Rerouting to a rerating

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1 Christmas crackers TomTom OUTPERFORM FROM NEUTRAL Rerouting to a rerating 16 DECEMBER 2014 Alexander Peterc WHY YOU SHOULD READ THIS REPORT After seven painful years of Satnav market implosion, TomTom s prospects are fi nally turning for the better with diversifi cation efforts paying off. This prompts us to overcome our long-standing caution on the stock we upgrade to Outperform and see c.50% upside. Embryonic only four years ago, the high-growth, highmargin Telematics business has quickly turned into TomTom s star performer and major EBIT contributor. The revamped Automotive strategy of selling modular content to car makers and OEMs is also starting to bear fruit. Transitioning from a boom-to-bust, hardware-centric B2C model to a subscription-based content/services B2B play implies an improved and more sustainable growth/margin outlook. Enough reason for the shares to rerate in the year to come.

2 CHRISTMAS CRACKERS The end of the year is a busy time. Annual reviews have to be written but investors also need to focus on the future and how to position their portfolios for next year. We hope to contribute to this process by providing you with some food for thought and ideas for next year. In this spirit, we present you with our "Crackers for 2015". And recognising that this time of year is not all about work, here is our ninth joke of the festive season. Yorkshire Constabulary have had all of their sat navs stolen. A spokesman said that they are searching for Leeds. Enjoy reading our ninth Christmas Cracker. Pharmaceuticals Eutelsat / SES ING Group ITV Plc Agencies Mining Suez Environnement FCA Group TomTom Season's Greetings from the Exane BNP Paribas Research Team

3 TOMTOM OUTPERFORM FROM NEUTRAL EUR5.1 TARGET PRICE EUR7.7 (UPSIDE 50%) TARGET PRICE EPS 15e EPS 16e 40% non material 26% Rerouting to a rerating 16 DECEMBER 2014 Alexander Peterc (+44) alexander.peterc@exanebnpparibas.com Alexandre Faure (+44) Jerome Ramel (+1) ithardware@exanebnpparibas.com Specialist sales Nav Sheera (+44) Business transformation takes hold - Upgrading to Outperform TomTom was long plagued by the drawn-out demise of its flagship product category (satnavs) and the burden of debt taken on to acquire TeleAtlas. As these concerns disappear (debt paid off) or become less of a burden (PND declines are easing; the category s weight in revenue is now significantly lower), TomTom s diversification is taking hold. The transition to content and services, after much soul-searching, is finally bearing fruit in Telematics and in the Automotive categories the cornerstone of our upgrade. On new forecasts, we hike our target price from EUR5.5 to EUR7.7 (51% upside) and upgrade the stock to Outperform (from Neutral). Highly promising development of Telematics is the cornerstone of our upgrade Telematics was still embryonic only four years ago but has quickly become the group s largest EBIT generator, surpassing Consumer in The development of this highgrowth business (15 20% underlying market growth) should accelerate following the acquisition of national European players such as Coordina, DAMS and FleetLogic (each adding 5 10% to TomTom s subs base) potentially doubling revenue in the coming three years and bringing strong EBIT margins (30%+). Our upgraded views of Telematics prospects are behind EUR1.5/share of our valuation upgrade. After much soul-searching, TomTom s revamped Automotive strategy is finally working Selling navigation know-how to car manufacturers has always been a strategic goal for TomTom, but the previous strategy (selling bundled software and hardware) did not deliver the expected results. TomTom officially unbundled the two in 2014 and now sells maps, traffic and navigation software in separate modules to the automotive industry. With EUR170m in fresh orders YTD (compared with the current EUR100m annual revenue runrate), TomTom s new Automotive strategy is finally working. It may take several years before the new >EUR150m revenue run-rate is reached, but its recent performance suggests TomTom is finally on the right track. Our upgraded views on TomTom s Automotive segment are behind EUR0.8/share of our valuation upgrade. Price (12 December 2014) EUR5.1 Performance (1) 1w 1m 3m 12m Market cap (EURbn) 1.2 Absolute(%) (6) (6) (16) 3 Free float (EURbn) 0.5 Rel. IT Hardware(%) (2) (8) (17) (12) EV (EURbn) 1.2 Rel. MSCI SMID(%) (1) (5) (14) (6) 3m avg volume (EURm) 7.0 Reuters / Bloomberg TOM2.AS / TOM2 NA Country / Sub Sector Netherlands / Consumer Electronics Financials 12/14e 12/15e 12/16e 12/17e Valuation metrics 12/14e 12/15e 12/16e 12/17e EPS, Adjusted (EUR) P/E (x) EPS, IBES (EUR) Net yield (%) Net dividend (EUR) FCF yield (%) EV/Sales (x) Sales (EURm) ,030 1,090 EV/EBITDA (x) EBITA, Adj. (EURm) EV/EBITA (x) Net profit, Adj.(EURm) EV/CE (x) ROCE (%) Net Debt/EBITDA, Adj. (x) Source: Exane BNPP (estimates) Thomson Reuters (consensus) (1) In listing currency with dividend reinvested Please refer to important disclosures at the end of this report.

4 Investment case On the face of it, it is rather odd, perhaps ironic, that we present TomTom as one of our Christmas Crackers this year. Indeed, anything one could call a satnav (that is NOT a smartphone or a tablet) hasn t been a cool Christmas present for nearly a decade. That s a lifetime in tech. For pretty much the same reason, we can t quite recall when we last recommended buying TomTom shares. Luckily, the Exane BNP Paribas Datacentre has a long memory: this last occurred in the course of the short, somewhat odd and now longforgotten GPS mini-bubble back in All-cash buy-outs of massively overpriced map assets TeleAtlas (TomTom s for EUR3bn) and Navteq (Nokia s for USD8bn) were definitely the nail in the coffin of that episode of GPS craziness, coincidentally only months before more or less everything else fell apart anyway (Lehman crisis, etc.). As the satnav market has crashed and burned ever since, so have TomTom shares, with an all-time low of EUR2.11 in 2009 when the stock bottomed out at less than 4% of its peak value. Brief periods of M&A speculation-fed rallies were repeatedly followed by relapses to all-time-lows, as the PND market s meltdown continued to cruelly disappoint already disillusioned TomTom shareholders. Figure 1: A protracted share price meltdown from the 2007 GPS bubble heights TomTom share price over the past 10 years Source: Exane BNP Paribas estimates We finally put an end to our protracted Underperform stance on TomTom almost three years ago, arguing that, while the worst of the PND contraction might have been approaching an end, we still struggled to see when (if ever) TomTom s top line could return to growth. New or newly acquired business areas failed to deliver (Automotive), remained unprofitable (TeleAtlas), or were simply too small to matter (Telematics). As long as TomTom s top-line recovery continued to be two or more years ahead, the shares valuation remained overly dependent on the optionality of the always rumoured, never confirmed M&A appeal of its Mapping business. Exane BNP Paribas Research TOMTOM 16 December 2014 page 2

5 Figure 2: Margin and sales have started to stabilise recovery ahead TomTom: Sales and EBITA margins Source: Exane BNP Paribas estimates, company data We believe this is now changing, for the following reasons: 1) Embryonic only four years ago, TomTom s Telematics is set to become the group s biggest EBIT generator this year, surpassing its former bread-and-butter business of PNDs. Our findings suggest that this high-growth (25-30%), highly profitable (30-35% EBIT margin) business with predominantly recurrent revenue streams can double its sales and earnings over the next three years, and constitutes the bulk of TomTom s projected margin recovery from 2016 onwards. 2) TomTom is successfully transforming its Automotive business. Unsuccessful previously, when the group was trying to sell bundled hardware and content/services to automotive clients (in the form of a custom PND as a dashboard component), TomTom changed gears in 2014 by unbundling its content offer (maps, traffic, navigation software can now be purchased separately). Automotive hardware is being phased out. TomTom s excellent real-time traffic offering, previously hobbled by bundling, has taken off: TomTom now commands a dominant 80% market share in traffic. The year-to-date automotive order intake of EUR170m points to significantly higher Auto content and services revenue in two to three years time compared to current levels (around EUR100m). This software business with very high (around 75%) gross margins should enjoy massive economies of scale once the current order intake translates into a steady revenue stream, in approximately two to three years. 3) TomTom revamped its map-making process this year (hence the steep capex hike). Real-time map making and incremental map updates should substantially improve the quality and real-time accuracy of TeleAtlas maps, making them more appealing to licensees in Automotive and in Licensing. The progressive extinction of the legacy batch map-making process (where entire maps were pushed to users in cumbersome large-size quarterly updates) should also generate savings over the next two years. 4) Consumer (PNDs, embryonic Sports Watch and legacy Automotive in-dash navigation hardware, previously in Automotive) continues to decline, but the rate is becoming more manageable. Some markets, particularly Europe, are showing signs of stability; the category is also helped by strong (albeit long-term uncertain) growth in Sports Watches, and good software/service revenue (such as smartphone apps). After years of steep double-digit declines, we see flat revenue in Consumer going forward, with specifically PND revenue declining terminally in the high single-digits. Exane BNP Paribas Research TOMTOM 16 December 2014 page 3

6 Figure 3: Sales growth back in the black from 2015 onwards; software and service to outgrow hardware in the course of 2016 Hardware, Software revenue (EURm); sales growth (%) Revenue composition: hardware vs software 1,800 1,600 1,400 1,200 1, % 5% 0% (5%) (10%) (15%) (20%) 100% 90% 80% 70% 60% 50% 40% 30% 20% 10% 0% Hardware Content & services yoy growth (%) Hardware Content & services Source: Company data (historical); Exane BNP Paribas estimates Based on our in-depth granular analysis of mini P&L structures of each of the individual businesses, TomTom s transformation is approaching a tipping point. By 2016, the group s top-line should be back in respectable growth territory (mid-single digits), with recurrent businesses driving this growth as content and services outgrow hardware sales (those were 85% of revenue back in 2008). This transformation should meaningfully change TomTom s margin structure in 2016 and beyond: essentially, the boom and bust B2C hardware-centric TomTom of yesteryear is transitioning to a recurrent, content/services SaaS B2B play. Figure 4: Content and services to continue growing while Hardware stabilises Growth in Hardware, in Content & Services, and ratio of Content & Services / Hardware sales 20% 15% 10% 5% 0% (5%) (10%) (15%) (20%) (25%) In '16, content & services outgrow hardware; top-line returns to growth (30%) E 2015E 2016E 2017E 2018E 2019E 2020E Hardware sales growth (%) Content & Services sales growth (%) Content & Services / Hardware (RHS) Source: Company data (historical); Exane BNP Paribas estimates Exane BNP Paribas Research TOMTOM 16 December 2014 page 4

7 Figure 5: TomTom profit generation: From boom and bust B2C to recurrent B2B income EBIT generation by division EBITDA generation by division % hardware, 20% content and services Consumer Automotive Licensing Telematics Consumer Automotive Licensing Telematics * Automotive hardware (in-dash PND components, 50-60% of pre-2012 Automotive rev.) was reallocated out of Automotive into Consumer in Source: Company data and Exane BNP Paribas estimates The New TomTom should, in our view, generate EBITA margins of close to 15% by 2020 (vs 8% currently). Assuming 2% long-term growth rates, our new TomTom valuation is hiked to EUR7.7/share (up from EUR5.5/share), with 51% upside from current levels. Risks to our investment case: The main risks and uncertainties, detailed in the following section, are USD appreciation (hardware is outsourced in a USD/CNY cost base; sales are predominantly EUR-denominated), automotive industry evolution (in favour or against embedded navigation supported by TomTom), and TomTom-specific transitions (map-making engine makeover; Automotive strategy revamp). Exane BNP Paribas Research TOMTOM 16 December 2014 page 5

8 Valuation What is behind our 40% target price hike? After a detailed re-examination of TomTom s business model, our views on the following divisional operating metrics have evolved. We previously underestimated the growth and margin potential of Telematics. Our new forecasts now reflect higher growth over the coming 3-4 years, with 15 20% underlying market growth, and an addition of around 30k subs through acquisitions of small local players. Our DCF reflects additional Telematics-related acquisition expenditure of approximately EUR20m/year. This is in line with what we believe TomTom paid for Coordina, DAMS and Fleetmatics. Consequently, we upgrade our e CAGR for Telematics to 20%, from 13% previously. We previously also modelled a margin normalisation to 25%; this seems overly conservative after a careful business model re-examination. We now keep Telematics margins at a higher level (33%), compatible with the division s recent track record. We added forecasting granularity in Consumer, concluding that we overestimated the impact of PND market declines on growth prospects. Our new breakdown singles out Sports Watches, Auto Hardware, PNDs and subscription revenue, resulting in a de-correlation of roughly 1/3 of Consumer revenue (2014e) from PNDs. This new development leads us to conclude that, even though the PND market may continue to decline in 2015 and beyond at a rate similar to this year s -8%, overall Consumer revenue may stabilise significantly sooner than previously thought. Specifically for Watches, we forecast a moderation in 2015 growth to 60% (in value) vs 100% currently, reflecting intensifying competitive pressure from adjacent segments (fashion/smart watches; increasingly sophisticated fitness bracelets) but at 13% of Consumer revenue (2015e), Sports Watches are starting to make an impact on the division s overall growth profile. We now model Automotive revenue longer-term on the assumption that TomTom s new strategy is working (as opposed to the backward-looking scepticism that previously influenced our forecasts). We downgrade 2015 Automotive revenues as we estimate that the impact of fading legacy contracts cannot just yet be offset by the newly signed EUR170m in fresh content-only contracts signed this year indeed, these deals will materialise in actual sales in 2 3 years from now, not in 2015 as previously thought. Conversely, using the EUR170m order intake data point as a solid-enough sign that TomTom s newly minted Automotive strategy is indeed working, and banking on the group s ability to replicate a similar level of orders in the coming years, we are significantly (by over 20%) upgrading our forecasts of TomTom s Automotive revenue. Given that this is a high (75%) gross margin business currently operating in moderate losses, operating leverage is substantial: we believe Automotive can reach EBIT margins of around 10% in the medium term (equivalent to peer Nokia HERE). In Licensing, we now model marginal benefits (opex decrease) resulting from the progressive de-commissioning of the legacy map-making engine. TomTom s realtime map making will go live in early 2015; the legacy system will continue to be updated for a transition period, but we estimate that once legacy is phased out and no longer needs to be updated, TomTom s Licensing opex may decrease by around EUR10m 15m (15 20% of sales) over the next two years. This would result in a moderate margin improvement from the hefty losses currently being incurred (impact of Google contract phase-out that slashed Licensing revenue by one third) and towards a slightly more normal mid-single-digit EBIT margin post Exane BNP Paribas Research TOMTOM 16 December 2014 page 6

9 Overall, our Licensing estimates are the ones that see the smallest revisions (and matter the least) in our overall forecast reshuffle. Valuation bridge to our new TP of EUR7.7 (51% upside) The overall impact of the above changes on our fair value calculation of TomTom shares, as presented in the central-case DCF below, can be summarised in the following bridge chart. Figure 6: The single biggest contributor to our upgrade is Telematics (+EUR1.5/share = +30%). Attractive risk/reward: 51% upside in Central scenario / +70% blue-sky / -18% downside to Bear case (floor) TomTom: Changes to our Central scenario and related Valuation bridge (in EUR/share) % upside % upside % downside (1.0) Ultra-bear: PNDs to -20% PNDs-20%/yr; p.a. declines no positive into perpetuity development in Auto, Telemat. Old FV Positive reassessment of Telematics growth, margin prospects New Automotive strategy is "working" Better Consumer outlook NEW Fair Blue-sky Value (2% Connected Car terminal scenario growth, 15% EBITA margin) Bull case Upsides / downsides are measured vs TomTom s current share price Source: Exane BNP Paribas estimates In addition to the tangible elements of scenario changes outlined below, we portray in the bridge chart two additional scenarios. A Connected car bull case where we add the incremental Automotive revenue (and related incremental FCF) that TomTom may derive from the proliferation of automated/self-driving cars in the most favourable long-term scenario, in which car makers embedded solutions dominate, with Nokia HERE and TomTom holding respectively 80%/20% maps and content market shares. For full details on various Connected car scenarios, please refer to our July 2014 Disruption report THE INTELLIGENT CAR: The End of the World (as we know it). A bear case reflecting our old, more pessimistic Automotive and Telematics scenarios, aggravated by a relapse of the PND market into heavy declines (-20% per annum from 2015 until 2020). In this scenario, TomTom s top-line remains stagnant at current levels; that said, despite such headwinds, the mix of more content/services and even less hardware leads to a mild EBITA margin improvement to 11% by 2020 (and beyond) vs 8% currently. This compares to our new Central Case long-term EBITA margin of 15%, driven by favourable mix changes and a better top-line outlook. Exane BNP Paribas Research TOMTOM 16 December 2014 page 7

10 DCF valuation: New fair value at EUR7.7 with 14.5% long-term EBITA margins As presented below, we value TomTom via a DCF using 2% long-term growth (compared to +3.5% in our last explicit forecast year 2020), which seems conservative given the fall into insignificance of PNDs (in secular decline), offset by solid secular growth trends in content, services and software this is particularly true if a favourable connected car starts to materialise beyond With a beta of 1.15 (historical observation over five years vs EuroStoxx index) and no debt (TomTom is now in a positive net cash position), we derive a WACC of 9.1%. Discounted cash flows point to a fair value of EUR7.7, after taking into account the net present value of small Telematics acquisitions (around EUR20m annually, in line with the maximum price per transaction TomTom probably paid for Coordina, DAMS and FleetLogic over the past three years). Note TomTom s capex, at a very high level in 2014E at EUR106m (up 25% y/y and double the 2012 capex) has ballooned due to the makeover of the map-making engine and should normalise in 2016E-17E (decreasing moderately by EUR10m/year, as the new platform is rolled out and the old one is progressively decommissioned, generating opex and capex savings). Figure 7: Key DCF assumptions WACC Calculation Comments Risk free rate 0.62% current Risk premium 7.35% current Exane BNP Paribas Beta 1.15 Historical 5-year Debt / Current EV 0% no more debt now Cost of debt after tax 7.9% assuming 1000bp WACC 9.1% Growth into perpetuity 2.0% LT EBITA margin 14.5% as compared to current (2014E) 8% LT EBITA margin improvement vs current 648 basis points Source: Exane BNP Paribas estimates Figure 8: Discounted cash flows DCF summary Turnover ,030 1,090 1,137 1,181 1,222 EBITDA Depreciation of tangible and intangible assets EBITA Taxes (normalised at 19%) (14) (16) (22) (26) (30) (32) (34) Variation in WCR (11) 8 5 (5) (4) (4) (3) Industrial investment (106) (96) (86) (89) (92) (94) (97) Free Cash-Flow Discounted FCF Sum of DCF Discounted terminal value 1,290 Source: Exane BNP Paribas estimates Figure 9: DCF output EUR7.7/share fair value in our new scenario Fair value calculation (EURm) EV - firm value 1,812 Adjusted net debt As reported Other liabilities 80 Provisions (warranty, other) Telematics acquisitions ( ) 91 Discounted NPV of EUR20m-worth of acquisitions/year Other assets 3 As reported - financial assets Minority interest 2 As reported Total Equity Value 1,732 Diluted number of shares Fair value per share (EUR) 7.7 Source: Exane BNP Paribas estimates Exane BNP Paribas Research TOMTOM 16 December 2014 page 8

11 Peer comparison: TomTom multiples broadly in line with CE peers Figure 10: IT Hardware - TomTom vs International peers Price Market Cap P / E (x) EV / Sales (x) EV / EBITDA (x) EV / EBITA (x) EBITA margin (%) Absolute Perf. (%) (12 Dec 14) (EURbn) CY15 CY16 CY15 CY16 CY15 CY16 CY15 CY16 CY14 CY15 CY16 1M 3M YTD 12M Apple (+) USD (1.2) Barco (=) EUR (3.1) Dialog Semiconductor (+) EUR EVS (+) EUR (8.7) (40.3) (33.1) FleetMatics (NR) USD Garmin Ltd. (NR) USD HTC Corp (NR) TWD Ingenico (+) EUR Logitech International (+) CHF Pace (+) GBP Technicolor (=) EUR (24.1) Telenav Inc. (NR) USD TomTom (+) EUR (5.6) (16.3) (0.1) 2.6 Trimble Navigation (NR) USD Median ratio TomTom vs Median ratio +14 (4) (0) +0 (13) (25) +33 (0) (21) (25) (24) Source: Exane BNP Paribas estimates TomTom shares have historically traded at elevated multiples, not least because of the stock s speculative appeal. At present, TomTom s multiples are actually in line with peers, having largely underperformed over the past three months (down 15% whereas peers have appreciated on average by 9%). Due to the heavy investment in its maps assets (requiring a substantial level of maintenance capex), TomTom s EV/EBITDA ratio is up to 25% below peers, whereas on EV/Sales, PE and EV/EBITA multiples, TomTom is pretty much in line. Compared to direct peer Garmin (main PND competitor, also active in sports watches and fitness electronic accessories), TomTom shares appear attractive: TomTom s EV/EBITDA is half that of Garmin (however, Garmin does not own the capexintensive Maps asset); on 2016 P/E and EV/EBITA, TomTom displays discount of around 30% to its main competitor. At our EUR7.7 target price, TomTom s forward multiples look demanding (P/E 16E at 17x, EV/EBITDA 7x, EV/EBITA at 12x), but these are justified by the significant transformation of its revenue base away from non-recurrent hardware to more predictable subscription and content/services-based revenue. We would also point out that, by 2016, TomTom s business model transformation will have only just reached a tipping point, with Content and Services expected to outgrow Hardware revenue. In 2016, TomTom s margin re-rating will be still a work in progress, at only 11% (vs 8% currently); our new fair value of EUR7.7 is, however, based on a longer-term business model with EBITA margins of 14-15% that we expect TomTom can reach towards the end of the decade, when its business model transformation will be closer to completion. Risks and uncertainties to our Outperform stance TomTom shares have recently underperformed for a variety of reasons, principally we believe as a result of the following elements already flagged by management: USD appreciation vs the Euro. TomTom CFO Marina Wyatt flagged on the Q3 14 earnings call that gross margins (that surprised positively throughout the current year) will come under pressure given recent FX movements. With a circa 10% USD appreciation vs EUR, all else equal, TomTom s gross margins are expected to contract by around bp not the end of the world, but definitely a negative going into We believe this is now fully integrated into consensus and our numbers, but TomTom should underperform when the US currency appreciates. Exane BNP Paribas Research TOMTOM 16 December 2014 page 9

12 Automotive revenue transition is under way, and growth in what is now purely content and services sales to the auto industry (legacy auto hardware having been moved into Consumer) is not expected before We and consensus are cautiously modelling a 5 10% decline in 2015 Automotive revenue we had previously expected flat to slight growth. This new degree of caution going forward has dampened some of the enthusiasm for the stock in the aftermath of strong Automotive order intake that TomTom publicised at the Paris motor show in Q3. Further disappointments or warnings of near-term revenue erosion to Automotive, however legacy-driven they may be, are a major near-term risk for TomTom shares that could seriously undermine our positive stance on the stock. Sports watches may come under pressure as the Apple Watch launch looms (and is seemingly moving closer as Apple s production bottlenecks appear to have been resolved). The risk to TomTom s top-line is minor (5% of 2014E rev.) but a collapse of the category could hurt 2015 prospects as much as the category s success has helped the current year s metrics (the watch was partly behind several guidance upgrades issued by TomTom, after perhaps having been too harshly warned on in early 2014). Key longer-term risks and uncertainties are as follows. The PND market, having shown some improvement despite the still-unfavourable macro conditions in TomTom s home markets (Western Europe), may relapse into severe y/y declines for a variety of reasons (larger-screen smartphones accelerating the substitution that has already been ongoing for a while; embedded and smartphonemirrored solutions taking even more share from PNDs, etc.). We currently model highsingle-digit secular declines, which seems rather pessimistic to us we ignore signs of stability in certain markets (e.g., Germany) as nothing more than an odd data point. Our analysis suggests a relapse to -20% unit declines in PNDs would shave EUR0.8 off TomTom s fair value negative but far from being the end of the world at this stage, as PND hardware revenue now represents only 36% of TomTom s overall revenue. Automotive prospects may dim if free (Google / Google Car) or smartphonemirrored (CarPlay, Android Auto) alternatives for navigation content and services win the battle for the dashboard (see THE INTELLIGENT CAR: The End of the World (as we know it). This is a tangible, but clearly long-term risk to navigation content suppliers, and the auto industry at large. Nokia HERE could increase the competitive pressure in Automotive. This is always a possibility; that said, with unsatisfactory returns (currently breakeven+; high-singledigit margins next year), HERE lacks the ammunition to go into a price war; besides, it is unclear whether the auto industry would give HERE a market share higher than the current 70-80% in embedded maps, even if HERE were to lower its prices. TomTom s map-making makeover could go wrong, take longer, or the new model could be costlier to maintain. This is a risk to future cash flows (durably higher capex, high maintenance costs of maps) that is difficult to quantify. Risks in Telematics are not that great, in our view. Competitive bidding for attractive small national fleet management targets could intensify, given the high returns commanded by the industry. That said, TomTom s largest competitors are either deeply entrenched in their national markets (Masternaut in the UK/Ireland) or confined to a specific continent (Fleetmatics in North America) as much as TomTom is restricting its M&A action to Continental Europe. We believe subscription pricing risks are minimal, as long as TomTom s solution provides highly satisfactory ROI for end-users (which is currently the case, with a 9- month payback and significant fuel, insurance and travel time savings for TomTom Telematics users). Exane BNP Paribas Research TOMTOM 16 December 2014 page 10

13 Telematics: TomTom s new crown jewel TomTom s Telematics division, which generated 2% of group sales back in 2008 (when it was still called TomTom WORK ), has grown considerably to 12% of total revenue in 2014E by quadrupling its revenue base (meanwhile, TomTom group sales have halved as PND sales have collapsed). Telematics is today TomTom s fastest-growing and most profitable division, representing the bulk of group EBIT earnings and 30% of Group EBITDA. The division is the market leader in European fleet management, active in 25 countries. TomTom s fleet management solution collects real-time vehicle data points, which are centrally converted into business intelligence that is ultimately delivered to end-users (mostly SMEs with an average fleet size of 10 vehicles) in a user-friendly manner. At the core of fleet management solutions lies cost and efficiency optimisation for commercial fleet owners. Key end-user benefits include: 5 25% fuel savings with a payback of 6-9 months; reduced CO2 emissions; increased mileage per vehicle; reduced travel time per visit; better understanding of their fleet for management; closer contact with drivers; increasing end-customer satisfaction; easier planning and compliance with working time regulations; greater safety for drivers and for the enterprise s assets and vehicles. The European fleet management market growth has experienced sustained mid-teens growth and TomTom predicts similar growth rates over the medium term (until 2018 at least). The penetration of fleet management solutions, or FMS, into Europe s commercial fleet market stands at a mere 14% (vs 20% in the more advanced US market, also seeing a CAGR of around 15%), with significant regional disparities. Figure 11: European installed base of FMS is growing 15% annually Installed base of active fleet management units in Europe million units E 2015E 2016E 2017E 2018E Source: Berg Insights, TomTom Exane BNP Paribas Research TOMTOM 16 December 2014 page 11

14 The solid underlying market growth is well reflected in the revenue trends of TomTom s overall Telematics division in recent years (2012 at 14%, 2013 at 16%). TomTom accelerated this underlying growth in late 2013 with the acquisition of Spanish FMS specialist Coordina. Doubling up on its M&A efforts this year with two similar-sized acquisitions (DAMS France, completed in Q2, and FleetLogic in the Netherlands, just announced), TomTom s Telematics is switching gears into super-growth of around 25 30%. TomTom management confirmed that approximately one similar-sized (30k subs) acquisition per year, maybe two if there is ample opportunity, should be a doable M&A target for the division over the next three years, a move that would continue to supercharge growth. Figure 12: Three sizeable Telematics acquisitions of similar size in Europe TomTom Telematics acquisitions Date M&A action Characteristic 02/12/2014 Acquisition of FleetLogic - leading Dutch FMS provider 27,000 subscription units; leader in enterprise fleets and government sales Strengthens TomTom Telematics' position as market leader in Netherlands and Europe Includes companies TripXs and Inalise 29/04/2014 Acquisition of DAMS Tracking in France 27,000 subscriptions France is the largest addressable telematics market in Europe (according to Berg Insight 2013), with about 6 million commercial vehicles in use (Light Commercial Vehicles, Trucks and Buses). Combination of existing TomTom Telematics and DAMS Tracking, makes TomTom the market leader in France 01/08/2013 Acquisition of Coordina 27,000 subscriptions Spanish market leader in FMS Source: Exane BNP Paribas estimates It is important to note that TomTom takes over the customer base but not the technologies of the acquired customer base. Clients have to migrate to TomTom s hardware (LINK BOX, PND) and/or software (WEBFLEET subscription SaaS model); the transition normally entails a takeover churn of less than 10% (normal churn runrate for WEBFLEET is a measly 0.5%). Figure 13: TomTom Telematics subscriber growth is accelerating with acquisitions of Coordina (Q3 13), DAMS (Q2 14) and FleetLogic (just announced) TomTom Telematics subscriber base (1,000s) Q3 07 Q1 08 Q3 08 Q1 09 Q3 09 Q1 10 Q3 10 Q1 11 Q3 11 Q1 12 Q3 12 Q1 13 Q3 13 Q1 14 Q3 14 Source: TomTom Exane BNP Paribas Research TOMTOM 16 December 2014 page 12

15 Telematic s revenue is 1/3 hardware (device in the actual vehicle), 2/3 service (the Webfleet SaaS solution) the latter generating recurrent revenue with relatively resilient ARPU. The key competitor is Masternaut in Europe (mostly UK/Ireland), which is slightly smaller than TomTom with around 350k subs (mid-2014). In the US, where TomTom Telematics is not active (other than via a reseller agreement with LoJack) large players such as FleetMatics, Trimble Navigation, Telogis and Zonar Systems dominate with around 300k-450k subscribers each (according to the latest Berg Insight report published in the current quarter, the top 10 players in the US market enjoy an installed base of around 2.5m active users, out of 4m total). The list of European vendors (some of which may be TomTom s future M&A targets) is a long one, including (not exhaustive): Alphabet, Astrata, Blue Tree Systems, Celtrak, Garmin International, GreenRoad, I.D. Systems, Matrix Telematics, Microlise, Mix Telematics, Trafficmaster, Transics, Arvento Mobile Systems, Mobiliz, etc. Figure 14: Telematics revenue model, which now includes 30k/year acquired subs/year in 2015E-2018E Telematics revenue Revenue - EURm e 2015e 2016e 2017e 2018e 2019e 2020e Telematics % of TomTom Group rev Telematics Hardware Telematics Subscription Telematics subscribers (k, year average) , ,302.5 Telematics ARPU (EUR/sub/month) Hardware ARPU Subscription ARPU y/y growth (%) E 2015E 2016E 2017E 2018E 2019E 2020E Telematics Telematics Hardware Telematics Subscription Telematics subscribers (k) Telematics ARPU (EUR/sub/month) (21) (7) (10) (17) (13) (6) (5) (4) (4) (4) (4) (4) - Hardware ARPU (8) (7) (6) (5) (5) (5) (5) - Subscription ARPU (5) (4) (3) (3) (3) (3) (3) Source: TomTom, Exane BNP Paribas estimates Figure 15: High operating leverage we believe TomTom Telematics can sustain >30% EBIT margins Telematics key operational indicators Telematics "mini-p&l" e 2015e 2016e 2017e 2018e 2019e 2020e Sales Gross profit Gross margin (%) Opex Opex/sales (%) EBIT EBIT margin (%) Telematics % of group EBIT D&A EBITDA EBITDA margin (%) Telematics % of group EBITDA Source: Exane BNP Paribas estimates, based on TomTom reporting Investors may be tempted to compare TomTom Telematics with one of its largest listed FMS peers, Fleetmatics (Nasdaq: FLTX) in the USA. A comparison of the operating metrics shows that the two players are similar in size (450k 500k subs) and achieve similar growth rates (c. 30%), gross margins (c. 75%) and EBITDA margins (30 35%) Exane BNP Paribas Research TOMTOM 16 December 2014 page 13

16 However, Fleetmatics displays an ARPU of USD40, twice that of TomTom Telematics, while its EBIT margins (20 25%) are roughly two-thirds those TomTom Telematics (30 35%). Ultimately, the EBITDA/EBIT discrepancy boils down to D&A c. 10% of revenue at Fleetmatics, vs only 2 3% at TomTom. The main reason for the differences between the two resides in the differences in their business models. The two companies also pursue entirely different go-to-market strategies which have significant P&L implications. Fleetmatics offers multiple fleet management platforms as a full rental concept; this revenue model is perfectly adequate in the US market. Fleetmatics thus pre-finances the hardware (hence significant capitalised hardware); its subscription price includes hardware rental, installation costs, sales costs and software (for a total ARPU of USD40). Consequently, the company has only one type of revenue (subscription), a high portion of which needs to be deferred. Pre-financed hardware needs to be amortised hence the higher D&A (and lower EBIT margin) at Fleetmatics. TomTom Telematics, on the other hand, has one legacy-free and fully scalable platform (WEBFLEET); it mostly sells the hardware upfront (i.e. receives the payment upfront) and charges the software subscription on a monthly basis. This explains the lower ARPU compared with Fleetmatics: TomTom s ARPU refers solely to the SaaS component, whereas hardware has been paid upfront by the end-customer a model favoured in Europe (TomTom now also offers a hardware rental model, that while still marginal is growing). Finally, Fleetmatics has a different go-to-market strategy, with telesales out of several US-based call centres. TomTom s Telematics relies on the indirect sales approach i.e., selling through value added resellers and distributors (partners e.g., LoJack in the US and in markets outside of Europe). Exane BNP Paribas Research TOMTOM 16 December 2014 page 14

17 TomTom may have finally found the key to Automotive navigation markets The Automotive division was at the core of TomTom s initial diversification attempts, when the PND market first started showing signs of weakness towards the end of the past decade. As navigation started to migrate away from PNDs and onto smartphones and the dashboard, TomTom management s initial idea was to literally transfer its highly successful PND into the dashboard. While this looked like a good idea to most observers at the time, numerous hurdles arose. The automotive industry and its subsets (OEMs) did not welcome a new entrant that wanted a piece of the action by supplying a crucial end-user-facing component (in-dash navigation). Where TomTom was successful (Renault, Fiat) and actually won a slot, it quickly became apparent that car makers demanded tailor-made (proprietary) solutions, negating scale economies in TomTom s Automotive business model. What was initially a business in loss as it built scale soon became a chronic money-loser. TomTom s industry-leading real-time traffic did not get the attention it deserved from the car-makers as long as it was bundled with TomTom s hardware. Many makers wanted to integrate the traffic, without committing to the hardware; however, TomTom s business model was not suited for such unbundling. Finally, the evolution of in-dash navigation as only a part of infotainment systems meant that TomTom was increasingly out of its comfort zone. The hardware it mastered (in-dash PND device) started to morph into an all-dancing, all-singing infotainment centre for the car. The combination of these roadblocks led to a progressive re-assessment within TomTom of what its automotive business should be. In the course of , the company started to offer its content in a modular format (maps, navigation software, traffic as independent components). Its first steps were very cautious but in early 2014 TomTom decided to unbundle its offer completely and to discontinue car component hardware altogether. As a result, the Automotive division now comprises content and services exclusively; hardware has been re-allocated retrospectively into Consumer (2013 is the first restated year, which renders past data of Consumer and of Automotive no longer directly comparable). The past adjustments showed that approximately half of old Automotive revenue was hardware, although there is no split (and, hence, no pro forma structure) available for pre-2013 divisional splits. The transition to this business model has several near-term consequences: Automotive hardware within Consumer has a residual revenue of c. EUR100m, that is now in terminal decline. We expect it to shrink by 20% pa and be negligible post The main residual revenue-generating clients are Renault and Fiat. What is now the new Automotive division, with only software and content, also sees the impact of the old contract phase-outs. The division now needs to generate fresh revenue streams by bidding for new contracts. In most cases these are bundled (maps/traffic/navigation software) but in some cases TomTom wins only real-time traffic (80% market share) and in others just maps (the highest ASP; TomTom has 20 30% share of in-dash maps). Exane BNP Paribas Research TOMTOM 16 December 2014 page 15

18 As a result, TomTom Automotive faces near-term revenue headwinds (phase-out of old hardware/software bundled contracts with Renault, Fiat), with potential future revenue growth stemming from contracts signed for future car models over the past months. Typically, there is a 3-year time lag between content/software deals and first related sales of the car model. TomTom s new strategy will therefore bear fruit only from 2016, as new revenue sources start offsetting legacy declines. With the Q3 results, TomTom s management announced a very strong order intake for its new perimeter Automotive division, with over EUR170m of content/software-only deals signed for future car models in the first nine months of This is sharply higher than the new Automotive division s revenue run-rate of EUR100m 110m. We understood from our discussions with management that this EUR170m backlog covers models that will sell in about 2 3 years, and usually spans 3 5 years from first sales until the model(s) in question are discontinued, refreshed or replaced. Assuming TomTom s thus-far successful strategy continues to deliver in the coming years, a similar level of intake should translate into a revenue stream that will start converging towards the EUR150m 200m mark in three years time. On this assumption, we have remodelled our assumptions for TomTom s automotive division as follows. Figure 16: TomTom s New Automotive revenue back to growth from 2016E onwards, as the new unbundled content strategy takes hold TomTom Automotive - Revenue Revenue - EURm (*) E 2015E 2016E 2017E 2018E 2019E 2020E Automotive yoy growth (%) (10) (47) 0 (9) % of TomTom group revenue * revenue includes Automotive hardware and content/services. As of 2013, Auto revenue consists of content & services only; Auto hardware has been moved to Consumer. Source: TomTom, Exane BNP Paribas estimates Figure 17: The new business model of Automotive (from 2013 onwards) carries significantly higher gross margins; high operating leverage implies much better EBIT margins when revenue growth resumes (2017+) TomTom Automotive mini-p&l Automotive "mini-p&l" E 2015E 2016E 2017E 2018E 2019E 2020E Sales Gross profit Gross margin (%) OPEX OPEX/sales (%) EBIT (12.3) (11.8) (7.2) (10.4) (0.2) EBIT margin (%) (6.9) (10.6) (6.5) (10.4) (0.1) Automotive % of group EBIT (6.6) (46.1) (27.3) (30.8) (0.2) D&A EBITDA EBITDA margin (%) Automotive % of group EBITDA * revenue includes Automotive hardware and content/services. As of 2013, Auto revenue consists of content & services only; Auto hardware has been moved to Consumer. Source: TomTom, Exane BNP Paribas estimates There is significant positive optionality in TomTom s Automotive business: once the map-making makeover is complete, TomTom will be able to provide incremental map updates to car manufacturers and subscribers. What is currently a once-per-quarter full map release will become a monthly incremental update, gradually decreasing to once every few days. It is possible (but not guaranteed) that TomTom will be able to increase its mapping market share when real-time maps go live in early 2015, if the transition is smooth. Exane BNP Paribas Research TOMTOM 16 December 2014 page 16

19 Figure 18: Key deals and partnership announcements in TomTom Automotive (2014) Date Partner(s) Description 16/05/14 Fiat Extension of long standing partnership with Fiat to equip the new Fiat Ducato with TomTom s navigation service 29/05/14 Audi & AutoNavi Partnering with AutoNavi to provide Audi s vehicles with real-time traffic information in China, starting initially with the Audi A3 model 09/09/14 Jeep Integrates TomTom s navigation and maps solutions into the Uconnect 5 Radio Nav infotainment system of the new Jeep Renegade line 02/10/14 Volkswagen Partnership with Volkswagen Group Research to develop Highly Automated Driving systems, developing the digital maps for use in automated cars 02/10/14 Toyota Extension of agreement with Toyota to supply traffic information to Toyota Motor Europe from 2016 to /10/14 Daimler Deal with Daimler to provide its full navigation systems in Daimler s Smart range of cars, in Europe from 2014 and US & China from /11/14 Fiat Partnership with Fiat to use TomTom s navigation technology in the Uconnect infotainment systems of its new Fiat 500X model in Europe from 2015 Source: Company, Beyond these near-term transition issues, the underlying market trends seem to point to a bright future for TomTom Automotive: new passenger car registrations are projected to grow at a CAGR of 5% over the next few years, with automotive sales gradually picking up worldwide; take-up rates of in-dash navigation continue to rise, from 25% in 2012 and 27% in 2013 to 34% by 2016e; For further details on the prospects for the Connected Car, see THE INTELLIGENT CAR: The End of the World (as we know it). Exane BNP Paribas Research TOMTOM 16 December 2014 page 17

20 Consumer: legacy hardware headwinds, promising but uncertain Sports Watch The Consumer division now carries the bulk of TomTom s legacy revenue sources, namely PNDs and automotive hardware. TomTom also bundles in this division the revenue of the nascent Sports Watch range (TomTom Runner, Cardio, Golf, etc.). Additionally, the division carries consumer service/content revenue tied to a variety of devices (PND maps updates, real-time traffic subscriptions, smartphone app revenue, etc.). It was previously easy to track TomTom PND units and ASPs. However, the segment s transformations and additions (Watches, Automotive hardware, etc.) as well as changes in revenue recognition (now part-deferred) rendered tracking these key PND metrics near-impossible. In revising our estimates, we made a fresh attempt to re-categorise Consumer revenue components, based partly on reported data, partly on our estimates. Our principal concern was to isolate the amount of revenue that is in secular decline, in order to model overall Consumer revenue patterns more accurately. Figure 19: TomTom Consumer flat revenue outlook as legacy hardware declines are offset by the Sports Watch and content/services TomTom Estimated Consumer revenue division breakdown Revenue - EURm e 2015e 2016e 2017e 2018e 2019e 2020e Consumer (incl. Auto HW from 2013 onwards) 1, , , Sports Watch Automotive hardware PND units PND (m) ASP PND (EUR/unit) Consumer content & services yoy growth (%) Consumer (incl. Auto HW from 2013 onwards) (21) (4) (28) (23) 2 (5) Sports Watch Automotive hardware (16) (20) (20) (20) (20) (20) (20) - PND (15) (9) (9) (8) (7) (7) (7) units PND (m) (4) (2) (17) (24) (23) (8) (7) (7) (6) (5) (5) (5) ASP PND (EUR/unit) (7) (2) (2) (2) (2) (2) (2) - Consumer content & services % of TomTom Group revenue Consumer (incl. Auto HW from 2013 onwards) Sports Watch Automotive hardware PND units PND (m) ASP PND (EUR/unit) Consumer content & services * Consumer includes (legacy) automotive hardware as of Source: TomTom, Exane BNP Paribas estimates We expect PND markets in Europe and North America to continue declining (units) for the foreseeable future, at rates similar to last year s high single-digit drops (a little softer in outer forecast years), with significant (6 9%) annual declines in ASP. Automotive hardware (legacy in-dash hardware contracts of the old Automotive business model), being phased out, will likely see 20% revenue declines for the foreseeable future and disappear in about five years). Exane BNP Paribas Research TOMTOM 16 December 2014 page 18