Archive for April, 2010
Protected: April 26, 2010 The Practical Boundaries of Health Insurance Regulation
April 22, 2010 Quick Thoughts: Lower Subsidies Will Delay Handset Recovery
1Q10 results and forward guidance from players on the wireless value chain have been largely uninspiring. While we are very bullish about the future of wireless technology, and in particular, the promise of 4G, we are more sanguine about the near term prospects for an immediate recovery in global demand. Replacement sales to existing subscribers make up more than 85% of the global device market. These sales are extremely sensitive to the subsidies that are provided by carriers – drops in subsidies cause users to hold onto their phones longer and to choose cheaper devices when they do replace. Global mobile device demand was very slow to recover from the 2001 recession, largely, because carriers were cautious in returning subsidies to pre-recession levels. We believe that carriers, facing sluggish industry subscription growth, will remain conservative on device subsidies and that recovery in mobile demand may lag the overall economy by more than a quarter or two.
The U.S. market has remained somewhat more robust, with a sharp shift toward smartphones, and in particular, iPhones and Google Android models, driving brisk replacement. Even here, there are some signs of concern, as carrier net subscriber additions have decelerated sharply and could portend a pull back in subsidy levels to refocus on profitability.
Subsidies and promotional spending on handsets are not reported by wireless carriers nor are they tracked by the various industry consultants publishing market data and projections. As such, they are typically ignored as a driver of mobile device sales, despite the fact that we estimate that carrier subsidies account for well more than half of spending on mobile devices worldwide, and in many markets, have consumers expecting free mobiles at the end of each contract. The effect of lower subsidies is felt both in weaker volumes and in lower average selling prices, as users trade down to account for the lower subsidy level.
Global mobile phone volumes were stagnant from 1999 to 2002 – and pronounced dead by many analysts – before reaccelerating to double digit growth in every year from 2003 to 2008. The millennial malaise coincided with a period of excessive leverage and inadequate cash flows at carriers that precipitated the 2001 recession and resulted in a significant reigning in of subsidies in the name of cash preservation. We believe the current focus of carriers is again on free cash flows to support dividends, and that most will resist the temptation to use subsidies to chase market share in the near term. Thus, we prefer to wait on the sidelines for stocks that are highly dependent on global handset volumes and average prices.
While carriers may be exercising restraint now, the connection between subsidies and market share has been well established and the lure to break ranks and crank up the level to draw subscribers is too strong to be ignored for long. We believe that we should see a return to more vigorous competition by 2011 and with it, higher subsidies and a reacceleration in the device market. Longer term, we believe 4G will catalyze growth and growing ASPs by 2013. Moreover, valuations in the wireless sector appear to be quite depressed, particularly in the wake of the poor 1Q10 results. Nonetheless, the near term prognosis is not promising for overeager investors and we recommend that investors wait until the news flow is unambiguously encouraging for handset-related stocks.
To view this entire report and to see other available research see “Prior Research”
April 20, 2010 A Thousand Paper Cuts: The Future of Cable TV
Cable operators face a panoply of threats that, taken individually, may seem distant and minor, but considered collectively, could reverse industry growth and seriously strain profitability. First, we believe that share gains in highly profitable residential telephony will reverse, as the trend toward mobile-only households accelerates. Second, we expect that multiple 4G wireless roll-outs will bring further competition for residential broadband, both pressuring prices and taking market share. Third, web-based video technology is improving rapidly just as the tools to access it via the television are becoming more widespread. We believe on-line television will soon begin to siphon viewership from traditional cable and shift the balance of power in negotiations for content away from multi-channel video operators, bringing significant pain even if the sea-change of internet related subscriber churn is a decade or more away. As such, we anticipate that the returns for cable and satellite TV providers will be amongst the worst in the TMT universe over the next few years.
The heavily fixed-cost nature of cable economics makes the industry particularly vulnerable to revenue disappointments. Gross margins in telephone and internet service are better than 75%, compared to less than 50% for television. With non-video sources generating more than 40% of industry revenues, and thus, the large majority of the contribution against fixed expenses, pressure on the price and market share of cable operators in those businesses is dangerous.
Since 2006, the percentage of US households relying only on wireless for telephone service has increased from 10.5% to nearly 23%. The demographic of this phenomenon skews very young, suggesting that we could see this trend continue long into the future. Moreover, the emergence of low cost fempto-cells that extend wireless coverage into homes by connecting into broadband connections could accelerate this process, putting a serious damper on cable’s share.
The recently released FCC National Broadband Plan (see our piece from April 6 “The National Broadband Plan: Windfall for Wireless, but Catastrophe for Carriers) is explicit in its intent to open 300-500MHz of new radio spectrum for wireless broadband, more than twice the bandwidth currently licensed by mobile carriers. The amount of spectrum to be made available and the proposed process by which it is to be assigned make it likely that the cozy Verizon and AT&T dominated club of American wireless could expand to 5-7 national 4G networks, each able to deliver better than 5 Mbps service to households. We believe that this would pressure broadband pricing, materially affect the penetration of cable broadband and spur additional capex for cable operators.
To date, internet television has been limited by technical shortcomings and lack of access to the living room TV. Higher speed networks, better compression, and faster servers are yielding dramatic improvements to video streaming and download performance, that we expect to spur significant increases in viewership. Deals with video console makers have opened a door to the television set for pioneers like Netflix that should be pushed open wider with the FCC recommended mandate for ending cable MSO domination of set-top-boxes. Shifting viewing patterns will make on-line platforms more attractive for content providers and advertisers. At the same time, a smaller audience would have the opposite effect on cable operators, who would find content owners driving harder bargains and advertisers losing interest.
As internet TV becomes a more viable alternative to cable, a key issue will be the decisions of the owners of the most desirable content to either embrace or stiff-arm internet distribution. For films, the process has begun with Netflix, Redbox and AppleTV. Most sports organizations have also begun to make their content available on web, although the next round of fee negotiations with broadcasters will undoubtedly bring this issue to the front burner. We believe the inherent benefits of internet TV – audience targeting, flexible terms for monetization (pay-per-view, subscription, ad-driven, commerce driven, etc.), location independence, flexible scheduling, etc. – will draw most, if not all, important content to the medium.
We believe that we will begin to see a meaningful exodus of households from multi-channel TV to internet-only viewing by the end of the decade. As this eventuality becomes more apparent over time, we believe investors will seriously question the long-term value of cable and satellite TV franchise assets, and that the stocks will suffer accordingly. The primary beneficiaries of these changes will be those technology companies that facilitate network competition – Cisco, Juniper, Google, Ericsson, etc. – and companies that are able to build successful internet-based video franchsies – Netflix, Apple, Google, etc. Companies that own or control compelling content – Disney, Viacom, Newscorp, etc. – face a mix of challenges and opportunities that will separate those companies with strong visions from the others.
To view this entire report and to see other available research see “Prior Research”
Why the Market Assumes too Much Margin Pressure on Insurers, too Little on Innovators
Narrow (below corporate level) application of MLR limits, and/or limiting premium growth to less than the rate of medical cost growth, work against regulators’ and the public’s interests. Thus neither practice is likely to be common; and insurers’ share-price reaction to these concerns appears over-done
If MLR limits are too narrowly applied, winning contracts cannot offset losing contracts, and insurers must price all contracts so that none lose. Gross premiums rise, reducing insurance uptake rates; and, beneficiaries’ excess paid-in capital is held prisoner for at least the duration of the contract period.
Incurring these two costs produces no gains – after rebates, MLRs under narrow limits net to the same figure as would have been achieved under broad application (corporate level) of MLR limits
If MLR limits are narrowly applied AND premiums cannot be raised in response, private capital exits geographies with such restrictions, reducing both competition and consumer choice. Private insurers’ ROIC’s already are below SP500 averages
State regulators are unlikely to carry through on isolated threats to hold premium growth below rates of underlying cost growth. Obvious effects include simultaneously reducing reserves and raising underwriters’ risk; less obvious, states that rely heavily on non-profits (e.g. Massachusetts) face the likely outcome of their non-profits having to seek capital – which almost surely means converting to for-profit
We provide further explanation and analysis of the pricing effects of the Independent Medicare Advisory Board (IMAB), showing that all of the IMAB’s 2015 – 2019 cost savings must come from roughly one-quarter of the Medicare cost base, and that innovators (brand pharma, biotech, devices, +/- capital equipment) are the most likely targets
We project that IMAB policies will reduce the Medicare sales of innovators by 11 to 19 percent between 2015 and 2019, and show why we believe this estimate is conservative
To view this entire report and to see other available research see “Prior Research”
April 5, 2010 The National Broadband Plan: Windfall for Wireless, but Catastrophe for Carriers
The FCC’s recently released “National Broadband Plan” makes recommendations that would accelerate the adoption and deployment of 4G wireless networks by freeing 300-500 MHz of spectrum and stimulate dramatically more aggressive competition amongst providers, including entirely new entrants. This is unambiguously bad for network operators, not only in wireless, where rivalry is likely to force spending on spectrum licenses and network build-outs and pressure pricing, but also for fixed line and cable TV, as the performance trajectory of 4G makes it a clear alternative to fixed broadband and a possible long term competitor to multi-channel television.
The plan would benefit companies with a stake in 4G LTE wireless technology (Qualcomm, Nokia, Ericsson, Interdigital, Samsung, LG, Broadcom, et al.), those already controlling spectrum or tower assets (satellite operators [see below], American Tower, Crown Castle, SBA Communications) and those pushing internet TV (Google, Cisco, Apple, Netflix, Tivo). We also note that several application areas are called out by the FCC report: Education (Apollo, Capella, Strayer, Blackboard), Public Safety (Motorola), Smart Grid (Itron, EnerNoc, Comverge, IBM), and Telemedicine (Cisco).
120MHz of new spectrum would come from broadcast TV frequencies. As with the successful relocation of stations during the recent transition to digital, we do not expect station owner objections to be a significant hurdle. Another 90MHz would come from allowing mobile satellite services operators to offer terrestrial broadband in the same bands as their space-based services, a windfall for these struggling operators – Inmarsat (ISAT.L), DBSD (ICOG), TerreStar (TSTR), Globalstar (GSAT) and Iridium (IRDM). Harbinger Capital has already filed plans with the FCC to build a wholesale only 4G LTE network on 53 MHz of spectrum controlled by its SkyTerra business and its partner Inmarsat.
We believe 5-7 new 4G networks will be built out in the U.S. over the next few years, most using the recently ratified LTE standard. While initial LTE speeds will likely be less than 10 Mbps, it is likely that upgrades will increase this several fold over the next decade. The theoretical maximum for LTE is 326 Mbps, and the underlying technology has the potential to offer speeds of greater than 1Gbps. LTE has been selected by almost all of the world’s largest operators, portending dramatic scale and development trajectory advantages over alternatives like WiMAX. This compounds the bad news for Sprint and Clearwire.
These LTE deployments will benefit equipment makers – Ericsson, Nokia Siemens Networks, and Huawei control almost 75% of the 3G market – and IPR licensors – Qualcomm has 32% of the declared essential patents. The increased complexity of dual mode 3G/4G devices and the hefty royalties associated with them will greatly favor large handset players with strong 3G and LTE IPR (Nokia, Samsung, LG). Finally, the possibility that 4-8 new 4G networks with near ubiquitous coverage would be built over the next few years is a potential windfall for tower companies already growing double digits on 3G deployments.
The FCC is also plans to insist that cable providers terminate their multi-channel TV service into a bare-bones box offering only conditional access, tuning and reception, and explicitly forbidden from delivering advanced functionality like navigation tools and DVR. This opens the door to internet based service competitors, such as NetFlix and Apple, who would initially be viable competition for “Video on Demand”, but could eventually threaten channelized video entirely. Moreover, the increasing capability of 4G wireless technology may someday make cable networks true “dumb pipe” commodities
To view this entire report and to see other available research see “Prior Research”