Wireless Sector Sends a Staticky Signal

This was supposed to be the year of convergence for mobile phones, when high-speed wireless telephone networks powered new generations of data-friendly handsets. Instead, it's turned into hunting season on wireless stocks.

It seemed a reasonable concept: After a dismal 2001, consumers would finally go out and buy handsets as Nokia (NOK Quote), Motorola (MOT Quote)and Ericsson(ERICY Quote) revamped their lines and pushed next-generation data-capable mobile phones.

Nine days into the new year, however, that theory was debunked by high-profile Wall Street skepticism about current projections for mobile-phone sales and capital spending budgets, and indications that the holiday season was a poor one for carriers. Barring an unlikely second-half rebound, 2002 could turn out results similar to glum 2001.

Wall Street has reined in its hope that data services -- run over 2.5G networks such as general packet radio service (GPRS) and 1X -- will ignite a handset stampede and greater carrier revenue. This week, the market seems determined to ground the soaring issues after hearing the evidence from all three parts of the wireless sector: wireless service, handset sales and infrastructure.

Both Verizon (VZ Quote) and RadioShack (RSH Quote) provided preliminary fourth-quarter data early in the week that suggested U.S. carriers won't be able to match the massive customer additions of years past.

Merrill Lynch and J.P. Morgan punctuated the gloomy preview of the 2001 holiday quarter with sector downgrades as Merrill advised clients to be underweight wireless stocks in their portfolios; J.P. Morgan slashed its ratings on Alcatel (ALA Quote), Ericsson and Nokia.

All this comes on the heels of a 60% run-up in Nokia's stock in the final three months of the year, alongside 54% gains from Ericsson, 58% in Alcatel and an 81% leap by Siemens (SI Quote) during the same period. Investors may have briefly forgotten that dreams of a late-2002 recovery were pushed out months ago to 2003.

"The business has plateaued," says W.R. Hambrecht's Peter Friedland. "Both [in] subscriber growth and handset sales. The industry is taking a bit of a breather. Growth will restart, but not at the same rate as in the past. It'll be a lower, more normal rate."

Slim Pickings

U.S. wireless carriers dodged the economic downturn for the first three quarters of 2001, signing up the masses. But with around 45% penetration, in 2002 they're going to have to fight harder and stoop lower for untapped mobile phone users. Verizon Wireless reported preliminary fourth-quarter results that tell the tale, adding only 715,000 customers in the holiday quarter, a 5% decline from the third quarter's 752,000 new customers and a 12% decline from the second quarter's 808,000 fresh faces.

Verizon's lagging results may account for some of the troubles RadioShack reported Monday concerning mobile-phone unit sales declines in December. Sprint PCS and Verizon Wireless sell their wares through the retailer's outlets, and held up RadioShack's returns in 2001 as PC sales grew dimmer.

Verizon's declining additions hint that perhaps other Baby Bell spinoffs AT&T Wireless (AWE Quote) and Cingular Wireless also might have suffered during the holiday season. AT&T Wireless forecast aggressive targets of 900,000 to 1 million new subscribers in its fourth quarter, after 748,000 signed up in the third quarter.

Sprint PCS, the leading seeker of low-end customers, set a high forecast of 1.3 million additions in the fourth quarter after enrolling a stunning 1.2 million users in the third quarter.

Fewer additions will force mobile-phone makers to sell phones the hard way, enticing owners to replace their handsets for something better. Phonemakers didn't have much success in that area in 2001, when dismal European sales nipped at Nokia and Ericsson's returns. The U.S. helped equipment makers survive Europe's downturn. This year, emerging markets such as China and Latin America are expected to pick up some, but not all, of North America's slack, as will India and other untapped markets in years to come.

"Over time, I really think most people using mobile phones will be using some kind of data on their handsets, but in 2002, does that make people run out and buy handsets?" Friedland says. "Our feeling is that it's going to take a lot longer than anticipated for replacement sales to be spurred by GPRS and enhanced handsets with features like digital cameras."

Rally Wallflowers

Wall Street has mentally prepared itself for the development, evident in U.S. carriers' shares' rally-defying fall pullback of 4% for AT&T Wireless and 11% for Sprint PCS.

Prices of smaller wireless-network operators Alamosa (APS Quote) and Western Wireless (WWCA Quote) shed 15% from Oct. 1 through Dec. 31, while Triton PCS (TPC Quote) lost 39% and Dobson Communications (DCEL Quote) fell 19%.

Spreading gloom also enveloped semiconductor makers with exposure to cell phones: RF MicroDevices (RFMD Quote) dropped $2.38, or 12.3%, to $17.02. TriQuint Semiconductor (TQNT Quote) fell more than 5% and cell-phone chip giant Texas Instruments (TXN Quote) was down 2.7% in Wednesday trading.

Equipment providers similarly tempered their expectations, forecasting flat growth to a 5% contraction in the infrastructure market in 2002. Now, investors are expected to do the same.