Telecom Sector

1
SIM
Telecommunications Sector
Kevin Ratliff Nitin Sharma
February 2008
2
Overview

• Portfolios and Composition
• Economic Analysis
• Business Analysis
• Financial Analysis
• Valuation Analysis
• Recommendations

3
SP and SIM Portfolios
Size and Composition - Weights

• SIM portfolio slightly overweight in Telecom
  compared to the current SP500 weights
• 3.5 in SP versus 3.78 in SIM
• Only telecom stock present in SIM portfolio is
  America Movil (AMX)

Portfolios and Composition
4
Composition - Industries

• Diversified Telecom Services
• Alternate carriers
• Providers of communications and high-density data
  transmission services primarily through a high
  bandwidth/fiber-optic cable network.
• Embarq, Citizen Communications
• Integrated Telecommunications Services
• Operators of primarily fixed-line
  telecommunications networks and companies
  providing both wireless and fixed-line
  telecommunications services.
• Verizon, ATT
• Wireless Communication Services
• Providers of primarily cellular or wireless
  telecommunication services, including paging
  services.
• Sprint-Nextel, NII Holdings

Portfolios and Composition
5
Composition Main Players

• Telecom Sector has underperformed the benchmark
  index this year

Portfolios and Composition
6
Economic Analysis - Overview

• Domestic
• US telecom market saw an increase of 11 revenue
  growth to 1025 Billion in 2007. Consolidation is
  the current mantra.
• Major drivers of high growth have been wireless
  communication and broadband access. 80
  households in US are already ONLINE
• Wireline is losing ground to wireless and VoIP
• Growth has slowed down in 2007 and is expected to
  remain muted given the current economic scenario
• International
• International market grew by over 12 to 1.3
  Trillion with fastest growth seen in the EMEA
• By 2010, the global market is expected to reach
  4.3 Trillion, up from 3 Trillion in 2006
• India added a whopping 66.4M mobile subscribers
  in 2007, a growth of 62 from 2006. Penetration
  (Tele-density) still remains a meager 23

Economic Analysis
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Economic Analysis - Factors

• Demand
• GDP growth ()
• Population growth especially growth in middle
  class of developing nations ()
• Unemployment rate (-)
• Personal Income ()

• Supply
• Energy Prices increase cost of operations (-)
• Commodity Prices increase price of inputs (-)
• Foreign Exchange Rates reduces profits from
  international operation (/-)
• Inflation increase input costs (commodities,
  labor, raw materials) (-)

Economic Analysis
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Economic Analysis

• Variation of Telecom Index price with Fed funds
  rate and GDP growth

Economic Analysis
9
Business Analysis 5 Forces

• High barriers to entry
• Dominated by large, well-established companies
• High capital requirements to enter sector
• Mature industry with strong brand identities
• Difficult to create wide distribution network
• High buyer power
• Undifferentiated product equates to low
  switching cost
• Low Supplier Power
• Long-term contracting/agreements common
• Low threat of substitution
• Wireless dominant, no real alternatives
• High threat of competition
• Consumers are price sensitive (despite brand
  loyalty) undifferentiated products
• Consolidation

Business Analysis
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Business Analysis

• Mature Industry Wireline carriers and Wireless
  companies
• Highly concentrated Top 50 companies (out of a
  total 11,000) hold 90 of the market
• Shrinking Margins
• Intense competition
• Pricing is key
• Globalization
• International expansion
• Outsourcing
• New technology drives the sector

Business Analysis
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Financial Analysis - Performance

• Mean weighted priced has not shown much
  appreciation in last 5 years
• Revenue growth is above average but trending down

Financial Analysis
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Financials Income Statement

• Consistent Negative earnings surprises do not
  bode well for Telecom stock prices

Financial Analysis
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Financials Balance Sheet

• Leverage steady in the 60-70 range
• Overall, balance sheet looks healthy

Financial Analysis
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Financials Cash Flow Statement

• Heavy on CAPEX and dividends
• Cash flows have remained flat or have experienced
  low growth

Financial Analysis
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Financials Earnings Dividends

• Steady dividend yields
• SP 500 average is around 2

Financial Analysis
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Valuation Analysis - Multiples

• Consensus growth estimate for Telecom is 9 with
  a standard deviation of 5.
• Consensus growth estimate for Market is 12.0
  with a standard deviation of 4.

Valuation Analysis
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Valuation Analysis - Multiples
Valuation Analysis
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Valuation Analysis Momentum
Valuation Analysis
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Summary

• Cyclical sector underperforms SP when economy
  is poor
• Mature industry with low growth rate
• Within Telecommunications, Wireless industry is
  expected to outperform with a CAGR of 10 over
  the next few years
• Telecom companies are facing cost and margin
  pressures
• Currently inline to slightly expensive when
  compared to SP 500
• High beta and high PEG ratio for Telecom sector
• Negative economic outlook GDP growth,
  Unemployment and Inflation

Recommendations
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Recommendations

• Telecom Sector should be even-weighted instead of
  28 Basis Points overweight
• Sell 28 basis points to bring the SIM weighting
  relative to the SP500 to 100
• Further underweighting in the future if economic
  conditions dont improve
• Wireless has better growth prospects
• Look for Telecom companies that have significant
  international exposure or for Telecom companies
  in countries that have strong domestic growth
  (China Mobile, Vodafone)

Recommendations
21
Thank you
What questions do you have?