Cutting the Line in Telecom

S&P's Todd Rosenbluth says wireless has the edge over wireline. So what's old-timer AT&T doing among his picks?

In the world of telecommunications stocks, wireless operations increasingly have an edge over the traditional wireline companies. Todd Rosenbluth, Standard & Poor's analyst of telecom stocks, points out that so far in 2004, wireless stocks are up 25% against a 6% drop for the wireline names. On balance, S&P now recommends a market-weighting for telecom in investor portfolios, he adds.

Among the stocks Rosenbluth personally covers, S&P has a buy rating on Alltel (AT ), whose wireline margins are among the industry's best, and on AT&T (T ). He views AT&T shares as undervalued in light of its plan for a wholesale wireless offering under the AT&T brand by yearend and of its market potential in the new VoIP (Voice over Internet protocol) services, which it it has recently been rolling out in markets such as Atlanta and Chicago.

Baby Bells such as BellSouth (BLS ) and SBC (SBC ) draw an avoid recommendation from Rosenbluth, and the best rating in that group -- a hold -- goes to Verizon Communications (VZ ).

These were a few of the points Rosenbluth made in an investing chat presented June 8 by BusinessWeek Online and Standard & Poor's on America Online, in response to questions from the audience and from BW Online's Jack Dierdorff. Edited excerpts follow. A full transcript is available on AOL at keyword: BW Talk.

Note: Todd Rosenbluth is a Standard & Poor's Equity Analyst. He has no ownership interest in or affiliation with any of the companies under discussion in this chat. All of the views expressed in this chat accurately reflect the analyst's personal views regarding any and all of the subject securities or issuers.

For required disclosure information and price charts for all S&P STARS-ranked companies, go to www.spsecurities.com and click on "Investment Research," and then click on "Required Disclosures & Standard & Poor's STARS vs. Closing Prices Charts."

Q: Todd, telecom has had its ups and downs in recent months, as has the broader market. How's your sector looking these days?

A:

As you noted, the telecom sector has bounced around year-to-date. Thus far in 2004, the telecom-services sector is down fractionally, underperforming the S&P 500 and S&P 1500. But when you look closer at the sector, there has been a divergence between wireline and wireless telecom stocks.

Indeed, the wireline subindustry has fallen nearly 6% as of early June. Meanwhile, the wireless subindustry climbed 25%. S&P Equity Research recommends investors take a market weighting of telecom in their portfolios.

Q: What's your outlook (six to 12 months) for Sprint (FON )?

A:

S&P has an avoid recommendation on Sprint FON shares. As I'm sure most are aware, Sprint has recombined its wireline and wireless operations in one stock, now Sprint FON. Given our view of Sprint's lack of leadership in the local, long-distance, or wireless markets, we find the shares' current premium to telecom peers on a p-e basis as unwarranted.

Q: What are your thoughts on BellSouth (BLS )?

A:

S&P has an avoid recommendation on BellSouth shares as well. The company's access-line losses remain a concern to us, and we see future profits for BLS hurt by discounted bundled offerings and the company's planned integration of AT&T Wireless (AWE ). BLS is one of the parent companies of Cingular Wireless, which as you know has agreed to acquire AWE, pending regulatory approval.

Q: Should I buy AT&T (T ) under $17? What's your opinion of T going forward?

A:

On the flip side of the other recommendations, we have a buy recommendation on AT&T shares. We view positively AT&T's agreement to provide its customers a wholesale wireless offering toward the end of 2004. We believe that the use of a strong AT&T brand will attract wireless consumers and allow AT&T to pick up market share.

Together with new VoIP [Voice over Internet Protocol] services, we contend that AT&T will be able to offset some of its competitive pressures in the long-distance market. On a variety of metrics, we believe AT&T shares are undervalued.

Q: Opinion on Nextel (NXTL )? Do you think NXTL is a takeover candidate, and what's your feeling about its stock price?

A:

I'm not the primary analyst on Nextel...so the following reflects my colleague's opinion. S&P has a buy recommendation on NXTL shares. S&P believes NXTL shares are priced well below the market, using our $2.10 2004 EPS [earnings per share] estimate. S&P recommends investors buy NXTL on our view of its strong operating outlook.

Q: Any thoughts on Nortel Networks (NT )?

A:

S&P has a hold opinion on shares of Nortel Networks. We believe uncertainty about its financial past performance and outlook may have a negative impact on its competitiveness in the global wireless market. NT shares are priced below peers', using our 2004 sales estimate, but given regulatory risks, S&P is recommending to not add to positions.

Q: I've held Ericsson (ERICY ) for several years now, and although I suffered through the misery times, I can't be happier. What do you think the future holds?

A:

S&P has an accumulate (4-STAR) recommendation on shares of Ericsson. S&P is encouraged by Ericsson's higher margins and continued cost cutting and recommends adding to positions. I must note that Ericsson is covered by one of my colleagues.

Q: I work for Verizon (VZ ) -- have all my money in my 401(k) on VZ. Any thoughts on VZ?

A:

We have a hold recommendation on shares of Verizon Communications. We anticipate that the company will have continued strength on the wireless side of the business as broadband offerings are launched on a national basis. However, we view Verizon's wireline operations as challenging and expect the the rules regarding the wholesale rates Verizon must offer to competitors will be appealed to the Supreme Court. We do note that there are a number of telecom stocks that have more favorable outlooks, as well as stocks within the broader market.

Q: What are the prospects on SBC (SBC )?

A:

We have an avoid recommendation on the shares. We see challenges for SBC regarding its relatively high labor costs, its aggressive bundled service offerings, its planned integration of AT&T Wireless into its Cingular Wireless product, and its earnings quality. We see additional competitive risks from wireless and cable telephony. We have a 12-month target price on SBC of $20 and would avoid the shares.

Q: Is the future bright for any CLECs [competitive local exchange companies], either publicly or privately held?

A:

S&P does not follow analytically any pure CLECs. However, you have already noticed our buy recommendation on AT&T shares. AT&T is providing competitive local service in many U.S. states, and we believe this service is helping to offset AT&T's long-distance challenges.

As for the broader CLEC industry, we expect news to affect it in the near term, as the rules regarding the wholesale rates the CLECs pay to use the Baby Bell networks are likely to be appealed, in our view, to the Supreme Court in the next few weeks. The rules for wholesale rates significantly affect the CLEC industry, and investors should keep an eye out for a decision.

Q: What kind of growth do you see in consumer VoIP in the next six to 12 months -- and through what sales channels?

A:

Consumer VoIP has started to pick up steam. We...are encouraged that AT&T has been rolling VoIP out in major metro markets, such as Atlanta and Chicago, in recent weeks. We believe that VoIP will add to the competitive pressures facing Bell companies such as SBC and BellSouth.

It's also noteworthy that cable companies, which are battling aggressively with the telcos for communication revenue, have begun trials and rollouts of VoIP throughout the country.

Q: You've said AT&T is a buy -- other 5-STAR telecom companies you follow?

A:

Among the companies that I follow, the other telecom company with a buy recommendation is Alltel (AT ). We believe Alltel is facing a more favorable operating arena than the Baby Bells. Alltel's access lines have held relatively steady over the past few years, and we see this continuing throughout 2004, keeping Alltel's wireline EBITDA [earnings before interest, taxes, depreciation, and amortization] margins among the industry's best. We have a 12-month target price of $60 on Alltel shares.

I previously mentioned a buy recommendation my colleague has on Nextel. And it's also worth noting our buy recommendation on Nextel Partners (NXTP ). NXTP provides wireless services using the Nextel brand name in midsize and rural markets throughout the U.S.

Among the other telecom-related buy recommendations S&P has is Motorola (MOT ). MOT is priced below peers, in the view of S&P, based on our 2004 sales estimate. We're also encouraged that today MOT introduced mass-market clamshell handsets that are complete with a camera and offer multimedia messaging services.

S&P also has a buy recommendation on Avaya (AV ) shares. My colleague who follows AV views it as an attractive play on the upward enterprise spending cycle toward Internet telephony.

Q: Whom do you like in cable-TV companies, if anyone?

A:

I don't follow any of the pure-play cable companies. As I have ownership interest in one of these names, I'm not going to comment on any of their prospects.

There are some telecom companies that we follow that offer a cable product, including the Alaskan communications company General Communications (GNCMA ). We believe GNCMA has done a good job bundling its local and long-distance telecom services with its cable product offering. S&P has a hold recommendation on GNCMA shares.

Q: What are your thoughts on UTStarcom (UTSI ), long-term?

A:

S&P has an accumulate recommendation on UTSI. We expect profitability to improve throughout 2004 on reduced product costs and an increased mix of revenue outside of China. One of my colleagues follows UTStarcom shares.

Q: In the fast-moving world of wireless, will broadband or other new developments shuffle the deck anew? The leading edge keeps moving, so to speak.

A:

We're encouraged that Verizon Wireless is putting capital toward its EV-DO product launch. EV-DO stands for Evolution Data Optimized. This is a CDMA network upgrade, which provides faster broadband connections than what Verizon is currently offering its subscribers. We believe that data services that are part of EV-DO provide growth potential for Verizon Wireless and will be carefully watching this broad offering of services throughout the nation.