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Telecom Stock Outlook - Sept. 2015

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The U.S. telecom industry has lately emerged as an intensely contested space where success depends largely on technical superiority, quality of services and scalability. Thus, in order to stay abreast of competition, existing players need to be constantly on their toes to introduce innovative products or merge with other companies despite strict vigil by the Federal Communications Commission (FCC). In the near future, the U.S. telecom industry is slated to witness further mergers and acquisitions (M&A) and product diversifications.  

Carriers to Benefit from Market Consolidation & Diversification

Mergers and acquisitions are not uncommon in the U.S. telecom industry, despite strict regulations implemented by the FCC from time to time to put a check on monopolistic practices. Telecom and pay-TV operators are often found to join together in order to derive synergies that can provide better and attractive bundled products to customers. Recently, AT&T Inc. (T - Free Report) has merged with DIRECTV to provide quad-play wireless, wireline, high-speed Internet and video services to a larger subscribers base comprising customers of both the companies.

Meanwhile, Charter Communications Inc. (CHTR - Free Report) is awaiting the regulatory approval for a mega merger with Time Warner Cable Inc. (TWC) and Bright House Network LLC in the cable MSO (multi service operator) space. Verizon Communications Inc. (VZ - Free Report) recently acquired AOL Inc. and has further decided to takeover Millennial Media Inc. (MM) to diversify its business in mobile video content creation and online real-time targeted-advertising market. Firing on all cylinders, Verizon is also likely to launch its mobile video services soon.

In the same league, Comcast Corp. (CMCSA - Free Report) has acquired FreeWhile Inc. and This Technology LLC to boost its digital ad platform. The company will also start offering Internet TV service later this year and probably has plans in store for a digital video platform as well. Notably, Comcast has decided to invest around $450 million in Vox Media and Buzzfeed.

Spectrum Auctions to Boost Network Capacity

Wireless networks are the key for future growth of the overall telecom industry. As wireless networks run on radio frequency, spectrums (airwaves) have naturally become the most sought after commodity in the industry. The FCC, which concluded an Advanced Wireless Servies-3 (AWS-3) spectrum auction in Jan 2015, accumulated a record-breaking $44.89 billion. The FCC also plans to conduct a broadcast incentive (spectrum with TV broadcasters) auction in 2016 to ease the pressure on wireless operators and thereby ensure uninterrupted transmission of data/voice packets.  

Unexpected high bidding for AWS-3 spectrum clearly indicates that telecom operators expect the demand for mobile data and video services to rise substantially in the near future. The spectrum license winners from different regions are gearing up to upgrade their respective networks to gain a competitive edge. Wireless network standards are continuously evolving around the globe to offer faster speed. This, in turn, is likely to result in increased capital expenditures and a surge in demand for telecom infrastructure gears.

High Dividend Yield

Telecom companies offer one of the highest dividend yields in the U.S. economy. The dividend yield, measured as dividends payed by a company in the last 12 months relative to its share price, is currently around 4.9% for the telecom sector compared with a mere 2.0% (approximately) for the benchmark S&P 500 index. Unlike other industries, the telecom operators generate their revenues predominantly in the U.S. This makes these stocks non-susceptible to the volatility of the foreign exchange rate as well as macro-economic fluctuations in the rest of the world. Going forward, we believe the dividend yield momentum will continue as the U.S. economy remains stable.

Geographical Expansion

Cutting across barriers is in vogue among telecom players. The motive is undoubtedly better service and customer convenience. In Feb 2015, AT&T launched a service which allows its prepaid GoPhone customers, on $60 data plans, the benefit of unlimited calling from the U.S. to Mexico without any additional charge. The company’s postpaid customers on World Connect Value plans can also avail unlimited calls to Mexico with a $5 add-on. Recently, T-Mobile US Inc. (TMUS - Free Report) also introduced an innovative “Mobile Without Borders” plan through which its subscribers will be able to make calls to Canada and Mexico without paying any roaming charges.

In Apr 2015, Sprint Corp. (S - Free Report) prepaid service division, Boost Mobile, launched an unlimited voice call and text message service plan to enhance connectivity between U.S. inhabitants and their friends and family in Cuba.

Moreover, Comcast and Liberty Global Plc. (LBTYA - Free Report) , the leading cable MSOs in the U.S. and Europe respectively, have formed an alliance to offer the industry’s first international WiFi roaming connectivity to their subscribers. The cross-continent WiFi interoperability will provide a free alternative to wireless data roaming facility.

New Growth Areas

We expect wireless networks to provide the primary impetus to the telecom industry. In this regard, Internet of Thing (IoT) holds potential to emerge as the numero uno factor for future growth in the space. The IoT is a network of physical objects embedded with electronics, software, sensors and connectivity that enables it to achieve greater value and service by exchanging data with other connected devices. Machine-to-machine (M2M) communications is a key example. IoT needs superfast wireless links to run effectively, which, in turn, implies massive growth for the telecom industry.

There is no doubt that wireless network standards are gaining utmost importance as fast Internet speed becomes the need of the hour. After significant growth of the next-generation 4G LTE network deployment, LTE-A (Long-Term Evolution Advanced) wireless network standard is gradually gaining a strong foothold. On the wireline front, large telecom operators are increasingly targeting small and mid-sized business customers with high-speed Internet on fiber-optic-based network at attractive prices.    

In the meantime, growth of software-defined networking (SDN) and network function virtualization (NFV) have encouraged telecom operators to invest heavily in the communications infrastructure market. SDN provides customers increased bandwidth utilization, higher reliability and reduced capital spending. Meanwhile, NFV is designed to consolidate and deliver the networking components needed to support a fully virtualized infrastructure – these include virtual servers, storage and even other networks. It utilizes standard IT virtualization technologies.

Furthermore, the cloud-managed WiFi market has become a major growth sphere for telecom operators as an increasing number of large and mid-sized business enterprises are adopting this technology. Moreover, as operators direct their investments toward LTE access, the introduction of advanced services such as voice-over-LTE (VoLTE) has gradually assumed more importance.

Zacks Industry Rank

Within the Zacks Industry classification, Telecommunications is broadly grouped in the Computer and Technology sector (one of the 16 Zacks sectors) and are further sub-divided into twelve industries at the expanded level: Communications Infrastructure, Satellite Communications, Cable TV, Diversified Communications Services, Internet Services, Wireless Equipment Supplier, National Wireless Service Provider, Rural Wireless Operator, Rural Wireline Operator, Non-U.S. Wireless Operator, National Wirleline Operator and Non-U.S. Wireline Operator. The level of sensitivity and exposure to different stages of the economic cycle vary for each industry.

We rank all the 260 plus industries in the 16 Zacks sectors based on the earnings outlook and fundamental strength of the constituent companies in each industry. To learn more visit: About Zacks Industry Rank. As a guideline, the outlook for industries with a Zacks Industry Rank of #88 and lower is 'Positive,' those between #89 and #176 is 'Neutral' while for those with #177 and higher is 'Negative.'

The Zacks Industry Rank for Communications Infrastructure is #60, Internet Services is #106, Satellite Communications is #40, Cable TV Operators is #162, Diversified Communications Services is #101, Wireless Equipment Supplier is #66, National Wireless Service providers is #162, National Wireline Operators is #106, Rural Wireless Operators is #106, Rural Wireline Operators is #10, Non-U.S. Wireless Operators is #85 and Non-U.S. Wireline Operators is #256. Looking at the Zacks Industry Rank of the twelve telecommunications industries, we derive that the near-term outlook for the group is tending more toward 'Neutral.'

Earnings Trend in the Sector

The broader Technology sector, of which the telecommunications industry is a part, delivers a moderate show with respect to earnings. So far, 100% of the sector participants have reported second-quarter 2015 financial results, which have been mixed in terms of beat ratios (percentage of companies coming out with positive surprises). Earnings and revenue growth figures have also been modest.

While the earnings beat ratio was impressive at 60.9%, the revenue beat ratio was 50.8% in the second quarter. Nevertheless, total earnings for the reported companies have shown a 2.0% year-over-year increase on 2.3% growth in revenues. This compares unfavorably with substantially higher earnings growth of 7.4% on 4.9% growth in revenues in the first quarter of 2015.

Meanwhile, the consensus earnings expectation for full-year 2015 depicts a mediocre trend. Earnings growth is expected to rise 2.8% in the third quarter but is likely to decline to a negative 0.7% in the fourth quarter of 2015. Similarly, revenue growth is expected to rise 8.8% in the third quarter but is likely to fall to 7.4% in the fourth quarter of 2015.

For a detailed look at the earnings outlook for this sector and others, please read our weekly Earnings Trends reports.

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