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The telecommunications industry is identified as a major driver of global economic recovery. Unprecedented growth in high-speed mobile Internet traffic, in particular for wireless data and video, has transformed the industry into the most evolving, inventive and keenly contested space. In addition, the emergence of wireless broadband technology has created several new service areas, which offer huge growth potential.

Currently, the U.S. Telecommunications Industry is evolving around broad factors, including wireless gradually becoming the future of the telecom industry, and consequently spectrum is gaining popularity. High-speed fiber-based network is projected to expand more aggressively, especially for video/TV offerings.

In addition, consolidation within the industry will continue, mainly due to shortage of airwaves and for attaining economies of scale. Innovative products will be launched in areas of m-Commerce, virtualization and cloud-based technology, high-speed metro Ethernet, to name a few. Apart from these, there still remains ample scope for expansion in the U.S. According to the Federal Communications Commission (FCC), nearly a fifth of rural American households lack broadband access.     

Wireless Is the Key

Despite the massive growth in fiber-to-the-home networks, we believe that wireless networks will boost growth in the telecom industry. Moreover, the sector is witnessing a fundamental change. The focus of the operators has shifted from voice calls to data and video. 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. Mobile broadband has become the most lucrative source of revenue for the wireless operators. Massive growth of data buoyed by mounting smartphone adoption is the main reason for this favorable scenario. The U.S. currently accounts for 70% of LTE subscribers in the world. Apart from the terrestrial wireless network, the U.S. has an advanced satellite broadband network, mobile satellite radio system and extensive WiFi network.

Spectrum Crunch

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.

The U.S. wireless industry is facing acute spectrum shortage, resulting in data packet dropping at times. Carriers are concentrating on the effective utilization of existing spectrums along with acquiring more of it.

Mergers and Acquisitions to Continue

We believe that the U.S. telecom industry will witness more mergers and acquisitions in 2013. As the scarce and valuable wireless spectrum becomes utmost necessity, mergers and acquisitions increased exponentially. The strong established players need more spectrums to gain competitiveness, small players prefers to merge with strong rivals rather than trying to establish a nationwide foothold which is extremely capital intensive.    

Verizon Communications Inc. (VZ - Analyst Report) bought spectrums from major cable MSOs including Comcast Corp. (CMCSA), Time Warner Cable Inc. (TWC - Analyst Report) and Bright House Networks. Recently, Verizon announced the largest acquisition proposal of the wireless industry. The company has decided to acquire the remaining 45% stake of the Verizon Wireless Network from Vodafone Group plc. (VOD) for about $130 billion. Verizon currently holds the majority 55% of this venture.

Pre-paid wireless operator MetroPCS has been acquired by T-Mobile US Inc. (TMUS - Snapshot Report) and another pre-paid operator Leap Wireless International Inc. (LEAP) is awaiting regulatory approval to be acquired by AT&T Inc. (T - Analyst Report). Softbank of Japan recently acquired a 78% stake in Sprint Corp. (S - Analyst Report) for $21.6 billion. Satellite TV operator DISH Network Corp. (DISH - Analyst Report) currently has a lucrative portfolio of spectrums (an estimated value of $10 billion) and is looking for a suitable merger option to develop a nationwide wireless network.

Product Innovation

Severe spectrum crunch coupled with gradual smartphone adoption is forcing the wireless operators to look for other options to raise revenues. These include new pricing plans, a shift from unlimited data usage to tier-based data usage, and higher upgrade fees for smartphones and tablets in order to offset handset subsidies.

In fact, the average revenue per user for most of the wireless carriers has been rising over the last two years. It is also expected to grow in the long term primarily due to massive growth in mobile data usage. Smartphone and tablet users are progressively uploading video content and are becoming broadcasters in their own right.
   
Over the last 15 years, the U.S. wireless sector has invested a whopping $300 billion to install the most efficient seamless communications networks worldwide. In 2012, the size of the U.S. wireless ecosystem was around $200 billion. The telecommunications industry generates over 2.6 million jobs in the U.S. This momentum is expected to continue in 2013 on increasing adoption of next-generation super-fast 4G LTE networks.

Moreover, growing demand for technically superior products has been the silver lining for the telecommunication industry in an otherwise tough environment. Metro Ethernet, IPTV, cloud computing, managed IP services, m-commerce, m-banking, telematics services are some of the major innovations in recent times. These developments are also helping telecom equipment manufacturers, infrastructure solutions providers, and mobile phone makers to consolidate finances.

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 seven industries at the expanded level: Communications Infrastructure, Communications Components, Satellite Communications, Communications Semiconductor, Wireless Equipment Supplier, National Wireless Service Provider and Non-U.S. Wireless 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 #77, Communications Component is #93, Satellite Communications is #216, Communications Semiconductor is #123, Wireless Equipment Supplier is #166, National Wireless Service providers is #204 and Non-U.S. Wireless Operators is #56. Looking at the Zacks Industry Rank of the seven telecommunications industries, we derive that the near-term outlook for the group is tending toward 'Neutral.'

Earnings Trend of the Sector

The broader Technology sector, of which the Telecommunications industry is part, remains weak with respect to earnings. Full 100% of the sector participants have reported second-quarter 2013 results, which have been strong in terms of beat ratios (percentage of companies coming out with positive surprises) but generated a negative growth.

Both earnings and revenues beat ratios were pretty robust at 66.7% and 50.7%, respectively. However, total earnings for the companies have shown a significant 10.1% year-over-year decrease on a modest 0.4% growth in revenues. This compares with a substantially lower earnings decline of 4.6% on a much higher 2.9% growth in revenues in the first quarter of 2013.

The consensus earnings expectations for the rest of the year however depict a fairly strong trend. Earnings growth is expected to stabilize at 0.2% in the third quarter and is expected to improve further to 3.4% in the fourth quarter. Overall, the sector is expected to register full-year growth of 1.3%.

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

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, 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.
  • Spectrum Auction: The FCC 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 proliferations of smartphones, tablets, and several other pocket-sized mobile devices have significantly increased the demand for bandwidth for seamless wireless connectivity. The spectrum auction is expected to shore up $15 billion in the U.S. government exchequer.  
  • 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 folds over the next five years.

The companies that match well with the aforementioned considerations include Arris Enterprises Inc. (ARRS) , SK Telecom Co. Ltd. (SKM - Analyst Report) , Shaw Communications Inc. (SJR - Analyst Report) and Harris Corp. (HRS - Analyst Report) . All these stocks currently have a Zacks Rank #2 (Buy).

WEAKNESSES

Generally 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. 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.
  • 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 Orange (ORAN - Analyst Report), JDS Uniphase Corp. (JDSU - Analyst Report), DISH Network Corp. (DISH - Analyst Report) and Gilat Satellite Networks Ltd. . All these stocks currently have a Zacks Rank #4 (Sell).

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