Deep analysis on telecom spending trends

Google, Apple, Broadcom can’t catch a sustained bid. Softee’s got a lot of pressure on it Friday with the release of Windows 8 and the Surface and it’s acting sick too.

Path of least resistance has been lower for the last couple weeks as I’ve been saying and at some point we’ll get a reversal that’ll rip higher, at least short-term. No sense rushing into anything if you’ve been patiently buying the panics and selling the relief rallies as we’ve been suggesting all year.

Juniper’s down 8% this morning after a decent quarter, but with weak guidance. I expected their new line of routers to get better traction already and I think backhaul spending is set to jump, so I’m growing increasingly concerned about the lack of growth here. I’ll work on this much more over the weekend.

As part of that, let’s a look at capital investment trends in the telecom sector. And while common wisdom points to wireless technology virtually taking over, in fact, that’s not entirely accurate. Because in order for that slick new 4G iPhone 5 to deliver 4G speeds, the cellular tower it’s talking to needs to have a backhaul connection that can deliver your signal to the switch at an equally fast pace. And most towers can’t. Think of it this way: Your signal is flying along the Autobahn, at delightfully fast speeds of 10-20 Gbps. But if there’s an old school T1 or microwave backhaul connection on that tower, as soon as your signal takes the exit, it’s landing in a traffic jam where speeds may well be under 1 Gbps. Not cool when you’re watching videos on YouTube.

The pileup at the tower diminishes the end-user experience and leads to unhappy customers and, ultimately, churn if you’re the wireless provider marketing a 4G experience (and they all do these days, despite the fact that technically not all wireless providers are serving up 4G … but I digress). Churn costs wireless providers a LOT of money. As a result, wireless service providers have been racing to deploy what AT&T terms “enhanced backhaul.” Enhanced backhaul is a catchall phrase that may or may not involve fiber. But one of the biggest trends we’re seeing this year related to the mobile/app revolution is the deployment of fiber to the tower, or FTTT.

Today, roughly one quarter of the United States’ 285,000+ cell sites are connected to the network by fiber. That means three quarters still aren’t. The Cellular Telephone Industry Association reported that 633 billion megabytes of data traffic travelled the nation’s wireless waves in the first six months of 2012 — and that was up 104% from the year earlier. With mobile data usage still doubling every year, it seems likely that in all but the most rural markets, fiber will continue to roll to towers.

Traditional telcos looking for growth have embraced the opportunity. WindstreamWIN +0.24% , CenturyLink CTL +1.28% , Frontier Communications FTR +0.87% and Lumos Networks LMOS +4.30% (the wireline arm of NTELOS that was spun out late last year) are all in the game, running fiber from towers to existing fiber networks that they’ve bought or built over the past several years.

CenturyLink, which is the third largest telco following its acquisition of Qwest in 2011, expects to connect between 4,000-5,000 towers this year, bringing its total to around 15,000. Windstream upped its capex budget for 2012 in order to capitalize on wireless provider demands for improved backhaul, and CEO Jeff Gardner said at an investment conference last month, “In market we’re earning in excess of our cost of capital and out of market it’s totally incremental revenue that we’ve won versus incumbent LECs and cable companies. We’re getting better and better at this and we’re going to spend $250 million on fiber to the tower projects.”

And Lumos said in a recent company presentation that monthly recurring revenue from selling backhaul services to the top six wireless carriers grew 41% annually from 2007 to 2011. The cable companies are rushing in as well — Time Warner Cable TWC +1.26% said its wireless backhaul revenue doubled in the second quarter versus 2011.

Does this mean we want to start buying up shares in Windstream or Time Warner Cable for the Revolution Investing portfolio? Probably not. High growth in a small revenue segment doesn’t fully offset declines in your biggest segment — like wireline voice revenue for a telco like Windstream or falling cable subscribers at TWC.

But there may be opportunities to invest in the FTTT trend and/or “enhanced backhaul.” One of our current Revolution Investing holdings, Broadcom BRCM -2.46%  unveiled a new line of switch solutions last winter “optimized to meet the bandwidth, scalability and efficiency demands of the fast growing small cell base station market. The BCM56240 series, which is based on Broadcom’s award winning StrataXGS architecture, offers the functionality of up to four stand-alone components on a single chip.” Deployment of small cell base stations (picocells, femtocells, microcells) is another way that service providers are working to alleviate data congestion — but it takes spectrum, which is also a scarcity in many markets. Still, it’s another arrow in Broadcom’s quiver and we’re still bullish on Broadcom’s Apple/iPhone relationship upside.

There are two more names familiar to RI readers that are also targeting the FTTT push: Level 3 Communications LVLT -7.31% and Corning GLW -8.65% . We exited our positions in both — LVLT just a few months ago because its lofty debt levels continue to scare off investors and second quarter results were underwhelming. No change at this time on that call, though we’ll be watching to see if/when LVLT can get the ship turned around. GLW was a losing trade for us back in 2010 after the Gorilla Glass movement failed to meet expectations. But with fiber deployment back in vogue, it might be time to reexamine Corning.





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