Telecom: Stuck on Hold

The industry now seems even further from recovery. If you do want to invest, analysts recommend sticking with tried and true names

When the World Trade Center collapsed on Sept. 11, telecommunications providers with facilities located nearby suffered serious damage. Verizon, the primary local carrier in New York City and along the Atlantic seaboard, lost two major switching facilities loaded with pricey equipment. At least 10 Verizon cell-phone sites also went dark. AT&T lost equipment it had housed in one of the Trade Center towers. The terrorist attack touched other carriers by clogging their networks.

The destroyed equipment can be replaced. Unfortunately, though, the hit to the U.S. and world economies could push recovery in the slumping telecom sector back even further. Analysts say the last thing corporate customers are worrying about in the wake of the tragedy is buying new telecom services.

That could force carriers to cut their already-reduced spending on infrastructure. Telecom outlays will drop 15% to 20% this year, according to investment bank TD Securities. And in 2002, carrier spending in North America could fall an additional 27% compared to 2001, estimates Ken Leon, analyst with investment bank ABN AMRO. Before the Sept. 11 attacks, most analysts expected next year to be flat or even exhibit singe-digit growth. That could make life even tougher for producers of optical and telecom gear such as Nortel Networks (NT ) and Juniper Networks (JNPR ).


  The effects of the terrorist attack plus the slumping economy are turning into a lethal combination. On Sept. 25, broadband equipment maker Redback Networks (RBAK ) said its revenues for the current quarter could be as much as 30% below Wall Street's expectations of $50 million-plus, thanks to order cancellations immediately after the tragedy.

That followed a Sept. 21 announcement from ONI Systems (ONIS ), which cut its revenue projection even more. For the third quarter ended Sept. 30, the company expects to see revenues of $40 million to $50 million, down from an earlier estimate of $75 million to $80 million. ONI's announcement is particularly surprising, since it provides equipment for connections to individual homes -- a sector that has held up well despite the telecom slump.

Any uptick in demand for replacement gear after the World Trade Center disaster will be minuscule compared with such shorfalls, says analyst Charles Pluckhahn of investment bank Stephens Inc. The same goes for purchases of emergency backup capacity, for which the disaster might have pointed to a need. Few carriers can justify the extra expense: "We grow our network based on success in the marketplace," not with an eye on emergencies, says Royce Holland, chairman and chief executive of Allegiance Telecom (ALGX ).


  According to Yankee Group, carriers that do continue to buy in the wake of the attack might eschew newer, cheaper optical equipment that allows for faster transmission of phone calls and Internet traffic in favor of older systems. Although more costly, some companies believe the older equipment is more reliable and harder to bring down, explains Courtney Quinn, a senior analyst there. That could be bad news for producers of next-generation optical gear, such as Ciena (CIEN ) and Sycamore Networks (SCMR ). They specialize in "intelligent" optical equipment that can reduce costs but that analysts say is less reliable.

The deepening slump is rippling out to components makers that supply parts for optical switches and routers. On Sept. 19, the world's largest, JDS Uniphase (JDSU ), wrote off $5.3 billion in assets, including inventory. That came on the heels of a $38.7 billion write-off earlier in the year. And the company's housecleaning might not end there. Jay Patel, a Yankee Group senior analyst, believes the optical-components industry has five months of inventory it won't work off anytime soon.

Several rays of light shine through this darkness. Cell phones proved crucial both during and after the Sept. 11 disasters, and that's now boosting demand for wireless services. In the two weeks since the tragedy, many wireless carriers sold as many cell-phone service contracts as they normally move in a month. Yankee Group thinks 2 million more people than were previously expected will sign up for wireless services this year, bumping the total count to 130 million.


  Consumers also shopped in droves for chargers and batteries, according to a spokesperson at AT&T Wireless (AWE ). As a result, shares of cell-phone carriers have held up well, even posting small gains while the rest of the market fell. Unfortunately, analysts don't expect any long-term rise in sales of mobile service or phones.

The one bright spot analyst Alex Trofimoff of investment house Sanford Bernstein sees on the horizon is tele- and videoconferencing. "When people are traveling less, those services are going to be used more," he says. The global conferencing market, which is negligible today, will grow to $11 billion by 2005, according to multimedia consultancy Wainhouse Research -- though with the economy weakening, whether it'll hit that number remains to be seen.

The lesson for investors looking for telecom plays is to stay with tried and true names. Local and regional telecom carriers that still resemble utilities will offer 8% to 10% annual earnings growth, predicts Patrick Comack, an analyst with investment bank Guzman & Co. Morgan Stanley is recommending such familiar names as Verizon, SBC (SBC ), and BellSouth (BLS ), which is discussing a possible combination with AT&T (see BW Online, 9/27/01, "AT&T and BellSouth Talk Merger". Conferencing-service companies such as PictureTel (PCTL ), Polycom (PLCM ), and Wire One (WONE ) could also do well long-term, analysts say, but it makes sense to be wary of their stocks, since all have seen big runups lately.

"This disaster has highlighted the importance of telecom services," says Floyd Greenwood, an analyst with Prudential Securities. "I think there is a ray of hope." That said, investors will likely have to wait -- and wait, and wait -- to see that hope fulfilled.

By Olga Kharif in Portland, Ore.

Edited by Alex Salkever

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