Scott Moritz

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Phone Suppliers Staying Single

Scott Moritz

The telecom industry is full of battle-hardened networking gearmakers. Having narrowly survived the sector wipeout of a few years back, outfits ranging from Lucent (LU Quote) and Nortel (NT Quote) on down the line have shown that they're lean enough to paddle on even through stormy market conditions.

But investors are feeling a little damp, finding that their reward for sticking with these outfits is minuscule growth. Worse yet, sales gains are probably going to get harder to find as big phone company customers merge -- and analysts don't see a corresponding merger wave on the equipment side for at least a year.

The last few months have brought proposed linkups between SBC Communications (SBC Quote) and AT&T (T Quote), Verizon (VZ Quote) and MCI (MCIP Quote), and Sprint (FON Quote) and Nextel (NXTL Quote). Around this time last year, Cingular and AT&T Wireless rolled out their own plans to fuse together.

It's no wonder that investors are calling for a corresponding pair-up trend across the telecom equipment sector. But observers say that while the rationale to combine forces with competitors is apparent, don't expect action anytime soon.

Despite increased speculation about talks heating up between tech giants like Motorola (MOT Quote) and Lucent, or rumors that Cisco (CSCO Quote) is interested in Nokia's (NOK Quote) wireless infrastructure business, industry observers and insiders say blockbuster mergers could be a year or more away.

Analysts say there are several reasons most outfits remain cool on consolidation. Some shops, feeling reborn after a long period of cuts, want to take their newly lean businesses for a spin in the market. Other shops that would offer reasonable strategic fits with North American shops -- such as overseas players Ericsson (ERICY Quote) and Alcatel (ALA Quote) -- seem to pose major cross-border cultural and political issues.

And as for the shrinking customer base, industry watchers say the big telco mergers are a good year from completion, and lots can happen between now and then. Deals can break. Supplier allegiances can shift. It may be too early for some gearmakers to throw in their lot with rivals.

"The real impetus to merge hasn't hit yet," says Telecom Pragmatics analyst Sam Greenholtz. "It could be a year until you see panic among the equipment suppliers."

For now, industry analysts and some insiders say that while there's not much on the big-bang deal front, there has been a definite interest in acquiring certain units within other companies.

The merger route may become the only path to growth, says Lehman Brothers analyst Steve Levy.

"The big driver will be sales growth," says Levy. Large equipment companies will begin to merge as they seek sales growth "outside their own customer base." But Levy says he doesn't think that will happen for another two years, or about the time when big shops see their profits start to slide.

Some players may be facing that scenario sooner than others.

Ericsson, for example, is at the tail end of a big third-generation, or 3G, wireless upgrade cycle in Europe. Unless it can gain traction in new markets such as the U.S. or Asia, a painful decline could set in.

Some observers say Ericsson could easily be interested in filling out areas of wireless technology such as code division multiple access, or CDMA, with the help of Lucent or Nortel.

Wireless remains one of the telecom industry's strongest growth markets. Motorola's rejuvenated focus on mobility has sparked its handset business, but it has notched few big wins at its network equipment unit. Meanwhile, rival Lucent has become a bit of a budding star in wireless infrastructure business with nearly a clean sweep of recent U.S. carrier contracts.

And while Cisco has had a disappointing journey into telecom's wireline side, some observers say a wireless networking acquisition like Lucent or Nokia would make sense.

Still, there are imperfections to the matchmaking. The idea of adding an overseas operation like Nokia's is daunting, say analysts. And Lucent is saddled with a declining phone switch business that may scare off many potential suitors. Similarly, Nortel's dreary old-line telecom unit and bizarre "bonusgate" keep it in the damaged-goods bin, say analysts.

Ultimately, say analysts, if mutual attraction won't drive merger deals, desperation will.