By Roger O. Crockett and Steve Rosenbush The massive wave of consolidation ripping through the telecommunications industry presents a huge problem for the outfits that design and build its equipment SBC Communications (SBC) is buying AT&T (T), Verizon (VZ) is buying MCI (MCIP), and Sprint (FON) is merging with Nextel (NXTL). Last year, wireless giant Cingular, which is owned by SBC and BellSouth (BLS), took over AT&T Wireless.
When those deals are done and the companies merged, analysts and industry observers expect to see them spending less on networks and other core technologies. That means suppliers, too, face a major consolidation -- and a struggle to survive. "Companies will perish on their own or they will consolidate," says Wojtek Uzdelewicz, a telecom-gear analyst at Bear, Stearns & Co. (BSC) "They have no choice."
Consider the math: Carriers' capital spending surged 11% last year, to $177 billion worldwide, but merger mania is expected to help hold growth to just 1% in 2005, according to UBS. Moreover, with fast-growing Chinese equipment vendors such as Huawei Technologies and UTStarcom (UTSI) making inroads, competition will be more intense than at the height of the telecom boom in 2000, predicts Bear Stearns.
ERICSSON'S EDGE. A handful of winners already has emerged in the four key telecom equipment markets: wireless equipment, wireless handsets, wireline equipment, and equipment based on Internet Protocol, known as IP. The remaining players are on shaky ground, and will need to consider finding partners that can help to expand the product portfolios and revenue bases they will need to survive.
In wireless equipment, the biggest winner appears to be Ericsson (ERICY), because it dominates in GSM the world's most popular standard. Lucent (LU) is in a strong position, too, because it holds sway over the market for wireless equipment based on another standard, CDMA. That's a good business for now, although some industry experts think Ericsson is better placed to benefit as the world moves to faster networks more closely linked to its GSM technology. All the other wireless-equipment players, including Motorola (MOT) and Nortel (NT), are at risk over the medium to long term.
The wireless-handset market also has produced two winners thus far -- Motorola and Nokia (NOK). Rivals, including fast-growing Asian players like Samsung and LG, may need to solidify their strategies.
NARROWER FOCUS. In IP, two more leaders are apparent: Cisco Systems (CSCO) and Juniper Networks (JUN). And the wireline market has produced one, Alcatel (ALA), which has a dominant position in digital subscriber lines, or DSL, which phone companies use to provide fast Internet access. Alcatel is the video integrator for SBC's IP video project, and it could look to acquire more video gear to make its lead in this hot area insurmountable.
Any number of scenarios is possible. It's unlikely that any one company will emerge as a soup-to-nuts provider of communications equipment. The days when a Lucent or Nortel could be everything to everyone are long gone. It's too expensive to catch up with Cisco or Juniper in the IP market, for example. Instead, companies will target one or two promising areas -- wireless infrastructure, for example -- and try to establish bases they can grow and defend.
The company with the weakest long-term position is Nortel, which is No. 2 in the wireless infrastructure market and struggling to overcome financial and accounting problems. It could benefit from finding a partner or breaking itself up and auctioning the pieces, analysts say. Nor can if offer the expertise in IP networks so in demand by SBC, AT&T, Verizon, and others.
MOTOROLA AND LUCENT? Moreover, industry leaders say Nortel IP equipment requires more testing than they have time for. "I have to get to market quick," says Randall Stephenson, SBC's chief operating officer. "They are not an entrenched provider in this space."
Motorola, which is strong in wireless handsets, also has a problem in the wireless-infrastructure market. While excelling in technology that transmits cellular radio signals, it lacks switching gear for routing data. It has the market lead in cable-TV set-top boxes, but not the wireline switching gear for voice and data calls. "Putting Motorola together with Lucent is interesting," says AT&T CEO David W. Dorman. "You end up having a pretty robust set of capabilities."
Asked at a wireless-industry conference in Cannes, France, about that possibility, Motorola CEO Ed Zander said: "I've heard those rumors, too. Everybody's running around buying everybody else." One reason why a deal would be unlikely: The tech business has never mastered the art of big mergers -- a fact Zander noted by quipping that he keeps a list of dozens of failed hookups, from AT&T/NCR to Compaq/DEC.
SNARLS AND SNAGS. With both its strengths and weaknesses, Lucent has several strategic options. The first would be to sell itself to a larger and more stable outfit, with perhaps the clearest choice being Ericsson. Lucent is No. 1 in CDMA wireless infrastructure, but that sector has a limited future. It would make sense to take that business, which is strong at the moment, and future-proof it by combining with Ericsson, No. 1 in GSM wireless infrastructure.
While the potential partners also would complement one another geographically, there are twin potential hurdles. First, any deal faces the complication of Ericsson's two-tier equity structure, which raises all sorts of problems in regard to control of a combined entity. The other issue: Lucent's management may not want to be remembered for having sold an American icon to a foreign-owned company.
Other possible Lucent buyers include France's Alcatel, but the national and management issues would still apply, as would recent history: Alcatel and Lucent came close to combining a few years back with the same group of people calling the shots, but the iodea couldn't be made to work.
LINK OR SHRINK. Cisco and Juniper are unlikely to bail out Lucent or Nortel, which would depress their margins and share prices. They're more apt to build on partnerships with these companies that strengthen their access to big customers like SBC. And as time goes on, they might buy smaller high-tech companies that will help them supply equipment for distributing video over high-speed phone networks.
However it unfolds, consolidation in the telecom-equipment sector is long overdue. In time, "some will have to drop out," says Alcatel Chief Operating Officer Philippe Germond.
Industry observers expected such a shakeout during the tech bust. But survivors like Lucent did such a thorough job of cutting costs that they emerged from the downturn with solid balance sheets and plenty of cash. Now they must find new sources of growth. And if growth can't be generated from within, finding partners will be essential. Crockett is deputy bureau chief of BusinessWeek's bureau in Chicago. Rosenbush is a senior writer for BusinessWeek Online, based in New York
with Andy Reinhardt in Paris