Industry Voices—Walker: Lower telecom capex, Huawei issues drag down Q2 vendor revenues

Telecommunications operators (telcos) have faced weak top line growth prospects for years. Industry revenues grew just over 1% in each of the last two years, and are trending downwards for many operators. This has forced telcos to focus on cost control in order to maintain profitability. It’s also encouraged telcos to transform their operations digitally, both to lower costs and open up new business opportunities.

Vendors that help telcos cope with these pressures are finding growth, even amidst a flat overall market.

Preliminary 2Q19 results: Vendor revenues down 2%  

With more than 70% of the vendors reporting their Q2 earnings, revenues in the telco segment are down about 2% year over year. (Fig 1) Many vendors grew but Huawei’s estimated 6.1% decline pulled down totals. The weak overall result is consistent with trends in telco capex, which fell ~3% year over year in both fourth quarter of last year and the first quarter of this year, per MTN Consulting stats.

Sources: Company reports, MTN Consulting estimates (Aug. 7, 2019)

Huawei’s troubles slowing an already weak market

Huawei’s situation is unique, as its supply chain and credibility has been hit by recent U.S. legal actions. The vendor remains well positioned to compete for 5G business. But in the near term, many large potential markets are evaluating rules that limit Huawei – or just ban it outright.

RELATED: Walker: Huawei chaos will define the rest of 2019

As much as Huawei rivals might like, this doesn’t just shift business their way. Not yet, anyways. Most operators are pushing regulators to allow as much flexibility as possible in vendor selection. Few policymakers are eager for an outright Huawei ban, especially if it's extended to installed networks. But this debate is ongoing, and already slowing down procurement schedules.

Huawei’s biggest network competitors, Ericsson and Nokia, both grew revenues to the telco market by about 2% in Q2. If you’re looking for a 5G bump, this is it. Each of these vendors has poured billions of dollars into 5G-related R&D, has a deep bench of 4G customers and waited many quarters for an upswing. A 2% bump is welcome, but not enough.

As confident as they appear publicly, Ericsson and Nokia are in a precarious position. They need a pickup from 5G. They’ve front-loaded costs in R&D and, according to some rumors, still deploy the “buy market share” tactic selectively with underpriced deals. Huawei can play this game too, though, and has deeper pockets. When and if Huawei overcomes the current supply chain constraints, it is likely to be cutthroat in going after Ericsson and Nokia business. Expect severe price competition, and more political maneuvering with loans and lobbying.

Q2's winners and losers (so far)  

Huawei, Ericsson and Nokia combined have about 45% share of the market for network infrastructure sales to telcos. Radio access network revenues are important for each, and technology transitions tend to drive fluctuations. So there’s a natural market interest in how these vendors are doing in 5G. But the revenue impact of 5G RAN is miniscule to date. More important drivers for vendor revenue growth in telecom relate to data center buildouts, network virtualization and digital transformation.

The figure below shows year over year growth rates for a sample of the 57 vendors already reporting second quarter earnings. This includes most top vendors but notably absent are Cisco and ZTE, which have not yet reported.

Sources: Company reports, MTN Consulting estimates (August 7, 2019)

Preparation for 5G and support for early deployments is responsible for growth at a number of the traditional network equipment vendors, including Nokia, Ericsson, Samsung, and NEC. IT services providers such as Tech Mahindra, TCS and Accenture are benefiting from early operator planning for 5G. Most of these are also involved in digital transformation overhauls for telcos (among other industry verticals.) 

Data center-related spending by telcos has benefited many vendors but particularly Intel. Intel has a much bigger business with telcos than most realize. We estimate its second quarter revenues to telcos grew 4% year over year to over $1.2 billion. Intel is serious about the telco sector, as telecom networks become more data center-centric and large operators are increasingly willing to work directly with the chip sector. Intel is putting some marketing cash into this push as well, for instance with its “Network Builders Innovation Summit” in Singapore next month. Beyond Intel, other vendors are benefiting from the telco virtualization push, including Arista, F5 Networks and Ribbon Communications.

Three disappointments for the second quarter came from Casa Systems, Juniper Networks and Harmonic. Lumpy spending patterns in the access network help explain some of the weakness at Casa and Harmonic. Both are moving towards a more software-intensive business model, as well. This transition can be bumpy but both expect better margins to result; Casa’s CEO said his company's margins jumped in Q2 despite revenues falling, “driven by a high portion of software license sales.”

Juniper’s revenues in the telco vertical declined in both 2017 and 2018, and its struggles are continuing into 2019. Juniper's telco revenues were down about 14%. Cisco’s revenues in the service provider sector fell in its last reported quarter (Q1) by 13% year over year, so Juniper has company. Juniper’s CEO said “the weakness we’re seeing is tied to our customers business model pressures and the expected timing of project deployments,” pointing to a possibly better second half.

Don’t bet big on the second half of 2019

Many vendors have expressed a similar sentiment. The ones that will succeed won’t rely on capex growth, though. They’re the ones that are positioning themselves for telcos’ changing buying patterns. The need for a lower cost base is one pattern, though not new. This helps drive some M&A in the sector, including consolidation in the optical transport and components space. For instance: Cisco-Acacia, Lumentum-Oclaro, and II-VI-Finisar. A shift to open networking, open source solutions is also aimed partly at lowering costs. That’s also affected some M&A, including IBM-Red Hat and Nvidia-Mellanox.

Also important is the rise of the cloud. There is some revenue upside for telcos in cloud services, which they’ve been pursuing for years. A more interesting angle now is how telcos can leverage the vast infrastructure built by webscale network operators (WNOs) – the big cloud builders – over the last decade. Large global operators with lots of enterprise customers are the obvious partners for webscale operators. AT&T’s big cloud partnership deal with Microsoft Azure fits this bill. But there are many other partnership examples. Alibaba is working with China Tower on edge computing, IoT and other areas, with Chinese telcos as the ultimate buyers/partners. Facebook and Amazon both sell wholesale fiber capacity on their networks to telcos. Telco and webscale players are learning how to get along.

Matt Walker is the founder and Chief Analyst of MTN Consulting, LLC, an independent market research firm. He has over 20 years of experience in telecom industry analysis, consulting and research program management. Based in Asia for most of his career, Matt currently lives in Chandler, Arizona. He can be reached by email at [email protected]. Follow him @mattwtelecom, or LinkedIn

Industry Voices are opinion columns written by outside contributors—often industry experts or analysts—who are invited to the conversation by Fierce staff. They do not represent the opinions of Fierce.