Telecom vs. Cable

It can be as earth-shaking as the greatest rivalries of modern time: Iron Chef's Morimoto vs. Bobby Flay; Muhammed Ali vs. Joe Frazier; Yankees vs. Red Sox; Democrats vs. Republicans; Roadrunner vs. Coyote; and telecom vs. cable.

I can hear the Monday Night Football-inspired music in the background as Howard Cosell excitedly proclaims, "It's two industries in the throws of evolution. With competition on the rise, will integration be in their future? Stay tuned for Telecom vs. Cable next on MNF, Motley Nightly Fool!"

Telecom's mixed blessing
There is no doubting that the FCC's 1996 Telecommunications Act inspired telecommunications services companies such as AT&T (NYSE:T), Sprint (NYSE:FON), WorldCom, and the then Baby Bells to new heights. Following a number of years of merger mania, the phone companies were prepared to bundle a variety of services to cater to customers' communications needs. AT&T's onetime dominant share in the long-distance industry has dropped to about one-third of the market. The loose translation is that there are now a handful of competitors, including AT&T, SBC Communications (NYSE:SBC), BellSouth (NYSE:BLS), Verizon (NYSE:VZ), and Sprint that are trying to compete for every last communications dollar.

The pressure of keeping up with the big boys has negatively impacted start-ups such as Qwest Communications (NYSE:Q), Global Crossing (NASDAQ:GLBC), and Williams Communications. These companies built up impressive infrastructures, anchored by cutting-edge Internet backbones, but have been unable to operate as efficiently as some larger competitors that leverage their critical mass.

The Telecom Act has been a mixed blessing for the services providers of the industry. The surviving companies have had to fight for every dollar like a bunch of vultures hovering over a carcass. Not only have their average revenue growths dropped from double-digits in the late 1990s to low single-digits today, the concurrent cost pressure on operating margins has caused the companies' cash flow to suffer. With competition at every turn, further consolidation in the industry can be expected.

Cable holds the line
The Telecom Act effectively woke up the sleepy cable industry and prompted its companies to revamp their old, stodgy infrastructure. With the wall lifted between cable and telecom players, the monopoly that was the cable industry was symbolically opened to competition.

The costs involved with converting the old analogue cable lines to digital was astronomical. For an industry that barely had to break a sweat, cable providers were finally under pressure to upgrade their service. Companies such as Comcast (NASDAQ:CMCSA), Cox Communications (NYSE:COX), and Cablevision (NYSE:CVC) were all prompted to make a move before the telecom companies invaded their markets.

The upgrade to digital has also taken on a new dimension with the increased market penetration of satellite television providers EchoStar (NASDAQ:DISH), which operates the DishNetwork, and Hughes Electronics (NYSE:HS), which runs DIRECTV.

Cable operators have found a few new sources of revenue that have broadened its offering base and enhanced growth prospects. With digital cable and high-speed Internet being all the rage, it should only be a matter of time before satellite providers offer a competitively priced broadband Internet service. With DSL offered by the phone companies and cable modems provided by the cable companies, it is about time that the satellite companies slice into some of that Internet pie.

EBITDA to the rescue
The primary item, or group of items, you have to be aware of when analyzing telecom and cable stocks is cash flow. When looking at the financial statements of these companies, focus on EBITDA (Earnings Before Interest Taxes Depreciation and Amortization), commonly called operating cash flow. These numbers will give you a purer idea of how well the company is functioning on an operating level.

Another important measurement that cannot be ignored is enterprise value, which is the market cap of a company (share price times number of shares outstanding) plus long-term debt, minus cash and cash equivalents. The following table compares the telecom and cable industry leaders on EBITDA, Enterprise Value/EBITDA, and Cash Flow from Operations from the trailing 12 months.

All that cash
By the looks of things, it appears that the main cable players are focused on acquiring entertainment-oriented companies. Although Comcast retracted its hostile bid to acquire Disney (NYSE:DIS), this attempt underscores the company's and the industry's desire to move in the Time Warner (NYSE:TWX) entertainment conglomerate direction.

The real question that should be answered is: "What should the telecom services industry companies do with all of that cash?" Just as real estate is all about location, location, location, Wall Street is firmly focused on direction, direction, direction. Where should the telecom industry turn? Should their direction turn to the sky in the form of acquiring a satellite provider (see: DishNetwork or DIRECTV), or should they stay grounded and go after companies like Disney?

I see pure telecom services as a virtual dead end. With local and long-distance services having already crashed into the brick wall and burned, it is only a matter of time before rampant competition for Internet and wireless services slows that expansion, too. If telecom wants to throw the bundling word around, it really must move its service base beyond pure telecom services.

I believe that customers would relish (and even pickle or mustard) the chance to be able to shop for all of their communications needs in a pure one-stop shopping environment. While both the telecom and cable operators have hinted at this one-stop notion, neither industry has fully committed to the strategy.

Battles turn to wars
The FCC's ultimate aim of the 1996 Telecommunications Act was to create a competitive landscape where both cable and telecom companies could compete against each other in an open environment. Eight years after the act went into law, we still view these two industries as separate venues to fill communications needs. I believe that over the next five years, the lines will become more blurred between these industries.

Currently, small battles are being fought to determine the eventual makeup of what will be called simply, the communications industry. It is not hard to foresee an all-out war between telecom and cable companies; this fierce struggle could be similar to the exhaustive war that has taken place in the telecom industry since 1996.

If I were forced to make a choice to buy either telecom or cable stocks right now, my vote would be with the cable companies. The cable companies have not had to battle for every inch of space like the telecom companies, and are therefore less scarred from the battles and not as far down the service evolution progression as the telecom players.

The telecom companies have to become more focused on what they want to be when they reinvent themselves. If that focus becomes refined, my selection process might swing back to the battle-tested telecom companies, which would probably be more ready for a war than the cable companies.

What do you think? Talk with other Fools on the Telecom discussion board.

Fool contributor Phil Wohl spent over 12 years on Wall Street and now concentrates his writing on more fictional characters. He has no stake in any firm mentioned above. The Motley Fool is investors writing for investors.