Ideas on Telecommunications Stocks - Still a Good Investment?

By: Y. Ng
Submitted: 2007-01-17 16:17:39
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Having been a finance person in the telecommunications industry for seven years, I would like to share my thoughts on this very dynamic industry. Are they a good buy now? If not, when, if at all?

Once a Pearl under the Straws

The telecom industry was once considered a “strategic” asset by government of many countries. Therefore, the fee and cost structures were closely guided and the operations normally run by pseudo-governmental monopolies.

To the outside world, telecom is a stable, low-profile, if not the most boring business, just like one of the utilities. In fact, the telecom was then a ridiculously profitable business – once the copper wire is in place, the company can charge the customer forever. Without competition, innovation was unnecessary and thus the R&D/maintenance cost was very low. The companies also charged the customers at a tolerable but unreasonably expensive level. Remember how much a long-distance call cost 10-20 years ago?

A darling in the late 90s, then…

As the deregulation of industry swept through the world in the 80s and early 90s, telecom companies went public and became darlings in the investment circle because of high profitability and bright future (read: Internet in the late 90s). But of course, money, greed and pride led to stupid mistakes: many telecom companies used their big pile of cash to buy unnecessarily huge capacities and bid up the 3G licenses to outrageous level. When the market crashed, they ended up in a bunch of state-of-the-art but rather useless fiber-optic pipes, an even more useless 3G license, and a very real, big pile of debt. Many of them almost went bankrupt.

In the 2000s, they became low-profile again, working hard to reduce the debt. By end of 2003 billions of debts were repaid and most companies were back in good shape.

Question: Have they become good buys again?

In my opinion, no, not now:

• Competition means lower profitability: Now that the telecom industry is fully deregulated (in developed countries at least), new nimble players have sprung up and profitability has become a lot lower.
• Internet is the killer: New, smart companies have introduced better, cooler and virtual free service via the internet. Examples: Skype and other providers of VOIP service. The traditional telecom service has become totally commoditized.
• Constant innovation is tough: Facing competition and threats from new technology, telecom companies need to find even better product to survive. 3G was a big thing, but no one so far can find a “killer” application that can realize the potential of 3G technology. Now, the “convergence” (combining telephone, broadband and television/media) is the latest theme, but any big innovation involves substantial capital spending and big risk.
• Market is saturating: In the past, the telecom industry has been quite successful in growing beyond its traditional products, e.g. mobile phones in the early 90s, and broadband in the late 90s. However, mobile phones markets are now saturated in developed countries (many Asian countries have >100% penetration rate), and broadband growth is slowing down. The next “thing” is supposed to be 3G, but it is a long way from critical mass.

Should we ignore the sector completely?

Well, no, because:

• Everything depends on timing and price: If you get in when everyone is getting out, e.g. in 2001-2003, you will get a pretty good return.
• Pick emerging markets: Telecom companies in emerging markets may still in the “honeymoon” phase, i.e. limited competition and tariff level (fees charged to customer) being protected by the government. At the same time, the emerging market has a lot of room to grow. Good examples are telecom companies in China and India, as well as Orascom, an Egyptian-based and London-listed company specializing in telecom operations in emerging markets around the world.
• Promising technologies: Nowadays mobile phone banking is widely-used in Japan, Korea and Philippines, and is getting popular in countries such as South Africa. This technology is most promising in developing countries and among migrant workers because it enables basic financial services (e.g. fund transfer, checking balances, bill payment) without even a bank account. Think of China Mobile’s 260 million users subscribing to such a service!

Conclusion

The telecommunications industry is a cyclical market -- it has a breakthrough technology every 10 years or so, and the moment before this technology hits critical mass is the best time to buy. What are the technologies? Mobile phone banking could be one of them. It is difficult to spot the trend, but the potential reward is huge!

Article source: Expert Articles