Why This Telco Stock's Outlook Was Disappointing

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After Verizon (NYSE: VZ) had given a mixed prognosis for the telco sector, the focus inevitably shifted onto AT&T (NYSE: T) and what it would be saying over spending. Going into the results there was a certain amount of hope and trepidation. Hope because it had previously excited the telco industry by outlining its plans to step up spending over the next few years. Trepidation because other tech companies have been warning of weak spending by the service providers. It looks like the pessimists won.

AT&T Giveth and AT&T Taketh Away

AT&T declared that it was keeping its capital expenditure forecast at $21 billion for this year but reducing it to $20 billion in 2014 & 2015 from $22 billion previously.  Moreover, its subscriber numbers and revenue trends were disappointing, and the stock fell heavily on the day of the results. Nor was there any let up in the negative commentary over the levels of caution being exercised by the enterprise sector. Verizon had argued that its enterprise customers were being very cautious and still stuck in cost cutting mode. AT&T said pretty much the same thing.

So it is a story of a weaker trading environment coupled with less spending by the major carriers. This is not great for the service providers and neither is it good news for the companies that supply them. While AT&T is not the only telco carrier out there, it is a huge company whose conditions do strongly reflect overall market conditions.

The usual bugbears were mentioned: persistent unemployment, regulatory fears, political instability, government budgets etc.  Frankly I’m coming round to the view that there is a bit more going on here, and the clues are in what the major carriers are saying about trends within their operations.

Simply put, things like smartphone penetration, cloud based activity and the shift to wireless from wireline services have increased in a quicker fashion than many companies had expected. It is a case of the good, the bad and the ugly. The good is the margin and revenue generating opportunities inherent in increasing smartphone penetration (they churn less, use more data etc). The bad is the implied loss in wireline revenues and small business choosing not to use them. And finally the ugly is the period of uncertainty that accompanies businesses when they adjust to unforeseen events. I want to talk more about the last point.

Certain Uncertainty

Apologies for going all ‘Donald Rumsfeld’ on you, but it’s the best way to describe the essence of the big question in technology investing. In other words, what effects will the rate of technological change have on my business? 

A classic example of this--and it relates strongly to the telcos--is Intel (NASDAQ: INTC). The company does face criticism for not being prepared for the shift to tablets and mobiles, coming late to the LTE party and being too optimistic over a potential demand pull from Windows 8. It’s easy to criticize, but it’s a lot harder to predict these changes. Anyone who scoffs and says they can should show me how they invested in these trades, because that is what really matters here.

So just as Intel found itself structured for a world and cycle that didn’t look like it had before, so the telco service providers have also seen the same challenges. It’s certainly true that they have been pushing out these services (Verizon started investing in LTE over five years ago), but when AT&T cuts its capital spending forecast by around $4 billion (or 9%) for 2014-15, it is obvious that something has changed.

The reasons given for the cut are that it got better deployment from LTE than it had previously expected. Its much vaunted Project VIP includes a commitment to expanding 4G/LTE to 300 million points of presence (POPs) by the end of 2014. The good news is that it expects to achieve 90% of this figure by the end of 2013. The bad news is (from the suppliers point of view) that this greater efficiency is lessening the necessity for spending. It is also shifting spending into newer technologies and away from legacy systems. Again not good for the suppliers.

Where Next for Telco Spending?

Unfortunately it looks like a similar year to 2012 for the telco suppliers: some hope in the first half which then evaporates into a weaker second half. Some of the weakness in Q1 will possibly turn out to be temporary, but when there doesn’t appear to be a major stimulus for increased spending by Verizon and AT&T is cutting future projects it is hard to be too optimistic.

On a more positive note the increasing adoption of newer technologies like 4G/LTE, high bandwidth capability and corporate mobility solutions will surely spur other telcos to invest in them, so the focus on investing in the sector in 2013 must be in these areas. The problem is that the telco suppliers are not constructed to surgically target these areas alone. In conclusion If you are bullish on the telco sector it probably makes more sense to stick with investing in the carriers right now. The floodgates of telco spending aren't open yet.


Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends Intel. The Motley Fool owns shares of Intel. 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!

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