NEW YORK (TheStreet) -- There has been a flurry of mergers in the telecommunications sector in recent years, but U.S. vendors such as Cisco (CSCO) could be threatened in a post-Edward Snowden world as nations look closer to home for vendors and avoid American companies because of the National Security Agency spying scandal.
First, some background.
Activist shareholders and private equity funds focusing on balance sheet re-capitalization, OPEX optimization and portfolio/customer synergies has spurred higher multiples and brought new attention to the telecom segment. That has, in part, spurred mergers and acquisitions.
Factors such as greater scale (fundamental in achieving more efficient cost structures), TAM expansion (and a faster time-to-market by the acquirer) and distressed asset opportunities have also contributed to this consolidation trend.
The pick-up in telecom M&A can also be seen in such things as industry concentration. Not surprisingly, the Herfindahl-Hirschman Index (HHI), a commonly accepted measure of market concentration, rose from 1,600 to nearly 2,300 over the past decade, which also coincided with a series of mergers (Alcatel-Lucent (ALU), the joint venture of Nokia (NOK) and Siemens (SI)) and distressed asset sales (Ericsson's (ERIC) purchase of Marconi and Nortel's wireless business).
However, the emergence of the Asian Tigers Huawei and ZTE has subdued the increase in market concentration, making it a bit less noticeable.
Nonetheless, industry consolidation is always a topic that frequently comes up in events such as the Mobile World Congress. This year, attendees engaged in lively discussions such as what Nokia might do after the sale of its devices business to Microsoft (MSFT).
Post-divestiture, Nokia would become sufficiently well-financed (having nearly 8 billion net euros cash) to potentially entertain the notion of expanding its current partnership with Juniper Networks (JNPR) into a merger or purchasing Alcatel-Lucent's wireless assets. The discussions typically involved product synergies (SDN, RAN for Juniper/Nokia and small cells for ALU/Nokia) in addition to increased footprint in North America (which will come for both scenarios -- in the ALU case, for instance, North America represented 73% of its overall wireless revenue in 2013).
In order to consider some of these mega-deals, a host of other factors must be considered.
One important exogenous variable is the impact of the fallout from Edward Snowden and the resulting U.S. National Security Agency scandal, which is still not very clear. Information keeps on dripping, making the analysis ever more complex.
For instance, earlier this week, German magazine Der Spiegel disclosed that the NSA infiltrated servers in the Huawei headquarters in Shenzhen, under an operation code-named "Shotgiant," whose mission was to find any connections between the company and China's People's Liberation Army, which have been alleged but never proven.
While the operation could not uncover any such ties, it did obtain company information such as client lists, internal employee training manuals and other sensitive data. Irony aside (after all, the NSA carried out the very activity some U.S. politicians and lobbyists claimed that the Chinese military did via Huawei), another mystery is: If the espionage determined that Huawei is, in fact, independent, without any unusual ties to its home country's government, then how come this knowledge was not publicly disseminated?
Operation Shotgiant's leak came just a few days before Chinese President Xi Jinping's European trip, where he held talks with leaders including German Chancellor Angela Merkel, who was also a target of NSA electronic surveillance.
Thus, the NSA scandal fallout will no doubt be a topic very much in play throughout 2014, including how the ripple effects will be felt by various vendors.
Some vendors such as Cisco have alluded to a bit of an aversion to U.S. companies in certain regions such as Asia/Pacific, but it remains to be seen if this will span out more than just one or two quarters. There were rumors flowing at the Mobile World Congress that this effect will be felt not just in "public cloud" government-led initiatives but also telecom infrastructure buildout projects.
In fact, there was speculation that preferences for new European infrastructure deals would be in the future given to an European vendor (e.g. Ericsson or NSN) and an Asian vendor (e.g. Huawei or ZTE), at the expense of U.S. vendors such as Cisco, Hewlett-Packard (HP), IBM (IBM) or Juniper.
A more important question is whether or not that could also mean the consolidation trend would come to a halt, or even worse, go the other way. More specifically, in a post-NSA scandal world in which countries are increasingly suspicious of other countries or foreign vendor activities, will we start seeing the balkanization of some companies become a reality?
Many operators and governments would prefer enlisting the help of vendors that are local or as close-to-home as possible instead of having to rely on foreign players or joint ventures with foreign player participants, particularly whenever national security interests are paramount.
Under such a scenario, new sub-scale carrier-focused vendors will struggle to reach a better operating leverage in their models, unless service provider capital expenditures remain robust for many years to come.
Such a fragmentation is not going to be a good outcome for the industry, so I hope governments and operators alike will recognize the need of a local relationship should not be allowed to trump market forces. They will need to start trusting more their vendors independently of their nationality.
This article represents the opinion of a contributor and not necessarily that of TheStreet or its editorial staff.