There Are Many Ways to Profit From Resurgent Carrier Spending, Except This One

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After going through the fourth-quarter earnings call of networking and communications equipment maker ADTRAN ), I’m hard pressed to think again whether a resurgence in telecom spending is indeed in the cards this year. Ever since AT&T (NYSE: T) sounded out its intentions of bumping up spending on wireless and wireline broadband networks late last year and committed $14 billion to the cause late last year, hopes of a rebound in telco spending were rekindled.

ADTRAN was expected to be one of the prime beneficiaries of Ma Bell’s capex dollars, and this was the reason why I was expecting some positive commentary on its fourth-quarter earnings call. However, management didn’t seem overly excited, but it did hint towards a possible rebound in telco spending.

Cautiously optimistic

CEO Thomas Stanton chose words carefully when he said, “Our focus remains on capitalizing on the significant network upgrades that lie ahead of us while maintaining tight cost control as we navigate through the current environment.” The statement indicates towards a veiled positive at best, but there weren’t many strong indications about where ADTRAN is headed.

Investors seemed confused as well, with the stock gaining close to 4.7% after earnings but lost 3.3% the next day. The company did satisfy estimates in the quarter, but declining revenue and a shrinking bottom line don’t make for the type of news any investor would like to hear. Thus, with low visibility over the short-term, it would make better sense to see if ADTRAN is well-equipped to ride the growth of faster networks in the long run.

A few positives

ADTRAN witnessed stability in Tier 1 carriers, lending further credence to the fact that spending might bounce back this year. Further, ADTRAN is counting on its presence across Tier 1, Tier 2 and Tier 3 carriers to rescue its declining top line. The company has grown its presence across Tier 2 and Tier 3 customers, and revenue from these accounts actually grew 22% from last year if the impact of project delays at an important Tier 2 customer is excluded.

ADTRAN also saw an improvement in networking sales to the tune of 12% in the U.S., driven by the increased number of value added resellers. Also, sales to Tier 2 Broadband Access customers improved 100% year-over-year. Moreover, management has pinned its optimism on the announcements made by both national and international telcos in the past few months, but there’s one point of concern which simply shouldn’t be ignored.

Worrisome trends

While presence across a wide spectrum of customers and markets is a big positive, declining sales of HDSL products, which happens to be the company’s legacy business, is a big problem along with tepid carrier spending. Two quarters back, revenue from HDSL halved on a year-over-year basis while the decline was 42% last quarter. The reason cited for huge declines in HDSL remain unchanged, as ADTRAN’s “large” Tier 1 customer has been reusing its installed inventory.

AT&T could well be this large Tier 1 customer, and the rate at which it is reusing older inventory is alarming. Apart from a slowdown in carrier spending, declining HDSL sales are proving to be a thorn for ADTRAN. Also, ADTRAN’s loop access business also took a major hit, declining to $16.7 million in the quarter from to $28.8 million last year.

ADTRAN’s product delivers high-speed digital communications over the local loop utilizing copper wire, but it seems that adoption of coaxial cable and mobile wireless has thrown the loop access business into jeopardy.

ADTRAN needs to speed up its research and development efforts to bring its products up to speed, and it seems to be doing that as evidenced by a 31% jump in R&D spending. However, in order to extract the maximum benefit from resurgence in carrier spending, it seems ADTRAN will need to put a lot more effort.

A solid alternative

A rebound in telco spending doesn’t necessarily mean a bounce back for everyone associated with the industry. And ADTRAN doesn’t look like a company destined for greatness in 2013 as it stands. It trades at an expensive 29 times earnings, while the industry average is half of that, and there isn’t much clarity about its future.

Instead, if you are looking to profit from a bounce back in carrier spending, Ciena ) looks like a better option. The company increased its annual revenue by 5% while the market declined 7%, and also sounded out a positive outlook. The company’s cutting-edge technology has pushed its order backlog higher and its new generation products such as 100G are finding great adoption. Also, it seems better-positioned than ADTRAN to gain from its AT&T account, and there’s every possibility that the stock will head higher this year

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