Spending, revenue diverge

North American carriers surprised analysts in the second quarter by upping spending on wireline networks beyond previous expectations, and curiously cutting spending on wireless networks. The trend divorces spending patterns from revenue patterns, since wireline revenues are shrinking while wireless revenues continue to grow. And analysts expect the trend to continue, testing the resolve of both wireless equipment vendors and carrier investors.

For as long as John Lively, Ovum-RHK's forecasting vice president, has been tracking the data, major mobile carriers have matched capex growth to revenue growth. In this year's first quarter, for example, they were both, in aggregate, 15%. But in the second quarter, mobile carriers as a group spent 18% less than they did a year ago, despite the fact that revenue was up 12%.

The spending dip was widespread among carriers but not attributable to a single cause, Lively said. Cingular Wireless was wrapping up integration of AT&T Wireless, Sprint may have been saving up for the upcoming WiMAX deployment announced last week (see page 8 for that story). In any case, it was an unpleasant surprise to major equipment vendors that had become highly reliant on the wireless sector in recent years. Lucent Technologies and Nortel Networks both blamed domestic mobile carriers for much of their disappointing June quarters.

And analysts expect some mobile belt-tightening to continue next year. UBS Investment Research lowered its mobile capex estimates by $350 million for this year and by $1 billion next year. Overall, U.S. mobile spending will be down 1% next year to $24 billion, UBS said.

At $27 billion, spending should be flat next year on the wireline side, where capex and revenue have been headed in different directions for several quarters. After a trough of tight spending following the telecom bubble burst, carriers are now building new access networks for new services (e.g., video) while upgrading backbones and metros. AT&T, for example, just raised its spending expectations for the year by what could amount to another half-billion dollars due to its current triple-play buildout. But investors will soon expect revenues to move in the same direction.

“If revenue growth does not improve in wireline, carriers may have a tough time justifying future capital spending growth in their wireline businesses,” UBS Investment Research wrote in a report this month.

“At some point, you've got to convince them it's paying off,” Ovum-RHK's Lively said. “I don't think [major carriers] can say that yet. Right now, it's all on faith. Fortunately for them, a lot of investors are willing to do that because if they're successful, it will be a big win.”

Pressure to justify wireline spending to investors may be what led Verizon Communications to a new level of transparency regarding its FiOS fiber-to-the-premises (FTTP) business last month. The company, spending more than its peers on new access networks, reported reaching a total of 375,000 FTTP subscribers and 10% market penetration of video service where the service had been available for six months. Calling the second quarter a “pivot,” Verizon CEO Ivan Seidenberg promised investors “a lot more daylight … ahead.”

Ken Twist, Ovum's vice president of technology consulting and broadband networks practices, as well as a self-described FiOS skeptic, sees daylight ahead as well. “If you follow how successful [service] bundles have been in increasing [average revenue per user] for [cable companies], it's not too hard to envision that Verizon will have a similar success,” he said. “Long term, if Verizon holds to their strategy, we think the FiOS investment will pay off.”

How long investors will wait, Twist said, “depends on their long-term and short-term positions.”

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