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DECEMBER 12, 2003
"Tread Carefully" in Telecom Stocks That caution comes from S&P's Todd Rosenbluth, who nevertheless sees a trio of appealing stocks among the rural wireline carriers Telecommunications is an area rife with challenges, and investors should "tread carefully," in the words of Todd Rosenbluth, Standard & Poor's analyst of telecom stocks. Even with the broad market testing new highs, Rosenbluth reports that S&P recommends underweighting telecom-services stocks. Among the challenges weighing on the industry are increasing competition between wireline and wireless service and the advent of two potentially powerful new trends: local-number portability and phone service via voice over Internet protocol (see BW Online, 12/12/03, "The Sound of Phone Cords Severing"). In addition, Rosenbluth considers that some telecom stocks "are currently trading at unwarranted multiples." However, he sees a few bright spots. He likes rural wireline carriers Alltel (AT ) (ranked buy) and accumulate-rated CenturyTel (CTL ) and Commonwealth Telephone (CTCO ). S&P also has buy ratings on Nextel (NXTL ) and Nextel Partners (NXTP ), he reports (see BW Online, 12/2/03, "An Easy Call on Nextel Partners"). These were among the points Rosenbluth made in an investing chat presented Dec. 9 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available from BusinessWeek Online on AOL at keyword: BW Talk. Note: Todd Rosenbluth has no stock ownership or financial interest in any of the companies in his coverage area. He's a registered representative of Standard & Poor's Securities, Inc. Other S&P affiliates may provide services to the companies under discussion. Q: Today was a banner day for the market, with the Dow touching 10,000 again. Is there any equivalent excitement in the telecom sector? How does it look? A: We remain negative on the wireline-services stocks and underweight the telecom-services sector, regardless of today's developments. We see a number of challenges facing the telcos as we head into 2004. Q: Is that because of business problems, valuations, or some of each? Amplify on those challenges, if you will. A: It's both business challenges and valuation challenges. On the business side, particularly for wireline telecom companies, we see challenges from wireless substitution, from cable competition, and increasing operating expenses to restrict profitability growth. Meanwhile, some of the telcos have climbed in value and are currently trading at unwarranted multiples. Q: What are some dividend-paying stocks in the telecom sector? A: A number of dividend payers are out there. Our favorite -- and only buy-recommended stock in the wireline space, is Alltel Corp. (AT ) -- its dividend yields more than 3%. There are less attractive total-return plays, such as SBC Communications (SBC ), which we believe faces greater operational challenges that will restrict overall investor gains in the stock. Q: Time-Warner (TWX ) just announced a deal with Sprint and MCI for cable Internet phone service using voice over Internet protocol, or VOIP. What's your feeling toward voice over Internet stocks? A: I don't cover Time-Warner or any pure-play VOIP stocks. However, we think that over the longer term, VOIP creates a challenge for the traditional telcos such as SBC and Sprint FON (FON ), which we have an avoid recommendation on. We think that VOIP is still a 2004-05 issue but remains a threat to the telcos. Q: How about Verizon (VZ )? A: We currently have a hold recommendation on Verizon. We have concerns regarding the wireline side of the business from increased competition. And we also are concerned about Verizon's earnings quality, given the significant charges the company will take regarding workforce cuts. However, due in part to the wireless arm and our valuation methodology, we would hold Verizon shares near our 12-month target price of $32. Q: When is Nextel (NXTL ) going north instead of sideways? The company is making money. A: Nextel, which my colleague Ken Leon covers, is one of our favorite telecom stocks. We have a buy on Nextel and believe its nationwide Direct Connect offers it differentiation in a challenging operating arena. We have a 12-month target price on Nextel shares of $31. Q: When will consolidation take place in the wireless sector? A: We believe that consolidation will need to happen in both the wireless and wireline space in order to reduce aggressive pricing competition. However, we don't expect anything to develop until all the potential players complete their balance-sheet restructurings and local-number portability shakes out. We expect local-number portability to be a bigger issue for the wireline companies in 2004. Q: What are your top picks? A: We favor rural wireline carriers, such as Alltel, CenturyTel (CTL ), and Commonwealth Telephone (CTCO ). And on the wireless side, we like Nextel (NXTL ) and Nextel Partners (NXTP ). Despite increased competition in the telecom space, these carriers stand out to us. Q: Are those last all buys? A: Nextel, Nextel Partners, and Alltel are buy-recommended shares. CenturyTel and Commonwealth Telephone are among our accumulate, or 4-STARS, recommendations. Q: Can AT&T (T ) make a recovery? If so, to what extent? A: We have a hold recommendation on AT&T shares. We believe the company will likely offset some of the challenges in its long-distance operations with an increased focus on local-service bundling and the enterprise space. However, we see margin pressure and operational risks restricting significant share price growth. Q: What are your thoughts on Vodafone (VOD )? A: S&P has an avoid opinion on VOD shares. Our analysis suggests that VOD lacks the competitive advantage to achieve industry-leading profitability and higher-than-average returns on capital. We believe the shares trade at an unwarranted premium to its European peers. Q: Will tax-loss selling affect prices in Qwest (Q ) the next two weeks? A: We believe Qwest shares will keep pace with the broader market. We're encouraged by the company's debt-reduction steps and that it has resumed filing quarterly statements. However, we see multiple operational risks in its wireline and wireless offerings and also believe this stock trades above its peers. Our 12-month target price is $4. We would hold Q shares.
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