Tuesday, March 30, 2004

Daiwa EuroTelcoblog No. 34, Wednesday 24th March 2004: CeBIT diary and reflections on DT investor day (original email blast 5:27 PM Wednesday, 24th March, 2004)

We visited CeBIT in Hannover, principally to attend the Deutsche Telekom investor day (which we discuss below), but also to drink in the rich atmosphere of the wider event, where attendance was up this year. This year offered many familiar sights, such as the wacky organ grinder serenading departing guests on the moving sidewalks (attachment 1), and the inconceivably large magenta T’s (attachment 2), but also much that was new.

The sheer size and scope of the event makes any unbiased appraisal of it virtually impossible, particularly for one-day visitors such as this author. Accordingly, the following account is characterized by our thematic biases, and is thus very subjective. Additionally, our colleague on the semiconductor and handset side, Kota Ezawa, gave a very good account of the handset scene at CeBIT last week (contact us for his piece), so we won’t spend any time on these issues, other than to say that there was indeed a huge buzz around the stands of handset manufacturers displaying megapixel camera phones and 3G devices, as well niche market suppliers such as PalmOne, whose Treo hybrid PDA/camera phone seemed to be attracting a lot of attention.

What was different this year

Last year CeBIT coincided with the beginning of mass market awareness of Wi-Fi technology, aided by Intel’s marketing push in support of Centrino. As we expected, this year is the year of VoIP in Europe, judging from the huge amount of VoIP-related stands in Hall 13, the first most visitors to CeBIT see.

There was still an awful lot of Wi-Fi stuff on display, but this year the focus seemed to be on how the technology can be harnessed, rather than the “wow, this stuff is cool” novelty aspect that prevailed last year. Lurking in Hall 13 we saw a couple of good examples, both Taiwanese manufacturers of 802.11 handsets, Senao and Tecom. We were most impressed with Senao, which demonstrated its SI-7800H handset (attachment 3) for us. Sound quality was great, and the form factor (20 x 44 x 125mm) and weight (83g) of the device would be entirely acceptable to the average mobile phone user in our opinion. The Tecom IP2050 device (http://www.tecomproduct.com/IP2050.htm) was less attractive, bulkier and features talk and standby times significantly shorter than the Senao handset (4 hours talk, 100 hours standby). We later saw a Finnish company called Convergens Oy which is marketing the Duravox 905 802.11 handset (http://www.convergens.fi/pdf/Duravox905_data.pdf) which also doubles as a wired Ethernet handset, and includes power over Ethernet for wired use and battery charging. These are interesting features, but the device is bulky (26 x 53 x 140mm, 145g), and though the four-hour talk time is identical to Senao’s, standby time of 24 hours is pretty short. Senao’s marketing representative was friendly and talkative, and suggested that a contract from a major US service provider was in the pipeline. He also indicated strong interest from carriers at CeBIT (we caught sight of the business card of the internet strategy director at a large UK operator among many left at the Senao stand.

The E-Plus i-mode stand was very active, as usual, and besides the greater variety of handsets on display, we also saw a demonstration of the next generation of Kodak image processing hardware which includes Bluetooth, to allow easier printing of camera phone images (the device also contained ports for the three common flash memory card standards). The E-Plus representative we spoke to was only a student under contract for the show, but he told us he believed the devices would be installed in selected E-Plus stores and that prints would probably be priced at around EUR0.50 each, which he suggested was a 100% gross margin price point. Whether this will represent a key source of incremental revenue for mobile operators in future, we can’t say, but we think it is an interesting illustration of how to extract value from camera phones beyond the MMS and data revenue aspects, particularly as mega-pixel cameras are coming into the mainstream.

Both powerline and satellite seemed to be more in evidence this year. We tried out the broadband satellite service from Astra (SES Global), and thought it was excellent. Powerline had its own “World of Powerline” superstand, where traffic seemed to be pretty heavy, considering that it is still viewed as a niche area by many. There also seemed to be a much heavier presence by Eastern European operators than we can ever recall seeing before.

We had a chance to stop by and see a demonstration of the Paradial RealTunnel product (http://www.realtunnel.com/), which enables firewall and NAT traversal for the MSN Messenger voice and video service, and were impressed. Video and audio quality were extremely good, even with bandwidth set to a miserly 82kbps. We expect this company to launch a public SIP service based on the RealTunnel capability, which should be worthy of further attention.

Most no-nonsense-stand-in-show award goes to Tele2, whose large-ish stand contained no products or equipment that we could see, and seemed to be entirely geared to signing up customers.

DT’s investor day

This event was less about numbers and more about management outlining its strategy and processes around generating growth in the three key areas of broadband, business customers and mobile. There wasn’t a huge amount of detail, but we did come away with a few extra data points, and a lot of insights into strategy. Clearly all three of these growth areas overlap to some extent, so rather than go through segment-by-segment, we have tried to synthesize the main messages from the presentations.

Building consumer broadband

DT is expecting to launch wholesale DSL from mid-2004, and to drive uptake is offering free line sharing from April 2004 to January 2005. DT is currently in discussions with RegTP with a view to halving the line sharing charge. As stated previously, DT expects to thus accelerate growth in the DSL market, to more than 10m lines by year-end 2007, and later cited a study predicting 12.6m by 2008, of which T-Online intends to have a 50 - 55% retail market share. T-Online is doing some interesting things with content, launching a paid music download service with 70,000 registered users at this point, and claims to be seeing strong interest in the Bundesliga football streams and paid Big Brother update clips. Most interestingly, the VoD service launched in November 2003 recorded 400,000 paid downloads to the end of 2003, just as a pure PC service. Now comes T-Online Vision (http://www.ihrfernseherkannjetztmehr.de/index.php?id=193), which brings broadband to the TV. Accompanying this is a push towards 3Mbps access at lower price points. Asked about the prospects for "naked" DSL in the German market, the response was that DT's strategy with AktivPlus voice packages was to lock users in to make them less amenable to such a scenario if ever it were to happen. The recently-introduced EUR4.22 per month bolt-on package offering EUR0.10 for calls lasting up to one hour was cited as an example.

T-Com’s CTO stated that he thinks DSL and Wi-Fi “have a great future together,” and the company (T-Com and T-Mobile jointly) is looking to accelerate uptake of Wi-Fi, both in public and in the home. DT is currently one of the largest retailers of 802.11 equipment in the German market, with over 200k units shipped at the end of 2003. On the device side, DT is also active, unveiling the T-Sinus wireless PDA device, which features a Microsoft Pocket PC operating system and both Wi-Fi and Bluetooth access. DT aims to increase the number of public hotspots available to its customers to over 15,000 globally by year-end, further extending the footprint via roaming agreements. In the German market, Wi-Fi will be marketed as an all-you-can-eat add-on for TDSL customers for EUR9.99 per month until October, after which the EUR9.99 price will include three hours of surftime, with overage charged at EUR0.08 per minute (ouch!). DT ended 2003 with 4,200 hotspots in the US, and 900 in Europe, and monthly run-rate revenues in the US rose from $400k in January 2003 to $1.6m per month by the end of 2003. This suggests that 4,200 hotspots are generating annual revenues of c.$20m, or roughly $13 per spot per day on average. Many of these locations in the States have backhaul over T-1 lines, suggesting a pretty poor margin on $400 average monthly revenue per spot.

Our own experience waiting for the flight to Hannover at the Gatwick Airport North Terminal, where there is a very prominent BT Openzone hotspot, suggested to us that usage in such commercial hotspots continues to be very low in Europe. We observed the spot for nearly two hours, and while many people (including us) took advantage of the swiveling laptop rests attached to the chairs (either to work or eat), no one was actually using Wi-Fi within the spot (attachment 4). Our work last year on the issue of the “virtually free” model (see PTT Pulse, issue 53, 21 March, 2003) suggested to us then that retailers and restaurant owners might scuttle the efforts of commercial operators, at least while extortionate pricing levels remain in place, as they do in Europe. Anecdotal evidence now suggests that this phenomenon is moving rapidly into the hotel segment in the US, where broadband internet access (via DSL or Wi-Fi) is increasingly viewed as an amenity of the hotel rather than a premium service. We think this bodes poorly for those investing heavily in a commercial model, though T-Mobile CFO Thomas Winkler stated the company’s view that the all-you-can-eat subscription plan ($19.99 per month for T-Mobile cellular subscribers, $29.99 for non-subscribers) has been a significant customer acquisition tool on the cellular side.


In the mobile operation, DT has adopted a brand identity of T-Mobile MultiMedia (tm3), with some clever marketing behind it (attachment 5). T-Mobile's CTO Hamid Akhavan hit the nail on the head in taking the industry to task for selling acronyms rather than services historically. By focusing on the tm3 concept, T-Mobile is trying to stress that 2.5G, UMTS and Wi-Fi are merely aspects of service. The focus for DT has moved towards a streamlined voice and data tariff structure, with pricing for data downloads uniform regardless of access. Much of this makes very good sense, particularly the move towards hybrid PCMCIA cards for laptops using a best-effort principle for network selection, and SIM authentication where possible, which allows integrated billing for T-Mobile customers. Relative to some European operators, T-Mobile has historically downplayed the significance of UMTS, though it confirmed for us that the company has built 6,000 UMTS cell sites to date in Germany, the UK and Austria, and will expand sites in these three countries to 11,000 by the end of this year (adding an estimated average annual OPEX of EUR30k per site per annum).

There was much to-ing and fro-ing with analysts on the subject of whether or not the cost efficiencies related to UMTS would lead to a collapse in average price per minute for voice, but DT management seemed convinced that tariff structures would stimulate voice minutes. Related to this however, DT revealed, for the first time, the total minutes of use for its European and US businesses, and we were surprised at the huge disparity between the two. Total European MoU in 2003 were estimated at >51bn minutes (we calculate that this means only 92 minutes per month for European subscribers) and >98bn for T-Mobile USA (this suggests 709 minutes per month, more than ten times the level estimated for Germany). Incentivizing European subcribers to take bigger minute bundles, which is DT's stated tariff strategy, looks challenging when they are apparently so reticent to talk. We will be interested to see what impact becomes visible from the launch of the Relax big bucket plans in the German market.

T-oIP? Nein, danke

DT is speaking the language of technology agnosticism in access, and in services it has made a step forward with the introduction of NetPhone, an IP PBX application for business with a user interface based in Outlook, a clear recognition of the VoIP phenomenon in the corporate space. This product apparently "opens up a new dimension of telephone functions," but apparently one which consumers will have to wait for, at least from DT. T-Com's CTO Roland Kittel claimed to see no reason to pursue opportunities in consumer VoIP products at present, if all that could be achieved would be a lower price point for a voice service less reliable than the PSTN. T-Com would invest, he said, when it could offer complete integration of voice and data services to customers. As with Swisscom management's comments today, DT's view seems to be that PSTN pricing is already sufficiently low that the marginal cost savings versus quality issues is an unattractive prospect for consumers. Mr. Kittel contrasted Europe with the US and Japanese markets, where ingredients such as high PSTN charges and affordable unbundling (Japan), and lack of PSTN-to-VoIP termination rates and imminent arrival of cable VoIP products (US) created a more conducive environment for uptake of VoIP as a consumer service. T-Mobile similarly downplayed the concept of a threat from VoIP over Wi-Fi or UMTS, again citing price differentials and quality issues as inhibitors.

However, we think both T-Com and T-Mobile are focusing on fixed-to-fixed and in-country mobile calling in their analysis, ignoring the potential for consumers (fixed or mobile) to avoid very un-trivial roaming and mobile termination payments by adopting access-independent VoIP. We have never argued that access-independent VoIP would completely obliterate PSTN voice revenues, but that the usage patterns were likely to be eclectic and focused on obvious price/location arbitrage opportunities. There are few more obvious in the European market than those of mobile termination and roaming charge by-pass. These are disproportionately lucrative product segments for all mobile operators.

It is interesting to note that in the hall directly opposite the venue for the DT event, two DSL operators were introducing access-independent SIP services for the German market. One, Broadnet Mediascape (http://www.mediascape.de/) looked more like a standard ATA-based service, but the much better known Freenet.de, has launched the iPhone, which offers both ATA and softphone interfaces (http://www.freenet.de/freenetiphone/). The softphone is free for use on a P2P basis, by any broadband user, though the break-out to the PSTN is restricted to Freenet.de DSL users. This is one of Germany's better-known ISPs, which nearly doubled its DSL subs in Q4 alone, apparently taking around 10% of net adds in the retail market. As we have long stated, we think a product like this could serve as an important differentiator for independent DSL players, particularly with the opening up of the DSL market in Germany, and we do not view this development as trivial.

DT unveiled much of interest at CeBIT, and a lot of what the company said seemed extremely reasonable. However, where we might disagree with management is in the conclusions we draw about the future. Our rating on DT remains 3 [NEUTRAL] and we look forward to more granularity around the inner workings of T-Systems through the analyst day on 1st April.

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