Expected Upside in the Telecom Sector in 2011 and Beyond (T, VZ, S, FTR, CTL, LEAP, PCS)

The earnings reports from telecom players are now mostly out and 24/7 Wall St. is looking up and down through the high-dividend sector to see which telecom players offer the most implied upside. Subscriber growth was sluggish for most companies, and worse for others. The seven companies we have been following are AT&T (NYSE: T), Verizon Communications  (NYSE: VZ), Sprint Nextel (NYSE: S), Frontier Communications (NYSE: FTR), CenturyLink (NYSE: CTL), Leap Wireless International  (NASDAQ: LEAP) and MetroPCS (NYSE: PCS).

One big weight on the entire group is the proposed $39 billion merger between AT&T and T-Mobile USA, a unit of Deutsche Telekom (DTEGY). If the merger is approved, AT&T’s subscriber count will surge even further past second-place Verizon’s.

Sprint has complained loudest about the proposed merger, and with good reason. While it now ranks third in subscriber numbers, it would almost certainly be the first casualty of the combined AT&T/T-Mobile. Sprint’s latest strategy — betting the company on the iPhone from Apple (NASDAQ: AAPL) — could really get hammered if AT&T is able to acquire T-Mobile’s low-end subscriber base. AT&T already offers an iPhone 3GS for just $49, an offer Sprint really would not be able to compete with.

CenturyLink, now the proud owner of Qwest, is going to be busy digesting that acquisition for some time. The company’s latest earnings report was littered with higher costs related to the merger.

Frontier’s landline business could be a profit generator for a while longer, and the company’s high dividend yield strongly recommends the shares. The company may offer the safest short- to medium-term play among all these stocks.

Leap and MetroPCS talked about a merger last year but were never able to agree on the deal. They may not have any other choice if they want to survive.

Here’s a closer look at some of the numbers. All data from Yahoo! Finance, with current prices gathered around noon today.

AT&T target price remained essentially flat at $32. The current price is $29.07, which equals an implied gain of $2.93, or 10%. The company’s dividend yield is 5.8%, and the forward P/E is 11.68. The implied gain has fallen a bit as the company’s share price has risen by about 1% since October 11th. The company is due for a dividend raise, probably about $0.01/share/quarter, if the past two years are any guide.

Verizon’s target price has been raised from $38.61 to $40.00. Today’s price is $36.94, marking an implied gain of $3.06, or 8.3%. The company’s forward P/E is 14.48 and the stock’s dividend yield is 5.3%. The stock’s 52-week high is $38.95, just 5% above the current price. Verizon raised its dividend by 2.6%, to an annualized $2/share in September.

Sprint’s target price has been lowered from a median of $5.68 to $3.15. The stock is currently trading at $2.87, for an implied gain of $0.28, or 9.8%. The share price today is also 23% higher than it was last month and could easily clear the very low bar set by the target price. When the company will return to paying a dividend is anyone’s guess, but do not expect one for at least another year.

CenturyLink’s target price has remained essentially flat at $44.00. The shares are trading today at $37.29, for an implied gain of $6.71, or 18%. The company pays a dividend yield of 7.7%, and its forward P/E is 8.72. The company’s annual dividend of $2.90 has not changed for seven quarters, but the solid dividend yield is still very attractive.

Frontier’s target price has fallen from $7.84 to $6.50. Shares are trading today at $5.43, for an implied gain of $1.07, or 19.7%. Of the stocks in our review, Frontier is the only one trading lower today than it was a month ago, and came within pennies of touching its 52-week low earlier today. The company’s 13% dividend yield is slightly higher than it was last month, due of course to the lower stock price. The annual dividend was lowered from $1/share to the current $0.75/share in September last year, but the company has committed to maintaining its dividend.

Leap Wireless’s target price has remained the same at $11.00. Shares are trading today at $9.04, for an implied gain of $1.96, or 21.7%. The company does not pay a dividend and its forward P/E is negative. The book value of the stock is $8.81/share, and the implied gain is a fantasy.

MetroPCS’s target price has fallen from $15.12 to $12.50. Shares are trading today at $8.65, for an implied gain of $3.85, or 44.5%. The company pays no dividend and the forward P/E is 8.21. Like Leap, MetroPCS’s survival likely depends on a merger, probably with Leap.

Finally, we should note that AT&T and Verizon are both growing their broadband subscriber bases, and that among large business users the two companies garner nearly half of all the internet service provider (ISP) business. Among medium-sized businesses, the two capture more than a third of all ISP business, and among small business, the two get 20% of all ISP business. AT&T gets 20% of all U.S. business traffic and Verizon gets 12%. Business ISP services are more competitive even than household services, so this could change quickly, except that neither AT&T nor Verizon is likely to allow themselves to be severely underpriced.

Unless and until the AT&T/T-Mobile merge is approved, telecom service in the U.S. is a two-horse race. If the merger is allowed, the race might turn into a runaway with an uncatchable leader, a couple of also-rans and a few stragglers.

Paul Ausick