The telecommunications industry is one which ticks all the boxes for long-term investors.
Sticky revenues? Tick.
Solid free cash flows? Tick.
High returns on equity? Tick.
Dividends, entrepreneurial management and long-term tailwinds? Tick, tick and tick.
The list can go on.
However, like any competitive industry, investors must ensure they pay the right price and keep abreast of the challenges facing the market and three companies at the top of investors' buy lists are Telstra Corporation Ltd (ASX: TLS), M2 Group Ltd (ASX: MTU) and iiNET Limited (ASX: IIN).
Telstra, our biggest telco by a long way and then some, currently has its back up against the wall on a number of fronts. For example, although it has dominated the fixed data (internet) and fixed voice (home phones) market for some time – thanks to its extensive copper cable network – the NBN Co will make these parts of Telstra's business even more competitive in coming years.
However it's important to note Telstra is getting (well) rewarded for giving up its infrastructure ,which as the internet moves from fixed to wireless (particularly mobile wireless) may be a good thing.
But the competitive pressures run deeper than just home phones and internet. Telstra's pay-tv business, Foxtel, is also facing increased threats from superior services.
Global streaming giant Netflix is looming, which according to pocketbook (as seen on valuewalk.com) already commands around 27% of Australia's online streaming marketplace – that's despite geo-blocking!
Then there are rivals like Optus – owned by Singapore Telecommunications Ltd (CHESS) (ASX: SGT) –and iiNET Limited (ASX: IIN), which offers Fetch TV.
Telstra will therefore be relying on its ability to offer competitively-priced bundled packages to maintain a dominant position. But I suspect margins will likely fall over time.
However the telco's most lucrative business, Mobiles, will continue to thrive for the foreseeable future. It can afford to charge lofty premiums on its products because its network coverage and reliability appear superior.
This division will also benefit from our reliance on internet-enabled devices, machine-to-machine communication and much more.
To counter increased competition and potentially slower growth in the domestic market, Telstra is looking offshore for its next wave of growth. But thanks to its healthy cash flows from local operations, it's unlikely its legendary dividend payment will be put at risk, as it increases its capital expenditure on regional growth.
A better bet than Telstra
Whilst I think Telstra would be a great stock to hold through a market cycle, at current prices I prefer M2 Group. M2 is the owner of brands such as Dodo, Primus, Eftel and Commander. It has aggressively acquired these businesses in recent years and although its debt levels appear quite high – thus restricting further acquisitions – organic growth will likely prove to be just as profitable in the years ahead. It'll do this by cross selling products and becoming an all-in-one utilities provider.
But before buying ANY telecommunications company, I urge you to watch this video…
