Nippon Telegraph and Telephone Corp. ADR (NTT) is at the zenith of the telecom business in Japan. The company has a 66.7% stake of NTT DoCoMo Inc. (DCM), the largest wireless service provider in the country with 62.2 million subscribers. And it also owns the two incumbent fixed-line operators, NTT East and NTT West, which account for a 50% market share. Moreover, it provides information and communications technology and data services, which the firm improved in 2010 by boosting its capabilities through the acquisition of Dimension Data and Keane.
A Narrow Moat
Its size and cost advantages have carved the firm a narrow economic moat. Apart from controlling half of Japan’s total wireline market, the company has a 43% market share of the wireless business. To manage such volume, Nippon has built the largest telecom networks in Japan, which support a higher percentage of calls, thus resulting in cost savings. Additionally, its scale provides it with a competitive upside when negotiating pricing discounts with suppliers.
Nippon generates a healthy free cash flow of over JPY500 billion annually, which it diligently uses to keep an edge over competition. Thus, it was the first company to launch LTE services in 2010, which gave it a two-year advantage over its rivals. Since then, its improved network has boosted data usage as well as average revenue per user.
Furthermore, Nippon recently gained access to the iPhone, which earns the firm the opportunity to reverse its share losses in the youth market. Earlier, market share on the wireless side had declined in favor of competitor Softbank Corp. (SFTBF), which had exclusive rights to sell Apple Inc. (AAPL)’s iPhone in Japan.
On the other hand, the firm is near to completing the roll out of its fiber to the home network, which has a broader reach than its competitors. Moreover, it allows broadband speeds of 200 Mb/second, which is faster than cable operators’ offering and a rarity among incumbent telecom operators.
However positive for long-term growth, the building of its FTTH network depressed Nippon’s returns on capital. Even though this situation is improving as the rollout nears completion, returns in the fixed-line division still lag those of most incumbent telecom operators.
Returns are also being pressured by KDDI Corp. (KDDIY), the second largest telecom operator in Japan. This firm acquired J:COM, the largest cable TV company in the country, in 2010. As a result, competition has turned more aggressive, since it now offers a quadruple play of services that includes broadband and television as well as wireless and fixed telephony.
A Clear Horizon
Nippon has a strong balance sheet with a solid cash position, which it is using to increase its dividend, buy back stocks, make acquisitions and pay down debt.
Despite the company having difficulties generating decent returns in its fixed-line division, revenue declines in this unit will be sufficiently offset by the growth expected in data usage and its wireless segment.
Nippon’s stock trades at 10.9 its trailing earnings, a compelling multiple compared to the industry median of 16.80. The growth of its earnings per share is also attractive, boasting a 2.2% against its rivals’ average of 0.60%. Its return on invested capital, in turn, showcases a healthy 26.5% compared to its competitors’ median of 23.05%, and will continue to grow as the rollout of its FTTH network finishes, giving capital expenditures a respite.
Hence, although investment gurus David Dreman (Trades, Portfolio) and Charles Brandes (Trades, Portfolio) reduced their holdings in the company I feel strongly bullish about Nippon’s ability to support its leading position in the long run.
Disclosure: Damian Illia holds no position in any stocks mentioned.