The article you’re reading is free and today’s internet users are accustomed to getting most information for free. However, unless you are reading this article at a Starbucks or a public library, you’re paying for the internet connection. Many of us have a data plan for our smartphones to access the internet. These data plans on average run at about $60 per month or $720 per year and with the average annual income in the U.S. at about $30,000 per year, this come to about 2.4%. This could be considered a tax as the government owns the airwaves and sells them to the wireless companies, who in turn charge for using the airwaves. In addition, the government imposes taxes and fees on our wireless bills and on the income generated by the wireless companies. Investors could benefit from this wireless boom by investing in the 4 largest wireless carriers in the U.S.
The most recent airwave auction run by the Federal Communications Commission (FCC) will gross over $38 billion for the federal government from companies like AT&T (T), Verizon (VZ), and T-Mobile (TMUS). In turn, these companies will provide wireless data plans to consumers. All this will make possible for the executives of AT&T and Verizon to earn a compensation of $23 million and $16 million, respectively, for 2013. Smaller rivals, T-Mobile and Sprint (S), CEOs earned respectable $29 million and $49 million, respectively in 2013 (Sprint CEO’s salary in 2012 was $11 million and the large bump was due to his separation from the company in 2013). Over 50% of this income comes from stock awards. At the same time, their stock return is either underperforming the S&P 500 in the case of AT&T and Verizon or is inconsistent in the case of Sprint (see table). Despite the disproportionate executive compensation for these 4 companies and given their sizes, they could still be a good long-term investment.
|1 Year||3 Year||5 Year||Annual dividend yield|
Note: As of Nov. 30′ 14. 3 and 5-year performance is annualized. Performance includes dividends.
Because demand for wireless communications is growing and the 4 largest wireless companies have basically monopolized the industry in a partnership with the Federal Government, their common stocks are likely to have a strong performance for the foreseeable future. Any competitor who comes with a better idea for exchanging information wirelessly is likely to be squashed by the Government on various grounds (security, health, and jobs). For example, in 2012 the FCC barred LightSquared from developing a nationwide wireless network on the grounds that the network would interfere with military frequencies. More recently, Tesla’s CEO, Elon Musk, spoke about lighter and cheaper satellites that will provide wireless internet access but he is known for offering futuristic ideas that sound good but are difficult to implement. If what Elon Musk is offering is possible, another company that offers internet radio, Sirius (SIRI), should already be able to provide internet access from its existing satellites.
While technological innovation could be a concern, the wireless business model should be stable in the foreseeable future. Of the four companies, only AT&T and Verizon have significant exposure to Cable TV, which is currently being challenged by Netflix, Amazon.com, and by network companies offering direct subscriptions to their programs.
|Wireless subscribers||118.7 mil.||125.3 mil.||55 mil.||52.9 mil.|
|Market capitalization||$183.5 bil.||$210 bil.||$20.2 bil.||$23.6 bil.|
|Debt||$75.6 bil.||$109.2 bil.||$32.3 bil.||$25.6 bil.|
|Cost of debt (est.)||5.0%||4.5%||7.6%||5.3%|
|Intangible assets||$137 bil.||$105.6 bil.||$54.8 bil.||$23.4 bil.|
|Intangible assets as a % of market cap||74.6%||50.3%||171.3%||99.2%|
|Price-to-Cash Flow From Operations||5.5||6.2||14.4||6.2|
Data is as of the most recent quarter-end.
As seen from the table above, all 4 companies have significant intangible assets largely comprised of the wireless spectrum they buy from the Federal government. It’s important to utilize this spectrum by gaining more wireless subscribers and it looks like Verizon utilizes its intangible assets most effectively while Sprint has the largest amount of intangible assets compared to its market capitalization. Having large intangible assets could be detrimental for equity investors if their valuation declines due to technological innovations or government regulations, for example. Also, intangible assets valuations are somewhat susceptible to management manipulation. However, there is a strong market for wireless spectrum. Even though spectrum is intangible, it should be considered more like a tangible asset and because it’s limited and used directly in providing wireless service.
Another characteristic that these four companies share is high debt levels. Sprint has the highest interest rate and the highest debt level compared to its market capitalization. Debt, or leverage, allows companies to deduct interest expenses from taxes (dividends are not tax deductible for companies) and to enhance equity returns if the company is growing and/or profitable. In addition, inflation erodes debt. At the same time, wireless companies can raise prices easier than other companies due to the limited competition, their investment in technology, and the cost and time with switching wireless providers.
On a price-to-cash-flow from operations (CFO), Sprint trades at 14.4 times its CFO, significantly higher than the 5 to 6 times price-to-CFO for the rest of the group. For comparison, Apple (APPL), which relies on the wireless carriers to a large extent, trades at a price-to-CFO of about 11.6 and Microsoft (MSFT), another strong cash generator, trades at a price-to-CFO of about 12.2. A price-to-CFO of under 7, could be considered a bargain for the wireless carriers.
In conclusion, the wireless service providers discussed above offer a good investment opportunity. Investors can expect lower volatility in their stock prices and higher returns over the long term. Wireless service providers operate in an area with large barriers to entry and where demand should continue to grow nicely for the foreseeable future. Importantly, the government benefits disproportionately from the wireless carriers (by selling spectrum to them and by imposing fees and taxes to consumers on their wireless bills) and is likely to support their business models. Finally, the wireless operators have significant debt levels and this allows to put their equity returns on steroids.
Of the four companies, Sprint looks like the riskiest while AT&T and Verizon the most stable with T-Mobile in the middle. An investment portfolio comprised of all four companies, will ensure that investors will benefit from the wireless business while ignoring any company-specific stock price fluctuations.