Why UTStarcom Is a Telecom Star

CFO Michael Sophie credits its strong sales to a focus on technologies that are fast-growing and allow carriers to make money

UTStarcom (UTSI ) isn't your typical telecom-equipment outfit. In the four years since its initial public offering, its sales have increased ten-fold, to $2 billion in 2003. Over the same period, during one of the industry's worst downturns, revenues of rival Lucent Technologies (LU ) shrank 78%, to $8.5 billion.

What's UTStarcom's secret? It focuses on the world's highest-growth markets -- and on selling the most in-demand telecom gear. Last year, it reaped 80% of its revenue from China, where telecom is growing at double the pace of the overall economy, says Lawrence Harris, an analyst with Oppenheimer & Co. in New York.


  It's also selling wireless gear and handsets, as well as equipment that enables high-speed Internet access, in red-hot markets such as India and Latin America. For certain types of gear -- such as technology used for local wireless access that 800 cities in China have deployed -- UTStarcom holds 60% share of the world market.

Its ambitions run high: UTStarcom hopes eventually to get 50% of its sales from outside of China and to reach $10 billion in total revenue. Already this year, it's on track for a 30% revenue increase, says Chief Financial Officer Michael Sophie.

How will it and other phone-equipment makers navigate the rough waters of telecom industry consolidation? Sophie talked about these and other issues with BusinessWeek Online reporter Olga Kharif on Feb. 27. Here are edited excerpts of their conversation:

Q: Last year, you more than doubled your sales -- while most other telecom-equipment suppliers were barely growing. What are you doing differently?


We've focused on high-growth markets such as China, whereas most telecom-equipment providers have concentrated on markets that aren't growing, such as North America and Europe. Plus, we're trying to focus on technologies that we think are fast-growing -- and that allow carriers to make money.

[The wisdom of this] was highlighted in the U.S. several years ago, when a lot of suppliers were selling lots of equipment to competitive local-exchange carriers that weren't making money and that eventually went out of business. We always want to make sure that carriers are making money with the equipment we're providing. If we can make money, if carriers can make money, and if consumers like the services -- that's a sustainable business model.

Q: One such technology you provide is something called PAS [personal access system]. How does it allow carriers to make money?


PAS is essentially a mini-cellular network: As long as you're within a certain geographic area -- say, a city -- you can make and receive wireless phone calls to and from anywhere in the world. But if you leave that, your phone -- which looks very much like a cell phone -- won't work. We've found that in markets such as China, 95% of people never leave their geographic area 95% of the time.

What's special about our equipment is that it's designed for markets such as China, where people can only afford to spend $5 or $7 a month on phone service. We've designed our products to be very cost-effective, so carriers can get two- and three-year paybacks, and it's driving profitability for them.

Q: Could we see this technology in the U.S.?


While there may be some opportunities here to offer coverage of corporate and university campuses or rural cities, those are niches. The country already has broad wireless coverage. So we're focusing more on markets that don't have that infrastructure, such as China, Latin America, the Middle East, and Africa.

Q: What kind of equipment do you expect to be in demand in the future in those and other markets?


We see several trends in telecom. The first one is that more voice traffic is moving from regular phones to wireless phones. So we see demand for our equipment. And with the move to 3G [next-generation] wireless networks, which allow for data services and more voice capacity, we're looking at a better than 70% compound annual growth rate for such wireless equipment.

Second, people want to reach the Internet and get short text messages -- that's why we're also focusing on equipment that links high-speed Internet lines to the telecom network. It can allow phone companies to provide video streaming over their existing copper wires, so they can get additional revenue. We're already selling equipment in Japan that allows for 46 megabit-per-second downloads for video-on-demand-type services. We see such equipment, a space that we dominate, having 72% compound annual growth from 2002 to 2005.

Q: Now that the economy is recovering, a lot of your competitors hope to grow again as well. How likely is that?


Recently, a lot of traditional equipment providers have shown some optimism. But if you look at projections for 2004 and 2005, global capital spending for telecom equipment isn't increasing. We've done some analysis on global capital-spending trends. It turns out that Western Europe is the largest telecom-equipment market, with about $60 billion spent in 2003. It will go up to maybe $61 billion in 2004 and then probably stay flat through 2005.

The U.S., with $35 billion spent in 2003, is the second-largest market. The projections are for that market to remain flat. So we're anticipating a very competitive market.

Q: Why is spending on phone equipment not growing? Is it because of consolidation among service providers?


There certainly appears to be consolidation in the industry, such as the recent merger between wireless service providers Cingular and AT&T Wireless (AWE ). And we think there will be more consolidation at the service-provider level -- and that it will flow through to equipment providers. Also, carriers are still very much focused on profitability and return on investment. They can't just roll out technology for technology's sake. That's why you aren't seeing huge growth in capital spending right now.

Q: Utilities and cable companies are starting to provide telecom services. Could that help boost phone-equipment demand?


The cable companies don't have much of an inroad outside of North America. In China, some of the utility companies are trying to enter the communications market, and they've had some initial success. But telecoms still spend the vast majority of money on equipment.

Q: You mentioned consolidation among suppliers. How do you plan to participate in that?


We've got tremendous organic growth. But there may be some merger and acquisition opportunities that will help the company grow even faster and create more value for our shareholders. We acquired the assets of CommWorks from networking company 3Com (COMS ) a year ago. And we're looking for additional products and technologies that we might be able to run through our sales channels in markets such as China.

Q: What do you expect to happen on the handset side of your business? A lot of analysts expect you to lose some of your market share this year as local Chinese manufacturers ramp up.


Several years ago, UTStarcom was reluctant to enter the handset business. We were an infrastructure provider. But we didn't see anyone else offering PAS handsets. So we got into that market to help support our infrastructure sales. We're [now] very successful: We shipped more than 16 million handsets last year in China -- probably no other manufacturer shipped more handsets into China in 2003. We held about a 70% market share on those handsets last year.

And PAS has turned out to be very successful. We went from 12 million subscribers at the beginning of 2003 to 35 million by the end of the year. PAS subscribers are projected to grow to over 60 million this year.

With this huge success, people are now seeing an opportunity in handsets -- and you're now seeing more competitors wanting to enter the handset market for PAS in China. So we don't think we'll be able to maintain a 70% market share, but we do feel that we'll be able to keep our market share in handsets above 50%. We have an advantage on cost. We've got the biggest family of products: We're introducing more than 20 new models in 2004. And we have the distribution -- the phones have to be sold to individual carriers, and there are more than 2,400 of those in China.

Q: You're developing a dual-mode handset, which will work on PAS as well as GSM [global system for mobile communications], which is the mainstream wireless technology used in Europe. Are you planning to go more head-to-head with handset makers Nokia and Motorola?


We aren't necessarily trying, at this point, to introduce stand-alone GSM handsets. We're just trying to capitalize on our strength in PAS. These handsets will serve the market in Taiwan, Vietnam, and China.

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