Telecommunications Industry Outlook - Nov. 2010 - Zacks Analyst Interviews - American Tower (NYSE:AMT), A

The telecommunications industry encompasses a lot of technology-related businesses. Besides the legacy local and long-distance wireline phone services, telecommunications also include wireless communications, Internet services, fiber optics networks, cable TV networks and commercial satellite communications. While our overall view is neutral for the industry, a number of stocks offer attractive opportunities for the mid-to-long-run time horizon.

Key Attribute

The world economy is currently going through a recovery phase, albeit at a very slow pace. Although we are not out of the woods yet, and a full-phased upswing may take longer to establish than previously expected, the Telecommunications Industry will be a key player in the economic recovery. We believe that the overall economic dynamics may shift in favor of this industry, primarily due to its key attribute of being a major infrastructure product for both emerging and developed nations.

Near-term Catalysts

The telecommunications industry benefits from: (1) an improving global economy which makes the overall macro-outlook buoyant (2) significant technological inventions that make even a mature market like the U.S. highly lucrative for the telecom operators.

During the downturn, several countries throughout the world initiated economic stimulus plans as a way out of the recession. Heavy government outlays -- including the U.S. broadband infrastructure development program and similar structural subsidies in China and India -- became a boon for select telecom service providers and equipment manufacturers.

Furthermore, as the global economy continues to recover, demand for real-time voice, data and video increases by leaps and bounds. All these developments are enabling wireless carriers to undertake large network extension and upgrade plans.

Big Push by the U.S. Government

The Broadband Stimulus Program of the U.S. government received significant acceptance among rural carriers. The total allotted fund is $7.2 billion, out of which the first round will inject $4 billion into the industry.

President Barack Obama has endorsed a wireless spectrum hike plan proposed by FCC, which will nearly double the currently available spectrum for wireless broadband services and increased Internet connectivity. The FCC together with the U.S. Department of Commerce will identify unused airwaves to raise the available spectrum size to 500 Mhz in the next 10 years.

International Markets

The largest emerging economy China is gradually deploying its home-grown TD-SCDMA (3G) network and has opened up a market opportunity of more than $10 billion for several wireless operators, telecom gear makers, and handset developers. India, the second largest emerging economy, recently completed its 3G spectrum auctions and some of the spectrum winners have already started 3G network deployments. Several Central American, Latin American and western European countries are quickly allotting spectrum for next-generation high-speed networks.

Technological Innovations

However, the major thrust for the telecommunications sector is coming from within the industry due to continuous network and product upgrade and invention by industry players. Telecommunications is one of the very few industries that continued to experience massive technological improvements even under the recession. Strong demand for technically innovative products has been the silver lining for the telecommunication industry in an otherwise tough environment.

Less than a decade ago, the telecom operators in the U.S., Western Europe and Japan were upgrading their existing networks to high-speed 3G technologies. Now the world telecommunications industry is talking about the installation of next-generation super-fast 4G technologies.

Several giant telecom operators globally are funding projects to deploy super-fast 4G networks of WiMAX and LTE (Long-Term Evolution). Cable TV operators, which are major competitors to the telecom giants, are also upgrading their networks with high-speed DOCSIS 3.0 architecture. These developments are likely to help telecom equipment manufacturers consolidate their top-lines.

4G LTE network has already been launched in several Scandinavian countries. 4G WiMAX is getting increasingly deployed in the U.S. and the country is on the verge of getting extensive LTE network deployment by large telecom carriers. Japan will also get LTE from end 2010.

Fundamental Change

In fact the global telecommunications industry is witnessing a fundamental change. Earlier it was voice calls that brought money to the operators. Therefore equipment manufactures were concentrating primarily on voice-enabled devices. Now, voice is taking a backseat, while data and video have become the core focus area. New network standards aim at faster data connectivity, quick video streaming with high resolution, and rich multimedia applications.

Smartphones have become the device of choice and are increasingly taking market share from basic mobile handsets. Smartphones are generally characterized by very powerful operating systems capable of supporting a variety of services and applications that need very high-speed network infrastructures.

Various industry sources estimate that smartphone shipments as a percentage of total mobile handset shipment are expected to increase from 20% in 2009 to more than 50% by 2012. This represents a key growth opportunity for all types of industry players.

Capital spending constraints among carriers over the last couple of years due to severe recessionary conditions were the main hindrance to the growth of this industry. However, with the economic recovery more or less in place, large telecom service providers are gradually expanding their fiber-based networks on the back of significant subscriber growth.

OPPORTUNITIES

Telecom carriers and equipment providers that offer the most attractive opportunities are focused on 3G wireless technologies, emerging 4G technologies, broadband and fiber-to-the-home/premises networking. We have seen that sector diversity is a less secure natural hedge in today's increasingly correlated world markets.

The telecommunications industry as a whole offers a number of attributes that are difficult to ignore from the standpoint of long-term 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, continues to grow. In addition, economic stimulus plans in the U.S. and throughout the world should boost select service providers and equipment manufacturers.
Massive growth of smartphones: In spite of the challenging global economy, the growth in the smartphone market maintains its impressive trend. This primarily reflects a shift in consumer preference towards feature-enhanced PDA devices from ordinary mobile handsets used primarily for voice telephony. This opportunity provides scope for telecom service providers, equipment manufacturers, chipset developers and wireless tower operators to retain new users and grow revenues moving forward.
International diversification: While diversification within a country offers only limited protection in the current highly-correlated world equity markets, it offers hedging opportunities from local economic weakness and associated currency exchange differentials.

Companies that match well with the aforementioned considerations include

Telephone & Data Systems Inc.

(

TDS

Vodafone Group Plc.

(

VOD

Shaw Communications Inc.

(

SJR

Qualcomm Inc.

(

QCOM

) and

American Tower Corp.

(

AMT

WEAKNESSES

Generally, telecommunications companies that have been under pressure in the recent downturn had high debt levels and large financial leverage ratios or were unable to cope with changing market trend. These companies will continue to have difficulties should the overall business activity take longer to revive as consumers and enterprises become more selective in their spending. Other risks that remain include the following:

Potential business slowdown: Lower overall top-line sales among carriers are expected to continue weighing on capital spending decisions -- a major problem for equipment vendors. Companies are expected to remain focused on balance sheet improvements, financial discipline and free cash-flow generation. Unfortunately for the equipment vendors, the method of choice for improving free cash flows remains disciplined capital outlays.
Weak credit profiles: Over the near-term, telecom companies may be exposed to high debt levels and limited liquidity, which puts a premium on sustainable cash flow to service debt obligations. As a result, telecom companies may have free cash flow impacted by a slowdown in demand.
Increased competition: The markets for broadband wireless solutions are emerging rapidly in terms of technological innovation. While the pure wireless/wireline service providers started entering the video services market for cable operators, the cable MSOs are in turn started entering the telephone business for the small & medium sized business enterprises.

Companies that match well with the aforementioned considerations include

Windstream Corp.

(

WIN

Sprint Nextel Corp.

(

Telecomunicacoes de Sao Paulo

(

TSP

) and

Amdox Ltd.

(