Yesterday, shares of local phone companies were hit after SBC Communications, the number-two local operator in the U.S., revised its earnings forecast for next year. The drop may have seemed unnecessarily steep, but analysts were concerned about more than just a few pennies less in earnings. Now that the baby Bells are offering more value-added services, they may be more vulnerable to a slowing economy.
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In a disastrous year for telecom carriers, the former baby Bell companies, particularly SBC Communications (NYSE: SBC), stood out. Thanks to growing data and wireless revenue, not to mention their "last mile" direct connections to their customers' homes and businesses, shares of companies like SBC, Verizon (NYSE: VZ) and Bell South (NYSE: BLS) avoided the shellacking visited upon their long-distance brethren such as AT&T (NYSE: T) and WorldCom (NYSE: WCOM), and on emerging carriers such as Global Crossing (NYSE: GX). SBC's stock was up over 9% for the year through Tuesday. Then, as if 2000 couldn't conclude without every last telecom carrier getting slapped down, yesterday the local phone companies got a taste of what the others have experienced. SBC announced before the market open that it was reducing its earnings expectations for next year, and was quickly given a 12% haircut (for a graphic illustration of what "gapping-down" means, check out this chart). The company closed yesterday at $46.56, down $6.75 -- its biggest one-day loss since the 1987 crash. Verizon, despite quickly issuing a news release reaffirming its earnings targets for the next two fiscal years, was hit for a 7% loss, and BellSouth, which announced a previously expected charge to its fourth-quarter earnings for a reorganization of its video entertainment business, was down almost 6%. What's going on? On the DSL front, the company said that service and maintenance upgrades in the Midwestern region served by Ameritech, which SBC acquired last year for $80.6 billion, continue to take priority, and have resulted in a slowdown of DSL deployment in that area. Nevertheless, the company continues to add between 3,500 and 4,000 new DSL subscribers a day, and expects that to increase by the second half of next year. Meanwhile, Verizon noted in its statement that it is also adding 3,500 customers daily and has already met its year-end target of 500,000 DSL subscribers, though it is still second to SBC in DSL deployment. No mercy In addition, some analysts were also spooked simply by the fact that a local telco was citing an economic slowdown as a problem. Generally, local phone service is a pretty reliable business, recession or not, and this made baby Bells a safe haven during tough economic times. But now that companies like SBC are looking to less-essential services such as voice mail, caller ID, and more expensive high-tech services such as DSL and wireless for revenue and earnings growth, they are more vulnerable to the effects of an economic slowdown and, as a result, more vulnerable to sharp downturns in their share prices.
SBC said that it now expects earnings per share (EPS) to grow 11% to 14% and sales to increase 8% or 9% next year, down from 14.5% and 10%, respectively. In a news release, the company cited three factors for the change: "the slowing national economy," delays in regulatory approval for long-distance service --particularly in California -- and service problems and other issues that will delay the rollout of its high-speed Internet service, or DSL. SBC now doesn't expect to enter California's $15 billion long-distance market until September of next year, later than planned.
Nevertheless, DSL is a critical new service for the baby Bells to implement, and it is not surprising that any sign of a delay impacted their shares. This is particularly true for SBC, which earlier this year trumpeted the $6 billion it is spending on "Project Pronto" to make DSL more widely available in its service areas. The company needs to show a return on that investment as soon as possible.
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