SmartMoney. The Battle of (Wireless) Britain [VOD rec]
April 13, 1999
By Alec Appelbaum
Olivetti's (OLVTY) strike at Telecom Italia (TI) showed investors that the merger mania sweeping
Europe runs beyond banks, into the telecom sector. The bid, and Telecom Italia's resistance, also
reveals the enormous growth potential that sector promises. Around the world, analysts expect
usage of mobile phones -- what we call wireless in the U.S. -- to grow by 60% or better in the next
few years. Well, if Olivetti can hunt for prizes, so can we. For today's screen, we searched the
world for international telecom companies that seem poised to benefit from significant demand
growth in the next five years.
When we screened for bargains in stocks trading as American depositary receipts (ADRs), we had
to adjust our focus. Cheap companies like Tele Danmark (TLD) look cheap for a reason: Earnings
growth is slowing. Equipment makers such as Israel's Nice Systems (NICE) or Finland's Nokia
(NOK) hardly seem like overseas plays, with major sales and administrative functions in the U.S.
And high-growth prospects like Telefonica de Chile (CTC) and South Korea Telecom (SKM)
look murky when we can't easily navigate their surrounding economies. We found 12 firms with no
recent analyst downgrades and long-term earnings projections above the S&P 500. Two British
wireless providers stood out as intriguing stocks for growth, if not for value, as they battle to serve
surging demand at home and eye fertile investments on other shores.
Both Vodafone (VOD) and Orange (ORNGY) are swinging in the U.K.'s current mobiles boom.
Roughly 24% of Britons use wireless phones, a paltry sample compared with usage rates in
Finland, Italy, Ireland and Portugal. But a European marketing phenomenon known as "prepaid" or
"calling party pays," in which consumers buy disposable debit cards to charge up their phones, has stoked demand. According to Jim
Friedland, an analyst at Arnold & S. Bleichroeder, prepaid cards pop up for sale at ATM machines; consumers can also grab them in grocery
stores and cabs. Merrill Lynch estimates that 78% of net new subscribers in the U.K. this spring have chosen the prepaid channel. Vodafone
drew 89% of its new subscribers this way, according to Merrill's Jo Oliver. Riding a healthy economy and a suburbanizing population, wireless
providers are trimming prices and, as prepaid plans spread, hacking their own billing costs. Analysts expect the market to double, reaching
half of Britain's 60 million residents, by 2002.
Good fundamentals support that projection. As Friedland points out, an older industry and a smaller coverage area in Europe make its
wireless stocks more reliable sources of cash flow than domestic firms like Nextel (NXTL) and Sprint PCS (PCS), which incur heavy losses
in network construction. Friedland asserts that growth projections in earnings before interest, taxes, depreciation and amortization (EBITDA) --
a common yardstick for wireless firms -- make European stocks look cheaper than their U.S. counterparts. If you like your costs upfront, you
may agree. A FirstCall consensus shows Vodafone, which trades near 200, growing earnings at an average of 23% over the next three years.
Merrill's Oliver forecasts sequential annual EBITDA growth for the next two years of 130% and 69% for Orange. By comparison, Nextel and
Sprint PCS show no earnings, because they're focusing on build-out (as we mentioned last week), but Nextel is also on tap to increase
earnings 68% in 2000.
The bullishness on British wireless stocks seems to have first come from Orange, the nation's No. 3 wireless provider, which added one
million subscribers to its U.K. wireless service in 1998. Friedland sees this cheeky competitor, which vends a digital "secretary" service
known informally as CyberChick, as a high-value marketer reaching up to 23% of the British mobile market this year. That's small potatoes
compared with Vodafone, which Merrill credits with 37% of the market, but it may be just as valuable to an investor, since London's Daily
Telegraph computes Vodafone's value per subscriber at 75% of Orange's. Why the premium for Orange? "You want to segment the market,"
says Friedland of Orange's strategy. "When the next generation of digital service comes, Orange will offer it in [high-margin] cities."
Europe's wireless picture is much more orderly than that of the rough and tumble U.S. Almost all providers and users rely on the same
technological standard, GSM; when CDMA, a technology we profiled last week, becomes dominant, Friedland argues that Orange will have an
easy time switching. Competition is also relatively thin, points out Friedland, allowing fatter profits. Fred Moran, an analyst with ING Baring
Furman Selz who follows Vodafone, puts his faith in prepaid-driven demand. And even if the doubling of usage runs more slowly than analysts
now expect, firms now have capital to invest outside their native markets. Orange is spending $700 million to help create a wireless network in
Hungary, for which it will participate in a licensing auction next month; Moran says Vodafone's acquisition of Airtouch Communications
(ATI) should close at the end of this year and spur growth in U.S. revenue that now accounts for less than half the company's business.
Another business colonizer -- and notable absence from our screen -- is British Telecom (BTY), whose acquisitive frenzy doesn't seem to
have helped its earnings growth projections. BT is developing a joint venture with AT &T (T) to service large international businesses, and it's
taken stakes in Hong Kong and Latin American firms in the past month. At the same time, it's trying to build market share by lowering rates
on cell phones. But BT carries a huge asset base, replete with wireline phone networks and cable, that hems in its prospects for earnings
growth. While Vodafone, Orange and its competitors are hardly scruffy startups, they're poised to face a clear and immediate wave of demand.
For overseas excitement, that sounds to us like a memorable ride.
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