TELUS: Excellent Value for a Canadian Telecom Company

Brief History:
TELUS is a national telecommunication conglomerate in Canada. The company has expanded itself from a local wireline phone company in Alberta, Canada to a national company that offers services in digital broadband/TV, wireline/wireless communication, and healthcare data services.

TELUS was established in 1990, following the reorganization of Alberta Government Phone Commission that established in 1958. In 1998, TELUS become a prominent telecommunication company in Western Canada when it merged with BC TELECOM, a legacy telecommunication company based in British Columbia, Canada.

Why TELUS is a BUY:
• When compared to its 2001-2008 share data, TELUS currently has the highest dividend yield at 6.1% and lowest P/E ratio at 9. TELUS share enjoyed strong dividend growth in the past five years with a current payout ratio of 66%
• If we think TELUS’s equity as a bond, it has a 10% floor return, which 4% is from annualized growth of book value per share in the past five years and 6% from current dividend yield.
• As the number of smartphone users increases, TELUS will be able to collect fees on wireless data usage like a toll bridge. Currently, data plan consist only 7% of total wireless revenue for TELUS
• TELUS, with BELL Canada as its partner, is ready to launch a nationwide GSM network in early 2010 to compete with Rogers communication and capture the advantage of being on a network that has over 80% of the global wireless phone users
• TELUS has a strong presence in Western Canada, a region that is expected to have higher economic activities compare to other parts of Canada.
• TELUS operates in a highly regulated business with high barriers to entry and few industry players. The long-term outlook for this business remains viable with new demand drivers for broadband/wireless communication

Company Analysis:
TELUS (TU), BELL Canada (BCE), and Rogers Communication (RCI) are the main players in Canadian wireless telecommunication industry. Each company controls roughly 30% of total wireless subscribers. Rogers Communication is the only national GSM network provider and has enjoyed substantial growth over the past couple years as most popular smartphones were available only on the GSM network. All companies have other complementary business segments such as cable TV, broadband, and wireline phones. Wireless communication makes up bulk of the revenue (close to or over 50%) for these companies and will be a key revenue growth for these companies going forward.

Couple new entrants, namely Shaw communications and Globalive, made substantial bids and acquired wireless licenses from government of Canada in 2008 and emerged as potential competitors. However, due to global economy turmoil and financing issues, Shaw, a cable based company in Western Canada, has abandoned its plan to build a wireless phone network in the near future. Globalive will likely roll out its wireless network later this year or early 2010, but its ability to be profitable is unclear. Globalive will need to spend $1.8B between the next ten years to establish its wireless business. The competitive landscape is likely to remain the same as the big threes throwing punches at each another.

As of fiscal 2008, Rogers enjoyed the highest average revenue per user (“ARPU”) at $75 dollar per month thanks to its exclusivity of GSM network and a number of smartphones. TELUS and BELL Canada, operators of CDMA network, have “ARPU” at about $63 and $54. When compared to the US counterparts, using AT&T as an example, AT&T has an “ARPU” of $55 (using a rate of $1.10 CAD/USD). If we make the assumption that future competitive pricing will trend towards AT&T’s “ARPU”, the revenue impact as a result of pricing competition will be minimal for TELUS because organic growth of wireless users can potentially offset the lower “ARPU”. As of fiscal 2008, Canadian wireless market only exhibit a 70% market penetration rate, whereas US has a much higher rate of above 80%.

Comparing some basic metrics on the attractiveness of TELUS share against BCE and RCI, TELUS currently has a comparable dividend yield against BCE at 6.1% with a much lower payout ratio of 66% to BCE’s 88%. Rogers has similar payout ratio but only a 3.4% dividend yield. When looking at P/B, P/E and P/S ratios, TELUS has the lowest ratio between the three companies, and TELUS, looking on a standalone basis, is attractively priced at a P/B of 1.3, P/E of 8.18, and P/S of 0.98, with ROE of 15% and EV/EBITDA of 4.2 times.

Another positive is TELUS’s stable senior management team. Darren Entwistle, CEO, and Robert McFarlane, CFO, have both worked in TELUS since 2000 and successfully implement TELUS’s goal to become a national telecommunication company. Book value per share, after share buyback and dividend payout, grew roughly 4% for the past five years. If we expect that 4% is the future book value growth, adding the current dividend yield of 6% will yield a floor return of 10%. This assumption is highly probable given the near-term competitive landscape, the company's stable senior management team, and the users’ demand for wireless services.

Other positives for TELUS include better projected economic prospect in Western Canada, strong brand awareness in Western Canada, overfunded pension plan, and high barriers to enter the wireless market. Also, it could be argued that TELUS may benefit from currency translation gain as Canadian dollar strengthen against US dollar in the long run. Some short-term speculative sparks includes Vancouver’s 2010 Winter Olympic game, GSM network deployment, and foreign investors’ appetite for investing in Canadian businesses.

There are key negative issues to consider. First, TELUS has poor cash position with only $58M cash on hand. TELUS does have a $2B credit facility with about $1B available at prime rate, an attractive 2.25% cost of borrowing. However, prime rate is a variable rate set between the Canadian banks, and an interest rate hike put TELUS at a significant disadvantage. In addition, Capital expenditure going forward should be considered as well. Capex intensity, which is capital expenditure by a percentage of total sales, has been rising from 17% in 2004 to 28% in 2008. The 28% figure includes the cost to obtain wireless licenses from government of Canada in 2008 and is non-recurring. Without the one time cost, the Capex intensity is about 19%, which is still higher when compared to BCE’s 17% and RCI’s 16%. Finally, continuous monitoring on the economic environment where TELUS operates and potential entrants such as Shaw and Globalive is required. It is unlikely for Shaw to give up without a fight, especially when Shaw spent $190M to acquire a significant percentage of wireless licenses in Western Canada from the 2008 auction.

Overall, TELUS has a solid business plan going forward, and its share is priced at a reasonable rate of risks. TELUS is unlikely to achieve admirable share appreciation like what some of the smartphone companies did in the last couple years. But no matter which smartphone company comes out on top in the future, TELUS will be there to collect its fees from customers. Warren Buffett often said “A bird in the hand is worth two in the bush” and the 10% floor return being offered by Mr. Market today is worth some serious consideration.

(All figures and sources are either from company’s SEC filings, Yahoo! Finance, or Financial Post articles)

(Disclosure: Recently long in TELUS)