U.S. Telecom Industry Stock Outlook - May 2016

The U.S. telecommunications industry is likely to witness reasonable growth through 2016. This industry has lately emerged as an intensely contested space where success thrives largely on technical superiority, the quality of services and scalability. Cut-throat pricing competition may put pressure on margins. Nevertheless, uninterrupted advancement in telecom technologies has helped telecom operators and equipment manufacturers adopt newer business models in order to boost revenues.

4G LTE Momentum Continues

Long-Term Evolution (LTE), the super-fast wireless communications technology, is gaining rapid momentum worldwide. 4G wireless networks primarily aim to cope with the substantial rise in demand for high-speed wireless data services and mobile video.

According to a research report published by the Global Mobile Suppliers Association (GSA), the number of LTE subscribers worldwide has crossed the 1 billion mark. In the fourth quarter of 2015 alone, LTE subscriptions grew by over 156 million. At this rate, 4G LTE is set to outnumber 3G (all forms of 3G technologies) subscribers globally by 2020. GSA further stated that in 2015 alone, 4G LTE generated a net 552.2 million subscription worldwide, reflecting a whopping 107% improvement year over year.

Moreover, as per a report by research firm IHS Infonetics, the LTE infrastructure market size has touched a record $13 billion in the fourth quarter of 2015, an improvement of 11% sequentially and 3% on a year-over-year basis.

Further Evolution of 4G LTE Technology

Wireless network standards are continuously evolving around the globe to offer faster speed. Following significant deployment of 4G LTE networks, LTE-A (Long-Term Evolution Advanced) wireless networks are gradually finding solid foothold globally. LTE-A is a more powerful version of the legacy LTE network offering increased speed and network capacity. The latest version of LTE-A network, which is popularly known as LTE-Advanced Pro (3GPP Release 13) will be a major step toward the smooth transition from 4G to the upcoming 5G network standard.

Upcoming 5G Wireless Technology

Several industry researchers hold that 5G network will provide a download speed of 1 Gbps (gigabit per second), which is 200 times the throughput of the currently available standard 4G LTE network. Latency period of data delivery will be in single milliseconds. Further, 5G technology is designed to be more power efficient than any other standard wireless networks available these days. Naturally, 5G-enabled mobile devices are likely to last much longer than their 3G or 4G counterparts.

According to the research firm ABI Research, 5G network deployment is expected to ramp up after 2020 and its market size may reach $247 billion worldwide by 2025. North America, Asia-Pacific, and Western Europe will be the three regions that will pioneer 5G network deployment.

As per a report from the research firm iGR, U.S. telecom operators will spend around $104 billion during 2015-25 to upgrade their existing 4G networks to 5G standards and thereafter, execute full installation of 5G wireless services. Consequently, telecom infrastructure developers will have enormous opportunity for growth.

U.S. telecom behemoth Verizon Communications Inc. ( VZ ) is currently conducting field trials for its upcoming 5G wireless network with its partners. The company is looking at mobile hotspot and fixed wireless for initial deployment of the next-generation 5G wireless networks in the U.S. in 2017. In Feb 2016, another U.S. telecom giant AT&T Inc. ( T ) requested the Federal Communications Commission (FCC) to grant a license to test 5G technologies. In Mar 2016, T-Mobile US Inc. ( TMUS ) sought the FCC's approval for a millimeter wave radio test license to conduct test run of 5G wireless standards. Leading mobile chipset manufacturer Qualcomm Inc. ( QCOM ) is working hard to develop chipsets for the 5G mobile standard.

Mobile Video Business Gaining Traction

Internet TV is gradually gaining a strong foothold in the U.S. The legacy pay-TV industry in the country has been facing severe competition from online video streaming service providers. The low-cost over-the-top video streaming service has resulted in massive cord cutting that is currently threatening the pay-TV business model.

Internet TV has emerged as a strong alternative to counter this competitive threat. At present, the web-based digital media market is growing rapidly. The digital media brands are gradually gaining significant market traction especially among the young generation. With demand for smartphones and tablets on the rise, target customers are increasingly watching videos online, preferring them over costlier legacy pay-TV connections.

New Growth Driver: Online Digital Advertisement

Advertisement on the mobile video platform is gradually shifting from simple selling of banner ads on the mobile web to automated or programmatic ad selling. Pay-TV operators are gradually adopting the data-driven advertising technique that is already popular in the web-based advertisement arena. To derive maximum synergies from the combined video content and video distribution platform, these companies are extensively penetrating into the advertising technology market.

Inclusion of dynamic ad-insertion, targeted audience advertising and data-driven TV advertisements are steps toward the same objective. According to market research company eMarketer, the global mobile ad market value is expected to reach $ $133.7 billion by 2017.

Key Attributes for 2016

(1) The telecommunications industry is essentially characterized by high barriers to entry. The deployment of network infrastructure requires significant capital expenditure, which very few entities can afford. Furthermore, it is not easy for a new telecom carrier to establish itself in the market as it requires government approval to transmit voice, data, and video. Such barriers protect the profits of incumbents.

(2) A major characteristic of the telecommunications industry is that it is immune to international geo-political disturbances even when they lead to economic fluctuations. This is because the need to remain connected springs from our earliest instincts to communicate with fellow human beings. Volatility in the global economy due to a slowdown in China and its currency devaluation, along with the sovereign debt crisis in Europe and political disturbances in the Middle East has had little impact on the sector.

(3) Wireless network strength is the key to future growth of the overall telecom industry. As wireless networks run on radio frequency, spectrums (airwaves) have naturally become the most sought after asset in the industry. Spectrum auctions conducted by the FCC from time to time will significantly boost network capacity.

(4) Telecom companies offer one of the highest dividend yields in the U.S. economy. The dividend yield, measured as dividends paid by a company in the last 12 months relative to its share price, is currently around 5% for the telecom sector compared with a mere 2% (approximately) for the benchmark S&P 500 index. Unlike other industries, U.S. telecom operators generate their revenues predominantly in the country. This makes these stocks less susceptible to volatility in the foreign exchange rate as well as macro-economic fluctuations plaguing the rest of the world. We believe the strong dividend yield momentum will continue as the U.S. economy slowly returns to stability.

(5) Mergers and acquisitions (M&A) are not uncommon in the U.S. telecom industry, despite strict regulations implemented by the FCC to put a check on monopolistic practices. Telecom and pay-TV operators often join forces to provide better and attractive bundled products to their customers. In order to stay abreast of competition, existing players need to be constantly on their toes to introduce innovative products or merge with other companies. In the near future, the U.S. telecom industry is slated to witness further mergers and acquisitions and product diversifications.

Major Upcoming Developments

(1) The FCC has started the auction of 600 MHz low-band spectrums on Mar 29, 2016. The 600 MHz airwaves auction, popularly known as "Incentive Auction" is crucial for wireless operators as the signals can be transmitted over longer distances and through brick-and-mortar walls in cities. These airwaves will be freed by TV broadcasters who have no productive use for the same. The FCC had concluded an Advanced Wireless Servies-3 (AWS-3) spectrum auction in Jan 2015, accumulating a record-breaking $44.89 billion.

(2) The court verdict on the FCC proposed net neutrality rules is expected in 2016. In Dec 2015, a federal appeals court in Washington D.C. took up the lawsuit related to the net neutrality norms. On Feb 26, 2015, in a historic decision, the FCC had approved net neutrality rules after a majority voting. The new laws classify high-speed broadband (Internet) as a public utility under Title II of the 1934 Communications Act instead of section 706 of the 1996 Telecom Act. By way of this, the FCC is poised to gain stronger control over the Internet Service Providers (ISPs). Leading ISPs and several other sector participants have strongly opposed the FCC's decision.

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 thirteen industries at the expanded level: Communications Infrastructure, Communications Components, Satellite Communications, Cable TV, Diversified Communications Services, Internet Services, 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,' those between #89 and #176 is 'Neutral' while for those with #177 and higher is 'Negative.'

The Zacks Industry Rank for Communications Infrastructure is #40, Communications Components is #108, Internet Services is #95, Satellite Communications is #196, Cable TV Operators is #18, Diversified Communications Services is #58, Wireless Equipment Supplier is #199, National Wireless Operators is #111, National Wireline Operators is #245, Rural Wireless Operators is #111, Rural Wireline Operators is #111, Non-U.S. Wireless Operators is #168 and Non-U.S. Wireline Operators is #212. Looking at the Zacks Industry Rank of the 13 telecommunications industries, we believe that the near-term outlook for the group is tending more toward 'Neutral.'

Earnings Trend in the Sector

The broader Technology sector, of which the telecommunications industry is a part, delivers a moderate show with respect to earnings. So far, 75.8% of the sector participants have reported first-quarter 2016 financial results, which have been mixed in terms of beat ratios (percentage of companies coming out with positive surprises). Earnings and revenue growth figures have also been modest.

While the earnings beat ratio was a strong 70.2%, the revenue beat ratio was 51.1% in the first quarter. Nevertheless, total earnings for the reported companies have shown a 5.6% year-over-year decrease on a mere 1.0% growth in revenues. This compares unfavorably with substantially lower earnings decline of 1.3% on 2.4% growth in revenues in the fourth quarter of 2015.

Meanwhile, the consensus earnings expectation for the next two quarters depicts a mediocre trend. Earnings growth is expected to decline 5.6% in the second quarter and further 2.2% in the third quarter of 2016. On the other hand, revenue growth is expected to rise 2.1% in the second quarter and further to 1.8% in the third quarter of 2016.

For a detailed look at the earnings outlook for this sector and others, please read our weekly Earnings Trends reports.

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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 Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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