United States

Technology, media and telecom industry outlook

From tariff issues to 5G networks, the sector remains extremely active

INSIGHT ARTICLE  | 

Key takeaways from the fall 2019 technology industry outlook

  • Tariffs are causing tech companies to evaluate changes to their supply chains, but the weaker yuan could result in short-term opportunities for U.S. companies purchasing Chinese goods.
  • The backlash from espionage allegations continues for the Chinese tech giant, Huawei, creating a ripple effect for some U.S. companies.
  • With declining ad revenue, broadcasters are relying more on retransmission fees.
  • 5G networks are coming, providing game changing opportunities not only for telecom and technology, but also other industries, including manufacturing and health care.

U.S. CHINA TRADE WAR HITS THE TECHNOLOGY ECOSYSTEM HARD

In August, the Trump administration announced plans for fresh 15% tariffs on an additional $300 billion in Chinese goods, effective Sept. 1. China responded by putting a freeze on U.S. agricultural products, and allowing its currency, the yuan, to drop to its lowest level in a decade. In mid-August, the president delayed implementation on some of the new duties until Dec. 15, a move designed to provide relief to retailers and consumers alike. Still, even with that delay, a fresh round of tariffs on $112 billion went into effect on Sept. 1.

The tariffs are forcing U.S. technology companies to continue to explore vendors outside of China, shifting their supply chain and logistics to avoid tariffs and the collateral damage caused by the volatile U.S.-China trade war. The Consumer Technology Association, a trade group, estimates that the new tariffs would have a $13 billion impact on technology imports. Furthermore, the CTA estimates that the U.S. tech industry paid $1.7 billion in tariffs in June of this year, and the additional 15% could raise overall monthly tariffs paid by the industry to approximately $3.5 billion.

Meanwhile, the weaker yuan could likely provide a shot in the arm to the Chinese economy and U.S. retailers, allowing consumer electronics and other technology concerns that rely on Chinese components to be sold more cheaply in the United States and other Western countries. A stronger dollar and weaker yuan present short-term opportunities for those U.S. companies purchasing Chinese goods. Some of those savings, however, would be offset by the latest round of tariffs.

MIDDLE MARKET INSIGHT U.S. technology companies can reduce the effects of the trade war between the United States and China by considering vendors outside of China and shifting their supply chain.

REGULATION OF CHINA’S TECH GIANT, HUAWEI

Products made by Chinese’s telecom giant, Huawei, are barred from a host of countries, including the United States, as a result of the company allegedly using its products for espionage. Some industry lobbyists in the United States have argued that restricting free trade by blacklisting Huawei is detrimental to the U.S. economy. For example, more than half of Huawei’s semiconductors are sourced from U.S. chipmakers. Huawei received a 90-day extension from U.S. sanctions in August, which pushes a decision on these sanctions till mid-November.

Beyond finding replacements for American hardware, Huawei’s 10,000 engineers are also working to develop replacements for American software. Huawei recently announced its own open-source operating system, HarmonyOS, which is designed to replace Google’s Android operating software.

Despite Huawei’s standing as the preferred provider of routers and other products to support the global rollout of 5G networks, the company will continue to battle the tarnish from espionage accusations. Telecom carriers like T-Mobile will—at least in the near-term—look to spend their 5G budgets with alternative radio gear companies, including Nokia, Cisco Systems and Samsung.

The continued strife between the United States and China is dividing the countries, a trend that is expected to continue. China is increasingly becoming a difficult place for U.S. tech companies to do business in. Hardware companies have looked at shifting supply chains out of China and into Southeast Asia or Europe, two geographic areas that are still less costly to manufacture in than the United States.

Shifting a supply chain is done only after significant consideration because it can be costly and take two to three years for some middle market businesses. Some companies have also decided against shifting any supply chains till after the next election. Additionally, some software vendors have significant challenges penetrating the China market because of strict censorship policies. As a result, many software companies have found that the headwinds tied to regulation and trade greatly outweigh the opportunities in China.

PULLBACK FOR SOFTWARE AND INFORMATION TECHNOLOGY SERVICES IN AN ECONOMIC SLOWDOWN

Slowed economic growth is trickling into the software and information technology service sectors. Spending within certain software verticals like cybersecurity should remain robust in the event of an economic downturn and is expected to outpace discretionary software vendors. Large enterprises will likely continue to spend on cloud solutions, but smaller and midsize companies could reduce their spending on discretionary IT solutions.

IT services is roughly a $1 trillion market and is generally more insulated than software and hardware in an economic slowdown. Approximately two-thirds of spending on IT services is considered to be nondiscretionary in nature. Conversely, the timing of hardware or software purchases often has more flexibility and might be delayed during an economic downturn.

MIDDLE MARKET INSIGHT In a potential economic downturn, cybersecurity spending should remain robust, but investments in discretionary hardware and software could be delayed.

Within IT services, the three largest areas of spending that are considered to be nondiscretionary are systems integration, software deployment and support, and application management. The largest areas of IT services considered to be more discretionary in nature are IT outsourcing, hardware deployment and support.

MEDIA OUTLOOK: RETRANSMISSION FEES GIVE LIFT TO TV BROADCAST REVENUE AS ADVERTISING DECLINES

Advertising revenue for broadcast television has been declining for the past decade as on-demand streaming options such as Netflix and Amazon Prime have proliferated. According to second-quarter 2019 Nielsen data, traditional television viewing among 18-24 year olds fell more than 50% from five years ago to a weekly average of 12 hours. Naturally, ad agencies have caught on to viewer trends and shifted their clients’ dollars away from cable and broadcast TV to the internet, creating significant headwinds for broadcasters reliant on ad revenues.

With a crowded presidential race, broadcast networks can expect a decent spike in campaign advertising dollars, as more viewers tune in to watch live debates, town hall events and the like. On-air campaignrelated advertising is projected to top $3 billion, according to Bloomberg LP, compared to $2.6 billion during the 2016 presidential election. While a $400 million increase may not seem significant, one might have expected a decline, given the fierce advertising competition from social media platforms, including Twitter and Facebook, which have been expanding their reach.

Although cyclical advertising revenue tied to the presidential race and major sporting events provides some lift for TV broadcasters, there is still a significant gap to make up for the decline in core advertising. Even amid their waning advertising revenue, TV broadcasters have outperformed the S&P 500 Index since the beginning of 2019 (see the figure in the next column). How is this possible?

RETRANSMISSION REVENUES: FROM ZERO TO HERO.

The answer lies in so-called retransmission fees. Broadcasters are making up for their ad revenue shortfall, in part, by placing more emphasis on the fees paid by cable, satellite and streaming platforms to retransmit local TV broadcast signals to their platforms. These fees, which are calculated based on viewership, have overtaken traditional TV advertising as a broadcast revenue source. In fact, just 10 years ago, this revenue was virtually nil for most broadcasting companies. Today, retransmission fees are expected to top $10 billion annually in the United States and to grow at a compounded rate of 15% each year (see figure below).

MIDDLE MARKET INSIGHT While broadcast companies can expect a rise in advertising revenue during the upcoming presidential campaign, retransmission fees have surged past traditional advertising as a revenue source.

The popularity and acceptance of these retransmission fees have sparked a slew of merger and acquisition activities in a race to become the most dominant player in the “retrans” market. Sinclair Broadcast Group’s recent acquisition of Fox’s regional sports networks for $10.6 billion positions the company as one of the largest local TV broadcasters by revenue. As other notable acquisitions (see the next figure) consolidate the industry, the federal government is likely to keep a closer eye on competition as monopolies or oligopolies start to form.

EVERYONE WANTS A CUT

However, while retrans revenue is steadily increasing, major networks such as NBC, ABC and CBS now want a cut, and are charging broadcast TV reverse retrans fees to stay within their networks. What was once a close relationship between broadcasters and the major networks has become more strained as networks are increasing fees, cutting into broadcasters’ newfound source of revenue. Networks have justified the fees to continue supplying prime-time content amid large licensing fees from professional sport affiliations like the NFL. According to Bloomberg, reverse retrans fees are projected to rise 4%, to $3.3 billion, in 2019.

Despite the revenue sharing, retrans fees will continue to give television broadcasters a much-needed lift to their revenues and share prices, at least in the immediate future.

TELECOM SECTOR PREPARES FOR 5G

For the telecom and technology industries, the fifth generation of wireless networks (5G) will provide game-changing opportunities that will expand to other industries as well—from manufacturing and retail to health care and education, to name a few. 5G stitches together technologies of the past decade and enables new technology use. It provides 10-100 times faster download speeds and up to 10 gigabits per second.

With 5G, data processing is faster and smarter, streaming is clearer and uninterrupted, and immersive experiences like those provided via augmented reality (AR) are remarkably real in a variety of applications, from virtual reality dressing rooms and mobile gaming platforms, to remote health care access and ARsupported maintenance solutions on the manufacturing shop floor.

5G technology is already available in some cities across the United States, with broader rollout in other cities and parts of the world in the coming 12-24 months. Industrial and enterprise customers will initially represent the largest portion of 5G subscribers, followed by mobile phone subscribers over the next five years. It’s expected that in just four years, mobile phone 5G adopters will climb to more than 179 million in the United States.

 

5G-use opportunities will continue to grow and be sustained for a longer period of time as well. This longtail timeline will allow for more businesses to leverage the technology and integrate it into current systems and services (see figure to the right). Interestingly, when 4G was launched, 5G was quickly nipping at its heels as technology industry innovators were already in planning mode for 5G. This pattern won’t likely be replicated with 5G since it appears to be the technology for both now and the future; 5G will therefore provide more long-tail opportunities and innovation for businesses.

MIDDLE MARKET INSIGHT The longer life cycle of 5G technology will allow more businesses to leverage the innovation and integrate faster data processing and download speeds into current systems and services.

VENTURE-BACKED INITIAL PUBLIC OFFERING WINDOW IS STILL OPEN, FOR NOW

So far this year, IPOs are significantly outperforming the New York Stock Exchange FANG stocks (see the figure below). Cybertech’s Crowdstrike, Zoom (software sector) and Pinterest’s internet platform have performed particularly well since their public market debuts. Uber and Lyft, two of the largest IPOs this year, have not fared as well, both returning losses in excess of 20%.

During the second quarter, Slack went public with a direct listing, not an IPO. It’s possible that more technology companies with solid cash positions on their balance sheets and good brand recognition will go public with direct listings next year.

COULD THE IPO WINDOW CLOSE?

Continued access to capital will be important for the technology industry, especially as the economy enters later stages in the growth cycle. It’s possible that a slowing economy, coupled with a significant amount of dry powder among venture capital firms, could keep companies private longer through investment vehicles like Softbank’s Vision Fund, which recently announced its second tech megafund ($108 billion in size). The Vision Fund had great success with investments like DoorDash and Slack.

That was before the IPO market hit a rough patch with the postponed offering of WeWork, a major Softbank investment, as well as the disappointing offerings of Lyft and Uber, another high-profile Softbank investment. A common concern in all of these cases was the lack of a clear path to profitability. The result has been a chill in the IPO market, as companies have been forced to delay or rethink their plans. Endeavor Group Holdings, for example, recently postponed its initial public offering, citing the gloomy market conditions. Still, there may be a window to go public for companies that fit a certain profile –pure technology companies that have a clear business model. Consider Crowdstrike Holdings, a cloud-based cybersecurity company, which has fared well since going public in June, or Zoom Video Conferencing, a cloud-based video conference company, which has also performed well. These two have shown that technology firms with a path to profitability can buck current market trends.

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Steve Ingram  
National Technology Practice Leader

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