Telecom Stocks

Telecom Stocks: Let's Play Monopoly
by Chris Mayer
The Rude Awakening
Wall Street, New York
Wednesday, October 19, 2005

Chris Mayer discusses the value in a couple of foreign Telecom Stocks in South Korea and New Zealand.

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Eric Fry, physically in New York, but still mentally in
Paris, reports...

"This is the place where rich American men bring their
trophy wives to shop," a French friend explained as we
strolled past the high-end boutiques surrounding La Place
Vendome in Paris. "They come for the weekend sometimes,
just to buy jewelry, and then return to the States."

"You must be exaggerating," your editor replied, "A few
Parisians must also shop here."

"I'm exaggerating a little, but not a lot," she insisted.
"Americans aren't the only ones shopping here, but they are
conspicuously present...We French can't afford this stuff.
We just sell it to you Americans."

"That's good to know," your editor nodded. "If I ever
become rich and marry a trophy wife, I'll remember to avoid
the place."

La Place Vendome features the who's-who of European "luxe"
and "haute couture." Names like Cartier, Hermes, Chanel and
Bvlgari surround the Place Vendome like a string of
glittering Christmas lights...And English-speaking shoppers
seemed to be occupying every store we entered.

But American tourists did not merely visit the Place
Vendome last weekend. They were "conspicuously present" all
over Paris. A weak dollar and a weakening U.S. economy,
apparently, pose few impediments to vacationing in Europe.

"Americans spend, Europeans save," Dr. Richebacher
explained to me in Cannes last week. "This is the big
difference between our two economies...and the big reason
why Americans are in so much trouble, even though they
don't realize it."

Your editor spent just enough of his employer's money to
visit Dr, Richebacher in Cannes, but not enough to make a
lasting impression on any of the retailers at La Place
Vendome. (In fact, he purchased nothing there. Instead, he
walked a few blocks more to the Galeries Lafayette to pick
up a couple of gifts for his kids.)

I'll be sharing many more highlights from my overseas visit
with Dr. Richebacher during the next few days. But for now,
Chris Mayer does a little globetrotting of his own in
search of unique and compelling investment opportunities...

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LET'S PLAY MONOPOLY
By Chris Mayer

The volatile oil stocks took another wicked tumble
yesterday, while boring old New Zealand Telecom gained more
than half a percent...Sometimes boring is better. As I
noted in last Friday's Rude Awakening, oil stocks are
looking dicey to me. So maybe it's not such a bad idea to
seek opportunities elsewhere for a while.

The freedom to roam wherever I find value is one of the
beauties of writing a letter like Capital & Crisis. I am
not limited to certain sectors of the market, or confined
by national boundaries. The quest for good ideas is
boundless.

Sometimes value turns up in some fairly exotic places.
Recently, I've found value in foreign telecoms —
particularly in South Korea and New Zealand.

In thinking about these entrenched monopolies, I find
similarities with some of our existing recommendations,
like Grupo Aeroportuario del Sureste (ASR:nyse), the
Mexican airport company that was added to our portfolio
last November.

ASUR, as it is known, operates a monopoly in running nine
airports in southeastern Mexico. For all practical
purposes, if you want to visit Cancun, you must pass
through ASUR's airport. And every plane that lands there
and every passenger that passes through its turnstiles
produces some sort of revenue for ASUR. The company
generates its revenues much like a toll road operator.

But there is more to ASUR than just its entrenched
competitive position. The company produces gobs of free
cash flow — cash that can be used to reinvest in the
business, buy back stock, pay dividends and do all the
other wonderful things that lead to higher stock prices.
ASUR is up 50% since I recommended it one year ago. So far,
so good.

The theme of this particular group is simply this:
Entrenched competitive positions and strong cash flow as
the backbone of an investment idea. Most of these companies
have dominant positions in the local calling market — a
cash-spinning business, as you'll see — and most pay a good
yield.

What follows is a short review of two of the most
intriguing foreign telcos:

Located way out in the South Pacific, New Zealand has got
to be one of the more geographically isolated Western-style
economies going. Two remote islands, together representing
a landmass about the size of Colorado, are home to more
than 4 million people... and about 40 million sheep.

But New Zealand is also home to one of the world's better
performing stock markets. The NZSX 50 Index, a benchmark
for New Zealand's stock market, recently hit all-time
highs.

Investors are enjoying the reforms of the 1990s, which
opened up New Zealand's economy. Today, it ranks as the
third most economically free country in the world,
according to the Heritage Foundation's Index of Economic
Freedom.

Moreover, investors fearful of the demise of the U.S.
dollar have found a worthy haven in the New Zealand dollar,
which has surged to 22-year highs against the dollar. And
the central bank maintains relatively high interest rates,
with the benchmark rate at 6.75%. Finally, over the last
few years, New Zealand's market has not moved lockstep with
the U.S. markets.

Therefore, New Zealand investments hold out a trifecta of
goodies – the promise of a hedge against a falling dollar,
juicy yields and diversification away from U.S. stocks.
Telecom Corporation of New Zealand (NZT:nyse) brings
together all of these attributes, with the added appeal of
being an entrenched native monopoly. NZT owns the nation's
only nationwide network and serves the vast majority of
consumers. NZT owns a 70% market share in local calling,
62% of the broadband market and 45% of the cellular market.

Most telecoms suffer from competition, particularly from
cable operators and cellular providers (as people migrate
from land lines to wireless). NZT does not.

In New Zealand, there is essentially no cable service. Paid
television services are delivered via satellite. And
cellular service in New Zealand is very expensive, because
the geographic area served is relatively large and the
population base is small. It is difficult for new
competitors to reach economies of scale such that it would
be worthwhile serving the New Zealand market.

NZT basically operates in a duopoly situation with Vodafone
as the only cellular players in this market.

NZT's monopolistic position shows up in its impressive
financial performance. The company's return on equity was a
mouthwatering 54% in 2004 and has consistently been more
than 45% since 1996.

The company earns fat profit margins and oozes cash flow —
much of which it pays out to shareholders — the estimated
yield on the shares is 6.6%, based on today's $34 stock
price.

NZT probably won't grow quickly. But it is trying to expand
into Australia. Then there is always the possibility of
expanding into other markets. NZT looks like an interesting
selection for those seeking a high-income dollar hedge.

Telecom Stocks: KT Corp

Meanwhile, a few thousand miles to the north, South Korea's
stock market is making new highs and has been one of the
best performing markets in the world, despite the antics of
its northern neighbor.

Korean shares used to suffer from a "Korea discount," due
to poor corporate governance and disclosure practices.
Plus, the economy was often unstable, leading to periodic
meltdowns. In the Asian crisis of 1997, the KOSPI, a
benchmark of Korean shares, plummeted from over 1,000 to
below 400. And as the KOSPI has rallied, most of the Korea
discount has dissolved away.

There are very good reasons for the recent climb in share
prices. Corporate governance issues and disclosure have
improved, and companies are delivering steady profits.

There are other macro factors at work, too. Only this year
have Koreans been able to allocate some of their retirement
funds to stocks. Currently, only about 6% of Koreans invest
in Korean shares. In the future, expect more Koreans to
invest in their stock market. This potential large inflow
of money could power the Korean shares to more "normal"
valuations.

Remarkably, even after the run-up in share prices, some
Korean stocks still look quite cheap. KT Corp. (KTC:nyse)
is one of them.

Like NZT, KT Corp. dominates the fixed-line telecom
business in South Korea, with 93% of the business, and also
has wireless and broadband capabilities. These businesses
collectively threw off about $2 billion in free cash flow
in 2004. Not bad for a company with a market cap of about
$9 billion.

Based on a current price of $22, KTC trades at price-
earnings ratio of about 8 times earnings. As with NZT, this
company also is not likely to grow quickly. The South
Korean telecom market is already nearly saturated — for
example, about 77% of households already receive Internet
service.

KTC is a cash cow, though, and it carries a nice dividend
yield of nearly 5%. As for the corporate governance issues
that have plagued Korean companies in the past, KTC scores
well on this front, winning several awards for its
corporate governance practices.

KTC is using its extra cash flow to increase its dividend
and to pay back stock. It's also investing in new growth
opportunities. If successful, KTC could surprise and its
shares could trade considerably higher than the $22 price
quoted today.

Neither KTC nor NZT will offer the thrill and adventure of
owning a high-flying (or low-falling) oil stock...but maybe
that's a good thing.

[Joel's Note: Hmmmm...We're still thinking about the free-
flowing tap serving our favorite brew. It is hardly
surprising to us, or Chris' avid followers, that he has
uncovered another batch of super value stocks. After all,
that's what he does best. If you have ever been interested
in getting in on ground floor companies, this is the
service for you. Check out Capital & Crisis here:

Capital & Crisis

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[Joel's final muttering: Cheers to all those who brightened
my Tuesday with a few choice jokes. One of my favorites had to be:

"Politicians are like diapers, they both need to be changed
for the same reason."

Write in to  aussiejoel@the-rude-awakening.com and let me know if
there are any issues you would like to see our gallant
editors tackle next week.

And the Markets...