One of the intents of this column is to explain new and unique trends as they develop. However, the market has been going about its business as usual over the last several months, so there hasn't been much to discuss in the way of developing trends. Oh sure, we've seen strength in the energy sector as oil prices have stayed relatively high, and we've seen the financial stocks struggle a bit as interest rates rise, but none of that was really out of the ordinary. There is a new trend brewing, though, that I do think is extraordinary enough to mention today. It involves telecom stocks. We're already seeing it to some degree, but I suspect we'll see more of it in 2005. It may be an important one to understand, as it could be a great opportunity for speculators as well as long-term investors.

I'll cut right to the chase. It looks like one of the key themes this year is going to be mergers and acquisitions within the telecom sector. We've already seen it happen a couple of times in 2005. Alltel (AT) is buying Western Wireless (WWCA) for $4.4 billion, and we heard a couple of days ago that Verizon (VZ) is merging with MCI Worldcom (MCIP). Oh yeah, SBC Communications (SBC) is acquiring AT&T (T) through  a stock transaction. That's three big mergers in a short period of time, and makes us wonder if there's not a bigger, underlying rationale here. I think there is........if you can't beat 'em, join 'em. Let's face it - telecommunication service is almost a commodity anymore. Gone are the days when the consumer had no choice. The federal government is pushing for greater competition between providers, in order to benefit the consumer with more choices and competitive pricing. Throw in the fact that the abundant cell phone services are quickly becoming an alternative ("instead of", as opposed to "also") to land lines, and it's going be tough to make a buck in the low-margin telecom service industry. The only viable choice is to eliminate the competition.....by owning your competition.

Now that the cat's out of the bag, let's at least look at the "why" behind this expectation. Basically, there are two key reasons why we could see a lot of M & A activity this year. 

First, these companies can afford to make these buyouts with a combination of cash, cash flow, and stock. Despite the fact that profit margins can be thin at times, the cash flows here are pretty dependable. And for some reason, current assets and cash (on hand) always seem to be fairly high for these companies. Point being, it's not like these companies have to really strain to do this.....especially in the case of the mergers.

Second, you'll find that in the grand scheme of things, the telecom stocks are still very cheap. And I mean cheap! Take a look at the chart below. On the top we've plotted the Dow Jones Telecom Index (DJUSTL) , and on the bottom we've plotted the Dow Jones Composite (COMP). Keep in mind that the Dow Composite includes the Dow Utilities and Dow Transportation indexes. The visual impact is stunning. The Dow Composite actually hit all time highs in January, fully recovering from the bear market. The telecom index hasn't even come close.

Dow Jones Telecom Index versus Dow Jones Composite - Weekly

If you're a numbers person instead of a visual person, here's some data for you. The telecom index is still 52% under its all time high, even after the 45% gain from its low from March of 2003. The Dow Jones Composite is basically right at its previous all time high (from May of 2001), but remember that it actually hit a new high last Month. Since the low from March of 2003, the Dow Composite has gained 62%. But whether you're a numbers person or a chart person, the story is the same - telecom stocks are just plain cheap right now compared to the rest of the market. I kind of suspect that the major telecom chiefs and CEOs know this, and want to go ahead and take care of any acquisition business before these stocks head higher and become too expensive to buy.

Of course, the counter-argument could be that these stocks are still lagging for a reason, and therefore are still undesirable. I'd almost agree with that, but a closer look at the fundamentals reveals that these companies are actually doing pretty well. The average P/E here is 17.9, earnings are growing at 18.6%, and revenue is growing at 5.1%. That's not the same red-hot numbers you might see in the tech sector, but it's still plenty respectable. The bottom line is this - as a long-term investor, the telecom stocks look attractive right now. For the same reasons, telecom stocks look attractive to other telecom companies right now as well.

OK, so how do you play it? A couple of ways, and it really depends on how much risk you're willing to take, and what your timeframe is.

For the outright acquisitions (e.g. Alltel buying Western Wireless), the stock of the buying company drops, and the stock of the company being bought rises. Go check out the charts of AT and WWCA from January 6th, and you'll see exactly what we mean. So the real trick here is making sure you're positioned right. You don't want to be short on the company being bought, nor long on the company doing the buying, on the day that the announcement is made. In the case of Alltel and Western Wireless, it was the big company buying the small one. And in general, that's usually the way it will be.

But that was the speculative, short-term point of view. If you're thinking strategically (like a long-term owner of the newly-formed company), you may want to own both stocks and enjoy the competitive advantage that the acquisition will create. Investors already seem to like the Alltel and Western Wireless merger more than they did when it was first announced. Both stocks rallied again on Tuesday in a major way. As the benefits of the acquisition become clear, we could see even further gains.

In the case of a merger, it's a bit trickier. Usually in these cases, the weaker company sees its stock move higher and the stronger company's stock moves lower. However, investors aren't always sure which is really which, and these stocks can get volatile without making any real moves. Go back and look at charts of 'SBC' and 'T' since January 31st and you'll see an example of this.

So with that, I'll leave you with a list of M&A candidates. I'm not going to say which ones are buyout candidates or which companies will be doing the acquiring (primarily because I don't know), but a little research on your part could be worth the effort.

Qwest (Q) was actually the original company in talks with MCI, and they'd have the most to gain from a merger now that SBC and Verizon are giants. The fact that they were trying to make a deal happen before Verizon got its arms around MCI suggests that their interest in a merger is sincere. I think we may hear the name "BellSouth" (BLS) pretty soon too. Why? Because the company specifically said they weren't interested an merging with, acquiring, or being acquired by any other companies. Being contrarians, the fact that they specifically said that tells us that the opposite will end up being the case. Also, keep Sprint (FON), Nextel (NXTL), and Vodafone (VOD) in your back pocket. All of them are likely to join this dance pretty soon too, but most of the buyout candidates are the smaller companies that tend to be off the radar.

Price Headley is the founder and chief analyst of BigTrends.com, which provides daily stock and options recommendations and education.