SBC Renews Spending Concerns

This morning (Tuesday) SBC Communications Inc. (NYSE: SBC), the number two provider in local telephone service, re-ignited concerns over capital spending and its effect on equipment vendors when it announced lower than expected quarterly results.

The service provider expects earnings for 2001 to grow between 11 and 14 percent. Analysts expected the company to report growth of around 14.5 percent. The company also reported that it expects its capital spending in 2001 to remain flat. The news sent SBC’s share price down 12.6 percent to $46 a share.

“It’s not a big revision,” says Tavis McCourt, an analyst with Morgan Keegan & Company Inc.. “But it’s definitely a reality check. You can’t grow capital spending when your revenues aren’t keeping pace. Basically, service providers are being forced to cut back until they prove that they can make good use of their capital.”

SBC isn’t the only large carrier getting squeezed in the capital market crunch. BellSouth Corp. (NYSE: BLS) recently announced that it also doesn’t expect to increase capital spending in 2001 and may in fact reduce it. This is in contrast to a 15 percent increase in spending from 1998 to 1999.

Clearly, this news isn’t that surprising to the investment community. The capital markets are extremely hostile waters for service providers these days. The news of failing competitive local exchange carriers (CLECs) has circulated through the rumor mills and ended up on the pages of Light Reading on several occasions (see GTS Moves up Debt Danger List).

What does all this mean for optical equipment vendors? It's not exactly good news.

“By and large, I don’t think the equipment market will be as robust as we’ve seen it in the last few years,” says McCourt.

But, as analysts have noted before, optical networking and next-generation equipment is likely to continue selling and will thrive in 2001 (see Analyst Report Defends Optical). Service providers are expected to cut spending on legacy equipment and focus purchases on products that will be able to give them more bang for their buck.

“Certain segments like optical networking will probably continue to grow,” adds McCourt. “Carriers will be forced to upgrade their networks to keep up with competition. And they will always opt for equipment that reduces their cost.”

Many analysts see the history of wireless providers repeating itself in the wireline market. After the Federal Communications Commission (FCC) auctioned off radio frequencies a few years ago, the market was flooded with new wireless providers. A shakeout followed, and wireless stocks fell out of favor.

The wireline market seems to be following the same pattern, analysts say. The shakeout is still in its early stages, but analysts predict that over the next couple of years languishing CLECs will consolidate and their assets will be bought by bigger players like SBC, Bell South, and Verizon Communications (NYSE: VZ).

“It’s the same dynamic and natural cycle,” says Max Schuetz, analyst with Thomas Weisel Partners. “The healthy carriers are just waiting for the weak and wounded to fall down, so they can buy their assets at firesale prices.”

Which is, ultimately, good news for equipment vendors. But more consolidation means fewer customers, making wins with traditional players even more important, says McCourt.

“Sometimes they have to take business where they can get it,” he says. “But all things being equal, it’s better to sell into a bigger player’s network.”

-- Marguerite Reardon, senior editor, Light Reading, http://www.lightreading.com

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