How Broadband Is Your Portfolio?, Part Deux
By Mitch Ratcliffe, Columnist
worldlyinvestor.com Sector of the Day
Friday May 19, 11:53 am Eastern Time
Fresh out of the broadband/cable fray, Ratcliffe wrings the Baby Bells.
Last time, my recommendations about cable modem technology ignited a storm among Excite at Home investors (Nasdaq:ATHM - news). This time, I'll enflame the passions of telephone company shareholders.
Broadband is the future, no doubt. But there is no such thing as a sure thing in technology markets, so investors have to account for a variety of potential futures. Last time, I recommended adding America Online (NYSE:AOL - news), especially with the pending Time Warner (NYSE:TWX - news) merger in the offing, as well as Excite at Home to give portfolios a solid position in the cable modem and content space.
Let me reiterate why I think digital subscriber line (DSL) telephone networks are a superior technology, cost-wise. While it is true that once a hybrid fiber-coaxial (HFC) cable network is upgraded HFC is ready for many years of capacity expansion, adding capacity over the long term is expensive. Several cable insiders said that it is easy and cheap to do this, and that's true if you don't have to do it very much to support more network usage.
But eventually we will all need massive up- and down-stream connections to support a wide range of new services to the home. The need for capacity will add up to much more than today's cable networks can deliver without ``splitting'' neighborhoods served by HFC networks to isolate homes for faster service.
If, as one cable investor wrote, it costs $250 to ``split'' a neighborhood into two network ``nodes'' that serve 250 homes each, that's great. But to deliver 27 Mbps service to every home, you ultimately have to split the network so that every home, or very small clusters of homes, has fast access, the $250-per-split costs add up fast.
So, at the service-to-the-curb level, I'll stand by my claim that DSL is cheaper to install and maintain.
Putting Premium DSL in the Tank
It's important to add DSL stocks to your portfolio to ensure you play this angle of broadband growth. However, just ``doing DSL'' isn't enough reason for you to invest in a telephone company or telecommunications equipment provider.
On the equipment side, I'd distribute investments into Cisco (Nasdaq:CSCO - news), which is in the midst of an acquisition binge to corner the market for broadband equipment; the battered but still promising Lucent (NYSE:LU - news); and Efficient Networks (Nasdaq:EFNT - news).
Lucent announced on Thursday a major investment in its fiber-optics business that, as this AT&T (NYSE:T - news) spin-off rights its corporate ship, should pay handsome dividends. At Thursday's closing price, $56.25, Lucent is well off its 52-week high of $84.19.
Efficient Networks -- unlike several key competitors, including the merging forces of ADC Telecommunications (Nasdaq:ADCT - news) and PairGain (Nasdaq:PAIR - news) -- is way off its 52-week high of 186 13/16. On Friday, it was down 5 7/16 at 47 5/8 in early trading.
Almost all the companies in this space are seeing fantastic increases in revenue. Efficient Networks saw revenue increase in the first quarter by 1400% year over year (losses widened due to merger costs). Efficient Networks insiders have sold some 2% of their shares in the wake of the lockup expiration at the beginning of 2000, but have been buying stock at recent low prices. ADC Telecommunications execs, by contrast, have been exercising and selling options in recent months.
Bad Baby Bells Botch Broadband
Let me generalize: Old phone companies -- that is, the Baby Bells -- are stubbornly clinging to the past. All of them are bad broadband investments.
Take my personal experience with US West (NYSE:USW - news), for example. I have had a T1 line -- and expensive dedicated circuit -- in my home since 1996. For the past year, I have tried to get DSL from US West, but I am told DSL isn't available in the area.
However, both Covad (Nasdaq:COVD - news) and Northpoint Communications (Nasdaq:NPNT - news) can deliver DSL to my home.
The phone companies aren't investing to displace the high-revenue T1 lines they sell today. The telecoms are strangling future revenue as they try to protect these older revenue streams by allowing the DSL ISPs to establish market share and brand.
Moreover, the Bells are not making the data connections at the back office that ensure robust network performance. Across the country, customers of regional-phone company DSLs are complaining that they get lousy service. While the DSL connection to the home is fast, their traffic gets packed into too-narrow pathways from the Bell central office to the major Internet backbones.
DSL ISPs Will Dangle in Short Term
Covad, Northpoint and Rhythms NetConnections (Nasdaq:RTHM - news), the major DSL ISPs, are investing heavily to displace the old dedicated-circuit business and to deliver high-speed connectivity to the home.
Nevertheless, all three will face substantial scalability problems as demand ramps and their backbone costs increase. Users will likely see slowed DSL service at various stages in the growth of the market -- just as AOL faced these challenges as its dial-up network expanded (remember the big waits in 1996 and 1997 as AOL's network capacity was overwhelmed?).
Among the DSL ISPs there is no clear leader. All have seen revenues and losses grow dramatically. Each is selling near a 52-week low. I'd suggest you add one or two of these securities to your broadband portfolio based on your research and, perhaps, ability to subscribe to and use the service -- use the Warren Buffett strategy of buying what you understand and use.
Excite at Home, too, has embraced DSL and has a large backbone investment, so it deserves consideration in this space, too.
Finally, I recommend MCI Worldcom (Nasdaq :WCOM - news; see my recent column, ``Investors Too Calm For MCI Worldcom?''), the owner of a fiber backbone three times the size of its nearest competitor. As network traffic to and from the home increases, MCI Worldcom is in an excellent position to capitalize on demand for backbone capacity. It is trading just a couple dollars above its $37.75 low and is a critical holding for the broadband investor.
To recap, then, the broadband portfolio is:
America Online/Time Warner
Excite at Home
Cisco
Lucent
Efficient Networks
Covad
Northpoint Communications
Rhythms NetConnections
MCI Worldcom
Now, who's upset about this? My worldlyinvestor.com chat on Yahoo! is next Wednesday, May 24, at 7 p.m. ET.
Ratcliffe is vice president and editor-in-chief of the ON24 Network, a personalized financial broadcast network for individual investors. He is also longtime executive and investor in the technology industry. Ratcliffe's insights and analysis of the high-tech industry will appear twice each week. He owns a position in America Online.
Go to www.worldlyinvestor.com to see all of our latest stories.
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