Wachovia analysts advise going long CenturyTel stock, short Verizon

By Ronda Fears

Nashville, April 4 - On expectations that there is more upside in CenturyTel Inc. than Verizon Communications Inc., Wachovia Securities, Inc. analysts Jeanine Oburchay and Jennifer Fritzsche recommend pairing a long CenturyTel stock position with a short Verizon position.

The analysts suggest a one-to-one share trade, long CenturyTel common stock and short Verizon common stock, which would be a spread of $8.09 based on Thursday's closing prices. They recommend closing out the position at a zero-dollar spread, which would be roughly $32.

"We believe CenturyTel should trade at a premium to Verizon," the analysts said, noting less competition for CenturyTel in rural markets and complicated regulatory entanglements for Verizon plus the overhang from its involvement with Vodafone.

Both companies generate positive free cash flow, the analysts said, noting they expect CenturyTel to generate more than $500 million in free cash flow in 2003 and Verizon should generate nearly $12 billion in free cash flow.

"As a result, we do not have concerns about the credit story of either company," the analysts said.

"However, we believe CenturyTel equity has upside from here, whereas Verizon does not appear to."

Over the next five years, the analysts project believe CenturyTel earnings will grow at a compound annual growth rate of 18%, which would translate to a 0.77 price to earnings growth ratio. Conversely, they see Verizon earnings over the next five years declining slightly, from $2.74 in 2003 to $2.69 in 2008.

CenturyTel and Verizon are both providers of local wireline telecom services with CenturyTel operating in rural markets whereas Verizon also offers wireless and long-distance services plus local service primarily in more competitive major markets.

"Verizon also differs from CenturyTel in that CenturyTel is a pure-play local service provider. Verizon, on the other hand, is looking for growth opportunities outside of its core local business, because price competition in its local markets puts pressure on margins," the analysts noted.

Historically, local service, Verizon's core business contributing more than 60% of its revenue, has provided an EBITDA margin in the low to high 40% range. The businesses driving future revenue growth, long distance and wireless, offer EBITDA margins that are substantially lower.

For instance, long distance has experienced dramatic price reductions over the past three years and currently generates an EBITDA margin in the low 20% range. In addition, with an average of 6 to 7 carriers in most major U.S. markets, pricing competition in the wireless industry continues to be intense.

"Although both companies are affected by negative economic conditions leading to access line declines, we believe an economic turnaround will be more beneficial to CenturyTel and in fact may not help Verizon, whose problems are more secular than cyclical," the analysts said.

"CenturyTel operates the local exchange carrier in rural markets. These are typically markets that are either exempt from competition, as written in the Telecommunications Act of 1996, or are less subject to competitive (and therefore pricing) pressures due to a high cost of entry relative to population density.

"Verizon operates in major markets, and since the recent FCC [Federal Communications Commission] Triennial Review the states now have jurisdiction over RBOC [regional Bell operating companies] pricing.

"Having 50 regulatory bodies will likely make the regulatory process a more complicated and time consuming one. In the five weeks following the FCC's decision, three states have lowered the wholesale rates the RBOCs are allowed to charge non-facilities-based competitors such as AT&T Corp. and MCI."

The last issue for the Verizon bear case is the Vodafone put, they noted.

Under the terms of Verizon's agreement with wireless joint-venture partner Vodafone, Vodafone has the right to put part of its ownership stake in Verizon Wireless to Verizon.

According to the agreement, Vodafone has a put that may require Verizon Wireless to purchase up to an aggregate of $20 billion worth of its interest in Verizon Wireless between 2003 and 2007. The purchase of up to $10 billion, in cash or stock, may be required in the summer of 2003 or 2004. The remainder, which cannot exceed $10 billion at any one time, may be required during the summers of 2005-2007.

"We do not expect the put to be exercised at this juncture given the tax considerations that would fall onto Vodafone, however, we would not be surprised to see both companies come to a mutual agreement on unwinding the partnership," the analysts said.

"In any case, we believe this risk will continue to serve as an overhang on Verizon's stock."

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