Telcos Look Ready to Bounce Back

05/09/2007 12:00 am EST

Focus:

George Putnam

Editor, The Turnaround Letter

George Putnam III, editor of The Turnaround Letter, says telecom companies have a lot of advantages in their battles with cable operators, and investors don’t seem to be giving them credit for it.

After years of concern about the cable companies invading their turf, the big telecom companies are now well-positioned to fight back. Most of them have thriving wireless businesses, which are constantly rolling out new services to generate more revenue. They are laying fiber optic cable to the home, which will allow them to offer a host of new video and data services.

Most of the telecom companies have solid balance sheets that will support the fiber rollout and implementation of new technologies. In contrast, the cable companies are highly leveraged and are stuck with their older, coaxial cable networks that may not be able to handle the full spectrum of future services. The phone companies also have great brand recognition and reputations for reliable service that position them well as they roll out new products.

Despite these potential advantages, the telecom companies trade at much lower valuations than the cable operators, [many with] price-to-sales ratios of below 1.3x, compared with over 3x for leading cable companies like Comcast and Time Warner Cable. Also, many of the telecom stocks pay generous dividends, while the cable companies are forced to use their cash to service their heavy debt loads.

AT&T’s (NYSE:T) recent merger with BellSouth gave it complete control of Cingular Wireless (since renamed AT&T Wireless), a leading wireless carrier that will account for about 35% of AT&T’s revenues. With revenues expected to be north of $120 billion in 2007 and substantial operating cash flow, AT&T (formerly SBC Communications) is a force to be reckoned with. The dividend was just raised for the 22nd consecutive year, and the company is expected to repurchase roughly $7 billion worth of stock in 2007. (The stock traded at $39 and change Tuesday—Editor.)

Qwest Communications International (NYSE:Q) is arguably in a tougher competitive position relative to its peers, as it is generally more reliant on traditional landline revenues (63% of total in 2006) [and] its wireless segment—it is actually a reseller of wireless services using Sprint’s network—remains rather small (4%). Its triple-play bundling package of voice, data, and video is being provided via satellite in partnership with Direct TV. However, as the smallest remaining Baby Bell, Qwest could be an acquisition target. (Qwest’s stock sold near its 52-week high of just below $10 on Tuesday—Editor.)

Verizon Communications (NYSE: VZ) is aggressively rolling out fiber connections with plans to reach 17 million homes by 2010. As the rollout progresses, Verizon could emerge as the leader in the quest to offer the “triple play”–voice, video and data. Wireless operations are provided through its 55% joint venture with Vodafone. Despite Verizon’s potential, the stock has languished for several years. With a yield over 4%, the stock is an attractive choice for conservative investors. (The shares changed hands just above $40 on Tuesday—Editor.)

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