Ma Bell's brood grows up

Kiplinger's Personal Finance Magazine, Feb, 1998 by Manuel Schiffres

The forces of change unleashed by the Bell System's breakup 14 years ago continue to rage today. A sweeping telecommunications law enacted in 1996 was designed to promote competition among local and long-distance phone companies. As a result, many of the players hope to become one-stop sources for all the communications needs of residential and, especially, business customers.

Nowhere is the turmoil more evident than in the current lineup of the Bell System's descendants -- the seven Baby Bells spun off by AT&T on January 1, 1984. Charged with providing local phone service, their number has shrunk to five. One of the Bells plans to split into two this year; four years ago, Pacific Telesis, one of the original septuplets, begat AirTouch Communications, a wireless phone-service provider. Pacific Telesis itself is no longer independent, having been bought by SBC Communications, another Baby Bell, in 1997.

The new AT&T, which under the original breakup agreement was given responsibility for long-distance service and equipment production, unloaded computer company NCR late in 1996. It jettisoned the world-renowned Bell Labs when it spun off Lucent Technologies, its equipment-manufacturing arm. Talk of further consolidation is rampant, including speculation about a merger between AT&T and one of the Baby Bells.

Most of the ten publicly traded securities that trace their lineage to Ma Bell remain critical players in telecommunications. Six are among the 45 largest U.S.-based companies in terms of market value, and most are among the most widely held in the nation. AT&T, with 3.3 million shareholders, is the nation's most widely held stock.

But as a result of deregulation and intensifying competition, the stocks of Ma Bell's progeny may no longer be suitable for conservative investors. In fact, most of Ma's brood see themselves as growth companies, and their stocks are no longer as stodgy, predictable and income-oriented as that of the old AT&T What follows is a look at today's AT&T and the remaining Baby Bells and the prospects for their stocks. All earnings estimates are the consensus of analysts' forecasts as gathered by First Call.

NO PLAIN OLD BELLS

The 1996 telecommunications law resulted in what Susan Lynner, who follows the regulatory scene in Washington, D.C., for Prudential Securities, calls a "judicial quagmire." Attempts by the Federal Communications Commission to establish rules for throwing open local service to competition have been undercut by challenges in federal court. Meanwhile, the FCC has rejected two proposals by Baby Bells to begin originating long-distance service within their territories, arguing that they still haven't done enough to open their franchises to competition. A third application, by BellSouth, was pending as we went to press. It, too, was likely to be rejected.

All this aside, the stocks of the Baby Bells in particular have been outstanding performers since the AT&T breakup. All five of the remaining Bells have outperformed Standard & Poor's 500-stock index since January 1984. And all of them, as AT&T, a long-term laggard, have been spectacular since late last summer. The Bells have been so strong recently that one analyst, Anthony Ferrugia of A.G. Edwards, cut his rating oh all five to "reduce" -- a euphemism for "sell."

On the surface, the Bells look similar. Traditional businesses -- local dial-tone service, in toll calls, and fees collect long-distance companies to local networks -- bring in of revenues, as they have since the breakup. All of the companies have sought higher revenues through enhanced services, such as caller ID and three-way calling, as well as by providing data and Internet services. The stocks trade about 17 or 18 times estimated 1998 profits (versus a P/E of 20 for the S&P 500), and analysts see earnings (except for US West) rising at an 8%-to-10% annual rate for the next three to five years. Yields are above average.

Ameritech

Don't tell Oren Shaffer, Amexitech's chief financial officer, that ids company is just another Baby Bell. Ameritech (symbol AIT, recent price $80), headquartered in Chicago, does provide local phone service in Illinois and four nearby states. But, notes Shaffer, Ameritech's cellular-phone-service revenues are seeing powerful growth -- a 30% quarterly increase in subscribers in the third quarter. Moreover, he says, Ameritech is pushing vigorously into such areas as security monitoring and cable television that "we can connect to our core business and that have higher growth rates."

Shaffer notes that at the end of 1994, Ameritech served only 44,000 customers in its security-monitoring business. Now, after the recent $610-million purchase of Republic Industries' monitoring business, Ameritech boasts more than one million customers. Over the past ten years Ameritech has doubled the percentage of revenues derived from nontraditional sources to roughly 30%.

Ameritech, like the other Bells, is also making significant investments in overseas companies. It owns chunks of Telecom Corp. of New Zealand; NetCom, a Norwegian cellular company; Belgacom, in Belgium; and Matav, the Hungarian phone company. It ,recently agreed to invest $3.2 billion for a stake of more than 40% in Tele Danmark, the Danish phone company. Ameritech's overseas strategy, Shaffer says, is to invest in the incumbent phone company and then use U.S. expertise to improve the foreign networks. "We've chosen to concentrate in Europe because that's the most stable social and political environment," he adds.