INDUSTRY QUEASY ABOUT '04 REBOUND

If there was any evidence required to prove the telecom industry is coming out of its three-year slump, one need only look at the second-quarter numbers reported by the largest carriers. Verizon recorded a 6% growth in operating revenues; SBC reported a 2% bump in total revenue; and BellSouth saw earnings per share jump 4.1%.

But a closer look at the numbers reveals that despite generally solid earnings, carriers have begun to redefine success during the current economic recovery. Gone are the standard access line counts, and in their place are operational numbers specifically geared to show growth. In the second quarter, for example, SBC made special note of its 315,000 new DSL customers and a jump in wireless net additions while quietly acknowledging the fact that its retail access lines dropped by 558,000.

Reporting the most positive numbers hasn't necessarily led to overwhelming optimism in the industry, however. In its most recent Service Provider Confidence Index, Sage Research reported a significant drop between June and July as many industry observers began fearing more job cuts.

Below are reports on several growth areas highlighted in recent earnings reports and how they are expected to fare for the rest of 2004.

DSL RUMBLINGS

While the RBOCs posted solid DSL numbers in the second quarter, growth was off from the first quarter's record pace. The only carrier to report quarter-over-quarter growth was Qwest, which recorded its highest quarter of net adds at 109,000 (see figure).

“Frankly, it's less than we'd like to see,” SBC CFO Richard Lindnar said.

The RBOCs cited seasonal factors and a short labor strike for the drop-off.

Despite the dismal tone, the RBOCs still had one of their best DSL quarters. SBC's second quarter was its fourth best in DSL adds, Verizon had its second-best quarter and BellSouth had its third best, with the added bonus of converting 100,000 customers to its new 3 Mb/s premium service.

In the last few quarters DSL has taken an increasingly prominent role in the RBOCs' earnings. Even in financial analysis, DSL numbers have begun to eke their way up higher in the notes. DSL still only accounts for a small percentage of RBOC revenues, but with access lines disappearing, DSL is viewed as the keystone of future revenues via bundling.

Customers with DSL are 50% less likely to churn than customers without DSL, said Brahm Eiley, an analyst with Convergence Consulting Group. By contrast, many wireless customers are dumping their wireline voice services entirely, which works counter to the bundling approach most of the RBOCs have adopted, Eiley added.

Even with the significant DSL gains of the last year, though, access line loss has continued at a relatively steady pace. But Eiley said that the losses probably would have been far worse if the incumbents hadn't pushed their DSL and bundling on customers. In fact, with AT&T exiting the consumer business and UNE-P going away, the RBOCs will have an opportunity to reverse that line loss trend and lock down many new customers with high-revenue DSL bundles — at least until the cable operators gear up their VoIP services.

“It's lunch, and the RBOCs are ready to feast on AT&T's local lines,” Eiley said.

FTTP SUMMER

The summer of 2004 could be called the summer of fiber-to-the-premises. By the time leaves start hitting the ground in the northern half of the country, Verizon Communications is expected to make FTTP available to every home in Keller, Texas, the first market in a nine-state fiber buildout. UTOPIA, Utah's 11-city municipal fiber network, landed an $85 million bond in July to fund the first phase of its plan, which will bring FTTP to six towns over the next 12 months. This month the Jackson Energy Authority in Jackson, Tenn., deployed its 2000th FTTP gateway. And California's SureWest Communications ended June with nearly 14,000 FTTP subscribers, an 80% jump from a year earlier.

And while FTTP was among the hottest buzzwords through the first half of the year, some anecdotal evidence shows the segment may be cooling off slightly. Last month the city of Palo Alto, Calif., shelved long-held plans to deploy municipal fiber after consultants told them it was too risky — “uncharted territory,” they called it. Qwest Communications CEO Richard Notebaert paid lip service to FTTP in the company's second-quarter earnings call. And SBC executives said its fiber plans wouldn't move forward until regulatory change goes first, which could take years.

Such realities are having a major impact on some of the equipment vendors supplying the major deployments. Riverstone Networks, which won the contract to provide access gear for UTOPIA's fiber project, is this week restating financial results after persistent disputes with lenders and an SEC investigation. Component shortages have caused Advanced Fibre Communications to miss two of its last five Verizon deadlines, incurring a $1 million fine and casting a pall over AFC's pending acquisition by Tellabs. After AFC's second-quarter earnings call, in which CEO John Schofield startled investors by revealing that Verizon had declared it “in breach” of its FTTP contract (without explaining the implications), Tellabs' board of directors requested a more current review of AFC's financial situation, a hint that the details of their deal could change.

Verizon CEO Ivan Seidenberg made a point of joining his company's second-quarter earnings call from the Dallas area, where he was overseeing the progress of Keller's FTTP deployment.

“We owe our investors more visibility into this,” Seidenberg said, vowing to provide more details in coming months. Though major FTTP deployment still is “uncharted territory,” some heavy cartography is now underway.

WIRELESS' MODEST RECOVERY

Modesty isn't one of the wireless industry's more obvious attributes, but second-quarter financial reports from carriers — though almost universally positive — were met with controlled enthusiasm by carrier and vendor executives, and left analysts wondering how long 2004's recovery will last.

For instance, despite revenue that was 29% higher and net income per share that was 90 cents higher than the second quarter of 2003, Nextel Communications' management team spent an inordinate amount of time on Nextel's second-quarter call defending the company's increasing investments in its expanding broadband trial, NASCAR partnership and Boost Mobile subsidiary.

“Our margins would have been higher without these expenses,” said Paul Saleh, executive vice president and chief financial officer of Nextel. Despite the overwhelmingly positive earnings report, Nextel's stock price went into a two-day slump immediately after the announcement.

Other national carriers posted relatively strong numbers for the second quarter in reports that culminated in T-Mobile USA's earnings last week. The carrier reported $717 million positive net income for the quarter, up from roughly $500 million in net income for the second quarter last year.

Wireless carriers have started stressing operational income before depreciation and amortization (OIBDA), OIBDA margins and net income as key metrics. Subscriber gains continue to be important, but there is a new effort to show Wall Street that carriers can maintain positive cash flow from quarter to quarter.

“The T-Mobile USA story is one of balancing subscriber growth with financial results, evidenced by a 46% sequential improvement in OIBDA, and an OIBDA margin of 29% in Q2 2004,” said Rene Obermann, CEO of T-Mobile International.

The improving operational and net income is giving carriers confidence to boost capital expenses. “Carriers slowly have returned to profitability and positive cash flow, and they are becoming comfortable enough with their cash positions to start spending again,” said Jagdish Rebello, senior wireless industry analyst at iSuppli. The agency is predicting “double-digit” growth in mobile infrastructure spending for 2004.

“Confidence has returned to the wireless industry,” said Carl-Henric Svanberg, president and CEO of Ericsson, during that company's second-quarter call. Ericsson continued a gradual recovery, posting $710 million in positive net income after a loss of almost $3 billion for the second quarter of 2003. Svanberg credited the recovery largely to increased deployment of 3G networks worldwide.

Rebello said 3G equipment will account for a much larger portion of overall capex in the years to come. But will the spending continue to grow? According to iSuppli's recent report “Momentum Rebuilds for the Wireless Infrastructure Market,” worldwide capex — slated to grow about 10% this year — will increase just short of 2% in 2005. The report also indicates capex will grow less than 1% in 2006, but might be on the upswing for 2007 and ensuing years.

With reporting from Kevin Fitchard, Ed Gubbins, Dan O'Shea and Vince Vittore