U.S. Telecom ETFs: Opportunities and Threats - ETF News And Commentary

TELECOM ETFs

Despite the sluggish economy, stiff competition and stringent regulations, the U.S. telecom service providers are delivering consistent growth making it attractive for betting. The industry is heavily weighted towards innovations, inventions, and technological changes as both the wireless and wireline market has saturated.

Several industry researchers estimated that the market size of the global telecommunications industry might reach $1.8-$2 trillion in the next three years. The U.S. telecommunications industry will hold the largest share of it. U.S. telecom revenue is expected to grow about 3.9% per year to $1.2 trillion through 2020 from the current $750 billion. (Read:Are Telecom ETFs in Trouble)

Growth Opportunities

Majority of the future growth of the telecom industry depends on the wireless business as subscribers are discontinuing landlines and moving quickly to wireless connections. The present wireless market is ready for the on-going boom in the wireless data space with the growing broadband services. Rising demand for data traffic, which has more than doubled over the last three years, is creating new growth opportunities for these carriers including IPTV offerings, cloud computing, videoconferencing, online video streaming and managed telepresence.

Carriers like Verizon, CenturyLink and AT&T are rapidly entering into the cloud computing, which is now a business prerequisite that is high on demand. The global cloud computing market is currently estimated at approximately $37 billion and is expected to hit $121 billion by 2015 at a growth rate of approximately 26%. Major players such as Apple and Google are gaining increased traction, and are enabling the developments in the mobile cloud computing. Additionally, managed telepresence services are gaining popularity and expected to reach market capitalization of approximately $1.5 billion by 2016, with an annual growth rate of approximately 25%. (Read: Three Technology ETFs Outperforming XLK)

Further, smartphones, in particular iPhones and Androids, tablets and 4G LTE are facilitating the companies to boost market share over the next several years. As the smartphone market is growing rapidly, companies are progressing fast to acquire more spectrum licenses to meet the explosive growth of Internet-connected smartphones and tablet computer. As a result, the US Congress eases spectrum access last month for next generation wireless networks, which would expand data services to more number of customers.

Besides, the LTE deployments will allow the global carriers to take advantage of the new and unused spectrums while expanding their abilities to deliver the strongest and the most advanced networks. In addition, enhancing network capabilities will lead to creation of new opportunities, economies of scale and will open up markets that were previously inaccessible.

Moreover, the wireless operator like Verizon may emerge as a strong winner in future following its announced agreements with several cable operators like Leap Wireless, Comcast, Time Warner Cable, Bright House Networks, and Cox Communications Inc. The deal would alleviate competition from cable operators, thereby solidifying their respective competitive positions in the telecom sector.

We believe the ongoing developments and inventions are the long-term beneficiaries of the telecom industry as a whole. These efforts to upgrade the existing network infrastructure would boost wireless growth prospects in the years ahead.

Threats

Continued expansions and obtaining wireless spectrum licenses have prompted huge investments. Most of the investments were directed towards technological updates, entering new markets, and enhancing capacity into the existing markets having poor standards of service quality. As a result, telecom companies may be exposed to high debt levels and limited liquidity, which puts a premium on sustainable cash flow to service debt obligations.

Additioanlly, telecom U.S. operations are subject to regulations by the Federal Communications Commission and other federal, state and local agencies. The 4G infrastructure, which has become the principal next-generation global standard, may be an obstacle if other service providers shift to different generation technologies.

Further, any economic meltdown resulting from the Euro-zone crisis, though expecting it to resolve, could delay the ongoing developments in the telecom industry leading to negative implications on its financials.

Telecom ETFs

As telecom sector is expected to outpace the economy in future, investors seeking solid returns on their investment might consider telecommunications industry Exchange Traded Funds (ETFs).

Vanguard Telecommunication Service ETF (VOX) tracks the Morgan Stanley Capital International (MSCI) US Investable Market Telecommunication Services 25/50 Index. Introduced in September 23, 2004, the ETF holds 36 stocks of companies, which provides wireless, high-speed, fiber-optic cable, fixed-line and cellular services, with 71.81% concentration risk in top 10 companies. Top holdings include Verizon (24.09%), AT&T (23.30%) and Crown Castle International (4.53%). The total assets as of March 5, 2012 were $431.2 million. This ETF has a below average expense ratio of 0.19% compared to its category average of 0.47%. On an annualized basis, the fund has generated 0.25% return over the last year. This has outpaced 1-year index return of 0.12%.

iShares Dow Jones U.S. Telecom (IYZ) tracks the performance of the US wireline and wireless telecom stocks as represented by the Dow Jones U.S. Select Telecommunication Index. The fund invests 69.83% in top 10 holdings with the largest concentrated in the hands of AT&T (17.08%), Verizon (12.92%) and CenturyLink (8.21%). It charges slightly higher 0.48% compared to category average of 0.47%. The total assets as of March 5, 2012 were $575.7 million representing 30 holdings. The ETF has underperformed its benchmark over the past year with annualized returns of negative 1.35% as compared to the index return of negative 0.95%.

SPDR S&P Telecom ETF (XTL) seeks to match the returns and attributes of the S&P Telecom Select Industry Index. Initiated in January 26, 2011, the fund has 58 holdings with total asset value of $6.8 million (as of March 5, 2012) and expense ratio of 0.35%. The top 10 holdings include Level 3 Communications, Leap Wireless, Harris Corp, Polycom, Finisar Corp, Ciena Corp, MetroPCS Communications, JDS Uniphase Corp, Crown Castle and Tw Telecom each having concentration around 2.3%-2.6% of assets. The fund had underperformed its benchmark with negative returns in one-year period.

Focus Morningstar Communication (FCQ) tracks Morningstar Communication Services Index. The fund consists of 35 internet services provider companies with $5.1 million of asset as of March 5, 2012 and charges low fees of 0.19%. The largest holdings are AT&T, Verizon and Comcast with 18.91%, 12.04% and 8.46% of assets, respectively. FCQ, launched on March 30, 2011, has outperformed its index (7.45% returns), producing substantial 8.58% returns year-to-date.

Recommendation

Of the ETFs discussed above, we would recommend FCQ as it has lower expense ratio and outperformed its index year-to-date.

FCQ represents the basket of stocks that provide internet services such as access, navigation and internet related software and services. The demand for broadband internet services including video streaming and cloud computing is riding high, which will boost subscriber accretion and improves churn rate (customer switch). This would ensure higher returns in the medium to long-term.

Although VOX delivered lower returns of less than 1%, we expect the fund is attractively valued at current levels. The ETF trades with a good volume, has lower expense ratio, and is the most diversified representing the stocks of large, medium, and small U.S. companies. These companies offer fixed-line, cellular, wireless, high bandwidth, and fiber-optic cable services. Hence, if the performance of any particular service will decline, the fund will likely be benefit from other services included in the portfolio. Hence, we consider this the best fund after FCQ.

 

 

 

 

To read this article on Zacks.com click here.

Zacks Investment Research

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report