For the past three months the three remaining Telecommunications titans on the ASX have taken a severe beating.  The largest Telco in Australia by far actually suffered the least.  Here is a three month price performance chart for Telstra Corporation Limited (TLS).

The second and fourth largest Telco’s in Australia, TPG Telecom (TPM) with a market cap of $5.9 billion, and Vocus Communications (VOC) with a market cap of $3.2 billion, both dropped double digits.  The decline might come as a surprise to some investors eagerly awaiting superior results from industry consolidation in 2015.  M2 Communications merged with Vocus following a flirtation with a takeover of iiNet Limited; a battle ultimately won by TPG.  
When the dust settled, Telstra remained the top Telco with its massive market cap of $59 billion with New Zealand’s Spark Infrastructure (SPK) coming in third place with a market cap of $5.8 billion.  SPK does not operate in Australia where there are differences between that country’s UFB (Ultra-Fast Broadband) and our own NBN (National Broadband Network.)  Here is how the stock price of the number two (TPM) and the number four (VOC) ASX Telco’s have performed over the last three months.

Given the steep falls in the share price of TPM and VOC after their shopping sprees, are they approaching bargain status or are they value traps whose best days are behind them?
Past history is no guarantee of future performance, but it serves as a starting point for both growth and value investors.  Sage investing advice tells us to look for “well-managed companies with future growth prospects.”  What better indicator of solid management can one find to replace historical performance over long periods – from five to ten years?  Once a potential investment passes the first test, the tricky task of “guestimating” future potential comes into play.
With that in mind, let’s look at the historical track records of these three Telco stocks.  The following table shows both earnings and dividend growth as well as average annual rates of total shareholder return.

Over five and ten years all three of these companies have rewarded shareholders with double digit returns that combine dividend payments and share price appreciation.  Although the numbers for Vocus trail rival TPG Telecomm, investors should know Vocus began paying dividends in 2013 – $0.01 per share.  By 2016 the dividend exploded to $0.173 per share, an increase of close to 1600% over three years.  
So what happened to drag these high-flying stocks back down to earth?  The risk investor’s face with most high-flyers is the market reaction to an unexpected drop in altitude.  Investors are bombarded with frightening warnings of evaporating growth.  Despite the stellar track records, the share price of TPM collapsed on the news the company expected meager growth for FY 2017.  The share price of Vocus suffered on the news as well.  So why was Telstra spared much of the pain?
Telstra’s long term performance stands as evidence to support the claim made by legendary US investor Peter Lynch -‘Big companies have small moves, small companies have big moves.’   One could argue that a market cap approaching $6 billion hardly qualifies as a small company, but TPG Telecom did not start out that way.  The following chart compares the ten year history of the Goliath of the sector against the David. 

However, investors looking for a “slow and steady” investment with marginal volatility should consider Telstra at an attractive price.  While classified as a telecommunications company with its full range of communication services in all telco markets, the company also qualifies as a technology company.  Telstra operates in 22 countries with a major focus on the Asia-Pacific Region.  The company has four business segments and its technology expertise comes into play primarily in the Global Enterprise and Services and Operations divisions, ranging from Data and Internet Protocol (IP) Networks to Network Applications and Services (NAS) products.  The Retail and Wholesale divisions house traditional services such as fixed and mobile communications.
The issue of what an attractive price would be depends to a large extent on an individual’s investing strategy.  There are measures that suggest value and the following table includes some of them for Telstra as well as for TPG Telecom and Vocus Communications.

We included Enterprise Value (EV) since it is one measure companies typically use to gauge the true value of a potential takeover target.  Enterprise Value starts with a company’s market cap, which is simply the number of common shares outstanding  multiplied by the share price, and first adds the company’s debt and total preferred shares and then subtracts available cash and cash equivalents.  
When EV exceeds market cap it is an indication the company’s debt load is higher than available cash.  In the case of capital intensive companies with asset bases that eat up cash, the higher EV may indicate greater value.  This is especially true for growth companies where taking on debt to expand the company can be considered desirable. However, companies with an EV close to or lower than its market cap have more cash available.  For our three Telco stocks Vocus stands out as one with more cash, which a comparison of financials for the three companies would confirm.  
The EV also indicates a fundamental difference between the three companies.  More than a decade ago TPG’s founder proclaimed his intention to make his company a worthy competitor for Telstra, a goal that has been met.  TPG now has a data and voice network second only to Telstra, with all the capital requirements of maintaining these assets.  When TPG acquired iiNet, it was essentially a marriage of twins, as the companies offered similar services to similar markets.   In contrast, M2 Communications operated primarily in the business market while Vocus focused on retail. This marriage avoids costs associated with merging operations performing similar functions and opens the joint company to new markets.   That difference might account for the substantial difference in earnings growth forecast between TPM at 10% and VOC almost five times as much estimated growth at 48%.
Full Year 2016 Financials also strongly favored Vocus.  TPG reported solid revenue growth of 88% and profit growth of 70%.  However, much of the result was attributed to the iiNet acquisition, not to organic growth at TPG.  Investors then heard their greatest fear – the company estimated EBITDA (Earnings before Interest, Taxes, Depreciation, and Amortization) growth of 6.5%, seemingly confirming the concern the days of rabid growth in the Telecommunications Sector may be waning.  TPG shares plunged, and Vocus shares fell as well.  Vocus took another hit a few weeks after the 21 September results announcement from TPM on the news two members of the newly configured Vocus Board of Directors resigned.  This followed an earlier release of the resignation of the company’s CFO.  Losing three members of top management rarely please investors. The Vocus drop came despite a stunning Full Year 2016 Results release that came on 23 August.  Revenues rose about 457% and profit was up about 372%.  These results included only one of the company’s recent acquisitions.  To the delight of investors, the M2 deal, finalised in mid-February, did not contribute significantly to the stellar results.
There are analysts and experts of the opinion the consolidation of the Telco Sector is sure to slow future growth.  There are simply too few smaller players from which the big players can take market share.  Vocus has grabbed a few additional acquisitions in 2016 but the well is drying up.  However, technology has a way of surprising and there are other experts predicting the completion of the NBN will remove Telstra’s copper network advantage, allowing better completion from both TPG and Vocus.  Both companies are pushing fibre optic connections, opening the door to possibilities not yet envisioned.  The analyst community as a whole remains convinced TPM and VOC have a bright future, with OUTPERFORM recommendations for both.  Telstra is rated a HOLD.

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