Credit Crunch Update (Part 7): If Telcos Don't, Cisco Will
Below is the seventh article in our series on the Credit Crunch and its effect on the TMT sector (previous here).
In 2008, venture capital investment flows in the US in Q4 fell by a quarter, private equity deal flow in Europe was down 59%, and hedge funds globally lost $582bn. Arguably, there are better times to seek funding for an innovative new idea. However, innovation is high on the agenda of government fiscal stimulus packages, which will be key determinants of economic growth, and entirely new industries are taking shape.
If telcos want to exploit a new ecosystem, they will need to actively invest in its creation - a concept which some cash-rich rivals are already demonstrating they understand...
The year is still young, and already we've experienced an unprecedented event of profound historical significance, which had its own unprecedented, if somewhat more prosaic, manifestations in the telecom world.
Inevitably, there were a few interesting twists behind the scenes, as one might expect with any 'unprecedented event of profound historical significance'. However, now that the champagne has run dry and the joyous music is but an echo, we awake to find ourselves right back in the same intractable situation we confronted before the party, with the brief burst of sunshine now replaced by fresh storm clouds on the horizon, and a growing sense that visibility in the market is now defined in terms of days rather than weeks or months.
None of this is helped by the fact that, as with all unfolding crises, perceptions are distorted by the lagging expectations of market forecasters and observers. Take as an example Verizon's Q4 results, which were greeted by a 3% decline in its share price in a rising market.
In the current climate, one would assume that a company reporting a seven-fold annual increase in its cash balance (largely through its ability to secure financing - itself far from a trivial achievement) would be welcome news, but the coverage in the financial media suggested that wireless net additions of 1.4m, vs. expectations of >1.5m, were somehow a disappointment.
This suggests that many analysts and commentators, despite all evidence to the contrary, are still viewing the world through the lens of "how things used to be" (i.e., it's all about growth), rather than in terms of what really matters for the foreseeable future - namely, cash preservation (=survival) and sustainability of asset value.
Stated in another way, in a climate such as the current one, the survival prospects of an industry or individual company rest on the ability of said industry, or company, to demonstrate that its assets and services are relatively more indispensable than others'.
Those who are successful attract what is left of the consumer's wallet, and, with costs and capital structure properly aligned, survive into the next economic cycle. Our proxy for the sector's performance globally, the STOXX 600 Telecom Index, continues to suggest that telecom falls into the non-discretionary category, consistent with our own thinking.
DJ STOXX 600 Sector Ranked Returns, 24 December 2008 - 27 January 2009
Source: STL Partners/Telco 2.0, from Bloomberg data
In an era when politics, national economic aspirations and fiscal stimulus plans will have much to say about the relative sustainability of many industries, from a telco perspective, it is heartening to see the latest instalment of the WEF's Global Competitiveness Report.The WEF defines "12 pillars of competitiveness", upon which it ranks the countries of the world:
- 3.Macroeconomic stability;
- 4.Health and primary education;
- 5.Higher education and training;
- 6.Goods market efficiency;
- 7.Labor market efficiency;
- 8.Financial market sophistication;
- 9.Technological readiness;
- 10.Market size;
- 11.Business sophistication;
However, we see a case to be made that telecom would appear to significantly influence, or have the potential to significantly influence, all the other factors covered here, i.e., 75% of what makes up an economically competitive society.
In particular, pillar 12, Innovation, is critical. As we cited two weeks ago in our discussion of the smart grid opportunity, as with telco rejuvenation itself, economic rejuvenation relies upon a mixture of revamping/optimising the old and creating entirely new market segments, ecosystems and industries.
The dilemma in addressing the latter at present is the glacial state of capital markets, and here the news flow is not particularly encouraging.
The National Venture Capital Association/PwC quarterly "Money Tree Report" (a detailed spreadsheet is found here) for Q4 2008 shows a 26% sequential decline in investment in the quarter, a decline mirrored by "Internet-specific" businesses, which comprise nearly one-fifth of all venture capital investment.
On a full-year basis, telecom and semiconductor venture investing posted 11 and six-year low levels, respectively, and software, still the largest segment, posted a 10-year low in the fourth quarter. While the Money Tree Report correctly observes that start-ups took in more investment during 2008, the overall sequential trend was one of decline from a great first quarter, with Q4 investment falling by 30% over Q3 levels.
Similarly, first sequence investment in expansion and later stage companies fell off a cliff in Q4, with later stage posting its worst quarterly decline since the dark days of Q4 2003.
In better times, early stage companies in need of funding might reasonably have turned to alternative sources of funding (or exit strategies), but recent deal flow in the private equity world is fairly moribund (note the comment that the malaise has spread to the middle market), and the hedge fund world is likely to be feeling far less adventurous after the carnage of the past year.
So, as in our previous articles on the theme, we again throw down the gauntlet to the telcos - there is a role to be played in proactively investing in creating the new ecosystems and opportunities which will drive growth through the crisis and into the future beyond the recovery.
Starting sooner, rather than later, might also be a good idea - just ask Cisco, whose latest acquisition press release mentions its mission via its "...'build, buy and partner' innovation strategy to move quickly into new markets and capture key market transitions."
The acquisition and market transition in question? Richards-Zeta Building Intelligence, a private company specializing in systems for allowing companies to integrate building and IT infrastructure over IP networks. Definitely sounds like telco territory, and probably a space which will emerge as a huge beneficiary of government fiscal stimulus programs - but what part of the value chain will be left for telcos without more vision and alacrity?