RIDING THE Telecom PHENOM - stocks to be considered

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

The transformation of AT&T over the past few years is nothing short of remarkable. Once a stodgy, slow-growing provider of long-distance service, phone equipment and computers, the company (T, NYSE, $55) is now poised to provide all the telecom services expected in the Internet age. And with that should come a sea change in investors' perceptions of the company as not just old American Telephone & Telegraph (its former name) but as a growth stock deserving of a higher P/E ratio and hence a higher price.

The transformation began in 1996 with the spinoff of Lucent Technologies (AT&T's equipment arm and no slouch itself) and computer maker NCR, and the sale of AT&T Capital and the Universal Card unit. Since then, AT&T has spent billions to purchase Teleport, an alternative provider of local phone service, Vanguard Cellular and, this year, cable powerhouse Tele-Communications for $54 billion. AT&T has also agreed to buy MediaOne, another cable operator, for $58 billion. AT&T is also involved in significant joint ventures with Time Warner, Microsoft and British Telecom.

Much of the credit for AT&T's metamorphosis goes to chief executive C. Michael Armstrong. When he arrived in 1997, the emphasis was on cutting costs. But his most important contribution, says Frank Gannon, head of large-stock investing at the SunAmerica funds, has been in his role as "a visionary to change the landscape and focus of the company." As a result of recent acquisitions, particularly the proposed deal with MediaOne, "AT&T is transformed from a passive observer of the Internet and the emergence of a digital economy into a company positioned to be one of its leaders," says Paine Webber analyst Eric Strumingher.

The key to AT&T's growth is a shift in its business mix. A bigger chunk of revenues is coming from such fast-growing businesses as wireless phone services and data transmission, including Internet services. Lehman Brothers analyst Blake Bath says revenue growth should accelerate into the low double digits over the next few years, with cash flow growing into the mid teens. Looking at AT&T's various parts, he figures the stock is worth $73 per share.

THE AGGRESSIVE WAY

Telephone companies must feed their virtually insatiable appetite for more speed and capacity. Whether they offer local phone service, long-distance calling, Internet access or even video transmission over cable lines, communications companies are spending feverishly on complex equipment to improve their networks. Tellabs, a Lisle, Ill., equipment maker, is well positioned to participate in this spending boom.

Tellabs' key product line, accounting for 60% of sales last year, is its digital cross-connects. These are basically big switches that transfer traffic from one telecom-service provider to another. As well as Tellabs has performed (revenues more than tripled between 1994 and 1998, and the stock has soared nearly 15-fold over the past five years), some observers are concerned that the company's cross-connects are headed toward obsolescence because they're not designed for the so-called packet-switching technology of the future.