Telecom stocks are back from the dead. During the past three years of bankruptcies, scandals, and lousy stock market returns, the industry has been busy cutting costs, restructuring debt, and launching new services. Now, the Standard & Poor's (MHP ) Telecom-Services Index is up 4.6% so far this year against an overall market that has been flat.
But while the climate has improved, the industry is still fiercely competitive. AT&T (T ) says its cash flow will decline sharply this year and next. And MCI (formerly WorldCom) is expected to put more pressure on prices when the company emerges from bankruptcy in April with much of its debt forgiven. Still, many investment pros think the worst is over and that long-term winners are emerging. The next year or two may be tough on earnings even for the well-positioned companies, but dividend yields as high as 5% can help tide investors over. Telecom "is a much safer place than it was three years ago," says Kaufman Brothers analyst Rick Grubbs.
For a while, with competition from wireless, cable TV, and long-distance rivals, local phone companies didn't look so safe. But Lehman Brothers (LEH ) telecom analyst Blake Bath says recent offerings that bundle long-distance and wireless services, Internet access, and TV provided by satellite partners will allow the two largest local companies, Verizon Communications (VZ ) and SBC Communications (SBC ), to boost revenues and stem customer losses.
Their sizable wireless businesses, meanwhile, should continue to see strong growth. Bath figures Verizon's overall earnings will fall 6%, to $2.45 per share this year, before climbing 14% in 2005. He expects SBC to see flat earnings this year and next largely due to its expected $41 billion purchase of AT&T Wireless Services (AWE ) with BellSouth (BLS ). But by 2007, the deal is expected to add to SBC's earnings as its wireless business realizes as much as $2 billion a year in savings from lower marketing and equipment costs.
With AT&T Wireless being acquired and Sprint PCS Group (PCS ) stock recombining with its parent company, Nextel Communications (NXTL ) is the only pure-play national wireless player left in which to invest. Janco Partners telecom analyst Thomas Friedberg estimates Nextel's earnings will jump 50% this year, to $2 a share, thanks to continued subscriber growth and cost containment. He thinks the stock would be worth $35 per share -- 40% more than its current price -- if Verizon, Sprint, or Vodafone (VOD ) wanted to snap it up. One note of caution: Industry sources say the Justice Dept. may be investigating Nextel's dominance in push-to-talk technology, but Friedberg doesn't think the investigation will turn up anything negative.
Unlike Nextel, Alltel lacks a national wireless presence. But the Little Rock company has a deal with Verizon that allows it to offer flat-rate national service to its 8 million wireless subscribers located mostly in small towns. The company has shifted its marketing emphasis from price to network quality and coverage, and that has led to higher revenues and better customer retention. Morgan Keegan analyst Tavis McCourt figures the company will see earnings of $3.15 per share this year and $3.33 next.
Rural phone providers are isolated somewhat from the intense competition in larger cities. For that reason, CenturyTel (CTL ) is a pick of Morgan Stanley (MWD ) analyst Jeannette Baez. Based in Monroe, La., the company provides local service to 2.3 million customers in 22 states. Baez expects earnings to stay flat at around the $2.14 per share this year and next. Even though the stock recently got a boost when the company announced a $400 million stock repurchase program that could retire up to 11% of the shares, at $28, it trades at a 17% discount to the average Baby Bell's multiple of 16 times estimated 2004 earnings.
Telecom companies won't offer the rip-roaring growth they did in the late 1990s. But an improving economy and the introduction of new services should deliver respectable returns for investors.
By Christopher Palmeri