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Industry Analysis: Telecom Services
Within the global Telecommunications Services Industry, investors will find equities with price growth potential, selections focused on generating income, as well as vehicles for growth and income. It’s also worth noting that during periods of merger and acquisition activity speculative opportunities may arise. Major business segments include wireline, wireless, broadband and enterprise services. The industry has a history of regulation. In recent years, deregulation has been in vogue, but telecom authorities still make their presence known from time to time.
Telcos are capital-intensive, but advances in technology have, aside from bringing new products and services to the fore, helped to improve network efficiency. Though equity funding is important, the industry relies heavily on debt issuances. Partnerships and vendor financing can help to temper this reliance. Stock market and financial risk runs the gamut, as evidenced by Safety ranks from 5 (Lowest) to 1 (Highest).
Selections for Income
The earliest telecom technology is wireline service. Ma Bell (or the original AT&T) gained monopoly status in the United States, prompting the establishment of federal and state agencies to regulate the industry. Deregulation law in the early 1990s, however, paved the way to a freer market, which fostered new services and companies, as well as stock arbitrage. Wireline telcos are still subject to regulation, i.e., rate-of-return and price-cap limitations. Managements have favored price-cap rules because effective cost control can produce greater profitability.
Competition from alternative technologies, namely wireless, instant messaging, and Voice over Internet Protocol (VOIP), has prompted residential and business customers to cancel their wireline service. Most wireline carriers are rural, thus peer competition is scarce. Access lines have been in decline for a number of years. Notably, developing nations are investing more in wireless networks, which are cheaper to build than traditional wired systems. To offset wireline revenue losses, managements have bundled local and long distance phone, broadband, data, and video offerings into appealing service packages.
In light of limited growth prospects, wireline companies manage their operations in order to maximize cash flow. Cash flow goes to maintain operations, pay down debt, buy back common stock, and reward investors with an attractive dividend. It's not unusual for these telcos to have payout ratios in excess of 100% and double-digit yields. Debt ratios may be rather high, as well. Segment consolidation has helped to improve revenue and cost synergies.
Selections for Growth and Income
Companies offering investors growth and income tend to have mature wireline businesses, while expanding their operations elsewhere. The remaining Baby Bells, after several rounds of consolidation, have the most prominent growth and income stocks. They have concentrated wired assets around metropolitan areas, while divesting outlying networks. Managements are shifting the mix in favor of wireless, broadband, data, video, and enterprise services, and that trend is accelerating. In these expansion markets, peer competition is significant. Cable companies also pose a threat to market share. Integrated service providers have large capital budgets to construct and maintain networks. Strong cash flow from wireline operations helps to fund expansion businesses and manage debt burdens. Aggressive lobbying efforts have enabled the telcos to limit regulatory constraints, especially in the video service venue.
Stocks of integrated telcos offer solid yields, typically in the mid-single digits, and decent dividend advance potential. Expansion businesses provide for a good share-price growth component.
Selections for Growth
New technologies, services and markets produce appealing opportunities for growth investors. Wireless and broadband are attractive growth avenues. Wireless voice, though still replacing wireline service, is mature in first-world countries. Service penetration in emerging markets, that is, in Latin America, Africa, the Middle East, Central Asia, and East Asia, remains somewhat modest, but is developing rapidly. Also, low-rate, unlimited prepaid wireless service is a fast-expanding market sector that is taking business from highly profitable postpaid (under contract) offerings. Companies are adding to the attractiveness of wireless by integrating wired networks, services and devices.
Though the cable providers have well-established wired broadband service, telcos, with their own offerings, are competing effectively, and scoring strong revenue and income gains. At the same time, wireless broadband, namely in the form of Long-Term Evolution (LTE) technology, is an improvement that holds strong growth prospects.
Stocks of wireless companies are volatile and pay, if at all, a modest dividend. Their appeal is that they offer wide long-term price appreciation. Aggressive network build schedules lead to large debt obligations, presenting financial risk. In certain cases, partnerships, with, for example, cable and tech companies, relieve some of the stress. The smaller players in this segment are often subjects of takeover rumors.
And Speculative Selections
Venturesome investors frequently find opportunities in the industry. Both pure wireline and wireless companies seek/consider consolidation to build scale and boost cost absorption. Large integrated carriers often weigh the merits of small takeover candidates that may provide new technology or entry into underserved markets. Seasoned and fledgling wireless telcos, with core operations in populous developing nations, such as Brazil, Mexico, India and China, have speculative appeal.