The stock market is, as is often said, a forward discounting mechanism. Things move in anticipation of events as people (and I guess computers) attempt to beat each other to ownership or sale of something that could be more or less valuable in the future. This is neither good nor bad, it’s just the way it is, but at times it does create opportunity. Trends develop on the possibility of future events and once those trends take hold become self-sustaining; a stock goes up because it is going up, or down because it is going down, and the move quickly becomes overdone.
Over the last year or so, US wireless telecom stocks have offered a good example of this. Traditional giants AT&T (T) and Verizon (VZ) are trading significantly lower than they were a year ago, while upstarts T-Mobile (TMUS) and Sprint (S) have had a great 12 months.
There are multiple reasons for this, but perhaps the strongest was the acquisition of Sprint by Softbank and the subsequent talk of a merger between the two smaller players in the US wireless business, Sprint and T-Mobile. The acquisition was of course a boost to Sprint, who had been struggling while losing both customers and money ever since their purchase of Nextel in 2004.
Even without the possibility of a merger with TMUS, the capital and aggressive pursuit of market share that Softbank brought transformed the market’s view of the ailing company. T-Mobile stock, in a similar way, was already gaining traction as they offered pricing models that challenged the accepted practices in the industry and gained a reputation as a disruptor.
The problem, as both companies have found out, is that the US wireless industry is not easy to disrupt. T-Mobile’s innovations were easily and quickly copied by the big firms, if not in substance then certainly in style, and the resulting margin squeeze is easier for a large firm to bear. True disruptors bring a product or service that revolutionizes an industry; they don’t just play with pricing models. Merging to compete is also not as simple as it sounds and may not solve the market share problem that both smaller companies have.
Softbank CEO Masayoshi Son recently lamented the poor position of the US wireless industry, and I completely agree. Having lived in Europe and Asia, I am only too aware that, when it comes to mobile service, the US is years behind the rest of the world. When I first moved here in 2002, for example, texting, which had been ubiquitous in Europe, was amazingly still in its infancy in America, and download speeds are slower than most other developed countries. Where I would disagree with Son is in his interpretation of why that is the case.
He, like I, was surprised, as an outsider, by this poor performance and started looking for reasons. Son’s conclusion was that the dominance of the market by Verizon and AT&T was the problem. There may be an element of truth to this, but having lived and worked in the US for a decade or so, I have become aware that there is another, more powerful reason. Put simply, the US is huge.
For Son, from the tiny island of Japan and for me, from the tiny island of Great Britain, wireless infrastructure is taken for granted. Here, however, gaining market share requires expanding a network into vast, lightly populated areas, which is an expensive proposition. Merging Sprint and T-Mobile would do little to solve that problem. There would simply be an overlap of networks serving more densely populated areas.
All of this is, of course, assuming that Son is able to convince regulators here in the US that decreasing the number of competing companies in the industry will increase competition. Looked at logically, it is little wonder that those regulators have so far doubted that. There is no way to be sure that the idea will be rejected, as American Airlines (AAL) successfully made that argument in their business recently, but early noises have not been encouraging.
Indeed, this article in Forbes would suggest that even Son views it as unlikely. If Softbank is looking in Europe for a partner it could be argued that that suggests that they have already given up on acquiring TMUS directly. The article does raise the interesting possibility of Softbank buying T-Mobile’s owner, Deutsche Telekom, and thus making a “backdoor” purchase of the US firm, but the outright offer for TMUS shares that the market has anticipated is beginning to look less likely.
So, how does all of this leave ATT&T and Verizon? Well, basically, just continuing to make money and beginning to look seriously undervalued. If we forget all of the predictions of what might happen and look at things as they stand, both stocks look like a decent buy for a couple of basic, fundamental reasons. Firstly, in a world where yield remains scarce, an investment split between T and VZ would yield an aggregate of around 4.8%. Secondly, neither stock looks overpriced at P/Es of 11.72 and 12.39 respectively.
With all of the talk of the possibility of merger and acquisition and innovative marketing strategies by the smaller US wireless companies, buying the traditional, giant firms may not be very sexy, but it will probably be reasonably safe at these levels. I may be an old fuddy-duddy, but in a capital intensive industry I would rather bet on what is than what may be, so it is time to buck the trend and invest in profit rather than potential.