High capital costs have been a drag on telecoms for more than two decades, but that could change as new technology, including Open RAN and vRAN, redefines mobile networks.
Telecoms are the gatekeepers for one of the most important megatrends of our time: Increased connectivity and driving demand for wireless broadband on everything from mobile devices to autonomous vehicles.
Yet, the high costs associated with building, maintaining and upgrading mobile networks, including the current rollout of 5G, have long been the sector's Achilles' heel.
The issue isn't the cellular towers, which companies lease or own and often share. The biggest cost relates to the Radio Access Network (RAN) that resides on those towers and connects individual devices to the rest of the network. RAN accounts for an estimated 60% of mobile capital expenditures (post spectrum), and operating expenses, and it's a continuous cost since operators typically “rip and replace'' the entire system when they roll out new networks (as they did for 4G).
These costs have driven sector underperformance since 2001—but that paradigm could soon change thanks to two technologies: Open RAN and Virtual RAN (vRAN).
The terms Open RAN and vRAN are often used interchangeably—and these technologies are complementary—but it's important for investors to understand how these developments differ.
Under the current model, RAN is an integrated platform of hardware and software from a single vendor. Open RAN unbundles networks into a series of standardized components so hardware can be 'mixed and matched' between vendors. This represents the potential to reduce equipment cost through better competition, avoid “vendor lock-in” and create higher quality and more specialized networks. Increased standardization could also lead to more cooperation between vendors interested in network sharing.
Key caveat: Open RAN is only interoperable with other Open RAN technology and cannot communicate easily with existing 3G and 4G networks. For existing networks to be functional, it would require a combination of new Open RAN sites and a replacement of existing RAN sites.
The other technology, vRan, essentially does for mobile networks what cloud computing did for computer applications. Whereas current RAN relies on physical hardware and on-premise software, vRAN allows components to be virtualized and operated in the cloud.
It reduces cost through less need for physical hardware and grants operators the potential to upgrade their networks through virtual updates rather than hardware replacement and scale networks up and down overnight. However, it’s worth noting that vRan implementation within Europe is currently limited by fiber-optic availability.
The investment implications for alternative RAN are significant. New technology could save on capital expenditures and boost free cash flow by allowing for lower cost through increased competition and easier innovation. There is also greater scope for network sharing due to standardized and 'open' equipment. One greenfield company estimates that a cost-effective 5G deployment could save around 40% on capex and 30% on operating expenses.
However, real savings won't happen until there is a more established ecosystem. With 5G network rollouts well underway in Europe, the pace of Open RAN adoption is likely to be too slow to materially lower 5G capex costs near term, however the market could see notable Open RAN presence by 2025.
Before Open RAN can be widely embraced, operators will first need to see proof that the technology is viable and can meet high expectations. The experience of early adopters will be key in determining the speed of Open RAN rollout.
Managing multiple vendors could prove complicated. Questions around security also need to be addressed as although increased vendor diversity could provide higher levels of security, using hardware from multiple vendors could create new vulnerabilities in networks.
Integration is more challenging for incumbent operators, who face layers of complication in integrating Open RAN into their existing networks. For these reasons, the take-up of alternative RAN solutions has been largely among new entrants, which have no legacy networks and therefore no interoperability headwinds.
Open RAN has the potential to redefine mobile networks, but another key debate centers around potential disruption for equipment vendors and mobile tower operators.
For vendors, there is meaningful disruptive potential from the rapid adoption of Open RAN. So far, however, industry conversations suggest a gradual, idiosyncratic trajectory focused on new entrant opportunities.
For towers, there is a risk that Open RAN will reduce top-line growth through higher sharing and reduced physical equipment at sites. Nevertheless, we do not see new RAN as a significant risk on a five-year view, for many reasons.
First, telecoms in Europe are tied into tower contracts for durations of seven to 20 years, providing a degree of protection. Plus, any short-term losses should be mitigated by 5G densification. Beyond that, tower companies may have the leverage to modify contracts with higher prices secured for primary tenancies—and generate additional revenue by implementing new solutions and providing active equipment.
Taken together, this cements our largely positive view on the Towers space.