The combination of high growth rates and tumbling stock prices can present rare opportunities for gutsy investors. We sat down with Brian Hayward, manager of the solid (ISWCX Quote)Invesco Telecommunications fund, to find out who might be the telecom bellwethers in the New Economy and where he's putting his shareholders' money these days.
Brian Hayward |  |
Fund
(ISWCX Quote)Invesco Telecommunications |
Managing Fund Since
June 1997 |
Assets
$3.5 billion |
YTD Return/Rank in Category
-7.1% / 1 of 13 |
1-Year Return/Rank in Category
39.3% / 1 of 17 |
Load / Expenses
None / 1.24% |
Top Holdings
SDL (SDLI Quote)
EMC (EMC Quote)
Juniper Networks (JNPR Quote) |
| Source: Lipper. |
1.
Ian McDonald: In the past several years, the telecom sector has kind of morphed into having overlap with technology, and some people might be a bit confused about where the sector's lines are drawn. What industries fall under the telecom umbrella these days? Brian Hayward: Well, network equipment and service companies. The overlap in technology does come from the equipment providers and the component suppliers to those system vendors. But it's primarily the equipment vendors, and we wouldn't be having much of a conversation if it wasn't for the Internet. That's really what's driving it, because the networks that were designed and deployed decades ago in mature markets were designed to carry three-minute voice conversations over copper wire. And that network is incapable of handling the kind of traffic that's being generated by the Internet and by machines talking to machines. So that's where technology and telecom can overlap.
2.
Ian McDonald: And by service companies, you mean folks who provide long distance and the old-school phone services people think of? Brian Hayward: Right. But we're more focused on new carriers that have arisen as a result of deregulation than the incumbents. The incumbents had a monopoly position before deregulation, so their market share only had one place to go and that was lower. Although, more recently, we have changed our focus away from just solely owning new carriers to regional Bells and the national phone companies. Anywhere [there's] a local loop, the last mile in the network, it's becoming clear that is an asset that will not be duplicated, and the owner of that asset controls the last mile.
3.
Ian McDonald: What trends and what companies are your favorites today and in the long term? Brian Hayward: There are three trends that we are emphasizing. I would say the most important right now would be the explosion of data traffic on the Internet and the changes it's causing in network infrastructure.
The next one would be deregulation, and that is creating a market for new carriers. We have to be very careful about choosing which carriers to invest in, because we are now starting to see a shakeout. Now there are too many and consolidation has started. But there are still opportunities, because the market share is still very small for these companies. They are able to sell their wares very easily because of the service that their target customers have had in the past from the incumbents. So there's still huge opportunity ahead of these carriers, but they do have to execute. I mean, it's been long enough now that people are starting to ask: When is the revenue going to come for all this money you put in the ground?
So, those two are still, I think, very much intact and offer investment opportunity. The last one -- we're still invested there but are emphasizing it less now than we were a year ago -- is wireless. The momentum is -- I don't know if it's absolutely gone, but it is certainly diminished dramatically this year vs. last. It looks like the majority of handset growth is going to come from replacements. A lot of people don't need brand-new voice phones, so there's a wait-and-see attitude for the data, the Internet wireless experience.
4.
Ian McDonald: In these three areas you're focused on, what are one or two companies in each that you are most bullish on? Brian Hayward: For the explosion of data traffic, it's system vendors and component suppliers to those vendors. And because it has to change from copper voice networks to optical networking -- that's the only medium that can handle the traffic -- it's optical systems and components. So that's why
SDL (SDLI Quote) is our No. 1 holding. Optical networks cannot function without lasers. And SDL is one of the top players in lasers that go into optical networks. We also own
JDS Uniphase (JDSU Quote). So when you combine those two, since they are merging, they are by far the largest holding. And we own more of SDL because of the arbitrage gap. We believe it will close, that the merger will be authorized by the regulators and the gap that's there now will close. So that's why we own more of SDL than JDS, but both of them have very strong visibility in the next couple of years at least.
In terms of system,
Nortel Networks (NT Quote). And for deregulation, we don't own any. Well, actually, deregulation also drives equipment spending, because the new carriers are starting with a clean slate and can offer services that are enabled by a new network. The incumbent carriers, not only do they have to upgrade the network to handle traffic that their customers are offering, but also to compete with the new carriers who are starting with a clean slate. So in that respect, deregulation also drives equipment spending, hence, the same names.
But on the service side, it's new carriers. And
Time Warner Telecom (TWTC Quote) is our largest weighting among the clecs -- the competitive local exchange carriers. But it's not among our top 10.
5.
Ian McDonald: You said you were de-emphasizing wireless these days. What are your favorites there? Brian Hayward: Actually, Nortel does play in the wireless space, and they've won a few contracts for third-generation infrastructure deployment. But I don't really think of them as a wireless play.
So for wireless, our largest holding -- also not in the top 10, but near the top 10 -- is
Comverse Technology (CMVT Quote). It's largely voicemail on wireless networks. But we also own
Nokia (NOK Quote). Nokia was in our top five this spring, and then as we were getting more and more negative data points on the margin, we cut our weighting by a third. We still hold it because our overall philosophy is to buy and hold industry leaders in their respective sectors. And Nokia is the industry leader in handsets.
6.
Ian McDonald: When you say telecom, investors who aren't aware of some of the technical issues are still thinking, to a certain extent, of some brand names like AT&T (T Quote) and Lucent Technologies (LU Quote). What do you make of these firms in the New Economy, in terms of building out these networks and moving quickly using new technology? Brian Hayward: We don't own AT&T or
Sprint (FON Quote). Actually,
Qwest (Q Quote) is in our top 10, but it isn't really an AT&T or a Sprint in terms of being exposed to long-distance consumers and business. In fact, they are causing problems for the incumbent carriers. But, overall, the long-distance group is suffering from a more rapid deterioration than thought earlier this year in consumer long-distance and business long-distance rates. For AT&T, 70% of their revenue and most of their cash flow comes from consumer and business long distance. So that's a problem. And in the meantime, they're spending significant capital expenditures on building the cable plant to offer bundled services, including telephone service. So we have that promise down the road. It's too early to say whether it will or will not work. But in the meantime, their main cash generator is deteriorating.
Lucent was the darling for quite a while, but the bet that they made on the direction of optical networking was incorrect. And Nortel moved to No. 1 in deployment of OC-192 technology. That's just a speed of service. It's 10 gigabits per second, as opposed to OC-48, which is 2.5, I guess. Lucent made the wrong bet, so Nortel was about the only game in town at the time when carriers began to move to OC-192, so they missed a product cycle and have been playing catch-up ever since. And even though Nortel also was exposed to the voice legacy architecture, the circuit switching architecture, Lucent was more exposed, and that's deteriorating. It won't be too much longer before people don't spend any money on those kinds of switches anymore, and that, plus software upgrades, was a huge generator of income for Lucent. That's under pressure now.
7.
Ian McDonald: We're at a crossroads, it seems, in telecom. Who would you point to as the two or three new bellwethers -- blue-chip companies that are going to be players on new networks and on the greater-bandwidth, faster networks? Brian Hayward: Nortel would be the top system provider. JDS-SDL in terms of lasers. There are chip companies that sell components to the system vendors --
Applied Micro Circuits (AMCC Quote) would be one. And
PMC-Sierra (PMCS Quote). And on the router side,
Cisco (CSCO Quote) has been and still is the dominant force. But, you know, they started off as an enterprise provider and are trying to move to the carrier space. And in the meantime, we have one company that is finally one of the first ones to crack the code and have software that is compatible with Cisco so their routers could be deployed in the network with Cisco routers. I'm talking about Juniper, which makes high-end routers. It's in every carrier-class network now. Because as the traffic grows, with the Internet growing the way it has, there's a demand for these high-end routers, and Juniper makes a faster, cheaper box that takes up less space. Carriers want that.
8.
Ian McDonald: Going back to wireless for a moment. A money manager I spoke to last week said, "I think Qualcomm(QCOM Quote) is a better company this year than it was last year, but it's not a stock I want to own." In essence, he was saying it's still a great company, but people aren't believing in it. They're not believing in that whole area. What are the prospects for wireless? Who do you see as the two or three wireless players that are strongest? Brian Hayward: The valuations have to come back in line with the elimination of the momentum. I mean, last year you could fall off a log and make money in wireless, and the valuations kept going higher because every revision of the estimates was higher. This year, we started off with handset numbers that were between 400 million and 450 million. None of the revisions have been higher; they've all been lower. So the momentum is gone.
The excitement about the prospects for wireless Internet was driven by the experience at
NTT DoCoMo, where they went from zero customers in February of '99 to over 10 million now. And it's generating almost a quarter of their average revenue per user per month. But it's still relatively slow service, and half of the revenue is coming from downloading personal cartoons and a personalized ring. It's not a real Internet experience. So I think there's more and more realization that perhaps the promise of wireless Internet is not going to be next year. It could be 2003. And how much will the carriers spend after they spent so much money on the licenses? This is over in Europe. So, it's still out in the future and it does have promise, but it may take longer and may not be as large a tsunami as people thought it might have been last year.
9. Ian McDonald: If you had to buy three stocks today and hold them for five years, which ones would top your list? Brian Hayward: Combination of JDS/SDL or just buy SDL to get JDS eventually. I think Nortel for a system vendor would be one. I don't want to avoid totally -- yeah, I do, I guess -- service companies. I'm not sure they'll still be battling with each other for a while. So the arms dealers are where you want to be. I'm leaning to Applied Micro. Those are all pretty liquid, large-cap. There are others that I think might do better over five years, but those companies are, I think, among the industry leaders that will still be standing and doing well in five years.
10.
Ian McDonald: One last question: The last new name added to the fund? Brian Hayward: I think it would be
Corvis (CORV Quote). [Purchased when still a private company.] We are increasing our exposure and our efforts [in private companies] for two reasons. One, hopefully it'll improve returns in the portfolio. So that's offensive. The other one is defensive. We want to try to stay abreast of changes that are occurring in this space. I guess, in a jargon way, we want to know if there's somebody out there in a garage that's coming up with a Cisco-killer.
