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The world economy is currently going through a recovery phase, albeit at a very slow pace. Although we are not out of the woods, and a fully phased upswing may take longer to establish than previously expected, the Telecommunications Industry is identified as a major driver of economic recovery. We believe that the overall economic dynamics may shift in favor of this industry, primarily due to its key attribute of being a major infrastructure product for both emerging as well as developed nations.
The telecommunications industry encompasses a lot of technology-related businesses. Besides the legacy local and long-distance wireline phone services, telecommunications also include wireless communications, Internet services, fiber optics networks, cable TV networks and commercial satellite communications. While our overall view is Neutral for the industry, a number of stocks offer attractive opportunities over the mid- to long-term time horizons.
The telecommunications industry benefits from: (1) an improving global economy, which makes the overall macro-outlook buoyant, and (2) significant technological inventions that make even a mature market like the U.S. highly lucrative for telecom operators.
Several countries throughout the world unveiled economic stimulus plans as a way out of the last 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 select telecom service providers and equipment manufacturers.
The Broadband Stimulus Program of the U.S. government has received significant acceptance among rural carriers. The total allotted fund was $7.2 billion, out of which the first round amounted to a $4 billion injection in the industry. President 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. 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.
The largest emerging economy, China, is gradually deploying its home-grown TD-SCDMA (3G) network and has opened up a market opportunity of more than $10 billion for several wireless operators, telecom gear makers, and handset developers. India, the second-largest emerging economy, recently completed its 3G spectrum auctions and is on the verge of 3G network deployments. Additionally, several Central American, Latin American and western European countries are quickly allotting spectrum for next-generation high-speed networks.
However, the major thrust for the telecommunications sector is coming from within the industry due to continuous network and product upgrade and invention by industry players. Telecommunications is one of the very few industries that witnessed massive technological improvements, even under the recession. Fabulous demand for technically innovative products has been the silver lining for the telecommunication industry in an otherwise tough environment.
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. Now the world telecommunications industry is talking about the installation of the 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). Cable TV operators, which are major competitors to the telecom giants, are also upgrading their networks with high-speed DOCSIS 3.0 architecture. These developments are likely to help telecom equipment manufacturers consolidate their top-lines.
The 4G LTE network has already been launched in several Scandinavian countries, while the 4G WiMAX is getting increasingly deployed in the U.S. and the country is on the verge of getting its first LTE network. Japan will also get LTE from the end of 2010.
In fact, the global telecommunications industry is witnessing a fundamental change. Earlier it was voice calls that brought money to the operators. Therefore equipment manufactures were also concentrating on voice-enabled devices. Now, voice is taking a backseat, while data and video have become the core focus areas. As such, new network standards are aimed at faster data connectivity, quick video streaming with high resolution, and rich multimedia applications.
Smartphones have become the next-generation choice and are increasingly taking over market share from basic mobile handsets. Smartphones are generally characterized by 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 from 20% in 2009 to more than 50% by 2012.
Capital spending constraints among carriers over the last couple of years due to severe recessionary conditions were the main hindrance to the growth of this industry. However, with the economic recovery more or less in place, large telecom service providers are gradually expanding their fiber-based networks on the back of significant subscriber growth.
We have seen that sector diversity is a less secure natural hedge in today’s increasingly correlated world markets. Nevertheless, telecom carriers and equipment providers belong in all well-diversified equity portfolios. Telecom carriers and equipment providers that offer the most attractive opportunities are focused on 3G wireless technologies, emerging 4G technologies, broadband and fiber-to-the-home/premises networking.
The industry offers a number of attributes that investors should always in keep while looking at the overall build of their portfolios.
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.
Massive growth of smart-phones: In spite of the challenging global economy, the growth in the smart-phone mobile market maintains its impressive trend. This primarily reflects a shift in consumer preference towards feature-enhanced PDA devices from ordinary mobile handsets used primarily for voice telephony. This opportunity provides scope for telecom service providers, equipment manufacturers, chipset developers and wireless tower operators to retain new users and grow revenues moving forward.
International diversification: While 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.
Companies that match well with the aforementioned considerations include ADTRAN Inc. (ADTN - Analyst Report), JDS Uniphase Corp. (JDSU - Analyst Report), AT&T (T - Analyst Report), TELUS Corp. (TU - Analyst Report), Qualcomm Inc. (QCOM - Analyst Report) and American Tower Corp. (AMT - Analyst Report).
Generally, telecommunications companies that have been under pressure in the current downturn have high debt levels and large financial leverage ratios or are unable to cope with the recent market trend. These companies may have difficulties should overall business activity take longer to revive as consumers and enterprises become more selective in their spending. Other risks that remain include the following:
Potential business slowdown: Lower overall top-line sales among carriers are expected to continue weighing on capital spending decisions -- a major problem for equipment vendors. Companies are expected to remain focused on balance sheet improvements, 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. While the pure wireless/wireline service providers started entering the video services market for cable operators, the cable MSOs are in turn started entering the telephone business for the small & medium sized business enterprises.
Companies that match well with the aforementioned considerations include Arris Group Inc. (ARRS - Analyst Report), Novatel Wireless Inc. (NVTL - Analyst Report) and United States Cellular Corp. (USM - Analyst Report).