Telecom Argentina: A Value Investor’s Dream

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There are few stocks that offer investors what Telecom Argentina (NYSE: TEO) does: (1) revenue and earnings growth of more than 25%; (2) a dividend of over 8%; and (3) a solid balance sheet.  After all, that growth rate rivals many of the dot com darlings, the dividend yield is higher than most utilities, and the fact that the company has a solid balance sheet is surprising because Telecom Argentina competes (sort of) in a sector that requires significant capital investments.  Fortunately, unlike many other telecom companies, this company is not that highly leveraged. 

How did this Company Emerge?

Like many other countries, in the early 1990’s Argentina started to privatize many of its state-owned utilities such as energy and telecommunications.  A monopoly of a state-owned phone service was split up into two territories: France Telecom (NYSE: ORAN) was given half of the country, and Telefonica (NYSE: TEF) was given the other half.  Those two companies were literally set up as monopolies, supposedly for a finite time period.  Although they inherited terrible conditions, they both managed to greatly improve the quality of service and easily turned a profit.    

So do they still have a Monopoly?

Apparently that monopoly officially ended on Oct. 8, 1999 – at least according to reports that came out of Argentina.  Over that time period, however, Telecom Argentina took a business that was very inefficient, reinvested a significant portion of its earnings back into its operations, upgraded to a state-of-the-art system, and in doing so created significant barriers to entry.  Today there are only three mobile phone companies in Argentina, which is about as close to a monopoly as you can reasonably expect.

What are the Key Risks?

The major risk here is governmental interference.  Similar to the way state-owned assets were auctioned off in the 1990’s, the Argentinian government could literally give away assets to less competitive companies or it could subsidize some companies in order to make them more competitive.  By favoring one company over another, the Argentinian government could reduce the barriers to entry and significantly alter the competitive landscape. 

A larger concern is that Argentine President Christine Kirchner – who has a record of expanding the reach of her government – may increase regulation of the telecom industry or continue to nationalize some of the companies that were formerly state-owned.  Nationalization of Telecom Argentina does, however, seem very unlikely for two reasons: (1) the performance of telecom companies improved greatly once they were privatized, and (2) Telecom Argentina has a very complex ownership structure (that is beyond the scope of this article).      

What are the Catalysts?

On the positive side, the company is very profitable and has the potential to increase its dividend.  A hike in the dividend would result in the stock receiving a nice pop.  Telecom Argentina shares could also pop if it were to issue an announcement placating analysts’ concerns regarding either the sustainability of its growth or the threat of increased regulation.    

On the negative side, a recent earnings miss has raised concerns about the company’s ability to continue to grow revenues and earnings.  In addition, it is unclear whether or not increased competition will result in a downward trend of declining operating margins.  Furthermore, there is considerable uncertainty regarding the future of the company’s dividend, namely whether or not Telecom Argentina will feel compelled to appease regulators and retain earnings and reinvest them into the company, instead of distributing them to shareholders.

What is a Fair Valuation?

A company like Telecom Argentina is very difficult to value, given the political and economic risks associated with Argentina that have the potential to impact the competitive landscape.  At face value, however, the company does have a very attractive valuation: it has a P/E ratio of less than 4, a dividend yield of over 8%, and it has generated close to $7 per share in cash flow over the past 4 quarters.  That suggests that Telecom Argentina is undervalued.

3 Reasons to Buy Telecom Argentina

  1. Telecom Argentina is attractively valued.  The company is generating approximately $7 of cash per share, which, when compared to the company’s current stock price of around $11 a share, provides a very attractive cash flow multiple and suggests that investors are not adequately factoring the value of future earnings into Telecom’s valuation. 
  2. Telecom Argentina has a track record of delivering earnings and revenue growth.  Over the past 5-years, Telecom Argentina has grown revenues by an average of 20.3% while it has grown earnings by an average of 35.07%.  In contrast, Telecom Argentina’s current valuation actually suggests that analysts’ expect this company to experience negative growth over the next few years.      
  3. Telecom Argentina has a very conservative capital structure.  A return of equity of over 30% and a return on assets of over 25% suggest that Telecom Argentina could even consider raising its debt capital in order to invest in what is currently a very profitable business – so long as its business stays stable.         

My Foolish Take

If Telecom Argentina can convince investors that its top line growth is sustainable and will lead to higher profits, then this company has a very good chance at delivering a total return of 50% – 100% or more over the next 1 to 2 years.  Telecom Argentina also has the potential to increase its dividend if it can maintain its underlying fundamentals. 

Owning this company does come with significant risks, most notably the threat of increased regulation and competition.  For the last several years, however, even though the monopoly technically formally ended on Oct. 8, 1999, Telecom Argentina has maintained a dominant position in the market.  On balance, I feel that a healthy upside for this company more than offsets its risks.           

RyanPeckyno is long Telecom Argentina. The Motley Fool owns shares of France Telecom (ADR). Motley Fool newsletter services recommend 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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