Morningstar Advisor - December 2012/January 2013 - (Page 32)

Sector Rap Hodel: Five years ago, the industry had cyclicality to its margins; people upgraded phones more often in December than in, say, April or whenever. That caused some seasonality in margins, but what the iPhone has done is caused that to become extreme. The quarter when a new iPhone is launched, margins will plummet for all the carriers that offer that device. Then, margins will snap back. In fact, you see very strong margins in quarters where people are anticipating the next iteration of the iPhone. For example, in the second quarter of 2012, there were record margins pretty much across the board in the wireless industry, because nobody was buying phones; everyone’s waiting for the iPhone 5 to come out. So, margins have become much lumpier than they had been historically. phone, over the spring and summer. The phone didn’t sell real well, but you will see all the carriers aggressively promoting Windows 8 in the holiday season. They’re trying to give Microsoft a strong place in the market, so they can dilute Apple’s power and bring the subsidies on the iPhone down. But ultimately what gives Apple the ability to extract that subsidy is the fact that they’ve created this device that the carriers believe they have to have to be the most competitive they can be. There’s still a level of competition in the marketplace that’s strong enough among the carriers that they’re willing to give Apple essentially what they want. If competition was less intense, carriers would be more willing to push back on Apple than they do today. Guziec: So, what are the opportunities out there for telecom? Hodel: AT&T and Verizon are the two most DTEGY owns Hellenic Telecommunications in Greece; it’s small, but sentiment-wise, it’s not good. Also, another issue is Iliad, which is a new competitor in the French market and has put a lot of pressure on all the French operators. France is where we see the most upside; they are all either in 5-star territory or close to it. France Telecom is our favorite name because they actually do have some countercyclicality with Iliad, because Iliad pays for usage of their network. As Iliad is successful there, its payment to France Telecom goes up, so that helps offset some of the losses that France Telecom is having elsewhere. It took time for the markets to catch on to this situation. In the fourth quarter of 2011, when the iPhone 4S was launched, margins in the U.S. took a big hit, and the stocks of AT&T and Verizon VZ got hit pretty hard. But it’s important to keep in mind that overall profitability isn’t necessarily dramatically different; it’s just that it’s bigger than it used to be. The iPhone is, by far, the most heavily subsidized device in the world. Rumor has it that it’s around $400 per device of subsidy that the carriers are kicking in for each iPhone sold. That compares to maybe $150 or $250 on an Android or Windows device. It’s interesting because the carriers are getting the same revenue stream off of either of those two devices. So, they would much rather sell you an Android or a Windows phone because they’re getting the same revenue stream off of you as a customer, and they’re subsidizing you much less heavily than they would if they sold you an iPhone. So, you have a lot of interest among the carriers to develop these ecosystems that diversify their customer basis away from the iPhone as much as possible. AT&T, for example, was aggressively pushing the Lumia 900 from Nokia NOK, which was a Windows 7 widely held stocks across the board in the U.S. The U.S. telecom industry has gotten to a point where most stocks across the sector are slightly overvalued at this point, and that’s because the sector is viewed as a relative safe haven for investors looking for yield. Nine months or so ago, AT&T and Verizon common stock yielded around 6.5%, and that attracted a lot of investors who see telecom as being a stable, recurring-cash-flow-type business. As a result, we’ve seen the price of those stocks run up pretty dramatically, to the point where their yields are down to the 4% range. Allan Nichols: Europe is very different. Many Another firm that we find interesting is NTT DoCoMo DCM in Japan. It trades at even a lower multiple than France Telecom; it’s around three and a half times enterprise value EBITDA with yields much lower relative to the Europeans, but for Japan, which has been in a recession for 20 years, a yield of 4.5% is huge. DoCoMo has no net debt, which is very rare for a phone company, and it has almost 50% market share. They do not have the iPhone, which has been one of the reasons that they’ve been hurt. They have refused to make a deal with Apple, so they have been losing some market share to KDDI and especially SoftBank. But despite that, DoCoMo is generating tons of cash, and they are close to two years ahead of the others in offering LTE, which they’ve had since December 2010. Love: I go back to the towers. American Tower AMT is best in class and on our best ideas list. It’s a play on that underlying theme of growing data demand. They pay a very small dividend, now only about 1.3%, but they are the only publicly traded tower company that offers a dividend. They are also the most diversified across the globe; they’re in Latin America, India, and Africa. They have the highest margins, and they’re also the least levered of bigger tower companies. That’s a pretty good combination. K Philip Guziec, CFA, is a derivatives strategist with Morningstar. of the telecoms there are very cheap because the dividend is not stable in Europe. Telefónica TEF outright canceled its dividend, France Telecom FTE and KPN KKPNY reduced theirs. Vivendi and Telecom Italia TI cut theirs. The euro crisis has certainly hurt them. Telefónica and Portugal Telecom PT have been hurt by interest rates going up and concerns about their debt positions. Deutsche Telekom 32 Morningstar Advisor December/January 2013

Table of Contents for the Digital Edition of Morningstar Advisor - December 2012/January 2013

Morningstar Advisor - December2012/January 2013
Contents
Contributors
Letter From the Editor
What Stands Between Me and Stupid
Why Do You Use Dynamic Funds of Funds?
Serving Clients and Community
How to Pick an ETF Managed Portfolio Strategy
Tactical View of Risk
Investments á la Carte
Investment Briefs
Unbundling ETF Managed Portfolios
Risks Loom Over Telecom Industry
Outsourcing Asset Allocation
ETF Managed Portfolios on the Rise
Age-Based Options Take Over 529 Industry
How the Landscape for Advisors Is Changing
Mark Egan Embraces Volatility
Alpha, Beta, and Now … Gamma
Performance Gaps
Gains in Momentum
Companies Where Management Teams Add Value
Our Favorite Mutual Funds
50 Most-Popular Equity ETFs
Undervalued Stocks With Wide Moats
The Once and Future King

Morningstar Advisor - December 2012/January 2013