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December 31, 2008

Telecom: 2008 Year In Review

Over they years I have expanded my universe from media to telecom as the two industries have converged. Technology advancement has triggered the convergence as broadband wireline and wireless networks have changed the business of content creation and distribution.
Telecom stocks performed better than the S&P 500 in 2008 although breadth was poor. SNL Kagan's Communication Index fell 36% but was buoyed by AT&T (-31%), Verizon (-23%), Comcast (-7%), and Time Warner Cable (-21%). Indices with exposure well beyond these large cap companies performed less well. Here is a summary of 2008 performance for the major SNL Kagan Communications indices through early Wednesday morning.

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Lack of breadth is particularly notable in the poor performance of the wireline and wireless indices and the small cap index.

There were four major themes in telecom in 2008. Each will roll forward to influence 2009 which may all be impacted by new faces and a new direction at an Obama-directed FCC....

....Smartphones and Wireless Data were the most important development in telecom in 2008. Smartphones are becoming dominant, accelerating a major trend toward data over voice. This had a major impact on devices and network infrastructure. It also impacted competition between major cable and telco companies and began to alter the pricing structure in the industry. The major telcos were winners and remain well positioned as cable companies lack wireless and face pressure on their dominant broadband delivery networks from wireless. I expect this to continue in 2009 but the telcos have to be wary about voice pricing especially as sub grwot will remain low with penetration near peak levels.

A second major trend with profound implications in the competitive battle between telco, cable, and satellite TV was the rollout of telco TV. T and VZ are using different technology but both are becoming serious players in TV with a combined subscriber base of over 2 million subs that is likely to grow significantly in 2009 as the geographic footprint of their networks expand. In certain markets, telco TV is getting double digit penetration. Telco is a winner here as well as it has a stronger bundle to compete with cable and satellite. However, it may be a pyrrhic victory as network build out and customer connection costs are enormous making profitability questionable. What really matters is that 2008 leveled the playing field in many cities in the cable/telco battle. Looking ahead, pressure on subscriber growth in telephony, TV, and high speed internet from the housing crisis and recession will continue. Whether its manifests itself with aggressive pricing will determine if cbale and telco stocks can again outperform the market. Stable pricing is good. Price cutting is bad.

A third major theme in 2008 was the collapse of emerging market wireless stocks. Many stocks fells 60-80% as the combination of fears of slowing growth due to economic pressures and collapsing emerging market currencies undercut earnings estimates, stock valuation, and investor sentiment. Many of these stocks look incredible cheap if growth expectations and currencies stabilize but it is a macro call at the moment which makes typical fundamental analysis at the industry and company level less useful.

The final theme in 2008 was consolidation. Several major deals were announced concluded including Verizon's acquisition of Alltel, CenturyTel's purchase of Embarq, and Time Warner's divestiture of Time Warner Cable. Given the current state of the credit markets further consolidation seems unlikely beyond smaller deals such as several completed by AT&T in 2008 to expand its wireless network. 2008's deals will impact 2009, however. Cost synergies will remain as will restructuring opportunities leading to more efficient operations and margin upside when fundamental trends improve.

I navigated the telecom landscape poorly in 2008. I held on to Northlake's position in NII Holdings as the stock collapsed, making the mistake of believing my ultimately correct analysis of the company's fundamentals would overcome the souring of investor sentiment. I also erred by throwing in the towel and selling Northlake's position in Comcast at the very end of 2008. Comcast didn’t make money for anyone in 2008 but I live in a relative performance world where a full position in a stock that only dropped 7% would have been huge.

Looking to 2009, in early December I purchased a position in AT&T. I think the defensive nature of its earnings and cash flow and the 5.6% dividend yield will lead it outperform the market again. I also continue to own NIHD which I believe will continue to beat estimates on a local currency basis. Valuation is extraordinarily cheap if I am correct providing a massive upside opportunity of double or triple your money.

Posted by Steve Birenberg at December 31, 2008 10:24 AM in Telephone