November - 2000 - issue > Cover Feature

Global convergence of the Internet with wireless telecommunications has resulted in the mobile Internet explosion. On the consumer side, the mobile Internet represents opportunities for companies to gain customer mindshare and to position for a larger share of future Internet revenues. The winners will offer a personalized, easy-to-use platform with rich content.

There are many reasons to be upbeat about wireless, none more so than the adoption rates. The adoption rate of the mobile Internet is one of the fastest of any consumer product ever introduced to the market. Although the overall market estimates for mobile Internet data access, mobile-commerce and mobile advertising revenues are still unclear, such revenues will be driven by eventual consumer adoption of mobile Internet service. There are multiple factors along the value chain that will contribute to the growth of the mobile Internet, including the speed and capacity of the components of the mobile devices, the speed and capacity of the wireless operator’s network, the evolution of a variety of global technical standards, the functionality of the device and service and the availability of compelling content. Early signs are encouraging as evidenced by the success of NTT DoCoMo’s I-mode service in Japan, the first widely deployed wireless Internet service, which has exceeded eight million users in slightly more than a year (in comparison, AOL has 26.9 million subscribers and EarthLink has 3.7 million subscribers). The wireless analysts at Goldman Sachs predict that users of wireless handsets will grow from 480 million at the end of 1999 to 1 billion by 2003. Furthermore, wireless Internet access is expected to grow from 4 million in 1999 to 411 million in 2003, or 41 percent penetration of all mobile devices. By 2003, the wireless communication devices are likely to be the leading connectivity service for Internet/data services, even exceeding that of PCs. This phenomenon will likely have a much more profound impact outside the US as wireless penetration rates in other parts of the world are higher than that of PCs.

From an investment perspective, we have separated the opportunity into three categories: equipment, operators and software infrastructure. Additional indirect beneficiaries would include established Internet portals, destination sites and semiconductor and IT services companies that will be able to expand their scope beyond the PC and into the wireless device. The performance in the three primary categories has been fairly volatile in the last several months as we’ve seen investor sentiment in this area swing widely due to both broad market sentiment issues (e.g., interest rates) and company specific issues (e.g., Nokia’s recent change in Q3 outlook). Due to the positive market sentiment and the extreme volatility, many institutional investors have spread their investments across the various categories. While the recent pullbacks have been hard to stomach, with declines ranging from 35 to 70 percent, one needs to look at the 70 percent-plus performance of each of the three categories in the past year.

The leading wireless equipment makers will benefit from the robust demand for wireless service, which will be turbo-charged by the future demand for wireless Internet service. The Goldman Sachs prediction of one billion handsets by the end of 2003 represents a huge opportunity for wireless equipment makers like Nokia, Ericsson and Motorola, which make mobile devices and network infrastructure. The past few years have witnessed frequent shortages in handsets, mostly due to the shortage of components within the handset. A clear sign is that demand has been outstripping supply. A similar pattern will likely continue on a global basis for the foreseeable future. The stock price of leading companies has been tied to the quality and quantity of devices available in the market and in the pipeline. The handset producers have to be particularly nimble in order to appeal to the wide array of consumer preferences. The market leaders mentioned above should be the key beneficiaries since the industry requires quantity and variety.

On the network side, massive investment is likely in network infrastructure to upgrade and replace existing networks for 2.5 and 3rd generation wireless service. Just a few months ago, there was a frenzied bidding war for UMTS spectrum in the UK by wireless carriers, which yielded a total of £22.3 billion for the UK government. Furthermore, US national licenses to be auctioned could each cost as much as $25 billion. The exorbitant prices paid for such spectrum reflects the bullish attitude toward the future of the wireless market. The cost of constructing a network in the UK is estimated from approximately £2.5 to £3.0 billion for a new operator and a new network. Over the next five years, billions of dollars are going to be spent to purchase spectrum and retrofit it for high-speed, packet-delivery. Leading network providers like Ericsson are well positioned to fulfill this demand.

Wireless operators have put billions of dollars of capital at risk and stand to be some of the key beneficiaries of the growth of the mobile Internet. By offering mobile Internet service, the operators seek to make money in the following eight ways:

● Increase in the number of subscribers

● Increase in minutes consumed per subscriber

● Decrease in customer churn as customers integrate personalized info

● Wireless Internet subscriber fee

● Commissions per mobile-commerce transaction

● Commissions per promotion/ advertisement

● Placement/slotting fees on the wireless portal

● Co-marketing arrangements between the wireless carrier and merchants

Estimates suggest that carriers expect to make from $5 to $15 or more in incremental average revenue per user (ARPU) per month. The performance of the wireless operators has been mixed over the past year as many investors are concerned over the massive costs associated with the service. The market has recognized NTT DoCoMo’s aggressiveness and good position for the growth of mobile Internet. Other leading players include AT&T Wireless, Verizon Wireless, Sprint PCS, VoiceStream and Vodaphone.

The market has been particularly excited about the growth in wireless technology vendors that enable the mobile Internet. Shares of companies like InfoSpace, Qualcomm, Phone.com and Aether Systems have experienced incredible stock performance over the past year and a half. In 1999, the Mobile Internet Infrastructure segment increased an average of 516 percent. The market views these companies based on future potential and current market positioning. As such, the average price/sales multiple is 77x, a significant premium to the average Internet price/sales multiple of 20.4x. The market got a little ahead of itself early in the year as investors began to recognize that the potential size of the mobile Internet is likely to be larger than the wire line Internet. The past four months have seen significant declines in the sector, as stocks have corrected to slightly more rational levels.

The wireless technology segment is very similar to the early days in the Internet segment, where demand outstripped supply and the leading companies commanded hefty market premiums. Experience from the early days of the Internet segment suggests that leading companies will break ahead of the pack and will experience a viral network effect that continuously propels them higher. As such, stock selections in the market segment could either yield a “home run” or a “strike-out,” even as high prices rule across the market segment.

Vik Mehta and Jason M. Jones are analysts at Goldman Sachs. Mehta covers the Internet infrastructure sector with a focus on wireless Internet and media services.