SUMMARY
* After 2 weeks of earnings reports from major vendors &
several new data points we have incorporated these into our
2001 wireless equipment thesis.
* We continue to believe there is risk to replacement sales
in 01 & have lowered our ests for handset shipments to 500
mn from 520 mn. We also do not expect GPRS shipments to
represent more than 6% of 2002 volumes, therefore we feel
the industry is already too aggressive with respect to the
impact it expects GPRS to have on the acceleration of
replacement sales in 2002.
* We believe the causes in the delays in GPRS, which are 1)
interoperability issues; 2) technical difficulties; and 3)
a lack of handsets, will be the same factors to delay WCDMA
deployments past 2002 and into 2003-2004.
* We are maintaining our cautious investment approach to
the wrls equip sector and would look to become more
opportunistic once we have better visibility w/respect to
handset growth, infra margins pressure & 3G timing, likely
3Q.
SUMMARY VALUATION AND RECOMMENDATION DATA
Earnings Per Share
Company (Ticker) Price FYE Rating Target LTGR Current Yr Next Yr
Ericsson (LM) Teleph- $11.38 Dec Curr 3M $10.00 16% $0.17E $0.34E
one Company (ERICY) Prev 3M $10.00 16% $0.17E $0.34E
Motorola, Inc. (MOT#) $21.33 Dec Curr 2M $19.00 0% $0.75E NA
Prev 2M $19.00 0% $0.75E NA
Nokia Corporation- $32.60 Dec Curr 3M $31.00 30% $0.83E NA
(NOK) Prev 3M $31.00 30% $0.83E NA
QUALCOMM, Inc. (QCOM) $86.81 Sep Curr 1H $110.00 0% $1.26E NA
Prev 1H $110.00 0% $1.26E NA
OPINION
After the past two weeks of earnings reports from the companies in our
coverage universe, as well as conversations with several industry sources in
Western Europe, we felt it would be helpful to incorporate these data points
into our overall industry outlook for 2001.
We continue to believe that the industry's estimates for 2001 handset sales
remain aggressive due to a risk in replacement sales. In fact, after seeing
replacement sales for the fourth quarter come in much softer than initially
expected we have lowered our estimate for handset volumes in 2001 to 500
million from 520 million. We also believe the industry is already overly
aggressive in its expectations for the replacement rate in 2002 due to GPRS
services. Although we expect GPRS to take up in 2002 we do not expect
handset volumes to be more than 6% of total shipments.
We believe 3G deployments will be delayed for the same reasons 2.5G was
delayed. The major causes were interoperability issues, technical
difficulties and a lack of handsets. In fact, we believe that 3G (in this
case WCDMA) is likely to be a 2003-2004 event rather than current
expectations of 2002. We believe this delay will not only impact the P&L's
of the handset and infrastructure vendors but will also put pressure on our
coverage universe throughout 2001 as the industry and investment community
struggle with timing concerns and poor visibility. As a result, we are
maintaining our cautious investment stance on the large cap wireless
equipment stocks, which include Nokia (NOK, 3M, $32.60), Ericsson (ERICY, 3M,
11 3/8), Motorola (MOT, 2M, $21.32) and QUALCOMM (QCOM, 1H, $86 13/16). We
would be more opportunistic once concerns surrounding handset growth,
infrastructure margin pressure and 3G timing became more clear. We feel this
is likely toward the end of the summer or late third quarter at best.
HANDSET ESTIMATES REDUCED TO 500 MILLION; GPRS WILL NOT SAVE THE DAY IN 2002
Motorola, Ericsson, Nokia, Siemens and Alcatel confirmed our thesis that even
the low-end of industry estimates for 2001 handset shipments were too
aggressive due to slower than expected replacement sales. In fact, many
vendors reduced their 2001 handset volume estimates on their respective
earnings conference calls. We continue to believe there remains substantial
risk to unit volumes throughout the year due to the replacement cycle, which
will lack a major new technology and service (e.g. data) until the fourth
quarter (at best). We have lowered our forecast for handset shipments this
year to 500 million from our already below consensus estimate of 520 million.
We believe data (i.e. 2.5G) services will help drive replacement sales in the
future, however we do not expect the deployment to be as early or as rapid as
many in the industry (primarily the handset vendors) currently believe. We
continue to believe GPRS services will be commercially available in 4Q01, at
best, but more likely 1H02. In fact, Nokia provided further evidence on its
earnings call last week when it indicated its GPRS phone would be available
in 3Q01 with volumes in 4Q01 as opposed to its earlier estimate of
availability in the 1H01. Telecom Italia Mobile and Vodafone both indicated
they do not expect GPRS handset volumes until 1H02. We will provide further
detail as to our concerns for GPRS timing below.
Our concern for industry estimates of handset shipments due to aggressive
replacement assumptions now extends beyond 2001 and into 2002. Many of the
major handset vendors believe the replacement cycle will accelerate in 2002
as GPRS services are commercially launched in several regions (mainly western
Europe and parts of Asia). We do not believe GPRS will be any more
successful than prior new technologies (i.e. GSM and CDMA) in its first year
after launch and therefore replacement sales for 2002 are already shaping up
to be too aggressive.
As we looked back on the industry at the success of new technologies in their
first full year of operation after they were initially launched, we found
they represented approximately 3-5% of the world's subscriber base. In 1993,
the first full year after its introduction, GSM represented 4.3% of the
world's subscriber base while in 1997, the first full year after its
introduction, CDMA represented 3.8%. We believe GPRS will fall in line with
its predecessor technologies and we are forecasting it will represent only 3%
of the world's subscriber base by the end of 2002. Based on our estimates we
expect the industry to ship 35.2 million GPRS handsets in 2002, or only 6% of
our 580 million estimate. Hardly enough to rapidly accelerate the world's
replacement cycle.
3G DELAYS SHOULD MIRROR PROBLEMS IN 2.5G
Through discussions over the past two weeks we have gathered several data
points that point to further deployment problems with GPRS. Current
consensus views for commercial availability for GPRS are now the end of 2001
as opposed to earlier expectations of 1H01. We continue to believe that GPRS
will be available, at best, in 4Q01 but more likely 1H02. Our bearishness is
predicated on our belief that GPRS will be further delayed to due to: 1)
interoperability issues between vendors' equipment; 2) technical issues; and,
3) lack of handsets.
Interoperability issues are not a new phenomenon, however they seem to
surprise many when they surface. The industry witnessed the same problems in
the early 1990's when GSM began and even in the early 1980's with AMPS.
First, it always takes longer to interoperate two different vendors'
equipment than it does one. Second, there is always some initial
disincentive for competing vendors to cooperate on interoperability. This is
a fact of life in a competitive environment.
In fact, we have seen evidence of this problem with Sonera's GPRS launch just
before Christmas where the carrier witnessed several problems including a 50%
dropped call rate anytime a customer tried to initiate a GPRS session.
Sonera is deploying Motorola handsets on its Ericsson/ Nokia network.
The other problems we are seeing are technical issues ranging from software
problems to network design issues to back office concerns. As new
technologies become much more complicated so do the issues with deployment.
Vimpelcom, a Russian GSM operator, has postponed its GPRS launch after it
witnessed network crashes due to software bugs while several operators in the
U.K. are witnessing deployment delays due network planners and vendors lack
of knowledge with packet-based solutions.
Last, but certainly not least, is the delay of handset volumes for GPRS. As
we highlighted above, Nokia, the world's largest GSM manufacturer, is not
expected to have volumes of GPRS handsets until 4Q01. As history has taught,
handset availability always lags infrastructure availability. This was
witnessed in analog as well as digital and is currently being seen in GPRS.
Nokia even highlighted this fact on its earnings call last week, calling it a
fact of life in the wireless environment.
We believe that certain 3G deployments (specifically UMTS) will also be
delayed due to the same reasons that are delaying GPRS, including: 1)
interoperability issues; 2) technical difficulties; and, 3) a lack of
handsets. These factors should push out the launches of WCDMA services
beyond 2002, in our opinion. In fact, several operators, including Telecom
Italia Mobile, believe that WCDMA handsets will not be available until 2004.
Therefore, 2002 is no longer the year of 3G deployments in our view, it is
the year of 3G delays. We believe this factor will not only impact the P&L's
of the major handset and infrastructure vendors, it will further cloud
manufacturers' and the industry's visibility with respect to the migration to
3G, thereby providing continued pressure on the stock universe throughout
2001.
3G WILL PRESSURE INFRASTRUCTURE MARGINS IN BOTH THE NEAR-TERM AND MEDIUM-TERM
Although there will not be any WCDMA revenues recognized in 2001 (with the
exception of NTT's WCDMA network), we believe there is concern for the
outlook of the major infrastructure vendors' P&L's in 2001 as well as the
next several years. Our main two concerns are: 1) the margin pressure which
will result from higher than expected initial operating expenses in
preparation for 3G shipments; and, 2) the initial margin pressure once 3G
revenues, and subsequent expenses, are recognized.
We had initially anticipated increased SG&A as many of the vendor's began to
increase staff and production facilities for the roll out of 3G equipment and
network deployments in 2001. However, we were not expecting to see as
significant an increase in R&D spending in 2001. The increased operating
expenses are resulting in 200-350 basis points in margin pressure for 2001
infrastructure operations compared to 2000 levels. Our estimates for
Ericsson, Nokia and Motorola infrastructure operating margins are 16.7%,
15.3% and 9.8%, respectively, versus 2000 margins of 19.9%, 17.6% and 12.5%.
We expect further margin pressure to occur once 3G networks are deployed and
manufacturers begin to recognize revenues. The initial margins for 3G
products will be extremely poor (breakeven at best) as the companies witness
higher costs due to expensive components and a lack of volumes to drive
efficiencies. The delays in 3G deployments will only push out this margin
pressure as well as create uncertainty with respect to revenue forecasts as
delays could cause an extremely "lumpy" sales environment. Please see our
report "2001: 3G Odyssey", dated January 5, for further discussions relating
to this concern.
QUARTERLY ESTIMATES PER SHARE DATA
Current Year* Next Year Next Year + 1
Ticker Period Current Previous Current Previous Current Previous
ERICY 1Q $0.00E $0.00E NA NA NA NA
2Q $0.05E $0.05E NA NA NA NA
3Q $0.05E $0.05E NA NA NA NA
4Q $0.07E $0.07E NA NA NA NA
Year $0.17E $0.17E $0.34E $0.34E NA NA
MOT# 1Q $0.12E $0.12E NA NA NA NA
2Q $0.17E $0.17E NA NA NA NA
3Q $0.21E $0.21E NA NA NA NA
4Q $0.25E $0.25E NA NA NA NA
Year $0.75E $0.75E NA NA NA NA
NOK 1Q NA NA NA NA NA NA
2Q NA NA NA NA NA NA
3Q NA NA NA NA NA NA
4Q NA NA NA NA NA NA
Year $0.83E $0.83E NA NA NA NA
QCOM 1Q $0.28A $0.28A NA NA NA NA
2Q $0.29E $0.29E NA NA NA NA
3Q $0.32E $0.32E NA NA NA NA
4Q $0.37E $0.37E NA NA NA NA
Year $1.26E $1.26E NA NA NA NA
Telecommunications Equipment 3G; The Odyssey That Will Stretch Well Beyond 2001
February 5, 2001 - T.C. Robillard Jr. - Karen O. Nielsen - SSB
please do not repost - ben |
