Four Things to Dislike about the Telecommunication Industry

The telecommunication industry provides an essential service for the economy. I’ve previously looked at some of the likeable characteristics that the industry can provide for investors. However, given the saturated landscape of the telecommunication sector in Singapore, what are some of the issues we should think about before investing in this sector?

1. Rise of the smartphone

One of the most important structural changes happening in the telecommunications space is the rise of the internet and connected-mobile devices. As telecommunication companies tend to charge their fees based on the usage of Short Message Service (SMS) and voice calls, users with smartphones now can choose other new apps such as Whatapps, WeChat, Viber or Skype (also known as over-the-top services) as alternatives to the traditional services.

This is a real threat to the telecommunication companies’ business and it is important to see how each company handles this situation. SingTel (SGX: Z74), the largest telecommunications company in Singapore, has since been investing heavily into software and apps makers in the hopes of being able to take part in the growth of the OTT segment.

In addition, SingTel’s chief executive, Chua Sock Koong, has also called on regulators to allow telecommunication operators to charge OTT service providers (like Whatsapp, for instance) for use of their networks to stem the decline in revenues from traditional services like SMS and voice calls.

2. Commodity-like pricing

Even though telecommunication services tend to be dominated by a few companies, the pricing power of the companies is still rather weak. In Singapore, the pricing of services offered by the three telecommunication companies – SingTel, Starhub (SGX: CC3), and M1 (SGX: B2F) – is quite similar. This might be due to the fact that switching costs for customers are very low and it is hard for the company to retain a customer if its pricing is not competitive.

3. High fixed costs

The provision of telecommunication services is a high fixed cost business where companies need to invest in huge infrastructure to build up their network before selling their services. Therefore, their profit margins can be greatly affected if there is disruption to their services or customer base.

4. High debt levels

All three telecommunication companies in Singapore reinvest around 30% to 40% of their annual operating cash flow back into their business in order to maintain their network and competitiveness. M1, the smallest of the three, spent about S$125 million in capital expenditures last year while Singtel spent about to S$1.8 billion to preserve its leadership position.

As debt financing is the preferred choice of financing for telecommunication companies, it is important to monitor their debt levels to ensure such companies do not overextend themselves. Currently, Starhub has the highest leverage ratio (Assets divided by Equity) among the three companies at 22.4x according to its lastest financials. Meanwhile, M1 has a leverage ratio of around 2.5x while Singtel maintains the strongest balance sheet with a leverage ratio of 1.73x.

Foolish Bottom Line

Although the telecommunications industry is far from being a perfect money maker, it can be considered a defensive industry as everyone would need their services regardless of the economic outlook.

As long as we understand the risks telecommunication companies have to face in their business, there is still a place for these companies to be in our portfolio.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Stanley Lim doesn’t own shares in any companies mentioned.