It has become virtually impossible to find established telco operators in developed markets with double-digit growth rates. Service revenue and subscriber numbers usually show low-single-digit growth at best nowadays. Despite this absence of high organic growth, there are still good reasons to invest in telco operators in their maturity phase. Investors may look for stable dividend yields or they invest in fixed income securities from the sector. The reliable cash flow from the monthly subscription payments allows some operators to pay juicy dividends. Retail investors can, for example, choose to buy shares of AT&T (T), Verizon (VZ), or Lumen (LUMN) for such stable dividend yields.
Next to investing in dividend-paying telcos from developed markets, it can be rewarding for investors to look at telco operators in emerging markets. These operators can at times trade at attractive low valuations. Growth rates in emerging markets can be higher than in the developed world. Investments here can bring higher returns.
One such operator, and also the company that is the topic of this article, is América Móvil (NYSE:AMX). I've been wanting to review this company since some time, because I've come across the name again when writing about Royal Dutch Telecom KPN (OTCPK:KKPNY), in which América Móvil has a sizable stake, and when writing about Liberty Latin America (LILA) (LILAK), with whom América Móvil recently made deals in Panamá and Chili. Yet another reason for wanting to take a closer look at the company was that I recently became aware of América Móvil's intention to do a spin-off of cell tower assets in Latin America. Capitalization of cell tower assets can sometimes bring good investment opportunities.
In the last year, I've written a number of articles about VEON (VEON), a telco peer of América Móvil with many similarities: both service hundreds of millions of subscribers, both have wireless as the main business, both focus on emerging markets and both operate in less stable developing countries. VEON has recently capitalized on Russian cell tower assets in what is generally viewed as a good deal. They sold 15,400 towers for close to a billion US dollar. VEON shares have risen over 50% YTD and more cell tower deals may push the shares up even further. The valuable cell towers are thus an important part of why I'm bullish on the prospects of VEON. It could be that América Móvil deserves a bullish stance as well with their upcoming cell tower spin-off.
Looking at VEON, the cell towers on the balance sheet are an important reason, but not the only reason, for being bullish. There are clear catalysts for a higher VEON valuation such as a likely reinstatement of a dividend, receding currency headwinds, and growth of VEONs fintech assets. VEON is also attractively valued with a low-single-digit EV/EBITDA. Similarly, looking at América Móvil, there may be additional reasons to be bullish, besides the cell tower assets. A closer look can make clear what catalysts exist and if the current valuation is attractive.
Two-thirds of the América Móvil top-line comes from wireless (source: Q2 earnings report). The pie chart of the service revenue split in Q2 2021, as shown below to the left, illustrates this.
Mobile postpaid and mobile prepaid jointly generate 30.9 + 36.0 = 66.9% of the total revenue.
The service revenue split shows that prepaid is the largest source of revenue, namely 36%. Such a large prepaid business is a characteristic of many emerging markets wireless operators.
Fixed-line services contribute about one-third to the overall service revenue.
The smallest revenue segment is "Fixed Voice", with a 2.1% contribution to the service revenue. One can wonder why the company is even reporting on this product separately. It shouldn't be a surprise to anyone that fixed-line voice services are at the end of their lifecycle and that revenues from this product are small and shrinking.
A more detailed look at the split of the wireless base, generating two-thirds of the total revenue, can give more insight into the business. The table below shows the split and growth trend of the nearly 300 million wireless subscribers. Nearly all of these subscribers are based in Latin America. The highest numbers of wireless subscribers are in Mexico, Brazil, and Colombia, where two-thirds of the total wireless base reside. Note that in all of these important countries for the business, there was a significant year-on-year growth: 4.5% in Mexico, 15.8% in Brazil, and 7.3% in Colombia. The overall year-on-year growth of the entire wireless base was 7.3% as stated in the bottom right-hand corner of the table. It needs to be mentioned that postpaid growth was stronger than prepaid growth, which is a good sign. Postpaid subscribers are generally preferred over prepaid because of the higher value and longer relationships.
The wireless subscriber growth across most of the footprint is encouraging, but there are some remarks that need to be made with that.
One year prior to the quarter mentioned in the table above was Q2 2020, which was the start of the pandemic. At the beginning of the pandemic, the base was shrinking, so part of the growth since then can be a compensation for that. The YoY growth percentages in the above table would normally be somewhat lower if these would compare to a normal quarter in the previous year.
The fixed-line base is not visible in the above table, but this has shown an overall decline of 0.6% year-on-year in Q2 2021. Any growth of the business is thus coming solely from wireless.
Overall service revenue growth year-on-year was 5.3% overall and 7.2% for wireless. The wireless service revenue growth rate is slightly less than the subscriber growth rate, which indicates a slightly negative Average Revenue Per User (ARPU) trend. ARPU trends differ a lot over the countries. In Mexico, they are up, but in Brazil, they are downward trending. The overall trend is slightly negative.
In the context of the maturing wireless industry, it's impressive that América Móvil manages to grow the wireless base by 7.3%, which equates to millions of subscribers, with over 50% being postpaid, in a single quarter. The thesis that more growth can be found in emerging markets seems to hold true for América Móvil.
Just recently, on September 29th, an extraordinary general shareholder meeting was organized with the objective to approve the spin-off of cell tower assets in a separate company. The scope of the spin-off was the towers in the countries outside Mexico. In Mexico, the cell towers are already in a separate company. The approval was obtained and 36,000 sites in the countries in the table below will be put into a new company, Sitios Latinoamérica, before the end of 2021.
América Móvil's shareholders will receive the same number of shares in Sitios Latinoamérica for every América Móvil share. The telco operator will not own any shares of Sitios Latinoamérica. The two companies will operate separately.
There's a simple logic behind the plan to spin off the cell towers. In one online article, it's stated like this:
As a point of reference, América Móvil highlights that at year-end 2020, each business specifically commands a very different valuation:
Major Telecommunications Companies: trade at 6.4x EBITDA
Telecommunications Infrastructure Service Providers: trade between 12.4x to over 27.4x EBITDA
In another online article, there's even a more elaborate analysis of EV/EBITDA multiples of different types of tower companies, including valuation discounts or premiums of different legal setups and ownership structures. The general conclusion is the same as with the above quote, however, that telco infra can expect to reach higher valuation multiples in a separate company. By spinning off the cell towers, the shareholders can expect to obtain an instant capital gain.
The Enterprise Value/EBITDA multiple that América Móvil is currently trading at is important in order to assess if and how much upside the spin-off of the 36k towers may bring to shareholders.
The above graph shows that the shares are currently trading at $17.31. If we multiply this with the number of outstanding shares at the end of Q2 2021, this means that the market capitalization is ~$57 billion. Debt is near $30 billion and cash $2 billion. The enterprise value of América Móvil is thus 57+30-2 = $85 billion. It's my estimate that EBITDA will end up around $14 billion in 2021, which gives an EV/EBITDA multiple of ~6x, which is close to the above-mentioned normal 6.4x multiple for telcos.
An estimate for the initial annual EBITDA of the spin-off tower business is $350 million US, which is relatively small in comparison with the EBITDA from the telco business (an estimated $14 billion). We can thus assume that the América Móvil shares will not decline by much due to the spin-off. If the EBITDA of Sitios Latinoamérica would, over time, from the moment of spinning off the assets, obtain a double or triple valuation multiple, from the current 6x to 12x to 18x to 24x, it could go from an initial $2.1 billion enterprise value to $4.2 billion to $6.3 billion to an $8.4 billion enterprise value. This step-up in enterprise value of the new tower company, from $2.1 to $8.4 billion, or an absolute amount of $6.3 billion, just by spinning off the cell towers, equates to over 7% of the current enterprise value of $85 billion of América Móvil. Not bad for making an organizational change! Note that the full amount of the step-up will probably be only partly be achieved when the spin-off is put into effect, at the exact moment when the shareholders receive the shares in the new tower company. It will initially probably go up a little, but when the new tower company starts to grow, the valuation will go up accordingly. The expected step up in value will be unlocked over time for the shareholders.
Next to the growth of the business and the tower company spin-off, it needs to be mentioned as another positive that América Móvil has shown to be a steady dividend payer over the last decade. The below table shows the dividend history since 2012.
The table shows that the dividend has been growing continuously. The total dividend for 2021 is expected to end up just under MXP $0.40. This equates to a dividend yield between 2 and 3% and can easily covered by the annual EBITDA per share of ~MXP $2.60. The dividend / free cash flow ratio has in general remained well below 80% in the past.
Another way of providing a return to shareholders is through share buybacks. 765 million shares were bought back in Q2 2021, which is over 1% of the ~66 billion shares. This amount of buybacks varies, but taken together with the dividend, it means a healthy return of well over 3%.
In part due to the proceeds of the sale of Tracfone in the US to Verizon, the net debt that América Móvil carries is below 2x EBITDA. This is a low, almost incredibly low, leverage for a telco, even lower than investment grade global peers. Fitch expects net debt to EBITDA to drop below 1.5x soon.
With the absence of debt-related risks, the remaining key risk to be mentioned is related to all the countries of operation, with Mexico and Brazil being the most important from a revenue perspective. It can be that politics or domestic economic issues negatively affect the business. It needs to be added here that the América Móvil is very diversified, so this offers a natural cushion if any country runs into trouble. This makes América Móvil a better pick than, for example, Telecom Argentina (TEO) with almost all of its business in Argentina.
While researching this article, I decided to go long América Móvil. I don't have a lot of exposure to Latin America and this company seemed a good addition to my portfolio. The healthy growth, the dividend, the share buybacks, the potential for capital gains associated with the upcoming cell tower spin-off and the low debt make this an attractive investment in my opinion.
In comparison with VEON, there are perhaps two characteristics where América Móvil is a little bit less attractive. The current valuation of América Móvil of ~6x EBITDA is higher and, perhaps more importantly, América Móvil is focused very much on traditional telco services. VEON, in comparison, has a lot of very successful fintech services and online commerce investments in various markets. These are additional value drivers that América Móvil lacks. For investors who want to invest a certain amount in emerging markets telecoms through a combination of VEON and América Móvil, I'd put more than half in VEON and less than half in América Móvil, while owning both is better than owning only one.
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Disclosure: I/we have a beneficial long position in the shares of AMX, VEON either through stock ownership, options, or other derivatives. 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.