Jack Willis

Opportunities coming down the line for telecoms

Jack Willis

In the 1980s, BT used the famous line “It’s Good to Talk” in the company’s TV advertising campaigns. Over the subsequent decades, the sector has moved way beyond just voice and we believe it continues to offer attractive opportunities for bond investors, particularly at a time when credit generally is facing headwinds.

As we have written in our recent series of articles, we remain confident in the medium to long-term outlook for credit despite shorter-term concerns and, within this, telecoms remains among our favoured areas for the Liontrust Monthly Income Bond Fund.

After several years of intense competition and M&A activity, the sector has begun to return to growth, with many companies enjoying improving operating trends. In part, this has been driven by an ever-increasing dependence on broadband and mobile networks, which has seen telecoms become a quasi-utility, providing what are now considered essential services. Virtually all companies depend on telecommunication products and/or services to function and forming a key part of national infrastructure means the sector is regulated by government-backed entities, resulting in high levels of transparency and stability among service providers.

Within the space, we favour the larger European incumbents such as Orange and Deutsche Telekom, former state-owned companies that held monopoly positions before markets opened up to allow competition.

Despite the introduction of competitors, however, incumbents largely retain dominant market share, partly due to the fact they have built unrivalled networks over time, creating high barriers to entry. Based on the investment and time required to build and deploy these networks, the only way for competitors to gain a foothold is often to pay incumbents for access to existing infrastructure. As a result, these larger players demonstrate strong cashflow generation, as demand for their network services continues to grow.

In order to promote fair competition, local regulators compel incumbents to allow access to networks while also determining pricing for access. More recently, however, there has been a shift in regulatory focus away from just pricing to improving network quality. This requires ongoing capital expenditure but is credit positive overall as it will help deliver sustained growth over the longer term.

These incumbents are generally of higher credit quality, demonstrating a powerful combination of strong fundamentals, size and scale, geographic diversification, a focus on improving balance sheets and reduced event risk as regulatory constraints limit the potential for M&A consolidation.

We see particularly good value opportunities in the US dollar market, where many of the European incumbents have bonds outstanding. These dollar-denominated bonds generally have the same credit quality/risk and similar durations/interest rate risk as their sterling or euro denominated counterparts, but offer higher income, higher yield and better value in terms of credit spread.

While you would typically expect such characteristics to be associated with higher levels of risk, several of these USD issues also have favourable optionality, typically a step-up in coupon payment in the event of a credit downgrade.

As we wrote recently, the flexible investment mandate for the Monthly Income Bond Fund allows us to identify cross currency opportunities within high-quality names and hedge out any unwanted foreign exchange and foreign interest rate risks.

As ever, it is sensible to be aware of potential headwinds and, for this sector, market saturation could become an issue as penetration levels cannot continue to climb indefinitely. Cybersecurity is also a potential concern as telecom companies become responsible for protecting an ever-growing volume of personal data from increasingly sophisticated cyber-attacks.

Despite these factors, and the rapid developments in the industry over recent years, however, we still see plenty of potential. The wireless segment looks set to be the key driver for the industry, with a number of technological developments in the pipeline. 5G is scheduled to launch in select locations as early as the fourth quarter of this year, improving broadband speeds, coverage and reliability of connections.

This will enable further developments around the Internet of Things (IoT), with the anticipated rise in smart/connected devices resulting in exponential growth in data usage. An example of a company in the portfolio benefiting from these trends is US telecom giant Verizon, which is heavily exposed to the wireless segment at 74% of 2017 revenues. The company’s business strategy is focused on being the market leader in terms of 5G development.

For a comprehensive list of common financial words and terms, see our glossary here.

 

Key Risks 

Past performance is not a guide to future performance. Do remember that the value of an investment and the income generated from them can fall as well as rise and is not guaranteed, therefore, you may not get back the amount originally invested and potentially risk total loss of capital. The majority of the Liontrust Sustainable Future Funds have holdings which are denominated in currencies other than Sterling and may be affected by movements in exchange rates. Some of these funds invest in emerging markets which may involve a higher element of risk due to less well regulated markets and political and economic instability. Consequently the value of an investment may rise or fall in line with the exchange rates. Liontrust UK Ethical Fund, Liontrust SF European Growth Fund and Liontrust SF UK Growth Fund invest geographically in a narrow range and has a concentrated portfolio of securities, there is an increased risk of volatility which may result in frequent rises and falls in the Fund’s share price. Liontrust SF Managed Fund, Liontrust SF Corporate Bond Fund, Liontrust SF Cautious Managed Fund, Liontrust SF Defensive Managed Fund and Liontrust Monthly Income Bond Fund invest in bonds and other fixed-interest securities - fluctuations in interest rates are likely to affect the value of these financial instruments. If long-term interest rates rise, the value of your shares is likely to fall. If you need to access your money quickly it is possible that, in difficult market conditions, it could be hard to sell holdings in corporate bond funds. This is because there is low trading activity in the markets for many of the bonds held by these funds. Mentioned above five funds can also invest in derivatives. Derivatives are used to protect against currencies, credit and interests rates move or for investment purposes. There is a risk that losses could be made on derivative positions or that the counterparties could fail to complete on transactions.

Disclaimer

The information and opinions provided should not be construed as advice for investment in any product or security mentioned, an offer to buy or sell units/shares of Funds mentioned, or a solicitation to purchase securities in any company or investment product. Always research your own investments and (if you are not a professional or a financial adviser) consult suitability with a regulated financial adviser before investing. 

Thursday, September 13, 2018, 10:28 AM