Analysts Predict More Capex Cuts
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