Analyst Interviews: Telecom Stock Outlook

The telecommunications industry is identified as 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. Several industry researchers estimated that the market size of the global telecommunications industry may reach $1.8 trillion ? $2 trillion in the next three years. The U.S. telecommunications industry will hold the largest share of it.

Structure

The telecommunications industry encompasses a lot of technology-related businesses. Besides the legacy local and long-distance wireline 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 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 would 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 expenditures, 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 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.

In last 15 years, the U.S. wireless industry invested an enormous $300 billion to install 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 gowning 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. The sector is witnessing a fundamental change. Earlier, it was voice calls that brought money to the operators. At present, 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. Growing demand for wireless products has been the silver lining for the telecommunication industry in an otherwise tough environment.

Recent Performance

Telecommunications industry is witnessing consistent growth despite experiencing a slow moving U.S. economy. Most of the large national telecom service providers together with the regional prepaid telecom operators generated net subscriber addition in the fourth quarter of 2011.
Verizon Wireless, a joint venture between Verizon Communications Inc. (NYSE:VZ) and Vodafone Group plc. (NYSE:VOD), added 1.2 million post paid subscribers, its second best result in last two years. AT&T Inc. (NYSE:T) added a net 717,000 wireless subscribers, its historic high quarterly figure. Sprint Nextel Corp. (NYSE:S) gained a net 161,000 postpaid subscribers. MetroPCS Communications Inc. (NYSE:PCS) and Leap Wireless International Inc. (NASDAQ:LEAP) added net 197,410 and 175,000 wireless subscribers, respectively, in the previous quarter.

Near-term Catalysts

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

In February 2012, The U.S. Congress has 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 generate $25 billion ? $30 billion in the U.S. government exchequer.

Furthermore, as the global economy recovers slowly, demand for real-time voice, data, and video increases by leaps and bounds. The FCC has estimated that within the next 5 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.

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.

GSM Association has forecasted that within the 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 2 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.

Mergers & Acquisitions to Continue

Despite the failed merger agreement between AT&T and T-Mobile USA, we believe the U.S. telecom industry will witness more M&A in 2012. AT&T needs spectrum to compete with its bigger rival Verizon Wireless. Similarly, small prepaid operators like MetroPCS and Leap Wireless may also join or merge with a nationwide carrier in order to attain economies of scale and pricing power. DISH Network Corp. (NASDAQ: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

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. 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 the other?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 for 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 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 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. 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. (NYSE:T), Verizon Communications Inc. (NYSE:VZ), MetroPCS Communications Inc. (NYSE:PCS) and CenturyLink Inc. (NYSE:CTL).

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 on the back of 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.

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The companies that match well with the aforementioned considerations include France Telecom (NYSE:FTE), United States Cellular Corp. (NYSE:USM) and NII Holdings Inc. (NASDAQ:NIHD).
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CENTURYLINK INC (CTL): Free Stock Analysis Report
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Source: http://www.dailymarkets.com/stock/2012/03/02/analyst-interviews-telecom-stock-outlook/

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