The U.S. telecommunications industry is currently evolving around five broad factors. These include: (i) the increasing traction of wireless networks in the telecom industry and the consequent popularity of spectrum (ii) the projection of aggressive high-speed fiber-based network expansion, especially for video/TV offerings (iii) consolidation within the industry which is likely to continue mainly on airwaves shortage and attainment of economies of scale (iv) innovative product launches are expected in areas of m-Commerce, virtualization and cloud-based technology, high-speed metro Ethernet, to name a few and (v) ample scope for expansion as nearly a fifth of rural American households lack broadband access, as per the Federal Communications Commission.
Telecom operators globally generated approximately $2 trillion in revenues in 2013, highlighting slight improvement from $1.9 trillion revenues recorded in 2012. According to a research report by Telecommunications Industry Association (TIA), the global telecommunications industry spending rose 5% in 2013 to $5.1 trillion.
Notably, the U.S. telecom industry spending rate (6.6%) had surpassed the global spending rate (4.5%) in 2013. Interestingly, this reverses a long-term telecom spending pattern that prevailed throughout the world. The TIA has also estimated that the U.S. wireless operators will spend $36.3 billion on network infrastructure and equipment in 2014, signifying an improvement of 8% year over year.
Wireless Remains the Key
Despite the massive growth in fiber-to-the-home networks, we expect wireless networks to provide a major impetus to the telecom industry. Wireless network standards are continuously evolving around the globe to offer faster speed. After significant growth of the next-generation 4G LTE network deployment, LTE-A (Long-Term Evolution Advanced) wireless network standard is gradually gaining a strong foothold worldwide.
LTE-A is the more powerful version of the legacy LTE network offering increased speed and network capacity. Carrier aggregation is the most important part of LTE-A technology as it allows wireless operators to create large spectrum assets by combining different frequency bands. Currently, there are more than 65 LTE-A network worldwide either in the form of commitments, trials or commercial deployment at the end of the second quarter of 2014.
The GSM Association's research wing, GMSA Intelligence, revealed its estimation of more than 1 billion global LTE connections by 2017. More than 465 LTE networks are expected to be commercially functional across 128 countries by the end of 2017. GSMA Intelligence further reported that LTE users consume an average of 1.5GB data per month, twofold of what is consumed by non-LTE users. In the developing countries, LTE users can generate 20 times higher average revenue per user (ARPU) to carriers than non-LTE users, whereas in the developed countries, ARPU can be 10-40% higher for LTE users than non-LTE users.
Technical Shift in the Telecom Vendor Market
The telecom infrastructure developer's market is witnessing a technical change globally. So far the main thrust of the communications service providers had been on developing advanced hardware that enabled them to attain enhanced speed, scalability and reliability. However, recent developments suggest that operators are gradually shifting focus from a hardware centric growth model to an IT/software centric business model. The primary reason behind this shift is the significant growth of cloud-based virtual networking.
Growth of software-defined networking (SDN) and network function virtualization (NFV) encouraged newly emerging digital media companies to invest heavily in the communications infrastructure market. SDN provides customers increased bandwidth utilization, higher reliability and reduced capital spending. Meanwhile, NFV is designed to consolidate and deliver the networking components needed to support a fully virtualized infrastructure -- including virtual servers, storage and even other networks. It utilizes standard IT virtualization technologies.
Broadband (High-Speed Data) Market Evolving
A major intra-industry shift has recently taken place in the high-speed Internet (Broadband) market. For the first time in the 65-year long history of the cable TV industry, broadband customer count surpassed the TV viewers count. According to a recent report by the Leichtman Research Group Inc. (LRG), the top nine cable TV operators accounted for a total of 49.915 million broadband subscribers as against 49.91 million video subscribers, at the end of second-quarter 2014.
LRG further reported that there were approximately 85.9 million high-speed data subscribers at the end of the last quarter. Out of this, cable TV operators command around 50.7 million customers (59%) and the remaining 35.2 million (41%) customers belong to telecom operators.
Mergers and Acquisitions to Continue
The U.S. telecom industry is likely to witness more mergers and acquisitions going forward. Owing to the rising demand for scarce and valuable wireless spectrum, mergers and acquisitions have increased exponentially. While established players need more spectrums to gain competitiveness, small players prefer to collaborate with strong rivals rather than trying to establish a nationwide foothold, which is extremely capital intensive.
Verizon Communications Inc.'s ( VZ ) takeover of the remaining 45% stake of Verizon Wireless from Vodafone Group plc. ( VOD ) for $130 billion marks the largest acquisition of the wireless industry. In Feb 2014, Comcast reached an agreement with Time Warner Cable Inc. ( TWC ) to acquire the latter in an all-stock deal valued at around $45.3 billion.
Softbank of Japan acquired a 78% stake in Sprint Corp. ( S ) for $21.6 billion. In May 2014, DIRECTV ( DTV ) reached a definitive agreement with AT&T Inc. ( T ) to sell its business to the latter for $48.5 billion. Satellite TV operator DISH Network Corp. ( DISH ) and French broadband operator Iliad SA are currently pursuing the acquisition of T-Mobile US Inc. ( TMUS ).
Severe spectrum crunch coupled with gradual smartphone adoption are compelling wireless operators to seek other options to raise revenues. Further, growing demand for technically superior products has been the silver lining for the telecommunication industry in an otherwise tough environment.
The cloud-managed WiFi market has become a major growth driver for telecom operators as increasing number of large and mid-sized business enterprises are adopting this technology. Large business enterprises generally have presence throughout the world. A strong and robust wireless network is essential for these companies to maintain connections with remote sites. Cloud-managed WiFi network has become indispensable for these large business houses as it offers several advantages like central manageability, smaller physical footprint and linear scalability.
The machine-to-machine (M2M) wireless communications technology has been significantly driving mobile data revenues for wireless service providers. M2M is a rapidly growing market opportunity. According to a report by research firm IDATE, the global M2M communications market is expected to generate revenues of over $53 billion in 2019, substantially up from $33 billion in 2013. Over the same time frame, the number of M2M module deployment is predicted to rise from 175 million to 470 million.
Zacks Industry Rank
Within the Zacks Industry classification, Telecommunications is broadly grouped in the Computer and Technology sector (one of the 16 Zacks sectors) and are further sub-divided into twelve industries at the expanded level: Communications Infrastructure, Communications Components, Satellite Communications, Cable TV, Communications Semiconductor, Wireless Equipment Supplier, National Wireless Service Provider, Rural Wireless Operator, Rural Wireline Operator, Non-U.S. Wireless Operator, National Wirleline Operator and Non-U.S. Wireline Operator. The level of sensitivity and exposure to different stages of the economic cycle vary for each industry.
We rank all the 260 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank. As a guideline, the outlook for industries with a Zacks Industry Rank of #88 and lower is 'Positive,' between #89 and #176 is 'Neutral' and #177 and higher is 'Negative.'
The Zacks Industry Rank for Communications Infrastructure is #173, Communications Component is #188, Satellite Communications is #48, Cable TV Operators is #190, Communications Semiconductor is #11, Wireless Equipment Supplier is #207, National Wireless Service providers is #73, National Wireline Operators is #106, Rural Wireless Operators is #106, Rural Wireline Operators is #106, Non-U.S. Wireless Operators is #181 and Non-U.S. Wireline Operators is #247. Looking at the Zacks Industry Rank of the twelve telecommunications industries, we derive that the near-term outlook for the group is tending toward 'Neutral.'
Earnings Trends of the Sector
The broader Technology sector, of which the Telecommunications industry is part, remains strong with respect to earnings. So far, as much as 98.5% of the sector participants have reported second-quarter 2014 results, which have been strong in terms of beat ratios (percentage of companies coming out with positive surprises) and have generated considerable growth.
Both earnings beat ratio and revenue beat ratio were fairly robust at 64.1% and 65.6% respectively. Additionally, total earnings for the reported companies have shown a significant 12.1% year-over-year increase on a 5.9% growth in revenues. This compares with a substantially lower earnings growth of 4.6% on a much lower 3.1% growth in revenues in the first quarter of 2014.
Meanwhile, the consensus earnings expectations for full year 2014 also depict an impressive trend. Earnings growth is expected to rise 2.4% in the third quarter and a stronger 6.9% in the fourth quarter. Overall, the sector is expected to register full-year earnings growth of 12.5%.
For a detailed look at the earnings outlook for this sector and others, please read our weekly Earnings Trends reports.
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, will continue to grow. In addition, economic stimulus plans in the U.S. and throughout the world should boost the performance of select service providers and equipment manufacturers.
- Barrier to Entry: The lack of public airwaves (spectrum) in the telecommunications industry creates a high barrier to entry. The U.S. telecom market is controlled by just four national players, as regional low-cost operators are not eligible to compete with large carriers. Furthermore, it is not easy to establish a new telecom carrier since it will require government approval to transmit voice, data, and video on public airwaves. Spectrum licenses are limited and therefore quite expensive. Moreover, the deployment of network infrastructure requires significant capital expenditure, which very few entities can afford. Thus, this barrier protects the profits of incumbents.
- Strong Demand: A recovering economy speeds up the demand for real-time voice, data and video manifold. The escalation in demand has encouraged telecom service providers to undertake large network extensions while upgrading plans. Moreover, the FCC projects mobile data demand to grow 25-50 fold over the next five years.
The companies that match well with the aforementioned considerations include Telefonica SA ( TEF ), China Mobile Ltd. ( CHL ), Cellcom Israel Ltd. ( CELL ), BlackBerry Ltd. ( BBRY ) and Cablevision Systems Corp. ( CVC ). Telefonica, China Mobile and Cellcom currently sports a Zacks Rank #1 (Strong Buy) while both BlackBerry and Cablevision have a Zacks Rank #2 (Buy).
In general, the telecommunications companies that are 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: Sales fluctuations of 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 sheets, financial discipline and free cash-flow generation.
- Product Overlapping: We may see more product sharing deals between telecom, cable TV and satellite TV operators as each of these players are trying to gain a foothold in each other's territory. Even pay-TV services, offerings to business enterprises, and mobile backhaul and metro-Ethernet segments may witness more convergence. While mobile phone makers are now gradually offering tablets (small laptops), chipset manufacturers -- who provide chips for personal computers and mobile phones -- frequently interchange their areas of operations.
- Increased Competition: Technological upgrades and breakthroughs have resulted in cutthroat price competition. Product life-cycle and upgrade-cycle have been reduced drastically as several firms are introducing new products and services within a short span of time. Increasing competition is forcing every player to offer heterogeneous and bundled services.
Signs of the above-mentioned weaknesses can be seen in China Unicom Ltd. ( CHU ), DISH Network Corp., Shaw Communications Inc. ( SJR ), Liberty Global plc. (https://www.nasdaq.com/symbol/lbtya>LBTYA) and Arris Group Inc. ( ARRS ). All these stocks currently have a Zacks Rank #4 (Sell).
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report