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Strong Growth Potential for U.S. Telecom Industry

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The U.S. telecommunications industry witnessed considerable growth in the first half of 2016. On average, the stock price of four major national wireless carriers were up nearly 22%, the stock price of five leading regional wireline operators surged over 39% and the top three pay-TV operators saw their stock price up 12.47%. (The benchmark S&P 500 index was up a meager 4.3% during the same time period.) We believe the industry is likely to maintain this momentum through 2016.

The telecommunications industry is continually changing at rapid speed. This industry has lately emerged as an intensely contested space where success thrives largely on technical superiority, the quality of services and scalability. Cut-throat pricing competition may strain margins.

Wireless carriers persistently compete for customers and spectrum, contending with each other and with potential new entrants such as cable MSOs (multi-service operators) and tech behemoths. Wireless operators are increasingly turning to content as a way of differentiating their services. As demand for data is growing by the day, cell tower operators become a major link in the wireless capacity chain. Nevertheless, uninterrupted advancement in telecom technologies has helped telecom operators and equipment manufacturers adopt newer business models in order to boost revenues.

Wireless Services Remain Key

Wireless network strength is the key to future growth of the overall telecom industry. As wireless networks run on radio frequency, spectrums (airwaves) have logically become the most sought-after asset in the industry. Spectrum auctions conducted by the U.S. Federal Communications Commission (FCC) from time to time will significantly boost network capacity. The FCC had concluded an Advanced Wireless Servies-3 (AWS-3) spectrum auction in Jan 2015, accumulating a record-breaking $44.89 billion. Recently, the FCC started a conducting auction of 600 MHz low-band wireless spectrums.

Upcoming 5G Wireless Technology

Several industry researchers hold that fifth-generation (5G) network will provide a download speed of 1 Gbps (gigabit per second), which is 200 times the throughput of the currently available standard 4G LTE network. Latency period of data delivery will be in single milliseconds. Further, 5G technology is designed to be more power efficient than any other standard wireless networks available at the moment. Naturally, 5G-enabled mobile devices are likely to last much longer than their 3G or 4G counterparts.

According to the research firm ABI Research, 5G network deployment is expected to escalate after 2020 and its market size may reach $247 billion globally by 2025. North America, Asia-Pacific, and Western Europe will be the three regions that will pioneer 5G network deployment.

As per a report from the research firm iGR, U.S. telecom operators will spend around $104 billion during 2015-25 to upgrade their existing 4G networks to 5G standards and thereafter, implement full installation of 5G wireless services. Consequently, telecom infrastructure developers will have enormous potential for growth.

In July 2016, in a landmark voting, the FCC unanimously decided to make available high-frequency radio spectrums (above 24 GHz) for the use of the upcoming 5G wireless network. With this, the U.S. becomes the first country in the world to identify and open up a significant amount of spectrum suitable for the ultra-fast 5G mobile standard.

The U.S. telecom behemoth Verizon Communications Inc. (VZ - Free Report) achieved a milestone in the same month as it became the first company in the world to issue an initial radio specification for the upcoming 5G wireless network. The industry-wide standardization specification by the 3GPP is likely to be ready in June 2018. Verizon, with its efforts to deploy 5G wireless network, seems to be far ahead of the others.

AT&T Inc. (T - Free Report) and T-Mobile US Inc. (TMUS - Free Report) have sought FCC approval for a millimeter wave radio test license to conduct a test run of 5G wireless standards. Leading mobile chipset manufacturer Qualcomm Inc. (QCOM - Free Report) is working rigorously to develop chipsets for the 5G mobile standard.

IoT to Drive Telecom Industry Growth

The “Internet of Things” (IoT), which enables any physical electronic device with a valid IP-address to transfer data seamlessly over a wireless network, is quickly gaining significant market traction and bringing about fundamental changes in business models. According to a recent report by research firm International Data Corporation (IDC), spending on IoT in the U.S. alone is projected to grow at a 16.1% compound annual growth rate (CAGR) between 2015 and 2019 to reach nearly $357 billion.

Next-generation superfast wireless networks (4G LTE, LTE-A, upcoming 5G) will provide the primary impetus to the telecom industry. In this context, IoT holds potential to be the number one factor in driving future growth in the space. IoT is a network of physical objects embedded with electronics, software, sensors and connectivity that facilitates it to achieve greater value and service by exchanging data with other connected devices.

At present, deploying innovative connectivity platforms to deliver seamless, fully integrated mobile communication with global networking has become essential for the success of wireless service providers’. Massive growth of 4G LTE (Long-Term Evolution) and LTE-A (Advanced) networks across the globe will lead the smooth transition from 4G to the upcoming 5G network standard. Superfast 5G mobile networks will be of utmost necessity in managing the exponential growth of IoT.

Mobile Video Business Gaining Traction

Internet TV is gradually gaining a strong foothold in the U.S. The legacy pay-TV industry in the country has been under severe challenge from online video streaming service providers. The low-cost over-the-top video streaming service has resulted in massive cord-cutting that is currently threatening the pay-TV business model.

Internet TV has emerged as a strong alternative to counter this competitive threat. At present, the web-based digital media market is growing swiftly. The digital media brands are progressively gaining significant market traction especially among the young generation. With demand for smartphones and tablets on the rise, target customers are increasingly watching videos online, preferring them over costlier legacy pay-TV connections.

Gradually, more customers are using the Internet to watch video, and they want mobility of their content. This provides wireless operators an opportunity to differentiate their products by offering access to selected content through their networks. By making deals directly with content developers, the wireless carriers are trying to entice customers with "bundles" of content such as streaming entertainment or sporting events, possibly with no additional data charges.

Online Digital Advertisement: The New Growth Driver

Advertisement on the mobile video platform is gradually leaning from simple selling of banner ads on the mobile web to automated or programmatic ad selling. Pay-TV operators are steadily adopting the data-driven advertising technique that is already popular in the web-based advertisement arena. To derive maximum synergy from the combined video content and video distribution platform, these companies are extensively penetrating into the advertising technology market.

Inclusions of dynamic ad-insertion, targeted audience advertising and data-driven TV advertisements are all steps towards the same objective. According to market research company eMarketer, the global mobile ad market value is expected to reach $133.7 billion by 2017.

Mergers and Acquisitions to Continue

Mergers and acquisitions (M&A) are not uncommon in the U.S. telecom industry, despite strict regulations enforced by the FCC to put a check on monopolistic practices. Telecom and pay-TV operators often join forces to provide better and attractive bundled products to their customers. In order to stay ahead of competition, existing players need to be constantly on their toes to introduce innovative products or merge with other companies. In the near future, the U.S. telecom industry is expected to witness further mergers and acquisitions along with product diversifications.

Recently cable MSO Charter Communications Inc. (CHTR - Free Report) acquired Time Warner Cable and Bright House LLC. Verizon has entered into a definitive agreement to acquire core business assets of Yahoo! Inc. . In addition, the wireless operator has acquired Telogis Inc. and has decided to takeover Fleetmatics Group plc to diversify in the M2M communications field. In Feb 2016, Verizon entered into a definitive agreement to buy XO Communications Inc.’s dark-fiber optic network.

Expansion of Fiber Optic Network

The fiber optic network is increasingly becoming the most sought-after technology for secure and fast data transmission over long distances. Going forward, the wireline industry will largely evolve around fiber-based superfast gigabit data transmission network.

In this regard, Verizon has decided to launch a fiber-to-the-premises (FTTP) network for both residential and business customers to deliver an exceptional 10 Gbps (gigabit per second) of upload and download speeds. Alphabet Inc.’s (GOOGL - Free Report) fiber network currently offers 1 Gbps of speed while Comcast Corp.’s (CMCSA - Free Report) “Gigabit Pro” provides 2 Gbps of residential broadband Internet speed. AT&T is gradually expanding its super-fast fiber optic broadband service – GigaPower. AT&T’s service offers 1 Gbps Internet speed to both residential and small business customers.

Major Upcoming Developments

(1) The FCC has started the auction of 600 MHz low-band spectrums on Mar 29, 2016. The 600 MHz airwaves auction, popularly known as “Incentive Auction” is crucial for wireless operators as the signals can be transmitted over longer distances and through brick-and-mortar walls in cities. These airwaves will be freed by TV broadcasters who have no productive use for the same. The TV broadcasters had agreed to free a substantial amount of 126 MHz of spectrums for a massive $86.4 billion. In the second part of the auction process, the FCC will resale these airwaves to wireless operators, cable MSOs or tech firms through competitive bidding.

(2) The court verdict on the FCC proposed net neutrality rules is expected in 2016. In Dec 2015, a federal appeals court in Washington D.C. took up the lawsuit related to the net neutrality norms. On Feb 26, 2015, in a historic decision, the FCC had approved net neutrality rules after a majority voting. The new laws classify high-speed broadband (Internet) as a public utility under Title II of the 1934 Communications Act instead of section 706 of the 1996 Telecom Act. By way of this, the FCC is poised to gain stronger control over the ISPs (Internet Service Provider). Leading ISPs and several other sector participants have stoutly opposed the FCC’s decision.

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 twelve industries at the expanded level: Communications Infrastructure, Communications Components, Satellite Communications, Cable TV, Diversified Communications Services, Internet Services, Wireless Equipment Supplier, National Wireless Service Provider, Rural Wireline Operator, 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,' those between #89 and #176 is 'Neutral' while for those with #177 and higher is 'Negative.'

The Zacks Industry Rank for Communications Infrastructure is #172, Communications Components is #75, Internet Services is #33, Satellite Communications is #205, Cable TV Operators is #80, Diversified Communications Services is #105, Wireless Equipment Supplier is #95, National Wireless Operators is #202, National Wireline Operators is #105, Rural Wireline Operators is #105, Non-U.S. Wireless Operators is #148 and Non-U.S. Wireline Operators is #197. Looking at the Zacks Industry Rank of the 12 telecommunications industries, we believe that the near-term outlook for the group is tending more toward 'Neutral.'

Earnings Trend in the Sector

The broader Technology sector, of which the telecommunications industry is a part, delivers a strong show with respect to earnings. So far, 98.4% of the sector participants have reported second-quarter 2016 financial results, which have been impressive in terms of beat ratios (percentage of companies coming out with positive surprises). However, earnings and revenue growth figures were negative.

Both the earnings beat ratio and the revenue beat ratio were strong at 85% and 75%, respectively, in the second quarter. Nevertheless, total earnings for the reported companies have shown a slight 0.5% year-over-year decrease on a 0.9% decline in revenues. This compares favorably with substantially higher earnings decline of 4.5% in the first quarter of 2016. However, revenues witnessed a modest growth of 0.4% in the first quarter of 2016.

Meanwhile, the consensus earnings expectation for the next two quarters depicts a mediocre trend. While earnings growth is anticipated to decline 2.8% in the third quarter, although it is likely to go up 1.0% in the fourth quarter of 2016. Similarly, revenue is expected to decline 1.2% year-over-year in the third quarter but is likely to revert to a positive 2.8% growth in the fourth quarter of 2016.

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