Fitch: Telecom Equipment Faces Increased Volatility in 2010

Fitch Ratings says that the global telecom equipment sector faces continued challenges in 2010 in the form of ongoing volatility, shifting competitive pressures, changing business models and accelerating technology migrations.

These pressures underline Fitch's Negative Outlook for the sector, although potential rating actions in 2010 are likely to be driven more by company-specific factors than the macro level outlook for the industry.

In a report due to be published tomorrow, Fitch says the sector is likely to continue to see its risk profile change, with higher-margin handset dynamics refocusing towards the ultra-competitive smartphone market and the increasingly competitive pressures in infrastructure exacerbated by Chinese manufacturers. These factors led Fitch to a number of negative rating actions in 2009 - including the downgrade of Nokia on 21 December 2009.

Demand conditions in 2010 should improve moderately as the global economy recovers and consumer interest in multi-media and convergent technologies in areas such as mobile internet and the demand for time- and place-shifted content grows. This shift should see a return to volume growth in the embattled mobile handset sector and help support average selling prices given a continued shift in value from the mass market to the smartphone segment.

The line between the handset, smartphone and other handheld device is becoming increasingly blurred, however, with all of the mass market handset vendors seeking to expand their smartphone presence. This is a segment that has witnessed the runaway success of the iPhone, and where a number of niche players (Research in Motion, HTC, for instance) already have a strong position. Nokia, meanwhile, has launched its first netbook and a number of PC manufacturers (Dell and Acer) are thought to be considering entering the handset market. Nokia's recent announcement that it will bundle GPS-type services, enabled by its USD8.1bn acquisition of NAVTEQ in 2008, is in the agency's view, a response to the threat posed by similar services being offered by Google, and a further sign of the changing business risk in the industry.

With telecom capex budgets remaining reasonably protected through the economic downturn, infrastructure spending may remain flat in 2010. However, increased traffic driven by burgeoning data consumption will put pressure on networks. This year is therefore likely to see continued challenges in network infrastructure, with pricing pressures continuing to reflect the competitive environment. These pressures were emphasised in the Q409 results announced by Ericsson ('BBB+'/Stable) this week, and further underlined by the 2010 margin targets set for NSN, Nokia's infrastructure JV with Siemens of between breakeven and 2%, at its Capital Markets Day last December.

While the growth ambitions of China's Huawei and ZTE continue to be disruptive, Fitch believes that pricing strategies are being driven aggressively by a desire among all the vendors to defend and/ or grow market share.

M&A will continue to present event risk as manufacturers continue to seek cost synergies and expand service offerings. The outsourcing of network management is increasingly being pursued as a key growth driver for the network vendors, given its potential for long-term annuity type revenues with higher margins and low capital intensity. While for the most part the vendors remain well-capitalised, evolving business risk and operational challenges offer the most significant threat to existing credit profiles.