Large-Cap Wireless Carriers Are Cheap

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

Out-of-favor industries are often the source of great investment ideas. Right now, large-cap wireless carriers are about as out of favor as they will ever be. Trading at low multiples of historical earnings and free cash flow, these telecommunication companies are navigating the changing technological landscape and trying to come out ahead.

Ridiculously Cheap

For instance, AT&T (NYSE: T) trades around $34 per share. Over the last four years, the company averaged nearly $6 in free cash flow. This implies a 5.6x free cash flow multiple. Over the last decade, the company averaged $12.5 billion in pre-tax income, or $2.17 per share (in today's shares). The stock currently trades at a 15.6x multiple of this figure, despite pre-tax earnings of $18-$20 billion in the latter-half of the last decade.

Verizon (NYSE: VZ) is available for less than $43 per share despite averaging $10.62 per share in free cash flow over the last four years. It has averaged $4.43 per share in pre-tax income over the same time period, for a pre-tax multiple of less than 10x.

Sprint (NYSE: S) trades for about $5.60 per share. It has averaged $1.63 per share in free cash flow over the last four years, but has posted negative GAAP earnings since 2007. Sprint is in a relatively poorer competitive position than its larger rivals.

Why They Might Succeed

AT&T and Verizon are far and away the best wireless carriers in the United States. The two dominate the wireless landscape, making it difficult for smaller rivals like Sprint Nextel to succeed. AT&T has direct access to its customers, allowing it to provide upgrades and other services to attract new customers and retain existing ones. However, it is somewhat at the mercy of the Apple iPhone, considering 40% of its customers use the device. AT&T's high-speed internet service is one of the most popular in the United States and is able to go toe-to-toe with Time Warner Cable's high-speed internet offering. AT&T will continue to benefit from bundling its voice and data plans.

Like AT&T, Verizon's old fixed-line business still makes up a large part of the company. However, the fixed-line business is a cash cow that should only increase cash flows once the current upgrades are complete. In addition, Verizon is the leader in the mobile phone coverage business and has a sticky customer base. The wireless business is also a cash cow, but Verizon is currently in a dispute with Vodafone over ownership in the wireless subsidiary. Once it gets the dispute resolved and the fixed-line upgrade complete, the market may re-value Verizon's shares.

Finally, Sprint is the third-place wireless carrier and lags the leaders by a significant margin. AT&T and Verizon have the resources and technology needed to solidify their duopoly in wireless coverage, making it doubtful that Sprint can ever earn outsized profits. Sprint is also far behind AT&T and Verizon in the shift from voice to data services. So, while Sprint may be producing a ton of free cash flow now, it is likely that free cash flow will eventually go the way of earnings -- straight down.

Final Thoughts

Out-of-favor industries are usually out of favor for a good reason. Many telecom companies that are struggling now will continue to struggle in the future. But there is reason to believe that AT&T and Verizon will come out of this stronger than the rest of the pack, so it may be worth taking a closer look.

titans8904 has no position in any stocks mentioned. The Motley Fool recommends Visa. 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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