re: SoundView Wireless Equipment Industry Update (Mobile Phones)
The 17 page report in PDF can be downloaded here:
research.soundview.com
There is quite a bit of detail in seven embeded graphic tables that I have not abstracted here.
>> Mobile Phone Market: 2Q02 and Beyond
Matt Hoffman
Jennifer Baxter
Jason Willey
SoundView
August 8, 2002
Industry Net:
Mobile phone unit sales were better than expected in 2Q02, driven by net subscriber additions in Asian GSM markets. Market leader Nokia saw pressure from Motorola, our top pick, in 2Q02 and cut price to keep share. Pricing was flat overall in 1H02, although we expect it to rise in 2H02. We reiterate our 428 million 2002 sell-through number.
• Exiting 2Q02, we are reiterating our 428 million handset unit
sell-through number for 2002, with minor modifications, and maintaining
our outlook for 2003 at 450 million units. Our estimates are among the
highest on the Street and remain above the forecasts of the major handset
OEMs, which we believe are under-reporting the market to inflate share.
• 2Q handset growth was driven by above-expectation subscriber growth,
especially in Asia, but was somewhat offset by lower churn (higher churn
translates into higher handset sales). Replacement sales drive our outlook
for 2H02.
• During the June quarter, Motorola clearly took market share and looks
best positioned to grow its share in 2H02. Nokia also participated in the
good 2Q02 market, but is fighting with an older entry-tier lineup. Both
vendors, especially Motorola, exceeded our 2Q02 handset estimates
handily.
• Our current checks at operators in Europe indicate they are wound up for
a good 4Q02, based in part on enthusiasm for the new product cycle.
Operators have low-cost GSM product available at subsidy-free prices
while phones with color displays and packet data prop up the high end.
• GSM is the fastest growing technology globally, easily surpassing the
growth rates of TDMA and CDMA. High-growth GSM countries China,
India and Thailand still have relatively low penetration.
Reports from 2Q02 can be best characterized as in-line to slightly better than expected for the handset vendors. Results were, to a large extent, previewed through mid-quarter updates and affirmations of guidance during June, and therefore it was the outlook for 2H02 that was of greatest interest to investors in the July earnings season. On the surface, OEM forecasts for mobile phone shipments in 2002 generally appeared to be lowered, and the stocks suffered as a result. However, we view the "lowered outlooks" somewhat skeptically. The global handset market exceeded expectations in 2Q02, coming in slightly above our estimates, while handily beating most Street estimates. We believe the market will continue to outperform in the second half of 2002, and that 1H02 is being under-reported so that OEMs can make higher market share claims. Though we appreciate that overall revenue estimates for the OEMs were generally revised downward, the most significant reductions came in infrastructure and other businesses, not in their mobile phone businesses.
Figure 1. Earnings Season Roundup (see PDF page 2)
Global Handset Market Update
SoundView measured 2Q02 actual handset sell-through at 100 million, compared to our estimate of 99 million. The results were driven mostly by strong consumption patterns in GSM markets in Asia, and to a far lesser extent sales of CDMA in North America, most notably at Verizon. At the same time, Europe did not deteriorate further and may actually be showing the first signs of a rebound given improving sales of high-end handsets in that all-important market.
We expect a good deal of noise from more bearish members of sell-side leaving 2Q02 as they try to explain the higher than expected numbers the industry reported in the quarter. We expect a good deal of the early discussion to center on methodology and how the numbers are collected and reported. As a reminder, we have always based our sell-through numbers on public reports from operators, including churn and subscribers, and from proprietary industry contacts that allow us to calibrate our replacement model against the exact consumption numbers from key operators globally.
We used the aforementioned demand, or sell-through, methodology to collect results from operators representing more than 60% of the world’s subscriber base over the past 30 days. The results of that survey led us to conclude that net subscriber adds for 2Q02 were 8 million higher than we expected, coming in at 47 million. Net add strength was the primary driver of upside handset sales in 2Q02. We go into more detail on the subscriber outlook in the latter portion of this report.
SoundView Handset Forecast: Still Bullish, With Minor Modifications
We are maintaining our high-side-of-the-Street unit forecast of 428 million this year and 450 million for 2003. We expect to see total market numbers drift up across the Street post the 2Q02 earnings season given the unavoidable fact that shipments for every player, save Sony Ericsson, beat expectations in the quarter. Motorola had the biggest upside in unit shipments this quarter, although Nokia, Samsung and Siemens also did well in 2Q02.
Figure 2 shows our new handset forecast for the second half of 2002 and 2003. While churn and replacement units were slightly lower than we expected in 2Q02, net add strength more than made up the difference.
For the year 2002 we are taking our net add numbers up and our churn assumptions down a tick, primarily to account for the dynamics we saw in the first half of 2002. For the second half of 2002, we are basically maintaining our estimates across the board, estimates which include our high-end-of-the-Street 2H02 handset sell-through estimate of 230 million units. We still expect good replacement sales in 2H02 on strength in the high-end GSM and in Asian CDMA markets.
While our handset forecast remains essentially unchanged, we want to point out the healthier composition we now see in the market. A handset sale, no matter whether from churn or a net add, is positive for the industry - but some are more important than others. Investors would rather see new handset sales coming from net additions, not higher churn. There are two primary reasons for being more positive on sales from net adds than churn. Reason one is that net adds grow the base of users, and the larger the number of users the larger the potential pool of upgrade phones in the future. Second, net add growth is rewarded by the Street because of its positive impact on future cash flow, whereas operators with high churn are often penalized because the length of time a subscriber stays on the system is reduced.
Figure 2. Mobile Phone Forecast through 2003 (see PDF page 5)
GSM Growing Fastest Right Now
Data collected through the first half of the year suggests that GSM is by far the fastest growing technology year over year. For the year 2002, Figure 3 shows we see GSM growing at almost 20% while CDMA grows at 8% and TDMA shrinks to 6%.
The explanation for the various growth rates lies in the fact that the major CDMA markets of Korea, Japan and North America are rapidly maturing, whereas GSM is still seeing very good growth in countries like China, India, Thailand and others with low penetration rates. TDMA sales are getting hit by operator defections to GSM and a weak Latin American market. The weak Latin American market is also affecting CDMA sales, but with very little GSM in the region, the latter technology largely escapes the weakness there.
We believe Motorola is the best-positioned OEM to take advantage of incremental strength in GSM this year.
Motorola maintains the largest market share in China, having historically placed emphasis on distribution and Chinese language support in its phones. Combined with an overall improvement in its products, Motorola should see good momentum in Asia in 2H02. CDMA may see higher growth next year on a 1X replacement cycle, but we remain wary about the actual size of that cycle. We usually point out that our low-end-of-the-Street numbers on QCOM for 2003 still project earnings growth for the company - the argument is over how much and what to pay for that growth.
Figure 3. Handset Sales by Technology (see PDF page 6)
Handset OEM Market Share
We are naturally suspicious when we see the high number of claims of market share gains like we saw in 2Q02.
Obviously not all OEMs can be taking market share. We think the clear outperformer in 2Q02 was Motorola, as shown in Figure 4. Please note that our "previous" estimates lines in Figure 4 refer to our estimates entering the July reports. In beating our unit estimate of 14.2 million by 2.5 million, MOT had the largest sequential jump in share. We wrote several times during the second quarter that TDMA sales at Motorola were going to drive results at the company and indeed we saw that as Motorola reported TDMA sales up more than 140% in 2Q02 over 1Q02. We expect to see continued good progress in TDMA from Motorola this quarter, and also expect CDMA sales will remain strong as its 1X product bows late in the quarter.
We now measure Motorola’s market share at 16.8%, up from 15.6% last quarter. We expected Nokia to lose share in 2Q02, but it is clear from the results that it did not lose as much as we had feared. Nokia moved aggressively on the price of individual, older models in GSM and TDMA to keep its market share high. Nokia has the lowest cost-to-build in the industry and can use that advantage anytime to drive unit sales up. However, we would point out that the pricing declines and share increase came at a cost. Nokia phone ASPs dropped precipitously in 2Q02 to $142 from $147, as seen in Figure 5. We see Nokia ASPs holding steady this quarter in spite of the new products the company has ramping in the quarter, like the 7650 camera phone, as the company presses sales of older 3300 series phones this quarter.
Figure 4. Nokia, Motorola, and SEMC Unit Market Shares (see PDF page 8)
Sony Ericsson had a rough 2Q02 after being the poster-child for rising industry ASPs the last three quarters. Although the company continued to see higher ASPs, now at $173, up from $171, the company only had unit shipments of 5.0 million, well below our estimate of 6.8 million. The company felt pressure in its TDMA and low-end GSM programs as key new models - including the T300 - were late to ship. The T68i, although not a high-volume piece, continues to be an excellent seller, but the company cannot drive enough volume to keep its overall share high with just one hot selling phone. CDMA continues to be tough for the company.
Another trend we would like to highlight is the increase in market share in "Others" compared to the Big Three OEMs. Vendors included in the other category include Samsung, Siemens, Kyocera, Audiovox, Mitsubishi, Matsushita, NEC, LG, and smaller Asian manufacturers. We currently forecast the Other category to gain three points of market share in 2002 away from SEMC and to a smaller extent Nokia. This shift is primarily attributed to the strength of Samsung in the first half as well as the Korean manufacturers on the rollout of 1X. Samsung shipped a healthy 19 million phones in 1H02 driven by a strong handset lineup in 1X.
Figure 5. Handset Selling Price Trends for Industry and Major OEMs (see PDF page 10).
"Lowered" 2H02 Forecasts Look Similar Across Vendors
We would like to echo our long-standing assertion that major handset OEMs are under-reporting the size of the total handset market, especially reported quarters. Despite the shock value of headlines citing reduced forecasts in the mobile phone industry for 2002, we would argue that 2H02 shipment forecasts actually look fairly similar from all three large OEMs.
Motorola and Nokia lowered their forecasts for 2002 shipments to 400 million (sell-in) and Ericsson now puts 2002 volumes at 390 million. Only Samsung holds onto a higher outlook at 415 million.
We would argue that investors need to look under the covers at these estimates, as the discrepancies between vendors (and our own SoundView estimates) lie in how these companies report the past, rather than how they predict the future.
The goal of every executive is to state they are outperforming the market, and while only a few actually do that, most try to report they are doing so.
Figure 6 shows that the major difference in the 2002 outlooks for the major OEMs is actually the past, not the future. In fact, there is only a 3 million difference between the high and low sell-through estimates as outlined by OEMs Nokia, Motorola and Sony Ericsson.
Figure 6 shows the historic and projected handset volumes for Motorola, Nokia, and Ericsson. After backing out what each vendor reports as industry volumes for 1H02, the sell-through forecasts for 2H02 are indeed fairly close together, ranging from 218 million at Nokia to 221 million at Motorola.
Figure 6. 2H02 Unit Shipment Comparisons (see PDF page 12)
SoundView sizes the 2Q02 market at 100 million based on our bottoms-up demand-first approach using operators and industry inputs. We would point out that Ericsson’s estimate of the 2Q02 market looks fairly absurd at 85 million sell-in. We expect it to be revised upward, given that we know the unit shipments for the top six vendors already reach 81 million with Nokia at 36 million, Motorola 16.7 million, Ericsson 5.0 million, Samsung 9.5 million, Siemens 8.2 million, LG 3.7 million, and NEC 1.8 million. And, the 81 million figure does not include Audiovox, which shipped around 2 million units this quarter, Kyocera, Alcatel, Sagem and smaller Asian manufacturers.
Seasonality Portends Big 4Q02
Implied 2H02 sell-in volumes of 218 million to 224 million (SNDV = 231 million) will be seasonally skewed toward 4Q02. Handset shipments in the third quarter are typically flat to up slightly sequentially, with 4Q the best performing quarter.
In 2001, sell-in volumes were up 15% 4Q01 over 3Q01 with 10 million units of excess inventory. Using Motorola’s forecast of 106 million in 3Q02, the company’s 4Q02 estimate of 118 million represents only an 11.3% sequential rise - not unreasonable. We believe the industry as a whole will seek to avoid the inventory build that occurred last year.
Outlooks provided by the OEMs, we believe, were conservative yet achievable. Motorola expects revenue to rise 11% in 4Q02 over 3Q02. Nokia appears to be a bit more controversial, we believe, as it pushes out its revenue ramp until 4Q02. Guidance for the remainder of the year banks on a big 4Q02 - up 25% sequentially.
Component Suppliers Confirm Positive Indications for 2H02
Reports from all the major handset component suppliers confirmed some of the trends we have identified this quarter.
Overall, Motorola began to appear as a larger customer at RFMD, TQNT, and SWKS, corroborating the outsourcing trends at Motorola as well as the gain in market share in TDMA and CDMA. At RFMD, Nokia declined as a percentage of revenue, and Samsung was announced as a new customer. RFMD expects revenue from Samsung to double sequentially on the ramp of new products. We believe these are 1X handsets that should continue to help Samsung hold its growing market share. Skyworks also validated strength at Samsung, citing volume production of front-end modules.
Regional Roundup - 2Q02 Global Subscriber Growth Exceeds Expectations
With the majority of major operators reporting their results for 2Q02, we believe the overall global subscribers for the quarter came in around 1.04 billion. This number is about 8 million subscribers ahead of our expectation of 1.032 billion we had entering the quarter. Actual results factored into our calculations include those from Vodafone Group, Orange, Telefonica Moviles, mmO2, Telia, Sonera, AT&T Wireless, Verizon, Cingular, Rogers Wireless, Bell Canada, Sprint PCS, Turkcell, and Telcel. We also were able to collect country results from China, Japan, Korea, Thailand, Singapore, Greece, India, Egypt, and Hungary. With this large and representative sample size, we are fairly comfortable with our numbers for the second quarter.
In terms of performance from individual geographies the quarter went largely as expected, with strength coming from Asia/Pacific and EMEA. More penetrated geographies such as Western Europe and North America continued to show slowing growth and Latin America was most affected by the general economic weakness.
Many themes from 1Q02 were present in the 2Q02 as the weakening global economy and increasingly high penetration rates in many countries have led to slower overall growth than was seen throughout 2001. However, 2Q02 results still beat expectations. Developing countries in Asia and the EMEA regions, with extremely low penetration rates (many below 20%), have enabled these markets to continue to grow despite an increasingly uncertain economy.
Asia Remains Key Region for Subscriber Growth
The stronger than expected performance in 2Q02 was almost entirely driven by upside in the Asia/Pacific region. Asia/Pacific accounted for 48.9% of the net adds in the quarter and remains a strong indication of where growth in subscribers will come from moving forward. We estimate the region’s overall penetration rate at slightly below 11%, leaving plenty of room for continued growth.
Particularly strong vs. our expectations were the results in Thailand and China. The results for these countries are laid out in Figure 7. Thailand showed 136% year-over-year growth, 41.1% growth quarter over quarter, and were well ahead of our expectations. China also continued to add subscribers at an impressive pace, with 14.8 million net adds for the quarter. Even with its current number of 176.2 million subs, China still has a penetration rate below 14%. We anticipate low-penetration Asia/Pacific countries such as China, Thailand, India, Pakistan, Vietnam and Indonesia will continue to show strong performance as they are still in the early stages of signing up voice subscribers.
Figure 7. Subscriber Growth in China, India and Thailand (see PDF page 14)
Japan and Korea showed growth in 2Q02 that was more consistent with seasonal trends in those countries. Their results also showed the effects of high penetration rates in Japan and handset subsidies in Korea. Japan added 1.6 million subs and Korea added 0.6 million vs. 2.0 million and 1.4 million, respectively, in 1Q02. While neither of these countries will be strong growth drivers moving forward, they both continue to add subscribers at a steady pace and are successfully transitioning to offering data services.
Data services in certain Asian markets continue to show good traction as the Korean operators and KDDI in Japan now account for the majority of the world’s 1XRTT subscribers. In Japan, J-Phone has seen strong traction with its photo messaging service signing up over 5 million users while KDDI has signed up over 1.6 million subs on its 1XRTT network since its April launch. One negative has been the uptake of NTT DoCoMo’s 3G FOMA service, which has only signed up 127,000 subscribers. DoCoMo has been actively reducing expectations for FOMA, and we think growth will not occur until W-CDMA/PDC dual-mode phones are available. We would point out that all W-CDMA phones going into Europe and the rest of Asia are dual-mode W-CDMA/GSM. We continue to believe disappointing numbers from FOMA are more related to poor geographic coverage and limited dual-mode phones than a lack of end-user interest in the service.
Growth Continues to Slow in Western Europe and North America
Net adds continued to decline quarter over quarter in Western Europe as high penetration rates have turned some countries into almost zero growth situations. Outside of approximately 800,000 net adds in both Italy and Spain, most Western European countries showed minimal growth over 1Q02. Results in Germany came in better than we had expected (still awaiting official T-Mobile release) and turned positive from the negative net add number we saw in 1Q02. In general, Western Europe continues to show slow growth, as high penetration rates in most countries combined with operator decisions to focus less on pre-pay customers to limit the potential new customer pool. Focus has shifted to improving the quality of the customer base and taking subscribers from competitors.
In North America we continued to see slowing growth in net adds as higher penetration rates have made compressions to 2001 results very difficult. In 2Q02 there was a shift in performance between the operators as Sprint PCS reported very disappointing results while Verizon and Voicestream both handily beat our expectations. Much of this shift in market share was related to promotional spending, as both Verizon and Voicestream were aggressive with pricing and promotion. Net adds for the quarter came in at 3.3 million vs. our estimates of 4.4 million.
Developing Regions Show Diverging Results
Latin America continues to remain weak as poor economic conditions have a greater effect on this region than in other markets. The total subscriber number of 90.9 million was relatively in-line with our expectations as net adds continued to decline, falling 3.7% quarter over quarter. Brazil and Mexico continue to account for over 60% of the region’s subscribers and both have penetration rates under 25%. We are still optimistic that with an overall penetration rate of around 18%, the Latin American region can be a larger growth driver moving forward.
The EMEA region met our net add number of 8.0 million subs and continued to grow at a positive rate of 6.9% quarter over quarter. Growth was particularly strong across Eastern Europe where penetration rates lag those of their Western counterparts. We expect solid results to continue in EMEA as the region’s penetration rate of 7.6% is far below that of any other geography. EMEA is the only region where we expect sequential growth in every quarter of 2002.
Subscriber Trends In 2H02 And 2003
We continue to believe that marketing plans for GPRS and MMS are going to be the primary focus in European operators in the replacement market in 2H02. In fact, we believe we are starting to see the re-emergence of subsidies on phones like the 7650 on which operators believe there will be an increase in ARPU.
The second major trend is the move by operators back to prepaid on the low-end. Unlike the prepaid subscriber model circa 2000, this year’s version offers consumers compelling price points, around $75 for a phone, but operators do not have to subsidize the handset to achieve those price points. Low-end GSM phones are now low cost enough to make that equation work.
Strong first half performance and our expectations for developing regions across Asia and EMEA have led us to raise our full year 2002 and 2003 subscriber forecast. We are taking our 2002 number from 1.123 billion to 1.130 billion and our 2003 number from 1.250 billion to 1.261 billion. However, we are trimming our churn estimates to effectively cancel out the net add increase. These moves bring our 2002 net add number to 180.6 million from our previous estimate of 171.6 million. The majority of this upside was captured in the first half of the year as our 2H02 net add numbers remain relatively flat with our previous estimates of 90.9 million. That forecast may well prove conservative.
We anticipate continued weakness in Western Europe and North America, primarily related to high penetration levels in these countries. We are still hopeful for a seasonally strong 2H02 in Latin America as operators and end users have become more comfortable with the current economic environment and adjust their promotional and spending behavior accordingly. Asia/Pacific and EMEA will remain the key growth drivers as we expect continued quarter-over-quarter growth in EMEA and only slight quarter-over-quarter declines in Asia/Pacific, with the total numbers remaining strong.
Stock Net
August is a difficult month for wireless as we try to predict the pace of sell-in and the likelihood that sell-in turns into sell-through. However, we still feel strongly that Motorola is the best-positioned vendor in a growing global handset market. With the recent market pullback and management changes leaving the stock at its historical 0.9x sales multiple trough, we would still have investors build positions at these levels. Nokia is also trading at historic trough levels on a trailing 12-month P/S basis, but until the new products show strength we would be more cautious with the shares. <<
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- Eric - |
