Telecom stocks sizzle

NEW YORK (CNNMoney.com) -- The big telcos are back.

Shares of telecom stocks have been on fire this year, bouncing back from last year's stupor. AT&T (Charts) has climbed 40 percent while Verizon (Charts) has surged 29 percent in 2006.

Dialing up gains Consolidation in the industry has lifted the stock price of many telecoms. Company Ticker Price Change (YTD) AT&T T +39.7% BellSouth BLS +66.2% Verizon Communications VZ +29% Source:Thomson Financial

But analysts have a mixed outlook on whether those stocks can go much higher, especially as cable firms keep making inroads into the territory of local phone companies.

Telecom shares have rallied this year largely because consolidation in the industry has led to a decrease in competitive pressure, according to Albert Lin, an analyst at American Technology Research.

AT&T is in the process of buying BellSouth and merged with SBC last year. Verizon completed its purchase of long-distance provider MCI earlier this year.

"The intensity of competition has lessened over the last few years, which is one of the reasons why investors are willing to pay a higher premium for the surviving large companies," he said.

Not all mergers in the sector have been successful though. Sprint (Charts) has struggled to make its marriage with Nextel work, and shares are down about 10 percent year-to-date.

But Lin said, overall, the outlook is positive for most large telcos.

"Demand for the networks these carriers own has never been higher," he said, referring to consumers' huge appetite for high-speed Internet services over phone lines as well as wireless offerings.

Wall Street isn't ignoring the headway cable operators have been making into the territory of traditional phone companies.

Cable operators such as Comcast (Charts) and Time Warner (Charts) have been winning away customers with their "triple play" bundles of cable, digital phone and high-speed Internet services. Time Warner, which recently filed for an initial public offering of its cable unit, also owns CNNMoney.com.

The "triple play" gives cable operators a real marketing advantage right now, said John Byrne, an analyst with Technology Business Research. "Unless [phone companies are] able to make similar offerings, their customers are ripe for the plucking," he said.

Telcos have plans to upgrade their networks so they can offer video services as well as faster Internet access. But that takes time to deploy and is expensive.

Citigroup analyst Michael Rollins estimates Verizon's total capital investment in its fiber-optic-based Internet access and TV service, called FiOS, will hit around $26.4 billion. And some analysts have expressed frustration with how long it is taking AT&T to roll-out its U-Verse TV offering to consumers.

"For the next couple of years, cable has the winning hand. They're going to do some damage," said Patrick Comack, an analyst for Zachary Investment Research. He has a "sell" rating on AT&T and rates Verizon "neutral."

Competition is already taking its toll. AT&T said last week that the number of primary consumer phone lines fell by 242,000 during the third quarter. Meanwhile, Verizon reported gains in Internet customers during the third quarter that were below some analysts' expectations.

Still, even though cable companies may be storming the gate, phone companies have some things going for them. For one, they have an edge in wireless.

AT&T will have complete control of Cingular Wireless, the nation's leading wireless provider, when its takeover of BellSouth (Charts) is completed. And Verizon owns a stake in Verizon Wireless, the second-largest wireless provider in the U.S.

But cable companies are also setting their sights on wireless. Comcast, Time Warner Cable, Cox Communications and Advance/Newhouse Communications have teamed up with Sprint to offer wireless services, giving them what some call a "quadruple play."

Whether telecom stocks see more upside will depend on growth in wireless, along with their ability to make the most of their consolidation drive, analysts said.

"Companies that continue to control costs and benefit from merger synergies are the most likely to produce margin and upside surprises, such as AT&T," Citigroup's Rollins wrote in a recent research note.

And it's too early in the game to be making predictions on which side will win the battle of the bundles in the long run, telecom analyst Jeff Kagan said.

The industry is in the midst of reinventing itself, he said. "Everything is looking good for cable right now, but two or three years from now, will they still be winning when they have more competition from telephone companies?" Kagan said.

None of the analysts in this story own shares of the companies mentioned, but Citigroup has done investment banking for the companies. Citigroup also is an adviser to BellSouth in the proposed acquisition by AT&T.

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