Convergence Plus Journal

On how the telecom and technology boom emerged in the late nineties and what turned into a bust is a fascinating story. Paul D. Baker, vice president, Comverse Technologies Inc., recently gave his analysis in an interactive presentation with some Indian journalists. In these extracts from the presentation, he tries to explain whether there will be another boom and how the telecom industry will shape up in the near future.

SINGAPORE -- On how the boom fed on itself In the second half of the nineties, the easy capital availability of low-cost capital in the non-US markets encouraged the telcos to aggressively build out and launch new networks. The market's mentality changed from the historic focus on profits, cash flows and balance sheet to growth. As the equity market accelerated, it began to go along a parabolic line and the emphasis shifted even more on growth at all costs. People would look the other way when it came to profits. As long as you could show the topline growth- and in case of wireless, subscriber or ARPU growth - the ability to raise additional funds presented itself.

All of these factors contributed to tremendous build out in telecom. The result was to support the growth in wireless subscribers' base and build new competitive networks, leading to one of the consequences of the competition - consumers ending up being winners. That was true in the Internet world, as much as in the wireless world. Competition created a very low cost accessible wireless service with handset subsidies to boost it further. The wireless world went from the beginning of the nineties from being a rich man's choice to becoming everyone's favorite. We came a long way in the nineties. No one worried much about profits. The virtual cycle was on, in which spending begot more spending. Anticipating that this trend will continue, there was more borrowing and more building and people were worrying only about growth.

A contrasting situation
For companies like Comverse, that made profits in the 1990s, this created a strange situation. Historically profitable companies were competing against those that were merely showing growth. The dotcoms -- who of course, made no profits and many had no prospects for ever making profits -- were favored on basis of their topline growth. It was a perverse dynamic where companies making profits, like ours, were competing against those whose only mandate from the investment community was to show the growth of the topline.

Then came the bust
As we went into the new millennium, carriers continued to spend based on the trends they had seen in the late nineties assuming that those trends would continue. In 2000-01, the critical capital spending on telecom was very healthy and forecasts were positive. Capital spending to sales as a ratio began to diverge from the historic norm and moved to allow even beyond 20 percent of sales, while most economists would pitch it at 16 percent. A consequence of this uncontrolled build up was incurring huge debt. The total worldwide debt of telecom companies went near $700 billion. Consequently, companies had a decreasing amount of money to spend on further purchases as debt servicing absorbed a large part of the cash.

The current market capitalisation
The total capitalisation of telecom industry has declined sharply from $four trillion to approximately $1.5 trillion. The carriers' equity market capitalization has declined from $4.2 trillion in March 2002 to $1.3 trillion in August 2002. The profits of the telecom equipment suppliers are down more than 85 percent. Another consequence of spending on new networks, training and launch, is that intense competition has brought the ARPU under pressure. Consumers have more choice and this puts pressure on carriers. People are moving from one network to another as they are getting a better deal. The overall downtrend in the world is also affecting telecom companies who have further lowered their expected growth. As a result, the balance sheet has degraded. The cost of capital and the ability to act as capital have also start declining. The liquidity has come under pressure. The vicious cycle has created more and more spending, and less and less growth. This is where we are now. As a result of this cycle, the debt remains on the book.

The Wall Street has been saying that you have to clean up the balance sheet. That means capital spending will be reduced. Lot of carriers are looking at long-term capex to sales target of 15 percent and many are working for 18 percent. The best estimate we have is that in 2002, telecom capital spending is likely to be down more than 40 percent per year over year.

Prospects for 2003
Right now, the estimates of telecom capital spending for 2003, at end of third quarter of 2002, looks to be 10 percent lower than the previous year. I have not seen any increment or improvement in estimates over the last couple of months (August-September). Any time, of course, this may change.

I believe that Verizon has said that it will be spending $12 billion in 2002 and $8 billion in 2003. One large carrier is looking for a reduction of 30 to 40 percent in capital spending. The consolidation of carriers is inevitable and necessary for long-term health of the industry. That is good and we welcome this. However, carriers are working out consolidation in a measured way where it will create a source of destruction of capital spending, which puts a supplier company in jeopardy as well. If you have a lot of carriers' consolidation, these numbers (in terms of lesser capital spending) are incrementally challenging.

Carriers are also focusing on debt reduction and restructuring. You have seen many 3G networks have cancelled rollout. Some have gone bankrupt. This is the worst thing. As I mentioned earlier, the suppliers' community, software and equipment of telecom, has vast, in my estimate, over $70 billion in dues since the beginning of 2001. That sort of dues would push many of our competitors to the wall.

Prospects for Comverse in this environment
From our point of view, as a company that has contained losses and has only begun losing money very recently, we have a strong balance sheet unlike many other telecom companies. We have $1.8 billion in cash, $2.5 billion in assets, and we are a very strong company. For the future, we are focusing more on revenue generation than manpower reduction. We are identifying opportunities that will bring further revenue of $180 to $190 million and we are already very near that number.

Long-term prospects for the industry
Let us remember that long-term telecom traffic growth remains very strong. Just a couple of year ago, The Yankee Group revealed that wireless usage is expected to double between 2001 to 2006 in the US. The worldwide telecom global wireless penetration is about 20 percent, wireless messaging penetration is about 10 percent and most value-added services like instant messaging, unified messaging, etc. are showing about 5 percent penetration. All these are businesses for us.

It is better to recall that about half the population is yet to make a telephone call. On the wireline side, the residential messaging penetration for six networks is around 5 percent. So many more opportunities remain at hand. For those who are about to come out on the other side of the crisis, as the survivors they will find a less competitive environment, healthier customers and lots of market opportunities.

Carriers are now facing commoditisation of voice connectivity and person-to-person communication has become a commodity. Pricing has come down and this will put pressure on us all. One of the challenges is to find new revenue generating applications, value-added services, such as the one facilitated by Comverse software, and these are very essential to solve the problem of keeping telecom carriers healthy and avoid the commoditisation track.

The carriers need to own and control the brain, own and control the user interface and services. When you gain customers, they would like to remain your customers when you provide them the best of services. We really want to be a service provider and dominate core communication services of all kinds in real time and non-real time. Messaging in particular has various forms. If the carriers own access to subscribers, it is a high probability area of success. Most carriers are now seeking to emulate NTT DoCoMo, which owns the access and provides third parties this access and shares the revenues with them.

Where is telecom headed for?
Opening up access to the third-party content developers, co-operation and competing entertainment. You can access your draft or composed messages, inboxes, missed call notification, voice services, Internet services. You can choose the format of your messages and address them one to one or one to many, and in various forms like email, SMS, MMS, etc, all in a complete unified interface box. Voice mail, e-mail, image messages and various information and entertainment services are pushed into the inbox, the facility to see the missed calls, sending the message back to the individual.

When you look at all these in a totality, we are offering total communications. This is what our telecom platform is evolving into. We believe that this core communication is going to create such an environment where people can communicate the way most convenient and most attractive to them, any time, anywhere. There, I think, the turning point for the industry will come.

(The author is the vice president of Comverse Technologies Inc.)

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