Hate Big Telecom All You Want

Just be sure to buy the stocks.

“Everyone hates the phone company.” That memorable line from the 1960s cult classic “The President’s Analyst” rings true in the stock market as much as ever.

Verizon Communications (NYSE: VZ) is the sector’s largest company. And its market share, revenue, earnings and dividends have risen consistently for decades.

Yet, as of Friday’s close, investors valued the company at just 9.3 times its projected next 12 months earnings. That compares to 27 times for the broad-based S&P 500.

The typical S&P 500 ETF pays a dividend yield of around 1.2%. Verizon, which just raised its dividend last month, yields more than 6%. And Verizon trades at just 1.88 times its book value, 1.3 times sales and 8.5 times cash flow. That compares to 5.2 times book, 3.3 times sales and 16 times cash flow for the S&P 500.

No Big Tech company would last five minutes without advanced telecommunications. Yet the Big Tech Nasdaq 100 sells for an even wider valuation gap of 8 times book and 22 times cash flow.

Even Wall Street’s favorite telecom—Deutsche Telekom’s (Germany: DTE, OTC: DTEGY) US affiliate T-Mobile US (NSDQ: TMUS)—sells at sharp valuation discount. And #3 telecom AT&T Inc (NYSE: T) is cheaper still.

Why do investors hate telecom? Simply, the sector has been far better known for business failures than successes since 1996 Deregulation, when Congress broke up the Baby Bell local phone monopolies.

The broad-based S&P Telecom Services Index hit peak of 339 and change at the end of 1999. Since then, it’s lost more than half its value. And more than a few of the 1990s index members no longer exist. Remember Bernie Ebbers’ Worldcom?

When a sector deals out enough pain, it can take years to repair the reputational damage. And for anyone invested outside the Big 3 of AT&T, T-Mobile US and Verizon the past couple decades, the hits have kept on coming.

Uniti Group (NSDQ: UNIT) has touted itself as a fiber broadband sector disruptor. Yet since announcing a merger with privately held Windstream Holdings—by far its largest source of revenue—the company has eliminated its dividend. Rural based Telephone & Data Systems (NYSE: TDS) cut its dividend more than -70% after announcing the sale of its wireless operations to T-Mobile US.

In late 2022, Lumen Technologies (NYSE: LUMN) dumped its dividend, a precursor to restructuring its daunting $19 billion debt load. That essentially has now happened, with S&P acknowledging a “selective default” by the company earlier this month. The company avoided filing Chapter 11 bankruptcy. But that’s cold comfort for the bondholders on the other end of the “distressed” exchange.

Lumen’s far from the only US telecom to give its investors a haircut this decade. And there’s more pain ahead: EchoStar Corp’s (NSDQ: SATS) wants to sell the former DISH Network’s satellite television operations to private capital company TPG. That’s part of a deal involving AT&T’s sale of its 70 percent interest in DirecTV to TPG for cash, which would effectively merge the US’ two largest satellite TV providers.

AT&T’s sale faces few regulatory hurdles. The actual merger of DISH and DirecTV might. But the real headline is EchoStar is attempting to disenfranchise bondholders of the former DISH, who have a claim on its extremely valuable and largely unused 5G spectrum.

This case is almost certainly headed for litigation. But the big picture is yet another telecom outside the Big 3 with far too much debt and dwindling ability to service it, much less make needed investments to compete on network quality and speed. It’s a formula for financial ruin, just as it’s been for literally hundreds of would-be telecom competitors since 1996 deregulation.

What’s going on here is simply US communications Great Consolidation.

Communications is more essential than ever to a functioning world. And as more industries adopt artificial intelligence, it will only become more vital, even as total global penetration of smart phones tops 100%.

But at the same time the business of operating communications networks is becoming ever more exclusionary. And it’s pretty clear only three companies in America have the financial power to stay in the race to offer the fastest and most efficient networks—mainly converged 5G wireless and fiber broadband augmented with AI capability.

As for everyone else, the ranks thin every year.

Thanks to the Federal Reserve’s pivot to lower interest rates, a window has again opened this year for consolidation by merger, rather than by failure. Investors who timed their investment in Frontier Communications (NSDQ: FYBR) post that company’s bankruptcy, for example, have already done very well, for example.

Acquirer Verizon is still getting a nice discount for its purchase. In the previous decade, the company sold territory with what was then mostly copper phone wires to Frontier for $10.5 billion. Now it’s paying just $9.5 billion or roughly $20 billion including assumed debt for the entire company. And that’s after Frontier has invested tens of billions of dollars in fiber over the past decade, turning revenue growth positive for the first time in years.

Verizon is also buying into a massive opportunity to further invest in and grow fiber broadband revenue. It expects some $500 million in annual savings by year three, in part by refinancing Frontier’s expensive debt. And by combining fiber and wireless networks into a single package, customer churn is expected to drop by 50% and 40% respectively for each service beginning in 2027.

So why is Frontier selling? The price is a considerable premium to where the stock traded pre-deal. But arguably, the company had gone about as far as it could as an independent entity, after bleeding $1 billion in cash the last 12 months.

In contrast, as part of Verizon, Frontier will have no balance sheet constraints on investment. That’s the case for all of the US Big 3. And it’s why they will continue to win and grow, regardless of how much investors may hate them.