Which Telecom Is Right for You?

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

Growth, income and stability are the three things that make up the holy trinity of investing. Companies that possess all of these qualities are rare, and typically produce something that is a backbone of society. The telecommunications sector seems to hit on all three. Telecom giants in the US and abroad typically have the power to raise rates (growth), have large dividends (income), and are necessary in their customers lives (stability).

Ole!

Telefonica (NYSE: TEF) is the Spanish telecom giant that is in the midst of acquiring Germany’s KPN for $10.7 billion. The company is betting big on Europe’s recovery, and the reduced competition in Germany will help it maintain its margins. 

Telefonica Deutschland’s new company setup is looking for approximately 5 billion to 5.5 billion euros in savings from the new joint venture. Old shareholders will see Telefonica maintaining a 65% ownership of the new venture. The combined company will be the second largest telecom in Europe. This will also geographically diversify the company and allow it to improve its earnings per share and free cash flow.

Telefonica is also looking to its large presence in Brazil and Latin America as an engine for growth in the future. These economies have shown over 11% revenue growth year-over-year. The company saw overall free cash flow generation increase by 16.5% on a year-over-year basis, even with currency fluctuation headwinds.  

During 2012, Telefonica faced an extremely challenging economic and financial environment, and the board of directors decided to cancel the dividend in response. Starting in November, however, Telefonica will again pay a 0.35 euro ($0.47) dividend bi-annually; this gives the shares a yield of 6.5% at today’s prices. Telefonica was able to reduce net debt by over 10 billion euros ($13 billion) while the dividend was suspended, giving itself more financial flexibility for mergers and acquisitions.

Going forward, Telefonica will be focusing on it’s global network and containing costs. The larger it can grow its network while reducing the number of its help centers and cutting redundant overhead, the better the company will perform.

Home is where the heart is

AT&T (NYSE: T) is the largest telecom company in the US with a market cap approaching $200 billion. This telecom giant has a gross margin of 56% and a net profit margin of 6%.

AT&T has been diversifying its revenue streams in the US and saw it’s U-verse revenue grow by 30% year-over-year. This service allows AT&T to become a one-stop-shop for land line, mobile, Internet and television for its customers. AT&T does have nearly 17% of it’s revenue coming from wireline, and has seen revenues from this segment stabilize as customers previously were “cutting the cord” with their landlines. 

AT&T has been making good use of it’s free cash by repurchasing shares. Ma Bell repurchased 4% of the shares outstanding, helping to increase earnings per share by 7.6% this quarter to $0.71. AT&T also had lower interest expenses during the most recent quarter as it took advantage of favorable interest rates this year.

AT&T will continue to give its shareholders a 5% dividend and good upside growth potential as the company's strong free cash flow position continues to reduce the number of shares outstanding. AT&T is also able to cover it’s network upgrades and maintenance and fund its pension obligations with operating cash flow. Now is a good time to be an investor in AT&T.

Size matters

China Mobile (NYSE: CHL) is the world's largest telecom company, and it keeps growing. Last month China Mobile added nearly 4.9 million customers, making the total added customers this year total 29.8 million. China Mobile also has the benefit of having a low percentage of customers using smartphones, as only 20% use 3G today.

China Mobile saw its revenue grow at 6.1% over this past year, with data services revenue growing by 29.7% and increasing the company's net profit margin by 23.1%. Since 2009, China Mobile’s stock has been essentially flat while the company is trying to grow revenue and shrink costs by moving operations to centralized locations to reduce costs. The company will continue to target 43% of earnings to be paid out as a dividend into the foreseeable future, translating to a 4.2% yield.

Going forward, management expects to see a larger percentage of its users upgrading to smartphones and is looking for smartphone penetration of nearly 50% within the next five years. The company is also planning ahead in regard to capital expenditures, increasing its spending by 50% on a year-over-year basis. China Mobile now anticipates that its new LTE network and a series of “seamless wireless” networks across China’s cities will draw in and keep customers and business clients.

Foolish bottom line

All three of these telecommunications companies offer a unique flavor of the industry. AT&T offers a steady 5% dividend, 6% growth in earnings, and a beta of 0.46. Telefonica is a bet on a European recovery, as well as income generation with a newly instituted 6.5% dividend. The European giant has a beta of 1.06, which means that investors will be in for a rocky ride. China Mobile is the most stable of the three, with a beta of only 0.33. This Chinese company pays out a dividend of 4.2%, though growth projections seem tepid as the Chinese market’s growth rate slows. Capital expenditures are higher than those of the rest of the group as well. 

After evaluating these three, I am keeping Telefonica on the top of my watch list. The synergies that it could realize in Germany and growth in Latin America are too good to pass up. However, more conservative investors should migrate to AT&T with its more balanced approach to growth, income and stability.

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Wes Patoka owns shares of Telefonica and AT&T. The Motley Fool owns shares of China Mobile. 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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