Riding the Economic Storm Out

How the Communications Sector Could Be Affected by the Economic Downturn

Talk of recession has dominated headlines, financial programs and business dealings for months. But whether or not we’re technically in a recession, it’s clear that the economy is taking a big hit from the subprime mortgage collapse, and the housing crisis and credit crunch left in its wake, as well as the high price of oil and the ongoing Iraq War.

“Since late last summer, the financial markets in the United States and in a number of other industrialized countries have been under considerable strain,” Federal Reserve Chairman Ben S. Bernanke said during a Jan. 10 speech. “The turmoil has affected the prospects for the broader economy, principally through its effects on the availability and terms of credit to households and businesses. Financial market conditions, in turn, have been sensitive to the evolving economic outlook, as investors have tried to assess the implications of incoming economic information for future earnings and asset values. These interactions have produced a volatile situation that has made forecasting the course of the economy even more difficult than usual.”

This tenuous situation has folks in the communications space wondering to what extent our industry will see the trickle-down effect of these economic woes. Will spending by businesses and consumers on communications products and services slow as a result, and if so, how much and in what areas? How will spending by service providers be affected? Should we brace for another telecom nuclear winter?

Conventional wisdom at this point seems to indicate that while the communications sector will not escape the effects of the economic slowdown, neither will it be unhinged by it. In fact, some companies and technologies stand to benefit from it, according to some accounts.

A study released in March by Compass Intelligence forecasts that the slowdown will result in lower business expenditures on IT products and services this year, with improvements expected as early as 2009. Specifically, the Scottsdale, Ariz.-based firm expects annual spending growth on services to decline from 5.3 percent growth in 2007 to 3.9 percent growth in 2008, but that 2009 growth should increase to 4.8 percent.

“In the past, there has been a strong parallel between total growth in the economy and growth in IT spending,” said contributing analyst Amy Cravens. “IT budgets are vulnerable. As corporate spending tightens, IT budgets are quickly impacted as they can be easily downsized.”

Companies have warned of slowdowns, not just for a quarter or two, but for the rest of the year. For example, in mid-March, Hitachi Ltd. warned it would see red for the second straight year and incur $700 million in net losses. Software maker Oracle Corp., meanwhile, reported higher earnings for its third quarter, but a drop in sales disappointed analysts. That has eld to speculation that the economy is leading to a drop in licensing purchases.

But while domestic IT spending growth is likely to slow, Compass Intelligence expects to see strong spending in managed/outsourcing services, an area for which the firm anticipates an increased growth rate for 2008 at 9.8 percent up from 8.6 percent in 2007.

As for the consumer side, while the credit crunch and the trend of more conservative spending could indicate more price sensitivity and perhaps even a motivation to drop some services, some also make the argument that if consumers are staying home more to save on gas and cut their restaurant and theater expenses, they may be willing to spend more on Internet-, wireless- and pay TV-related services.

Adding heft to this argument is the fact that we already have seen explosive growth in network traffic, fueled by video sites like YouTube, social networking through such destinations as Facebook and MySpace, and VoIP and gaming applications. According to the recently released 2008 Telecommunications Market Review and Forecast, presented by TIA, bandwidth consumption doubled in 2006 and quadrupled last year.

This bandwidth boom — and the adoption of IP technologies — to support new services on both the business and consumer services front has led service providers to make significant investments in fiber and gigE infrastructure, notes the TIA study, which forecasts “sustainable growth” both domestically and abroad in carrier and customer spending on communications services and equipment through 2011.

“We’re now on an upswing, and we believe this upswing is a sustainable upswing,” said Arthur Gruen of Wilkofsky Gruen Associates, which works with the TIA to produce its annual review and forecast.

Telecom spending in the United States increased 8.3 percent (with $1 trillion in revenue) last year; it should rise an additional 9.3 percent this year, and will see 7.2 percent CAGR through 2011, according to the report. Meanwhile, the forecast projects the global telecom market will hit $4.9 trillion in 2011.

Gruen said despite concerns about the economic downturn at large, the telecom nuclear winter will not be repeated.

“During the late ’90s and early 2000s there was a huge level of investment in anticipation of traffic growth,” added Gruen, comparing today’s situation with the economic downturn of a few years ago, when telecom was at the epicenter of the slide and spending on telecom equipment plummeted from $45 billion in 2001 to $15 billion in 2003. “The traffic growth did not immediately materialize, and then the recession followed, and what happened was there was a lot of this excess capability, the investment could not be monetized and there was a huge drop-off in spending. Now we’re in a situation where the investment is not in anticipation of demand, it’s following demand. And that’s why we think it’s a sustainable growth path.”

One sign indicating the growth is expected to continue is Switch & Data Facilities Co. Inc.’s March 31 announcement that it has obtained $157.5 million in debt financing from a syndicate of banks led by RBC Capital Markets and GE Corporate.

“We actually closed on a line of credit as well as financing, or a loan, in a tough credit environment, funding our expansion,” said Ernie Sampera, senior vice president at Switch & Data, a network-neutral provider of colocation and peering which early last year went public. “The fundamental message that we’re trying to position out there for folks is that there’s still a lot of strong demand in this market and this industry.”

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