Tech Sector Outlook 2008: Part 2

(page 4 of 4)

Communications Equipment

Analyst: Ari Bensinger

Increased use of the Internet is creating strong demand for broadband access equipment, as data transmission is now the overwhelming majority of traffic carried on the telecommunications network. Moreover, the growing popularity of user-generated-content Internet sites and peer-to-peer traffic is fueling an exponential increase in the transport of video over the network. Being multimedia intensive, Internet Protocol video is a significant occupier of bandwidth that can potentially strain the transport network.

To handle the sharply higher demand for data and video transmission, telecom operators are in the midst of migrating from narrowband networking of voice services to broadband networking of data services. Traditional circuit-switched networks are being rapidly replaced with packet-based systems, and they are being better equipped to handle video and mobile applications.

On top of the strong end-demand for Internet and video, an increasingly competitive environment between the telecom and cable operators is helping to push industry growth. Operators continue to rebuild and upgrade their networks to better handle triple-play offerings of voice, video, and data. Given that the triple-play package holds the key to attracting new subscribers, improving customer loyalty, and increasing the average revenue per user, each camp has little choice but to spend on the communications equipment gear that enables this service.

While we expect these growth drivers to continue for the foreseeable future, industry pricing and margin pressure are intensifying because of increased consolidation in the telecom sector. Additionally, the spending shift toward next-generation equipment, specifically for fiber access projects, has materially decreased sales visibility for equipment providers.

In light of these factors, our fundamental outlook for the communications equipment industry is neutral. Overall, Standard & Poor's forecasts mid-single-digit growth for the communications equipment market for 2008.

Our top pick is networking gear supplier Netgear (NTGR; $34), which carries our strong buy recommendation. We see the company benefiting from increasing broadband penetration, particularly in emerging countries, as well as a growing number of interconnected networks, with computers being increasingly connected to home entertainment and storage devices. While industry competition remains intense, we believe Netgear will continue to gain market share by successfully introducing new products at attractive price points.

Kessler follows technology stocks for S&P Equity Research .