what does sam stovall think?
"We forecast that CDMA is likely to be the protocol of the future because it offers cutting-edge technology at a reasonable cost."
Sam Stovall, Senior Investment Strategist at Standard & Poor's, Talks Telecom ? Part 2
Interviewed by Lauren Keyson
As we finished our salads at Harry's at Hanover Square, I steered my conversation with Sam Stovall toward the telecom industry's leading companies. Mr. Stovall, a member of Standard & Poor's investment policy committee, spots industry trends that will guide stock-market investment decisions over the coming six months to a year. In the first part of our interview, Mr. Stovall had painted a bullish outlook for the telecom sector. Now, I wanted the names of three to five companies that he considers the industry's key players.
[LAUREN KEYSON] Who are the telecom bellwethers? What companies should I be watching if I want to know where the industry is going?
Sam Stovall
Standard & Poor's
[SAM STOVALL] Well, certainly AT&T (T) and MCI WORLDCOM (WCOM). They're behemoths and they're running neck and neck in terms of being total providers. AT&T and MCI WORLDCOM are definitely going to be the leaders in long distance. I think it's going to be difficult for the Baby Bells to compete in this arena. The Bells don't have national coverage, and the long-distance companies have the more modern networks. What's more, the Baby Bells don't have a competitive nature, they just haven't had to compete the way the long-distance companies have.
Right now, AT&T and MCI WORLDCOM get about 60% of their revenue from long distance, where growth is 3% to 4% a year. That's pretty slow growth. Five years from now, most of growth will be in wireless. The two companies are staking their futures on wireless.
Incidentally, AT&T is also betting quite heavily on cable. It plans to take over MEDIAONE (UMG), a cable provider, having already acquired TCI, another cable company. What they're looking to do is go straight to the local consumer via cable, rather than the local telephone lines. In a sense, AT&T has gone right to the consumer and squeezed out the local Bell companies.
But back in the cellular world, MCI WORLDCOM is in the process of taking over SPRINT (FON) and then, mercifully, it will change it's name to just WORLDCOM. Probably the only pure wireless play left is VODAFONE AIRTOUCH (VOD). VODAFONE is forging a strategic alliance with BELL ATLANTIC (BEL), which is buying GTE (GTE). The companies have created a jointly held marketing venture for their wireless assets in the United States.
It looks as though we're going to end up with four or five true worldwide competitors. We're not going to come out with just one winner in the end. The question is, "Will the tremendous growth in wireless continue?" Growth is being driven by the dramatic drop in prices for cellular service. The decline is not only bringing in lots of new subscribers, it's increasing usage by existing subscribers. We see about 40% of the wireless revenue coming from new subscribers and 60% coming from use by existing subscribers.
[LK] For investors, do you suggest overweighting telecom in a portfolio?
[SS] S&P does recommend an overweight of the telecommunications group in consumer portfolios. Communications services represents about 7% of the market cap of the S&P Super 1500. (When you add the technology sector, you're talking about 40% of market cap of the Super 1500.) For a portfolio with 7% in telecommunications stocks, a good rule of thumb is to increase the exposure by 20%.
Our feeling is that, longer term, you probably will benefit by being in the telecom area, despite the fact that the industry has had a rough year so far in the stock market. Most investor concerns have been focused on the long-distance pricing pressures, or price wars, that are going on between MCI and AT&T. Again, we see wireless ? not long distance ? as the future growth area. We don't think long-distance pricing is a big negative for future revenue and earnings.
[LK] What's exciting on the international scene?
[SS} Wireless, again, is the hot category. You might think that America is pretty far along in adopting wireless, but only about 25% of Americans use cellular. In Europe, by comparison, 35% of the population uses cellular and the penetration is as high as 50% in Scandinavia. Some countries and continents are much further along than the U.S. in embracing cellular.
Latin America is seen as a tremendous opportunity for wireless. Right now, only about 5% Latin American telecommunications is wireless. Obviously, the growth potential is tremendous. Asia and China are also areas of opportunity, but it could take longer for the growth to materialize. That's why I think most companies are focusing on Latin America.
[LK] Even though Latin America doesn't have a very strong infrastructure yet?
[SS] If you mean political infrastructure, well, I think most of the governments know that it's in their best interest to embrace the new technology. Look, there is not a lot of physical communications infrastructure in parts of the Americas. Wireless is going to be dominant in emerging nations because it's prohibitively expensive to try to add wireline service in these areas, especially since many are so remote.
[LK] Are there any other important international developments?
[SS] A critical question is which of the competing wireless protocols is most likely to be embraced worldwide. Right now, three different technologies are used for cellular communications. First there is Global System for Mobile Communications (GSM), which Europe has embraced. There are also the Time Division Multiple Access (TDMA) and Code Division Multiple Access (CDMA) protocols. The U.S. and Asia look like they are settling on CDMA. We forecast that CDMA is likely to be the protocol of the future because it offers cutting-edge technology at a reasonable cost.
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