Shares digital

by Russ Mould

Spring’s sale of mobile bandwidth in the US by the Federal Communications Commission (FCC) raised double the expected price, reaffirming just how valuable a commodity the wireless spectrum really is. Over a hundred bidders spent $19.1 billion on 1,090 individual licences across five blocks of 700MHz bandwidth. AT&T and Verizon spent $16 billion between them and they will use the newly acquired bandwidth to offer 4G mobile broadband services.

This 700MHz additional spectrum will be freed up in 2009, when US broadcasters make the move from analogue to digital. The UK also has plans to sell off 900MHz bandwidth released by the same switchover, possibly in 2009.

Ofcom already has plans in 2008 to auction the ‘L-Band’, found between 1452-1492 MHz, for mobile television applications, and also 2.6GHz spectrum. The latter is ideal for broadband technologies such as 3G wireless and also Worldwide Interoperability for Microwave Access (WiMax).

But the auctions are just one development investors will need to track closely in a rapidly changing industry.

Evolution and revolution

Capacity utilisation of Vodafone’s 3G network averages only 20% across Europe, but plans are already under way for the launch of 4G services.

4G network equipment will undergo trials in Japan later this year and the commercial launch is planned in the US and UK around 2012. Yet this timetable could easily slip, as rival technological standards battle for supremacy. Vodafone, Verizon and China Mobile have backed the European Long Term Evolution (LTE) technology, which offers an easy upgrade path from 2G, 2.5G and 3G Global Systems Mobile (GSM) systems.

However, America’s Qualcomm continues to push Ultra Mobile Broadband (UMB) as an alternative. The San Diego firm even bought five licences for $555 million in the recent US auction to get a toehold for UMB, which is the latest generation of the cdmaOne and CDMA2000 technologies championed by Qualcomm, and deployed in the US, Latin America and Asia, for 2G and 3G respectively.

A more radical development is the rise of WiMax. This has been championed by Intel and US operator SprintNextel, but also has a powerful UK advocate in the form of Freedom4 Communications.

Freedom4 is a 52-48 joint venture between Intel and Freedom4, which is all that remains of the old Pipex business after the sale of its hosting and broadband services and April’s cash tender to shareholders.

With access to around £30 million in cash, Freedom4 has already launched its fixed broadband service in Manchester, Warwick and Milton Keynes, which is aimed at small businesses and operates at the 2.6GHz band. But chief executive Mike Read applied for a mobile licence in February, and plans to increase his firm’s reach in time cannot be ruled out.

‘We want to continue focusing on the business side, as average revenues per user (ARPU) is better and we have the products businesses want,’ says Read. ‘But the cream would be to add mobile and get the consumer to sign up to us.’

Read will watch this year’s Ofcom 2.6GHz auction with interest, as he believes his firm’s £17.3 million market cap will be left looking too low. ‘Yes, we worry it could bring competition but it will take months to build a network and will also help establish a value in the market for us,’ he says.

New business models

New business models are emerging alongside new technology. America’s Verizon Wireless created a stir in February when it offered unlimited voice calls for $99.99 a month, a move swiftly copied by its key local rivals. Vodafone has also been experimenting with price elasticity, launching a sharp price cut for data services two weeks ago.

Yet a more dramatic shift in model has been proposed by newcomer Blyk. Founded by former Nokia President Pekka-Ala Pietila, Blyk is a mobile virtual network operator, offering its service across the existing Orange network. Blyk is available only to 16-24 year-olds and funds itself solely through advertising. In return for accepting advertising messages on their mobiles, users get a number of minutes and texts each month for free. Once that amount has been exceeded, usual pay-as-you-go rates apply. Over 100,000 members have signed up since the UK launch last September and Blyk claims a 29% average response rate to advertisements, way ahead of the single-digit percentage acknowledged by Vodafone.

Vodafone CEO Arun Sarin was fighting for his job in 2006 after disappointing financial results, but his aggressive management of the telco’s portfolio has largely won over the doubters. Holdings in mature markets such as Japan, Sweden and Belgium were sold and the cash recycled into growth areas such as Turkey and India. This process may not have reached its conclusion.

‘There is a bunch of things they would quite like to do, but they are quite expensive still,’ asserts John Davies of investment bank Dresdner Kleinwort. ‘Private equity is not in the game, but lots of others will be, particularly if an emerging market asset is put up for sale,’ he adds.

Davies’s words have already been confirmed by last week’s bid from India’s Bharti Airtel for a 515 stake in South Africa’s MTN, an operator that had in turn increased its reach across Africa and the Middle East with its 2006 purchase of Investcom. Vodafone tried, and failed, to secure control of South Africa’s Vodacom last year.

Major changes in competition, technology and services offer opportunities as well as challenges to the operators, and also to smaller players within the industry. These include software platform providers, who enable telcos to offer value-added content, such as data, video and banking services and it may be here that the greatest upside lies for stock market players.

‘There is so much money in the mobile internet,’ argues Dresdner Kleinwort’s John Davies. ‘If they [software platform providers] can grab even a few basis points of that, it’s a huge opportunity,’ he concludes.

TOP ANALYSTS

John Davies, Dresdner Kleinwort - Data is key

Despite the mobile telecommunications sector’s marked underperformance so far in 2008, Dresdner Kleinwort’s John Davies remains convinced rising data usage will drag it out of the doldrums. ‘It’s the sheer quantity of stuff that is now data,’ he enthuses. ‘Just look at the charts from Vodafone’s analyst day in April. If you extrapolate from those, there’s now more data traffic than there is voice, which is quite surprising.’

Davies identifies pricing concerns and the European Commission’s investigation into termination rates as the reasons for the sector’s laggard showing, but believes both concerns are overdone.

He points out Ms. Reding failed in an attempt to totally eliminate roaming costs, even though she had broad-based support from MEPs, and suggests a repeat could be on the cards. Davies also believes valuations now discount the pricing worries raised when Verizon Wireless’s February offer of unlimited monthly voice calls for $99.99 was immediately matched by AT&T Mobility and T-Mobile.

‘There was a leg down in valuations from seven times to six times EBITDA on the back of all-you-can-eat tariffs in the US, but that’s done and dusted now,’ he says. ‘If you see the recent reports from AT&T and Verizon, they are actually very happy. $100 is actually a hell of a lot of money and if every customer offered to pay that, they’d probably take it.’

Such reassurances mean Davies continues to highlight Vodafone as a Buy. His 250p price target is based on a discounted cashflow model.

Jonathan Groocock, Investec - Calls on Vodafone

Investec’s Jonathan Groocock joined the firm from Oriel Securities last year and quickly established himself after a telling sell call on Vodafone last November, when the shares hit a seven-year high of 195.7p. The shares swiftly rattled back to 150p, prompting Groocock recently to upgrade back to a neutral rating, with a 160p price target.

‘We upgraded on valuation, as the shares seem quite well supported around the 150p level’, he says. ‘On a trading basis they seem well underpinned too, and they are structurally very exposed to the euro against sterling. Their guidance for fiscal 2009 will be based on the euro-sterling cross rate from the end of March, which will be likely to result in earnings upgrades at results on 27 May.’

Despite assistance from foreign exchange movements, Groocock identifies key challenges still confronting the mobile telco giant, including spectrum auctions in India and America. ‘Competition in India is increasing and at some point there will be 3G licence auctions, too. If you have a five-year payback plan [on the investment in India] then returns could be pushed out,’ he suggests, before arguing the cloud cast by threatened regulatory cuts to termination rates across Europe remains a pressing negative.

However, Ofcom’s proposed licence auctions of 700MHz in the UK are seen as less of an issue, as Groocock believes the 2009 timetable could slip.

Michael Armitage, Charles Stanley - Small is beautiful

Charles Stanley’s highly experienced Michael Armitage focuses on small cap opportunities; he retains a sceptical stance on Vodafone. The former Morgan Stanley and Altium analyst highlights competitive threats such as that posed by the Voice over Internet Protocol (VoIP) service offered by Aim-listed Vyke.

‘This won’t be causing Vodafone too many sleepless nights, but it’s another irritant, chipping away at the margin,’ he argues.

Instead of focusing on the sector giant, Armitage emphasises the attractions of software platform providers 2 Ergo and WIN.

Burnley-based 2 Ergo’s shares have been boosted by its relationship with Blyk. ‘2 Ergo claims to have exclusivity on carrying traffic for Blyk, delivering the ads, although WIN’s [CEO] Graham Rivers claims there is no exclusivity,’ smiles the analyst.

Interim results from 2 Ergo should reveal more on 19 May, while Armitage stresses the disparity in valuation between WIN and mobile marketing specialist HipCricket, which floated last November on Aim with a market cap of £75 million, even though it had sales of just $2.1 million and lost money last year. By contrast, WIN was profitable yet trades on a market cap to sales ratio of less than 0.5 times.

BEST BUYS

WIN - Back from Crazy Frog

The regulatory clampdown on premium SMS services after 2005’s ‘Crazy Frog’ ringtone scandal hit profits hard and prompted the arrival of new management in November 2006. Under chief executive Graham Rivers, WIN has de-emphasised its initial SMS activities and sharpened its focus on interactive mobile services, particularly for the enterprise. Meanwhile, Rivers has also overseen a selective acquisition programme. Music specialist Pocket, Switzerland’s Quattrocom and digital marketing provider Pop I-Media have broadened WIN’s product portfolio and created a European footprint from London to Athens.

A market capitalisation of £14 million compares with 2007’s sales of £39.2 million and stated pre-tax income of £1.65 million. This equates to a historic PE of barely seven, and profits are expected to rebound sharply in 2008, taking the prospective PE to around five. This is a fraction of the forward multiples attributed to key comparables such as 2 Ergo and Velti, which trade on 2008 PEs of 19 and ten respectively, suggesting WIN’s move away from the lower-value-added SMS arena has yet to be fully recognised. The stock even paid a 2p dividend last year.

Monitise - Building a strong position

Sunk investment of £35 million has created a tremendous market position for the mobile banking specialist, and further evidence in 2008 of more banking client wins, the addition of new international partners and more service functionality all bode well.

The key concerns remain banks’ willingness to invest in the technology when times are tough and money is tight, and whether Monitise can therefore get sufficient traction before it exhausts its precious cash resources.

UK consumer acceptance of mobile banking has been a touch slower than hoped, even though banks representing 53% of UK current accounts have signed up. This has left the City-based firm with £15 million of annual overhead costs whittling away a cash pile that stood at £15.4 million at the end of 2007.

Investment by key partners could ease any funding concerns – concerns which are not shared by chief executive Alastair Lukies – in the event that cash does become tight. Qualcomm’s $210 million acquisition of rival Firethorn highlights Monitise’s strategic and financial potential and the lowly £22.3 million market cap means there could be rich rewards if licence and transaction fees start to roll in as Lukies expects.

2 Ergo - Looking to Latin America

Lancashire-based 2 Ergo’s Multiserve platform provides content aggregation, delivery and billing capability to communications service providers who want to offer interactive, multi-channel content to their customers.

A strong presence in the UK was supplemented by last year’s acquisition of Proteus in America. Proteus was swiftly restructured and has begun to contribute profitably on a monthly basis. Management intends to use the operation as a springboard into the booming Latin American markets.

The creation of a new division, Interactive Media Services, through which 2 Ergo plans to focus on rising demand for targeted advertising over mobile phones, should also further boost growth.

Recent deals with Vodafone targeted mobile advertising start-up Blyk and a five-year contract from Telefonica’s O2 for its MultiSend interactive messaging suite are all testimony to 2 Ergo’s technological prowess.

February’s trading statement reassuringly noted trading remains in line with expectations and £13 million in cash and investments help to underpin the £64 million market cap.

Good free cashflow means further acquisitions are likely and a prospective PE of around 19 is no bargain when compared with the lower multiples attached to comparables such as WIN and Velti. Underlying double-digit trend earnings growth should propel the shares upward, however, particularly if the advertising venture starts to gain traction.

STEER CLEAR

GMO - Unresolved debt issues

A regulatory clampdown and the uncertain timing of the launch of 3G services in China have hit GMO’s growth prospects and made it harder for the firm to service the debt associated with January 2007’s acquisition of a stake in Wisdom Choice Investments (WCI).

February’s publication of full-year results for 2007 showed the 20% stake in WCI contributed $344,000 of pre-tax income. But the $20.2 million of debt taken on to fund the stake, in the form of Murabahah Loan Notes (‘MLN’), arranged in accordance with Islamic principles, generated $1.64 million in financing payments and drove GMO into loss.

Under the terms of the notes, the debt is to be redeemed within two years of issue and profit payments are to be made on each anniversary of their issue. GMO’s cash pile has been whittled down to just $1.6 million and the firm has now asked the loan note holders to reschedule payment and accept repayment over a longer time period.

GMO’s shares have already plunged but until a deal is reached, the shares should be avoided, even if a £2.4 million market cap looks enticing at first glance relative to 2007’s $7.6 million of sales and $1.7 million on EBITDA.

GMO operates primarily in China and provides wireless value added services (WVAS), a market that was hit by 2006’s crackdown by China’s Ministry of Information.

iPoint-Media - High price, high risk

iPoint-Media’s expertise in 3G and internet protocol (IP) video telephony means the Israeli firm is strategically well positioned, with recent contract wins in the UK and Spain. But a £37.4 million market cap dwarfs last year’s sales of £1.3 million and the lofty valuation already prices in a lot of future growth, making the firm a high-risk bet.

After listing on Aim via a reverse takeover by Plus-listed Elm Investments in 2006, iPoint acquired All New Video in spring 2007 and made organic progress too. Its GOliveTV enables media and broadcast companies to develop new types of interactive television show formats that incorporate moderated user-generated content (UGC) from viewers with 3G mobile phones and internet webcams. The BBC has already signed up for the service, supplementing the Vitrage video calling application platform, which Ericsson has agreed to market to its mobile operator client base.

A shift in business model, from one-off licences toward a leased licence approach, supported by long-term managed service agreements, should reduce revenue and earnings volatility, although it could dampen short-term revenue recognition and growth.

Mobestar - Reality check on sales

April’s update, accompanied by a £550,000 cash raising, seemed as upbeat as last October’s, when the mDate dating service had been in commercial service for five weeks. Yet chief executive Peter Richards admitted ‘take up of the core products has been slower than anticipated,’ perhaps explaining why the shares have fallen from 24p to 9.25p in a year.

October’s statement, showed some £30,000 of revenue from mDate in the five weeks after launch with Gaydar UK, yet by April’s update this figure was only up to £50,000.

GaydarMobile, a white-label version of mDate, has now launched in Australia and Spain, with releases set for South Africa, Europe and Japan by September. With a deal with 3 to promote GaydarMobile, and Bonefish’s launch of mCast in April, this should boost sales, and support Richards’ assertion Mobestar is ‘experiencing a steady growth in its customer base and subsequent revenue streams’.

New prepackaged services, such as Morf, and Meter, should also help. But slow progress with Gaydar suggests Mobestar is still establishing mobile social networking, even if a lower £4.2 million market cap means expectations are now more realistic.

RISING STAR

Lukies looks forward - The Monitise chief executive focuses on glittering prospects despite huge spending

It may seem odd to pick out as a rising star a firm whose share price has slumped from 22p to 8.25p since it was spun-off onto Aim last June. Yet chief executive Alastair Lukies is not fazed. ‘We have done the equivalent of what Link has achieved in 17 years in just four. We are encouraged by our pipeline of prospects,’ he says.

Monitise was established in 2003 and spun off from IT consultant Morse in summer 2006, raising £21.4 million in fresh cash. The company facilitates banking services over mobile phones, including balance and transaction enquiries, bank transfers and payments and mobile phone top-ups. SMS balance alerts are already available. The platform is agnostic regarding which bank or mobile phone the customer uses and deploys one consistent user interface.

Developments such as contactless payment, ATM locators, international remittance and a Visa shopping voucher scheme are planned for 2008, with expansion beyond the UK and US. But Lukies sees the start-up nature of his firm presents challenges. ‘We could do a lot more business in Africa and South Africa, but we are capacity-constrained,’ he admits. ‘Our model is one of joint ventures and licence partners and it is labour-intensive.’

Dual approach

Monitise has built what Lukies calls a ‘mobile banking ecosystem’, with two different routes to market.

First, Monitise uses partners such as Visa, Germany’s T-Systems and BT to penetrate markets. Further international partner signatures are in the business plan for 2008 and beyond.

Second, its operations currently centre on two joint ventures. Monilink is a 50-50 venture with VocaLink, formed in 2003. Over half of UK current account holders are now covered by Monitise customers. Royal Bank of Scotland and Ulster Bank offer the service. Alliance and Leicester has begun to roll it out to business clients. Meanwhile, Monitise Americas appeared in July 2007. Venture partner Metavante owns 51% of Monitise Americas and Monitise the other 49%. The service only went live last Christmas, but Metavante has already signed up 20 banks in the US. Metavante’s leadership in banking and payments, and its US listing and multi-billion dollar market cap, give credibility and great market access.

Focus on income

Income has mainly come so far from consultancy with prospective and confirmed clients, but partnerships and joint ventures are geared toward generating licence income from customers. Usage fees from every transaction over the platform will follow.

Given the world’s three billion mobile users, the potential is vast. Monitise currently generates roughly 55p per user per month from Monilink, while it plans to take 3%-5% commission on transactions such as prepay top-up and international remittance.

But this long-term picture has not helped the share price in the short term. February’s interims saw Lukies acknowledge consumer uptake of mobile banking & payments services has been slower than hoped, although 110,000 clients had registered by late December. Overhead costs of around £15 million a year dwarf revenues that reached £392,000 in H1. Costs break down between £10 million of intellectual property and platform development spend and £5 million in expanding territorial reach. Ongoing start-up losses will go on eroding a £15.4 million cash pile in 2008, even if development spending should start to plateau this year.

Once that cash is adjusted for, a market cap of £22.3 million values Monitise’s business at barely £7 million, although that cash pile is going to diminish, as start-up losses continue. But the stock looks worth a punt given the benchmark set by Qualcomm’s $210 million purchase of rival Firethorn, and Lukies’s previous successes, which include a Malaysian events and conferences business and co-founding and selling Westminster portal epolitix.com.

Lukies believes fears over his firm’s long term ability to keep funding its losses are overcooked. ‘A rights issue is not our only option [if cash is needed]. We have valuable assets that we have created over the past five years,’ he says, before hinting at interest from possible partners when he adds: ‘There are always people looking.’

30 second Monitise

• Founded in 2004 and floated on Aim June 2007

• Market value just shy of £22 million

• Chief exec Alastair Lukies co-founded epolitix.com, the portal for Westminster and Whitehall

• Monitise recognised as Technology Pioneer by World Economic Forum in 2006

• Winner of Innovative New Product award at European Banking Technology Awards 2007

CHARTING THE SECTOR

The 18 months to the end of 2008 saw the telecoms market index of FTSE 350 stocks rise by over 75% and during 2007 the index largely traded within a bull channel, the base line of which provided clear support as it coincided with the 200-day average.

As the new year dawned the market was trading off the upper channel return line having briefly made an upside breakout in the autumn. This move now appears to have been a final exhaustion move and the return to the channel should have warned chart followers that further weakness was on the cards. In the event the index dropped to test the channel base line and bounced to test resistance from the 50-day average at the state of February. The subsequent return of selling saw the index break below the channel base to test congestive support close to 3,400.

Now the index has broken above the bear trend line drawn off the highs seen during the sell-off and has also climbed above the 50-day average. In doing so it has built a double bottom pattern which targets a move above 3,900, some 5.5% above current levels. In the longer run we need to be cautious as there is obviously the possibility that we are forming the right-hand shoulder of a massive head and shoulders top that has been developing over the last 12 months so if the market broke below 3,400 there would then be risk of the index dropping by a further 1,000 points (30%).

Vodafone (VOD)

BUY - 154p

TARGET - 178p

STOP LOSS - 146p

For followers of Fibonacci, the shares failed to make it above the important 38.2% Fibonacci retracement level of the big sell-off before suffering a further significant sell off which saw the shares drop by 24% between October and March. In doing so, support from the base line of the bull channel, established during 2007, was breached and a subsequent re-test of clear congestive support at 148p occurred. Now we have a small bounce, the break of the near-term bear trend line and indeed the possibility of the completion of a double bottom which would target a re-test of the 200-day moving average close to 170p, coincidentally also the 50% retracement of the last sell-off from 196p and a gap on the daily high/low/close chart. The worry for bulls is that the last six months has been characterised by noticeably low volume. A move below trend line support at 161p would risk the failure of the double bottom and signal a likely re-test of 148p via channel extension support at 154p, with any further weakness giving bears hope of seeing 125p. There is also the possibility that we are seeing the right hand shoulder of a large head and shoulders pattern play out that would itself target the 100p area. The safest approach is to await a move closer to 154p and to buy with close protective stops just below 148p.

Inmarsat (ISAT)

BUY - 468p

TARGET - 520p

STOP LOSS - 454p

We were a little early with our bull call in mid-February. Subsequent weakness saw the shares move down to test the coincident bull channel base line and previous congestive resistance (which was now to be strong support) at 420p in mid-April. This move resulted in a breach of the 200-day average and caused the 50-day to cross below too, however no ‘dead’ cross was formed as the 200-day continued to rise. With last week’s rises completing this pattern, we have a suggestion of a target of 500p via possible bear trend line resistance at 490p. Above these levels a test of 520p could be seen and with the top of the channel currently set at 560p, the possibility of a new all time high is there. Only a move below 442p would call the bullish scenario into serious question and point to a re-test of the bull channel base line, currently rising through 428p. Of course a move below this latter level would be highly bearish but is considered unlikely. For choice, the upside attracts with the expectation of the price being into the 500s.