Intel’s Communication Group - Destiny Fulfilled

Intel corp (INTC) lands on Page A1 of the WSJ with a story covering their Analyst Day presentation in New York yesterday. The big news that is getting widespread coverage in many media outlets- including BusinessWeek - is that they are cutting $1BB (8%) in spending but without across the board job cuts.

The big problem is Intel’s work force grew 17% in the last year alone. So, the obvious path is to find businesses with high costs and low revenue, and spin those out to people who can manage them tighter. It sounds like this is exactly what Intel plans to do.
Continue reading

DVD Format War Hype

As Godzilla thunders across Japan, the guardian monsters move to stop him. Baragon is the first to challenge Godzilla. Though he struggles valiantly, the burrowing reptile is no match for the overwhelming power of Godzilla. When Godzilla marches on Tokyo, the two remaining guardians, Mothra and King Ghidorah, combine their power in a final battle against the unstoppable juggernaut. Will Admiral Tachibana and the military be able to tip the scales in favor of the guardian monsters? Can Yuri stay alive long enough to tell the story? Can anything stop Godzilla?

Does anyone really care?

With all of the hype surrounding Blu-Ray and HD-DVD, you would think that Hollywood was trying to write a new Japanese B-movie script.

First, we get the trash talk from Matsushita (Panasonic) indicating that reconcilliation is impossible, and “The market will decide the winner.” Then, rumors abound that Sony (SNE) plans to ship the Playstation 3 in November, complete with Blu-Ray drive and $399 price tag - never mind that no working Blu-Ray player is on the market right now. It isn’t clear how $399 is economically feasible given Toshiba is wrapping $100 bills around every HD-DVD player it ships out at a $500 ASP. And even this is shocking given their HD-DVD player is commodtiy IDE PC drive disguised as home electronics.

I’m still sticking with the opinion that both formats win in different applications. This opinion appears to be echoed by Reed Hastings, CEO of Netflix Inc. (NFLX), during their latest quarterly conference call.

In Q2, both HD DVD and Blu-ray are soft launching, in preparation for a larger retail push in Q4. We believe Microsoft (MSFT) sees studio support of HD DVD as very important to their game format battle with Sony (SNE). We also believe that X-box and Vista will support HD DVD more directly with every one of their product updates.

Therefore, since neither Sony nor Microsoft will concede nor win in this format war for at least several years, there will be a protracted competition which will hurt the adoption of high-definition DVD, despite everyone’s best intentions to avoid a format war.

There is, however, a practical solution. If all studios were to embrace both formats agnostically, consumers would be reasonably comfortable buying either format and presumably making their purchase decisions based on hardware, price and features.

Studios have supported VHS and DVD for years, so supporting two formats is not something new.

Embracing both formats is exactly what studios will do, and they will use the formats to price differentiate their product.

The reality is that 10 years from now getting your media on a silly plastic disk will seem as ridiculous as…. watching a Godzilla movie marathon. Movies are going to be downloaded to your set-top-box/DVR/home theater PC.

Is It Different This Time?

A well proven leading indicator for economic disaster is when people begin to proclaim “It’s Different This Time” as a way of explaining how a short term movement becomes a long-term trend. Dig up your memories (and your forecasts) of Optical Networking from 1999 and you’ll agree.

I read GaveKal’s “Brave New World“, a treatise on the new economy and thought it was excellent. The authors even poke fun at the fact that they are claiming it is different this time. The GaveKal book is a heavyweight analysis and is excellent reading, particularly their concepts of platform companies.

Andy Kessler recently opined in the same way, echoing opinions from his book “Running Money“.

Oil is over $70 a barrel, Iran’s got nukes, and soon they’ll price gas per ounce. The Fed has jacked short rates up 15 times. Guys, you’re killing us. The yield curve is as flat as a subsidized Iowa corn field. There’s $1 trillion of teaser rate Adjustable Rate Mortgages about to burst all over Southern California and ’burbs everywhere. Gold is over $600, commodities are roaring, the dollar is dropping again, there are trade deficits as far as the eye can see and GM is on life support. Drunken sailors in D.C. are running a sea of red ink and every time it’s sunny, some antigrowth global warming nutjob wags his finger at your $100-to-fill SUV. It feels like the ’70s all over again, a blaze of malaise. Except . . .

In order to inoculate myself from what increasingly seems like groupthink I’ve started to read Marc Faber’s “Tomorrows Gold: Asia’s Age of Discovery“. Faber is a really smart guy, more so because of his decision to isolate himself from day-to-day nonsense by living in Thailand. He is the antihesis of the “This Time It’s Different Crowd”.

I think the reality of the situation is best captured in a cartoon posted today at The Big Picture. No one can really explain how virtually every asset class has increased in value over the last three years. It simply makes no sense.

AT&T Project Lightspeed - Too Little Too Late

I’ve written in the past about the drawbacks of Project Lightspeed, AT&T’s ( T) program to provide video and broadband services to the home. In short, I think it’s a half measure at best and provides no competitive advantage over cable.

It looks like this opinion is starting to be echoed within the financial community. AT&T also neglected to offer any details on Lightspeed in their recent quarterly earnings call.

Investment pundits love to point out that Verizon (VZ) is being ‘punished’ for overextending themselves with FiOS capital expenditures, and praise the measured investment being made by AT&T with FTTN.

The reality of the situation is Verizon is purchasing infrastructre usable for the next 100 years with 6% long term credit. AT&T has chosen to delay an inevitable infrastructure upgrade. It’s hard to see how AT&T’s financial position will be significantly better 5 years down the road without making the upgrades now. Just like most homeowners refinanced their houses in the last few years, AT&T (to be fair, SBC) should have taken the cheap money and done the same with their residential network.

This is short-term Wall St. driven thinking at it’s finest.

Philidelphia Municipal WiFi Analysis

MuniWireless cracks open the terms of the Philadelphia Municipal WiFi contract with Earthlink Inc. (ELNK). It’s worth a look. The contract outsources virtually all business risk to Earthlink. It seems like a great idea. I thought the San Francisco proposal looked economically solid, but SFO is about as tech-savvy as cities get, and is an ideal environment for MuniFi. I’m not so sure about Philly.
Continue reading

Future of Optical Networking - Lightreading Conference

I attended the Lightreading “Future of Optical Networking” conference in New York last week.

I had high expectations for the conference based on one I attended two years ago on Ethernet in the WAN. At that conference there were a number of participants from start ups and established companies who led a vigorous debate about what the future of SONET/SDH looked like. Even though I lived and breathed Ethernet over SONET/SDH at the time, and met regularly with the companies on the panel, the debate that ensued was highly educational and enlightening.
Continue reading

Why Broadcom is a Scary Competitor

Broadcom (BRCM) is a scary company to compete with. They execute aggressively and have backup plans for when they don’t. They can bring to bear ridiculous amounts of resources, and justify the profligate fixed R&D expense on any one project by targeting high volume markets.

Here’s a question from Fridays Broadcom earnings call that highlighted yet another scary Broadcom trait.

Michael Masdea - Credit Suisse

…. As you converge more and more of certain pure play companies functionality into what youre doing, what kind of competitive responses are you seeing? Do you get worried when you start to take a company’s whole livelihood away that you’re going to see some irrational sort of competition?

Scott McGregor - CEO

Well there’s always a risk. What many companies do if they feel threatened is they cut their price to try and hang onto sockets. What our strategy is with our broad IP portfolio is we do integration of all the different technologies. So we end up eliminating sockets. It’s pretty hard to compete if the socket that you’re in today has been eliminated by being integrated into a larger SOC.

I.e. if you are a niche player you should probably accept that buyout offer from Broadcom before they nuke your business.

Transcript Courtesy Seeking Alpha

Vitesse - Options Backdating Saga Continues

Tomorrow’s Saturday edition of the WSJ has a short article on Vitesse Semiconductor (VTSS) and the cancellation of Monday’s earnings call.

According to a release made today by Vitesse, the suspension of three executives was related to the “integrity of documents” involving its stock-option program. They also cancelled the earnings release and call scheduled for Monday.

The announcement, made Thursday night, came two days after Vitesse placed CEO Louis R. Tomasetta, its chief financial officer and an executive vice president on administrative leave and said it established a special committee of directors to probe option-grant timing.

It isn’t clear exactly what the company meant when it referred to the documents’ integrity, and the company didn’t respond to requests for elaboration.

I spent a large part of my life and a tremendous amount of sweat equity working at Vitesse and it rips my guts out to see what the company is currently going through. What is most frustrating is I am certain that the imminent threat of shareholder-class lawsuits from nice folks like Lerach are making public information scarce and rapid resolution of the issue impossible. I’d like to know what the hell happened, just like everyone else.

PMC-Sierra (PMCS) paid $400M cash for the Avago (Agilent) storage semiconductor business that was generating $110M a year in revenue. Storage makes up roughly 1/2 of Vitesse revenues ($200M a year) and their prospects in the SATA market look solid - a transitive valuation of the Vitesse storage business is roughly $500M. The Telecom and Ethernet divisions generate another 100M a year.

Best of luck to everyone at Vitesse.

Original article from the WSJ that started it all can be found here.

Vitesse Trading Halted - Rumors Abound

I’m in New York at a Lightreading conference. Trading has been halted in Vitesse Semiconductor (NASDAQ: VTSS) all day.

Consolidation in the communication semiconductor area is long overdue. The length of the delay (5 hours now) would indicate that someone, somewhere was surprised.

There is also the WSJ article on options backdating, though it’s hard to see why an investigation would halt the stock for so long.

I’m keeping an open mind and hoping that they are helping lead the consolidation of the industry, as they did a year ago in the aborted AMCC (NASDAQ: AMCC) merger (and the echo-rumors that followed). This is what needs to happen.

UPDATE: An internal investigation is being launched into stock options backdating…. but why the sudden surprise and trade halt?

Tivo - Barron’s Reports

This weeks Barrons has a short article ($$$ link) on Tivo (TIVO) that highlights the acquisition option as well as the need to pursue Cablecos for licensing deals. No new analysis beyond what I’ve written over the last few days, but the article is getting media attention so I thought an excerpt was in order.

With a name that’s become a verb, plus great software, TiVo could be acquisition bait. But its share of DVRs is on course to be eclipsed this year by Scientific-Atlanta (SFA) and Motorola (MOT), the two largest cable set-top makers.

Most of its subscribers come from a deal with DirecTV (DTV), the satellite operator, which pays TiVo $1.15 a subscriber, and accounts for nearly 70% of TiVo’s users and 20% of its revenue. DirecTV last week extended the deal to 2010. It won’t market TiVo’s service, but the deal prevents TiVo from losing existing customers.

Last week’s jury verdict may boost TiVo’s chances to sign up cable operators other than Comcast (CMCSA), with which it already has a deal. Cable guys will find it difficult to work around TiVo’s patents, says Terence Clark, a lawyer who heads the national intellectual property practice at Greenberg Traurig. That could force Time Warner Cable and Cablevision (CVC) into licensing deals.

But the case doesn’t solve TiVo’s most pressing long-term problem. It still has a long road ahead as it tries to win over cable operators with its patent claims.

A buyout may in fact be the best exit strategy for TiVo. In the meantime, selling on Thursday’s pop in TiVo shares may be the best exit for investors. What lies ahead are many years of knocking on cable operators doors, a long, long story with no fast-forward button in sight.

Hat Tip - Seeking Alpha

Net Neutrality Double Standard

Spent today working outside in the yard wishing I was out cycling. Had a lot of time to think.

What I find funny is the same people who pound the table about how the internet was born a wild, free, medium, how this is it’s biggest advantage, and how this is the manifest destiny of the network now cry foul when the internet might evolve into paying for multiple tiers of service.

Folks who make an argument for government mandated net-neutrality are asking to halt the untethered evolution they proclaim to be essential. That’s pretty funny.

Tivo - Better Off Without The Legal Jackpot

Tivo (TIVO) won the patent infringement lawsuit against Echostar Communications (DISH).

Tivo wasn’t starved for cash before, and having a lot of money sloshing around typically doesn’t help companies focus on solving their core problems. While winning anywhere between $73.9MM and $220MM at the litigation roulette wheel (there will be appeals, and the judge can treble the $74M in damages) can hardly be positioned as a bad thing, it doesn’t help solve, and worse, may fundamentally distract Tivo from the core problem they face- they are not growing as fast as the DVR market.

From the WSJ today($$$ link):

The common explanation for this is that the cable companies have developed their own clone systems that are inferior but cheaper than Tivo. Perhaps they even egregiously violated some patents in the process. They didn’t take these risks and get into the equipment business because they didn’t want to pay Tivo $1/month in licensing.

The bottom line is the Cablecos and other Video transport companies know that letting Tivo control the set-top-box, particularly one with a broadband uplink, is effectively allowing Tivo to roll a Trojan horse into the living room of every one of their subscribers. If the DVR patents truly are bulletproof my guess is the cable guys would rather not offer DVR’s than let Tivo get between them and their customers.

With this legal victory, my concern is that Tivo will now seek market penetration by legal bludgeoning rather than innovation and market leadership. Rambus (RMBS) is trying this, and will eventually fail, because it is an awful and painful strategy. It’s analogous to terrorism. Customers refuse to be coerced in the long run and will eventually find their way to freedom through technology or legal means. Companies that get sucked into this business model eventually realize it is just as bankrupt as it’s political counterpart.

Tivo faces a decision, one we have outlined before. Either they need to become friendly with cable/telco/satellite video providers and swear up-and-down to never compete with them. Or they need to mount a full scale assault and convince consumers that the Cableco DVR represents the old media model by offering truly innovative downloadable video and content services. Getting Yahoo! Weather and amateur video blogs on my TV doesn’t count. This would require making nice with the content providers and showing them a path to generous revenue models.

Tivo now has more cash (note the difference between cash and cash flow) but that doesn’t necessarily mean they will use it intelligently. What they do in the next year will be critical.

Apple, France, and Irony

Apple Computer Inc. should have anticipated that the exclusive union of its iPod music players and online iTunes store would be challenged in France, Trade Minister Christine Lagarde said.

Anyone else find it incredibly ironic that Apple (AAPL), who lobbied tirelessly and endlessly, both domesticly and in Europe against Microsoft’s (MSFT) monopoly power, is now finding the same accusations leveled against themselves?

A copyright bill before the French parliament on downloading music and films could lead the online music store, Apple’s iTunes, to withdraw from France because it would be reluctant to opening up its proprietary system, experts say.

Apple Computer Inc. has always refused to allow its paid-for music files downloaded via iTunes to be converted into another format, which would allow them to be listened to on a music player other than its iPod.

We’re not Apple investors. I don’t own an iPod because I refuse to buy into the ‘roach-motel’ model of iTunes, where any music purchased is locked up in the iTunes universe ad infinitum. But I admire how Steve Jobs cleverly used sexy hardware and ease-of-use to convince millions of consumers to lock themselves into the Apple DRM model.

I love the hardware too, and if they had a subscription model I would jump. I think the only reason Apple has not offered a subscription model is that they want consumers to buy songs on iTunes in order to landlock them as Apple customers, eventually migrating them into other areas like Video and the digital living room. Nice Job Mr. Steve.

Now, having obtained near market share dominance of 80%, his Steveness has now encountered the same antitrust forces he helped unleash years ago in his battles with Microsoft.

(Minister Christine Lagarde) met with Charles Phillips of Oracle Corp., John Chambers of Cisco Systems, and Scott McNealy of Sun Microsystems, but not with any Apple Computer Inc. representatives.

McNealy. Oracle. Sound familiar? This was the same wrecking crew that went after Microsoft.

Comme on faict son lict, on le treuve.

Translation: “You’ve made your bed, now lie in it”. It is of 16th century French origin.

How appropriate.

Quoted article here. Link Courtesy Engadget.

Broadband Gap = Economic Substitution

The OECD released updated broadband statistics yesterday. The US is ranked 12th. Included is some historical trend data that I think sheds some light on why a broadband ‘gap’ exists between the US and the rest of the world.

I don’t believe the broadband gap is a problem that needs to be solved. I think many folks are happy with dial-up in the US, and don’t subscribe to broadband because no incentive exists for them to switch.

In Europe, few people were happy with dial up. Unlike the USA, where local phone calls to the AOL modem pool were free, Europeans were charged per-minute fees. There was no such thing as a free local call. Europeans who spent hours on the phone with their ISP hated dial up not just for poor speeds but also high cost. This leads to a large proliferation of Internet cafes and initially, low internet use.

Let’s look at growth trends in Asia, North America, and the EU over the last few years.

Note - The EU-15 are comprised of Belgium, France, Germany, Italy, Luxembourg, The Netherlands, Denmark, Ireland, United Kingdom, Greece, Portugal, Spain, Austria, Finland, Sweden.

I think there is a pretty simple explanation at work here. Once broadband technology became available, Europeans rapidly ditched their dial up lines not just because of speed, but because of cost. European broadband exploded with a spectacular 73% CAGR while the USA grew at a slightly less rate of 39%. I don’t think the lack of government intervention in the broadband markets provides an explanation for the difference in growth rate. The government can’t make things grow that fast and there is only one thing that can - economic substitution. There was a huge economic incentive to move to the fixed rate connections offered by DSL.

In Korea and Japan, the government creates financial incentives in other ways to move people to broadband whether they want high speeds or not.

Now that $19.99 DSL is becoming widely available in the US, and AOL has increased prices for dial-up so that they are higher than their bundled DSL offering, I expect you will see the same movement here in the US, the broadband gap with Belgium, Canada, Iceland, and Japan will be closed, and global catastrophe averted.

DirecTV Can’t Kick the Tivo Habit

Tivo (TIVO) announced today that they have extended their agreement with DirecTV (DTV) for three years. In addition to this, both parties have agreed to not assert patent rights against each other. The previous agreement was due to expire in 2007.

The market appears to be viewing this positively. As investors in Tivo, we won’t complain, but fundamentally the two companies have not changed their relationship. DirecTV continues to develop and market their own set-top with homegrown DVR software and not market the Tivo version.

From the Reuters Article:

DirecTV is a top TiVo customer and the extension of the deal was initially greeted positively on Wall Street, where there had been concerns that DirecTV would transition their TiVo customers to its own service if an extension was not reached.

This is silly. Extending the agreement is much cheaper and easier than replacing 3 million set top boxes. The reality is DirecTV could have done nothing, and their customers with Tivo boxes would have continued to work. From the most recent Tivo 10-Q:

While DIRECTV would have the right to continue to service existing DIRECTV receivers with TiVo service without payment to us, it would not have the right to add new DIRECTV customers with TiVo service. And while TiVo would no longer be able to generate additional revenue from the then-current DIRECTV customers with TiVo service, we would have no further obligation to provide upgrades, fixes, new features, or software support.

Tivo currently gets about $1/month per box from DirectTV, or around $36MM a year in revenue. The announcement indicated that the new agreement has very similar pricing.

In short, we’re a little stumped why the market thinks this is such a great deal beyond protecting a recurring revenue stream. If DirecTV had agreed to use Tivo exclusively and stop in house development, that would be big news. All that has really happened is a further extension of the status quo. Regardless, if this brings more attention to Tivo and the strong value they provide, I’m OK with it.

The consensus opinion on Tivo is that they are in a death spiral, attacked by low-end commodity DVR’s from all sides. Their ‘only hope’ is to hit the litigation jackpot with Echostar and land a big wad of cash. We disagree vehemently with this opinion. Tivo is an exceptionally strong brand and commands incredible user loaylty. The Tivo software provides a significant differentiator in a future of commoditized video delivery by Cablecos and Telcos.

Our worst case scenario for Tivo assumes that they transform themselves into a software-as-a-service company, selling subscriptions to run on set-top-boxes from a multitude of hardware suppliers. A $12/year income stream from 20 million households (roughly 20% of US market) would yield $250M/year in revenue at substantially higher margins than the company enjoys now.

A more optimistic future would have Tivo turn their hardware devices into content delivery systems, utilizing the broadband connections available in homes to deliver content to the hard drive in each Tivo. Instead of recording a show from the tuner, content would be downloaded and stored on the Tivo. The new Series 3 Tivo will have HDTV capabilities and provides an ideal platform for storing and delivering content. DirecTV is working with Microsoft to potentially use the Xbox 360 as a content delivery platform, it’s unclear why they wouldn’t pursue a similar agreement with Tivo.

The problem with both scenarios is that they are totally incompatible business models. The first would require strong relationships with the content delivery folks, and an implicit agreement that the second model would not be implemented as a way to compete with the video delivery mechanisms of their customer. The second would require significant partnerships with content owners and distributors to provide them with an alternative way to distribute content. Disney’s recent decision to make shows via the web could just as easily be an agreement to make shows downloadable to Tivo, with an agreement from Tivo that the commercials could not be skipped.

Our frustration with Tivo, something I voiced in my post titled “Tivo Should be Sold” is that the company doesn’t appear to be pursuing either outcome. There has been little in the way of innovative hardware, software, or business models from Tivo in recent months that would indicate a move in either direction. The pursuit of the current business model of selling hardware DVR’s on retail shelves implies a future move to scenario two- the high risk/high reward strategy. However, the lack of any announced partnerships, as well as the vaporware Netflix agreement would indicate it isn’t being pursued aggressively enough.

If the company is not driven strongly in one of these two directions, it should be sold to a company that will. Some market and technical leadership needs to emerge from Tivo in the near term, because the market has priced in what we feel is a very reasonable 600M-800M acquisition value, based on continued pursuit of their original business model.

PMC-Sierra - More on the Passave Acquisition

I covered the PMC-Sierra Inc. (PMCS) acquisition of Passave 6 days ago.

While I was not given the opportunity to ask questions during the conference call, I did receive a written response to questions I phoned in and left on voice mail.

Question #1 What products are expected to benefit from the acquisition, and what type of revenue multiplier is expected - i.e. for every $1 in Passave MAC’s sold we expect to sell $x.xx in existing PMC products.

We have not closed the acquisition yet and our team and Passave are working on combined roadmaps and pull-through opportunities. We are not commenting further on this, and you may see some of our CEOs comments in the transcript below referring to VoIP-related and Res Gateway-related opportunities going forward.

Continue reading

Net Neutrality - Rearranging the Deck Chairs

The Net Neutrality ship continues to sink with the recent removal of wording from legislation that would have removed the right of carriers the to tariff based on application.

I’ve always felt Net Neutrality is a concept that expropriates the property rights of carriers in order to allow media and content companies a free-ride on their infrastructure. Google, Yahoo and other media and content companies lack ownership of a layer-one digital right of way to the consumer- so the easiest approach is to legislate the theft of it.

Anyone who thinks this is a reactionary opinion should consider what Rep Ed Markey said about the failure to pass the bill. From the CNET article:

There is a fundamental choice. It’s the choice between the bottleneck designs of a…small handful of very large companies and the dreams and innovations of thousands of online companies and innovators.

What if this debate was over a privately owned road? Would Mr. Markey feel the same way?

The good of the many is more important than the good of the few. But there are laws that cover the taking of private property rights - if you determine the greater good requires that the few forfeit their deed of ownership then you should compensate them for it.

When it comes to “fundamental choice”, I’ll go with property rights over government re-appropriation any day.

Additional Observation: Note the title of the CNET article - “Republicans defeat Net neutrality proposal“. As it’s prospects wane, the debate on Net Neutrality is moving from a technical and economic argument to a political one. Never mind that 4 of the 11 Democrats on the committee voted against the provision - nothing like a little political fire-stoking to keep debate rolling.

San Francisco MuniFi Economics

San Francisco gave the green light to Google (GOOG) and Earthlink (ELNK) to offer wi-fi throughout the city. You’ll get free 300kb/s ad-supported service from Google, or $20 a month for 1Mb/s ISP service from Earthlink.

Total capex is $15MM to install, though I bet that number will at least double to deliver full coverage. Assuming Earthlink spends $15MM on it’s own, they would need around 8,000 subscribers at $250/year to justify the investment and deliver a 15% return. This seems very, very achievable in a city like San Francisco. If Earthlink can win peering agreements with guys like T-mobile to allow roaming outside of SFO, it looks even better.

San Francisco is always on the vanguard of both good and bad.

Correction I neglected to include any provision for Opex in the above calc. Anyone care to take a guess at what that might be?

Jim Cramer + Valium = Brilliant

I may be one of the few folks on the planet who has never seen more than a minute or two of Jim Cramer’s show “Mad Money”.

I don’t like the theatrics of his show and I think they depreciate the intelligence of Cramer, who is clearly a very bright and passionate guy.

The Big Picture points us to a simple video interview with Cramer where you get a chance to see the real guy, not the actor. All of his passion comes through, none of the nonsense. In the video, he even admits that the theatrics are purely to gain viewers.

If you’ve ever devoted 30 minutes of your life to the “Mad Money” circus take 15 minutes and watch this video. I’d like to see Jim Cramer do more of this, and less of the circus master act.

click for video

Das Steigende Telekom (The Rising Telekom)

The WSJ Heard on the Street column ($$$ link) looks at Deutsche Telekom’s (DT) valuation. I’ve included a good summary of the metrics at the end of this post for those who don’t have access to the online WSJ - courtesy of Seeking Alpha’s Telecom Stock Blog.

The WSJ article makes the case that even though the valuation of Telekom is attractive on paper, the continued price erosion in wireless and expanding competition in broadband will cap revenue growth.

What the article misses is the groundswell in Europe to deregulate the Telecom sector further in order to spur deployment of next generation broadband infrastructure. Regardless of what the Digital Elite want you to believe, the US is ahead of France, Germany, Spain, Italy and the UK in broadband deployment. And the gap in next generation services is growing. From the article:

In a bid to separate itself from the pack, Deutsche Telekom is spending €3 billion ($3.64 billion) to build a broadband network that will connect residential customers to the Internet at a much faster speed than is currently available and allow it to offer a “triple play” of high-definition television, wireless and Internet access. But regulators in Brussels want to force the company to share the network with rivals at imposed rates, and high-definition TV is expected to remain a marginal business in the near term.

Spanish and French carriers are agitating with the EU to remove the requirement to share the network (UNE) on the basis that it will stifle new broadband infrastructure deployment - I think they are right and that they will get their way. The German Government is throwing it’s weight around the EU and the last thing the Europeans want to do is fall further behind the US in broadband deployment.

Expect to see Deutsche Telekom secure more, not less market share once this happens, and expect higher, not lower margins when it does. People will get advanced broadband, but they will have to pay for it. Es gibt kein freies Mittagessen.

Take this trend, and combine it with the competitive advantages of a carrier offering both fixed and mobile services and Telekom has distinct advantages, not disadvantages over it’s rivals. Softbank bought Vodafone’s mobile business in Japan for this exact reason, and I think it’s a winning strategy. Check out my thoughts on the acquisition.

From Seeking Alpha:

• Share Price: DT shares have dropped 10% over the last year on the background of general telco weakness in Europe and falling revenues from fixed-line services. Its dividend yield, therefore, is 5% higher than peers Vodafone (VOD) and Telefonica (TEF)
• Enterprise Value/EBITDA: EV is 5.4X EBITDA, compared with 5.8X for European telcos (Goldman Sachs estimates). Juan Carlos Acitores from Spanish firm Ahorro Corporación Financiera SV has higher earnings estimates for DT resulting in a 4.8 EV/EBITDA multiple, one of the lowest in global telecom.
• P/E: DT is currently trading at 12X expected 2006 earnings, slightly higher than competitors’ P/E. According to Acitores, who has a ’strong buy’ recommendation on DT, “The stock is significantly undervalued.”
• Falling Operating Earnings: Thomson Financial reports that earnings per share are projected by analysts to be €1.14 in 2006 and €1.21 in 2007 (2005 earnings were €1.31 per share). Analysts expect Vodafone and AT&T, on the other hand, to grow earnings by more than 9% in 2006 and 2007.
• Falling Revenues: DT’s domestic revenue-the source of more than half total revenue-dropped 1.6% in 2005. Wireless prices are expected to fall up to 20% this year, and the company has lost substantial market share in DSL (from 83% in 2004 to 62% in 2005).
• Tough Restructuring: DT slashed net debt from €74 billion in mid-2001 to €38.6 billion. The current restructuring plan calls for eliminating 32,000 jobs over three years at a cost of €3.3 billion. And according to the WSJ, “some analysts say that even the 32,000 job cuts wouldn’t be enough to get operations sufficiently lean.”
• T-Mobile USA: With a 27% increase in revenue last year, DT’s US mobile offering provides a glimmer of light. However T-Mobile’s ARPU has been declining faster than rivals’, and churn has been a bigger issue as well. “Because T-Mobile doesn’t have the same amount of spectrum as its competitors, it can’t offer expensive third-generation services to its customers. The unit will have to spend several billion dollars in the next couple of years to upgrade its network.”