Clicking With the Telecom Connection All-Star analyst Stephanie Comfort
is known for her fearless forecasts -- like predicting that AT&T will be
a $100 stock. By Eneida Guzman In an industry like telecommunications
that is constantly undergoing simultaneous regulatory and technological
changes, picking the right stocks can be a risky business. So how should
investors go about picking good plays? Stephanie Georges Comfort, 34,
recommends sticking with aggressive, nimble companies that have a
national footprint and that are seizing the opportunities presented by
changes in the industry. The Morgan Stanley analyst had a superb year in
1997, with picks up a collective 32%. She was voted the No. 1
telecommunications-carriers analyst in the Wall Street Journal's
All-Star Analyst survey, and she also had her first child. Investor
spoke to Comfort about the greatest growth opportunities in the
telecom-carrier services sector for 1998, her belief that AT & T (T)
will be a $100 stock and the impact of last week's controversial ruling
by a Texas judge that appears to favor the regional carriers. Of all the
changes going on in the telecom industry, which do you feel are the most
important for shareholders to keep in mind? I'd probably narrow it down
to two basic categories. One is regulatory changes that have come out of
the Telecom Act over the last 12 to 18 months. The Federal
Communications Commission has tried to interpret the federal law and
what it means in terms of opening up the telecom industry to
competition. That's been an overriding theme. It's been an overhang on
the stocks for quite a while, as investors have been confused about the
implications of the Telecom Act, and how it's going to play out, in
terms of competition, in the various segments of the industry.
ÿContents Finding Internet Winners Small and Aggressive Wins AT&T
Marketing Muscle ÿÿÿÿIt's even easier than it is in the U.S. for a U.S.
company to go overseas and compete for lucrative segments of those
markets. Chasing The Local Market You're referring to the long-distance carriers
getting into the local service market. That's right. I'm referring,
really, to anyone's ability to compete with the local companies. There
are questions as to how the rates will be set; how companies will be
allowed to enter this market, and over what period; and under what
circumstances the Bell companies will face more competition, so that
consumers will have a choice for their local provider as opposed to it
being a monopoly business. And that whole evolution has created all
these new companies called CLECs -- Competitive Local Exchange Carriers
-- such as Teleport Communications (TCGI), Intermedia Communications (
ICIX) and McLeodUSA (MCLD) that are building networks to compete with
the local carriers. The evolution has also created the development of
things like wireless technologies that can provide local service as well
to the residential customer. The other big issue that investors are
struggling with is technology and how technology is changing. And
there's this whole evolution of the data network, how data is carried,
how companies are positioned for that, whether networks are antiquated,
how the Internet plays in. There are questions as to whether Internet
telephony is a real competitive threat to the long-distance business or
to the telephone business in general. The other issues concern
everything that comes along with a dramatic change in technology, such
as the speed of the network and the changes that involves. You believe
that international expansion in telecom-carrier services and the
Internet represent the greatest opportunities for growth in the sector.
I think international and Internet are both very high-growth segments
that really haven't been taken advantage of by a lot of players in the
industry. They're growing so fast, and there are so many opportunities,
whether they're arbitrage opportunities in terms of pricing differences
or just technology opportunities that allow small or opportunistic,
nimble companies to come in. There's so much data traffic on the
Internet, whether it's at the residential customer level or the business
customer level. Companies are changing the way they're doing business.
The international side is similar. A lot of the competitive dynamics
that we're seeing in the U.S. -- the local market opening to
competition, the long-distance market opening to competition -- are
being replicated internationally. And it is even easier than it is in
the U.S. for a U.S. company to go overseas and compete for the lucrative
segments of those markets. So everything that's happening in the U.S. is
being replicated in the foreign markets, but with a bigger pricing
umbrella, and up against a less efficient, even less technologically
savvy foreign telephone company. I think that's creating an opportunity
for companies that are willing to go overseas and capture some of that
growth.
ÿContents Chasing The Local Market Small and Aggressive Wins AT&T
Marketing Muscle ÿÿ Finding Internet Winners Your firm's Internet analyst believes that the
Internet will grow from its current 35 million users to about 150
million users by the year 2000. Even if a fraction of this happens
through phone lines, we'll see a further boom in the connectivity
market. Who wins here and who's at risk? There are several different
angles in terms of how one sees the winners of the explosive growth that
our Internet team foresees. First, the people who carry the calls on the
network -- the long-distance carriers, both new ones and the traditional
ones -- the AT&Ts, MCIs (MCIC), Sprints (FON), as well as the Qwest
Communications (QWST) and the IXC Communications (IIXC). The companies
like AT&T and WorldCom (WCOM) that are building high-speed, broad-band
networks will win. When you look at the Internet, it is a compilation of
local networks and a long-distance network being used in an efficient
way. So you have the opportunity for long-distance carriers to benefit
from that volume. The risk on the long-distance carrier side is really
that they don't have enough capacity on their network, so you've been
seeing a great deal of investment in their infrastructure. Also on the
communications side, winners are companies that have built Internet
facilities to capture that traffic and bypass the local carriers, or at
least benefit from some of that transition. So we like facilities-based
Internet service providers like UUNet, which is a subsidiary of
WorldCom. The ones that, to us, are at risk -- at least in the near term
-- are the RBOCs or the regional Bell operating companies. They are not
getting fully compensated for the high level of Internet traffic on
their networks because the Internet providers don't need to pay access
charges to the local telcos. So as calls come in through the Internet,
they don't get fully compensated the way they do for a conventional
long-distance call, and it's really straining their network.
ÿÿSnapshot3-year Chart Overview Earnings Estimates Snapshot3-year Chart
Overview Earnings Estimates In November, WorldCom and MCI announced
their agreement to merge, which, when implemented in mid- to late 1998,
will make the merged entity the fourth-largest long-distance company
around. What does this mean for the sector overall? There's a sense
that it really does marry a company that's very good on the marketing
side and has a very extensive network on the long-distance side with a
company that has done a great job in the small to medium-size customer
segment. So you're marrying marketing and network capability with a
company that has a very complementary customer base and a very good
Internet capability. The merger gives you a powerful, full-service
provider to the business market, and ultimately to the residential
market. So I think it marries some very complementary assets and creates
a new paradigm for a telecom company. The MCI-WorldCom combination has
the residential long distance; it has the business long distance; it has
the network; it has the Internet; and it has the logo. There are no
other long-distance carriers or telephone companies in the U.S. that
marry all of those capabilities. So we will see more of these types of
marriages in the telecom industry. Exactly. We really look for much
more consolidation, both vertical and horizontal, over the next five
years. It's being driven by regulatory changes that, for the first time,
allow companies to cross borders in terms of providing local,
long-distance and Internet service. And it's also being driven by
technology. As technology has changed and driven consumer demand, it's
created a need for these companies to provide a variety of different
services that weren't necessary before.
ÿContents Chasing The Local Market Finding Internet Winners AT&T
Marketing Muscle Small and Aggressive Wins Your stock picks seem to favor some of the
up-and-coming aggressors that are going after the more established
titans of the industry. We've had this theme in our telecom group --
whether it's wireless, land line or international -- that the incumbents
in the business really face some big hurdles because of their legacy
systems, their high cost structures and the fact that there are
subsidies that exist in the industry. New companies are coming in that
are much more nimble -- that are benefiting from new, lower-cost
technology. They can also target high margin segments of the market,
whereas the incumbents have this broad base of customers that they have
to maintain -- if they don't protect their market share it will decline
very rapidly. So we feel that the incumbents have some real issues that
they have to work through over the next five years as this transition
occurs, whereas new carriers don't have the legacy, either
technologically or in terms of the way they are operating. We like
companies like ICG Communications (ICGX) and ITC DeltaCom (ITCD). They
are smaller-cap, higher-growth companies that are well-managed new
entrants into a traditional business.
ÿÿSnapshot3-year Chart Overview Earnings Estimates ÿÿSnapshot3-year
Chart Overview Earnings Estimates What is your opinion of Sprint? We
like Sprint (FON). We think Sprint has done a great job on the
long-distance side. It seems to have very good market share and
operating momentum in the long-distance business. They still have costs
to come out of the business, so they also have some margin expansion as
they continue to reduce costs. But we also think that there's a hidden
asset at Sprint, which is their wireless business. They are building a
nationwide PCS (digital cellular) network, and it will be essentially
finished by the end of 1998. We have valued that asset alone at about $7
per share. So if you take that out, Sprint's long-distance company is
really only trading in the low teens as a multiple of earnings -- around
12 to 13 times, which in this market is very cheap. So we think that
they have a great long-distance business and a great hidden asset that
investors will start to recognize as we get into 1998 and as that
network gets built out. AT&T has had quite a rebound from $32 a share
just a few months ago. You were recommending the stock when the rest of
the world was giving up on it. And you continue to recommend it. Why?
This is a question a lot of people are asking me. In fact, we came out
with a report last August titled, "Why in the World Do We Still Have a
Strong Buy on AT&T?" that tries to address that question. But put
simply, we just felt that the franchise was valuable, and that while it
was being mismanaged, we felt that there was an opportunity either
internally for things to turn around, or for a catalyst -- someone
coming in from the outside -- to change things. And the stock has acted
beyond our wildest dreams. It has exceeded our target and the earnings
power looks even better than we thought. But we felt that it all really
came down to the asset. All the work we had done showed us that AT&T's
brand -- despite everything that had happened to it -- was still very
powerful in consumers' minds. We saw that if somebody could take that
brand and leverage it, and focus on the cost structure, there was a
powerful company underneath all of that. So, very much like what
happened at IBM, we felt that with the stock in the low $30s, everyone
was throwing in the towel and really losing sight of the franchise. Now
that you have a new management team in there, we think the stock has
still got some upside, to the mid-$70s over the next 12 months, and it
could potentially be a $100 stock over the next two years.
ÿContents Chasing The Local Market Finding Internet Winners Small and
Aggressive Wins ÿÿIt looks like the RBOCs are going to meet or beat
expectations over the next several quarters. AT&T Marketing Muscle Will AT&T become the player that it hopes to be
in local services? That is an excellent question. I think AT&T has
everything it takes to do that. Like I said, they have the brand; they
have the network; they have the system; they have the people; they have
the marketing expertise. They have a lot of things in the local business
that new entrants really take for granted, but that are hard and costly
to develop. AT&T spends 29% of its revenue on marketing. That's $15
billion on marketing -- a huge number. That may be too much, but if
focused in the right direction, it's something that can really be
leveraged. The real factor is regulatory. AT&T can't rebuild the entire
Bell system, so they really have to depend on leasing other people's
networks, or on new technologies like wireless, delivering local
service. Where do you stand on the local service carriers that you
cover? We were actually very negative, and then we turned neutral on
them earlier this year, which was really the right move. The
long-distance and local carriers have pretty much performed in lockstep,
which I think was interesting considering that most analysts on Wall
Street tend to pick a side. Going into 1998, we really feel that the
RBOCs or the local-exchange carriers are going to see some good
near-term earnings visibility. They look like they're going to meet or
beat expectations over the next several quarters. The reason really
hinges on the fact that there's no local competition playing out.
Towards the end of 1998, though, we do see competition starting to build
in the local business, and that will affect the outlook from 1998 on. A
ruling last week in Texas, in a suit brought by SBC Communications and U
S West Communications, would apparently open the long-distance market
more quickly for regional telephone companies. Am I right that this
should be good news for the local telephone companies? We believe that
the Telecom Act is too important and high-profile to hang in the balance
of one judge in Wichita Falls, Texas. We therefore see a clear path to
the ruling being stayed and ultimately appealed in the Fifth Circuit
Court of Appeals -- a process that could take several months and could
ultimately wind up in the Supreme Court. In the meantime, we believe the
ruling creates a buying opportunity for investors looking to play some
of the long-distance stocks. (Ed. Note: The ruling initially hurt those
stocks. |
