Telecom Disruption in Optical and RAN Showing Growing Importance

Internet Services and Satellite Services will clash with Telecom Services in the coming years, causing changes to equipment demand. Hyperscalers and Satellite services companies are more vertically integrated (they make more of their own equipment) and, in the future, will deliver more services that compete with Telecom services. Our forecasts, for instance, for both Optical Transport and Mobile RAN, contemplate disruption from the emergence of coherent modules and LEO direct-to-cell technologies. In recent quarters, financial results of Optical Transport and Mobile RAN equipment suppliers have suffered and the companies have cited customer inventory reduction and macroeconomic challenges. We see signs that these suppliers may see more tough times due to industry specific disruptions.

Optical Transport disruption. Optical Transport devices consist of two parts, transponder and line systems, making up roughly equal revenue contributions to the Optical Transport market, respectively. We are seeing transponder shelves demand diminish as optical coherent modules get used instead in Metro deployments. What is behind the move away from transponders is in the past few quarters, all the main Hyperscalers have prioritized using coherent modules (ZR-class) plugged into switches and routers instead of front-ending switches and routers with transponders. ZR unit shipments were at record highs in 1Q24, the same quarter when DWDM revenues declined 10% Y/Y, the industry’s worst performance since 2Q18. We think that Hyperscalers are carrying a growing amount of traffic relative to what Telecom Services companies carry, and these operators have now shifted towards ZR-class of modules, significantly reducing their demand for transponder shelves.

RAN disruption. We called for a 2021 RAN revenue peak in 2019, and with the AT&T and Verizon announcements of temporary C-Band two-year spending surges, we pushed our peak call to 2022. The RAN market has been sliding ever since, and we don’t expect the terrestrial RAN market will experience a rebound to old levels in 2030, as most pundits say will happen when the 6G begins. We are conservative because Private Cellular will only deliver $1-2 B by then and because direct-to-cell LEO Satellite will disrupt the public cellular market. We see evidence that major operators are taking steps to address LEO risk.

In the past couple of months, we’ve seen both AT&T and, more recently, Verizon announced plans to work with AST SpaceMobile, and over a year ago, T-Mobile US announced plans to work with Starlink. At the face of it, it looks like these three MNOs are “hedging their bets” by working with LEO companies that have proven their satellites can connect directly to phones. But what is really happening is they are only partially hedging their bets – they are not rocket companies and, up to now, have fully committed to terrestrial RAN. If LEO can connect to phones, then it means only densely populated regions need terrestrial RAN systems. We think eliminating the need for rural towers will decrease the size of the RAN market and make 6G smaller than the 5G market.

Industry disruption in telecom will be an increasingly important theme in the coming years and will trump cyclical factors like inventory corrections. We are seeing signs that technology changes are underway and may be an increasing reason for traditional telecom supplier challenges we have seen in recent financial results.

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