Avoid These Telecom Value Traps

Piyush is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

The smartphone industry grew by 45.1% in 2012, while the mobile phone industry showed meager growth between 1-2%. Some reports suggest that the trend is expected to continue in 2013, which means that more users would be opting for high speed wireless data services. This would eventually boost the high speed subscriber base of telecom companies, which derive a major share of their revenue from data services. Moreover, the widespread adoption of 1080p and the introduction of 4k resolution is only going to strain the available bandwidth. This presents a bullish case for wireless telecom companies but not all of them get a “Buy” rating.

All is Well?

France Telecom (NYSE: ORAN) is a geographically diversified company, providing services to over 200 million subscribers in 35 countries. However, the telecom company derives a major share of its revenue from France, and its shares have mainly been under pressure due to the looming European crisis. But should you buy it?

France Telecom is planning to expand in Africa. Its strategy head explained that expanding in Benin, Burkina Faso, Mauritania and Togo would be accretive to its portfolio due to the close proximity of Orange’s existing operations. Besides that, company repurchased its 11% stake in Orange Kenya, which took its overall stake to 60%. Moreover, France Telecom also announced that it's trying to strike deals with existing telecom companies in Algeria and Libya, in order to expand its global footprint. The company is aiming to touch a turnover of $9.3 billion from emerging markets, by 2015.

With so many expansion plans, France Telecom should skyrocket, right?

I believe France Telecom would make a lousy investment.

Over the last 3 years, its net income has dropped by a massive 87%. Its shares have lost nearly 70% of their value over the last 5 years, and debt/equity ratio of 120% is higher than most of its peers. The only thing that attracted the contrarians, was its high dividend yield, but recently its management announced dividend cuts. Its current yield of 14.15% appears unsustainable as its payout is still close to 100%. In my opinion, the risks associated with the company outweigh the rewards and investors should stay distant from this one.

AT&T and Vodafone too?

I believe that AT&T (NYSE: T) is also making the wrong moves. According to reports, the company is eying M&A opportunities in Europe. Yes, its acquisitions would come cheaply, but wouldn’t its investments be exposed to a great deal of risk? There is still no solution to the European sovereign debt crisis, and AT&T is unnecessarily looking to reach the eye of the storm. There are plenty of opportunities in India, China and African nations, which should have been its natural course of expansion.

Vodafone (NASDAQ: VOD) is also struggling with its European operations. To add to its worries, Indian government authorities are alleging Vodafone for not coughing up its due taxes. According to authorities, Vodafone India deliberately undervalued its Transfer Pricing, in order to save taxes. Shares of Vodafone have slid by nearly 20% over the last 5 years, and without a practical turnaround plan, the slide may continue.

The Savior

Shares of Verizon (NYSE: VZ) may have risen by 20% over the last 5 years, but I believe there is still potential upside. The company is focusing largely on domestic growth, and its balance sheet appears to be solid.

<table> <tbody> <tr> <td> <p>Company</p> </td> <td> <p>Forward P/E</p> </td> <td> <p>Net Profit Margin</p> </td> <td> <p>5 yr. EPS growth estimate</p> </td> <td> <p>ROI</p> </td> <td> <p>Yield</p> </td> </tr> <tr> <td> <p>Verizon</p> </td> <td> <p>14.15x</p> </td> <td> <p>9.11%</p> </td> <td> <p>7.41%</p> </td> <td> <p>7.14%</p> </td> <td> <p>4.64%</p> </td> </tr> <tr> <td> <p>AT&T</p> </td> <td> <p>13.19x</p> </td> <td> <p>5.92%</p> </td> <td> <p>5.9%</p> </td> <td> <p>3.14%</p> </td> <td> <p>5.06%</p> </td> </tr> <tr> <td> <p>France Telecom</p> </td> <td> <p>6.74x</p> </td> <td> <p>8.17%</p> </td> <td> <p>-2.05%</p> </td> <td> <p>5.57%</p> </td> <td> <p>14.18%</p> </td> </tr> <tr> <td> <p>Vodafone</p> </td> <td> <p>10.68x</p> </td> <td> <p>-3.42%</p> </td> <td> <p>7%</p> </td> <td> <p>-1.35%</p> </td> <td> <p>3.75%</p> </td> </tr> </tbody> </table>

(Source Finviz)

Although, Verizon appears to be trading at a premium, it’s not overvalued by any means. That apart, Verizon sports the best set of financial metrics amongst the mentioned peers. Its shares have risen by 22.83%, and have clearly outperformed the industry returns over the last 1 year.

Foolish Conclusion

Verizon is the market leader in wireless market. The company has been reporting solid growth in cash flow from operations, and over the last 5 years, the metric has expanded by nearly 25%. Although the company’s quarterly financial performance was mediocre, it is however less susceptible to market risks due to strong fundamentals and distance from troubled economies. Since its peers have their share of problems, investing in them won't be as profitable. AT&T is the closest peer, but its expansion plans for Europe is the only thing going against it. Thus, only Verizon gets a Foolish Buy Rating!

PiyushArora has no position in any stocks mentioned. The Motley Fool recommends France Telecom (ADR) and Vodafone. The Motley Fool owns shares of France Telecom (ADR). 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!

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