By Olga Kharif If you think it's a good time to buy tech stocks, take a look at telecommunications before putting money on the table. Telecom shares may indeed be bottoming out, as some analysts contend, but at the moment investors have no sure guides to turn to. The reason: Telecom analysts, who recommended WorldCom, Global Crossing, and other star-crossed companies, have lost all credibility.
With scandals and earnings shortfalls spreading like a flu epidemic, it's nearly impossible to tell good companies from bad, or to know if the crisis of confidence will end anytime soon. Explains Jeffrey Carmen, a Manlius (N.Y.) behavioral psychologist: "I don't think anybody trusts anybody anymore."
One reason is that, amazingly, the promoting of telecom stocks continues -- despite the bankruptcies, accounting fraud, and other scandals that have plagued the sector. Dave Sherry, portfolio manager with the $140 million EGM Communications & Technology Strategy hedge fund in San Francisco, found that out last month.
DUBIOUS ADVICE. Just two hours before wireless services provider Sprint PCS (PCS) admitted that growth in its customer base was slower than expected, Sherry received a visit from a broker peddling the stock. Luckily, he decided against buying. Following the June 13 news, Sprint's share price slid 27%, to $4.40, and it has since remained in the dumps.
All too often, bullish analyst assessments are still the norm -- for doubtful performers as well as solid ones. It seems reasonable on its face that 15 of 27 analysts recommend the world's largest cell-phone maker, Nokia (NOK). While the Finnish company on June 20 cut its sales estimates for the second half of 2002 to 10% growth, from 15%, it's also the dominant company in a dynamic market niche.
However, what should investors make of the fact 17 of 41 analysts covering telecom-equipment maker Nortel Networks (NT) rate it a buy or a strong buy? That's down from 20 two weeks ago, but it sure seems overly optimistic for a company that's one of WorldCom's major suppliers.
OFFENDERS. Skepticism of analysts is warranted, since the reckless boosterism of the recent past made the telecom sector one of the most treacherous in the entire market. As recently as mid-June, several analysts were still hailing WorldCom as the best investment in telecommunications. "They are in the midst of a turnaround," declared Vik Grover, an analyst with Kaufman Bros., who did not return repeated calls from BusinessWeek Online regarding his assessment of the stock.
Salomon Smith Barney analyst Jack Grubman has been a highly visible offender. He recommended Global Crossing's shares until two months before the telecom services provider filed for Chapter 11, on Jan. 28. Grubman's $20 million annual salary and his being called to testify before Congress on July 8 make him stand out.
Grubman was far from alone, though. Even after WorldCom (WCOME) announced on July 1 that it might have to restate its financial results back to 1999 -- and saw its stock price dropped to 6 cents -- 2 of the 13 analysts following the company (from Robertson Stephens and Kaufman Bros.) still had a hold on its shares, rather than a sell recommendation.
FUND DISASTERS. Little wonder, then, that not one telecom analyst made it into the Top 10 list of stock pickers for 2001 at StarMine.com, which rates analysts (see BW Online, 7/10/02, "A Gold Mine of Analyst Info"). Most telecom analysts remained bullish even as the Nasdaq Telecommunications Index was in the midst of falling 59% since January, resulting in billion-dollar losses.
Mutual funds that invest in telecoms dropped an average of 40.3% in value since January, according to mutual-funds tracker Lipper. The net worth of 39 funds covered by Lipper fell to $2.7 billion at the end of May, from $4.1 billion at the close of 2001. "Those [analysts] pounding the table for 9 to 12 months -- I don't think they have credibility," says Sherry.
Still, some smart money is following telecom stocks these days. Gabelli Funds, which for years has done its own stock research, is overweighted in the industry, says Ivan Arteaga, a vice-president at Gabelli, managing about $170 million in telecom shares. Although far from a raging bull, Sherry also recently increased his telecom holdings to 30% of his total portfolio of tech stocks, from 15%.
BULL-SPEAK. What's the rationale for continued bullishness? "Not every company hides $3.8 billion in expenses and their auditor can't find it," reasons Patrick Comack, an analyst with Guzman & Co., who recommends several wireless companies. Also, most telecom stocks are dirt-cheap. Jeff Halpern of Sanford Bernstein recommends local-phone company SBC Communications (SBC), reasoning it's a solid outfit that has been beaten down with all the others.
Why should anyone listen to him? Analysts, who typically earn salaries well into the six figures to find out what's going on in the industry, have too often missed the obvious. "Given the magnitude, [the accounting irregularities at WorldCom] must have been transparent," says Lew Johnson, a finance expert at Queen's University in Canada. More likely than not, he says, some analysts simply haven't done enough legwork -- talking to vendors and suppliers to determine a company's health -- to support their ratings.
Others don't have the accounting background to dig deep and ask the tough questions, says Stephan Thomas of management consulting firm REL Consultancy Group. "Their job is not to make accurate predictions," says Benjamin Cole, author of The Pied Pipers of Wall Street: How Analysts Sell You Down the River (Bloomberg Press, 2001). "They are seeking investment-banking business."
Some analysts seem to have learned a lesson -- at least for now. David Burks, an analyst with J.J.B. Hillard, W.L. Lyons, is proud that for the past four months his firm has had a hold on all telecom-related stocks except one: He has a long-term buy on local-phone company Verizon (VZ). "There is seemingly no light at the end of the tunnel" for telecom stocks, Burks cautions. For now, investors are feeling their way forward in the dark. Kharif is a technology reporter for BusinessWeek Online in Portland, Ore.