It has become a lot harder to find hated names on the public exchanges. As the rising tide of the market has lifted many sectors, long-term value investors are sitting on growing cash positions, lusting for the long-gone pessimism of 2009.
But not every sector is currently basking in the market's glow. A number of European telecom carriers have seen enormous stock price erosion, thanks to a sluggish economy, price competition, and regulatory changes. But for the long-term investor, these prices may have overreacted to the downside.
Luckily for U.S. investors, a number of these companies trade as American Depositary Receipts (ADRs) on U.S. exchanges, and are therefore within easy reach. For example, Telefonica (NYSE:TEF), Magyar Telecom (OTCPK:MYTAY), and Portugal Telecom (NYSE:PT) all appear cheap and all trade in the U.S.
But perhaps the cheapest one of them all, especially considering its debt ratios relative to its peers, is France Telecom (FTE). France Telecom has fallen over 50% from its 2009 lows, and trades for less than $10/share for the first time since 2002. As a result, though the company has generated free cash flow of over 24 billion euros over the last four years, France Telecom current trades for less than 20 billion euros! To be sure, the challenges facing the company are nothing to be taken lightly. But the long-term investor can likely wait most of these out.
The first challenge is Europe's sluggish economy, which has taken a bite out of France Telecom's revenues. To deal with this, the company has been cutting costs. It has stated this as a priority in its releases, and it has shown falling operating expenses for three straight quarters. The good news here is that Europe's economy is not likely to stay sluggish forever, though it certainly does feel like it might! But buying when sentiment is negative can yield excellent results.
France Telecom's challenges are not just from the economy, however. A fourth operator has joined the competitive fray in France, forcing incumbents like France Telecom to drop prices. But this new company, Iliad, does not yet make money. It currently faces the daunting task of trying to build out a network (90% of its traffic is currently leased through France Telecom) while losing money, thanks to its low prices.
There's a reason telecom carriers don't go under very often. The large networks the carriers have created act as a barrier to entry, making it difficult for new entrants to disrupt the market. Eventually, pricing should rationalize as Iliad will be forced to make money. When that happens is anybody's guess, but when it does, the long-term investor will benefit from having bought while the market feared everlasting pricing pressures.
The staying power of incumbents in this industry also allows them to finance themselves comfortably with debt. Currently, these companies are able to refinance debt at incredibly low rates, allowing equity holders the benefit of low-cost debt capital.
But there is one difficulty that is not likely to go away anytime soon, even for the longest of the long-term investor: the regulatory one. It would take an army of analysts to understand all the government involvement in this industry, which touches on issues such as:
- labor (i.e. cost-cutting)
- ownership (e.g. the French government owns a stake in FTE)
- prices (revenue is hurt by mandated price reductions)
- investments (subsidies make certain projects worthwhile)
Any policy changes on such issues can materially harm or help results. But getting a handle on all of these is near impossible; new regimes with new policies can and do arrive. This is further complicated by the fact that these telecom companies operate not just in Europe, but throughout Africa and South America as well, with each country preferring its own policy at any given time.
For the above reason, the future is not as certain as it otherwise would be, considering the strong market positions of these incumbents. Nevertheless, as a small part of one's portfolio, a basket of these companies (starting with France Telecom!) is likely to do well over the long-term, considering their current valuations.