From my perspective, there are three mega-trends influencing communication services companies' growth, margins, and returns, which I believe should drive earnings and stock prices in 2019 and over the long term.
The first trend is convergence. To compete for customer engagement, companies are overlapping on more fronts than ever before. For example, America’s largest phone company, AT&T, now owns cable network HBO. With its recent acquisition of Time Warner, and its ownership of DirecTV, AT&T is now producing and distributing content. The competition around scripted content has never been more robust, with tech companies Netflix, Amazon, Apple, and Google producing exclusive intellectual property (see chart below). Comcast and Charter Communications are now selling mobile phone services. With 5G on the horizon, some households will be able to purchase home broadband wirelessly.
With cable companies offering mobile plans and tech platforms fighting for their share of the living room, the lines within communication services are blurring and value chains are being reshaped. This diversity adds complexity from a simpler world where consumers would buy their mobile phones and "Game of Thrones" from separate providers, but also creates opportunity for more differentiated results from individual companies.
The second major theme is digitalization. Broadband usage is a good barometer of the unrelenting growth in digital. Some telecom company networks are now seeing as much traffic in one hour as they did in an entire week less than a decade ago. However, earnings are not keeping pace with that explosion of usage. Without the ability to pass pricing on to users, the transition to digital can be massively deflationary. As unlimited data plans are now the standard, people are using more broadband without paying more, unlike they do with electricity or fuel.
Here, the opportunity lies with those companies that can harness growth in digital most profitably. As we’ve seen in the past with newspaper and music sales, being on the wrong side of digital can mean disruption for an entire industry, where the shift has been positive for consumers but damaging to shareholder value for legacy companies unable to make the most of this powerful trend.
The third mega-trend is scale. Fewer than 5 years ago, having 25 million video subscribers or 100 million wireless subscribers was considered massive, but that's not the case in today’s terms. The next generation of user bases have redefined scale. For example, Google has over two billion monthly active users of YouTube. With its Android phone and maps, chrome, search, and Gmail applications, the company has six additional services, each with over a billion monthly active users.
Globalization is playing a big part in scale, and the internet has broken down barriers to reaching customers. Where we stand today, just over half the world is online but fewer have a smartphone. So, there remains a large untapped market, and new consumer bases will be mobile first and in some cases, mobile only. Companies that are geographically constrained or don’t have a direct-to-consumer relationship over mobile are falling behind in scale.
The sweet spot for investing in the communication services sector moving forward will be sticking with those companies for which these trends come together as a tailwind. One such industry is interactive media, including video games. Engagement in video games is growing, as games have become more social and socially acceptable. While viewership of sports appears to be plateauing in the US, viewership of eSports, or video game competition, is growing albeit off a small base.
So what does this mean for profits? Monetization can grow faster than engagement since unlike other forms of entertainment, more gameplay drives an even higher propensity to spend within the game. Unlike TV, where one-size-fits-all bundles are losing appeal, video games are starting from an attractive value proposition per hour consumed. Faster bandwidth and advanced graphics rendering is driving better and more engaging experiences. Cloud computing will also accelerate the ability for more mass online games to come to mobile. For all these reasons, I believe the duration of growth here is long, and there are catalysts for acceleration.
Next steps to consider
Research the Fidelity® Select Telecommunications Portfolio (FSTCX).
Get more investing ideas and sector insights.
Go back to the full 2019 sector outlook.