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Analysts Predict More Capex Cuts

Light Reading
News Analysis
Light Reading
12/24/2002

Capital spending budgets are expected to be slashed even further in 2003, but analysts say the cuts likely won’t be as deep as they once thought. While this sounds as if it should be good news for equipment suppliers, analysts like Steven D. Levy of Lehman Brothers and Stephen Kamman of CIBC World Markets warn that equipment providers aren’t out of the woods yet.

In a research note published yesterday, Levy cites results from a survey of 14 North American carriers. In it he says that spending in 2002 was down about 30 percent or more from the previous year, and carriers are expected to cut another 15 percent from their budgets in 2003. This is an improvement over predictions from three months ago, when Levy and others said they’d slash budgets by 20 percent. This matches Kamman’s prediction, in his November 2003 preview research note, stating that capex budgets in 2003 would be down roughly 14 percent from 2002.

These revised estimates imply that analysts believe that the decline in carrier spending should hit bottom in 2003. But Levy and Kamman both warn that any improvement in carrier capital spending in 2003 or even 2004 may not translate into improvement for equipment company revenues.

One reason for this is that carrier capital budgets aren’t exclusively spent on new equipment. Historically, carriers have spent about half of their budgets on new gear and the other half on labor and software. But the traditional proportions shifted in 2002, and it looks like carriers spent a larger portion of their budget on software and labor. In other words, equipment providers were getting a smaller piece of an already reduced pie.

“The first thing to be cut is the spending on new equipment,” says Kamman. “That’s the low-hanging fruit that is easy to cut right away. Reducing staff and eliminating program development takes a lot longer.”

Levy notes in his report that equipment company revenues declined more rapidly than carrier spending budgets, something he says is a major concern. Indeed, companies like Ciena Corp. (Nasdaq: CIEN) and Riverstone Networks Inc. (Nasdaq: RSTN) respectively reported roughly 80 percent and 77 percent declines in revenue in the third quarter of 2002 versus the same period a year earlier (see Ciena Improves Outlook and Riverstone Slapped in Face of Good News). Compare this to the 30 percent reduction in carrier spending budgets over the last year.

“We still see an important and difficult-to-understand disconnect between carrier spending and equipment company revenues,” writes Levy. “We noted the disconnect six months ago but assumed that the relationship would become more connected over time. As the disconnect becomes larger and more mysterious, the timing of the reconnection becomes more difficult to predict.”

There are other reasons to be cautious about the coming year. From a macroeconomic perspective, the overall economy isn’t expected to improve anytime soon, says Levy. In general, the U.S. economy is still uncertain, as investors contemplate a possible war with Iraq. Stock markets continue to be volatile, and the dearth of new jobs persists.

Equipment providers have long pinned their hopes of a recovery on regulatory relief and long-distance approval for local incumbent carriers in the United States. SBC Communications Inc. (NYSE: SBC) and BellSouth Corp. (NYSE: BLS) have just announced they are expanding their coverage into key states (see RBOCs Get Long Distance Go-Ahead). Levy and Kamman agree that these are meaningful events in the long term, but they will not immediately impact revenues dramatically.

The Federal Communications Commission (FCC) is expected to release a new set of rulings soon, including definitions of which network elements incumbents must share with competitors, thus putting an end to the uncertainty around UNE-P (see ILECs, CLECs Face Off Over UNE-P). Several bills before Congress are also expected to come to the floor this year, potentially resolving other regulatory uncertainty. Incumbents seem optimistic about the outcome of these proceedings and claim that relief in this area would encourage them to spend more of their budgets on metro and access broadband deployments. Levy and Kamman say they believe regulatory relief is important, but they are cautious about the amount of the potential upside.

In his note, Kamman warns of another wrinkle that could prove to be a negative for equipment companies next year: Consolidation in the wireless carrier market could shake things up.

“Any merger would imply a 6-12 month FCC and Department of Justice approval process, with a consequent delay in capital spending,” he writes in his report. “With wireless representing 40 percent to 50 percent of revenues at Lucent Technologies Inc. [NYSE: LU] and Nortel Networks Corp. [NYSE/Toronto: NT], this represents a significant risk to both players, although more so to LU than NT.”

So what about the end of 2002? Many analysts have been predicting a large flush of spending in the fourth quarter. While raw math would suggest that Verizon Communications Inc. (NYSE: VZ) and SBC have the budget to increase sequential spending by 92 percent and 67 percent respectively, it’s more likely that spending will either remain flat or increase only slightly, says Kamman.

Levy agrees that a huge spending increase is unlikely.

“Looking at seasonality, we believe all the old rules have been thrown out the window,” says Levy. “Many carriers have adopted success-based spending plans that occur when immediate return on investment and revenue opportunities arise and are identified – only then are the carriers willing to open the purse strings.”

— Marguerite Reardon, Senior Editor, Light Reading

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BobbyMax
BobbyMax
12/4/2012 | 9:07:31 PM
re: Analysts Predict More Capex Cuts
The US carriers cannot afford to spend too much money on ca[pex and opex. There is a continuing decline in the number of access lines. In fact, some RBOCs have lost close to 4% of their access lines. Some of the business have been lost to wireless service providers. Some of the expensive items such as #5ESS Switches used to be acquired by the carriers every six years or so. Un this sense, the switch installation was cyclical.But now a days some equipment vendors want to sell almost every year. This kind of practice can not be practiced by any carrier, large or small.

It was predicted that in the year 2003, the capex and opex expenses would be down by 23% and for the next 3-4 years, the spending would go down at least by 7%. There have been tremendous losses experienced by all RBOCs, with QWest being in the front.

Even if RBOCs are permitted to engage in long distance business, the revenue genrated would not justify the business model. This model is simply not sustainable. Unlike other businesses, RBOCs are not freely allowed to adjust their workforce according to the estimated revenue. SBC, for example, is at least overstaffed by 10,000 personnel. They can reduce the workforce as they have seek permission from all PUCs in their business area.

Thev number of equipment suppliers is so large, that every thing deployed by the carriers may more or less llok like a commodity product. In fact, development and marketing of telecom equipment is more akin to cottage industries in some Third World countries. There is almost no product distinction, value added features and technology distinction from the best to the worst equipment vendor, at least externally. The entire practice has become so deceptive that it is almost impossible to know who to buy from and who to trust.

From eqipment vendors to service providers, the shareholders have lost 90% of their investments. Mr. Levy, rightly points out in his report, that the war hysteria would lead to further decline in telecom revenues and prolong the period of recovery indefnitely.

The long distace revenue for every service provider is the worst in the history of the industry. At the top of these difficulties some foreign carriers, e.g., China Telecom which seeking to do business in the US promises further to bring down the prices. Our orominent carrier, AT&T, is almost bankrupt. It is hard to understand the US Government policy to create competition betwen long distance carriers and RBOCs.

There is some misunderstanding about the cost of implementing UNE-P. It needs to be realized that in order to implement UNE-P, at least over dozen system need to be changed by RBOCs. It may cost billion of dollars to make these changes. Furthermore, these changes can be made by Telcordia Technologies ( formerly Bellcore) and Lucent alone. If the government insists on UNE-P, it has to pay Telcordia and Lucent upfront. It is very sad that our own government wants to dismantle the best service in the world.
willywilson
willywilson
12/4/2012 | 9:07:30 PM
re: Analysts Predict More Capex Cuts
1. In fact, some RBOCs have lost close to 4% of their access lines. Some of the business have been lost to wireless service providers.

2. There have been tremendous losses experienced by all RBOCs, with QWest being in the front.

3. It is almost impossible to know who to buy from and who to trust. [Note: referring to hardware vendors]

4. The long distace revenue for every service provider is the worst in the history of the industry.

5. It is hard to understand the US Government policy to create competition betwen long distance carriers and RBOCs.

6. To implement UNE-P, at least over dozen system need to be changed by RBOCs. It may cost billion of dollars to make these changes. Furthermore, these changes can be made by Telcordia Technologies (formerly Bellcore) and Lucent alone. If the government insists on UNE-P, it has to pay Telcordia and Lucent upfront. It is very sad that our own government wants to dismantle the best service in the world.

--------

1. Yes, and who owns the two largest wireless providers?

2. The RBOCs have not lost money. Their cash flows continue very strong. The *growth* of cash flows has come down. This is their own fault, for having delayed implementation of technology that could have raised revenues. Qwest's losses have nothing to do with their core business. The company crawled into bed with the worst of Silicon Valley and Wall Street. Before that, U.S. West was the worst of the RBOCs.

3. Agree. The telecom sector was invaded at both ends by Silicon Valley and Wall Street corruption.

4. Wireless carriers have obliterated the concept of LD, and fiber has dramatically reduced transport costs. If the carriers hadn't engaged in massive fraud relative to the access network, and instead had worked to remove the last-mile bottlenecks with technology that we all know is currently available very cheaply, we'd have already seen an explosion of new revenue-producing services by now.

5. Competition is a good thing. The government failure was in enforcing the laws pertaining not only to competition, but to securities fraud.

6. The Telecom Act mandated UNE-P. Instead of fighting it all the way to the Supreme Court twice (in 1999 and in 2002), the RBOCs should have been preparing for it by introducing high-bandwidth technologies and services that would have made POTS an irrelevancy. Instead, they engaged in delaying tactics and often played footsie with securities fraud.
BobbyMax
BobbyMax
12/4/2012 | 9:07:10 PM
re: Analysts Predict More Capex Cuts
Following the lead provided WillyWilson, I would collect together the corruptions that have destroyed our business ethics and morality. Our system (Government and Businesses} are based on absolute honesty and integrity.Unlike many other countriers,any time these principles are violated, the equilibrium is lost and everyone is impacted.

The decades after 1980 have witnessed the greatest corruption in our country. It has destroyed almost everything we aspire for in our lives.

The following list is not exhaustive and is based on my observations. I am limited my comments to the high-tech industry. However, the same comments and observations apply to the entire system.

1. Our system is deficient in selecting and appointing personnel based on merit. Anyone can be appointed to any position regardless of their qualifications.
2. The current salary structure of CEOs is simply obscene. With 70 million Americans making less than minimum wages, it is simply uncontionable that about 95% CEOs of the US companies make 500 times the salary of average workers. No other country has this kind of salary structure. This uneven treatment demorlizes the entire workforce.
3. Corruption at Wall Street, where stocks are brought up and down at will. As we have seen there is no punishment for engaging in corrupt activities.
4. Under the government regulations, almost no rights are granted to the shareholders. This promotes financial corruption. IIn almost all instances a corrupt CEO is allowed to stay on as he can give financial favors to the board members.
5. Corruption among the VC community is very rampant,especially in State of California where there is no one to watch the VCs and their companies. Their behavior is reflected in valuation of the start-ups. They also want to relize 300%-to-400% times more than their investments.They encourage their funded companies to lie about their products and technologies in their efforts to sell their companies to other companies at exhorbitant prices.
6. Very few employees can report the unethical behavior on the part of their employers as they can and do lose their jobs with no protection from the state and federal governments. Both state and federal governments have instituted what is known as employment at will. This tool has stregthened the underlying corruptions which we see very frequently. This law was enacted to opress slaves but has been kept on the books without any justification.
7. Too many companies doing exactly the same thing have been funded by the VCs.To give an example, about 850 optical companies were funded by the US VCs doing the same thing.
8. Lies about publicly traded companies to boost up the stock value.
9. Presenting false information to foreign governments and investors to attract capital investments.The combined loss by foreign investors is estimated to be close to 8 Trillion dollars. They will never get a penny back.
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