Thursday, September 27, 2012

3 Telecom Giants To Consider In 2012

When it comes to smartphones, the name of the game is "faster" - consumers want lightning fast phones and data that makes it all seem to work at the speed of thought. Telecom companies AT&T (T) and Verizon Wireless, which is a joint venture between Verizon Communications (VZ) and Vodafone (VOD), are leading the pack, introducing 4G LTE (it stands for "fourth generation long-term evolution network").

The difference between 4G LTE and 3G is significant to say the least. These 4G LTE networks allow users to download 10 times faster than they could using 3G service. Given that many of today's devices are heavily data-driven - streaming movies is sort of a smartphone standard and that is to say nothing of the applications they use - that increase in data speed is monumental.

The problem is that in order to offer that type of speed, the telecom company has to build the network - and it is a huge investment. The kind of money a company needs to offer 4G LTE is big enough that it is out of reach for most smaller companies. Instead, they have to find new ways to compete - namely price and features.

Take Sprint Nextel (S) for example. The company doesn't have a 4G network as large as Verizon's or AT&T's, so it started offering unlimited data for smartphones, plus added personal hotspots and flexible upgrades. Once that wan't quite enough, Sprint practically bet the company to be able to secure the rights to sell the iPhone, pledging to buy at least 30.5 million Apple (AAPL) iPhones - spending roughly $20 billion at current rates. At that price, Sprint isn't expected to actually make good on the deal until 2014.

At the same time, Sprint is trying frantically to develop its own 4G LTE network and enhance existing 3G service by the middle of this year. It is adding the upgrades for better data speed but it is also developing its systems that will increase its signal density and voice quality. Ironically, Sprint was one of the forerunners of the 4G technology, launching it in 2008 but has since fallen behind in the race for 4G. These upgrades could rectify that.

Sprint is planning to spend roughly $5 billion upgrading its networks over the next several years. The company is also promoting its wholesale business, which includes companies like America Movil SAB (AMX)'s Tracfone which helped it boost its customer numbers by 2.7 million last year. One of the ways it is doing this is through acquisitions and strategic agreements. "We have signed contracts on LTE," said Sprint's president of wholesale solutions and new ventures Matt Carter, teasingly adding "it's in the double digits." Carter has not publicly identified the companies but information on a few companies has trickled through. In a press release dated March 1, Sprint announced that it had signed an agreement to serve as the wireless engine for Chrysler's Uconnect technology.

Things could be looking up for Sprint but whether or not its stock follows suit is another story altogether. The company recently traded for $2.79 a share. According to Yahoo Finance, analysts give the stock a mean one-year estimate of $3.80. It does not pay a dividend. It they are right, that is an increase of over 36% - but with the sweet comes the sour.

Sprint's net income is significantly lower compared to the same quarter last year. It went from negative $929 million to negative $1.3 billion. Its operating cash flow didn't fare much better - it fell almost 26%. Sprint's return on equity also fell, indicating some weakness in the company, as if the rest of its metrics didn't point to a similar conclusion. The company has a high debt-to-equity ratio of 1.77 and its share price fell over 40% last year. However, for as bad as it sounds, I think a fair portion of this falls to its issues with a small company called LightSquared, owned by hedge fund manager Phil Falcone and his Harbinger Capital.

Sprint had a $13.5 billion deal in place with the startup. LightSquared was supposed to give Sprint $9 billion in payments and $4.5 billion in service credits in exchange for the company to build and operate its network but LightSquared failed to get clearance from the FCC. It ruled that LightSquared's technology, which converts satellite into the sort that can be used for cell phones, would interfere with the nation's global positioning systems.

Now Sprint may cut ties with the company, putting it in a position to walk away and put its money toward more lucrative endeavors like acquisitions. If played right, this could put Sprint back in the game. After all, there are a few things to the company's favor - like its strong quick ratio of 1.35. Sprint also has been able to boost its return on assets quarter over quarter. At the same time, it has been able to keep its debt level, boost its cash and improve its net sales.

I am hopeful on Sprint, but I'm don't think that now is a good time to buy. It's hard to say what will happen with the company and the price will probably go lower before it goes back up. I think the best course of action is to invest in companies like Verizon and AT&T that are going to see increases as more and more people switch to smartphones and existing users opt to transfer service to them to take advantage of their 4G networks. Also, given the size of these networks and their speed, AT&T and Verizon can charge a premium. This way, their average amount per subscriber will be higher than a company like Sprint, which will invariably add to their respective bottom lines. They are already in a better position than Sprint and I think the relative strength of that position will only increase.

Verizon, which recently traded at roughly $40 a share, has strong revenue growth - at nearly 8% it is outpacing its industry's average of 4.0%. This didn't seem to benefit its bottom line - its earnings per share actually declined - but I think the decrease is temporary. Verizon's income increased by almost 52% compared to the same quarter last year and has had net operating cash flow increases (bringing it to 1.44%) at a time when the industry's average cash flow growth is at a loss of almost 6%. It also pays a high dividend of $2 per share (5.10% yield).

AT&T recently traded at roughly $32 a share and pays a high $1.76 dividend (5.60% yield). The company has been lacking in the net income growth area and has a low 0.55 quick ratio, but its return on equity is outpacing the industry and it has a low debt-to-equity ratio. AT&T recently lowered the premium it charges for its service and provided more value in many of its existing plans. The company was hurt a little in its failed acquisition of T-Mobile, but I think that it is moving forward and will take off soon.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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