U.S. Telecommunications Industry Outlook - July 2017

The U.S. telecommunications industry is currently balanced with almost equal proportions of positive and negative influences. This year, we expect this industry to witness growth more or less in line with the broader market. Telecom has of late emerged as an intensely contested space where success largely depends on technical superiority, the quality of services and scalability.

Positive Factors

At present, the U.S. telecom industry enjoys several positive attributes. First, the Trump administration’s new telecom regulatory body – Federal Communications Commission (FCC) – has given enough indications that it will be less stringent compared with the Obama administration, and is likely to roll back several regulations of the previous regime. Second, the less restrictive nature of the FCC will aid mergers and acquisitions which are likely to spur growth in 2017. Third, President Trump has decided to improve broadband availability in rural areas. Rural broadband development will be an element of his ambitious $1 trillion infrastructure plan he will submit to Congress soon.

Negative Factors

However, several near-term headwinds prevail in the telecom industry. The chief ones include growing price competition for wireless services that are likely to reduce carriers' revenue growth in 2017. Leading cable MSOs (multi-service operators) have decided to enter the wireless field this year, which is likely to intensify competition in an already saturated market.

Further, capital spending by U.S. telecom carriers may be muted in 2017. 4G LTE wireless penetration is currently 83% in North America. This can primarily be attributed to most carriers’ intention to upgrade to the 5G wireless network standard which requires massive investment. However, a full-phased 5G network deployment is unlikely before 2020.

Telecom - Media Convergence Now a Reality

Massive growth of smartphone and tablets together with continuous development of super-fast data transfer technologies have acted as a key driver of the convergence of the Telecom and Media sectors. Cable TV giant Comcast Corp. (CMCSA) became a media mogul after acquiring NBC Universal in 2011. AT&T Inc (NYSE:T). (T) is currently awaiting the regulatory approval for its proposed $85.4 billion cash-and-stock deal to acquire media giant Time Warner Inc (NYSE:TWX).

Verizon Communications Inc (NYSE:VZ). (VZ) has already acquired AOL and the Internet-based assets of Yahoo (NASDAQ:AABA) to establish a strong foothold in the Telecom - Media space. The company is also mulling over buying out any powerful media giant to remain competitive. AT&T currently holds a Zacks Rank #4 (Sell) while both Verizon and Comcast carry a Zacks Rank #3 (Hold). You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here.

Telecom Operators & Cable TV Operators: Segments Overlapping

The broader telecom sector has turned out increasing competitive as both basic phone service providers and cable TV operators are increasingly entering into each other’s territory. While Verizon and AT&T have long been servicing customers with fiber-based video networks, leading cable MSOs (multi-service operators) like Comcast and Charter Communications Inc (NASDAQ:CHTR). (CHTR) have entered the wireless network field.

Currently, both companies are negotiating with national wireless carrier Sprint Corp. (S) for a possible MVNO (mobile virtual network operator) deal or an outright purchase of Sprint. Meanwhile, AT&T has strengthened its pay-TV services after the acquisition of largest satellite TV operator Directv.

Online Digital Advertisement: Solid Prospects

Advertisement on the mobile video platform is gradually shifting from simple selling of banner ads on the mobile web to automated or programmatic ad selling. Pay-TV operators are steadily adopting the data-driven advertising technique that is already popular in the web-based advertisement arena. To derive maximum synergy from the combined video content and video distribution platform, these companies are extensively penetrating the advertising technology market.

Inclusions of dynamic ad-insertion, targeted audience advertising and data-driven TV advertisements are steps toward the same objective. According to market research company eMarketer, the global mobile ad market value is expected to reach a worth of $133.7 billion by 2017.

Wireline Industry: Going All Out for Consolidation

In the past decade, U.S. wireline phone companies have lost a significant number of customers to wireless service providers and cable multi-service operators. In order to tackle this critical situation, wireline operators have decided to merge to attain economies of scale with respect to fiber optic cable networking and cloud-based network services. Meanwhile, small and medium business (SMB) services have become a high revenue-generating segment in the data communications industry.

In Apr 2016, Frontier Communications Corp. (FTR) completed the purchase of Verizon’s wireline assets in California, Florida and Texas. Currently, the company operates landline business and provides broadband, video, voice and FiOS services in all the three states. In Nov 2016, CenturyLink Inc (NYSE:CTL). (CTL) and Level 3 Communications Inc. (LVLT) entered into a definitive agreement, through which the former will acquire the latter in a cash and stock transaction.

In Feb 2017, telecommunications and data service firm Windstream Holdings, Inc. (WIN) acquired EarthLink Holdings Corp. In addition, in Apr 2017, the company entered into a deal to acquire Broadview Networks, a leading provider of cloud-based unified communications solutions to SMBs. In Jul 2017, Cincinnati Bell Inc. (CBB) announced that it will buy Hawaiian Telecom Inc.

Growing Demand for Fiber Optic Network

The fiber optic network is increasingly becoming the most sought-after technology for secure and fast data transmission over long distances. Going forward, the wireline industry will largely evolve around the fiber-based superfast gigabit data transmission network.

Fiber optic cable is a vital infrastructure to meet the surging need for cloud-based business data, along with more video streaming services by individuals. Moreover, fiber-optic cable network is vital for backhaul and last mile local loop, which are needed by wireless service providers for their upcoming 5G network.

Fiber networks are essential for the growing deployment of small cells. The increase in adoption of small cells is because of the inconvenience in installing large towers in inaccessible areas. Verizon stated that small cells will be used to augment its existing 4G LTE and upcoming 5G network and will primarily concentrate on high traffic locations like a business district or shopping mall. Small cells will increase voice capacity and data speeds as well as complement wireless service providers LTE infrastructure.

Valuation Indicates Some Upside

Going by the P/E (price to earnings per share) valuation metrics, which is often used to value telecom sector stocks, the industry looks stable at this stage. The industry currently has a trailing 12-month P/E ratio of 16.33x, in line with the median value in the past year.

Additionally, the reading compares favorably with the market at large, as the current P/E for the S&P 500 is pegged at 20.61x and the median level is 20.10x. At present, the telecom industry looks undervalued compared to the overall market. This indicates a near-term upside potential for the stocks.

Another commonly used valuation metric for this sector is P/S (price to sales) which also depicts the same picture. The industry’s current P/S of 1.52x compares favorably with the market at large, as the current P/S for the S&P 500 is at 3.20x and the median level is 3.13x.

What the Zacks Industry Rank Indicates?

Within the Zacks Industry classification, Telecommunications is broadly grouped in the Computer and Technology sector (one of the 16 Zacks sectors) and is further sub-divided into 12 industries at the expanded level: Communications Infrastructure, Communications Components, Satellite Communications, Cable TV, Diversified Communications Services, Internet Services, Wireless Equipment Supplier, National Wireless Service Provider, Rural Wireline Operator, Non-U.S. Wireless Operator, National Wirleline Operator and Non-U.S. Wireline Operator. The level of sensitivity and exposure to different stages of the economic cycle vary for each industry.

We rank 265 industries in the 16 Zacks sectors, based on the earnings outlook and fundamental strength of the constituent companies in each industry. We put our industries into two groups: the top half (industries with the best average Zacks Rank) and the bottom half (the industries with the worst average Zacks Rank). Over the last 10 years, using a one-week rebalance, the top half beat the bottom half by a factor of more than 2 to 1. (To learn more visit: About Zacks Industry Rank.)

Earnings Trend in the Sector

The broader Technology sector delivered a strong show with respect to first-quarter 2017 earnings. Total earnings have shown a strong 17% year-over-year increase on a 6% rise in revenues. This compares favorably with earnings growth of 9.1% in the fourth quarter of 2016. Revenues witnessed a rise of 5.6% in the fourth quarter.

However, the consensus earnings expectation for the next two quarters depicts a lukewarm trend. While earnings growth is anticipated to grow 10.1% in the second quarter of 2017, it is likely to grow 8.3% in the third. Similarly, revenue is expected to grow 5.9% in the second quarter of 2017 and 5.5% in the third.

For a detailed look at the earnings outlook for this sector and others, please read our weekly Earnings Preview reports.

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