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Making Money on Overseas Calls

Our analysts describe the layout of the global telecom landscape.

Haywood Kelly, 03/09/2010

On one hand, global telecom firms offer huge cash flows, high dividends, and, in some cases, good growth potential. On the other, they're exposed to massive risks of technological change and government regulations. To help make sense of the opportunities in global telecom, we chatted with members of Morningstar's telecom team--Allan Nichols and Imari Love.

Haywood Kelly: Big picture, what's your team's thesis on global telecom? Where do you see this industry 10 years from now?

Imari Love: A lot can happen in 10 years. If we look at how the telecom industry has evolved since 2000, the metamorphosis has been startling. Ten years ago, much of the wireless industry was defined by companies with high leverage and low visibility. Firms were still trying to figure out exactly how much they could get away with charging and the best ways to manage their cost structure. These days, the economics of the business are better understood. Throughout all of the global telecom sectors, cash flow and dividend yields have increased, while debt ratios have dropped off considerably. Cell phones have gone from being a luxury to being a necessity, and the carriers are now viewed as defensive plays that pay out healthy dividends and buy back stock. And in 10 years, the landscape will look a lot different.

Allan Nichols: We see continued integration between communication methods: fixed-line, wireless, broadband, and television. In 10 years, wireless communication will be ubiquitous. People will be able to receive a wireless signal almost anywhere in the world and virtually every adult and youth will have a mobile phone. Smartphones will rule the planet, with data being the biggest driver of revenues. We expect some tumultuous times as carriers revamp pricing strategies to charge users for the bandwidth they use. Currently, voice charges are paying the bills, but voice doesn't use a lot of bandwidth. AT&T T recently stated that 3% of its smartphone subscribers account for 40% of its data traffic. Current unlimited data plans don't cover the cost of such usage. Carriers need to lower the cost of voice and increase the cost of data. In the developing world, wireless phones will act as a computer for many people. Fixed-line networks often only cover about 20% of the population, and they are unlikely to be expanded. In developed markets, however, we expect the fixed-line network to remain the primary distributor of broadband. It is, and will remain, faster, more secure, and easier to view. Today, many cable firms are offering broadband speeds at 100 Mb/second or faster, which is much faster than the 20 to 30 Mb/second being offered by most European carriers. We expect greater competition between the cable firms and telephone carriers as they each offer the others services. We expect that phone companies will need to push fiber further out. We also think broadband speeds could reach 1 Gb/second in 10 years as fiber is built all the way to people's homes and new technology is invented.

HK: What would keep you awake at night if you ran a major telecom firm?

AN: My biggest concern would be regulation. The regulators continue to cut the fees carriers are allowed to charge other operators using their network, which could make it uneconomical to upgrade the network. Without upgrading, cable firms will eat their lunch. Cable companies are pretty much unregulated, providing an unfair playing field, in my opinion. Either cable firms need to be required to share their network or telecom firms need to be given greater pricing freedom. Otherwise, there is a real risk of carriers refusing to upgrade and consumers being left with slow data speeds.PAGEBREAK

HK: What countries are best positioned competitively?

IL: There are three things we focus on when trying to gauge the investment upside of a country's telecom sector:

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