RIDING THE Telecom PHENOM - stocks to be considered

Kiplinger's Personal Finance Magazine, Sept, 1999 by Manuel Schiffres, Ian Baldwin

Opportunities abound to make substantial profits as voice and data networks mushroom. These six stocks range from relatively sedate to downright speculative.

Alexander Graham Bell would feel right at home amid the wheeling and dealing in the telecommunications industry of today. On an October Friday 120 years ago, shareholders of his National Bell Telephone Co. (later to become AT&T) entered into an auspicious agreement with Western Union. The dominant telegraph service, in exchange for a 20% cut of royalties for 17 years, agreed to cede the telephone business to Bell. A newspaper noted then that Bell shares had risen from $100 to $700 in a matter of months "though the company has not yet paid a dividend."

Today, barriers between providers of telephone, cable-TV, and Internet service are crumbling under a furious assault of regulatory overhauls and technological advances. The Bell lesson of 1879 rings even truer: Determined visionaries reap the richest rewards.

THE DEREGULATION SMORGASBORD

The feds broke up AT&T's Ma Bell monopoly in 1984, and long-distance calling is now a free-market poster child. Commercials, junk mail and dinnertime telemarketing spiels lay out a bazaar of prepaid cards, "10-10" dial-arounds and ever-changing plans from AT&T, MCI WorldCom and Sprint, the triad that accounts for about three-fourths of the market.

But while interstate long-distance rates have dropped 1.8% annually since 1984, local rates have been gaining 3.6%, easily outpacing consumer price inflation. That's because the Baby Bells have kept a tenacious grip on their monopolies. Still, local competition, a central goal of the Telecommunications Act of 1996, is heating up as competitors make end runs around the Bell companies' urban networks with wireless microwave antennas or fiber-optic wire. TV cable entering the home can also serve as a local line, as AT&T's proposed acquisition of cable operator MediaOne makes clear.

But some of the best telecom investments may lie outside the realm of traditional calling. Voice traffic grows at less than 10% a year, but Internet usage doubles every 100 days. The line between voice and data is already blurring: More phone calls are being routed using cheaper "Internet protocol," which involves divvying up spoken words into packets of data and zinging them around a network just like e-mail or Web-page packets.

The capacity to send and receive those packets is called bandwidth, an industry buzzword that's now popping up in the mainstream. To understand how crucial bandwidth will be, think of data--whether it's online trading or a phone call to Grandma--as water. Telecom companies see their consumers as people living in a vast desert served by thin, rickety pipes. The Internet explosion has revealed the pipes' limitations, as anyone who has ever spent hours trying to download a big software file knows. The solution is to plug a water main directly into the home and office via modified TV cables or a phone-line upgrade called DSL (a third, still-developing option is wireless technology). Because either conduit can supply Internet access at more than 100 times the speed of the fastest dial-up modem, the "broadband race" between phone and cable is on.

With broadband, you'll get used to downloading CD albums in a matter of seconds and watching streaming video while making a phone call. "Information seems to fill the pipe available for it," says Phil Otto, CEO of Terraops, a high-speed video-transmission company. "Capacity leads to demand, which leads to more capacity." Providing the capacity is where telecom companies expect to cash in.

STOCK ANSWERS

In fact, they've already started. Total revenues for all U.S. carriers in 1997 were up 40% from four years earlier. The number of fax machines roughly doubled in that period, suggesting that the data revolution was under way before the Internet became a household word. Wireless calling was the fastest-growing sector, but rather than rest on their laurels, manufacturers are pushing ahead with mobile phones that tap directly into the Internet.

From Wall Street, the word is go. Over the year that ended June 30, the Dow Jones index that tracks telecom carriers returned a robust 40%; its three-year annualized return was 32%. The racier Nasdaq telecom index returned 59% for the year and an annualized 43% over three years. Brian Stansky, manager ofT. Rowe Price Media & Telecommunications fund, compares the group's run-up to the biotech bubble of the early '90s. "It's like having too many tadpoles in the pond--eventually there will be an epidemic that takes a lot of them out," he says.

Larger companies are hedging their bets by buying into or merging with other players in their search for new technology or new markets. Two significant deals were reached recently: US West, a Baby Bell that provides local telephone service in 14 states, agreed to merge with Qwest Communications, an upstart long-distance company. And Global Crossing, a two-year-old firm that operates a trans-atlantic fiber-optic cable, struck a pact With Frontier Corp.