4G – The Cure for the Common Cord

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Paul Sagawa

203.901.1633

sagawa@ssrllc.com

November 22, 2010

4G – The Cure for the Common Cord

  • 4G technology is following a 10 year roadmap toward download speeds that will allow wireless carriers to successfully compete for broadband and video with traditional cable, satellite and telco operators. With the added advantage of mobility, the ability to launch service to areas of up to 50 square miles with the investment of a single base station, and a flood of new spectrum likely to be made available over the next decade, 4G is the alternative that will make cord cutting the rule rather than the exception. Meanwhile, the march toward true 4G performance will further enhance the appeal of portable computing platforms – e.g. tablets, smartphones and netbooks – and cloud applications, hastening the demise of the traditional PC
  • While the new services being touted by US carriers as “4G” may not meet the ITU definition as offering at least 100Mbps mobile download speeds, the >5Mbps speeds offered are a step function improvement vs. the previous generation, adding greatly to the utility of smartphones and tablets by giving them wide-area wireless performance comparable to what is typically realized by residential wired broadband users. Moreover, these new services are a step forward on a long-term roadmap that is expected to bring speeds of 100Mbps to mobile users and up to 1Gbps for residential applications within the decade. These speeds will be more than sufficient for wireless networks to compete directly for residential broadband and video, particularly given the Government’s intention to make 100’s of MHz in new spectrum available for commercial use
  • Sprint (WiMax) and T-Mobile (HSPA+) have ballyhooed their recently launched networks as 4G, although the roughly 5Mbps peak speeds available on these carriers is obviously short of the ITU definition of 100Mbps+ download speeds to mobile users and 1Gbps+ for semi-mobile users. Verizon and AT&T are 6-12 months behind with their LTE networks, but will have advantage with 6-12 Mbps speeds, scale economies given the global dominance of the standard, and superior industry resources devoted to push LTE down its technical roadmap to true ITU 4G performance as quickly as possible
  • In 2011, these pre-4G networks are roughly a 4x improvement over 3G and will be a significant enabler in the likely success of portable devices – e.g. smartphones, tablets and netbooks – and cloud-based applications – e.g. streaming video, social networking, etc. – that rely on high speeds and fast response times. However, as the technology progresses over the next decade through future upgrades toward achieving the ITU goals, new applications, such as HDTV for mobile AND residential consumers, will be enabled. In particular, we believe residential wireless broadband – at speeds of 1 Gbps or more – could threaten the hegemony of wired broadband and hasten the demise of traditional channelized video
  • The long-term threat to wireline broadband will be amplified by new spectrum likely to be made available for commercial purposes. This week, the US NTIA identified 115 MHz currently used for government purposes that could be made available within 5 years. This is in addition to 300 MHz called out in the FCC’s National Broadband plan for the same timeframe, which included 120 MHz of prime 700 band spectrum currently licensed to TV broadcasters. Finally, The NTIA notes nearly 2 GHz in further spectrum bands – some recommended for global broadband use by the ITU and some subject to agreement with neighboring nations – that could be made available on longer term basis. While most of this spectrum is at higher frequencies with limitations for in-building penetration, it would be viable for line-of-sight residential broadband and cell site backhaul applications
  • We expect the combination of new spectrum, advancing technology, and government policy favoring competition to spur greater rivalry amongst wireless carriers and by these carriers against wired broadband operators. The American market has the 2nd highest wireless prices amongst developed nations, we believe, due in part to the superior spectrum holdings of the dominant leaders Verizon and AT&T. New spectrum auctions, which could more than double the spectrum allocated to commercial use, might enhance the viability of industry also-rans and/or attract powerful new entrants
  • We expect LTE, which was specified by the 3GPP organization, to be the predominant wide-area wireless technology world-wide, as both GSM/WCDMA and CDMA technologies will converge to it as a single standard. The process by which the standard was established favored traditionally dominant wireless technology providers, with Qualcomm the biggest patent holder at 28%, followed by Interdigital (25%), Ericsson (15%) and Nokia (14%). A further study by Informa suggests that 60% of Qualcomm and Nokia’s patents are likely to be deemed essential to the standard, compared to 33% for Ericsson and significantly less than that for Interdigital
  • We believe that the winners in 4G will likely come from patent licensors (e.g. Qualcomm), chip vendors (e.g. Qualcomm, Broadcom, ARM, etc.), tower companies (e.g. American Tower, Crown Castle, SBA, etc.), mobile software platforms (e.g. Google, Apple, etc.), and leading mobile applications (e.g. Apple, Google, Amazon, Facebook, etc.). While the market for LTE network equipment is quite concentrated amongst Ericsson, Nokia Siemens Networks, Huawei and Alcatel-Lucent, the history of these companies and their inability to monetize similarly strong positions in 3G lead us to be cautious about their potential looking forward

4G – It’s One More than 3G, Right?

Sprint began its ads in the spring – “America’s first 4G network.” T-Mobile joined in a month or so ago, trumpeting that it has America’s largest 4G network. Verizon and AT&T have announced that they too will be offering 4G in major markets by early 2011. Amidst all of this has been some inter-carrier squabbling over who should be considered 4G and who should not (Exhibit 1).

According to the International Telecommunications Union (ITU), the chief global standard’s setting organization for the industry, none of the US carriers should be labeling their services as 4G. Amongst other criteria, the ITU expects true 4G systems to support peak data rates of 100 Mbps for high speed mobility and 1 Gbps for limited mobility (Exhibit 2). Sprint’s WiMAX network and T-Mobile’s HSPA+ system are delivering speeds in the range of 5 Mbps, a dramatic improvement over the previous generation of 3G wireless, which topped out at about 1.5 Mbps, but still a far cry from the ITU benchmark. Verizon and AT&T, both of which opted to wait for the release of the Long Term Evolution (LTE) standard from the 3G Partnership Project (3GPP) organization, will introduce LTE service in early 2011 that will top out somewhere south of 12Mbps, a further improvement over Sprint and T-Mobile, but also well short of the ITU target.

Ain’t What You Do, It’s the Way That You Do It

Despite the facts that none of the US carriers offers a true 4G service and that the speeds realized on T-Mobile’s network are comparable to the others, the competitors are crying foul. Both WiMAX and LTE utilize an air interface technology, known as Orthogonal Frequency Division Multiple Access, or OFDMA, while HSPA+ continues with the Wideband Code Division Multiple Access, or WCDMA, that is used in most 3G networks. While a point of contention for Sprint, which prefers to define terms that leave it the first and, still, only 4G network, OFDMA does not confer any pure speed advantage over WCDMA. Both technologies – used to separate the data of multiple users on a wireless system – are bound by the laws of physics, which limit the number of bits of information that can be coded onto a single radio wave. As such, the theoretical maximum carrying capacity of both OFDMA and WCDMA in any given amount of spectrum is the same (Exhibit 3).

The advantage of OFDMA vs. WCDMA is that the former is somewhat more robust to interference yielding a more stable communications path at the cost of a greater degree of computational intensity. Because the onward march of processor evolution has dampened the cost of computational intensity, those setting standards intending to take us to true 4G have universally chosen OFDMA, not because it is any faster, but because the likelihood of acceptable signal strength is higher. As such, the initial speeds for HSPA+ are comparable to WiMAX.

For speed, the secret sauce is a technology called Multiple Input, Multiple Output (MIMO) (Exhibit 4). Historically, digital radios have had to cope with the existence of signal echoes that interfere with the original signal. In an analog transmission, these echoes manifest themselves as static or ghosts. In a digital transmission, they can make the signal incomprehensible. To resolve this problem, engineers designed sophisticated filters that could identify the main signal and the echoes, keeping the former and eliminating the latter. The idea with MIMO is that if you can identify an echo and eliminate it, you can also identify an echo and decode it separately. Moreover, if you purposely send a second signal at the same frequency from a separate antenna in a slightly different direction, you can transmit an entirely different stream of data that can be decoded by the receiving device. Thus, a single channel can be used multiple times simultaneously to multiply the amount of data being transmitted, sidestepping the physical limitations for packing more bits onto a single wave form. HSPA+, WiMAX and LTE all use MIMO with two antennae at either end to achieve a step-function improvement in overall system speeds.

Alphabet Soup

The US 4G situation is directionally reminiscent of previous standards battles over 2G and 3G. In 2G, the first digital generation, AT&T, Southwestern Bell, and Bell South, then separate companies, supported an American specification based on “time division multiple access” or TDMA. Meanwhile, Bell Atlantic, GTE, and AirTouch (later to combine as part of Verizon), along with Sprint chose the Qualcomm championed CDMA technology. A further handful of carriers –led by Pacific Bell and Omnipoint – opted for GSM, a non-compatible form of TDMA that had been mandated as standard in Europe. Finally, Nextel – burdened by a patchwork quilt of frequencies – turned to Motorola’s iDEN and its unique “push-to-talk” capability. 3G was a bit better, with the TDMA carriers having collapsed to two – AT&T and T-Mobile – both completely shifting to the WCDMA standard established by the Europeans, and the two big CDMA carriers remaining on the Qualcomm-driven technology track, Sprint absorbing Nextel in the process.

There actually just two major technology tracks for 4G. LTE has been specified by the 3GPP organization that is also responsible for the evolution of the WCDMA standard as well (Exhibit 5). It has been designed to make transition from WCDMA (and CDMA) as seamless as possible given the radical change in radio air interface, and is supported by the largest wireless technology companies and carriers. HSPA+ is an extension of the WCDMA line, to allow carriers that do not have enough spare spectrum to facilitate a smooth transition to LTE to offer a competitive speed upgrade. It is likely that the carriers that are pushing this technology will execute their own transition as they are able to resolve their spectrum issues.

The alternative technology is WiMAX. This standard is specified by the IEEE and driven by a collection of companies, led by Intel, Motorola and Samsung, that have been frustrated with their inability to influence the relatively closed community that dominates 3GPP. WiMAX uses the same basic technology concept as LTE, but implements it in a way to minimize the importance of the big patent holders in the 3GPP standards. By virtue of its smaller working group, the WiMAX standard reached specification faster than LTE, hoping to take advantage of time to market as a weapon against the broad consensus building around LTE (Exhibit 6).

For 4G, Sprint and its ally Clearwire adopted WiMAX as a gambit. The two companies controlled a 150 MHz swath of spectrum in the 2.5GHz range acquired from other companies over the course of several years. By choosing WiMAX, the companies hoped to get a two year head-start on the competition. Unfortunately, by introduction, the head start had been whittled to a single year. With more than 80% of the wireless carrier community committing to LTE and enormous development resources lined up behind the standard, Sprint and Clearwire face a decision: either stick with WiMAX and cope with the substantial cost and equipment availability disadvantages that come with suboptimal scale, or invest to build out yet another network to comply with the emerging global LTE standard.

Please Sir, May I Have More?

Another factor in wireless speeds and capacity is the amount of spectrum available. Both LTE and WiMAX are designed to allow the system to devote as much as 20MHz to a single user. In contrast, WCDMA is limited to 5MHz channels (Exhibit 7). This capability alone would support a 4x increase in data speeds IF the spectrum were available to do it. Today, Verizon operates two separate networks on 88MHz of total spectrum while AT&T operates three over its 84MHz of frequency licenses. Neither is really sufficient to support widespread use of 20MHz channels.

One solution is to get more spectrum. To that end, the US Government has been at work identifying blocks of frequencies that might be made available for commercial wireless use. In the widely distributed National Broadband Plan, the FCC advocated making an additional 500MHz available before 2020, including 300MHz that were identified as potentially available before 2015 (Exhibit 8). The National Telecommunications and Information Administration added another 115MHz that could also be made available in the next few years, while identifying wide tracts of spectrum at higher frequencies that could be freed up over a longer time frame (Exhibit 9).

My Spectrum is Better Than Your Spectrum!

Not all spectrum is created equal. The higher the frequency, the more quickly the signal deteriorates and the less well it penetrates through solid objects. This translates into poor relative reception indoors and many more cell locations needed to cover a geographical area, which in turn translates into bad service, high costs, and big capex. This is part of the advantage of Verizon and AT&T, both of which hold most of their spectrum in the 850MHz and 700MHz bands. In contrast, Sprint and T-Mobile operate their 3G networks at 1900 MHz, with the Sprint/Clearwire WiMAX network operating all the way up at 2500 MHz (Exhibit 10). The higher frequencies are a particular disadvantage in providing coverage to less populated geographies, where a network at 2500MHz might need as many as 25 cell sites to provide the same coverage as a single site operating at 700MHz.

Of 2.26 GHz identified by the NTIA and the National Broadband Plan as potential candidates for long term commercial availability, 140 MHz are at frequencies below 1 GHZ, 280 MHz are between 1 and 2 GHz, 490 MHz are between 2 and 3.1 GHz, with the remainder at frequencies up to 4.4 GHz (Exhibit 11). Above 3 GHz, the best use of these frequencies may be for applications that can be restricted to line-of-sight, such as backhauling traffic from cell towers or providing semi-fixed service for residential broadband.

Blame Canada

Of the world’s mobile users, only Canadians pay higher monthly bills than Americans, with the average US user paying nearly 50% more than the third place Finns (Exhibit 12). A big reason for this is the concentration of our market, where the top two carriers – Verizon and AT&T – each have nearly double the revenues of the third place player. Verizon and AT&T do not compete on price, they compete on device availability and coverage.

In contrast, the FCC’s National Broadband Plan is explicit in its advocacy for competition. The first element of the plan tasks the Government to “Design policies to ensure robust competition and, as a result maximize consumer welfare, innovation and investment” and goes on to identify a range of actions to spur competition in both wireless and wireline broadband. When rules for the use of spectrum assigned to satellite communications were recently relaxed to allow Harbinger to acquire SkyTerra and offer a wireless broadband service on a wholesale basis, the FCC mandated that AT&T and Verizon together could not make up more than 25% of the resulting company’s traffic.

We believe that it is reasonable to expect that future spectrum auctions will be designed to encourage new competitors. Moreover, the growing attention to wireless broadband could spur relatively deep pocketed new comers to take advantage, particularly given the potential synergies with the expanding portable device and cloud-based application markets.

Tablets and Clouds

High speed wireless connectivity is an obvious boon to the growing population of tablet and smartphone users. The jump to 5 Mbps and beyond begins to enable HDTV quality video streams and bring response times for popular cloud-based consumer applications, like social networking, search, email, shopping, gaming, etc. to levels equivalent to most desktop connections (Exhibit 13). This will hasten the transition from traditional PCs to these devices, as the performance gap closes and the convenience advantage takes precedence. With a ready population of users looking for improving network performance, carriers may find that the interest in the new “4G” services takes hold more quickly than did uptake in 3G nearly a decade ago. More types of devices will embed 4G connectivity and more users will access the service more frequently. This is an obvious boon to companies with a stake in the devices and those which create on-line services that gain favor with the newly mobile users.

Manifest Destiny

Harking back to the ITU’s vision for 4G, we note that it specifies 100 Mbps speeds for “high” mobility users and 1 Gbps for “low” mobility users. This can be interpreted as 100 Mbps maximum speed if you expect to maintain connectivity in a moving vehicle travelling from cell to cell, but that the higher speed should be available if you are content to remain within a single cell. To us, this speaks to direct competition with landline broadband.

The 3GPP LTE roadmap is explicit in its intention to meet the ITU definition and aims to do so with its Release 10 LTE Advanced specification expected to be ratified in 2012. While we do not expect commercially deployed networks to achieve these benchmarks much before the end of the decade, the threat to wireline is clear. Each HDTV channel requires about 7 Mbps for undisturbed streaming. 37 Mbps can support BluRay quality 1080p video. 4G will be fast enough to enable cord cutting – not just channelized video service, but the whole triple play bundle.

One potential roadblock is pricing. If wireless carriers, and their newfound love of usage based pricing make it prohibitive to use 4G for watching television programs, the scenario would be obviously different. In this, the Governments actions to increase industry spectrum and promote competition will be key to bringing about competitive pricing for 4G broadband.

The cost of wireless broadband need not be excessive, particularly if there are carriers focused on it as their primary opportunity. A single cell site at 700 MHz can serve an area of as much as 75 square miles and all homes within reach of the signal would be “passed” by the service. In contrast, Verizon’s FIOS build required fiber optic cable to be drawn down every street in that same 75 square miles to get the same coverage (Exhibit 14). While the backhaul from cell site to the connection to the national Internet is an issue, it is not a difficult one to solve, particularly if the Government also makes higher frequency spectrum available for that purpose.

Patents, Essential and Otherwise

In wireless, the winners are often tied to ownership of intellectual property. We expect LTE to be the dominant standard for 4G, and that the largest patent holders will likely prosper. However, not all patents are created equal. The European Telecommunications Standards Institute (ETSI) maintains a data base of patents and patent filings claimed by their holders as essential to LTE. An analysis of this data base by Informa yielded a distribution showing InterDigital as the largest patent holder, followed by Qualcomm, Huawei and Samsung (Exhibit 15). However, Informa’s assessment of the likelihood of these patents were actually essential to the standard suggested that only a third of the total data base could be considered essential, and that certain companies, Qualcomm and Nokia in particular, had a much higher than average percentage of their claims that appeared to be essential. We also note that more than half of the IPR in the data base were patent applications rather than patents that had been issued. Assessing only patents issued, Qualcomm moves to first place and Ericsson and Nokia move up to third and fourth respectively.

Winners and Losers

We are optimistic that LTE will gain traction in the US market faster than many observers assume and that subsequent upgrades will bring performance to 4G thresholds by the end of the decade. Against this we see several categories of winners and losers (Exhibit 16).

First, there will be considerable opportunities for patent holders to monetize their technology positions. Here Qualcomm is the obvious play, and we note that investors may be underestimating the strength of their IPR portfolio in the critical MIMO technology underlying 4G. Moreover, we expect most devices to remain dual mode for the foreseeable future, forestalling the threat of royalty renegotiation.

We are cautious about the opportunities for equipment manufacturers, as the inability of leaders like Ericsson and Nokia Siemens Networks to monetize their leading position in 3G infrastructure as Chinese competitors entered the market portends more of the same for 4G. We are more enthusiastic about opportunities for tower companies, such as American Tower, Crown Castle and SBA, which should benefit from the deployment of multiple new networks. Companies with a stake in the already booming smartphone and tablet markets will benefit from the availability of 4G connectivity. Apple and Google are the obvious candidates, with HTC, Motorola, Samsung, LG, and Nokia dependant on their own execution. Semiconductor suppliers – such as Qualcomm, Broadcom, ARM Holdings, SkyWorks, TriQuint and others – should also benefit.

We are not enthusiastic for the wireless carriers themselves – e.g. Verizon, AT&T, Sprint, and Clearwire – as we believe new spectrum licensees may pressure prices lower over the long run. We are also concerned for the impact of wireless broadband on traditional wired broadband and eventually, on the channelized television model. Cable operators – e.g. Comcast, Time Warner Cable, CableVision, etc. – appear particularly threatened.

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