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US News: Scott Rostan “How to Invest in the Evolving Telecom Sector”

By Matt Whittaker | Contributor

While it isn’t a sure thing if or when the latest telecom merger between AT&T (ticker: T) and Time Warner (TWX) will be completed, it’s clear that in the telecom sector, content is still king.

The $85.4 billion deal – which rises to $108.7 billion when Time Warner’s debt is included – would allow AT&T to distribute content such as HBO programing on a distribution network it controls. But the proposed merger will have to pass regulatory scrutiny. While the proposal values Time Warner shares at $107.50, they are priced closer to $87, an indication about Wall Street’s pessimism on the merger.

The deal is among several in recent years where companies have sought content, including Comcast Corp.’s (CMCSA) 2013 purchase of the remainder of NBC Universal that it didn’t already own, Verizon Communications’ (VZ) purchase of AOL last year and this year’s announced deal between Verizon and Yahoo (YHOO).

But AT&T’s much larger purchase of Time Warner is a more ambitious play for content, says Scott Rostan, CEO of Training the Street.

Sean O’Hara, president of PacerETFs Distributors, a division of Pacer Financial, says that the merger means telecom is strengthening its ability to deliver content as ways people consume media and entertainment have been undergoing a major shift. Consumers are moving away from television and radio in favor of smartphones or devices that are tied to distribution companies such as AT&T and Verizon.

O’Hara believes there may be some more acquisitions in the industry or strategic partnerships as content providers are looking for more viewers and distributors want more content.

But Rostan cautions investors against trying to make bets on who might be the next takeover target.

While it may make sense for companies such as Apple (AAPL), Alphabet’s (GOOG, GOOGL) Google, Comcast and Verizon to want to pick up a company like Netflix (NFLX) with its captive audience and original content, it’s better to invest in companies because of their individual fundamentals, he says. If you happen to pick one that ends up getting a takeover premium, great, but just remember the takeout speculation that hasn’t panned out with Twitter (TWTR), he says.

For investors wanting to bet on content providers, John Ripley, senior portfolio manager with Alpine Partners, also recommends caution. Right now, concerns that the deal might not go through because of regulators have left the difference in Time Warner’s merger price and the stock’s actual price wide, he says. And valuations of other companies that might be targets will fluctuate depending on sentiment related to the AT&T deal, he says.

While some content providers such as smaller entertainment properties – think Hulu, of which Time Warner owns 10 percent – could get a boost from takeover speculation, the AT&T merger isn’t likely to raise telecom valuations across the board, O’Hara says.

Competition in the sector will still continue to pressure providers’ pricing power, and they will have to figure out new revenue streams – such as what AT&T is attempting with Time Warner, he says.

“Investing in takeover speculation is a dangerous game,” Rostan says. “It’s hard to pick that next winner.”

It’s better to buy on a company’s valuation and growth prospects, Rostan says.

O’Hara thinks that Verizon and AT&T are the strongest telecom companies to invest in based on their free cash flow and dividends.

Verizon and AT&T are the telecom industry leaders and could make good bets for investors looking for bellwethers in the sector that pay generous dividends and have the potential to increase those dividends, Rostan says.

Multiples for both Verizon and AT&T based on enterprise values and trailing 12-month earnings before interest, taxes, depreciation and amortization, are less than that of the average company in the Standard & Poor’s 500 index, he says.

That means investors looking for more exposure to the telecom sector can get companies offering strong dividends for cheaper than the average S&P 500 company, Rostan says.

AT&T and Verizon are also both yielding much more than U.S. Treasurys, he adds.

However, investors may want to look for an entry point in these stocks, say, if their price declines by 5 percent to 10 percent, Rostan says.

One concern for AT&T is whether or not the merger threatens its dividend, Rostan says. With the Time Warner debt adding to AT&T’s borrowings, AT&T’s ability to maintain the dividend’s current level or increase it could be limited if merger projections don’t come in as expected.

That would be important for retail investors on fixed incomes who want dividend streams that are growing faster than inflation, he says.

AT&T has said it expects the purchase of Time Warner to improve its dividend coverage and its revenue and earnings growth.