Latin Americans love to use mobile phones, yet fund managers remain cautious about investing in the region's telecoms sector. George Mitton finds out why.
América Móvil is the largest telecommunications firm in Latin America, with a 70% share of the mobile market in its home country of Mexico and nearly 250 million mobile customers across the Americas. It is thought to have the largest fibre-optic cable network of any operator and is controlled by the world’s wealthiest man, Carlos Slim.
And yet despite its power, or perhaps because of it, the company keeps finding itself impeded by regulators. América Móvil would love to enter the pay-TV market in Mexico, but it is banned from doing so. In May, the company dodged a record $925 million fine from Mexico’s anti-trust body for allegedly using its pricing power to sideline competitors.
The experience of América Móvil reveals one of the downsides of investing in telecoms. Although these firms spend millions on value-added services from social networks to branded content – anything not to seem a “dumb pipe” that merely delivers bandwidth – their basic business is akin to a public utility, and that is how they are seen by regulators.
The risk of regulatory interference is one of many reasons, despite the huge growth opportunity offered by telecoms companies in Latin America, many fund managers are ambivalent.
There is much to like about the telecoms sector, though. The market is large and growing, driven by network roll-outs and new technology. Ericsson, which provides networks, said Latin America was its fastest-growing market in the first quarter of the year, and said the region’s value to the company was up 20% compared with the same quarter in 2011.
Then there is the fact that mobile penetration is still rising. Pyramid Research, a US-based firm that provides communications analysis, estimates that mobile penetration will rise to 130% by the end of 2015, up from an estimated 109% now. The percentages are high because pay-as-you-go contracts are common in the region and many mobile owners have more than one SIM card.
“The mobile market in the region is far from being considered saturated,” says Vinicius Caetano, senior analyst at Pyramid Research.
The devices that users own are changing, too. Smartphones, which let users consume multimedia content as well as make calls, are growing in popularity, and with them comes a demand for data services. This is an important revenue stream for operators. Much of Latin America is still on a 2G network, which means demand can expand hugely once 3G and eventually long-term evolution (LTE) networks become the norm.
For managers of telecoms firms, there is a further opportunity offered by integration. An example came last year when Brazilian operator TIM Brasil acquired the fibre-optic network of infrastructure firm AES Atimus. The deal will allow TIM both to offer high-speed broadband to fixed-line customers, and to increase the capacity of its mobile network, because the optic fibre in the network will be able to carry mobile traffic.
This and other such deals help operators in their pursuit of the “triple-play” model, in which they supply high-speed internet access, TV and telephone through a single broadband connection. Many in Latin America are pursuing triple-play and there will be significant rewards for those players that succeed, since the integrated networks are highly efficient.
And yet, despite all these growth opportunities, the telecoms sector has not always attracted fund managers. BNY Mellon ARX Investimentos, which is based in Rio de Janeiro and invests predominantly in Brazil, was underweight the telecoms sector for six years, between 2002 and 2008 (this was prior to its takeover when it was still called ARX Capital Management).
Alex Gorra, senior investment strategist, says his team was discouraged by what he calls poor governance and opaque structures, which made life complicated for shareholders. There were often multiple share classes with different voting rights, and holding companies obscured the ownership of the business. On top of that, the telecoms space in Brazil was hard to navigate.
“You had 16 cellular operators, three fixed-line operators. It was fragmented and complex, with lots of different partners and consortiums,” he says.
In the latter half of 2008, BNY Mellon ARX changed its opinion on telecoms and went overweight, encouraged by low valuations and high dividend yields for telecoms stocks. Mergers and acquisitions reduced the number of players in the market, giving the remaining companies more pricing power. And efforts to untangle the convoluted share structures in this and other Brazilian sectors seemed to be having an effect.
But at the end of last year, BNY Mellon ARX reverted to its previous position and it is once more structurally underweight the telecoms sector, with the exception of some specific stocks such as Vivo, a Brazilian operator owned by Telefónica.
“As a whole, we are underweight but have a couple of picks we still like,” says Gorra.
Aberdeen Asset Management is another investor in Latin America that is cautious about the telecoms sector. According to Stephen Parr, equity investment manager at the company, telecoms firms share many characteristics with utilities, which are often subject to government intervention.
“For utilities, country-specific regulatory risk can be challenging,” he says. “Valuable percentage points of growth can be taken off the operators.”
Parr concedes that telecoms firms have more growth potential than most utilities because they can expand data services, and says that for this reason they are “in a sense, utility plus opportunity”.
But he also identifies challenges concerning the pricing of data. Gaining the maximum revenues from a data network is a kind of balancing act between setting the right prices to fill the network and minimising dropouts due to overcapacity. An underutilised network is effectively a wasted resource, but an unreliable one that creaks under the strain of too many users gives its operator a bad reputation.
Another drawback concerning telecoms stocks is that they tend to be relatively expensive. Data provider Morningstar gives an average price-to-earnings ratio of 22.4 for the telecoms industry, which is well above the average for the S&P 500 of 15.3. América Móvil has a lower price-to-earnings ratio of 16.5, while Telefónica, which is América Móvil’s main rival in the region, has just 9.3. But on a sector-wide basis, it seems that telecoms stock prices are high.
There is also the risk of new and surprising forms of competition for telecoms firms. In their efforts to be more than dumb pipes, telecoms companies have begun activities such as social networking, selling music and apps, and even creating branded content. These are industries where trends move at lightning speed and new formats can threaten existing business models. An example is Skype, which allows mobile users to make phone calls over the internet, and which has threatened traditional voice calling revenues for telecoms operators.
The combination of negative factors means Parr is cautious about the telecoms sector in Latin America, although, like BNY Mellon ARX, Aberdeen does own some stocks, such as América Móvil.
“Telecoms is not an easy industry,” says Parr. “It’s highly capital intensive, there are non-traditional forms of competition and there is regulation. It’s quite tough.”
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