3G: Short for Going, Going, Gone?
Enthusiasm for building next-generation wireless infrastructure is waning on both sides of the Atlantic, grim news for several big players
What a difference six months can make. Last summer, next-generation wireless networks were red hot. Analysts touted the stocks of equipment manufacturers as strong buys. It was easy to see why: The new networks promised faster connections and an infrastructure that could support more users than existing wireless-phone systems. A one-two punch, it was supposed to unleash customer demand for new services, such as zippy wireless Internet browsing and video streaming.
All music to the ears of execs at Nortel and Ericsson, which are building the guts of these networks. Of course, no one knew how much customers were willing to pay for the new services. But that didn't stop European wireless carriers from coughing up about $100 billion in 2000 for licenses to operate these new, so-called 3G networks based on Europe's stringent standards.
That was then. Now a chill is blowing through 3G's wonderland. With no business model in sight that will allow carriers to charge customers enough to quickly recover the invested billions, debt-strapped European wireless carriers are trying to scale back costs by teaming up to construct networks.
"LESS THAN HOPED." Meanwhile, as they watch what's happening in Europe, U.S. wireless carriers are slowing down schedules for rolling out their own 3G networks, which are supposed to offer data-transmission speeds ranging from 384 kilobits to 1.4 megabits. Equally troubling are questions about the ability of the new technology to deliver whiz-bang applications -- or anything significantly better than souped-up existing networks.
The upshot? "There's no doubt that the wireless-infrastructure market will be less than hoped," says Andrew Cole, analyst with technology consultancy Adventis in Boston. Cole figures infrastructure spending on the new networks in Europe over the next few years will come in at around $30 billion -- some $10 billion short of previous estimates. Pioneering Europe will represent 40% of the 3G wireless market for at least the next five years, according to Adventis, so any slowdown there could hurt the entire sector for years to come -- in particular, telecom giants such as Nortel (NT ), Ericsson (ERICY ), Lucent (LU ), and Nokia (NOK ). All may be forced to lower their next-generation wireless-sales projections going out several years.
Many of these players already have sizeable next-generation commitments: About a quarter of Nokia's revenues depends on infrastructure sales. But that pales beside Ericsson, where infrastructure sales represent close to 80% of total business, estimates Sean Gardiner, an associate with Morgan Stanley Dean Witter in London.
SHAKEOUT AHEAD? Not all of that business will be 3G-related. For the next few years, both Ericsson and Nokia expect most of their revenues to come from so-called 2G and 2.5 standards. Still, because they have based so much of their future revenues on projected 3G buildouts, the companies could be hit hard, Gardiner says.
As the gearmakers scramble to prove analysts wrong and meet lofty revenue predictions, competition will likely be cutthroat. Nokia already has announced it wants 35% of the total market. Ericsson, which holds the early lead, has its eye on 40%, while French telecom giant Alcatel expects to grab between 20% and 25%. Siemens also has ambitions of locking up perhaps a quarter of the market, as does the wireless division of Canadian optical maven Nortel.
Since these figures add up to a lot more than 100%, they could well signify a coming a shakeout. "There's definitely going to be some hard times ahead for people building mobile gear. It's already starting now, though companies are not going to admit to that," says Maribel Lopez, analyst with technology consultancy Forrester Research.
RISKY PROPOSITION. To gain customers, infrastructure manufacturers are already showering telecoms with discounts of 30% and deeper, says Morgan Stanley's Gardiner. With the new networks, gearmakers will be forced to offer more vendor financing than ever before, often lending the money to cover 100% of the purchases. That's a risky proposition as many of the telecoms needing that help went deeply in debt to pay for their next-generation licenses and could default.
Here's some indication of the investments already made: In August 2000, six telecoms bid more than $50 billion for next-generation licenses in Germany alone. But with so many competitors vying for a slice of the infrastructure pie, it's a buyers market. According to Gardiner, even Ericsson, which has tried to avoid vendor financing, is becoming more open to subsidizing customers.
Such reliance on vendor financing could leave some players out in the cold. As of Dec. 31 last year, Lucent already provided $5.7 billion in customer financing and had guaranteed $1.8 billion in customer debt. Like Lucent, Nortel has extended billions in financing to customers for sales of its optical networking gear. That could leave these two giants very little room to offer vendor financing on 3G networks in the future.
WAITING FOR UPGRADES. With U.S. carriers likely putting off their rollouts of 3G networks until 2004, a huge chunk of the 3G market remains a distant prospect. And even with ongoing sales in Europe and Asia, the infrastructure companies might wait years before they see profits.
According to Morgan Stanley Dean Witter, an infrastructure company with a contract to build out a 3G network will likely receive the money only after the network goes live. Until then, the sale itself is a losing proposition for manufacturers: Most companies will likely record a loss of about 10% on sales of 3G equipment in the first few years of the networks' introduction, Gardiner says. These companies make their profits from infrastructure upgrades, which cash-strapped telecoms are not likely to want for at least four years after the networks are up and running, he adds. And any delay in purchases of upgrades by carriers could have some infrastructure makers dripping red ink on their balance sheets.
Such upgrades seem an even more distant prospect in light of the unproven technology behind 3G. Many telecoms went after 3G lured by the promise of "killer applications" like streaming video, which allows users to watch TV, or each other, while talking on a wireless phone at the same time. But streaming video requires huge amounts of bandwidth, so any wide acceptance of this technology could overburden even 3G networks and anger customers.
LINGERING QUESTIONS. The wireless carriers might also have to do some fancy public-relations footwork: The first 3G phones, which are available in Japan, tend to overheat. That has fueled more cancer fears, which have not been substantiated.
Meanwhile, Adventis' Cole claims that more advanced second-generation networks being installed now can handle 90% of the applications promised by the much-hyped next-generation ones. In Japan and Europe, where cell-phone penetration is higher and wireless networks are overburdened, carriers are likely to roll out 3G since they have already paid for the licenses, and the networks do promise greater capacity. Yet, the questions linger as to whether the benefits warrant the costs.
Meanwhile, many U.S. carriers are biding their time -- pushing back roll-out dates for 3G networks by a year or more. Analysts now say the service will go live in the U.S. in 2004. But in other parts of the world, such as Latin America, 3G's increased capacity may not be needed anytime soon. "We're not going to see the repeat of the huge dollars [spent on wireless-spectrum auctions] that we saw in the European market," says Forrester's Lopez.
UNDER PRESSURE. 3G gearmakers say market concerns are exaggerated, continuing to predict that applications and consumer demand will follow the bandwidth buildup. Says Mark Tharby, a vice-president for wireless at Nortel: "Challenges come up, it's not unusual. The key is just that we understand that all technologies have their challenges in coming to market." Brian Bolliger, director of wireless marketing at Lucent, echoes the sentiment, saying: "We've been down this path before." At least one company, Ericsson, has entertained the possibility that a slowdown is coming -- but it continues to push full-steam ahead with the development of 3G gear.
But the impending slowdown of 3G's adoption clearly has put wireless builders under pressure. If sales don't materialize as expected, and profits don't meet forecasts, companies such as Nortel and Lucent, which have significant exposure in the flagging optical networking market, will have some explaining to do. Likewise for companies that rely on the slipping cell-phone handset market, such as Nokia and Ericsson. Add all this up and the next-generation dream could turn into a next-generation nightmare.
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