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.



Microsoft, Apple and Big Tech for the Remainder of 2012

Last week, I suggested that Microsoft ($MSFT) would be the ultimate winner in the long war for dominance of the smartphone and tablet markets.

Though Apple ($AAPL) dominates today, it has no real defensible “moats” that would prevent an aggressive competitor from muscling in on its turf.  Consumers are notoriously fickle, and there is little to lock them into the Apple ecosystem.  You can access your key services—such as Facebook ($FB), Twitter, Skype and even Apple’s iTunes—from just about any device, after all.  And if Microsoft is able to leverage its dominance of the desktop market by familiarizing users with its Windows 8 operating system—which looks and feels more or less the same on desktops, tablets and smartphones—Microsoft may well dig the elusive moat that Apple has thus far been unable to dig.

Moreover, Apple’s “idea man,” the late Steve Jobs, is not something that can be replicated, and going forward Apple will find it increasingly harder to stay ahead of its competition.

As Apple discovered to its dismay during the PC era of the 1980s through the mid-2000s, computers are ultimately commodity products for which it is difficult to charge a premium (and yes, I lump smartphones, tablets and PCs together as “computers”).  The iPhone’s popularity has been bankrolled by generous subsidies by service providers like AT&T ($T), Verizon ($VZ) and Sprint ($S).  But as these carriers start to push back against subsidies, Apple will find it harder to maintain its margins without lowering its prices—something the company will be reluctant to do.  In a very short period of time, Apple may again see itself fall from the position of industry leader to that of a niche provider.

None of this suggests Apple’s imminent demise, of course.  As I wrote in the previous article, I’m talking about a long war of attrition that may take a few years to play out.

But none of this matters in the short term.  In the short term, I expect most Big Tech stocks to move together in a fairly tight correlation as investors reassess the economic picture.  For the remainder of 2012, I see investor risk appetites returning, and I see Apple and its competitors Microsoft and Google ($GOOG) leading a rally in technology shares.

I recommend investors pick up shares of the Technology Select SPDR ($XLK) and plan on holding for the remainder of 2012.

With the bad earnings releases of the third quarter mostly digested, I expect to see a broad-based market rally, and I expect more cyclical sectors such as technology to lead.

Disclosure: Charles Sizemore is long XLK through his Tactical ETF Model. This article first appeared on TraderPlanet.

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