Here we go again
Increased broadband use and growing Internet access in Asia mean the telecom industry is taking off again. When it will peak is anyone's guess
Wynn Quon
National Post
Friday, December 13, 2002
Investors burned by the collapse of telecom share prices in the past two years may not want to hear this, but it's true. This most vilified of industries is about to regain its luster, and for three reasons.
First, new killer apps are rapidly chewing up the excess bandwidth capacity built during the boom. Second, emerging countries in the Asia Pacific region are adopting the Internet at an accelerated pace. Finally the peculiar economics of the post-bubble telecom era lend themselves to a rebirth. The prospects are strong enough that yet another speculative boom and bust could be on the horizon.
Remember the go-go years in the late '90s when anything Internet-related was growing at double-digit rates? You would think that those days are forever gone, but they aren't. Take a look at what's happening in broadband Internet access. According to Nielsen, the number of high-speed Internet users in the United States (those using cable modems or DSL) grew from 15.9 million to 25.2 million, or 58% in the year ending April, 2002.
What's going on? Why are people flocking to high-speed access? Two words: sheer fun. They're signing up for the free music, video and software provided by file sharing networks like Kazaa. At any given time, there are upwards of 4 million users on Kazaa providing a base of over 500 million mostly pirated music files (enough to give any music industry executive Internet apoplexy). They're playing online games, experiencing the visceral thrills of cyberwar. It's true that much of this is already available to the dial-up-56K user, but the difference that speed makes is crucial. A broadband user can download 100 songs (or about 10 albums) in 30 minutes. The dial-up user, on the other hand, is in for a thumb-twiddling wait of over four hours. And while it's possible for dial-up users to play chess and card games over the Internet, compelling online gaming experiences such as CounterStrike, Unreal Tournament and the newer Xbox titles are only available to broadband users. A sign of how big online gaming will become: Xbox Live, the new Microsoft broadband gaming module, completely sold out in its first week of release in late November.
While the United States is taking broadband to heart, demand for bandwidth in emerging economies, particularly in the Asia-Pacific region, is also on a tear. While it's inevitable that China will be wired to the Internet, what's surprising is that this is happening at an unexpectedly rapid pace. This year China surpassed Japan as the country with the second highest number of Internet users in the world (the United States takes first place) with over 50 million users, according to Nielsen. This is remarkable given that there were only 22 million users last year. Furthermore, the government has set a goal to have 200 million people online by 2005.
Torrid growth is a natural result of two good things: Consumer incomes are rising and PC prices are plummeting. (An internet-capable PC can now be bought for less than US$300.) When it comes to broadband demand, the Asia-Pacific region is no slouch either; in fact it's red-hot. According to Instat/MDR, the number of DSL users alone leaped from 6.9 million to 10.3 million users in the first six months of 2002, a compound annual increase of about 100%.
The boom in broadband business and the explosive growth of Internet users in Asia means billions of dollars for telecom operators and telecom equipment providers alike. What's more, the competitive structure of the telecom industry (or lack thereof) is likely to juice profits. The '90s was supposedly the decade of deregulation and competition. The local telephone monopolies were seen as fat, easy prey for nimbler New Economy carriers. Hundreds of competitive carriers rose to the challenge buoyed by free-flowing venture capital.
But in an ironic twist, after the decimation of the past couple of years, it is the monopolies like SBC and Verizon that remain standing. Carriers like Global Crossing and many others have flamed out spectacularly, selling their assets for pennies on the dollar. The result is that, in a world of continually falling technology prices, the telecom carriers have preserved their pricing power.
This is particularly true in broadband access. Customers wanting fast Internet access are generally limited to two providers, their local phone company or their local cable provider. As a result broadband prices have remained high. In the United States, local telecom giant, Verizon, for example, charges US$70 per month for its DSL service. Despite this pricey offering, customers are flocking to the service. Verizon has seen its DSL subscriber base grow 70% annually. Here in Canada, the cost of Bell's Sympatico DSL service has actually increased 10% in the past year.
It's well known that the biggest problem facing the telecom industry is the massive debt burdens taken on during the boom years. The good news is that renewed vigour in broadband markets and in overseas Internet access means that the debt will be worked off a lot faster than the markets are currently anticipating. In fact, as telecom carriers become newly flush with cash, the ripple effect will prompt a resurgence in the entire sector.
What's the telecom investor to do? Conventional wisdom holds that the days of making a fortune in the likes of Nortel and Lucent are over. It's said that Nortel will never hit $120 again. That may be true, but canny investors don't need it to. In the Great Telecom Bubble from 1998 to 2000, Nortel's price rose tenfold. In the Telecom Bust of 2002, Nortel sank to a low of US$0.43. It has only to rise to a little over US$4 for the same tenfold performance.
Of course, a telecom resurgence is not guaranteed. The principal risk, though, doesn't lie within the industry. The main threat: a global economic slowdown that precipitates a debt crisis. But on the plus side, the markets seem to have taken this at least partly into consideration. Prices for telecom stocks are still at decade lows. The combined market capitalization of the two top telecom equipment makers -- Nortel and Lucent -- is about US$12-billion, even though their total sales for the past year are twice as much. Prices for telecom carriers are also cheap, considering that many sport a dividend yield of 4% or more.
It's also worth taking a longer perspective. To see what's likely to happen in telecom in the next few years, let's review a lesson from distant history. Many tech investors now know that the Telecom Bubble was similar to the speculative boom associated with the introduction of the railroad in the 19th century. What is less known is that the railroad mania was not a single event. The first episode of railroad mania happened in 1837 in England, but this was followed by further booms in 1847, 1857 and 1873 as railroad construction swept through Europe and then North America.
The same kind of cyclical boom-and-bust scenario is likely with telecoms. It's hard to guess when the next telecom boom will peak. The interval between telecom booms may be shorter than the 10-year intervals between the railroad booms simply because the cost and time to deploy Internet and broadband access is considerably less. Rates of adoption are hence faster, and this shows up as rapid, exponential growth in subscriber bases and revenues.
One thing is for sure though: The last fortune in telecoms has not yet been made.
Wynn Quon is chief technology analyst at Legado Associates. E-mail: wynn_quon@hotmail.com
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