Value Line is regarded as the best independent research available. More than just recommendations, Value Line provides the rationale behind its picks for greater understanding.
- Don D., California
Industry Analysis: Telecom Equipment
The Telecommunications Equipment Industry produces technologies and services that are used to facilitate people's communication. Major products include cell phones, chipsets, wireless and landline infrastructure equipment, digital subscriber-line (DSL) and cable modems, and networking devices, such as routers and switches. The industry's customer base is highly diversified, including multi-national corporations, telephone companies, governments, universities, institutions, commercial businesses and consumers. Though spending on telecom equipment is generally considered non-discretionary, many customers will delay plans to upgrade/expand their telecom systems or purchase products during an economic downturn.
Competition among companies in this industry can be intense. Most products are technologically advanced, entailing significant research and development. This, and the need for great economy-of-scale and international distribution facilities, creates a high barrier to entry. Thus, many subsectors only have a small number of well-heeled competitors. Mergers and acquisitions help equipment makers to maintain favorable market positions. Transactions may be of the small bolt-on variety or massive combinations. There are a number of small players in the industry that have found safe niche markets, serving enterprises and commercial businesses. But in such markets, demand may, at times, be volatile. Large companies who sell to the telcos usually receive steady, reliable orders.
Consolidation within the Telecom Services Industry has resulted in fewer customers that have greater buying clout. Competition among equipment manufacturers is keen and pricing power has suffered. Offsetting some of this pressure is the emergence of new technologies and service providers. Cable companies, for example, offer Voice over Internet Protocol service. Too, telcos are building out broadband networks that provide television and high-speed Internet services. Equipment manufacturers benefit from telco/cable competition, as companies strive to construct systems that provide top-quality bundled packages. Increasing demand for mobile, big-capacity products and services augurs well for equipment makers' results.
Telecom services companies still depend on landline business for cash flow. When economic times are tough, customers tend to disconnect these lines and rely more on wireless and broadband communications. Also, consumers will gravitate to the most economical voice and Internet plans. This pressures telco budgets, resulting in scaled-down or delayed network expansion. Equipment providers can weather difficult periods by helping telcos to maintain and/or enhance existing systems. Conversely, when times are good, demand for advanced services rises, and telcos and businesses have more cash to invest in their operations, which lifts equipment maker results.
There are trends signaling favorable long-term revenue and earnings growth for the industry. One is that the number of global cell phone users continues to increase. First world nations, located in North America, Europe and the Pacific Rim, offer limited revenue opportunity, since they have mature wireless markets; handset replacements and upgrades are the primary growth drivers. But developing countries, where advanced wireless netwrok market penetration is low, hold much potential for new subscriber accounts and related equipment sales. Companies with an extensive international presence should perform well.
Another positive trend is expanding consumer and business demand for Internet bandwidth, fueled by the popularity of video downloading and conferencing. Large telcos are working to satisfy heightened capacity requirements by building fiber-optic systems that offer quick upload and download speeds.
A third, fortuitous trend is innovation. To remain competitive, telcos need to offer the most useful and efficient service available. For instance, fiber-optic and advanced cable networks are replacing older, slower DSL and cable systems. Too, mobile communications is transitioning to improved broadband wireless fidelity networks. Such undertakings are expensive, and good business for equipment makers.
The Telecom Equipment Industry is fairly cyclical, conforming to the multiyear boom and bust swings of the economy. Typical network infrastructure contracts, though, are long-term, thereby lending stability to operating results. The degree to which its products are technically advanced determines an equipment maker's pricing power. Hi-tech offerings allow for higher prices and improved cost absorption. Research and development is one heavy outlay that must be covered. When margins come under pressure, managements turn to popular cost reduction measures, inventory reduction, headcount elimination and back-office consolidation among them.
Cash flow is important. Good cash generation allows them to adequately fund, in order of priority, R&D, acquisitions and stock buybacks. Sometimes, R&D spending at a company, especially a small one, can temporarily exceed cash flow, when a promising product is under development. The industry is not heavily reliant on debt funding. Long-term debt-to-total capital ratios are often below 25%. To supplement cash funding, management will issue new equity.
Stocks in this industry tend to be volatile. Stock Price Stability and Earnings Predictability scores are commonly low. Telecom Equipment issues are best suited to venturesome investors seeking to capitalize on market upswings.