NEW YORK – U.S. phone companies, once regarded as resilient to economic crises, are feeling the pinch of this downturn as frozen credit markets stall the mergers and investments they need to grow and compete against cable services.

Phone companies are also more dependent these days on consumer wireless sales and corporate clients, which make them vulnerable to macroeconomic slumps at a time when they are in the midst of massive capital investments in new wireless and video technologies, analysts say.

“The telecom sector is among the most scale-intensive and capital-intensive in the world, and so it will feel the shock far more than most,” said Sanford Bernstein analyst Craig Moffett.

Investors used to treat AT&T Inc, Verizon Communications Inc and their peers as a safe haven during a recession, like utility companies. But shares of both companies are down around 30 percent from a year earlier, tracking the Nasdaq composite.

Unlike a decade ago, consumers can now disconnect their home phones and go completely wireless or pick alternative services from cable and Internet-based providers. That makes phone companies more susceptible than ever to consumer sentiment.

In addition, AT&T and Verizon are focusing on bolstering sales to corporate customers, which are more likely to respond to a weak economy by cutting their own costs.

“Enterprise spending is at significant risk, particularly the longer a recession goes on. And there's pressure on the consumers. Toss that into the mix with wireless substitution and cable competition, that's not going to make... numbers good for anyone,” said Stifel Nicolaus analyst Chris King.

“They're not your grandfather's Bell carriers anymore.”

U.S. carriers have been stepping up their investment in high-speed Internet and video to compete with cable companies offering packages of phone, video and Internet services.

AT&T, which has also been acquiring wireless spectrum, had $16.5 billion in debt maturing within a year as of the end of the second quarter. Its second-quarter free cash flow totaled $3.2 billion after $5.3 billion worth of capital spending.

M&A AND REFINANCING

Analysts said weaker economic conditions put smaller players at a disadvantage as they lack efficiencies of scale, pricing power, and the ability to effectively invest in advanced wireless and broadband technologies.

Both AT&T and Verizon have grown over the past few years through a series of mergers, and smaller carriers like Qwest Communications International Inc, Embarq Corp, and Citizens Communications Co are expected to follow suit eventually.

But with the doors to financing closed shut, few deals are imminent, analysts said.

The Wall Street Journal reported last week that Embarq's plans to put itself up for sale were thwarted by the credit crunch. The company has declined comment on the report.

“We are likely to see mergers among all the players but the hard part will be whether or not these companies can successfully line up the financing,” said Moffett. “The mergers of equals are easier because they don't require the same level of debt financing.”

One test for the industry may be Verizon's planned $28.1 billion acquisition of wireless provider Alltel, which includes raising $20 billion in new debt to refinance existing Alltel liabilities.

The deal would make Verizon the biggest carrier in the U.S., surpassing AT&T, but analysts say the cost of the debt refinancing is likely higher than originally estimated due to the tough credit conditions. Such worries hit credit default swaps last Friday as Alltel's debt protection costs jumped to their highest in four months.

Bank of America analyst David Barden said the telecommunications sector appeared to have enough cash to weather credit market volatility and that the sector's interest rate risk is limited as most debt has fixed rates. But he said it could be hard to convince Wall Street.

“In our conversations with investors, it would appear leverage is very much front and center as the ultimate litmus test of investability,” he said in a recent note to clients.

One money-losing Internet phone company, Vonage Holdings Corp, has not yet been able to close a deal needed to refinance $253 million in convertible debt redeemable in mid-December.

(Editing by Derek Caney)