Tag Archives: Oliver Wyman

5G: Telecom Hype or Saviour

John Legere of T-Mobile is a canny operator and knows how to play the sycophant to Trump’s nationalist instincts in touting the ability of a combined T-Mobile & Sprint to invest in a super-charged 5G roll out, as per this presentation, playing the job creation and beat the Chinese technological advancement cards. Legere cites an Analysys Mason report commissioned by the US industry lobby group CTIA to back up such claims which in turn cites an Accenture report from 2017 on 5G in the US which claims that “telecom operators are expected to invest approximately $275 billion in infrastructure, which could create up to 3 million jobs and boost GDP by $500 billion”. In 2016, the European Commission in this report stated that 5G “investments of approximately €56.6 billion will be likely to create 2.3 million jobs in Europe”. An IHS Markit 2017 report commissioned by Qualcomm claims that in 2035, “5G will enable $12.3 trillion of global economic output” and “the global 5G value chain will generate $3.5 trillion in output and support 22 million jobs” on the basis that “the global 5G value chain will invest an average of $200 billion annually”.

These are fantastical figures. Many assumptions go into their computation including the availability, range and cost of spectrum plus infrastructure spend and policy in relation to streamlining procedures and fee structures for the deployment of the small shoe-box cell sites (between 10 to 100 more antenna are required for 5G than current networks). Larger issues such as privacy and security also need to be addressed before we enter a world of ubiquitous ultra-reliable low latency networks as envisaged by the reports referenced above. Those of us who lived through, and barely survived, the telecom boom of the late 1990s can be forgiven for having a jaundice view of a new technology saving the telecom industry. This blog illustrates some of the challenges facing the wired telecom sector and the graph below shows the pressures that the US mobile players are under in terms of recent trends in service revenues.

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The mobile service revenues trends are remarkably similar to those in the enterprise and wholesale space. The graph above also shows the rationale for the T-Mobile/Sprint merger in terms of size as well as the impact of T-Mobile’s aggressive pricing strategy. All these trends are in the context of the insatiable increase in bandwidth traffic, as illustrated by the IP figures from Cisco below.

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This report from 2017 by Oliver Wyman is one of the better ones and contains some illuminating context for the 5G era. It shows that in Europe despite a 40% annual increase in mobile subscribers and a 36% annual increase in European IP traffic from 2006 to 2016, mobile service revenue and total telecom service revenue decreased by 22% and 19% respectively, as per the graphic below.

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The Oliver Wyman report concludes as follows:

“In the next five to ten years, demand in fixed-line broadband bandwidth will grow exponentially, leading to speeds that can only be supplied by FTTH/B. Mobile broadband demand will follow in parallel. Virtual reality is the “killer app” that will drive massive demand. Mobile broadband supply will begin to reach its limits, with spectral efficiency gains and additional attractive spectrum in the current bands not growing as fast as they have in the past. High-frequency beam technology in 5G will be radically new and will be able to meet future demand. At the same time, however, it will create massive mobile backhaul demand. The outcome is likely to shake the industry, leading not only to a new balance of power between mobile-only and integrated/fixed-line operators, but also to new potential revenue growth for the first time in many years.”

Another interesting graphic from the report, as below, is the historical and projected broadband usage.

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This 2017 report from Deloitte argues that “5G, across both the core and radio access network, stands to have a potentially greater impact on the overall ecosystem than any previous wireless generation”. Deloitte sees a “convergence of supply between wireline and wireless broadband, as almost all devices become connected over short-range wireless”. Deloitte concludes that “with an increasingly converged ecosystem of network and content players, an increasingly software-managed and defined physical networking space, and the demands and needs of consumers becoming complex enough that they no longer can manage individually, 5G and its associated technologies may have the power to reset the wireless landscape”.

This paper from an Infinera executive called Jon Baldry highlights the need for “improvements to the overall network infrastructure in terms of performance, features and bandwidth” to support 5G “using software-defined networking (SDN) control and network functions virtualization (NFV) will play a major role in the optimization of the network”. I came across an interesting claim that SDN and network virtualisation can reduce opex and capex by 63% and 68% respectively compared to traditional telecom networking. Baldry concludes that “these improvements will drive new fiber builds, and fiber upgrades to an ever-growing number of cell sites, creating significant opportunity for cable MSOs and other wholesale operators to capture significant share of cell backhaul and fronthaul services for 4G and 5G mobile networks”.

Whether all these investments and resulting new networks will halt the declining revenue trend for the telecom sector or merely provide a survival avenue for certain telecoms is something I have yet to be convinced about. One thing seems certain however and that is that tradition telecom models will change beyond recognition in the forthcoming 5G era.

A Tale of Two Insurers

My negativity on the operating prospects for the reinsurance and specialty insurance sector has been articulated many times previously in this blog. Many of the same factors are impacting the broader commercial insurance market. Pricing conditions in the US and globally can be seen in the graph below.

click to enlargeUS and Global Commercial Insurance Pricing

Two insurers, at different ends of the size scale, which I have previously posted on, are AIG (more recently here and here) and Lancashire (more recently here and here). Given that a lot has happened to each since I last posted on them, I thought a quick update on both would give an interesting insight into the current market.

First up is AIG who have been under a lot of pressure from shareholders to unlock value, including a break-up plan for the insurance giant from the opportunistic rascal Carl Icahn. The graph below shows a breakdown of recent operating results (as ever with AIG longer term comparisons are hampered by their ever changing reporting segments). The improvement in the UGC mortgage insurance business has been dwarfed by the poor non-life results which were impacted by a significant reserve strengthening charge.

click to enlargeAIG PreTax Operating Income 2012 to 2015

In January, Peter Hancock (the 5th CEO since Hank Greenberg left in 2005) announced a new strategic plan to the end of 2017, the main points of which are

  • Return at least $25 billion of capital to shareholders through dividends and share buy-backs from operating profits, divestitures and other actions such as monetizing future life profits by $4-5 billion through reinsurance purchases.
  • Enhance transparency by separating into an operating portfolio with a goal of over 10% return on equity and a legacy portfolio that will focus on return of capital. Reorganize into at least nine modular, more self-contained business units to enhance accountability, transparency, and strategic flexibility.
  • Reduce general operating expenses by $1.6 billion, 14 percent of the 2015 expenses.
  • Improve the commercial P&C accident year loss ratio by six points.
  • Pursue an active divestiture program, including initially the 20% IPO of UGC.

The non-life reserve charge in 2015 amounted to $3.6 billion. 60% of the charge came from the (mainly US) casualty business, 16% from financial lines (again mainly in the US) and 15% from the run-off business. After the last material reserve strengthening in 2010, the worrying aspect of the 2015 charge is that approximately two thirds comes from accident years not yet 10 years old (which is relatively immature for long tail casualty business particularly when 42% of the charge is on excess casualty business). The impact of the reserve hikes on the commercial P&C segment can be clearly seen in the graph below.

click to enlargeAIG Commercial P&C Combined Ratio Breakdown 2008 to 2015

Perhaps the most aggressive target, given current market conditions, in the strategic plan is the 6% improvement in the commercial P&C accident year loss ratio by the end of 2017. The plan includes exiting approximately $1 billion of US casualty business, including poorly performing excess casualty business, primary and excess auto liability, health-care and financial lines business. Growth of $0.5 billion is been targeted in multi-national, financial lines, property upper middle market and major accounts which involve specialist engineering capabilities, international casualty and emerging risks such as cyber and M&A insurance. AIG also recently announced a two year reinsurance deal with Swiss Re on their US casualty book (it looks like a 25% quota share). The scale of the task for AIG in meeting this target can be seen in the exhibit below which takes a number of slides from the strategy presentation.

click to enlargeAIG Commercial P&C Metrics

I was struck by a quote from the firm on their turnaround plan – “We will use the data and analytical tools we have invested in to significantly differentiate and determine where we should focus our resources.” I suspect that every significant insurer would claim to have, or at least aspire to have, similar analytical capabilities. Big data and analytical driven underwriting is undoubtedly the future for large insurers with access to large amounts of quality data. Fortune had an interesting recent article on the analytical firm Palantir who are working with some insurers on sharpening their underwriting criteria for the social media age. An analyst in Citi even suggested that Goggle should look at buying AIG as a fintech play. The entry of the big internet firms into the insurance sector seems inevitable in some form or other, although I doubt AIG will be part of any such strategy.

As to the benefits of staying a large composite insurer, AIG cited an analysis commissioned by consultants Oliver Wyman supporting the benefits of diversification between the life and non-life business of AIG. Using the S&P consolidated model as a proxy, Oliver Wyman estimate a $7.5 billion capital benefit to AIG compared to separate life and non-life businesses, as envisaged in Icahn’s plan.

So, can AIG achieve the aggressive operational targets they have set themselves for the P&C business? Current market conditions present a considerable challenge. Combined with their recent results, an end of 2017 target for a 6% improvement is extremely aggressive. Too aggressive for my liking. However, the P&C results should improve somewhat over the short term (particularly if there is no more big reserve charges) and actions such as expense reductions, monetizing future life profits and divestitures will give AIG the fire power to hand out sweeties to shareholders. For those willing to take the punt, the return of a chunk of the $25 billion target in dividends and share buy-backs over the next 2 years for a firm with a current market value of $61 billion, trading at a 0.72 multiple to book value (trading around 0.92 of book less AOCI and DTA), may be too tempting to resist. It does have a certain allure…..

Lancashire, a London market specialty insurer and reinsurer with a mantra of disciplined underwriting, is at the opposite end of the scale spectrum with a niche focus. Long cherished by investors for its shareholder friendly dividend policies, Lancashire has been under pressure of late due to the heavy competition in its niche markets. The energy insurance sector, for example, has been described by the broker Willis as dismal with capacity chasing a smaller premium pool due to the turmoil in the oil market. A number of recent articles (such as here and here) highlight the dangers. Alex Maloney, the firm’s CEO, described the current market as “one of the most difficult trading environments during the last twenty years”. In addition, Lancashire lost its founder, Richard Brindle, in 2014 plus the CEO, the CFO and some senior underwriters of its Lloyds’ Cathedral unit in 2015.

The graph below shows the breakdown of reported historical calendar year combined ratios plus the latest accident year net loss ratio and paid ratio.

click to enlargeLancashire Ratio Breakdown 2008 to 2015

The underwriting discipline that Lancashire professes can be seen in the recent accident year loss ratios and in the 30% drop in gross written premiums (GWP), as per the graph below. The drop is more marked in net written premiums at 35% due to the increase in reinsurance spend to 25% of GWP (from approx 10% in its early years).

click to enlargeLancashire GWP Breakdown 2008 to 2015

The timely and astute increase in reinsurance protection spend can be seen in the decrease in their peak US aggregate exposures. The latest probable maximum loss (PML) estimates for their US peak exposures are approximately $200 million compared to historical levels of $300-350 million. Given the lower net premium base, the PML figures in loss ratio terms have only dropped to 40% from 50-60% historically. Lancashire summed up their reinsurance purchasing strategy as follows:

“Our outwards reinsurance programme provides a breadth and depth of cover which has helped us to strengthen our position and manage volatility. This helps us to continue to underwrite our core portfolio through the challenges posed by the cycle.”

As with AIG, the temptation for shareholders is that Lancashire will continue with their generous dividends, as the exhibit below from their Q4 2015 presentation shows.

click to enlargeLancashire Dividend History 2015

The other attraction of Lancashire is that it may become a take-over target. It currently trades at 1.4 times tangible book level which is rich compared to its US and Bermudian competitors but low compared to its peers in Lloyds’ which trade between 1.58 and 2.0 times tangible book. Lancashire itself included the exhibit below on tangible book values in its Q4 2015 presentation.

click to enlargeInsurance Tangible Book Value Multiple 2012 to 2015

It is noteworthy that there has been little activity on the insurance M&A front since the eye boggling multiples achieved by Amlin and HCC from their diversification hungry Japanese purchasers. Many in the market thought the valuations signaled the top of the M&A frenzy.

Relatively, AIG looks more attractive than Lancashire in terms of the potential for shareholder returns. However, fundamentally I cannot get away from current market conditions. Risk premia is just too low in this sector and no amount of tempting upside through dividends, buy-backs or M&A multiples can get me comfortable with the downside potential that comes with this market. As per the sentiment expressed in previous posts, I am happy with zero investment exposure to the insurance sector right now. I will watch this one play out from the sidelines.