Saturday, December 22, 2012

The Outlook for Telco Spending in 2013

If any telecom investor wants a good clue as to how his company’s top line numbers will develop, he would be best advised to look at the capital spending plans of the leading carriers. In the case of North America, the bulk of spending is done by the top tier carriers like AT&T (NYSE: T), Verizon (NYSE: VZ) and Sprint Nextel (NYSE: S). I decided to do a roundup of what they are saying with regards to spending.

For the larger networking players, it is the global telecoms market that counts, but I see the US carriers as the ‘swing’ hitters at the moment. Everyone knows (and has priced in) that European spending overall will be weak in the near future. As for Asia/Pacific, there are real signs of slowing with Chinese companies like ZTE warning of a lower spending environment. The vagaries of China’s stimulus spending remain, and few telco companies, at least so far, have seen the second half ramp up from China that they were expecting earlier in the year. However, the US economy seems to be on a better trajectory, and Cisco Systems (NASDAQ: CSCO) recently said that it saw some signs of better trends in North America. Is this confirmed in the recent results and outlook from the leading players?

As for other telco networking related stocks, I noted that revenues declined for the third quarter in a row for F5 Networks. Similarly, something like Acme Packet (NASDAQ: APKT) reported a weak spending environment but believed that things would pick up in a year or so. I happen to think that Acme Packet is a stock well worth taking a look at, because at some point the carriers are surely going to increase investment in Voice over LTE (VoLTE ); but the question is if the stock can outperform when the overall telco market is getting weaker? I doubt it.

AT&T’s Efficiency

AT&T has been the big hope this year because it has been spending relatively more than the others in line with its need to build out its 4G/LTE network. With that said, by the last quarter the majority of its network was already on an enhanced back haul. In other words, there was growing pressure on it to reduce its spending plans going forward.

To the surprise of many, it stuck to its earlier CapEx forecast last quarter but then reduced it this quarter by announcing that they would be at the lower end of $19-20 billion. The good news is that this is largely because it felt it had generated enough efficiency in spending to be able to do this without changing its program. It also declared that it was ahead of its LTE roll-out plans.

This is all good news for AT&T, but the increase in second half spending is going to increase. Furthermore, if AT&T is spending less due to greater ‘efficiency,’ it could be because it is getting better purchasing ability out of a weak telco market.

Verizon Lowers Expectations

Over the last year, Verizon has been making a virtue of reducing capital spending as a percentage of revenue. This is part of a long term plan to get this metric down. In a sense this is implicit recognition that it has already built out a large part of its wireless network, having spent more last year in order to launch the iPhone.

Moreover, smartphone adoption continues to increase (from 50 to 53% over the quarter), as does the migration to 4G/LTE from 3G with 35% of its data traffic on the 4G/LTE network already. These kinds of shifts will inevitably put pressure on Verizon but for now there is no sign that there is a necessity for increased spending.

On the contrary, Verizon’s full year capital spending plans have been reduced over the year. Going back to Q2, Verizon announced that full year capital spending was likely to be flat to down vs. last year’s $16.2 billion. If we fast forward to Q3 the expectation is now for lower spending.

It is a subtle change and might not appear significant, but when telco suppliers have been talking about a second half spending increase, it is a clear disappointment.  Even in wireless Verizon is spending less than last year, so while wireless remains an area of relative strength (Cisco reported good numbers), the trend is not improving, at least for Verizon.

Sprinting Towards LTE

It’s a similar story with Sprint Nextel, which has been aggressively rolling out its 4G/LTE network. Indeed, it is doing it early with the strategic aim of creating awareness as they build out sites. All of which implies that spending should be increasing. However, the story is mixed.

In Q2 Sprint said it was keeping its full year capital expenditure plans unchanged at $6 billion; however, in Q3 it announced that it expected them to be less, partly due to a timing shift of expenditures on towers falling into 2013. There are two points here:

First, an earlier deployment hasn’t caused a pull forward or an increase in spending. Second, it’s funny how many times companies talk of delayed orders moved into the next quarter. The market usually responds to this with disbelief and marks the stock down, so why shouldn’t it have the same skeptical attitude when a company talks about expenditures moved into the next quarter?

In general I try to stay neutral when these things happen and take the company’s word for it unless other indicators are suggesting it is wishful thinking. In this case, I would watch what Sprint says in the in next quarter very closely.

Telco CapEx Spending?

In conclusion, I don’t think there is strong evidence (at least from the carriers plans) that spending plans are trending higher. On the contrary, they have been getting weaker. It’s all very frustrating because increasing smartphone adoption and data traffic should be creating investment ideas for stock pickers. Indeed, I think some niche areas are worth pursuing, but overall things don’t appear to be getting better just ye