Telecoms: Great Dividends, But Their Desperation Is Showing

Rumors flew over the weekend that AT&T ($T) had made an offer to buy Spain’s Telefonica ($TEF) for $93 billion—a roughly 50% premium to today’s market cap.

Telefonica was quick to dispel the rumor, and AT&T had no comment as Monday afternoon.

My gut reaction is that this rumor is exactly that: a rumor.  The sheer size of the deal makes it unlikely that it would ever make it past the assorted national telecom regulators without provoking anti-trust hysteria.  AT&T is the largest telecom firm in North America, and Telefonica is a dominant player in Europe and Latin America.

But while I don’t see a deal happening, the prospect does raise a few questions.   Given that mobile phones are ubiquitous in the United States, smartphones are not far from the saturation point, fixed-line telecom is in terminal decline and broadband internet and paid TV are well past the saturation point, where does a behemoth like AT&T go for growth?

One obvious answer is emerging markets, which is why Telefonica was allegedly on AT&T radar screen.  Telefonica gets roughly half its revenues from Latin America, where fast internet and smartphone subscriptions are both still growth businesses.

The problem is that there aren’t a lot of assets there left to buy.  The Latin American market is essentially a two-horse race between Telefonica and America Movil ($AMX), the company controlled by Mexican billionaire Carlos Slim.

AT&T actually already owns 9% of America Movil, making it the company’s second –largest shareholder.  This would also make it complicated for AT&T to make a serious offer for America Movil’s bitterest rival.

There aren’t a lot of easy targets elsewhere either.  The European telecom giants tend to dominate in their countries’ former colonial holdings, with Telefonica being a prime example.  France Telecom ($FTE) is active in 21 Middle Eastern and African countries, and Britain’s Vodafone ($VOD) has most of the rest of the world covered.   Vodafone operates in 30 countries, many of which are attractive emerging markets, and has partnerships in place with local providers in over 50 more.

So, an American newcomer like AT&T would be competing on price against some entrenched competition for a capital-intensive business that doesn’t have particularly great margins.  Perhaps an aggressive emerging markets growth strategy is not so attractive after all…

I raised a few eyebrows earlier this year when I suggested that my favorite “tobacco stock” was semiconductor giant Intel (INTC).

By “tobacco stock” I was referring to companies in slow-growth industries that had high barriers to entry.  Because their growth prospects are limited, they tend to use their excess cash flows to buy back their own shares and pay out monster dividends.

This is where AT&T, Verizon ($VZ) and Sprint ($S) are today.  Barriers to entry are not as high in mobile telecom as they are in, say, tobacco or semiconductors.  Consider the recent success of discount providers like Metro PCS ($PCS), which recently merged with T Mobile.  But given the limited spectrum available and the cost of building out a network, the current providers have little to worry about in the way of new entrants.

Sprint is a train wreck right now, which is thankfully being bought out by the Japanese telco Softbank ($SFTBY)—a company so desperate for growth in its moribund Japanese home market that even a dog like Sprint looks attractive).

But how do AT&T and Verizon look?

AT&T yields 5% in dividend and is aggressively buying back its shares.  Verizon yields 4% and has not made any recent announcements regarding share repurchases.

5% and 4%, respectively, are not bad yields in this environment.  This puts the two major telecom companies about on par with triple-net REITs and MLPs.

But if I have to choose between telecom stocks and REITs and MLPs, I’m taking the REITs and MLPs.  Both should benefit from an improvement in the economy, as a healthier economy means rising rents and increased energy usage.  Both are also better positioned to weather any uptick in inflation.

AT&T and Verizon might also benefit from an improving economy, as more employment means more business phone and data lines and, to some extent, upselling to more expensive personal plans.  But both operated in an inherently cutthroat and deflationary business.  Quality real estate appreciates in value over time.  Telecommunication equipment does not.

Bottom line: in a diversified income portfolio, there might be room for the likes of AT&T or Verizon.  But I would give a higher allocation to quality REITs and MLPs.

Sizemore Capital is long TEF. This article first appeared on InvestorPlace.

Charles Lewis Sizemore, CFA, is chief investment officer of the investment firm Sizemore Capital Management and the author of the Sizemore Insights blog.



Charles Sizemore on Bloomberg TV: Investing in Europe

Charles Sizemore gives his thoughts on how to invest in Europe to Bloomberg’s Guy Johnson, live in London.  To watch the interview, see Emerging Market Exposure via Europe

Telefonica: Latin American Growth, Crisis Prices

“Buy low and sell high” is the standard advice of any value investor. It can also be remarkably hard to put into practice.

You see, we humans are herd animals, and we tend to think and act as groups, particularly during times of stress. Call it the primal human instinct to seek strength in numbers.

Unfortunately, while this instinct may ensure our survival during times of war or natural disaster, it handicaps us as investors. When we see others panicking we too sell in fear or stand paralyzed in indecision at exactly the time we should be buying with both fists.

All of this is a lengthy introduction to the subject of this article, Spanish telecom giant Telefonica (NYSE:TEF).

Telefonica has had a rough year. The price of its U.S.-listed ADR are down nearly 70% from their pre-2008 highs. The domestically-traded shares have fared slightly better do to the lack of currency movements, but results have been dismal nonetheless.

Spain’s crisis has become Telefonica’s crisis. As the most liquid stock in the Spanish stock market, Telefonica has become a proverbial punching bag and an outlet for traders wanting to short the embattled Eurozone country.

This article was published on GuruFocus.  To read the full article, please see The Case for Telefonica.

Christmas May Come Early This Year

It’s a little early for Christmas in July, but now is the time for investors to be putting together their “Christmas lists” of sorts.

Recently, I wrote a piece that described an old investment strategy of Sir John Templeton (see “An Anniversary We’d Prefer to Forget”).  Sir John would make a list of companies he’d love to own “if only” they fell to a more attractive price.  He would then place limit orders to buy those companies at prices substantially below the current market price.  In the event of a sharp selloff, the limit ordered would be executed, and Sir John would have his shares at the prices he always wanted.

His rationale for the strategy was simple enough: we humans are instinctively herd animals, and we tend to panic when we see others around us panicking.  We lose our independent judgment and we freeze in fear at exactly the moment we should be buying aggressively.  Templeton’s move was designed to take his own emotions out of the equation; Sir John understood his own human shortcomings, and essentially gamed himself.

Today, with Europe teetering on the edge of a potential meltdown,  I’m going to recommend that investors take a similar approach, though mine has the added bonus of adding a little extra income.

I recommend that you make a list of strong multinational companies based in Europe that you are confident can survive Armageddon with their businesses intact.  Ideally, these companies would have significant percentages of their revenues coming from outside of the Eurozone.

Once you have your list of stocks, consider selling deep out-of-the-money puts on them.  If prices remain relatively stable or rise, the options expire worthless and you pocket the premium.  And if the share prices take a nosedive, the options will be exercised and you will be obligated to buy the shares at the prevailing market price—which was your objective all along.  And you still get to pocket the premium.

Here a little explanation is needed.   When you buy an option, whether it be a call or put, your risk is limited to the price you paid for the options.  You are buying the right to buy or sell shares at a given price, not the obligation.

Selling, however, is a much trickier business.  Your upside is limited to the premium at the time you sell the option.  But your downside is much, much bigger.  In fact, when selling a naked call option, your risk is theoretically infinite.  For example, if you sell the right to buy Facebook (Nasdaq:$FB) at $38 to another investor and the stock rises to $100 the next day, you’re on the hook to buy at the prevailing market rate of $100 and sell at $38.  Not an appealing prospect.

Likewise, when you sell a put, you are giving an investor the right to sell you shares at a price that might be far higher than the prevailing market price.  So, when selling put options on your list of European stocks you’d like to own, make sure that you have the cash on hand to handle the trade if it is exercised.  Don’t get greedy and sell contracts for more shares than you can afford to buy or that you would ideally like to own.

I’m not going to recommend specific put option contracts for you to sell because the entire point of this article was for you to create a list of stocks you like at prices you want to pay.  I also want the advice in this article to be general and something that you can use months or years from now; recommending a specific contract would make this article too short-term for my liking.

I will, however, toss out a few company names for you to consider.  Last week, I recommended Spanish bluechips Telefonica (NYSE: $TEF), Iberdrola (Pink:$IBDRY)and Banco Santander (NYSE:$STD) (see “Bargain Hunting in Spain”).

I continue to like all three, and to this list I would add French oil major Total (NYSE:$TOT) and British telecom giant Vodafone (NYSE:$VOD).  While Vodafone is not a Eurozone stock, it has significant operations in the Eurozone and I would expect its share price to take a tumble in a general market rout.

If you’re not comfortable with options, that’s ok.  You can accomplish essentially the same thing by placing limit orders like Templeton.

Disclosures: Sizemore Capital has positions in TEF.

This article first appeared on MarketWatch.

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