Calling Telecom Investors...


By Sam Stovall Telecom investors have two things to be thankful for: A positive 12-month investment outlook by S&P's Kenneth Leon for the wireless telecommunications subindustry, and a recent telecommunications-services sector upgrade by Leon and Todd Rosenbluth, S&P's wireline telecom-services analyst, to marketweight, from underweight.

In its short history, the telecom-services sector has tended to be a strong performer, as the economic expansion matures with the recovery in business spending. While we see pricing competition remaining high, pressuring profitability of the Baby Bells, we believe investors will be gravitating selectively toward higher cash-generating and dividend-paying wireline stocks, as well as wireless outfits offering a differentiated service (see BW Online, 3/5/04, "Telecom Stocks to Dial For").

BOOST FROM MERGERS. On Mar. 2, Rosenbluth upgraded AT&T (T

; $19.79) to buy, from hold, contending that its fundamentals will stabilize. S&P sees the voice over Internet protocol (VOIP) service rollout helping to control the cost structure and views recent debt reduction and strong cash balance as additional catalysts for AT&T shares.

In the wireless-services area, merger news has helped boost the shares recently. On Feb. 17, Cingular Wireless, a joint venture of SBC Communications (SBC

; 2 STARS, avoid, recent price: $25.15) and BellSouth (BLS); 2 STARS;, $28.80), announced an agreement to acquire AT&T Wireless (AWE

; 3 STARS, hold; $13.44) for roughly $15 per share, or $41 billion. The deal is expected to close as soon as the end of 2004, subject to approvals.

Cingular sees merger benefits from cost synergies, including workforce reductions. This may distract AT&T Wireless employees in servicing its customers, which number 21.9 million at the end of 2003. We see an opportunity for other nationwide carriers to gain market share from AT&T Wireless as 20% to 30% of its customer contracts expire in 2004.

CINGULAR DISADVANTAGE. Last November, the FCC decision on number portability went into effect in the top 100 U.S. markets, which may have a growing impact on competition in 2004. Some wireless carriers extended weekend calling rates to Fridays, while others are promoting larger discounts on handsets. In their December results, AT&T Wireless, Cingular, and T-Mobile USA reported higher monthly customer churn and increased handset costs, which may be attributed to portability. We see portability's full impact being felt in the first half of 2004.

We believe pricing in wireless services may hit a speed bump with number portability and then stabilize by mid-2004. We expect the group to still show quality growth, with stable-to-higher average revenue per user (ARPU), but EBITDA margins may decline slightly during the expected peak period for portability and then expand later in 2004.

Of the five nationwide wireless carriers, we see Cingular at a disadvantage in the market as it tries to plan the integration of AT&T Wireless. In our opinion, Nextel Communications (NXTL

; 5 STARS, buy; $25.43), T-Mobile USA, and Verizon Wireless (VZ

; 3 STARS; $39.30) should continue to gain share, while Sprint PCS (PCS

; 2 STARS, $9.43) expands its wholesale business with Qwest (Q

; 3 STARS; $4.90) and Virgin Mobile.

In the second-tier markets, number portability will go into effect on May 24, 2004, and, given less competition in rural and suburban markets, we see less risk for fast-growing carriers such as Nextel Partners (NXTP

; 5 STARS; $13.35).

RESALE RELIANCE. Besides AT&T, other stocks that Rosenbluth and Leon rank buy are Alltel (AT

; $52.53), Nextel Communications, Nextel Partners, and Intrado (TRDO

; $19.71).

However, we at S&P recommend that investors avoid shares of Sprint PCS and Sprint FON (FON

; 2 STARS, $18.84). On Mar. 1, Sprint announced that it will combine the shares of its tracking stocks for its FON Group and its wireless PCS carrier. We see PCS shares trading closer with FON under the recombination terms, which will convert each PCS common share into 0.50 shares of FON on Apr. 23. While the plan should help cost savings, we don't expect Sprint to be a stronger competitor from this initiative. We also don't see its wireless business taking market share from its wireless peers.

We believe Sprint is beginning to direct capital spending in wireless to local markets where FON has a local telephone presence, thereby offering bundled services. This may erode Sprint's competitive position as a national carrier. We're also concerned with the size and growth of PCS' wholesale resale business with Virgin Mobile and Qwest. Relying on resale significantly more than its peers, S&P says investors should avoid PCS and FON tracking stocks.

Industry Momentum List Update

For regular readers of the Sector Watch column, here's this week's list of the 11 industries in the S&P Super 1500 with Relative Strength Rankings of "5" (price performances in the past 12 months that were among the top 10% of the industries in the S&P 1500) as of Mar. 5, 2004.

Industry/Sector

Company

S&P STARS* Rank

Aluminum/Materials

Alcoa (AA)

4 STARS

Casinos & Gaming/Consumer Discretionary

Harrah's (HET)

5 STARS

Catalog Retail/Consumer Discretionary

Insight Enterprises (NSIT)

Not Ranked

Consumer Electronics/Consumer Discretionary

Harman International (HAR)

5 STARS

Consumer Finance/Financials

MBNA Corp. (KRB)

5 STARS

Diversified Metals & Mining/Materials

Phelps Dodge (PD)

4 STARS

Electronic Equipment Manufacturers/Info. Tech

Vishay (VSH)

5 STARS

Homebuilding/Consumer Discretionary

D.R. Horton (DHI)

5 STARS

Internet Software & Services/Info. Tech.

Yahoo! (YHOO)

3 STARS

Steel/Materials

Nucor (NUE)

5 STARS

Wireless Telecom Svcs./Telecom Svcs.

Nextel Communications (NXTL)

5 STARS

* S&P's stock appreciation ranking system for the coming 6- to 12-month period: 5 STARS (buy), 4 STARS (accumulate), 3 STARS (hold), 2 STARS (avoid), 1 STAR (sell). Stovall is chief investment strategist for Standard & Poor's


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