In Telecom, Invesco’s Hayward Focuses on Infrastructure Ideas
Technology stocks in general have been the market’s stars over the last year, but some of the hottest tech names have been in the telecom sector--issues such as JDS Uniphase, Qualcomm and Nokia.
Indeed, telecom has been a strong story for much of the last decade. Among major stock mutual fund categories, telecom sector funds rank second only to tech funds in performance over the last 10 years.
And in the last five years, Brian Hayward’s Invesco Telecommunications fund in Denver has been the best performer in the sector, with an average annualized five-year return of 54.9%, versus 38.8% for the average telecom fund.
We recently spoke to Hayward to get his views on the telecom sector’s outlook, prospects for individual stocks and how he’s investing the $2.7-billion fund. The following are excerpts from the interview:
* Hayward on what’s driving the telecom sector: Well, there are three [themes] that we’re emphasizing in the portfolio. We know they’ve been driving the market up for the past several years. We think it can continue for the next five to 10 years, at least.
One of them is deregulation, which happened with the Telecom Act in the U.S. [in 1996]. It happened with the European Economic Union. It’s happening all over the world.
Another one is the explosion of data traffic, driven primarily by the Internet. And that play is focused primarily on the fact that the voice networks that were designed and deployed in this country and in other industrialized countries decades ago were designed for three-minute voice conversations.
Most people still access the Internet today online with a modem, and they’re on in the U.S. for more than one hour a day [on average]. So you do the math: It was designed to handle three-minute voice conversations on circuit switch networks. But people are on that same network through the phone lines for over an hour. So that can’t last. It’s already jamming up the system.
Plus, the speed that is required to handle the kind of traffic that will be available once the network is fast enough--like video streaming, things like that--requires a whole new architecture. The new carriers are already doing it. The existing carriers, like AT&T; [ticker symbol: T] and MCI WorldCom [WCOM] are rebuilding.
Then the third [theme] is the proliferation of wireless services. Even though voice is still growing, the next big step will be data. We’re just scratching the surface right now in the U.S.
The largest [test case] market so far is in Japan. NTT Docomo is the first. Watching what’s happening with them is why everybody is so excited about the future. Because their subscriber growth of people taking data services as well as voice is exceeding all expectations.
Eventually you’ll be able to literally videotape something and send it real-time over a wireless network across the country. When that happens, it’s going to require another significant infrastructure build.
* On how he invests for his major themes: For deregulation, the rule of thumb is [it’s] good for CLECs, but not good for the incumbents. CLECs are competitive local exchange carriers. Those are companies like WinStar Communications [WCII], Nextlink [NXLK], McLeodUSA [MCLD], Allegiance Telecom [ALGX] in the U.S. The biggest and best example overseas would be Colt in the U.K.
We are overweighted in CLECs and underweighted in companies like the regional Bells and the national phone companies in Europe. They were the former monopolies. The regulatory bodies have said there will be competition. You must open your networks. If you have 100% market share and the government does something like that, there’s only one place for your market share to go and that’s lower.
For data, it’s the equipment companies. We want to own the arms supplier in the arms race. You know, sell the bullets to the combatants. That’s a safe thing to do. [Names like] Nortel Networks [NT] and Ciena [CIEN] . . . JDS Uniphase [JDSU] is still our No. 1 holding.
And there’s another company that’s in our top five by now called SDL [SDLI], which is a competitor to JDS. The demand for that segment of optical networking components is so strong, we have revenue visibility for those companies for at least two years. So until it looks like they’re stumbling on the fundamentals--and we haven’t seen that--even though I could not give you an argument that says they’re still cheap, it’s a mistake to sell.
* On the dawn of wireless data services in the U.S.: Sprint PCS [PCS] is already offering short messaging on the phones and that kind of thing. It’s so small [as a market] it’s not an issue. It could become an issue if companies really start pushing it and people start using it.
If [carriers] want to allocate the spectrum to data services, they’re going to have to take it away from voice services until they get the capacity for both upgraded.
Either way, you want to own the companies that do the infrastructure.
* On why he doesn’t own Lucent Technologies (LU), the largest telecom equipment maker: The old infrastructure for those voice networks I talked about--the three-minute voice conversations--that was Lucent’s main business before. Everybody knows that’s going away. Everybody knows it’s moving toward optical networking, the fastest speed optical networking. Lucent knows it. But they couldn’t execute. They couldn’t move to that infrastructure as quickly as . . . you know, Nortel is already there.
Last year, Nortel was in the doghouse and Lucent was the darling. This year, it’s completely reversed.
We got out of Lucent. That’s somewhat of an unusual bet, being completely naked to a stock that’s that big in the [Standard & Poor’s 500 index of blue-chip stocks] and in the industry.
That’s a short-term call. That’s a company you can bet on longer term, but we think it’s dead money for two quarters.
* On how he’s investing new money: Most of it is going into existing positions . . . 30 names--our top names. I have not added to JDS the last two times I spent money, because, given the spike that the stock had, and the concerns out there, right or wrong, about their E-Tek merger, until we get a sense that it’s settling . . .
We’ve added to companies like Nortel, computer networker Cisco Systems [CSCO], Nokia [NOK], PMC-Sierra [PMCS, a telecom-chip maker], Applied Micro Circuits [AMCC, another chip maker].
Not so much on the service guys. We added a little bit to some of the CLECs, especially the U.S.-based ones. And the last two times, I put a little into AT&T; because we have a relatively small position. I don’t know what the catalyst is going to be--except for the wireless tracking stock--that will get AT&T; going again, but the risk seems to be reflected in the price already. So if there is a value play in that fund, that might be considered one of them.
* On other opportunities: Between 65% and 70% [of the fund] is in North America, about 7% is in Japan and China, [and] the rest is in Europe.
We are moving more toward Europe. We’ve added two or three new offerings from last year. Jazztel [JAZZ] was one. Terra Networks [TRRA] is another. Jazztel is a local exchange carrier in Spain. Terra is an Internet service provider originating in Spain but focusing on Spanish-speaking populations.
So we’re moving more toward Europe, a little bit toward Latin America. But because of our bias in favor of the equipment companies, the best ones are still in North America.
* On Cisco Systems: Cisco is liable to be the first trillion-dollar market-cap stock. And it probably can get there this year. It’s possible.
They are a machine. They might not have the best mousetrap. There are lots of new companies that keep being touted as the “Cisco Killer.” But it doesn’t happen. One of the things that Cisco has as a benefit is they have the best distribution of anybody in that space.
And they have the service organization and relationships with their customers that [equipment buyers] aren’t going to risk their jobs [if they bet] on Cisco. They would risk their jobs betting on somebody with a better mousetrap but no service.
We do own companies that could become Cisco killers. Juniper Networks [JNPR] has a high-speed router that’s faster and cheaper than Cisco’s top end. But they’re limited in their distribution channels, in their service offerings.
If somebody gets ahead of [Cisco], they either buy them or they’ll develop it themselves in a year or two. It’s tough to bet against those guys.
* On his approach to smaller stocks: An example would be the integrated circuit communications companies--the chip companies for telecom companies like PMC, AMCC, Vitesse [VTSS] and Conexant Systems [CNXT].
What we did there instead of making a big bet on one, we bought them all. We had a basket of them. When we started out, they were all about 50 basis points in the fund [as a percentage of total assets] by themselves. So the total weight was like 2.5% or 3%. So it was like holding a top 10 position in a space we really liked, but because of volatility, we thought it might be better to spread the bet a little bit.
* On what he looks for in terms of a company’s fundamentals: We look for top-line [sales] growing better than peers in the industry, and with that should be improving margins. [We ask,] What gives them their leadership? Is it sustainable? Is it defensible? Is it the technology, or is it distribution? Is it service? Is it all of those things?
With Cisco, it’s all of those things. Especially with the newer companies, like the CLECs, it’s a management call as much as anything else, because they haven’t been around long enough to have a track record to say, ‘Yeah, they did this. This has been their top-line growth, this is their margin expansion.’ They don’t have the numbers yet, so we look for companies that are run by people who have done it before.
So like all the CLECs we own, the ones we own have management teams that have done it before. The best example I give is Allegiance Telecom, which is run by a guy named Royce Holland, who was one of the two people who founded MFS Communications [now a part of MCI WorldCom], which is one of the main and earliest CLECs.
This guy’s done it before. He scaled that company into a multibillion-dollar operation. You want to bet on the guys who can make it work.
Times staff writer Paul J. Lim can be reached at paul.lim@latimes.com.
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Ringing Up High Returns
The telecommunications sector, including many phone companies, telecom equipment suppliers and networking companies, has been on a hot streak for the last year in particular. And the $2.7-billion-asset Invesco Telecommunications fund, managed by Brian Hayward, has over the last three years outperformed not only the average telecom fund but also the average technology stock fund.
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Recent Top 10 Holdings
Major holdings of the Invesco Telecommunications fund, as a percentage of the fund’s portfolio at Jan. 31:
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For more information on Invesco, the company’s Web site address is: https://www.invesco.com.
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Sources: Morningstar, Invesco
