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JULY 10, 2003
By Olga Kharif Too Many Calls for Telecom-Gear Stocks? A snappy rally may be setting investors up for a fall, since the industry's underlying strength isn't keeping pace with rising share prices Over the past three months, telecom-equipment stocks have rallied faster than most other market sectors, rising about 24%, according to mutual-fund tracker Lipper. Most of the several dozen companies in the group are trading at an historically high 27 to 29 times projected 2004 earnings. But while the industry has morphed from Typhoid Mary to Sexy Sadie, Wall Street's love affair with it could be short-lived. Chances are that investors have once again gotten ahead of themselves. In fact, many makers of phone-company gear are still struggling with high debt and are bleeding red ink. And while the industry is almost certainly nearing the bottom of a sickeningly steep slide, its recovery is likely to be mild at best: As recently as 2000, phone carriers spent 36% of their revenue on capital purchases. That figure has since plummeted to 12% and is projected to nudge up only to 14% by 2005, according to telecom consultancy RHK. The gap between this stark reality and the share price run-up amounts to a big fat warning, analysts say. Investors typically want to get into stocks at the start of a rally, but "it's one thing to be early, and another thing to be too early," says Steve Levy, an analyst with Lehman Bros. And it can be particularly hard to distinguish between the two when some on Wall Street are continuing to blast hot air into the sector. In mid May, for instance, Salmon Smith Barney, former home of disgraced telecom analyst Jack Grubman, upgraded phone-gear maker Juniper Networks (JNPR ) from inline to outperform. The stock has risen 14% since, to $14.85, making it vulnerable if the sector's current bubble bursts. PARTY POOPERS? For investors who fear trouble, one sign to watch will be the guidance equipment outfits provide for the third quarter -- projections that analyst Paul Sagawa at Sanford Bernstein expects to be guarded at best. Companies such as Ericsson (ERICY ), the world's largest wireless-equipment maker, could even suffer a sales decline in that quarter vs. the second, Sagawa believes. If he's right -- and if other suppliers offer the same outlook -- the eight-month party in share prices could fizzle. There's also a longer-term reason to worry. Much of the world's wireless infrastructure is already built-out for now, and a new wave of orders could be a year away. Demand for regular phone equipment could remain slack for another year as well: Faced with declining revenues, the Baby Bells are keeping their purses clasped -- and it will be several years before they feel enough competition in their core phone business from cable companies to force them out of their capital spending lethargy, predicts Kate Horricks, a senior analyst at RHK. As a result, North American telecom capital spending will remain flat this year, at $31 billion, and won't start rising until late 2004 or early 2005, according to RHK. That sounds inconsistent with some recent good news. At the end of May, three Baby Bells -- BellSouth (BLS ), SBC Communications (SBC ), and Verizon (VZ ) -- announced that they'll jointly evaluate and buy equipment needed to string fiber to homes and offices in order to standardize their networks and take advantage of deeper discounts. But their purchases might not kick in until late 2004, analysts say. Moreover, the joint-buying arrangement could push down equipment prices even further.
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