Wireless Firms' Big Spending Worries Investors

Wireless service providers are spending money like Internet companies did before their fall.

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In a rush to prepare themselves for wireless technology's next generation, service providers such as AT&T Wireless (AWE), Sprint PCS (PCS) and Nextel Communications (NXTL) are ready to spend big money to buy spectrum and then build new networks.

And while many investors missed seeing excessive Internet company spending as a sign of the top, they're already fretting about whether service providers are digging too deep. So far this year, AT&T Wireless has fallen 41%, Sprint PCS has plunged 52% and Nextel has tumbled 53%.

The builders of these expensive networks will benefit, but two, Ericsson (ERICY) and Motorola (MOT), are wrestling with severe problems in their mobile-phone handset businesses.

Given all this, Nokia (NOK) seems the only safe bet in the wireless sector, but even it faces challenges.

Throwing Money Around

The spending concerns stem in part from the big money service providers shelled out in Europe earlier this year. European telecommunications companies paid nearly $90 billion for spectrum licenses across the continent.

Wireless Wipeout Investors have battered many wireless stocks this year

Merrill Lynch estimates the totals here will be lower, for instance, around $18.5 billion for the ongoing spectrum auction that's likely to finish in mid-January and covers the 1,900 megahertz PCS (personal communications services) segment. Then there's an auction of third-generation licenses in the 700-megahertz band in March.

Spectrum is the range of electromagnetic frequencies used in the transmission of voice, data and video. Only a fixed amount is available, which makes spectrum a coveted commodity. The more spectrum a carrier has licenses for, the more services it can offer, especially as data traffic increases with the development of third-generation, or 3G, networks.

On top of the sheer spending levels, there are concerns that all this is being done for the promise of technologies that may not come to fruition for years. In addition, the process of upgrading to 3G technologies can be a complex and messy one.

I've Got More Networks Than You

Take AT&T Wireless' embrace of a faster migration to W-CDMA, a 3G technology. The migration -- which entails billions of dollars of contracts with Ericsson, Nokia, Nortel Networks (NT) and Lucent Technologies (LU) -- means the company will effectively operate six networks at the same time.

"It sounds very inefficient," says one hedge fund manager, who has no position in AT&T Wireless.

A company spokeswoman says: "That sounds like it might be overwhelming, but it's not unmanageable by any means. We've operated multiple networks before."

Qualcomm (QCOM), which pioneered the CDMA (code division multiple access) standard of wireless technology, is believed by many to be in a good position to benefit from further adoption of 3G CDMA standards. But with the impending spinoff of its chipset business, the company is set to make much of its money from the licensing of CDMA technology.

One fund manager, who has no position in the stock, fears that Qualcomm is becoming "almost a pure royalty company. And how do you project royalty?"

Also at issue next year is whether it can finally nail down the Chinese market, after much hemming and hawing by the government in Beijing. A memorandum of understanding endorsing an earlier agreement for China's second-largest mobile carrier to adopt CDMA was signed recently.

"Look how important Korea is to Qualcomm's earnings," the fund manager continues. "If you extrapolate for the Chinese market, you can see how important China will be."

Help From Mergers?

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One thing that could help the stocks would be a more merger-friendly Justice Department under the Bush administration. It could approve the pending acquisition of VoiceStream Wireless (VSTR) by Deutsche Telekom (DT), despite discomfort over the German government's majority stake in Deutsche. The approval could pave the way for other foreign entities to move into the U.S., including Orange, a France Telecom (FTE) subsidiary, and the Netherlands' Royal KPN (KPN). Potential targets include Sprint PCS and Nextel.

On the equipment side of the business, Nokia remains the most important story.

"They have a huge advantage of scale, as well as a product portfolio that is much wider than the competition," says Johan Carlstrom, an analyst with Swedish investment bank Handelsbanken. "They are superior in the low-end market and one of the best players in the mid- and high-end." (He rates Nokia a strong buy, and his firm hasn't done underwriting for the company.)

However, Herschel Shosteck, president and chief executive of international consulting firm Herschel Shosteck Associates, says Nokia would do best to cooperate with a consumer electronics company such as Sony (SNE), Sharp or Casio to develop devices that offer more features. "There's a disconnect amongst conventional [mobile-phone] manufacturers and the end user," Shosteck says, estimating that Nokia cannot provide all the features consumers want on their phones without forming an alliance with a company that possesses such expertise.

We're Fine

A Nokia spokeswoman counters that the company is a consumer electronics company with "enormous in-house expertise." She adds that Nokia has at least a couple of distinct advantages over other consumer electronics concerns: mastery of the wireless transmission of voice as well as market segmentation, i.e. knowing which consumers want which features.

Motorola and Ericsson's handset woes are well-documented, with Schaumburg, Ill.-based Motorola warning of a fourth-quarter earnings shortfall just two weeks ago. Sweden's Ericsson is also racking up big losses on the handset side.

"Motorola is a second half or mid-year story because it has to show visibility on its handset business," says Jeffrey Schlesinger, an analyst with UBS Warburg. (He rates Motorola a buy and his firm has done underwriting for the company.)

Ericsson is "trying to turn this supertanker around," Carlstrom adds. "It will take all of next year."

If it doesn't manage the turnaround by the third quarter, he estimates that Ericsson could either sell the handset business or form a joint venture with an Asian manufacturer, such as Matsushita Communication Industrial [maker of the Panasonic brand] or Sony, that's strong in consumer electronics.

Even so, Ericsson will remain the dominant player in the mobile infrastructure business, though Nokia is making strides in that area too. "Nokia's stock will do great. I expect the fourth quarter to be very good," says Carlstrom. On the other hand, "The upside is substantially larger in Ericsson's case because it hasn't started to perform. Long term, it's a better bet."

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