The great vendor shakeout: the planned Alcatel-Lucent merger better than anything else reflects the forces driving the telecom industry: carrier consolidation, the fall in cost and price, the need for scale, the drive to convergence and the challenge from Chinese vendors

Telecom Asia, June, 2006 by Robert Clark

Whatever else happens between now and December 31, the $25 billion combination of Alcatel and Lucent is the biggest telecom event of the year.

It's not because of the financial scale, or the disappearance of the original telecom company, or even the shock of a French enterprise seeking cohabitation with an American one.

It's because the new trans-Atlantic giant better than anything else reflects the forces driving the telecom industry: carrier consolidation, the fall in cost and price, the need for scale, the drive to convergence and the challenge from Chinese vendors.

The deal, announced in late March, was the second time around for the two partners.

The two CEOs, Serge Tchuruk and Patricia Russo, seem this time to have navigated successfully through the shoals that wrecked the 2001 attempt. They've fenced off Lucent's sensitive US government work and look set to sell Alcatel's satellite business to Thales.

Shareholders from both companies will vote on September 7, but it could take until early 2007 before the merger wins all the regulatory approvals.

The immediate result is the world's biggest DSL vendor, the second biggest in cellular and second in services, with a marquee customer base that includes BellSouth, AT&T, Cingular and China Mobile.

The larger effect is to make further rationalization of the vendor sector inevitable.

The main driver, says Yankee Group senior analyst Nick Maynard, is the consolidation of Tier 1 carriers, which account for the bulk of telecom capital spending.

"That makes it difficult for a dozen or so global vendors to chase after fewer and fewer customers, and to get those accounts, they need to provide end-to-end solutions--not just wireline, not wireless but both," he explains.

Vendors are looking to "fill in the gaps in their coverage" with acquisitions, such as Ericsson's recent takeover of Marconi and Lucent's purchase of Ethernet company Riverstone.

Among the global vendors, next on the sale block most likely is the loss-making Siemens networking group, Siemens Com. Siemens management are looking to exit telecoms and this year have already offered it to Nokia and Motorola without success.

Nortel, which hired its third CEO in four years last year after a series of stock exchange re-filings, is also vulnerable.

Jeff Heynen, an analyst at Infonetics Research, thinks Nortel-Siemens is a good fit. Combined they would be first or second in enterprise telephony, next-gen voice, optical switching and wireless infrastructure. "In addition, the combination would satisfy Nortel CEO Mike Zafirovski's demand that Nortel remain active only in markets in which it can achieve at least a 20% market share."

"I think we will see some more mergers, but I have not been able to pinpoint any," said Bengt Nordstrom, vice president and chief strategy officer of European consultancy inCode. "If you take the top five to seven players, I cannot see an obvious one. Most of the potential mergers have a very strong overlap on the product side."

Yankee's Maynard says at the company level M&As will only get harder: "The first [merger] is probably the easiest. You have the whole field as your dance partner. As it narrows down and regulators get more wary, you may see some mergers that don't make as much sense."

He predicts the comms vendors will shake out in a way similar to the auto market, with global players dominating, but regional, niche, high-end and low-end segments being filled as well.

That said, the Lucent-Alcatel marriage has been well-received. Maynard says the partners have a good product and geographic fit, and also have the benefit of good timing, with North American and European telcos set to spend on next-gen networks and 3G in the coming years.

"There's a huge amount of infrastructure that is to be put in place. That's an opportunity, but also a danger. If they're not able to execute well, if they spend the next 12 to 18 months trying to figure out the merger and not winning market share, that's a major opportunity lost," he says.

Reduced risk

Nordstrom sees the new combination as a top player in fixed and optical access, but weak in W-CDMA. "Since access, but weak in W-CDMA. "Since W-CDMA will be dominating cellular technology for the next seven to ten years, they have to build a stronger position there."

Its best bet in the mobile space would be the coming 3G bids in China, thinks Nordstrom. There's an irony in that, given the impact of the Chinese vendors on the market with their aggressive price competition (see "Huawei's long journey", page 20).

Yet no matter how many vendors remain, they must deal with the reality of compressing margins and demanding carrier customers. Price competition is just going to intensify and rationalization is a "historic inevitability", says Huawei chief marketing officer Xu Zhijun.

Andrew Coward, vice-president for engineering for Juniper Asia-Pacific, says the pressure on vendors is to reduce the risk for carriers. Telecom networks are treading in the path of IT two decades ago, where dedicated hardware and software evolved to into open platforms capable of running any kind of software. Carriers are keen to consolidate their networks, he says, because of the cost and uncertainty of legacy technology.