Investors don't love telecom service providers like they used to, largely due to extreme competition that has made it difficult to grow revenue or improve margins, all the while spending billions on equipment to keep the network current. It's arguably worse in the case of SK Telecom (NYSE:SKM), as management here has made it clear that they believe they're able to do more than just run a telecom business and have deployed billions of dollars in questionable non-telecom investments. While the sharp run-up over the past year was largely reasonable, as it brought SK Telecom back into parity with many of its global peers, it's hard to argue that these shares deserve to go much higher.

LTE Is Great, But How Much Further Can It Go?
SK Telecom has been very good at signing up subscribers for its LTE service – at nearly 10 million subs, SK Telecom has the fourth-largest LTE business in the world. With LTE average revenue per user (ARPU) more than 40% above the company's blended average, that's a very valuable business.

SEE: How To Pick The Best Telecom Stocks

The question I have is whether this can go much higher. SK Telecom's primary rivals, KT Corp (NYSE:KT) and LG U+, have stepped up their game as well and competition for subs in South Korea in the past has been notoriously brutal if not economically irresponsible. With SK Telecom's ARPU up 4% in the most recent quarter (and down slightly on a sequential basis), I think it's fair to argue that business has more or less settled into a steady state for now. 

Focusing On Keeping What It Has
SK Telecom's market share has been around 50% to 51% for some time now, despite the aforementioned fierce competition. It's unlikely that the company is going to significantly expand that, and so management has been focused on increasing retention and reducing subscriber acquisition costs. The company has been introducing plans that give monthly data “refills” based on how long of a contract the subscriber signs, and has likewise been trying to cut its marketing costs. Even so, first quarter operating income fell 18% and 24%, respectively, so there's more work left to do.

Iffy Capital Deployment Decisions
Even with the high ongoing capital investment requirements of a mobile network, telecom service providers generate pretty solid cash flows. Unfortunately, SK Telecom management's record of redeploying that cash is spotty at best.

At one point, SK Telecom did have a go at becoming an international player, but most of those ventures didn't work out so well. A joint venture with China Unicom (NYSE:CHU) worked well enough I suppose, but SK Telecom long ago sold back its stake. The company's business in Vietnam didn't go nearly as well (and the company bailed a while ago), and the venture in Mongolia has pretty unimpressive market share (below 15%).

Those are veritable success stories compared to the company's experience in the U.S. The Helio venture was nearly a 75% loss, while the $60 million investment into now-bankrupt LightSquared is likely to be a major loss as well. Moreover, given the moves from Verizon (NYSE:VZ), AT&T (NYSE:T), T-Mobile, and Sprint (NYSE:S) – Softbank, I don't see all that much room left in the U.S. market if they wished to try again.

With such a poor track record in telecom investments, perhaps I shouldn't be surprised that management elected to buy a large stake in SK Hynix – a major manufacturer of DRAM and flash chips. While Hynix is a relatively good player in the memory space (good enough, at least, that Apple (Nasdaq:AAPL) uses its chips), this is an exceptionally volatile business and one with high ongoing capital requirements.

The Bottom Line
In essence, I see SK Telecom as a telecom service provider competing in a difficult market (South Korea) where government-mandated price cuts and often-irrational competition will offer consistent pressure on ARPU, churn, and profitability. Moreover, the company is led by a management team that would seemingly prefer to take the cash flow and invest in questionable directions rather than return it to shareholders.

SK Telecom has historically converted more than 10% of revenue to free cash flow (and sometimes more than 16%), and that underpins the value here. While the big move in the stock has brought the shares back to a fair valuation level, I don't see why the move should go much further. Even with consistent low-teens free cash flow margins, I don't see fair value much above $22 today.

Related Articles
  1. Investing

    Decoding the Merger of Alcatel-Lucent and Nokia

    Alcatel-Lucent and Nokia have a history of difficult mergers. But, their merger with each other may turn out to be the right fit for both companies.
  2. Mutual Funds & ETFs

    What Exactly Are Arbitrage Mutual Funds?

    Learn about arbitrage funds and how this type of investment generates profits by taking advantage of price differentials between the cash and futures markets.
  3. Investing News

    Ferrari’s IPO: Ready to Roll or Poor Timing?

    Will Ferrari's shares move fast off the line only to sputter later?
  4. Stock Analysis

    5 Cheap Dividend Stocks for a Bear Market

    Here are five stocks that pay safe dividends and should be at least somewhat resilient to a bear market.
  5. Investing

    How to Win More by Losing Less in Today’s Markets

    The further you fall, the harder it is to climb back up. It’s a universal truth that is painfully apparent in the investing world.
  6. Fundamental Analysis

    Use Options Data To Predict Stock Market Direction

    Options market trading data can provide important insights about the direction of stocks and the overall market. Here’s how to track it.
  7. Stock Analysis

    2 Oil Stocks to Buy Right Now (PSX,TSO)

    Can these two oil stocks buck the trend?
  8. Investing News

    What Alcoa’s (AA) Breakup Means for Investors

    Alcoa plans to split into two companies. Is this a bullish catalyst for investors?
  9. Stock Analysis

    Top 3 Stocks for the Coming Holiday Season

    If you want to buck the bear market trend by going long on consumer stocks, these three might be your best bets.
  10. Investing News

    Could a Rate Hike Send Stocks Higher?

    A rate hike would certainly alter the investment scene, but would it be for the better or worse?
  1. How do dividends affect retained earnings?

    When a company issues a cash dividend to its shareholders, the retained earnings listed on the balance sheet are reduced ... Read Full Answer >>
  2. What is the difference between called-up share capital and paid-up share capital?

    The difference between called-up share capital and paid-up share capital is investors have already paid in full for paid-up ... Read Full Answer >>
  3. Why would a corporation issue convertible bonds?

    A convertible bond represents a hybrid security that has bond and equity features; this type of bond allows the conversion ... Read Full Answer >>
  4. How does additional paid in capital affect retained earnings?

    Both additional paid-in capital and retained earnings are entries under the shareholders' equity section of a company's balance ... Read Full Answer >>
  5. What types of capital are not considered share capital?

    The money a business uses to fund operations or growth is called capital, and there are a number of capital sources available. ... Read Full Answer >>
  6. What is the difference between issued share capital and subscribed share capital?

    The difference between subscribed share capital and issued share capital is the former relates to the amount of stock for ... Read Full Answer >>

You May Also Like

Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!