| Telecom Services (OPENX) : Way back in June, Briefing.com upgraded the telecom services sector to Outperform. Specifically, we were more positive on the prospects for the financially sound names in the telecom group. The logic was that they were poised to benefit from the demise of their upstart competitors. Though demand growth was shrinking due to the weak macroeconomic environment, supply was shrinking even faster due to the financial duress being experienced by so many service providers. The latter supply argument has been borne out by the continued string of failures in the telecom industry. But demand weakness has been worse than expected, both before Sep 11 and certainly moreso after the 11th. This demand weakness (relative to expectations) has been much more severe on the data side of the business than on the legacy voice business. Hence the damage to Qwest (Q 17.55) and Broadwing (BRW 9.84), both companies that we liked due to their combined exposure to the cash-rich local voice business and the fast-growth long-haul data business. We were wrong on both, as the data business has seen disappointing growth due to the weak economy. But we were right to believe that financially stable RBOCs and long distance providers could outperform the market. The group has certainly not prospered, but it has outperformed, with VZ, SBC, BLS, T, and FON all falling by low-mid single digit percentage rates since our June update, while the S&P 500 is off 13%. WCOM is an exception, as it has shed 25%. Looking forward, we are standing by our Outperform rating on the sector, and reemphasizing that financial stability is the primary criterion for investment in the sector. We still believe that Q and BRW are sufficiently stable to be included on this list, with Q a safer bet then BRW. And certainly the RBOCs qualify. With the likelihood that we are now closer to an economic trough, this sector still offers long-term promise and can benefit from the reduction in supply which sets the stage for a better pricing picture when growth returns. Our track record since June on this sector has been sub-par, particularly with the Q/BRW calls, but most of these issues are cyclical demand problems which will be resolved with an upturn in the cycle, and we continue to believe that the market is undervaluing the benefits to be enjoyed by incumbents due to reduced supply. - Greg Jones, Briefing.com |
