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24/06/20194 mins

A Game of Phones

Does the abbreviation TMT ring any bells? Twenty years ago, TMT – telecommunications, media and technology – was the hot investment theme. Telecom companies were seen – rightly – as an integral part of a brave new digital world. As dotcom mania took hold, their shares were dialled up to extraordinary levels. It couldn’t last, of course, and when the bubble burst, investors hung up. Telecom shares have been on hold ever since, languishing well behind the broader market. We believe it’s about time this out of favour sector was reappraised.

Change is afoot

With cheap money and speculative trends driving the market since the 2008 financial crisis, telecom shares have suffered from being viewed as dull and defensive – the less eligible sibling of the technology and media stockmarket darlings. However, political machinations have been one of the biggest factors in their underperformance.

That’s because telecommunications – and especially the internet – are now a crucial part of our lives. We rely on the internet in almost every aspect of life –­ to work, learn, communicate, socialise and entertain ourselves. An internet connection is now almost as essential as electricity. It is, in many ways, a utility.

Utilities always attract regulation. Consequently, telecom companies have been shackled by onerous constraints. Regulators in many countries have long taken a dim view of mergers in the belief that competition would keep prices down for consumers. That has largely proved correct.

While that may seem like welcome news for billpayers, it masks other costs. By duplicating expenditure and spreading it over a smaller base, service providers are less efficient at serving us than they ought to be. Furthermore, the threat of price-focused overseers changing the rules of the game has stymied investment.

The ‘digital economy’ will rely on ultrafast networks based on 5G and FTTP (fibre to the premises) which will require massive spending on the part of the telecom companies. A fair return on investment is vital to encourage the development of the next-generation of infrastructure upon which our economy depends.

Regulators seem to be waking up to this. For example, the European Union recently approved the merger of Deutsche Telekom and Tele2’s Dutch operations, reducing the number of mobile operators in the Netherlands from four to three. If this heralds a more relaxed regulatory approach overall, investors in telecom companies also stand to benefit.

Growth opportunity

Additionally, next generation networks could provide an opportunity for the industry to return to growth. On the horizon is 5G – shorthand for the fifth generation of mobile networks, which will succeed the decade-old 4G standard as the leading network technology. It is expected to be up to 100 times faster.

But being able to load web pages a bit quicker is perhaps the least interesting advantage. Once 5G is introduced, demand on telecoms networks is forecast to surge as a greater number of internet-connected devices emerge – from smart traffic lights to self-monitoring industrial equipment to internet-connected cat collars! It may also help realise some of the big ideas that could transform our lives – such as remote healthcare, smart cities and self-driving cars.

Winter is coming

Besides the potential that could be unleashed by changing regulation and heightened demand, telecoms companies offer other intrinsic attractions. With the great quantitative-easing experiment potentially coming to an end, markets appear to be entering a more uncertain phase. In this environment, the defensive qualities of telecoms firms – with robust finances and attractive valuations – look ripe for reassessment.

Healthy dividends present another attraction. Because they’re steady, ‘unexciting’ businesses, many telecoms companies are able to sustain attractive dividends. When stockmarkets are soaring, reliability can be an easily overlooked characteristic. So much of the growth boom in ‘exciting’ sectors has been driven by debt. In the long term, that’s likely to prove unsustainable. When the macroeconomic tides recede, we may, in Warren Buffet’s words, see who’s been swimming naked.

Going Dutch

We’ve recently added several telecoms investments to our portfolio, including KPN and Tele2.

KPN is the leading Dutch telecoms provider. Expectations for the business are low following a decade of shrinking revenue. A change of leadership often brings improving fortunes and KPN’s new CEO has set out a credible plan to return the company to growth. New network technology will be key to those plans and recent consolidation provides a platform to capitalise on that opportunity.

Tele2 operates throughout Europe but the bulk of its sales come from its home country of Sweden, where it recently completed a merger with cable operator Com Hem. This tie-up should offer significant financial benefits. Meanwhile, the merger of their Dutch operations with Deutsche Telekom creates the prospect of a lucrative exit from the Netherlands in the coming years.

Patient opportunities

These companies exemplify the opportunities that we see in the telecoms sector. (Social) media and technology have been the toast of the market in recent years, but we think that many investors are forgetting that they depend on the other T in the old TMT triangle. With opportunities for growth, and political change looking more likely, that dependence could well provide a pay off for patient, contrarian investors.

Please remember that past performance may not be repeated and is not a guide for future performance. The value of shares and the income from them can go down as well as up as a result of market and currency fluctuations. You may not get back the amount you invest.

Please note that SIT Savings Ltd is not authorised to provide advice to individual investors and nothing in this article should be considered to be or relied upon as constituting investment advice. If you are unsure about the suitability of an investment, you should contact your financial advisor4

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