StarHub Ltd (SGX: CC3) is one of the three major telcos in Singapore. It has five business segments, namely, mobile, pay TV, broadband, enterprise fixed, and equipment sales.
Lately, StarHub’s share price has fallen drastically. From its 2018 peak of S$2.99, its shares have plunged 41% to S$1.77 at the time of writing. Is there value in StarHub shares following the fall? There’s no quick answer to that, but we can get some insights by turning to a six-point acquisition criteria for businesses formulated by Warren Buffett.
1. Pre-tax earnings of at least US$75 million
Buffett has this criterion in place because the conglomerate he controls, Berkshire Hathaway, is a US$500 billion behemoth, so his acquisition targets need to be of a certain size to move the needle for Berkshire.
For its financial year ended 31 December 2017, StarHub had earnings of S$304 million, which meets the first criterion.
2. Demonstrated consistent earning power
The second criterion helps Buffett determine if a company has a stable and/or growing business. Companies that have a history of steady and growing earnings tend to have competitive advantages that help their businesses grow over time.
The table below shows the net profit for StarHub over its past five financial years:Source: S&P Global Market Intelligence
StarHub’s net profit has fallen from S$380 million in 2013 to S$249 million in 2017 with the company facing intense competition in most of its business segments. As such, StarHub looks unlikely to have a durable competitive advantage.
3. Good returns on equity (ROE) while employing little or no debt
This criterion’s purpose is similar to the second: It helps Buffett identify companies with competitive advantages. Generally, a company that has a history of generating good ROE while employing little or no debt has a high chance of possessing durable competitive advantages.
The table below illustrates StarHub’s ROE from 2013 to 2017:Source: S&P Global Market Intelligence
StarHub ended 2017 with an ROE of 92.5%. The ROE is elevated as the telco employs lots of debt for its business, as seen from its total-debt-to-equity ratio of more than 100%. As of 31 December 2017, StarHub had S$345.2 million in cash and S$977.5 million in total debt.
4. Management in place
Buffett included this criterion because he did not want to have to provide a management team when he acquires a company. For retail investors like you and me, this criterion has no real meaning, since public-listed companies almost always have leaders in place. However, this point is a reminder for us to take a look at the people running a company when researching a stock.
StarHub’s chief executive officer (CEO) is Peter Kaliaropoulos, who began his current role in July this year after replacing Tan Tong Hai. Kaliaropoulos has 35 years of working experience in the global information and communications technology sector, holding senior leadership roles in well-known telcos worldwide.
5. A simple business
In my view, StarHub is a simple company to understand. It is in the business of providing mobile, internet and pay TV services.
However, it is worth noting that Buffett had this rule in place to cater to his circle of competence. He is only interested in acquiring businesses that he understands. Going with this train of thought, what I think is a simple business may be complicated for you, and vice versa.
6. An offering price
This is another criterion in Buffett’s checklist that is not applicable for stock market investors, since stocks have quoted prices that are easily seen, unlike the private businesses that Buffett evaluates for acquisitions. This criterion, though, serves as a useful reminder that the price we pay for a stock is crucial.
StarHub, at its share price of S$1.80 on 20 December, had a trailing price-to-earnings ratio of 16 and a dividend yield of 8.9%. The high dividend yield may look enticing for income investors, but they should not invest based on the dividend yield alone.
The Foolish takeaway
Even though StarHub’s shares have declined substantially in recent history, I feel now is not the right time to be a contrarian and pick up some shares. The competition in the industry looks to only intensify with the entry of the fourth telco, TPG Telecom. TPG, which is from Australia, revealed on 21 December that it would be doing a trial on its mobile service in 2019.
In a recent interview with The Business Times, Kaliaropoulos acknowledged that the competitive intensity in Singapore’s telco market would increase dramatically in the next couple of years. As such, I would be monitoring StarHub closely in the coming years to see if it can turnaround its business successfully, before analysing again if it’s a buy.
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Editor's note: Criterion 3 above erroneously stated that total debt for StarHub was S$977.5 billion. It should be S$977.5 million instead. We apologise for the typo.
The information provided is for general information purposes only and is not intended to be personalised investment or financial advice. Motley Fool Singapore contributor Sudhan P doesn’t own shares in any companies mentioned.