The Best and Worst
Stocks of 1997
Loser -- ATC Communications
(Nasdaq: ATCT) Price: $1 7/8
The Company's Biz. ATC Communications specializes in that profession that many people dread above all others -- telemarketing. To be more specific, ATC specializes in teleservices outsourcing for companies that have decided to give up on their in-house marketing services. The company began as an attempt to construct a synergistic business around the related fields of database management, telemarketing, and direct mail, but in the early 1990s abandoned that effort in favor of a more concentrated focus on phone solicitation.
Although ATC has invested heavily in up-to-date computer technology, its business remains labor-intensive, dependent upon operators who call people asking them to change long-distance service, modify their existing service, etc. ATC reportedly spends a great deal of time training its workers, but it remains unclear exactly how this training differentiates it from other similar companies. Telemarketing is a remarkably competitive, low-margin business, which is not surprising when one considers the commodity-like nature of the product. As many as fifty companies compete for exactly the kind of business ATC specializes in.
The Story. The ATC story is actually two stories in one: the tale of a high-flying company whose dependence on one large client and whose inability to differentiate itself from the crowd eventually caught up with it; and the tale of an overvalued, commodified industry that finally saw investors recognize the underlying realities of the business.
Prior to 1997, ATC looked like a company on the move. It reported earnings of $0.25 a share in 1996, and analysts projected earnings growth of 30%+ for the next five years. Even at that pace, ATC was probably fully valued early in 1997, but two straight quarters of estimate-beating earnings convinced many that it would be a worthwhile investment. Unfortunately, ATC's business is a difficult one to project, because many of its contracts are short-term and the sheer number of competitors in the industry makes market share a hard thing to control. The strong earnings in 1996 now look like something of an anomaly, the result -- as the company warned they could be -- of large orders that would not necessarily be duplicated.
In 1997, they weren't. ATC saw its earnings drop 75%, while the company actually reported a loss in its last quarter. Revenues for the year were up just slightly, and in the last two quarters they dropped precipitously. More strikingly, the company's operating margin was but a third of what it was in 1996, while its net margins were less than a fourth of the previous year's. Its debt load also rose sharply as the amount of cash on hand shrank.
ATC's stock was punished, then, because its performance was dismal. At the same time, the industry as a whole went through a re-valuation by investors, who finally brought P/E ratios back down to earth. After trading at valuations well above expected earnings growth, most telemarketing stocks were punished as investors noticed the growing commodification of the industry.
How Could You Have Avoided This Loser. In the first place, one could have noticed that no one likes telemarketers. More to the point, one could have seen that the lack of proprietary technology in the field -- there is some, but little of consequence -- meant that pricing pressure would be incessant, and that the absence of long-term contracts made the future remarkably uncertain.
At the same time, a glance back at 1995 -- when ATC turned in a year very much like 1997 -- might have suggested that 1996 was a surprise that was unlikely to be repeated, and that low operating margins and slow earnings growth were the baselines for this company. A more careful application of the PEG ratio might also have led one to wonder what telemarketers did that was wonderful enough to merit PEGs of 1.3 and higher.
The Future. The temptation is to say: bleak. Coming off a quarter in which it lost eight cents per share, ATC's future looks no brighter than that of any company making an undifferentiated product in a fiercely competitive industry. On the other hand, the fact that the future was hard to predict after 1996 means that the future is still hard to predict now. When a company is doing just $97 million in sales, a couple of big contracts can alter earnings dramatically. And if ATC seems to be no better than its peers, it's not exactly clear that it's much worse, either. Similarly, while ATC does 30% of its business with AT&T, and suffered this year from cutbacks in spending at Ma Bell, that relationship obviously offers the possibility that an upturn in business at AT&T -- which looks as if it could be happening -- might also boost ATC's fortunes. It's probably also true that the next few years will see consolidation in the telemarketing industry as companies look to rationalize production through mergers.
Nonetheless, none of this makes ATC an interesting investment in the near future. Although any stock trading around $2 always seems to be tempting -- this is the "How low can it go?" philosophy of investing -- ATC is probably fairly valued at this point, since analysts' projections of 30% earnings growth over the next five years smack more of pie-in-the-sky optimism than of a real interrogation of the business. More importantly, there's no reason to believe that ATC is more likely to rebound from 1997 than to turn in another year of low margins and shrinking revenues. It's probably true that telemarketing is not going away, but it's not clear what ATC's role in that industry will be.
-Jim Surowiecki (TMF Cinder)
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