Let's Play Monopoly
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
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
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,
These telecom companies are similar. They are entrenched in
their markets, dominating their field, like quasi-
monopolists. They also throw off copious amounts of cash
flow — like a free-flowing tap serving your favorite brew.
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
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
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
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 Zeland 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
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.
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"
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
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
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
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.
And the Markets…
WTI NYMEX CRUDE