 years.

Notably, these divergent views of low-capex 5G networks held by some telco network providers stem from their vision of 5G networks with only limited improvements from present LTE-A networks. Verizon views 5G as a fixed wireless broadband solution to the home9; while Onoe recognises the need to develop a new generation of wireless networks, he opined that these networks should not support such a broad range of applications.

Consequently, these low capex 5G networks are drastically different and might fall short of meeting the low latency, high speed, reliability, and full coverage requirements as described in the preceding paragraphs. For a network to support the IoT, autonomous vehicles, remote medical procedures, and patient monitoring applications, it will inevitably involve massive amounts of investments, regardless of who implements it.


Optimised capex and opex


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e believe the 2-3x capex burden of 5G will be prohibitively high for telcos, the existing network providers, to bear individually. In addition, the greater interconnectivity required to reduce latency between competitors’ networks erodes network advantages and is therefore unlikely to sit well with telcos.

As a result, 5G will likely be implemented by leasing access from a single network. Under this model, telcos would make regular lease payments for shared access to 5G, implemented by a single network provider.

Benefits of a Single Network

A single 5G network would eliminate duplicated equipment and installation costs, reducing overall capex by several fold, while achieving similar levels of coverage and capacity of multiple separate 5G networks. As 5G potentially represents a 2-3x increase in capex over 4G, these savings will be crucial to 5G’s commercially viability in the medium term. In addition, overall running costs of 5G networks can be reduced by removing duplicated administrative (staff, maintenance, security, etc.) expenses.

According to GSMA, sharing part, or all, of the radio access network (RAN) could result in up to 20% increase in free cash flows for a typical European operator10. According to TMG, a consultancy specialising in telecommunications, RAN sharing can save 30-40% in costs11. In addition, Ericsson estimated that 40% of savings on total assets and 31% improvement to cash flows could be achieved (where all the network resources are shared)12. Consequently, even with the massive capex spending involved under the single 5G network model, network providers, telcos or otherwise, would be able to achieve double-digit or near double-digit ROIC.

5G Single Network Implementation Model

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Impact of network sharing on telcos’ capex

* Models that include active sharing Source: Ericsson13

Network sharing model Asset savings Cash flow improvement

Roaming N/A N/A

Passive JV ~10% Up to 13%

TowerCo ~20% Up to 17%

Active and passive JV* ~20% Up to 23%

Wholesale* ~40% Up to 31%


By maintaining a single network, the technical roadblock of maintaining interconnectivity between telco networks of competing providers would be resolved.

As the only network that is capable of supporting the demanding data needs of emerging smart solutions, the business of providing the single network will be a monopoly. Therefore, 5G network providers will be able to generate predictable returns akin to other infrastructure and utilities projects. The high visibility on the revenues and profits of the single network is likely to attract funding at favourable rates, which will drive down the cost of ownership of the network even further.

Shared Networks: Tried and Tested

Sharing active network infrastructure among operators has become more ubiquitous in recent years. According to Analysys Mason, close to 36 active network sharing arrangements had been reached by 2014. A number of telcos in Europe including Telenor, Vodafone, and O2 have agreed to share active networks. Canadian telcos, Telus and BCE, started sharing their networks as early as 2001, where BCE gained access to Telus’ wireless network in Western Canada while Telus gained access to BCE’s infrastructure in Ontario and Quebec (Eastern Canada)14.

Sharing a single network laid out by a third party is also not a novel concept for telcos. The Next Generation Broadband Network (NGNBN) in Singapore, for example, is owned by the government and broadband capacity is made available to network operators for a fee. Stockholm has a similar policy where Stokab, a company owned by the City of Stockholm, lays out fibre optic networks in Stockholm, which are in turn lease it out to telcos.

Despite the structural similarity, it is worth noting that the key difference between common networks mentioned above and 5G lies in 5G’s exclusivity. Unlike NGNBN in Singapore or Stokab in Sweden, as existing players would need to pool their spectrum portfolios when deploying 5G, access would only be to the original incumbent network providers. New entrants to the telco industry are likely to experience significant barriers to access the 5G networks e.g. significant upfront costs.

Forms of Network Sharing

Whilst it is too early to specify which elements of the network the telcos would retain control over, the shared 5G network would resemble the network sharing standards in use today.

• Multi-Operator Radio Access Network (MORAN)

The simplest form of active network sharing where the operators share the RAN – including towers and base stations that are responsible for connecting individual

Revenue and profit visibility


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devices to the network. Spectrum and core networking infrastructure will not be shared in this type of agreements and telcos would have greater control on the network than other forms of active network sharing.

• Multi-Operator Core Network (MOCN)

Telcos pool their spectrum resources in addition to sharing the RAN. Each operator would have its own component (Enhanced Packet Core) that separates the RAN from the telco’s core network. MOCN offers greater flexibility for telcos though at a relatively higher capex than GWCN, which in turn offers lower flexibility.

• Gateway Core Network (GWCN)

In addition to sharing the RAN, telcos will also share mobile switching centres, which are responsible for routing calls and SMSes within the network and other components (Serving GPRS Support Nodes and Mobility Management Entities) responsible for packet data routing.

We believe the network sharing model for 5G will resemble GWCN with possibly better integration such as the sharing of backhaul assets. As telcos lose their ability to compete on network advantages with the deployment of a common network, they would be more willing to share as many components of the network as possible in a bid to minimise their investment on the network.

Regulatory Response a Key Determinant

Given the importance of having a single network, we believe regulators will need to play a massive role to expedite the 5G network roll-out. A single network needs to be backed and possibly even initiated by regulators to be viable. Furthermore, as a single network will remove the network differentiation among telcos, we are likely to see some industry pushback, especially from telcos with a superior network and stronger balance sheet.

As national telco regulators generally support efforts to increase network quality and lower costs, we believe many regulators would be agreeable to a national 5G network, as long as it improves service quality and lowers prices. This has already been seen in fixed networks such as Singapore’s NGNBN.

However, in markets where regulators are not keen on playing an active role in 5G network implementation, we are unlikely to see much progress in the segment. Telcos are likely to invest selectively in areas with the best returns while ignoring certain aspects of 5G networks such as lowering latency, which would lower capex burdens, but also limit the network’s usability.


or telco network providers to reap the economic benefits of 5G, they would have to invest approximately US$4 trillion in R&D and capex by 202015. To put this into perspective, the total mobile network provider capex for the same period without 5G is estimated to be between US$200-250 billion annually16.

This represents a 2-3x increase in capex on 5G annually (from 2015 to 2020), compared to the total ongoing 2G, 3G, and 4G investments around the globe.

Leasing 5G Network

Telcos as lessees of the single 5G networkBased on our projections, telcos would be inclined toward adopting the leasing model, where they would obtain access to 5G networks from a single provider. Their ROICs would stand to gain close to 300 basis points (bps) compared to telcos which implement their own 5G networks. This is largely due to their asset-light business model, coupled with buoyant earnings from the savings in depreciation and 5G-related opex. While telcos would have to make lease payments to a regulated 5G infrastructure provider, there are economies of scale to be enjoyed under this model with multiple telcos utilising the infrastructure. Thus, this would lead to a 15% ROIC upon the rollout of the 5G network in 2020.

Source: DBS Bank


5G’s Financial Implications

F2-3x jump in capex, investments

Based on our financial model, telcos under the leasing model would be able to achieve comparable earnings as telcos that implement and own the 5G network. They would, however, lose the competitive advantages from network differentiation. We believe that this is a reasonable trade-off as telcos should progress to differentiate themselves in the domain of digital services, which represents a market that is 7x larger than that offered by connectivity services. The savings on 5G-related capex of telcos under the leasing model would serve as a prime opportunity for them to invest in fast-growing and established digital businesses, and achieve a transformation of their business model.

Single 5G network infrastructure providerThese are likely to be equipment vendors, given their technical expertise in rolling out extensive and complex 5G infrastructure projects, and a desire to transit toward a utilities business model with more stable cash flows.

In our analysis, we consider an equipment vendor as the lessor of the single 5G network infrastructure assets, operating under a regulated ROIC of 15%. We assumed these assets to have a useful life of ten years and would be leased out to three telcos. The absence of competitive pressures as a single regulated network provider and accompanying stable cash flows would positively contribute to the infrastructure provider’s credit positioning. Its ability to raise debt at a lower cost (assumed to be at 5% per annum in our model) to finance the 5G network capex, as compared to telcos in the 5G sharing model, would create additional economic value. The leasing model is therefore preferred to the sharing model.

The sensitivity analysis of the telcos which lease the 5G network reflect resilience of the leasing model. Even with an 500bps increase of the infrastructure providers’ ROIC requirement to 20%, there would be a less-than-proportionate fall in the telcos’ ROIC by approximately 120bps to 13.8%. On the other hand, telcos in general, regardless of which 5G implementation model they adopt, would be highly sensitive toward growth rates of 5G-driven revenues. This further emphasises the need for telcos to diversify their income and transform their business model by investing in fast-growing and established digital businesses.


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Sensitivity analysis of Asian telcos’ ROIC projections in 2020

Source: DBS Bank

5G infrastructure providers' ROIC

10.0% 12.0% 15.0% 18.0% 20.0%

5.0% 13.9% 13.4% 12.8% 12.1% 11.7%

7.0% 14.6% 14.2% 13.5% 12.8% 12.4%

8.0% 16.0% 15.6% 14.9% 14.2% 13.8%

9.0% 16.7% 16.3% 15.6% 14.9% 14.5%

10.0% 17.4% 17.0% 16.3% 15.7% 15.2%Telc

os 5

G-r

even

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Sharing 5G Network

Telcos which share the 5G network would retain some network advantages over customers within their area of coverage. They would, however, have to incur capex on the 5G equipment in their coverage area. We have assumed this to be 60% of the 5G infrastructure capex under the ownership model, consequently reflecting a higher depreciation charge. We also expect that there would be some 40% savings on 5G-related opex from the network sharing agreements relating to operating co-located cell base stations and content servers. Notably, the additional time taken to transmit signals between networks owned by different telcos might jeopardise the achievement of 5G’s low latency requirements. It remains to be seen how telcos would overcome these operational challenges.

Nevertheless, additional revenues brought by 5G would outweigh incremental expenses, resulting in a rise in the telcos’ earnings. An enlarged capital base of some portion of the 5G infrastructure would, however, mitigate the improved earnings, resulting in a slight decline from the current ROIC of 16% to 15% under the 5G network sharing model.

Owning 5G Network

Telcos which decide to retain all their network advantages would own and individually implement the 5G network. This would incur the highest amount of capital outlay and operational costs, which are expected to outweigh the incremental revenue brought by 5G, thus resulting in a significant reduction in earnings. Capex is expected to be at 2-3x that of current levels, causing an enlargement of the capital employed by these telcos. As a result, telcos which own and operate the 5G infrastructure would see the largest fall from the current ROIC of 16% to 12% in 2020.


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Asian telcos’ ROIC projections under various 5G implementation models in 2020*

2017 5G Rollout in 2020

Telco without 5G Telco owns 5G network

Telco shares 5G network

Telco leases 5G network

Equipment vendor as 5G infrastructure provider

Projected ROIC

16% 12% 15% 15% 15%

Asian telco average over the past five years

Lowest ROIC due to extensive capital outlay and reduced earnings

Reduced ROIC despite higher earnings due to greater capital outlay

Similar ROIC as 5G network-sharing despite smaller capital base as lease payments weigh down on earnings

Regulated ROIC

Earnings $160 $147 $172 $147 $50

Based on ROIC Decline in earnings as depreciation charge on 5G capex exceeds revenue growth

Based on increased revenues, 40% savings on opex & lower depreciation

Decline in earnings as lease payments outweigh depreciation under sharing model

Based on ROIC of 15%

Capital employed

$1,000 $1,213 $1,123 $996 $326

Baseline figure Highest capital employed (adding cash flow shortfall to 2017 baseline)

Reduced capital employed

Savings from capex may be used to invest in fast-growing digital businesses

Deployed towards capex

Capex $121 $326 $226 $77 $326

Asian telco average at 17% of revenue over the past five years

5G-related capex at 43% (or 2.5x 17%) of revenue based on GSMA estimates

40% savings on 5G-related capex

Maintenance capex based on 10% of revenue

Assumed to be on par with telcos which implement their own 5G networks

*We have based our analysis on a baseline capital of US$1,000.Source: DBS Bank


*We have based our analysis on a baseline capital of US$1,000.Source: DBS Bank

Pro-forma income statement of Asian telcos’ under various 5G implementation models in 2020*

2017 5G Rollout in 2020

Telco without 5G Telco owns 5G network

Telco shares 5G network

Telco leases 5G network

Equipment vendor as 5G infrastructure provider

Revenue $710 $767 $767 $767 $185

Assumed 71% of capital employed based on 2015 Asian average

Assumed 8% revenue growth in 5G era: 3% from IoT connectivity & 5% from data usage in other areas

Similar to individual telco implementation of 5G

Similar to individual telco implementation of 5G

Assumed ~50% EBITDA margin

Opex (excluding 5G lease & depreciation)

($470) ($507) ($492) ($477) ($34)

Baseline figure Opex growth at 8% in line with revenue growth

Sharing active networks generate 40% savings in 5G-RAN opex

Assume 80% savings from 5G-related opex

Assume 10% savings of 5G-related opex due to cost synergies achieved as a single network provider

5G lease payments

- - - ($62) -

Assume three telcos leasing 5G infrastructure

EBITDA $240 $260 $275 $228 $93

Depreciation ($80) ($113) ($103) ($80) ($33)

Assumed to be ~11% of revenues

Ten-year useful life of 5G-related capex

From reduced 5G-related capex

Absence of 5G-related capex

Ten-year useful life of 5G-equipment capex

Interest expense

- - - - ($10)

Assume 60% of 5G equipment financed by debt at 5% p.a.

Earnings $160 $147 $172 $147 $50

Strategic Responses to 5G

I

Technical know-how

Volatile operating environment

f telcos were to back down from the herculean task of rolling out the 5G network, there would be two possible contenders to fill their shoes. The government could lay down the network at its expense and lease it out to network operators. However, given the immense scale, complexity, and administrative intricacies involved, we believe that the

government’s involvement would likely be limited to financial ownership and backing.

Telco Equipment Vendors Well Positioned

In our view, the most likely entity to deploy the network would be telecommunication-equipment vendors, i.e the likes of Ericsson, Alcatel Lucent, and Huawei. These equipment vendors are well-positioned to participate in 5G deployment as they possess the technical know-how. We also expect these equipment and infrastructure providers to achieve a 15% ROIC by operating under a regulated environment due to the likely monopoly market structure. This gives the equipment vendors a large incentive to shift toward this business model which provides greater operational stability than what they have now.

Given network equipment vendors’ prior experience in managing projects of comparable scale, they would possess the core technical capabilities required to implement the single 5G network. Their superior expertise on 5G technology relative to telcos could translate into the rollout of an optimised network.

Utilities model: Shift from challenging operating environment toward stable cash flowBy leasing out the 5G network, network equipment vendors would gain visibility of their future revenue streams, eliminating the volatility and seasonal effects inherent to their top lines under their existing business model. By allowing multiple operators to access and utilise the network, equipment vendors could also save on costs, largely driven by improved network capacity utilisation, translating into better operating margins. This would be reflected by the stable ROIC of 12% under a regulated operating environment.

While obtaining funding for a project of this scale could pose a problem to the equipment vendors, securing project financing would not be an uphill battle, given the visible and stable cash flow and likelihood of gaining regulatory support.

Major telecom equipment vendors such as Ericsson and Alcatel Lucent have witnessed volatile earnings and depressing margins over the recent past. Intensifying competition


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from Asian equipment vendors, such as Huawei and ZTE, and seasonality attached to major network deployment; these have been the primary reasons behind the vendors’ unpredictable top-line numbers.

The volatile earnings and depressing margins attached to the telecom equipment business have also taken a toll on the share prices of these equipment vendors. Hence, we believe their entry into a business that provides stable cash flow and revenues would be favourable to their success and survival.

Telcos at a Critical Crossroad

Telcos will arrive at an important crossroad that could change the whole structure of the industry when 5G is rolled out. The single-network-operator model would erode the network advantages they currently possess. In response, we believe telcos should invest in fast-growing and established segments of digital businesses (beyond network ownership and connectivity) to transform their business models.

Network equipment vendors’ revenues and operating margins over the past ten years

Source: Reuters

Diminishing returns on improvements to network connectivityThe incremental revenues of rolling out 5G is likely to be relatively low for telcos, despite the extremely high capex burden. The telcos’ revenue leakage points toward a larger trend of network commoditisation, where telcos would not be able to differentiate themselves by solely providing network services.


25

Source: DBS Bank

Source: Analysys Mason

Loss of network advantages with 5G roll-out to prompt differentiation through digital services

Leakage of revenue due to inability to fully monetise data usage


Aspects such as net neutrality laws being implemented around the globe also significantly erode the advantage telcos gain through network ownership over the long term. As a result, we believe telcos would shift away from their traditional role as network providers; equipment vendors would take over as consolidated network providers, benefitting from the stable but lower returns of network ownership.

Due to the protracted implementation of 5G (at least till 2020) and the relatively capex efficient network deployments of alternative cellular solutions of Heterogeneous Networks (HetNet) and Narrowband IoT (NB-IoT), telcos will be in a position to drive down their network capex over the next five-year period. This occurs even as telcos under the leasing model discussed before would be able to achieve comparable earnings as those under the 5G network infrastructure ownership model. As a result, telcos under the leasing model should use the capex savings on network investments to develop new digital businesses and pay out dividends, in our view.

Digital businesses: More than network ownership and connectivityThe advent of hyper-connectivity brought about by 5G would be a major growth catalyst for digital businesses. 5G is expected to facilitate use cases in IoT, rich media, and other initiatives to improve productivity in people’s daily lives. However, our previous studies have shown that connectivity services, which telcos have been traditionally been entrenched in, represent only the tip of the iceberg in the universe of digital businesses.

For example, Gartner’s forecasts suggest that IoT will support total services spending of US$263 billion by 2020, and only US$32 billion of the total IoT service opportunity or 12.3% is attributable to connectivity services. As the revenue base of telcos’ fixed and mobile revenue is large, it will translate to less than 3% of their total revenue. Conversely, the revenues attributable to digital services and applications are approximately 7x that of connectivity services, comparable to approximately 21% of the telco market.

Major growth catalyst


Source: DBS Bank

In addition to IoT, there is an array of fast-growing digital segments that telcos are qualified to establish themselves in. For example, telcos own a great deal of data such as customer demographics, spending patterns, commonly visited locations, websites, all of which could be used to provide targeted advertising solutions for digital advertisers. What’s more exciting is that the mobile advertising market is set to grow at a CAGR of 32% from 2015 to 2018, reaching US$114 billion by 2018, according to ZenithOptimedia17 . The firm also predicts that mobile advertisements would account for 87% of all new ad dollars added to the global market during these years.

Similarly, telcos could also potentially use the vast amounts of customer data and techniques already used within the industry to establish themselves in the Big Data analytics segment. Telcos naturally have an advantage in Big Data with the sheer amount of data that they hold. Many telcos already use this data to customise their offerings to reduce churn rates, analyse upcoming trends to offer proactive solutions, and so on. Research firm Wikibon estimates the Big Data market to be worth US$50 billion by the end of 2017, growing at a CAGR of 21% from 201418.

Telcos could also venture into not-so-obvious segments such as Big Data analytics or production of virtual reality (VR) content. Whilst these segments may require the acquisition of new capabilities, they would likely carry attractive return on investments, given the rapid growth and expanding market. Acquiring VR content production capabilities could also provide telcos with access to a market that is expected to exceed US$21 billion by 2020, according to research firm, Tractica19.

Telcos around the globe have already tested these waters. For example, in the mobile-advertising segment, Verizon acquired Millennial Media, which specialises in mobile advertisements, in 2015 for US$208 million. This was on top of the acquisition of AOL, which also possessed mobile-advertising capabilities, among other things. Similarly, Telefónica20 and Singtel21 have already made forays into the mobile-advertising segment.

Why telcos have not taken on a more dominant role in digital businesses yetTelcos have seen mixed results when they’ve invested in non-core, emerging services, which in many cases has reinforced their attitudes towards focussing on their core network business. Many of the non-core investments have been in areas with which telcos are not familiar, and which require long periods to yield positive results. Telcos need to build up human and intellectual capital to compete with digital-services companies that have operated in those areas for years. However, with strict dividend commitments and markets discounting non-core investments, telcos have only really dabbled in non-core investments.


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Capitalising on data

Acquisitions


However, the environment of stable, positive returns from investing in network assets is likely to change in a 5G world. According to ABI Research, 5G revenues are expected to reach US$247 billion by 2025, mostly from North America, Asia-Pacific, and Western Europe. Even after including non-IoT related revenue such as increased data usage from Augmented Reality (AR) / VR, telcos are unlikely to see incremental revenues from 5G connectivity that will justify sky-high capex commitments in 5G. Once we consider the additional operational expenses of maintaining the 5G infrastructure and the capex expectations of US$4 trillion, the ROIC of 5G is likely to deteriorate to the mid-single digits even in the most optimistic scenarios.

Flat and positive ROIC of telcos worldwide

Source: Reuters

The environment of stable, positive returns from investing in network assets is likely to change in

a 5G world

Telefónica realised that small scattered investments don’t result in sufficient returns

Telefónica, one of the largest telco groups in the world, was one of the telcos to aggressively move into the digital space. Telefónica Digital was created in 2011, functioning independently from the core telco business, so it will have the speed and agility to push the boundaries of digital service innovation. Telefónica believed that the unit would allow the telco to bring benefits in areas such as entertainment, financial services, and advertising.

As part of its expansion into digital services, the company invested in various areas that covered both telco-related and non-related areas such as hosting, cloud and enterprise communications, over-the-top (OTT) communications, financial services, health, advertising, and OTT content. Telefónica’s digital investments include Axismed, a Brazilian chronic-care management firm; TokBox, a video-chat platform; Boku, a global mobile-payments network; Everything.me, a service that adds contextual capabilities to mobile phones; AddFleet, a mobility platform enabling users to track the location of transport units in real time; and many more. Many of these services were invested at the start-up level and some, including Everything.me, have folded.

However, despite Telefónica Digital’s annual revenue growth of over 20%, the unit was closed down in 2014. The management believed the digital businesses needed to be embedded more deeply in the main organisation for them to succeed, and reorganised Telefónica Digital services into other existing telco units. This also meant that many products and services formally provided by Telefónica Digital would be bundled with existing telco services going forward.

We believe this is a clear example of telcos’ pursuit of a wide range of small investments in relatively new and sometimes unrelated areas which do not yield expected results. Telefónica only realised afterwards that its best strategy to grow new digital businesses is to focus on synergies that their existing network and brand can have with the new services, so they can be effectively bundled and sold as a more compelling product to customers.


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Recent notable acquisitions by telcos outside their core businesses

Acquirer Acquisition Deal Value Year of Acquisition

Industry of the Target

Description of the Target

AT&T Time Warner Cable

US$85.41 billion

2016 Content Production & Delivery

Provider of film and television entertainment services. Owns some major TV networks such as HBO, CNN, and Warner Bros

Verizon Sensity Systems

N/A 2016 IoT Provider of remotely controllable light-emitting diode technology

Verizon Fleetmatics Group

US$2.37 billion

2016 Machine-to-Machine or M2M

Offers fleet-management solutions. Provides software-as-a-service (SaaS) solutions for vehicle location, fuel usage, speed and mileage, as well as mobile-workforce solutions

Verizon Yahoo US$4.83 billion

2016 Content and Advertising

Internet search engine and advertising business. The acquisition includes Yahoo! Mail, Yahoo! Sports, and Tumblr blogging services

Verizon Telogis Inc N/A 2016 M2M Provider of cloud-based fleet-management software

Verizon RYOT Corp N/A 2016 Content Producer

Producer of motion pictures and videos. Operates a VR recording studio

Verizon Volicon Inc N/A 2016 Media Intelligence

Provides solutions for compliance monitoring of videos, ad verification, and competitive analysis, as well as repurposing video for the web and social media

Telefónica AxisMed Gestao Preventiva da Saude

N/A 2016 Healthcare Provision of chronic patient and preventive health-management solutions

Singtel Trustwave US$770 million

2015 Cyber-Security

Leading provider of managed security services in the US

Telia Sonera

Springworks N/A 2015 Mobile Gaming

Developer of mobile games

Verizon Millennial Media

US$248 million

2015 Mobile Advertising

Developer of mobile-advertising software


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Source: DBS Bank

Acquirer Acquisition Deal Value Year of Acquisition

Industry of the Target

Description of the Target

Verizon AOL US$4.07 billion

2015 Content and Advertising

Owner of online blogs: The Huffington Post, Engadget, and TechCrunch. Operates several digital-advertising platforms

Telefónica Synergic Partners

N/A 2015 Big Data Big Data consultancy services

Telefónica Weve Ltd N/A 2015 Digital Advertising

Provides mobile-marketing and commerce services; solutions include marketing through mobile messaging and data-matching concepts

Singtel Adconion Media

US$209 million

2014 Digital Advertising

Multi-Channel (mobile/social/video) digital-advertising firm with operations in the US and Australia

Singtel Kontera Technologies

US$150 million

2014 Digital Advertising

Analysis of digital content to customise digital advertisements to better suit users

AT&T Fullscreen N/A 2014 Content Production & Delivery

Multi-media company involved in creating and sharing of videos

Telia Sonera

Ipeer AB N/A 2014 Cloud Service Provider

Swedish provider of cloud and hosting services

Telia Sonera

Zound Industries

N/A 2014 Electronics Swedish manufacturer of electronic accessories

Vodafone Cobra automotive

€140.76 million

2014 Telematics Provides telematics software to car manufacturers including Audi, Bentley, Lamborghini, and Renault

Telefónica eyeOS SL N/A 2014 Cloud services

Operates a private-cloud application platform with a web-based desktop interface

Singtel Gradient X US$15 million

2013 Mobile Advertising

Mobile advertising and marketing platform with real-time bidding capabilities


Getting into fast-growing and established segments could pay offWith much cash in their coffers, telcos should focus on the acquisition of capabilities in more established segments that are of a strategic fit with their traditional role of a network provider. Albeit more expensive, integrating acquisitions with the telcos’ existing operations would be easier. Moreover, such acquisitions are likely to be viewed favourably by shareholders, as opposed to investments in emerging, high-risk segments. The already established human and intellectual capital would enable telcos to quickly show positive results.

How Verizon expanded into digital advertising

Verizon has long been very keen on expanding into segments that transcend its traditional role as a network operator. The company has made several multibillion-dollar investments in an array of businesses but its acquisition of AOL stands out.

Verizon acquired AOL, a digital-content producer and advertiser for US$4.4 billion in 2015, establishing itself as a key player in digital advertising and online blogging. AOL owned a range of digital-advertising platforms and adtech including “One by AOL”, an automated platform for buying ads across different media, and “Pictela”, a high-definition global content-marketing platform. According to comScore, AOL was also the owner of several famous blogs including the Huffington Post, Engadget, Moviefone, and TechCrunch22. Verizon supplemented the digital advertising business of AOL, by acquiring Millennial Media, a developer of software for mobile advertisers.

The acquisition of an established digital advertiser and content developer allowed Verizon to gain a strong foothold in the US digital advertising market, set to reach US$105 billion by 2020, according to eMarketer23. The company gained access to the digital-advertising platforms, customers, and adtech owned by AOL, which could now be cross-matched with subscriber data of over 108 million wireless subscribers of Verizon, to offer marketers new advertising options. The acquisition was also of a strategic fit for Verizon as the company now owned the content it delivered through its networks.

Furthermore, the acquisition of AOL buttressed Verizon’s plans to develop its own OTT video-streaming service to compete with the likes of Netflix and Hulu. AOL’s blogs, including the Huffington Post and TechCrunch, were very popular among millennials and offered attractive content-development platforms for Verizon to capitalise on. Soon after the acquisition of AOL, Verizon announced the launch of its video-streaming mobile app, Go9024. Whilst the platform has received mixed reviews, it has put Verizon in a position to boost its mobile-video advertising business, poised to record strong growth in the future.

Since the consolidation of AOL in 3Q15, the company has contributed over US$2.7 billion to Verizon’s top line, accounting for about 2% of revenues each quarter. Verizon anticipates that AOL will generate close to US$20 billion by 2020, according to a Bloomberg report25. AOL’s capabilities, combined with the potential acquisition of Yahoo, would place Verizon among the leaders of the global digital-advertising market.

Hence, despite the hefty price tags these acquisitions had carried, they have provided Verizon with much-needed capabilities in growing segments that have helped mitigate the declining appeal of its traditional telecom operations.


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The implementation of 5G will be initially driven by government and regulator interest in improving connectivity and providing smart solutions. Telcos are also likely to take part willingly in cases where there is regulatory support and financial benefit. As a result, after looking at the three developed regional telco markets of the US,

Europe, and Asia, we believe that Asian markets would most likely be the pioneers of 5G. This will be closely followed by developments in European markets.

Asia: Ahead of the Pack

Asia’s hyper-connected, politically committed, and financially sound nations, such as South Korea, Japan, Hong Kong, and Singapore, as well as China, are the most likely candidates to implement 5G.

South Korea has vowed to get 5G ready for the PyeongChang 2018 Winter Olympics, and has even brought forward the commercial launch by a year to 2019. This is also observed in Japan, where NTT DoCoMo intends to launch a 5G trial network in 2017 and plans to adhere to a government-prescribed timeline for a commercial launch in 2020.

Underpinning China’s Internet Plus strategy – set in its 13th Five-Year Plan from 2016 to 2020 – is the enabling infrastructure of an integrated mobile network and connected population. This is evident in China Mobile’s efforts and plans to execute a commercially viable and mass 5G network by end-2020. Chinese telecom equipment vendor, ZTE, also intends to conduct trials of 5G equipment spanning over 100 cities in China26.

This dynamic is similarly seen in Singapore, where a nation-wide 5G network would be essential to the successful implementation of the government’s Smart Nation plans. The 5G roll-out would also be much easier in Singapore, given its relatively smaller size. The largest telecom operator in Singapore, Singtel, has already joined hands with telecom equipment vendor, Ericsson, to study this technology27. The two companies recently conducted a demonstration of 5G technology that achieved download speeds of 27.5Gbps28.


Now Till 2020: 5G Implementation Roadmap

T

Asian markets would most likely be the pioneers of 5G

Internet Plus


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Europe Will Be Next

European telcos have witnessed declining returns on their capital over the past six years amid intense competition and tighter regulations. The European Telecommunications Network Operators’ Association estimates that revenues of European operators have fallen 11% to €248 billion from 2009 to 201529. According to the Wall Street Journal, most European Union (EU) countries have at least four mobile operators30. Tightening regulatory conditions, such as the abolition of roaming charges and adoption of net neutrality laws, may worsen operating conditions for telcos.

Against this backdrop, European telcos are more likely to collaborate to share their active network infrastructure, which could be crucial to the successful deployment of a 5G network. According to Analysys Mason, Europe accounted for 61%31 (or 22) of the active network-sharing arrangements in the world in 2014.

Furthermore, European telcos would have extensive support from regulators when rolling out 5G. After the delay in rolling out 4G services in the Eurozone, the EU is seemingly keen on pioneering the deployment of 5G. The EU Commission has already set out an action plan for the deployment of 5G32. The commission is also discussing supplementary regulations, such as the sharing of radio-spectrum resources33 among telcos, which could ease the process of sharing active infrastructure among telcos. According to the action plan, the commission intends to host preliminary trials on 5G by 2017 and introduce the network by 2018. 2020 has been set as the deadline for large-scale commercial introduction of the technology among

Source: Reuters

ROIC dipping downwards

Extensive support

member-states. The EU Commission also established a €700-million public-private-partnership in 2013 to ensure the availability of 5G technology in Europe by 2020.

Hence, we believe Europe would be the most likely region to commercialise 5G technology, given the motivation of the telcos to share their network assets and extensive support from regulators.

Interim Technologies

Given 5G’s massive capex burden, we are unlikely to see such networks being commercially available in the immediate future. Of the current developments in mobile technology, we believe there are a few that could be implemented in the interim to address uses that would otherwise be addressed by 5G.

Narrowband IoT (NB IoT)

Narrowband IoT is an energy-efficient network built to connect a multitude of devices at low data rates. Many IoT applications that need to connect a large number of devices with relatively small bandwidth, such as the collection of sensory data, would be facilitated through this network. As the narrowband IoT relies heavily on existing cellular infrastructure, the overall additional capex required to implement the system would also be lower.

Heterogeneous networks (HetNet)HetNet uses multiple wireless communication technologies to connect devices, thereby boosting the overall capacity and data speeds of a given area. Some trials are currently looking to supplement existing LTE network capacity using Wi-Fi. As the technique will be mostly used to supplement existing networks, telcos are likely to roll out Wi-Fi and other supporting technologies only in selected heavy-traffic areas where they need to improve data speeds and capacities.


Europe would be the most likely region to commercialise 5G technology


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mobile_revolution/

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20. Financial Times - Telefónica launches mobile ad exchange

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33. https://ec.europa.eu/digital-single-market/en/promoting-shared-use-europes-radio-spectrum

Disclaimers and Important Notices

The information herein is published by DBS Bank Ltd (the “Company”). It is based on information obtained from sources believed to be reliable, but the Company does not make any representation or warranty, express or implied, as to its accuracy, completeness, timeliness or correctness for any particular purpose. Opinions expressed are subject to change without notice. Any recommendation contained herein does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee.

The information herein is published for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. The Company, or any of its related companies or any individuals connected with the group accepts no liability for any direct, special, indirect, consequential, incidental damages or any other loss or damages of any kind arising from any use of the information herein (including any error, omission or misstatement herein, negligent or otherwise) or further communication thereof, even if the Company or any other person has been advised of the possibility thereof.

The information herein is not to be construed as an offer or a solicitation of an offer to buy or sell any securities, futures, options or other financial instruments or to provide any investment advice or services. The Company and its associates, their directors, officers and/or employees may have positions or other interests in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking and other banking or financial services for these companies.

The information herein is not intended for distribution to, or use by, any person or entity in any jurisdiction or country where such distribution or use would be contrary to law or regulation.


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