Monday, July 25, 2005
July 25, 2005 - Financial Times The stocks of American local telephone companies are down substantially from their heyday of the late 1990s and they have been facing problems on many fronts, including fierce competition from cable operators. But not all phone companies are created equal. In the middle of the South Pacific, Telecom Corp of New Zealand, or NZT, competes in a quite different environment. A unique geography and a relatively small market are responsible for a very atypical competitive environment. New Zealand's two forgotten islands are roughly the size of Colorado, with a population of 4m people. Cellular: There are only two players in the wireless market, Telecom of New Zealand and Vodafone, competing in a cosy duopoly environment. The relatively small market size and fairly large terrain can only support a few wireless market players. Economies of scale are crucial in this business. It would be very difficult for a new player to enter the market at a scale large enough to compete effectively against the incumbents in such a small market. Both NZT and Vodafone are aware that they have it as good as it gets, and are likely to milk the good thing for as long as they can. In fact, in its earning press release NZT hints (to investors as much to Vodafone) that its only aspiration is to grow along with its roughly 50 per cent market share. Although New Zealand's wireless market is quite saturated, with a 80 per cent installed base (this number is likely to be overstated by prepaid customers), the growth is coming from the provision of previously unavailable but very popular data services: texting, instant messaging, ringtones downloads and so on. Data accounted for 15 per cent of wireless revenues and grew 90 per cent in the last quarter - it is likely to remain strong in the future. Broadband: The story only gets better. Cable service is basically non-existent in New Zealand, paid television services are offered through satellite, making NZT a de facto monopoly in the wired line and broadband spaces. It introduced a DSL product in a meaningful way only last year (although DSL is available in 92 per cent of the country), and it is one of the main drivers of revenue growth. NZT has a more than 50 per cent market share of the very competitive dial-up market. It has been making a graceful exit from that arena by switching customers from dial-up to DSL (a much higher margin product). NZT's DSL penetration is still a relatively small 13 per cent, thus this segment will be growing at a fast pace for a long time as consumers switch to a faster, more convenient internet connection. Wireless services are much more expensive in New Zealand than in the US, hence you do not see the level of defections from landlines to cellphones as observed in the US. In the absence of cable competition, there is little rivalry left in the residential line business. Revenues in this segment declined 1 per cent, due in part to the decrease in number of second phone lines as customers switch to DSL. NZT subsidises the DSL modems and cell phones it provides to customers, the cost of which is expensed right away, not depreciated. NZT's earnings growth over last year was hindered by the explosive growth of the DSL and wireless business. As these costs gradually filter through, NZT's margins should expand back to typical levels and its operating profitability should start keeping pace with its top line. The weakest link in NZT's performance is its long-distance business, which declined 11 per cent. Long distance is a shrinking market. However, it has been in decline for a while and as it gets smaller the rate of decline should decelerate and it should have less impact on the bottom line as its base shrinks.
Telecom New Zealand easily passes the quality, value, and growth test. Quality: NZT has strong and sustainable competitive advantages, which show in its above industry margins and return on capital of 18 per cent, twice that of Verizon or SBC. Its debt is rated A by S&P and debt payoff ratios are respectable considering the stable and recurring nature of NZT's cash flows. Value: NZT trades at about 13 times earnings and about 12 times free cash flows. Based on our discounted cash flow model, there is no growth priced into the stock, an unlikely scenario. In addition, NZT's secure dividend yield of 7 per cent should serve as a cushion in the market that has delivered no returns for the last seven years. Growth: NZT generates ample cash flows to invest for growth, pay a dividend and pay down debt. As the declining long distance business gets smaller and fast growing DSL and cellular businesses get larger, NZT's bottom line growth should accelerate to about 5 per cent a year. Adding a 7 per cent dividend on top of that produces a respectable rate total return and that is without factoring in any price earnings expansion, which is warranted. NZT has another unique feature: because it is a foreign-listed ADR, it could also work well as a hedge against the falling dollar. The author is a portfolio manager with Denver-based Investment Management Associates and teaches equity research at the University of Colorado. His firm owns shares in New Zealand Telecom. FT.com / By region / Asia-Pacific - Small telecoms market means NZT is nearly alone in its field Vitaliy N. Katsenelson, CFA