What lies ahead for the USA during 2006???

We have everything bad to talk about the US…Increasing trade deficit being funded by the foreigners, negative savings rate, consumption led by mortgage backed loan, narrowing yield spread and at times an inverted one also, heated real estate price, possibility of USD depreciation so on and so forth!!!

Oh too many negatives…isn’t it? The current hot topic to discuss is the negative yield curve. On 2-3 occasions during 2005 end, the 2 year bond’s yield was ahead that of the10 years’ one. That gives no incentive for the financial institutions to borrow short term loans and lend for longer terms to enjoy the spread. We all know that the previous 6 recessions were preceded by the inverted yield curves.

Last time when US went into recession during early 2001, it was preceded by inverted yield curve during 2000 end and 2001 start. But we also have the example of Australia where the yield curve is negative since September 2004 but the Australian Ordinary Index is climbing all time highs every passing day and is up 28% since September 2004 end!!! But some arguments support for the rise in Australia…They are:

Australia is rich in minerals and due to commodity boom the demand for the raw materials was high and so were the prices…that helped Australia to cash in on the commodity boom.

Also real estate boom has fired up the Australian stock market as many of the real estate companies are listed on the bourse.


We also know that 10 out of previous 12 crashes (if not recession) were preceded by heated housing market couple with rising interest rate. Real estate market in the US is in fire…thanks to the low long term interest rates. But in the rising short term interest rate scenario, many people think that the real estate party is over and the recent November 2005 lower housing sales data vindicates the fact. As happened in Japan the asset price bubble led to the fall of the economy and finally it went into recession and crippled for 15 long years before it gained steam during 2005.

History of Japan…something US should learn from it…

Japan was the market to invest in during 1980s. Since the onset of 1984 the Japanese stock market rose by a whooping 380% to reach an all time high of 38915 at the end of 1989. The stock market rise was accompanied by the real estate boom, low interest rate of around 2% that led to asset price bubble. By 1990, Japan’s real estates (which is smaller than California in size) were valued at around $17tn (3 times of the US then). Real estate prices were at crazy heights. The rising inflation led the Central Bank of Japan to raise the key interest rates from around 2% to 6% in the span of 15 quick months!!! It led to a decrease in housing demand, rise in default rates and ultimately the stock market crashed. Though US has not increased its interest so sharply!!!

So inverted yield curve and heated housing prices along with rising interest rates are some reasons which can bring the US nearby to 1990s Japan.

To make the things worse the consumption led economy, which the US is… is already at a record high trade deficit. The US is facing a zero or negative savings rate for the past few years (first time since 1933). The US consumers are taking loans against their houses to finance their consumption, and cashing on the housing boom. Hence real estates are acting as an ATM for domestic consumption. Imagine what will happen to the consumption pattern should housing prices, thus loan against it, fall. There will be no loan as loan against houses would be considered risky enough, and thus the consumption would take a hit.

During 2005, factors other than the US worked for the rising USD (please read “Why did USD appreciate despite widening trade deficit and weak US market during 2005?”)
Imagine what would happen if anything reverses…the mighty USD would take a big hit. And for the same volume of imports-as were in 2005- the US will have to shell out more USD and thus trade deficit would widen and thus arises the fear of vicious circles (USD depreciation due to widened trade deficit and vice versa.)

Hence the picture for 2006 has several black spots for the US, and the strategic think tanks of the US have very tough task on the anvil for 2006 and the onus is on Mr Bernanke who is soon to replace Mr Greenspan during January 2006 as Fed chief. Otherwise the US might go into recession which can have ripple effect on the world…which no body wants.

There is one more smoke signal at the corner. S&P has recently downgraded the bonds of GM, the largest automaker of the US, and is at now 2 notches above the junk status. S&P is not so sanguine about GM’s future with its declining sales. GM, whose interest burden is more than its market capitalization of $11bn, has a net debt (Total debt less cash) of $260bn!!!. What will happen if it attains a junk status? The lenders would queue in front of it and the company might go in for the bankruptcy protection and there will be a wide spread uproar in the debt market.

Why did USD appreciate despite widening trade deficit and weak US market during 2005?

The USA will tick more than $700bn as trade deficit during 2005...its highest till date...and this was the most important reason why market stalwarts like Warren Buffett and currency traders like Deutsche Bank, UBS and Citigroup has a negative view on USD against the likes of Sterling, Euro etc. But to their surprise, USD appreciated against the major world currencies putting all above stalwarts in losses. Mr Buffett lost around $1bn this year being short on USD.

The US’s market has largely underperformed its peers’ (Europe and Japan). The Japan market is up by whooping 40% and the European markets are up on an average of 20% as against a mere rise of 4% rise in the US S&P 500 Index. Though of late the sanguine GDP growth figures did provide confidence to the economy but was not strong enough to give an upward thrust to the market. Despite having underperformed its peers and global markets’ it saw its currency…the mighty USD appreciated against the GBP, Euro and Yen. It appreciated 10% against GBP and 14% against Euro and Yen each during 2005.

One factor was of course the continuous rise in the short term interest rate. The Fed Rate which was at 2.25% at the start of the year 2005 and is now at 4.25% at the end of year. So, to benefit favorably foreign investors invested in the US bonds to enjoy higher yields. But that is in the short term bonds. And this is not that much strong an argument to justify the rise. It made me think other factors which could have played besides the rising short term rate. I did think 2 another equally strong if not more arguments to justify why the USD rise against the global heavyweights. They are:

 As written in the article dated 28th Dec. 2005, “Flattening yield curve in the US…why?”, I argued for the lower long term bond yield because of foreigners buying heavily into the US bonds. Because of this there was a huge demand of USD against Euro and Yen, and this can be another factor for the rise.

 Another one equally strong argument is the GCC (Gulf Cooperative Council) factor. The GCC include 6 oil exporting countries Saudi Arabia, the UAE, Kuwait, Oman, Qatar and Bahrain. These countries have pegged their currencies against the USD for long. With the rising oil demand and thus the prices, these countries have made their fortunes and have earned around $250 bn during 2005 as oil revenue. Now since these countries’ currencies are pegged against the USD and given the fact that these countries maintain their reserves (which are swelling) primarily in USD, the demand for USD increased for the payment for Oil especially during 2005. So gave another boost to the USD rate.

Hence despite having a record trade deficit (which is set to touch $750 bn for 2005), having been devastated by the most dangerous hurricanes, and the Wall Street legendary Warren Buffet’s not so sanguine view on USD and in fact he is believed to be sitting short on the USD to the tune of $16bn!!! down from $21bn during early 2005…the USD has increased during 2005.

So, the USA should not feel complacent enough…

This could be the big for 'Retailing' in india

Often the organised sector participants complain of having a tough competition from the unorganised players. What if they had left a big market totally for the unorganised players, without a single participation from any organised players, especially for those who boast of having interest in Retailing.

The market which is bigger than the Air-Condition market (Rs. 1600 cr), the market which is equal to, if not bigger than, the Branded Garments market
( Rs. 2500 cr.).

Still not guessed, yes it’s a weird market………………..called the Gents Beauty Parlour!!!!

This market is totally at the disposal of small unorganised players…..the next stop barbers and a few chain of hair cutting saloons in few big cities.
It can be a big opportunity for corporate players, having an estimated market potential of Rs. 2500 cr. annually (on a modest estimation).

Analysis of and assumption for the market potential:
India’s estimated population:100 cr. (Conservative)
Taking 55% male population
So, No. of males: 55 cr.

1. Hair cut:
Assuming atleast 75% of them use to have hair cut,( to leave the poverty stricken people). The figure comes out at 41.25 cr.:
• Out of it 50% use to get it once in a 2 month ( generally in rural areas) and average charge they use to pay is Rs. 3 per hair cut. It comes to 6 times a year.
• Another 35% use to get the hair cut once in 1.5 months (semi urban and towns) and average charge they use to pay is Rs. 5 per hair cut. It comes to 8 times a year.
• Rest 15%, who comes in elite group ( like me!!!) use to get it once a month (cities and metros) and the average charge comes to be Rs. 7 per hair cut. It comes to 12 times a year.

2. Shaving:
Assuming out of the 41.25 crore males , only 10% use to hav
e shaving from the next door barbers (this does not include me…..). To make calculation more realistic, so that the critic may leave me, let us assume that out of the 4.125 cr. males (i.e. 10% of 41.25 cr.):
• 70% use to get it once in 2 weeks, thus 26 times a year, and pays Rs. 3 per shave.
• Rest 30% use to get it once a week, thus 52 times a year, and pays Rs. 5 per shave.

Calculation of the estimated market potential:
• Hair cut
20.625 cr.x 6 times x Rs. 3 = Rs. 371.25 cr.
14.4375 cr.x 8 times x Rs. 5= Rs. 577.5 cr.
6.1875 cr.x 12 times x Rs. 7= Rs. 519.75 cr.
Total Rs. 1468.5 cr.

• Shaving:
2.8875 cr.x 26 times x Rs. 3= Rs. 225.25 cr.
1.2375 cr.x52 times x Rs. 5 = Rs. 321.75 cr.
Total Rs. 547.00 cr.

Overall Calculation:
Hair cut: Rs. 1468.5 cr.
Shaving: Rs. 547.0 cr.
Other premium services Rs. 484.5 cr.
Total Rs. 2500 cr.

So, the retail group, supposing to have an interest in retail sector expansion, is invited to take a pie in the virgin market, and also have the first mover advantage. So, the Rahejas (Shopper Stop), the Goenkas (Food World), the Kasliwals (About to make a debut) et al should wake up and pull up their socks to conquer and leave a mark on the upper terrain of men, and pay an unsolicited consultancy fee to the under-signed.

Flattening yield curve in the US…why?

The current hot topic to discuss is the negative yield curve. Yesterday (27th December 2005) the 2 year bond’s yield of 4.347% was 0.4 bps ahead of 10 years’ 4.343%. As we all know that the previous 6 recessions were preceded by the inverted yield curve. That gives no incentive for the financial institutions to borrow short term loans and lend for longer terms to enjoy the spread.

Why the long term bond interest rate is abysmally low in the US…is it because of the gloomy US economic future or something else driving it? Long term yield should be more as it contains duration risk…higher duration leads to higher inherent rate and market risks. If we see from the angle of demand and supply we can unearth a reason. As with other economic products, interest rate is also determined by the demand and supply of the bonds which are further driven by factors like expectation, growth, political and financial uncertainty, etc.

Higher the demand for bonds, higher will be the bond price and thus lower bond yield (as interest rate/yield is inversely related to the bond price). The demand-supply study revels that the current interest rate is heading downwards because of the huge demands of US bonds by the global exporters like Japan and China and also by the European investors.

Thanks to the US consumption led economy, it is facing a record trade deficit (which is at a run rate of $750bn for 2005…more than the size of Indian economy!!!). The exporting countries like China and Japan are enjoying a huge trade surplus with the US. Now with zero or negative savings rate in the US, how the US will fund for these deficits? The exporters come into the picture and they finance the US’ import by supplying enough of Dollars by buying the US Dollar denominated bonds. Japanese had the incentive to invest in the US bonds as they give interest of around 4.5-4.7% as against their home rate of near zero. Thus USD is transferred to the US’s coffer. Also, this year Europeans have invested in the US bonds as to enjoy the spread and to avoid any uncertainty in the home markets due to a number of factors like:

• Uncertainty in the EU after France and the Netherlands did not agree to the EU legislation earlier during 2005. Some felt that it may lead to the gradual fall of the EU.
• Increasing German unemployment rate which now hovers in double digits
• Social unrest in France during November
• Terrorist threat post 7/26 in the UK.

The European did not mind putting in their money in foreign country when it is the US. So, the exporters led bonds’ demand coupled with the European factors increased the bond’s prices thus led to the fall in the interest rates of the long term bonds. And the 14% rise of USD against the Euro and JPY each can also be associated with this argument, as the European and Japanese would need USD to buy the US bonds. Hence, among others, increase USD demands against the Euro and Yen led to the rise in the USD this year.

Asian effect on India’s FII: What’s in store for 2006!!!

India attracted around $10bn of inflow in the stock market from the foreign equity investors during 2005, higher than $8.5bn brought by them during 2004. But this year was different besides the fact that it has attracted more foreign funds. For the first time Japanese investors have contributed around 35% of the FII inflow as they found India more attractive than their local market. So there was the Japan factor in the current year rise. But of late Nikkei-Japan Stock Market Index had shown a stupendous rally post August 2005, and it is around 50% up from its 52 week low of 10770 (May 2005). Macro economic indicators in Japan have shown improvement after having lull performance for the past 5-6 years. Japan is believed to have come out of deflation, whaich it was experiencing for the past many years. The Japanese market is at 5 years’ high, and if the enthusiasm of the local traders is anything to go by- Japan is set for another good year. Due to the near zero interest rate, investment has starting paying off. The consumption is showing an uptrend and export market is doing pretty well partly due to the weak Yen.

Now with near zero interest rate, the Japanese have no incentive to put money in banks (only to see them depreciating in real terms!!!). Their investment has started paying off. They have also invested in foreign bonds, primarily the US (and along with China have financed its huge trade deficit). This has led to the appreciation of the USD against Yen. And with the rising interest rate scenario in the US the trend is expected to continue for a while (US provide more incentive than the Europe with 4.25% interest rate as compared to Europe’s 2.25%). So the export market is expected to remain robust. As we have also heard the rhetoric of Toyota which is set to overpower GM in the world to become the largest car manufacturer.

So the improving consumption pattern and the robust export market promise to give another boost to the Japanese stock market during 2006. So, the Japanese who were gung ho about the Indian market would come back to their home to benefit from the turnaround. Since this year Japanese have invested around $3.5bn in India, so less of US and European investors have invested in Indian markets this year in absolute terms. These factors can be a danger signal for the Indian market.

Also during 2006, China is schedule to come out with big tickets IPOs in either its local market or Hong Kong. It will lead to chipping in transparency in the Chinese companies to adhere to the stock market regulations. So, the FII who could not participate in the China story would invest in the Chinese IPO (which they were eyeing for years). So, lower fund would come in India as they would divert their emerging market fund to China.

Hence the above factors provide some smoke signals to the euphoria in India.

But wait, of late the Middle East funds like AL-Madina, Noor Capital etc. have started investing in India after the Gulf markets have been trading at a crazy valuations of 25-30x PE multiple. So, who knows Gulf investors would do Japan to the Indian markets…as we can raise no question to their extended pockets since the Gulf economy is expected to have more than $50bn in trade surplus during 2005, due to the rise in oil price.

Telecommunications- The USA: The US Wireless Sector (April 2005)

The US Wireless market is growing by leaps and bounds, with a net addition of around 4-5 million (mn) subscribers made in each quarter – in fact, it is arguably the best growth market in the developed world, as Western Europe is pretty much saturated, with 90% plus penetration in most markets. The US Wireless market has an estimated 185mn wireless subscribers with an estimated wireless penetration of merely around 64% at the end of Q1 Y05. Post 2002, almost all the US wireless companies have improved their operations and have come out of the red, albeit with a few hiccups. The companies have been improving their cash flows and operating figures, which indicates the improving health of these companies in particular and the sector in general.

Significant M&A activity in the US Wireless Sector had been in a lull for several years, post the acquisition of Voice Stream and Powertel by Deutsche Telekom (DT) in mid-2001. However, this lull has been broken and Cingular Wireless (SBC & BLS) has acquired AWE in the largest ever M&A in the US Wireless Sector and the biggest all cash deal ever of $41 bn, Consolidation in an industry sometimes means a reduction in level of competition. At other times it may mean a change in competitive position for one of the other players, which may require changed tactics. There may be other intended and unintended consequences for various players in the industry.

Enthused by the smooth merger of Cingular and AWE, Sprint and Nextel during December ’02 have agreed upon their marriage that will make the company ‘Sprint-Nextel’ the strong 3rd largest wireless company in the US. During Jan ’05, Alltel (AT) has agreed acquired a small wireless outfit Western Wireless (WWCA) for around $6.5bn. All these deals are to get approved by the govt. authorities.

The US Wireless sector has been dominated by two giants Cingular and Verizon who controls more than 50% of the total market. The other two big players are Sprint-Nextel and T-Mobile (a wireless subsidiary of DT). All four companies cumulatively hold around 80% of the market. Other smaller players are Alltel, Virgin, Tracfone etc. Verizon and Cingular have launched their 3G services in the selected markets in the US, while Sprint would soon launch its 3G services. T-Mobile would launch 3G during 2007 in the US.

In the US, MVNOs (Mobile Virtual Network Operators) are also experiencing robust growth. Companies like Virgin Mobile, Boost, Tracfone-all are doing well on the subscriber addition front. A MVNO is a mobile operator, which does not have its own spectrum and usually does not have its own network infrastructure. Instead, MVNOs have business arrangements with traditional mobile operators to buy minutes of use (MOU) or they lease the use of wireless infrastructure from another company for sale to their own customers. These MVNOs primarily target the youth segment, which still remains an under-penetrated market in the US. Qwest Communications (Q), Virgin Mobile, Boost Mobile, etc are some of the successful MVNOs, which are adding subscribers at much faster rates. While the former two operate on PCS’ network, Boost operates on NXTL’s network.

The US market is lagging behind its European peers in terms of penetration level, primarily because of under penetrated prepaid market that constitutes youths and teens. The large operators target the contract segments to maintain their key operating metrics. They were reluctant to the prepaid segments, until they realized the segment’s importance as was evident by the strengthening MVNOs that largely target the prepaid segments. Of late the biggies have come out with their special plan to target the untapped segment-Prepaid.

The big wireless operators perform various credit checks before signing up customers and in most of the cases, also require a customer to sign a contract for certain duration. This is one of the most important reasons for the lower wireless penetration in the US market, as many of the interested ‘would be’ customers fail to fulfill their criteria. These policies also eliminate a large portion of the youth market, which is a substantial market segment elsewhere, and also a significant driver of non-voice revenues.

T-Mobile has lagged behind other biggies in the ongoing M&As activities and hence would become a distant 4th post Sprint-Nextel merger. However if it acquires smaller players like US Cellular and Rural Cellular it can spread its presence across the US and would become a strong no. 4. Though there would be some technological issues as US Cellular operates on CDMA while T-Mobile operates on GSM.

Telecommunications- The USA: The US Wireline Sector (April 2005)

Prior to 1984, the U.S. Telecom market was a monopoly. AT&T owned the 22 local Bell telephone companies that sold local, long distance, international long distance, the white and yellow pages and telephone equipment. Customers typically had only one option for telephone service – their local Bell Company, a subsidiary of AT&T.

WorldCom MCI and Sprint had entered the long distance market as competitors to AT&T. However they were at a significant disadvantage, as they needed the services of a local Bell company for the origination and termination of calls. As AT&T, the owner of the Bells, itself was a provider of long distance they were not very accommodating to the competitive carriers. Competitors frequently complained to the US Justice Department about AT&T’s lack of cooperation. As a result, the Justice Department filed an antitrust suit against AT&T in 1974 which was finally resolved in 1984.

In the settlement, the 22 local Bell companies were divested from AT&T and seven Regional Bell Operating Companies (RBOCs) were formed – Ameritech, Bell Atlantic, BellSouth, NYNEX, Pacific Telesis, Southwestern Bell Communication (SBC) and US West. Each RBOC was granted a distinct geographic territory, termed a Local Access Transport Area (LATA) in which they would operate. They were allowed to sell calls only within their LATA. For call extending outside their LATA they needed the service of a long distance carrier. The RBOC’s were also permitted to continue publishing and marketing the telephone directories but were not permitted to manufacture equipments.

Thus, AT&T lost control of the local business but continued to be the leader in interstate and international long distance. It also had the telephone equipment business that was later spun off into a separate company – Lucent Technologies.


The Telecommunication Act 1996

The next major impetus for change in the US telecommunication industry came in the form of the Telecommunication Act 1996. The main factors that led to the Telecommunication act of 1996 were

• RBOCs lobbying efforts to enter interstate long distance

• Long distance carrier’s desire to enter the local market

• To increase competition in the local market – it was thought that increased competition would force the RBOCs to upgrade their network in order to stay competitive with the upstart carriers.

The Telecommunication Act of 1996, in order to promote competition in local telephony, introduced legislations that forced local telephone giants to offer rivals low-cost access to their networks. Since it was felt that it would not be possible for new entrants to build facilities that could compete with the incumbent’s, they were allowed unbundled low-cost access to the incumbent’s facilities. This provided an easy entry for competitors and the ones to benefit most were long distance carriers like AT&T and WorldCom as they could then offer both long distance and local service to consumers.

The act was such structured that it would loosen the incumbent’s hold on the local market but provide them with the means of entry in the long distance market – something the RBOCs desperately wanted. Thus, the RBOCs had to comply with a 14 point “competitive checklist” before they filed for entry into long distance. The 14 points ensure that the incumbent have opened their network to competition. The clauses of the “competitive checklist” are as follows:

• Competitors must be allowed to interconnect to the incumbent’s facilities, allowing them to access pieces of the incumbent’s network.

• Competitors must be allowed nondiscriminatory access to unbundled network elements.

• Competitors must be allowed nondiscriminatory access to RBOC-owned poles, ducts, and rights-of-way.

• Competitors must be given access to unbundled local loop transmissions from the central office to the customer’s premise.

• Competitors must be given access to unbundled trunk transmission.

• Competition must be given access to unbundled local switching as distinct from transmission services.

• Competitors must receive nondiscriminatory access to 911, E911, directory assistance, and operators.

• RBOCs must supply white pages directory listing for competitors’ customers.

• RBOCs must provide competitors’ customers nondiscriminatory access to telephone numbers.

• Telephone number portability and interim telephone number portability until full portability is possible must be available.

• Nondiscriminatory access to services that allow competitive carriers to supply dialing parity (allowing competitors’ customers to choose their long distance provider) must be made available.

• Reciprocal compensation agreements must be in place.

• RBOCs must provide for the resale of telecom services at cost, with no provision for profit.

Industry Structure

Local Exchange carriers (LECs)

Local exchange carriers are typically the first and final link between customers and the party that is called. The major local carriers in the US are still the RBOCs referred to as the incumbent local exchange carriers (ILECs). There are currently 4 RBOC’s of the 7 originally– SBC, Bellsouth, Verizon and Qwest.

SBC Communication – SBC merged with Pacific Telesis in 1997 and Ameritech in 1999 (both bell companies), which has made it the incumbent local service provider in 13 states.

BellSouth – BellSouth operates as the incumbent in 9 states. It has got approval to provide long distance in all states.

Verizon – Verizon was formerly known as Bell Atlantic Corporation, which was formed as a breakup of AT&T. It merged with NYNEX in 1997. It again merged with GTE Corporation in June 2000 after which it started operating as Verizon Communication.

Qwest – The Company, formerly US West, operates as the incumbent in 14 states.

As the RBOCs have gained entry into long distance the competition in local service has stiffened (as they have to satisfy the 14 point competitive checklist). The competitors referred to as Competitive Local Exchange Carriers (CLECs) are in a better position to fight the RBOCs as they now have more flexible access to the incumbent’s network. The CLEC’s include among others the long distance providers AT&T and Sprint who are now operating as CLECs in few states.

Long Distance Carriers or Inter Exchange Carriers (IXCs)

Long distance carriers carry the calls from one (the dialing party’s) local exchange to another (the receiver’s) local exchange. The main players in the long distance market are AT&T, WorldCom MCI and Sprint. Until 1984, AT&T held a virtual monopoly but since then Sprint, MCI and various small players have been gaining share from AT&T. However in a major reshuffle Recently in Jan ’05, SBC has acquired AT&T in a $16bn stock and cash deal. While Verizon has acquired MCI for around $8.6bn cash and stock deal, however it is still to get ratified by the shareholders.

Entry of the RBOCs into long distance has led to heightened competition in the long distance market and thus led to a steep fall in long distance prices over the last couple of years. The RBOCs can package all the services (local, LD, wireless and broadband) in one attractive bundle, which appeal more to the consumers. Thus the long distance carriers have been losing market share, particularly in the consumer segment. Though Sprint and AT&T have also entered some states as CLECs, long distance still constitutes majority of their revenues.

Telecommunication- Europe: European Telecom Sector (Wireless) March 2005

European wireless sector has matured and now the companies there are in the cash cow stage. The Western Europe is fully saturated with a wireless penetration of almost 98-100%. The important markets are the UK, Germany, France, The Netherlands, Spain and Italy. In Europe, big wireless companies like Vodafone, Orange (wireless subsidiary of France Telecom), T-Mobile (wireless venture of Deutsche Telekom), MMO2 and KPN are present in 3 or more European markets. Other wireless biggies that are incumbents in their home markets (and operates primarily in their home markets only except for the first two) are TEM (Spain), TIM (Italy), Telia-Sonera (Finland-Sweden), Telenor (Norway), Swisscom (Switzerland), Portugal Telecom (Portugal) etc. Some wireline biggies are Deutsche Telekom (Germany), KPN (The Netherlands), France Telecom (France), Telefonica SA (Spain), Telecom Italia (Italy) are the incumbents in their home markets.

These companies rode the M&As wave during the TMT boom and spend around €100 bn to acquire 3G license during the auction. The phase was largely driven by irrational exuberance. Everybody wanted to become big. Vodafone, once failed to acquire Manesmann in its €75bn bid during 2000, finally acquired it by paying around €150bn the very next year, only to write off the large amount of goodwill. Many of these companies like KPN were on bankruptcy stage. Almost all of the European telcos were debt laden and were negatively rated by the international rating agencies. After acquiring 3G license for Germany for a fortune, British Telecom hived off its wireless venture (that was named as MMO2) to save upon its near bankruptcy. However since 2003, the telcos chipped in efficiency and began improving upon their operations. Markets developed and matured, margins improved, cash flows strengthened and consequently debt reduced. All the companies are now in comfort zone as far as their balance sheets are concerned.

Wireless call rates in the Europe are the costliest among the sectors covered by us (that excludes APAC). Of late, as the market saturates some price based competition has started across the markets like the UK, Germany, Spain etc. Subscriber acquisition activity that was done to generate additional source of revenues has been substituted by the subscriber retention activity to defend the topline. Hence profit centric activity has been converted to the cost centric activity. Prices would decline and so the margins. Though increasing data revenues would be a savior to the falling voice ARPU- the blended ARPU would witness the downward pressure. No frill wireless operators like EasyMobile and MVNOs like Virgin and Tele2 are posing a lot of threat to the existing incumbents. We believe the European wireless sector would be an Underperformer in the longer run, though the underperformance would not be too sharp.

Telecommunications- Latin America: Latin American Wireless Sector (April 2005)

From less than 20 mn subscribers to 160 mn subscribers in a span of just 8 years, the Latin America wireless market has achieved a stupendous growth, with a compound growth rate of more than 30% in the last 5 years. During the last 6 years, the penetration rate has grown from an abysmal 8% to nearly 30% at the end of March 2005.

The growth in the Latin American market kicked off during the late ‘80s and early ‘90s, when the governments of various Latin American countries began deregulating their telecom sectors and opened the sector for private participation. The incumbents began witnessing competition and various American and European telcos got the opportunity to enter the highly under-penetrated and lucrative markets. The new entrants relied on inorganic entry into various key markets, like Brazil, Mexico, and Chile, etc. Chile was the first Latin American country to allow competition in the telecommunications sector in 1978 and it privatized its state-owned companies in 1988. Mexico and Argentina followed soon thereafter and a spate of market liberalization and privatization began in the region.

Brazil, Mexico, Argentina and Chile are the major markets in Latin America. With a total population of around 525mn the average wireless penetration in Latin is around 30% with Chile leading the pack with penetration of more then 55%. Brazil (145mn Pops) with 38% and Mexico (104mn Pops) with 40% penetration are our 2 focused markets there.

The Latin American region is poorly served by wireline telephony, with a poor penetration of around 20% - which has been overtaken by wireless services. There are about 95 mn wireline subscribers in the region, as compared to around 145 mn wireless subscribers. Given the poor basic telephony penetration, wireless telephony in Latin America is all set to achieve a healthy growth in the future.

We particularly expect a steady rise in wireless penetration in Mexico, where AMX enjoys a lion’s share of around 78% of the market. Mexico has a per capita GDP of around $6400 as compared to its emerging market peers - Russia’s $4000, Poland’s $5900 and Chile’s $5600, while it has a wireless penetration of only around 35%, as compared to Russia’s 47%, Poland’s 48% and Chile’s wireless penetration of around 55%.

The growth of GSM mobile technology in Latin America is outpacing the growth of its rival CDMA technology. GSM technology has a 72% share in the incremental digital mobile market in Latin America.

In the Latin American wireless market, all the major players, namely AMX, Telefonica Moviles (TEM.MC) and Telecom Italia Mobile (TIM.MI) are expected to grow their revenues by around 32-35% Y-o-Y each during 2005. While AMX would derive 92% of its revenues from Latin America, TEM and TIM would derive only 46% and 22% respectively. AMX would generate an EBITDA margin of around 33% from its operations in that region, while TEM and TIM are expected to post an EBITDA margin of 16% and 24% respectively in the region during 2005.

Telecommunications- Russia: Russian Wireless Sector (May 2005)

Telecommunications- Russia: Russian Wireless Sector (May 2005)

Russia has baffled us with its tremendous growth on the wireless front…both relatively as well as absolutely. During the full year 2004, it added a total of 37 mn wireless subscribers (the second highest additions in the world after China) totaling to around 74 mn, and its wireless penetration shot up by 25 percentage points (p.p.) to around 51% as at the end of 2004. The growth accelerated further during the last quarter of 2004, when a total of 14.8 mn wireless subscribers were added and the month of December alone witnessed a contribution of 8.3 mn to the total tally, with an increase of 5 p.p. in penetration!!!

Russia’s superlative performance clearly dwarfed the additions made by its emerging market peers, such as Brazil, Mexico, India, etc. During 2004, Brazil added a total of around 19 mn subscribers, Mexico added around 6.5 mn and India added a total of around 19 mn during the full year 2004. On the penetration front, Russia was again the clear winner in comparison to its peers during 2004, which saw Brazil increasing its wireless penetration by around 10.4 p.p. to 37%, Mexico by around 5.5 p.p. to 34.5% and India by around 1.7 p.p. to 4.5%.

The region continued its growth story during Q1 CY05 as well by adding close to 12 mn subscribers (after adding close to around 15 mn subscribers during Q4 CY04) to cross the 86 mn mark and consolidated as the No. 1 wireless market in Europe ahead of Germany by a huge margin. During Q1 CY05, the wireless subscriber addition in Russia was the largest in the world after China and the wireless penetration rate jumped to more than 59%, marking an increase of 9 percentage points from that in 2004 end, which was the largest increase in wireless penetration (with a sizable population, of course) in the world! We expect Russia to add close to 35 mn wireless subscribers during 2005 and to close the year with a wireless penetration rate of around 75%. However, going forward, we expect the subscriber addition to cool down during 2006, with the subscriber addition to be somewhere around 18 mn and the wireless penetration to be 87%.

Mobile TeleSystem (MBT) and Vimpel Communications (VIP), the top two American-listed Russian wireless companies in the region, have also been doing tremendously well. Having built up a strong base in Moscow and St. Petersburg, the top two wireless markets in Russia, these companies have been expanding their bases in regional parts of Russia, such as the Far East, Siberia, Urals, etc. primarily through the acquisition mode. Unlike global wireless giants, which went for high premium acquisitions that eventually hurt their profits (through huge write-offs), as well as their balance sheets (large debt for the funding of acquisitions), the duo have been amazingly enjoying handsome profitability and clean balance sheets, despite having done a deluge of acquisitions. MBT and VIP enjoy an EBITDA margin of around 45-50% (while the big players like Vodafone, T-Mobile, Verizon, etc. earn less than 40%) and a net profit margin of around 20%, while their balance sheets also remain attractive with a debt equity ratio of less than 1x, as a major portion of their acquisitions have been funded by their operating cash flows.

Not satisfied with the domestic expansion-led growth, these operators began to quench their thirst for growth by expanding in neighboring poorly-penetrated CIS countries, such as Ukraine, Belarus, Kazakhstan, Uzbekistan, etc. These operators are also exploring various opportunities for expanding their operations in other CIS regions that are poorly penetrated.
The only red signal on these stocks is the political risk that is country specific. The risk makes us a bit cautious on the stocks but the attractive valuations more than compensates for the risk and MBT and VIP are top picks in the market.

The wireless penetration in Moscow and St. Petersburg surpassed 100% and 90% respectively; henceforth the growth will come in from the regional part of Russia where the penetration level stood at around 42% at 2004 end. We believe that 2005 will be the last big year to witness a quantum jump in the wireless penetration level and subsequently, the subscriber base in Russia.

Telecommunications- India: Indian Wireless Sector (May 2005)

The Indian wireless market has been witnessing a metamorphic change. Like other emerging markets, poor penetration of fixed line telephony (around 3% at 2001 end, when the incredible growth of wireless began) largely helped to drive the initial growth in wireless telephony. The growth was later driven by competition due to the introduction of fourth license Cellular Mobile Service Provider (CMSPs). Post 2002, the heightening of price-based competition after the entry of Reliance Infocomm and the introduction of Calling Party Pay (CPP) regime led to the exponential wireless growth.

India has been adding on an average of 1.6 mn mobile subscribers during the past 7-8 months, however of late the rate has been around 1.5mn due to strictness in the subscriber verification, and the total base stood at around 53.65 mn at the end of April 2005. Such is the spectacular growth and the future potential that the multinational telecom equipment companies are ready to finance the working capital or even the long-term funding needs of the Indian wireless companies. However, despite the spectacular growth, India is multi years behind that of its emerging market peers in terms of penetration, with its penetration standing at around 5%, as against China’s 27%, Brazil’s 39%, Russia’s 61% and Mexico’s 40%. The huge contrast in the income level provides an idea of the reason behind the penetration disparity. For instance, while a person earning less than $80-85 (at the current price) per month is categorized as falling below the poverty line in emerging countries, such as Brazil and Russia, ironically India’s per capita income is a mere $50 per month.

Nevertheless, with the Indian economy expected to grow at a sustainable rate of more than 6-7% (real growth rate) for the next 10 years and with a huge middle class population (23% of the total population) of 240 mn, which contributes around 42% to the total consumption, the wide gap in the penetration rate is expected to narrow down. We also believe that the increasing level of income would have a multiplier effect on the mobile penetration rate. Our Penetration Per Capita Income Index of 0.56 (definition explained in the Appendix) for India makes a stronger case for the propelling growth expected in the Indian wireless space in the coming future.

India, due to its immense potential, is in the crosshairs of foreign biggies like Vodafone, which has time and again showed interest in India. Germany has also shown interest in participating in India’s growth in infrastructure, telecom, etc. The Russians (Vimpel, MBT) are also into talks with Indian operators, on and off, for entry into the Indian mobile market. Plus, a host of smaller regional players (Aircel, Essar, after its stealth takeover of BPL recently) are expanding rapidly in the growth regions of smaller Indian towns and cities.

We believe that foreign operators were wary only of the foreign ownership issue, as they like to have a controlling stake rather than a minority stake. It is now pretty much clear that 74% foreign ownership issue will get the final government approval. It’s a just question of "When" rather than "If".

To seek an All India telephony license (i.e. for 23 circles) a new operator needs to shell out only around $400mn. i.e. INR 1600 crs. (For NLD- INR 100 crs and ILD- INR 25 Crs.) Metros and Circle “A” are the expensive belts for which the total license cost comes to around $275-300mn. Circle “B” and “C” provides better opportunity for growth than Metro and “A” circles (with lower entry cost), because of the relatively poorer penetration (penetration in these circles are around 2.8% as compared to around 9% in Metros and "A" circles). Also there are lower marketing and subscriber acquisition cost in these circles that make the “B” and “C” all the more attractive. All the operators whether big (Bharti Televenture and Reliance Infocomm) or small (Aircel and Essar group) are betting big on these circles.

GSM operators have been allocated spectrum in the 900MHz & 1800MHz radio bands in India, while CDMA operates in the 800MHz band. There is enough space left in the 1800MHz band to accommodate at least 2 new GSM operators across India. Moreover a part of 1800 MHz band which is currently used by Indian military forces, will be available for GSM operation as the military has agreed to vacate the same and move to some other band.

In fact recently, Indian telecom regulator TRAI has recommended that the GSM operators would get an additional spectrum in the 1800 MHz radio band by 2006 end that has been currently occupied by the defense authority. CDMA operators would get an additional spectrum in the 800 MHz band. Much anticipated 1900 MHz band is currently not available, as the defense sector has occupied the same that cannot be vacated. However, TRAI has recommended that GSM and CDMA operators would also be given spectrum in the 2 GHz radio band.

CDMA operators can launch their 3G services using the additional 800 MHz band however they will face some handset related problems, however that will be sorted out in the near future. Although, the GSM operators cannot provide the 3G services in the 1800 MHz band as this spectrum is configured for normal cellular services, they will have to wait until they get a few spectrums in the 2 GHz radio band.

In India, currently CDMA operators operate in 800MHz radio band, while GSM operators operate on 900MHz and 1800MHz radio band.

TRAI has also recommended that the ceiling on annual spectrum charges be reduced to 4 per cent of the adjusted gross revenue (AGR) from the existing 6 per cent.

These recommendations are to be approved by the Govt. of India.

Vibrant wireless India… incorporating various developing technology (December 2004)

Now comes a different business model!!!

Wireless telecommunications is one of the few technological areas where India is very closely watching the dynamism around the world and is gradually reducing the lag time to embrace various new developments happening in its tech savvy peers. India is walking hand in hand with its emerging partners like China, Brazil, Mexico, Russia etc. and sometimes even overtook them and came closer to the big daddy US and Europe ahead of its peers. Agreed that with a mere 5% wireless penetration, India is largely dwarfed by its peers’ rate of around 30-40% or even more, hence it has to still pull up its socks to catch them. But leaving beside the penetration story, if we analyse India’s performance in embracing the advanced wireless technology, the conclusion would make every Indian smile and encourage the wireless operators to achieve even more milestones.

India has seen the launch of Push-to-Talk (PTT) service (a Walkie-Talkie feature, once confined to the US), simultaneously or even ahead of its launch in Europe by the biggies like Orange and T-Mobile. While the term is absent in its peer nation, only Mexico’s Telefonica Moviles Mexico has launched the PTT service recently. Tata Teleservices is one of the first CDMA operators outside the US to launch PTT service and also the first wireless operator in the world to commercially launch Qualcomm’s BREW (BREW) Chat solutions while launching its Push to talk service early this year.

The GSM technology has been upgraded to EDGE in India (during early 2004) much faster than its peers, albeit with a few exception like Brazil where Telecom Italia Mobile launched EDGE during 2003 end, while Russia still works on GPRS. The launch of the ‘Ring Back Tone’- a recent buzzword in the wireless world capable of generating worldwide revenues of $4bn by 2006, by the operators like Airtel, Hutch etc. in India coincides with that of the US and Europe in timing. Verizon has launched the service (the first of its kind in the US) during November 2004 and is planning to launch it nationwide by next year, while many operators in Europe are launching the additional revenue generator service.

Now comes in India, another business model in the wireless world - Mobile Virtual Network Operator (MVNO), which is highly successful in the US and Europe. A MVNO is a low cost mobile service provider/operator that does not own its own spectrum and usually does not have its own network infrastructure. They buy wireless minutes from the mobile operators having all the resources, and further sell the wireless minutes to their customers after packaging the same with some other features under their own brand. They have full control over the SIM card, branding, marketing, billing, and customer care operations. Virgin Mobile has been very successful MVNO player, and has become one of the top ten wireless operators in the US within two years of its launch and the fifth largest in the UK. In the US it uses Sprint’s network (a CDMA operator) while in the UK it uses T-Mobile’s network (a GSM operator). It is a kind of win-win situation for both-the provider of network and the MVNO. While the infrastructure provider can earn revenues from their otherwise idle lying infrastructure (inevitable in the wireless industry) without much additional expenses, while the MVNOs save their infrastructure building cost, and deprecation thereon, which runs in billions of dollars. Their main focus remains on the branding and generally they target youths and teens with their life style branding strategy.

Virgin Mobile has shown interest to have its footprint in the booming Indian wireless industry, incorporating the same business model of MVNO. If serious on India, Virgin would go in for a joint venture (the strategy adopted in the US and UK) with the prospective infrastructure provider in India. It might seek the wireless infrastructure from the CDMA players like Reliance Infocomm, Tata Teleservices or GSM players like Airtel or Hutch.

The dynamic wireless India promises to provide world-class communication experience and should this model arrive in India, we can experience a totally different wireless world and all the new form of competition too.