Telecom stocks have rung up gains of 28% since hitting a low in mid-March. Could this rally mark the end of the three-year death spiral that has erased 70% of the sector's value? Not for all of telecom, of course, but there are good values among wireless players, cable specialists, and some local providers. Says analyst Erik Zamkoff of TheStreet.com's (TSCM ) Independent Research Group: "It's a matter of finding the gems among the rubble."
Lesser-known outfits are a good place to dig. Alltel, a Little Rock (Ark.) wireless and local provider, is the dominant player in the Midwest and Southern markets it serves. Alltel boasts better fundamentals than huge Baby Bells such as Verizon Communications and BellSouth, says Todd Rosenbluth, a Standard & Poor's equity analyst. It posted a 17% jump in both year-on-year first-quarter profits and revenues, to $227.6 million and $1.91 billion respectively. Its earnings are growing at 7% a year, vs. flat or declining earnings for its peers, yet the stock trades at roughly the same multiple -- 15 times next year's earnings.
Now that the industry has sunk $70 billion into building infrastructure, companies developing services and applications to run on that network have the best prospects. "It's a big fat interactive pipe into the consumer's home," says Zamkoff. "Broadband data and video-on-demand are nice businesses, but the big payoff is cable telephone." Cable telephone uses the cable system to carry calls, often circumventing the local provider. Zamkoff's favorite pick is Arris Group, an emerging leader in cable-telephone gear. Based in Duluth, Ga., Arris, which is second only to Cisco Systems in so-called CMTS devices, is expected to get more orders than Cisco from key customers such as Comcast and Adelphia Communications (ADELQ ) The stock trades at $4.80 a share, and Zamkoff's 12-month target is $7.
Marquee names still make the cut for some money managers, and Cisco is a good example. At $18, the shares sell at 25 times next year's earnings, which are expected to grow by between 8% and 12% a year. "It's pricey because it's a high-quality company," says Robert N. Gensler, manager of T. Rowe Price Media & Telecom (TROW ) fund. The $500 million fund is No.5 among telecom funds, up 21.8% so far this year. "Cisco is just exceedingly well-placed to continue to take market share," he adds.
HEADING ABROAD. In telecoms, international outfits often can be better bets than their U.S. counterparts because they face less competition. While six national carriers and a host of local players duke it out in the U.S., the British wireless company Vodafone has unmatched stature in Continental and Asian markets. "For a market leader with earnings growth close to the midteens, they're giving this stock away," says Gensler about his top holding. To him, the $20 stock would have to jump by more than half before he would think it was pricey. S&P's earnings-per-share estimate for fiscal 2004, which ends next March, is $1.30, up 20% from 2003. The stock trades at about 16 times next year's earnings, while AT&T Wireless Services (AWE ) sells at a multiple of 33. S&P's 6-to-12-month target for Vodafone is $27. Other international players hold similar promise, including NII Holdings, of Reston, Va., which provides services to Latin American markets, Mexico City-based America Movil, and SK Telecom, a Korean mobile provider.
THE REWARDS OF PATIENCE? Bold managers say it's time to dip into some of the most famously beaten-down stocks. Zamkoff is bullish on Nortel Networks, which is focusing on technology that converges voice and data traffic on one network. Nortel, which made a huge investment in its optical business before the sector crashed, returned to profitability this year. Meanwhile, competitors such as Lucent Technologies continue to redefine themselves. Nortel's shares still trade at just $3, down from a peak of $87 in July, 2000, but Zamkoff's target is $3.75. "The market does not fully recognize the value of Nortel's product portfolio," he says.
Even Lucent may be worth a chance. Kevin Rendino, managing director at Merrill Lynch Basic Value Fund, sees Lucent, which at $2 a share is 97% off its December, 1999, high of $65, as a value play. The Murray Hill (N.J.) company has slashed its workforce by two-thirds, to 38,000, cut operating expenses from $2.9 billion in the fourth quarter of 2000 to $700 million in the quarter through Mar. 31, and has probably put its worst days behind it. "It's a painful wait, but we think it'll make sense," say Rendino.
Weighed down by depressed earnings, telecom stocks are still expensive, trading at 51 times estimated 2003 earnings and 33 times 2004 estimates. But those lofty prices haven't put off Leuthold Weeden Capital Management, which also is scouring the telecom world for survivors. The money manager's top picks among equipment makers: ADC Telecommunications and 3Com (COMS ) Leuthold analyst Eric Bjorgen says 3Com is shifting its sales and marketing away from the telecom carriers toward the corporate market. In addition, he believes that a partnership with China's Huawei Technologies will turn 3Com into a leading information-technology provider in that country.
However, most telecom contrarians are taking extra precautions. They're steering clear of the equipment makers that are still digesting their intemperate capital spending of the 1990s. And they're avoiding large, U.S.-based telephone companies and wireless providers that are locked in a fierce battle over a fixed number of customers. But investors who call up the right stocks can avoid most of the static in this neighborhood.
By Mara Der Hovanesian