As I have posted in prior blog posts over the past few months, I have been generally positive on Alcatel-Lucent and Ericsson given my view these two stocks were under valued and that a cyclical bullish trade in these two stocks was likely given a better telecom capital spending environment would materialize in 2013. This past week, three data points came to surface that continue to make me comfortable with this thesis.
- Telecom Italia announced it was cutting its dividend by about half, to help fund its capital spending plan for 2013-2015 to support needed network investments in both LTE and fiber based broadband networks. Capex in each year in the 2013-2015 period would likely remain consistent with the 2012 capex level of about €3 billion. While cutting the dividend to help fund capex is not ideal, the fact that a large European telecom operator is committing to a reasonably healthy capital spending outlook for the next three years is encouraging, especially for a Southern European telecom operator given the weak economic condition in that region.
- Telecom operator KPN of the Netherlands reported 2012 capex of €2.2 billion, at the high end of its guidance of €2.0-2.2 billion. KPN is another European telecom operator that had cut its dividend in 2012, yet actually spent at the high end of its capital spending guidance. More importantly, KPN announced that for 2013-2015 annual capex would be in the range of about €2.2-2.3 billion, suggesting capex in each of the next three years would be at the 2012 level or slightly higher. Once again, the drivers for capital spending would be the build out of its 4G wireless network and a more robust broadband wireline network.
- Sprint reported 4Q 2012 results Wall Street analysts significantly raised their 2013 and 2014 capex estimates from about $5.5-$6.5 billion per year to about $7.5-$8 billion per year. This level of capex compares to $5.4 billion in 2012. Clearly Sprint is planning to be aggressive with its capital spending given the planned investment by Softbank and Softbank’s desire to be major force in the US wireless market.
Europe Has Been Underinvesting; New Competitive Dynamics in the US
What I infer from these data points as well as the analysis of historical capital spending trends is that most telecom operators in Europe have been under-spending given the weak macro-economic conditions in the region as well as pressure to preserve current dividend payouts. It seems to me that the mindset of European telecom operators might be changing from “preservation” to “growth” which in some cases is supporting dividend cuts in favor of capital spending in growth initiatives like 4G and wireline broadband initiatives. In addition, the US market could be poised for a new competitive dynamic where the virtual duopoly of AT&T and Verizon will be challenged by a newly funded and aggressive Sprint and the re-emergence of T-Mobile as another wireless operator that invests for growth. T-Mobile may not have long term aspirations like Sprint in the US and eventually may seek to sell itself to Sprint or another entity. But in the interim period of the next two years, T-Mobile will likely be more of in the investment mode in its network rather than a harvest/sell mode.
While I Remain Favorable, Telecom Equipment Stocks are Very Risky
The telecom equipment market is still a very competitive industry with aggressive pricing pressure. A more favorable capital spending environment is certainly a positive, but does not ensure stocks in the sector will perform well. While this is still a risk, I continue to think the bullish cyclical trade has not run its course and remain positive on both Alcatel-Lucent and Ericsson. Alcatel-Lucent has additional risks of turning around negative cash flow performance since the merger of the two former companies and a sub-scale business. Thus, it is a much riskier investment than Ericsson.
Plot Thickens at ALU With A New CEO Search and Press Reports on NSN
In the case of Alcatel-Lucent, the company also announced it is looking for a new CEO. The outcome of this CEO search will certainly be an important factor impacting the stock performance of ALU in the future. The WSJ sites NCR current Chairman and CEO Bill Nuti as one potential candidate. Bill has an accomplished career and I think would be a good choice for ALU. On the other hand, the job of turning around ALU will be challenging for any new CEO as the company has a high cost structure, especially in Europe, and needs to focus its R&D in fewer areas of the telecom equipment market. The high cost structure in Europe is a major over-hang, as typical severance packages in France and other parts of Europe require up to three years of salary when employees are downsized. Large severance payments in Europe will make it difficult for ALU to successfully complete its restructuring in my view. Thus, any new CEO, regardless of talent and vision, will have to somehow overcome this restructuring over-hang.
Another interesting French corporate development to watch that may or may not have implications for ALU is how the French government deals with similar cost and market demand issues at French auto manufacturer Peugeot. Press articles discuss that the French government might get involved in the restructuring/turnaround of Peugeot to preserve the company and jobs in France. Peugeot, however, employs significantly more people in France (about 100,000) than ALU (about 10,000). In addition, there is precedent in the auto industry for governments to help struggling companies (e.g. the US bailout of General Motors), but we have not seen such support in the telecom equipment market (e.g. the Canadian government did not get involved when Nortel fell to bankruptcy).
Increasing the intrigue on the CEO selection and ongoing restructuring at ALU is another recent press report from Bloomberg indicating that Siemens would like to exit its 50% ownership of the Nokia Siemens Networks (NSN) joint venture with Nokia (Nokia owns the remaining 50% of this joint venture). NSN has shown three good quarters in a row and is well down the road in its own restructuring plan. Thus, it is not a surprise that Siemens would want out of the JV as Siemens has been exiting its telecommunications businesses over the past several years and NSN is now more of a stable entity. Nokia likely wants to stay in the wireless infrastructure business as smartphone competitor Samsung is attempting to win business by bundling smartphones and wireless infrastructure equipment in several of Nokia’s markets. According to the Bloomberg article, Nokia is considering buying Siemens’ stake directly or in a partnership with ALU. If in-fact ALU would end up being a part owner of NSN, this would likely be a positive for both ALU and NSN as they would be partners rather than competitors in the wireless infrastructure and services markets. Given both are distant players behind Huawei and Ericsson in the wireless infrastructure market; a partnership between the two would help both companies. This of course assumes, that ALU is able to fund a purchase of a partial ownership in NSN and the ability for both ALU and NSN to implement further restructuring in their respective wireless equipment and services businesses that would likely result from a partnership between NSN and ALU. The other interesting angle in a potential partnership between ALU and NSN would be whether NSN would begin favoring ALU for IP routing equipment instead of Juniper Networks, its long time partner for IP routing. That could be another positive for ALU to come out of such a partnership, besides better competitive dynamics in the wireless infrastructure and services markets.
Disclosure: I own shares of Alcatel-Lucent and Ericsson mentioned in this blog post. I currently and in the future may solicit any company mentioned in this blog for consulting or advisory board services for NT Advisors LLC.