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Promise of Fiber Optics Justifies Bet on Battered Telecom Stocks

Original Article

Original Article
In case you haven’t noticed, the market has pretty much been treading water since I called attention to the postelection euphoria of a few weeks ago. I’ve noticed the big market moves recently have come in short-term bursts of trading, which make it more important than ever to anticipate trends. Even in a market of short attention spans, long-term thinking is critical.

This is the rationale behind my recent investments in the beleaguered telecommunication-equipment sector. I will be the first to admit that my holdings in this area have gone nowhere, including Nortel Networks, whose stock I both own and have recommended. Nortel got up to about $4 before plunging after announcing it was delaying yet again its financial restatement. It is hovering just under $3.50, about what I paid for it.

While Nortel’s failure to restate its earnings as promised has shredded the company’s credibility on Wall Street, I continue to believe the underlying business is sound, and that the results, when they do appear, will be reassuring. (The company’s next pronouncement on the subject is set for next week.)

I recognize that this is a dwindling view, and agree that the company’s repeated broken promises are inexcusable. I can only hope that Nortel’s dealings with its customers are more professional and reliable. That said, I’m still willing to give it the benefit of the doubt that the accounting issues are so esoteric that there has been no ready resolution. And far better to get the restatement right, no matter how long it takes, than get it wrong and have to do it all over again.

Nortel’s accounting issues aside, you might well ask why I’m even bothering with any company in the telecommunications sector, which has been plagued by overcapacity, ruthless price-cutting, nonsensical government regulation and high-profile bankruptcies. The reason is that I believe communication is a mainstay of the global economy. It is marked by rapid technological innovation, growing demand and a convergence of related businesses, from entertainment to banking.

I also like telecommunications for the simple reason that almost no one else does, which means stocks are cheap. Two weeks ago, I reported selling some positions with big profits. I like to use the proceeds to buy something out of favor, and telecommunications fit the bill. The immediate trigger for my recent buying was the announcement by SBC Communications that it was spending $4 billion to build a fiber-optic network into homes.

You may not remember George Gilder, the technology guru behind the “Gilder Technology Report,” but I do. Few things excited Mr. Gilder as much as the promise of fiber-optic cables into the home. The collapse of the technology bubble discredited Mr. Gilder’s stock picks, but I’m not sure his analysis was so far off the mark. The fact is that fiber-optic cable does offer enormous advantages in speed and capacity, something local Bell customers are likely to discover when they download a movie on their DSL lines.

If SBC succeeds with its fiber-optic rollout, and I predict it will, the market for telecommunications gear is going to burgeon way beyond $4 billion. SBC hasn’t said where it is spending the money, but the food chain of equipment companies is well-known. Corning makes the glass fiber. Ciena and JDS Uniphase produce some critical components, as do Lucent Technologies, Nortel and Alcatel. Cisco Systems and Brocade Communications Systems make routers. I already own Cisco, Corning and Nortel. A few weeks ago I added JDS Uniphase, Lucent and Ciena. You don’t need to put a lot of money at risk. Ciena was recently trading at $2.55, JDS Uniphase at $3.18 and Lucent at $3.98 (about where they were when I bought them).

I recognize my endorsements are highly contrarian; it’s hard to find anyone on Wall Street who likes them. Are these stocks likely to take off tomorrow? I doubt it. It may take years to determine if I’m right. But I plan to be patient.

James B. Stewart is an editor at large at SmartMoney magazine and a contributing editor at SmartMoney.com. He may have positions in the stocks he writes about.