RealMoney Silver - Accelerated Spending Bodes Well for Telecom

Accelerated Spending Bodes Well for Telecom
By Cody Willard
RealMoney.com Contributor
8/30/2007 4:36 PM EDT

There's a lot to like fundamentally/cyclically in tech right now. Ciena (CIEN) is the latest tech company to confirm what John Chambers and Hewlett-Packard (HPQ) have told the world in the last few weeks -- tech investment is picking up.

Cisco (CSCO) and Ciena have both reported upsides in recent weeks and are looking for more strong growth ahead. Both are seeing good traction in telecom carrier spending, and there are a lot of names that we should be looking at to play that pickup. First, a little history of the telecom cycles to bring us to where we are at this stage.

Ramping up, Cycling Down

Back in 1996, the ironically named "Telecom Deregulation Act of 1996" created all kinds of new regulations, incentives and rules for the telecom world. Somehow, the collective genius of the world's financial markets decided that any company with the word "telecom" in its business model should have access to hundreds of millions of dollars.

Meanwhile, LTCM, the Asian crisis and other macroeconomic factors and fears were prompting the Fed to keep the financial markets full of excess artificial capital. By the time the Fed cut rates to help out LTCM and its cronies in 1998, the bubble in telecom was forming.

When you include all the Level 3s (LVLT) , 360 Networks, Williams Communications, Winstars, Teligents, Covads (DVW) and my former company Broadview Networks and all the money they tapped and spent, more than a trillion dollars of capital went into the telecom services world from 1996 to 2000. Thank goodness the Fed cut in 1998 and 2000, right?

From 2000 to 2002, telecom spending from these carriers plummeted. In optical spending, 2003 sales were 10% of what they were in 2000. Imagine a 90% cyclical decline taking place over about 30 months.

By late 2003, though, the excesses of the bubble were working themselves out and stability in carrier spending became the trend. From 2003 to 2006, telecom carrier spending was growing slowly, initially showing low-single-digit compound annual growth rates. That slow growth has been accelerating, and 2007 is starting to look like it could be the first year of strong double-digit telecom spending growth since 2000.

The Revolution Hits Telecom

Currently, the telecom carrier spending looks as though it's accelerating. These networks have to get optimized for the Internet Video Revolution. That's what Ciena and Cisco both told us on their recent quarterly reports.

Ciena, Cisco, Nortel (NT) and Alcatel are some of the higher-profile names to watch here. I like the former two because they have fewer legacy, pre-Internet product lines to defend in the Internet-protocol-centric-technology times we live in.

And as you can see from the history, we can't get away from the impact that a Fed cut would likely have on carrier spending. With the acceleration in spending for video technologies making the marketplace fundamentals stronger already, a Fed cut would really juice things for Cisco, Ciena and the rest of the vendors. Valuations and multiples would expand on the stock prices on top of those fundamentals the Fed would be juicing.

Another step for my Echo Techo Bubble to build from. Much like with the semis, I'll be looking to build up some more aggressive positions in these telecom vendor names if and when the "mass repricing of assets" that I'm looking for makes things get uglier in the near term.