Telecoms in Crisis: Capex Slump Continues


By: R. Scott Raynovich

Don't look now, but the telecommunications industry is in a stealth crisis. And this year's earnings season indicates the trend may be getting worse, as earnings fall and debt loads weigh.

First, the long-term trends: The costs of maintaining telecom networks are increasing at an unsustainable rate, according to sources in the industry. The revenue and earnings of many large telecommunications providers are flat or falling. At the same time, major companies in the industry have taken on huge amounts of debt in an attempt to diversify away from their core business.

These facts are contributing to a stealth crisis in telecom land, which is being felt in the network equipment sector. Traditional equipment providers such as Cisco (CSCO), Ericsson (ERIC), Juniper (JNPR), and Nokia (NOK) continue to have inconsistent financial results, which they use to blame telco-land.

The trend was emphasized with AT&T's (T) recent debacle of an earnings warning, in which it announced DirectTV subsidiary had lost 90,000 subscribers and its stock price had its worst slump since 2013, declining 3%. The trends have also contributed to a recent negative pre-announcement from Juniper.

Telco capex slump hits networkers

Wall Street analysts have pounced on this, pointing to the fact that financial pressures continue to result in lower telecom capital spending (capex) relative to all the other capex in the world -- namely, cable and the cloud.

"For 3Q17, we expect total domestic carrier and global data center capex spending increased 2% sequentially to $29.1 billion, reflecting telco capex down 2% sequentially, cable capex up 5%, and web scale capex that increased 5% vs last quarter," wrote Simon Leopold, an analyst with Raymond James, in a recent note to investors.

So what's this mean? The clear trend is that cloud is sucking all the air -- and capital -- out of the room. Cloud companies such as Amazon (AMZN), Google (GOOG), Microsoft (MSFT), Netflix (NFLX), and others are far more adept at using the broadband and mobile revolution to monetize services, relegating the telecoms to lowly pipe providers. Unlike the telcos, Amazon has show a savvy use of this capital -- increasing capital spending dramatically -- to build an all-purpose cloud infrastructure that can offer up just about any services. Few could argue that this long-term vision hasn't been a good investment.

Content strategy could backfire

So what's the answer? The answer from North American giants AT&T and Verizon might make you nervous. AT&T paid nearly $50 billion to buy DirectTV in 2015, but DirectTV was a direct contributor to AT&T's weak quarter as it battles the cord cutters when it lost 90,000 subscribers in the quarter.

Meanwhile, Verizon is pursuing its own content strategy with the acquisitions of AOL and Yahoo, as it tries to take on content-savvy players such as Amazon, Disney (DIS), and Netflix. Does that seem like a good idea to you?

For AT&T and Verizon, the bloated debt on the balance sheet is not showing many returns. In just the last four years, AT&T's long-term debt has ballooned from $75 billion to $114 billion, to pay for the DirectTV acquisition as well as 5G spectrum. Cashflow from operations has only gone from $32 billion to $40 billion. Capital expenditures are relatively flat, at $21 billion.

Verizon's balance sheet is more stable, but still significantly leveraged, at $105 billion in long-term debt at the end of 2016, down a tad from the $110 billion level in 2014. Verizon's acquisitions have been smaller, including the Internet content company Yahoo, but that has also had less of a an impact on revenue and cashflow. Operating cashflows actually declined from $30 billion in 2014 to $22 billion in 2016, according to public filings.

The international landscape isn't much different. Telefonica (TEF), a global giant in telecoms, has total debt of $75 billion against a market cap of $54 billion, meaning the balance sheet shows negative net equity. That's like owing more than your house is worth.

But a bigger problem here isn't the long-term developments in the telecoms' financials (which show stagnant operating cashflows and growing debt) but the larger trends in the industry and the flawed strategy to become content providers.

With the telecoms pitching new services to access consumers and provide content, you have to ask one question: How will they compete with Amazon? Or Netflix? Does Verizon really think that by acquiring Yahoo, it's now a power in consumer Internet?

It ain't gonna happen. Telecom executives aren't media savvy. Period.

The bottom line is that carriers keeping capex investment flat, while the rest of the world is increasing it. Capital is flowing out of the industry. There is no easy answer to the core problem for the communications carriers, as they remain forever trapped in the pipe-providing business, while the costs of maintaining the pipes continues to increase faster than their revenue.