Concerned about the impact of the softening economy, Oppenheimer analyst Timothy Horan this morning turned cautious on the “emerging telecom sector.” He cut his ratings on both Level 3 (LVLT) and Cogent Communications (CCOI) to Underperform from Perform, while chopping TW Telecom (TWTC) to Perform from Outperform.
Horan notes that in the second quarter, the company saw slowing demand and decreases in pricing power from both Cogent and Paetec Holding (PAET). He said Level 3 showed “anemic revenue growth” in the quarter, “but great expense controls.” Horan says that while the sector has already been under pressure, the companies are heading for a “difficult six to nine month period.”
Writes Horan: “We believe the sector will suffer from a slowdown in customer demand [and a] pick-up in churn typical for a slowing economy. This will in turn lead to further price competition, particularly in the long-distance markets. Volume growth is slowing at the same time that the long-distance industry has added huge amounts of capacity. Unfavorable market conditions will likely limit access to new capital.”
Horan adds that he thinks estimates are too high for all three companies he downgraded today. “These business models have high operating leverage and a slight slowdown in revenues will have a very negative impact on EBITDA,” he writes. “We expect some of the smaller, private CLECs to go bankrupt, which could pressure valuations in the sector.”
In today’s trading, Level 3 is down 22 cents, or 6.5% to $3.16. Cogent is down 49 cents, or 4.86%, to $9.60. And TW Telecom is down 82 cents, or 5.2%, to $14.98.