Like people, companies change as they grow older. America Movil (NYSE:AMX) was once a premier Latin American growth stock at a time when retail investors had few good options for investing in that region. Since then, both the company and its markets have matured, and investors now have numerous other options for investing in emerging markets. Given the company's maturing model and its ventures into Europe, is America Movil still a growth stock and is it still worth owning?
Still Room To Flex Its Market Muscle
America Movil has spent more than a decade building itself into one of the leading mobile network operators in Latin America. Active in 17 Latin American and Caribbean markets, America Movil is the dominant player in Mexico (70% share), Colombia (63% share), Ecuador (69%), and a significant competitor in large markets like Brazil (25% share), Argentina (31% share), Chile (22% share), and Peru (42% share).
That sizable footprint is both boon and bane to the company. Although America Movil has emerged as a stronger company than rivals like Telefonica (NYSE:TEF), NII Holdings (NASDAQ:NIHD), Millicom, and Iusacell, regulators in Colombia and Mexico have looked to stimulate competition at the company's expense.
Elsewhere, the company's ventures in Brazil haven't been wholly successful. America Movil built its Brazil business through a series of deals, and though it's a large market (a population of around 200 million), the company hasn't managed to overtake Vivo (owned by Telefonica Brasil (NYSE:VIV)) or TIM Brasil (NYSE:TSU) (owned by Telecom Italia). Worse yet, the Brazilian market has also delivered sub-optimal profitability, as EBITDA margins have been tracking at about two-thirds of the company average and Brazil only represents about 6% of company EBIT (on par with the US).
Despite that uninspiring backdrop, I think America Movil still has significant opportunities to drive better margins and harvest growing free cash flows from the region. Rates in Mexico are already low enough that threats of asymmetric mobile termination rates (MTR) aren't really much of a threat. What's more, America Movil has a big advantage in the quality of its Mexican network and, despite consistent efforts to introduce competition into the Mexican mobile market, the company has actually added a little market share over the past decade.
In Brazil, I believe there is a limit to how much longer America Movil's rivals can maintain their current level of competitive pressure. Neither Vivo nor TIM have especially good margins or returns on capital, and TIM recently got sanctioned by Brazilian regulators in 19 of 27 states for poor network quality. Said differently, America Movil has the balance sheet to survive years of cutthroat competition, but its rivals do not and they will eventually realize this - at which point America Movil's margins will likely improve.
Pay TV Still A Growth Driver
While America Movil has had mixed results so far from its mobile ventures in Brazil, it has been much more successful in the pay TV market. The company holds over 50% of the fast-growing Brazilian pay TV market, and together with DirecTV (NYSE:DTV) they control more than 80% of the market. Add America Movil's strong Brazilian pay TV business to the mix and suddenly their overall share in the Brazilian communications/media market looks quite a bit stronger.
Sooner or later, I believe the company will launch a similar pay TV business in Mexico. While Mexican authorities have been dragging their heels for some time on granting permission, it increasingly seems like a "when, not if" event - particularly if Mexican leaders are going to follow through on their pledges to encourage competition across the country's communications and media markets. Incumbent Televisa (NYSE:TV) will be no pushover, but America Movil's ability to bundle mobile, pay TV, and broadband access could prove difficult to match, and this should be a lucrative new venture for the company.
If there's a significant negative story to the America Movil story (aside from worries about market share and margins in Latin America), it is in the company's recent capital allocation decisions. Instead of increasing the dividend payout, the company has spent considerable sums in 2012 to acquire large minority stakes in both KPN (OTCPK:KKPNY) and Telekom Austria (OTCPK:TKAGY).
The bear argument against these moves is pretty straightforward. KPN is the incumbent telecommunications company in the Netherlands, and also has operations in Belgium, Germany, and Spain. Those are not what anybody would call growth markets. Likewise, while Telekom Austria has a little more growth flavor with its operations in Bulgaria, Croatia, and Belarus, the majority of the company's business is in Austria.
In other words, America Movil spent cash generated from its still-growing Latin American businesses and invested them in iffy operators in slow-growing mature markets in Europe. So far at least, these look like value-destroying moves. Not only did KPN management fight America Movil's moves, but the shares of both have since declined (and not by trivial amounts).
Bulls will argue that many of the company's Latin American acquisitions were panned too at the time, but ultimately end up being quite successful. Moreover, while the share price declines may be discouraging, they're actually helpful if the long-term plan is to attempt to acquire controlling stakes. Further, while Europe may not be a high-growth market overall, there's still money to be made from improving the companies' operations and gaining share in their respective markets.
From Growth To GARP
I'm not going to rush to defend America Movil's expansion into Europe. I think the money could have been better spent expanding into areas with more growth potential like Africa, Asia, or the Mideast/CIS. At the same time, I see the long-term cash-harvesting potential from this business and Carlos Slim (who controls the company) is known for positioning his assets for the long-term.
When it comes to the potential of the core Latin American business, I believe America Movil can make the transition from a growth story to a GARP story. I believe the money spent in building its network in Mexico will pay dividends for years to come in terms of market share, and I likewise believe that the company's rivals in Latin America (and particularly Brazil) are going to have to start making business decisions with a view towards their long-term sustainable returns and not short-term share gains.
While irrational competition can pressure margins here and now, I think America Movil wins once its rivals choose to (or have no choice but to) become more rational. Likewise, I think markets like Brazil will eventually see more consolidation, and America Movil has the business mix and balance sheet to be one of the winners of that process.
The Bottom Line
Consistent with those views, I think America Movil may only see long-term revenue growth in the mid-single digits, but I think the company's long-run free cash flow margin can improve from the mid-teens over the past decade to the high teens over the next ten years. Should that happen, America Movil will still be looking at low double-digit free cash flow growth - sufficient not only to pay higher dividends, but also fund further acquisitions.
Unfortunately, low double-digit free cash flow growth only works out to a fair value in the high $20s today, making America Movil a somewhat marginal pick today (particularly given its low yield and the likelihood of further M&A). It's also worth noting that Carlos Slim is not a young man, and his departure from the scene (whenever that may come) is likely to create a lot of uncertainty regarding the company's future direction.
Since I am on board with America Movil's current strategy, and the stock is about 20% undervalued, I intend to hold on and would buy shares if they retreated closer to $20. In the grander scheme of Latin American investing, though, investors now have many more options and while America Movil holds potential as an increasingly global communications play, there are faster growers and bigger discounts to be found today.
Disclosure: I am long AMX. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.