Tailwinds in the Telecom Tempest


While the overall outlook for the telecommunications industry has gone from glum to glummer, the fact is that some telecom gear sectors remain red-hot. Equipment to build wireless networks is in demand as is optical-networking gear designed to improve data- and voice-transmission efficiency and bandwidth in congested metropolitan areas.

That's in sharp contrast to demand for long-haul optical equipment used to connect cities, which is expected to stay virtually flat for the rest of the year as telecoms complete their long-haul networks and look to areas where they see the most need, according to telecom consultancy RHK.

While mobile-phone handset growth may be slowing, wireless remains a high-growth business. And the metro markets are where most telecoms expect to notch real revenue growth. "We are in the business to make money, so our investments follow where our customer demand is," says Fred Harris, vice-president for research, architecture, and design at Sprint (FON) (see "How Well Does Your Cell Phone Work?").

OWN VS. RENT. That demand appears to be in heavily populated metropolitan areas. Sprint, which recently cut its overall spending for the year, is dropping a bundle on metro-area networks to improve data and voice services to plum business customers. The company, which serves 20 million business and residential users, hadn't invested in metro-area networks before 2001, says Harris. That's because Sprint was busy building long-haul networks and thought it could get by renting some space on metro networks from Baby Bells.

It turns out Sprint would rather own a metro network than pay another company for the bandwidth, says Harris. That's in part due to declining costs of building these networks as fewer buyers compete for the equipment and are able to make favorable deals.

Indeed, the body blows keep on coming for telecom equipment makers. On June 14, once rock-steady Nokia (NOK) shocked markets by announcing that its growth had slowed considerably as consumer demand for handsets wilted. The news sent the Finnish wunderkind's stock plummeting 20% in a single day.

Then, on June 15, the king of the optical telecom sector, Canadian gearmaker Nortel Networks (NT), floored investors with the revelation that it would post a $19.2 billion loss for the quarter as demand for the switches and routers it makes has shriveled.

CATALYST FOR DOWNGRADES. That announcement points to a litany of upcoming troubles for most telecom equipment makers. Spending by carriers will fall 6% this year, from $122 billion in 2000 to about $115 billion in 2001, according to investment bank Robert W. Baird & Co. It will continue to decline until at least the early part of 2002, says David Blitzer, chief investment strategist with Standard & Poor's. Last week's bad news seemed to be a catalyst for downgrades. On June 15, Credit Suisse First Boston hacked its estimates for most telecom gearmakers, including Lucent (LU) and Tellabs (TLAB). Credit Suisse also downgraded optical components maker JDS Uniphase (JDSU) to hold.

However, several equipment makers are positioned to take advantage of these new opportunities. ONI Systems (ONIS), which sells optical gear specifically for metro and regional networks, will do well, says Eric Gonzales, partner at venture-capital firm Doll Capital Management.

Other players that stand to benefit from this focused spending might be Foundry Networks (FDRY) and Extreme Networks (EXTR), which make switches and other products used in local and metro networks, and Cabletron's Riverstone Networks (RSTN), say analysts. Cabletron builds routers for metro networks. According to RHK, the $8.1 billion 2000 metro market is expected to grow at a steady annual rate of 8% through 2004. Many other analysts predict double-digit growth, however.

WIRELESS UPTICK. The bullishness extends to many companies selling wireless gear, which will be "the strongest area of capital expenditures in the next several years," says Charlie Pluckhahn, analyst with investment bank Stephens Inc. Spending in this sector should increase from $21.3 billion in 2000 to $22.7 billion in 2001, according to Robert W. Baird & Co.'s estimates. That 7% rise is significantly lower than the historical average increase in telecom gear spending of 12% to 13% and the annual growth rate of 40% from 1998 to 2000. Still, any growth at all looks good next to the sales declines expected in long-haul optical and other telecom gear sectors.

The uptick in wireless will also come in spite of rapidly slowing spending on next-generation networks (also known as 3G) designed to dramatically increase the speed of moving wireless data. Rather, wireless carriers will be spending on hybrid wireless local area networks, a more economical way to offer high-bandwidth wireless data coverage in key areas. They'll also spend to expand current-generation wireless infrastructure and upgrade their networks to accommodate increased customer demand, say analysts. That money will most likely go to wireless-equipment giants, such as Nokia and Ericsson (ERICY).

Another area where carriers are expected to spend, due to the potential for quick returns on investments, is cable telephony. These systems let cable-TV companies offer phone service over cable networks. That could be a bright spot for beleaguered data-networking company Cisco Systems (CSCO) and Nortel, according to Pluckhahn.

NEW OPENINGS. Finally, uncertainty caused by the troubles at giants such as Lucent, Cisco, and Nortel could create some opportunities for secondary players and startups, says Ted Moreau, analyst with Robert W. Baird & Co. For instance, Nortel recently exited its digital subscriber line business in response to a price squeeze, opening up the market for competitors Alcatel, Nokia, and the startups.

During the economic downturn, "someone is being voted off the island on a weekly basis," says Allegiance Telecom (ALGX) Chairman and CEO Royce Holland, comparing the Survivor reality-TV series to the telecom shakeout. The survivors will keep making and selling telecom equipment -- as long as that's what customers still need and want. By Olga Kharif in New York


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