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Don't Underestimate the New Telecom Troubles

Jim Seymour

I was glad to see Jim Cramer repent a little in Thursday morning's RealMoney.com Columnist Conversation on his disdain for the importance of continuing reports of capital-expenditure declines in telcos -- because I was about to go after the boy on this, taking the other side of the trade, perhaps with a little bad language thrown in.

I think what we're seeing now in telco shrinkage -- revenues and prices, as well as stock prices -- is genuinely bad news, and portends trouble well beyond the borders of TelcoLand.

This is bad news especially, I think, for such telco suppliers as the Big Three -- Cisco (CSCO Quote - Cramer on CSCO - Stock Picks), Nortel (NT Quote - Cramer on NT - Stock Picks) and Lucent (LU Quote - Cramer on LU - Stock Picks) -- and the Six Dwarfs -- Juniper (JNPR Quote - Cramer on JNPR - Stock Picks), Foundry (FDRY Quote - Cramer on FDRY - Stock Picks), Copper Mountain (CMTN Quote - Cramer on CMTN - Stock Picks), Extreme (EXTR Quote - Cramer on EXTR - Stock Picks), Redback (RBAK Quote - Cramer on RBAK - Stock Picks), and Sycamore (SCMR Quote - Cramer on SCMR - Stock Picks).

Some data points to consider:

• Pricing on long-distance voice service continues to fall. The decline may be slowing a little, and some even say it has stopped (though I don't see that in the numbers). But over the next two years, long-distance voice service, especially residential long-distance service, is headed for a $0 per-minute pricing. It will be the giveaway used to buy customers for presumably higher-value-added/higher-margin services -- but many of those businesses aren't so hot, either. And it won't be a cheap giveaway: There are still real costs in long-distance service, especially for those telcos (nearly all) with sizable chunks of out-dated circuit-switched equipment.

• While prices are falling, telco revenues are, at best, flat.

• The Competitive Local Exchange Carriers (CLECs)? Don't even ask: a bloodbath.

• The domestic telco companies are investing $300 billion-plus this year. With revenues flat, that's not sustainable.

• This year the telcos' return -- the inverse return -- in terms of new revenue for every new dollar invested is 1:3. That's right: Telcos are spending three times as much in capital expenditures as they're gaining from that investment in new revenue. And it looks like that inverse return will be 1:4 next year.

• The big telcos simply have to cut back on their capital expenditures. Again: This is not sustainable. Viewed in terms of revenue, the U.S. telco business is already massively overcapitalized.

• Consolidation is picking up speed. US West is gone to Qwest, and I don't expect to see Qwest independent much longer. AT&T may not be in its traditional long-distance business soon, selling that off to try to get the company back on track. Sprint is desperate for a partner after the failed WorldCom deal. Overseas, Sonera, the Finnish national telephone company, is being fought over by Deutsche Telekom, France Telecom and others. Within a few years, I expect to see other European national telcos fall, with the emergence of a Pan-European mega-telco. Political issues make this difficult to imagine right now, but British Telecom and maybe Spain's overly-ambitious Telefonica seem likely to be among the first to be absorbed into that Euro-maw. (Skeptics should recall the course of the "impossible" DT-Italia Telecom deal.)

• With fewer buyers out there, fewer pieces of telecom gear will be bought. That will hurt the tel-tech outfits, badly.

• The tel-tech-gear makers already have to finance -- in many cases, the word should be subsidize -- their telco customers' purchases. Even if you lay that debt off quickly on third parties (at an increasingly high cost, further hurting revenues), there is a limit to the amount of vendor financing the telecom suppliers can provide.

• The domestic telcos have, almost without exception, been beaten down already. Not just the obvious dead men walking, like AT&T and WorldCom, but look also at the price for Verizon (VZ Quote - Cramer on VZ - Stock Picks). Only SBC (SBC Quote - Cramer on SBC - Stock Picks) and BellSouth (BLS Quote - Cramer on BLS - Stock Picks) look even halfway healthy -- and they're down sharply, too.

It gets worse. Beyond the current and future damage to the telcos themselves, and the coming erosion for their tel-tech suppliers, consider what's going to happen in the market as this telco/tel-tech train starts to slow. We've relied on those industries for much of the market energy of the past two years -- and no healthy replacements are in sight.

I think there's a real chance a precipitous fall in telcos and tel-techs will trigger a marketwide slide.

I've been saying since May that I thought we'd see a quiet summer, then things would pick up after Labor Day, and after a month or so of choppiness, we'd take off again, with the Nasdaq ending the year not far off its early-2000 highs.

I still hope for that, but the rational mind says it no longer seems very likely.

I've scaled out of my tel-tech positions except for Lucent and Cisco, and hold only two small telco positions, in Qwest and WorldCom. I think it's time to take profits where you have them in telecom, broadly defined. And to eat some losses, too, if you have them, before they get worse. It's not going to get better anytime soon.

We've gotta look for some new horses. Can't ride these anymore.