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Description: The telecom sector in Europe has underperformed the market significantly during the last quarters. There are a number of reasons for this: a) telecom operators run a highly cyclical business, and with the financial crisis taking its grip on day-to-day consumer spending, operating profits have fallen, b) the introduction of VoIP (e.g. Skype, WhatsApp) means that consumer behavior has changed at the expense of the traditional operators, c) in terms of provision capacity, the traditional operators have made important efforts to build the adequate infrastructure to serve 3G clients and lately 4G clients. The problem which arises now in crowded areas like city centers, high-rise buildings and railway stations, is that system capacity is being reached relatively quickly because more than ever, consumers are consuming online during their spare time. While building an even higher distribution network is no longer possible (due to wireless smog), telecom operators need to create a different business model when it comes to servicing and charging clients. So far, only a very few telecom operators are in the process of adapting their pricing model, (pay for getting always versus pay for getting data access on priority case-basis). Given the expected changes, it can be assumed that the telecom sector in Europe will remain weak and subject to potential takeovers and mergers. The Spanish based telecom operator Telefonica (TEF) could be one of the potential sweet spots in the market. It is one of the world’s largest integrated telecommunication operations providing communication, information and entertainment solutions via mobile, fixed line, internet and data transmission services. On a worldwide basis, TEF employees about 260,000 people, it has a presence in 25 countries (6 in Europe, 13 in Latin America and the US, Morocco, and 3 more, through strategic and industrial alliances), and a customer base that amounts to nearly 274 million accesses around the world. The company also holds a stake in China Unicom and Telecom Italia. At present, the major source of it revenues are made in the LatAM region.Telefonica’s operating profits have decreased dramatically in recent years. This is mainly due to the financial crisis, which damaged operational activities in Europe. Moreover, some of Telefonica’s profits in Venezuela have been sequestered and monetary devaluations in South America where Telefonica has another business stronghold have also impacted. Given the recent positive economic news from Europe, (business confidence has turned, consumer sentiment is positive in the major market, i.e. Germany, and GDP is bottoming out), it could well be the case that Telefonica, which has been a negative performer for the last 3 years, starts to regain the attention it had in the past. Lately, the stock has been subject to takeover rumors; it was argued that TEF could be approached by AT&T. A takeover could make sense for AT&T as it would provide exposure to markets where until now, it has had little exposure, and from the purely financial point of view, European telecom operators, and in particular TEF, offer investors an attractive dividend of about 5%. While a potential takeover would be financed by debts, the purchase would only generate a few additional costs for AT&T. On the other side, the Spanish government, which still holds a major stake in the company, could potentially exit at a suitable price. Strengths and weaknesses analysis / Fundamental analysis: Strengths:
Weaknesses:
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