Telecom Stock Outlook - Oct. 2012 - Industry Outlook

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The unprecedented growth of high-speed Internet traffic, particularly for wireless data and video, has transformed the Telecommunications industry into the most evolving, inventive and keenly contested space. In addition, the 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.

Research firm Gartner reports that worldwide revenue of telecom service providers is expected to reach $1.686 trillion in 2012, an improvement of 1.4% year over year. Similarly, worldwide revenue of telecom equipment manufacturers is expected to reach $377 billion in 2012, improving 10.8% year over year.

Recent Performance

Despite the slow moving U.S. economy, the outlook for the U.S. telecommunications industry remains favorable. This is evident from the stock price movement of the large nationwide carriers.

During the first three quarters of 2012, the stock price of Verizon Communications Inc. ( VZ ) and AT&T Inc. ( T ) was up a respective 19.1% and 29.3%, while the stock price of Sprint Nextel Corp. ( S ) shot up 135.9%. In comparison, over the same time period, the benchmark S&P 500 index was up by just 12.8%.

Structure

The telecommunications industry encompasses myriad technology-related businesses. Besides the legacy local and long-distance phone services, the telecommunications industry also includes wireless communications, Internet services, fiber optics networks, cable TV networks and commercial satellite communications.

A major characteristic of the telecommunications industry is the high barriers to entry due to scarcity of public airwaves (spectrum). The U.S. telecom market is controlled by just four national players, as 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.

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. Telecommunications is one of the very few industries which witnessed massive technological improvement even under recession. The major thrust of the telecommunications sector is backed by continuous network and product upgrade and invention by the industry players.

For the last 15 years, the U.S. wireless sector invested an enormous $300 billion to install the most efficient seamless communications networks in the world. The telecommunications industry as a whole generates over 2.4 million jobs in the U.S., which is expected to grow by another 200,000 in 2012 due to increasing adoption of next-generation super-fast 4G LTE networks.

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.

Wireless is the Key

Despite the massive growth in fiber-to-the-home networks, we believe wireless networks will be the key player in the telecom industry growth story. Besides, the sector is witnessing a fundamental change. Earlier, it was voice calls that brought money to the operators. Currently, data and video have become the focus.

Any new network standard aims at faster data connectivity, quick video streaming with high resolution, and rich multimedia applications. Currently, the U.S. has approximately 300 million wireless subscribers.

Spectrum Crunch & Market Saturation

The U.S. wireless industry is facing acute spectrum shortages, sometime resulting in data packet dropping. Carriers are investing heavily for more effective utilization of their existing spectrum holding and are trying hard to add more spectrums to their portfolio.

In addition to the four nationwide carriers, all the smaller pre-paid wireless operators are also opting for a sound LTE network to offer hassle free broadband video streaming and data transmission. Meanwhile, smartphone penetration has crossed more or less half of the total U.S. post-paid wireless subscribers.

Severe spectrum crunch coupled with gradual smartphone market saturation is forcing the wireless operators to look for other options to raise revenue. These include new pricing plans, a shift from unlimited data usage to tier-based data usage, and higher upgrade fees for smartphones in order to offset handset subsidies. In fact, the average revenue per user for most of the wireless carriers is rising over the last two years and is expected to grow in the long term primarily due to massive growth in mobile data usage.

As smartphone users are now increasingly downloading multimedia contents, video has become the primary driver of 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 in their own right. Several industry researchers expect video to account for 60% of total network traffic by the end of 2012.

Near-term Catalysts

The U.S. telecommunications industry is likely to be benefit in the near future from two developments: (1) recent approval of the FCC to initiate a fresh round of spectrum auction for the wireless industry; (2) significant technological inventions and innovations that make even a mature market like the U.S. highly lucrative for the telecom operators.

On September 28, the FCC decided to free up spectrum currently used by TV broadcasters for commercial wireless networks and to deploy a nationwide interoperable public-safety broadband network. Huge proliferation of smartphones, tablets, and several other pocket-sized mobile devices significantly raised the demand for bandwidth for seamless wireless connectivity. The spectrum auction is expected to shore up $15 billion in the U.S. government exchequer.

Moreover, a recovering economy speeds up the demand for real-time voice, data, and video manifold. The FCC has estimated that within the next five years, mobile-data demand will grow 25-50 folds from its current level. These latest developments are enabling the telecom service providers to undertake large network extension while upgrading plans. The decision of Congress is mainly aimed to solve growing consumer demand for efficient wireless networks.

Merger and Acquisition to Continue

The failed merger between AT&T and T-Mobile USA appears to have propelled the latter to get together with MetroPCS Communications Inc. ( PCS ) to improve its competitive position. AT&T needs spectrum to compete with its bigger rival Verizon Wireless. Verizon recently bought spectrum from major cable MSOs including Comcast Corp. ( CMCSA ), Time Warner Cable Inc. ( TWC ) and Bright House Networks. DISH Network Corp. ( DISH ), which holds a large wireless spectrum, has already declared that it is not averse to a deal as an acquirer or an acquired entity.

Competition Looms Large

Technological upgrades and breakthroughs have resulted in a cut-throat telecommunications industry. Product life-cycle and upgrade-cycle have been reduced drastically as several firms are coming out with new types of products and services within a short span of time. Increasing competition is actually forcing each and every player to offer heterogeneous and bundled services.

We may see more product sharing deals between telecom, cable TV, and satellite TV operators as each of these players are trying to get a foothold into another's territory. Even pay-TV services, offerings to business enterprises and mobile backhaul and metro-Ethernet segments may witness more convergence. Mobile phone makers are now gradually offering tablets (small laptops); chipset manufacturers are offering personal computers and mobile phones are frequently interchanging their areas of operations.

OPPORTUNITIES

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

  • Telecommunications - 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, will continue 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 the FCC, which will nearly double the currently available spectrum for wireless broadband services while increasing Internet connectivity. The 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 ), Verizon Communications Inc. ( VZ ) and MetroPCS Communications Inc. ( PCS ).

WEAKNESSES

Generally telecommunications companies that were under pressure have high debt levels and large financial leverage ratios or are unable to cope with the recent market trends. 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 faced by equipment vendors. The companies are expected to remain focused on improving their 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.
  • Market saturation: Slow growth of the postpaid wireless subscribers in the second quarter of 2012 indicates potential market saturation. The four major U.S wireless carriers added a net 405,000 postpaid subscribers, which is less than half of the net subscribers these companies together added in the year-ago quarter.
  • 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- and medium-sized business enterprises.

Showing signs of the abovementioned weaknesses include SK Telecom Co. Ltd. ( SKM ), Telefonica Brasil S.A. ( VIV ) and NII Holdings Inc. ( NIHD ).


 
COMCAST CORP A (CMCSA): Free Stock Analysis Report
 
DISH NETWORK CP (DISH): Free Stock Analysis Report
 
NII HLDGS-CL B (NIHD): Free Stock Analysis Report
 
METROPCS COMMUN (PCS): Free Stock Analysis Report
 
SPRINT NEXTEL (S): Free Stock Analysis Report
 
SK TELECOM CO (SKM): Free Stock Analysis Report
 
AT&T INC (T): Free Stock Analysis Report
 
TIME WARNER CAB (TWC): Free Stock Analysis Report
 
TELEF BRASIL SA (VIV): Free Stock Analysis Report
 
VERIZON COMM (VZ): Free Stock Analysis Report
 
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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , Business , Investing Ideas , Stocks

Referenced Stocks: CMCSA , DISH , NIHD , PCS , S

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