U.S. Telecom: Looking Ahead at '12

The telecommunications industry is growing consistently despite a volatile U.S. economy. This industry is identified as a major driver of economic recovery. Telecommunications is one of the few industries to have seen rapid technological improvement even during the last recession.

Given the significance of the telecommunications industry as an infrastructure product, we expect the overall economic dynamics to shift in its favor. We also expect the telecommunications industry to grow faster in 2012 compared with 2011.

Invention and Innovation

The major thrust for the telecommunications sector is coming from nonstop network inventions by carriers. The introduction of super-fast networks such as HSPA+ and LTE has enabled handset developers and chipset manufacturers to develop innovative products that are compatible with the latest network technologies. Products like Apple Inc.’s ( AAPL - Analyst Report ) iPhone, iPADS, and several new smartphones and tablets using the Google Inc. ( GOOG - Analyst Report ) developed Android software that entered the market are tagged with higher prices but lured customers in spite of a tight money market.

An unprecedented growth in high-speed mobile Internet traffic, in particular for wireless data and video, has transformed this industry into the most evolving, inventive, and keenly contested industry. At present, these innovations are forcing telecom carriers to deploy high-speed networks in order to remain competitive.

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.

Where to Find Spectrum

A major characteristic of the telecommunications industry is the huge barrier to entry due to scarcity of public airwaves (spectrum). Spectrum licenses are limited and therefore quite expensive. This created some strange bedfellows. For instance, Verizon Wireless, a joint venture between Verizon Communicatons Inc. ( VZ - Analyst Report ) and Vodafone Group plc. ( VOD - Analyst Report ) decided to buy spectrum from its rival cable operators, such as Comcast Corp. ( CMCSA - Analyst Report ) , Time Warner Cable Inc. (TWC), Cox Communications and Bright House.

We believe the small companies which are holding wireless spectrum will be in a favorable position in 2012. In this respect, DISH Network Corp. ( DISH - Analyst Report ) may become a clear winner.

Merger and Acquisition to Continue

Despite the failed merger agreement between AT&T Inc. ( T - Analyst Report ) 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 Communications Inc. ( ) and Leap Wireless International Inc. ( LEAP - Analyst Report ) may also join hands or merge with a nationwide carrier in order to get economies of scale and pricing power. DISH Network has already declared that it is not averse to a deal with T-Mobile USA.

Key Attributes for 2012

(1) The telecommunications industry is known for its huge barriers to entry. Deployment of high-speed network infrastructure requires significant capital expenditure, which very few entities can afford.

(2) The sector is immune to the sovereign debt crisis in Europe. A potential slowdown in China or any non-U.S. economic fluctuation will not have any immediately impact on this industry. On the other hand, U.S. telecom carriers will have the option to expand globally through partnerships as several emerging nations are installing 3G and 4G networks rapidly. Besides traditional telecom services, carriers can also offer value-added services, such as securitized data management, cloud computing and mobile banking.

(3) We expect telecom carriers to continue paying handsome dividends in 2012. In 2011, AT&T paid a dividend of approximately 6.1% and Verizon paid an equally impressive 5.2%. Other telecom service providers such as CenturyLink Inc. ( CTL - Analyst Report ) , Windstream Corp. ( WIN - Analyst Report ) and Frontier Communications ( FTR - Analyst Report ) currently offers even higher dividend yields of approximately 8.2% 8.6% and 15.20%, respectively.

(4) 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.