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Summary

Second quarter 2016 earnings are in for well over 90% of the telco (communications service provider/CSP) universe. CSP revenues grew about 1% in 2Q16 versus 2Q15. This year-over-year (YoY) growth is the first for CSPs since 3Q14; recent network upgrades (e.g. LTE support) and business expansion (some via M&A) are fostering this modest recovery. Pressure on costs remains high, though, and telcos continue to hope software will deliver network and operational efficiencies.

CSP forecast on track to meet 2% revenue growth target; capex a bit stronger than expected

Based on preliminary data, CSP/telco capex ended the last 12 months (3Q15–2Q16) at roughly $340bn, flat versus the prior two years. Revenues have been falling, though, leaving the CSP market with a historically high capital intensity nearing 20%. Further, most big telcos need to reserve cash for M&A; Verizon's recent all-cash, $4.8bn acquisition of Yahoo is a case in point. As such, there remains strong downward pressure on telco capex, which we still expect to decline in 2016. That's despite an otherwise good quarter in 2Q16, with telco revenues up YoY for the first time since late 2014.

Software, speed, QoE, and saving costs

One trend cutting across many large CSP capex budgets is a focus on virtualizing networks with software, and hence lots of SDN/NFV activity. That includes recent commercial contract announcements from AT&T, China Unicom, China Telecom, NTT, Softbank, Telefonica, Telstra, and Verizon. An example: In April 2016, Verizon completed an NFV OpenStack cloud deployment across five of its US data centers.

Many large mobile CSPs are targeting capex not (just) at network upgrades or geographic expansion, but at improved performance in existing service areas – better quality of experience (QoE). China Telecom is refarming 800MHz spectrum to improve network performance. Various operators are focused on network densification through small cells. The C-RAN architecture is one approach; China Mobile is deploying Huawei's CloudRAN to improve network performance by handling issues related to interference at the cell edge of an ultra-dense network.

Fixed CSPs tend to be more focused on driving fiber deeper into the access network, as with Fastweb and Telecom Italia's July 2016 plan to jointly roll out FTTH to 13 million homes and businesses in Italy by 2020. Fixed operators are also expanding their clouds – either by building out co-location in carrier-neutral facilities, or through direct ownership/construction of data centers. Deutsche Telekom, for instance, is building three new data centers for its core European network; its data center in Hungary is online now, with Poland and Greece to follow next year.

Saving costs through shared assets is a focus for many CSPs. That's true in China in particular, where telcos have struggled to contain capex budgets amidst a push for growth. All three of China's national operators expect cost savings, eventually, from China Tower, the new tower carrier-neutral provider (CNP). The scale of sharing is, as are so many things in China, enormous. China Telecom estimates the new venture is leasing roughly 550K towers. Other cooperation is also occurring; China Telecom says it is co-building or sharing up to 60K new 4G base stations and 14,500km of fiber. Over time, China Tower should help the market get capex/revenues down to a more sustainable level; it's been around 28–30% for several quarters.

Telcos will use M&A, not just capex, to expand asset base

Structural changes in the industry from M&A are also affecting capex. The US is an example. Most big US telcos have either recently been engaged in M&A or have a deal pending. Verizon's acquisitions of AOL and Yahoo have pushed it towards the ICP business model; AT&T's DirecTV deal significantly expanded its video proposition. Sprint's absorption into Softbank, a telco which is also buying a chip company (ARM), has brought confusion to some, and deep budget cuts: Sprint now expects 2016 capex of $3bn, from $5.6bn in 2015. Add to that the many cable deals in the US: Altice-Suddenlink, Altice-Cablevision, Charter-Time Warner, Charter-Bright House, and Comcast's foray deeper into content, buying DreamWorks Animation. The US regulators in charge of reviewing these deals have been busy.

This is not the end of telecom M&A. While the US may be running low on M&A candidates, other global markets have the potential for much more consolidation, as well as stretch deals across industry lines. Tech vendors selling into the telecom vertical should study carefully the top recent dealmakers in the industry, notably Altice, AT&T, BT, Hutchison, Liberty Global, NTT Communications, Softbank, Telefonica, Verizon, and Vodafone. Many of these have already shown eagerness to use M&A to expand into adjacent markets, and they're also among the biggest capex spenders.

Appendix

Further reading

"Carrier-neutral provider revenues grow 12% in 2Q16, data center buildouts benefit," TE0006-001273 (August 2016)

"ICPs report strong 2Q16; full-year capex approaching 7% of revenues," TE0006-001269 (August 2016)

Google's MVNO Project Fi: A Step Closer to Launch in Europe, TE0014-000417 (July 2016)

Telco Services Innovation Radar 2015: Analysis and Case Studies, TE0009-001529 (July 2016)

"With its $4.8bn deal for Yahoo, Verizon is gunning for Google and Facebook," ME0002-000689 (July 2016)

Microsoft and Facebook to build the Marea subsea cable, TE0017-000068 (June 2016)

Communications Provider Revenue & Capex Highlights: 1Q16, TE0006-001253 (June 2016)

Communications Provider Revenue & Capex Forecast: 2015–20, TE0006-001167 (December 2015)

Author

Matt Walker, Principal Analyst, Intelligent Networks

matt.walker@ovum.com

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