Optimists Look Toward 2003

Just when will this telecom market regain its footing? Are there any glimmers of hope on the horizon?

There are no easy answers. There is some optimism among some equipment vendors that think the next capital spending and RFP (request for proposal) cycle, which is largely determined in the fall, can only bring good news. But analysts warn against thinking about any quick recoveries.

Sources line up on a continuum of hope, with the optimists favoring a turnaround by the end of the year, and the pessimists -- well, let's just say they don't think it's any time soon.

Let's start with those who see turnaround signs on the horizon. Steven Levy of Lehman Brothers says comparison of recent carrier capital spending adjustments with revenues from leading equipment vendors indicates things are stabilizing. Further, he predicts a modest uptick by year's end:

"If you look at the June capex actuals reported to date, the carriers are definitively reporting at least flat sequential numbers compared to March, and the outlook is clearly pointing to a flat second half at a minimum but more probably a small uptick."

One line of reasoning by the optimists goes like this: Even though carriers have cut back on their capital spending budgets for 2002, much of that budget hasn't been spent yet. So there is money left in the 2002 budget that could be spent in the second half of the year.

Levy acknowledges that figures from Verizon Communications Inc. (NYSE: VZ) are still needed to firm up his theory of an uptick. Verizon's numbers will be decisive, since they have one of the largest telecom budgets in North America -- totaling about $14.5 billion at last report, almost double what AT&T Corp. (NYSE: T) and SBC Communications Inc. have earmarked.

Also needed is definitive evidence that equipment vendor revenue growth is following the carrier capex pattern Levy's identified, and he says that's not likely to appear until the September quarterly results are in. He's also met with skepticism from "every one" of the equipment makers he's laid his theory out to, he says. But "as we now know, they didn't see the downturn coming until they were well into it either."

Levy's hardly alone in his thinking. A group of hopefuls looks to the upcoming autumn timeframe, the traditional period when North American incumbent carriers set their budgets, as the turning point in the present crisis.

"There are a lot of RFPs out right now... The budgeting cycle for most carriers starts in October, so it will be early next year before the contracts go through and we'll see things really come back," says Bert Whyte, director and CEO at Network Equipment Technologies Inc. (net.com) (NYSE: NWK), which makes service creation gear. There's no lack of proposals waiting resolution (see BellSouth to the Rescue?, Verizon RFPs: More Fizzle Than Sizzle, Sprint RFP Raises Hopes, and Capex Cuts: How Low Can They Go?). Decisions on even a few of these could help set expectations for the coming months and determine who's in and who's out of the market. That surety, the thinking goes, could help generate new equipment inventory cycles and get the wheels of growth going again.

And many think decisions are in the offing. "We won't see any big volume rollouts until early next year, but the decisions on those rollouts will get made this year," says Chad Dunn, director of product marketing at multiservice edge switch maker WaveSmith Networks Inc..

But others warn against this line of reasoning. Even if RFP decisions are made this year, that's no guarantee they’ll be reflected in budget plans, they say. "We're seeing RFP champions within carriers move forward, then the project gets pulled back by the CFO," says Steve Kamman of CIBC World Markets.

Others say RFP decisions also can take unexpected turns due to political clout, unraveling supply chain expectations. "The decision can be made, then undone with a phone call from a higher-up," says one analyst, who asked not to be named. "I've seen it happen over and over."

”Even [purchase orders] can be cancelled or withdrawn or ordered suspended,” says Michael Howard, cofounder and principal analyst at Infonetics Research Inc. “Even though certain startups had signed valid POs on which to base their future, the rug was pulled from under their feet, causing them to crash and quickly burn.”

Others say that while carrier budgets may be getting set in the fall as usual, they're being reevaluated every quarter. "These are the new rules, the ones followed by the rest of the business world," says Frank Dzubeck, president of Washington, D.C., consultancy Communications Network Architects. "Telecom was sloppily managing large amounts of cash in the old days. But for the past two years, goals are set in the fall, but actual budgets are reassessed quarterly."

Carriers seem to support the view of budgets as works in progress. “I would say budgets are worked on for most of the year,” writes BellSouth Corp. (NYSE: BLS) spokesman Jeff Battcher in an email, “and we are always getting RFPs for projects. That's because tech is changing so fast we have to be ready to give our customers what they are asking for.”

For his part, Dzubeck sees recovery starting maybe late in 2003. "Carriers need to get their debt in line, then things will start to take off." As carriers find ways to buy up assets of competitors, he says, some may be able to make debt equal assets more closely, leading to profitability.

Some industry watchers aren't putting a date on when the rebound will come. "Let's just say that we expect aggregate worldwide capital spending by carriers to fall in 2003 again," says David A. Jackson of Morgan Stanley Dean Witter & Co.

Kamman of CIBC is another who thinks early signs may be a mirage. He says that even if carriers take to adjusting their budgets every quarter, the total allotment will be set this fall -- and it will likely be comparable to, or even smaller than, it was last year. "I think you'll see folk reallocate spending within a budget, but the total won't move a lot. And dollars spent will be dollars hard-fought," he says. For Kamman, 2004 is the very earliest the industry is likely to see substantial recovery -- and then only if macroeconomic conditions hold steady.

Still, he leaves open the possibility things could happen a bit faster. In a note issued yesterday, Kamman says that for the first half of 2002, for instance, RBOCs SBC and BellSouth reported capex at 18.6 percent and 22.3 percent of revenues, respectively, versus 18.2 percent and 17.7 percent last quarter. “Judging from past evidence (we have data back to 1955}, this represents a pretty good basis for estimates of ‘sustainable’ long-term spending going forward... That says nothing, however, about near-term spending.”

Kamman and colleagues say they think it’s likely long-haul carriers AT&T and Sprint Corp. (NYSE: FON) may have cut as much as they can for awhile. Wireless carriers such as Cingular Wireless are spending more as a percentage of revenue than they did last quarter, but lack of past data makes it tough to determine how they’ll spend in 2003. In general, whatever timeline the recovery takes, it's likely to start at the network edge and work its way to long haul, Kamman maintains, with components to follow.

— Mary Jander, Senior Editor, Light Reading
http://www.lightreading.com

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