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Stock Strategist

Four Great Reasons to Look Abroad for Wireless Stocks

These firms are financially fit and poised to weather the downturn.

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Signs of economic weakness are beginning to show in markets outside the United States, including parts of Europe and Asia. Conventional wisdom would caution investors to avoid companies that are heavily tied to consumers in countries where economic conditions are worsening, on the fear that spending growth will decelerate--or worse, that spending will contract. Such concern has caused the share prices of wireless service providers to fall meaningfully in recent weeks. Although top-line growth and earnings will undoubtedly be pressured in a recessionary environment, we believe that wireless services are more than a discretionary purchase for many consumers, and that wireless companies in most nations should be able to navigate a downturn with relative ease. In addition, non-U.S. telecom stocks give U.S. investors the added benefit of diversification, as many of these firms generate strong cash flows in currencies other than the dollar.

Wireless Goes Mainstream
While wireless services used to be perceived as a luxury, mobile phones have become so prevalent in our day-to-day lives that many would consider them a necessity. This is especially so in developed markets. For example, New York University recently began requiring students to provide a wireless number to the school for emergency purposes, and students were not allowed to register for classes if a number was not given.

However, we think the same is increasingly true for subscribers in less-developed markets as well. We've seen wireless penetration rates in country after country steadily rise over the past decade through a variety of economic conditions--albeit at varying rates. For example, penetration rates in Korea continued to climb in 2002 and 2003, despite the fact that consumer spending growth was slowing significantly as personal debt levels reached unsustainable levels. Argentina's wireless penetration rate also continued to increase in the late 1990s and early 2000s, despite the crisis in which the country's currency was being devalued. The ability to connect to people, resources, and information "anytime, anywhere" gives users freedom and convenience that is hard to give up and often economically necessary.

Why Some Operators Are Attractively Priced
This is not a "one size fits all" argument, however, and we would be remiss to say that all wireless operators will fare equally under poor economic conditions. Because telecom stocks around the world have recently taken a beating, we think investors can afford to be picky, focusing on companies that are positioned strongly. We believe  France Telecom (FTE),  SK Telecom (SKM),  Rogers Communications (RCI), and  Hutchison Telecom (HTX) fit the bill and that each is attractively priced currently. Although these carriers reside in vastly different parts of the world, all four are dominant providers operating in mature wireless markets, where customers have become accustomed to having a cell phone. A loyal postpaid customer--especially one on contract--is less likely to forfeit a mobile phone than a subscriber who has had a prepaid phone for a few months and can easily disconnect.

Wireless penetration rates are also high in the markets these firms serve. This creates a network effect, as the need for and use of cellular services are much greater when a high percentage of a country's population have cell phones. (Just ask the teens who pester their parents for a cell phone because everyone else has one). We're not saying that customer behavior won't change at the margin in a downturn. Fewer new customers may opt to use cutting-edge data services, and some may cut back on minutes used. But in markets that utilize a "caller-pay" system, such as Hong Kong and Korea, the broader flexibility in pricing plans will allow users to cut spending without outright termination or migration to a prepaid service.

Another key attribute each of these firms share is a strong financial position--healthy balance sheets and steady cash flows are both important attributes in a downturn. France Telecom, Rogers and SK Telecom each carry a net debt load that is less than 2 times operating income excluding depreciation and amortization. These three firms also produce free cash flow in excess of 10% of sales. Although Hutchison's cash flow isn't as robust, it is one of the best capitalized telecom companies worldwide. The firm received a hefty price for its Indian operation from Vodafone in early 2007 and it is now sitting on $3 billion in net cash. Apart from added stability, scale also gives these firms advantages that smaller players lack, including the ability to shoulder greater promotional activities and lower prices in the short run.

Finally, each of these telecom operators--with the exception of Rogers--offers varying degrees of exposure to emerging markets, providing a way to benefit from long-term growth in these areas with little risk of a complete disaster in the short run. At one extreme, Hutchison holds positions in a number of underpenetrated wireless markets, including Indonesia and Vietnam. The firm's management team has deep experience building wireless businesses from the ground up and is slowly deploying its cash in these markets. If Hutchinson's operations in one nation completely fail, investors have mature operations in Hong Kong and Israel to fall back on. France Telecom and SK Telecom also offer interesting opportunities through their investments in markets such as Africa and China, although these operations are fairly small relative to their core operations.

 SK Telecom (SKM)
5 stars
SK Telecom dominates Korea's wireless market, with more than 50% market share. Increasing competition has caused expenses to escalate as of late, resulting in lower margins for the company, but SK remains the most profitable wireless carrier in the country by a significant  margin. We think the firm will also benefit from its purchase of Hanaro Telecom, the country's second-largest fixed-line provider, as it can now offer bundled service packages to customers. The Korean wireless market is very mature, but investments in China and Vietnam offer good growth prospects. Our biggest concern is that foreign ownership restrictions continue to strain the firm's ability to return value to shareholders.

 Hutchison Telecom (HTX)
5 stars
Since selling off its Indian operations, Hutchison Telecom's stock performance has been uninspiring. Network hiccups in Vietnam at the beginning of the year have exacerbated concerns that firmwide growth isn't going to accelerate much as emerging markets come on line. We expect the firm will face some pressure in the near term, but its seasoned management team should serve it well as it seeks to become a sizeable player in these markets. Furthermore, Hutchison's operations in Hong Kong and Israel continue to perform well. The firm is also extremely well capitalized, granting it greater flexibility when seeking new opportunities.

 Rogers Communications (RCI)
5 stars
Wireless services generate a bit more than half of Rogers' revenue, with cable services providing most of the balance. It is the largest of three carriers that control most of the Canadian wireless market. Its position as the sole GSM network operator there gives it a slight advantage as phone models are typically introduced more quickly for this standard--including  Apple's (AAPL) iPhone--and are often less costly. Rogers' stock price has been pressured lately as a result of declining average revenue per customer during in the second quarter and uncertainty around a recently concluded wireless spectrum auction. While cable provider  Shaw Communications (SJR) won a big chunk of the spectrum, but we think it will be difficult for the firm to gain share against entrenched competitors such as Rogers.

 France Telecom (FTE)
5 stars
France Telecom is the incumbent telephone operator in France and is the largest wireless service provider there with roughly 48% market share. The company also has significant wireless share in the United Kingdom and Spain and has exposure to faster-growing areas such as the Middle East, the Dominican Republic, and various countries in Africa. To offset the declining use of traditional fixed-line services, the firm quickly embraced voice over Internet protocol technology and is now the leading VoIP provider in France. The company has also taken steps to delever its balance sheet in recent years and met debt targets a year ahead of schedule.

Jacqueline Zhang does not own (actual or beneficial) shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.