FYI | Jun 07 2006
You still find them in today’s market: telecom specialists who haven’t acknowledged yet the fixed line incumbents have landed in a new paradigm of low growth.
The team at Credit Suisse, for instance, still rates Telstra (TLS) a Buy (Outperform in their terminology). When it comes to Telecom New Zealand (TEL) there are currently three analyst teams who are of the opinion that the stock will outperform the rest of the share market over the next twelve months. The teams with a Buy on Telecom NZ are at JP Morgan, Smith Barney Citigroup and UBS.
Who is to say with 100% certainty that these experts are wrong?
The only thing we can conclude is that their optimistic view is currently not shared by the majority of other experts in the market. Judging by the share price movements of both telecom operators, it would seem that investors have a less bullish view on both companies as well.
Telstra shares slumped from a little above $5 a year ago to $3.80 today and the share price hasn’t been above $4 since the beginnings of 2006. Did Telecom NZ fare better? Well, it took a bit longer for the share price to fall from what seemed to be a comfortable A$5.50, but once the process started it was pretty much the same story.
Telecom NZ shares can be bought nowadays for around A$3.80 on the Australian Stock Market. The year low for the shares was reached only weeks ago at A$3.53. Telstra’s year low is $3.62.
Sometimes investors are smarter than the ones who are supposed to help and guide them.
Merrill Lynch’s team of telco specialists had a look at the Asia Pacific sector recently, and they came to exactly the same conclusion, even though I have still to encounter the terms "new paradigm" and "low future growth" in any of their reports.
Dividing the sector between operators that are solely in mobile communication and those that have the fixed line heritage, Merrills came to the observation that the first group had seen its share price appreciate by 15% from a year ago, including a decline during the recent correction, while shares of fixed line operators in the region were still at the same level as last year.
Given the strong losses booked by both Telstra and Telecom New Zealand, this implies their offshore peers must have seen some gain, though it won’t be anywhere near the share price appreciation enjoyed by the mobile operators.
Under the right circumstances, any savvy investor knows, it would now be time to cast an eye over the laggards in the sector. A difference in share price performance of 15% is nothing to be sniffed at, but this doesn’t appear to be one of those times.
Again, Merrills doesn’t think along the lines of a new paradigm and all that, but the team states bluntly that mobile operators (or wireless) have the highest, most secure growth prospects.
After taking a calculator at hand, the analysts believe the mobile sector should enjoy an average EPS compound annual growth rate (CAGR) of 14% over the coming two years. Compare that with a CAGR of 2% only for fixed line incumbents. To make it even worse for the Telstra’s and Telecom NZ’s in the region, both groups are trading on PEs of 11-12x forecast FY07 profits.
Now where would you park your money if you were looking for some telecom exposure?
For investors willing to go abroad, Merrills would advise to go for high quality mobile operators in the developing markets. The team notes especially strong momentum in the markets of China, Indonesia and India.
The team’s list of most preferred candidates is a reflection of this. Merrills likes China Mobile, Bharti (India) and Total Access Communication (Thailand) the most, followed by Reliance (India). If you’re really looking for a fixed line operator to invest in, the team would advise to pick PT Telkom (Indonesia).
So where are Telstra and Telecom NZ on this list? Funny you should ask. Apparently, Telecom NZ was still in the top until recently. Since it became clear the company will now be facing a much more aggressive and restrictive regulator, it has sunk to the bottom of the list, where Telstra is.
If you think all this is too negative you should maybe have a chat with Paul Budde who runs a well regarded consultancy and research firm for the industry from his home office in NSW, Australia.
In Budde’s opinion, Telstra’s profits have peaked and will "at least halve" over the next few years. It is maybe worth pointing out that Budde is not a securities specialist. He analyses the market, on a global scale, and sells his knowledge and insights to management teams in the sector.
Budde doesn’t believe the bad news for the sector sticks with the incumbents only, at least not in Australia. As Telstra, in ultimo defense, is putting the squeeze on the wholesalers in the market, Budde believes the players in that arena are "slowly starving to death".
He says the "halfway house" with DSLAMS (think iiNet) looks profitable now but, with copper networks to be replaced by fibre sooner rather than later, what has the future on offer for Telstra wholesalers?
He’s not keen on mobile telco’s in Australia either. The mobile operators are trying to outdo each other with ads promoting their $0 products and capped services, so where does the future profit growth come from, he asks.
When I called him two weeks ago it only took me two sentences to discover we are both on the same wavelength when it comes to the outlook for telecom in Australia.
The main difference is that Paul Budde does this for a living, and so his views and insights are much more in-depth and knowledgeable than mine will ever be.
Paul Budde has one simple solution for the Australian government: separate the infrastructure from the retail services at Telstra.
It is his conviction this is the only chance Australia has for a thriving telecom industry in a few years from now. A status quo of the current all-in-one construction will only lead to further deterioration of profits for the sector as a whole, he believes. For Telstra it will mean "significant profit losses", for many other players it will bring certain death.
To make things worse, Budde believes the ongoing stand-off between Telstra, its competitors and the Australian government will only result in more regulations, "as this is unfortunately the only weapon the government has to show its displeasure with Telstra".
I must admit, my view about the future outlook for the industry has turned darker after talking to Paul and reading some of his views.
Maybe Credit Suisse should invite him over for a two hour seminar.
Your happy-I-am-not-in-Sol-Trujillo’s-shoes editor,
Rudi Filapek-Vandyck
(supported by the Fabulous Four: Greg, Rob, Chris and Terry)