High Above the Earth
By Monica Rivituso
January 23, 2003
yahoo.smartmoney.com
A STRING OF dreary trading days has managed to cast a shadow on 2003's brief, sunny run. It took only five downbeat sessions to wipe out the Dow Jones Industrials' 500-point, or 6%, gain since the beginning of the year. The Nasdaq might still be hanging on to a meager 1.8% gain, but the broader Standard & Poor's 500, too, has dipped its head back underwater — familiar territory after three consecutive years of losses.
Yet surprisingly, a handful of names in the famously beaten-down wireless sector are sporting some healthy returns of late. In 2002 — when the Dow, S&P and Nasdaq shed 16.8%, 23.4% and 31.5%, respectively — Nextel Communications (NXTL) tacked on 5.4%. So far this year, it's up nearly 15%. Likewise, AT&T Wireless Services (AWE) has surged 19% in January. Sprint PCS (PCS) is also sitting on a gain for the year, albeit a fractional one.
Are we headed back into a telecom boom? Hardly. Has there been fantastically optimistic news on the industry's near-term prospects? Nope. Has a rich new market opened up, promising heady growth? Um, no.
So what gives?
For starters, investors punished these stocks roundly last year, Nextel notwithstanding. Sprint PCS plummeted 82% in 2002, while AT&T Wireless shares suffered a 61% slide. "The reality is that these stocks fell too far, too fast in the summer months and had been left for dead," says Morningstar analyst Todd Bernier. "That said, the fundamental problems haven't gone away."
Indeed, concerns still weigh on these companies, in varying degrees. Nextel is in better shape than most, thanks to its proprietary technology that allows customers to use their phones as "walkie-talkies" — a feature that's attracted a strong following among small businesses. But that doesn't promise rapid sectorwide growth, or anything close. "We think the gains of 2003 will be short-lived," says Todd Rosenbluth, wireless-services equity analyst at Standard & Poor's.
Most of the industry's issues are longstanding, to be sure. Voice service has become a virtual commodity, with many competitors chasing a stagnant pool of customers. As a result, pricing is plummeting. That's especially troubling for a sector that never managed to make big profits in the first place and has wracked up massive debt in recent years. (At least AT&T had a century of monopoly rule before competitors began driving prices toward zero in the 1980s.) Analysts expect Nextel, the sector's frontrunner, to post a profit of 64 cents a share in 2003 — after nearly a decade of massive losses. Consensus estimates show AT&T Wireless is expected to earn a penny a share in fiscal 2002 (excluding goodwill) when it reports fourth-quarter results Jan. 28 and seven cents a share in 2003. As for Sprint PCS, Wall Street isn't forecasting profitability until 2005.
There's been endless talk of the need to consolidate, but very little action on that front. "It's like playing a rich poker game," says Bernier. "The more money you have in the pot, the less likely you are to drop out." BellSouth's (BLS) disappointing news Thursday that Cingular Wireless — its joint venture with SBC Communications (SBC) — lost customers for the second straight quarter will undoubtedly kick up old rumors of a linkup with Deutsche Telekom's U.S. subsidiary T-Mobile USA. The fact that Cingular continues to bleed subscribers isn't encouraging, given how this industry has focused much of its energy on grabbing customers from competitors. That's why carriers have become so heavy-handed with their promotions. It's great for consumers who can get more free minutes for their buck, but it's crushing for this industry's financials.
With voice-service pricing falling rapidly, carriers not only need ways to differentiate themselves from one another (as Nextel has with its "walkie-talkie" feature) — they also need brand new revenue streams. Enter mobile data. For years, the prospect of using cellphones to send and receive big chunks of data (be it text, pictures or music) at high speeds over the Internet has been viewed as the industry's Holy Grail. But it's been more like a Holy Snail, with progress coming slowly. Carriers have been reluctant to shoulder the capital burden of upgrading networks when demand for newer services remains so cloudy. AT&T Wireless announced last month that it was paring back its schedule for next-generation networks. Instead of upgrading networks in 13 cities by mid 2004 to support high-speed mobile data, the company now plans to upgrade just four.
"It's early 2003 — the calendar is still really fresh," says S&P's Rosenbluth. "There's a lot of hope that things will be better, that the fundamentals will improve, that there may be less competition. But I think as companies begin to report results, investor optimism will wane."
Others, however, are more optimistic. Legg Mason analyst Craig Mallitz says the market has already discounted the sector's myriad ills, and companies are beginning to improve their cash flow. Nextel, for example, is expected to be cash-flow positive for the second consecutive quarter when it reports fourth-quarter results in late February. By 2004, Nextel, AT&T Wireless and Sprint should all be free-cash-flow positive, according to Mallitz. Based on his 2004 estimates, Nextel trades at seven times free cash flow, while AT&T Wireless and Sprint — less efficient companies — carry multiples of 12 and 13, respectively. Given the jump Nextel has in generating free cash, Mallitz still finds its stock attractive at current levels. (Mallitz owns shares of Nextel; Legg Mason has no investment-banking ties to the company.) "From a free-cash-flow basis, you're at the early stages where you're going to see things accelerate," he says.
But remember: This industry has skyrocketed before. Investors would do well to know where the emergency exits are, just in case. |
