Sector review: International telecoms
Are you tired of Verizon and AT&T? Alternatives are out there.
Telecommunication companies have been market laggards for many many years - and obviously for many reasons. When would be their time to shine again? It is difficult to say, but, as we will see, at least by owning them you will get paid to wait. Verizon (VZ) and AT&T (T) have been popular among the dividend investors, but especially with AT&T there lurks the possibility for a dividend cut after the new entity is formed. Are there any alternatives for these dividend investor favourites? Let’s find out.
What are the reasons behind the poor performance of telecommunication stocks? Let’s look at them individually:
Slow growth: Last decade the industry has seen stagnant development of revenues after wireless communication has reached high penetration level and the dynamics of the industry have been mostly about fighting over market shares and operational efficiency.
High capex: Technological development has required telecoms to invest heavily in their infrastructure in order to keep up with the competition and requirements of the governments.
High debt levels: High investments levels are visible on the balance sheets that are often highly levered up. High spending on infrastructure has meant reducing returns on equity for the telecommunication companies.
Competition and price wars: Despite the oligopoly-like market structures, the commoditization of the basic services provided by the telecoms has led to price competition and occasionally to heightened price wars.
Flat-rate deals: In the most mature markets flat-rate subscriptions have become market standard, which means that telecoms will charge the customer a monthly fee irrespective of how much the customer uses the service.
Less roaming during corona: During corona the industry suffered from reduced travelling by losing $25 billion roaming charges.
Poor strategic choices: Several telecoms have ventured out of their core business. As we are seeing with AT&T, often these endeavours have led to failures and to a lot of destroyed value and investor capital.
Substitutes of bonds: For many investors telecom stocks have acted as substitutes of bonds. A high and relatively reliable dividend has been the source for income for funds and private investors. If investors increase their exposure in bonds, it might cause selling pressure on telecom stocks.
There are certainly challenges that would keep an intelligent investor out of investing in telecommunication companies. However there are also positives that are worth to be listed:
Utility-like: Telecoms are often compared to or described as utilities. Their services are necessities for consumers and companies - it’s difficult to live without internet and phone connection.
Predictable revenues: Utility-like nature provides predictable revenues that increase together with population and living standard. In addition, the competitive situation in many individual markets has oligopolistic characteristics.
Valuable assets: Often telecoms possess fixed assets that are highly sought-after by private equity investors and companies such as American Tower (AMT). Telecoms in western hemisphere have been disposing of these assets in order to enhance their returns on equity. Mature, utility-like telecoms are valued based on their ROEs.
For example, Nordic telecommunications company Telia sold part of its wireless tower portfolio to Brookfield. America Movil (AMX) is about to spin-out its towers as a separate business, called Sitios Latinoamerica. Turckcell is evaluating different strategic options for its tower portfolio, fiber network data centers and fintech businesses.
Oftentimes these businesses are valued with much higher multiples as separate businesses than they are within the telecom company.
Cross-sales: Large customer base is one of the valuable assets of telecoms. The incumbents are often selling for example electronics, streaming and cybersecurity subscriptions to both consumers and businesses and data center and cloud services to businesses.
Optionality: As mentioned, many telecoms have pursued to venture out of basic telecommunications. Some of the telecoms are involved in various businesses. For example, Airtel Africa holds the number two position in mobile banking in the continent, PLDT was recently awarded with one of the seven banking licences in the Philippines and, as an extreme example, Turkcell is a partial owner of an electric vehicle enterprise.
5G: New generation of telecommunications will enable higher speeds for mobile communication, but in addition telecommunication companies expect a high demand for private 5G networks in the enterprise segment, for example replacing old wired connections with wireless networks in manufacturing plants.
Internet of things: Faster 5G networks and IoT, the worn out buzz word, provides new business opportunities for telecoms, however it remains unclear what’s the exact role and potential for telecoms.
Work from home and streaming: The global pandemic and technological advancement seems to have caused a shift in how people work and consume entertainment. Working from home and streaming services will often require faster internet speeds at home. The trend drives demand for upgraded subscriptions.
North America vs. International
So there are also a few reasons to look further into telecommunication companies and stocks. International telecommunication companies, especially the ones in developing nations, offer to an investor more fruitful hunting ground. First, the population growth is often higher, which increases the addressable market. Second, rising living standards help telecoms to sell new and more expensive mobile phones and faster subscriptions to consumers and companies, although the smartphone penetration rates are already high in most countries. In international markets the fundamental macroeconomic trends drive demand for the basic telecommunication services.
Without question, the macroeconomic risks, currency depreciation and political turmoils, can limit or even wipe-out potential profits, as it has been the case with Turkish Turkcell when the ADR in NYSE has lost its value along with depreciating lira. Oftentimes, these risks are clearly visible in the valuations of the international telecommunication companies. Measured with several different traditional multiples, international telecommunication companies are valued significantly lower than their counterparts in North America. Additionally, international telecoms often carry more assets in their balance sheets and have many interesting emerging businesses.
The table above definitely isn’t complete. It includes the ones that can be bought and sold on the NYSE. There are also other international telecoms available in NYSE, such as Telefónica Brasil (VIV), Vodafone (VOD) and Veon (VEON).
Compared to American peers international telecommunication companies offer higher dividend yield together with lower payout ratio. The average P/E ratio is half of the level where BCE, AT&T, T-Mobile US and Verizon are trading at. The same goes for P/S ratio. The average EV/EBITDA is nearly 40% lower and P/B ratio over 20% lower for international telecoms. On the flip side, three year revenue growth is lower, but if T-Mobile US (TMUS) is excluded the growth rates are in the same ballpark. Furthermore, international telecoms have been able to grow their EPS compared to three years ago and provide significantly higher ROE.
By investing in international telecoms one can get emerging market exposure at relatively low valuations in businesses that can provide high dividend income (please note that the dividend is dependent on the exchange rate). At least, it’s sometimes easy to forget that there’s other oceans to fish in. It could be a time to look at some of the names, such as Turkcell (TKC), PLDT (PHI) and Mobiletelesýstems (MBT).