CSFB on USW and other RBOC capex spending for broadband data:
Telecom Services - Wireline)
USW news reflects need of all ILECs to step up data cap ex,
but don't expect SBC, BLS, CTL, AIT to miss 1999 EPS.
Summary
USW announcement of higher cap ex and lower earnings is not
surprising given its foot dragging on opening its market, and
the growth opportunity that exists in data.
The earnings disappointment USW has created should not be
repeated by SBC, BLS and AIT, because they've all been
spending heavily already to open their local markets in
compliance with FCC rules.
CTL is not bound by the same open market requirements, and
won't face competition any time for the foreseeable future,
and should continue strong earnings growth.
Despite higher long term capital spending in the group, SBC,
BLS, AIT, and CTL should be bought on weakness, and are all
Buy rated stocks.
Investment Summary
US West announced it would increase cap spending this year 9
%, from $3.5 billion to $3.8 billion, with $100 million of
the increase going to network upgrades to accommodate FCC
requirements for opening its local market, and $200 million
to accelerate construction of video, data, and wireless
capabilities. In addition it cut earnings guidance $0.15 to
about $3.30 for 1999. In 1998 the company earned $3.02, and
25 cents of the increase expected this year is from a
software accounting change - so absent this, the company has
almost no growth. It attributed higher spending levels in capex
to expanding competition.
Other incumbent local phone companies got hit on this news
for three reasons. One fear that competition is more
imminent than everyone assumed; two because of the fear that
other companies will follow suit and raise capital spending
and cut earnings estimates; and three, because investors
have been owning these stocks seeking the comfort of
predictable results, and this news seems to burst this bubble.
We have two reactions to this news. One, as we've been
saying all along with our equipment analyst, Jim Parmalee,
all of the Bell companies have been under spending on network
upgrades for data and broadband. We believe all other Bell
companies will end up raising cap ex related to data and
broadband because they'll have to. They'll have to in order
to capture the growth opportunity, and they'll have to in
order to offset the risk of cable modem penetration. We also
expect higher capital spending in order for these companies
to become dominant Internet providers. And, we expect higher
capital spending in wireless in order to keep up with growth,
capture the wireless data opportunity, and to keep up with
intensifying competition.
More capital spending, appropriately deployed, along with
effective marketing of new services, would have positive long
term effects. However, it is our view that the local
telephone business has enjoyed its "salad days" over the past
few years, and that higher capital spending, along with lower
margins in the local sector (because of competition),
inevitably will lead to lower returns on capital. We make
the distinction that we're talking about the "local sector",
not the local companies per se. The distinction is that well
run ILECs are recognizing this change in operating
environment in the local part of their business and are
seeking to alter the mix of their businesses in order to
maintain strong growth and adequate returns. Even as the
local part of their business eventually won't enjoy the high
ROICs that have become common over the past few years, they
are trying to tap into growth opportunities. Thus, we're quite
positive on SBC/AIT, BLS, and Century Tel for this reason.
The second reaction to the USW news however is that not all
ILECs will suffer disappointing earnings in 1999.
Specifically we don't expect it from SBC, BLS, Century
Telephone , and Ameritech , all companies that shared in the
down draft yesterday. These companies will not
disappointment on earnings related to the need to open their
local markets - SBC, BLS, and AIT have been spending heavily
already to do this, and Century is not required to open its
markets in the same way. USW has been dragging its feet on
this necessary spending, and has been encountering service
quality problems, and therefore it is in a very different
position versus these other companies.
Thus, as a group the reaction was over done, because we
expect no short term earnings disappointments for some of the
companies, and there should be a recovery in some of these
stocks. But longer term we continue to expect higher capital
spending for broadband, data, Internet, and wireless - all
areas that will have strong growth opportunities and increasing
competition.
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