Last March, the federal government announced plans to loosen foreign ownership rules on telecommunications companies. The new rules will allow non-Canadian companies to own Canadian phone carriers with less than a 10% share of the national market. With most of us locked into long-term contracts with Rogers (which owns Canadian Business), Bell and Telus, this policy decision isn’t going to affect the average cellphone user anytime soon. But it will affect investors in the sector, which is increasingly all about wireless telecommunications.
“There are really only three players in the industry,” says Mark Grammer, a growth manager with Mackenzie Investments. If you own stock in the big brands, you may experience volatility as new entrants enter the market. A serious challenger could offer lower price points, causing profitability to go down all around. But while the Canadian telecom space will “likely see little or no growth in the next few years,” Grammer says, the same is not true overseas.
In general, telecoms offer investors stability and dependable dividends. Economic cycles do affect profits and stock prices—when times get tough people find ways to save on their bills—but something extraordinary has to happen before people give up their Internet and mobile phones altogether. In many ways, telecoms are like utilities: they collect regular payments on a monthly basis. Investors can easily predict cash flow and revenues, and many of these companies pay attractive yields too.
And yes, the global industry is still growing. While most people in developed countries now have mobile phones, in many cases they are basic models that require only voice plans. The real money is in smartphones and data usage, currently used by just 26% of the world’s population. As networks improve (many companies are now upgrading from 3G networks to higher-capacity 4G or LTE networks), more people will use data-sucking smartphones, and profits should rise accordingly.
Finding the right foreign telecoms, though, takes some work. Growth prospects, regulation and wireless penetration—an important factor when trying to figure out growth potential—vary from country to country. There are a lot of opportunities in Europe right now because of the eurozone’s financial crisis. Amber Sinha, a portfolio manager with Empire Life, advises sticking to countries where the macroeconomic environment and borrowing costs are fairly stable. Telecoms tend to carry a lot of debt to fund improvements to their networks. Businesses exposed to countries where sovereign debt yields are rising will find it more expensive to refinance their credit. Investors need to be wary of high dividends, especially in volatile countries. People may look wide-eyed at France Telecom’s 14.5% yield but, says Sinha, there’s a good chance it will get slashed if cash flow gets tight.
Paul Ehrlichman, head of global equity with Global Currents Investment Management based in Wilmington, Del., says that people can find good buys in Germany, the U.K. and other European countries that aren’t making the six o’clock news. He likes Germany most because it’s in the best shape of all the eurozone countries and smartphone penetration lags behind North America. According to comScore, only 41.8% of German mobile users accessed data using a smartphone, while Canada’s smartphone penetration is around 50%. “There’s been less investment in networks because of all this uncertainty, but that’s changing,” he says. Germany is also attractive because it’s becoming less competitive. Ehrlichman says the third- and fourth-largest telecoms will either merge or pull back. If that happens, the average revenue per user (ARPU)—the metric that matters most to telecoms—will rise.
Malcolm White, a portfolio manager with Signature Global Advisors, prefers Asia for his telecom buys. The dividends, he says, are still high, economic growth is stronger and there’s no sovereign debt risk. “It’s a more conservative play,” he says. Smartphone penetration varies from country to country—South Korea has a 50% penetration, while China’s is around 14%—but all countries show significant upside. China, says White, has massive potential. Its main telecom, China Mobile, has suffered lately because the government forced it to adopt a domestic mobile technology that no one else in the world used. Now, though, it’s building a 4G network that will be compatible with every new phone on the market. As well, rising incomes and demand for middle-class amenities means more and more people will be signing up for new mobile services.
It helps that the phones themselves are getting cheaper in China. White says the “magic number” at which people will upgrade their handset is about $100. The country has recently introduced a smartphone for 500 renmimbi, which is about $80.
Investors can also find good telecoms in Latin America and in Africa but, again, it pays to shop around. Own a company that’s gaining market share, says Ehrlichman. As a value manager, he likes buying businesses other investors won’t touch, but telecoms are different. They “can’t be out of favour with customers,” he says. He also wants to see ARPU rising. The more revenue the company can generate from each individual user, the better.
Grammer likes to see companies increasing dividends by between 5% and 10% every year. He also buys businesses with yields of at least 5%, but he says he can find good companies playing closer to 9%. Investors need to make sure those dividends are sustainable by looking at free cash flow yields. Grammer is comfortable with cash-flow yields in the 7% to 10% range. “That allows them to pay out the dividends without running the risk that they’ll have to cut their payouts if they have to expand their capital expenditures,” he says.
Look at debt too. Because telecoms generate predictable monthly income, most don’t have problems meeting their debt obligations. However it can become an issue if a company’s debt-to-EBITDA ratio—the metric rating agencies use to measure debt load—is above two times, says Sinha.
Sinha also suggests using enterprise-value-to-EBITDA to assess affordability. That ratio offers a more even comparison of companies than price-to-earnings, which is important when you’re looking for businesses across the globe. He says anything with an EV/EBITDA of more than six “has to be something special.” China Mobile, a company he’s keen on, trades at four times EV/EBITDA. “It’s a great investment, so why would I pay more for something else?”
Finally, pay attention to the mix of product offerings. Avoid telecoms that sell mostly landline products. “The world is becoming more and more mobile,” says Grammer. “You want to be at the epicentre of this change.”
THE CB HOTLIST
China Mobile Ltd.
(NYSE: CHL) P/E: 10.9 | Yield: 4.2% 1-year total return: 21.1%
China’s largest telecom suffered when the government forced it—and not its competitors—to use an inferior domestic network standard. Now, though, it’s building a world-class 4G network. Portfolio manager Amber Sinha thinks it’ll regain lost market share and capitalize on the country’s eventual smartphone boom.
VodaFone Group Plc
(NASDAQ: VOD) P/E: 13.1 | Yield: 7.2% 1-year total return: 16.6%
Based in Newbury, U.K., Vodafone is one of the largest telecoms in the world. The company owns a 49% stake in Verizon, a top U.S. telecom. It recently funnelled a $10-billion special dividend from Verizon to shareholders.
Deutsche Telekom AG
(ETR: DTE) P/E: 105.5 | Yield: 8.3% 1-year total return: -12.0%
This telecom based in Bonn, Germany, is one of Paul Ehrlichman’s favourites. The portfolio manager likes the German market’s relative stability and low smartphone penetration.
(EPA: VIV) P/E: 11.1 | Yield: 6.9% 1-year total return: -16.5%
Paris-based Vivendi is a diversified conglomerate owning 100% of French telecom SFR, but it also has stakes in video game company Activision Blizzard, Universal Music Group and other telecoms in Brazil and Morocco. This diversification makes it less risky than, say, France Telecom.