After Much Flapping, Could Telecoms Be Ready To Soar?

With the cordless phone celebrating its 32nd birthday this month, we review the developments and opportunities in this sector.

In April 1983, BT launched the Hawk cordless phone in test mode before rolling it out properly later in the year.  The promise was that the “Hawk is a telephone that loosens ties on the customer rather than getting him to the end of his tether.”*  Whilst in many ways a precursor to mobile telecoms it was not a technology that was designed for the mass market – the radio transmitter within the unit had a range of 100m and there were only 8 radio channels in the UK limiting the density of usership as well as the obvious portability issues.

Since then trillions of dollars has been spent on wireless capex worldwide.  In the past 10 years alone, almost $800bn has been spent as network upgrades required for the roll out of 3G were quickly followed by more for 4G.  For the companies spending this money, these big roll outs were both very expensive and a “jam tomorrow” story in the short term – the graph below shows how the Return on Equity falls when all the money is spent and rises again as the benefit comes through more customers and improved revenue per customer.  It falls again as the next generation of expenditure ramps up.

Return on Equity for the World Wireless Telecommunications Industry

Source: Waverton/Computstat/FactSet

The roll out of 4G over the past few years is largely over for some developed markets which means that we should expect these returns to start to improve again.  We think that there are a couple of differences in this cycle though.  Firstly, mobile ‘phones have become an increasingly essential part of everyday life which means that not only do we consume much more data now than we did on voice and texts 10 years ago but also that we are prepared to pay more for improvement of 4G than we did for 3G.  Secondly, the next generation – 5G – will be limited to high density cities and is likely to require only additional transmitters rather than the construction of a new set of stations like 3G and 4G did.  This will cost significantly less and should mean that the high return period should last longer.  This means more free cash is generated and can be used to pay down debt or increase returns to shareholders.

As ever with telecoms, the risk is regulation.  European players in several countries are desperate to consolidate – they have had to take on enormous debt to fund their capex programmes of recent years and now want to profit with more rational pricing and lower costs – but the European regulator appears to be increasingly reticent to approve anything that might reduce competition.

However, there are developed markets where the competitive environment is rational, regulatory risk reasonable and the shift to smartphones (which improves profitability) has a way to run.  In a world of, at best, uncertain growth this improvement in returns and cash flow is very attractive to us and we continue to focus our attention on quality telecommunication companies across the globe from Vodafone in the UK to KDDI in Japan and seize upon reasonably priced opportunities as they arise.

By George Palmer

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