Telecom Companies: The Market's Endangered Species -- Update

In 2000, the S&P 500 telecom sector was stuffed with a dozen companies, including Nextel Communications and WorldCom Inc. Today, it is down to four.

This has created a strange dynamic for the group, which can swing wildly when one or two of the companies change prices.

That was on display on Wednesday, when the S&P 500 telecom sector climbed 3%, led by a 5% gain in shares of AT&T Inc., which reported a rise in profits for the second quarter after the market closed Tuesday. The broader S&P 500 rose less than 0.1%.

The question now awaiting investors is: Will the sector disappear entirely?

Telecom's influence on the broader S&P 500 has waned over the years as companies have merged, been acquired or spun off businesses -- leaving it the next obvious choice for a makeover, investors and analysts say. Telecom, which is made up of Verizon Communications Inc., AT&T, CenturyLink Inc. and Level 3 Communications Inc., is the smallest of the S&P 500's 11 sectors.

"Right now when you look at what telecom is doing, it's usually just one of four stocks moving," said Art Hogan, chief market strategist at Wunderlich Securities. "It makes a great deal of sense to look at the sector."

A wave of possible changes to the S&P 500's classifications could overhaul the group and reshuffle billions of dollars in index-tracking funds that stay aligned with the makeup of the S&P 500. S&P Dow Jones Indices and fellow index provider MSCI Inc. said earlier this month that they are considering rolling out a new sector, the communication-services sector, that would fold telecom stocks in with select media, entertainment, consumer-internet and digital- services stocks.

Telecom was 2.1% of the S&P 500's overall market capitalization as of the end of June, according to S&P Dow Jones Indices, down from 8.7% in 1990.

Over that time, giants like the former SBC Communications bought Ameritech Corp. and AT&T Corp. before rebranding itself as AT&T, while GTE Corp. merged with Bell Atlantic and renamed itself Verizon Communications. More recently, CenturyLink has been preparing to complete its purchase of Level 3 Communications, a move that would further reduce the number of stocks in the telecom sector.

Much of the deals activity in the telecom sector reflects the pressures the industry has faced.

The sector "is changing as landlines disappear, smartphones become more affordable and internet connections become increasingly important," S&P Dow Jones Indices and MSCI said in a statement explaining their rationale for the proposal. "Companies in the sector are adapting by diversifying into internet services, cable, media content and other areas by consolidating with other companies."

The flagging telecom sector could get a boost if the two index providers decide to move some internet-focused companies out of the existing consumer-discretionary and information-technology sectors.

Many such stocks have rallied this year as investors bet on fast-growing firms. Shares of Facebook Inc. have jumped 44% this year, while eBay Inc. has added 25% and Google parent Alphabet Inc. has risen 22%. Meanwhile, the S&P 500 telecom sector has shed 13%.

Investors, asset managers and analysts have said that the telecom sector is too narrowly defined and that it was due for a review, said David Blitzer, head of index policy and governance at S&P Dow Jones Indices. There doesn't appear to be any exchange-traded funds that exclusively track the telecom sector, Mr. Blitzer said.

Instead, funds like the Vanguard Telecommunications Services ETF, the iShares U.S. Telecommunications ETF and the SPDR S&P Telecom ETF track a broader and larger group of stocks, including companies like U.S. Cellular Corp. and Boingo Wireless Inc. that don't belong to the telecom sector.

Still, there are no guarantees of what names, if any, will be incorporated into a new communication-services sector. S&P Dow Jones Indices and MSCI are still weighing whether companies that focus on search engines, social media and mobile messaging, as well as web hosting and web-design services, should be folded into the sector, they said.

The two index providers are soliciting feedback on the proposal from members of the investment community between July and September 29. If they decide to move forward, they would announce the changes by November and roll out the changes sometime in 2018, S&P Dow Jones Indices and MSCI said in a statement.

In 2000, the S&P 500 telecom sector was stuffed with a dozen companies, including Nextel Communications and WorldCom Inc. Today, it is down to four.

This has created a strange dynamic for the group, which can swing wildly when the stock price of one or two of the companies change.

That was on display Thursday, when the S&P 500 telecom sector climbed roughly 4%, led by a jump in shares of Verizon Communications Inc., and on Wednesday, when it rose 3%, boosted by a rally in AT&T Inc., after both companies reported quarterly earnings. The broader S&P 500 rose 0.2% Thursday.

The question now awaiting investors is: Will the sector disappear entirely?

Telecom's influence on the broader S&P 500 has waned over the years as companies have merged, been acquired or spun off businesses -- leaving it the next obvious choice for a makeover, investors and analysts say. Telecom, which is made up of Verizon Communications, AT&T, CenturyLink Inc. and Level 3 Communications Inc., is the smallest of the S&P 500's 11 sectors.

Telecom was 2.1% of the S&P 500's overall market capitalization as of the end of June, according to S&P Dow Jones Indices, down from 8.7% in 1990.

Much of the deals activity in the telecom sector reflects the pressures the industry has faced.

The flagging telecom sector could get a boost if the two index providers decide to move some internet-focused companies out of the existing consumer-discretionary and information-technology sectors.

Many such stocks have rallied this year as investors bet on fast-growing firms. Shares of Facebook Inc. have jumped 52% this year, while eBay Inc. has added 24% and Google parent Alphabet Inc. has risen 22%. Meanwhile, the S&P 500 telecom sector has shed 9.2%.

Write to Akane Otani at akane.otani@wsj.com

(END) Dow Jones Newswires

July 27, 2017 12:06 ET (16:06 GMT)