The Investigative Approach to Stock Investments

There are a couple of quantitative methods for analysing stocks, such as the Dividend Discount Model (DDM). A lot of people use them for stock analysis and investment as they are relatively simple to use and do not require qualitative analysis of the business strategies, competitive environment, corporate governance, etc. For a very long time, I was also a keen user of such methods, looking at only earnings, dividends, cashflows, debts, book value, etc. to identify value stocks. Such an approach has served me well in the past. However, there are times when this approach turned up value traps whose stock price keeps on declining. Over the past 2 years, I have gradually moved away from such quantitative analysis.

Let us use the DDM as an example of the quantitative approach. A simple form of the DDM is:

where P    = Intrinsic value of stock

           D1  = Dividend for the next financial year

           r     = required rate of return

           g    = perpetuate rate of growth in dividends

It is simple to use, as there are only 4 parameters to estimate. A lot of times, in the absence of qualitative analysis, these parameters are estimated from past performance. However, past performance do not necessarily represent future performance. An example of this is Starhub. Since 2010, Starhub has been paying a constant dividend of 20 cents every year. The dividend has been so regular that it is commonly assumed that the 20-cent dividend will continue every year. Last month, Starhub dropped a bombshell by announcing that the dividend will be cut from 20 cents to 16 cents in FY2017. This is the perils of looking just at the financial numbers and extrapolating past performance into the future.

An alternative approach to stock investment is to carry out a qualitative analysis of the company and the industry it is in. One of the best known techniques in this approach is the scuttlebutt technique, which is made famous by Philip A. Fisher in his book "Common Stocks and Uncommon Profits". For the past 8 weeks, I have attempted the use of such an investigative approach in the analysis of telco stocks, looking at the business strategies, competitive environment, (my own) customer experience and industry trends. My skills are still rudimentary compared to the scuttlebutt technique, but the investigative approach does provide a glimpse of where the business is heading rather than extrapolating from past performance.

It is tough work reading through and comparing all the telco price plans, financial results, annual reports, industry statistics and trends, technology news, etc. But the end result is a better understanding of the prospects and risks of the company and whether the money can be safely invested in it. 

So far, 2 industry analyses have been completed, namely, Oil & Gas and Telcos. I hope to complete more industry analyses in time to come.

See related blog posts:

• A Look-Back at My Blog for 2016
• Being A Co-Owner of GLP
• Fundamentals of Stock and Bond Picking

Challenging Times Ahead for Starhub's Dividends

When M1 announced its results in end Jan, I went to buy both M1 and Singtel, but I did not buy Starhub. The conventional wisdom is that between M1 and Starhub, Starhub would be better able to manage the competition from the fourth telco, as it has Pay TV, broadband and enterprise fixed services besides mobile services. That is true provided the other business segments are generating stable, recurrent cashflows. However, is that true?

First of all, let us look at the revenue contribution from its 4 business segments.

Fig. 1: Starhub's Service Revenue Breakdown

Excluding equipment sales, mobile services constitute the bulk of Starhub's service revenue in FY2016, contributing 55% of the revenue. The second largest segment is enterprise fixed services, contributing 18%. Pay TV is third with 17% contribution while broadband services is smallest with 10% contribution. Let us look at the prospects of each business segment.

Mobile Services

Over the past couple of weeks, I have tried to understand the mobile services business by analysing M1, because M1's mobile services constitute 79% of its service revenue and is closest to a pure mobile services company. You can refer to the following blog posts for more information about the mobile services business:

• The Telco Landscape in Singapore
• Telcos From A Consumer's Point of View
• Impact of SIM-Only Plans on Telcos
• Impact of Data Upsize Plans on Telcos 
• Can Telcos Stop the Decline in Profitability?
• Do Telco Investors Need to Fear the Fourth Telco?

Generally, based on my assessment of M1, mobile services is facing a decline in revenue due to the introduction of SIM-only plans and data upsize plans in the short run. However, the effects are transient and should disappear in the later half of the year. Over the long run, mobile services is still a viable business despite the threat of the fourth telco. 

Pay TV

An entire blog post is dedicated to the analysis of Starhub's Pay TV business in Is Pay TV Still A Reliable Cash Cow? Generally, the Pay TV business is facing intense competition from over-the-top (OTT) providers such as Netflix, CatchPlay, Apple TV, etc. The cost structure for the business is mostly fixed cost for the cable network infrastructure and premium TV content. Thus, the declining Pay TV subscription means that there are less subscribers to spread out the fixed cost. Furthermore, there is also the threat of TV content owners moving away from Pay TV providers to OTT providers. Starhub's response to OTT providers is to roll out similar video on-the-go services, which are priced lower than traditional Pay TV offerings. It also invested in mm2 Asia to acquire locally made video content.

Thus, from the cashflow perspective, there is reduced cashflow as subscribers move away from its Pay TV network and if Starhub continues to make investments in media companies.

Wired Broadband

The wired broadband business can be categorised into cable broadband and fibre broadband. The total no. of broadband subscribers have remained stable in the last 2 years. However, on closer inspection, there is declining subscription for cable broadband, offset by a corresponding rise in fibre broadband subscription. See Fig. 2 below.

Fig. 2: Starhub's Broadband Subscriptions

If the total no. of subscriptions stays the same, does it matter if one type of subscription is declining while another is increasing? Yes, it matters. As explained in the analysis of the Pay TV segment (see Is Pay TV Still A Reliable Cash Cow? for more details), the cable network infrastructure is a fixed capex cost, thus, the less cable broadband subscribers Starhub has, the less customers to spread out the fixed cost. Although Starhub has raised the monthly rates for cable broadband, that is still insufficient to offset the declining subscription. Fortunately, since the cable TV/ broadband businesses have been in operation for many years already, the infrastructure cost should have been mostly depreciated.

On the other hand, fibre broadband has a variable cost structure. Fibre broadband is provided through the Next Generation Nationwide Broadband Network (NGNBN) which is owned by NetLink Trust. Starhub leases the network capacity from NetLink Trust. Thus, the more fibre broadband subscribers Starhub has, the more money Starhub has to pay NetLink Trust. It is still a profitable business nonetheless, but the profit per subscriber is smaller than for cable broadband.

Moreover, the fibre broadband business is also facing intense competition from other telcos as well as broadband service providers like MyRepublic. M1 and Singtel have to bundle mobile broadband and digital home voice to stand out from the competition.

Thus, from the cashflow perspective, there is reduced cashflow from the wired broadband segment as subscribers move away from its cable broadband network.

Enterprise Fixed Services

Perhaps the only rising star is the enterprise fixed services segment. This segment is a cluster of InfoComm Technology (ICT) solutions such as managed security services and analytics, as well as infrastructure solutions such as data centres and islandwide fibre network. Revenue from this segment has increased by 3.9% in FY2016. However, to earn increasing revenue from this segment, Starhub has to continue to invest to build up the network infrastructure, which is expensive. In Jun 2016, Starhub issued a medium term note of $300 mil. In addition, Starhub has announced that dividends for FY2017 will be cut by 20%.

Moreover, this segment is not without competition. ICT solutions are in direct competition with Singtel, while infrastructure is in direct competition with the NGNBN owned by NetLink Trust and Singtel's own network. Thus, even this bet is not guaranteed.

From the cashflow perspective, this segment will require a lot of capex instead of contributing to the cashflow, at least in the short term while the network infrastructure is being built up.

Conclusion

Going back to the opening paragraph, the conventional wisdom is that between M1 and Starhub, Starhub would be better able to manage the competition from the fourth telco, as it has Pay TV, broadband and enterprise fixed services besides mobile services. Yet from the analysis above, it can be seen that the Pay TV and broadband segments are no longer the reliable cash cows that they used to be. Although enterprise fixed services is a rising star, it is soaking up cashflow at a time when the other 2 business segments are not generating as much cashflow as before. Starhub is facing challenging times ahead.

P.S. I am vested in M1 and Singtel.

See related blog posts:

• Is Pay TV Still A Reliable Cash Cow?
• Who Moved Starhub's Cheese?
• Is Starhub's Dividend of 16 Cents Sustainable?

Is Pay TV Still A Reliable Cash Cow?

For the past 6 weeks, I have been blogging about the mobile services segment of telcos. It is time to move on to the next segment -- Pay TV. I will analyse Pay TV using Starhub's results, as Singtel has more business segments and operates in many countries.

The figure below shows the no. of Pay TV subscriptions in FY2015 and FY2016. Starhub is kind enough to disclose its market penetration rate in its financial results, which allows me to work out the total size of the Pay TV market in Singapore.

Fig. 1: Pay TV Subscriptions

As shown in the figure above, Starhub's Pay TV subscriptions has been on a gradual decline, dropping by 8.6% from 1Q2015 to 4Q2016. In contrast, the overall market for Pay TV has grown significantly by 20.5% over the same period. In particular, the growth picked up speed in 1Q2016. What happened in 1Q2016? The answer is Netflix. Netflix entered the Singapore market in Jan 2016, offering viewers an alternative way of watching videos over the internet instead of subscribing to Starhub's or Singtel's Pay TV.

How does Netflix's pricing compare with Starhub's Pay TV pricing? Starhub has a basic subscription of $26.75 per month for a few groups of channels. If you wish to watch sports, you will need to add another $21.40 for the sports channel. In contrast, Netflix is available at $10.98 per month for the basic plan. Nowadays, you can even watch sports on M1's fibre broadband or even Mediacorp's Toggle channel. You no longer need to subscribe to Starhub's or Singtel's Pay TV to watch videos or sports.

What is the cost structure of the traditional Pay TV segment? Firstly, there is a cable network infrastructure to deliver video to customers' set-top boxes. This is a fixed capex cost which does not vary with the number of subscribers. Thus, the less subscribers Starhub has, the less customers to spread out the fixed infrastructure cost. Fortunately, since the cable TV segment has been in operation for many years already, the infrastructure cost should have been mostly depreciated. In fact, Starhub mentioned in its financial results that some assets have been fully depreciated, although it did not mention which infrastructure it referred to.

The second cost for Pay TV providers is programming cost, or cost for the TV content they are distributing. For regular channels, this is likely to be a variable cost that varies according to the number of subscribers for that channel. However, there could also be premium content such as sporting events that charges a fixed cost for the broadcasting rights (see How the costs of sports broadcast rights have shot up in Singapore). Again, fixed cost is bad news for Pay TV providers facing declining subscription rates.

It is not only subscribers who can move away from a Pay TV provider. Content owners also can. Starhub and Singtel have been competing for the broadcasting rights for sporting events and the rights are awarded to the highest bidder. Prior to IMDA introducing cross-carrier rules in 2011, subscribers had to switch between different Pay TV providers to watch their favourite sporting events, which were exclusive to the winning bidder. Thus, there is no reason why content owners that are currently providing content to Pay TV providers could not switch to over-the-top (OTT) providers such as Netflix, which will further erode the reason to subscribe to Starhub's or Singtel's Pay TV.

Having said the above, Starhub is also not idling. It has introduced Starhub Go, which allows subscribers to watch videos for $9.90 per month on-the-go, like Netflix. Not only that, subscribers who are also Starhub's mobile services customers do not need to pay mobile data charges while streaming video on 4G. This is an advantage over OTT providers, whose customers incur mobile data charges while streaming video.

Starhub is also riding on the popularity of Netflix by offering Netflix as one of its channels on fibre TV (but not available on cable TV, because it requires an internet connection). I understand that there is minimal overlap between the content on Netflix and Starhub so far, but that could change in the future.

Starhub has also invested 9.05% in mm2 Asia for $18 mil in Mar 2016 to acquire locally made video content to better compete with OTT providers. This investment also has the advantage of ensuring mm2 Asia's content do not end up in rivals' Pay TV networks. Perhaps we might see Starhub continuing to invest in other media companies in the region. However, if that is the case, there will be less cashflow for dividends. This creates a difficult balacing act for Starhub. If Starhub invests in media companies, it can better safeguard its Pay TV business, but at the expense of dividends to shareholders. However, if it allocates more cashflow to dividends, it is less able to safeguard its Pay TV business from further competition.

Thus, from the cashflow perspectives, there is reduced cashflow as subscribers move away from traditional Pay TV providers like Starhub and Singtel. Not only that, there is less cashflow available for distribution to shareholders should Starhub continues to make investments in media companies.

In conclusion, the Pay TV segment is facing challenges and is no longer the reliable cash cow that it used to be.

P.S. I am vested in M1 and Singtel.

See related blog posts:

• Challenging Times Ahead for Starhub's Dividends
• Who Moved Starhub's Cheese?
• Is Starhub's Dividend of 16 Cents Sustainable?

Telcos From A Consumer's Point of View

In previous weeks, I have been blogging about telcos from an investor's point of view. This week, the focus will be on a consumer's point of view, which actually provides some useful insights into how telcos price their services.

Telco charges (inclusive of handphone, mobile data, broadband and fixed line) have been one of the biggest bugbears for my monthly expenses. Part of the reasons is that the combination of lines have been fairly unsatisfactory. I have 2 handphones, 2 mobile data lines, 1 wired broadband and 1 digital home line. The other part of the reasons is that telco charges have been increasing, especially in recent years. The figure below shows the approximate monthly telco expenses since 2004 (using January's figures).

Fig. 1: Telco Expenses Since 2004

Wired Broadband

I have been a subscriber of Starhub's cable broadband since 2003. Initially, I paid $58.80 per month for a bandwidth of 2Mbps. Later they upgraded the bandwidth to 6Mbps at no extra costs. Along the way until 2009, they would have some discounted prices if you sign a 2-year contract. Generally, the monthly expenses stayed around $45 to $60.

In 2010, a telemarketer offered me a promotion to upgrade to 25Mbps for nearly half my monthly expenses. Similarly, there would be some discounted prices for some months for 2-year contracts, but the monthly expenses stayed around $20 to $30 generally.

Last year, Starhub sent me a letter saying that the 25Mbps plan was no longer offered and upgraded me to a 100Mbps plan at nearly double the cost! I have been coping very well with 2Mbps in 2003. Thus, with the latest upgrade, Starhub effectively sold me 98Mbps that I do not need for $25 more per month!

If you read Starhub's latest financial report for the broadband segment, it said "Broadband service revenue for 4Q2016 and full year increased by 3.9% and 8.2% respectively, mainly due to the higher mix of customers on fibre and take-up of higher speed cable plans". So, when you read the underlined portion, you can relate to what is actually happening on the ground. And it is as if I have options not to take up the higher speed cable plans!

As discussed in The Telco Landscape in Singapore, more and more people are switching from cable broadband to fibre broadband, which means that there are excess capacity for cable broadband. In the coming months, would Starhub send me another letter offering to quadruple my bandwidth to 400Mbps at double the cost again?!

Needless to say, I am very upset when Starhub upgraded my plan to 100Mbps and increased the price. If Starhub were to repeat the same trick again, I will definitely switch to some other forms of broadband. Thus, if Starhub's next financial results report that the number of cable broadband subscribers has continued to drop, perhaps I would be one of the subscribers who switch out of cable broadband!

Mobile Data

I subscribed to a mobile data line in 2009 and again in 2014. If I recall correctly, the earlier plan was a 2Mbps line, while the later plan is a 3G line with data bundle of 2GB. Notice the key difference between the 2 plans. The earlier one had unlimited data transfer, while the later one caps the data transfer to 2GB. This explains why telcos have been able to collect more money from the increased data usage and pay better dividends in recent years (until 2016). As an example, M1 increased its annual dividends from 13.4 cents in 2008 and 2009 to 14.5-21.0 cents from 2010 to 2015.

If you have recently subscribed or renewed your mobile data plan, you would notice that the 3G plans have quietly disappeared from the telcos' offerings. Only the 4G plans remained. Needlessly to say, the 4G plans are more expensive than the 3G plans. Using M1 as an example, the lowest 3G plan for 2GB data bundle costs $12, while the equivalent 4G plan costs $19.90.

Perhaps, at some point in time, M1 might repeat the same trick that Starhub did with cable broadband and offer to upgrade me to 4G for faster data transfer at higher cost!

Handphone

I have 2 handphones, one corporate line and another personal line. The corporate line is paid by the company, so I will only talk about the personal line. I first subscribed to the line in 2009 at a cost of $28.91 per month. This cost increased to $35.63 in 2011 as I subscribed to multi-SIM to share the mobile data packaged with the line. In 2014, I switched my telco from Singtel to M1 and lowered the cost by subscribing to the lowest plan (but adding a new mobile data line to replace the multi-SIM). In 2016, I switched from the regular plans that provide a subsidy for new handphones but at higher monthly costs to the SIM-only plans that have lower monthly costs. For more information about the impact of SIM-only plans on telcos, you can refer to Impact of SIM-Only Plans on Telcos.

Similar to the case with mobile data plans, telcos had retired the old mobile plans with unlimited data and replaced them with 4G plans with data caps. Not only that, 4G plans cost more than previous plans.

When telcos upgraded from 3G to 4G technology, they increased the price of mobile plans. When 5G comes on-board, they will likely do the same.

Conclusion

Firstly, by looking at our own dealings with telcos as consumers, we can relate the financial results reported by telcos to what is happening on the ground. Not only that, we might even be able to estimate whether telcos are going to generate more or less revenue in the coming quarters.

Secondly, the entry of a fourth telco may potentially lead to a price war. But when the dust on the fourth telco settles and all of them are in a steady-state equilibrium, when 5G comes on-board, they will all raise charges again. Every upgrade is an opportunity for telcos to raise charges and increase revenue.

P.S. I am vested in M1 and Singtel.


See related blog posts:

• Impact of SIM-Only Plans on Telcos
• The Telco Landscape in Singapore
• Do Telco Investors Need to Fear the Fourth Telco?