BUSINESSWEEK ONLINE: DAILY BRIEFING
December 21, 1998

SECTOR SCOPE by James A. Anderson

LONG-DISTANCE STOCKS MAY HAVE THE LEGS FOR A MARATHON

Talk about corporate makeovers. For the past two years, the big long-distance companies have rushed headlong to recast themselves as anything but plain old long- distance companies. AT&T (T), for instance, laid out $33 billion to snatch up cable giant Tele-Communications Inc., and for an encore bought a data network from IBM. Worldcom (WCOM) swallowed MCI and has pushed headlong into all of Europe like no one has since Napoleon. Not to be outdone, Sprint (FON) cut loose its wireless operations in a fall spinoff.

Identity crises of this sort don't always boost shareholder value, and on that score all this shuffling by long-distance companies has been a mixed success. It's true that as a group they've fared quite well; as of Dec. 11, the Standard & Poor's long distance index had rung up a 46.6% gain, compared with 20.2% for the S&P 500. Look at the companies individually, though, and wider variation emerges. MCI-Worldcom, the sector's frontrunner, is up 128% since Jan. 1, and Sprint has risen 38%. But AT&T trails the market for the year, having climbed 19%.

Just why are big, brawny corporations like these in a tizzy? First and foremost, there's deregulation, a 12-letter swear word in phone circles. True, the Telecommunications Act, the weighty legislation that marks its third anniversary in January, hasn't loosed the sweeping competitive changes many thought it would. In fact, the Baby Bells probably won't make their debut in long-distance until later in 1999. What the act has done, however, is work the long-distance players into a lather, with each scrambling to get into new businesses before new phone competitors show up.

Their concern may finally be justified: Brian Adamik, a senior analyst with the Yankee Group, a Boston consulting firm that tracks the communications industry, says that after tripling between 1984 and 1993, long-distance usage is now increasing by only about 5% annually. Couple that with the pricing pressures AT&T, Sprint, and MCI Worldcom inflict on one another, and you have a business whose revenues are stagnant or at best growing modestly. "The consumer market is a tough one to make money in," says Adamik. "It's very volatile and the trend is for rates to keep coming down."

It should come as a comfort to investors that in their skirmishes over the past decade and a half, AT&T, MCI Worldcom, and Sprint have all had a taste of what the future might bring. "These guys have had to live with competition for a long time, so they know how to cope," says Philip D. Wohl an analyst with Standard & Poor's.

The long distance companies are also fortunate that a number of the new frontiers they're exploring look promising. Start with the gold-rush called the Internet. Online traffic is doubling roughly every three months, and all three long distance players want their share. Then there's data communications, a market analysts say is growing at a double-digit clip. International phone markets, another bonanza, are attractive now that other countries are opening their borders to outside competitors. Wireless communications is yet another market where revenue promises to grow by 10% to 20% annually. And finally, there's the mother lode: The $100 billion local phone market that Sprint, MCI WorldCom, and AT&T are all trying to enter.

That may seem like a messy tangle for investors to sort out, but keep this in mind: Analysts say the key to picking the right telecom stock is to spot the players that are doing the most to limit their exposure to long-distance, and to expand their reach in newer worlds.

Arguably, no one is doing a better job at that kind of refocusing than MCI Worldcom. Fresh from the merger that was wrapped up in September, the company enjoys superstar status on Wall Street. Of the 32 analysts covering the stock, 25 rate it a strong buy, while another six have a buy recommendation on it.

The reason: MCI Worldcom has set down promising roots in growth markets. It is one of the biggest handlers of Internet traffic and provides access onto the Web for both America Online and Compuserve. In Europe, meanwhile, MCI-Worldcom operates a 2,000-mile fiber-optic network linking 27,000 buildings in the United States with 4,000 in Europe -- an attempt to attract large multinationals. MCI's management has thus whittled down the company's exposure to the consumer long-distance market to no more than 20% or so of total revenues according to some estimates. To top it off, the company predicts that the MCI-Worldcom merger could generate as much as $2.5 billion in cost reductions.

The Street thinks MCI Worldcom can increase earnings by 30% annually over the next five years, according to Zacks -- and its shares are trading at about 35 times the $1.95 per-share earnings the company is expected to bring home in 1999. "You look at the Internet, Europe, and some of the company's other growth drivers, you combine that with cost savings from the merger, and you have some of the reasons why we like this stock," says Liam Burke, a portfolio manager for Alex Brown & Sons and sub-advisor for the Flag Investors Communications Fund.

Not to be outdone, AT&T has been on a strategic tear as well. In January, the company spent $11 billion to buy Teleport Communications and break into the local market for business customers. Less than six months later, it grabbed Tele-Communications to gain access to residential customers. Then earlier this month came a $5 billion deal for IBM's Global Data Network, which is meant to bolster the company's standing in international data services.

In short, AT&T seems at last to have a clear game plan for the future. Shorter-term, however, AT&T remains beholden to the consumer long distance market for about 40% of its revenues. Indeed, Wall Street analysts currently expect the company's earnings to increase by 11.6% annually over the next five years, less than half the prediction for MCI Worldcom. Another concern: Proxy documents for AT&T's takeover of TCI aren't expected until January, and many on Wall Street may be leery of recommending the stock until they have a better notion of just what the deal entails. Nonetheless, AT&T garners a buy or strong buy rating from 19 of the 27 analysts that follow it, according to Zacks.

Sprint has had a busy year, too. In a major move last fall, the company spun off its personal communications service (PCS). Analysts applaud the move, saying that it will help stem earnings dilution because of the investment Sprint would have had to sink into its PCS infrastructure. At the same time, Sprint is spending heavily to beef up its international and local businesses. Though that should penalize earnings for now, it should prove beneficial over the long-term, according to Value Line analyst David M. Reimer.

One industry newcomer worth watching is Qwest Communications International (QWST), which is building a fiber optic telecommunications network from scratch. The company has incorporated into its system the latest Internet and data transmission technology. Twelve of the 14 Wall Street analysts covering the stock rate it a buy or strong buy, and according to consensus estimates the company should earn 28 cents a share in 1999, its first year of positive earnings. Even Microsoft is getting on board. It announced last week that it will invest $200 million in Qwest. According to Zacks, Wall Street expects Qwest's earnings to increase an average 42% annually over the next five years.

Fund investors migh take a look at Flag Investors Communications Fund (TISHX). Under the direction of Alex Brown's Burke, who manages the fund's portfolio, Flag currently has 14% of its assets parked in long distance stocks, including 9% invested in MCI Worldcom. With less than two weeks left in the year, the Flag fund is up nearly 50% -- and it has an average annual total return of 35% over the past three years.

Anderson, who teaches journalism for the City University of New York, writes Sector Scope every other week.


News Flash Archives



Copyright 1998, Bloomberg L.P.
Terms of Use