Look again: 2005's budget flush showed up

Equipment vendors and their investors awaiting fourth-quarter earnings reports were made nervous last month by fears that December brought no “budget flush” — carriers' perennial practice of emptying out their annual budgets with year-end spending surges. Lucent Technologies ignited that fear by complaining that its fourth-quarter revenue fell short of expectations due largely to the budget flush that wasn't there. “We just flat out didn't see it,” Chief Executive Pat Russo said. “We actually saw a tightening up [of customer spending] very late in December.” Soon after, Adtran reported similar results, with a 6% sequential revenue drop in the fourth quarter.

In truth, there was a budget flush among major carriers at the end of 2005. Vendors just had to know where to look. Bell companies spent 29% of their annual 2005 budget in the fourth quarter alone, increasing their capital spending 14% sequentially to $5.5 billion. Among the three biggest Bell companies and Alltel, fourth-quarter spending even exceeded the expectations of UBS Investment Research. Cingular Wireless was perhaps the biggest flusher, spending $2.97 billion, or about 40% of its annual budget, in the fourth quarter.

Verizon was the lone standout in that club, shifting spending from other areas to fund its fiber-to-the-premises (FTTP) initiative. The carrier cut its domestic capex 5.3% sequentially in the fourth quarter to $3.6 billion (trimming wireless spending 6% to $1.5 billion and wireline spending 4.5% to $2.1 billion). Lucent may have been particularly exposed to that belt-tightening, as most of its wireless revenue comes from Verizon Wireless and Sprint. However, Verizon expects to increase its capex 3% to 5.5% this year, which Lehman Brothers analyst Marcus Kupferschmidt believes should help Lucent rebound, especially in the second half of the year.

Vendors can miss out on budget flushes by being in the wrong markets, said John Celentano, president of Skyline Marketing. For instance, Bell companies spent 40% of their 2005 budgets on access infrastructure, he said, which helps explain why Tellabs, whose biggest source of fourth-quarter revenue was access gear, didn't complain about budget flush in its earnings call. “I don't know what budget flush is, frankly, and I don't know if it's relevant in this day and age,” Tellabs CEO Krish Prabhu said. Tellabs is Verizon's chief FTTP supplier.

“Lucent is out of this action completely,” Celentano said of the access market.

Of course, that doesn't explain why access vendor Adtran missed out on the budget flush. But Celentano said Adtran's loss, like Lucent's, was company-specific, stemming from a current lack of demand for small-capacity broadband access gear.

As for the predictions of the future ahead for vendors in general, UBS expects U.S. carrier capex to grow 10% in 2006, with no slowing in the first half. But while last year's spending was driven by wireless, this year's will be driven by wireline access initiatives and upgrades to AT&T's and Verizon's backbone networks, UBS said.