What the Telcos are Saying About Spending
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
We are in the full flow of earnings season, and one sector that has been particularly interesting is telecoms. A slew of equipment manufacturers have warned that telco spending was not currently as strong as they had hoped it would be, even though analysts had rosy forecasts. This is creating a somewhat confusing picture. I decided it would be interesting to look at what the North American telecom carriers and service providers have been saying with regards to spending.
Telco Spending Has Slowed
Aside from the warnings and negative commentary from the likes of Acme Packet (NASDAQ: APKT), Cisco (NASDAQ: CSCO) and Finisar (NASDAQ: FNSR) it is clear in the numbers from the carriers that spending has slowed.
We can see that if we look at a graph of capital expenditures versus depreciation. Over time, this ratio should approximate to one because, unless a business is in decline or has found a way to ‘super’ sweat its assets, companies should be replacing their depreciating assets. The ratio will swing around as companies invest for future growth with expansionary CapEx or reduce it in line with slowing growth.
Here is the current situation.
The dip in the last data points is causing the consternation right now. Simply put, the telecom equipment manufacturers that sell to the carriers expected this to tick up, not down.
On closer inspection of the situation, a clear difference can be observed. AT&T (NYSE: T) is expecting capital expenditures to trend up in the second half while Verizon (NYSE: VZ) seems determined to carry on reducing spending as a portion of revenues. Indeed, the latter specifically mentions the aim of reducing this ratio until at least 2014.
So what are the trends in telco spending and why the difference between AT&T and Verizon?
Trends in Telco Capital Expenditures
Essentially, in North America, the trend is toward wireless from wireline and for the increased rollout of 4G-LTE networks, but these decisions take time. Telco CapEx spending tends to be long cycle and involves significant financial commitments. This means that if the service providers are seeing slowing growth and a weaker macro-economic environment, they will cut back on expenditures for the foreseeable future. Cisco was adamant that it is seeing a broad weakness in Telco spending, largely as a result of Europe and macro-economic issues, and we are seeing this confirmed in what the carriers are saying.
If we think globally for a second, there is the issue for service providers of committing to a technological platform for its customers. More developed service providers are increasingly being faced with the choice of rolling out a new 4G/LTE network or expanding their existing 3G operations. Whereas in the emerging world, while 3G spending remains active, some service providers face the choice of just jumping to 4G/LTE anyway. These sorts of considerations can delay decision making, because the service providers will have a tendency to wait until economic conditions are ripe in order to decide.
So in summary, for consumers in the developed world it is wireline to wireless and 4G-LTE. In the emerging market world it is wireline to wireless but 3G rollout still has great significance.
AT&T Sticks to Spending Guidance but Pressure is Building
Starting with AT&T, it expects CapEx to pick up in the second half, and the company decided to stick with its CapEx guidance for the year. It more or less admitted it had been prudent in the first half but with efficiencies now in place the second half is likely to see a sequential tick up.
The spending mix is set to be weighted towards wireless where AT&T spent 60% of its CapEx in the first half. Moreover, the company is engaged in an ongoing and intensive build out of LTE, and management affirmed that 90% of its data traffic is on enhanced backhaul already.
With this kind of build out already in place and wireline growth clearly moderating while the economy is slowing down, it is natural to conclude that AT&T will feel under pressure to reduce its spending plans. However, the company stuck by its CapEx guidance.
We shall see.
Verizon Looking to Moderate Spending
It is a different story at Verizon. Its first half capital spending was down 16% year to date with an outlook of flat to down for the full year. In addition, while AT&T was expanding wireless spending, Verizon spent 23% less in the second quarter, although this was largely due to a ramp up last year in order to support its initial launch of the iPhone.
The issue with Verizon is that it has already rolled out an extensive 4G LTE platform, and migrating traffic onto it from 3G has generated significant cost and capital efficiencies. Its argument is that it can continue to try to reduce CapEx as a percentage of revenues because its 4G network is utilizing capacity well enough to enable them to do this. If this is the case then the pressure on AT&T to do the same will be greater in the future as well.
Where to Next?
The overall picture is somewhat puzzling. On the one hand, data usage and smart phone growth suggest that the exponential growth in traffic will force North American carriers to ramp up spending. On the other hand, both major service providers are being cautious about spending and, in Verizon’s case, arguing that operating efficiencies generated by switching to already built networks will ensure that they don’t need to significantly step up spending for a few years. AT&T has a more positive story, but we will need to see how that develops in the second half.
I consider it appropriate to listen to what these companies are saying and not try to guess against them, particularly when the global economic outlook is so uncertain. It is hard to be too positive about telco spending if the carriers are not sharing this opinion.
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