The Growth Sectors Within Telco
Lee is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
It’s always a good idea to keep an eye on what your stock's peer group are reporting even if they come from overseas. In this article I want to focus on the telco sector and discuss some takeaways for the industry that came out of Spirent Communications' latest results. It’s a UK listed company, a strong rival to Ixia (NASDAQ: XXIA) and has activities that cover many areas of telco spending. In summary, the results weren’t great for Spirent (the stock closed down more than 7% on the day), but there were enough strong trends identified within them to suggest that other telco plays could do better this year.
Spirent’s Mixed Results
I’m going to list the main points and then develop them in the commentary:
- Spirent reported the familiar refrain on telco spending with weakness ensuing from May onwards but a more recent pick up in orders. The first half will be challenged due to a weak backlog.
- US Government spending slowed and impacted results, and the problem appears to be due to the political standoff.
- The transition from 1GB Ethernet spending to 10GB, 40GB and 100GB appears to be accelerating.
- Management is positive on resumption of telco spending in China.
- Spending on legacy systems like UMTS and CDMA was weak, but this is more a function of macro uncertainty. In other words, spending is still capable of growing on them in future.
- In an uncertain economy carriers preferred to spend on newer technologies like 4G/LTE, high speed Ethernet and data center rather than legacy systems. This highlights the necessity for spending in these areas.
- Spending on wireless devices increased significantly, and Spirent recorded 20% growth here.
- Data Center spending remains strong.
In case you don’t know much about Spirent or Ixia there is a primer article linked here (on Ixia), which should explain things. My conclusion over the results was that conditions are still currently weak but are getting better. Spirent is more burdened with legacy systems revenues than Ixia, and it has been slower to invest in the right areas.
I’m long Ixia, and I liked the commentary from Spirent. It talked about investing in Wifi because of the proliferation of enabled devices that are being created. There is a particular need for testing solutions among enterprises that are investing in this area. These are both areas where Ixia has been investing and developing product, so in an sense, Spirent is giving a nod of approval to their rival.
On a more sobering note, the outlook for ‘modest growth’ implies that its organic growth would be flat to negative this year, and its worth reminding ourselves that much of Ixia’s growth is coming from its acquisitions, Breaking Point and Anue. Furthermore, Spirent was forthcoming in stating that not enough positive data points were out there for it to be overly positive about the second half.
What Does This Mean for the Industry?
As ever, thoughts turn to Cisco Systems (NASDAQ: CSCO). Looking back at the recent results it is easy to forget that its US enterprise orders were up 9%, and it's becoming clear that Cisco has been disproportionately hit in its core switching and routing divisions by weak government spending. But if that is the situation now then surely there is upside for Cisco once the political standoff is resolved?
Moreover, the specifics of where spending is going suggest good times ahead for Ciena (NASDAQ: CIEN). I like the company because it has a heavier weighting towards next generation networking and higher speed Ethernet solutions. It will benefit disproportionately from the kinds of shifts in telco spending being outlined by Spirent, and I note that Ciena reported record orders in Q4.
The strength in mobile device testing and the release of a solution for enterprises to test, assess and monitor applications online is also a good sign for F5 Networks (NASDAQ: FFIV). Its core market is in Application Delivery Controllers (ADC), which help ensure that applications get moved around networks quickly and without denudation. The increasing usage of bandwidth rich application on mobile devices plus the expansion of next generation networks will only increase demand for ADCs. Riverbed Technology also has an ADC, and its core market of Wide Area Network (WAN) Optimization is also heavily exposed to these trends. Incidentally higher speed networks do not render WAN Optimization obsolete! Moreover, both companies have telco as key verticals, and any indication of increased spending will quickly drop into their profits.
The Bottom Line
In conclusion, it was a pretty positive report for some areas of telco spending, but it’s also clear that the global telco industry is still reticent to spend in an uncertain environment. I think the best way to think of this is that investing in the industry is still a function of your macro-economic view, but the pent up demand and rate of technological development mean that the upside is considerable should the economy hold up in 2013.
SaintGermain has a position in Ixia. The Motley Fool recommends Cisco Systems, F5 Networks, and Riverbed Technology. The Motley Fool owns shares of F5 Networks and Riverbed Technology. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!