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Communication breakdown?
Telecom stocks have been among the market leaders this year, but that might not last for long.
March 17, 2004: 2:05 PM EST
By Paul R. La Monica, CNN/Money senior writer

NEW YORK (CNN/Money) - Telecom, one of the most beaten up sectors during the past few years, finds itself in an unfamiliar position this year: market leader.

While the overall market has pulled back drastically in recent weeks and tech stocks have taken a particularly notable drubbing, telecom stocks have so far held on to their gains.

The telecom stocks in the S&P 500 are up an average of 8.4 percent year-to-date, compared to a slight loss for the overall index and a 1.3 percent decline in S&P tech stocks.

Among mutual funds, telecom portfolios are the second best domestic performers of the year (trailing only real estate funds), up about 5 percent. Over the past three months, telecom funds are up nearly 12 percent. By way of comparison, tech funds are this year's worst performers. They're down almost 3 percent year-to-date and are up just 2 percent over the past three months.

Don't bet on more wireless mergers

However, a large part of the telecom sector's rise can be attributed to Cingular's acquisition of AT&T Wireless and the resulting game of "Who's Next" that Wall Street has played.

To that end, shares of AT&T Wireless are up 70 percent this year while the tracking stock of Sprint PCS has surged 51 percent. Smaller carriers such as Ubiquitel and Western Wireless have gained more than 30 percent.

As such, the two top telecom funds so far this year are specifically wireless sector funds: the ProFunds Ultra Wireless fund and Fidelity Select Wireless fund, up 27.5 percent and 14 percent respectively.

Good connection
Telecom stocks have outperformed many other high profile sectors so far this year.
SectorYTD Price Change
Telecom3.7%
Consumer staples2.8%
Heatlh care-0.2%
Consumer discretionary-2.0%
Information technology-4.3%
* based on S&P sector indices and prices as of 3/16/
Source:Thomson/Baseline

But the market may be setting itself up for disappointment when it comes to wireless mergers.

"We don't think Cingular and AT&T Wireless will spark additional consolidation," said Patrick Brogan, assistant director of research for Precursor, an independent telecom research group. That could be bad news, he said, because more mergers will probably be needed in order to ease some of the pricing pressures facing the wireless industry.

Pricing has become even more competitive in the past few months due to wireless number portability, which allows consumers to switch their carriers and keep their number, said Greg Gorbatenko, an analyst with Marquis Investment Research.

Number portability rules took effect in November for the 100 largest markets in the country but should be available to all consumers by May.

Fundamentals remain weak

Pure-play wireless companies are not the only telecoms that have fared well. Baby Bell Verizon, which has a strong wireless component, is up 6 percent while rural telecom carrier Alltel has gained 7 percent. Sprint is up nearly 4 percent. (Sprint will combine its FON and PCS shares next month)

Michael Mahoney, managing director with hedge fund EGM Capital, said that some of the traditional phone companies have fared well because they are perceived as carrying slightly lower risk. Verizon, Alltel and Sprint all pay healthy dividends, for example.

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"If we continue to see selling off in tech, telecoms are a good place to hide," Mahoney said.

But the industry's fundamentals don't appear to have changed all that much for the better, Mahoney said. Earnings are expected to fall this year for Baby Bells SBC Communications and Verizon while profits are expected to increase by just 2 percent. Longer-term, annual earnings growth estimates for these three range from only 2 percent to 4 percent.

So if there is a turnaround in market sentiment, telecoms could be in trouble.

Wireline companies like the Baby Bells and long distance companies AT&T and Sprint have done a better job of stemming customer defections lately by bundling services. But Brogan still thinks their long-term growth prospects are somewhat weak.

"There is this conventional wisdom that we are seeing some stabilization in the sector but that's a little bit of an illusion," he said.

Looking ahead, Brogan expects wireline companies to continue to losing customers to cellphone rivals, as well as to the emerging voice over Internet protocol (VoIP) technology, which allows customers to make calls over an Internet connection.

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Even though the Bells and long distance companies are trying to bolster their presence in wireless and VoIP, Brogan thinks there will wind up being some cannibalization of sales.

There will also be more competition, said Henry Hewitt, manager of the Light Revolution fund. He thinks VoIP start-ups such as Skype and Vonage will continue to gain customers. In addition, cable companies like Comcast and Cox Communications, which he owns in the fund, are aggressively rolling out VoIP services.

Hewitt owns some shares of Verizon and wireless carrier Nextel but he said he's more bullish on the cable companies and international telecoms, such as China Mobile. "Most of what I own in telecom is not traditional telecom," Hewitt said.

All in all, this paints a bleak picture for U.S.-based telecom stocks.

"There's not a lot of juice left on the telecom service provider side," said Gorbatenko.  Top of page




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Most stock quote data provided by BATS. Market indices are shown in real time, except for the DJIA, which is delayed by two minutes. All times are ET. Disclaimer. Morningstar: © 2018 Morningstar, Inc. All Rights Reserved. Factset: FactSet Research Systems Inc. 2018. All rights reserved. Chicago Mercantile Association: Certain market data is the property of Chicago Mercantile Exchange Inc. and its licensors. All rights reserved. Dow Jones: The Dow Jones branded indices are proprietary to and are calculated, distributed and marketed by DJI Opco, a subsidiary of S&P Dow Jones Indices LLC and have been licensed for use to S&P Opco, LLC and CNN. Standard & Poor's and S&P are registered trademarks of Standard & Poor's Financial Services LLC and Dow Jones is a registered trademark of Dow Jones Trademark Holdings LLC. All content of the Dow Jones branded indices © S&P Dow Jones Indices LLC 2018 and/or its affiliates.