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Emerging Technology Trends (78 pages)

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Please see analyst certification and other important disclosures starting on page 73.
Page 1
Industry
Equity Research
North America
Morgan Stanley 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. Customers of Morgan Stanley in the United States can receive independent, third-party
research on the company or companies covered in this report, at no cost to them, where such research is available. Customers can access
this independent research at www.morganstanley.com/equityresearch or can call 800-624-2063 to request a copy of this research.
Industry Overview July 15, 2005
mark.edelstone@morganstanley.com
mary.meeker@morganstanley.com
rebecca.runkle@morganstanley.com
david.togut@morganstanley.com
ross.macmillan@morganstanley.com
louis.gerhardy@morganstanley.com
Emerging Technology Trends
peter.kuper@morganstanley.com
anantha.narayan@morganstanley.com
brian.pitz@morganstanley.com
julie.santoriello@morganstanley.com
timm.schulze-melander@morganstanley.com
harlan.sur@morganstanley.com
scott.coleman@morganstanley.com
brian.fitzgerald@morganstanley.com
kathryn.huberty@morganstanley.com
laurie.kennedy@morganstanley.com
bernie.mahon@morganstanley.com
john.marchetti@morganstanley.com
charles.murphy@morganstanley.com
• At a recent offsite, Morgan Stanley US tech analysts presented thoughts
on emerging technology trends
Ten years into the launch of the commercial Internet, we believe we have
entered a new period of tremendous global innovation and change (read
growth and disruption). Our presentations touch on some of the trends we will
continue to focus our research on, including wireless and consumer
electronics semiconductors; wireless Internet; VoIP; broadband Internet;
digital music; on-demand software; security; biometrics and offshoring.
• Common links for the themes are: 1) connectivity; 2) productivity; 3)
global acceptance; and, to an extent; 4) consumer usage
A tremendous amount of technology-related change has occurred over the
past decade. That said, we believe the degree and pace of change is
accelerating - it appears that the events of the last ten years were simply a set
up for what’s about to come. We will endeavor to stay ahead of the trends and
determine which companies will win…and which companies will lose.
• Overweight-rated companies that match the trends highlighted in this
report include…
Apple, Cadence Design, Cisco, Cogent, Google, Motorola, NVIDIA,
Polycom, RSA Security, salesforce.com, Tata Consultancy Services, and
Yahoo!.
All of Morgan Stanley’s equity research reports are available on the Internet through
Client Link at https://secure.ms.com. If you wish to receive this service, please contact
your institutional sales representative.
Additionally, this report (along with other technology overview reports) is available at:
http:// www.morganstanley.com/techresearch/
GICS SECTOR INFORMATION TECHNOLOGY
Strategist's Recommended Weight 13.9%
S&P 500 Weight 15.2%
Technology
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 2
Morgan Stanley Global Technology Research Team
Hardware
U.S. Enterprise Systems & PC Hardware
Rebecca Runkle (rebecca.runkle@morganstanley.com) (212) 761 6466
Kathryn Huberty (kathryn.huberty@morganstanley.com) 6249
Fei Chen (fei.chen@morganstanley.com) 0227
U.S. EMS/Components/Distribution
Bernie Mahon (bernie.mahon@morganstanley.com) (212) 761 6274
Aaron Husock (aaron.husock@morganstanley.com) 7678
Tatiana Feldman (tatiana.feldman@morganstanley.com) 7134
Japan Electronic Components
Tomohiro Murata (tomohiro.murata@morganstanley.com) +81 3 5424 5341
Mikiko Kayama (mikiko.kayama@morganstanley.com) 5924
Asia/Pacific Systems and PC Hardware
Ellen Tseng (ellen.tseng@morganstanley.com) +886 2 2730 2864
Asia/Pacific Hardware Components/ODM
Evelyn Ou (evelyn.ou@morganstanley.com) +886 2 2730-2866
Jasmine Lu (jasmine.lu@morganstanley.com) 2870
Bonnie Chang (bonnie.chang@morganstanley.com) 2861
Asia/Pacific Hardware Components
Shawn Kim (shawn.kim@morganstanley.com) +822 399 4939
Jonathan Rhee (jonathan.rhee@morganstanley.com) 4846
Asia/Pacific TFT LCD/DRAM
Frank Wang (frank.ay.wang@morganstanley.com) +886 2 2730-2869
China Technology
Viktor Ma (viktor.ma@morganstanley.com) +852 2848 5903
Flora Lau (flora.lau@morganstanley.com) 5636
Danita On (danita.on@morganstanley) 5214
Communications
U.S. Communications Equipment
Scott Coleman (scott.coleman@morganstanley.com) (212) 761 6055
John Marchetti (john.marchetti@morganstanley.com) 8940
David Feinberg (david.feinberg@morganstanley.com) (415) 576 2189
Europe Telecom Equipment
Adnaan Ahmad (adnaan..ahmad@morganstanley.com) +44 (20) 7425 9227
Peter Dionisio (peter.dionisio@morganstanley.com) 3504
Rupert Lion (rupert.lion@morganstanley.com) 3436
Asia/Pacific Media/Entertainment/Publishing
Minyan Liu (minyan.liu@morganstanley.com) +852 848 6729
Asia/Pacific Hardware Components
Shawn Kim (shawn.kim@morganstanley.com) +822 399 4939
Jonathan Rhee (jonathan.rhee@morganstanley.com) 4846
China Technology
Viktor Ma (viktor.ma@morganstanley.com) +852 848 5903
Consumer Electronics Devices
Asia/Pacific Technology
Sunil Gupta (sunil.gupta@morganstanley.com) +65 6834 6732
Praveen Choudhary (praveen.choudhary@morganstanley.com) 6744
Japan Electronics
Masahiro Ono (masahiro.ono@morganstanley.com) +81 3 5424 5362
Shima Nakao (shima.nakao@morganstanley.com) 5378
Kayo Sano (kayo.sano@morganstanley.com) 5332
Tomohiro Murata (tomohiro.murata@morganstanley.com) 5341
Mikiko Kayama (mikiko.kayama@morganstanley.com) 5924
Naoki Sato (naoki.sato@morganstanley.com) 5927
Kazuo Yoshikawa (kazoo.yoshikawa@morganstanley.com) 5389
China Technology
Viktor Ma (viktor.ma@morganstanley.com) +852 848 5903
Internet & PC Applications Software
U.S. Internet & PC Applications Software
Mary Meeker (mary.meeker@morganstanley.com) (212) 761 8042
Brian Pitz (brian.pitz@morganstanley.com) 4133
Brian Fitzgerald (brian.fitzgerald@morganstanley.com) 4276
Ramji Srinivasan (ramji.srinivasan@morganstanley.com) 6281
Dan Silver (dan.silver@morganstanley.com ) 4967
Europe Internet & Media
Javier Marin (javier.marin@morganstanley.com) +44 (20) 7425 3503
Edward Steel (edward.steel@morganstanley.com) 4486
China Internet
Richard Ji (richard.ji@morganstanley.com) +852 2848-6926
Korea Internet Services
Mitchell Kim (mitchell.kim@morganstanley.com) +82 2 399 4936
Semiconductors
U.S. Semiconductors
Mark Edelstone (mark.edelstone@morganstanley.com) (415) 576 2381
Louis Gerhardy (louis.gerhardy@morganstanley.com) 2391
Harlan Sur (harlan.sur@morganstanley.com) 2359
Sonia Kimotsuki (sonia.kimotsuki@morganstanley.com) 2388
Jay Iyer (jay.iyer@morganstanley.com) 2607
Sanjay Devgan (sanjay.devgan@morganstanley.com) 2382
U.S. Semiconductor Capital Equipment
Timm Schulze-Melander (timm.schulze-melander@morganstanley.com) (415) 576 2324
Sashin Shah (sashin.shah@morganstanley.com) 2615
Europe Semiconductors/Semi Cap Equipment
Stuart Adrian (stuart.adrian@morganstanley.com) +44 (20) 7425 3299
Kirsten Parker (kirsten.parker@morganstanley.com) 8617
Rudolf Dreyer (rudolf.dreyer@morganstanley.com) 9895
Japan Semiconductor Production Equipment
Naoki Sato (naoki.sato@morganstanley.com) 5927
Kazuo Yoshikawa (kazoo.yoshikawa@morganstanley.com) 5389
Aya Kurita (aya.kurita@morganstanley.com) 5334
Asia/Pacific Semiconductors
Keon Han (keon.han@morganstanley.com) +822 399 4933
Jonathan Rhee (jonathan.rhee@morganstanley.com) 4846
China Technology
Viktor Ma (viktor.ma@morganstanley.com) +852 2848 5903
Asia/Pacific Technology
Sunil Gupta (sunil.gupta@morganstanley.com) +65 6834 6732
Praveen Choudhary (praveen.choudhary@morganstanley.com) 6744
Software & IT Services
U.S. Computer Services & IT Consulting
David Togut (david.togut@morganstanley.com) (212) 761 6388
Charles Murphy (charles.murphy@morganstanley.com) 4990
Laurie Kennedy (laurie.kennedy@morganstanley.com) 7038
Dhruv Chopra (dhruv.chopra@morganstanley.com) 3867
U.S. Specialized IT Services
Julie Santoriello (julie.santoriello@morganstanley.com) (212) 761 8582
Matthew Spiegelman (matthew.spiegelman@morganstanley.com) 4130
Xuying Chang (xuying.chang@morganstanley.com) 4217
U.S. Enterprise Software
Ross MacMillan (ross.macmillan@morganstanley.com) (212) 761 0156
Andrew White (andrew.white@morganstanley.com) 6126
Keith Weiss (keith.weiss@morganstanley.com) 4149
U.S. Securities Software
Peter Kuper (peter.kuper@morganstanley.com). (617) 856-8751
Brian Essex (brian.essex@morganstanley.com) 8753
Europe Software & IT Services
Gary Rollo (gary.rollo@morganstanley.com) +44 (20) 7425 4619
James Dawson (james.dawson@morganstanley.com) 9646
Jonathan Tseng (jonathan.tseng@morganstanley.com) 6609
Japan Software & IT Services
Masaharu Miyachi (masaharu.miyachi@morganstanley.com) +81 3 5424 5321
Hiroko Ando (hiroko.ando@morganstanley.com) 5324
India Technology
Anantha Narayan (anantha.narayan@morganstanley.com) +91 22 209 7161
Parag Gupta (parag.gupta@morganstanley.com) 7915
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 3
Emerging Technology Trends
Introduction
The technology landscape may be going through a period
of change at a pace not ever witnessed. The Internet’s
expansion helped drive what we have called “a boom !
bust ! boom-let period for new-company creation and a
boom-let ! bust ! boom period for wealth creation.”
That said, the underlying trend of technology investment
has remained relatively constant (see Exhibit 1). The
unrelenting stream of private investment may be one
indisputable data point - not only has venture capital
remained healthy throughout the past ten years, in the
midst of the bubble bursting, technology actually increased
as a total percentage of all venture capital investments and
has remained above levels seen during the increased
attention in the late 90’s.
1999 and 2000 were clearly very aggressive years for
venture investment. While a large portion of the those
investment dollars will never generate a return, a relevant
portion drove investments that have been developed, cured
and are being converted into products / services. It's
notable that if we look at the four year period before 1999
and compare the aggregate tech venture investment of
$20B with the four year period after 2000 when aggregate
tech investment was $50B - overall tech investment rose
150% for the period.
Exhibit 1
US Venture Capital Technology Investment Relative to
Total Venture Capital Investment
0%
20%
40%
60%
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Semiconductors
Computers and
Peripherals
IT Services
Networking and
Equipment
Software
Source: PricewaterhouseCoopers/Thomson Venture Economics/National
Venture Capital Association MoneyTree™ Survey
Exhibit 2
US Venture Capital Technology Investment Relative to
Total Venture Capital Investment
(US$ in Millions)
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004
Software $1,120 $2,249 $3,339 $4,496 $10,242 $23,587 $10,015 $5,147 $4,228 $5,014
Semiconductors 224 288 593 605 1,224 3,531 2,211 1,438 1,626 1,986
Networking Equip 328 598 989 1,486 4,508 11,643 6,059 2,448 1,730 1,546
IT Services 176 454 624 1,080 4,120 8,637 2,438 1,113 760 718
Computers & Periph 347 400 392 368 826 1,731 656 348 358 535
Total Tech $2,195 $3,990 $5,937 $8,034 $20,920 $49,128 $21,378 $10,495 $8,701 $9,800
Other 5,658 7,004 8,710 12,869 32,653 55,730 19,455 11,044 10,513 11,198
Total $7,853 $10,993 $14,647 $20,903 $53,573 $104,858 $40,833 $21,538 $19,214 $20,998
1995-1998 Total Tech $20,155
2001-2004 Total Tech $50,374
Source: PricewaterhouseCoopers/Thomson Venture Economics/National
Venture Capital Association MoneyTree™ Survey
There are multiple other data points that suggest we are in
the midst of a groundswell of technology innovation and
growth. The headlines tell the stories (whether it’s the
acceptance of blogging, podcasting or investments in
broadband over power lines [BPL]) and the data does the
same (see The Global Technology Data Book at:
http://www.morganstanley.com/institutional/techresearch/
global_techdatabook0605.html) Portable computing
devices are quickly becoming more powerful, heavier
draws on the rapidly-expanding wireless Internet;
entrepreneurs are selling everything from cakes to cars
over the Internet…Technology is indeed a robust
investment opportunity.
Unfortunately, successful investment is more demanding.
As much as we would like it to be a “rising tide lifting all
boats phenomenon,” it isn’t. For public market investors,
it is a stock pickers market - ever since the NASDAQ
pierced the 2,000 level over four years ago (week of March
15, 2001) it has been unable to free itself from the gravity
pull of that surface for more than 10% upside. Yet stock
picking is an essential key to making money. And that rule
must be applied even within so-called “hot” sectors. For
example, that same week of March 15, 2001 where the
NASDAQ pierced 2,000, Checkpoint Software (CHKP,
Underweight-V, $21) closed at $63.19. Today the stock is
worth just one-third of that at $21 per share. Yahoo
(YHOO, Overweight-V, $37) on the other hand has leapt
five-fold - having gone from under $8 to nearly $40 over
the same time period.
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 4
Exhibit 3
CHKP vs. YHOO: Price Performance Past 5 Years
'01 '02 '03 '04 '05
20
40
60
80
100
120
10.00
20.00
30.00
40.00
50.00
60.00
70.00
21.21 -0.14 -0.66% 03:03:31 PM 7/14/2000 - 7/13/2005
Check Point Software Technologies Ltd. (Right) Yahoo! Inc. (Left)
Source: FactSet.
Within this report, we have summarized a number of key
trends across the technology landscape to give investors a
relatively seamless reference to identify, if not capitalize
on these trends. From wireless, to broadband to VoIP,
there are concurrent threads running through each sector
(never mind the software and security to maintain
performance). It is our intent to use these specific trends to
identify some of the potential winners most impacted by
these emerging trends. Our first pass list follows.
Wireless / Consumer Electronics Semiconductors
NVIDIA (NVDA, Overweight-V, $28, Edelstone): In
the consumer electronics space, NVIDIA has leveraged its
expertise in graphics processing to deliver leadership
products in the game console market (PlayStation 3),
cellular handset market (through its wireless media
processor family), and consumer desktop/notebook market.
From a longer term perspective, we believe the company is
solidly positioned to capture more silicon and dollar
content in consumer electronics products as digital media
processing and broadband communications requirements
continue to proliferate.
Cadence Design (CDN, Overweight-V, $15, Sur): We
believe Moore’s Law will help serve as a key enabler in
the consumer electronics market as products integrate more
features, functionality, and software into fewer integrated
circuits. We believe Cadence is solidly positioned to
benefit from the increasing chip and system complexity as
they provide the advanced chip design software tools to
enable complex digital and mixed signal chip designs.
Additionally, the company’s leadership in chip and
system-level verification tools should help customers
speed time-to-market by enabling hardware and software
co-verification in a single integrated platform.
Wireless Internet
Motorola (MOT, Overweight-V, $19, Coleman): In the
short-term, Motorola is poised to capture mobile handset
market share in China and Western Europe. Over the next
few years, Motorola’s experience across wireless,
broadband, and video positions it well for how networks
evolve, services converge, and consumers’ demand “any
content, anywhere.”
VoIP
Cisco (CSCO, Overweight-V, $20, Coleman /
Marchetti): Cisco has not only has leveraged its
dominance of the enterprise networking market into a
leading position in the enterprise voice market with its IPPBX
offering, but is also a major participant in the
consumer VoIP market with its Linksys product offering.
Going forward, we expect Cisco to be the main beneficiary
of functional integration within enterprise networking
equipment, like VoIP and security operation built directly
into routers and switches.
Polycom (PLCM, Overweight-V, $16, Coleman /
Marchetti): Polycom benefits from VoIP in two ways.
First, it supplies VoIP handsets to several smaller PBX
vendors, IP conference phones to Avaya, Cisco and Nortel,
and has joint development agreements with Avaya,
Microsoft, and Nortel for voice and video products. VoIP
the fastest growing aspect of Polycom’s business over the
past year. Second, the proliferation of VoIP networks
drives video-over-IP deployments (i.e., V2oIP) as the
underlying IP network lowers total cost of ownership for
video and improves ease-of-use.
Broadband Internet
Google (GOOG, Overweight-V, $296, Meeker / Pitz): If
Google continues to execute in online advertising as well
as Web products/services innovation, it should be well
positioned to benefit from (and help drive) ongoing,
secular Internet user, usage and monetization growth.
Yahoo! (YHOO, Overweight-V, $37, Meeker / Pitz):
Yahoo! should continue to be a beneficiary of the share
shift to online advertising, both in branded advertising and
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 5
sponsored search. In our view, Yahoo! should be primed
to capture share of both offline and online ad dollars.
Digital Music
Apple (AAPL, Overweight, $38, Runkle / Huberty):
Apple isn’t likely to stand still in the digital consumer
market, and we believe the company is likely to release
new iPod devices between now and year-end. Based upon
Apple patent applications, job openings, Apple’s current
strategy and user trends, Apple should introduce wireless
and video-based product over the coming 12+ months.
These features, when combined with the iTunes, iPod and
Mac platforms, should continue to differentiate AAPL’s
offering and maintain the company’s lead in the
burgeoning convergence market.
On-Demand Software
salesforce.com (CRM, Overweight-V, $24, MacMillan):
Salesforce.com is the leader in the On-Demand software
market, which is gaining share over the traditional
enterprise software model. Subscription revenues at
salesforce.com have grown over 80% Y/Y for the past 6
quarters and the company has been winning hands-down in
the On-Demand CRM market for some time (it added more
than 2X the number of subscribers in its last reported
quarter than Siebel On-Demand did in its entire last year).
We expect revenue growth to decelerate over coming
quarters, as growth in ASP and the subscriber base begins
to plateau, but we think the company’s guidance is
conservative. We are encouraged by emerging
opportunities within enterprise customers, new signings
(such as Merrill Lynch), the validation provided by the
strategic partnership with Accenture, and, longer-term, by
the potential of the company's vision — becoming a
platform, where ISVs and customers write applications on
top of a managed, shared, secure database.
Biometrics
Cogent (COGT, Overweight-V, $40, Santoriello):
Cogent is the first, pure-play, publicly traded biometric
systems provider with a solution that is already mainstream
and a business model that is both high growth and high
profit today. Cogent could prove to be a unique, long-term
investment opportunity for four reasons: 1) technology and
price/performance leadership, 2) high barriers to entry, 3)
opportunities for commercial adoption, and 4) strong
revenue and EPS growth.
Security
RSA Security (RSAS, Overweight, $17, Kuper): RSA's
core products focus on authentication which remains a
cornerstone of security. With a strong foundation of
established authentication technology we do not see the
death of the token at hand as others have predicted. RSA
stands to benefit from numerous trends we have identified
in our sector. These include embedded technology,
inclusion/exclusion, and data protection. With the ability
to provide alternative authentication form factors (USB
tokens, smart cards, etc.) to products experiencing
competition, the company continues to work on building
out its complimentary web access and single sign on
businesses. Current fears of data leakage in the consumer
and enterprise markets make a good case for the benefits of
strong authentication. The consumer market appears to be
gaining some momentum as evidenced by the popularity of
the company's E*Trade tokens and the potential for
authentication revenue from Microsoft. Core business
concerns such as token volume erosion and pricing
pressure are already built into our model.
Offshoring
Tata Consultancy Services (TCS.BO, Overweight-V,
$29, Narayan): Over the past twelve months, we have
seen strong growth in offshore demand and we believe a
disproportionate share of revenue growth has gone to
larger companies. TCS is the largest provider of offshore
IT services and should continue to grow ahead of industry
rates. TCS has the largest proportion of fixed-price
business among its large offshore peers and has among the
highest operating margins (excluding the domestic CMC
business) relative to peers. This is despite higher
proportion of onsite revenue and higher client
concentration. In our view, this reflects solid execution of
fixed price business. We view the large proportion of fixed
price and solid execution positively as we believe that
more and more offshore work, especially large-sized
projects, will gravitate towards being fixed price in nature.
The stock trades at 15%+ discount to top peers which
presents an opportunity in our view.
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 6
Wireless and
consumer
electronics are two
key verticals that
should deliver
some of the most
attractive new
product cycles in
the semiconductor
industry over the
next 5 years
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
1
Wireless & Consumer Electronics
Semiconductors
Presented by Louis Gerhardy, Harlan Sur
Covered by Mark Edelstone, Louis Gerhardy, and Harlan Sur
Integration of
wireless regimes
into a seamless
global service
remains a major
opportunity
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
2
• Wireless semiconductors represented about 21% of the
semiconductor industry in C2004 and should be one of the
fastest growing semiconductor end markets over the long run
as innovations in satellite, WWAN, WMAN, WNAN, WLAN, and
WPAN are introduced.
• We focus on wireless handsets that represent about 70% of
the wireless semiconductor opportunity. Handsets are the
likely point of convergence for (a) the disparate wireless
services offered today and (b) consumer electronics.
-
10,000
20,000
30,000
40,000
50,000
60,000
70,000
2002 2003 2004 2005 2006 2007 2008 2009
Millions of $
Other Mobile Communications
Mobile Comm Infrastructure
Wireless LAN Access
Point/Bridge
Wireless LAN Client Access
Wireless Broadband Access
Pagers & Messaging Devices
Mobile Handsets
Digital Cordless Phones
Analog Cordless Phones
Nomadic
Cordless
Fixed
Data Rate
2G
(IS-95,
Cellular)
Mobility
High
PSTN Phone
Cordless WLAN
Broadband (xDSL)
DMB
3G
(W-CDMA)
SSeerrvviiccee PPoossiittiioonniinngg
2.3GHz
Wibro
Wireless Semiconductors
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 7
It’s harder to send
bits through the
airwaves than
through copper
wires
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
3
The Fundamental Challenge/Opportunity
Technology Cost/Megabyte
Cable/DSL 1x
CDMA2000 1x EV-DO ~3x
CDMA2000 1x ~7x
WCDMA/UMTS ~8x
GPRS ~40x
Source: Morgan Stanley estimates and Qualcomm
0
1
10
100
1,000
10,000
100,000
1970 1975 1980 1985 1990 1995 2000 2005
Theoretical Download (kbps)
Wireline
Wireless
300bps
2.4kbps
9.6kbps
1.2kbps
56kbps
28.8kbps
128kbps
100Mbps
VDSL2
3Mbps
Cable
9Mbps
ADSL
14.4kbps
9.6kbps
64kbps
153kbps
625kbps
2.4Mbps
• The cost to send a bit of data
through the airwaves (versus
a piece of copper) is higher.
Minimizing the price
differential through
technology innovation (cost
reduction) is a key
opportunity.
•Disparate wireless services
need to be integrated to
provide seamless and
uninterrupted sessions.
Semiconductor companies
providing a complete
solution may take all.
•New modulation and air
interface schemes are
increasing the bandwidth and
spectrum efficiency.
OFDM and OFDMA
are poised to
deliver more
wireless services
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
4
Wireless Semiconductor Technology Evolution
1G 2G 3G 4G 5G
AMPS TDMA/AMPS CDMA/TDMA OFDM/CDMA ?/OFDM
AMPS CDMA/AMPS CDMA/CDMA OFDM/CDMA ?/OFDM
Note
1) Standards based on TDMA technology include GSM, GPRS, IDEN, and TDMA
2) Standards based on CDMA technology include CDMA2000, WCDMA, UMTS, etc.
Technology Evolution
• Getting the modulation and access scheme right is
critical to success in the baseband (or DSP) market.
• The baseband revenue opportunity ranges from 25%
to 50% of the semiconductor opportunity in a wireless
handset.
• We do not believe innovation stops with CDMA, and
many standards based on OFDM technology are
emerging and worth monitoring very closely.
Technology Technology
- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -- - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - - -
……. Standards ……. Standards …….
3G XG
TDMA-Time Division Multiple Access
TDMA
2G
OFDMA=Orthogonal Frequency D CDMA-Code Division Multiple Access ivision Multiplexing
CDMA
OFDM
802.11 WLAN
FLO Qualcomm
802.20 FLASH-OFDM FLARION
802.16 WIMAX
TD-SCDMA
WCDMA
CDMA2000 1X EV-DO Rev. 0/A
CDMA IS95A/B
IDEN
TDMA
GPRS
GSM
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 8
More innovations
beyond modulation
and access are
needed to drive
traffic to wireless
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
5
Other Key New Product Areas
• Analog: Battery management (charging and protection), voltage regulation, DC/DC conversion,
power supervision, load switching, port power, and current limiting. (Linear Technology, Maxim,
National, Semtech,Texas Instruments)
• Applications Processors: DSP and microprocessors, 3D graphics, MP-3, digital camera. (ATI,
Nvidia, Qualcomm, Texas Instruments)
• Image Sensor: Higher resolution (CMOS versus charge coupled devices (CCD). (Agilent, Cypress,
MagnaChip, Micron, OmniVision)
• Location: Global Positioning System (GPS), E-OTD, TDOA, AOA, GLONASS, and GALILEO.
(Motorola, Qualcomm, SiRF)
• Magnetic Storage: Low power/small form factor for HDDs. (Agere and Marvell)
• Memory: DRAM, NAND, PSRAM. (AMD, Cypress, Intel, Micron, SanDisk, ST Micro)
• Packaging: Multiple semiconductor devices in a single package. (SIP, MCM, MCP) and stacked die.
• Radio Transceivers: CMOS radios, CMOS power amplifiers, new frequency bands, MEMS. (Atheros,
Infineon, Qualcomm, Silicon Labs, Texas Instruments)
• Streaming: MPEG-4 and more sophisticated audio coders/decoders. (Broadcom, Qualcomm, Texas
Instruments)
• TV: Satellite to tower to handset (FLO, DVB-H) or satellite to handset. (DMB).
Sanyo SCP-5500
Profits in wireless
semis
concentrated at
Qualcomm and
Texas Instruments
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
6
For Now, a Wireless Duopoly
• Most wireless semiconductor companies (ANAD,
RFMD, SWKS, TQNT,…) orbit around Qualcomm
and Texas Instruments who control the “heart” of
a cell phone…..and a majority of the profits.
• Qualcomm held ~21% unit share of the wireless
handset baseband market in C2004 and realized
about $2B in pre-tax profit from this business
($900MM from semiconductors an $1.1B in
licensing).
• Texas Instruments’ C2004 unit share was likely
>2x the size of Qualcomm’s and TI realized about
$800MM in pre-tax profit from wireless.
• No coup d’etat just yet, but a number of existing
and new wireless semiconductor/technology
innovators are worth watching closely.
Texas
Qualcomm
Instruments
RFMD
ANAD
TQNT
SWKS
FSL
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 9
We see
deceleration in
global wireless
handsets in 2005
and 1H06 as gross
adds and
replacement
demand cool off
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
7
Highlights and Risks
• Innovation,
execution, and timeto-
market.
• Service provider
driven model.
•Consumer driven
market.
• Political.
1999 2000 2001 2002 2003 2004E 2005E
Total Wireless Subscribers 482 728 960 1,160 1,401 1,693 1 ,977
New Subscribers 170 247 232 200 241 292 284
Y/Y Growth 58% 45% -6% -13% 20% 21% -3%
Forecasting slowing new
subscriber growth
Total Handset Sales (units) 295 415 413 427 520 674 730
Y/Y Growth (Units) 68% 41% -0% 3% 22% 30% 8%
Replacement Units 125 169 182 227 279 382 446
Y/Y Growth (Units) 82% 35% 8% 25% 23% 37% 17%
Forecasting replacement rate
will slow
Replacements % Total 39% 42% 41% 44% 53% 54% 57%
WCDMA units 3 22 51
WCDMA Average Selling
Price $475 $400 $321 Price too high for major unit
upside in 2005 and 1H 2006
Source: Morgan Stanley Estimates
Incumbents must
innovate and outexecute
newcomers to
maintain share
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
8
Conclusion-Wireless Semiconductors
• There are significant opportunities for innovation in wireless semiconductors and a virtual flood of
new product cycles await the winners. Incumbents will likely get upset if they do not constantly
innovate and out-execute the competition.
• More bandwidth and higher levels of spectrum efficiency require new modulation and access
schemes. These capabilities reside in baseband integrated circuit that represents the “heart” of a cell
phone and the point for forward integration.
• Beyond the baseband and DSP, many new products and technologies are emerging to reduce cost,
add features, or facilitate seamless service.
• Wireless semiconductor companies will likely need to rapidly expand the breadth of their capabilities
to help drive the convergence of a variety of wireless services (satellite, WWAN, WMAN, WLAN,
WPAN) and the integration of consumer electronic devices (digital camera, MP-3, GPS, electronic
wallet, etc.).
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 10
FCC DTV mandate,
popularity of digital
video recording
drive digitalization
of audio and video
MP3 players
should continue to
grow as price per
MP3 megabit
continues to
decline
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
9
Emerging Trend Highlights: CE Semis
•Wireless Broadband to and in the home
–WiMAX (to the home), MIMO WLAN (in the home), UWB (between devices)
•Digitalization of the A/V infrastructure
–Digital TV, MP3, Home media servers, DSC
•Home control/automation/security
– ZigBee (802.15.4), intelligent sensing systems (i.e. biometrics), GPS, RFID
•Mobile entertainment
–Quest for the ultimate gaming experience wherever, whenever
•Convergent products
–MP3/DSC, LCD TV/DVD/DVD-R/DVR, PSP
Look for increasing
silicon dollar
content as more
functionality and
features are
embedded within
CE systems
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
10
Consumer Semi Trend Background/History
0
10,000
20,000
30,000
40,000
50,000
60,000
70,000
2001 2002 2003 2004E 2005E 2006E 2007E 2008E
11.0%
12.0%
13.0%
14.0%
15.0%
16.0%
17.0%
18.0%
19.0%
20.0%
21.0%
Total Consumer
Semiconductor
($M)
Semi $ Content
(%)
Source: iSuppli, 2005
CE Semis:
9% CAGR
2001-2008
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 11
Moore’s Law to
drive digital,
analog, and RF
integration into
fewer chips
Challenge: to
design complexity
while delivering
more value to
customer
Key: collaboration
with OEMs and
value migration
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
11
Implications for the Semi Industry
• Moore’s Law will continue to drive performance and cost for CE Semis
– 1999: chip design statistics: 75% of designs < 4M gates
– 2004: chip design statistics: 50% of designs> 4M gates, 25% > 32M gates
– Digital, analog, and RF integration is key
• Silicon design evolution: dealing with complexity, delivering more value
– More collaboration (NVIDIA/Sony, ATI/Microsoft, Apple/PortalPlayer)
– Chip suppliers deliver silicon, software, and reference design (LSI/DVD-R, TI/DSC)
• Need to have competencies in DSP, broadband, GPU, analog, software and systems
– DSP: CE is all about algorithms – MPEG, H.264, QAM, Viterbi, FFT, WCDMA
– Broadband communications: required for universal content delivery, modulation
– GPU: performance driven, need hardwired solution for speed, some programmability
– Analog: real-world interface, power consumption
– Software and Systems – not just chips but full reference platforms
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
12
Moore’s Law
100
1000
10000
100000
1000000
1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003
# of Transistors (000s)
Intel MPU
NVDA GPU
Moore's Law (24m)
TI DSP
XLNX (Normalized Logic Cells)
386
486 DX
Pentium
Pentium Pro Pentium II
Pentium III
Pentium IV Prescott
RIVA
TNT 2
GeForce 2
GeForce 3
GeForce 4
GeForce FX
320C50
320C5510
320C556x
Source: Intel, NVIDIA, Texas Instruments, Xilinx, and Morgan Stanley
TI (DSP) and NVIDIA (GPU) will need to continue to take advantage of
Moore’s Law to compete in the CE Semi market
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 12
Complexity
growing
exponentially
CE value migrates
from product OEMs
to semi suppliers
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
13
Examples
500
1000
1500
2000
2500
DSP OPS
(Billion
MAC/s)
2002 2003 2004 2005 2006
Voice
over IP
HDTV,
MPEG4
Video
over IP
3G Wireless/
WCDMA
4G
Wireless
Future
Broadband
Source: Xilinx
DSP Processor Performance Roadmap
DSP performance requirements for new
communication technologies
DSP performance
requirements
CE to follow same evolution
as wireless handset mkt
1999
Digital
Baseband IC
2004
•Digital Baseband IC
•Firmware, RTOS, Apps SW
•Motherboard design
•FTA approved reference
handset
Low barriers to
entry in emerging
products
OEM partnerships
open door for
smaller chip
players
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
14
Key Issues and Risks
• Successful OEMs in high volume markets may eventually choose an ASIC
solution to achieve lower costs
– Example: Nokia in handsets, Apple iPod?
•Opportunity for smaller, focused chip companies to gain entry into the
market
– Examples: PortalPlayer (MP3), Atheros (WLAN)
•Disruption in the traditional supply chain
– Rise of ODM model provides opportunity for small chip
companies and or Asian chip companies to gain entry into the
market
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 13
Required:
successful
execution and solid
management team
Also need
competency in at
least one
consumer/
communicationscentric
product
category
Equity Research
Wireless, Cons. Elec. Semis
Morgan Stanley
Technology Research
15
Potential Winners
• Winners: Semiconductor Suppliers
• Texas Instruments - DSP, Broadband, wireless, analog, systems development capabilities
• Qualcomm – wireless intellectual property (IP) and systems development capabilities
• NVIDIA - GPU, broadband, multimedia
• Broadcom - Broadband, DSP, wireless, systems development capabilities, analog / RF
• Linear Tech, Maxim - High Perf. Analog real-world interface and power mgmt expertise
• Xilinx, Altera – DSP, programmability (time-to-market)
• SanDisk – IP, vertical integration, brand
• Winners: Chip Design Software suppliers
• Cadence - advanced digital/analog SOC design tools, systems design/verification software
• Winners: Semi IP suppliers
• ARM - focus on lower power and CE, highly penetrated architecture
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 14
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
1
Wireless Internet
Presented by David Feinberg and Ramji Srinivasan
Mobiles should
have access
speeds comparable
to PCs by 2007
Migration to
always-on, fast
connections key to
adoption of mobile
Internet services
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
2
Global Footprint – Wireless Infrastructure
1980s 2000 to 2004 2005 2007+
1G 2.5G 2.75G 4G
GPRS EDGE
HSCSD Release 99 Release 5 (HSDPA) WiMAX
AMPS 9.6 Kbps 57.6 Kbps 171 Kbps 384 Kbps 1.92 Mbps 10 Mbps 802.16e*
70 Mbps
CDMA2000 (1xRTT)
IS-95-A IS-95-B Rev. 0 Rev.A
down link 14.4 Kbps 57.6 Kbps 307 Kbps 2.4 Mbps 3.1 Mbps
up link 14.4 Kbps 57.6 Kbps 153 Kbps 300-600 Kbps 1.2 Mbps
* We expect 802.16e standard to be ratified by mid-year 2005.
1990s 2005 to 2007
Morgan Stanley Equity
Research Estimate
CDMA
2G 3G
GSM UMTS = WCDMA
CDMA EV-DO
First to Fourth Generation Wireless Internet with Maximum Data Rates
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 15
Growth drivers for
wired and wireless
Internet likely to be
similar
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
3
Internet Background / History
Wired Internet – Selected factors behind its growth
Cheap Hardware
Sub $1,000 PCs
Unlimited Service
Unlimited monthly
usage schemes
Rich Applications
Broad selection of readily
available content
First innings of
figuring out killer
data apps
Text messaging
(SMS) and
ringtones
dominate, picture
messaging not
popular
Data still less than
10% of carrier
revenue WW
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
4
Recent Highlights / Metrics
(1) Source: CTIA, 3/04.
(2) Morgan Stanley Research.
Nokia – Largest Seller of Digital Cameras (1)
Ringtones – At $3.5B, account for 10% of music industry revenue (1)
But data is only 5-10% of carrier revenue, globally and in the US (2)
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 16
Lower G3 handset
price points ($150)
critical to mass
adoption
Like early wired
Internet, content
only available in
walled gardens…
…But walls are
coming down (TMobile)
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
5
Key Issues – Handsets & Content
Video
Data
Voice
“Walled Garden” of
Content & Services
Converged
Devices $200+
Handsets and
PDAs have smaller
screens, slower
data connections,
less computing
power than PCs
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
6
Industry Structure Today… and Tomorrow
The Wired Internet is coming to Wireless Devices, via applications like Opera’s mobile browser…
…but full content in a handset form factor is still an awkward end-user experience
Wired Webpage Wireless Webpage Handset
•Opera’s mobile
browser was included
on 3MM mobiles
(+103% Y/Y) in
CQ4:04 (1)
•10MM+ installed
based of Opera
Mobiles as of 4/05 (1)
(1) Source: Opera, Morgan
Stanley estimates.
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 17
Skype’s sweet spot
could arrive with
reliable,
widespread WiMax
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
7
New Applications: Skype – The Basics
Skype develops software for calling people on their computers or phones
How Skype Works
User and
Headset
PC with
Skype
Software
+
PC with
Skype
Software
Regular
Telephone
User
Free Skype-to-Skype
Per-minute SkypeOut
Skype provides
developmental
ground for new
VoIP apps
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
8
New Applications: Skype Testing Ground
Skype Quick Facts
•45MM registered users
as of 7/05
•100+ employees
•1.2MM registered users
of SkypeOut, launched
7/04
•10B+ minutes served,
as of 7/05
•Source code released
CH2:04
•1,000+ open-source
developers
Source: Skype, CNET (4/05).
•Initial developers under the
Skype creating VoIP applications
that mimic the basic functionality
of mobiles—SMS, voicemail,
ringtones, etc.
•As developers mature, believe
that innovation on the Skype
platform could spawn
commercially viable applications
•Like eBay, ecosystem and
innovation could be potentially
self-reinforcing
Ecosystem
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 18
Emerging
applications in
Internet telephony
leverage
immediacy of voice
and network
intelligence
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
9
New Applications: Tellme
Tellme Quick Facts
•168 employees
•2B+ speech transactions
processed and 3MM+
utterances transcribed
•411 provider for Verizon in
NY, NJ, Delaware, eastern
Pennsylvania, Idaho,
Washington, Nevada,
Oregon, Arizona and
California
•1B minutes committed by
enterprises on Tellme
Voice Application Network
in 2001
Source: Tellme, Verizon (4/05).
•Basic premise – Overlays speech recognition over
Internet and telephony network to create “world’s
largest Voice Application Network”
•Applications – Powers services like AT&T Wireless
VoiceDial voice portal
•DialTone 2.0 – Pick up the phone and speak your
request (“I’d like to buy two tickets to Meet the
Fockers”)
Freeing of content
helped wired
Internet grow
T-Mobile’s removal
of its proprietary
site a first step in
wireless Internet
evolution
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
10
Industry Structure Today… and Tomorrow
Wired Internet – Selected factors behind its growth
Inexpensive Hardware
Sub $1,000 PCs
Unlimited Service
Unlimited monthly
usage schemes
Rich Applications
Broad selection of readily
available content
Wireless Internet – Parallel factors could drive growth, in our view
Inexpensive Phones
Sub $200
Converged Devices
“All-you-can-eat” Data
Unlimited monthly
usage schemes
Rich Applications
Yet-to-be invented
?
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 19
Equity Research
Wireless Internet
Morgan Stanley
Technology Research
11
Potential Winners and Losers
Operators Services
Winners
Losers
Mobile Local Search,
Ads
?
Mobile Content, Ads
“Killer App” – Still
not invented
Mobile Content
Infrastructure
Windows Mobile
uptake in question
On-the-
Border
Slow-moving yellow
page providers
Handsets, and
Infrastructure
Leading GSM Vendor
WW
?
3G “Must Have”
Mobile Device –
Still not invented
?
Service Providers – who
will be first to cut prices +
open the Walled Garden”
Handsets represent
80% of sales
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 20
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
1
Voice over IP (VoIP)
Presented by Scott Coleman and John Marchetti
Covered by Scott Coleman and John Marchetti
Next-generation
wireline (and
eventually
wireless) voice
protocol that treats
voice conversation
like data
transmission
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
2
What Is VoIP?
• VoIP transmits telephone calls over a data network like a LAN or the
Internet.
– Lower cost. IP networks tend to be more efficient that circuit-switched
networks. Cost synergies possible if running a single voice and data network.
– Increased functionality. Calls can be routed wherever you plug into the
network, for example.
– Can be less reliable. Security issues, power outages, latency, etc.
• Voice over Internet Protocol (VoIP) can mean several things:
– IP trunking
– IP to the end-user
– IP end-to-end
• We break VoIP into three categories:
Service Provider Equipment Vendor
• Carrier AT&T, Comcast, Time Warner Sonus, Cisco, Nortel
• Enterprise NA Avaya, Cisco
• Best Effort Skype, Vonage NA
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 21
In last 12 months,
legacy wireline
carriers and new
entrants have
seriously targeted
VoIP
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
3
VoIP Background / History
Key Point: It’s Still Very Early
1995 PC-to-PC connection using Internet phone software, a sound card and a
microphone
1998 Gateways enable PC-to-phone and eventually phone-to-phone
connections using IP
Apr 1999 CableLabs releases DOCSIS 1.1 specification
May 2000 Sonus Networks (SONS) goes public
Sept 2000 Avaya introduces IP-PBX and IP telephones
Jan 2001 Vonage founded
Sept 2002 Cisco introduces its VoIP PBX (Call Manager v2.2)
Aug 2003 Skype founded
Feb 2003 Tekelec buys Santera (private)
Mar 2004 AT&T launches CallVantage
May 2004 Lucent buys Telica (private)
July 2004 Verizon launches VoiceWing
Sept 2004 Alcatel buys Spatial Wireless (private)
Oct 2004 Time Warner Cable launches VoIP in NYC
VoIP’s drastically
lower cost of
service changes
business model for
voice
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
4
How VoIP Works and Money is Made
• Changing service provider business models:
– Attacking the service provider model: all-you-can-eat replaces distance-based pricing.
– No longer need to own a network, but is this sustainable (virtual network operators)?
– Network convergence: combining the wireline/wireless and carrier/enterprise networks
• Changes in the equipment providers landscape:
– Carriers will augment and eventually replace circuit switches with soft switches and media
gateways. This opens the door to new entrants (whither the LEMMNS?)
– Enterprises consolidating to a single platform? Does voice or data win? Do services?
– Incumbency can be very meaningful … if you have the products.
• Vonage case study:
– Customer acquisition costs of $150 (mostly advertising and a router)
– Monthly ARPU around $22
– Monthly opex of $13 (mostly for access charges)
– IRR = 15%
– Adding $2 regulatory tax reduces IRR to 0
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 22
VoIP service
optimized for next
generation IP
networks
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
5
Global Footprint
Deep impact
across wireline
value chain
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
6
Recent Highlights / Metrics
• Best Effort VoIP
– Vonage adding 15,000 subscribers a week (~550k subscribers)
– Skype has 135m downloads, 1.2m SkypeOut customers, and 10bn minutes served
• Cable VoIP
– Time Warner Cable is adding 11,000 VoIP subscribers a week and had 200k subs as of
YE2004 (~2% of homes passed for telephony)
– Cablevision has deployed VoIP to its entire footprint and had 282k at YE2004 (~6% of
homes passed)
– Rich B. estimates cable telephony subs grow from 1.5m in 2004 to 12.3m in 2010
– Over 109 cable modems and 34 CMTSs have been certified for DOCSIS 1.1
• Enterprise VoIP market
– IP-PBX market around $2.5b in 2004 growing at a 20% CAGR through 2009, although
mostly offset by declines in the traditional PBX market.
– Avaya and Cisco are market leaders with 23-24% market share in 2004
– Cisco has shipped 4m IP phones out of the industry total of 11m over the past four years.
• Carrier VoIP
– AT&T CallVantage has around 53,000 subscribers
– Carrier VoIP equipment market grew 55% in 2004 to $942m and is forecasted around $5bn
in 2009 (44% CAGR). Mostly offset by declines in the TDM switching market, which was
$10bn in 2004.
– Leaders in the carrier VoIP equipment market are Cisco, Nortel, and Sonus.
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 23
2005 should be
pivotal in
accelerating
growth
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
7
Key Drivers / Metrics
WW Packet Voice Minutes of Use (MOUs)
Bn MOUs
Source: Probe Research, Inc.
VoIP Carrier Equipment Market
Source: Synergy
90
18
155
53
281
144
463
309
736
550
1050
822
0
250
500
750
1,000
Long-distance Local
2002 2003 2004 2005 2006 2007
Source: Morgan Stanley.
US Cable VoIP Subs
-
5
10
15
20
25
2004E 2006E 2008E 2010E 2012E 2014E
VoIP Subs (m)
0%
5%
10%
15%
20%
25%
Penetration of Homes Passed
0
1
2
3
4
5
2001 2002 2003 2004 2005 2006 2007 2008
Revenue ($Bn))
0
10
20
30
40
50
60
70
Ports (mm)
Revenue ($ billion) Ports (m)
0
100
200
300
400
500
2003 2007
PBX Lines
TDM lines IP lines
Global PBX Lines
Source: Avaya
Equipment
vendors, service
providers face
risks
Regulatory change
a wild card
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
8
Key Issues and Risks
• Business Risk for Equipment Vendors
– Technology shifts create risk and opportunity
– Changing port-to-user relationship may reduce the revenue opportunity
• Business Risk for Service Providers
– Open access, open networks
– Deflationary impact of VoIP
• Technology Risk for Service Providers
– IP is less reliable than TDM
– E911, CALEA, numbering issues unresolved
– Higher bandwidth is needed for quality of service
• Regulatory Environment Likely to Change
– Information service vs. telecom service
– Who pays the taxes?
• access charges: saves VoIP providers 1-6 cents/minute
• subscriber line charge: $6 monthly charge
• universal service fee: 6-7% of gross revenue
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 24
Incumbents vs.
new entrants —
carriers
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
9
Winners and Losers: Carrier Market
Tekelec 0% 4% Yes
Sonus 0% 17% Yes
Cisco 0% 15% Yes
Siemens 10% 7% Yes
NEC 14% 0% No
Nortel 7% 22% Yes
Huawei 15% 2% Yes
Ericsson 3% 0% No
Lucent 12% 2% Yes
Alcatel 22% 4% Wireless only
TDM VoIP
VoIP
Solution?
2004 Market Share
Incumbents vs.
new entrants —
enterprise
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
10
Winners and Losers: Enterprise Market
Cisco 0% 28% 11%
3Com 0% 2% 1%
Siemens 17% 5% 12%
Nortel 21% 12% 16%
NEC 10% 3% 7%
Ericsson 3% 0% 2%
Avaya 8% 24% 12%
Alcatel 10% 14% 11%
TDM VoIP Enterprise Voice
2004 Market Share
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 25
Equity Research
Voice over IP (VoIP)
Morgan Stanley
Technology Research
11
Disruptive Technologies – Skype…
• As of 7/05, Skype has more than 45MM registered
users and is adding 140K+ new users per day, with
134MM total downloads
• On average, 2.6MM people are simultaneously
using Skype to place calls.
• Skype is seeing a 22% growth in minutes of traffic
which is currently at 1.5B minutes per month; this
accounts for 46% of VoIP traffic in North America
• Announced partnership with Boingo Wireless for
$7.95 unlimited calling from Boingo Wi-Fi hotspots
Since Skype began licensing / giving away its source
code in CH2:04, 1,000+ programmers have joined,
creating dozens of free and commercial products for the
skype service...
…And as, Microsoft CEO Steve Ballmer drilled into the
heads of Microsoft employees, building a viable
developer community is a key step in the evolution of
software dynasties.
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 26
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
1
Broadband Internet
Presented by Brian Pitz
Covered by Mary Meeker, Brian Pitz, and Brian Fitzgerald
Broadband
penetration has hit
an adoption sweet
spot - 30%+
household
penetration in the
US
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
2
The pace of online innovation continues at an unprecedented pace…
• Through blogs, syndication, RSS
• With digital media and web services
• On mobile devices, linked to the Internet
In first generation of the Internet, or Web 1.0, we had the “dial-up” experience: growth around
basic email, chat rooms, message boards, homepages, and rudimentary sites
Through the later part of the Web 1.0 experience, we believe residential broadband ramp has
served as an important inflection point for Internet usage, with broadband (vs. narrowband)
users spending more time and money online, owing in large part to…
• Significantly faster speed
• “always-on” functionality
• higher user satisfaction
Overview
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 27
Internet today like
early TV and cable
— viewers out of
sync with revenue
(ad dollars)
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
3
Overview
Source: Media Dynamics, Television Bureau of Advertising, Veronis Suhler, Universal McCann, as quoted by Yahoo! at company’s
5/04 Analyst Day
Note: Cable shows all wired households.
Still believe that the development of the Internet is still in its early
stages – we parallel this to the stage of network and cable TV during the
20th century
Broadband users
spend more time
and money online
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
4
Overview
•Broadband users spend an average of 13 hours per week online
vs. 8 hours for dial-up users
•Residential broadband users spent 64% more purchasing dollars
online (to $868) over previous 12 months than those with dial-up
access
•Per comScore, only 34% of US Internet users were “broadband”,
but this group accounted for 55% of the total time online,
reinforcing the point that broadband users spend significantly
more time online
Source: comScore Media Metrix – March 2003; *Arbitron/Edison Media Research
The broadband “inflection point”…according to a survey* of US consumers...
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 28
See 41%
broadband
subscriber growth
in 2005, driven by
Asia-Pacific,
Europe, Latin
America
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
5
Global Broadband Subscribers
C2000 C2001 C2002 C2003 C2004 C2005E
Global Broadband Subscribers (000's) 12,759 30,221 57,057 96,791 147,997 208,797
Y/Y Growth -- 137% 89% 70% 53% 41%
Q/Q Growth -- -- -- -- -- --
North America 6,759 13,481 20,991 29,361 39,038 48,447
Y/Y Growth -- 99% 56% 40% 33% 24%
Q/Q Growth -- -- -- -- -- --
Europe 983 2,872 9,966 24,693 42,225 60,301
Y/Y Growth -- 192% 247% 148% 71% 43%
Q/Q Growth -- -- -- -- -- --
Japan 625 2,836 7,806 13,641 18,295 23,526
Y/Y Growth -- 354% 175% 75% 34% 29%
Q/Q Growth -- -- -- -- -- --
Asia-Pacific 4,351 10,707 16,991 26,836 44,115 69,935
Y/Y Growth -- 146% 59% 58% 64% 59%
Q/Q Growth -- -- -- -- -- --
Latin America 41 324 1,304 2,259 4,324 6,588
Y/Y Growth # -- 689% 303% 73% 91% 52%
Q/Q Growth # -- -- -- -- -- --
Source: Morgan Stanley Research, Rich Bilotti, Simon Flannery, Paul Marsch, Mitchell Kim, Nick Sebrell, Vera Rossi
US Broadband
penetration in the
25-30% sweet spot
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
6
Broadband Ramp in 25-30% Sweet Spot…
0
10
20
30
40
50
60
70
80
2002 2003 2004 2005E 2006E 2007E 2008E 2009E 2010E 2011E
US Residential Broadband
Subscribers (MM)
0%
10%
20%
30%
40%
50%
60%
% of Total US Households
US Residential Broadband Subscribers % of Total US Households
Morgan Stanley Research.
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 29
Many metrics
document
broadband Internet
revolution
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
7
Recent Highlights / Metrics
•Strong recent growth momentum, up 45% Y/Y in CQ1:05 to 151MM
global broadband subscribers; Sub/user multiplier could be more
than 2x.
•“This Land” and “Second Term” JibJab videos viewed an estimated
80MM times
•Jordan Eason (Chief CNN News Executive) and Dan Rather’s
resignations, spurred by bloggers
•917MM streaming sessions (primarily music videos) on Yahoo!, up
119% Y/Y in CQ4:04
Expect 20-30%
global broadband
Internet growth
over next several
years
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
8
•Still in early stage with 30% US household penetration, which could
reach as high as 50%+ penetration by 2010, in our view
•Estimate 20-30%+ broadband growth over next several year to
continue to help creation of the Internet as premier information /
distribution channel, bringing it to the next level of development
(call it “Web 2.0”), which, at a high-level, should consist of:
– rich, creative and personalized media content
– a high-degree of user-interaction
–more accessibility (including various mobile devices, as well as the PC
desktop) and integration than ever before
Broadband Internet Outlook
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 30
Global broadband
Internet growth
over next several
years drives user,
usage and
monetization
growth
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
9
Global Internet Thesis
10-15% user growth
20-30% usage growth
30%+ monetization growth
Internet ad
spending low
relative to Internet
media
consumption
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
10
Internet Media Usage to Ad Spend
(1) Adapted from SRI-Knowledge Networks, Fall 2003. (2) Adapted from Universal McCann, (6/03); Internet Advertising Bureau (3/04). (3) Veronis Suhler Stevenson (2003),
Yahoo! Analyst Day (5/04). Youth defined as age 17 and under. Ratios are calculated as percent of US media usage on a medium divided by percent of US ad spending on
a medium.
US Media Usage (1) to Ad Spending (2) Ratios
4.7x
0.0
2.0
4.0
6.0
8.0
10.0
12.0x
Newspapers
+ Magazines
Total TV Radio Internet
Youth Media Usage (3) to Ad Spending (2)
Ratios
11.3x
0.0
2.0
4.0
6.0
8.0
10.0
12.0x
Newspapers
+ Magazines
Total TV Radio Internet
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 31
eBay’s advertising
mix may signal the
direction
advertising
budgets are
shifting
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
11
Advertising Moving Online at Rapid Clip
eBay Advertising Spending (2)
Offline
38%
Online
62%
Global Advertising Spending (1)
Offline
97%
Online
3%
(1) PricewaterhouseCoopers, 2003 totals (6/04). (2) eBay (2004), Morgan Stanley.
Online advertising
inventory remains
in its early stages
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
12
Inventory!
• Video
• Mobile
• User-Generated Content
• In-Game
• IPTV
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 32
User-generated
content: An
example…
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
13
Video
You just heard you missed one of the greatest
golf shots in the history of the game. You want
see it and you are happy to pay to watch it or
perhaps view an ad in front of the footage.
You just want to watch it…
Can’t find the video
on Google or
Yahoo!
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
14
Google / Yahoo! Search Don’t Help
Search: Tiger Woods 16th hole Augusta video
• Lots of news stories
•No video
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 33
Can’t find the video
on Google or
Yahoo! video
search
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
15
Google / Yahoo! Video Search Don’t Help
Search: Tiger Woods 16th hole Augusta
• Pictures, text
•Not video we’re looking
for
But the video is
posted on a blog
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
16
What Does Help?
• Blogger posts video in the spirit of
creating a prototype Nike ad
• It’s downloadable, it’s free, but
potentially missing appropriate
permissions…
Source: Blogger.
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 34
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
17
The Shot!
Note: Adobe Acrobat Reader 6.0 or greater required to play video clip.
(Click image to play video.)
Content creators
and distributors, in
tandem with
payment
mechanisms, need
to come to the
bargaining table to
make it happenand
they just might
make it up on
volume
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
18
We Want it – Make it Easy!
Content / Rights
Owners
User searches for
content
Search Engines
Content owners receive payments via payment mechanism or ad
User gets content
Payment Mechanism Advertisements Such as…
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 35
Monetization
opportunites…
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
19
Making Money on Online Content
Yahoo! — 917MM streaming video (mostly music) sessions (CQ4); < 10%
preceded by streaming ads (rising to 50%, in our view) with compelling
CPMs
Korea — TV channels allow users to download shows for ~$1
Google — launched upload.video.google beta (4/05)
Camera Phones – 263MM sold globally in 2004
Digital Music — 300MM iTunes / 16MM iPods sold
Digital sales could rise to as much as 25% of global music sales in five years…
At long last the threat has become the opportunity… -- IFPI, Digital Music Report, 2005
PayPal — 72MM accounts (CQ1); 22MM active users; 110MM payments
with $6B in volume; 3-8% of iTunes
Online Paid Content — $1.8B US revenue in 2004 per OPA
Consumers want
intergrated
content, when they
want it
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
20
Center of Content is Consumer not Device
• Play games, check email, watch videos on handhelds
• Watch high-quality video stored on PVRs or Media Center PCs
• Program PVRs / similar devices / open garage door from mobile
phone
• HD video and audio on the consumers’ schedule, allowing
consumers to create their own prime time
• Listen to purchased music at home / work / in car without having to
carry around many devices, mediums or wires
Consumers want integrated content, when they want it
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 36
User-generated
content, from
reviews to blogs
and uploaded
videos, is a key
component of the
broadband
experience
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
21
User-Generated Content…
Yahoo! Movie Reviews eBay Feedback Ratings
Blogs
Google Video Search
Next-generation
and user-generated
content should
continue to gain
traction
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
22
Broadband Internet Outlook
1. “Next-generation content” / “user generated content” should gain traction in both
usage and users, and discover an appropriate revenue model
– Blogs
– Rising usage of RSS syndication by content providers, continued ramp in the production
of blogs and other user-generated content, easy-to-use integration of RSS feeds and
blogs for end users of content
– According to Pew Internet research, 7% of the 120MM US adults who use the Internet
have created a blog (8MM people), while 27% of Internet users say they read blogs, up
58% in 2004, but only 38% of all Internet users actually know what a blog is
– Increased Usage of Premium Online Video Content
– Short-Form - JibJab, AtomFilms, Yahoo! Launch, news items, sporting events, TV-like
sitcoms and other programming
– Long-Form – MovieLink and other distributors, made-for-Internet movies…though this
will not likely be as much of a factor until much later in this decade
– Continued Growth in Online Music Usage…(Covered in more detail next by Katy Huberty)
Specific broadband-enabled opportunities as we see them taking shape…
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 37
Personalization
and localization
online will be the
norm
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
23
Broadband Internet Outlook
2. Increased personalization and localization likely to become more of the norm online, and
especially in ads
– Personalization of everything from Internet searches to online purchases, will likely
become more of the norm on the Internet. Personalization integrates user behaviors and
profiles based on past history and user-defined attributes for everything from news alerts,
start/home pages or search preferences to when and where to buy groceries, contact lenses
or dog food
– Localization, basically one of many attributes of personalization, will also likely become
more important. Roughly 25% of searches are local and ~10% of local searches have
commercial intent, per the Kelsey Group, so targeting consumers on a local level
continues to increase in importance. Site such as Google already uses
national/regional/local IP targeting for delivering language specific content,
advertisements and other information, which we believe will become even more prevalent
in the future
Specific broadband-enabled opportunities as we see them taking shape…
See Microsoft as a
leader in nextgeneration
digital
rights management
solutions (DRM)
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
24
Broadband Internet Outlook
3. Digital Rights Management
– Legislation has been proposed to require government-approved copy protection to be engineered
into all devices capable of playing digital media
– Consumers continue to push against DRM solutions for music, video and written content, as
they demand flexibility in how, when and where they can use their purchased content
– Microsoft is a leader in the development of DRM solutions – they have formed a group called the
Next-Generation Secure Computing Base (NGSCB)
Specific broadband-enabled opportunities as we see them taking shape…
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 38
Broadband Internet
increases need for
data storage
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
25
Broadband Internet Outlook
4. Data Storage Becomes Increasingly Important in the Broadband Internet World
– Content-collection and hoarding is now the norm – with digital content everywhere – JPG
picture files, MP3 audio files and MOV video files in abundance, consumers do not have time to
consume all of this media at once, and require mass archives to recall (and back-up) the media on
demand. PVR’s such as TiVo have also been helpful in creating a sense that the user needs mass
storage for content
– Consumer storage needs versus physical space needs become more obvious - a consumer can
save 10,000 photos on a chip that is thousands of times smaller than a stack of 10,000 paper
photos…the same goes for CD jewel cases and DVD cases as well
– …and all the while storage costs continue to come down -- one can easily buy an extra 250GB
of space for $200
Specific broadband-enabled opportunities as we see them taking shape…
Interactive
entertainment and
online gaming here
to stay
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
26
Broadband Internet Outlook
5. Online Broadband Interactive Entertainment (Games) are here to stay
– MMORPG’s (massively-multiplayer games) been drawing role-playing gamers online for hours and
hours a day for a number of years; Examples are Sony’s Everquest or the Legend of Zelda
– Broadband-only, subscription-based online gaming services will continue grow, and at an
accelerating pace – driven by collaborative and integrated infrastructures such as Microsoft’s Xbox
Live that provides a relatively seamless user experience across a myriad of titles that should continue
to pay off for the company
– In less than one year, Microsoft has achieved over 1MM paid subscribers on its Xbox live platform,
more than twice as fast as other media services including cable (HBO), online (AOL) or even TiVo
– MSFT’s next-gen Xbox platform, major focus seems bent on online gaming – including online
marketplaces with “microtransactions” and “gamer cards” helping players connect over the Internet,
among other features (Buy a bigger sword for $0.10; Buy a stronger spell for $0.05; Download the
latest U2 song and have it play as background music for $0.50; etc.)
Specific broadband-enabled opportunities as we see them taking shape…
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 39
Mobile Internet a
significant growth
area, though killer
app still to come
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
27
Broadband Internet Outlook
6. Mobile opportunities – Gaming (Shanda, EA), Local Search (Yahoo!, Google),
Content (Yahoo!, MSN), Messaging (Yahoo!, AOL) – but the killer application still
isn’t here yet…
Specific broadband-enabled opportunities as we see them taking shape…
Many potential
beneficiaries on
the broadband
Internet
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
28
Potential Winners
• Content creators –content remains key, and those that develop new, compelling
content and applications (including video, music, or other user-generated content)
to be delivered over broadband, will succeed; We believe that the mainstreaming of
Web syndication technology such as RSS though such services as My Yahoo! or
Blogger could help to create a new business model / revenue stream for freelance
Web journalists and content providers, as well as content distributors
• Content extenders – similar to content creators, those using the broadband internet
to enhance the value of offline content such as broadcast, cable or movies, should
also benefit
• Internet leaders – Next-generation broadband content should positively affect
Internet leaders and content aggregators such as Yahoo!, Google and eBay, as they
continue to leverage their distribution channels and/or content and services
• Digital rights management providers – that can provide a very flexible, but robust, DRM
system to consumers; Microsoft appears to be leading the charge on DRM to date,
though we believe there will be other significant players that will emerge in this
space
• Online interactive broadband entertainment platforms – i.e. Microsoft Xbox Live, or
other similar offerings from competing platforms in their next generations (Sony
and Nintendo)
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 40
Legal battles likely
over content and
privacy, consumer
resistance to payfor
models as well
as technology
limitations
Equity Research
Broadband Internet
Morgan Stanley
Technology Research
29
Key Issues and Risks
• Continued legal battles on sharing / distribution of “Next-generation content” will likely continue to
plague the industry – resolved through advances in digital rights management (potentially led
by companies such as MSFT or AAPL)
• Advances in online personalization will likely result in increasing privacy concerns – leading to
slower and more costly implementation of broadband applications that “think like the user”
• Increasing threat of content distributor disintermediation – by content creators given new, robust,
distribution channels
• Consumer resistance – to paying for content
• Limited network capacities
• Lack of single integrated platform – for content consumption (the TV vs. the PC), as well as a
lack of common file standards for content (MP3 vs. WAV files or MOV vs. MPG files)
•We are not there yet – even in places where broadband is built out, it is often not the easiest
experience to hook up, or connect to, broadband connections or content. When even the
quintessential “techie” has a hard time logging on to a given network, it means there is still a
long way to go in terms of standardization and user friendliness for the average online user
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 41
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
1
Digital Music
Presented by Katy Huberty
Covered by Rebecca Runkle, Katy Huberty
Apple’s latest
move: free podcast
support
Could introduce
video content,
related players
over next 6-12
months
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
2
Digital Music Trend Background / History
+ + +
1999 2001 2005
Most important is “What’s Next?”
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 42
Owning the player
+ iTunes software +
accessories gives
Apple more
flexibility than
other MP3 and
music store
players
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
3
Hardware: Profitable in most cases today (unlike
cell phones)
Content: Mixed profitability but a large portion
goes to content owners
Value of Customer Installed Base: Winners will
leverage the installed base. In Apple’s case:
•Accessories
•Systems
•And more content...
Digital Music T How Digital Murseincd W Boarckksg &ro uMnodn /e Hy iisst oMryade
Apple offers more
content (roughly
500K more songs
plus podcast
support) than other
digital music
providers
iTunes bread-even
target may give
Apple an edge over
others’ need for
profits
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
4
Apple iTunes Napster Rhapsody Yahoo! Music
Est. Online Music Market Share
Pay-per-song market 85%+ ~1-2% ~5% NM
Online subscription market NM ~10% ~50% NM
Business Model Pay-per-Song Subscription/Per Song Subscription/Per Song Subscription/Per Song
Cost for Song / Album $0.99/$9.99 $0.99/$6.95+ $0.89/$8.99 $0.79/NM
Cost for Subscription (monthly) NM $14.95 $14.99 $6.99
Number of Songs Available 1.5 million 1 million 1 million 1 million
Number of Songs Downloaded 400,000,000
Number of Subscribers 400,000+ 1,000,000
File Technology protected AAC WMA MP3, WMA, unprotected AAC WMA
Number of compatible Devices iPod only 75 100 13(1)
Inception of Service 2003 2000 2001 2005
2004 Revenue $220M(2) $46.7M $266.7M NM
2004 EPS break even / slight loss ($1.43) ($0.14) NM
Stated Business Goal Break Even Profit Profit Profit
How Digital Music Works & Money is Made
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 43
International iPod
growth key going
forward
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
5
Global Footprint
Largest PC penetration with
30% with 2 PCs
Mobile email, music
mainstream
Mobile gaming, video just
starting
30% of homes with PC, 20%
with 2 or more
Broadband more expensive but
one of the fastest growth regions
PC Ownership similar to Europe
Broader use of mobile technology
with 3G infrastructure
Largest number of broadband users
23M in 2004(1) 16M in 2004(1)
10M in 2004(1)
(1) Number of portable music players shipped.
Apple has sold
over 480 million
songs as of 7/7/05
iTunes users
downloaded over 1
million free
podcasts in first
two days post
iTunes 4.9 launch
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
6
Recent Highlights / Metrics
•Apple iTunes alone sold roughly 340 million songs over the past 12 months (implies 50+ songs
purchased per iPod)
-
20.0
40.0
60.0
80.0
100.0
120.0
140.0
3Q03
4Q03
1Q04
2Q04
3Q04
4Q04
1Q05
2Q05
Quarter
Million Songs
-
2,000
4,000
6,000
8,000
10,000
12,000
14,000
16,000
18,000
iPod Installed Base (K units)
iTunes Sold iPod installed base
Source: Morgan Stanley Research
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 44
Estimate 10-15% of
US music
purchases digitally
downloaded in
2004
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
7
Recent Highlights / Metrics
•Despite strong 2004 growth, digitally downloaded music accounted for only 7% of global
music purchase
Source: Morgan Stanley Research
2,556M units
200M units
Digitally Downloaded Traditionally Sold
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
8
Recent Highlights / Metrics
•Over 30 million portable digital audio players shipped globally last year; growing 34%
through 2008
-
20.0
40.0
60.0
80.0
100.0
120.0
2003 2004 2005 2006 2007 2008
Year
Million Units
0%
20%
40%
60%
80%
100%
120%
YTY Growth
HDD Flash Total MP3 Unit YoY Growth
Source: IDC and Morgan Stanley Research
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 45
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
9
Recent Highlights / Metrics
•Transition from geek toy to lifestyle accessory (age 35-54 is forming a growing segment)
Source: Morgan Stanley Research with help of 3rd party research firm
33%
11%
5%
3%
49%
Weekly iPod Usage
Q18. How many times per week do you use your iPod?
Every day
4-6 days
per week
2-3 days
per week
Once a week
Less than
once a week
Base: (200)
19% 17%
9%
24%
32%
Weekly MP3 Player Usage
Every day
4-6 days
2-3 days per week
per week
Once
a week
Less than
once a week
Base: (54)
= Significantly higher than non-iPod owners at the 90% confidence level
Broad usage
patterns of iPod vs.
other MP3 players
indicate that Apple
can expand into
new content,
portable, and Mac
offerings
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
10
Recent Highlights / Metrics
89%
52%
25%
22%
20%
18%
12%
6%
Q20. Please indicate all the ways you use iPod.
Q21. Please indicate when you listen to your iPod.
Uses for iPod Use iPod While . . .
68%
67%
53%
50%
30%
Working/Studying
Exercising/working out
Commuting (not in a car)
Driving
Hanging out with friends
To listen to music
(through headphones)
To listen to music
(through home stereo)
As a portable hardrive
To play games
To listen to books
As an address book
and calculator
To take voice notes
To listen to music in
car/through stereo
Base: (200) Base: (200)
(Average nearly 3 types of occasions)
•Uses span beyond just music....
Source: Morgan Stanley Research with help of 3rd party research firm
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 46
Expect Apple
peripherals
revenue to grow
from $1.2B in FY04
to $3.4B in FY06,
driven by iPod and
Mac unit growth
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
11
Recent Highlights / Metrics
•iPod customer base purchased an average of 2.8 accessories to-date
Source: Yahoo.com, CNET.com, and Morgan Stanley Research with help of 3rd party research firm
64%
46%
46%
44%
37%
27%
3%
Q24. What accessories have you purchased for your iPod?
Headphones
Car Connectors
Power Chargers/Adapters
Cases/Arm Bands/Sleeves/Travel bags
Docking Station
External Speakers
Other
Base: (200)
(2.8 accessories per person, on average)
•iPod has the lion’s share of the accessory market, based on the number of items found at
Yahoo! and CNET
iPod
Dell
Jukebox
Creative
Zen Rio
Yahoo! 4,875 4 32 339
CNET 353 2 9 11
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
12
Key Drivers / Metrics
Digital Music is just the beginning of something
that is potentially huge. What to watch:
Broadband adoption...fatter pipes for digital content
Resistance from the content owners...watch the buck
Perpendicular disk drive technology...shipping later this year
Cell technology...could be game changer
Power consumption an issue in small form factors
Product and content availability will continue to be key -
Gaming, video, broadcast downloads, podcasts, photo...
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 47
Podcast support
through entire
HDD-based iPod
product line
All classic iPods
now offer a color
LCD screen.
Apple could launch
video-capable
iPods over next
6-12 months
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
13
•Signs of an appetite for additional functionality within the current iPod customer base
•Apple’s recent move to combine the classic and iPod photo lines acknowledge this trend
Source: Morgan Stanley Research with help of 3rd party research firm
Q9. Earlier, you indicated you owned an Apple iPod. Which type of iPod do you currently own?
Q25a/b. If you lose your iPod tomorrow and have to replace it, what brand of MP3 player would you most likely
buy? And which specific type of iPod would you be most likely to buy?
4%
6%
5%
7%
24% 10%
22%
59%
42%
17%
iPod
iPod Photo
Currently Own
(200)
iPod Mini
iPod U2 Special Edition
iPod Shuffle
Future Purchase
(141)
"
"
= Significantly higher at the 90% confidence level
70% of
current iPod
owners said
they would
repurchase an
iPod.
Key Drivers / Metrics
Digital musiccapable
cell
phones
complement rather
than compete with
traditional music
players
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
14
•Global cell phone appetite is also shifting towards more advanced, converged devices
Source: Morgan Stanley Research with help of 3rd party research firm
0
100
200
300
400
500
600
700
800
900
1000
2001 2002 2003 2004 2005 2006 2007 2008
Year
Million Cell Phone Units
0
0.05
0.1
0.15
0.2
0.25
0.3
YoY Growth %
Entry Midrange High-end Converged YoY global unit growth%
11.6% CAGR
Key Drivers / Metrics
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 48
Intel’s new Pentium
D chips have
embedded DRM to
protect content
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
15
Key Issues and Risks
•Digital Rights Management: At the end of the day
everyone wants a piece of the pie.
•Getting the Infrastructure Right
•Industry Standards: Success is majority of content
available at one source and can work on many devices.
•Business Models also at Risk: Players need to
manage growth and Investment based on technology
and infrastructure availability. Leap-frogging is also a
risk given the ever evolving market.
Apple looks best
positioned to go
after digital living
room from
investment, brand,
product
perspectives
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
16
Industry Structure Today … and Tomorrow
Most Likely Near Term Future – “Digital Hub”
• Wireless functionality
(iPod, iMac)
• Video functionality
(iPod, iMac)
• iPod cell phone
Garage
Today
iPod
Stereo
System
Home
Monitor
“Mini-Mac”
Wi-Fi,
Airport
TV
•Storage, Content increases in importance
•Ease of use and software remain important
•Does “Intel Inside” expand beyond PCs?
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 49
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
17
Potential Winners and Losers
Potential Winners Potential Losers Unclear
Still very much a debate but some initial thoughts...
Vendors with integrated
solution, strong brand;
related component suppliers
Point-product providers It is unclear whether
companies that benefited
from the client-server era
will also benefit from the
digital consumer era
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
18
•Apple iPod brand recognized most for ease of use, reliability and functionality (including
iTunes)
PKoetye Dntriiavle Wrsi n Mnertrsi casnd Losers
64%
58%
53%
48%
48%
44%
35%
30%
26%
5%
Q12. Please indicate the reasons why you chose to purchase the Apple iPod over all other brands.
Base: (200)
Easy to use
It is a brand I trust
It offered all the features I was looking for
Compatible with iTunes
It's the most popular player around
A friend recommended it
The price was right
It is the player that all my friends have
The best accessories are only available for the iPod
Other
(Average about 3 reasons per person)
Source: Morgan Stanley Research with help of 3rd party research firm
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 50
Apple should help
grow the overall
MP3 market
Can continue to
gain share with
new content
offerings,
expanded retail
distribution), and
international
expansion
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
19
•Windows based players (HDD-based) still haven’t caught up, although some introduced
their products before the iPod
Potential Winners and Losers
0
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
Apple Creative Labs RIO iriver Samsung RCA Other
Vendor
Last 12 Month Units (in 000s)
0%
10%
20%
30%
40%
50%
60%
70%
80%
90%
100%
Market Share %
Units Market Share
Source: NPD and Morgan Stanley Research,
Equity Research
Emerging Technology Trends
Morgan Stanley
Technology Research
20
•iPod Shuffle took 47% of U.S. flash memory based MP3 player market share just 3 months
after debut
PKoetye Dntriiavle Wrsi n Mnertrsi casnd Losers
0
50
100
150
200
250
300
350
400
450
Apple Sandisk iriver RIO RCA MemorexSamsung Creative Sony Others
Vendor
Last 3 Month Units (in 000s)
0%
5%
10%
15%
20%
25%
30%
35%
40%
45%
50%
Market Share %
Units Market Share
Source: NPD and Morgan Stanley Research,
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 51
Equity Research
On-Demand Software
Morgan Stanley
Technology Research
1
On-Demand Software
Delivery Models
Presented by Ross MacMillan
Covered by Ross MacMillan
On-Demand,
subscription
models challenge
the traditional
software business
model
Equity Research
On-Demand Software
Morgan Stanley
Technology Research
2
What is the On-Demand Model?
Software delivered as an
Online Service that offers
immediate benefit without the
substantial cost, resource,
and time investment
associated with enterprise
software.
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 52
On-Demand
models attractive
to risk-averse
customers, may
expand
addressable
market
Equity Research
On-Demand Software
Morgan Stanley
Technology Research
3
On-Demand Changes the Economics
For the Customer
•Lower risk and cost
•Faster go live and payback
•Lower upgrade costs
•Broader access to complex functionality
For the Vendor
•Higher adoption rates
•Lower development and support costs
•On-Demand model should not lower the revenue
opportunity
On-Demand
promises lower
customer TCO with
similar lifetime
revenue for
vendors
Systems
integrators are real
losers
Equity Research
On-Demand Software
Morgan Stanley
Technology Research
4
Lower the Total Cost of Ownership
Source: Morgan Stanley Research Estimates, Yankee Group
*
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 53
Lower initial
investments make
subscription
models attractive
to risk-averse
buyers
Subscriptions
should offer
vendors similar
payback longer
term
Equity Research
On-Demand Software
Morgan Stanley
Technology Research
5
Annuity-Like Subscription Model
Year 1 Year 2 Year 3 Year 4 Year n. . .
$
Traditional Perpetual License Model
Year 1 Year 2 Year 3 Year 4 Year n. . .
$
Subscription Model
• Longer term, revenues
should be similar
•Reasons why the
subscription model is more
attractive
– faster ROI
– no large upfront
investment
– higher flexibility
– switching cost remain
high
Area under the curve should be similar
On-demand model
associated with a
handful of highprofile
start-ups,
but usage fairly
widespread
Several established
suppliers offer
subscriptions
Equity Research
On-Demand Software
Morgan Stanley
Technology Research
6
Growing Universe of On-Demand Models
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 54
Valuations look
high on traditional
metrics, rarely look
cheap even on free
cash flow
Equity Research
On-Demand Software
Morgan Stanley
Technology Research
7
Out Performance of On-Demand Vendors
Vendor Ticker Price Market Cap Revenues Customers
Free Cash
Flow
CY04
Operating
Margins
CY05
Forward P/E
salesforce.com CRM $20.11 $2,132 86.0% 56.2% 301.6% 3.7% 125.7X
WebEx WEBX $25.43 $1,143 33.4% 26.4% 56.5% 28.1% 22.1X
Websense WBSN $54.04 $1,292 35.5% 19.2% 41.4% 34.6% 36.5X
Growth Metrics (2002 to 2004)
0
50
100
150
200
250
6/6/2003
8/6/2003
10/6/2003
12/6/2003
2/6/2004
4/6/2004
6/6/2004
8/6/2004
10/6/2004
12/6/2004
2/6/2005
4/6/2005
6/6/2005
Composite - (CRM/WBSN/WEBX) Softw are Holders Index
Relative Stock Performance of Select On-Demand Vendors
On-Demand
models still the
exception, but
potential for
disruption to status
quo remains
Equity Research
On-Demand Software
Morgan Stanley
Technology Research
8
What Does the Future Hold?
•On-Demand model becomes mainstream
•Incumbent vendors get more involved
•New competition emerges
•Ultra-value tier emerges: On-Demand + Open
Source combo
•Cross-over with internet assets
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 55
Equity Research
Evolution of Security
Morgan Stanley
Technology Research
1
Evolution of Security
Presented by Peter Kuper
Covered by Peter Kuper
Security solutions
can’t be static
given varying
vectors, threats
New technologies
exacerbate
problem
Equity Research
Evolution of Security
Morgan Stanley
Technology Research
2
•The security market is rapidly evolving
– External, perimeter-facing defenses losing investment to internal,
application and data-focused defenses
– Evolving threats rendering classic security products mostly useless
– Open source no easy answer – critical updates for mozilla on the rise
•Evolving attacks creating persistent demand for
innovation
– No end in sight of evolving attacks with increasing intensity and
duration – Witty Worm a major warning – destructive payload
– New products/protocols create new vectors (wifi, bluetooth, RFID,
VoIP)
SCerceuatreit yD Qebuaictek:l yS Eecvuorlvitiyn gEvolution
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 56
Still not fully
protected
Equity Research
Evolution of Security
Morgan Stanley
Technology Research
3
•Security has been an afterthought
– Massive tech build out of the late 1990’s was entirely focused on access
– First wave was reactionary – shut down the outside threat but runs
counter to intentions of e-commerce, insider threat realities
•And despite all the spend, still losing the battle
LCargegatine gD Bebeahtien:d S Tehcrueraity E Evvoolulutitoionn
“Given the widespread use of automated
attack tools, attacks against Internetconnected
systems have become so
commonplace that counts of the number of
incidents reported provide little information
with regard to assessing the scope and
impact of attacks. Therefore, as of 2004,
we will no longer publish the number of
incidents reported.”
-CERT
0
20,000
40,000
60,000
80,000
100,000
120,000
140,000
160,000
1995 1996 1997 1998 1999 2000 2001 2002 2003
$0
$1,000
$2,000
$3,000
$4,000
$5,000
$6,000
$7,000
$8,000
$9,000
(millions)
Incidents Security Software Revenue
Paradigm shift is
coming – invest
accordingly
Equity Research
Evolution of Security
Morgan Stanley
Technology Research
4
•New model required – Inclusion/Exclusion
–Migration to contextual, conditional access paradigm requires
spend concentrated in different security segments
– Internal focus will shift spending from perimeter
•Spending on traditional, mature areas will be less
given refocused efforts, embedding of technology
in other products and services.
– This will drive all technology providers to become security
companies
•Security will become a technology and business
enabler, not a multi-billion stand alone industry
AC rDeiaffter Denetb Vatie:w S oefc tuhreit yM Eovdoelution
Technology – July 15, 2005
Please see analyst certification and other important disclosures starting on page 73.
Page 57
Market dynamics
will sway stocks –
play the trends
Equity Research
Evolution of Security
Morgan Stanley
Technology Research
5
• Suites and appliances to rule
– Buyers want to deal with fewer vendors, plug and play capability. Ease of use
a big issue with the multi-pronged framework of effective security.
• Bundling drives pricing lower
– As buyers seek more protection from any single vendor, pricing goes lower as
suppliers look to maximize total dollars per client, not dollars per product.
• Security to be included as a part of the product – 99.999% uptime
– Large tech providers are incorporating security to make the core product more
reliable – whether a load factor or a hacker, availability still the main
requirement
• Security as a business enabler, contra-expense
– Security has been the priority given pressing needs howeve