Fund manager view: why data growth is one of my investment themes
Mobile phone apps, video streaming, social media, on-demand television and faster networks all add up to prodigious consumer demand for high-speed data within the telecommunications industry.
These long-term structural growth trends, known as secular growth, have the potential to form overarching investment themes for the global equity income team at Henderson.
Picking the right stocks
Once a theme is identified we look at the underlying stocks and choose investments with the potential for capital as well as income growth. We base our investment decisions on a few factors: whether they generate a lot of cash in their normal operations and whether they encapsulate the three ‘U’s; companies that are undervalued and unloved by the market, and those with earnings underappreciated by the market.
So how does the data theme play out? At the end of the 1990’s many of the big telecommunication companies were highly profitable. They invested heavily in 3G data licences for their networks, believing that rising demand for mobile internet would drive future earnings.
Communications technology, however, took longer to develop than expected. It meant that effective mobile internet did not become a reality until 2007, following the invention of the smart phone by Apple. Regulators around the world added to the technological headwinds faced by the sector by scrutinising the tariffs operators charged and encouraging new competitors. This led to the sector under-delivering on earnings forecasts and a period of poor performance.
We think the tides have turned. Two new sources of revenue growth seem to have emerged.
Firstly, there are signs that average revenue per user is stabilising as the demand for data grows. For those companies that have invested heavily in faster networks – typically 3G in emerging economies and 4G in developed markets – this is translating into growing market share and profitability as customers become more likely to use more data if they can access it more effectively.
Secondly, in some markets, regulators are shifting their focus towards infrastructure investment in a bid to remain technologically competitive. This has the potential to drive further data use through faster networks and has provided support for consolidation in the sector, which picked up significantly in past few years. High profile bids included the c. €17bn takeover of SFR – Vivendi’s French mobile phone business – by Altice, and in Germany, the acquisition of KPN’s operations by O2 Deutschland. [Merger and acquisition activity in the telecoms sector should result in higher margins and increasing profitability through scale advantages.]
Using our contrarian, value-driven approach, we are uncovering some exciting opportunities that offer the potential for capital as well as income growth. French telecommunication company Orange, which currently yields 3.95%, is a good example. The company was unloved by investors, who were disheartened by past regulatory and competitive issues, and low returns on investment.
The catalyst to invest was a change in management behaviour and a vicious price war that had lowered prices across the industry. We believed the market was underappreciating Orange’s focus on cash generation and value creation from cost cutting in its legacy business. It had also recently acquired Spanish cable group, Jazztel, for €3.4bn, with the potential to enhance earnings, and there was further potential for consolidation in France. As such we initiated a position for Henderson International Income Trust on October 2014.
We’re conscious that the most significant risk in the sector is often regulatory in nature. Therefore, we take advantage of the Trust’s global mandate to reduce this risk by spreading its allocation across eight companies based in eight different countries around the world: Bezeq (Israel), NoS (Portugal), Orange SA (France), Verizon (US), HKT (Hong Kong), Telenor (Sweden), SK Telecom (South Korea) and Spark (New Zealand).
Ben Lofthouse is fund manager of the Henderson International Income investment trust