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October 25, 2006

BellSouth: Going Out in Style

In what will likely be its final quarter as a public company, BellSouth (BLS) reported solid quarterly earnings beating estimates on the back Cingular and revenue and margin upside in its wireline business. The results support a continued bullish outlook for AT&T (T) over the next six months as the merger closes and synergies favorably impact the financials.

The results from T and BLS indicate that the pricing environment in the battle with cable operators remains sanguine for all concerned. There is no doubt that the battle for subscribers is fierce but for now the battle is being fought on features, not price. Trends in average revenue per unit, especially for broadband, show that pricing has been stable this year. This is definitely better than most observers expected earlier this year.

How long the pricing remain benign will be the key to future performance of cable and telephone shares. I suspect that for the next several quarters all will be OK. T and VZ are benefiting from wireless growth and wireline cost cutting. These factors are overcoming the loss of access lines such that T and VZ can meet or beat their earnings growth targets. Additionally, penetration in high speed internet is still growing fast enough that DSL and cable can both achieve their subscriber goals without competing on price. BLS stated that its broadband subscriber growth is shifting in favor of higher speeds at higher price points. This is a strong indication that the broadband market is healthy enough to prevent a near-term price war.....

Getting back to BLS, the company reported EPS of 65 cents on revenues of $9 billion, ahead of consensus of 59 cents and $8.8 billion. Over half of the EPS upside came from Cingular which reported results last week that were not yet incorporated into the BLS consensus. Not to be overlooked is better than expected results from the wireline business. Revenues were slightly above expectations driven by broadband, small and medium size businesses, and data, but the real story was continued margin expansion. EBITDA margins rose 290 basis points year over year due staffing reductions, tight operating expenses, and good weather. Even adjusting for a benefit of as much as 150 basis points due to the lack of hurricanes this year, the margin performance is very good.

BLS spent a lot of time talking about stabilizing line losses. For three straight quarters line losses have now hovered around 7%. Lesser wireless substitution and limited incremental rollouts of cable telephony were cited.

The story at T over the next six months will be whether DSL, data, and small and mid-size business revenues can grow fast enough to offset continuing high levels of line losses. Assuming recent trends can stay in place, cost cutting driven by merger synergies should be enough to drive earnings growth at least as expected. The shares have come a long way but if the basic fundamental drivers don’t shift, more upside lies ahead.

Posted by Steve Birenberg at October 25, 2006 08:08 AM in Telephone