Fed move can't mask woes

"'Round and 'round she goes; where she stops, nobody knows." It's a standard line for the supervisors of Wheel of Fortune-type games at carnivals and roulette tables in Las Vegas. Unfortunately for investors, it's become a mantra of bad tidings to stocks in the telecom sector.

It started with the fallout of dot-com companies, whose well-chronicled failures have helped to undermine ISPs. The ISPs' inability to pay bills is cited as the reason for many competitive carriers' financial woes.

As these competitive carriers struggle to maintain their existence, plans to expand their networks drop precipitously on their priority lists. This means fewer contracts for equipment vendors, many of which also are having difficulty collecting money owed to them from previous vendor-financed contracts.

No one seems to be immune. Faced with more than $60 billion in debt and shrinking profits in its core long-distance business, AT&T officials have decided to break up the company and significantly slash its dividends - a longtime hallmark for investors. RBOCs SBC and BellSouth have issued earnings warnings, and even Wall Street darling Cisco has been downgraded by an analyst for "guilt by association" with the industry.

Yet for a fleeting moment, the recent surprise decision by the Federal Reserve to lower interest rates by half a point let telecom stocks revisit their glory days. Fueled by news of the interest-rate cut, the telecom sector went wild for a day, with double-digit percentage gains seemingly the norm.

Yes, it seemed like the good old days, when telecom stocks regularly led Wall Street's big gainers amid a seemingly unending tide of good economic news. You may remember this era, as it ended less than 10 months ago. Things were so good that many people abandoned jobs that contributed to the gross national product to pursue their new-found "expertise" in the stock market as day traders.

According to market logic, the easing of interest rates makes it easier for companies to access cash needed to access more customers by building networks, which require equipment and value-added contracts that keep hardware and software vendors happy. Everybody's stock goes up, creating a gravy train investors love to ride.

This fervor seemed to resurrect itself briefly when Alan Greenspan and company eased interest rates for the first time in two years. But this sentiment was short-lived, with the Nasdaq giving back almost all its gains within a week.

I wouldn't pretend to understand why the market moves the way it does, but the inability of the telecom sector to benefit from the Fed's action makes sense from at least one perspective: Favorable interest rates are helpful immediately only to those in a position to borrow.

Put simply, problems in the telecom sector are related more to the principal, not the interest, involved in doing deals. While the Fed dropping interest rates is welcome news, it can't hide the fact that many telecom companies are not profitable. As a point of comparison, a family struggling to pay the rent on an apartment while fighting its use of high-interest credit cards isn't in a position to buy a new house, even if the interest rate is nil.

The good news is the long-term outlook for the telecom industry remains strong. The demand for telecom services continues to grow, so the opportunity to generate revenue will be available to industry players that survive the current shakeout period. For these companies, the benefits of the interest-rate drop should be apparent within the year.

For others, the Fed's action is too little, too late.