The companies that connect our phones and computers and those that deliver our favourite films and TV shows are rapidly becoming one and the same. Mounting competition, aggressive regulation and declining demand for landlines have weighed on telecom providers, leading many to focus on selling 'quad-play' bundles of broadband, TV and both mobile and fixed-line telephony. Investors had front-row seats to this seismic industry shift last year, and 2015 promises to be no different.
FTSE 350 telecom companies have turned to acquisitions to broaden their range of services, relieve competition and realise cost savings, scale benefits and network effects. That strategy also reflects the global proliferation of smartphones and tablets, soaring demand for online video and high-speed '4G' wireless coverage, and surging interest in internet-connected cars, homes and accessories. Those trends have strained telcos' capacities, and consolidation can be a cheaper option than upgrading costly network infrastructure.
The old national monopoly BT (BT.A) is an illustrative example. It launched its BT Sport television service in 2013 and now plans to enter the UK mobile market by buying carrier EE for £12.5bn. Meanwhile, pay-TV titan Sky (SKY) convinced 37 per cent of its subscribers to take 'triple-play' bundles of telephony, pay-TV and broadband in the year to 30 June 2014, and its broad offering attracted 342,000 new customers - the most in three years. It was also busy with acquisitions: Sky Italia and Sky Deutschland widened its customer base from 11.5m to 20m.
The convergence of the telecoms and broadcasting business models raises concerns for investors, though. Shareholders in both BT and Sky will be nervously awaiting the upcoming auction for the Premier League broadcasting rights. Broker RBC Capital thinks the two companies will spend £3.9bn - 30 per cent more than last time - which could dent short-term profitability. If Sky cedes any rights, it risks losing subscribers.
Challenger telco TalkTalk (TALK) has taken a different tack: it aggressively courts consumers with cut-price telecoms packages. That approach helped it attract 300,000 TV customers in the six months to end-September - taking the total to 1.2m - and add nearly 90,000 broadband and mobile users. Moreover, it recently strengthened its TV offering by buying Tesco's Blinkbox business, netting the troubled grocer's broadband and voice customers in the process. Investors will want to see TalkTalk make progress towards doubling its cash profit margin to 25 per cent by 2017.
Mobile carrier Vodafone (VOD) has trailed the pack due to fierce competition, onerous regulation and tumbling service revenues in Spain and Italy. Those forces drove its adjusted operating profit down 30 per cent in the half-year to end-September. It has responded by putting to work the $130bn (£86bn) windfall from the sale of its stake in US carrier Verizon Wireless. For instance, it expanded in Europe and broadened its services by buying Kabel Deutschland and Spain's Ono for nearly €15bn (£11.7bn) last year. And its extensive network investment programme, 'Project Spring', has widened its 4G coverage from 32 to 59 per cent of Europeans. Damage control in Europe, investments in faster-growing emerging markets and the launch of a broadband service are likely to be on the agenda this year.
It was also a tough year for Telecom Plus (TEP), one of 2013's star performers. Shares in the utility, telephone and broadband provider slumped about 28 per cent as a hot summer dried up domestic energy demand. The absence of the previous year's price hikes from the UK's 'big six' energy suppliers didn't help, either. Still, the company grew its customer base by 7 per cent, sending first-half operating profit up almost a third to about £15m.
Satellite communications group Inmarsat (ISAT), meanwhile, was hit by US defence cuts and troop withdrawals from the Middle East. Shareholders will want to see progress on Inmarsat's worldwide high-speed broadband network, Global Xpress, which suffered launch delays last year.
The structural challenges posed by rapidly evolving technology and consumer habits remain daunting, but Britain's big telecoms and broadcast companies have largely coped - so far - by transforming their range of services. That leaves the sector's key attractions for investors unchanged: strong cash generation, excellent revenue visibility and decent dividend yields. Trends such as 'big data' and the 'internet of things' are likely to play an important role this year - albeit in unpredictable ways - and it seems likely telcos will continue to react through consolidation, technological investment and diversification.
| Company | Price (p) | Market value (£m) | P/E ratio | Dividend yield (%) | 1-year performance | Last IC view |
|---|---|---|---|---|---|---|
| BT Group | 421 | 34,298 | 14.2 | 2.7 | 10.4 | Buy, 405p, 17 Dec 2014 |
| Cable & Wireless Comms. | 51 | 1,409 | 12.4 | 4.8 | -7.7 | Hold, 45p, 06 Nov 2014 |
| Colt Group | 130 | 1,164 | 39.6 | 0.0 | 3.1 | Sell, 132p, 28 Feb 2014 |
| TalkTalk Telecom Group | 327 | 3,122 | 36.7 | 3.9 | 2.9 | Hold, 282p, 12 Nov 2014 |
| Telecom Plus | 1,126 | 902 | 19.8 | 3.4 | -40.6 | Hold, 1,298p, 19 Nov 2014 |
| Entertainment One (Di)* | 288 | 850 | 12.3 | 0.4 | -2.2 | Buy, 310p, 06 Jan 2015 |
| ITV* | 228 | 9,162 | 19.0 | 1.7 | 11.2 | Hold, 204p, 30 Jul 2014 |
| Sky* | 927 | 15,927 | 15.2 | 3.5 | 8.1 | Buy, 943p, 08 Dec 2014 |
| Inmarsat | 834 | 3,739 | 28.8 | 3.4 | 12.2 | Buy, 708p, 07 Aug 2014 |
| Vodafone Group | 238 | 63,132 | 15.6 | 4.7 | -2.3 | Hold, 220p, 12 Nov 2014 |
| *FTSE classification: media | ||||||
Favourites
Shares in independent TV and film distributor Entertainment One (ETO) delivered the sector's best return in spite of a muted box office. That reflected the phenomenal Peppa Pig franchise, which recorded over $1bn in retail sales and landed nearly 200 new broadcast and licensing deals worldwide. The group also bought a prominent Hollywood producer, strengthening its foothold in the key US market. Its shares have delivered an eightfold return since our buy tip (39p, 20 November 2009), but we think that's just the trailer. We also favour broadcaster ITV (ITV): first-half sales slid at the broadcaster's fledgling production business, but it boasts top-class content and a promising online and interactive division.
Outsiders
Cable & Wireless Communications (CWC) is attracting subscribers and whittling down its operating costs. But the Caribbean and Latin American telco is in the middle of a wide-ranging investment programme, and its $3bn purchase of rival Columbus International may well disrupt its short-term performance. We also have doubts about IT, data and network services specialist Colt (COLT). Restructuring and lower equipment sales depressed its revenues and cash profits in the quarter to end-September, and weak European demand and zealous regulation remain troublesome.
