2 Telecom Equipment Stocks That Could Thrive Despite AT&T's Cut

AT&T announced disappointing sales guidance, and its capital expenditures are tracking below estimates, yet these two telecom equipment companies should still thrive, thanks to innovation

Jun 9, 2014 at 12:30PM

AT&T (NYSE:T) sparked fear last week when it projected no wireless revenue growth in the second quarter, and Jefferies then reported that AT&T has significantly cut its capital expenditures budget. While both a lack of wireless growth and lower capital expenditures don't bode well for telecom equipment stocks, Ciena (NYSE:CIEN) and Alcatel-Lucent SA (NYSE:ALU) look as though they will be better than fine.

Replacing existing hardware with software
As it stands today, AT&T's capital expenditures budget is about $200 million lower than last year's, at $21 billion. The company just spent $48.5 billion on a single acquisition and continues to show an emphasis on U-verse, or broadband services. Therefore, it's no shock that its capital expenditures budget is expected to fall below expectations.

Nonetheless, Ciena is one company that looks poised to thrive. The company's fiscal second-quarter report serves as a good indication of strength, as Ciena grew revenue by more than 10%, year over year, and its guidance and margins also tracked above Wall Street expectations.

In regards to AT&T, many of its initiatives are believed to be done with the rollout of Domain 2.0 in mind. This initiative utilizes a software-defined network, or SDN, that interacts with existing switches and routers, but creates greater flexibility, lower costs, and a quicker response.

This initiative on behalf of AT&T bodes well for Ciena, as the company is currently developing SDN control software, which will be used in data centers, and more or less cater to AT&T's Domain 2.0. The company noted on its conference call that several software launches in the second half of this year will build on its existing hardware offerings and expand its addressable market.

Therefore, with Ciena's existing business already thriving -- including 80% of its revenue coming from products rather than services -- Ciena has a large opportunity in the software space, regardless of AT&T's capital expenditures.

Utilizing spectrum more efficiently
Alcatel-Lucent is a large and well-diversified telecom equipment company, and is a main vendor to AT&T. Therefore, any significant cuts to capital expenditures will affect the company to some degree. The effect won't be too bad. The reason is Alcatel is a global company and also because of its small-cell initiative.

As explained in this article, the company has placed an emphasis on a technology called lightRadio that uses cell towers to provide mobile broadband, basically using the components in a device the size of a baseball, which redirects and amplifies broadband. This is a market that Alcatel-Lucent estimates could be worth $16 billion annually.

The purpose of small cells is to improve coverage and capacity, and just last month AT&T committed to adding 1,500 to 3,000 new small cell sites to its network per year over a multi-year term. This means that despite cuts, one of Alcatel-Lucent's most promising businesses -- one that's expected to become a large chunk of its business pie -- will grow and remain important.

Final thoughts
In recent years, AT&T and other telecom giants had to spend tens of billions annually to boost their network coverage and handle the increased data load that came with smartphones and tablets. However, thanks to the innovation of companies like Ciena and Alcatel-Lucent, telecom companies now have initiatives in place to reduce costs, increase scale, and improve networks.

Furthermore, two of the most significant initiatives are SDNs and small cell networks. SDNs virtualize hardware functions into software, leading to significant cost cuts and increased flexibility. Meanwhile, the small cells provide more reliable service for users, maximizing existing and precious spectrum. With all things considered, these two facts make Alcatel-Lucent and Ciena both good long-term investments, as it relates to AT&T and other telecoms.

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Brian Nichols owns shares of Alcatel-Lucent (ADR). The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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