Cape Town - Although it is tempting to believe
that the high and stable historical growth trend in the telecommunications
industry revenue will persist and thus continue to support the investment
case for most telecoms companies, Allan Gray's experts believe such a
simplistic conclusion is inappropriate.
Jan Silvis, writing in Allan Gray's quarterly commentary
circulated on Monday, said: "After an extended period of high growth we would
argue that the risks are to the downside."
"As investors," he said, "we are more interested in a company's free
cash flow than its revenue. It is therefore more relevant for us to examine
the trend in operating profit, rather than reported revenue."
Although he agreed that profits have been increasing dramatically as
telecommunication companies capture some of the value they create for
society - operating profits are up 13.3 times in nominal and 4.6 times in
real terms - he pointed out that growth in industry profits has not kept up
with growth in industry revenues.
He also said that despite stable revenue growth, the industry profit
pool has grown significantly below trend in the past three years.
The fact that the voice market is maturing is one reason for this. Voice
services still contribute approximately 80% of industry revenues, but
revenue growth has declined to single digits. The voice traffic carried on
Telkom's fixed-line network has declined by about 25% over the past
five years, mobile SIM card penetration now exceeds 100% of the
population, and the annual growth rate of voice traffic carried on mobile
networks is declining.
Competition is increasing, through both market liberalisation and
technological changes. The adoption of new technologies, such as voice over
internet protocol, has converged voice and data services. Now traditional
data market participants, like the internet service provider Internet
Solutions, can compete with the incumbent operators in the voice market.
Finally, the operating profit pool has declined in real terms. Silvis
showed that when adjustments are made for the effects of inflation, the
industry profit pool peaked in 2006 and actually declined in 2008. "It is
interesting to note," he said, "that in real terms, the Telkom fixed-line
voice and data business currently earns a similar level of operating profit
as in 1993."
He indicated that in sharp contrast to the annual price increases
typical of most consumer goods like food, beer, cigarettes or luxury goods,
telecommunication unit prices (per minute or per megabyte) have tended to
decrease over time. The main reason for this trend is that operators have
shared some of the technological and scale cost benefits they have enjoyed
with their customers in their efforts to attract and retain subscribers.
"Since 1993 the secular growth in mobile voice and data traffic volumes
has more than offset the impact of declining real unit prices, resulting in
increasing profits," he said.
"However, in a mature and more competitive
market, operators are likely to find it more difficult to manage the
relationship between revenue and both operating and capital costs to their
advantage. In real terms the operating profit pool may well decline
further."
Silvis concluded that the industry is currently attracting record levels
of new capital investment, but the returns generated on those investments
are likely to be lower than those achieved in the past.
- I-Net Bridge