The 3 Phases of 5G: Coverage, Density, and Applications

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Paul Sagawa / Tejas Raut Dessai


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Twitter @PaulSagawaSSR

May 23, 2019


The 3 Phases of 5G: Coverage, Density, and Applications

5G will drive a bigger and longer investment cycle than most carriers have publicly stated and that analysts have assumed, a much bigger step-up than the 4G upgrade and more like the comprehensive 3G build-out of the mid-2000’s. While 5G will be a catalyst for a number of future services – such as AR, multiplayer gaming, IoT, vehicle2vehicle, residential broadband replacement, etc. – the initial rationale is coping with the relentless growth in wireless data traffic. Carriers will be caught in a prisoner’s dilemma, with early and heavy 5G spenders gaining advantage and forcing more cautious rivals to catch up. Globally, we expect spending to ramp over several years, as more geographies begin deployment, and as macro cell (coverage) investment transitions to small cell (densification) in later phases. 5G devices are likely to ramp more slowly – initial 5G benefits are bigger for the carrier than the user. Look for modest acceleration in smartphone replacement 2021-2024. We believe the adoption for IoT, AR glasses, and other 5G use cases could take until 2023 or later to gain traction. For investors, we see three overlapping phases (timing varies by market): 1) Coverage build-out (now-2023) – Starts with test equipment, optical backhaul, and tower leases, bridging to macro-cell deployment; 2) Densification (2021-2026) – small cells, user devices, residential broadband; 3) New Use Cases (2023 and beyond) – IoT, automotive V2V, AR. Carriers may or may not see obvious payback for their 5G investments – outcomes will rest on market share shifts, cannibalization of fixed broadband, and on late blooming new use cases.

  • 5G is a major upgrade from 4G. Every ten years or so, relentless technology advances compel the wireless industry to transition to a new generation network standard. The change from 4G to 5G will be particularly complex, as 5G utilizes wide swaths of new spectrum, introduces revolutionary antenna and air interface technologies, and favors a dense network topology radically different from the architectures that have come before it. Building out the macro network for coverage is just the first phase of a many-year investment program for carriers as they begin the generational shift.
  • Carriers are in a prisoner’s dilemma. Relentless wireless data demand growth pressures carriers to expand capacity. 5G carries substantial initial costs, but further capacity expansions are much less expensive than 4G and performance is superior. If all carriers agreed to proceed cautiously with 5G and keep prices high, investment might be minimized, but if one carrier moves aggressively, all have to follow as the leader would otherwise gain long term cost and service performance advantage. Carriers would also give incentive for their heaviest users to adopt 5G to alleviate congestion, while other users would be drawn by faster and more reliable connection speeds.
  • New use cases will be late to emerge. 5G advocates often emphasize applications that will be enabled by the technology – Internet of Things (IoT), vehicle-to-vehicle (V2V), Augmented Reality (AR), fixed broadband replacement, multiplayer mobile gaming, and others. However, 5G is just a prerequisite for these use cases, and the revenue opportunities from them for carriers will emerge years after the initial network build and will require further investment in densification to realize. This, and the staggered timing of buildouts in various geographies, should keep the 5G investment upcycle going for longer than many assume.
  • Smartphone upgrades and new 5G device sales will start modestly. The impetus for 5G is carrier economics. For consumers, the primary selling points will be speed and novelty – ubiquitous coverage will not be available on any network until a few years after introduction, nor will new applications seem compelling at first. The initial 5G devices will be expensive, and AAPL will not even have 5G product until late in 2020. We expect a replacement upcycle in countries with early build-outs to ramp in 2021, yielding some relief to participants in the smartphone ecosystem. We believe meaningful sales growth for industrial IoT installations, AR glasses, and other 5G application specific hardware are further out.
  • 5G mobile users will begin to drop fixed broadband. Mobile carriers will use fixed broadband replacement as a selling point targeting young, single subscribers early in the build-out. Later, small cell densification targeted at residential neighborhoods with attractive demographics and available optical backhaul will support more aggressive fixed broadband cannibalization strategies. We believe services based on mid-range spectrum that combine mobile and residential broadband will be the winning strategy rather than fixed wireless using limited range, line-of-sight millimeter wave frequencies.
  • For investors, 5G will have 3 phases of opportunity. The first wave (now – 2023) of 5G has begun in early markets, like S. Korea, Japan and the US, with investments in optical backhaul, tower contracts, test equipment and beginning macro base station deployments. (N.B. We believe US 5G spending would accelerate sharply with approval of the TMUS/S merger) Within a few years (2021-2026), these initial markets will begin “densification” with spending shifting to small cells, as consumers accelerate smartphone upgrades and begin cutting their residential broadband cords, and as later markets ramp their initial deployments. Finally, a third phase will kick in five years or so from now (2023-?), as the network services needed to support new use cases become ubiquitously available and IoT, V2V, AR, multiplayer mobile gaming, and other applications get traction.
  • Carriers may not earn positive returns. The primary value of 5G for carriers is in avoiding the catastrophic market share losses and shrinking margins they would have incurred by failing to invest in the technology. Depending on the vigor of competition in each market, mobile data prices are likely to fall considerably with 5G, with unlimited plans likely increasingly common, and we do not expect significant carrier revenue growth for basic services. Revenues from new 5G applications will be late to ramp and are unlikely to be sufficient to deliver classic “return on investment” for the network outlay. Residential broadband replacement has the most promise for incremental revenue but will be a double edge sword for carriers that also compete in fixed broadband. Winners will be those that can use 5G to take share from others.
  • Winners (and Losers). Phase 1: Test equipment (KEYS, NATI, etc.), Optical back haul (CIEN, CSCO, INFN, etc.), Towers (AMT, CCI, SBA), Macro base stations (NOK, ERICB); Aggressive carriers (TMUS – presuming merger approval) Phase 2: Small cells (COMM, Samsung, NOK, ERICB, etc.), fiber backhaul (CTY, CTL, ZAYO, CCI, etc.), smartphones (AAPL, QCOM, Samsung); Phase3: New Apps (many start-ups, hard to pick winners); share gaining wireless carriers; Losers: Cable operators, share losing wireless carriers.

5G Spending May Be Bigger Than It Appears

Once a decade, the wireless industry releases a new standard specification for mobile networks. The main purpose of 5G, like all of the Gs that came before it, is to increase the potential capacity of networks so that carriers can more economically address the extraordinary growth of wireless traffic. Of course, users will get faster speeds and lower latency, along with relief from congestion, but the impetus for the change comes from network economics.

Carriers are telling investors that they believe they can implement the new standard without raising CAPEX much, if at all. We think this is wishful thinking. Of course, if all the carriers could collude, signing a pact in a smoky backroom to respond to growing demand with higher prices rather than new network capacity, they could delay 5G, skimp on it, or even avoid it entirely. However, in the real world, the advantage gained by leading in 5G is too enticing to keep spending down for very long. For 4G, global carrier annual capital spending rose more than 30% between 2010 and 2015 before pulling back in ’16 and ’17. 3G, which was a bigger architectural change than 4G, saw a similar prolonged bump in carrier capex in the prior decade. Once begun, the wireless operators have to see it through.

The spend on 5G has just begun and we expect a steeper and longer lasting climb than most analysts are projecting. This spending will go through 3 overlapping phases as the standard spreads, country by country around the globe. First, is the macro-cell buildout to provide coverage. It began with test equipment and beefing up optical backhaul networks, sees carriers securing new space on towers, and is proceeding to the actual macro cell deployment. This is well underway in South Korea, Japan, China, and the US, although we believe the investment in the US has been held up by the uncertainty around TMUS’s acquisition of S. If the deal is consummated, we believe aggressive spending by the combination would further spur VZ and T to keep up.

Once the basic coverage is in place, 2-3 years from now, the carriers will turn to driving subscriber adoption (and device upgrades), “densifying” their networks with a proliferation of small-cells and displacing fixed residential broadband with mobile wireless in neighborhoods with ample backhaul capacity. The final phase, beginning about 5 years from now, will see the emergence of new applications that exploit 5G’s low latency, flexible bandwidth and relatively low costs. This is when AR glasses and other wearables will flourish. This is when Internet of Things applications will gain traction. This is when self-driving vehicles will start to coordinate with each other.

The opportunities for investors will be many-fold. Test equipment vendor KEYS has been in our model portfolio for 7 quarters appreciating by 106.5% in that time. Optical gear maker CIEN has been in since 12/17, delivering 62.1% returns to the portfolio. We think both companies and others in their subsectors still have juice left in Phase 1. So do tower companies. Historically, NOK and ERICB have been extremely frustrating investments during capex upcycles, but there is hope that the more concentrated industry structure could make it different this time. For Phase 2, smartphone makers and their suppliers could enjoy a 2-3 year upcycle in user replacement, beginning in 2021 or 2022. Small cell makers, like COMM, and Samsung and local fiber network operators (backhaul) should prosper. Residential fixed broadband providers will begin feeling the impact of cord cutters. Further out, Phase 3 will bring an army of start-ups pushing IoT, AR, V2V and other acronyms. Its still a bit too early to call out specific Phase 3 winners.

The Fifth G

First generation cellular, based on analog radio transmission, was commercialized in the ‘80’s. By the ‘90’s, traffic growth demanded a solution that could fit more phone calls into swath of spectrum and a handful of digital standards – GSM, IS-136, CDMA, etc. – were developed by regional telecom technical consortia and deployed to accommodate the rising tide of subscribers. Interestingly, the first digital mobile phones were obviously bulkier and power hungry, driving carriers to target their biggest users with phone subsidies and unlimited calling plans to give them the incentive to switch. Retrospectively, these digital standards became known as “2G” or second generation wireless, a moniker that was cemented with the launch of “3G” in the early years of the millennium. 3G was the first globally developed standard, a fairly wrenching technical change that harmonized the incompatible 2G standards to closely related specifications based on the CDMA tech that had been championed by QCOM and adopted by carriers in the US, Korea and a few other places. The 4G roll out began at the start of our current decade and was somewhat less radical than the change to 3G. Now that 4G is ubiquitous in developed markets and spreading in emerging ones, it is time for 5G (Exhibit 1).

Like the “G’s” that came before it, the impetus for 5G is carrier network capacity. Cisco’s most recent analysis of internet traffic growth forecasts mobile data usage to expand at 46% annual rate over the next 5 years.

Exh 1:  Timeline of Wireless Standards Development and Deployment

Exh 2:  8 Key Capabilities of IMT-2020 (5G) in Comparison with 4G LTE

Accommodating this would require substantial further investment in 4G, with the realistic prospect that service at busy times in busy places would soon deteriorate well below currently acceptable parameters (Exhibit 2, 3). While 5G requires significant upfront investment to build out network coverage, it can project more than 10 times more capacity into busy locations than could the previous standard, with marginal capacity expansion based on inexpensive small cells to supplement the coverage provided by the initial macro-cell deployment (Exhibit 4, 5, 6).

Once in place, the other benefits of 5G – ultra-low latency, high user speeds, support for cheap low-power connections, etc. – will spur a user device upgrade cycle and enable new applications, like Augmented Reality (AR), Internet of Things (IoT), Vehicle to Vehicle communications (V2V), multiplayer wide-area mobile gaming, and many others. Still, the initial catalyst for upgrade comes from the carrier.


A Prisoner’s Dilemma

In a perfect world for carriers, price hikes could dampen the unrelenting traffic growth, returning to strict usage limits and speed throttling, and controlling CAPEX and protecting operating cash flows. Fortunately for consumers, we believe rivalry in most markets will prove sufficient to thwart tacit collusion. If even a

Exh 3:  SSR Criteria for 5G improvements in critical functions over 4G

Exh 4:  Monthly Mobile Data and Internet Traffic, 2017 – 2022E

Exh 5:  Forecasted Traffic Density in Major Global Urban Centers, 2017- 2025E

single carrier in a market pushes ahead on implementing the new network standard, their performance advantage would draw churn from other carriers. In the US, AT&T’s slow adoption of 3G – it first had to transition its 2G network from the US TDMA (IS-136) standard to GSM – allowed Verizon to take a market share lead that it has yet to relinquish. Verizon was also first with 4G service, helping to blunt the relative share gains that AT&T had built with its US iPhone exclusive. A carrier that is one “G” ahead can quickly resolve congestion points with new capacity that is cheaper on the margin, ignoring the sunk costs of building full coverage for the technology.

This is a classic “Prisoner’s Dilemma” – that staple of game theory that shows how individual actors might achieve a collectively superior outcome if they could collude, but the incentive to break ranks is too strong for all of the players to resist (Exhibit 7). Once one actor chooses selfishly, the others must follow or suffer. In this case, US carriers are signaling through their cautious capex guidance that they would like to delay 5G adoption and hold down spending, but this is wishful thinking, particularly if T-Mobile gains approval for its acquisition of Sprint. That combination, if approved, would carry significant commitments for a rapid and complete 5G build-out in extremely attractive spectrum holdings (Exhibit 8). This would be a serious threat to Verizon and AT&T, likely forcing much more aggressive investment on their part.

Exh 6:  Timeline of when operators begin to run out of capacity in at least 50% of sites globally


Exh 7:  SSR Analysis of Options and Likely Outcomes of Wireless Prisoners’ Dilemma

Phase One – Build out Coverage

Once a carrier has committed to deploying 5G and plans have been drawn, the first steps are to secure space on towers for macro cells, beef up optical networks for backhaul, and to order the test equipment needed to assure each cell is perfectly calibrated. Base station deployment proceeds geographic market by geographic market, typically taking years to complete. While much attention has been paid to 5G’s support for high frequency millimeter wave spectrum, the distance and in-building penetration limitations in that spectrum assure that most coverage for the standard will be provided in more typical frequency bands. Service may be launched on a very limited basis, and as there will be very few 5G enabled smartphones available over the next 12-18 months, the initial applications will be fixed broadband and wireless modems for laptops and tablets (Exhibit 9).

Phase One is well underway in a handful of markets – Japan (which is pushing to showcase 5G networks at its 2020 summer Olympic games in Tokyo), and South Korea appear in the lead, China and the US are making progress behind. The specter of a US/China trade war could have significant implications. China’s Huawei is the world’s leading supplier of wireless base stations and a rising global challenger in smartphones. Sanctions prohibit it from selling the US and in other allied countries and block important US suppliers, like Qualcomm, Xilinx and Google, from supplying components and software that are critical to Huawei competing successfully in world markets. Should trade difficulties deepen, western suppliers, such as Ericsson, Nokia, and Samsung, should benefit, although we continue to believe that a resolution will arise sooner rather than later.

Exh 8:  Snapshot of US Carrier Capex Spending during 3G and 4G buildout

Exh 9:  SSR Thesis of 5G Opportunity, broken down in deployment phases


The US is an interesting case. T-Mobile, which has been an aggressor against the market leading duopoly of Verizon and AT&T, is treading water, awaiting the verdict from US regulators evaluating its planned acquisition of Sprint. If the deal is approved, we expect significant 5G spending commitments to be an important part of the deal along with stronger support for MVNOs that might resell service on the network. With the extraordinary spectrum resources of the combination, including Sprint’s treasure trove of valuable 2.5MHz mid-band spectrum, the new T-Mobile could deploy most of its coverage cells into the long-range 600MHz spectrum that it recently licensed at auction and use the mid-band for the next deployment phase. It would avoid using the high-band “millimeter wave” spectrum for most customer services, reserving the high capacity but line of sight limited frequencies for backhaul and for servicing densely crowded venues like stadiums.

Without a deal, T-Mobile’s spectrum resources, particularly for the next “densification” phase would be limited and it would not gain the substantial cost synergies to be gained in combination with Sprint. We would not expect it to be nearly as aggressive in its 3G investment. Meanwhile, Sprint, burning cash and losing subscribers, looks like lost cause if left to its own resources.

Against this drama, Verizon and AT&T, have been soft-pedalling their 5G investment requirements, telling investors that the technology can be adequately deployed without significant added spending. Verizon was able to cut its CAPEX in 2018 and forecasts 2019 spending only a touch higher than the $17.1B that it spent in 2017 (Exhibit 10). AT&T, sweating under the load of debt it took on to complete its 2018 acquisition of

Exh 10:  Consensus Estimates for Total US Carrier Capex are Conservative

TimeWarner, is forecasting 2019 capex to drop from 2018 levels, contending that its investment in the US Government’s FirstNet public safety system has significant synergies with its deployment of 5G onto the same towers. We suspect a T-Mobile/Sprint approval would meaningfully accelerate Verizon and AT&T’s deployment plans.

Our model portfolio investments in Phase One 5G have been test and measurement equipment vendor Keysight (up 106.5% since added in 7/17), optical backhaul supplier Ciena (up 62.1% since added in 12/17), base station chip maker Xilinx (up 123.7% since added in 12/16) and T-Mobile (up 11.5% since added in 2/19) (Exhibit 11, 12, 13). We believe these stocks, and others that play similar roles, still have further upside. We have not included tower companies but are generally in favor of all three (AMT, CCI and SBA). We have not included the major base station equipment names, Nokia and Ericsson, even though these companies stand to benefit greatly from the controversy around Huawei. Historically, the two Nordic wireless leaders have struggled to deliver profitability while scaling up to meet demand from new generation network deployments. Of course, previous network transitions have seen more vigorous competition. Alcatel-Lucent, Siemens, Nortel, and Motorola have exited the wireless market, absorbed into Nokia and Ericsson. Perhaps network bidding will be more realistic this time around, and if so, we would prefer Nokia.


Phase Two – Densification

A key benefit of 5G vs. 4G is its flexibility for adding capacity via small cells with tightly focused antennae enabling spectrum re-use in closely adjacent cells. Each small cell is inexpensive (<$4,000) so carriers can

Exh 11:  Wireless Equipment Vendor Revenue, 2010 – 2018

Exh 12:  Optical Backhaul Players Consensus Growth Estimates and Summary

deploy them to multiply capacity as needed, assuming adequate locations and backhaul facilities can be secured. Locations only require civic cooperation, as small cells can be installed at any secure spot above

Exh 13:  Testing Equipment Consensus Growth Estimates and Summary

street level with access to power. Optical networks for backhaul are preferred, but line-of-sight wireless backhaul in the high capacity millimeter wave spectrum is a viable alternative. In competitive markets, we would expect densification to drive further capex upside, with the sheer volume of small cells outweighing their relatively low per unit costs. This will be opportunity for companies like CommScope and Adtran, which are likely to participate in small cells and their associated backhaul needs.

Phase two densification will also see an acceleration of user adoption, as the panoply of 5G devices arrive and carriers begin to raise incentives for heavy users to switch. We expect this to drive a shortening of the upgrade cycle for premium smartphones beginning in 2021, yielding a 2-3-year cyclical upturn for flagship devices. This will obviously benefit the top OEMs – e.g. Apple, Samsung, and others – but also their component suppliers – e.g. Qualcomm, Skyworks, Qorvo, and others.

We also expect phase two to see the rise of residential broadband cord cutting, as reliable mobile speeds of better than 200Mbps and unlimited use plans induce younger demographics to drop their fixed services to rely entirely on their wireless connection. This could drive some in-home peripherals and will begin to erode the cable modem and telco fixed broadband installed base. While wireless operators will cherry pick the neighborhoods where it presses broadband replacement, the impact will be serious for the incumbent providers. This could be a substantial opportunity for wireless providers, although those with fixed line businesses may see more pain than gain.

Investors will need to be patient for phase two opportunities – we do not expect densification to begin in earnest until 2021. As we draw closer to that rough timeframe, we will look for good entry points in stocks like CommScope, Adtran, Apple, Qualcomm, and others.


Phase Three – New Applications

Most discussions of 5G begin with new use cases – augmented reality glasses, vehicle to vehicle communications, internet of things, etc. We do not expect these applications to have much impact until 5G networks can offer nearly ubiquitous coverage and reliable high bandwidth service, even in busy times and places. Realistically, these conditions will not be available until a few years into network densification – say


Exh 14:  Avg. No. of Connected Devices per US Household, 2018 – 2023E

2023 or later for the initial geographic markets. This will lead to inevitable false starts and handwringing, as media thought pieces decry the missed potential of 5G. Smart investors will have patience.

5G will be a significant catalyst for augmented reality – the sharp reduction in network latency to below 10ms means that applications can serve images from the cloud without noticeable lag. Current AR solutions require adjunct processing and storage well beyond the reasonable capacity of a smartphone, along with expensive and bulky optics. 5G will resolve the first issue, but progress on inobtrusive AR glasses has been slow. We believe it will all come together 5 years or more from now.

IoT applications have suffered from a lack of low cost, standard, reliable, broad reaching wireless connectivity. 5G will eventually fill that gap, as the technology supports offering low speed service over the same network infrastructure as the high-performance connections (Exhibit 14). We do not expect carriers to make IoT support a priority in their initial network roll-outs, so the rise of IoT may not get traction until well into the densification phase. Once this happens, we see significant opportunities for embedded sensors, low-cost 5G radios, and application software.

Autonomous robo-cabs will emerge without a need for network connectivity, but further functionality could be enabled with reliable, high-speed vehicle-to-vehicle and vehicle to network communications. With 5G ubiquity, autonomous fleets and private vehicles could travel in energy efficient convoys, better coordinate parking and other close maneuvers, and increase the efficiency of roadways. Municipalities could instantly alert traffic to accidents, impending roadwork, and other obstacles to facilitate rerouting.


Exh 15:  5G will enable a range of new, on-the-go applications

Even current mobile use cases could be expanded with 5G. Mobile gaming would benefit greatly from faster speeds and lower latency – currently wide area multiplayer games are greatly limited, and fast-twitch real-time gaming is essentially impossible. Video streaming to mobile devices will be higher quality and more reliable. The “Tactile Internet” concept imagines applications where devices can interact with the user’s physical environment, taking sensor input and providing user mechanisms – visual, audio, haptic, etc. – to give active feedback. For these use cases, nearly ubiquitous 5G will be a prerequisite (Exhibit 15).

We believe this third phase of 5G will not gain traction for 5 years or more, but that substantial new business opportunities, both already imagined and wholly new, will arise. It is too early to call out specific winners, but we expect low cost sensors, high end optics, and AI-infused software to play important roles.


Many Wireless Carriers Will Be Losers in 5G

While we expect almost all wireless carriers to invest in 5G networks, mainly to protect their competitive position, the return on investment is likely to be poor for many of them. The flexibility for new spectrum ranges, increasing focus on data service quality, and flood of capacity will level the playing field for traditionally weak carriers who had been limited by their higher frequency spectrum holdings. Aggression from below will demand response from market leaders, who will begin to lose their historical ability to demand higher prices for better coverage. Some challengers, like T-Mobile in the US (assuming its merger with Sprint is approved) will gain strength, but many will founder against greater price competition. Wireless operators that also have fixed network businesses may also find significant new competition for residential broadband.


Our 5G Investment Strategy

Our 15-stock model portfolio currently contains several 5G related investment recommendations. Keysight, a market leader in wireless test and measurement equipment, has more than doubled since we added it to our portfolio nearly two years ago – we believe there is a bit more upside for it in phase 1 despite a notable recent downgrade. Optical backhaul supplier Ciena is up 62% in 18 months as a portfolio constituent – we have some concerns with the potential impact of US/China policy. Xilinx, maker of FPGA chips widely used in wireless base stations, is up 124% over 30 months in our portfolio, driven both by 5G and its relevance for AI datacenter processing. Finally, T-Mobile is up 11% since we returned to the portfolio in February. We see significant synergies from the potential Sprint merger, with major share price upside once the deal is approved. Right now, we see that as more likely than not. We are interested in Ericsson and Nokia, particularly in the face of sanctions against market leader Huawei, but remain a bit gun shy given both companies’ history of mispricing new network deployment contracts (Exhibit 16).

Looking ahead to phase two, we see transitioning our portfolio to companies with exposure to small cells and user devices. This move is likely to begin sometime next year to be in place for what we expect to be significant opportunity in 2021.

Exh 16:  SSR Summary of 5G Winners and Losers

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