Piecing Together a Telecom Gear Rebound

An Oct. 26 earnings report by Tellabs (TLAB) is the latest sign that the worst of the telecom spending slump may be ending. The seller of products that can boost network bandwidth said third-quarter revenue rose 1% from the previous quarter, the second straight period of sequential growth. Tellabs executives said the company may see added growth in the period that ends in December.

Tellabs has yet to start growing from last year—third-quarter revenue was 8.3% lower than a year earlier—but its report provided further evidence that the telecom gear market may be bottoming out. The industry went into a tailspin last year, when enterprises slashed spending on networks and phone and cable providers curtailed investment in systems that deliver phone and other communications services.

There are other signs of a rebound. On Oct. 22, Juniper Networks (JNPR), a maker of networking equipment, said third-quarter sales rose 5% from the previous period. Two days earlier, Infinera (INFN), which makes equipment used in fiber-optic networks in metro areas, reported a 21% sequential sales increase and a 3% gain from a year earlier. "It looks like the first half of this year was the bottom," Infinera CEO Jagdeep Singh says in an interview. "It looks like we are in the early stages of a recovery."

Second-half carrier spending on wireless and wireline equipment may rise 4% to 8% from the first half as carriers try to improve their networks after delaying some upgrades, according to consultant IDC. "We may be turning around," says David Emberley, an IDC research manager. Government stimulus packages aimed at improving broadband access in the U.S. and other countries may spur demand as well.

Fear of a Double-Dip Recession The U.S. government has earmarked about $7 billion in broadband spending so far, and Federal Communications Commission Chairman Julius Genachowski aims to boost nongovernment spending, too. "There is no question that it will take a lot of private investment to do what's necessary," he told BusinessWeek. "And we're looking at what are the ways we can incentivize private investment."

Full-blown recovery may not kick in until 2010, and many industry insiders say spending on telecom equipment could sink again if the larger economic recovery falters. Customers "will be conservative at the beginning of the year, just to make sure we don't hit the double dip," says Kim Perdikou, an executive vice-president at Juniper. "Now they are very strategically pinpointing where the revenue growth is and spending in those areas."

Some equipment vendors are recovering more quickly than others. Sales of equipment that helps carriers and corporate users cope with the skyrocketing use of video and wireless devices is already picking up. Overall telecom equipment sales may grow 0.2%, to $96.8 billion next year, after a dip this year. But some areas, including some types of next-generation wireless gear and servers needed for video-on-demand services, will rise by double digits, according to IDC.

Is Alcatel-Lucent a Takeover Target? Many equipment makers expect to benefit from recent mergers and acquisitions that have reduced the player roster and lessened price pressures. After filing for bankruptcy protection, Nortel Networks has sold most of its businesses in the past several months. On Oct. 13, Cisco (CSCO) snapped up wireless telecom gearmaker Starent Networks for $2.9 billion.

More deals may be in the offing. Shares of Alcatel-Lucent (ALU) have gained 20%, to 4.31, in the last month, partly because of speculation that it may become a target for Chinese vendor Huawei or Nokia Siemens Networks of Europe. Simon Leopold, managing director at Morgan Keegan, says the stock may keep rising to as high as 6 or 7 in the next 12 months, even without a sale.

Some analysts are already upping their forecasts for other telecom equipment vendors. On Oct. 23, Piper Jaffray (PJC) analyst Troy Jensen upgraded Juniper to neutral, from underweight.

Increased demands on the world's wireless and wireline broadband networks from devices such as smartphones and netbooks and applications such as video will probably drive demand for gear. On AT&T's (T) network, users of the iPhone and other mobile gadgets have already boosted traffic 5,000% in the past three years, according to the company. Increased use of netbooks, which allow people to access the Web wirelessly, is also placing demands on network capacity.

Cost-Cutting, Streamlining Continue With increased popularity of online video downloads from Netflix (NFLX) and Web sites such as Hulu and Google's (GOOG) YouTube, traditional wireline networks are filling up capacity as well. Wired broadband usage is rising at 35% to 40% a year. That's lower than the peak gain of 60%, but still substantial, says Eve Griliches, a program director at IDC.

Some telecom gear makers will need to rely on cost savings and streamlined operations—as well as rising demand—to eke out bottom-line growth amid still-formidable competition from Chinese manufacturers. Ericsson (ERIC), for instance, is focusing on software and services. This summer, Sprint Nextel (S) outsourced its network management and 6,000 related employees to Ericsson.

"In this industry, opportunities keep emerging," says Ericsson CEO Carl-Henric Svanberg. "It is a very rapidly evolving industry with lots and lots of opportunities. Most analysts are good at predicting where the businesses you are sitting on will go. But what surprised me most at a company like Ericsson is seeing the new opportunities and changes. That's what makes it exciting."