India: Price inflation creates one of the best opportunities for EM telco investors in recent years.
Change in the telecom industry tends to be gradual. National telcos can be thought of as super-tankers, with large and slow turning circles. Investment cycles are long. Return on capital drives value creation and doesn’t tend to fluctuate rapidly.
In this context what has happened in India in recent months is without precedent for the telco industry in a large country in our view. Ever since 13 licences per region were issued in 2008, India has a been a hypercompetitive market where creating value has been hard. Direction of travel for price has been in one direction – down. However, everything changed with the Supreme Court ruling in October. A $13bn fine on the industry (HERE) which the SC recently upheld (HERE) has broken the current structure and change is coming.
Over the past two decades, the number of companies listed on the US stock market has almost halved. From 2006 to 2017, the number of private backed companies has doubled. In 2013, a quarter of equity raised came from private markets – and today it is closer to half. Yet despite this, relatively few telecoms companies have taken themselves private. However, those that do, or even their subsidiaries, have delivered significant value for public market investors – think Altice, which was one of the best performing telcos in 2019 and took advantage of this trend across multiple subsidiaries. For other telcos, particularly those embarking on heavy infrastructure projects like BT, the opportunity could be there too.
The last decade has really been a decade of two halves for the European telecoms sector. After outperforming in the first half of the decade, the period from 2015-2018 was a torrid one as the reality of aggressive regulation finally became apparent. Looking back though over the past 12 months, our upgrade of the European telecoms sector a year ago has been somewhat of a pyrrhic victory. On one hand, the sector has delivered a positive total return of 7% – the first time in four years the return has been positive. However, telecoms has not enjoyed the magnitude of re-rating seen by other geographies or industrial sectors this year, as the industry still tries to rebuild confidence with investors. Lack of headline growth and ongoing concerns over earnings risk still seems to dominate discussions. We look ahead to 2020 to pick out the best opportunities, the key themes ahead and set out our thoughts for what we would be doing if we were CEO of one of the European telcos in the decade ahead.
5G has been a hot topic this year, which peaked in November when we hosted our 5G conference in New York. We have written extensively about the key takeaways (HERE, HERE and HERE) but one central theme was the newsflow out of Asia, and in particular a presentation from LG U+ in Korea showing the incredible usage stats since they launched 5G. This week we have had a few more data points out of Asia that has made us increasingly optimistic that 5G is likely to be the key focus for the Asian markets as we head into 2020. It is these data points, and the resultant optimism that has entrenched our stock views as we look to the New Year. Furthermore, we see a great pair trade for those investors looking for 5G-specific telco opportunities.
Rakuten is the highest profile virtualised Radio Access Network project in the world, and CEO Mikitani’s MWC tub-thumping lifted vRAN to the top of the ‘hot topic’ list for 2019. Speakers at our recent 5G conference (key takeaways from the telecom team HERE and the tech team HERE), and plenty of other news flow, have indicated that virtualisation of the core and the RAN is the way forward for lower unit costs and more flexible, secure, and scalable networking.
We don’t see this as a change of trend – unit costs have been falling relentlessly for several decades – but virtualisation is one of the key drivers for continued declines over the next decade. Virtualisation has a large and growing band of global enthusiasts too, including heavyweight operators, and an increasingly wide ecosystem.
Precisely because Rakuten put vRAN front and centre in its extravagant pitch to MWC earlier this year, it’s natural to suspect that vRAN is at the root of its disappointing trajectory since then. But, just as vRAN isn’t central to Rakuten’s story, in our view (see HERE), it also isn’t why the launch is late and impact being downgraded. This diagnosis matters for the Japanese market, but it also matters for vRAN globally.
In the past, EM growth has been a major driver for some of the developed market equity stories. Telefonica’s expansion into Latam was one of the big telco stories from the mid-1990s. Telenor’s aggressive Asian expansion in the early part of this millennium also made their equity story stand out as core EU earnings were under pressure. However, EM exposure for developed market telecoms companies has been gradually diminishing over the past 5 years and Telefonica’s announcement this week that it now defining all of its Latam assets ex-Brazil as non-core (see HERE for our view) marks a further retreat. However, arguably no EM market has been more volatile than India. Last week we took Vodafone management around London (see HERE for more details), and one of the key concerns that shareholders were bringing up was India and whether Vodafone could be liable for yet more cash injections into India on top of the £17bn already committed over the past 10 years. However, just as the roadshow was entering its final meeting, the Government announced a moratorium on spectrum fees, potentially marking a major inflection point in Government thinking and suggesting the risk-reward is now skewed to the upside (see HERE for more details) and EM exposure could potentially become a major driver for a developed market telco again.
We got a fright when we saw T-Mobile announce a conference call for Monday morning with no mention of what it would focus on. We worried that they may announce that they were abandoning the deal. I am not sure why it didn’t occur to us that Legere might be stepping down to focus his energies on Slow Cooker Sundays.
As we broke open the models in preparation for the call and started running through scenarios around what might come next for each of T-Mobile and Sprint, we realized that the world had changed quite materially since we first set out our thesis for the deal. We have some work to do mapping out the no-deal scenarios in more rigorous detail, but in the meantime, we have some thoughts on what the options for both companies are, and the pros and cons of each.
Trying to turbocharge Vodafone’s inflection
Is opening your network to wholesale partners a value-accretive move? This is one of the debates that has raged in European telecoms for as long as any of us can remember and Vodafone seems to have been at the heart of this debate for years. Hence, the announcement last week for Vodafone to sign a wholesale MVNO agreement with Virgin Media (see HERE) marks a substantive turning point that should help to turbo-charge their recovery; make life tougher for existing providers of wholesale access; and help out the MVNOs. We pick the winners and losers from this.
We have written about spectrum, its value, and its impact on competitive dynamics continually over the past decade. The past few weeks have delivered a particularly rich seam of new bands we haven’t thought about before, an old band we had forgotten about, and evolving thoughts on the big and obvious bands that have been at the forefront of investors’ attention.