European Telecoms The Digital Telco - a Big Data ‘re-rater’? Industry Overview Equity | 04 September 2017 New opportunities for Telco in a Digital World Europe Telecommunications So far Telco has been the facilitator of the digital revolution. But telco too must adapt as customer demands change, digital applications proliferate and new disruptive technologies and companies threaten traditional profits. However telco is well positioned to do so, in our view, thanks to its Big Data commodity. New processes, tools and techniques could see telco exploit Big Data to defend and upsell existing revenue streams, driving cost and capex efficiencies. Analysis suggests up to 30% value upside to Euro telco as a potential mid-term re-rating catalyst. Big Data questionnaire indicates Euro Telco progress We asked questions of 13 Euro Telcos on the subject of Big Data. Responses indicate to David Wright >> Research Analyst us that progress could already be significant; the majority of telcos who answered our MLI (UK) +44 20 7995 6355 questions shifted over the past 12m from inconclusive projects to NPV +ve results. Most [email protected] focus at this stage is on Customer Care and Sales & Marketing. However there is still a Haim Israel >> long way to go with most projects still regional and not yet coordinated at Group level. Research Analyst Merrill Lynch (Israel) [email protected] Boosting revenues through data growth and new avenues Frederic Boulan, CFA >> Digitalisation fuelled by Big Data analytics provides telco with a means to better offset Research Analyst MLI (UK) legacy revenue decline and upsell existing customer relationships, while exploring new [email protected] growth opportunities. In B2C, demand for data ensuing from new digital platforms such Sunil P. Patel >> as TV, music, gaming and cloud should provide an ongoing opportunity for telco to Research Analyst MLI (UK) stabilise and potentially grow revenues, especially as legacy decline becomes less [email protected] material. This conflicts with bundled connectivity however, where upselling discounts on Parin Shah, CFA >> mobile Sims etc. could mean lower revenues, but also lower churn. In B2B, opportunities Research Analyst MLI (UK) include managed service solutions, cloud, M2M and IoT to offset legacy pressure. Other [email protected] drivers include Big Data analytics (US$203bn opportunity by 2020), Government (global Florian Henritzi >> spending on public cloud services and infrastructure is expected to reach $122.5 billion Research Analyst MLI (UK) in 2017), while smart cities is expected to be a US$ 1.3-1.6tn opportunity by 2020E. [email protected] Mobile advertising is anticipated to be a USD 100bn opportunity globally by 2016. Digitalisation as a key source of efficiency Recent BofA Merrill Lynch Global Research Reports We believe digitalisation will be a key driver of cost reduction across a number of cost brackets, including (1) Customer care: using analytics and AI to better predict (and reduce) Title: Subtitle Primary Date churn, plus predictive fault detection to reduce call centre costs, (2) Distribution/commission Author Published savings from an increasingly on-line sales channel and digital provisioning, and (3) IT cost [email protected] Outlook H2/2018: David 31 August savings through transformation of IT infrastructure to a digital model with reduced engineer Conviction can return Wright 2017 costs, better capacity/load and fault management. Network virtualization enables telcos to Deconstructing more- David 01 September reduce their dependence on hardware and migrate services to the cloud. We see up to 10- for-more: mobile Wright 2017 15% value upside as potential laggards reduce IT costs to best-in-class levels, while misfiring / fixed better commercial cost potential increases value upside to a 20-30% range, with further to go as organisations take digitalisation to a next level in the field of customer management, sales, network and IT. Stock by stock we find TDC is already efficient, while there is notable upside potential to Orange, TI and Vodafone. >> Employed by a non-US affiliate of MLPF&S and is not registered/qualified as a research analyst under the FINRA rules. Refer to "Other Important Disclosures" for information on certain BofA Merrill Lynch entities that take responsibility for this report in particular jurisdictions. BofA Merrill Lynch does and seeks to do business with issuers covered in its research reports. Unauthorized redistributionofthisreport isprohibited.Thisreport is intendedfor As a result, investors should be aware that the firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision. Refer to important disclosures on page 44 to 45. Analyst Certification on page 43. 11783735 Timestamp: 03 September 2017 10:00PM EDT Contents Conclusions 3 How much is it all worth? 5 Big Data fuelling the Digital Opportunity 6 The Digital Phenomenon 6 Big Data & the Digital Telco 7 Where is Euro telco today - Big Data questionnaire 10 Revenue Opportunity 16 B2C – protecting/growing revenues with bundling 16 B2B - gradually gaining traction 21 B2Government - still in early stages 25 Big Data analytics - external monetisation 27 Cost Opportunity 30 Digitalisation a key enabler of cost cutting 30 The benefit of lower churn: 1pp lower churn drives 2% EBITDA uplift 32 Benchmarking IT costs 33 Commercial costs: VOD and Telenor have most room to optimize 34 Online vs offline – a leaner distribution 35 Case Study – Vodafone cost evolution 35 All-IP: 1-2pp upside to long term margins 36 Capex / investment needs 38 2 European Telecoms | 04 September 2017 Conclusions Telcos undergoing (r)evolutionary change So far Telco has been the facilitator of the digital revolution. But telco too must adapt as customer demands change, digital applications proliferate and new disruptive technologies and companies threaten traditional profits. However telco is well positioned to do so, in our view, thanks to its Big Data commodity. New processes, tools and techniques could see telco exploit Big Data to defend and upsell existing revenue streams, driving cost and capex efficiencies. The digitalisation of Telecommunications is a $2trillion opportunity (World Economic Forum) Big Data re-rater? From Gigabytes to Terrabytes to Zettabytes to Brontobytes, the proliferation of digital applications in an increasingly on-line world means data growth is unrelenting. Thus the term Big Data is used to represent the sheer volume of information accrued. But just as Big Data is a challenge to manage through the ‘three Vs’ of volume, velocity and variety, so it is also an opportunity to know more than ever about the customer and their evolving needs. Exhibit 1: Relentless data growth ahad Source: Hewlett Packard Here Telcos have a huge opportunity, we think, if only because they are the key enabler of data access and carrier of data itself. This confers multiple opportunities to empower their existing business model, defend against attackers and diversify into new areas. BofAML questionnaire confirms Euro Telco is up and running What is encouraging from an investor perspective is that Euro telco is already up and running; we asked questions of 13 large cap Telcos with >E310bn market capital on the subject of Big Data, confirming that within 12 months projects have evolved from an inconclusive basis into more sustainably NPV value accretive. Telco’s initial focus on the Big Data opportunity lies, unsurprisingly in Sales & Marketing and Customer Care. European Telecoms | 04 September 2017 3 Chart 1: Questionnaire - How would you describe the status of Big Data within your company? Big data processes established pervasively across the group, deriving NPV +ve results Big data processes established across certain divisions/geographies, deriving NPV +ve results Big data processes established, results inconclusive Today 12m ago Analysing projects and opportunities No formal big data projects 0 1 2 3 4 5 6 7 8 9 10 Source: BofA Merrill Lynch Global Research Telcos evolving Revenue/Opex models Digitalisation fuelled by Big Data analytics provides telco with a means to better offset legacy revenue decline and upsell existing customer relationships, while exploring new growth opportunities. Considering these: • B2C: Demand for data ensuing from new digital platforms such as TV, music, gaming and cloud should provide an ongoing opportunity for telco to stabilse and potentially grow revenues, especially as legacy decline becomes less material. This conflicts with bundled connectivity however, where upselling discounts on mobile Sims etc. could mean lower revenues, but also lower churn. • B2B: With the shift away from legacy services comes the opportunity to sell new managed service solutions, cloud, M2M and IoT. Other potential drivers include: • Big Data analytics: According to IDC, Big Data and business analytics globally is expected to reach US$203bn by 2020, growing at a CAGR of 11.7%. Telecom companies are expected to contribute significantly to this. • B2G (Government): According to IDC, global spending on public cloud services and infrastructure is expected to reach $122.5 billion in 2017, 24.4% growth over 2016. Public cloud spending will reach $203.4 billion growing at a CAGR of 21.5% about seven times IT spending growth. Meanwhile based on our Thematic Investing team report (Thematic Investing: 21st Century Cities: Global Smart Cities Primer 02 March 2017), smart cities is expected to be a US$ 1.3-1.6tn opportunity by 2020E. • Mobile advertising: According to eMarketer mobile advertising is anticipated to be a $100bn opportunity globally by 2016. Perhaps the most transformational aspect of digitalisation and biggest potential driver of value creation is in the cost line. • Customer care: using analytics and AI to better predict (and reduce) churn, plus predictive fault detection to reduce call centre costs; • Distribution/commission savings from an increasingly on-line sales channel; • Wider IT cost savings through transformation of IT infrastructure to a digital model with reduced engineer costs, better load and fault management.