Network Equipment Providers Restoring Investor Trust... In that context, it would be easy to assume that all participants along the broad communications industry value chain, from telco
Trang 1Network Equipment Providers Restoring Investor Trust
Trang 2Global penetration of mobile data subscription is expected
to exceed 100 percent by 2015 In some markets that figure could reach as high as 150 percent (ie 1.5 times more subscriptions than individual subscribers).1 The growth of smartphones and IP-connected devices has driven exponential growth in data traffic And examining the volume of data sent and received by devices such
as smartphones it is easy to see why the increase is so marked When compared to a standard phone, the data traffic generated by new devices is many times higher Smartphones, for example, send and receive 35 times and tablets over 100 times the amount of data of a standard mobile phone.2 The use of mobile devices is extending
to almost all activities and areas of life, from travel to education, and from social networking to making financial transactions And as more and more people do more and more online, and IP-enabled devices directly communicate, the demand for data traffic will only continue to grow around the world
1
Trang 3In that context, it would be easy to assume
that all participants along the broad
communications industry value chain, from
telcos, to network equipment providers and
newer entrants such as over the top content
and service providers would benefit – albeit to
different extents – from that huge increase in
traffic After all, network operators should be
able to capitalize on the increasing demand
for data traffic and accordingly would need to
continue investing in improving their network
capacity and performance That should mean
investors would view all their prospects with a
degree of optimism But the financial picture
shows that intuition could be wrong Investors’
sentiment towards network equipment
providers (NEPs) does not demonstrate a
high degree of confidence in NEPs’ ability
to achieve growth Comparing the multiples
at which NEPs are traded with others in the
communications value chain shows a marked
discrepancy: investors do not necessarily trust
NEPs to generate returns in line with present
results, let alone deliver growth.3
To try and understand the reasons behind
this apparent lack of trust, Accenture has
carried out detailed financial analysis of
listed businesses in the sector and carried out
in-depth interviews with investor analysts
who cover at least two companies in the NEP
segment This point of view looks at some of
the underlying factors and suggests some steps
that NEPs may need to address in order to
rebuild investor trust
Growth forecasts for the NEP sector show only modest annual increase (+ 4 percent 2011
to 2016) for the core area of their business:
carrier network infrastructure The important area of telecoms operations management system licenses shows just slightly higher annual increase (+ 6 percent 2011 to 2016).4 Limited growth is partly attributable to advances in technology that are eroding equipment prices Greater competition from lower cost manufacturers in China has also played a part
On the other hand, telecom operators’ demand for professional services is expected to grow annually by 12 percent, which should, on the surface, open up a strong growth opportunity.5 However, services is a broad area It’s partly new territory for NEPs, in particular system integration and related changes to business operations Furthermore, the large IT service providers and software providers are already well established in this segment, which means
it presents a different competitive landscape for NEPs to navigate
+ 4%
2016
100,561
2011
82,807
Professional Services, Total addressable market*
USDm
+ 12%
2016
164,800
2011 93,500
Carrier Network
Infrastructure Equipment
USDm
Source: Gartner forecast Carrier Network Infrastructure,
Worldwide, 2009-2016, 2Q12 update Source: Informa Telecoms and Media: Managed Services: Strategies for network, service and support systems
outsourcing, Dec 2011
* Total addressable market includes services related to Consulting/Advisory, Integration and Management across the areas of Networks, Data/Applications, and OSS/BSS
9,053
+ 6%
2016
12,181
2011
Telecom Operations Management Systems, Licenses only
USDm
Source: Gartner forecast Telecom Operations Management Systems, 2009-2016, 2Q12 update
Financial analysis methodology
Accenture carried out financial analysis
to validate the hypothesis that Network Equipment Providers (NEP) are traded at lower multiples and hence lower investor expectations of their future performance
To do this, we compared NEP peerset performance across a number of financial metrics including:
• Current value/future value breakdown on enterprise value
• Enterprise Value per Invested Capital
• Revenue and Free Cash-Flow development
Peersets include
• Network Equipment Providers: All main vendors
• Telecom operators (22 companies across global geographies)
• IT service providers (6 companies)
• Over The Top service providers (7 companies)
1 Source: Pyramid Research DataTracker, Q4 2011
2 Source: Cisco, Virtual Networking Index Mobile, 2012
3 Source: Accenture analysis based on data from S&P Capital IQ
4 Source: Gartner, Forecast: Carrier Network Infrastructure, Worldwide, 2009-2016, 2Q12 update, June 2012 (Peter Kjeldsen,
Ian Keene and Akiyoshi Ishiwata); Gartner, Forecast: Telecom Operations Management Systems, 2009-2016, 2Q12 update,
June 2012 (Kamlesh Bhatia, Norbert Scholz and Martina Kurth)
5 Source: Informa Telecoms and Media: Managed Services: Strategies for network, service and support systems outsourcing,
Dec 2011 (Kris Szaniawski)
Forecast growth per market sector
2
Trang 4No recovery in sight
Over the last decade, the NEP industry
has seen increased competition leading
to significant consolidation This has
taken the form of M&A activity as well
as the development of joint ventures and
the failure of some players in the market
alongside the emergence of new players
from emerging markets In 10 years, the
number of major players has contracted
from nine to six, who between them make
up more than 80 percent of the market.6
From 2003 until 2007 NEPs enjoyed
steady growth in enterprise value with an
almost equal weight consistently placed
on current and future values However,
in 2008 as a result of the financial crisis,
value collapsed Future value shrank from
an average of 41 percent in 2007 to just 3
percent in 2008 Unlike other companies
in the communications sector, NEPs’ value
has failed to bounce back In 2011 the
future value of the sector entered negative
territory, seeing its total valuation fall by
more than 60 percent from peak levels in
2007 Yet in 2007, investors displayed more
confidence in the prospects of NEPs than
they did for telcos Today, that has reversed
completely, and telecom operators’ value
puts them back at the level they were at in
2006, with investors still identifying some
future value.7
In even more marked contrast, however, is
the valuation of the most recently emerged
segment in the value chain: the over the
top (OTT) content and value added service
providers While the comparison has to take
into account other factors driving the high
valuation given to the segment (such as
participation in other industries – there are
few pure OTT businesses for which public
data is available) investor confidence in the
ability of the segment to achieve strong
future performance stands in marked contrast
to NEPs IT service providers have also fared better than NEPs, showing steady growth over the last decade, with current values continuing to grow after the financial crisis, and maintaining a consistent proportion of future value over the last few years
An additional measure of investor sentiment
is the investor premium on invested capital Here again, NEPs are seriously underperforming their peers in other industry sub-segments Investor premium for NEPs
is negative and has more than halved since
2003 Given that this headline figure includes
an assessment of services (an area that typically requires less capital to generate returns) as well as equipment, the figure may mask an even greater negative sentiment for equipment than face value suggests
From our analysis of available financial data, it’s clear that from an investors’ point of view NEPs do not present an attractive proposition for future returns On the measures that we used, they compare poorly to other segments
of the communications value chain To try to find out what some of the reasons for that perception might be, we conducted in-depth interviews with investor analysts that cover at least two NEPs
Enterprise value defined
• Enterprise value = total value of a business
Formula: Market capitalization + Net debt
• Current value = the present value of current operations Formula: Net operating profit less tax/weighted average cost of capital
• Future value = the portion of Enterprise value that represents the expectations from investors on future cash-flow levels Formula:
Enterprise value – current value
2,5
1,8 1,2
6,6 1,4
2,0
3,0
7,9 1,9
2,9 5,4 0,9
IT service provider subset OTT subset Telco subset NEP
2011 2007 2003
Source: Accenture analysis based on data from S&P Capital IQ
Investor premium on Invested Capital multiple (Enterprise Value/Invested Capital)
6 Accenture analysis of company performance
7 Source: Accenture analysis based on data from S&P Capital IQ
Enterprise Value (bn USD) and Future Value weight
Investor premium on Invested Capital multiple (Enterprise Value/Invested Capital)
2011
160
-19%
2010
232
15%
2009
241
21%
2008
232
3%
2007
420
41%
2006
357
38%
2005
373
50%
2004
355
48%
2003
343
50%
Future value Current value
Enterprise Value (bn USD) and Future Value weight
279
6%
280
13%
253
18%
232
8%
330
38%
282
27%
285
37%
238
32%
196
25%
2007 2006 2005
2004
NEPs
Telecom operator subset
Source: Accenture analysis based on data from S&P Capital IQ
2011
592
49%
2010
477
56%
2009
364
56%
2008
191 45%
2007
357
82%
2006
201 82%
2005
169 83%
2004
78 86%
2003
25 92%
OTT subset
2011
433
22%
2010
434
22%
2009
397
21%
2008
287
-4%
2007
366
39%
2006
333
48%
2005
274
41%
2004
276
48%
2003
256
55%
IT service provider subset
3
Trang 54
Trang 67 5
3
6 2
3 4
Predicting/understanding customer
demand, market development
Lack of detailed information
on products, contracts etc
Understanding competitive
dynamics and differentiation
Understanding impact of
future technology development
Measuring/predicting
gross margins
Understand operators’ technology
roadmaps and intentions
Other
Top 3 challenges in analyzing the Network Equipment Provider segment
Number of responses
Base: All (14 interviews)
Source: Accenture survey of Network Equipment Provider Investment Analysts, 2012
Top 3 challenges in analyzing the Network Equipment Provider segment
A clearer picture needed
The survey reveals that analysts face some
serious challenges understanding the network
equipment industry They express their difficulty
in obtaining a clear picture of the market’s
development and associated demand as the
largest single barrier, followed by the lack of
detailed information on products and NEPs’
contracts as well as more generally the impact
of technological development on the future
shape of the market and the demand it will
drive While analysts do not find it hard to
understand NEP’s present business models,
they struggle to display the same confidence
when it comes to predicting future earnings
and the drivers behind them And one of the
reasons for that lack of confidence is the dearth
of information analysts have to help support
their view of the industry’s future – and their
requests for additional information include both
broad and more detailed information
“ The disconnect between carrier capex and equipment spending, […] they give
their capex budgets only about half the budget or less to spend on active equipment linking what carriers are doing back to what equipment revenues are likely to be.”
“…the main problem is actually lack
of information on their contracts
so it is essentially a business which is
determined by some very, very large contracts but we have very little understanding of these contracts.”
“How productivity and equipment improve going forward I think is
probably the #1 issue […] There are things
we know today but it is technology so there will always be innovation.”
”It is really hard to know what is going
to happen next Revenues can be very volatile and market shares can change
quickly.”
5
Trang 7“The OTT guys are high-growth profitability companies, the carriers are
low growth but high profitability and the vendors are low growth, low profitability companies That’s why the multiples move the way they do.”
“…for OTT’s, compare growth…
… service providers show superior earnings and stability in earnings compared to the equipment vendors.”
“ The over the top guys are growing, the other ones (NEPs
and Telcos) aren’t.”
Revenue & Free Cash-Flow (USD m)
NEPs
200,000
100,000
0
2011 2010 2009 2008 2007 2006 2005 2004
2003
40,000 30,000 20,000 10,000 0
400,000
300,000
Revenue Huawei revenue
FCF
Source: Accenture analysis based on data from S&P Capital IQ,
Accenture survey of Network Equipment Provider Investment Analysts, 2012
OTT subset
40,000 30,000 20,000 10,000 0 100,000
200,000 300,000
0
2011 2010 2009 2008 2007 2006 2005 2004 2003
FCF Revenue
Revenue & Free Cash-Flow (USD m)
Comparing segments
When asked about the difference in the basis
for valuing NEPs compared with OTTs and
telcos, investor analysts generally point to the
difference in growth Some analysts ascribe
the slightly higher valuation of the telcos
to their higher and more stable earnings
Analysts see the returns from investments in
telcos producing smoother returns, with fewer
surprises NEPs, on the other hand, have been
subject to significant volatility and cyclicality
6
Trang 8Variation from Analyst Consensus on Net Income in quarterly reporting, 2006-2011
NEP
Telco subset
IT Service Provider subset
Telco subset average
IT Service Provider subset average NEP average
% of Reporting Times Below
Consensus Expectations
100%
90%
80%
70%
60%
50%
40%
30%
20%
10%
0%
Average Negative Deviation from
Consensus Expectations, (% of revenue)
16% 14%
12%
10%
8%
6%
4%
2%
0%
Variation from Analyst Consensus on Net Income in quarterly reporting, 2006-2011
Not only do NEPs have more volatile earnings,
they also more frequently fail to communicate
effectively with investors about those
fluctuations On average, in two out of three
reporting instances over the past five years
NEPs failed to meet analyst consensus on
earnings (net income), and negative deviations
expressed as a percentage of revenue are on
average 6.1 percent.8 This is clearly higher
than for the IT service provider peer set studied during the same period NEPs also
on average underperform when compared
to the telco peer set However there are big differences in the performance of individual companies in both groups
8 Source: Accenture analysis based on data from S&P Capital IQ
7
Trang 9No future consensus
Analysts’ recommendations about where NEPs should invest show no clear consensus They demonstrate a wide range of views about the extent to which investments should
be focused on existing and new revenue opportunities The areas for future investment are similarly vague and diverse with very few concrete suggestions – though solutions to manage data and traffic bottlenecks attract the largest number of recommendations
The conservatism of those views is echoed
in analyst projections of the shape of the industry in the future Most believe that there will be fewer larger providers in five years’ time, and believe that network equipment will remain the core business for leading competitors, though some argue that provision of services will dominate in future
In sum, analysts’ relative pessimism about the prospects for the sector continues to depress their assessments of value They see little evidence that the growth the sector experienced in the years between 2003 and 2007 will return.9 However, the lack
of evidence that they see may be partially explained by the lack of information that they identify and the associated inability to spot the future trends – whether in the market, from technology or from customers – that will drive future growth
“I think there is [sufficient] investor confidence I don’t know if much can be
done to boost it any further ”
“[Owing to] cyclicality [these businesses]
can go from boom to bust very quickly and with very little warning, [therefore] you don’t want to overpay for these companies.”
“[One challenge] for investors [is that they] can be completely blindsided by a real slowdown - [without that] it would
be more predictable and they could invest with more confidence.”
9 Source: Accenture survey of Network Equipment Provider Investment Analysts, 2012
Investor analysts’ examples of attractive investment areas
Most attractive investment balance between existing and new revenue opportunities
Analyst K Analyst J Analyst I Analyst H Analyst G Analyst F Analyst E Analyst D Analyst C Analyst B Analyst A
Existing New
8 2
3
6
Higher level networking (layer 4-7)
Next generation wireless
in general
Solutions to manage data and/or reduce traffic bottle necks
Other
• When asked, most investor analysts suggest investments in traditional network equipment domains
• Several investor analysts want to see investments in technology to help operators manage the growing data volumes
• Expansions into new domains, such as new verticals, or new business models, such as Cloud computing, are not frequently mentioned
• There is no consensus view among the investor analysts on how investments should be balanced by existing and new revenue opportunities
Source: Accenture survey of Network Equipment Provider Investment Analysts, 2012
Number of responses
Base: All (14 interviews)
Most attractive investment balance between existing and new revenue opportunities
Investor analysts’ examples of attractive investment areas
• There is no consensus view among the investor analysts on how investments should
be balanced by existing and new revenue opportunities
• When asked, most investor analysts suggest investments in traditional network equipment domains
• Several investor analysts want to see investments in technology to help operators manage the growing data volumes
• Expansions into new domains, such as new verticals, or new business models, such
as Cloud computing, are not frequently mentioned
Investor analysts’ examples of attractive investment areas
Most attractive investment balance between existing
and new revenue opportunities
Analyst K
Analyst J
Analyst I
Analyst H
Analyst G
Analyst F
Analyst E
Analyst D
Analyst C
Analyst B
Analyst A
Existing New
8 2
3
6
Higher level networking (layer 4-7)
Next generation wireless
in general
Solutions to manage data and/or reduce traffic bottle necks
Other
• When asked, most investor analysts suggest investments in traditional network equipment domains
• Several investor analysts want to see investments in technology to help operators manage the growing data volumes
• Expansions into new domains, such as new verticals, or new business models, such as Cloud computing, are not frequently mentioned
• There is no consensus view among the investor analysts on how
investments should be balanced by existing and new revenue
opportunities
Source: Accenture survey of Network Equipment Provider Investment Analysts, 2012
Number of responses
Base: All (14 interviews)
8
Trang 10Regaining investor trust
Addressing investors’ concerns is likely
to require two fundamental things: first,
delivering both top and bottom-line growth
and second, enabling better predictability
by stabilizing earnings and communicating
performance to the market more effectively
In a context, such as the NEP industry,
where companies are struggling to deliver on
the former, the latter is still important but
may not yield a significant positive impact
on investors’ trust But for all companies,
effective execution and demonstrating
tangible results is key to regaining investors’
trust NEPs need to establish some clear and
measurable success stories before they set
expectations about future performance
The range of industry options
While this paper does not intend to address
the fundamental growth challenge facing
the NEP industry, it is worth reflecting on
the various positions in which different NEP
players find themselves Each of the major
NEP players exhibits different financial
positions, as shown by the growth-and
spread-matrix (above) Companies with a
positive spread should focus on growing top
line with maintained margin Creating growth
in a mature market is not easy and there
is no one-size-fits-all solution Essentially,
companies have two options They can either
try to capture additional market share, or
they can grow their addressable market by
expanding their coverage both horizontally
and/or vertically We see examples of both
in the market One of the more successful
examples of the latter is Ericsson’s expansion
into the service domain Another example,
which is too early to evaluate, is Huawei’s
move into semiconductors
Companies with negative spread but positive growth could remain in this position short-term to gain market share, but eventually need to define a plan to turn the growth they achieve into a sustainable business Fast-growing companies in particular could have much to gain from taking measures to improve their internal efficiency
For companies with negative spread and negative growth, survival is the name of the game Finding a way out of their current position could be very challenging They need
to focus on one dimension at a time and should prioritize profitability over top line growth One option for them could be to focus
on specific areas where they could establish
a profitable position as one of the leading competitors and divest other, non-profitable segments
Stabilize and communicate
Companies in the sector will need to achieve closer alignment between reported results and consensus forecasts That means avoiding successive profit warnings that have been so obviously damaging to investor trust NEPs may also need to explore business models that can help smooth the flow or revenues and profits in order to reduce the obvious manifestations of volatility that have made it hard for analysts to create a picture of future performance
As well as addressing performance stability, NEPs may need to invest time in how they communicate with investors There is a clear information gap between what analysts are able to acquire today and what they say that they need to make more accurate assessments of potential for the sector
NEPs should, where possible, try to augment existing information with the insights that could serve to increase investors’ analysis
-20
-10
0
10
20
Company 5
Company 1
Company 3 Company 2
Company 8 Company 7
Company 6
Company 4
Year-on Year Revenue Growth (Percent)
Growth and Spread Matrix over Network Equipment
Providers, Fiscal Year 2011
* Spread: Post-tax Return on Invested Capital less the Capital Charge
of future developments While balancing transparency with competitive pressures is clearly not easy, the more information that NEPs can offer the greater their chances of increasing levels of trust among investors That may mean creating a clearer link between the evolution of technology and its likely impact on financial performance It may also mean providing guidance on future market trends and company performance That might involve rethinking how performance is reported by redrawing it in line with different segments or categories that are independent
of organizational structures, for instance
by giving insights into volumes and related financial dynamics for both services and products In that way, analysts will have greater transparency and find it easier to make comparisons over time than they do today
And finally
Our analysis shows that NEPs have considerable work to do to transform their prospects But with the continued strong growth across all markets in the need for better, faster and broader data networks there is still much to play for There are opportunities for NEPs to capture growth and generate profits But they need to make sure that they create and communicate a clear strategic response to investors in order to rebuild trust
Growth and Spread Matrix over Network Equipment
Providers, Fiscal Year 2011
9