Telecom sector: Impact of Pricing, MVNOs and LINE Calls

14 April 2014 Asia Pacific/Japan Equity Research Telecommunications Equipment (Telecommunication Services (Japan)) / MARKET WEIGHT Telecom sector: Im...
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14 April 2014 Asia Pacific/Japan Equity Research Telecommunications Equipment (Telecommunication Services (Japan)) / MARKET WEIGHT

Telecom sector: Impact of Pricing, MVNOs and LINE Calls Research Analysts Hitoshi Hayakawa 81 3 4550 9952 [email protected]

THEME

Entering a new strategic stage Telecoms equity investment strategy in latter half of eight-year mobile cycle Figure 1: MVNOs

Source: NTT Communications, NTT DoCoMo

■ Initiating coverage of JCI: We initiate our coverage of mobile virtual network operator (MVNO) pioneer Japan Communications (9424) with an OUTPERFORM rating and a ¥620 target price. ■ DoCoMo needs to take further steps: Even after introducing the iPhone,

NTT DoCoMo (9437) continues to bleed loyal long-term customers. We think it needs to switch from a strategy focused on securing new customers under mobile number portability (MNP) to focus on rewarding long-term customers with new pricing plans. We believe a merger with NTT Communications to enter the MVNO market must be a part of that strategy. We also believe DoCoMo needs to anticipate the entry of Yahoo Japan (4689) as a mobile carrier, which constitutes a serious threat in our opinion. ■ New pricing, MIC regulatory reforms, LINE Call and Y! mobile all valuationnegative: Average monthly call time per user in Japan is 57 minutes. We estimate smartphone call apps will reduce sector revenues by about ¥100bn, based on monthly minutes of use (MOU) per user falling by five minutes. We see little earnings impact on a sector generating ¥1.7tn in OP from annual sales of ¥9.5tn. The industry can probably protect current profits with policies to handle MNP issues, but we think smartphone call apps will be negative for valuations because users may migrate to these apps and that they also herald a new era of price competition. Similarly, MIC regulatory reforms would probably be negative for valuations in the sector as well.

■ Telecoms stocks: Our top sector pick is Nippon Telegraph and Telephone (NTT; 9432), reflecting: (1) the company’s move into real estate (see our report), (2) management’s EPS commitment, (3) share buybacks, and (4) group restructuring. We have ratings of OUTPERFORM on NTT and JCI (9424), NEUTRAL on KDDI (9433), which we think is vulnerable to the impact of Y! mobile and MVNO players, and UNDERPERFORM on NTT DoCoMo (9437). Our target prices are ¥6,000 for NTT, ¥620 for JCI, ¥6,300 for KDDI, and ¥1,600 for NTT DoCoMo. We downgrade our forecasts for NTT DoCoMo. DISCLOSURE APPENDIX AT THE BACK OF THIS REPORT CONTAINS IMPORTANT DISCLOSURES, ANALYST CERTIFICATIONS, AND THE STATUS OF NON-US ANALYSTS. US Disclosure: Credit Suisse does and seeks to do

business with companies covered in its research reports. As a result, investors should be aware that the Firm may have a conflict of interest that could affect the objectivity of this report. Investors should consider this report as only a single factor in making their investment decision.

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14 April 2014

Table of contents Assessing impact of DoCoMo’s new pricing and LINE Call service Minimal profit impact on industry for three reasons Reason 1: Call minutes already in steep decline Reason 2: Curtailing discounts can offset revenue drag from apps Reason 3: The nuisance factor Earnings impact of smartphone call apps on industry New pricing and smartphone call apps negative for valuations What are MVNOs? MVNOs and MNOs Like travel agents, not budget airlines MVNO market now at 1.5mn subscribers in mobile market of 100mn users Smartphones and SIM cards Apple now selling SIM-free handsets Mobile carriers exert strong control over consumers SIM swapping not common among Japanese consumers How should NTT DoCoMo respond? Limited scope for profits on the iPhone Righting the wrongs of MNP-focused strategies DoCoMo needs to offer incentives to long-term users Y! mobile poses an emerging threat Win new customers with MVNOs Make NTT Communications a subsidiary? Strategy for Article 30 of Telecoms Business Law Need to unify chain of command NTT DoCoMo (9437): Cutting our forecasts sharply Initiate coverage on Japan Communications (9424) Company overview Business model Earnings outlook Rival companies and their charges FMC phones Valuation Appendix

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

3 3 4 5 7 7 9 11 11 11 12 12 13 13 13 15 15 15 16 17 17 17 18 20 21 23 23 23 24 25 25 27 35

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Assessing impact of DoCoMo’s new pricing and LINE Call service Minimal profit impact on industry for three reasons In considering the impact of DoCoMo’s new Kake-hodai (fixed-rate) voice call pricing, LINE and other smartphone apps on Japan’s mobile telecoms industry and related shareprice trends, we believe the two most important perspectives to adopt are: (1) earnings, and (2) valuation.

Impact on earnings and valuation

Following large-scale acquisitions of chat apps Viber by Rakuten ($900mn) and Whatsapp by Facebook ($19bn), the unlisted Japanese LINE Corporation announced plans on 26 February to begin offering a low-cost phone service. The LINE Call service (branded LINE Denwa in Japan) is to provide fixed-line and mobile call capabilities to users in Japan and overseas. LINE has a user base of around 400mn, with many of them in Japan (as shown in Figure 2).

Smartphone apps in the limelight

Figure 2: Apps for smartphones

East Asia

Europe

Latin America

Anglo

FB Msngr Kakao Talk

LINE

Pinger

WeChat

WhatsApp

12%

1%

1%

8%

1%

9%

17%

1%

2%

-

2%

18%

15%

-

1%

-

1%

49%

19%

1%

4%

-

5%

22%

29%

-

-

-

-

96%

32%

-

4%

-

-

90%

27%

-

26%

-

-

96%

31%

-

14%

-

-

94%

29%

-

1%

-

-

91%

13%

-

44%

-

-

99%

19%

-

1%

-

-

17%

33%

-

3%

-

-

93%

-

2%

11%

-

82%

15%

21%

3%

46%

-

53%

96%

18%

9%

71%

-

6%

8%

6%

95%

12%

-

-

3%

Source: Onavo Insights

Figure 3 shows the user plans with LINE Call. Under the least expensive plan, users can call mobile devices for ¥6.5/min. This is about one-sixth of the ¥42/min rate that the leading Japanese mobile carriers charge for calls to mobiles. LINE apparently does not plan to charge for flag fall or levy a monthly service fee.

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

LINE Call service overview

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LINE users can choose either “Call Credit” or “30-Day” service plans. With the 30-Day plan, there is a further choice between a landline-only service and plans where users can call landlines or mobiles. With Call Credit, users prepay the number of minutes they wish to use. The price per minute is higher than on the 30-Day plan. The 30-Day plan offering 60 minutes of call time to landlines or mobiles costs ¥390 (thus equivalent to ¥6.5/min), while 60 minutes of call time to landlines only costs ¥120 (equivalent to ¥2/min). Figure 3: LINE Call pricing To mobile phones LINE Call Call credit 30-day plan (max 60 min./ can call both fixed line and mobile) 30-day plan (max 60 min./ can call only to fixed-line)

(JPY) To fixed-line phones

14

3

6.5 2

Source: Company data, Credit Suisse

We think the loss of industry earnings due to smartphone calling apps such as LINE Call is likely to be minimal. We outline our three-pronged rationale for this below. Three reasons for minimal impact

Reason 1: Call minutes already in steep decline A breakdown of ARPU by service type shows that making calls—the service most at risk from smartphone call apps—only generates about 20% of overall industry ARPU (Figure 4). Figure 4: ARPU breakdown ARPU (JPY) 3,302 1,100 913 152 5,466

Data Basic charge Outgoing calls Incoming calls

Breakdown 60.4% 20.1% 16.7% 2.8% 100.0%

Note: i-mode/SP mode base, before ARPU discounts Source: Credit Suisse estimates

Smartphone users with the LINE app installed have been able to call other LINE-enabled devices for free since before LINE unveiled its new Call service. We think the main users of these smartphone apps are friends calling one another, with few people using them for business. The question of sector impact from these apps seems to turn on the degree of potential cannibalization of existing landline, business-to-business, and emergency calls.

Will LINE Call be used for serious conversations?

Figure 5: NTT DoCoMo outgoing MOU (min.) 100 90 80 70

57

60 50

1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 3/10

3/11

3/12

3/13

3/14

Source: Company data, Credit Suisse

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The decline in minutes of use (MOU) as seen in Figure 5 suggests that most Japanese customers are only using a mobile to call somebody if the call is necessary and to make sure to reach the person. We see the fall in MOU as a symptom of the fairly advanced migration of mobile communications to SMS and chat apps. We do not expect the emergence of the LINE Call service to spark a more rapid decline in MOU. Moreover, users need a smartphone to access apps such as LINE Call. Migration of more services to smartphones should tend to boost data ARPU, given the current level of data charges levied on smartphone users (¥6,000/month). This implies that adoption of LINE Call could yet turn out to be a positive for carriers and partly explains DoCoMo’s new pricing.

Smartphone calling apps to boost data ARPU

We expect voice dependence for the Japanese mobile telecoms industry (measured in terms of the proportion of total ARPU attributable to voice) to fall to 30.6% by the end of March 2014. This reflects the decline in voice ARPU coupled with growth in data ARPU. In our view, falling voice ARPU is a function of: (1) the effect of the discounts that users receive for purchasing a handset in installments, and (2) the decline in MOU. LINE Call is unlikely to eradicate monthly service fees around the ¥1,000 level or the existence of voice mail services for mobile users: we do not believe voice ARPU will decline to zero even if MOU continues to fall. However, the trend exhibited in Figure 6 suggests that the carrier most vulnerable to the impact of LINE Call is NTT DoCoMo, because it has the highest voice dependence of the major Japanese carriers. Figure 6: Voice revenue ratio (%) 60 50 40 30 20 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 4Q 1Q 2Q 3Q 3/10 Industry

3/11 NTT DOCOMO

3/12

3/13 KDDI au

3/14

Softbank Mobile

Source: Company data, Credit Suisse

Reason 2: Curtailing discounts can offset revenue drag from apps Based on calculations we explain in detail later in this report, we estimate the drag from the LINE Call service on industry earnings at ¥20bn per minute of call migration. This puts the total drain at approximately ¥100bn per year from five minutes of average MOU moving to smartphone apps. This amounts to little more than a gnat bite for a ¥9.5tn industry. However, we think DoCoMo’s new pricing will help deter some users from migrating to app-based call services.

LINE Call unlikely to inflict much pain

DoCoMo has struck the right strategic note with its new pricing. In terms of future revenue, we think the more pressing problem the industry must address is widespread discounting. Softbank has pioneered the system of offering call service discounts to users that agree to buy the handset in installments, as a way of cutting upfront purchase costs and short-term churn rates while making it easier to sign up users to mobile plans. This approach is now the industry standard in Japan, and Sprint looks likely to pioneer its introduction in the US. Over the two-year contract period, users pay for the handset in monthly installments while receiving a fixed-sum discount on monthly call charges.

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

Free handsets are the real issue for mobile carriers

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Since for accounting purposes the installment receipts are treated as offsetting receivables, no sales are booked despite payments by the customer. At the same time, though, the call charge discounts are booked as adjustments to net sales. It goes without saying that the combination lowers ARPU. Our analysis reinforces the conclusion that this practice is a strong drag on industry earnings. Carriers are now augmenting these upfront incentives with cash rebates. As we argue below, these incentives are a corollary of an industry structure that has been significantly skewed by the iPhone and, above all, by the need to secure net adds in an age of mobile number portability (MNP). We think this is symptomatic of the sector entering the second half of the eight-year mobile cycle.

Industry structure skewed by MNP

Figure 7: Japanese mobile telecommunication revenues

(JPYbn) 10,000 8,000 6,000 4,000

8,646

8,778

9,145

9,535

9,861

9,957

-259

-267

-417

-821

-1,234

3/10

3/11

3/12

3/13

3/14E

-1,462 3/15E

2,000 0 -2,000

Total domestic mobile telecommunication revenue

Discounts

Source: Company data, Credit Suisse estimates

We calculate that total call charge discounts for Japanese carriers grew from ¥258.6bn in FY3/10 to ¥820.5bn in FY3/13 and are set to expand to around ¥1.5tn in FY3/15. Handset sales via installment help prevent short-term churn while boosting profits from the sale of devices, but at the same time tend to undermine the growth in data ARPU associated with widespread smartphone uptake. Carriers are thus effectively giving back some of their earnings growth to users in the form of sales offsets.

Total industry discounts set to exceed ¥1tn

Incidentally, Japanese carriers are now competing fiercely to offer cash-back incentives to users in marketing campaigns that are adding to operating expenses. While carriers are watching their bottom lines, they appear to be competing with an eye on balancing the following four sales indicators: ■

Data ARPU growth (from smartphone uptake);



Voice ARPU decline (from falling MOU, smartphone apps, higher monthly discounts);



Subscriber net adds;



Sales of handsets and other items;

and the following four expense items: ■

Cash rebates;



Handset CoGS;



Network operating costs;

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

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Other expenses.

We conclude that the emergence of smartphone call apps such as LINE Call is a relatively minor factor for OP. Even if smartphone apps grew to have a sizable impact on industry earnings, carriers would be able to maintain current profit levels by controlling monthly discounts or scaling back cash rebates.

Reason 3: The nuisance factor Concerns about the threat to the profitability of incumbent carriers from IP-based call apps have been prevalent since the emergence of Skype. Ultimately, Skype only captured a small percentage of usage and did not prove fatal for the fixed-line or mobile industry paradigms. Whether using landline or mobile, users prefer the convenience and reliability of the services offered by carriers for urgent calls or cases where a high-quality connection is required while on the move. We think few customers will choose to buy prepaid 30-day LINE Call service plans and track detailed call usage to realize potential savings. It is still too early to assess potential uptake for DoCoMo’s new Kake-hodai plan, but we believe it is the right strategy to take on the apps.

Earnings impact of smartphone call apps on industry Our calculations show the impact on industry income of one of the 57 minutes of average mobile monthly call usage migrating to smartphone call apps would be about ¥20bn. If the overall call migration amounted to five minutes, this would lower the aggregate sales of the leading three carriers by about ¥100bn.

Revenue fall of ¥20bn/min of MOU migration

Figure 8: Relationship between MOU increase in smartphone call apps and impact on industry income 1

3

5

10

15

20

25 (min.)

0 -100

-200 -300 -400 -500 -600 (JPYbn) Source: Company data, Credit Suisse

Figure 9: Assumptions

Industry revenue (annual, JPY trn)

9.5

Industry revenue from outgoing voice (annual, JPY trn)

1.2

% of voice revenue Mobile phone subscribers (average, million)

12.1% 108

Outgoing MOU (min. / month)

57

Outgoing ARPU (JPY / month)

894

Voice revenue / min (JPY, month)

16

Source: Company data, Credit Suisse

The assumptions for our calculation are shown in Figure 9. The key statistic to note here is that a minute of call usage currently generates ¥16 in fee revenue, whereas the figure for LTE smartphones is ¥42 for the top three carriers. Taking into account the free usage in 3G plans, where users pay a basic service charge, we can see that the call revenue per

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

Scope to boost fee revenue per minute from LTE

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minute is clearly less than ¥42. LTE migration from ongoing smartphone adoption would thus eliminate the free call usage contained within the basic service charge. With this at around ¥1,000 per month, average fee revenue from calls will tend to increase to nearer ¥42 per minute as users receive no free calls. Also, voice ARPU could bottom if DoCoMo’s Kake-hodai plan, priced at ¥2,700 per month, gains traction among users. We expect that, having grown steadily due to smartphone uptake, the call and data revenues of Japan’s mobile carriers will enter a transitional phase. We believe data revenues will continue to rise but domestic mobile telecommunication revenues will stagnate due to the increasing use of monthly discounts. While KDDI and Softbank should manage to maintain restrained top-line growth, we see DoCoMo struggling. We expect it to trim costs in response to declining revenues, enabling the sector to maintain positive earnings growth on aggregate.

Top-line growth negative at DoCoMo, positive at KDDI and Softbank

Figure 10: Japanese mobile telecommunication revenues (voice/data breakdown) (JPY bn) 7,000 6,570 6,510 6,572 6,509 6,478 6,577 6,000 5,000 4,000

3,000 2,000 1,000 0 3/10

3/11

3/12

3/13

Voice

3/14E Data

3/15E

Source: Company data, Credit Suisse estimates

Figure 11: Japanese mobile telecommunication revenue (by carrier) (JPY bn) 6,570 6,510 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 3/10 3/11 NTT DOCOMO

6,572

6,509

6,478

3/12 KDDI au

3/13 3/14E Softbank Mobile

6,577

3/15E

Source: Company data, Credit Suisse estimates

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Figure 12: Domestic mobile telecommunication operating income (JPY bn) 2,000

1,611

1,681

1,706

1,742

1,868

1,948

1,500 1,000

500 0 3/10

3/11 3/12 3/13 NTT DOCOMO KDDI au

3/14E 3/15E Softbank Mobile

Source: Company data, Credit Suisse estimates

New pricing and smartphone call apps negative for valuations As explained above, we see only a limited impact on earnings from new pricing plans and smartphone call apps. However, we expect a negative impact on valuations because the apps are likely to prompt investor concerns about a gradual shift in economic value from legacy carriers to over-the-top (OTT) apps—irrespective of the magnitude of the earnings impact of such apps. We will be watching to see how popular the Kake-hodai plan (fixed rate for voice plan) will be among users and whether DoCoMo's rivals will follow suit with their own plans.

Limited earnings impact, but negative for valuations

NTT DoCoMo, which opened up the world of the mobile internet with its i-mode service, has been decidedly slow off the mark in smartphones, in our view. Why did it fall behind? We believe it was mainly because i-mode was a major success on DoCoMo platforms. It appears that DoCoMo knew the emergence of smartphones would force it to become just a conduit for other services, restricting its ability to offer added value to consumers, and that the popularity of i-mode and its reluctance to become a conduit delayed its move into smartphones. DoCoMo has invested significant management resources and pursued an M&A strategy to develop proprietary content such as music and videos for distribution over its network, an approach aimed at differentiation to avoid the fate of being a dumb pipe (i.e., only a provider of access to a network). Now it is struggling, though, because users have quickly realized they can access the services they want (OTT apps) via the internet, which is accessible through the carrier networks. Some communications carriers are working hard to resist this significant trend, but we think the transformation of carriers into dumb pipes is irreversible from a medium-to-long-term perspective. Telecoms infrastructure plays an important role and has the potential to generate significant cash for its owners. Infrastructure will therefore likely continue to have substantial value. However, many of the services that the carriers have launched to take on the rising tide of OTT apps have fallen by the wayside, and user bases have failed to expand. Meanwhile, OTT apps like LINE have appeared nearly overnight and seen rapid growth in subscribers. The equity market’s assessment of a company’s ability to generate stable cash flow from telecoms infrastructure appears influenced by global conditions, risk appetite in equity markets, and investment trends in the sector at the time. Based on our eight-year cycle scenario for mobile communications, we had forecast positive growth in sector earnings coupled with a positive re-rating of sector valuations. However, with smartphone uptake now in excess of 50%, coupled with a gradual shift in value in the sector to LINE and other OTT call apps, we now see limited prospects for further upside to telecoms valuations.

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

Value gradually shifting to OTT apps

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Also, we believe the mobile communications sector is on the verge of a new phase of restructuring, driven by the emergence of MVNOs.

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

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What are MVNOs? MVNOs and MNOs MVNO is short for “mobile virtual network operator.” Companies like NTT DoCoMo, KDDI au, and Softbank, which control the networks, are mobile network operators (MNOs). MVNOs purchase access to these networks from MNOs and provide services under their own brands.

Like travel agents, not budget airlines MVNOs do not usually have their own mobile network infrastructure such as base stations. To use a travel analogy, MNOs are the equivalent of big airlines such as JAL or ANA, or major hotel chains like Hilton, while MVNOs are like travel agents such as HIS and JTB. MVNOs and MNOs do not compete directly, as they rely on each other for business. Looking at the travel comparison, then, MVNOs have different market positions than lowcost carriers like Air Asia. Figure 13: MVNO overview

IP network (Internet)

MNO network

GTP POI (Point of Interface)

Network terminator 3G / GGSN LTE / PGW

3G / NodeB, SGSN LTE / eNodeB, SGW

Authentication server MNO equipment

MVNO equipment

Source: Credit Suisse

Airlines and hotels do not need to sell seats or rooms at wholesale rates to travel agents if capacity is high and they are making a profit. The mutually beneficial relationship JAL and JTB have created in the travel sector is slightly different than the kind of relationship MNOs and MVNOs have in mobile communications. MNOs are investing heavily in infrastructure to meet sustained growth in traffic (demand), but profits are still at healthy levels. We believe that is why there is almost no incentive at present for any of the MNOs in Japan to sell access to their networks. Travel sector companies work to boost profitability by reducing the number of empty seats and vacant rooms to increase load factors and capacity utilization. Mobile carriers, on the other hand, have a different profit motive.

Limited incentive for MNOs to sell network access

Given this backdrop, why have MVNOs appeared in Japan? We believe the story goes back to 2007, when the Ministry of Internal Affairs and Communications (MIC), a supporter of MVNOs, essentially forced NTT DoCoMo to open up its network to other providers. As a result, DoCoMo is the only major carrier in Japan to sell network access to MVNOs at the layer 2 level. Hence, DoCoMo has been reluctant to comply with the MIC’s guidelines on opening up networks to MVNOs.

MIC behind emergence of MVNOs

MNOs such as DoCoMo can generate profits through interconnection services for MVNOs, but MVNOs could turn out to be a thorn in their side if subscribers start shifting to MVNOs. Although MVNOs face certain restrictions on service speed and data volume compared with the leading carriers, MVNOs can offer cheaper plans, putting them in direct competition with the MNOs. Therefore, at the moment, the relationship between MVNOs

DoCoMo the only MNO to allow layer 2 access

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and MNOs more closely resembles the relationship between full-service airlines such as JAL/ANA and low-cost carriers (LCCs). This means there is a strong possibility that price competition with MNOs could break out once MVNOs become big enough.

MVNO market now at 1.5mn subscribers in mobile market of 100mn users According to data released by Japan’s Ministry of Internal Affairs and Communication (MIC), the number of MVNO service subscribers totaled 7.17mn as of end-December 2013, but this number also includes subscribers to MVNO services offered by MNOs. There is currently no accurate data showing the number of MVNO users who swap SIM cards in their smartphones or tablets to access services from MVNO providers such as Japan Communications, IIJ and NTT Communications. We estimate there are roughly 1.5mn users.

Around 99% of mobile phone users are MNO customers

As of end-March 2014, the three leading mobile phone carriers had a total of 109.8mn subscribers with IP enabled phones, indicating more than 99% of mobile phone users have contracts with MNOs. In Japan, MVNOs are still very minor players, and many consumers do not even know they exist. However, the press has recently started to cover MVNO-related topics including the move by retailing giant Aeon to begin offering smartphones. Awareness of the MVNO concept appears to be increasing rapidly.

MNOs have over 100mn mobile subscribers; MVNOs tiny in comparison

Smartphones and SIM cards Mobile phones will not work without a SIM card (a type of IC chip). SIM is short for subscriber identity module. As the name suggests, SIM cards contain information about each mobile phone subscriber. Figure 14: SIM card

Source: NTT DoCoMo

In Japan, most handsets have locked SIM cards. That means handsets become inoperable if users swap SIM cards with ones from a different carrier or MVNO. DoCoMo handsets are the exception. Japan Communications and IIJ have layer 2 interconnections with the DoCoMo network, which means their SIM cards are equivalent to those sold by DoCoMo. As a result, users should be able to use Japan Communications and IIJ SIM cards even with SIM-locked DoCoMo handsets. KDDI au and Softbank handsets do not work with non-proprietary SIMs.

Many SIM cards compatible with DoCoMo networks

Although not widely recognized, MNOs, and particularly DoCoMo, face other problems from the emergence of MVNOs. Subscribers that sign up to a DoCoMo plan with a free handset can immediately cancel their contract, keep their phone, and then switch to services provided by Japan Communications using a new SIM card. Subscribers buying their handsets through a two-year installment plan could also switch to Japan Communications using mobile number portability (MNP) after the end of their contract. They would have the same phone and number while enjoying services at half (or even less than half) the cost of their previous plan. This could spur a shift in subscribers away from DoCoMo as consumers become more aware of MVNOs.

Other problems for MNOs

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This trend could have both a positive and a negative impact on DoCoMo. Later in the report, we look at how DoCoMo could strategically use MVNOs to its advantage based on the longer-term prospects for the industry.

Apple now selling SIM-free handsets Apple started selling SIM-free handsets through the Apple Store in November 2013. The iPhone 5S handsets are priced at ¥71,800 for the 16GB model, ¥81,800 for the 32GB model, and ¥91,800 for the 64GB model. For better or worse, Japanese consumers are now used to the 24-month interest-free handset installment plans offered by the leading carriers, so buying a SIM-free handset from the Apple Store at such prices is a major upfront cost. Also, some of the carriers offer discounts on monthly charges if customers sign up to two-year plans. However, when the contract comes to an end, customers can only use the handset with the original MNO (except for handsets bought from DoCoMo), which means they would have to continue paying high fees to their existing carrier. For people who plan to use the same handset for longer than two years, often travel overseas, and do not need that much data, the most cost-effective option would be to buy a SIM-free iPhone from the Apple Store, use a Japan Communications SIM card in Japan, and buy prepaid SIMs overseas.

Buying a handset is expensive

Mobile carriers exert strong control over consumers Japan’s top three mobile phone carriers spent a total of ¥155bn on marketing in FY3/13. Advertising is spread across all types of media, from TV and the internet to newspapers and magazines. Well-known celebrities, such as SMAP in Softbank’s ads, are now used widely in marketing campaigns.

Annual marketing spend of ¥155bn

Figure 15: Advertisement expenses of major telecom companies (FY3/13)

Softbank Mobile JPY 59bn

NTT DOCOMO JPY 70bn

KDDI au JPY 26bn

Source: Company data, Credit Suisse

This level of marketing has created powerful brands. These brands, together with a supposedly tendency for Japanese consumers to blindly buy products other people own or have endorsed (certain handsets such as the iPhone have traditionally attracted a disproportionate level of demand in Japan) mean MVNOs face significant challenges to growth.

The unique spending habits of Japanese consumers

SIM swapping not common among Japanese consumers In Japan, when you buy a new phone, store staff usually insert your new SIM card for you. And because most handsets in Japan are SIM-locked, many people just keep the SIM card in their handset and do not take out their SIMs.

Do you know how to take out a SIM card?

We believe a basic understanding about how to swap SIM cards is needed for MVNOs to gain in popularity. We expect increased uptake of SIM-free handsets and used handsets

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actively marketed by new players, plus support from MVNO sales staff, will be key to changing consumers’ mindset.

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How should NTT DoCoMo respond? Limited scope for profits on the iPhone In Japan, the iPhone 5s, which is one of the latest and most advanced phones on the market today, is already available for free with some plans. Handsets are thus being given away. We believe this vindicates our mobile communications eight-year cycle scenario. As the shift to smartphones loses momentum and the pace of subscriber growth slows, the sector is seeing the worst possible environment, with carriers putting priority on securing MNP customers from rivals by offering discounts and cash back on new handsets. If customers want the iPhone, carriers should be collecting money from them for the handset. By offering generous cash back deals or large discounts on monthly charges, carriers are effectively giving away the handset for free. This only benefits the consumer and puts a strain on the sector as a whole. Figure 16: Telecommunication fee discounts (JPY bn) 3/10 3/11 3/12 0

3/13

3/14E

Mobile carriers must change MNP-focused strategies now

3/15E

-500

-1,000

-1,500 NTT DOCOMO

KDDI au

Softbank Mobile

Source: Company data, Credit Suisse estimates

The iPhone has the lowest margin of all smartphones today if carriers fail to attract a new customer when they sell the handset. When Softbank was the sole iPhone supplier, wealth in the sector shifted from KDDI and DoCoMo to Softbank. KDDI’s decision to start selling the iPhone stemmed the outflow from KDDI. Softbank and KDDI then battled for customers through aggressive marketing, while DoCoMo remained out of the picture. With DoCoMo unable to bear the outflow of customers any longer, it finally decided to start selling the iPhone in 2013 after a significant delay. At that point, iPhone users had little incentive to return to DoCoMo, because Softbank and KDDI had largely completed their LTE networks.

Only the carriers can prevent disaster at the end of the eight-year cycle

The consequence is that all three Japanese carriers are vying to sell premium iPhone handsets at low margins. These developments have been disastrous for Japanese handset makers, and mobile phone distributors are also in dire straits. A significant amount of Japan’s national wealth has now shifted to Cupertino, California. This situation is unlikely to change unless the three carriers make a conscious decision to stop using iPhone sales as a tool to win new MNP customers.

National wealth shifted to Cupertino

Righting the wrongs of MNP-focused strategies Softbank took the lead in mid-March in trying to scale back the frenzied cash rebate-based marketing campaigns. This has been good news for the industry, in our opinion, and we can only hope that the situation continues to improve. Using cash rebate-focused marketing strategies, mobile carriers have been targeting new customers by offering discounts and other generous incentives while asking their loyal long-term customers to keep paying standard fees. This approach seems unreasonable. In this kind of market environment, customers can derive a greater economic benefit by using MNP to regularly switch provider, rather than stick with the same carrier. As a result,

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market conditions in the mobile phone market appear now quite unhealthy. In our view, customer loyalty is given no value, and users have little incentive to stay with their carrier. NTT DoCoMo has timed the announcement of its Kake-hodai (fixed-price voice plan) and Pake-aeru (data sharing plan) services perfectly, and we appreciate the company launched policies that reward families and long-term customers. In the past, mobile carrier email services (with company-specific suffixes such as @docomo.ne.jp) were the main form of online communication for many customers, and this helped to stem any outflow of subscribers when the MNP system was introduced. Today, though, customers have a much wider choice of communication options, such as LINE, Gmail and Facebook. Owing to these advances in technology, customers have no qualms about or disincentives to changing their carrier. If a rival carrier offers them cash back or a free handset, the decision becomes even easier. With the MNP system, customers can derive the greatest economic benefit by changing their carrier every two years. Customers who stick with a company for longer lose out. This has created underlying tension in the market, which could erupt into a major backlash from customers at any time. When that happens, DoCoMo, which has the largest share of subscribers and the most long-term users, would probably be hit hardest. We will be monitoring the impact of the new pricing plans closely and waiting to see what steps its rivals take in response.

Carrier email now much less effective at preventing subscriber outflow

Figure 17: Market share of IP connection service

Figure 18: Market share of IP connection service

(end-FY3/08)

(end-FY3/12)

Softbank 16%

Softbank 25%

au 28%

NTT DOCOMO NTT DOCOMO 56%

Source: Company data, Credit Suisse

au 29%

46%

Source: Company data, Credit Suisse

DoCoMo needs to offer incentives to long-term users Backed up by new pricing plans, we think DoCoMo needs to immediately change its marketing approach, switching its focus from new MNP customers to loyal long-term customers.

Ending incentives for new MNP customers

Specifically, we believe DoCoMo has to end all incentives for new MNP customers and channel its entire marketing budget into encouraging long-term users (three years and longer) to upgrade their handsets. Cash back incentives should only be limited to longterm users and family users. DoCoMo would have to roll out a major advertising campaign that communicates its new focus on existing customers. We believe it has to make a bold decision to end its unsustainable sales tactics aimed at winning new customers, and then clearly tell consumers how it is changing tack. We think it needs to entice its longer-term customers into DoCoMo shops, where it can offer them financial and service support to upgrade handsets, rewarding them for loyalty to the DoCoMo brand.

Taking steps to end reliance on new MNP customers

DoCoMo could also stop the outflow of MNP customers by taking steps in-house. By giving MNP call center operators greater authority, staff could be allowed to offer discount coupons or cash back offers for new handsets to long-term customers (three years or

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more) who are making a number portability request. We believe boosting the motivation of operators by offering financial incentives for preventing MNP outflows would also be important.

Y! mobile poses an emerging threat Softbank has successfully brought Willcom and eMobile into the group. Using these acquisitions, Softbank seems to be preparing to take on its rivals with a fourth mobile phone carrier. Softbank had planned to set up a new joint venture and launch a new brand on 1 June 2014. However, on 27 March Yahoo Japan made what we see as a significant announcement, that it would acquire eAccess for ¥324.0bn. Yahoo Japan plans to launch a new carrier brand with Softbank Mobile called Y! mobile. As this venture is to offer differentiated handsets and data plans to Softbank Mobile, this sounds to us like an LCC.

Softbank aiming for an LCC strategy

We believe this move by Softbank presents a completely new threat to DoCoMo and KDDI, neither of which have low-cost brands. Willcom and eMobile have only been bit players in the sector until now, but their move into the Softbank Group via Yahoo Japan should allow them to share sales networks and marketing expertise with the parent. This is likely to be a major concern for DoCoMo and KDDI because their focus on premium brands will likely give them limited scope to adjust pricing for equivalent services. Figure 19: NTT DoCoMo (9437): Data packet pack (monthly, per one group) For single subscriptions For families

Plan Data S pack Data M pack Share pack 10 Share pack 15 Share pack 20 Share pack 30

Data usage limit* 2GB 5GB 10GB 15GB 20GB 30GB

Limit sharing

Price (JPY) 3,500 5,000 9,500 Quota sharing permitted; 12,500 up to 10 lines 16,000 22,500 Quota sharing permitted

Note: If monthly data exceeds the customer’s selected limit, they can continue to use data at the reduced communication speed of 128kbpsmaximum, or enjoy their regular data speed for ¥1,000 per 1GB for the remainder of the month. Source: Company data, Credit Suisse estimates

Win new customers with MVNOs Returning to our main point, a decision by DoCoMo to refocus its incentives on long-term users could lead to a continued outflow of customers for a while if Softbank and KDDI revive their marketing campaigns aimed at new MNP customers. However, we believe DoCoMo has to grit its teeth and take the punches. We expect that if DoCoMo were successful in attracting and holding onto long-term customers, the battle between Softbank and KDDI would have no economic rationale, and the excessive marketing aimed at new MNP customers would naturally die out. When we say the carriers should shift their incentives away from new MNP customers, we do not mean they should end all efforts to attract new customers. This could be done using MVNOs, which we think will play a crucial role in countering Softbank’s LCC strategy.

Win new customers with MVNOs

Make NTT Communications a subsidiary? NTT subsidiary NTT Communications offers MVNO service under the OCN Mobile One brand. Not surprisingly, the MNO is NTT DoCoMo. OCN Mobile One is a data-only service with no voice capacity. For reasons of confidentiality the company does not disclose whether the connection is layer 2 like Japan Communications (JCI) or simply SIM resale, but like at JCI’s the system does have the capacity for voice service. Looking at potential longer-term structural changes in the mobile carrier sector, we think one possibility might be for NTT DoCoMo to acquire NTT Communications from NTT. As a wholly owned subsidiary, NTT Communications could provide MVNO interconnectivity

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using layer 2, and the company could sell its own OCN Mobile One service through the NTT DoCoMo shop. We believe NTT DoCoMo clearly needs to find ways to attract people to the NTT DoCoMo shop and will need to leverage MVNO to retain quality customers over the long term. DoCoMo would do well to keep at arm’s length fickle customers who bounce from one carrier to another using MNP. MVNO companies can offer services at lower prices by controlling speed and volumehandling capacity. The main downside risk is downgrading the premium DoCoMo brand to that of a simple MVNO, but the upside is the potential to capture MNP churn from other carriers. Of course, the move would also establish an effective counter to Softbank’s new Y! mobile brand (a fusion of the Willcom and eMobile brands via Yahoo).

Potentially valuable counter move to Y! mobile

A genuine move into MVNO services could also boost demand for used handsets. The company could differentiate itself by partnering with a trading company to establish a distribution system and marketing the used handsets to meet both new and replacement needs. By driving an increase in foot traffic to stores, this could also provide a boost to the membership rosters of acquisitions like Radish Boya and ABC Cooking.

Used handset business also offers potential synergy gains

We believe that offering OCN Mobile One also could provide NTT DoCoMo a powerful tool for capturing users who want a second phone but are put off by high monthly fees. NTT Communications could benefit as well by leveraging NTT DoCoMo’s mobile functionality and expertise to expand its cloud and solutions businesses.

Mobile functionality would also boost NTT Communications’ selling capacity

Strategy for Article 30 of Telecoms Business Law NTT DoCoMo is designated as an exclusive operator under Article 30 of the Telecommunications Business Law, which means that under current conditions it cannot act as an exclusive agent for OCN Mobile One and offer the service through the NTT DoCoMo shop because NTT Communications is a wholly owned subsidiary of NTT. It appears the only way around this problem is to make NTT Communications a subsidiary of NTT DoCoMo. Even then, it is possible that the Ministry of Internal Affairs and Communications could frown on the move in its interpretation of the Telecommunications Business Law. Softbank and KDDI would likely not take it lying down either. However, we expect this does not matter. Given its current earnings predicament and its slide within the mobile communications business in general, we believe DoCoMo, along with parent firm NTT, would have no choice but go to the mat with the regulatory authorities.

Restrictions due to Article 30

Article 30 of the Telecommunications Business Law prohibits “unfair discriminatory treatment,” and NTT DoCoMo is subject to ex-ante application of this regulation. Incidentally, NTT West and NTT East are also subject, which prevents them from offering fixed and wireless services in discounted bundles. Talking about discount packages is to digress. It would be pointless for us to get on a soapbox to argue for amendment of Article 30 of the Telecommunications Business Law—but we would like to think that NTT DoCoMo is up for the challenge. It is not difficult to imagine this regulation restricting NTT DoCoMo’s operational freedom. The relative market shares of the three carriers have barely changed since it was enacted, so we believe it is absurd for NTT DoCoMo alone to be subject to Article 30. DoCoMo has requested the MIC to repeal what we view as skewed regulation, but while discussions with the ministry will likely proceed, the outcome is uncertain at this point. One possibility is that Softbank and KDDI, which have seen their market shares grow since enactment, will simply be made subject to the regulation alongside NTT DoCoMo.

Making DoCoMo the regulated carrier is illogical

Incidentally, under current regulations NTT DoCoMo cannot deny a connection request from another company. Now that Softbank is Sprint’s parent company, this means that Sprint theoretically could demand connection service from NTT DoCoMo and enter the market as an MVNO that way. This clearly indicates to us that the ex ante application of Article 30 is skewed.

Sprint could theoretically demand MVNO access from DoCoMo

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NTT Communications is a wholly owned subsidiary of NTT, handling domestic longdistance and international telecommunications as well as cloud, Internet, and solutions services. Figure 20 provides an overview of its earnings. For the past 10+ years, it has consistently generated sales in the neighborhood of ¥1tn and EBITDA in excess of ¥200bn. Figure 20: NTT Communications P&L (¥mn) FY Sales Operating profit EBITDA

3/00 1,075,301 129,552 233,552

3/01 1,355,520 90,356 225,756

3/02 1,275,161 75,742 225,342

3/03 1,152,074 145,311 297,211

3/04 1,106,601 116,215 253,315

3/05 1,090,072 69,877 207,777

3/06 1,127,893 67,562 206,162

3/07 1,145,496 77,348 216,848

FY Sales Operating profit EBITDA

3/09 1,127,190 100,874 231,474

3/10 1,079,268 97,513 223,713

3/11 1,033,415 93,268 208,268

3/12 981,021 105,748 211,348

3/13 944,812 118,137 230,737

3/14E 924,920 117,621 224,997

3/15E 910,989 113,273 219,635

3/16E 913,245 114,871 220,231

3/08 1,154,505 104,731 248,131

Source: Company data, Credit Suisse estimates

Figure 21 shows the balance sheet. The company has solid finances, with total assets of about ¥1.2tn and shareholders’ equity around ¥734.5bn. Figure 21: NTT Communications balance sheet (FY3/13)

(JPY mn)

Tangible fixed assets 463,434

Fixed liabilities 171,383 Current liabilities 255,554

Intangible fixed assets 82,864 Investments and others Shareholders' equity 376,287 734,483 Current assets 315,951 Valuation, translation adjustments 77,116

Total assets 1,238,538

Total liabilities and equities 1,238,538

Source: Company data, Credit Suisse

It is unclear whether NTT Communications will be made a subsidiary of NTT DoCoMo. It is also unknown whether NTT is even considering the idea. But in our view it would be a far more proactive approach than continuing to petition the government to repeal Article 30. If the company does not start moving with a greater sense of urgency to make appropriate changes that are in harmony with existing regulations, the ongoing slide in the Japanese telecom industry and among telecom equipment makers may become irreversible. We view the MVNO business model as having been introduced as a result of prodding by the Ministry of Internal Affairs and Communications. Making NTT Communications a wholly owned subsidiary of NTT DoCoMo in order to establish MVNO operations seems entirely consistent with the stated goals of the ministry.

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Need to unify chain of command We would like to see the merged NTT DoCoMo and NTT Communications named NTT DoCommunications. NTT DoCommunications naturally would have just one president. The system of using past presidents as advisors essentially should be abolished (they could be allowed to remain with the company, but should be banned from attending board meetings or important strategy meetings as observers), and a decision-making system in which the president holds final authority should be created. We believe the company would need a strong leader to drive the organization forward. NTT Communications alone is a massive organization with more than 8,000 employees. Including overseas operations, it runs businesses that differ considerably from NTT DoCoMo’s, suggesting that even if it were made a wholly owned subsidiary, little would need to change in its established businesses. Since there are almost no overlapping departments, there would likely be no need for restructuring either. At the same time, there is considerable compatibility between NTT Communications’ broad array of enterprise solutions, including virtual PBX and conference systems, and NTT DoCoMo’s MVNO and wireless communications technology, and we would expect to see synergy gains. KDDI and Softbank have been able to leverage proposal-based sales of packages bundling fixed-line with iPad or iPhone, while NTT group companies are prohibited from doing the same. Without blaming the Telecommunications Business Law, we would like to see this unbalanced situation rectified through either reform of the current legal system or change in corporate structure, aided by the capital markets, that makes regulatory amendment unnecessary. It has been 17 years since NTT’s reorganization into four separate entities as a result of amendment of the NTT Law in 1997. In our view, time and technological evolution have created a considerable gap between what was envisioned at that time and the current state of industry, in which OTTs and NCCs (ascendant companies like Softbank and KDDI) steadily chip away at the legacy carriers. The slide at NTT DoCoMo is not desirable for anyone other than Softbank and KDDI. The creation of NTT DoCommunications and the reestablishment of the NTT group’s reinstatement in the Fixed Mobile Convergence (FMC) sector would be a positive development, in our view. It appears that under the current strategy, DoCoMo is damned whether it adopts an offensive or defensive posture. We believe a radical change in the overall strategy of the NTT Group is needed.

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NTT DoCoMo (9437): Cutting our forecasts sharply According to Bloomberg, sell-side analyst ratings for NTT DoCoMo include six buys, 11 holds, and three sells. We maintain our UNDERPERFORM rating, making us one of the three sells. This seems like a low number of sell ratings, which are not that rare anymore, but on the assumption that the neutrals could incorporate sell sentiment our view is that only five of the 20 ratings are actually buy recommendations.

Ratings include five buys, 11 holds, and three sells

Bloomberg consensus estimates for consolidated OP are as follows: ■

FY3/14 — median ¥836.9bn, high ¥849.6bn, low ¥800.0bn



FY3/15 — median ¥825.8bn, high ¥901.1bn, low ¥786.2bn



FY3/16 — median ¥843.6bn, high ¥945.7bn, low ¥800.0bn

We lower our forecasts, as shown in Figure 22, following the announcement of the company’s new pricing plans. We have assumed that FY3/14 consolidated OP would miss guidance, at ¥834.9bn versus ¥840.0bn, but we now further lower our forecast to ¥814.0bn. Our downward revisions for FY3/15–16 are steep: from ¥843.7bn to ¥805.7bn for FY3/15 and from ¥880.3bn to ¥802.9bn for FY3/16. These cuts reflect changes to our assumptions for growth in monthly support impact, handset procurement costs, and salesrelated costs, particularly customer-acquisition costs. We intend to closely monitor the impact of the new pricing plans, but for the moment, we have factored in an improvement in the churn rate and a slower rate of decline in voice ARPU in FY3/16. Figure 22: NTT DoCoMo (9437): Consolidated earnings forecast summary Sales ¥mn YoY (%) Consolidated 3/13 A 3/14 CS E

3/15

CoE IBES E CS E

3/16

CS E

(new) (prev)

(new) (prev) (new) (prev)

4,470,122 4,584,834 4,545,085 4,640,000 4,555,380 4,556,693 4,632,641 4,637,893 4,683,892

5.4 2.6 1.7 3.8 1.9 -0.6 1.9 1.8 1.1

Operating profit ¥mn YoY (%) 837,222 814,008 834,955 840,000 834,009 805,722 843,720 802,874 880,344

-4.3 -2.8 -0.3 0.3 -0.4 -1.0 1.0 -0.4 4.3

Pretax profit ¥mn YoY (%)

Net profit attributable to NTT DoCoMo ¥mn YoY (%)

841,700 -4.0 495,675 6.8 831,602 -1.2 507,552 2.4 845,555 0.5 516,160 4.1 842,000 #ERR: Invalid 0.0 time510,000 period: 'Error 2023' 2.9 842,300 0.1 516,106 4.1 816,522 -1.8 498,162 -1.8 854,520 1.1 521,717 1.1 813,674 -0.3 496,396 -0.4 891,144 4.3 544,420 4.4

EPS ¥ YoY (%) 120 122 124 123 124 120 126 120 131

6.8 2.4 4.1 2.9 3.6 -1.8 1.1 -0.4 4.4

DPS ¥ 60 60 60 60 60 64 64 64 64

P/E (x) 11.9 12.5 12.3 12.4 12.4 12.7 12.2 12.8 11.7

Source: Company data, I/B/E/S, Credit Suisse estimates

The key point is that we expect consolidated OP to drop to around the ¥800bn mark from FY3/15. We have expected right from the beginning of the year that FY3/14 OP would fall short, but the consensus estimate only finally began to decrease after release of 3Q results, and there are now some estimates below the ¥840bn level. This can be interpreted to mean that the potential for the consensus to swing to a shortfall has risen. However, our forecasts for OP below ¥800bn from FY3/15 onwards are still at odds with the consensus view. Although we will need to assess the impact of the new pricing plans, OP lower than ¥800bn still looks like a distinct possibility.

Consolidated OP could fall below ¥800bn

Short-term pain would appear to be inevitable when undertaking a major strategic shift to long-term users. Regardless of whether OP declines below ¥800bn over the next few years, if this were the result of attempts to focus on long-term users or to strengthen the MVNO franchise, we as market participants would support the move wholeheartedly. In contrast, if the company sticks with its current strategy or its new pricing plans fail to take off, leading to a decline in OP past ¥800bn, we would confidently maintain our UNDERPERFORM rating and ¥1,500 TP.

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Figure 23: NTT DoCoMo (9437): Operational data FY3/11

FY3/12

FY3/13 CoE

Subscribers Net adds ARPU Total Voice Data Churn rate Handset unit sales New Replacement

('000) ('000)

58,010 1,928

60,129 2,120

61,536 1,407

63,400 1,870

(¥) (¥) (¥) (%) ('000) ('000) ('000)

5,070 2,530 2,540 0.47 19,055 5,118 13,936

4,870 2,200 2,670 0.60 22,089 6,376 15,676

4,500 1,730 2,770 0.82 23,555 7,415 8,463

4,570 1,340 2,720 0.60 24,500 -

FY3/14E CS Prev New 63,136 63,105 1,600 1,569 1,380 2,740 0.75 24,415 7,210 17,205

4,530 1,360 2,680 0.86 22,908 7,947 12,921

FY3/15E CS Prev New 64,736 64,225 1,600 1,120

FY3/16E CS Prev New 65,936 65,145 1,200 920

1,150 2,950 0.75 25,001 7,354 17,646

1,000 3,100 0.70 24,721 6,688 18,033

4,410 1,120 2,760 0.70 21,748 6,468 15,280

4,480 1,040 2,870 0.68 21,723 6,198 15,524

Source: Company data, Credit Suisse estimates

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Initiate coverage on Japan Communications (9424) Company overview We initiate coverage on mobile virtual network operator (MVNO) pioneer Japan Communications (JCI) with an OUTPERFORM rating and ¥620 target price. Over the longer term, we expect JCI to attain a market cap in the vicinity of ¥100bn. We think there is a good chance that the company will ultimately be acquired by one of the leading mobile network operators (MNOs). As an MVNO founded in 1996, JCI built the foundations for today’s domestic MVNO market. In effect, it has single-handedly grown the MVNO market in Japan. On more than one occasion the company has filed lawsuits against NTT DoCoMo and, through arbitration from the Minister of Internal Affairs and Communications (MIC), it has been able to secure interconnection at layer 2, as well as to lower interconnection fees. Prior to establishing JCI, founder Frank Seiji Sanda served concurrently as Vice President of Apple Computer and CEO of Apple Computer Japan. Not surprisingly, a number of JCI executives previously worked for Apple. The company takes pride in having developed its MVNO business model from scratch independently.

MVNO pioneer

Business model Primarily, JCI's focus has been on: (1) offering SIM card products for the Japanese market, (2) building a proprietary communications platform, and (3) developing a solutions business. The company also has a US subsidiary, Contour Networks, providing wireless ATM connectivity. We expect the SIM business in Japan to become the main driver of earnings. For consumers, JCI offers SIM cards on monthly postpaid plans or prepaid plans and offers the same services to corporate customers. We estimate that JCI has around 126,000 retail SIM contracts (67,000 on monthly postpaid plans, and 59,000 on prepaid plans), and about 146,000 corporate SIM contracts (a legacy business). This amounts to 272,000 contracts in total. Figure 24: Japan Communications (9424): Monthly chargeable, prepaid and corporate lines SIM lines Total number of contract Monthly chargeable SIM line Prepaid SIM line Corporate SIM line (CS estimate)

FY3/13 261,647 60,362 47,285 154,000

FY3/14 E 272,227 66,975 59,252 146,000

FY3/15 E 347,227 142,975 66,252 138,000

FY3/16 E 519,227 302,975 86,252 130,000

FY3/17 E 828,227 578,975 127,252 122,000

Source: Company data, Credit Suisse estimates

Looking ahead, JCI’s mainstay product is likely to be the so-called "Smartphone Phone SIM”. For a monthly fee of ¥1,560 (¥1,638 with tax), the Smartphone Phone SIM enables voice communication (¥42/60s additional, as at the three major carriers), with LTE data also available (maximum speed of 200Kbps; unmetered usage). A high-speed (150Mbps) option is also available, at a monthly fee of ¥3,120 (¥3,276 with tax).

”Smartphone Phone SIM” for ¥3,120 per month

The ¥3,120 Smartphone Phone SIM is half the cost of the leading carriers’ plans. Admittedly, at 3GB the data cap is smaller than the 7GB limit set by the top three carriers, but we believe most users would be hard pressed to consume 3GB of data. Even as a daily user of the internet via an iPhone, this author rarely consumes more than 2GB of data per month. In any case, it is possible to purchase additional data packs in the event that 3GB is exceeded.

Half the cost of leading carriers’ plans

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JCI has four sales channels; SIM cards are sold directly and through Amazon, Aeon, and Yodobashi Camera. The company also supports MNP, allowing customers to port their number over from other carriers.

SIM cards sold directly, and through Amazon, Aeon, and Yodobashi Camera

Recently, there has been a marked increase in sales of prepaid SIMs to visitors from overseas; we expect the 2020 Tokyo Olympics will almost certainly boost demand from international tourists. The government is aiming for 20mn overseas visitors to come to Japan in 2020. A range of related measures are under consideration to double tourist numbers, including a new law on casinos (currently under parliamentary debate). All of this should help JCI. Figure 25: Overseas visitors to Japan

Millions 25

Gov't target for year 2020: 20million

20 15 10

5 0

2020

2013

2012

2011

2010

2009

2008

2007

2006

2005

2004

2003

Source: Company data, Credit Suisse estimates

JCI’s CoGS consists of interconnection fees paid to NTT DoCoMo. As shown in Figure 26, these fees have declined over the years. In FY3/14, layer 2 connectivity cost JCI ¥1,234,911 for every 10 megabits per second. Figure 26: NTT DoCoMo (9437): MVNO interconnection charges (10Mb/second) (JPY) Layer 2 connection Layer 3 connection

FY3/14 1,234,911 -57% 1,795,815 -51%

FY3/13 2,846,478 -41% 3,691,297 -31%

FY3/12 4,843,632 -35% 5,371,852 -40%

FY3/11 FY3/10 FY3/09 FY3/08 7,458,418 9,396,038 12,671,760 -21% -26% 8,889,321 12,567,408 14,414,934 15,000,000 -29% -13% -

Source: Japan National Tourist Organization (JNTO), Credit Suisse

Earnings outlook On the sales front, JCI’s future earnings potential appears to rest squarely on increased recognition and user numbers for MVNOs. From a cost perspective, the pressure points are likely to be charges for interconnection with NTT DoCoMo, and sales-related expenses. These in turn are likely to hinge upon: (1) The savviness of Japanese consumers; (2) The extent that SIM-free phones (offered by manufacturers) gain popularity; (3) The degree of decline in interconnection fees paid to NTT DoCoMo; and (4) JCI’s ability to expand its sales routes in a cost-efficient manner. As outlined earlier in this report, the three leading mobile carriers spend an enormous among on advertising (in excess of ¥150bn), capturing demand by offering locked-SIM handsets for effectively nothing (where upfront costs are nil and the customer pays monthly installments over the course of a two-year contract). They also offer other incentives, including cash rebates. Our earnings outlook is very much dependent on the degree to which consumers break free from the leading carriers' influence and shift their loyalty to JCI and other MVNOs.

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To that end, we prepared three different earnings scenarios with the number of SIM contracts as the variable element. Under our normal scenario, FY3/17 net profit comes to ¥4.1bn, as compared with ¥5.4bn under our bullish scenario and ¥6.6bn under our uberbullish scenario. Our assumptions concerning the number of retail SIM contracts are 828,000 under the normal scenario, 1,060,000 under the bullish scenario, and 1,290,000 under the uber-bullish scenario. Figure 27: Japan Communications (9424): Net profit scenario (JPY '000) FY3/14 E FY3/15 E CS estimates 627,075 1,057,027 Bull 627,075 1,120,225 Super bull 627,075 1,183,422

FY3/16 E 2,136,344 2,543,558 2,950,772

FY3/17 E 4,128,556 5,356,433 6,584,311

FY3/16 E 519,227 612,727 706,227

FY3/17 E 828,227 1,061,227 1,294,227

Source: Credit Suisse estimates

Figure 28: Number of contracts by scenario (JPY '000) FY3/14 E CS estimates 272,227 Bull 272,227 Super bull 272,227

FY3/15 E 347,227 369,727 392,227

Source: Credit Suisse estimates

We still see significant scope for growth in the MVNO market in Japan, where there are now more than 100mn subscribers to IP-based mobile services. The MVNO business model has also aided in capturing demand for additional handsets (tablets, etc.). We would not be at all surprised to see mobile contracts growing to 1.5x the current number ten years down the line. We see JCI’s retail SIM contracts numbering up to 1.29mn under our uber-bullish scenario, which we believe at that point in time would translate to a market share of under 1%. If we assume an MVNO market share of 30% for JCI, the MVNO market as a whole would amount to 4.3mn contracts, which is still just 3% of the 150mn or so total subscribers for IP-based mobile services. Once Japanese consumers realize what MVNOs have to offer, we think the market could reach gargantuan proportions.

Significant potential for market expansion

Rival companies and their charges JCI’s competitors include the Sony-affiliated So-net, the NTT group companies IIJ and NTT Communications, and NEC Biglobe. The MIC estimates that as of end-March 2013, there were 161 MVNOs registered in Japan. In Figures 30-33, we outline the pricing plans for Japan’s leading MVNOs. All have very low charges for data communications because MVNOs limit how much data can be used, and at what speed. In addition, some offer data services but do not support voice and/or SMS.

FMC phones We think JCI differs from other MVNOs in that its interconnection with NTT DoCoMo at layer 2 gives it the capacity to control speeds according to usage, conduct its own authentication and accounting, and maintain a good grasp of individual customers’ usage patterns. We believe all of this contributes to the stockpiling of know-how and is made possible by JCI’s strength in technological development and its wealth of software assets. We expect that when combined with the technologies developed to date, this know-how will enable JCI to offer a variety of solutions to corporate customers. FMC phones constitute a prime example. An FMC (fixed-mobile convergence) phone is essentially a smartphone that can handle both internal and external calls. In an office, one would normally use a fixed line to call a colleague, dialing a four-digit extension. This internal communication is routed via a private branch exchange (PBX). At Credit Suisse, for example, one dials a four-digit number to

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

25

14 April 2014

speak to colleagues within the Tokyo office. Employees can reach overseas branches by dialing "*" followed by the country code and extension, rather than placing an outbound international call. This is already standard practice at many non-Japanese companies. With JCI’s FMC phones, this same function is available on a mobile phone. When in Japan, one can use a mobile phone to dial colleagues anywhere in the world via their extension number (without incurring call charges). This applies even when one is overseas, using a mobile phone with roaming turned on. In such cases, outbound calls are charged at the rate used for fixed lines. This will likely prove highly attractive to corporate customers looking to rein in costs. In short, we see business opportunities for JCI outside of the retail arena.

Potential for FMC phones

Note that we have not factored any contribution from FMC phones into our JCI forecasts. Figure 29: FMC phone External phones

NTT

IPPBX

NTT DOCOMO network Smartphone

Antenna base station ・ Possible to call from mobile phone as a fixed-line ・ Possible to call to mobile phone from outside as an internal call

Source: Credit Suisse

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

26

14 April 2014

Valuation We initiate coverage on JCI with a ¥620 target price (market cap of ¥82.5bn), based on our FY3/17 EPS estimate of ¥31 and a P/E of 20x (referencing the average sector P/E for the leading Japanese carriers and JCI’s earnings growth). This amounts to upside of about 86%. While acknowledging that many investors will shy away from JCI because of its JASDAQ listing and low liquidity, we believe a proactive stance is warranted for funds looking to invest in small and mid-cap stocks. Note that under our uber-bullish scenario, we see EPS reaching ¥49, in which case a ¥620 target price would imply a P/E of 12.7x. As outlined above, we believe the MVNO business model has huge potential in Japan. This being the case, JCI would seem to be the ideal investment candidate. On a P/E of 20x, the stock’s PEG ratio would be 0.2 assuming ongoing 100% NP growth, falling to 0.8 for growth of 25% in FY3/17 and beyond. The CFROI using the Credit Suisse HOLT model is shown in Figure 30 (based on a growth rate of 25% after five years). The warranted share price based on these assumptions is ¥510. Figure 30: Japan Communications (9424) – Credit Suisse HOLT CFROI analysis

Source: Credit Suisse HOLT Lens

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

27

14 April 2014

Figure 31: MVNO pricing - 1 Company

Plan

1

Japan Communications

b-mobile No basic charge SIM

2

Japan Communications

b-mobile X SIM Plan I

945

3,150

0

150Mbps

366MB/3 days

3

Japan Communications

b-mobile X SIM Plan N

980

3,150

0

150Mbps

-/3 days

4

Japan Communications

b-mobile Smart SIM Monthly fixed-charge 980

980

3,150

0

150Mbps

366MB/3 days 1.2GB/1 month

5

Japan Communications

b-mobile X SIM Plan B

1,580

3,150

0

150Mbps

366MB/3 days

6

Japan Communications

Smartphone SIM Free Data

1,638

3,150

5 months (JPY8,400)

200Kbps

366MB/3 days 1.2GB/1 month

7

Japan Communications

b-mobile Smart SIM Monthly fixed-charge 1980

1,980

3,150

0

150Mbps

366MB/3 days

8

Japan Communications

b-mobile 4G

1,980

3,150

0

150Mbps

366MB/3 days

9

Japan Communications

b-mobile 3G/4G Fair

2,449

0

0

150Mbps

n/a/3 days

10 Japan Communications

b-mobile 3G/4G U300 6months

2,483

0

6 months (JPY0)

300Kbps

366MB/3 days 1.2GB/1 month

11 Japan Communications

b-mobile 4G 6-months fixed-charge SIM package (180 Voicedays) call Light Start Plan

2,483

0

6 months (JPY0)

150Mbps

366MB/3 days

2,681

0

0

300Kbps

366MB/3 days 1.2GB/1 month

13 Japan Communications

b-mobile PairGB SIM

2,970

3,150

0

150Mbps

366MB/3 days

14 Japan Communications

b-mobile Smart SIM Monthly fixed-charge 2980

2,980

3,150

0

150Mbps

366MB/3 days

15 Japan Communications

Smartphone SIM Free Data (3GB)

3,276

3,150

5 months (JPY8,400)

150Mbps

366MB/3 days

16 So-net

Mobile LTE Entry Plan

1,815

3,150

0

150Mbps

n/a/3 days

17 So-net

Mobile LTE Light Plan

980

3,150

1 yr (JPY3,150)

150Kbps

500MB/3 days

18 So-net

Mobile LTE +Talk plan

2,310

3,150

1 yr (JPY5,250)

150Mbps

500MB/3 days

19 So-net

Mobile LTE +Talk S plan

2,810

3,150

1 yr (JPY8,400)

150Mbps

n/a/3 days

20 So-net

Mobile 3G

2,980

3,150

2 yrs (JPY9,975)

14Mbps

192MB/3 days

21 So-net

Mobile LTE High-speed M plan

2,980

3,150

2 yrs (JPY49,575)

150Mbps

360MB/3 days

22 So-net

Mobile LTE High-speed S plan

2,989

3,150

2 yrs (JPY9,975)

150Mbps

n/a/3 days

23 IIJmio

Light Start Plan

1,596

3,150

2 months (JPY0)

150Mbps

120MB/3 days

24 IIJmio

Voice - Minimum Start Plan

1,995

3,150

2 months (JPY0)

150Mbps

366MB/3 days

25 IIJmio

Voice call Family Share Plan

3,738

3,150

2 months (JPY0)

150Mbps

366MB/3 days

26 IIJmio

Minimum Start Plan

945

3,150

2 months (JPY0)

150Mbps

366MB/3 days

27 IIJmio

Prepaid package

1,306

0

0

150Mbps

n/a/3 days

28 IIJmio

BIC SIM Voice call Light Start Plan

2,646

3,150

2 months (JPY0)

150Mbps

120MB/3 days

29 IIJmio

Family Share Plan

2,688

3,150

2 months (JPY0)

150Mbps

366MB/3 days

12 Japan Communications

Monthly fee Original cost Cancellation Max. speed (JPY) (JPY) charge (JPYJPY) 0 3,150 0 150Mbps

Data limit

Fixed charge

366MB/3 days

○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○

High- Cancell speed ation charge

○ ○ ○ ○ ○



○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○

LTE

○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○

SMS

○ ○



○ ○

○ ○ ○ ○ ○ ○

Source: Company data, Credit Suisse, Note: Data as of 26 March, 2014

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

28

14 April 2014

Figure 32: MVNO pricing - 2 Company

Plan

Monthly fee Original cost Cancellation Max. speed (JPY) (JPY) charge (JPYJPY) 980 3,150 0 150Mbps

Data limit

Fixed charge

-/3 days 30MB/1 day

○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○

○ ○

○ ○ ○ ○ ○ ○

○ ○

○ ○ ○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○

30 OCN

Mobile ONE 30MB/day

31 OCN

Mobile ONE 1.0GB/month

1,260

3,150

0

150Mbps

366MB/3 days

32 OCN

Mobile ONE 30MB/day (*two SIM cards)

1,453

3,150

0

150Mbps

-/3 days 30MB/1 day

33 OCN

Mobile ONE 60MB/day

1,480

3,150

0

150Mbps

-/3 days 60MB/1 day

34 OCN

Mobile ONE 2.0GB/month

1,580

3,150

0

150Mbps

360MB/3 days

35 OCN

Mobile ONE 1.0GB/month (*two SIM cards)

1,732

3,150

0

150Mbps

366MB/3 days

36 OCN

Mobile ONE 30MB/day (*three SIM cards)

1,925

3,150

0

150Mbps

-/3 days 30MB/1 day

37 OCN

Mobile ONE 60MB/day (*two SIM cards)

1,953

3,150

0

150Mbps

-/3 days 60MB/1 day

38 OCN

Mobile ONE 7.0GB/month

1,980

3,150

0

500Kbps

-/3 days

39 OCN

Mobile ONE 60MB/day (*three SIM cards)

2,425

3,150

0

150Mbps

-/3 days 60MB/1 day

40 OCN

*two SIM cards)

2,452

3,150

0

500Kbps

-/3 days

41 OCN

OCN Mobile ONE for Business 200kbps

840

3,150

0

200Kbps

n/a/3 days

42 OCN

Mobile ONE 2.0GB/month (*two SIM cards)

2,052

3,150

0

150Mbps

366MB/3 days

43 OCN

Mobile ONE 1.0GB/month (*three SIM cards)

2,205

3,150

0

150Mbps

366MB/3 days

44 OCN

Mobile ONE prepaid SIM card

2,293

0

0

150Mbps

-/3 days 30MB/1 day

45 OCN

Mobile ONE 2.0GB/month (*three SIM cards)

2,525

3,150

0

150Mbps

366MB/3 days

46 OCN

*three SIM cards)

2,925

3,150

0

500Kbps

-/3 days

47 BIGLOBE

LTE・3G Entry Plan

980

3,150

0

150Mbps

360MB/3 days

48 BIGLOBE

LTE・3G Light S plan

1,580

3,150

0

150Mbps

360MB/3 days

49 BIGLOBE

Google Nexus 7 (2013) ×BIGLOBE LTE/3G: Entry Plan

2,589

3,150

0

100Mbps

360MB/3 days

50 BIGLOBE

WI-FI Smartphone + LTE/3G Entry Plan

2,949

3,150

0

100Mbps

360MB/3 days

51 BIGLOBE

LTE・3G Light M plan

2,980

3,150

0

150Mbps

360MB/3 days

52 @nifty

do LTE Entry two-year plan

1,207

3,150

2 yrs (JPY9,975)

150Mbps

n/a/3 days

53 @nifty

do LTE Light two-year plan

2,236

3,150

2 yrs (JPY9,975)

150Mbps

n/a/3 days

54 @Mobile-kun

LTE 200MB

980

3,150

0

150Mbps

n/a/3 days

55 @Mobile-kun

LTE 1GB

1,900

3,150

0

150Mbps

200MB/3 days

56 @Mobile-kun

3G

2,400

3,150

0

14Mbps

200MB/3 days

57 @Mobile-kun

LTE 2GB

2,800

3,150

0

150Mbps

200MB/3 days

58 ASAHI net

LTE 128K

785

3,150

0

128Kbps

-/3 days

59 ASAHI net

LTE 1GB

1,950

3,150

0

150Mbps

100MB/3 days

High- Cancell speed ation charge



○ ○

○ ○ ○



LTE

SMS

○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○

○ ○

○ ○ ○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○

○ ○

Source: Company data, Credit Suisse, Note: Data as of 26 March, 2014

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

29

14 April 2014

Figure 33: MVNO pricing - 3 Company

Plan

60 BB.excite

Mobile LTE 3G (one SIM card)

61 BB.excite

Mobile LTE LTE500MB (one SIM card)

62 BB.excite

Monthly fee Original cost Cancellation Max. speed (JPY) (JPY) charge (JPYJPY) 787 2,625 2 months 200Kbps (JPY0)

Data limit

Fixed charge

366MB/3 days

○ ○ ○ ○ ○ ○ ○ ○ ○ ○

892

2,625

2 months (JPY0)

150Mbps

366MB/3 days

*three SIM cards)

1,155

2,625

2 months (JPY0)

150Mbps

366MB/3 days

63 BB.excite

Mobile LTE LTE1GB (one SIM card)

1,260

2,625

2 months (JPY0)

150Mbps

366MB/3 days

64 BB.excite

Mobile LTE LTE 500MB (three SIM cards)

2,100

2,625

2 months (JPY0)

150Mbps

366MB/3 days

65 BB.excite

Mobile LTE 1GB (three SIM cards)

2,415

2,625

2 months (JPY0)

150Mbps

366MB/3 days

66 BB.excite

Mobile LTE LTE 2GB (three SIM cards)

2,940

2,625

2 months (JPY0)

150Mbps

366MB/3 days

67 DTI

ServersMan SIM LTE

490

3,150

0

150Kbps

n/a/3 days

68 hi-ho

LTE type D minimum start

980

3,150

1 yr (JPY5,250)

150Mbps

366MB/3 days

69 hi-ho

LTE type D minimum start: 1-yr package discount campaign

875

3,150

1 yr(JPY0)

150Mbps

366MB/3 days

70 hi-ho

LTE type D Assort

1,480

3,150

1 yr (JPY5,250)

150Mbps

366MB/3 days

71 hi-ho

LTE type D Family share

2,980

3,150

1 yr (JPY5,250)

150Mbps

366MB/3 days

72 NTT DOCOMO

Prepaid Data Plan 20h

326

2,100

0

128Kbps

n/a/3 days

73 NTT DOCOMO

Prepaid Data Plan 100h

415

0

0

128Kbps

n/a/3 days

75 NTT DOCOMO

Fixed-charge Data Plan 128K Value (Fixed-charge Data 128K with discounts)

1,580

3,150

2 yrs (JPY9,975)

128Kbps

366MB/3 days

74 NTT DOCOMO

Fixed-charge Data Plan 128K Value

3,160

3,150

0

128Kbps

366MB/3 days

76 NTT DOCOMO

Raku-Raku Packet

2,980

0

0

14Mbps

366MB/3 days

77 NTT DOCOMO

Raku-Raku Packet

2,980

0

0

150Mbps

1GB/3 days

78 NTT DOCOMO

Xi Data packet for Juniors

2,980

0

0

150Mbps

1GB/3 days

79 NTT East

InfoSphere Mobile Light Plan for "Flets"

1,980

3,150

0

500Kbps

183MB/3 days

80 NTT East

InfoSphere Mobile Light Plan for "Flets"

2,715

3,990

0

500Kbps

183MB/3 days

81 NTT West

InfoSphere Mobile Light Plan for Flets (W) LTE

1,770

3,150

0

500Kbps

183MB/3 days

82 NTT West

foSphere Mobile Light Plan for Flets (W) LTE Value 1

1,980

3,150

0

150Mbps

183MB/3 days

83 NTT West

InfoSphere Mobile Light Plan for Flets (W) LTE Value 3

2,580

3,150

0

150Mbps

183MB/3 days

84 TikiTiki

TikiMobile LTE Light Type M

980

3,150

3 months (JPY2,000)

150Kbps

-/3 days 500MB/3 days

85 TikiTiki

TikiMobile LTE Light Type D

980

3,150

3 months (JPY2,000)

150Kbps

-/3 days 30MB/3 days

86 TikiTiki

TikiMobile LTE Light Type W

1,281

3,150

3 months (JPY2,000)

150Mbps

-/3 days 180MB/1 week

87 TikiTiki

TikiMobile 300K Two-year plan

2,580

3,150

2 yrs (JPY16,000)

300Kbps

366MB/3 days 1.2GB/1 month

88 TikiTiki

TikiMobile 300K 6-months plan

2,980

3,150

6 months (JPY8,001)

300Kbps

366MB/3 days 1.2GB/1 month

89 TikiTiki

TikiMobile 7.2 Two-year plan

2,980

0

2 yrs (JPY16,000)

7.2Mbps

366MB/3 days 1.2GB/1 month

○ ○

High- Cancell speed ation charge

○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○ ○

○ ○

LTE

SMS

○ ○ ○ ○ ○ ○ ○ ○ ○ ○

○ ○ ○ ○ ○ ○ ○ ○ ○ ○

○ ○

○ ○

○ ○ ○ ○ ○ ○ ○ ○ ○ ○ ○



○ ○ ○ ○ ○ ○ ○ ○







○ ○ ○

○ ○ ○

○ ○ ○

○ ○

○ ○ ○ ○ ○ ○

○ ○ ○

○ ○ ○



Source: Company data, Credit Suisse, Note: Data as of 26 March, 2014

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

30

14 April 2014

Figure 34: MVNO pricing - 4 Company

Plan

90 Toppa!

Value SIM 200 plan

91 U-NEXT

U-mobile*d Double fixed

92 U-NEXT

U-mobile * d Standard

93 SIGNAL

Monthly fee Original cost Cancellation Max. speed (JPY) (JPY) charge (JPYJPY) 970 3,150 0 200Kbps

Data limit

Fixed charge

366MB/3 days



714

3,150

0

150Kbps

n/a/3 days

1,764

3,150

0

150Mbps

n/a/3 days

MVNO Service 150Kbps

945

3,150

0

150Mbps

183MB/3 days

94 SIGNAL

MVNO Service 300Kbps

1,155

3,150

0

300Kbps

183MB/3 days

95 Softbank

(For iPad) Prepaid plan

1,825

0

0

7.2Mbps

n/a/3 days

96 PanaSense

Wonderlink LTE Entry Plan

2,340

3,150

2 yrs (JPY11,100)

150Mbps

n/a/3 days

97 PC Depot

o’zzioMobile LTE SIM Card Plan

1,050

3,150

1 yr (n/a)

150Mbps

n/a/3 days

98 PC Depot

o’zzioMobile LTE SIM + Tablet set Nexus732T(2012)

2,089

3,150

3 yr(JPYn/a)

150Mbps

n/a/3 days

99 PC Depot

Google Nexus 7 (2013) ×BIGLOBE LTE/3G: Entry Plan

2,614

3,150

3 yr(JPYn/a)

150Mbps

n/a/3 days

100 Big Camera

BIC SIM Minimum Start Plan

945

3,150

2 months (JPY0)

150Mbps

366MB/3 days

101 Big Camera

BIC SIM Light Start Plan

1,596

3,150

2 months (JPY0)

150Mbps

120MB/3 days

102 Big Camera

BIC SIM Voice call Minimum Start Plan

1,995

3,150

2 months (JPY0)

150Mbps

366MB/3 days

o’zzio Mobile LTE SIM + Tablet set Nexus7LTE(2013)

2,646

2 months (JPY0)

150Mbps

104 Big Camera

BIC SIM Voice call Family Share Plan

3,738

3,150

2 months (JPY0)

150Mbps

366MB/3 days

105 Big Camera

BIC SIM Family Share Plan

2,688

3,150

2 months (JPY0)

150Mbps

366MB/3 days

106 Plala

Plala Mobile LTE Fixedcharge plan (two stages)

380

3,150

1 yr (JPY10,500)

150Mbps

100MB/1 day

107 Plala

Plala Mobile LTE Fixedcharge Light Plan (50MB)

945

3,150

0

150Mbps

-/3 days 50MB/1 day

108 Plala

Plala Mobile LTE Fixedcharge plan

1,980

3,150

1 yr (JPY10,500)

150Mbps

-/3 days 100MB/1 day

109 freebit

freebit mobile (Voice call)

3,100

4,725

2 yrs (JPY10,290)

150Mbps

n/a/3 days

110 freebit

freebit mobile

2,100

3,150

2 yrs (JPY10,290)

150Kbps

n/a/3 days

111 Marubeni Access Solutions

VECTANT Broadband Access LTE(D) Entry Plan300M

934

3,150

n/a

150Mbps

n/a/3 days

112 Rakuten Broadband

LTE Entry Plan

875

0

0

150Mbps

n/a/3 days

113 Rakuten Broadband

LTE Entry Plus Plan

945

0

0

150Mbps

400MB/3 days

114 Rakuten Broadband

LTE Light Plan

1,500

0

0

150Mbps

150MB/3 days

115 Rakuten Broadband

LTE Light Plus Plan

1,960

0

0

150Mbps

400MB/3 days 4GB/1 month

116 Rakuten Broadband

LTE Active Plan

2,980

0

0

150Mbps

300MB/3 days

103 Big Camera

3,150

○ ○ ○

High- Cancell speed ation charge





LTE





○ ○ ○ ○

○ ○ ○

SMS



























○ ○

○ ○

○ ○

○ ○

○ ○





















































○ ○ ○











○ ○ ○

○ ○ ○

○ ○ ○

○ ○ ○

















120MB/3 days



○ ○ ○ ○

Source: Company data, Credit Suisse, Note: Data as of 26 March, 2014

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

31

14 April 2014

Figure 35: Japan Communications (9424): Consolidated profit and loss statement (JPY thousand) FY3/08 FY3/09 Revenue 3,419,097 3,675,095 COGS 2,475,452 2,599,996 Gross margin 943,645 1,075,098 Provision for deferred gains on telecommunication services- 1,388,173 Reversal of reserve for deferred gains on telecommunication - services 920,862 Net gross margin 943,645 607,787 SG&A 1,832,228 1,720,301 Operating profit -888,583 -1,112,513 Non-operating revenue 28,647 5,741 Interest received 22,127 3,260 Foreign exchange profits 0 0 Others 6,520 2,480 Non-operating expenses 203,418 85,207 Interest expense 20,704 32,840 Euity method losses 0 0 Foreign exchange losses 146,779 25,505 Others 35,933 26,859 Recurring profit -1,063,353 -1,191,979 Extraordinary profit 1,902 0 Profit on reversal of equity warrant 0 0 Others 1,901 0 Extraordinary losses 909,159 4,146 Losses on disposal of fixed assets 37,765 3,326 Impairment losses 731,326 0 Expenses for business reconstruction 38,434 0 Others 101,632 820 Profits before taxes -1,970,610 -1,196,126 Total taxes 6,095 -3,704 Corporate taxes, inhabitant taxes and business taxes6,095 6,196 Tax adjustments 0 -9,900 Profits before minority interest 0 0 Minority interest -29,925 0 Net profit -1,946,779 -1,192,421

FY3/10 2,565,017 2,157,252 407,765 691,669 772,510 488,606 1,585,163 -1,096,557 5,680 1,735 0 3,944 100,051 33,464 0 51,071 15,514 -1,190,927 351 351 0 46,952 118 14,834 0 32,000 -1,237,529 4,562 6,196 -1,633 0 0 -1,242,091

FY3/11 3,642,085 2,521,778 1,120,307 412,305 619,552 1,327,553 1,402,105 -74,551 2,834 1,458 0 1,375 202,204 29,438 0 170,713 2,052 -273,921 15,165 6,334 8,831 90,928 120 0 86,442 4,365 -349,684 9,966 5,191 9,966 -359,650 0 -359,650

FY3/12 3,724,141 2,109,984 1,614,157 165,838 297,572 1,745,891 1,434,947 310,943 5,626 1,329 3,826 469 44,675 32,730 10,362 0 1,583 271,894 462,101 15,889 446,211 41,821 33,338 0 8,484 0 692,175 -305,670 4,186 -309,857 997,845 0 997,845

FY3/13 3,940,730 2,113,419 1,827,311 2,826 48,579 1,873,063 1,514,760 358,302 39,857 766 36,529 2,560 46,765 38,536 1,595 0 6,633 351,394 253,622 253,622 0 159,381 0 0 0 159,381 445,635 159,979 10,875 149,103 285,656 0 285,656

FY3/14 E 4,227,273 1,926,861 2,300,411 620 1,939 2,301,729 1,697,051 604,677 35,746 365 35,307 71 42,730 39,866 0 2,494 370 597,693 8,410 0 8,410 15,700 0 0 0 15,700 590,404 -36,673 58,327 -95,000 627,075 0 627,075

FY3/15 E 5,863,830 2,525,977 3,337,853 400 1,600 3,339,053 2,131,023 1,208,029 400 400 0 0 33,955 33,955 0 0 0 1,174,475 0 0 0 0 0 0 0 0 1,174,475 117,447 117,447 0 1,057,027 0 1,057,027

FY3/16 E 10,573,390 4,327,003 6,246,387 400 1,600 6,247,587 3,700,686 2,546,901 400 400 0 0 33,955 33,955 0 0 0 2,513,346 0 0 0 0 0 0 0 0 2,513,346 377,002 377,002 0 2,136,344 0 2,136,344

FY3/17 E 19,933,273 7,763,578 12,169,695 400 1,600 12,170,895 6,976,646 5,194,249 400 400 0 0 33,955 33,955 0 0 0 5,160,695 0 0 0 0 0 0 0 0 5,160,695 1,032,139 1,032,139 0 4,128,556 0 4,128,556

Shares outstanding (including treasury stocks, thousand 22,492 shares) 23,606 Treasury stock (thousand shares) 0 0 Average shares outstanding (thousand shares) -

133,724 0 127,090

133,861 0 133,729

134,283 0 134,118

134,356 0 134,314

134,746 0 134,746

134,746 0 134,746

134,746 0 134,746

134,746 0 134,746

0 -10 -

0 -3 -

0 7 7

0 2 2

0 5

0 8

0 16

0 31

DPS (JPY) EPS (JPY) EPS after dilution (JPY)

0 -87 -

0 -51 -

Source: Company data, Credit Suisse estimates, Note: Shares outstanding reflect stock split (1:100) as of 1 April 2014.

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14 April 2014

Figure 36: Japan Communications (9424): Consolidated balance sheet (JPY thousand) Current assets Cash and deposits Accounts receivable - trade Marketable securities Merchandise Inventory Accounts receivable - other Deferred tax assets Others Allowance for doubtful accounts Property, plant, and equipment Buildings and structures Depreciation Buildings and structures (net) Motor vehicles and transport equipment Depreciation Motor vehicles and transport equipment (net) Industrial tool, equipment Depreciation Industrial tool, equipment (net) Mobile handsets Depreciation Mobile handsets (net) Lease assets Depreciation Lease assets (net) Total property, plant and equipment Intangible assets Trademark right Patent Telephone subscription right Software Software suspense account Investments and other assets Rental deposits and guarantee deposits Others Total fixed assets Total assets

FY3/08 1,005,616 196,682 356,507 230,196 139,147 6,617 2,199

FY3/09 1,088,062 363,362 409,339 59,275 188,728 9,452 1,503

FY3/10 2,001,379 1,047,887 400,323 221,404 211,983 7,499 58,893

-1,149 202,770 46,759 -26,684 20,074 9,803 -9,186 617 515,937 -417,372 98,565 3,211 -2,535 676 112,800 -29,962 82,837 202,770 933,138 2,629 1,638 1,294 613,397 314,178 59,088 58,278 810 1,194,998 3,196,378

FY3/11 2,681,802 1,315,859 658,977 200,283 459,248 12,927 2,261 5,321 39,490 -12,566 155,347 37,406 -24,523 12,883 9,803 -9,393 410 512,317 -435,228 77,088 3,248 -411 2,836 112,800 -50,671 62,128 155,347 823,431 2,991 1,259 1,345 494,323 323,512 65,145 54,370 10,775 1,043,924 3,725,726

FY3/12 3,819,407 2,014,801 453,880 200,396 444,047 9,474 287,645 315,112 107,941 -13,893 145,677 35,521 -25,556 9,964 9,803 -9,543 260 541,493 -461,261 80,232 738 -445 292 124,801 -69,873 54,927 145,677 650,565 2,493 1,194 1,345 607,548 37,984 64,917 52,487 12,430 861,160 4,680,567

FY3/13 3,849,391 1,968,238 681,893 200,482 284,329 10,109 320,123 166,762 232,180 -14,728 451,897 164,018 -16,204 147,813 9,803 -9,612 191 566,683 -472,825 93,858 258 -186 71 352,637 -142,675 209,961 451,897 651,152 3,410 2,490 1,345 543,593 100,313 147,199 136,647 10,552 1,250,249 5,099,640

FY3/14 E 4,654,773 2,562,196 750,000 200,000 350,000 10,000 300,000 262,577 240,000 -20,000 483,796 180,000 -26,204 153,796 9,803 -9,803 0 620,000 -500,000 120,000 258 -258 0 390,000 -180,000 210,000 483,796 757,345 3,500 2,500 1,345 650,000 100,000 152,000 140,000 12,000 1,393,141 6,047,914

FY3/15 E 5,403,421 3,210,844 800,000 200,000 400,000 10,000 300,000 262,577 240,000 -20,000 523,796 180,000 -36,204 143,796 9,803 -9,803 0 680,000 -520,000 160,000 258 -258 0 420,000 -200,000 220,000 523,796 857,345 3,500 2,500 1,345 750,000 100,000 152,000 140,000 12,000 1,533,141 6,936,562

FY3/16 E 7,399,767 5,107,190 850,000 200,000 450,000 10,000 300,000 262,577 240,000 -20,000 563,796 180,000 -46,204 133,796 9,803 -9,803 0 740,000 -540,000 200,000 258 -258 0 450,000 -220,000 230,000 563,796 957,345 3,500 2,500 1,345 850,000 100,000 152,000 140,000 12,000 1,673,141 9,072,908

FY3/17 E 11,338,323 8,945,746 900,000 200,000 500,000 10,000 300,000 262,577 240,000 -20,000 603,796 180,000 -56,204 123,796 9,803 -9,803 0 800,000 -560,000 240,000 258 -258 0 480,000 -240,000 240,000 603,796 1,107,345 3,500 2,500 1,345 1,000,000 100,000 152,000 140,000 12,000 1,863,141 13,201,464

74,345

57,462

54,537

-81 223,731 45,115 -16,617 28,497 9,803 -6,631 3,172 477,064 -305,229 171,834 41,314 -21,088 20,225 223,731 1,070,649 3,363 2,273 1,294 595,009 468,709 124,251 52,933 71,318 1,418,633 2,424,249

-1,062 272,800 46,913 -21,992 24,921 9,803 -8,895 907 502,394 -372,396 129,997 14,007 -7,485 6,522 112,800 -2,350 110,450 272,800 1,014,637 3,147 2,021 1,294 748,109 260,064 66,590 55,050 11,540 1,354,029 2,442,091

Current liabilities Accounts payable - trade Short-term debt Maturing long-term debt Maturing corporate bonds Lease obligations Accounts payable - other Income taxes payable Deferred income Deferred telecommunication services income Allowance for loss from lawsuits Others Fixed liabilities Corporate bonds Long-term debt Lease obligations Others Total liabilities Shareholders' equity Common stock Additional paid-in capital Retained earnings Less: Treasury stock Valuation and translation adjustment Foreign currency translation adjustments Unrealized gain on available-for-sale securities Stock acquisition rights Total shareholders' equity Total liabilities and shareholders' equity

1,260,506 294,520 200,000 266,400 94,567 9,342 347,244 48,431 534,000 400,000 134,000 1,794,506 612,085 2,279,780 671,561 -2,337,515 -1,741 -25,671 5,740 -31,411 43,327 629,742 2,424,249

1,250,140 279,883 180,000 134,000 25,877 62,998 12,399 6,428 467,311 81,241 886,922 800,000 86,922 2,137,063 188,793 2,672,996 1,064,369 -3,546,379 -2,191 40,347 40,210 136 75,887 305,028 2,442,091

1,239,253 156,531 20,000 400,000 24,840 85,655 14,981 4,259 386,470 32,700 113,813 464,113 400,000 64,113 1,703,366 1,262,368 3,831,102 2,221,929 -4,788,471 -2,191 94,926 94,926 135,716 1,493,011 3,196,378

1,529,182 454,520 280,000 25,876 65,747 14,549 329,969 179,223 32,700 146,595 841,879 800,000 38,236 3,643 2,371,062 916,423 3,837,955 2,228,782 -5,148,122 -2,191 241,177 241,177 197,063 1,354,664 3,725,726

1,387,637 382,549 360,000 40,426 100,409 9,575 256,389 47,489 190,797 817,777 800,000 8,343 9,433 2,205,414 1,975,455 2,030,595 394,963 -447,910 -2,191 241,091 241,091 258,606 2,475,153 4,680,567

1,371,846 289,825 291,670 69,460 41,407 241,174 14,565 148,768 1,737 55,100 218,137 1,181,673 800,000 108,310 168,914 104,449 2,553,519 2,265,032 2,032,555 396,923 -162,254 -2,191 221,655 221,655 59,433 2,546,121 5,099,640

1,499,900 470,000 210,000 168,380 46,000 130,000 34,000 100,000 720 70,800 270,000 1,347,436 800,000 348,180 144,250 55,006 2,847,336 2,913,296 2,043,149 407,517 464,821 -2,191 208,744 208,744 78,538 3,200,578 6,047,914

1,331,520 470,000 210,000 0 46,000 130,000 34,000 100,000 720 70,800 270,000 1,347,436 800,000 348,180 144,250 55,006 2,678,956 3,970,323 2,043,149 407,517 1,521,848 -2,191 208,744 208,744 78,539 4,257,606 6,936,562

1,331,520 470,000 210,000 0 46,000 130,000 34,000 100,000 720 70,800 270,000 1,347,436 800,000 348,180 144,250 55,006 2,678,956 6,106,668 2,043,149 407,517 3,658,193 -2,191 208,744 208,744 78,540 6,393,952 9,072,908

1,331,520 470,000 210,000 0 46,000 130,000 34,000 100,000 720 70,800 270,000 1,347,436 800,000 348,180 144,250 55,006 2,678,956 10,235,223 2,043,149 407,517 7,786,748 -2,191 208,744 208,744 78,541 10,522,508 13,201,464

Source: Company data, Credit Suisse estimates

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

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14 April 2014

Figure 37: Japan Communications (9424): Consolidated cash flow statement (JPY thousand) Cashflow from operating activities Income before income taxes and minority interests Depreciation and amortization Interest and dividends income received Interest on marketable securities Interest expenses Head office reallocation expenses Investment losses on equity method Gain on reversal of equity warrant Losses from lawsuits Losses on sales of fixed assets Losses on disposal of fixed assets Impairment losses Losses on sales of shares in affiliates Exchange-rate loss Losses on sales of marketable securities Impact of adoption of Accounting Standard for Asset Retirement Obligations Expenses for business reconstruction Decrease (increase) in notes and accounts receivable-trade Decrease (increase) in inventories Increase (decrease) in notes and accounts payable-trade Increase (decrease) in accounts payable-other Increase (decrease) in advances received Increase (decrease) in accrued expenses and accrued consumption taxes Increase (decrease) in accrued telecommunication service profits Others Sub total Interest and dividends income received Interest expenses paid Expenses for business reconstruction Income taxes refund (paid) Head office reallocation expenses Losses from lawsuits

FY3/08 -405,694 -1,970,610 461,154 -6,361 -15,766 20,704 20,341 62,287 731,326 130,203 9,901 151,870 -40,799 -6,506 -87,466 -16,951 183,598 -373,076 22,127 -19,983 -28,847 -5,915 -

FY3/09 -661,247 -1,196,126 342,698 -2,215 -1,045 32,840 -

FY3/10 -923,187 -1,237,529 333,640 -1,443 -292 33,464 -

FY3/11 170,576 -349,684 295,747 -1,319 -145 29,438 -

FY3/12 311,076 692,175 309,071 -1,194 -141 32,730 10,362 -15,889 -

FY3/13 269,864 445,635 335,252 -659 -107 38,536 22,202 1,595 -253,622 137,179

FY3/14 E 961,067 590,404 300,000 -365 0 39,866 0 0 0 0 0 0 0 0 -35,307 0 0 0 -68,107 -65,562 180,175 20,123 -48,768 19,435 -1,017 -6,848 924,029 365

FY3/15 E 1,310,982 1,174,475 320,000 -400 0 33,955 0 0 0 0 0 0 0 0 0 0 0 0 -50,000 -50,000 0 0 0 0 0 0 1,428,029 400

FY3/16 E 2,390,299 2,513,346 320,000 -400 0 33,955 0 0 0 0 0 0 0 0 0 0 0 0 -50,000 -50,000 0 0 0 0 0 0 2,766,901 400

FY3/17 E 4,382,510 5,160,695 320,000 -400 0 33,955 0 0 0 0 0 0 0 0 0 0 0 0 -50,000 -50,000 0 0 0 0 0 0 5,414,249 400

10,835 32,457 20,356 -52,597 -52,617 -14,124 -341,010 10,871 467,303 102,624 -639,748 3,260 -18,650 -6,110 -

687 14,834 60,563 899 8,609 -20,316 -120,312 -1,733 6,031 -80,840 93,463 -910,274 1,736 -8,452 -6,196 -

221 162,520 4,365 86,442 -268,535 -256,352 300,121 56,632 326,084 28,433 -207,246 53,950 260,672 1,465 -4,316 -81,049 -6,196 -

34,621 -446,211 951 8,482 204,337 18,465 -71,800 -285,452 -73,511 -10,950 -131,734 47,077 321,387 1,336 -6,455 -5,191 -

-40,819 -219,130 161,324 -95,548 -32,451 -107,618 -31,448 -45,752 61,758 376,324 767 -10,973 -4,267 -9,907 -82,079

36,673 0 0

-117,447 0 0

-377,002 0 0

-1,032,139 0 0

Cashflow from investing activities Purchase of property, plant and equipment Purchase of intangible assets Deposit of fixed-term deposit Withdrawal of fixed-term deposit Acquisition of marketable securities Payments for business divestitures Sales of stocks of subsidiaries and affiliates Payment of rental deposist and guarantee deposits Recovery of rental deposits and guarantee deposits Increase in loan receivables Collection of loans Others

-554,898 -142,272 -347,386 -50,000 -3,668 -11,571

-252,607 -46,741 -203,858 -6,052 -30,000 30,000 4,044

-216,094 -26,615 -183,858 -400,000 400,000 -241 -239 -5,140

-281,699 -21,752 -129,891 -120,000 -2,483 3,633 -11,204

332,078 -13,414 -117,216 -200,000 240,000 -30,000 464,211 -10,160 11,295 -12,715 77

-291,705 -80,923 -212,525 80,000 -112,501 21,217 12,715 313

-138,092 -31,899 -106,193 0 0 0 0 0 0 0 0 0 0

-340,000 -40,000 -300,000 0 0 0 0 0 0 0 0 0 0

-340,000 -40,000 -300,000 0 0 0 0 0 0 0 0 0 0

-340,000 -40,000 -300,000 0 0 0 0 0 0 0 0 0 0

Cashflow from financing activities Net increase (decrease) in short-term loans payable Proceeds from long-term loans payable Repayment of long-term loans payable Proceeds from issuing stock Proceeds from issuing stock warrant Proceeds from retirement of stock warrant Proceeds from issuance of bonds Repayment of lease obligations Purchase of treasury stock

-152,064 -300,000 -266,400 12,960 7,042 394,332 -

889,953 -20,000 -266,400 782,426 4,980 -9,750 399,193 -496

1,989,941 -160,000 -134,000 2,311,904 -4,116 -23,846 -

244,658 260,000 9,499 -24,840 -

96,358 80,000 43,702 -27,344 -

47,857 -68,330 200,000 -22,230 3,920 781 -66,284 -

155,341 -81,670 400,000 -168,380 20,602 9,453 -24,664 -

0 0 0 0 0 0 0 -

0 0 0 0 0 0 0 -

0 0 0 0 0 0 0 -

Source: Company data, Credit Suisse estimates

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

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14 April 2014

Appendix Figure 38: NTT DoCoMo (9437): Consolidated profit & loss statement (JPY bn) Operating revenue Wireless revenue

3/09

3/10

3/11

3/12

3/13

3/14E

3/15E

3/16E

4,448.0

4,284.4

4,224.3

4,240.0

4,470.1

4,584.8

4,556.7

4,637.9

3,841.1

3,776.9

3,746.9

3,741.1

3,712.0

3,548.1

3,488.3

3,571.1

Handset revenue

606.9

507.5

477.4

498.9

758.1

1,036.9

1,068.3

1,066.8

3,617.0

3,450.2

3,379.5

3,365.5

3,632.9

3,770.8

3,751.0

3,835.0

Depreciation

804.2

701.1

693.1

684.8

700.2

703.2

689.3

666.0

Amotization

69.7

47.0

44.3

40.3

64.2

57.6

40.0

40.0

Operating Profit

831.0

834.2

844.7

874.5

837.2

814.0

805.7

802.9

Non-operating revenue/expense

-50.5

1.9

-9.4

2.5

4.5

17.6

10.8

10.8

4.6

5.1

4.9

2.8

1.8

1.8

2.0

2.0

Operating Expense

Interest expense Interest revenue

2.2

1.3

1.3

1.4

1.6

2.0

2.8

2.8

-48.0

5.7

-5.8

3.9

4.7

17.4

10.0

10.0

Pretax profit

780.5

836.2

835.3

877.0

841.7

831.6

816.5

813.7

Tax

308.4

338.2

337.8

402.5

337.6

319.8

310.4

309.3

-0.7

-0.9

-5.5

-13.5

-18.8

-9.2

-8.0

-8.0

471.4

497.1

492.0

461.0

485.3

502.6

498.2

496.4

-0.5

2.3

1.5

-3.0

-10.3

-4.9

0.0

0.0

Net profit that belongs to NTT DoCoMo

471.9

494.8

490.5

463.9

495.6

507.6

498.2

496.4

EPS (¥)

111.7

118.6

118.0

111.9

119.5

122.4

120.1

119.7

EBITDA

Others

Equity Method Profit Loss Net profit Minority Interest

1,678.4

1,568.1

1,565.7

1,583.3

1,569.3

1,550.2

1,535.1

1,508.8

Capex

737.6

686.5

668.5

726.8

753.7

706.0

690.0

680.0

DPS (¥)

48.0

52.0

52.0

56.0

60.0

60.0

64.0

64.0

4,223,871.5

4,170,573.8

4,157,685.9

4,146,760.1

4,146,760.1

4,146,760.1

4,146,760.1

4,146,760.1

Average shares outstanding ('000 shares)

Source: Company data, Credit Suisse estimates

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

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14 April 2014

Figure 39: NTT DoCoMo (9437): Consolidated balance sheet (JPY bn) Total current assets Cash and cash equivalents Accounts receivable Inventories Other current assets Total fixed assets Depreciation assets Land Investment in related companies Intangible fixed assets Other fixed assets Total assets

3/09 1,828 602 893 123 210 4,660 2,393 199 572 579 917 6,488

3/10 2,061 761 949 141 210 4,696 2,325 199 578 629 965 6,757

3/11 2,155 907 905 146 198 4,636 2,229 199 525 672 1,011 6,792

3/12 2,358 894 1,152 147 166 4,590 2,203 200 480 681 1,026 6,948

3/13 2,237 535 1,093 181 427 4,992 2,487 200 352 692 1,261 7,229

3/14E 2,756 699 1,480 150 427 4,660 2,155 200 352 692 1,261 7,416

3/15E 2,968 891 1,500 150 427 4,620 2,116 200 352 692 1,261 7,589

3/16E 3,169 1,092 1,500 150 427 4,594 2,090 200 352 692 1,261 7,764

Total current liabilities Accounts payable, trade Short-term borrowings, maturing debt within one year Other current liabilities Total fixed liabilities Long-term debts Allowance for point mileage Employee benefits Other fixed liabilities Total liabilities

1,148 669 29 451 996 610 94 146 146 2,145

1,188 632 181 375 906 430 152 138 187 2,094

1,123 609 173 340 791 255 200 153 184 1,914

1,154 739 76 339 685 181 173 160 172 1,839

1,131 706 83 342 628 171 141 171 145 1,759

1,139 750 46 342 562 101 141 176 145 1,701

1,124 750 31 342 531 71 141 175 145 1,655

1,109 750 16 342 504 41 141 178 145 1,613

Shareholders' equity Common stock Additional paid-in capital Retained earnings Valuation and translation adjustment Less: Treasury stock Minolity interests Total shareholder's equity Total liabilities & shareholder's equity

4,342 950 785 3,062 -66 -389 2 4,343 6,488

4,636 950 757 3,348 -37 -381 27 4,662 6,757

4,850 950 733 3,622 -77 -377 27 4,878 6,792

5,063 950 733 3,862 -105 -377 46 5,109 6,948

5,428 950 733 4,117 5 -377 42 5,470 7,229

5,673 950 733 4,363 5 -377 42 5,715 7,416

5,892 950 733 4,582 5 -377 42 5,934 7,589

6,109 950 733 4,799 5 -377 42 6,151 7,764

BPS (JPY) shares outstanding ('000 shares) Treasury stocks ('000 shares) Shares outstanding excluding treasury stocks ('000 shares)

1,040

1,114

1,170

1,221

1,309

1,368

1,421

1,473

4,395,000

4,379,000

4,365,000

4,365,000

4,365,000

4,365,000

4,365,000

4,365,000

219,019

218,426

218,240

218,240

218,240

218,240

218,240

218,240

417,598,070

416,057,420

414,676,010

414,676,010

4,146,760

4,146,760

4,146,760

4,146,760

Source: Company data, Credit Suisse estimates

Telecom sector: Impact of Pricing, MVNOs and LINE Calls

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Companies Mentioned (Price as of 11-Apr-2014) AEON (8267.T, ¥1,142) ANA Holdings (9202.T, ¥221) Amazon Japan K.K. (Unlisted) Apple Inc (AAPL.OQ, $519.61) Biglobe (Unlisted) Facebook Inc. (FB.OQ, $58.51) Internet Initiat (IIJI.OQ, $10.21) JTB Corp。 (Unlisted) Japan Airlines (9201.T, ¥4,990) Japan Communications Inc. (9424.T, ¥333, OUTPERFORM[V], TP ¥620) KDDI (9433.T, ¥5,131, NEUTRAL, TP ¥6,300) LINE Corporation (Unlisted) NEC (6701.T, ¥294) NTT Communications (Unlisted) NTT DoCoMo (9437.T, ¥1,530, UNDERPERFORM, TP ¥1,500) NTT East (Unlisted) NTT West (Unlisted) Nippon Telegraph and Telephone (9432.T, ¥5,159, OUTPERFORM, TP ¥6,000) Rakuten (4755.T, ¥1,274) Softbank (9984.T, ¥6,900) Softbank Mobile (Unlisted) Sprint Corp (S.N, $8.25) Viber Media, Inc. (Unlisted) WILLCOM, Inc. (Unlisted) WhatsApp Inc. (Unlisted) Yahoo Japan (4689.T, ¥467) Yodobashi Camera Co., Ltd. (Unlisted) eAccess (Unlisted)

Disclosure Appendix Important Global Disclosures I, Hitoshi Hayakawa, certify that (1) the views expressed in this report accurately reflect my personal views about all of the subject companies and securities and (2) no part of my compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report. 3-Year Price and Rating History for KDDI (9433.T) 9433.T Date 30-May-11 27-Sep-11 29-May-12 24-Oct-12 18-Apr-13 06-Sep-13 27-Jan-14

Closing Price (¥) 2,855 2,880 2,468 3,020 4,150 4,895 5,965

Target Price (¥) 3,350 2,750 2,850 3,900 5,000 6,000 6,300

Rating O N O

N

* Asterisk signifies initiation or assumption of coverage. O U T PERFO RM N EU T RA L

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3-Year Price and Rating History for NTT DoCoMo (9437.T) 9437.T Date 20-Feb-12 29-May-12 01-Nov-12 10-Dec-12 22-May-13

Closing Price (¥) 1,369 1,251 1,172 1,232 1,647

Target Price (¥) 1,500 1,500 1,200 1,200 1,500

Rating N O N U

* Asterisk signifies initiation or assumption of coverage.

N EU T RA L O U T PERFO RM U N D ERPERFO RM

3-Year Price and Rating History for Nippon Telegraph and Telephone (9432.T) 9432.T Date 01-Jun-11 03-Jun-13

Closing Price (¥) 3,835 4,985

Target Price (¥) 4,700 6,000

Rating O

* Asterisk signifies initiation or assumption of coverage.

O U T PERFO RM

The analyst(s) responsible for preparing this research report received Compensation that is based upon various factors including Credit Suisse's total revenues, a portion of which are generated by Credit Suisse's investment banking activities

As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark*over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non -Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; Austr alia, New Zealand are, and prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, 12-month rolling yield is incorporated in the absolute total return calculation and a 15% and a 7.5% threshold replace the 10-15% level in the Outperform and Underperform stock rating definitions, respectively. The 15% and 7.5% thresholds replace the +10-15% and -10-15% levels in the Neutral stock rating definition, respectively. Prior to 10th December 2012, Japanese ratings were based on a stock’s total return relative to the average total return of the relevant country or regional benchmark.

Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Volatility Indicator [V] : A stock is defined as volatile if the stock price has moved up or down by 20% or more in a month in at least 8 of the past 24 months or the analyst expects significant volatility going forward. Analysts’ sector weightings are distinct from analysts’ stock ratings and are based on the analyst’s expectations for the fundamentals and/or valuation of the sector* relative to the group’s historic fundamentals and/or valuation: Overweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is favorable over the next 12 months. Market Weight : The analyst’s expectation for the sector’s fundamentals and/or valuation is neutral over the next 12 months.

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Underweight : The analyst’s expectation for the sector’s fundamentals and/or valuation is cautious over the next 12 months. *An analyst’s coverage sector consists of all companies covered by the analyst within the relevant sector. An analyst may cover multiple sectors.

Credit Suisse's distribution of stock ratings (and banking clients) is: Global Ratings Distribution

Rating

Versus universe (%)

Of which banking clients (%)

Outperform/Buy* 43% (53% banking clients) Neutral/Hold* 41% (50% banking clients) Underperform/Sell* 14% (46% banking clients) Restricted 3% *For purposes of the NYSE and NASD ratings distribution disclosure requirements, our stock ratings of Outperform, Neutral, an d Underperform most closely correspond to Buy, Hold, and Sell, respectively; however, the meanings are not the same, as our stock ratings are determined on a relative basis . (Please refer to definitions above.) An investor's decision to buy or sell a security should be based on investment objectives, current holdings, and other individual factors.

Credit Suisse’s policy is to update research reports as it deems appropriate, based on developments with the subject company, the sector or the market that may have a material impact on the research views or opinions stated herein. Credit Suisse's policy is only to publish investment research that is impartial, independent, clear, fair and not misleading. For more detail please refer to Credit Suisse's Policies for Managing Conflicts of Interest in connection with Investment Research: http://www.csfb.com/research and analytics/disclaimer/managing_conflicts_disclaimer.html Credit Suisse does not provide any tax advice. Any statement herein regarding any US federal tax is not intended or written to be used, and cannot be used, by any taxpayer for the purposes of avoiding any penalties. Price Target: (12 months) for NTT DoCoMo (9437.T) Method: We derive our ¥1,500 target price for NTT DoCoMo from our FY3/15 EPS estimate of ¥120.1 with a P/E of 12.3 as well as our FY3/15 DPS estimate of ¥64. Our multiple is the two-year average sector P/E of 12.18 multiplied by DoCoMo's two-year average sector-relative P/E of 1.01 (12.18 x 1.01 = 12.3). Risk:

Risks to our ¥1,500 target price for NTT DoCoMo include a substantial change in its business strategy, earnings and shareholders' returns (via, for example, the consolidation of NTT Communications).

Price Target: (12 months) for Japan Communications Inc. (9424.T) Method: We set our target price of Japan Communications as ¥620 based on our FY3/17 EPS estimate of ¥31 and a P/E of 20x (referencing the average sector P/E and earnings growth for the leading Japanese carriers). Risk:

Risks to our ¥620 target price for Japan Communications include sluggish SIM card sales and higher support costs in tandem with rapid earnings expansion.

Price Target: (12 months) for KDDI (9433.T) Method: Our ¥6,300 target price for KDDI comes from ¥6,240 using a theoretical P/E of 12x and average of FY3/15-16E EPS of ¥520 (fully-diluted). Our multiple uses the two-year sector average P/E (10.7x) and KDDI's sector-relative P/E plus one standard deviation (11.6 x 1.1 = 12.8). Risk:

Risks to our ¥6,300 target price for KDDI include stagnation of smartphone sales and large-size M&A announcements.

Price Target: (12 months) for Nippon Telegraph and Telephone (9432.T) Method: Our ¥6,000 target price for NTT references: (1) the ¥5,070 theoretical share price based on FY3/14E EPS of ¥507 and a 10x fair-value P/E derived in turn by multiplying the 10.4x sector-average P/E for the past two years by the 0.95 average for NTT’s sector-relative P/E over the same period (10.4 × 0.95 = 10x); and (2) a ¥6,474 price derived by valuing the company's real estate assets. Implied P/E is 12x FY3/14E EPS. Risk:

Risks to our ¥6,000 target price for NTT, in our view, are deteriorating profits at NTT East and NTT West as a result of weak demand for optical fiber, and setback of management's policy on shareholders' returns.

Please refer to the firm's disclosure website at https://rave.credit-suisse.com/disclosures for the definitions of abbreviations typically used in the target price method and risk sections. See the Companies Mentioned section for full company names

The subject company (9432.T) currently is, or was during the 12-month period preceding the date of distribution of this report, a client of Credit Suisse.

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Credit Suisse provided non-investment banking services to the subject company (9432.T) within the past 12 months Credit Suisse expects to receive or intends to seek investment banking related compensation from the subject company (9433.T, 9432.T) within the next 3 months. Credit Suisse has received compensation for products and services other than investment banking services from the subject company (9432.T) within the past 12 months As of the date of this report, Credit Suisse makes a market in the following subject companies (9432.T).

Important Regional Disclosures Singapore recipients should contact Credit Suisse AG, Singapore Branch for any matters arising from this research report. The analyst(s) involved in the preparation of this report have not visited the material operations of the subject company (9437.T, 9424.T, 9433.T, 9432.T) within the past 12 months Restrictions on certain Canadian securities are indicated by the following abbreviations: NVS--Non-Voting shares; RVS--Restricted Voting Shares; SVS--Subordinate Voting Shares. Individuals receiving this report from a Canadian investment dealer that is not affiliated with Credit Suisse should be advised that this report may not contain regulatory disclosures the non-affiliated Canadian investment dealer would be required to make if this were its own report. For Credit Suisse Securities (Canada), Inc.'s policies and procedures regarding the dissemination of equity research, please visit http://www.csfb.com/legal_terms/canada_research_policy.shtml. Credit Suisse has acted as lead manager or syndicate member in a public offering of securities for the subject company (9437.T, 9432.T) within the past 3 years. As of the date of this report, Credit Suisse acts as a market maker or liquidity provider in the equities securities that are the subject of this report. Principal is not guaranteed in the case of equities because equity prices are variable. Commission is the commission rate or the amount agreed with a customer when setting up an account or at any time after that. To the extent this is a report authored in whole or in part by a non-U.S. analyst and is made available in the U.S., the following are important disclosures regarding any non-U.S. analyst contributors: The non-U.S. research analysts listed below (if any) are not registered/qualified as research analysts with FINRA. The non-U.S. research analysts listed below may not be associated persons of CSSU and therefore may not be subject to the NASD Rule 2711 and NYSE Rule 472 restrictions on communications with a subject company, public appearances and trading securities held by a research analyst account. Credit Suisse Securities (Japan) Limited..................................................................................................................................... Hitoshi Hayakawa For Credit Suisse disclosure information on other companies mentioned in this report, please visit the website at https://rave.creditsuisse.com/disclosures or call +1 (877) 291-2683.

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