SmartMoney: The Next Growth Stocks:
Looking For Real Earnings Growth? Then
It's Time That You Expanded Your
Boundaries Beyond Our Shores; Here Are
Seven
Dow Jones Newswires
No further information is available at this time.
This story appears in the April issue of SmartMoney
magazine.
By Nellie S. Huang & Gerri Willis
SK telecom has everything you want in a growth stock. Market leadership.
(It's the biggest wireless-service provider in one of the biggest wireless
markets.) Innovation. (It's about to launch a service that allows people to
view the Web on their cell phones.) And big- time numbers. (Its earnings
are expected to soar 177 percent this year.)
You'd think that with those kinds of attributes, this stock would be
swarmed by U.S. investors. But you're not likely to hear it talked up on the
Silicon Investor Web site or on CNN's Moneyline. Chances are, your
buddy next door, the one you're always comparing investment results with,
has never even heard of it.
That's because it's based in Seoul, South Korea, some 5,640 miles from
downtown Silicon Valley.
Without a doubt, the U.S. is the white-hot epicenter of technology. From
Cisco Systems to Lucent Technologies to JDS Uniphase, the leading edge
begins right here on our shores. (Indeed, most of the companies in last
month's "Ultimate Tech Portfolio" cover story make their homes in the
U.S.) But while it was American companies that led the PC revolution,
foreign companies such as SK Telecom are helping push the next wave of
technology -- telecommunications. To ignore markets such as South Korea
right now is to turn your back on some of the world's best investment
opportunities.
It's not just about technology, either. There are plenty of other places to
find growth overseas these days. The fact is, foreign markets aren't just
recovering -- they're in serious expansion mode. Already, the effects are
showing up in the stock markets. Last year, for the first time in five years,
Morgan Stanley's index of European, Australian and Far Eastern stocks
(EAFE) beat the Standard & Poor's 500-stock index, posting a 27.3
percent return, six percentage points ahead of the U.S. index. And history
shows that when the lead between U.S. and foreign stocks changes hands,
it tends to stay that way for at least two years. The best part is, you won't
have to pay the kind of premiums overseas that you do here. The average
price/book value -- a ratio used to compare the costliness of stocks in
various markets -- is 5.4 for U.S. companies, but it's only 3.3 for the rest
of the world. (More specifically, it's 4.0 for Europe, 2.4 for Japan and 2.3
for the rest of Asia.)
Don't get us wrong. The U.S. economy should still go strong -- analysts
expect GDP growth to clock in at an inflation-adjusted 3.7 percent this
year. But that's down from 4.0 percent last year and 4.3 percent the year
before. Meanwhile, foreign markets are just getting rolling. Developed Asia
(South Korea, Hong Kong, Taiwan and Singapore), for instance, is
already growing faster than the U.S., at an estimated 5.8 percent this year.
In Asia, all the ingredients for a bull market are in place. Last year
countries throughout the region recorded immense GDP growth: China, an
estimated 7.1 percent; Taiwan, 5.5 percent; and Korea, a whopping 9.5
percent. Interest rates, down considerably from their sky-high 1997 levels,
are staying relatively low -- 8 to 10 percent in Hong Kong, Taiwan and
South Korea. Meanwhile, inflation is in check, holding at about 1 percent
in developed Asia and Japan. All of this has pushed corporate earnings
higher. In Japan, Singapore, South Korea and Taiwan, earnings growth this
year is expected to hit at least 20 percent -- the ceiling Salomon Smith
Barney puts on its estimates. "In fact, some of those countries show even
greater growth," says Holly Sze, a global asset-allocation analyst with
Salomon Smith Barney.
In Europe, the economy is not growing so fast (1.9 percent last year), but
that growth is accelerating. It's expected to hit 2.8 percent this year.
Another good sign: In the wake of state-run companies privatizing,
businesses are becoming more market-driven; they're restructuring and
streamlining to cut costs and improve profits. Mergers and acquisitions, the
ultimate indicator of corporate change, hit a record level last year, with
$1.3 trillion in announced deals, more than twice 1998 levels, according to
Thomson Financial Securities Data. M&A activity is "at full speed already,"
says Morgan Stanley Dean Witter European-equity strategist Teun
Draaisma.
The European stock markets are beginning to respond, but a weak euro
has dampened the results. Last year, for instance, markets in Germany and
France gained 41 and 52 percent, respectively, in local currency terms. But
factor in the euro's slump against the U.S. dollar and those returns shrink to
20 and 30 percent. The flip side, of course, is that the weak euro offers a
great buying opportunity for U.S. investors. "There's every reason to think
that the euro will be higher a year from now," says Carol Franklin, manager
of the Scudder Greater Europe Growth fund.
Even without a rise in the euro, the landscape for European stocks looks
promising. In all but one of the 14 EU countries -- Switzerland -- analysts
expect corporate earnings to grow 14 percent or better this year.
Expectations haven't been this high in four years. "All indicators suggest
that the bottom is over for corporate profit cycles," says Markus Barth,
Merrill Lynch's director of European quantitative strategy. Morgan
Stanley's Draaisma agrees: "The momentum is with Europe. The change is
happening in Europe."
Optimism around the world, in fact, is high. The index of global earnings
revisions -- upward minus downward revisions over total revisions, a
measure Morgan Stanley strategists believe is a leading indicator of
economic activity -- has been rising steadily for the last year. Granted, this
rise seems to have tapered off in 1999's final quarter. Even so, the last time
the index climbed steadily (from 1993 to 1995, though there was a blip in
the middle), it coincided with a two-year rally in which the EAFE index
outpaced the S&P 500.
That brings us to this question: Where to invest?
With rising growth rates in places such as Malaysia and Latin America, you
might be tempted to consider stocks in emerging markets. Before you do,
take a look at their track record since 1990. Not only have
emerging-market stocks been volatile, they haven't even provided a high
reward for the risk. Over that period, stocks in emerging markets had a
cumulative total return of 44 percent, less than half the return for those in
developed foreign markets. For that reason, we limited our picks to
developed Asia and Europe.
In Asia, in interview after interview with analysts and strategists, Taiwan,
South Korea and Japan came up again and again as the best places to
invest. "Larger and developed economies are more likely to duplicate the
success achieved in the U.S. and Europe -- economies that grow strongly
with low inflation," says Ana G. Chapman, an equity strategist for Asia at
Goldman Sachs. These countries are also less likely than some others to
suffer from U.S. interest-rate hikes because they control their own
monetary policy -- unlike Hong Kong, for example, where the currency is
pegged to the U.S. dollar.
In Europe, we focused on countries within the European Monetary Union.
Despite the euro's disappointing first year, the new currency has helped
create an open culture for business that mirrors the American corporate
style. You can see it in the region's burgeoning venture- capital industry, in
business-friendly proposals such as Germany's corporate tax cuts and even
in the arrival of hostile takeovers. Not so long ago, share buybacks were
not allowed in many European countries. Not anymore, and companies are
taking advantage of that to boost shareholder value. Buybacks were up 28
percent last year.
Next, we zeroed in on industries growing 20 percent or more over the next
two years. That led mostly to tech sectors such as telecommunications,
semiconductors and Internet infrastructure. The semiconductor industry, for
instance, is in only its second year of a recovery after a three-year supply
glut. Following four years of basically no growth, sales climbed 15 percent
last year and are expected to grow 21 percent next year.
Telecommunications, too, was an easy choice. The demand for Internet
access and cell-phone services is booming across the globe. Last year
consumers worldwide bought more than twice as many cell phones as
PCs, and most of those new users live in Europe and Asia. Now all eyes
are on the next stage of wireless technology: phones that double as Internet
surfing devices. By 2002, analysts say, 12 percent of all cell- phone users
will be hooked up to the Web through their handsets.
Whatever the industry, we looked for companies that either were leaders in
their sectors or were instrumental in changing the way business is done.
Taiwan Semiconductor Manufacturing, for instance, recognized early on
that there was a market for supplying chips to manufacturers who couldn't
afford to build the plants themselves. Now it's reaping the benefits as more
companies move to outsource chipmaking. We also paid close attention to
companies that have successfully completed a restructuring -- streamlining
their business, spinning off noncore assets, trimming their workforce.
No further information is available at this time.
We ran the companies through a simple screen, too. Earnings or revenue
had to be growing at least 20 percent a year. We made an exception for
Vivendi, a French company that is transforming itself from a water utility
into a new-media powerhouse. Its earnings estimates are lower, at around
12 percent, largely because analysts haven't yet factored in some deals the
company has in the works.
All seven of the companies we picked trade on U.S. exchanges as
American Depositary Receipts. Prices are as of Feb. 18.
ASIA
Nomura Securities
Japan
(NRSCY, $275.00)
Picture the U.S. brokerage industry before discount brokers, before most
Americans had 401(k) plans, back when the mutual fund industry, now
filled with some 10,000 funds, had only 1,000 names. That's what Japan
looks like today.
But not for long. The landscape there for individual investing is changing
rapidly -- in ways that will make it look more like the U.S. -- and Nomura
Securities, Japan's biggest financial-services firm, is adjusting to take
advantage of that. Take the pension, that guaranteed payback for a
Japanese worker's years of toil. It is becoming a thing of the past. The
Japanese version of the 401(k) hasn't arrived quite yet, but Nomura will be
front and center when it does. More than a year ago, the company teamed
with one of Japan's largest banks to provide consulting for businesses
trying to set up plans.
Last October, Japan deregulated pricing on brokerage commissions. The
result? Imagine fast-forward versions of the discount-broker and
online-trading revolutions that have hit the U.S. Even before deregulation,
Nomura was offering online trading, and last year it set up a service that
allows investors to buy investment trusts -- what Japanese call mutual funds
-- by phone. The timing was perfect: When the Nikkei rebounded last
year, individual investors came out in droves.
One of Nomura's best-kept secrets is its subsidiaries. Nomura Research
Institute, for instance, announced in January that it's joining with Exodus
Communications, a U.S. data-hosting service, to build Japan's biggest
Internet data center, supporting e-commerce, online trading and Net
banking. Meanwhile, Nomura Asset Management launched the biggest
Japanese stock fund ever in February. Called the Big Project N, it already
has $7 billion in assets. Nomura plans to increase its ownership in that
subsidiary from 5 to 51 percent and spin off the research institute in a
public offering this fall. "Investors will see several jewels that have not been
recognized," says Seung Kwak, a manager of Scudder's Japan fund, which
owns a stake in Nomura and ranks near the very top of its peer group in
three-year returns.
Nomura's current good fortune caps a remarkable turnaround. A year ago
it was down on its knees. Brokerage commissions had declined two years
running. Over a three-year period, from fiscal 1997 through fiscal 1999,
the company lost about $5 billion. Nomura restructured, focusing on its
new growth strategies and cutting costs elsewhere. It trimmed its overseas
workforce by 19 percent, closed offices in Europe and Asia and scaled
down its commercial mortgage-backed securities business in the U.S. and
its lending operations in Amsterdam and London.
When the market began to turn around in November 1998, so did
Nomura's business. For the six months ending in September, revenue was
up 47 percent from a year earlier. Underwriting fees -- Nomura led a
number of stock offerings -- soared 367 percent. For the half- year, the
company turned a $697 million profit.
"The new Japan is not just the Internet," Kwak says. "Part of the new
Japan is financial services. And Nomura is going to be a big beneficiary."
SK Telecom
South Korea
(SKM, $40.94)
Last year, analysts were down on SK Telecom. They argued that South
Korea's dominant cell-phone-service provider was bound to lose ground,
since it was facing stiff competition in a saturated market. To make matters
worse, the company issued $1.4 billion in shares last summer, despite
protest from minority shareholders, and refused to detail its plans for the
money. That, says Scott Brixen, a telecom analyst at Morgan Stanley Dean
Witter in Singapore, "gave shareholders a black eye."
A year later, all is forgiven. The reason for the about- face? For starters,
the company hung on to a 43 percent stake of the established market,
while winning 44 percent of new subscribers. Its secret: SK Telecom
realized that members of the Network Generation -- 18 to 24 years old --
were a great revenue source. They spend 39 percent more time on their
phones than the company's average subscriber, and they're more likely to
embrace new telecom technology. The company launched special rate
programs designed to appeal to young users, and now a fourth of all SK
Telecom subscribers are under 30.
As for the money it raised, SK Telecom put it to good use: It bought a 51
percent stake in Shinsegi Telecom, the market's No. 3 player. The deal not
only solidifies SK Telecom's leadership -- it now has a 57 percent market
share -- it also will boost earnings by an estimated 10 percent in 2001. Not
that SK Telecom needs any help driving earnings. Analysts expect them to
grow at an annualized rate of 86 percent the next two years.
What's next? SK Telecom already offers a mobile-data service that allows
customers to access information such as stock quotes and news on their
cell phones. The company has high hopes for the souped-up version it's
launching this year that allows them to view Web pages. It's figuring on
landing nearly 4 million subscribers by the end of 2003. Goldman Sachs
analyst Candice Hwa, who is particularly bullish on the company, expects a
16 percent boost to its discounted cash flow as a result. NTT DoCoMo
has a similar service in Japan, and it drew 4 million subscribers in the first
year.
Now comes news that SK Telecom is looking for an international partner.
Rumors ran wild last year that the company was going to hook up with
Vodafone AirTouch, the British wireless company, but nothing came of
that. Talks between SK Telecom and NTT DoCoMo on a next-
generation-technology joint venture are continuing. Is a merger or
acquisition a possibility for SK Telecom this year? "Definitely," says Brixen.
At $41 a share, the stock carries a price/earnings multiple of 55 times
2000 earnings. That's high for its industry, which trades at an average
multiple of 27. But this company is growing fast enough to justify its price.
Earnings are expected to climb an annualized 45 percent over the next
three to five years, according to IBES International. That's more than three
times as fast as its Asian peers. "This is definitely one of the best telecom
stocks in Asia," Brixen says.
Taiwan Semiconductor
Taiwan
(TSM, $59.75)
It is, without a doubt, the world's hottest chipmaker. Sales at Taiwan
Semiconductor Manufacturing climbed 46 percent in 1999, and earnings
jumped 60 percent. Then there's the stock: It's up 293 percent for the past
12 months.
Too late to buy? Get this: This year will be even better for the company.
Goldman Sachs analyst Douglas K. Lee, who correctly timed the dramatic
turnaround in South Korea- based Samsung Electronics' stock last year,
expects Taiwan Semiconductor's sales to jump 106 percent and its
earnings, 86 percent. The reason is twofold: a global recovery in
semiconductors and a trend within the industry to outsource chipmaking to
foundries such as Taiwan Semiconductor.
With the 21 percent growth that analysts expect this year, chip sales
worldwide should exceed 1995's peak levels, which preceded a three-year
slump. As a maker of a wide variety of chips -- computer, telecom,
consumer goods and industrial -- Taiwan Semiconductor stands to benefit
on all fronts. That's one reason we included it in March's "Ultimate Tech
Portfolio."
The company is getting an added boost because manufacturers that used to
make their own chips are coming to Taiwan Semiconductor to do it for
them. It recently signed supply contracts with NEC and Motorola, the
second- and third-largest semiconductor producers in the world. Lee
predicts that outsourcing will account for as much as 35 to 40 percent of
the industry's foundry sales over the next 12 to 18 months, up from 27
percent last year.
Already, demand has risen so fast that the company almost can't keep up.
In fact, nobody can. Industrywide, according to the Semiconductor
Industry Association, demand for chips has outpaced supply since
mid-1999. Other chip companies have been scrambling to add capacity
internally. But Taiwan Semiconductor found a better solution: It went out
and bought capacity. Last December, in a stock swap, the company
gobbled up the rest of Taiwan-Acer Semiconductor Manufacturing, in
which it already had a 30 percent stake. And two weeks later it agreed to
buy Worldwide Semiconductor Manufacturing, the third-largest foundry in
Taiwan, in a stock deal worth $5 billion. "This provides necessary
capacity," says Goldman Sachs's Lee, "at a time when clients need it." It
also gets rid of two potential competitors. Rumor has it that more
acquisitions are to come.
No further information is available at this time.
Wall Street darlings come at a premium, of course. This stock trades at 70
times 2000 earnings. But given the long-term growth prospects -- Lee
expects earnings to grow 30 to 35 percent a year over the next three years
-- it's worth the price. One of its competitors, Chartered Semiconductor, a
Singapore foundry, trades at a much higher P/E multiple, 132, and has
lower growth prospects (29 percent a year). No pure-play chip foundry
exists in the U.S.-and that makes Taiwan Semiconductor a must- own tech
stock for U.S. investors.
EUROPE
Equant
Netherlands
(ENT, $115.19)
To understand telecommunications in Europe, sometimes you have to
know as much about politics as about business. The governments there
have a habit of meddling in the affairs of their former state utilities. Not so
with smaller challengers such as Amsterdam-based Equant N.V., a
data-network provider.
But then, Equant's roots are nothing like those of its large rivals. The
company started in 1949 as a reservations network for airlines -- a sort of
European version of American Airlines' Sabre. As the telecom industry
was deregulated, the network's owners, a nonprofit cooperative called
SITA, figured there might be a way to make money off the system. After
all, the cooperative had a secure network linking international capitals at a
time when demand for such systems was booming. Morgan Stanley
invested $200 million to build out the network, and SITA spun off Equant
as a public company in 1998.
The strategy worked. From September 1997 to September 1998,
Equant's data traffic tripled. Today Equant connects 220 countries -- the
world's largest data network in terms of geographic scope. The data
market is now expected to grow 26 percent this year and the same in
2001. And Equant has found other ways to make money. It sells products,
such as Web- and application-hosting and e-commerce software. (One
such client is Priceline.com.)
Like a lot of challengers to the incumbent telcos, Equant wants to get
bigger. It plans to add network capacity on all major continents. But it
does so differently than many rivals. Instead of laying its own fiber-optic
cable, it leases or buys space from other telco providers, putting together a
network more cheaply and with greater flexibility. For that reason, Equant
is in a stronger financial position than many of its competitors, with $270
million in cash easily covering its $25 million in long-term debt. That should
protect it if interest rates continue to rise.
There should be more good news for Equant this year, as it continues to
phase out an employee stock plan that has been sucking $60 million to $80
million each year from earnings. The company is replacing it with a less
expensive stock-option plan. U.S. analysts already ignore the impact of the
old stock plan and view Equant's operations as profitable, but the company
won't officially be in the black until the end of this year.
Unlike shares of other telecom upstarts such as U.K.- based Colt
Telecom, Equant shares have room to rise, say analysts. Salomon Smith
Barney's Jack Grubman, a three- time Wall Street Journal All-Star, rates
the stock a buy and has a $120 price target. "ENT is able to capitalize on
serving the sweet spot of the telecom space-global data services," he wrote
recently.
L.M. Ericsson
Sweden
(ERICY, $88.69)
Sure, shares of telecom plays such as Qualcomm and Nokia have gone
through the roof, but it's not too late to get in on the wireless revolution.
There's another round of spending in the offing as consumers upgrade to
phones that double as Internet surfing devices. This is no Jetsons-style
fantasy. Analysts expect the number of mobile Internet subscribers to grow
to 13 times today's 10 million in just two years.
Getting the technology in the hands of consumers requires more than just
designing cool handsets. The entire system of base-station transceivers and
controllers, which relay the signals, has to be upgraded. That's where
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