SIM

Telecommunications
Sector

Kevin Ratliff
February 2008 Nitin Sharma

January 4, 2009 1
 Overview

 Portfolios and Composition

 Economic Analysis
 Business Analysis
 Financial Analysis
 Valuation Analysis
 Recommendations

January 4, 2009 2
 S&P and SIM Portfolios

Size and Composition - Weights

SIM Portfolio - Sector Weightages
S&P 500 Sector Weightages

Utilities, 3.6% Cons Discr, 8.92%

Telecom 3.5% Energy, 12.3% Health Care, 16.12%
Information Con Staples, 9.85%
Materials, 3.4%
Technology, 15.6%
Financials, 16.78% Energy, 8.49%
Industrials, 11.7%

Utilities, 2.32%
Consumer
Financials, 18.6% Materials, 4.54%
Discretionary, 8.8% Industrials, 10.59% Info Tech, 18.62%
Consumer Staples,
Health Care, 12.1%
10.3%

Telecom, 3.78%

•SIM portfolio slightly overweight in Telecom compared to the current S&P500

weights
•3.5% in S&P versus 3.78% in SIM
•Only telecom stock present in SIM portfolio is America Movil (AMX)
Portfolios and Composition
January 4, 2009 3
 Composition - Industries

 Diversified Telecom Services

 Alternate carriers

Providers of communications and high-density data transmission services
primarily through a high bandwidth/fiber-optic cable network.
 Embarq, Citizen Communications
 Integrated Telecommunications Services
 Operators of primarily fixed-line telecommunications networks and
companies providing both wireless and fixed-line telecommunications
services.
 Verizon, AT&T
 Wireless Communication Services
 Providers of primarily cellular or wireless telecommunication services, including
paging services.
 Sprint-Nextel, NII Holdings
Portfolios and Composition
January 4, 2009 4
 Composition – Main Players

Ticker Company Price P/E ratio Market Cap ($B) SIM

AMT American Tower Corp. $ 37.53 143.17 15.64 No
AMX America Movil $ 61.69 14.75 108.3 Yes
T AT&T Inc. $ 38.49 14.38 231.36 No
CTL Century Telephone $ 36.91 17.66 11.25 No
CZN Citizens Communications $ 11.47 22.25 3.77 No
EQ Embarq Corporation $ 45.30 14.53 7.05 No
Q Qwest Communications Int $ 5.88 21.85 10.58 No
S Sprint Nextel Corp. $ 10.53 24.49 29.69 No
VZ Verizon Communications $ 38.84 16.75 111.48 No
WIN Windstream Corporation $ 11.61 15.04 5.6 No

Telecom Sector has underperformed the

benchmark index this year

Portfolios and Composition

January 4, 2009 5
 Economic Analysis - Overview
 Domestic
 US telecom market saw an increase of 11% revenue growth to $1025
Billion in 2007. Consolidation is the current mantra.
 Major drivers of high growth have been wireless communication and
broadband access. 80% households in US are already ONLINE
 Wireline is losing ground to wireless and VoIP
 Growth has slowed down in 2007 and is expected to remain muted
given the current economic scenario
 International
 International market grew by over 12% to $1.3 Trillion with fastest
growth seen in the EMEA
 By 2010, the global market is expected to reach $4.3 Trillion, up from
$3 Trillion in 2006
 India added a whopping 66.4M mobile subscribers in 2007, a growth
of 62% from 2006. Penetration (Tele-density) still remains a meager
23%
Economic Analysis
January 4, 2009 6
 Economic Analysis - Factors
 Demand
 GDP growth (+)
 Population growth –
especially growth in
middle class of developing
nations (+)
 Unemployment rate (-)
 Personal Income (+)
Economic Analysis
January 4, 2009
 Supply
 Energy Prices – increase
cost of operations (-)
 Commodity Prices –
increase price of inputs (-)
 Foreign Exchange Rates –
reduces profits from
international operation
(+/-)
 Inflation – increase input
costs (commodities, labor,
raw materials) (-)
7
 Economic Analysis
Variation of Telecom Index price with Fed funds rate and GDP growth

Economic Analysis
January 4, 2009 8
 Business Analysis – 5 Forces
 High barriers to entry
 Dominated by large, well-established companies
 High capital requirements to enter sector
 Mature industry with strong brand identities
 Difficult to create wide distribution network
 High buyer power
 Undifferentiated product equates to low switching cost
 Low Supplier Power
 Long-term contracting/agreements common
 Low threat of substitution
 Wireless dominant, no real alternatives
 High threat of competition
 Consumers are price sensitive (despite brand loyalty); undifferentiated products
 Consolidation

Business Analysis
January 4, 2009 9
 Business Analysis
 Mature Industry – Wireline carriers and Wireless companies
 Highly concentrated – Top 50 companies (out of a total
11,000) hold 90% of the market
 Shrinking Margins
 Intense competition
 Pricing is key
 Globalization
 International expansion
 Outsourcing
 New technology drives the sector

Business Analysis
January 4, 2009 10
 Financial Analysis -
Performance

•Mean weighted priced has not shown much appreciation in last 5 years
•Revenue growth is above average but trending down

Financial Analysis
January 4, 2009 11
 Financials– Income Statement

•Consistent Negative earnings

surprises do not bode well for
Telecom stock prices

Financial Analysis
January 4, 2009
 Financials – Balance Sheet

•Leverage steady in the 60-70% range

•Overall, balance sheet looks healthy

Financial Analysis
January 4, 2009 13
 Financials– Cash Flow Statement

•Heavy on CAPEX and dividends

•Cash flows have remained flat or have experienced low growth

Financial Analysis
January 4, 2009 14
 Financials – Earnings & Dividends

•Steady dividend yields

•S&P 500 average is around 2%

Financial Analysis
January 4, 2009 15
 Valuation Analysis - Multiples

Absolute Relative to S&P

Multiple Mean Current Mean Current

P/Forward E 19.1 12.2 0.99 0.94

P/S 1.71 1.52 1.1 1.14
P/B 2.5 1.8 0.78 0.71
P/EBITDA 5.9 5.1 0.72 0.82
P/CF 6.4 5.9 0.53 0.64
P/E/G ratio 1.7 1.5 1.35 1.31
ROE 0.13 0.11 0.84 0.63

•Consensus growth estimate for Telecom is 9% with a standard deviation of

5%.
•Consensus growth estimate for Market is 12.0% with a standard deviation of
4%.
Valuation Analysis
January 4, 2009 16
 Valuation Analysis - Multiples

Valuation Analysis
January 4, 2009 17
 Valuation Analysis –Momentum

Valuation Analysis
January 4, 2009 18
 Summary
 Cyclical sector – underperforms S&P when economy is
poor
 Mature industry with low growth rate
 Within Telecommunications, Wireless industry is
expected to outperform with a CAGR of 10% over the
next few years
 Telecom companies are facing cost and margin
pressures
 Currently inline to slightly expensive when compared to
S&P 500
 High beta and high PEG ratio for Telecom sector
 Negative economic outlook – GDP growth,
Unemployment and Inflation
Recommendations
January 4, 2009 19
 Recommendations
 Telecom Sector should be even-weighted instead of 28
Basis Points overweight
 Sell 28 basis points to bring the SIM weighting
relative to the S&P500 to 100%
 Further underweighting in the future if economic
conditions don’t improve
 Wireless has better growth prospects
 Look for Telecom companies that have significant
international exposure or for Telecom companies in
countries that have strong domestic growth (China
Mobile, Vodafone)

Recommendations
January 4, 2009 20
 Thank you

What questions do you have?

January 4, 2009 21