Cingular Deal Could Chill Networking Surge

Outfits like Ericsson and Nokia could suffer if capital spending feels the expected squeeze.
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The Cingular sensation may not be a pleasant one for investors in the red-hot networking sector.

On Tuesday, No. 2 wireless carrier Cingular hammered out a

$41 billion cash deal for

AT&T Wireless

(AWE)

. News of the agreement -- discussion of which had kept the wireless industry in suspense for a solid month -- ignited another surge in AT&T Wireless' long-torpid stock. It also set off relief rallies in nonbidders such as

Nextel

(NXTL)

and

Vodafone

(VOD) - Get Report

.

But as good as the deal looks for the big service providers, it is likely to mean hard times for the networking companies that make the gear to run wireless networks. With two of the three big wireless players joining forces, capital spending appears certain to be squeezed. Going by preliminary 2005 numbers bandied about Tuesday, about 8% of the Cingular-AT&T Wireless capex budget could fall under the ax.

That fact could undercut 2004's wild rally in networking stocks. The biggest loser appears likely to be

Ericsson

(ERICY)

, a big 2004 gainer that is also a big supplier to both Cingular at AT&T Wireless. But rivals

Nokia

(NOK) - Get Report

,

Nortel

(NT)

and

Lucent

(LU)

-- all of which have also moved up sharply early this year -- could also suffer.

Disruption

With Cingular eager to cut costs to make a higher-than-expected merger price work, capital spending plans could soon come under pressure. Observers warn that the pending deal could dislodge network expansion plans and shake out some equipment-buying projects.

The combined capital spending budget for Cingular -- a joint venture of

SBC

(SBC)

and

BellSouth

(BLS)

-- and AT&T Wireless is pegged in the neighborhood of $6.5 billion this year.

Both companies said business would continue as usual until the anticipated merger close date in the fourth quarter. But observers say integration uncertainty, network overlap and the debate over new upgrade technology are likely to disrupt current spending plans.

Of course, there are many moving parts in a deal of this size. Cingular executives noted Tuesday that both parent companies would have to raise as much as $24 billion in the debt market to finance the deal. The merger agreement carries a $1.4 billion penalty if for some reason Cingular does not follow through on its commitment.

AT&T Wireless, which has one of the lowest network quality ratings and one of the highest customer defection rates in the industry, must meet certain performance targets specified in the merger agreement, but Cingular executives did not disclose the terms of those covenants.

AT&T Wireless CEO John Zeglis will be out of a job when the deal closes, and Cingular says it has made no retention agreements to keep him on.

Budget Flush

Among the networking companies most exposed to Cingular and AT&T Wireless is Ericsson, which is one of the top suppliers of wireless infrastructure to the two cell-phone service giants. By some analysts' estimates, about 7% to 10% of Ericsson's revenue comes from Cingular and AT&T Wireless.

Ericsson shares were up 2% to $28.52 in midday trading Tuesday. The stock hit a one-year high last week after the company reported surprisingly strong fourth-quarter sales. But as with gear rivals Nortel and

Juniper

(JNPR) - Get Report

, Ericsson's latest quarter benefited in part from a year-end surge in spending as phone companies used their remaining cash.

Meanwhile, after cash constraints forced telcos to take a break from their network upgrades in recent years, the outlook for a spending recovery remains tentative. Also, the inroads that Ericsson and Nortel made in moving AT&T Wireless toward wideband code division multiple access, or WCDMA, may hit a snag as the much less data-focused Cingular folks take over the upgrade plans.

Cingular and AT&T Wireless have national networks that overlap in some 10% to 20% of their combined cities. Though the Justice Department will have to determine whether those overlapping operations are allowable under antitrust laws, Cingular CEO Stan Sigman said the merger would not require any divestiture of assets. But Cingular executives, on a conference call with analysts Tuesday, did say they would see some cash advantages from the sale of duplicate network equipment such as antennas.

Fewer antennas are not a good sign for wireless gearmakers.

Before the merger bid, analysts pegged annual capital spending at each company in the $3.3 billion range. But so-called synergies will lead to a $750 million savings in capital expenditures next year and as much as $1.2 billion in savings by 2007, according to Cingular.

If consolidation catches on, those numbers could start to add up.