Investment in telco companies: broadband and mobile data growth plus low valuations and low expectations?

Telcos: the dotcom crash all over again?

Has the telephone's death has been greatly exaggerated? - photo by Sean Davis on Flickr licensed under Creative CommonsOne 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).      

The serious home office needs wireline broadband - photo by Rynosoft on Flickr licensed under Creative CommonsOn 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?  


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

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

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

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 and mobile data - best national coverage - photo by Willislim on Flickr licensed under Creative CommonsFinally, 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):

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

This post was written by mike on June 13, 2010

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K Rudd magic & why the mining super-profits tax is a superannuation tax

Troughs, pigs and magic taxes - photo by Perfektionist on Flickr licensed under Creative Commons
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

This post was written by mike on June 1, 2010

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Superannuation & government deficits: political risk is back

Watching the Obama government fiddle around with the various creditors in Chrysler (and in other government bailouts where political calculations are coming into play in Australia and the UK) it’s pretty obvious that there is ‘political risk’ coming back into investment in a big way.

It is something that Bill Gross at Pimco was also keen to stress in his latest podcast, “2+2=4”, that equity and debt holders may be looking at a highly regulated future where the ‘dead hand of government’ plays a significant role in setting future growth rates and income distributions (no doubt Mr Gross would be horrified by this oversimplification).

Another way to look at it is simply that the debt being run up in stimulus packages may create an irresistible temptation for governments to tap funding sources which currently might appear to be protected.

One obvious group of people who are being ‘stuffed’ in the current environment are holders of cash, with interest rates of .5% in the UK or a (comparatively) generous 3% in Australia, perhaps a realization which may play a small part in the recent market runup.  In a future environment it may be that holders of non-inflation protected assets are also going to get stuffed.

As someone I know puts it more succintly, “the older generation are going to get stuffed somehow.”

However one other obvious source for governments to target are Super funds and pension funds.

As Kris Sayce puts it well in ‘Money Morning’ with regard to Australia:

“perhaps the biggest giveaway is the $1 trillion held in private superannuation accounts. At the moment these balances are almost untouchable by the government. It is up to the fund managers and trustees of the funds to decide where the money is invested.

That is a position that no government will allow to remain for too long. Not when there is a $300 billion public sector debt to be paid off. And a $100 billion public sector pension liability to be financed.

Not to mention all the increases in welfare payments that will arise in the next few years.”  

Given the time horizons involved we should all be thinking about what the government might do to get their hands on it to pay their bills. Mr Sayce’s view is that there may be inducements from the government to “swap their defined contribution super plans in return for a defined benefit government pension”, however we probably need to consider other possibilities as well. For example:

  • could the government change the tax rates on super funds from 15%?
  • could the government set maximum super fund sizes?
  • could the government change the cap on non-concessional contributions (currently $150k)?
  • could the government change the preservation age (the age most of us can access their super) – it’s been suggested that preservation age move to 67 by the interim Henry Review?
  • could the government further target temporary residents (it is already taking their unclaimed super within 6 months of them departing Australia)?
  • introduce tax on super income streams after preservation age (60), currently for most people there is no tax if the cash was taxed ‘going’ in).

From the government’s point of view there are  two risks:

  1. loss of votes amongst a segment of the population that is getting larger (retirees)
  2. reducing the savings rate (pretty much what it wants to do at the moment anyway and of course a mandatory super contribution level in effects sets a savings rate the government can fiddle with as well)

The level of risk overall should a key factor (especially for wealthier individuals given the budget changes to super) in whether you choose to put your money into the superannuation sandbox or operate outside it.

Posted under investment strategies, Risk

This post was written by mike on May 18, 2009

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The credit crunch: the fine print changes at banks

Whilst the more visible mass layoffs at banks like Citigroup, RBS and HBOS grab the headlines, there have also been some subtle changes at banks which are equally designed to shore up their balance sheets.

This time however they’re looking to you, the customer, to do it.

In Australia we usually hold the cash component of our super fund in St George term deposits (St George is soon to merge with Westpac).

The way that St George configures term deposits is, of itself, of some interest as the “12 month term deposit”, if you read the fine print, actually translates into an ‘indefinite deposit’ if you fail to give the bank “Notice” during a 14 day maturity window at the end of the term deposit. Put simply, if you don’t tell the bank that you wish the term deposit to mature at that point they will simply re-invest it for the identical term at whatever the prevailing interest rate is at that time. 

Leaving aside the somewhat misleading nature of a ‘term deposit’ with an indefinite term (which has always been the case at St George) what has changed with the onset of the credit crunch is that it has suddenly got considerably more difficult to give them the Notice in the form in which they require it…

“You are able to continue to send a signed fax to Fixed Terms with a copy of your passport and drivers licence, outlining your request.  A contact number is required in order for our staff to make a verbal confirmation of the request received.  The Bank’s decision to implement these additional safeguards is to protect your funds and personal information.  As your security is of the utmost importance to us, if we are unable to contact you or identify you once contacted, the request will not be actioned.”


So, for ‘personal security’ reasons you can no longer inform them, in advance, that you wish the deposit to mature as specified in the term (we used to be able to do this by email or using phone banking) and in their online banking system whilst you can extend or vary the term you cannot mature it.

They actually now require verbal instruction to mature a term deposit using their phone banking service.  Bad luck if you’re on holiday or you happen to overlook the maturity statement they provide you in the mail … or if, like us, you happen to be travelling in a different timezone expect to spend some time late at night making sure your term deposit matches the term you agreed in the first place.

Naturally, the real motivation here is likely to be that many clients will overlook the fine print, and the bank will end up with some percentage of term deposits renewing when their owners in reality had the intention of moving the money to a better return elsewhere.  As interest rates fall this is a good thing to keep an eye on.

Posted under Risk, Setup

This post was written by mike on November 25, 2008

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Legislative risk – or “I’d rather have the cash now thank you”

Whether you put money into a SIPP or SMSF, in the back of everyone’s mind is the question (especially with voluntary contributions) of whether it makes sense to lock your money up in this way.

In Australia the point comes to the fore more with voluntary contributions as superannuation is compulsory at 9% of salary (so it’s not as if you have a choice on salary as to whether you contribute or not).

The Australian government made contributions compulsory in 1992 – if ever the UK government does the same buy an index fund or better still buy stock in a fund manager – estimates put the ‘new’ savings engendered by this move in Australia at 62c on the dollar.

The key point is obviously that you cannot access the money contributed to pensions/super until ‘preservation age’ (in Australia 60 years of age for most people who are not close to retirement).

Want to take the holiday of a lifetime before 60 on this money – you can’t.  Want to give a lump sum to a child – you can’t.

There are some exceptions for hardship, so if you’re starving in a garrett at 55 you will probably be able to get access to your super before preservation age, but that’s about it. If you die relatively young (although it would have to  be abnormally young – average life expectancy in Australia is now about 80; for the UK it’s 78) this could prove seriously annoying.

Some other more governmental / political risks might be:

  • between now and your retirement the government in its wisdom decides to change preservation age. In 1997 the Australian government pushed back the ‘preservation age’ by a whole 5 years from 55 to 60. Presumably the thinking behind this, as with much of the government’s rationale, was to stop people cashing in their super relatively early and then relying on State benefits in the later stages of life. What are the chances of this happening again? Probably relatively high…. But bear in mind that last time they did it they ‘tapered’ the results so that those close to the previous preservation age could still obtain most of their superannuation at close to the old figure of 55 years old
  • the government decides to change the tax rate on super from the current 15% level (in Australia). However if they did this it would be unlikely to be retrospective so it would only affect ‘future’ income and not the balance you had already built up. You could hope that perhaps you would be able to transfer the fund offshore and still retain the benefits but who knows. Against this you need to balance the significant difference in tax rates on money in super funds and money outside super. At the average income in Australia (around $49,000) you are paying a marginal tax rate of 30% for everything over $30,000 and 40% over $75,000. Against this, a tax rate of 15% for money in your super fund looks pretty attractive (if at some stage of your life you’re earning less than $30,000 it might be worth keeping your money outside a super fund – you pay the same tax rate of 15%).

A perhaps more common scenario is where a new investment opportunity arises which if you were not self managing your super/pension you could not take advantage of this because you were constrained by the options on offer from your managed fund.  With the new ability to even buy property in a fund there is a lot of freedom, although you cannot borrow, so if you are fond of margin lending to finance your share portfolio you can’t do this in a SMSF. All in all though, having a self managed fund does not greatly restrict your options, assuming you are a relatively conservative investor.

Posted under Risk, Setup

This post was written by mike on September 13, 2008

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