Why U.S. Telecom Is Losing Juice

Growth is sputtering because so many people already have cell phones and broadband. A shakeout ahead?

For the U.S. telecom industry, January has been bloodier than a Quentin Tarantino movie. After leading the market for most of 2007, telecom stocks have been beaten to a pulp this month, with the Standard & Poor's Telecom Services index off 10%. That's more than the Dow, the S&P 500, even the much- pilloried investment banking index.

What's going on? In a nutshell, the industry's two growth engines for the last decade—wireless and broadband—are sputtering. Fact is, more than 80% of Americans now have a cell phone, and 79% of homes with a PC have broadband service. This year, according to Banc of America Securities (BAC) analyst David Barden, wireless subscriber growth is expected to drop to 7%, the first year ever in single digits. Broadband subscriber growth is expected to hit 12%, down from 18% in 2007.

To be sure, AT&T (T) and Verizon Communications (VZ), the industry's two giants, reported solid fourth-quarter earnings and respectable outlooks for 2008. They may be more insulated than rivals such as Sprint Nextel (S) and Qwest Communications (Q). Still, with the economy expected to slow in the months ahead, the challenges with wireless and broadband will have a significant impact on the way communications companies operate and compete.

Most important, with fewer new customers signing up for those services, companies must figure out how to get existing users to write bigger checks. Innovation and investment in new technologies will be more important than ever. For the wireline players, that means upgrading networks to offer faster Internet connections and new services, such as TV over fiber-optic lines. For the wireless sector, it means persuading customers to use their phones for more than just voice conversations and also to tap into the Net for maps, games, and other information.

Look for the strong players to get even stronger—and not only because they have larger war chests. Their scale gives them other advantages, including savings on equipment and first dibs on hot new products. AT&T's exclusive deal to sell Apple's (AAPL) iPhone helped it sign up a record 2.7 million wireless subscribers last quarter.

The competition is going to get even rougher. Several investors are afraid that the troubled Sprint could launch a price war in an attempt to regain falling market share. The wireless carrier is testing an all-you-can-talk plan under its Boost Mobile brand for $55 a month in a dozen states. "If they make that a national offering, all bets are off," says Todd Rosenbluth, an analyst with Standard & Poor's (MHP).

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