The telecommunications industry is identified as a major driver of global economic recovery. Unprecedented growth in high-speed mobile Internet traffic, chiefly 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 significant growth potential.
According to a report by Infonetics Research, telecom operators globally generated approximately $2 trillion in revenues in 2013. This is a slight improvement from $1.9 trillion revenues recorded in 2012. Notably, the report also stated that telecom carriers are increasingly spending on network upgrades with the latest technologies. In 2013, carriers’ expenditures rose 6% year over year and are expected to rise at a CAGR of 2% from 2013 to 2019, most likely to reach a significant $367 billion.
While the telecom growth momentum is expected to be maintained in the U.S. over the near term, the major impetus is likely to come from the emerging markets of China, India, Brazil and Russia. Carrier expenditures have increased in Japan and even major telecom operators in Western Europe, the most economically vulnerable region, have raised their budgets.
Currently, the U.S. telecommunications Industry is evolving around 5 broad factors. These include wireless gradually becoming the future of the telecom industry and the consequent popularity of spectrum. 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 attainment of economies of scale. Innovative product launches are expected 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 Key
Despite the massive growth in fiber-to-the-home networks, we believe that wireless networks will boost growth in the telecom industry. The GSM Association’s research wing, GMSA Intelligence, recently revealed its estimation of more than 1 billion global LTE connections by 2017. Currently, approximately 274 LTE networks are commercially available in 101 countries. More than 350 LTE networks will be commercially functional by the end of 2014. By 2017, the number is likely to reach nearly 465 LTE networks across 128 countries. At present, there are approximately 200.1 million LTE subscribers globally.
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. Apart from the terrestrial wireless network, the U.S. has an advanced satellite broadband network, mobile satellite radio systems and extensive WiFi networks.
Research firm ABI Research recently reported that a significant boost for LTE network is expected to come from the Asia-Pacific region. In 2014, the Asia-Pacific region is likely to excel all other regions in the world with respect to LTE base-stations installation. LTE base-stations, which are popularly known as radio access networks (RAN), are expected to grow eight fold in the region this year. Also, wireless operators are projected to spend around $35 billion for RAN in 2014, globally, with Asia-Pacific accounting for the major share.
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 was on developing advanced hardware, which would enable 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. 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.
Mergers and Acquisitions to Continue
The U.S. telecom industry is likely to witness more mergers and acquisitions in 2014. 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.
Recently, Verizon Communications Inc. (VZ - Analyst Report) announced the largest acquisition proposal of the wireless industry. The company has decided to acquire the remaining 45% stake of Verizon Wireless Network from Vodafone Group plc. (VOD - Analyst Report). Verizon currently holds the majority 55% of this venture. 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 recently acquired a 78% stake in Sprint Corp. (S - Analyst Report) for $21.6 billion. Sprint is further eyeing T-Mobile US Inc. (TMUS - Analyst Report) to acquire. Satellite TV operator DISH Network Corp. (DISH - Analyst Report) boasts 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.
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. According to a recent report by IDC, worldwide cloud-managed infrastructure and managed services revenues are estimated to reach $653 million in 2014 and might scale up to $2.5 billion by 2018.
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 networks have become indispensable for these large business houses as they offer 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 timeframe, the number of M2M module deployment is predicted to rise from 175 million to 470 million.
The global pay-TV market size may reach up to $270 billion by 2017. Similarly, for the cable TV operators, a new growth area is the small and medium sized business (SMB) segment. Currently, the market size of the U.S. Business Services segment is approximately $8 billion. Various industry researches estimate that the SMB segment is anticipated to offer a market opportunity worth $20 billion to $30 billion in the long term.
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 nine industries at the expanded level: Communications Infrastructure, Communications Components, Satellite Communications, Communications Semiconductor, Wireless Equipment Supplier, National Wireless Service Provider, 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 #168, Communications Component is #186, Satellite Communications is #110, Communications Semiconductor is #49, Wireless Equipment Supplier is #104, National Wireless Service providers is #95, National Wireline Operators is #110, Non-U.S. Wireless Operators is #236 and Non-U.S. Wireline Operators is #245. Looking at the Zacks Industry Rank of the nine 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 strong with respect to earnings. So far, as much as 81.3% of the sector participants have reported first-quarter 2014 results, which have been strong in terms of beat ratios (percentage of companies coming out with positive surprises) and generated a positive growth.
Although earnings beat ratio was pretty robust at 73.1%, the revenue beat ratio was a moderate 59.6%. Additionally, total earnings for the reported companies have shown a 4.9% year-over-year increase on a 4.2% growth in revenues. This compares with a substantially higher earnings growth of 5.3% on a much higher 6.1% growth in revenues in the fourth quarter of 2014.
Nevertheless, the consensus earnings expectations for full year 2014 also depict a lackluster trend. Earnings growth is expected to decline at 0.1% in the second quarter and is expected to decline further to 1.5% in the third quarter. Overall, the sector is expected to register full-year earnings growth of 2.5%.
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.
Barriers to Entry: The lack of public airwaves (spectrum) in the telecommunications industry creates high barriers 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, these barriers protect 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 Polycom Inc. (PLCM - Analyst Report), Arris Group Inc. (ARRS), Juniper Networks Inc. (JNPR - Analyst Report), BlackBerry Ltd. (BBRY - Analyst Report) and Citrix Systems Inc. (CTXS - Analyst Report). Both Polycom and Arris currently sports a Zacks Rank #1 (Strong Buy) and the rest of these stocks 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 these weaknesses can be seen in Rogers Communications Inc. (RCI - Analyst Report), Motorola Solutions Inc. (MSI - Analyst Report), NII Holdings Inc. (NIHD), Vodafone Group plc. (VOD - Analyst Report) and Frontier Communications Corp. (FTR - Analyst Report). Motorola Solutions, Vodafone and Rogers currently have a Zacks Rank #5 (Strong Sell) while the rest have a Zacks Rank #4 (Sell).