The Wall Street Journal-20080213-Wireless Technology- Network Makers Expect Bumps

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Wireless Technology: Network Makers Expect Bumps

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The companies that make the phone towers, switches and cables that power the world's mobile-communications networks are in for a bumpy ride this year.

Operators, including AT&T Inc., Vodafone Group PLC and Telefonica SA's O2 unit have spent billions over the past few years to increase the amount of data their networks can handle. Data traffic has shot up, but not enough to cause bottlenecks in the newly expanded networks. This is good news for carriers, but it signals tougher times for the equipment makers.

With room to satisfy growing demand and eyes on lowering costs, operators have slowed upgrades and other investments, directly affecting network-equipment makers such as Alcatel-Lucent SA, Telefon AB L.M. Ericsson and Nokia Siemens Networks, a joint venture between Nokia Corp. and Siemens AG. Capacity upgrades and booming emerging markets helped the segment for mobile-network equipment to post strong growth the past few years, and while the year ahead might not look like the downturn of 2002, companies are anxious about slowing growth.

Mobile-phone carriers use a honeycomb of masts, or base stations, to send and receive call and data signals to customers. The wider the geographic coverage area, the greater the number of towers that are needed. Not only do the world's largest carriers have a lot of stations in place, they are saving money with rivals by splitting investment in new ones.

Companies end up with better geographic coverage for less cost. The savings aren't likely to trickle down to consumers, but teaming up could help operators give better coverage faster while protecting profit margins.

"In a mature market, the base-station investment is driven by capacity growth, which is driven by the increase in traffic," says Nokia Siemens Networks Chief Executive Simon Beresford-Wylie. "A lot of the networks deployed over the past few years have a fair amount of capacity in them, and in many cases operators are still drawing down on the capacity already out there." As a result, "we are expecting to see very slight growth in the overall market."

Investment world-wide in mobile-phone infrastructure peaked in 2006 at $59.56 billion, fell to $56.67 billion last year, and is seen slipping to $56.25 billion and $55.91 billion this year and next, respectively, before climbing again in 2010, according to Gartner Inc. analyst Sylvain Fabre in London. A forecast from London-based Nomura Securities analyst Richard Windsor is slightly more optimistic, projecting wireless-infrastructure growth that is flat to up about 2% this year.

Stockholm-based Ericsson, the world's largest wireless-network maker by market share with slightly more than 40% of the world's mobile- phone networks, said the first quarter might well be the toughest of the year, with earnings improving over the longer term. The company on Feb. 1 lowered its forecast for this year, projecting flat growth.

Ericsson Chief Executive Carl-Henric Svanberg cites operators trying to cut costs through sharing deals, and a larger proportion of low- margin "rollout" deals as the root of his company's October profit warning. Rollout deals are often fiercely bid contracts to build or expand mobile-phone systems in countries such as India, China and other fast-expanding economies. They have been important for network makers to help lock in customers who ultimately are expected to need higher-margin network expansions and upgrades. The company shocked the market with the warning, and its shares have plummeted nearly 50% since.

Mr. Svanberg took the helm at Ericsson in 2003 after the company's share price fell to 3.37 Swedish kronor, about 50 U.S. cents, a share from an all-time high of more than 165.2 kronor a share when the tech bubble burst in 2000-01. The network-equipment market collapsed after telecom operators poured money into their networks, creating overcapacity. Ericsson's sales fell 47% to 117.7 billion kronor, or about $18.1 billion, in 2003 from a high of 221.6 billion kronor in 2000.

There is little question that sharing deals are hot right now. Vodafone has agreements to share base stations with Telecom Italia SpA in Italy and with France Telecom SA's wireless unit Orange in the U.K. Vodafone formed a joint venture with Bharti Airtel Ltd. to help feed expansion in India, where millions of subscribers are added each month. T-Mobile U.K., a subsidiary of Deutsche Telekom AG, and Hutchison Whampoa Ltd.'s 3 unit announced a third-generation network- sharing partnership in the U.K. that will deliver estimated cost savings of GBP 2 billion, or roughly $4 billion, over 10 years.

Still, "network sharing brings opportunities," says Mr. Beresford- Wylie, who has led Nokia Siemens Networks since its creation in April. "Now there are more opportunities to manage these networks. We don't see it as all doom and gloom. It's just a shift in how the business model is playing out." The company opened a service center in India partly to better position itself for the increasing number of carriers who need help maintaining infrastructure.

The total mobile subscriber base is expected to increase to five billion from 3.5 billion within seven years, with 90% of the growth in the emerging markets of the Asian-Pacific region, the Middle East and Africa. Only 180 million mobile-phone users are now on high-speed, third-generation networks, a figure that indicates that many older networks will need upgrading. "There is obviously good, good potential off that subscriber base," Mr. Beresford-Wylie says.

The network-equipment companies have a tricky balance to strike in the emerging markets. Winning less-profitable infrastructure projects is crucial for gaining market share and creating the economies of scale so important to offering competitive pricing. "Timing is important," Mr. Svanberg says. "If you lose market share, you won't gain it back."

But such deals can hurt profitability because the competition to win the building contracts is so intense. Ericsson and Nokia Siemens Networks last year separately bid for a large expansion and upgrade of a network using the GSM standard for India's state-run mobile-phone company, Bharat Sanchar Nigam Ltd. Ericsson won a 60% piece of the deal and accepted the government's price, but Nokia Siemens Networks declined the remaining 40% of the contract, deeming the price too low, according to Mr. Beresford-Wylie. Ultimately, Ericsson declined the remaining stake, too, saying it preferred to "ensure superior quality and delivery to all of our customers in India."

Both companies say they are focused on balancing footprint growth with improved profitability. "We just aren't going to be irrational," Mr. Beresford-Wylie says. "It won't be a case of market share at any cost. BSNL is an example of that."

Ericsson declines to comment on the Indian deal's pricing. "We have a few things going against us in the market right now, but over time there's no doubt that the need for communication is just increasing and creating exciting services for users and spreading Internet and communication and mobile telephony to emerging markets," Mr. Svanberg said at the company's fourth-quarter news conference.