(T) Telecom Stock Outlook – November 2011 – Industry Outlook

Telecommunications industry is witnessing consistent growth despite experiencing a sluggish U.S. economy. Most of the large national telecom service providers together with the regional prepaid telecom operators generated net subscriber addition in the third quarter of 2011.

In the last couple of years, capital spending constraints among telecom operators due to severe recessionary conditions were the main hindrance to the industry’s growth. However, with the economic recovery in progress, albeit a slow pace, telecom service providers are gradually expanding their network coverage on the back of significant subscriber growth.

The telecommunications industry is a major driver of global economic recovery. An unprecedented growth of high-speed mobile Internet traffic, particularly for wireless data and video, has transformed this industry into the most evolving, inventive and keenly contested industry. In addition, emergence of mobile broadband technology has created several new service areas, which potentially offers huge growth potential. This includes IPTV, collaboration and cloud computing, videoconferencing and mobile payment, to name a few.

Structure

The telecommunications industry encompasses a lot of technology-related businesses. The legacy local and long-distance wireline phone services, telecommunications industry also include wireless communications, Internet services, fiber optics networks, cable TV networks and commercial satellite communications.

A major characteristic of the telecommunications industry is the huge barriers to entry due to scarcity of public airwaves (spectrum). The U.S. telecom market is controlled by just four national players; regional low-cost operators are not eligible to compete with these large carriers.

Furthermore, it is not easy to establish a new telecom carrier since it will require government permission to transmit voice, data and video on public airwaves. Spectrum licenses are limited and therefore quite expensive. Moreover, deployment of network infrastructure, whether high-speed wireless (3G/4G) or wireline (fiber optic), requires significant capital expenditure, which very few entities can afford.

Increasing competition is actually forcing each and every player to offer heterogeneous and bundled services. For example, big telecom operators, which were predominantly providing voice transmission are now offering video services, whereas cable operators are now providing both Internet and telephony services.

On line Internet video streaming companies are also becoming major competitors to the existing players of the telecom industry. Mobile phone makers are now gradually offering tablets (small laptops); chipset manufacturers for personal computers and mobile phones are frequently interchanging their areas of operations.

Key Attribute

We believe that the overall economic dynamics may shift in favor of telecommunications industry, primarily due to its key attribute of being a major infrastructure product for both the emerging and the developed nations. In fact, the global telecommunications industry is witnessing a fundamental change.

Earlier, it was voice calls that brought money to the operators leading the equipment manufactures to concentrate on voice-enabled devices. At present, voice is taking a backseat, while data and video have become the core focus area. Any new network standard aims at faster data connectivity, quick video streaming with high resolution, and rich multimedia applications.

Telecommunications is one of the very few industries that witnessed massive technological improvement, even during the recession. The major thrust for the telecommunications sector is coming from the industry due to continuous network and product upgrade and invention by the industry players.

Growing demand for technically superior products has been the silver lining for the telecommunication industry in an otherwise tough environment. These developments are also helping telecom equipment manufacturers, infrastructure solutions providers, and mobile phone makers to consolidate their finances.

Near-Term Catalysts

The telecommunications industry benefits from: (1) an overall improving global economy, although facing fluctuations due to sovereign debt crisis, (2) significant technological inventions and innovations that make even a mature market like the U.S. highly lucrative for the telecom operators.

Several countries throughout the world have undertaken economic stimulus plans as a way to get rid of the recession. Huge government expenditures — including the U.S. broadband infrastructure development program and similar structural subsidies in China and India — have become a boon for telecom service providers and equipment manufacturers.

Furthermore, even as the global economy recovers slowly, demand for real-time voice, data and video increases by leaps and bounds. These developments are enabling the telecom service providers to undertake large network extension while upgrading plans.

Technological Innovations

Smartphones and tablets have become the next-generation choice and are increasingly taking over market share from the basic mobile handsets. Although the economy is under recovery phase, and we are not completely out of the woods, the growth in the smartphone market maintains its impressive trend.

This reflects a shift in consumer preference toward application-rich devices from ordinary mobile handsets used primarily for voice telephony. Smartphones are generally characterized by very powerful operating systems capable of supporting a variety of services and applications that need very high-speed network infrastructures.

Various industry sources estimate that smartphone shipments as a percentage of total mobile handset shipment are expected to increase by 58% by 2011 over the last year. This opportunity provides scope for telecom service providers, equipment developers, chipset manufacturers and wireless tower operators to retain new users and grow revenues moving forward.

Less than a decade ago, the telecom operators in the U.S., Western Europe, and Japan were upgrading their existing networks to high-speed 3G technologies. At present, the world telecommunications industry is talking about the installation of next-generation super-fast 4G technologies.

Several giant telecom operators globally are funding projects to deploy super-fast 4G networks of WiMAX and LTE (Long-Term Evolution). As of now, 19 LTE networks are commercially operational throughout the world. Cable TV operators are also upgrading their networks with high-speed DOCSIS 3.0 architecture.

The GSM Association has forecasted that within next 5 years, telecom operators will invest approximately $100 billion to upgrade their respective networks for accommodating hassle free transmission of mobile data and video traffic. The major technical areas will be High-Speed Packet Access (HSPA), 3G mobile broadband, and next-generation (4G) LTE. One simple example of this significant rate of growth is that LTE network, which was globally first deployed in late 2009, at present provides over 1 million connections.

As smartphone users are now downloading increasing multimedia contents, video has become the primary network traffic. What is more interesting, in addition to download, the smartphone and tablet users are uplinking more and more video content, and in turn, becoming broadcasters on their own. Several industry researchers predicted that video may account for 60% of total network traffic by the end of 2012.

Competition and Consolidation

Massive technology invention and innovation have resulted in significant competitive atmosphere within the telecommunications industry. Product life-cycle and upgrade-cycle have been reduced drastically since several firms are coming out with new types of products and services within a short span of time. As a result, we are witnessing hectic merger and acquisition activities to consolidate the market share.

The biggest of the merger and acquisition activity is AT&T’s (T) proposed buyout of T-Mobile U.S. If this deal gets regulatory approval, it might become the largest acquisition in this industry in the post-recession period. However, this deal is facing stiff hurdles from the U.S. Department of Justice. CenturyLink Inc. (CTL) has acquired Quest Communication, Qualcomm Inc. (QCOM) obtained Atheros Communications, and Comcast Corp. (CMCSA) has purchased NBC Universal’s 51% stake. Further, LM Ericsson AB (ERIC) has acquired Telcordia Technologies.

OPPORTUNITIES

The telecommunications industry as a whole offers a number of attributes that are difficult to ignore from the standpoint of investors.

  • Telecommunications is a necessary utility: The need for telecom in both rural and urban areas, and its role in the infrastructure of both developed and developing markets, continues to grow. In addition, economic stimulus plans in the U.S. and throughout the world should boost select service providers and equipment manufacturers.
  • Structural Subsidies: The Broadband Stimulus Program of the U.S. government has received significant acceptance among rural carriers. President Barack Obama has endorsed a wireless spectrum hike plan proposed by FCC, which will nearly double the currently available spectrum for wireless broadband services and increase Internet connectivity. FCC together with the U.S. Department of Commerce will identify unused airwaves to raise the available spectrum size to 500 MHz in the next 10 years.
  • International diversification: Though diversification within a country offers only limited protection in the current highly-correlated world equity markets, it offers hedging opportunities from local economic weakness and associated currency exchange differentials.

The companies that match well with the aforementioned considerations include AT&T Inc. (T), Qualcomm Inc. (QCOM), Verizon Communications Inc. (VZ), j2 Global Communications Inc. (JCOM) and Brightpoint Inc. (CELL).

WEAKNESSES

Generally, telecommunications companies that were under pressure in the recession have high debt levels and large financial leverage ratios or are unable to cope with the recent market trend. Other risks that remain are as follows:

  • Potential business slowdown: Lower overall top-line sales among carriers are expected to continue to weigh on capital spending decisions — a major problem for equipment vendors. The companies are expected to remain focused on improving balance sheet, financial discipline and free cash-flow generation. Unfortunately for the equipment vendors, the method of choice for improving free cash flows remains disciplined capital outlays.
  • Weak credit profiles: Over the near term, telecom companies may be exposed to high debt levels and limited liquidity, which puts a premium on sustainable cash flow to service debt obligations. As a result, telecom companies may have free cash flow impacted by a slowdown in demand.
  • Increased competition: The markets for broadband wireless solutions are emerging rapidly in terms of technological innovation. The pure wireless/wireline service providers started entering the video services market for cable operators, while the cable MSOs are entering the telephone business for the small & medium sized business enterprises.

The companies that match well with the aforementioned considerations include Tellabs Inc. (TLAB), Research In Motion Ltd. (RIMM), NII Holdings Inc. (TRV) and RadioShack Corp. (RSH).

BRIGHTPOINT INC (CELL): Free Stock Analysis Report

COMCAST CORP A (CMCSA): Free Stock Analysis Report

CENTURYLINK INC (CTL): Free Stock Analysis Report

ERICSSON LM ADR (ERIC): Free Stock Analysis Report

J2 GLOBAL COMM (JCOM): Free Stock Analysis Report

NII HLDGS-CL B (NIHD): Free Stock Analysis Report

QUALCOMM INC (QCOM): Free Stock Analysis Report

RESEARCH IN MOT (RIMM): Free Stock Analysis Report

RADIOSHACK CORP (RSH): Free Stock Analysis Report

AT&T INC (T): Free Stock Analysis Report

TELLABS INC (TLAB): Free Stock Analysis Report

VERIZON COMM (VZ): Free Stock Analysis Report

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