ATHR Atheros Communications, Inc. (MM)

The world economy is currently going through a recovery phase. The momentum is expected to remain strong in 2011. The Telecommunications Industry is identified as a major driver of the global economic recovery.

Capital spending constraints among telecom operators due to severe recessionary conditions were the main hindrance to the growth of this industry. However, with the economic recovery in full swing, large telecom service providers are gradually expanding their network coverage on the back of significant subscriber growth.

The telecommunications industry encompasses a lot of technology-related businesses. Besides the legacy local and long-distance wireline phone services, telecommunications industry also includes wireless communications, Internet services, fiber optics networks, cable TV networks and commercial satellite communications.

Key Attribute

We believe that the overall economic dynamics may shift in favor of telecommunications industry, primarily due to its key attribute of being a major infrastructure product for both the emerging and the developed nations. In fact, the global telecommunications industry is witnessing a fundamental change.

Earlier it was voice calls that brought money to the operators, which led equipment manufactures to concentrate on voice-enabled devices. Now, voice is taking a backseat, while data and video have become the core focus areas. Any new network standard aims at faster data connectivity, quick video streaming with high resolution, and rich multimedia applications.

Near-Term Catalysts

The telecommunications industry benefits from: (1) an improving global economy, which makes the overall macro-outlook buoyant (2) significant technological inventions that make even a mature market like the U.S. highly lucrative for the telecom operators.

Several countries throughout the world have undertaken economic stimulus plans as a way to get rid of the recession. Huge government expenditures -- including the U.S. broadband infrastructure development program and similar structural subsidies in China and India -- have become a boon for telecom service providers and equipment manufacturers.

Furthermore, as the global economy continues to recover, demand for real-time voice, data and video increased by leaps and bounds. All these developments are enabling the telecom carriers to undertake large network extension and upgrade plans.

Big Push by the U.S. Government

The Broadband Stimulus Program of the U.S. government has received significant acceptance among rural carriers. The total allotted fund is $7.2 billion, out of which the first round already injected $4 billion into the industry.

President Obama has endorsed a wireless spectrum hike plan proposed by FCC, which will nearly double the currently available spectrum for wireless broadband services and increase Internet connectivity. FCC together with the U.S. Department of Commerce will identify unused airwaves to raise the available spectrum size to 500 MHz in the next 10 years.

International Markets

The largest emerging economy China is gradually deploying its home-grown TD-SCDMA (3G) network and has opened up a market opportunity of more than $10 billion for several wireless operators, telecom gear makers, and handset developers. India, the second largest emerging economy, has also witnessed the deployment of the first phase of 3G networks by several telecom operators. Several Central American, Latin American and Western European countries are quickly allotting spectrum for next-generation high-speed networks.

Technological Innovations

However, the major thrust for the telecommunications sector is coming from within the industry due to continuous network and product upgrades and invention by the industry players. Telecommunications is one of the very few industries, which witnessed massive technological improvement even under recession.

Smartphones have become the next-generation choice and are increasingly taking over market share from the basic mobile handsets. Smartphones are generally characterized by very powerful operating systems capable of supporting a variety of services and applications that need very high-speed network infrastructures. Various industry sources estimate that smartphone shipments as a percentage of total mobile handset shipment are expected to increase from 20% in 2009 to more than 50% by 2012.

Fabulous demand for technically innovative products has been the silver lining for the telecommunication industry in an otherwise tough environment. These developments are also helping telecom equipment manufacturers, infrastructure solutions providers and mobile phone makers to consolidate their finances.

Less than a decade ago, the telecom operators in the U.S., Western Europe, and Japan were upgrading their existing networks to high-speed 3G technologies. At present, the world telecommunications industry is talking about the installation of next-generation super-fast 4G technologies. Several giant telecom operators globally are funding projects to deploy super-fast 4G networks of WiMAX and LTE (Long-Term Evolution).

As of now, 19 LTE networks are commercially operational throughout the world. Cable TV operators are also upgrading their networks with high-speed DOCSIS 3.0 architecture.

Competition and Consolidation

Massive technology invention and innovation have resulted in significant competitive atmosphere within the telecommunications industry. Product life-cycle and upgrade-cycle has been reduced drastically since several firms are coming out with new types of products and services within a short span of life. As a result, we are witnessing hectic merger and acquisition activities to consolidate the market share.

The telecom carriers are gradually entering the basic video market, capturing subscribers from cable operators. Satellite TV providers are also eating up the video subscribers of the cable operators. On the other side, cable operators are gradually offering triple play voice, video, and data services and taking away subscribers from the telecom carriers. On line Internet video streaming companies are also becoming major competitors to the existing players of the telecommunications industry.

The biggest of the merger and acquisition activity is AT&T’s (T) proposed buyout of T-Mobile U.S. If this deal gets regulatory approval, then it might become the largest acquisition in this industry in the post-recession period. CenturyLink Inc’s (CTL) proposed acquisition of Quest Communication International (Q) already received FCC approval. Qualcomm Inc. (QCOM) is set to acquire Atheros Communications Inc. (ATHR) and received its shareholders’ approval. Comcast Corp. (CMCSA) recently acquired NBC Universal’s 51% stake.

OPPORTUNITIES

Telecom carriers and equipment providers that offer the most attractive opportunities are focused on 3G wireless technologies, emerging 4G technologies, broadband and fiber-to-the-home/premises networking. We have seen that sector diversity is a less secure natural hedge in today’s increasingly correlated world markets.

The telecommunications industry as a whole offers a number of attributes that are difficult to ignore from the standpoint of investors.

• Telecommunications is a necessary utility: The need for telecom in both rural and urban areas, and its role in the infrastructure of both developed and developing markets, continues to grow. In addition, economic stimulus plans in the U.S. and throughout the world should boost select service providers and equipment manufacturers.
• Massive growth of smartphones: Although the economy is under recovery phase, and we are not completely out of the woods, the growth in the smartphone market maintains its impressive trend. This primarily reflects a shift in consumer preference toward feature-enhanced PDA devices from ordinary mobile handsets used primarily for voice telephony. This opportunity provides scope for telecom service providers, equipment manufacturers, chipset developers and wireless tower operators to retain new users and grow revenues moving forward.
• International diversification: While diversification within a country offers only limited protection in the current highly-correlated world equity markets, it offers hedging opportunities from local economic weakness and associated currency exchange differentials.

The companies that match well with the aforementioned considerations include Telus Corp. (TU), Qualcomm Inc. (QCOM), Brightpoint Inc. (CELL) and Vivo Participacoes S.A. (VIV).

WEAKNESSES

Generally, telecommunications companies that have been under pressure in the current downturn have high debt levels and large financial leverage ratios or are unable to cope with the recent market trend. These companies may face difficulties provided the overall business activities take longer to revive as consumers and enterprises become more selective in their spending. Other risks that remain are the following:

• Potential business slowdown: Lower overall top-line sales among carriers are expected to continue weighing on capital spending decisions -- a major problem for equipment vendors. The companies are expected to remain focused on balance sheet improvements, financial discipline and free cash-flow generation. Unfortunately for the equipment vendors, the method of choice for improving free cash flows remains disciplined capital outlays.
• Weak credit profiles: Over the near term, telecom companies may be exposed to high debt levels and limited liquidity, which puts a premium on sustainable cash flow to service debt obligations. As a result, telecom companies may have free cash flow impacted by a slowdown in demand.
• Increased competition: The markets for broadband wireless solutions are emerging rapidly in terms of technological innovation. While the pure wireless/wireline service providers started entering the video services market for cable operators, the cable MSOs are, in turn, started entering the telephone business for the small & medium sized business enterprises.

The companies that match well with the aforementioned considerations include Tellabs Inc. (TLAB), Novatel Wireless Inc. (NVTL), RadioShack Corp. (RSH) and American Tower Corp. (AMT).
 
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