In a technology driven world, it has become a prerequisite for
the telecom companies to constantly upgrade themselves lest they
fall behind. But remaining up-to-date involves technological
changes and innovations that raise the capital spending needs of
the telecom carriers and in turn put pressure on the companies'
bottom lines. The recent smartphone frenzy has also prompted huge
investments in spectrum purchases to boost video content and other
data services.
Developments notwithstanding, investments in telecom stocks seem
risky as the global market faces the threat of yet another
recession. While we await a political resolution to Euro-zone
sovereign debt crisis, the contagion is spreading globally,
weighing down on economic growth. The problems in Europe are
spilling over to the rest of the world and might even put a halt to
the slowly moving U.S. economy.
We believe any economic meltdown could delay the ongoing
developments in the telecom industry leading to negative
implications on financials, pulling down the stock prices.
Considering the risks, if an investor still wants to bet on telecom
stocks, our discounted cash flow (DCF ) analysis can be counted on
for solid returns.
Our 50-yearDCF valuation model discounts free cash flow (i.e.
cash flow from operating activities minus capital expenditure)
using an appropriate discount rate (i.e. expected or required
return on a company's stock) to derive the company's Fair Value.
The ratio of Share Price (
P
) to Fair Value per share (DFCF ) gives us an idea whether the
stock is undervalued (P/DFCF is less than 100%) or overvalued
(P/DFCF is more than 100%).
We are providing some insight to the U.S. companies that provide
both wireless andwireline services. Wireless services are the major
contributors to the future growth of telecom companies as
subscribers are discontinuinglandlines and moving quickly to
wireless connections.
Given below is a detailed analysis of valuation for the top
three U.S. mobile operators--
Verizon Communications
(
VZ">VZ
),
AT&T Inc.
(
T
) and
Sprint Nextel Corp.
(
S
), which look attractive at present.
Taking share prices of the first trading day of the New Year
(i.e. January 3, 2012), ourDCF model yields a Fair Value of $39.74
and $94.81 for AT&T and Verizon, respectively. This implies
that the stocks are trading at respective discounts of 23.5% and
58.1% for AT&T and Verizon. P/DCF for the stocks are less than
100%, showing both AT&T (P/DFCF : 76.5%) and Verizon (P/DFCF :
41.9%) are undervalued at current levels.
Coming to Sprint, the Fair Value derived from ourDCF model
represents a negative number of $7.86, sending P/DCF (-29.8%) to a
negative territory indicating that the company's shares are
undervalued. Notably, Sprint is a loss making entity and as a
result giving a negative Fair Value.
Despite the negative Fair Value, Sprint is showing the largest
consolidated revenue and earnings per share growth, each more than
4% over the next 50 years. Wireless revenue should grow at aCAGR
(2011-2062) of 4.4%. Verizon should also grow at the same rate as
Sprint with regard to revenue and earnings per share. Wireless
revenue will be the strongest at Verizon, increasing at a rate of
4.8% over the next 50 years.
Revenue growth is the least for AT&T, the second largest
U.S. mobile operator, showing only 2.4% growth for the next 50
years with declining earnings per share growth of 0.4%.
Over the next 10 years (2012-2022), revenue for Sprint and
Verizon would grow about 4% but the AT&T growth rate would be
almost half in contrast to its peers. Further, earnings per share
look highly attractive for Sprint with substantial growth of 8.9%
followed by 3.8% growth for Verizon. Notably, AT&T is expected
to generate negative earnings per share growth of approximately
13%.
Conclusion
Based on our analysis, we find Sprint much superior to the other
two although it has been incurring losses over the past several
quarters. Its outlook looks promising on plans to start deploying
its own4G Long-Term Evolution (LTE ) based networks in mid 2012.
The developments made by the company would help it emerge as a
strong winner in the years ahead.
Further, Sprint is slowly turning around its business and is
expected to register new highs in the upcoming years backed by
reducing churn (customer switch), improving average revenue per
user, increasing adoption ofsmartphones and the strong sales of
Apple Inc.
's (
AAPL">AAPL
) iPhone.
Furthermore, we see a good chance of Sprint's share price moving
up faster than Verizon and AT&T, as it is trading 60% below the
year-ago price. Hence, Sprint would be our favorite bet for the
long term.
But if investors do not want to bet on Sprint given the
associated risks and its present performance, picking the stock of
the largest U.S. mobile operator Verizon would be the next best
option.
We believe Verizon is on track to meet its revenue and earnings
targets based on the introduction ofsmartphones , tablets and data
devices in the wireless segment as well as continued strongFiOS
fiber-optic network and strategic services in thewireline business.
Additionally, the iPhone and the entry into the cloud computing
business makes Verizon attractive for investment as it would boost
the company's growth going forward.
AT&T, which was the hot pick last year, lags Sprint and
Verizon, going by ourDCF model. The unsuccessful ending to the
T-Mobile merger story shattered AT&T hopes of becoming the
largest U.S. wireless carrier by dethroning Verizon. The company is
in now in need of additional airwaves to expand its high-speed4G
services.
Already criticized for dropped calls and poor network coverage,
AT&T will face more constraints in its capacity deployment than
Verizon, hurting subscriber growth. Nevertheless, AT&T is
expected to generate strong growth primarily driven by iPhone and
smartphone sales coupled with growth in tablets and connected
devices that will accelerate subscriber gains while reducing
churn.
The company's recent launch of4G LTE networks, expanding U-verse
services, and entry into cloud computing and hotel WiFi businesses
would boost its profitability. In addition, AT&T was the first
wireless carrier to provide mobile social gaming options on
itssmartphones and tablets, which differentiates it from other
operators. Hence, we will be carefully watching the movements of
AT&T for acquiring additional airwaves to increase its capacity
networks.
APPLE INC (
AAPL
): Free Stock Analysis Report
SPRINT NEXTEL (
S
): Free Stock Analysis Report
AT&T INC (
T
): Free Stock Analysis Report
VERIZON COMM (
VZ
): Free Stock Analysis Report
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