The market is freaking out over news that Verizon Communications Inc. is expanding into Canada’s telecommunications market – offering $700-million for Wind Mobile, according to The Globe and Mail, and starting talks with Mobilicity.
The initial impact on Canadian telecom heavyweights has been big. In early trading on Wednesday, BCE Inc. was down as much as 6.3 per cent, Telus Corp. was down more than 7 per cent and Rogers Communications Inc. was down more than 10 per cent – and these declines follow share-price weakness that began a month ago.
If you could ask Warren Buffett what is going on here, he might respond with “I told you so”: He is famous for preferring companies that have so-called moats around them, or a competitive advantage that protects their profitability from competition. This advantage can come from a dominant market position, superior brand value or low product prices.
With investors now tripping over themselves to ditch their incumbent Canadian telecom stocks, it would appear that few of them can see any moat around BCE, Telus or Rogers. If the companies are that vulnerable to new competition, you have to wonder why the stocks had been so strong in recent years.
At the same time, though, the market is prone to overreaction – and while Canadian telecom companies might not be surrounded by Buffett-approved moats, they might not be as vulnerable as some believe, either.
The market has panicked before on the impending arrival of a U.S. behemoth, fearing devastation, only to calm down soon after.
The best example is Canadian Tire Corp. in the 1990s, when Home Depot Inc. bought up a Canadian competitor and moved in. By 1994, Canadian Tire’s share price had cratered about 45 per cent from its high a year earlier, investors no doubt concerned that Home Depot’s gargantuan size (now 17-times bigger than Canadian Tire, in terms of market capitalization) would crush it.
The concerns were overblown though. Canadian Tire is not only still in business, its shares hit a record high in 2007 and are still up eight-fold over that 1994 low.
However, the arrival of Wal-Mart Stores Inc. in Canada – in particular, the rollout of Wal-Mart’s massive supercentre concept, announced in 2005 – offers an example of why a panicked response can be appropriate.
Loblaw Companies Ltd. shares slumped 30 per cent over the next two years as it geared up for the oncoming competition. Earnings retreated and the once-rising dividend didn’t budge for more than seven years. Loblaw shares are still 38 per cent below their record high in 2005.
To be sure, this isn’t all Wal-Mart’s fault; Loblaw stumbled in its reaction to the competitive threat, and investors now value the shares at a lower price-to-earnings ratio. Whereas the shares traded at more than 21-times earnings in 2004, that valuation metric is now just 17-times earnings.
Yet, years after Wal-Mart’s arrival, the effects are still being felt: Loblaw has taken a bigger interest at discount retailing, earnings remain off their highs and sales growth is struggling.
The question for investors: Are Canadian telecom stocks more like Loblaw or more like Canadian Tire? Over the next several months, investors are unlikely to make any distinction.