AT&T Vendors Sing Merger Blues
Adtran, Tellabs, ADC (Nasdaq: ADCT), and Alcatel-Lucent (NYSE: ALU) all rely (some more than others) on access equipment sales to AT&T to beef up revenues. Each of these companies reported poor results recently, and Tellabs and Adtran in particular tied the poor results to spending slowdowns at AT&T because of the merger. (See Carrier Cutbacks Hit Tellabs and Adtran Revises Q4 Outlook.) Yet, capex numbers did not go down. AT&T spent $2.2 billion during the fourth quarter, up from $2.1 billion in the third quarter. Separately, BellSouth spent $760 million in the fourth quarter, up from $740 million in the third.
"Tellabs had a terrible quarter and terrible guidance, ADC reported a bad October and issued a weak guidance for January, all citing the same reasons, but the capital spending at the operators is still pretty strong," says Brean Murray & Co. Inc. analyst Eric Buck. "I can't get anybody to give me a rational explanation, or even an irrational explanation for that."
Simon Leopold of Morgan Keegan & Company Inc. suggests AT&T's capex may have included year-end, one-time purchases using money that normally would have gone to vendors like Adtran and Tellabs.
Looking at Adtran's case in particular, Leopold says: "Lumpiness is not abnormal. I think its important to look at other customers like Windstream Communications Inc. (Nasdaq: WIN) and Embarq Corp. (NYSE: EQ) that were probably trying to control spending as they went into the end of the year, and that probably also put a hurt on them."
But Brean Murray's Buck doesn't buy that theory. "I think what's driving that is there's a shift going on in the marketplace from deploying pure DSL-based technologies to more of the triple play, whether it’s the Verizon Communications Inc. (NYSE: VZ) FiOS or the AT&T/BellSouth fiber-to-the-node architectures," he says.
If AT&T CEO Ed Whitacre's recent earnings call comments are any guide, the transition to fiber-to-the-node (FTTN) will happen faster than the carrier had indicated previously, and that may have put Adtran and Tellabs in an awkward position.
Take Tellabs. The aggressive FTTN plans Whitacre talks about could be at odds with the fiber-to-the-curb (FTTC) architecture Tellabs hopes to sell to the operator. That's true even in BellSouth's territory, as the old SBC has a history of imposing its way of doing things on its acquisitions. (See Wall Street Frets About BellSouth Suppliers.)
"With the AT&T merger now completed, it's possible -- even likely -- that AT&T will deviate from BellSouth's views on the FTTC deployment and retrofit programs," Jefferies & Company Inc. analyst George Notter wrote in a report on Tellabs last week.
"Retrofit" refers to Tellabs' plans to upgrade 1.5 million installed fiber lines for AT&T. "Will they upgrade those lines? I can't speak for it," CEO Krish Prabhu said during his company's earnings call recently.
The Tellabs 1150 multiservice access device supposedly supports both FTTC and FTTN architectures, and Prabhu assures investors this will help secure his company's future as a primary AT&T vendor.
Notter is less certain. "It's unclear to us that Tellabs' new 1150 platform is truly competitive in the marketplace," he writes.
Adtran is in a similar position.
One of AT&T's two incumbent DSLAM providers, Adtran regularly depends on AT&T for 10 percent of its revenues. But in the fourth quarter, its revenues from AT&T were down by around $3 million from the previous quarter, a decrease of about 10 percent.
In the days after the merger closed, it appeared Adtran's DSLAM business at AT&T would be in good shape, because AT&T's concessions to the Federal Communications Commission (FCC) included a commitment to roll out broadband service throughout the AT&T/BellSouth footprint.
But Whitacre's comments suggest a larger part of that build could be done with fiber access, at the cost of future DSL rollout. (See AT&T Reports Healthy Q4.)
"If AT&T and Verizon accelerate their FTTx deployments and de-emphasize DSL, the company could face a shrinking DSL market, and coupled with a slowing of its traditional businesses, revenue and EPS [earnings per share] would likely decrease," writes JP.MorganChase analyst Ehud Gelblum in a January 23 brief.
Like Tellabs, Adtran has a fiber access product, its Total Access 5000 multiservice access and aggregation box.
But AT&T might not be ready to buy that device. "At this point the RBOCs, the major customers out there, aren’t really looking for second or third sources," Buck says. "They're still in the early deployment phases of these new [fiber] technologies."
Both Buck and Morgan Keegan analyst Leopold describe Adtran as a "fast follower," a vendor that waits for the market to decide what flavor of technology it wants, then enters with a product that beats the competition on price.
But the transition to fiber might not be a great time for fast followers. "In times of transition, they're not going to do as well as in times of technology stability," Buck says. At least at AT&T, Buck suggests, Adtran may have entered one of those transition periods.
Leopold doesn't believe that transition period has arrived yet. "If you look at where fiber penetration is, we're still in early days," Leopold says. "Adtran offers an outside plant-type DSL solution that meets market needs."
— Raymond McConville and Mark Sullivan, Reporters, Light Reading