Hagan School of Business
. Peter Kennedy has covered telecommunications services at
Morgan Stanley Dean Witter
since 1994. Before that, he was a director of finance at
Nynex Network Systems
Industry Outlook and Style
Competitive local exchange carrier stocks turned in stellar performances in 1999, but since March and April the sector has swooned more than 40%, a victim of the overall
Morgan Stanley's Peter Kennedy has weathered the CLEC storm by focusing on a singularly compelling trend: strong demand for -- and scarce supply of -- local broadband capacity. (By some estimates, less than 5% of U.S. office buildings have a direct fiber-optic connection.) Convinced that this "bottleneck," as he calls it, is a key force propelling the competitive local exchange carrier marketplace, he has spent the past year persuading clients that companies with rich local broadband assets would be the best long-term performers.
Time Warner Telecom
is Kennedy's favorite stock. "We continue to see strong demand for local connectivity, and we think Time Warner Telecom has the most extensive independent local assets in the group," says the Morgan Stanley analyst. He notes that the company has more than 400 fiber-optic miles in each of its markets, whereas most other companies have less than 50 miles. Time Warner advanced 273% from its mid-1999 IPO through its peak in mid-March, though it has fallen on hard times of late, along with the rest of these names. Since March 15, the stock has lost more than 30%, recently trading in the low $50s. (Morgan Stanely lead-managed Time Warner Telecom's May 1999 initial public offering and co-managed its March secondary offering.)
Kennedy's No. 2 pick is
( MCLD), which sells traditional local and long-distance voice services as well as data services. Like those of its peers, McLeod's shares have pulled back in the past eight months -- the stock peaked at $34 in early March but has since shed half its value.
Despite the stock's miserable recent performance, Kennedy believes its long-term prospects are good. "We think its annual growth rate will continue to exceed 50% year over year, which is impressive considering its revenue base is much bigger than that of most CLECs." Kennedy also expects profit margins to increase now that McLeod is moving from being "a low-margin reseller to building their own facilities."
McLeod began operating in Iowa in 1994, and it has since captured 50% of that state's market share, says Kennedy. In addition, the company can claim double-digit market share in six other states, and it has gradually been expanding nationwide. Kennedy's target price is $40, which he believes can be reached by year-end 2001, assuming fundamentals begin driving these stocks again. (Morgan Stanley was a co-manager for McLeod USA's IPO as well as being involved in a host of subsequent secondary deals.)
As for the CLEC industry as a whole, Kennedy expects top-line growth to be driven primarily by data services and such innovative offerings as enhanced 1-800 services for voice, consulting and outsourcing. "CLECs will take a disproportionate share of the market growth at the expense of the incumbents -- the regional Bell operating companies," the analyst predicts. "We've already started to see an acceleration in share take, to one half a percent a quarter as of the first quarter of 2000, and we see that increasing over the next several quarters." Kennedy contends that this increased market share will translate into revenue growth more robust than the current low levels, particularly in the case of the strong, well-managed companies.
Favorite stock for next 12 months:
Time Warner Telecom; 12-month target price: $90
"We think strong demand for local connectivity will lead to more on-Net traffic, which equates to higher-margin traffic. And we think it'll lead to double-digit sequential quarterly top-line growth over the next three or four quarters. The stock is now $52 though it got as high as $89 in March."
Rate Their Stock Picks:
Which stock do you like best?
Henry: XO Communications
Kastan: McLeod USA
Kennedy: Time Warner Telecom