Investors who have had their hard earned money invested in telecom have had a rough few years. What once was a lucrative growth story has turned into a high-risk adventure that for some reason still has people calling the remaining skeletons value plays. Alcatel-Lucent?….No thanks. Ericsson?…..Ugh. Nokia Siemens?….I don’t think so. Motorola?….right. Nortel, Marconi?….don’t exist anymore. Cisco?….what have you done for me lately?
A boatload of factors has contributed to the demise of these former high flyers. Lack of focus by management trying to be everything to everyone everywhere, macro-economic issues causing drastic reduction of Communications Service Providers (CSPs) CAPEX budgets, fierce competition by the entry of Huawei and ZTE driving prices and margins down, using what many suspect are unfair practices and government support. Valid reasons, but not the complete story. There is an often overlooked issue that I think should be the biggest concern:
Although they will never publicly admit to it, the CSPs simply do not consider the networks as a differentiator anymore. And it so happens that despite all the other solutions and services that Alcatel-Lucent, Ercisson, Nokia Siemens, and even Huawei and ZTE have to offer, networks remain their core business. Unfortunately for them, CSPs’ networks are now considered by their owners to be commoditized pipes that do not contain the intelligence that is required to create a competitive advantage. That is the real reason why margins are so compressed. CSPs are just not prepared to pay the premiums they once did.
The problem is that the above-mentioned corporations are, despite all the reorganizations, still built as if their network equipment solutions sell at premium pricing. They don’t anymore. In reality, network infrastructure solutions have become a commodity business. I am staying away until I see them really re-invent themselves, and that is going to take years.
So what else is there if you are a growth investor and look for telecom opportunities? You can have a look at some of the smaller vendors such as Infinera. Lots of promise for a long time, but will they ever deliver against that promise? Maybe worth a small bet?….maybe.
ATT, Verizon? You have to look elsewhere for growth, unless they decide to seriously expand internationally, which would be out of character and unlikely to be in their best interest.
If you want to find growth in telecom, you have to look at Latin America and China. I prefer Latin America as there is less of an issue with government involvement and quite frankly, Latin American telecom is doing much better, A good indicator is troubled Alcatel-Lucent Q3 earnings report in which they highlighted the one bright spot: double-digit revenue growth in the Caribbean and Latin America. Why is that?
Most countries in Latin America only have about 30% high-speed internet penetration rate mostly limited to urban areas. This penetration rate is not due to lack of demand, but rather due to incumbent operators, so far, not seeing the business case in expanding their networks to the non-urban population
Something is changing though. Improvements and expansions in high-speed internet infrastructure are directly related to economic progress. Governments realize that these investments are necessary to continue to advance their development. As a result, across the region they are now heavily promoting and investing in national broadband and fiber network deployments so that their people can access the internet.
Due to this lack of investment, in many Latin American countries, the telecom sector is heavily fragmented. It is very common to see incumbent operators focusing on the densely populated urban areas and neglecting the rest of the country. You will find within, but especially outside of, the big cities, tens or hundreds of small local cable operators. For example, Ecuador has over 200 and Paraguay more than a 100 cable TV operators. But what these local operators offer are video services, not high speed internet. So these cable TV operators have thousands of customers, existing revenue, they truly understand their local markets and they know they can sell broadband services into the majority of their customer base, if they have the budget. This is similar to the environment that existed 20 years ago right here in the USA.
Here in the USA, twenty or so years ago, ComCast built a powerhouse by consolidating regional players under one umbrella. I think that is exactly what will happen over the next decade in many of the Latin American countries.
Two companies seem to be well positioned for this wave of consolidation:
1. America Movil (NYSE: AMX)
This is the Mexican telecom top dog in Latin America. Owned by the world’s richest man – Carlos Slim, who also sits on the United Nations broadband commission that is pushing the agenda of enabling 60% of the population of all third world countries access to high speed internet at pricing less than 5% of GDP per capita. AMX Operates in 18 markets across Latin America and the Caribbean where in most cases they have the #1 or the #2 market share. They are expanding their reach worldwide by acquiring larger positions in European operators such as KPN (The Netherlands) and Telekom Austria.
More importantly, with the increased push by countries to execute on their national broadband plans combined with the existing fragmentation in many of the markets AMX operates in, they are ideally positioned to lead the next inevitable wave of consolidation. AMX has the financial power to instigate the consolidation. And if governments are prepared to subsidize some of the investment to realize their national broadband plans AMX can create a profitable business case. Combined with an accelerated growth of the region’s middle class who will have more money to spend on both basic and more sophisticated telecom services, AMX is poised for growth over the next 10 years.
2. Liberty Global (Nasdaq: LBTY)
Another company that may even be more likely to jump in the middle of the Latin American consolidation wave is Liberty Global, one of the leading international cable operators in the world with their headquarters in Colorado. I really like LBTY. They are opportunistic, patient, and decisive. Always looking for expansions. 11 of their 13 operations are in Europe, with the remaining two in Puerto Rico and Chile. They expanded in Europe by taking advantage of their own industry consolidation wave. LBTY has been there before. They know how to do this, which is an advantage they have over AMX, as AMX’s background is a legacy of being the incumbent, not the challenger.
With the ongoing crisis in Europe, I think their investment dollars will for the majority be redirected from Europe to Latin America. They have had a few years of familiarizing themselves with doing business in the region, a necessary step that is often overlooked by many North American and European companies aiming to do business in Latin America. The acquisition of VTR, the leading operator in Chile, in my opinion will prove to be a great launching pad to expand their presence in the region. I cannot see them buying into just two operations in a high growth region without the intention to replicate their successful European business model.