More to Talk About
SBC Communications’ plan to buy Baby Bell sibling Ameritech is just one more example of how hot the telecommunications sector has become--in terms both of mergers and stock prices.
Telecom stocks have soared over the last year thanks to a mix of factors, including dependable earnings growth at some of the companies, blue-sky potential in others and low overall exposure to troubled Southeast Asia.
What, exactly, is a telecom stock? There’s no one answer. The field encompasses a panoply of industries, including local and long-distance phone companies, equipment makers and wireless services providers.
The following is a brief look at the prospects for five major telecom industry categories, and some of the better-known stocks in each.
Baby Bells
And then there were four.
That is, there will be if SBC succeeds in buying Ameritech, reducing further what had been seven Baby Bells formed by the 1984 breakup of the old American Telephone & Telegraph.
Of the four, SBC and Bell Atlantic are considered to have the best growth prospects. SBC last year gobbled up Pacific Telesis, and Bell Atlantic took out Nynex. The other two Baby Bells are US West Communications and BellSouth.
SBC and Bell Atlantic are regarded as having the strongest managements and have been blessed with strong local markets, in Texas and New York, respectively.
The Baby Bell stocks lagged the gains of the overall stock market in 1995 and 1996 but have come on strong in the last year for several reasons. Earnings growth has been solid, in the high single- or low double-digits. Combined with the stocks’ decent dividends, the shares have been attractive at a time of slowing earnings growth in other industries.
What’s more, the companies’ lack of exposure to the Asian financial mess also has lured investors.
What now? The common wisdom floating around Wall Street on Monday was that SBC will at some point try to buy US West to fill out its geographic reach over the Western U.S., and that Bell Atlantic will scoop up BellSouth to solidify its hold on the East.
However, some analysts say neither deal is likely to happen immediately, if at all. To start, stocks of both BellSouth and US West have jumped more than 50% in the last year, in part on merger hopes.
What’s more, there are specific stumbling blocks in each case.
For SBC, most observers expect the Ameritech deal to go through, but not without lengthy review by regulators. A deal for U.S. West could raise even greater antitrust concerns. Also, while U.S. West covers some fast-growing markets, it also encompasses sparsely populated regions that can be expensive to serve.
As for Bell Atlantic, its stock slumped $1.31 to $93.19 on Monday on fears it would feel pressure to respond to SBC by doing a costly deal with BellSouth.
Instead, some experts say, Bell Atlantic is more likely to merge with a British phone company. British Telecom is mentioned. In part because such a large percentage of international phone calls involve New York, Bell Atlantic is likely to be the first Baby Bell to offer service outside its territory when regulators permit it, said Michael Mahoney, who runs the GT Global Telecommunications fund.
Long-Distance
AT&T; won plaudits in January with its plan to buy Teleport Communications, a local phone service provider that specializes in business customers. But beyond that, sentiment is split toward the biggest U.S. long-distance carrier.
The problem AT&T; faces is simple: Hard-nosed rivals on all sides have eaten away at its long-distance dominance for years. Meanwhile, AT&T;’s past efforts at breaking into local service were pathetic. And its ability to do so today is debatable, in part because customers are content with the Bells and seem loath to take the trouble of changing carriers.
To be sure, AT&T; has several factors in its favor. Its new chief executive, C. Michael Armstrong, is widely respected, and he’s refocusing the business on more profitable services. AT&T; also has a strong balance sheet with low debt and strong cash flow that it can wield to make acquisitions.
“They have a great brand name, a great business and one of the strongest managements,” said Marc Gabelli, co-manager of the Gabelli Global Telecommunications fund.
Even so, AT&T;’s wireless service is growing slowly and it’s facing new challenges to its long-distance business. For example, Qwest Communications is one of several firms working on rolling out state-of-the-art fiber-optic long-distance.
Whereas AT&T; has made repeated strategic blunders, rival WorldCom has done virtually everything right and is now making its boldest gambit yet with its planned purchase of MCI Communications. Indeed, Jackson, Miss.-based WorldCom has the best prospects in the long-distance field, many analysts believe.
WorldCom has been been on a fervid acquisition binge in the last decade and has successfully netted some strong companies, including the former MFS Communications, a prize that many observers once thought would go to AT&T.;
While “AT&T; got off on the wrong track many times, [WorldCom] hasn’t missed yet,” said Brian Hayward, manager of the Invesco Worldwide Communications fund.
Among other players, Sprint has an attractive fiber-optic network, and “it’s among the hit-list names of takeover targets because its core long-distance business is very strong,” Hayward said.
Competitive Local Exchange Carriers
This unwieldy term refers to a crop of upstart companies formed in the last 10 years to challenge the Baby Bells. They offer mostly local service to business customers. The two best-known C-LECs, as they’re called, were MFS and Teleport before their buyouts.
While long-distance carriers don’t worry the Baby Bells all that much, the C-LECs are sometimes formidable rivals. Though their overall market share is still small, they have stolen lucrative small and mid-size business customers that were overlooked by the Bells.
The stocks of many C-LECs have had big run-ups in the last year, but enthusiasts say there’s more to come as long-distance players snap up C-LECs in their quest to enter local markets.
Many C-LECs aren’t yet profitable, because of the infrastructure costs associated with their businesses. The industry, often valued on cash flow rather than earnings, came into favor when it appeared to be breaking even in terms of cash flow, Haywood said.
Hayward has devoted 16% of the assets in his fund to C-LECs and is high on ICG Communications and Intermedia Communications. Other C-LECs include Winstar Communications, USN Communications and Nextlink Communications.
Equipment Makers
As communications companies scramble into one another’s businesses, equipment makers have been the big beneficiaries. And no company has been helped more than Lucent Technologies, the equipment spinoff of AT&T.;
Lucent’s stock has been on a tear, jumping a remarkable 132% in the last year. The logic behind the gain in Lucent--and in stocks such as Northern Telecom--is that cable, phone and Internet companies all will need to invest heavily in new equipment to do battle with one another. “You want to own the arms producers in an arms race,” Hayward said.
The issue with equipment makers is valuation. Lucent’s trailing price-to-earnings ratio is a heart-stopping 215, although its forward P/E is a more reasonable 45. But given that Lucent’s earnings are only growing in the high teens, it’s extremely pricey by any measure, Mahoney said.
“Lucent is crazy,” he said.
Instead, Mahoney likes P-Com Inc., which makes radio equipment used by wireless networks. The stock has been held back because some investors think bigger equipment firms will invade its turf, Mahoney said. But he doubts rivals can move in so easily and thinks P-Com could be taken over.
One danger the equipment makers face is the possibility that orders will be delayed or eliminated because of mergers. In February, for example, shares of Ciena Corp. sank 28% in a day when it said WorldCom, one of its biggest customers for equipment that relieves capacity constraints on fiber-optic networks, had delayed orders.
However, Ciena said strong orders from other customers would make up for any revenue loss, and the shares have since recouped almost all of the loss.
Wireless / PCS
The wireless arena holds some of the best potential as well as some of the biggest risks. Supporters think wireless stocks could continue to soar in the next few years for two reasons. First, use of cellular phones and other wireless devices seems sure to become more widespread in the United States. Second, many parts of the developing world are bypassing traditional wire line services for wireless.
The problem is identifying who the winners will be and when. The major phone companies all have wireless units; AirTouch is a major global competitor, and there are a bevy of smaller players.
Picking the stocks also is a bit trickier with the advent of personal communications service, or PCS, considered the next generation of wireless. Companies bid for the rights to offer PCS licenses in the last few years and are steadily rolling out the services.
Gabelli likes Centennial Cellular and Vanguard Cellular Systems, both of which he expects to be bought out.
“The outlook is great for wireless, and scale is the name of the game,” Gabelli said.
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Stock Sampling, by Sector
The telecom business is a lot more than a few big phone companies. Here is a sampling of some of the competitors in five major sectors of the industry.
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Ticker 52-week Monday Company symbol high/low close Regional Bells Ameritech SBC $50.25/$30.13 $46.00 Bell Atlantic BEL 106.00/67.38 93.19 BellSouth BLS 68.69/42.38 65.94 SBC Comm. SBC 46.56/26.75 38.81 US West Comm. USW 58.00/34.13 51.44 Local Phone Service Providers GST Telecomm GSTX $16.88/14.00 $14.69 GTE GTE 64.38/40.50 59.19 Hyperion Telecomm HYPT 20.13/16.75 18.63 ITC DeltaCom ITCD 36.50/13.88 28.38 Nextlink Comm. NXLK 38.25/19.56 30.75 Teleport Comm. TCGI 60.94/27.75 52.25 USN Comm. USNC 23.00/13.75 15.50 Winstar Comm. WCII 46.31/11.69 38.75 Ticker 52-week Monday Company symbol high/low close Telecom Equipment Makers ADC Telecomm. ADCT $45.00/16.75 $31.38 Ericsson Tel. ERICY 56.63/33.50 55.06 Lucent Tech. LU 79.00/30.38 73.00 Motorola MOT 90.50/52.00 55.88 Nokia NOK 69.75/31.63 68.69 Northern Telecom NT 67.00/38.31 63.56 P Com PCMS 29.38/13.25 19.44 Qualcomm QCOM 71.94/43.25 54.81 Tellabs TLAB 73.38/42.63 69.50 Long-Distance Companies AT&T; T $68.50/32.00 $57.50 Frontier FRO 33.88/16.75 30.06 LCI International LCI 40.19/19.56 39.50 Level 3 Comm. LVLT 83.75/55.25 59.81 QWest Comm. QWST 41.06/13.19 39.03 Sprint FON 75.63/44.00 69.31 WorldCom WCOM 45.38/25.25 42.94 Wireless/PCS* Companies 360 Comm. XO $36.25/15.25 $29.94 Aerial Comm. AERL 10.63/5.00 7.13 AirTouch ATI 57.56/24.80 51.88 CoreComm COMM 20.75/9.75 19.38 Nextel Comm. NXTL 34.13/13.25 25.13 U.S. Cellular USM 36.88/24.75 33.44 Vanguard Cellular VCELA 20.19/10.13 18.63 Western Wire WWCA 24.63/11.13 20.50
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