A Different Way to Play the Wireless Internet Market

These days it's impossible to watch television or listen to the radio without hearing or seeing an ad from one wireless carrier or another claiming to have the fastest network. While mobile Internet access has become much more common in the United States in the past couple of years, it has been around for more than a decade in Japan. Since  NTT DoCoMo  introduced i-mode in 1999, the Japanese have rapidly embraced wireless data services. Despite all the recent hype surrounding so-called 4G networks in the U.S., it's interesting to note that around half the country has yet to adopt a 3G device. In Japan, by contrast, that figure stands at about 97% of the population--with customers typically paying more per month for the privilege to boot. With its history of gobbling up new technologies, Japan is likely to provide a very hospitable environment in which to generate returns of future network investment.

As in the U.S., DoCoMo has begun rolling out 4G technology, choosing the LTE standard that both AT&T (T) and Verizon Wireless  (VZ) have embraced. When DoCoMo first introduced 3G services, new subscribers significantly increased usage and average revenue per user (ARPU) jumped significantly. Unfortunately, the firm is facing a major headwind this time around. As with most of the rest of the world, wireless voice revenues are declining in Japan as operators follow the U.S. pattern of offering bundles of minutes for a set price rather than charging by the minute. While bundles initially gave ARPUs a boost, the prospect of future usage-based ARPU growth is minimal and competition has pressured prices as well.

We don't expect as large a movement in ARPUs with the transition to 4G as DoCoMo witnessed with 3G as a result of the pressure on traditional voice revenue, but we do think the firm is positioned well relative to other carriers around the world. DoCoMo already derives 42% of its wireless service revenue from data charges, which are among the highest in the world. The average in the U.S. is about 35%. With the transition from voice revenue to data well under way at DoCoMo, the firm should see less drag going forward.

While DoCoMo has historically been the technology leader in Japan, that gap has closed as smaller carriers have worked to catch up over the past decade. One result of this parity is that Apple (AAPL) chose to grant Japan's third-largest carrier--Softbank--exclusive rights to the iPhone, allowing Softbank to take some market share. DoCoMo dropped below 50% market share for the first time in 2010 and has routinely been capturing less than 25% share of new subscribers. We expect the move to 4G services will once again establish DoCoMo as the technology leader in Japan for some period of time (potentially as long as two years before other operators launch LTE services), allowing the firm to counter the inroads Softbank has made. In short, DoCoMo's massive scale relative to its rivals allows it to handle shifts in technology more easily.

We don't believe DoCoMo's share price reflects the strength of its business currently or the prospect of improved performance in the near term. In addition, as the largest wireless operator in Japan, DoCoMo provides a good proxy for exposure to the Japanese stock market, which has struggled for more than 20 years. The stock provides a nice 3% yield, significantly higher than Japanese government bonds. While the Japanese government faces one of the highest debt loads in the world--the OECD puts debt at about 200% of GDP--DoCoMo enjoys solid financial health, with a net cash position. DoCoMo also has minority positions in several emerging market countries, including a 26.5% stake in Tata Teleservices, the fourth-largest wireless operator in India. Finally, a DoCoMo investment also provides exposure to the Japanese yen, a currency that has benefited from the weakness in the euro and the dollar.