For many investors, telecom stocks are something of a paradox. On one hand, owners are treated to tremendous cash flow and, generally, higher-than-average dividend yields. On the other hand, it is generally considered that to get these things investors give up on growth opportunities due to stagnant fixed line and pay-TV businesses offsetting the popular but heavily contested mobile and Internet service provider businesses.
So the key to evaluating the two major telecoms -- Verizon and AT&T (NYSE:T) -- is deciding if there's a possible opportunity for growth that analysts are undervaluing. And when it comes to the latter, I feel that opportunity is currently presenting itself. Between a growing Latin American middle class and Mexican President Enrique Nieto's reforms to address telecommunication monopolies, AT&T has a runway for growth that doesn't appear to be reflected in the stock valuation.
Carlos Slim's pain could be AT&T's gain. Source: American Movil
Carlos Slim's monopoly is coming to an end
Earlier this year, Mexico's Federal Telecommunications Institute ruled Slim-owned American Movil (NYSE:AMX) entities Telmex (landline) and Telcel (mobile) are subject to strict anti-monopolistic measures including lower prices, expanded access, and requirements to share infrastructure with competitors to increase competition. That's in an attempt to lower the market share of those subsidiaries to no higher than 50%. Considering Telcel owns an estimated 70% or more of the wireless market, the company will have to divest a significant portion of their subscribers.
To be fair, this monopoly was harmful to the country. A 2012 report from the Organization for Economic Cooperation and Development found Mexican citizens were overcharged $13.4 billion a year for telecom service -- that's 2% of its GDP lost through monopolistic pricing and rent seeking-behavior. And after divesting itself of $5.6 billion of American Movil shares (more on that later), AT&T is entering the country with its purchase of Lusacell.
By paying $2.5 billion, inclusive of debt, AT&T enters Mexico by grabbing 8.6 million subscribers. Although the company covers 70% of Mexico's population, the service hasn't been able to acquire substantive market share due to Telcel's monopoly and financial resources. AT&T, unlike Iusacell, has the wherewithal to compete with Telcel on both an operational and financial basis.
AT&T also wants in on the pay-TV market
Earlier this year, AT&T announced it would acquire another entity: DirecTV (NYSE:DTV.DL). And while many in the United States felt this was odd considering the pay-TV market is going through a managed, but long-term, decline, it appears DirecTV's Latin American operations are the crown jewel of the service. The numbers over the last three years are simply astonishing for a pay-TV business: subscribers up 26% per year, revenue up 24% per year, consolidated adjusted operating income before depreciation and amortization up 21% per year.
And while it should be noted the Latin America service is more than just Mexico, DirecTV has a strong footprint. According to last year's annual report, the company is in an estimated 37% of pay television households in Mexico. Eventually the market share could present problems for future growth (President Nieto's monopoly reforms extend to pay-TV providers as well), as more Mexicans enter into the middle class and can afford pay-TV this ceiling should continue to grow. Unlike the United States where the market is shrinking. The opportunity is so huge AT&T sold its stake in American Movil to clear the way for this deal.
Better operationally and a willing government climate
All things considered, AT&T's Mexican and Latin American strategy appears to be strong. The company is going against a sluggish mobile monopoly that is widely known to overcharge customers. AT&T should be able to acquire substantive market share and still turn a hefty profit. In addition, the company appears to be targeting a growing Latin American middle class with its purchase of DirecTV.
In Mexico, AT&T finds a government willing to let competition reign, rather to cozy up to the existing moneyed class to curry favor for campaign contributions. In the end, both AT&T and Mexican citizens will win.
Jamal Carnette owns shares of Verizon Communications and will purchase shares of AT&T as soon as our trading guidelines allow. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.