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Big gains for tiny telcos?
Sure, the industry giants are all merging. But you should be taking a closer look at small telcos.
February 3, 2005: 2:34 PM EST
By Paul R. La Monica, CNN/Money senior writer

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NEW YORK (CNN/Money) The big just keep getting bigger in telecom.

Sprint (Research) is buying Nextel (Research). SBC (Research) is scooping up AT&T (Research). And now Verizon (Research) and Qwest (Research) are said to be looking at MCI (Research). At this pace, it seems like there will be just one major nationwide telecom carrier left standing by the end of 2006.

Or will there? Despite all the consolidation among the big brand name companies in the sector, there are still plenty of tiny telecoms out there.

Clearly, the telecom industry was ripe for consolidation. There are too many carriers and the intense competition has created a pricing environment that, while great for consumers, is disastrous for the financial health of the telecom companies.

But that might only be the case on a national scale. In several areas, competition isn't nearly as tough because the markets are just not lucrative enough for the Verizons, SBCs, and Sprints of the world to care about.

Baked Alaska

Consider Alaska. Two small telecoms there, Alaska Communications Systems (Research) and General Communication, Inc (Research). (GCI), face little in the way of competition. "They're in the middle of nowhere, so there's not much reason for the big guys to grab that part of the market," said James Lee, an analyst with Decision Economics Investment Research.

Both companies have fairly steady and predictable revenue streams, Lee said. And Alaska Communications Systems pays a dividend that yields 8.5 percent.

GCI does not pay a dividend yet but Lee thinks it will soon initiate one and that the stock is a good value play. Earnings are expected to increase nearly 30 percent this year and the stock trades at 18 times 2005 earnings estimates.

For sure, Alaska Communications Systems and GCI are probably not the next telecom takeover targets. But Lee said there are some smaller wireless companies catering to smaller markets that could be acquired in the near future.

To that end, Alltel (Research) announced last month that it was buying regional wireless carrier Western Wireless (Research). Lee said two other small wireless firms, Dobson Cellular (Research) and Rural Cellular (Research), could be the next to be taken over.

Ringing up gains in the IPO market

Want more evidence that there is interest in Lilliputian-sized telecoms? There are even telecom initial public offerings for investors to consider.

Two regional telecom carriers are set to go public this month. FairPoint Communications, based in Charlotte, N.C, is tentatively set to debut on Friday. The company hopes to raise about $500 million in its offering. Next week, Irving, Texas-based Valor Communications plans to go public and is expected to raise about $530 million.

These IPOs come on the heels of two similar deals late last year. Otelco (Research), a rural carrier based in Oneonta, Alabama, sold shares of a hybrid security known as income deposit securities (IDS), which are a mix of equity and high-yielding debt, in December. The stock is up slightly since its debut.

And in November, Iowa Telecommunications Services (Research), headquartered in the Hawkeye state's city of Newton, went public. The stock is up about 6 percent since its IPO. But what's more noteworthy is that Iowa Telecom pays a dividend that yields a whopping 8 percent, much higher than the Baby Bells.

"For these smaller telecom companies, earnings are very predictable. They churn out quite a bit of free cash flow and the yields are attractive to income-driven investors," said Lee.

Both FairPoint and Valor have said in filings with the Securities and Exchange Commission that they plan on paying dividends as well.

Jonathan Atkin, an analyst with RBC Capital Markets, expects more rural carrier IPOs in the near future since the market has shown an appetite for them.

"The appeal of the rural companies is that they have a lot less competition, fewer unknowns in their business and that they have decided to opt into these high dividend strategies," Atkin said. "There is less chance that management will use cash for a significant acquisition or invest in things that are away from the core business."

So as rumors continue to swirl about the next merger between telecom heavyweights, investors might want to pay closer attention to the industry's small fries flying under the radar.

RBC Capital Markets has done banking for Iowa Telecommunication Services and Otelco. Atkin does not own either stock or others mentioned in this piece. Lee does not own shares of companies mentioned and his firm has no investment banking relationships with the firms.


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