Chapter 3

TELECOM SECTOR COMPOSITION

You should now understand Telecom basics and have reviewed the sector’s historical development. In this chapter, we’ll examine how the Telecom sector fits into the global stock market, review the different industries that make up the sector, and take a peek at some of the sector’s biggest companies. Establishing the sector’s composition will provide a structure we can build upon. It lays the foundation for business drivers in Part II and is a blueprint for portfolio construction in Part III.

GLOBAL INDUSTRY CLASSIFICATION STANDARD (GICS)

We’ve talked a lot about sectors and a little about industries thus far, so before we go any further, let’s define exactly what we mean. The Global Industry Classification Standard (GICS) is a widely accepted framework for classifying companies into groups based on similarities. The GICS structure consists of 10 sectors, 24 industry groups, 68 industries, and 154 sub-industries. This structure offers four levels of hierarchy:

• Sector
• Industry group
• Industry
• Sub-industry

The Telecom sector is narrowly focused on communication services and has a much simpler hierarchy than most sectors, with just one industry group, two industries, and three sub-industries. Telecom’s industries and corresponding sub-industries are:

Industry: Diversified Telecommunication Services

• Sub-industry: Integrated Telecommunication Services
• Sub-industry: Alternative Carriers

Industry: Wireless Telecommunication Services

• Sub-industry: Wireless Telecommunication Services

Before delving deeper into the industries, it’s vital to understand what the Telecom sector looks like globally and how it fits into a broader benchmark.

GLOBAL TELECOM BENCHMARKS

What’s a benchmark? What does it do, and why is it necessary? Simply, a benchmark is your guide for building a stock portfolio. It’s a point of reference—a standard for measurement and evaluation, and an investor’s roadmap for building a stock portfolio. You can use any well-constructed index—like the MSCI World or S&P 500, for example—as a benchmark. This is just as true for a sector as it is for the broader stock market. And by studying the index’s composition, you can assign expected risk and return to make underweight and overweight decisions for each category. (We’ll talk more about benchmarks in Chapter 7.)

So what does the Telecom investment universe look like? It depends on the benchmark. Table 3.1 shows seven indexes with the weight of each of the 10 market sectors. All of the indexes, except for the S&P 500 Composite, are float-adjusted (i.e., they exclude shares held by the government). The broadest benchmark is the MSCI All-Country World Index (ACWI)—which includes both developed and Emerging Markets (EM). The MSCI World includes only developed countries; the EAFE, only developed foreign countries; and the Eurozone is what it sounds like. The S&P 500 and Russell 2000 are specific to the United States and United States small cap stocks, respectively.

Table 3.1 Benchmark Comparison

Source: Thomson Reuters, as of 12/31/09.

Why Doesn’t Telecom Have More Weight?

Telecom is clearly one of the smallest sectors in the global stock market. But how can a sector that plays such a fundamental role in the global economy be such a small part of the investment universe? There are two primary reasons:

• Telecom is a relatively small part of the global economy—it’s approximately 3 percent of the Organisation of Economic Co-operation and Development’s (OECD, a group of 33 developed countries) GDP.1
• There aren’t many publicly traded Telecom stocks to choose from because of high government ownership, heavy regulation, and high fixed costs.

Benchmark Differences

Though Telecom tends to be a small portion of the broadest equity benchmarks, the sector is a major portion of some regional markets. Table 3.2 shows MSCI Telecom weightings in selected countries. Telecom weightings vary greatly, based on the region’s market liberalization and the number of other country holdings in the index. The wide range is exemplified by two neighboring islands, New Zealand and Australia. Telecom New Zealand, which was separated from the Post Office and then privatized, is a whopping 27.6 percent of the country weighting. Telstra, formerly Telecom Australia and similarly separated from the Post Office and then privatized, is only 1.6 percent of its country weighting. Whereas there are only 5 companies in the New Zealand benchmark and Telecom New Zealand is the largest, there are 71 in the Australian benchmark and Telstra is scrawny compared to mining giants like BHP Billiton.2

Table 3.2 Telecom Weights by Country

Source: Thomson Reuters, as of 12/31/09.

Understanding how benchmarks are structured is crucial to developing a portfolio because of the wide deviations in sector weights. For example, if you put 5 percent of your portfolio in Telecom, you would be significantly underweight relative to a New Zealand benchmark, but you’d be overweight relative to an Australian benchmark.

Benchmark Changes

Benchmark composition isn’t fixed and can change over time due to performance differences, additions, and deletions of companies in the index, plus a variety of other factors. The potential volatility of a benchmark weighting is illustrated in Figure 3.1. Due largely to the explosive share performance of the Telecom sector in the late 1990s, its weight in the global stock market was almost three times its current weighting!

Figure 3.1 Telecom Weight in the MSCI World Index

Source: Thomson Reuters, MSCI ACWI Index, 1995–2009.

As benchmarks change, investors may need to adjust their portfolios just to maintain stable relative overweight and underweight allocations.

Sector Benchmarks

Just like the broader market, sectors have their own benchmarks, and each industry constitutes a portion of the overall Telecom benchmark. And just like the broader market, investors may overweight and underweight different categories based on their expected risk and return characteristics. Table 3.3 shows the weight of each industry and sub-industry for seven different Telecom benchmarks.

Table 3.3 Industry and Sub-Industry Weights by Benchmark

Source: Thomson Reuters, as of 12/31/09.

With the exception of Emerging Markets, Diversified Services is the dominant benchmark weighting due to Integrated Services companies. Integrated Services consists of the huge fixed-line monopolies or government-owned companies that were privatized (like AT&T). Today, such companies are often a mix of both fixed-line and wireless services.

Whereas Integrated Services companies can do just about anything, Wireless Services companies concentrate only on wireless. Wireless Services has a larger weight in the Emerging Markets benchmark because of generally high government ownership in fixed-line providers and the rapid deployment of wireless technologies. In many developing regions, companies have elected to bypass the costs and time to lay fixed lines because those areas typically lack the infrastructure of the developed world. It is much cheaper and quicker to build a network of wireless towers than to string phone lines everywhere.

INDUSTRY BREAKDOWN

Now that you’ve got a sense of what the sector looks like at a high level, we can take a look at some of the distinguishing characteristics of its industry and sub-industry categories. We’ll cover some of the basics here and then drill much deeper in Chapters 4 through 6 to understand what really drives the businesses and share prices.

Diversified Telecommunication Services

This industry is composed of two sub-industries: Integrated Services and Alternative Carriers. We focus almost entirely on the former because the latter is only a puny piece of almost all benchmarks. If you have a global portfolio with an approximate 5 percent weight to Telecom and you want to be in line with benchmark weightings, just 0.05 percent of your investments should be in Alternative Carriers—they’re small potatoes.

Integrated Services

These are the big boys. The 10 largest Diversified Services firms are listed in Table 3.4, and they’re all Integrated firms—not one is an Alternative Carrier. In fact, there’s not one Alternative in the top 30. Although AT&T still boasts a huge market cap, it has fallen from its perch as the world’s largest corporation. Like many of its peers, it started in the fixed-line business. But because fixed line is a mature product with few growth opportunities, many traditional fixed-line providers (AT&T included) have ventured into wireless, broadband, TV, and foreign geographies to grow their bottom line.

Table 3.4 Ten Largest Diversified Services Companies

Source: Thomson Reuters, MSCI ACWI Index as of 12/31/09.3

It’s worth concentrating on Integrated Services bellwethers like AT&T because how they perform will dictate how the industry performs and give you a better understanding of broad trends and investment themes. Integrated Services is concentrated—the top five companies in the MSCI ACWI account for 57 percent of its benchmark weight.4

Alternative Carriers

MSCI defines this group as providers of communications and high-density data transmission services primarily through a high bandwidth or fiber-optic cable network. It’s a small list made up of a hodgepodge of companies—the major satellite and cable firms that provide communication services also provide television services and are therefore categorized in the Consumer Discretionary sector. Although they are relatively small, the leading Alternative Carrier companies are Inmarsat (a British satellite company) and Iliad (a French company that offers broadband, traditional phone services, and insurance policies online).

Wireless Telecommunication Services

The providers of cellular and wireless services, including paging services, have grown in importance and weight in the Telecom sector. Falling prices for handsets and minutes have made wireless services affordable for billions of consumers and given rise to billionaires like Carlos Slim—CEO of America Movil, Telmex, and Telcel, and one of the wealthiest men in the world.

Similar to the Diversified Services industry, Wireless’ weighting is concentrated in the top five bellwethers, which account for 61 percent of the benchmark5—see Table 3.5. Unlike Diversified firms, numerous leading Wireless firms are in developing countries. Traditional wireline businesses may not be as big in developing countries, and in many cases, the wireless business is separate from the incumbent wireline provider. The US and some other countries are different. For example, AT&T and Verizon are leaders in both wireless and wireline services—because they offer both, they’re categorized in the Diversified category.

Table 3.5 Ten Largest Wireless Service Companies

Source: Thomson Reuters; MSCI Inc.,6 MSCI ACWI Index as of 12/31/09.

A US company that did make the Wireless list is American Tower. While most Wireless companies provide wireless services to consumers, tower companies are a little different—instead of selling directly to consumers, they lease space on their towers to service providers.

SAME, SAME, BUT DIFFERENT

The GICS Telecommunication sector contains just three sub-industries. They are companies that provide communications services primarily through a fixed-line, wireless, cellular, and high bandwidth and/or fiber optic cable. That leaves out competing Cable & Satellite companies like Comcast and Time Warner (found in the Consumer Discretionary sector) and Communications Equipment companies like Cisco and Nokia (located in the Information Technology sector) that make routers, switches, phones, and the other equipment used for communications. If you thought you’d play the iPhone popularity and buy Apple as a Telecom company, think again—it’s in the Computers & Peripherals industry, which falls under the Information Technology sector.

Chapter Recap

In order to understand what drives the Telecom sector and how to build a portfolio, we have started with the sector’s composition. We use the Global Industry Classification Standard (GICS), a widely accepted framework for classifying companies into groups based on similarities, to structure the sector’s composition. The GICS structure consists of 10 sectors, 24 industry groups, 68 industries, and 154 sub-industries.

• The Telecom sector has a simple structure—it’s composed of just the Diversified Services and Wireless Services industries and three sub-industries.
• Diversified Services has two sub-industries: Integrated Services and Alternative Carriers.
• Integrated Services is the bulk of the industry weighting and includes companies like AT&T—the huge, traditional telephone companies that, in many instances, have expanded into wireless, broadband, and TV. Bellwethers like AT&T often provide insight into broad Telecom trends and investment themes.
• Alternative Carriers are generally composed of an assortment of cable and satellite companies that offer communication services, but not television. Alternatives are such a small part of Diversified Services’ weight, even a small portfolio position would likely represent an overweight relative to common benchmarks.
• Due to declining prices and expansive availability, the Wireless Services sub-industry growth has been robust in both developed and emerging markets. Wireless services enable emerging markets to bypass many of the costs and much of the time needed to develop an extensive fixed-line infrastructure.