Telecoms vendor results in 2Q09: has the bleeding stopped?

Total revenues – including handsets – for 14 top telecom vendors amounted to $52.3 billion in 2Q09, down 20% from 2Q08. This year-on-year (YoY) decline is roughly the same as the YoY declines seen in both 1Q09 and 4Q08. If handsets are excluded, 1H09 group revenues fell by 14%; the downturn has hit consumer spending harder than carrier capex.

Profit results from 2Q09 showed stability, but there remains pressure to cut costs and/or consolidate. The continued rise of Chinese vendors accentuates these trends.

Huawei and ZTE together increased corporate revenues by 17% YoY in 1H09; excluding handsets, their revenues grew at the slightly higher rate of 20%. Since most other vendors suffered, Huawei and ZTE increased their respective shares of group revenues – excluding handsets – to 12.1% and 4.3% (from 9.7% and 2.1% in 1H08).

Some of their good performance was due to extraordinary spending in China related to 3G, but both are performing well globally – Huawei especially well in Europe; ZTE in Africa and South Asia. Chinese carrier capex will moderate after the initial 3G wave, but both vendors are starting to make real strides in the US market; a US ramp-up could offset a return to moderation in their domestic market.

In our revenue dataset, Nokia and Motorola had the biggest exposure to the handset slowdown in 1H09: collectively, their device sales in 1H09 dropped 40% to $20.6 billion, from $34.1 billion in 1H08. But even excluding handsets, both companies struggled in 1H09. Nokia’s share of group non-handset revenues dropped from 12.1% to 10.1%; Motorola’s dropped from 9.6% to 9.1%.

Ericsson, Alcatel-Lucent, and Nokia’s NSN division are carefully avoiding head-to-head hardware competition with Huawei and ZTE, which are stronger in hardware than services.

Some of their competitors are on the verbal attack; NSN’s services division chief, for instance, recently claimed that NSN is three to five years ahead of Chinese vendors in services and solutions. Huawei and ZTE recognize their weak spots, however, and are investing aggressively to get up to speed; if the past is a predictor, their growth in services could surprise the competition.

For the remaining 11 vendors, on average operating and net profit margins were down substantially from 2Q08, but versus 1Q09 there was a slight improvement in both profit metrics.

Cisco continues to outperform the crowd in operating and net margin, and retains a huge hoard of cash. It is not immune to a slump in demand, though: its 2Q09 operating profit margin was 19.7%, down from 26.6% in 1Q09 and 25.8% in 2Q08.

For the other ten vendors, Tellabs and Commscope had the best 2Q09 results: their net profit margins weren’t great (4.1% and 2.0%, respectively, around the group average), but both have negative net debt (more cash than debt), their 2Q09 operating profit margins were better than 1Q09, and they handily outperformed the group average.

Also, while Nokia and Motorola were hardest hit by the handset market decline, both managed to improve – slightly – net and operating profit margin in 2Q09, versus 1Q09.

Outlook for consolidation: need for VC influx

As discussed in the 2Q09 edition of our Financial Deals Industry Insight – Telecommunications report, vendor M&A has been rare lately, apart from the Nortel breakup. Assuming the market starts to recover in 2010, further near-term big deals seem unlikely. Rather than merge to gain market power and scale, many vendors are cutting staff to cope with the downturn.

The recent Alcatel-Lucent and Nokia-Siemens deals have reminded us that mergers can be distracting and messy – integration of products and intellectual property is the easy part; people and organizations are complex. Hence, deals aimed at buying technology to enter a new market or get ahead of a competitor in a current market seem more likely.

Recent cutbacks in VC funding of telecoms startups are worrisome, as this puts part of the innovation pipeline at risk. So, finding the right purchase will be harder than before, putting pressure on internal innovation just after vendors have cut back on their R&D outlays.
Note: Vendors included are ADC, Alcatel-Lucent, Ciena, Cisco, Commscope, Ericsson, Juniper, Motorola, Nokia, Tellabs and ZTE. Huawei and both NEC and Fujitsu’s telecoms operations were included in revenue comparisons but not in profitability and balance-sheet analysis.

Matt Walker is a senior analyst in Ovum's Network Infrastructure practice.