Thus, from a list of high-yield candidates to replace two holdings that have been ditched from the Bearbull Income Portfolio (see last week's column), first I have tackled Manx Telecom (MANX).
Roughly speaking, Manx Telecom does what it says on the tin. It supplies telecoms services - fixed-line, mobile and broadband - to the 85,000 folk who live on the Isle of Man and, as monopolies go, few are more comprehensive than Manx's. It is the only operator of a copper network on the island, connecting to 35,000 homes and 4,000 businesses. That produces 51,000 voice lines and approaching 26,000 broadband customers. In addition, its mobile services have almost 35,000 pre-paid customers and 29,000 on contracts.
A monopoly of such depths is both good and bad, although mostly good. As Manx's bosses said when the company got its Aim quotation in 2014: "Significant capital expenditure would be required for direct competition, leading to high barriers to entry, as the relatively small market deters larger players from targeting the Isle of Man." Innocuous though that sounds, barriers to entry rarely come stronger than those provided by dominance of a small market. For the biggest players, what's at stake isn't worth the bother, so they don't get involved. Meanwhile, those smaller players, for which a chunk of the Isle of Man's market might be worthwhile, may struggle to compete. Some won't have the spare capital; others may lack Manx's pricing power, although that may be constrained by the restrictions placed on the company by the island's communications commission, which has granted Manx a licence that runs to 2019.
The monopoly is bad to the extent that the communications commission could revoke the licence - after 2019 Manx is on 12 months rolling notice. The more obvious restriction is that the group's growth is tied to the expansion of the island's economy. Wealthy though the islanders are and resilient though the island has proved to be, the Isle of Man's economy is not growing fast. With a near-static and elderly population - the median age is 43.4 years, about three years older than the UK's - how could it be?
Thus the company seeks to grow via new services and to capture new customers not based on the island. That means Manx has been pouring capital into its 4G mobile network and into data hosting. That enables it to provide mobile networks to so-called virtual operators and 'machine-to-machine' services, which usually involves providing monitoring services such as vehicle tracking. These additions may boost revenues per subscriber and bring in new customers, although such plans hardly set Manx apart.
The long and the short of it is that Manx's growth will be sedate at best. But that does not matter so long as (a) the company can maintain its dividend and (b) buying at the current 202p share price offers some upside. The company is helped by the fact that there is no corporation tax on the Isle of Man. Partly as a result, in each of the past five years free cash flow - the cash profits left for shareholders - has comfortably exceeded the £11.2m cost of 2014's 9.9p per share dividend. Even when capital spending leapt to £12m in 2014 - as management spent heavily on the 4G network and a new data centre - free cash flow was still almost £17m. The lowest it has been in the past five years is £13.6m in 2010, the year Spain's Telefonica sold Manx to private-equity buyers.
Whether the shares are cheap at the current price is more debatable. As we know, there will be little growth, but if the company can maintain operating profits at their latest level - £23m in 2014 - then they are definitely cheap. However, 2014 was exceptionally profitable, so that assumption carries little margin for safety. A cautious investor seeking the 8.5 per cent annual return that Bearbull targets needs to be confident the group can consistently produce £19.5m of operating profits before making the bullish conclusion. Assuming the upwards trend in operating profits over the past five years does not falter, such confidence would be easy. But if profits reverted to the average of the past five years, the shares look pricey.
However, I have bought a holding in Manx for the Bearbull income portfolio. I am more influenced by the likely reliability of the dividend than the possibility of share price growth, though - either way, the chances are that Manx's monopoly will stand it in good stead. I have put the remainder of the fund's spare capital into Vesuvius (VSVS) - see Bearbull, 24 July 2015 - and soon enough to pick up the 5.15p interim dividend. That means the fund is fully invested, but there is still the need to replace some holdings - GlaxoSmithKline (GSK) in particular - so there is work to be done.
