Fund strategists’ views on the telecom sector

Tim Price, senior investment strategist at Ansbacher Wealth, notes that BT, “stripped of its wireless arm and growth story”, is now trading below its 1997 level. Vodafone, on the other hand, is at levels last seen in 1998. But BT may be of more interest to investors, says Price. “As we concentrate on income and yield plays, Vodafone, with a less-than-impressive net dividend yield of around 1.5%, is unlikely to feature on our radar for some time – global market leader or not,” says Price. “With a market capitalisation of £93bn, we would also ask how much growth in new ownership is on the cards, because our lingering concern would be that every active fund manager already owns the stock. “BT, on the other hand, shorn of the mobile growth prospects of its daftly named subsidiary mmO2, looks distinctly ex-growth, but has an increasingly interesting-looking yield of over 4%. Can BT grow earnings in broadband faster than it loses income from fixed-line telephony? That would be our main concern. “The technology landscape – voiceover internet protocol, for example – is also evolving fast enough to make us wary of big buys. In short, the sector looks to us like one that is brutally transitioned from an over-hyped growth story to a more realistically priced utilities story. But do we have much exposure to telecoms? No. And we are unlikely to until higher dividend levels justify a purchase.” Helena Scott, investment manager at Smith & Williamson, says she is keen on Vodafone in the long term although, like most analysts, she is concerned about the speculation over a bid for AT&T: “I cannot see that this is a very attractive prospect, although Vodafone may be able to turn it around. The problem is that Vodafone has a 45% stake in a rival US operator, Verizon Wireless, and it will incur a tax liability if it sells this. “But in the long term we like the mobile sector, of which – in the UK – Vodafone is the largest player. There is good growth in the wireless market, including overseas. There is 10% growth in revenue for Vodafone in Eastern Europe.” Scott says that mmO2, which has operations in Germany and Ireland as well as the UK, has lower margins but has scope to increase these. She highlights the fact that Hutchison’s relaunch this year will have an impact on the wireless market. According to Scott, mmO2 is on 32x 2003 earnings but only on 10x the earnings expected in two years’ time. The uncertainty is whether it will be able to achieve “what is required to get there”. Graham Neale, director of Killik & Co, says investors must consider two issues when buying telecom stocks. The first is that stocks such as Vodafone, BT and mmO2 comprise a large proportion of the FTSE 100, so there is a limit to how far they can diverge from the performance of the index.The second is that easy money from telecoms has been made over the past year. Neale repeats the bullish view about Vodafone in the medium term, but is uncertain about the effect of events in the US in the short term. He is confident Vodafone will benefit from voiceover IP technology and other new data. According to Neale, mmO2 is in a weaker competitive position than Vodafone, particularly as it has failed to grow Germany as much as hoped by analysts. He says BT should be viewed like a utility stock generating regular cashflow. The question facing BT, says Neale, is how much market share it will be forced to concede to rival companies by the Government. “BT is trying to build value-added services so it can diversify its revenue streams away from fixed-line, for which prices are falling. It has been quite successful and is making good progress, but it takes a long time to change course.” While investors should look to mobile operators for a growth story, BT offers a more attractive yield. Neale says BT is now on a yield of 5.6% at a share price of £1.76, but he is cautious about how quickly it can grow its revenue. He is also sceptical about BT as a yield play: “I think there are better defensive stocks to try to gain a good income, such as Gallaher, which is expanding its geographical markets.” The biggest winners from BT’s declining market share may be mid-cap telecoms such as Colt Telecom and Kingston Communications. Neale says these stocks have rallied after being oversold when the technology bubble burst. “These companies generally have good cashflow and are winning customers. Colt Telecom will benefit from a pan-European network that will enable it to link up its corporate clients. Bandwidth is becoming more of a commodity. The other advantage of Colt over BT is that it can offer a more sophisticated service.” Of the mid-cap telecom stocks, Neale believes Colt is in the strongest position. In contrast to Colt’s capitalisation of £1.7bn, Thus has a value of £490m while Kingston Communications is worth £270m. Neale describes Cable & Wireless as a “completely different investment issue” from other telecoms stocks. “C&W blew itself it up but got new management, restructured and its share price appreciated by 207% last year. It has some strong businesses in the UK.”