Emerging market operators make the right calls

Growth investors can still capitalise on the expansion of telecoms networks in emerging markets – as well as growing global demand for smartphones – according to sector analysts.

Network operators with a global presence offer the potential for capital growth and attractive dividends, backed by strong free cash flow, claims Chris Whitehouse, a UK-based telecoms analyst for US firm T Rowe Price. “Companies that have good geographical exposure – like Vodafone to the US and emerging markets – have a rising free cash profile that more than supports a very generous capital return to shareholders,” he says.

But while some focus on the income payouts to shareholders, Whitehouse suggests that network companies provide long-term growth opportunities, too. He points out that Vodafone has been performing well in emerging economies. In the year ending March 2011, its revenue from Africa, the Middle East and Asia Pacific was up 11.8 per cent, with operations in India and Turkey among the main contributors.

Other global operators can offer a similar combination of growth and income. “Telefónica has good geographical diversification in Latin America and is yielding 11 per cent next year,” notes Whitehouse.

Mobile telecom providers are seeing revenue growth in these developing regions because of the lack of fixed-line infrastructure, or landlines. Unlike developed markets, there is no legacy fixed-line provider with a monopoly market share – as was the case in the UK with BT. Emerging-market customers only want mobiles, says Mark Dampier, a fund analyst at advice firm Hargreaves Lansdown. “The first thing an Indian peasant will buy is a mobile to keep in contact with the village nearby,” he argues. “We did things differently here. We had landlines first because we didn’t have mobiles.”

UK fund managers have been adding emerging market exposure to their existing telecoms holdings. Fidelity’s Global Telecommunications Fund, for example, has 9.8 per cent of its assets invested in US telephone network AT&T, its largest stake in any company. But it also holds shares in China Mobile and Singapore Telecom. Fund manager Aditya Shivram prefers companies that are forecast to generate higher-than-average earnings growth, as well as those that appear undervalued.

Some mobile operators now offer income plus the growth potential of the smartphone market. Vodafone – which last month announced the payment of a £2bn dividend in February, from its 45 per cent holding in US group Verizon Wireless – is now about to release a cut-price smartphone in conjunction with Facebook, integrating the social networking site. Shares in the UK-listed operator rose 3.6 per cent in July.

However, dedicated handset manufacturers have struggled to compete with new entrants. Research in Motion, maker of the BlackBerry smartphone, last month said it is to shed 2,000 jobs. Its move follows shareholder demands after disappointing financial performance in the past six months. Once the market leader in smartphones, the Canadian company has been overtaken by Apple and Google – and has seen shares lose 60 per cent of their value since the beginning of the year.

Data and apps, as much as the handsets themselves, are the new focus for specialist funds. Sylvia Sejournet, manager of Pictet’s Digital Communications Fund, has refocused her shareholdings to take advantage of opportunities in web-based smartphones and data exchange.

Her fund now invests mainly in IT applications and content, to capture demand for cloud computing, online advertising and video games. “When we moved from being a 100 per cent telecom fund to being an interactive tech fund, we decided to capture demographic and social media mega-trends,” Sejournet says. She believes that the number of smartphones in use will increase from a current 463m worldwide to a projected 730m by the end of 2011.

But Sejournet suggests the real opportunity is in e-commerce and financial services. “We expect mobile banking activity to ramp up in emerging markets because the mobile network is already there, whereas the banking network is not as developed,” she explains.

Although the west’s banking infrastructure is more advanced, there is scope for growth in mobile e-commerce in the UK, too – consumers have tended to use PCs for most online transactions. According to a study by the Mobile Entertainment Forum earlier this month, 91 per cent of respondents claimed to have either researched a product or purchased one on a smartphone. Barclaycard is aiming to roll out small-scale mobile phone payments to the mass market by 2012.

Not all investors are giving up on fixed-line operators, though. At the start of August, private-client stockbroker The Share Centre named BT as its “share of the week”. Nick Raynor, investment adviser, cites the company’s ability to “secure its largest-ever contract in Latin America”, its 6 per cent reduction in operating costs year-on-year and its dividend yield of 4 per cent. “In six months it has trebled its customer base,” he notes.