The telecommunication sector is made up of companies that make communication possible on a global scale, whether it is through the phone or the Internet, through airwaves or cables, through wires or wirelessly. These companies created the infrastructure that allows data in words, voice, audio or video to be sent anywhere in the world. The largest companies in the sector are telephone (both wired and wireless) operators, satellite companies, cable companies, and internet service providers.
Not long ago, the telecommunications sector consisted of a club of big national and regional operators. Since the early 2000s, the industry has been swept up in rapid deregulation and innovation. In many countries around the world, government monopolies are now privatized and they face a plethora of new competitors. Traditional markets have been turned upside down, as the growth in mobile services outpaces the fixed line and the internet starts to replace voice as the staple business.
Evolution of the Telecommunications Sector
The telecommunications industry began in the 1830s, with the invention of the telegraph, the first mechanical communications device. It shortened communication from days to hours—much as modern mobile technology has shortened the time span of sending large amounts of data from hours to seconds. The industry broadened with each new invention: telephone, radio, television, computer, mobile device. These technological advances changed how people live and do business.
At one time, telecommunications required physical wires connecting homes and businesses. In contemporary society, technology has gone mobile. Now, wireless digital technology is becoming the primary form of communication.
The sector's structure has also changed from a few large players to a more decentralized system with decreased regulation and barriers to entry. Major public corporations act as the service providers, while smaller companies sell and service the equipment, such as routers, switches, and infrastructure, which enable this communication.
- The telecommunications sector consists of companies that transmit data in words, voice, audio, or video across the globe.
- The telecommunications sector consists of three basic sub-sectors: telecom equipment (the largest), telecom services (next largest) and wireless communication.
- Telecom is growing less about voice and increasingly about video, text, and data.
- Telecommunications companies can appeal to both growth- and income-oriented investors.
- Although individual stocks can be quite volatile, the telecom sector overall has exhibited stable long-term growth, as telecommunications has become an increasingly important basic industry, impervious to business cycles.
How Telecommunications Companies Make Money
Plain old telephone calls continue to be the industry's biggest revenue generator, but thanks to advances in network technology, this is changing. Telecom is growing less about voice and increasingly about video, text, and data. High-speed internet access, which delivers computer-based data applications such as broadband information services and interactive entertainment, is rapidly making its way into homes and businesses around the world. The main broadband telecom technology, Digital Subscriber Line (DSL), has ushered in a new era. The fastest growth comes from services delivered over mobile networks.
Of all the customer markets, residential and small business markets are arguably the toughest. With literally hundreds of players in the market, competitors rely heavily on price to slog it out for households' monthly checks; success rests largely on brand name strength and heavy investment in efficient billing systems. The corporate market, on the other hand, remains the industry's favorite. Big corporate customers, who concerned mostly about the quality and reliability of their telephone calls and data delivery, are less price-sensitive than residential customers. Large multinationals, for instance, spend heavily on telecom infrastructure to support far-flung operations. They are also happy to pay for premium services like high-security private networks and video-conferencing.
Telecom operators also make money by providing network connectivity to other telecom companies that need it, and by wholesaling circuits to heavy network users like internet service providers and large corporations. Interconnected and wholesale markets favor those players with far-reaching networks.
Key Telecommunications Industry Segments
The telecommunications sector consists of three basic sub-sectors: telecom equipment (the largest), telecom services (next largest) and wireless communication.
The major segments within these sub-sectors include the following:
- Wireless communications
- Communications equipment
- Processing systems and products
- Long-distance carriers
- Domestic telecom services
- Foreign telecom services
- Diversified communication services
The smallest, but fastest-growing, area within the sector is wireless communications, as more and more communications and computing methods shift to mobile devices and cloud-based technology. This piece of the industry is the anticipated keystone for the continued global expansion of the telecommunications sector. There is still ample room for growth, even in developed countries: As of 2018, the Federal Communications Commission (FCC) reported that approximately one-fifth of the rural American population still does not have access to broadband networks, for example.
Looking forward, the sector's biggest challenge is to keep up with people's demand for speedier data connectivity, higher resolution, quicker video streaming, and ample multimedia applications. Meeting people's needs for faster and better connections as they consume and create content requires significant capital expenditures. Companies that can meet these needs thrive.
Investing in Telecommunications
Telecommunications companies are a rarity among equities: Their shares have, at times, exhibited characteristics of both income and growth stocks. For growth investors, the small companies offering wireless services provide the best opportunities for share price appreciation. In contrast, larger companies dealing with equipment and services tend to be havens for conservative, income-focused investors.
Value investors also can find good pickings in the telecommunications sector. The need for telecommunications services, an integral part of the global economy, persists regardless of changes in the business cycle. However, while the demand is constant, individual suppliers can rise and fall. For several years, a company may enjoy its regulatory privileges (like other utilities, telecom firms often are protected from competition by government mandate), and produce reliable, generous dividend yields (generated by high monthly revenue from its stable customer base). Then, suddenly, technological advances or mergers and acquisitions create uncertainty and leave room for loss—and recovery, with fresh growth.
If a firm hits a slump because of shifts in the industry (like the growing importance of wireless devices), value investors might snap it up, provided its fundamentals remain strong and it proves adept at adapting to change. The telecommunications sector's record in paying and regularly raising dividends makes the waiting period for share prices to improve more enjoyable.
However, all of the three major telecom sectors present some risk to investors, with stocks registering anywhere from 7% (for services) to 15% (wireless) to 24% (equipment) more volatility than the broader market. Investors with heavy exposure to telecom can expect stronger-than-average gains during bull markets. But, when a recession or bear market hits, losses from this sector can be severe.
Evaluating Telecommunications Companies
It is hard to avoid the conclusion that size matters in telecom. It is an expensive business; contenders need to be large enough and produce sufficient cash flow to absorb the costs of expanding networks and services that become obsolete seemingly overnight. Transmission systems need to be replaced as frequently as every two years. Big companies that own extensive networks—especially local networks that stretch directly into customers' homes and businesses—are less reliant on interconnecting with other companies to get calls and data to their final destinations. By contrast, smaller players must pay for interconnection more often in order to finish the job. For little operators hoping to grow big one day, the financial challenges of keeping up with rapid technological change and depreciation of equipment can be monumental.
Earnings can be a tricky issue when analyzing telecom companies. Many companies have little or no earnings to speak of. To gauge a company's value, telecom industry analysts might turn to the price-to-sales ratio (stock price divided by sales). They also look at average revenue per user (ARPU), which offers a useful measure of growth performance, and the churn rate, the rate at which customers leave (presumably for a competitor).
The Telecommunications Act, signed into law by President Bill Clinton in 1996, was passed to stimulate competition in the U.S. telecom sector.
Big Players in Telecommunications
Current industry leaders worldwide can change from year to year. Determining which are the largest depends on whether one looks in terms of total sales numbers or in terms of market capitalization value as well. As of 2018, the top five telecom companies ranked by market capitalization are as follows:
- Verizon (VZ), which provides wireless and wireline services, in addition to broadband and information services, has a current market capitalization value of approximately $200 billion. It remains attractive as a dividend provider because of its rock-solid financial condition: It is the largest telecom company in the U.S. and operates in 150 countries.
- China Mobile Ltd (CHL), which has only been in business since 1997, has a market cap value of approximately $185 billion due to the growth in the use of cell phones and Internet services in China within the past 15 years.
- AT&T (T), the oldest company in the telecommunications business, has a market value estimated at approximately $182 billion. China Mobile has eclipsed AT&T in just a little more than a decade of being in business. Still, the former Ma Bell has one-third of the U.S. wireless market share and an impressive 30-year history of increasing dividends.
- Vodaphone Group (VOD), the largest telecom company in the United Kingdom, provides voice, broadband, and data services and equipment, and it has a market cap value of approximately $97 billion.
- Japan's SoftBank Corp, providing IT software as well as wireless and Internet services, has a current market capitalization value just over $90 billion.
The rankings shift noticeably if you judge in terms of total sales revenue. While Verizon, China Mobile, and AT&T all remain in the top five, Verizon drops to #2 behind Nippon Telegraph & Telephone Corporation (NTT) of Japan, which is a major manufacturer of telecommunications equipment in addition to providing extensive landline, cellphone and Internet services. Spain's Telefonica (TEF) rounds out the top five rankings based on revenue.
Smaller Players in Telecommunications
Some telecom stocks are stuck in penny stock territory, trading at less than $5 a share for numerous reasons. Current ones at that level that show promise include the following:
- Alaska Communications Systems Group (ALSK). With its long distance to the contiguous United States, Alaska makes infrastructure complicated. Alaska Communications is the largest broadband provider in the state.
- Cincinnati Bell (CBB) reports more than 220,000 residential voice lines, 307,000 business lines, and 281,000 Internet subscribers. Cincinnati Bell continues to increase revenue and power its future with growth in fiber-optic communications (fioptics for short) and IT services. This is helping to set up the company for long-term success and also helps connect enterprise customers throughout Ohio.
- Frontier Communications (FTR). Frontier offers telecommunications service to 28 states and has been around since 1927. It has more than 3.1 million residential customers and nearly 300,000 business customers. Revenue is likely to rise soon as the company continues to integrate large acquisitions from the likes of Verizon and AT&T. Frontier is betting big on being the leader in wireline communications across the country and is also expanding its broadband base in new territories to increase revenue.
- Vonage (VG) connects customers with its cloud communications business. Both consumers and businesses use the company’s technology to connect to mobile numbers and landlines all over the world. The company has 98 patents and 245 pending applications, and Vonage is continually working on monetizing them. Vonage is also aggressively buying back shares of its own stock. The company has bought $148 million worth of its shares since 2012. Vonage shares trade close to the border of penny stock range: between $4.17 and $7.42 over the last 52 weeks.
Several exchange-traded funds (ETFs) serve as alternatives to directly investing in individual telecom firms. Telecom ETFs have varying focuses on geography or industry specialization. Some of the most popular include:
- The Vanguard Telecommunication Services ETF (VOX) is composed of 98% U.S. stocks, ranging from small, regional telecom firms to the big three, Verizon, AT&T, and Sprint.
- The iShares Dow Jones U.S. Telecommunications Sector Index Fund (IYZ), similar in holdings to Vanguard's Telecommunication Services ETF, also tracks the largest telecom service companies in the U.S.—Sprint, AT&T, and Verizon—along with a handful of smaller regional service providers.
- The iShares S&P Global Telecom Fund (IXP) is focused internationally, with 70% of its holdings in companies headquartered outside the U.S. Notable stocks include the top five telecom companies ranked by market capitalization: Verizon, AT&T, China Mobile, Vodafone, and Softbank Corp.
Other popular telecom ETFs include the Fidelity MSCI Telecommunication Services Index (FCOM) and the SPDR S&P Telecom ETF (XTL).
Telecommunications Sector Outlook
Analysts foresee that product innovation and an increase in mergers and acquisitions will only facilitate the continued growth and success of the telecommunications industry. There are many opportunities for investors, and an increase in investors will only serve to benefit the sector further.
The average annual historical growth rate of the telecommunications sector.
The stability of the sector's growth, even during periods of recession, means that it is considered to be a solid defensive investment while maintaining its appeal to growth investors. Even during uncertain and volatile economic times, the steady demand for voice and data services, along with extensive subscription plans, assures a stable source of revenues for major telecom firms.
Telecommunications has become an increasingly important basic industry, which bodes well for its future prospects and continued growth. The continuing advances in high-speed mobile services and Internet connectivity between devices keep driving innovation and competition within the sector. Much of the industry focus is on providing faster data services, especially in the area of high-resolution video. Essentially, the driving forces are toward quicker and clearer services, increased connectivity and multi-application usage.
Emerging market economies continue to be a boon for the industry, with the growth rate of the cell phone industry in countries such as China and India pushing the abilities of hardware producers to keep up with the level of demand.
In the U.S., analysts are paying close attention to issues surrounding net neutrality as the demand for data and video services continue to increase well into the future. There is still a strong demand for wireless spectrum rights, as indicated by the FCC's Incentive Auction that took place in April 2017, not to mention an increasing trend toward consolidation through mergers and acquisitions.
The Bottom Line
Telecommunication companies, like other forms of utilities, often operate with stable customer bases that are protected from competition by government mandate. These pseudo-monopolies allow for consistent dividends. However, the dynamic nature of communications has led to mobile and Internet-based phone systems, undermining the demand for traditional landlines. When this happens, telecommunication companies either suffer or adapt, incorporate the new technology and grow rapidly as consumers buy the latest equipment.