Buy the
Telecom Bottom
By Roger Conrad, editor,
Utility Forecaster
"Calling a bottom in any market requires a
certain amount of dumb luck. But when no one has anything good
to say about an investment, chances are the worst selling is
over. Waiting for recovery takes patience. But as long as the
case is sound, you're practically guaranteed a massive payoff.
Here in summer
2001, it's hard to envision an industry more battered and bad-mouthed
than telecommunications. A seemingly never-ending stream of bankruptcies
an disappointing earningsmost recently from equipment maker
Nortelhas chased all but the hardiest from the sector.
Comments like "this year is written off" reflect an
increasingly gloomy Wall Street consensus.
Telecom, however, is still an essential service with powerful
long-term fundamentals. To be sure, many small tels won't survive
the next few years. Even big boys like AT&Twhich
is headed for a history museum after this summer's breakupwill
stumble.
But every year, millions more worldwide hook up to the Internet,
buy wireless phones and plug into cable television service. Businesses
become increasingly data-centric and dynamic technologies like
the wireless Internet become reality. Even in the depths of what's
been termed an industry depression, large and small players alike
are ringing up record revenues.
Following, I
present three groups of telecom buys, all of which are cheap
and ripe for a dramatic recovery.
The first is
an emerging bank of dominant players, distinguished by their
growing pricing power. The second are asset-rich wrecks offering
uncommon value that will be recognized as industry conditions
improve. The third are telecom income plays, which pay you in
cold cash as their recoveries unfold.
Pricing Power
Nothing demonstrates dominance over a market better
than the ability to raise prices. The best examples of communications
pricing power are the fantastic five: AOL Time Warner, BCE, Cox
Communications, SBC Communications and Verizon Communications.
Few companies
have ever ruled an industry more absolutely than AOL Time
Warner (AOL $50.90). At a time when most Internet players
have long since gone belly up, the company pushed through a 9
percent increase in its basic monthly subscription rate last
month, even while adding customers at a rapid rate. Management
is aggressively integrating Time Warner's unmatched collection
of media and entertainment assets into its Internet world.
Expected annual profit growth of nearly 30 percent will accelerate
further when wireless web applications start to hit the scene
with the developments of third generation (3G) and 4G systems.
AOL is a compelling bargain below 60 for aggressive
and conservative investors alike.
The Baby
Bells were the surprise winners of the first five years of telecommunications
deregulation. And they'll continue to astound the skeptics for
at least the next five.
Almost alone in its industry, Verizon Communications
(VZ $52.45) has consistently met earnings expectations over
the past year. And it should easily do so for the rest of 2001.
At the core
is its Northeast local phone business, which continues to hold
market share at the retail level while expanding its wholesale
business to competing carriers. Steady improvements in service
quality are carrying over into robust growth in long distance
market share in New York and Massachusetts.
The company
in on the verge of gaining regulatory approval to offer long
distance in Connecticut and Pennsylvania, and expects to enter
a half dozen more states by early next year.
That, in turn,
will open up the fast-growing data business, which it could dominate
by mid-decade in the Northeast. Investors will receive a windfall
gain when the company spins off a portion of 55 percent-owned
Verizon Wireless, probably by early next year. Buy
Verizon, which trades at just 15 times 2001 estimates, up to
60.
Despite problems with regulators this year over service quality
and a slowdown in its most important market California
SBC Communications (SBC $40.31) also
ranks in the must-buy category. The company's Cingular Wireless
unit and international operations continue to grow strongly,
fueled by steady cash flow from its local phone franchise.
Like Verizon,
SBC has also enjoyed heady success in the long distance market,
dwarfing any loss of sales to local phone competitors. Still
rated AA- and selling a third off its highs, SBC is a superb
buy up to 45.
Canada-based BCE's
(BCE $25.08) Bell-like characteristics have fueled
its robust growth in everything from wireless to entertainment
ventures, both at home and around the world. At the root is its
Bell Canada unit also 20 percent owned by SBC
which continues to dominate the country's post-deregulation communications.
Unlike the Baby Bell Counterparts, BCE has been treated as a
national champion in Ottawa and has used its dominance to speedily
wrest market share in everything from wireless to long distance
through its Teleglobe unit. The result is annual profit
growth has reached more than 17 percent. Selling at just 14.5
times 2001 estimates and dishing out a generous 3.2 percent dividend,
BCE is a low-risk bargain up to 30.
With satellite
television fading as a credible competitor to their virtual monopolies,
cable television companies also enjoy considerable pricing power.
My favorite is Cox Communications (COX $39.75), which
serves more than six million customers in mostly fast-growing
rural and suburban markets. The sluggish economy has hurt growth
of some advanced services. But the company continues to enjoy
solid cash flow growth and sales should get a shot in the arm
from a deal to offer AOL's service over its wires.
My preferred
way to buy Cox is the 7 percent convertible preferred,
which will be converted into a range of 1.1962 to 1.4414 shares
of Cox common on August 16, 2002, with a target of $50. Buy
up to 60.
Asset-Rich, Price Poor
My second group of stocks lack pricing power. But
each possesses assets that will attract investors and very likely
suitors once the industry starts to rebound. And off an average
of 56.7 percent from their highs, there's little downside risk.
ALLTEL's
(AT) rural wireline and wireless base is attractive for its
growth, the lack of competition and recently increased federal
subsidies. Broadwing dominates communications in Cincinnati,
making it one of few certain survivors in the broadband sector.
WorldCom (WCOM), though battered, is still the king of
global business communications and should benefit from the spinoff
of its shrinking long distance operation.
Telefonica
(TEF) and Vodafone (VOD) are the premier Spanish speaking
and wireless companies in the world, respectively. And by separating
its long distance, broadband and cellular units into individual
companies, AT&T (T) is unlocking shareholder value
it never would have as a single company.
Each of these
companies is either in the red or has failed to meet Wall Street's
earnings expectations over the past year. They likely won't recover
until the industry overcomes its current glut of capacity. But
all are sure to survive to join in the recovery. Buy and lock
away ALLTEL (up to 65), Telefonica (60), Vodafone (45) and WorldCom
(22), which spun off one share of its MCI long distance unit
per 25 of its own last month.
AT&T (buy up to
22) shareholders will receive one share of AT&T
Wireless (22) for every three of the parent they own
on July 9, and the company plans to divvy out the broadband unit
later this year. Note my favorite way to buy Broadwing is with
the 6.75 percent convertible preferreds in the
Income Portfolio, which are exchangeable for 1.442 shares of
the common. Buy up to 52.
Tele-Income Plays
Debt has been
the downfall of scores of communications companies over the past
year. Former pillars of financial stability like AT&T, British
Telecom, Deutsche Telekom, France Telecom and Telecom
Italia have seen their credit ratings crumble from AAA toward
junk status. Dozens of their smaller rivals have been forced
to close their doors, and we probably haven't seen the worst.
The good news is intermediate-term bonds of many promising companies
now feature yields well into double digits. As long as they survive
until the bonds mature, investors in the following four securities
Citizens Communications 8.5 percent notes of 5/15/2006 ($104.01),
Global Crossing 6.375% Conv Pref (OTC GBLXO $45), Nextel
Communications 10.65% Sr Disc Notes (NXTL $70.75), and Williams
Communications 11.88% Sr Notes of 8/8/10 (WCG $42.21) will
enjoy huge cash returns with little inflation risk.
That's a very good bet. Utility Forecaster's Income Spotlight
Citizens Communications 8.5 percent notes of May 15, 2006
are by far the safest pick. Global Crossing and Nextel
are still bleeding a river of red ink. But both are now past
their major capital spending phases and are nearing profitability
as they add customers.
Only Williams
Communications poses a major default risk. But a cash infusion
prior to the spinoff from its parent Williams Companies should
give it enough breathing room for the industry to rebound and
its state-of-the-art network to sell its abundant capacity. Yielding
more than 30 percent, its bonds are only suitable as a speculation,
however.
The newly issued
tracking stock for WorldCom's long distance operations, MCI
Group (Nasdaq MCIT $17.92) is slightly lower risk income
play, boasting a yield of 13.3 percent.
The risk is MCI's revenue stream from long distance could fall
too fast for the company to make it up in local phone and small
business operations. The threat that poses to the dividend has
already landed the stock on the Dividend Watch List. But aggressive
income players in search of a telecom bet won't do much better
than buying MCI up to 20.
Editor's Note: Roger
Conrad is editor of the Utility Forecaster, 1750 Old Meadow
Rd., Ste. 301, McLean, VA 22102, 1 year, 12 issues, $129.
