Failure to Communicate
By James B. Stewart
November 30, 2004
IN CASE YOU HAVEN'T noticed, the market has pretty much been treading water since I called attention to the post-election euphoria1 of a few weeks ago. I've noticed that the big market moves recently have tended to come in short-term bursts of trading, which make it more important than ever to anticipate rather than follow trends, which is one of the aims of this column. Even in a market of short attention spans, long-term thinking is critical.
This is the rationale behind my recent and longer-term investments in the telecommunication-equipment sector, one of the most beleaguered segments of the economy. I'll be the first to admit that my holdings in this area have gone nowhere, including Nortel Networks (NT2), whose stock I both own and have recommended in this column. Nortel got up to about $4 before plunging anew after announcing that it was delaying yet again its financial restatement. It's now hovering just under $3.50, about what I paid for it, and a level that I've invoked before as a buying opportunity.
I continue to closely scrutinize Nortel's announcements of further delays in its accounting review, and while its failure to restate its earnings as promised has shredded the company's credibility on Wall Street, I continue to believe that the underlying business is sound, and that the results, when they finally do appear, will be reassuring. (The company's next pronouncement on the subject is scheduled for next week.) I recognize that this is a dwindling view, and agree that the company's repeated broken promises are inexcusable. I can only hope that Nortel's dealings with its customers are more professional and reliable than this hapless performance with its investors. That said, I'm still willing to give it the benefit of the doubt that the accounting issues are so esoteric that there's been no ready resolution. And far better to get the restatement right, no matter how long it takes, then to get it wrong and have to do it all over again.
Nortel's accounting issues aside, you might well ask why I'm even bothering with any company in the telecommunications sector, which has been plagued by overcapacity, ruthless price-cutting, nonsensical government regulation and high-profile bankruptcies. The reason is that I believe communication is and will continue to be a mainstay of the evolving global economy, a fundamental human need. It is marked by rapid technological innovation, growing consumer and business demand, and a convergence of related businesses, from entertainment to banking to shopping. I have no idea where all this is headed, but I'm convinced that someone is going to make money from it.
I also like telecommunications for the simple reason that almost no one else does, which means that stocks are cheap. Two weeks ago I reported3 selling some positions with big profits. I like to use the proceeds to buy something out of favor, and telecom fits the bill. Not that I do this blindly. I can be a contrarian at times, but I also recognize that most stocks are cheap for a reason. The immediate trigger for my recent buying was the announcement by SBC Communications (SBC4) that it was spending $4 billion to build a fiber-optic network into homes.
You may not remember George Gilder, the technology guru whose "Gilder Technology Report" was awaited breathlessly by ardent traders riding the crest of the late-90s technology bubble, but I do. Few things excited Gilder as much as the promise of fiber-optic cables into the home, except maybe satellite communications. The collapse of the bubble discredited Gilder's stock picks, but I'm not sure his analysis was so far off the mark. It was just premature. The fact is that fiber-optic cable does offer enormous advantages in speed and capacity, something that the local Bell customers are likely to discover when they go to download a movie on their DSL lines, which I predict will soon be as outdated as cable modems.
If SBC succeeds with its fiber-optic cable rollout, and I predict it will, the market for telecom gear is going to burgeon way beyond the $4 billion it has already committed. SBC hasn't said just where it's spending the money, but the food chain of companies who supply this kind of equipment is well-known. Corning (GLW5) makes the glass fiber. Ciena (CIEN6) and JDS Uniphase (JDSU7) produce some critical components, as do Lucent Technologies (LU8), Nortel and Alcatel (ALA9). Cisco Systems (CSCO10) and Brocade Communications Systems (BRCD11) make routers. I already own Cisco, Corning and Nortel. A few weeks ago I added JDSU, Lucent and Ciena. You don't need to put a lot of money at risk. Ciena was recently trading at $2.55, JDSU at $3.18 and Lucent at $3.98 (about where they were when I bought them). What else can you buy for that kind of money?
I recognize that my endorsement of these companies is highly contrarian; it's hard to find anyone on Wall Street who likes them. Are these stocks likely to take off tomorrow? I doubt it. It may take years to determine if my theory is right. But I plan to be patient, and look forward to the day when I'll have a fiber-optic line into my own home.
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