Over the past six months, a number of telecommunication companies have come on the market offering 8% to 10% yields at current share prices. These companies have been generating a fair amount of buzz on the Income Investor discussion boards because of the great opportunity to realize a market-beating yield. Since they're telecommunications companies, these firms also have limited competition and a recurring revenue structure. The situation is almost too good to be true.
What's the rest of the story?
But in investing, what sounds too good to be true almost always is. IowaTelecommunications Services (NYSE:IWA), FairpointCommunications (NYSE:FRP), and Valor Communications Group (NYSE:VCG) are no exception. They're not bad companies and because rural customers have fewer options for phone and high-speed Internet services, these telecoms are likely to see a slower decline in business than giants Verizon (NYSE:VZ) or SBC (NYSE:SBC). But they have limited growth prospects, are likely to see their businesses slowly decline, and are subject to state and federal regulations. As such, they just don't stack up as long-term dividend investments.
Lifting the veil
In many cases, rural customers that depend on these companies will continue to rely on them because they don't really have much of a choice. From that standpoint, there isn't a lot of immediate business risk, but there are other risks to their business models that should not be ignored.
While I like the geographic diversification of Valor and Fairpoint, those two rely on Universal Service Funds (USF) for too much of their revenue -- 23.7% and 9%, respectively. USF are paid by the government to rural carriers to help offset the high costs of operating in a rural environment. The payments are normal for rural operators, but particularly in the case of Valor, it is too large a portion of its business for my comfort.
At the other end of the spectrum is Iowa Telecommunications, which does not rely on USF. The company operates in just one state. One. If Iowa changes its telecom regulations, Iowa Telecommunications' business could be negatively affected.
And none of these companies have operating histories as public companies. Far too often, recently public companies stumble out of the gates. Although these companies could turn out to be steady investments that pay absolutely stunning dividends, I'm going to wait for them to get a few more 10-Qs under their belt with dividend payments and free cash flow. If prospects look good a few quarters from now, I might take another look.
Foolish final words
But boring industries with recurring revenue structures are a great place to look for long-term dividend investment. Fool analyst Mathew Emmert has dug up two great opportunities in the sector for Income Investor subscribers: Alltel (NYSE:AT) and Citizens Communications (NYSE:CZN) have delivered dividends and solid capital gains with future growth on the horizon. Since Mathew recommended Alltel, the investment has given subscribers a total return of 27.7% vs. the market's 8.6% over the same period.
There are loads of great dividend payers in America, but they're not the market's hottest stocks. To view Mathew's almost four dozen favorite income stocks, join the ship of dividend-loving Fools with a 30-day free trial to Income Investor. There's no obligation to subscribe, and a trial includes access to all back issues and previous picks, mid-month updates, current risk-adjusted values, and dedicated discussion boards, where Mathew posts regularly and where you'll find hordes of like-minded investors sharing wisdom, ideas, and analysis.
Nathan Parmelee owns no shares of companies mentioned here. You can view his profile here . The Motley Fool has an ironclad disclosure policy.
