February 8, 2005 2:16 PM PST

Merger wave could leave telecom gear makers at sea

The rapid consolidation of phone companies in the telecommunications industry could spell trouble for equipment makers, analysts say.

Telephone companies are merging left and right, changing the landscape of the telecommunications market forever. Last week, local phone giant SBC announced it is buying AT&T for $16 billion. MCI is believed to be the next carrier on the auction block. Last week, Qwest Communications International offered to buy the carrier for $6.3 billion. So far, no deal has been reached, as sources speculate that MCI is holding out for a better offer.

So what does all this consolidation mean for the equipment companies that supply them? Experts say it could be a mixed bag.

The good news is that spending is shifting toward newer technologies that use the Internet Protocol instead of ones based on older telecommunications technology. To compete with the cable companies, the phone companies must deliver bundles of services that include voice, video and broadband. But the bad news for suppliers is that a shake-up in the purchasing and planning process, coupled with fewer players buying equipment, could slow spending.

"Carriers don't consolidate so they can increase spending."
--Erik Suppiger, analyst, Pacific Growth Equities

"Historically, industry consolidation has disrupted sales to suppliers," said Mark Sue, an analyst with RBC Capital Markets. "There's typically a period where spending slows down. The newly merged carriers will have to re-evaluate their networks."

Sue also pointed out that with fewer customers in the market, these carriers will have stronger purchasing power, which could lead to lower profit margins on equipment. Some weakness has already been felt in the wireless market due to the merger of AT&T Wireless and Cingular Wireless, Sue said. And with the Sprint-Nextel Communications merger pending, the pressure could continue, he added.

The new wave of mergers among the local and long-distance phone companies could have a similar impact, he added. The list of equipment suppliers that could be affected is long, including IP equipment makers Cisco Systems and Juniper Networks, optical gear supplier Ciena, and long-standing telecom equipment makers Alcatel, Lucent Technologies and Nortel Networks.

The pain of loss
Analysts say an equipment supplier is hurt more severely when it sells to both consolidating companies. Cisco and Juniper supply AT&T and SBC with IP routing and security products. Cisco in particular had been selected to help build SBC's nationwide IP backbone.

"Generally speaking, we consider the merger may be slightly negative for Cisco, as it seems SBC no longer needs to expand its own IP backbone to a true national scale," Tim Luke, an analyst with Lehman Brothers, wrote in a research note he published last week to investors.

On the other hand, a merger between Qwest and MCI could hurt

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