ANALYSIS - Embattled telecom gear makers head for shakeout

Models display Huawei mobile phones in Kuala Lumpur in this December 20, 2005 file photo.

PARIS/HELSINKI (Reuters) - As telecom operators keep a tight rein on budgets, sustained pressure on the ailing telecom equipment sector threatens to push some of its weaker players to sell off businesses or enter into mergers.

Market research firm Gartner predicts the market to shrink 2 percent this year after a 7-percent fall in 2009, and even the most optimistic industry players see only slight growth ahead.

The $81.7-billion telecom gear industry was hit hard last year by the recession. Rivalry from Chinese firms Huawei and ZTE also intensified, pressuring margins and profits at European companies.

"Current prices are clearly not at levels that sustainably can support multiple mobile infrastructure players. Our prediction is that the number of global full infrastructure players will be reduced to three during 2010," said Bengt Nordstrom, the head of Swedish telecoms consultancy Northstream.

Several analysts and industry leaders, including new Nokia Siemens Chief Executive Rajeev Suri, agree with Nordstrom's view, but stop short of saying consolidation will definitely come this year.

Today, there are five major telecom gear makers: Sweden's Ericsson, Finnish-German Nokia Siemens Networks, Alcatel-Lucent, Huawei and ZTE.

Analysts said Ericsson, helped by its larger scale and leadership in mobile, and Huawei, thanks to its low-cost base and increasing technological edge, are the best-positioned to survive the turmoil.

But the three smaller vendors might not all survive in their current forms.

Last year, Canada's Nortel became the first victim of the market downturn, declaring bankruptcy and then auctioning off its assets.

A PROBLEM OF SCALE

Alcatel-Lucent -- which has reported 12 straight quarters of losses since it was formed in a merger in 2006 -- is seen as the weakest major player due to its smaller scale in mobile gear, higher cost base, and ongoing restructuring.

Five-year credit default swaps on Alcatel-Lucent were at around 579 basis points versus 91 basis points for rival Ericsson. That means it costs six times as much to buy protection against an Alcatel debt default.

It could be the target of a takeover or be forced to sell assets this year or even one of its business lines if a turnaround does not materialise, say analysts.

The Franco-American firm does not have deep-pocketed owners like Nokia and Siemens, who each own 50 percent of the NSN venture, and could bankroll the struggling vendor.

Nokia Siemens is expected to report an operating loss for 2009, and restructuring costs are set to weigh.

The company has focused on improving results in the last few years but has lost market share as a result of its reluctance to cut prices, which has made it more difficult to reach profits.

Under new CEO Suri, who started last October, the firm has become more aggressive battling for deals and seeking acquisition targets.

Investors are betting that the problems of Alcatel-Lucent and U.S. rival Motorola are not behind them, with Alcatel-Lucent shares trading only at 0.36 its sales and Motorola at 0.58.

Stronger players like Ericsson have a price-to-sales ratio of 1.03. Auctions for Nortel assets took place at levels of 0.7 to 0.8 times sales.

LTE NO PANACEA

Even trends that push telecom operators to spend on new equipment, such as the advent of a new wireless technology called LTE and the boom of Internet usage on mobile phones, are not expected to boost the market.

Some top industry executives are sceptical that LTE, which can boost mobile broadband speeds more than ten times faster than most of today's 3G networks, will prove the saviour, because telecom operators may just trim spending elsewhere to pay for it.

"This year is going to be tougher for these companies than last year," said Paolo Pescatore, analyst at CCS Insight.

Telecom operators' sales in mature markets rarely grow fast enough to justify any major investments to shareholders.

"Total dollars being spent ... I don't believe they will increase," Bruce Brda, the head of Motorola's wireless networks unit, told Reuters in an interview in December. Competition for early LTE contracts is so fierce that prices are being pushed down, with vendors battling for the first major deals which can be used as references to win new orders.

"If there is no growth, operators must push cost cutting, renegotiate infrastructure prices as well as system support and maintenance fees, which is a key income source of the vendors," said Pal Zarandy, partner at telecoms consultancy Rewheel.

Ericsson, having won several key deals, is considered to be the leading player in LTE, but Alcatel-Lucent, Huawei, Motorola and Nokia Siemens have also won major LTE gear orders.

(Editing by Sitaraman Shankar)