Growing use of data, low valuations and greater M&A potential have been highlighted by several European equities managers as key attractions for investment in the telecommunications sector.
Dean Tenerelli, portfolio manager of the three crown-rated T. Rowe Price Continental European Equity fund, said telecommunications stocks were the largest overweight position in his portfolio.
Performance of indices over 1yr
Source: FE Analytics
Tenerelli said it had increased the €88.4m fund’s allocation during the first quarter of the year, with ongoing corporate consolidation making the sector more attractive.
“We believe valuations do not reflect improving industry fundamentals – based on the explosive growth of mobile service data and online video, which is boosting high-speed broadband penetration,” he added.
“There is a continuing desire for mergers & acquisitions that both improve market structure and drive fixed-mobile convergence.”
The manager said the fund’s exposure to the sector is concentrated and includes German firm Telefonica Deutscheland and French company Iliad.
A further holding is Com Hem, Sweden’s high-speed broadband and fixed telephony provider, which he said offers “above-average growth and M&A potential”.
“We also invested in two Spanish companies during the first quarter of the year, Cellnex Telecom and Euskaltel,” he continued.
“We were attracted to Cellnex Telecom, an operator of wireless telecommunications and broadcasting infrastructures in Europe, after the company recently reached a deal with Bouygues Telecom for the acquisition and construction of up to 3,000 sites in France.
“We believe the deal has consolidated Cellnex's presence in France, while maintaining its long-term relationship with Bouygues. Cellnex also reported strong results for the fourth quarter of 2016 and has a strong pipeline of opportunities.”
He added: “Euskaltel, a cable and internet services company based in the northwest of Spain, is delivering strong results as demand increases for wireless web browsing and online video and music services.”
Stuart Mitchell, manager of the €58m SWMC European fund, has allocated 10 per cent of his portfolio to the sector in expectation of further consolidation and improvement in pricing.
He said: “Over recent years there has been growing acknowledgement that Europe is falling behind the rest of the developed world in the provision of world class telephony.”
“This is primarily due to years of intense competition in the industry, which has led to crippling price deflation. This is coming to an end in our view.
“Regulators in Europe are increasingly becoming more supportive of the incumbent operators and are easing up on regulation, which is stimulating investment in new technologies. The number of operators has also been allowed to fall from four to three in many European countries – and we see no reason why the consolidation cannot continue.”
He added: “Recent quarterly results announcements in the sector – from the likes of Orange, Deutsche Telekom and Telecom Italia – have been very encouraging.”
Chris Hiorns, senior fund manager on the £87.5m EdenTree Amity European fund, warned that companies in the sector are still under pressure from falling revenue per user, however.
He said the end of roaming charges across the EU would have an impact on user revenue, while consolidation in national markets had not brought about the better pricing forecast by some.
Hiorns explained: “Hopes in-country consolidation of mobile players would lead to a better pricing environment have largely gone unrealised, with regulators keen to maintain competition.
“Even in the case of Germany, when Telefonica Deutschland bought KPN, regulators effectively required Telefonica Deutschland to help create a new fourth competitor through the sale of capacity to Drillsch.”
Hiorns said that with top lines under pressure, companies in the sector have sought to reduce costs by cutting back on capital expenditure and sharing infrastructure, which he said should improve profitability and cash generation.
“This has negative consequences for the telecom equipment providers, with companies like Ericsson experiencing a sharp drop in demand,” he explained.
“Telecom equipment providers would argue this fall in capex is only cyclical, as most players have already rolled out 4G technology and fifth generation is only in its infancy. Still, it is clear telecom companies are seeking to make significant saving in capex in the face of falling revenues.”
The manager also highlighted increasing trends within the sector as companies seek to provide both fixed and mobile services to customers.
“This can help companies differentiate themselves, increase revenues and reduce churn,” he explained. “For example, KPN has pursued this strategy and has succeeded in halving the number of existing customers moving to another provider, compared with mobile-only players.”
Hiorns added: “Overall, the telecommunications sector in Europe looks attractively valued after underperforming the market by 20 per cent over the last year.
“This is despite displaying good cash flow generation, high dividend yields and predictable revenue streams. It likely reflects the move into more cyclical areas of the market, which are expected to benefit from the long-awaited recovery in the eurozone economy.”