SAN FRANCISCO -- If Charles Darwin were around today, he'd likely have something to say about the future of the emerging telecom firms called competitive local exchange carriers. A looming shakeout in the sector will show soon enough which ones are fittest for survival.

CLECs, which compete with the Baby Bells for business customers, had been seen as a high-tech bet because of the sore need for bandwidth. This week, though, the stocks of even the largest, strongest and most liquid CLECs have been pounded into near oblivion.

Whether they have good news or bad, the Street persists in punishing the CLECs. Last week, for example, Tampa, Fla.-based

Intermedia

(BNET:OTC BB) plunged on rumors the company would preannounce poor third-quarter results. The stock failed to rebound after the rumors proved groundless. Thursday

GST Telecommunications

(GSTX)

of Vancouver, Wash., announced it installed 30,000 new lines in the third quarter, an increase of over 40%. Its stock fell more than 15% to 3 11/16 despite the news.

The CLECs are adding new access lines at twice the speed of the Bells; they install state-of-the-art fiber optic lines and digital switching equipment that will yield returns on capital much higher than the outdated RBOC systems, which are still heavily laden with copper wire. The cream of the sector is well managed and well capitalized. Yet the bloodbath in share prices continues with no end in sight.

What gives?

In a nutshell, the CLECs are suffering from the malaise affecting nearly all growth stocks in the run-for-cover market. Fundamental reappraisals of risk and time horizons are going on in all financial markets, and telecom investors are stating clearly they don't want to buy rosy prospects, they want earnings growth and dividends -- and they want them now, not later. CLECs are mostly early-stage ventures that still must spend heavily on infrastructure and, while a few such as Intermedia are going cash-flow positive, they are still years from profits.

"People are sticky on fundamentals now," says Liam Burke, co-manager of the

(TISHX) - Get Report

Flag Investors Communications fund, which held 225,000 shares of New York-based

WinStar

(WCII)

as of June 30. "Futures have less appeal than they did a few months ago."

Vik Grover, telecom analyst at

Kaufman Brothers

, puts it less subtly: "Anything with fiber or CLEC in it is getting chopped to bits."

In contrast, defensive, interest-rate sensitive stocks like the regional Bells, which have little or no international exposure and a solid history of earnings growth have "smelled like roses throughout this turmoil," says

Goldman Sachs

analyst Richard Klugman.

BellSouth

(BLS)

saw its shares rise 3 5/16 to a record 82 1/8 Thursday after the Atlanta-based phone company said it expected to post 12% to 14% earnings growth in 1999, higher than analysts had expected.

In the meantime, how bad can things get for the CLECs? A poster hanging in Grover's New York office underscores the mood among those involved in analyzing and financing the sector. The poster depicts partying bears, dancing and eating meat in a forest clearing - an image that hits a little close to home this week. "The bears are definitely dancing. Maybe I should take the thing down," he says.

Looking forward,

Bear Stearns

telecom analyst James Henry thinks the meltdown will lead soon to a winnowing of the sector, with the weakest CLECs being acquired or going bust and the strongest emerging in a solid position to challenge the RBOCs for local market share. CLEC survivors, he says, will have not only strong management and solid business plans but enough financing to ride out what could be a long-term drought in the capital markets.

"The equity and unsecured high-yield markets are closed for the foreseeable future," said Tom Lord, chief financial officer of Dallas-based

Allegiance Telecom

(ALGX)

. "If you're a cash-rich CLEC, you're in a good position. If I were running a company that needed cash in the next six months, I'd put the company up for auction or find a partner to take a 10% or 20% stake."

Lord says his company is sitting on $500 million in cash, enough to finance its business plan for the next two years.

Bear Stearns' analysis of the cash positions of major CLECs at the end of the second quarter shows that deep-pocketed

NextLink

(NXLK)

, which was founded by cellular phone pioneer Craig McCaw, holds $1.341 billion and is financed through the second quarter of 2000. Intermedia, with $763 million, and WinStar, with $703 million, can hold their own for the same period.

ICG

(ICGX)

, of Englewood, Colo., with $652 million also is financed through the middle of 2000; while GST, at $558 million is set through the first quarter of 2000.

Strapped CLECs could get reprieves, however, from big telecom equipment makers, which sometimes are willing to extend credit to their customers. Recently, for example,

Lucent

(LU)

said it would provide $150 million in credit to

Advanced Radio Telecom

(ARTT)

. "If these equipment giants are seeing slowdowns in capital spending at the high end of the market, they have an incentive to help out the new competitive players," says Henry of Bear Stearns.

But even that source of relief may slow to a trickle. Bob Ray, a senior vice president at

Moody's

who tracks telecom debt securities, says he isn't so sure that the practice will remain widespread if financial institutions tighten credit. Typically, equipment vendors sell credit paper to banks and insurance companies.

Given growing uncertainty about the economy, those institutions are "taking a closer look" at the quality of the credit they buy, Ray says. "It doesn't mean it's going to dry up and go away, but anecdotal evidence shows it's getting harder to quickly place that kind of paper."

And that's bad news for those CLECs that have but a tenuous grasp on the evolutionary ladder.

For more info on institutional holders of these stocks, as well as financial statements and earnings estimates, please see the

Thomson Company Reports.