Shares digital

When you can’t even rely on defensives to save your bacon you know something is amiss. Russ Mould rallies the troops and looks to telecos to save the day

One of the most difficult issues investors face is how to deal with markets that are at best volatile and at worst falling. Traditional havens have included sectors such as pharmaceuticals, utilities, tobacco, food retailing, food production and oil. All have historically shown relatively low earnings volatility, limited dependence for growth upon the economic cycle and healthy cashflow.

Yet none of these have made a particularly favourable impression in 2008, hindered by concerns such as drug patent expiries, margin pressure from price inflation in agricultural commodities or simply valuation (see table).

Last week saw the Telecoms sector become the latest seemingly defensive sector to come in for a hammering. FTSE 100 heavyweights Vodafone (VOD), BT (BT.A) and Cable & Wireless (CW.) all lurched downward after American telco Verizon Wireless launched a new unlimited calls pricing plan.

Verizon’s offer of unlimited monthly voice calls for $99.99 was immediately matched by its major rivals, AT&T Mobility and T-Mobile, which are part of AT&T (T:NYSE) and Deutsche Telekom (DT:GDAX) respectively. Verizon’s offer chopped out domestic roaming and long-distance fees, while T-Mobile’s offer distinguished itself by including text and picture messaging as well, for which Verizon subscribers will need to pay an extra $20 to $40 per month.

Whatever the small print, the big picture looks suspiciously like a price war. Hence the pasting handed out to telco share prices worldwide, and to Vodafone in particular.

The world’s leading mobile phone operator, which has 252.3 million subscribers worldwide, owns a 45% stake in Verizon Wireless and last year had to stare down a shareholder rebellion over its plans for the holding. Hedge fund Efficient Capital Structures, spearheaded by former Marconi boss John Mayo, argued the Berkshire firm gains no economic benefit from its stake, as Verizon Wireless, in which US telco giant Verizon (VZ:NYSE) owns the other 55%, currently pays no dividends.

Vodafone boss Arun Sarin won the day by arguing Verizon Wireless was rapidly paying down its then $25 billion debt mountain and that dividend payments could begin as early as 2009. The latest price war could make this scenario less likely as it pressures short-term cash flow and profits at the US firm.

Despite his active management of his firm’s portfolio, and successful forays into markets such as India and Turkey, Sarin could again be put under pressure about both the Verizon Wireless stake and his firm’s competitive position. New competitors such as Vyke Communications (VYKE:AIM), Barablu and fring, who offer mobile Voice over Internet Protocol (VoIP) services, all bypass traditional cellular networks and offer mobile calls much cheaper than their more established rivals.

Even given such risks, the sell off could be overdone. If emerging markets can ‘decouple’ from the US and Western economy and ride out the current turbulence, Vodafone’s exposure here will leave it well positioned to cash in. A 41.5% jump in data revenues in the three months to December also illustrates the firm’s secular growth potential, and such growth will be highly prized if the global economy really does tank.

It clearly has not paid to blindly buy ‘defensives’ so far in 2008, as global interest rate cuts have fired hopes any economic downturn will be shallow and short. Yet these hopes could still be dashed and secular growth such as Vodafone’s, or fat yields such as BT’s 6.8%, could still come back into vogue.

Shares says:

BUY Vodafone, Cable & Wireless

HOLD BT, Vyke