Online Extra: Telecom Picks from a Pro
Telecom stocks are no longer the scourge of the
market. Since the start of this year, the 45 companies in the Standard & Poor's Global 1200 Telecom Services index have gained 11.5% -- less than the overall Global 1200 but better than energy, consumer staples, and health care. Investors clearly believe the worst is past.
Fund manager Phillip Sundquist, 41, who runs the $57 million Zurich-based Clariden Communications Equity Fund, has outperformed the index, with 15% appreciation this year. An 11-year veteran of Credit Suisse (CIK ), Clariden's parent, Sundquist began managing the Communications Equity Fund in 2001 after eight years as a telecom credit and equity analyst. He spoke with BusinessWeek European Technology Correspondent Andy Reinhardt about his picks and pans, general market trends, and how he has beaten the averages. Following are edited excerpts from their conversation:
Q: What are the guidelines for your fund? A:
Q: What are the guidelines for your fund?
A:Our guidelines allow me to invest in a wide universe -- telecom services, telecom equipment, and even some media-related areas like broadcasting. Our benchmark is the MCSI World Telecom Services Index, so the emphasis is clearly on telecom services. But I can and do invest in related areas that have something to do with communications. It's also a global fund, which means I can invest outside of Europe and the U.S. So I have investments worldwide, including in emerging markets.
Q: Your performance in the last three months and year-to-date has outpaced the benchmark. How did you do it? A:
Q: Your performance in the last three months and year-to-date has outpaced the benchmark. How did you do it?
A:I try to pick stocks that offer value and a balance between growth potential and a reasonable price. My fund has done well thanks to a combination of investing in emerging markets, plus having exposure to high-beta [more volatile, higher-risk] stocks. This has paid off handsomely.
I'm also careful about certain areas that I think are underperforming. For instance, my bet to underweight the big U.S. Baby Bells -- the regional Bell operating companies -- has paid off.
Q: What's your stock-picking methodology? A:
Q: What's your stock-picking methodology?
A:I look at valuation and a number of different measurements, such as price-to-earnings ratio, price-earnings growth, and ratio of enterprise value to EBITDA [earnings before interest, taxes, depreciation, and amortization]. But I use valuations as a means, not as an end. I respect fund managers who use quantitative models, but I don't think that should be a substitute for fundamental analysis.
I think you need to understand a company and how it's managed, understand its strategy, and understand the competitive advantage -- if there is one. For me, it's more fundamentally driven than quantitatively driven.
Q: What are some of your current favorites? A:
Q: What are some of your current favorites?
A:My seventh-largest holding is now Mobile Telesystems (MBT ), a Russian mobile operator. And AT&T Wireless (AWE ) is No. 10. These are two stocks that have done well recently.
I have a lot of exposure to Russian stocks: In addition to Mobile Telesystems, I have two regional operators, Uralsvyazinform (UVYZY ) [the largest fixed-line operator in the Urals area east of Moscow] and Volga Telecom [a fixed-line operator in the Volga river region southeast of Moscow]. A fourth stock I have in the fund is Rostelecom (ROS ) [Russia's nationwide long-distance carrier]. All four of these stocks have had very strong performance.
Q: Why so many Russian companies? A:
Q: Why so many Russian companies?
A:The Russian telecom market is hot now. But I got into these stocks last year. The reason they're attractive is that in Russia, like in many emerging markets, telecom is still a growth industry. As markets develop economically, they see telecom as a strategic industry, and it's an area the governments promote. They see as vital for their economic well-being.
Just putting in the basic infrastructure for making phone calls is still a growth area. And in addition to basic telephony, there's also mobile, which is interesting because it's a status symbol. If people have a mobile phone, it's a sign of wealth
Q: Are you in other emerging markets? A:
Q: Are you in other emerging markets?
A:Yes. I have two Mexican stocks: América Móvil (AMX ), which is arguably the best-run wireless company in Latin America, and Telmex, which is the incumbent operator. Telmex still has some attractive growth opportunities and the valuation is quite reasonable.
Q: Emerging markets can be risky. What attracts you about these telecom plays? A:
Q: Emerging markets can be risky. What attracts you about these telecom plays?
A:Liquidity is often an issue when you invest in emerging markets. But in many of them, one of the largest companies on the stock exchange is usually the incumbent operator. That means these stocks are highly liquid. That's interesting for foreign investors because you can get in and out of them quickly.
Q: What are most attractive large incumbents? A:
Q: What are most attractive large incumbents?
A:Right now, the market is favoring incumbents that have aggressive restructuring plans in place -- companies like Deutsche Telekom (DT ), France Télécom (FTE ), and KPN (KPN ). These companies were burdened with high debt levels, and now they're taking steps to reduce debt and improve free-cash flow.
During the last couple of years, when the market was going through the downturn, investors got quite worried about the financial health of these operators. Now they're rewarding companies that took serious steps to address the problems.
I also like [Spain's] Telefónica (TEF ). It has a combination of a very strong position in its home market and exposure in Latin America. Even though the situation in Latin America is still uncertain and there's still a lot of volatility, I think the investment will pay off long term. It makes sense for Telefónica to be in that part of the world, given the historical and language ties. In contrast to some of the other European incumbents, Telefónica still has genuine growth potential, given its Latin American position.
Q: How worried are you about the decline in fixed-line voice-service revenues and its potential impact on incumbent telcos? A:
Q: How worried are you about the decline in fixed-line voice-service revenues and its potential impact on incumbent telcos?
A:It does affect my strategy. Companies that are still dependent on fixed-line are facing a situation where their core business is shrinking. They need to stem the decline, and so they're adopting strategies like investing in broadband.
In the U.S., Verizon (VZ ) is also turning to bundling, where it offers a variety of different telecom services to clients. The dilemma is that while fixed-line is declining, it's also a cash cow. So companies can use the money to invest in areas like wireless or even Wi-Fi [high-speed wireless Net access], where they see growth potential.
Q: What areas are you generally avoiding? A:
Q: What areas are you generally avoiding?
A:There are two areas that I'm underweight, but I wouldn't say I'm avoiding them. The first is the U.S. Baby Bells, and the second is European incumbents. You have to keep in mind that most of the Europeans are fully integrated operators with wireless divisions and in some cases media subsidiaries, so they're not pure telecoms. Still, they face some of the same issues in trying to address falling fixed-line revenues.
Realistically, we're going to see more growth at wireless companies and in emerging markets. Some of the alternative carriers also could see growth. It's really the large incumbents that are struggling.