America Movil's Challenges Keep Coming
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The Mexican telecom market isn't known for its quality or affordability. America Movil (NYSE: AMX) is the dominant player, and it has been able to use its strong grip on the nation's infrastructure to fend off competitors. Now, calls for more competition are squeezing America Movil's margins. The company is still a dominate monopolist with strong local connections, but it is important to contextualize its financials.
The free market mantra is popular, but only sometimes does it lead to concrete changes. The current Mexican president, Enrique Peña has decided to take the free market one step further with an attempt to improve Mexico's telecom market.
A regulatory agency recently studied the quality of wireless networks in Mexico City, and its findings do not bode well for America Movil. 16.5% of the time America Movil failed to establish an internet connection on its 3G network, while other competitors like Telefonica's (NYSE: TEF) Movistar had a failure rate around 3.5%. Wireless phone calls also place Telefonica's network far ahead of America Movil's. Telefonica's 2G network dropped 0.27% of calls, and its 3G network dropped 0.34%, while America Movil's 2G network dropped 1.63% and its 3G network dropped 0.75%.
Why Are Margins Falling?
The poor quality of America Movil's wireless network is only part of the reason why its margins are falling. Falling interconnect fees are important parts of the equation. America Movil owns a large portion of Mexico's national network. Its competitors are commonly forced to use America Movil's network when they want to make calls. Until recently, America Movil charged excessive interconnect fees to make it prohibitively expensive for competitors to use its network.
In 2011 things stared to change as the government forced America Movil's subsidiary Telmex, to cut its interconnect fees from 11.55 pesos to 3.951 pesos. In a bid to get monopoly allegations off of its shoulders, America Movil was forced to cut rates by 21%. Now, America Movil has a profit margin of 11.2%, an earnings before interest and taxes (EBIT) margin of 20.4% and a return on investment (ROI) of 13.3%. Lower interconnect fees mean less income, lower margins and more competition; discouraging trends for any company.
Telefonica's Movistar has suffered from falling margins, but for other reasons. Telefonica is based in Spain and has significant operations throughout Europe. When your home country has growing unemployment currently at 27.2% it is hard to expand your margins.
On the positive side, Movistar keeps moving forward in Latin America. If Telefonica can maintain infrastructure superior to America Movil's, its profit margin should turn around. Already, Telefonica's EBIT margin of 24.3% and gross margin of 72.6% are above America Movil's respective EBIT margin and gross margin.
The Blackstone Group (NYSE: BX) is involved with the Mexican broadband and telecom provider Axtel. Axtel offers fixed line phone services for local and long distance calls, but its low market share gives the company many challenges. When it comes to Internet services, Axtel is one of America Movil's main competitors. In its most recent quarter Axtel's Internet business continued to expand as the number of Internet lines grew from 583 thousand the previous year to 743 thousand.
While Axtel is publicly traded in Mexico, it isn't available on any U.S. exchanges. Blackstone is one way for U.S. retail investors to invest in the company, but it is important to note that Blackstone invested just $600 million in Axtel. Given that Blackstone has a market cap over $13 billion and 2012 EBIT of $1.09 billion, Blackstone's exposure to Axtel is very small. Blackstone's hedge fund operations and large number of private equity investments make it a better representative of the global financial system.
America Movil is facing increasing competition and falling margins, but it is still highly profitable with an ROI of 13.3%. While the company is facing regulatory pressures, it was able to use fancy legal work to decrease a recent fine from $657 million pesos to $638 million pesos. The recent stream of news has been negative, but it is important to remember that America Movil is still a money-making monopoly.
Telefonica is a good company to watch. Europe's problems continue to weigh down the firm, but its Latin American operations are growing. Axtel focuses on higher-end customers and has a strong Internet business. Buying Blackstone is one way to play Axtel, but it would better to contact your broker and try to buy Axtel shares directly on the Mexican stock exchange. Axtel is the underdog, and it could grow substantially in the coming years.
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Joshua Bondy has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!