The submarine cable industry was a poster child for the dot com internet boom/bust nearly two decades ago. Irrational exuberance, huge upfront CAPEX, an aggressive wholesale-cable model, uncertain future demand, and a big scope for price wars led to the bursting of the bubble in international undersea cables, highlighted Tim Stronge of TeleGeography in a presentation. An onslaught of bankruptcies followed. Not a single new undersea cable was laid across the Atlantic for 12 years after the bust.
Now, the bandwidth glut has evaporated, and the subsea cable industry is facing a potential capacity shortage, reviving demand to lay new cables. Much of the current infrastructure laid 15 years ago is also approaching the end of its useful life and must be upgraded and/or replaced. Over 700,000 miles of undersea cables carry 97% of the world’s internet traffic, supporting $10 trillion of daily financial transactions.
Global demand has been growing 40%-50% annually—doubling every two years—led by content providers and cloud networks. By 2022, global IP traffic will jump threefold, according to Cisco. Over 50 new subsea systems have been completed or are under construction, with another 35 systems planned for completion before 2022, notes an Analysys Mason report.
What does it mean for investors? First, the buildout of 5G networks and the IoT, and its convergence with AI and quantum computing, augmented reality, and other new technologies will fuel a surge in demand—accelerated by the intensifying global tech arms race. Indeed, the Pokemon Go game, one of the first augmented reality games, achieved widespread use worldwide in 2016, generating a 50X jump in associated traffic demand, far exceeding Google’s estimate of a five-fold leap, highlights TeleGeography.
Second, structural changes in the industry over the last few years mitigate the risk of another bubble forming. Telecommunications firms are no longer the primary drivers of submarine cable construction. Rather it is private networks led by hyperscale cloud companies and large content providers.
In the original bubble, nearly all capacity was built by third-party resellers, with speculative builds on the same routes, and wholesalers chasing sales targets, underscores Stronge. In the current market, new cables are heavily underwritten by content providers, with no huge upfront CAPEX, and a diminished role of wholesalers.
Third, leading providers of submarine cable systems, trading at discounted valuations, could outperform.
Consider the following:
- Soaring demand for data and the need to interconnect cloud data centers is driving growth. Content and cloud providers use international cable infrastructure to distribute content via servers located at data centers closer to the consumers of content. Other factors driving investment include:
- Replacement of older cables or upgrading some systems to 100 gigabits.
- Development of shorter routes and more regional systems for underserved markets—increasing inter-data center connectivity.
- New trans-ocean routes to increase connectivity to underserved areas.
Global demand for subsea cable bandwidth grew 52% in 2017 to 689 Tbps of capacity, calculates Broadbandnow.com. Last year, 62,000 miles of subsea cable were added globally, above the high-end averages of 19,000 miles between 2013 and 2016, underscores Network World.
SubTel Forum projects global submarine cable capacity will increase up to 143% by 2022. In 2018, investments in new subsea cables are expected to reach $7.5 billion. In 2019, global capacity could increase 45%, notes The Economist.
- Technological advances in recent years that have made it cheaper to build systems with greater bandwidth are driving the investment renaissance. In 2013, new systems average 9 terabits per second (Tbps). In 2018 and 2019, multiple systems are planned that have design capacities of 60 Tbps. By 2020, capacity could reach 80 Tbps.
Laser technology and cleaner glass to carry data has eliminated the need for “regen” equipment that was required to repeat optical signals whose strength was limited to previously limited to 100-400 kilometers. As a result, optical signals can now often travel the ocean with no need for signal repeaters. Consequently, layers of cost and complexity associated with installing, powering and maintaining equipment has been phased out.
Innovations in optical transmission have also made a new interconnection model possible providing fast, direct, and more secure access to the cloud and other industry ecosystems.
- If no more cables are built, the world could run out of subsea cable capacity by 2021, notes Tim Stronge of TeleGeography. Growth in the “lit” share of capacity on subsea cables has been growing faster than “potential capacity.” “Lit” capacity is the amount of bandwidth available for use on an undersea cable, while potential capacity is a cable’s total bandwidth that can be made active through additional Capex. The ratio of lit capacity to potential capacity has hovered around 30% for the last few years. However, TeleGeography models assume a 38% CAGR in the bandwidth requirement of private networks (primarily content providers), based on their 50%-60% growth rate in recent years. As a result, unless data transfer dynamics change, TeleGeography concludes that bandwidth technology upgrades to utilize unused “potential capacity” may not be able to keep data traffic growth in check (see chart).
- Growing awareness of security vulnerabilities is fueling demand for greater control over infrastructure, route diversity, and redundancy. Reports of foreign nation states, such as Russia, operating mini-submarines in the vicinity of subsea cables have raised alarm about the potential to cut vital internet cables—in effect creating the ultimate denial-of-service cyber weapon. It is not clear what the submarines have been doing, but it is possible that the primary target is the Pentagon’s secret DoDIN network that is distinct from the civilian system, notes The National Interest.
The risk is driving demand to lay new cables on different routes. Users with large demand requirements may not be able to acquire sufficient capacity on existing cables and are acquiring capacity by building their own systems. As a result, big cloud and content providers have been directly investing in subsea cables to gain greater control over their infrastructure. For instance, Google directly owns 63,605 cable miles. Chinese cloud providers are now also beginning to make investments.
- New submarine cable investment could super-charge technology leapfrogging by developing countries. For every 10% increase in fixed broadband penetration, annual per capita GDP growth increases by about one percentage point, concludes a World Bank study. Submarine-cable investment historically has focused on trans-Atlantic, trans-Pacific, U.S.-Latin America, and intra-Asian routes.
However, since 2003, the share of submarine cable investment serving less-developed and emerging markets has risen from one-third to over 60%. In 2005, 79 civilian-inhabited countries and territories were unserved by fiber, notes Terabit Consulting. By 2015, only 29 countries remain unserved. Huge investment is now going into the southern Atlantic region. Providers are connecting: South America-Africa, India-Singapore, India-Europe, and Europe-Africa.
- Leaders in the submarine cable sector are trading at relatively-low valuations. Potential candidates for a subsea cable portfolio include:
- Nokia (NOKIA FH, 5.266 euro) – is the world’s only fully-integrated provider of turnkey submarine networks—trading at 8.9 times EV/EBITDA, below its median of 9.4 times.
- Corning Inc. (GLW, $31.98) –is a provider of optical fiber, including Vascade subsea-optical cables—trading at 8.4 times EV/EBITDA, below its historical trailing median of 10.2 times.
- Prysmian SPA (PRY IM, 16.685 euro) – operates three of the world’s most advanced cable-laying vessels—trading at 16.3 times free cash flow and 7.7 times consensus EV/EBITDA, below its median of 8.6 times.
- KT Submarine Ltd. (060370 KS, 3470 KRW) – provides installation and repair services for submarine cable systems—trading at 11.5 times free cash flow and 11.1 times trailing EV/EBITDA.
- Fujitsu (6702 JP, 7228 yen) – is a leading provider of integrated subsea systems—trading at 23.8 times free cash flow and 5.1 times EV/EBITDA.
- Lumentum (LITE, $44.86) – is a world leader in intercontinental subsea communication networks worldwide, providing a range of optical- network equipment—trading at 13.7 times free cash flow and 7.8 times EV/EBITDA, below its 10.9 times median.
- II-VI Inc. (IIVI, $34.27) – provides a range of equipment for undersea cables and is one of the few suppliers of pump lasers trusted to operate on the bottom of the ocean floor—trading at 9.1 times EV/EBITDA below its trailing median of 11.6 times.
- NEC Corp. (6701 JP, 3600 yen) – manufactures subsea fiber-optic cables—trading at 18.4 times free cash flow and 6.8 times EV/EBITDA.