U.S. Telecom Market's Future Depends on Carrier Capex

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1 AV U.S. Telecom Market's Future Depends on Carrier Capex Published: 8 May 2002 Analyst(s): Tim Smith Capital expenditure (capex) plans announced by major U.S. carriers indicate that 2002 and 2003 will be difficult for telecom equipment vendors. Equipment spending is unlikely to recover in the short term. Analysis Capex Plans: A Supply-Side Proxy Gartner Dataquest has been analyzing the public infrastructure equipment market for more than a decade. This analysis of the supply side of various technology markets includes looking at vendor sales of technology to telecommunications service providers. Service providers' equipment expenditure constitutes the demand side of these same markets. In this sense, the capex plans of service providers act as a proxy for the behavior of supply-side markets. In this issue of the Telecommunications Spotlight, we examine the capex plans of, and trends shown by, the major U.S. service providers. In the United States, there is a significant amount of information about capex plans in the public domain because of public disclosure rules for, and customs of, public companies. These disclosures contain information on all forms of capex from desks to trucks, and optical cables to switches. However, when properly analyzed, capex plans provide valuable insight into the development of infrastructure markets, particularly in terms of overall trends. In examining capex plans, it is not Gartner Dataquest's intent to duplicate the work of the multitude of companies that routinely publish detailed numerical analysis of service providers' capex plans. Our goal is to use capex information as a key input in forecasting the behavior of public infrastructure equipment markets. Methodology and Assumptions The methodology used in this research involved collecting and reviewing multiple sources of capex information, and comparing this information with traditional supply-side analysis. Analysts then used their judgement to draw conclusions about the expected behavior of infrastructure markets. Capex analysis has always been a part of Gartner Dataquest's supply-side research methodology.

2 However, recent dramatic changes in capex plans and overall market behavior warrant an explicit and detailed look at these plans. The analysis in this document examines U.S. wireline capex plans and was developed using multiple sources of information including financial reports, company statements, press releases, individual analyst discussions and company conference calls. Results of the Capex Analysis In this analysis of carrier's capex, we examine three types of carrier as follows: Incumbent local-exchange carriers (ILECs) and regional Bell operating companies (RBOCs). These include Verizon, SBC, BellSouth and Qwest (Qwest is an interesting case because it has a significant interexchange carrier [IXC] dimension as well. We have chosen to include them in the ILEC category for this analysis, based on the U S WEST acquisition). IXCs, which include WorldCom, AT&T and Sprint. Emerging carriers, which include Broadwing, Level 3, Global Crossing and Williams Communications. A fourth category consisting of competitive local exchange carriers (CLECs) could also be considered, but because of the troubled state of the CLEC community and the relatively low level of capex from this sector, we consider them only for technology direction insight. Although CLECs have become an insignificant factor in the overall spending scenario, the dramatic decline in their spending in 2002 has reduced the total telecommunications equipment market by almost $10 billion. Consequently, the CLECs' absence skews year-over-year percentage growth analysis of the market. Capex Facts Totals and Trends Figure 1 shows a top-level estimate of the capex spending trends of the three types of carrier identified above. This figure shows that the troubled nature of the telecommunications equipment market will last through 2002 and into All major service providers have announced reductions in capex of varying degrees. All the reductions have been significant. Gartner Dataquest's previous research has shown that there are a number of factors contributing to this slowdown including oversupply, in places, resulting from overexpansion and failure of competitive carriers, lessaggressive service growth than anticipated and an extremely conservative financial environment. The resultant picture of 2002 capex plans is shown in Figure 2 and Figure 3. Page 2 of 6 Gartner, Inc. AV

3 Figure 1. Capital Expenditure Change by Carrier Type United States, ILECs a nd RBOCs -3% -12% -1% IXCs -6% -17% -5% Eme rging Ca rrie rs -40% -90% -50% Total -9% -24% -2% ILECs = Incumbent local-exchange carriers IXCs = Interexchange carriers RBOCs = Regional Bell operating companies Source: Gartner Dataquest Figure 2. Capital Expenditure by Carrier United States, (Billions of Dollars) Chang e ILECs and RBOCs S BC $11.0 $9.5-14% Ve rizon $12.2 $ % Be lls outh $5.1 $4.3-16% Qwe s t $8.5 $3.2-62% Tota l $36.8 $ % IXCs AT&T $4.9 $4.2-14% S print $5.3 $6.4 21% WorldCom $7.9 $4.5-43% Tota l $18.1 $ % Emerging Carriers Globa l Cros s ing $4.2 $0.1-98% Willia ms Communica tions $1.4 $0.1-96% Le ve l 3 $2.5 $0.4-82% Broa dwing $0.6 $0.3-54% Tota l $8.7 $0.9-90% To tal $63.6 $ % ILECs = Incumbent local-exchange carriers IXCs = Interexchange carriers RBOCs = Regional Bell operating companies Source: Gartner Dataquest Gartner, Inc. AV Page 3 of 6

4 Figure 3. Capital Expenditure by Carrier Type United States, % ILECs and RBOCs IXCs Emerging Carriers 2% 67% Total Capex, 2002 $48.5 Billio n Source: Gartner Dataquest The Outlook Examination of the capex plans announced by major carriers in the United States leads to one unmistakable conclusion: 2002 and 2003 will be difficult years for telecommunications equipment vendors. The capex trends indicate that spending is unlikely to recover in the short term, creating a negative bias for our market forecasts and adjustments. Recommendations Technology suppliers should be painstaking in their choice of target markets and execution within those markets. Competition for increasingly scarce revenue will be fierce and there will be no room for unclear messages, strategies and tactics. Technology suppliers should align their offerings and messages to the needs of ILEC and RBOC, and IXC customers. These carriers will be the most-reliable sources of revenue until Telecommunications service providers should focus more heavily on generating new revenue from new technology investments. This will maximize the benefit of these investments, improve the providers' competitive position, facilitate market share gains and increase customer loyalty. Page 4 of 6 Gartner, Inc. AV

5 Features "The Real Truth About Carrier Capex" (TELC-WW-DP-0168). U.S. carriers' capex will not start to recover until 2003, which we expect to be a flat year overall but with growth beginning in some technology areas. By Tim Smith "Musical Chairs in the Telecom Boardroom" (TELC-WW-DP-0169). The U.S. telecommunications value chain will evolve through the current economic downturn to reveal a very different competitive landscape; its participants should plan for moderate market growth. By John Mazur "Balancing Network Usage With Service Value" (TELC-WW-DP-0167). U.S. carriers should develop revenue models to ensure that revenue flow keeps pace with continuing strong growth in dataoriented traffic, which will support investments in infrastructure technology. By Tim Smith "Searching for Consistency in U.S. Carrier Capital Expenditure" (TELC-WW-DP-0166). Estimates of U.S. carrier capex, which have been calculated using different methods that give very similar results, indicate difficult market conditions for telecommunications technology suppliers until the end of By Tim Smith Gartner, Inc. AV Page 5 of 6

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