As some readers might have noticed over the past few months, I'm bullish about a number of telecom stocks, ranging from fast-growing, pure-play wireless companies such as American Movil
Obviously, these companies operate in markets with wildly different characteristics (i.e., BT Group operates in a mature, slow-growing economy, while China Mobile addresses an underpenetrated market in the world's fastest-expanding economy), but they all have a number of common denominators. Each dominates its respective market, each carries an attractive valuation, and each has good opportunities for growth, either through continued expansion of its subscriber base or the adoption of new technologies.
After that scintillating introduction, I'm sure it's no surprise that I have another telecom play that might be of interest to international investors -- namely, Chunghwa Telecom
I know, I know. Taiwan's not exactly a growth market. The island has a population of only 23 million, virtually all homes have fixed-line service, and the wireless penetration rate is roughly 86%. Furthermore, the chances of a Taiwanese telecommunications company expanding into the logical market -- China -- are somewhat less than a snowball's chance in hell.
That being said, I believe that Chunghwa represents an attractive investment opportunity for patient, long-term investors for the following reasons: Chunghwa's dominant position in all aspects of Taiwan's telecom market, the company's ongoing transition to higher-margin 3G wireless services, and the forthcoming rollout of Chunghwa's next-generation IP network. It also doesn't hurt that the stock is attractively valued and carries a yield of roughly 7%.
Let's take a quick look, shall we?
Chunghwa Telecom is not only the largest telecommunications player in Taiwan, but also the only fully integrated operator in the country. That gives it a competitive advantage in terms of offering "bundled" services. The company operates in four business segments -- fixed-line (34.2% of H1 2006 revenue), mobile (39.6%), Internet and data services (24.7%), and other (1.5%). As of the second quarter ended June 30, 2006, Chunghwa derived 98% of its revenue from Taiwan and a mere 2% from the international market, primarily from operations in countries such as Japan, Indonesia, and South Korea.
Now, as I stated before, while such heavy dependence on a single, relatively small and mature market might be off-putting to some investors, I believe that Chunghwa's dominance in every market segment offers investors a great deal of downside protection, even as its previously mentioned network expansions and ugrades will drive growth going forward. A quick examination of factors should hopefully illustrate my point.
The company's fixed-line business consists of local, domestic long distance, and international calling. As of year-end 2005, Chunghwa's market share in these segments was, respectively, 97%, 85%, and 58% -- well ahead of the competition. As is the case with all traditional incumbent carriers, fixed-line revenue has been declining as people increasingly turn to mobile services. In the first half of 2006, the fixed-line services business accounted for roughly $939 million, down 6.2% from last year's period, while the total number of fixed-line subscriber remained flat at 13.2 million.
Not too pleasant, eh? Luckily, growth in Chunghwa's wireless and Internet and data businesses is offsetting this inevitable decline.
Chunghwa remains the leading wireless provider in Taiwan, with roughly 8.3 million wireless subscribers as of June 30, 2006; it holds a 41% share of the 2G market. For the first half of 2006, wireless revenue came in at $1.09 billion, up 1.7% over the prior year period, driven by a 3.9% increase in post-paid subscribers (i.e., higher-margin customers) and demand for value-added products such as ringtones, music video clips, etc.
While wireless growth isn't as robust as it once was, Chunghwa -- in collaboration with Nokia (NYSE: NOK -- has been expanding its 3G networks. These 3G services are increasingly in demand and are likely to be significant growth drivers s soon as the middle of 2007.
Internet and data services
Just as Chunghwa dominates the fixed-line and mobile markets, the company is also the king of Taiwan's Internet and broadband industry. As of Dec. 31, 2005, Chunghwa was the country's largest Internet provider, with a 57% share of the market and a whopping 85% share of the broadband market. For the first half of the year, Internet and data revenue climbed 10.4% to $676 million, driven by a 6% increase in HiNet (Internet service) subscribers to 4.22 million and a 14% increase in broadband (high-speed ADSL) customers to 3.83 million.
All in all, Chunghwa's dominant position in each of these markets allowed the company to generate approximately $1.4 billion in revenue during the second quarter, essentially flat with the second quarter of 2005, as well as $817 million in cash from operations (up 22.8% over last year's quarter) and $646 million in free cash flow. While net income in the quarter was down 18.2% to $315 million, the decrease was primarily due to a one-time expense related to a head count reduction -- a reduction that should lower operating expenses significantly in the near future.
Starting to sound pretty interesting, isn't it?
Well, let's not forget that the company has committed itself to transitioning all its businesses onto a single converged IP network by 2013, at a cost of roughly $4 billion. By 2011, Chunghwa plans to provide this service to 75% of Taiwan's population, and by 2013, the network should cover all of Taiwan, as well as six-12 cities around the globe where Taiwanese companies operate. This network will significantly lower operating expenses while providing a boost for both domestic and international growth.
Last but not least, let's not forget a balance sheet with roughly $2.4 billion in cash and short-term investments and virtually no debt. Furthermore, institutional interest obviously remains strong, as the Taiwanese government (and Taiwan Mobile) just sold a 7% stake in Chunghwa after the close on Sept. 28 at no discount to the stock price of $16.99.
At a recent price of $18.45 per ADS, shares of Chunghwa Telecom trade at 12 times fiscal 2007 estimates of $1.56, estimates that are likely to be conservative given the recent headcount reduction and the continued migration of customers to higher margin 3G wireless services. The 7% yield carried by the shares offers both a great deal of downside protection, as well as a nice return while investors wait for Chunghwa's growth to accelerate in 2007. I'd suggest that patient investors dial up Chunghwa's financials and take a close look at the king of Taiwan's telecom market.
*For purposes of currency translation, $1 = 33.3 Taiwan dollars.
Fool contributor Will Frankenhoff is enjoying his time writing for The Fool more than playing golf, reading the Financial Times, or taking a nap. He welcomes your feedback. He does not own shares in any of the companies mentioned above. The Fool has a disclosure policy.