Telecommunications Sector
Pravin Talreja
Agenda
1.  Sector Overview
2.  Business Analysis
3.  Economic Analysis
4.  Financial Analysis
5.  Valuation Analysis
6.  Recommendation
Agenda
1.  Sector Overview
2.  Business Analysis
3.  Economic Analysis
4.  Financial Analysis
5.  Valuation Analysis
6.  Recommendation
Sector Size: S&P 500 and SIM
•  Total Telecommunication Sector Market Cap: $1.8 trillion
•  S5TELS Market Cap: $416.4 billion = 2.27% of S&P 500
•  The only telecom holding: VZ @ $279.7 thousand = 2.88% of
SIM – overweight by 0.61%
Telecommunic
ation Services,
2.27%
S&P 500
Consumer
Utilities, 2.82% Discretionary,
12.80%
Materials,
3.13%
Consumer
Information
Staples, 9.43%
Technology,
19.63%
Energy, 7.78%
Telecommunic
ation Services,
2.88%
SIM
Utilities, 3.00%
Materials,
2.25%
Information
Technology,
20.79%
Consumer
Discretionary,
12.61%
Consumer
Staples, 8.39%
Energy, 7.37%
Financials,
17.76%
Industrials,
10.09%
Health Care,
15.42%
Financials,
16.63%
Industrials,
9.41%
Health Care,
16.16%
Telecommunication Industries
•  Diversified Telecommunication Services
•  Wireless Telecommunication Services
1 – Canadian companies with common stock, not part of S&P 500
2 – American company with common stock, not part of S&P 500
QTD and YTD Performance
QTD S5TELS vs. S&P 500
YTD S5TELS vs. S&P 500
Agenda
1.  Sector Overview
2.  Business Analysis
3.  Economic Analysis
4.  Financial Analysis
5.  Valuation Analysis
6.  Recommendation
Telecom Industry Dynamics
Industry Life Cycle
•
–  Segment in decline stage with
revenue falling YOY
–  Commoditized product
–  Wireless substitution
Wireline
Wireless
Wireline:
•
Wireless:
–  Segment in mature stage with
revenue increasing, but at a
slower pace
–  Differentiation based on
network dependability
–  Disruptive price competition
–  Internet Of Things could prove
to be a catalyst
Business Cycle
•
Information Technology,
Consumer Discretionary,
and Healthcare doing well
•
Interest rates are set to go
higher, but the increase
may be moderated given
timid inflation levels and
GDP growth
Business Cycle (cont.)
•
Currently in mid to late stage
of the business cycle
•
Not a typical business cycle
given extremely low interest
rates, combined with
controlled inflation and a
still-delicate economy
Correlation to S&P 500
•  Second lowest
correlation
among the S&P
500 sectors:
•  0.600
•  Beta: 0.777
Geography and Users
•
The White House
administration
confirmed that 98%
of all Americans
have LTE coverage
(confirming
Verizon’s claim)
•
Wireless
penetration at 110%
- 355.4 million
subscriber
connections
–
•
ARPA becoming less
relevant as a
measure as more
subscribers have
multiple devices
connected
44% of US
households are now
wireless only
Industry Trends
•  Internet Of Things: Wireless M2M connections projected to increase
from 36 million in 2013 to 263 million by 2018 (Cisco)
•  Vertical Integration: The sector is experiencing a wave of
consolidations that puts content and distribution under one roof:
–  Verizon and AOL
–  AT&T and DirectTV
–  Rumored:
•
•
DISH and T-Mobile
T-Mobile and Sprint
•  Mobile Data to Double: Mobile Data is expected to double by 2018
leading to high demands and pricing on scarce spectrum
bandwidths.
Porter’s Five Forces
Buyer Power (Moderate)
- Despite moderately differentiated
product, buyers have low switching costs
due to no-contract plans.
Supplier Power (Moderate)
- Many manufacturers of equipment
- FCC regulates Spectrum availability
Competition and Rivalry
(High)
- Intense rivalry involving
price
Barriers to Entry (High)
- Few large players that dominate this
industry
- Highly contested mature industry
- Capital intensive
Threat of Substitution (High)
- VoIP services proving to be the biggest
threat
- Disruptive innovation through
consolidation of technology and telecom
sectors
Agenda
1.  Sector Overview
2.  Business Analysis
3.  Economic Analysis
4.  Financial Analysis
5.  Valuation Analysis
6.  Recommendation
Interest Rate
•  Correlation
with 10-yr US
Generic Govt.
Yield: -0.0785
•  10-year
treasury on
the rise –
reduces the
attractiveness
of telecom
industry
Interest Rate (cont.)
•  Latest FOMC
consensus is for a
rate hike in
September
•  The new mid-point of
~ 70 basis points is
lower than their
March mid-point of ~
90 basis points due
to economic recovery
conerns
Agenda
1.  Sector Overview
2.  Business Analysis
3.  Economic Analysis
4.  Financial Analysis
5.  Valuation Analysis
6.  Recommendation
Sales Growth: Sector vs. S&P 500
Sales Growth % S5TELS vs. S&P 500
35.0%
30.0%
25.0%
20.0%
15.0%
S&P 500
10.0%
S5TELS
5.0%
0.0%
-5.0%
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-10.0%
-15.0%
•  Mature Sector - Three consecutive years of sales decline
•  S&P has better sales growth since the financial crises –
business cycle impact
Sales Growth: Key Firms (VZ & T)
Sales Growth % Key Firms
100.0%
80.0%
60.0%
VZ
40.0%
T
20.0%
0.0%
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TTM
-20.0%
•  Verizon has recorded marginally better sales growth rates than AT&T
since 2011
Gross Margin: Sector vs. S&P 500
Gross Margin % S5TELS vs. S&P 500
70.0%
60.0%
50.0%
40.0%
S&P 500
30.0%
S5TELS
20.0%
10.0%
0.0%
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•  Telecom sector has significantly higher gross margins than S&P 500
•  Verizon is highest in terms of Gross Margin % within the sector
Profit Margin: Sector vs. S&P 500
Profit Margin % S5TELS vs. S&P 500
12.0%
10.0%
8.0%
6.0%
S&P 500
4.0%
S5TELS
2.0%
0.0%
-2.0%
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-4.0%
•  S&P 500 has recorded better bottom-line figures than Telecom in
most years
•  Telecom is capital intensive with high depreciation
ROE: Sector vs. S&P 500
ROE S5TELS vs. S&P 500
25
20
15
S&P 500
10
S5TELS
5
0
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-5
•  Telecom has had lower ROE than S&P 500 in most years
Leverage D/E: Sector vs. S&P 500
Leverage (D/E) S5TELS vs. S&P 500
250
200
150
S&P 500
S5TELS
100
50
0
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•  Capital intensive industry that took advantage of cheap funding
•  Increased spending on Spectrum
•  Portion of 2014 increase can be attributed to VZ acquiring 45%
Vodafone stake
Agenda
1.  Sector Overview
2.  Business Analysis
3.  Economic Analysis
4.  Financial Analysis
5.  Valuation Analysis
6.  Recommendation
Multiples: Absolute & Relative S&P 500
•  Absolute: Most dials look expense, except for P/E
•  Relative to S&P 500: Valuations appear cheaper
P/E and P/S: Sector vs. S&P 500
P/S S5TELS vs. S&P 500
P/E S5TELS vs. S&P 500
2
1.8
1.6
1.4
1.2
S&P 500
1
S5TELS 0.8
0.6
0.4
0.2
0
25
20
15
10
5
0
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S&P 500
S5TELS
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P/B and P/CF: Sector vs. S&P 500
P/B S5TELS vs. S&P 500
P/CF S5TELS vs. S&P 500
4
3.5
3
2.5
2
S&P 500
1.5
S5TELS
1
0.5
0
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20
18
16
14
12
10
8
6
4
2
0
S&P 500
S5TELS
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Agenda
1.  Sector Overview
2.  Business Analysis
3.  Economic Analysis
4.  Financial Analysis
5.  Valuation Analysis
6.  Recommendation
Recommendation
SIM weight equal to S&P 500
Reduce SIM weight by 0.61% to 2.27%
•  IoT provides an exciting opportunity for market expansion
•  Stable dividends provide support for prices, given modest economic
recovery
•  FOMC takes a delicate stance on interest rate hikes
Risks
•  Highly contested market; aggressive tactics by competitors
•  High leverage could impose strain on cash available for capital
expenditures (especially coupled with increasing interest rates)
Questions?