Ifs, ands and cuts

Virtually all vendors in the handset business are outsourcing production.

Amid a slowing economy, the telecommunications sector will limp into its largest trade show in Atlanta next month, and the question on everyone's mind is how much carrier spending has declined.

The U.S. wireless industry has turned out to be a mixed bag. Some vendors are seriously wounded by the fact that their carrier customers aren't spending as much this year. Yet most carriers say they still are spending aggressively.

“It's important for us, not only in strong economic times but in weak ones as well, to focus on our network,” says Dennis Strigl, president and CEO of Verizon Wireless, the country's largest mobile phone operator.

“Our capex continues to be higher than last year, although we did cut it slightly,” he says. “When a carrier says they are cutting their capex budget substantially, that's trouble. One of the things we learned years ago is that the most important thing to do is to continue to invest. When you cut capex while [minutes of use] continue to grow, that causes problems down the road.”

While Verizon still is spending aggressively, its capital expenditure budget is rising only slightly from $4.3 billion in 2000 to $4.6 billion in 2001.

Sprint PCS has increased its capex budget slightly for 2001 to add more cell sites to the network, says Charles Levine, president of Sprint PCS. Yet capex during the first quarter was lower than the previous year. The carrier spent $693 million in the first quarter 2000 vs. $655 million during this year's first quarter.

AT&T Wireless' mobility unit spent $1.12 billion in the quarter, an increase of 41.2% from the year-ago quarter.

“The majority of spending this quarter was related to quality and capacity improvements in our TDMA networks,” says Mohan Gyani, president and CEO of AT&T Wireless Services, during the company's quarterly conference calls with analysts.

Supplier slump

Despite the jump in capex from the previous quarter for AT&T Wireless, Ericsson indicates its largest North American customer has significantly curbed its spending, which has hurt the equipment supplier. Ericsson has warned the investment community that infrastructure sales would be flat in North America during the first half of the year.

“We see a definite slowdown,” says Per-Arne Sandström, executive vice president of Ericsson North America.

“Carriers build for capacity during the good times…. During difficult times, you are more careful with spending and see how long you can live with the investments you've already made,” Sandström says.

“It's very much on the cost-saving part of the equation. We're staying in touch with operators to manage this in the best possible way,” Sandström added.

Ericsson couldn't handle all the business AT&T Wireless threw its way back in 1999 after the carrier launched its popular Digital One Rate pricing plan. The popularity of the plan — which charged a flat fee for all wireless minutes regardless of whether they were long-distance or roaming charges — took AT&T Wireless by surprise, and it vigorously built out coverage areas and bolstered capacity throughout 1999 and 2000. That trend slowed significantly in 2001.

“There has been tremendous growth over the last few years, and everyone has kept that on a hockey-stick curve,” says Larry Swasey, senior vice president of communications research for Allied Business Intelligence.

“Today it is mostly upgrades of existing infrastructure. Looking at the overall cost of what carriers are putting in for the software and hardware upgrades, it's typically 10% to 15% of base station costs,” Swasey said.

“I've seen the phenomena with carriers saying they are still growing, yet vendors saying growth is flat,” says David Berndt, director of wireless and mobile technologies with The Yankee Group. “We're still seeing contracts going out for capacity, but it's pretty flat year over year. On new contracts, we're seeing a 5% lift. It is an increase but not a lot, so we're labeling it as a holding pattern.”

None of Lucent Technologies' carrier customers has indicated it is cutting capex budgets this year, said Cindy Christy, chief operating officer of Lucent Technologies' wireless networks group.

“We do know that all of our customers are reviewing their capital plans,” she says. “They are pushing us to see what we can do in terms of improving capacity in the investments that they have today.”

More spending to come

Vendors are confident that spending will pick up in the latter half of this year as carriers move to more data-intensive networks.

AT&T Wireless has indicated that spending on its new GSM/general packet radio service nationwide network will pick up during the second half of the year as the carrier works to provide coverage to 40% of its covered pops. The carrier plans to turn on its first market in Seattle this summer.

Sprint PCS says it's on track with its plans to build out high-speed 1XRTT technology, a software upgrade to CDMA technology that offers peak data speeds of 144 kb/s and double voice capacity.

“One could say there is a race,” says Levine. “We'll get there first on a national basis. We'll be deploying 1X through the rest of this year, and we'll have every single market the beginning of next year.”

Sprint PCS has set out a four-pronged migration strategy. By early 2003, it will enhance 1X technology's data capabilities to 307 kb/s through compression technologies. In late 2003, it plans to deploy 1X Evolution, a more enhanced version of 1X technology that will allow for speeds of 2.4 Mb/s.

Earlier this year, Verizon Wireless and Lucent inked a $5 billion, three-year contract to deploy the first phase of 1X technology later this year. It was the largest wireless contract Lucent has ever signed. Verizon, which has been testing the technology in Princeton, N.J., will deploy 1X later this year.

VoiceStream Wireless is aggressively pursuing deployments of GPRS. Nextel plans to overlay its integrated Digital Enhanced Network (iDEN) with CDMA 1X service, while Cingular Wireless is mulling a move to either GSM/GPRS or CDMA 1X. Investments will move fast as carriers find they face heavier competition in the wireless data environment.

“In the wireless space, all the markets we're operating in are very much looking at the demand for wireless Internet services and trying to satisfy that demand through technologies like 1X and GPRS,” says Mark Tharby, vice president of wireless Internet solutions marketing for Nortel Networks. “There is solid demand for 3G services. On the [2G] side, carriers are managing the growth of their networks.”

The wireless sector is still growing aggressively, he says, so they are forced to address that demand. “They have to build infrastructure to support that.”

Even carriers that don't plan to invest heavily in more advanced wireless data networks will spend. For example, TDMA operator TeleCorp PCS, an AT&T Wireless affiliate, isn't spending much this year on moving to GPRS.

Building GPRS doesn't make sense for the carrier because its strategic partner will only cover 40% of the market by the end of the year. And it doesn't see vendors delivering volumes of GSM/TDMA handsets until 2002.

Instead, the carrier is focusing on reaching EBITDA-positive by 2002 through a robust voice offering.

“TeleCorp is bullish about the voice business,” says Gerald Vento, TeleCorp's founder and CEO. “We can get good capitalization from voice that we can't justify on data today.”

‘This is the fastest dive in our industry that we have ever seen.’
— Kurt Hellström, Ericsson

TeleCorp recently selected Cisco Systems' IP+ATM backbone architecture as well as voice-over-IP solutions to reduce overall IT and network interconnect operating expenses. Vento says the deal underscores the company's desire to become profitable and create a foundation for future high-speed data services.

“It immediately gives us the ability to reroute mobile to mobile long-distance traffic on our own network,” Vento says. “With Cisco, we can eliminate tons of circuits with WorldCom and others. This gives us the ability to become a lot more cost-effective. Clearly, it's worth investing the money, and it's a very valuable tool in our effort to go EBITDA-positive.”

Verizon Wireless selected Cisco to develop and implement a new ATM core that will provide extended bandwidth, QOS and more reliability in its network as well as support third-generation network services.

Painful wait

As vendors wait for their customers to spend again this year, they are laying off employees, cutting costs and streamlining operations.

The first quarter was brutal for Ericsson, and President and CEO Kurt Hellström indicated it wouldn't get much better in the second quarter. “We have a downturn in the economy, and it has been a very rapid downturn that has taken everyone by surprise,” he told analysts. “This is the fastest dive in our industry that we have ever seen.”

The company has declined to give guidance for the rest of the year because of the severe uncertainty in the world's economy.

Ericsson announced a 90% decrease in profits for the first quarter and says it would lay off as many as 12,000 additional workers — 2000 from its handset division — to bring its job cut total for the year to as much as 20,000. Ericsson, which saw sales in its mobile-handset division fall 52%, signed a joint venture deal last month with Sony to address the losses in the handset business.

Motorola missed its first-quarter earnings, falling below the reduced guidance it provided in February. Leading the losses for Motorola was the company's handset business. Year over year, the business' sales were down 29% to $2.3 billion, giving it an operating loss of $42 million. The second quarter will be just slightly better, Motorola officials say. The company is working to reduce head count by 26,000.

“Everyone is taking a step back and saying there isn't an endless amount of money,” says Paul Dittner, an analyst with Dataquest. “All are scaling back and focusing on their core competencies.”

Virtually all vendors in the handset business are outsourcing the production of handsets to focus on more profitable parts of their businesses as well as pulling back on certain product lines.

Ericsson, which is pressured to sell its wounded handset business, is moving its mobile-phone production from Kumla, Sweden, and its U.S.-based facility in Lynchburg, Va., to other suppliers. In the U.S., it is concentrating its product portfolio on GSM handsets and 3G phones. It has pulled back on sales of CDMA and TDMA handsets.

Ericsson also has refocused its efforts on selling handsets to network operators rather than a heavy push through retailers.

In January, Motorola closed its last domestic mobile-phone production plant in Harvard, Ill., as part of its strategy to cut costs and streamline its business. The company is consolidating the remaining manufacturing activity into lower-cost locations and its outsourcing partners. Motorola says it wants to redirect its focus to the varying technology innovations wireless operators will come to demand such as software-based solutions that will be embedded in phones.

Lucent Technologies is de-emphasizing its fixed-wireless business and focusing on higher growth areas, mainly more advanced 2.5G and 3G wireless networks.

“Historically, we've tried to be all things to all people,” says Christy. “What we want now is to be the leader in providing the most advanced wireless services and make money at the same time. We're sharply focusing on where we are investing. Mobility is one clear focus, and we really have decided to spend on the mobile Internet.”

Ericsson's woes

2% margins Net income fell 90% Mobile-phone sales decreased 52% Potential reduction of work force by 12,000 in 2001

Motorola's woes

Handset sales fell 23% Operating loss of 42% in handset division Reduction of work force by 26,000 in 2001