Should You Keep Putting Money Into Wireless?

 Should You Keep Putting Money Into Wireless?

Capital was cheap and wireless service providers invested extensively during the late 90s go-go period due to ever increasing customer predictions. Then it all came crashing down. Operating margins were severely hit by brutal price competition and the subsequent customer churn, causing the DJ Wireless index to plummet more than 90% between March 2000 and October 2002. When it comes to prices, the sector has finally gotten its act together. The rate of customer attrition has decreased. The company has reduced its capital expenditure and increased its operating margins. Companies carrying a lot of debt have been able to enhance their financial positions because to the historically low interest rates. One company that has managed to reduce its debt by a significant amount is Nextel Communications (NDQ: NXTL). Significant investor attention has been drawn to the wireless technology businesses' improved operational performance. Since the end of 2002, the net asset value of Fidelity Select Wireless (NDQ: FWRLX), a mutual fund that primarily invests in this industry, has doubled. Is it time to hang up the phone? That is the most natural question for investors.
To provide our predictions for the future of the cellular industry, we take a look at the key factors from an investment standpoint.
The expansion of subscribers in developing economies.
Since emerging economies like Russia, China, and India have poor per capita wire-line connection, wireless technology provides a low-cost alternative for their populations to get connected without investing in costly wire-line infrastructure. Shares of Russian cellular service providers, such as Vimpel Communications (NYE: VIP) and Mobile Telesystems (NYSE: MBT), have increased by more than 140% in the last 52 weeks, thanks to 75% year-over-year growth in both revenues and profitability. There is still a lot of space for substantial growth in wireless customers in these countries because the number of users is far from saturation. According to projections made for the years 2005–2010, the number of subscribers in China will increase at a rate almost three times faster than in developed economies. Qualcomm (NDQ: QCOM) and LM Ericsson (NDQ: ERICY) are two firms that look to continue benefiting from the substantial investment in wireless infrastructure that is necessary to accommodate such big subscriber base growth. For instance, QCOM set a new record for shipments of phone chips in the first quarter of 2004 at 32 million. The company has predicted that demand will rise in the second quarter of 2004, prompting it to explore increasing manufacturing capacity. The previous 52 weeks have seen a 100% increase in QCOM shares and a 200% increase in ERICY shares.
Possibilities to Enhance Revenue in Established Markets.
New phone features, such as integrated cameras, and legislation, such as telephone number portability, have contributed to subscriber growth ticking up in mature markets like the U.S. This acceleration is more of a passing fad, in our opinion. As we approach saturation levels, the growth in the number of subscribers will reduce in the long run. Wireless providers will need to maintain high service standards to reduce customer attrition as they prepare for the nationwide implementation of phone number portability at the end of May.
New high-speed wireless data, wireless Internet access (or Wi-Fi), and wireless information services present a wealth of revenue development potential, even though subscriber growth will inevitably level down. There will be double-digit growth in both data revenue and wireless data services in the years to come. Mobile-Fi, which extends Wi-Fi to moving cars, and Wi-Max, a new type of high-speed, longer-range wireless networking, are expected to see significant adoption in 2006 and 2007.
If they want to compete for wireless data service opportunities, cellular operators will need to upgrade to 3G wireless networking. With 3G wireless networking, wireless service quality is enhanced and data transmission is added. As 3G network development gains momentum in 2005, this bodes favorably for both well-capitalized cellular service providers like Vodafone (NYSE: VOD) and wireless equipment vendors like ERICY and Alcatel (NYSE: ALA). Research in Motion (NDQ: RIMM), with its Blackberry brand, is also in a prime position to take advantage of this potential.
Unreliable Telecom Users.
From 2003 levels, sales of handset units are expected to rise by 10% in 2004. A robust handset replacement cycle has been driven by new features like color displays, integrated cameras, short messaging, and web access capability in mature regions, while a growing subscriber base in emerging economies continues to stimulate handset demand. Nokia (NYSE: NOK), the world's leading cellphone manufacturer, has been losing ground in the market share race for a while now, despite the fact that the overall pie has been expanding. The fall in NOK's market share appears to have benefited other phone makers, such as Motorola (NYSE: MOT), Samsung Electronics (005930.KS) of South Korea, and SonyEricsson, a 50/50 partnership between Sony and Ericsson based in London.
Value Creation through Consolidation.
Major telecom and wireless service providers are interested in acquiring wireless assets due to pressures from a falling long-distance business and economies of scale in the wireless service industry. Despite the formidable challenges posed by a falling long-distance business, the struggling telecommunications service providers see wireless as a potential area for expansion. When AT&T Wireless (NYSE: AWE) went public earlier this year, it drew strong interest from both large telecom companies and wireless service providers. At a cost of $1,850 per AWE client, Cingular—a joint venture between SBC Communications and Bell South—was the eventual successful bidder. Given Cingular's meteoric rise to the position of top wireless carrier in the country, we anticipate further consolidation in the industry.
The recent merger of Sprint's "tracking stocks," FON and PCS, suggests that the corporation may be involved in consolidation efforts (NYSE: FON). U. S. Cellular (ASE: USM) and similar specialty wireless companies are also renowned. Others who could be involved in the industry-wide push for consolidation include NXTL and Verizon Communications (NYSE: VZ).
Finally, we believe that the sector's easy money has been made and that share prices may consolidate for a while. However, any decline is likely to be a purchasing opportunity because the industry's growth prospects are still appealing. Wireless infrastructure provider QCOM is our current favorite. Restructuring play MOT, a handset maker that seems to be on the mend, has extra appeal. Because of its dominance in the building and manufacturing industries, NXTL is our preferred wireless service provider. The possibility for value creation through consolidation makes investments in wireless service providers all the more appealing. Despite the fact that future capital appreciation rates will most certainly be lower, we still think this sector has a good chance of outperforming more general averages, such as the unmanaged Wilshire 5000 Total Market Index.
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