Telecom Roundup: Pros & Cons

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

If you are looking for steady streams of income, telecom may be your thing. But there are more reasons than just shareholder-friendly distributions (which are, in any event, a reflection of limited growth prospects) to back the industry. From exploiting secular transitions in calling and video to takeover activity, the industry is ripe with unrecognized upside potential. Below, I review several stocks and see how the fit within this backdrop.

The Good & Bad About Verizon (NYSE: VZ)

Verizon has one major catalyst that none of its competitors have: an early-mover advantage in 4G. The company has a greater 4G LTE network than what all the other carriers have combined. The network's entire rollout is expected to be completed by mid-2013--60 months ahead of schedule. By the year's end, Verizon will have covered 260 million individuals versus 150 million expected for AT&T. In addition, Verizon generates substantial free cash flow. $18 billion in free cash flow was generated in the twelve trailing months ending 3Q12, which represents a terrific 14.3% yield. Coupled with a dividend yield of 4.7%, this promises strong returns for interested shareholders.

But for new investors the company is a mixed bag in terms of risk/reward. With a return on invested capital of 3% (versus an industry average of 7.2%), the company is theoretically destroying value. Moreover, the company has struggled to provide local Internet services and recently had to shut down its app store for Android and BlackBerry devices. The V Cast mobile video service is coming to an end as well. And while I like the strategy of partnering with Hulu and Netflix in aggregating content, I am doubtful about its ability to be monetized given the intense online competition. The firm has also partnered with Redbox in Internet video streaming, which, again, will be challenged by the competition. Vodafone has also not been so adamant about maintaining its 45% interest in Verizon--if it decides to sell, that would be a significant wet blanket for bulls.

On the other hand, the company continues to be rated the #1 carrier by Consumer Reports. The reaction to the company being particularly bad hit by Sandy was extremely myopic, because it says nothing about the fundamentals and long-term growth trajectory. In the end, stock prices reflect the underlying business, which Verizon has shown to be strong and consistent.

AT&T's (NYSE: T) Winning Returns Will Trump Sprint (NYSE: S)

AT&T also represents a promising bet. It is aggressive in catching up to Verizon, yet is reasonable with shareholder cash. Management recently hiked the payout while aiming for $22 billion in capital expenditures from 2013 to 2016. $8 billion of this budget is specifically focused on catching up in 4G LTE. Management is guiding for mid-single digit EPS growth. Coupled with a leading 5.3% dividend yield and a reasonable multiple, this should be enough to provide attractive returns. AT&T has around half the volatility of the broader market, so this is compelling risk/reward.

While Consumer Reports rated AT&T the worst domestic carrier, it is at least a carrier that more and more consumers are signing on to! The company's 4G LTE coverage is now accessible in 23 new markets. Management has also proven itself to be bullish on scale, as evidenced by the negotiations with regulators over acquiring T-Mobile. It is now looking to swallow smaller spectrum targets to gain capacity. The introduction of a 2 year data plan for 3G/4G tablets that comes with a $100 discount will the company take away Sprint's leading reputation as the cheapest provider of data.

Speaking of Sprint, I recommend avoiding the stock. Ma Bell's launch of a push-to-talk phone will steal away the Nextel subscribers that Verizon fails to win back through its legacy business. More troublingly, in light of the debt load, Sprint will be challenged to pursue accretive takeover deals. The cost of financing is high enough that I don't foresee the company neither catching up on 4G nor targeting the next big secular transition. The $480 million acquisition of PCS spectrum from US Cellular may showcase some viability in growing capacity, but it's a small step forward in a marathon. Having risen 172.4% from the 52-week low, I do not believe the market is factoring in this headwind.

TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool has no positions in the stocks mentioned above. 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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