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Telecom software: Exposure or opportunity? - Views on News from Equitymaster
 
 
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  • Jul 20, 2002

    Telecom software: Exposure or opportunity?

    Once upon a time not so long ago, revenues from the telecom vertical, for an Indian IT services company, was the indication of a company doing high end work and today the same is being termed as ‘exposure’, very much in the same way that dot-coms are referred to as today. So is the ‘exposure’ to the telecom segment a reason to worry about? No, we don’t think so.

    The usual suspects
    Wipro 1QFY02 1QFY03
    Embedded systems & Internet accees devices 19.0% 17.0%
    Telecom & Internetworking 30.0% 17.0%
    Telecom & Internet Service Providers 3.0% 7.0%
    Total (R&D Group) 52.0% 41.0%
    As a % of Wipro Technologies Revenues    
    Infosys
    Telecom 16.7% 15.2%
    As a % of total Revenues    

    Irrational exuberance
    Before we put forth our case, a brief recap of what has happened so far. The telecom companies can broadly be classified into the telecom equipment (or box) manufacturers and the telecom service providers. The box makers make equipments that move data and voice from one end of the globe to the other in absolutely no time (like routers and switches), while service providers buy these equipments and provide telecom and/or internet services i.e. move data and/or voice (like MTNL and VSNL in India). During the technology boom, as Internet opened new business possibilities, these companies set up huge capacities, committed significant amount of capital and now, are not finding many takers for their products and services. Consequently, their financial statements are looking really ugly. Both the segments of the industry are victims of their irrational exuberance. To put things in perspective, Cisco’s stock is down by 83% as compared to March 2000, height of the technology boom.

    Internet on the move
    But does not mean that new products and offerings will not be developed? On the contrary, desperate to woo the ‘all-powerful consumer’ telecom companies are in a frenzy to innovate and offer newer technologies. Now that the world is a big network thanks to the Internet, the effort is to connect those who are not plugged in, people on the move. The spectrum of technologies offering wireless access to the Internet include 3G (third generation) mobile services like i-mode at one end and on the other end are technologies like Wi-fi that provide wireless access over a very short distance

    After the tremendous success of its i-mode technology that offers 3G mobile services, NTTDoCoMo, a Japanese mobile operator, has launched its services in Germany. i-mode introduced in Japan not so long ago already has 31 m users in the country. And Wi-fi too has been equally successfully. According to The Economist, ‘In America, the technology (Wi-fi) has inspired a mania unseen since the early days of the Internet boom’. According to research from Cahners In-Stat Group, the overall Wi-fi market will grow from 3 m total units shipped in 2000 to 23 m units in 2005.

    The Indian USP
    While new technologies definitely bring in customers, the imperative is to bring them in profitably. Thus, the development costs of new technologies will have to be cut. That is exactly where the Indian software companies come in. Telecommunications technologies have been one of the most dominant forces shaping the face of mankind in the recent past. Business models have evolved around newer possibilities offered by these technologies, and will continue to do so. Thus, the software companies that have competences in this domain are likely to see a lot of business coming in. The question is when?

    Growth drivers…
    What will driver the growth? Firstly, the next generation networks that will be built will need to communicate with legacy networks. A lot of software has to be written that will help the legacy networks communicate with the next generation networks. This has been one of the traditional strong hold of Indian software companies focused on the communications space. Companies like Wipro and Hughes Software Systems (HSS) that have a very strong presence in the space provide software known as protocol stacks that help networking devices to talk to each other. Both the companies are working on 3G. Hughes currently has about a 150 people working in the domain, while Wipro too is said to have a large team working on it.

    Also, if customers are willing to order for goods or trade stocks through their mobile devices the corporates that provide these services and products need to get their systems in place. This means that the enterprise systems that had to be extended to the Internet will have to go one step further. Also, in the future there will be a demand for a host of applications that will be specific to 3G. However, it will take sometime before demand of this nature translates in strong cash flows, as the initial effort is likely to be directed at getting a proper 3G infrastructure in place.

    Another area that offers an opportunity is that of billing. The billing systems that are in place are incapable of handling 3G systems. This is due to the fact that the customer in the future is likely to be billed based on the quantity of data rather than the time used for, as is the case currently. However, the Indian software industry does not have much of a presence in this domain. Companies like Amdocs (US based) are the leaders in this segment.

    Despite the slowdown, the share of in the telecom vertical increased from 12% of the total software exports in FY01 to 14% in FY02, a growth of 17%. This is quite a commendable performance by the Indian software industry. It is true that the telecom companies have been hit by excess capacity and a slowdown in the economy however mismanagement of capital structure is equally responsible. Thus, going forward when the companies get their act together, things then companies with strong expertise in this domain may have a the last laugh.

    Mr. Warren Buffet, one of the best-known value investors, has made his first bet on technology, and surprisingly it is not software or IT services but it is a telecom company he has invested in. This move comes at a time when, the telecom companies are going through very tough times. The point we are trying to make is that though telecom companies are in a bad shape and are likely to be so in the near future, going forward things are going to change for the better.

     

     

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