Here’s Why I Love Telecom Stocks – And You Should, Too…

Let’s say you’re spending the next year on a deserted island. You can take one modern convenience along with you.

What do you choose? Perhaps an air conditioner. Maybe a shower. Or a microwave.

I think I know what most people would choose: Their mobile phone. Provided it could reach some distant network, I have little doubt it would end up being the top choice. No contest.

According to Gallup, approximately 92% of U.S. adults have a smartphone within arm’s reach at all times. The majority of those polled (84%) admitted they couldn’t cope without their trusty device for even a single day. If given a choice, two-in-five Millennials would rather forfeit their car or pinky finger than lose their phone. A majority would give up food, alcohol, and even sex for a week before severing their connection to the world.

I won’t use the word “addiction.” But for many, the phone is right up there with air and water in terms of essential priorities

…not necessarily in that order.

An Essential Service

It’s understandable. These devices aren’t just a magic portal into music, books, games, television, and endless other forms of entertainment. They also help us perform daily tasks (like making a dinner reservation or booking an Uber) and keep in touch with friends and family. Personally, I’m old school and prefer physical media like DVDs and hardback books. But then again, I’m in the minority.

I could throw facts and figures at you all day. The billions of text messages. The terabytes of data coursing through the veins of the nation’s telecom networks. But at this point, I don’t think anyone needs convincing that the world is glued to the phone.

Approximately 1.2 billion mobile phones are purchased annually. That means roughly 3.2 million are unpackaged (and connected) daily. You can see that tremendous demand in Apple’s $3 trillion market cap, to say nothing of vendors that provide chips, display screens, and other vital components.

But think about it. These hand-held computers aren’t much more useful than a paperweight without wireless service.

I tried to order a snack on a plane recently and was informed that the airline didn’t accept cash or debit/credit cards for in-flight purchases. Payment could only be made via an American Airlines smartphone app. It’s almost more of an obligation than a choice — you can barely function in society anymore without a phone.

And a wireless plan.

While not technically compulsory, there are now 310 million smartphone users in the United States, one for nearly each of the 331 million citizens. And as we all know, that cell phone bill must be paid every 30 days.

Source: Statista

This brings us to those two lovely words: recurring revenues. The Tier One wireless carriers generally charge $50 or so for standard monthly service, considerably more for unlimited data plans. So forecasting income is a simple exercise in second-grade math. Just multiply that figure by ‘X’ number of subscribers, and you have a ballpark idea.

There are other ancillary sources of income. And the top line may deviate somewhat from period to period as a few old subscribers jump ship and a few new ones come aboard. But with low industry churn rates of around 1%, this is one of the most transparent and predictable cash flow streams you’ll find.

A Predictable Business

On the downside, there are few real avenues for growth. When market saturation reaches close to 100%, new accounts are inevitably harder to come by. So the larger goal is to coax an increase in average revenues per user (ARPU) or average revenues per account (ARPA).

Another caveat: immense capital spending requirements. In one 12-month stretch last year, Federal Communications Commission (FCC) auctions for midband wireless spectrum licenses raised a staggering $117 billion. For perspective, that’s more than Americans spent on clothing over the same time frame.

And that doesn’t count the vast sums plowed into cell towers and other critical infrastructure to support nationwide 5G rollouts. AT&T, for instance, spent $24 billion to build and maintain its network last year, fully one-fifth of its revenues.

But that’s the price to attract (and retain) subscribers. Fortunately, it also acts as a natural barrier to entry. While dozens of small operators showed up to the spectrum party, all but a few were outbid and went home empty-handed. Between that and natural consolidation, this lucrative market has become a tight oligopoly.

Nearly all of the wealth has been concentrated in the hands of just three major players. You undoubtedly know them. Verizon (NYSE: VZ) and AT&T (NYSE: T) each control around one-third of the market and battle for supremacy. Both of them are paying investors over 7% right now, by the way. T Mobile (Nasdaq: TMUS) (following its merger with Sprint) is close behind. A host of smaller regional operators like Mint Mobile (which was just bought out) carve up the remainder.

You’ll find that apples-to-apples comparisons aren’t always straightforward in this sector. Terms such as subscribers and connections aren’t exactly measuring the same thing, since a single customer can connect multiple gadgets. Users are further subdivided into prepaid and postpaid groups (the latter being more profitable).

But one thing is clear: Smaller competitors have found it difficult to chip away at the big three.

Thanks to their size and scale, the incumbent leaders can spread fixed expenses over a larger base, minimizing costs per subscriber and undercutting would-be rivals with thinner margins. That economic advantage leads to more subscribers, thereby widening the lead. It’s the same virtuous cycle that TCI founder John Malone used to become a kingpin in the media world.

Translation: the strong get stronger.

Closing Thoughts

We’ve reached a point where the largest players are almost at parity and aren’t interested in pursuing a destructive price war (with margins becoming collateral damage) just to gain a point or two of market share. That equilibrium is a good thing.

Now, put it all together, and that’s music to the ears of dividend hunters like us. It’s also why now is the opportune time to dial up my favorite player in this space.

Since I just made this pick, I can’t give it away. But, again, this is a small paying field. In the meantime, if our readers want to know more about what we’re doing over at High-Yield Investing, they can check out my latest report here.