A Wrong Number for Telecom:
Big Operators Cut Spending 19%
Fact Spells Yet More Headaches
For Equipment Manufacturers
By ALMAR LATOUR, DENNIS BERMAN and SCOTT THURM
Staff Reporters of THE WALL STREET JOURNAL
So much for a budding recovery in the telecom sector.
Investors' recent hopes that the beleaguered sector might be turning a corner, bringing better times to the equipment makers in particular, are being dashed as the nation's biggest telecom companies disclose reductions in first-quarter capital spending to recent new lows.
The depth of the cuts is disappointing analysts and investors alike. All told, spending on equipment by the six major telecom operators that have reported was down an average of 19% in the first quarter compared with the same period the year before, widely considered to be the worst year in the telecom industry's history.
AT&T Corp. and Sprint Corp. took the opportunity to lower their expected spending levels for the year even further. While the phone companies could spend more aggressively in the latter half of the year, most analysts expect them to pare back their budgets further as some shore up unsteady balance sheets.
The cutbacks spell more headaches for the likes of Nortel Networks Corp., Corning Inc. and Lucent Technologies Inc., equipment makers that have feverishly cut costs only to have revenue continue to erode beneath them.
Cutbacks also are evident in Europe, where Sir Christopher Gent, chief executive of Vodafone Group PLC, Europe's largest wireless operator with more than 100 million customers, recently said he expects the company's annual capital-expense budget of £s;5.5 billion ($8.8 billion) to be reduced. People close to the company say Vodafone's capital expenditures may be cut by as much as 10%. That is bad news for equipment makers Telefon AB L.M. Ericsson and Nokia Corp.
There are frustrations in the broader tech industry, too, where hardware sales seem to be stabilizing at low levels but software makers continue to lay off workers. Siebel Systems Inc. and PeopleSoft Inc., which make business-productivity software, each announced additional layoffs last week after posting disappointing quarterly results. Even Microsoft Corp., which has escaped the brunt of the tech downturn, indicated sales growth could slow in the fiscal year beginning July 1.
Another wild card for equipment makers is the outbreak of severe acute respiratory syndrome, or SARS, which may prompt delays in the rollout of network equipment. People familiar with the situation say that the installation in Hong Kong of Siemens AG third-generation wireless base stations for Hutchison Whampoa's telecom arm already has met with some delays. The reason: As fear of being exposed to the SARS virus grows, engineers can't enter some apartment buildings in which the base stations need to be erected.
Hopes had been higher at the start of the year, when many were predicting that the telecom industry would slowly, but surely, begin climbing out of its three-year slump. Observers say that the war in Iraq, while brief, still adds to all the uncertainty.
Stocks in telecom-equipment makers such as Nortel and Corning have rebounded sharply from their 52-week lows. Shares of Nortel, for instance, traded as low as 43 cents last fall and had recovered to $2.52 as of 4 p.m. in New York Stock Exchange composite trading Friday, up six cents on the day. Nonetheless, the uncertain market conditions have kept most companies at extremely low valuations. Nortel, once valued at $274 billion, was valued at $10 billion on Friday afternoon.
Merrill Lynch & Co. expects global telecom capital expenditures to decline by 7% during 2003 from last year's level, a bigger fall than the 5% drop the firm forecast earlier this year. In a new report, it notes that first-quarter capital spending for AT&T, SBC Communications Inc. and Sprint PCS was down, on average, 26% from the year-earlier period, far off the 10% drop Merrill had expected for all U.S. carriers.
In a sign that doesn't bode well for the overall economic recovery, part of the problem is that "telecom is less capital-intensive than it used to be, due to investments made over the last five years and improvements in the technology," says Joe Mathias, who follows the telecom industry as a vice president at Atlanta investing company GMT Capital.
Some equipment makers say they aren't surprised by the new developments. Ciena Corp., which makes optical gear for telecom networks, isn't expecting any growth in its sector until late 2005 at the earliest, says senior vice president for corporate strategy and marketing Steve Chaddick. For the market to recover, Mr. Chaddick says, "there has to be rationalization" of the country's telecom carriers.
Lucent spokesman William Price says the market isn't as bad as it was last year, though the company doesn't yet see a recovery. Lucent officials say they have cut enough to ensure they don't miss their goal of returning to profitability by the end of September. Similarly, Nortel's own cost-cutting -- which slashed the work force by nearly two-thirds -- delivered the company's first quarterly profit in years for the first quarter, and it occurred one quarter earlier than the company expected.
Simple economics play into the telecom cutbacks: Competition has increased while the regional Bell operating companies have seen demand for local phone services drop during the past few quarters. "Telecom operators are being extremely conservative on their spending," says Zach Wagner, a telecom analyst at Edward Jones.
Meanwhile, companies remain unsure when the economy will recover. Rating agencies are forcing many telecom companies to pay attention to their high debt levels, further reducing incentives to invest. Add to that a layer of regulatory uncertainty from a recent Federal Communications Commission ruling that opens the nation's local phone markets to increased competition.
SBC's chief financial officer, Randall Stephenson, said last week that until he knows what the final FCC ruling is, he can't decide about expanding broadband, or high-speed Internet access, to additional markets. SBC cut first-quarter capital spending 49% from the year-earlier period, a sharper cut than rivals made.
Four months into the year, AT&T now says capital spending will tally $3 billion for the year, down from an earlier projection of as much as $3.5 billion. In 2002, AT&T's capital spending was $3.9 billion.
In February, telecom operator Sprint set annual capital spending for its wireless and traditional phone business at $4.6 billion; now, it says it will spend $4.1 billion. It has cut the number of new cellular-phone sites it will build to 1,700 from 2,400.
For the time being, most phone companies say their capital-spending targets for the full year remain the same and they chalk up part of the weak first-quarter spending to seasonality: Telecom companies tend to buy less equipment during the first quarter.
In the broader tech market, signs of recovery are mixed. Despite downturns in the software industry, hardware mainstays such as International Business Machines Corp., Intel Corp. and EMC Corp. said they don't see conditions eroding further. Orders and shipments of high-tech goods in March were a little stronger than expected, according to government statistics released Thursday, though some analysts cautioned that the increase may reflect attempts by some customers to build inventories ahead of the Iraq war.
The general upward drift in tech shares in the past few weeks reflects results that were "better than feared," combined with "hope" for improvement later in the year, Banc of America Securities analyst Joel Wagonfeld noted on Thursday.
The next big signal for tech shares will come May 6, when networking-equipment maker Cisco Systems Inc. reports fiscal third-quarter results. Analysts expect Cisco's revenue to decline for the second consecutive quarter. Telecom operators account for about 20% of Cisco's revenue. |
