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Telecom Offers A World of Opportunity

Telecom Offers A World of Opportunity

There can be little doubt that the smart phone is on the top of the current economic pyramid.  Rarely in the history of commerce has a single product become so rapidly indispensable for so many people across the globe. For many, the act of forgetting one's phone at home renders a naked feeling of being disconnected from the outside world. These increasingly small devices are no longer just about phone calls. They connect us through word, picture, video and sound to everything. In this digital age, they are practically like another appendage. 

For good or ill our growing thirst for ubiquitous information has taken global telecommunications on a wild ride of new frontiers and revenues. Every time that the electronics manufacturers dream up a new game changing device, the telecom companies need to provide bandwidth so the device can perform its miracles. What was once the stale territory of quasi-state utilities is now a vibrant investment sector. Most importantly, the telecom revolution is a truly global phenomenon. The United States is very far from the front of the pack in terms of digital penetration. And there are many developing countries that are making the leap directly from smoke signals to digital wireless connectivity. This creates a world of opportunity for discerning investors. 

Telecom's initial growth in the last decade began with development of smart phones (and later tablets) that allowed mobile access to the internet. As a result, consumers now spend increasingly more time using telecom bandwidth and less time watching television or  reading print media. The shift in advertising spending is a testament to this fact. Prior to the advent of the latest smart phones, total advertising dollars spent in print media was more than five times that spent online.  Since then, the balance of advertising dollars has moved steadily towards online marketing. In fact, 2012 marked the first year that marketers spent more money advertising online than in print ($39.5 billion online advertising versus and $33.8 billion in print).

Easy mobile access to the internet has also resulted in an explosion of online content. With each passing day, the amount of content generated online and accessible by mobile phones, tablets, and notebooks grows exponentially: social networks, online games, online dating, YouTube, Twitter, Facebook, Instagram, television, magazines, blogs, podcasts, and untold other applications. Businesses are increasingly demanding access to cloud computing, mobile application platforms, and mobile payment platforms as it provides greater data storage, broader access to potential customers, and faster processing of transactions. 

The question for investors is how to best capitalize on the trend. At the core, there are essentially three ways to tap into the information revolution: 1) invest in manufacturers of hardware (i.e. those who produce the cell phone, tablets, and computers we thrive on) 2) invest in manufacturers of content (i.e. those who produce the applications, social networks, games, websites) or 3) invest in the providers of service or connectivity (i.e. telecommunication services). There are certainly good options in each market segment, but I would argue that the connectivity providers offer one of the more stable and reliable means to gain exposure. 

Both manufacturers of hardware and content must appeal to  human sensibilities and taste. As a result, the market for devices and services can be difficult to gauge. Though the barriers to entry are significant, they do not shield companies from competition. Case in point is Apple and how quickly they were able to take over the mobile phone market at the expense of Research in Motion. Interestingly, Samsung has now emerged into an epic battle with Apple over mobile market share, while both Samsung and Microsoft are poised to challenge Apple in the tablet arena.

Not surprisingly, the market for content is even more fragmented than hardware. The amount of content online is endless, with barriers to entry extremely low. After all how much does it cost to start a website? Remember back in 2005 when Newscorp paid $580 million for social networking site MySpace. Despite the backing of one of the world's leading media conglomerates, MySpace has now almost completely disappeared from our collective consciousness. Newscorp resold MySpace for $35 million in 2011. Or more recently, consider Groupon, the daily deal website that had created so much buzz in 2010 and 2011. In the face of stiff competition from a plethora of copycat competitors the company's shares have lost 82% since its November 2011 initial public offering. 

On the other hand, providers of connectivity are not held to the same whims of the marketplace. Buyers of bandwidth are not investing in a product, rather in a service. Consumers and businesses are interested solely in connectivity, network capacity, speed, and cloud based solutions. Providing these services is by no means a simple task and requires telecommunications companies to be constantly investing in and updating the infrastructure. However, this also means that barriers to entry are vast, ensuring less players and higher profit margins. Generally speaking there are only a few dominant players within each national market, and this is likely to contract further as many anticipate consolidation due to consistently high capital expenditures. As a result, telecoms are fast becoming virtual monopolies in many countries with dominant market shares and pricing power. 

While the telecom industry expects continued growth within the United States, it will be much slower than growth internationally. According to Insight Research Corp's “2012 Telecommunications Industry Review: An Anthology of Market Facts and Forecasts,” telecom service providers overseas are anticipated to have a combined revenue growth rate over the next five years that is 45% higher than North American providers. The report anticipates that the strongest growth will come from Asia and the Pacific Rim, Latin America, and the Caribbean. 

Smart phone and internet penetration in developing markets is still behind that in the developed world and thus still has significantly more room to run. For this reason alone, exposure to telecoms in developing markets is worth considering for some investors. And while growth prospects for the industry look promising, it is also worth noting that the sector as a whole pays some of the highest aggregate dividend yields when compared to other industries. 

According to Factset's December 2012 Dividend Quarterly, the aggregate dividend yield from Telecom companies in the S&P 500 was 4.7%, the highest among all sectors.  A sample set of 15 foreign telecoms from earlier in the year had an average yield of 7.24%. The tremendous growth prospects and yields make telecom companies an attractive option for both growth and income oriented investment strategies. 

In the end, owning telecommunication services is a long term play on the increasing reliance on the internet and mobile devices. With the information revolution still in its nascent phases, exposure to telecoms is something that many investors should consider. In fact, Euro Pacific Capital currently recommends a number of large non-dollar telecom stocks that offer high dividend yields and attractive valuations. 

David Echeverria is an Investment Consultant in the Los Angeles, CA branch of Euro Pacific Capital.

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