Sifting for Gold in the WorldCom Silt

In the wake of WorldCom's(WCOME Quote - Cramer on WCOME - Stock Picks) bombshell accounting scandal, investors are choosing sides in the battered telecom industry.

Companies with a hint of accounting woes or high leverage are being shunted aside, while other companies with better balance sheets and what are seen as more conservative business practices have seen their stocks escape investors' wrath over the last two days.

Consider the stock action in the telecom sector Wednesday, the day investors digested WorldCom's news that it had inflated its financial statements by some $3.8 billion over the last five quarters. Companies such as Qwest(Q Quote - Cramer on Q - Stock Picks) and Sprint (FON Quote - Cramer on FON - Stock Picks) saw their shares tumble, while some of the regional bell operators, such as BellSouth (BLS Quote - Cramer on BLS - Stock Picks), SBC (SBC Quote - Cramer on SBC - Stock Picks) and Verizon (VZ Quote - Cramer on VZ - Stock Picks), the nation's largest telephone company, ended mainly flat on the day.

Polaroids

"We believe Wednesday's market activity serves as a snapshot of our thesis on the telecom sector, with the lower-leverage and high-cash-flow-generating RBOCs outperforming the long-distance players," wrote Jefferies analyst Richard Klugman in a note published Thursday. He has accumulate ratings on Verizon, SCB and BellSouth, and hold ratings on Sprint and Qwest.

More than investor perception is at play, say analysts. Many of these companies could see their businesses improve from WorldCom's meltdown. "In the long-distance business, the intense media focus and liquidity crunch at WorldCom should make it difficult for WorldCom to maintain market share," said John Hodulik of UBS Warburg.

AT&T (T Quote - Cramer on T - Stock Picks), which slipped 3% Wednesday and was off another 4% Thursday, could be one of the chief beneficiaries, say analysts, if WorldCom loses market share in the long-distance and enterprise businesses.

Stalking

Some analysts, including Hodulik, say a likely outcome of the WorldCom situation is that one of the regional bells buys the company. Many of the bells have looked at buying WorldCom in the past, particularly for the company's Internet backbone and its position in enterprise markets, but antitrust concerns have cropped up.

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But now regulators may be more willing to relax their antitrust worries and allow a deal because of the negative impact on customers, including the military, if WorldCom fails, according to Blair Levin of Legg Mason.

The regional bells have not been immune to the telecom recession, as BellSouth and SBC both announced job cuts recently. But neither have they suffered from melting stock prices as Qwest and WorldCom have.

Other telecom-related companies were also attracting investors. In particular, Conexant (CNXT Quote - Cramer on CNXT - Stock Picks), a chipmaker for communications companies, was up lately 27 cents, or 25%, at $1.36, following a Lehman Brothers upgrade.

Fallout

Qwest, already beaten down this year, appears to be the biggest loser from the WorldCom mess. Shares in the Denver-based company fell by 57% Wednesday; they regained some of those losses Thursday, up lately 31 cents, or 17%, at $2.10. Qwest is most closely associated with WorldCom because it faces its own SEC probe into its accounting practices and is highly leveraged.

Sprint may be the wild card in all this. The company's shares fell as much as 22% Wednesday, but ended the day down 11%. Lately the stock was off an additional 41 cents, or 4%, at $9.69. Sprint has had financing problems during the telecom recession, but has not been named in any accounting probes, although many have speculated that bad news could be forthcoming.

On Thursday management backed its accounting practices. In a prepared statement, William Esrey, Sprint's chairman and CEO, said: "Accounting fraud and misrepresentations destroy trust between businesses and their customers, investors and employees. The accuracy of Sprint's financial statements, the ethics of our employees and the fairness of our business practices are paramount in importance."

Added CFO Robert Dellinger: "We are confident that our accounting is complete and accurate, and we welcome any questions related to our accounting practices."

Sprint can be sure investors will take him up on that offer.