Dialing Up Telecommunications Stocks

For the twelve months ending April 30, 2013, telecommunications stocks have been on a tear.

The group - which is mostly just two stocks, Verizon and AT&T - rose by nearly +23% over the past year.  Not only were investors cheered by the recent strong growth of wireless, but both stocks paid very attractive dividends (over 4%) which was very alluring for many investors.

I have never been a big fan of the stocks. Both companies have huge cost structures; large pension obligations; and very expensive health care obligations to their retirees.  Moreover, the product they offer is fairly commodity-like; while service is important in choosing a wireless carrier, many people are driven by cost.  Finally, the wireline business has been dropping like a stone in recent years; most people under the age of 30 do not even get a phone installed in their home.

So it goes without saying that I missed the move in telecom stocks over the past year.

Recently, however, the stocks have been weak, and I have been wondering whether a buying opportunity was developing.

I had the chance to talk yesterday to Michael Rollins of Citicorp yesterday. Michael is a highly-respected telecom analyst, and has been consistently among the top vote-getters in the annual Institutional Investor survey.

In general, Michael did not disagree with my overall lukewarm view of the stocks in his group.  Revenue growth has been a meager +1% to +2% a year over the past few years,  and there is little likelihood that this will accelerate any time soon.  With the weakness in wireline, and the price-sensitive nature of the wireless business, Michael agreed with my assessment that it is hard for the industry to create value for shareholders.

That said, Michael did feel there were other ways other than organic growth for the stocks to work.  First, there are numerous restructuring opportunities in both companies that could result in significant cost savings and bottom line improvements.  Second, the companies could try to figure out new ways to drive top line growth either through promotions or price reductions.  And, third, there are numerous smaller telecommunications companies that could still be acquired that could be immediately accreditive to earnings.

Michael's favorite stock is Verizon.  There was a rumor that Verizon was going to offer Vodaphone $100 billion (!) for the part of Verizon Wireless that the European company owns.  Although I gulped at the numbers involved, Mike said that their analysis indicated that it was very doable, mostly because of today's very low interest rates.  He felt that if Verizon were able to convince Vodaphone to sell it would be a +20% boost to earnings in the first year.