BCE maintains second spot for research spending, despite 13.6% decline

Research spending by Canada's two largest telcos dropped sharply in 2007, despite healthy profits, according to the latest top 100 list of industrial research and development (R&D) spenders. And the survey's author warns things will likely only get worse as research-intensive companies look for ways to reign in expenditures in response to a worsening global financial crisis.BCE Inc. has scaled back its R&D activities more than 26% over the past two years. In FY2007, it reported research expenditures of $1.26 billion, a 13.6% decline over the previous year, and $1.46 billion in 2006, 13% less than in 2005, according to Research Infosource Inc's 2008 Top 100 Corporate R&D Spenders List. (Click here for telco results)Despite the cutbacks, BCE was once again Canada's second largest industrial R&D spender, a position it has held since 2003, trailing only Nortel Networks, where R&D spending has plummeted more than 68% since its $5.9 billion peak in 2000. In this past year, Nortel dropped 15.8% to $1.85 billion - a record low for Nortel that is still five times more than the third ranked spender, IBM Canada Ltd ($377 million).It was also a dismal year for R&D at Telus Corp., which dropped from #19 to #26 on the Top 100 list. Telus' fall (34.6%) was even more significant than BCE's, which is in stark contrast to the 4% increase in R&D it reported for FY2005-06. In 2007, Telus spent $85 million on research, compared to $130 million in 2006.The other telco to make the Top 100 list was Bell Aliant Regional Communications LP, which saw research spending decline 10.3%, from $26.4 million 2006 to $23.7 million in 2007.The results suggest that Canadian industry's commitment to R&D is not tied to profits. "These are the results for what was a very good year for the telecom services sector. It suggests that in a not very good year things are not likely to improve much. I think what you're going to see at most companies is a review of budgetary spending and cutting back on anything that doesn't deliver short term benefits," says Ron Freedman, CEO of Research Infosource.Other factors at playOne reason for BCE's two-year decline in R&D spending could be its pending privatization, which the company has said it set to close on or before December 11."No doubt they were trying to shore up their balance sheet to make the company look better," suggests Freedman. "One of the problems with R&D is that it's treated as an expense and not an investment, so there's a natural tendency to cut back on things that reduce the bottom line."BCE's leveraged buyout may also be wreaking havoc with the company's long-term strategies, which would include R&D, adds Freedman. "If you don't know who your owners are going to be and you don't know what they're going to want from you then the tendency is going to be to not get involved in long term R&D commitments, lest they turn out to be incorrect."BCE could also face a cash crunch after its privatization deal closes. A consortium of private-equity investors led by the Ontario Teachers' Pension Plan has offered $42.75 a share, 20% higher than its current trading price, which will mean higher interest payments on the $34.8 billion acquisition."The big concern is that the acquisition price is considerably higher than the current value of the company, as it is for many companies these days. So I suspect that they're going to be in a period of significant belt tightening over the next year to try to meet their numbers," adds Freedman.Then there's the exorbitant prices paid by companies in the Advanced Wireless Services (AWS) spectrum auction - Bell and Telus are on the hook for close to $800-$900 million each. This unexpected financial windfall for the federal government could have been yet another factor in the companies' decisions to reign in research spending last year.Where might research spending increase?Under Industry Canada rules, the AWS licensees will be required to contribute 2% of their revenues to R&D once they start using the spectrum. Telus and Bell Canada have announced plans to launch services in 2010 using their new spectrum for HSPA, which means they won't have to show they contributed the 2% until 2011. The timetable will be sooner for new entrant Globalive, which will have to demonstrate 2% in R&D contributions to Industry Canada in 2010, if it launches service next year as planned.Freedman expects there will also be some significant development costs by Bell and Telus to facilitate the 3G network they will be overlying onto their existing CDMA networks by 2010. "It's not just a matter of buying an off the shelf system and installing it. You have to manage the conversion."Industrial R&D spending down nationallyThe poor results are not unique to telecom services companies. Industrial research expenditures declined nationally by 3%, from $10.6 billion in FY2006 to $10.3 billion in FY2007. Spending among Top 100 companies has fallen four out of the past six years, despite year-over-year increases in revenue. However, Canada's two largest spenders - Nortel and BCE - do skew the national results. When removed from the list, R&D spending increased by a total of 3.3%, which when inflation is taken into account, means spending was essentially flat over the period.As usual, information technology (IT) companies dominated Top 100 spending in 2007, accounting for 51% of the total, compared to 53% of the total the year prior. The big research spenders within the IT category are communications/telecom equipment companies, which accounted for 27% of the total, down from 28% in 2006. BCE, Telus and Aliant accounted for 13% of the Top 100 spending, down from 15% of the total in 2006.Not all IT companies were spending less, however. The exceptions last year were Research in Motion, which reported a 42% increase in R&D activities, and Alcatel-Lucent, where spending increased by 26.1% in 2007.The IT sector was followed by Canada's pharmaceutical/biotech companies, which accounted for 19% of total R&D spending last year, up 1% from the previous year. No IT companies ranked among the top 10 most R&D intensive (R&D as a % of revenue), which isn't surprising as pharmaceutical/biotech companies tend to be the most research-intensive.Telus reported one of the steepest spending declines last year (-34.6%), coming third from the bottom of the list, ahead of natural resource companies Tembec and EnCana. Research spending at SR Telecom, a WiMAX solutions company, dropped 19.9%, putting it 10th from the bottom.Canada's industrial R&D performance could face a further setback depending on what happens with Nortel over the coming months. Financial analysts are already warning that the company will have to initiate drastic restructuring measures if it wants to survive the current economic crisis. Also, if the company does manage to find a buyer for its metro Ethernet business, which accounts for about 14% of its revenues and includes its optical and carrier Ethernet technology for Internet infrastructure, further research activities will be lost. Although the company said it would maintain R&D investments for the division while it worked to sell the business, it added that further consolidation would be necessary.Perhaps the worst case scenario, says Freedman, is a foreign takeover of Nortel. "With stock prices being as low as they are, somebody has to be looking at Nortel as a possible acquisition or breakup target," he speculates.Time to review Canada's S&T strategyInformation and communications technology companies are Canada's largest R&D performers. ICT was tagged by the federal government in its Science and Technology Strategy as one of four priority research areas for the country. The government's science advisory council has also identified four sub-priorities within the ICT sector: new media, animation and games; wireless networks and services; broadband networks; and telecom equipment.Although the strategy was released just 16 months ago, Freedman says it may already be time for a review considering it was formulated at a time of substantial economic growth and wealth creation. "We're now into the inverse period with economic decline and wealth destruction. I suspect the government will want to go back to the drawing board and tailor the strategy accordingly."

BCE maintains second spot for research spending, despite 13.6% decline

News | 10/29/2008 6:38 pm EDT

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