Tuesday, January 26, 2010

Beware Telecom Stocks

For accounts looking for income, high dividend paying stocks like Verizon (current yield 6.2%) and AT&T (current yield 6.6%) might seem attractive. However, I am very cautious about the telecom sector - I don't believe the dividends are sustainable longer term, as the business fundamentals remain terrible.

Background: Ten years ago, in 2000, I attended a technology conference here in Boston. One of the featured speakers was John Chambers, CEO of Cisco.

The one key takeaway from John's talk was this statement: "Voice will be free".

In other words, the world was moving towards an internet-based communication system in which consumers and businesses would eventually pay nothing for telecommunications.

Since John's talk, the big telecom stocks have been terrible performers, underperforming the S&P 500 by 2300 basis points. I don't believe the next few years will be any different.

Investing in stocks where the price of the services they provide is continually heading lower, but the costs of providing those services keeps going higher, is probably not a mix that will lead to long term business success.

On top of this, the major telecom companies have huge legacy obligations (pension and health care).

I could go on, but here's an excerpt from a news story today about layoffs at Verizon from Dow Jones (I've highlighted the key parts):

JANUARY 26, 2010, 1:05 P.M. ET

Verizon Swings To 4Q Loss On Layoff Charges

  By Roger Cheng
Of DOW JONES NEWSWIRES

NEW YORK (Dow Jones)--Verizon Communications Inc. (VZ) swung to a fourth-quarter loss as a result of heavy charges, and announced another round of layoffs as executives cast a downbeat note on the economic recovery.

While the New York telecommunications giant's wireless arm remained resilient in the face of lower consumer spending, its legacy wireline segment wasn't so fortunate. Verizon said there haven't been any indications of a pickup in spending on the business side, while the number of new FiOS customers disappointed Wall Street.

"The economy won't help us as much as we thought," said Chairman and Chief Executive Ivan Seidenberg, adding that he doesn't see a significant improvement until the end of the year. As a result, the company plans to shed another 13,000 jobs in 2010, roughly the same amount cut in each of the past two years. The latest represents 11.1% of its total work force of 117,000.

Verizon shares fell 2% to $30.06.

The company reported a loss of $653 million, or 23 cents a share, compared with a year-earlier profit of $1.23 billion, or 43 cents. Excluding one-time items, among them the costs from cutting some 8,000 jobs, earnings fell to 54 cents a share.

Revenue jumped 9.9% to $27.09 billion. Both profits and revenue disappointed analysts, who were already bracing for weaker results.

Verizon Wireless' decision to move into the prepaid arena through a reseller deal, as well as the recent price cut on its unlimited voice plan - which prompted AT&T to follow suit -underscored the pricing pressure the industry faces for voice service.

Verizon Wireless - which is jointly owned by Verizon and Vodafone Group PLC (VOD) - saw revenue rise 22.5% to $15.73 billion as a result of a higher reliance on smartphones with data services.

Wireline revenue, however, continued to drag on Verizon, falling 3.9% to $11.5 billion.

"Today's results were eye-opening, if only because of the magnitude of the divergence," said Craig Moffett, an analyst at Sanford C. Bernstein & Co. "Wireline results were at least as weak as wireless was strong."

The company has pegged its growth on its FiOS services, which include a faster Internet connection and television. In the quarter, it added 153,000 customers to both FiOS Internet and FiOS TV services, driving a 12.6% increase in its average revenue per user. FiOS TV growth, however, was down 50% from a year ago, and results were considered a disappointment.