Southeastern local phone company BellSouth (NYSE: BLS) yesterday lowered its projected earnings growth for next year, leading to a sharp drop in the company's shares this morning. The Atlanta-based telco said that higher costs from a faster-than-expected rollout of high-speed Internet services and an expansion of its wireless business in Colombia would cut projected earnings per share (EPS) growth for 2001 almost in half, from 13%-15% to about 7%-9%.

In addition, the company noted that it will restructure its consumer video entertainment business, which delivers digital TV over satellite and other media, and may take a charge to earnings as a result. BellSouth projected revenue growth would also be in the seven-to-nine percent range next year, which excludes Cingular, the company's wireless alliance with SBC Communications (NYSE: SBC). Including Cingular, revenues should grow 9%-11%. The company isn't changing forecasts for the current year, during which it is expected to earn $2.22 per share.

BellSouth gets on DSL train
The smallest of the remaining regional Bell operating companies, or RBOCs, BellSouth has trailed its brethren Verizon (NYSE: VZ) and SBC Communications in signing up DSL customers, but now sees a "window of opportunity," according to Chief Financial Officer Ron Dykes. The company plans to triple its DSL rolls to 600,000 by the end of next year. DSL, or Digital Subscriber Line, technology enables high-speed Internet access over regular copper phone lines, while still allowing regular voice calls over the same line.

As of the third quarter of this year, Bell South had 134,000 DSL subscribers, a significant jump from the previous quarter's 74,000, but still behind Verizon's 350,000 and SBC's 516,000. The company noted in a conference call yesterday that daily installs have increased from "just under" 300 at the end of the first quarter to about 1,000 per day as of the third, and the company plans to boost that to 1,500 by next year. This is largely due to a high success rate of self-installs and stepped-up marketing of the service. The company expects $225 million in revenue from DSL next year and $500 million in 2002.

Why the drop in shares?
It's certainly a good thing that BellSouth is getting up to speed with DSL, and the company can be given credit for taking a temporary hit to earnings in order to do so. And while a company's stock will always fall when it cuts earnings growth projections in half, investors may wonder why the market's reaction was so harsh.

To begin with, there are the costs of the roll-out, which are expected to cut about $0.07 from EPS next year (the expansion of the company's wireless business in Colombia should reduce earnings by another $0.06 per share). While the company stipulates that capital expenditures should remain the same as previously forecast -- $6 to 6.5 billion this year, $5.5 to $6 billion next year -- operating expenses resulting from customer service, advertising and equipment such as DSL modems will rise along with the increase in subscribers.

Some analysts in last night's conference call questioned whether the increase in DSL subscribers fully justifies the hit to earnings. While a tripling of DSL customers looks impressive, BellSouth will nevertheless add 70,000 new subscribers this quarter, and on a per-quarter basis that will only increase to 100,000 next year. On a quarter-to-quarter basis, therefore, the increase doesn't seem as dramatic, and investors may be wondering whether BellSouth was caught flat-footed by the response to its DSL service. In fact, according to Dykes, earlier this year the company was forecasting half as many DSL subscribers for 2001 as it now expects.

Other factors weighing down the shares would include the possible charge that the company mentioned related to its video services. Finally, unlike the big long-haul carriers, BellSouth's shares have actually done fairly well recently, up about 8% for the year, and about 40% since September. As a result, it's not surprising that some air has come out of the stock with an announcement like yesterday's.