The year 2020 has not been kind to telecom operators. Facing a flat revenue outlook, they started the year with a focus on slimming down their operations and cutting costs. Then COVID-19 hit. Telco revenues dropped 2 % year-over-year (YoY ) in 1Q20, and fell 5.4% in 2Q20. Meanwhile, the rapid shift to working and studying from home benefited telcos’ nimble competitors in the cloud. Revenues in the webscale sector surged by over 20% YoY in 1H20, and the sector recorded an average free cash flow margin of over 20% (2Q20 annualized) despite surging capex.
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Third quarter telco results are still trickling in, but so far the top line remains weak. Revenues for both AT&T and Verizon declined in Q3 in the 4% to 5% range on a YoY basis. In Europe, revenues at Orange were flat YoY in the third quarter, but down 12% YoY at Telefónica. For 2020 as a whole, MTN Consulting expects telco revenues to fall by about 4% to $1.75 trillion. There will be a modest bounce-back in 2021, with revenues likely to climb by about 2%.
5G: A long slog ahead
What about 5G? We now have enough evidence from early adopters to suggest that 5G is going to be a long slog, even after the Covid-19 pandemic is resolved. Aggressive marketing and device subsidies may encourage rapid 5G adoption but doesn’t create profitability. As with many technology upgrades, committing rapidly to the new one puts at risk the safer, relatively high margins of the last generation. KT, for instance, reported a blended wireless ARPU of 31,620 won in 3Q20, down from 32,372 in 3Q18, before 5G. KT’s company-wide EBITDA margin in those two quarters was an identical 19.9%, and net income margin a bit lower in 3Q20 (3.8%, v. 4.0% in 3Q18). Covid-19 can’t be ignored, as it has hit the mobile roaming revenues of telcos like KT. But telcos are disappointed with the results nonetheless.
Vendors hit hard by weak telco spending but Q3 represents progress
Amidst the weak 1H20, telcos also cut back on capex, roughly in proportion to revenue declines. Capital intensity for the telco industry remained at the relatively low level of 16% of revenues (annualized) from 4Q19 through 2Q20. This hit the vendors selling into the telco network infrastructure (telco NI) market. In the first half of 2020, telco NI revenues declined 3% from 1H19: Huawei and ZTE combined to average 5% YoY growth, but the rest of the vendor industry saw revenues fall 5% YoY.
Preliminary results for 3Q20 show that Huawei and ZTE continue to benefit from China’s early, rapid buildout of 5G. Their combined telco NI revenues jumped by over 25% YoY in 3Q20. This incredible growth comes as both vendors face supply chain restrictions and a wave of Chinese vendor bans in key overseas markets. Only a Chinese government top-down push could engineer such a counterintuitive result. Next year will be much tougher for these vendors as China’s initial 5G splurge tapers off.
Another surprise from preliminary Q3 vendor results is an improvement in the rest of the industry. Telco NI vendor revenues for the industry, minus-Huawei and ZTE, dropped by a modest 1% YoY in the third quarter. That’s based on over 85% of the vendors reporting. A 1% decline isn’t cause for a party but it's better than 1H20, at least. It comes as Covid-19 continues to rage in many large markets, and mobile operators take it slow on 5G due to spectrum limitations, a need to reevaluate vendors and architectures, and business model uncertainty.
Figure 1 illustrates YoY revenue growth in the telco NI market for the last four quarters, contrasting trends at Huawei and ZTE with the rest of the vendor market.
Telco NI vendors: Who’s up, who’s down
You can’t talk about the telco NI market without addressing the quirks of the China market. For the last two quarters, Huawei and ZTE have benefited from a coincidence of strong Chinese government support for rapid 5G adoption, and a domestic policy aimed at helping prop up local suppliers. Nokia hasn’t even bothered to focus on the China market given how uneven the playing field has become. Ericsson has pushed hard on China, but even with this emphasis China still accounts for less than 10% of the company’s revenues, significantly less than China’s share of global telco capex (~15%).
Focusing on vendors with over $500 million in third quarter sales in the telco NI market, the big winners in were Huawei, ZTE, Fujitsu, FiberHome, Hengtong, Ericsson, and NEC. All of these suppliers saw YoY revenue growth of 5% or more. Fujitsu and NEC stand out, though, as they don’t play in the China market and instead have grown from a mix of domestic Japanese 5G spending and increased penetration in overseas markets. Their prospects appear especially bright with increased telco interest in Open RAN architectures, something that will play out over several years.
On the losers’ side of the equation, Samsung, CommScope, MasTec, Cisco, and Accenture each saw YoY declines of 5% or more. Samsung is in a unique position, as its drop is due to Korea but simultaneously it has seen its fortunes rise abroad, especially the U.S. with a big win at Verizon. Revenues haven’t hit from that deal though.
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For CommScope, this company tends to swing up and down with the North American broadband market, but it has also suffered from a lack of clear focus given its acquisition history. A new CEO is likely to eventually create a much different structure, possibly selling off some units. MasTec supports telco construction and engineering in the U.S., which has been slow lately due to both COVID and a shift towards software-based networks.
Cisco has had a declining position in the telco market for many quarters, again in 3Q20, and continues to point to future adoption of stand-alone core 5G networks as benefiting its portfolio. Accenture has been a strong partner for telcos in digital transformation and customized software projects, but competition is rising in this space from companies like Tech Mahindra.
The figure below illustrates 3Q20 YoY revenue growth in telco NI sales for a selection of the larger telco NI vendors.
Note that acquisitions are part of the growth story for a number of vendors, and affect 3Q20 YoY comparisons. Such deals include: Hengtong-Huawei Marine, Ericsson-Kathrein, Amdocs-Openet, and IBM-Red Hat.
Telco NI vendors have an opportunity for growth in 2021
In 2021, telco capex is likely to grow 4%, offsetting the decline of 2020. The software component of capex will rise slightly to just under 20%, as software-based features and network automation solutions are more widely deployed. Mobile operators’ 5G rollout plans will get back on track as more spectrum auctions complete and supply chains settle. Bandwidth growth remains strong and will benefit transmission vendors.
Fiber buildouts to cell sites and small cell spots will kick up again. Telcos will need help on the services and systems integration side as they step into Open RAN architectures. They’ll also need outside help reaping the benefits of cloud collaborations with the webscale sector. Network operations opex budgets will be a more compelling opportunity for vendors, as telcos layoff more of their own staff and look for efficiencies.
Vendors with a telco focus are used to coping with tight budgets, and helping their customers with mundane tasks like lowering their cost of operations. In 2020, COVID-19 and a slowdown in 5G deployments have been disappointing to vendors, but far from catastrophic. There is hope in 2021.
[Note: This column includes data excerpted from a forthcoming MTN Consulting publication: “Network operator capex to hit $520B in 2025.”]
Matt Walker is the founder and Chief Analyst of MTN Consulting, LLC, an independent market research firm. He has over 20 years of experience in telecom industry analysis, consulting and research program management. Walker currently lives in the Bangkok Metropolitan Area. He can be reached by email at [email protected]. Follow him @mattwtelecom, or LinkedIn
Industry Voices are opinion columns written by outside contributors—often industry experts or analysts—who are invited to the conversation by Fierce staff. They do not represent the opinions of Fierce.