Telcos: the dotcom crash all over again?

One of the market themes that is starting to looking interesting is telcos. You know, those boring mature industries, whose fixed phone line legacy business is gradually being whittled away by the internet?    

The ones who are dying a slow death whilst being whipped by regulators at the same time?    

Doesn’t really sound attractive?

Well some of the charts bear this horror story out – take a look at the largest Australian telco, Telstra for example:  

If you’ve been sitting in this stock for 5 years you wouldn’t have been too pleased – and why should the situation change?   

For example isn’t it the case that:    

• telcos like say Telstra are haemorraghing fixed line subscribers and competing at the same time with VOIP?
•  cellphone service providers like Vodafone are going to be wiped out by upcoming technologies like Wimax?

Well… maybe … and maybe not.

Telco investment risk mitigation factors

What if it’s not quite as bad as the market perceptions of risk? What about:   

• PEs in single digits and high dividend yields (5-10%)
• growing broadband subscribers
• growth in mobile data (all those iPhones out there are the automobile equivalents of Hummers in the smartphone world and there is an avalanche of iPhone pretenders from manufacturers like HTC for Android – and soon Windows Phone 7 – emerging every month now)
• in the case of the larger telcos quite geographically diversified operations (i.e. natural currency hedges)
• for segments like mobile data with significant network effects (users want the widest possible signal coverage wherever they travel) there is limited competition from only one or two other players 

Here are some comparative figures for BT and Telstra (mixed mode telcos) and Cable and Wireless and Vodafone (more mobile based revenue): 

Valuation Comparisions 14/12/09	PE	Price / Cashflow	Market Cap £ Billion	Rev Growth 1Y % *	Div Yield 13/6/10
BT	7.48	2.5	9.7	-2% *	5.44
Telstra	8.97	4.05	20	-2.9% **	8.8
Cable & Wireless Communications	11.92	6.52	1.5	n/a	9.8
Vodafone	8.41	5.81	70	-1.6% *	6.44

* Preliminary results to 31/3 

** half year ended 31 Dec 2009 v same period previous year 

The low digit PEs imply there is relative risk about some of these companies (and yep, as we all know it’s really risk that revs up your return).      

On the risk to fixed line revenues as they migrate to mobile-only households point consider a situation where 25% of the population works from home all of the time and a good proportion occasionally.  Are they going to rely solely on wireless for their connection to the cloud and business contacts?

What about the booming online gaming market (where latency is really important)? And what about the increasing availability of online movie download systems (whether legal or illegal!) – with the average movie over a gigabyte in size (Cisco is currently forecasting huge growth in video traffic over the next few years)?  

And as for the VOIP point, again you still need the underlying wireline for VOIP. And for many of these (use of web based applications, increased video, and voice)  latency is important and data flowing back ‘up’ the pipe to the telco is important (as opposed to situations like cable television based internet connections where the ‘up channel’ is much slower).   This all means more data coming up and down the pipes owned by these telcos.   

Wimax reportedly has quite a lot of issues in handling high volumes of traffic at its backend, and just to further naunce (hopefully that’s a verb) this picture there is also the issue of IPv6 (the world basically running out of IP addresses so if you currently have significant IP address range allocations, as some of these companies do, that could be regarded as a valuable asset).   

The best telcos if you believe data demand will support these stocks

If you think that perhaps reports of the death of the fixed line has been greatly exaggerated and data demand will soar, where might you go?  

Vodafone

Well Vodafone is more of a pure-play in mobile data if you look at their revenue  breakdown:

Vodafone
voice	66%
messaging	12%
data	11%
fixed line	8%
other	4%

 

but at the same time it is a very European play if you are worried about currency exposure with about 3/4ths of its revenue from Europe.  

     

So Vodafone’s one possibility if you are not worried about the Euro exposure. 

BT I have also been in and out of over the last 18 months however the issue with BT as a pure play (on the rise in IP-based data consumption on mobile and fixed lines) is that it has a large services component.  

If, however, you do not think it’s necessary to discriminate between telecoms companies on the basis of the revenue splits and currency exposure you could also always consider iShare’s Telecommunications ETF. Top holdings as at  11 June 2010 might also give you some other ideas as to specific stocks:

15.59%	AT&T INC
11.21%	VODAFONE GROUP PLC
8.42%	VERIZON COMMUNICATIONS INC
8.06%	TELEFONICA SA
5.14%	CHINA MOBILE LTD
3.88%	FRANCE TELECOM SA
3.50%	DEUTSCHE TELEKOM AG-REG
3.14%	TELSTRA CORP LTD
3.12%	NIPPON TELEGRAPH & TELEPHONE
2.70%	AMERICA MOVIL-ADR SERIES L

Cable and Wireless Communications

A less obvious play on mobile data (and less popular than Vodafone) which I’m currently holding is Cable and Wireless Communications

CWC
mobile	40%
broadband	9%
domestic voice	19%
international voice	8%
enterprise, data and other	24%

 

which is 84% USD “pegged or earned” revenue but diversified across some more interesting geographical regions (which however are not Europe and not the USA) such as Panama, the Caribbean, Monaco, and Macau (in order of descending EBITDA). 

The chart is somewhat meaningless since it was demerged from C&W earlier this year but here it is if you want to look at it. 

Telstra

Finally, I also hold Telstra (see chart at the top of this article). 

It is currently plagued in somewhat similar manner to BP by issues around regulatory risk as the Australian government implements the national broadband network.  

However it is also a very widely held share in Australia (i.e. the government would lose a lot of votes if it destroyed the value in it) and BT survived being split into a wholesale and retail arm so I think it is likely that Telstra will also survive.

The risk of the publically funded National Broadband Network (NBN) fibre to the home project not buying its assets or doing a deal with it is really factored into the price at this point – and looking at its revenue sources is probably most likely to impact on an area that is already in decline (PSTN revenue):

Telstra
mobile	36%
pstn	34%
fixed retail broadband	9%
ip and data access	10%
ads and directories	11%

 

Telstra saw a reasonably chunky fall in PSTN by 6.9% over the last half year but actually would have actually had a revenue increase in spite of this if not for a fall in advertising revenues, and actually grew free cashflow by 37% to the end of 2009 (you almost have to feel sorry for Telstra management in the circumstances). 

Telstra seems like a stock where the bad news is in the price: it’s mostly A$ exposure (and with franking if you are an Australian shareholder the dividend is huge) and my view is that it makes sense just to wait out the regulatory / NBN uncertainty and be paid while you do.

You would not be entirely alone if you decided to hold it:  Maple Brown Abbott, a good long term value fund here in Australia, has Telstra as their largest holding.

To spread your risk further you could probably safely hold all three: Vodafone, CWC, and Telstra.

Posted under individual stocks, Risk

My utmost admiration for the government on the Miner’s Super-tax. There’s a true symmetry to this which just has to be mentioned.

It’s called a Super tax because it’s a tax on ‘Super-profits’ in the mining sector.

But of course the beauty of it is that it is really also a tax on the superannuation (‘super’) savings of most Australians (the impact on project starts, jobs etc is well covered elsewhere).

A mining tax on fat cat mining companies, that’s fine isn’t it? Well mining companies make up 20% of the ASX market cap.

Let’s assume that BHP’s share price fall from the date of the announcement on May 2nd as a big diversified miner is a proxy for the fall in the mining index associated with K Rudd’s new super dooper tax. As of today (4 weeks later at June 1st) it’s fallen about 10% (from $71 to $64).

So any Australian’s superannuation portfolio which mirrors the ASX may have seen that fall about two percent (10% of 20%) to the extent that it mirrors the ASX 100.

How much is Mr Rudd going to get from that tax – well Ernst and Young had it at about $9bn per annum.

Some fairly old Wikipedia estimates of the Oz market cap put it at 1.39 trillion (yeah I know these figures are really rubbery but you get my drift).

2% of $1.39 trillion (that’s 13 with 11 zeros after it) is the market cap decline because of this tax or $26 billion.

But hey it’s not that bad because 40% of the market is owned by furriners (we don’t need them to buy in and support our market!) who we don’t care about so the market might only really have declined for Australian shareholders as a result of this tax by $15.6bn (60% of $26bn).

And Australian superannuation fund holders only hold part of the market owned by Australians (maybe 80% if we assume they mostly hold domestic portfolios) so maybe Australian collective super funds are down by $12.48bn.

Now we could go on but I can see you are yawning –  it’s not over yet because the tax revenue only comes in about 2 years time (2012) and that nasty forward-looking market seems to have made the money disappear now – so you’d have to discount cash Mr Rudd is not going to see for at least 2 years. On the other hand you could argue that some of the fall relates to Europe and not K Rudd.  Anyway I’ll stop here  …  you can see where this is going.

Magical huh?  A tax that is supposedly applied to fat cat miners turns out to really come out of Australian worker’s pockets, and makes a net $3.5billion just disappear (after you net off a -$12.48bn decline in national super holdings and $9bn in tax revenue on the plus side in 2012).

Poor Mr Rudd huh? Things you can do with a nation’s savings and a publically traded stockmarket are not the same as what you do with your own household budget.

 PS. I do not hold a position in ANY mining stocks (don’t understand them). And if you want more accurate figures go get ’em – mine are only based on some crude estimates and an hour’s work in Wikipedia (a dodgy website that the government needs to filter out presumably).

Posted under Risk