A Lumbering Giant Becomes More Agile

05/21/2008 12:00 am EST

Focus: STOCKS

Nick Lanyi

Editor, High-Yield International

Nicholas Lanyi, editor of High-Yield International, says Deutsche Telekom is getting more competitive, and the weak dollar makes its dividends even richer for Americans.

One of the world's largest telecommunications companies, Deutsche Telekom (NYSE: DT) generates more than half its revenue from outside Germany—from diversified operations across Europe and in the US.

That's not to say its German business isn't important to DT. The company's core local phone service still accounts for about 30% of its revenue. Its local phone customers—DT claims 36 million voice lines—are key in generating strong free cash flow.

But revenue is shrinking as customers defect to other telecom providers. DT makes up for the decline in its traditional business by increasing sales for its broadband Internet (14 million Internet access lines in Germany) and wireless services (120 million subscribers).

Outside Germany, DT garners more growth from its wireless operations in Eastern Europe, the UK and the US. Most of these operate under the well-known T-Mobile brand. Overall, worldwide wireless activities account for about 55% of the company's revenue. The German government owns 32% of the company.

Deutsche Telekom's dividend has risen steadily over the past few years in its native euro currency. Thanks to appreciation of the euro versus the US dollar, these dividend increases have been augmented for US investors buying the {American Depository Receipts]. I expect modest dividend gains every year, with a currency boost adding to the increase.

Critics of DT say its wireless operations face stiff competition in Germany, the UK, and the US, which will curtail growth; further, DT has lower profit margins than many of its peers, a result of a bloated workforce at home.

Bulls—including me—argue that the glass definitely is half full. The company's relatively low profit margins and market shares mean there's room for improvement; when they execute well, such companies tend to regularly exceed analysts' earnings estimates, giving the stock a boost. DT is poised for better times ahead.

Over the past three years, the firm's revenue from foreign operations (everything but Germany) has grown nearly 50%, but its gross profit margin remained flat because of the costs associated with boosting those sales.

But DT has spent the past two years lowering its long-term debt and reducing its once-bloated employee count in Germany. That should lead to higher profit margins in 2008 and 2009.  Furthermore, DT has especially strong growth prospects in fast-growing Eastern Europe.

I look for DT's revenue to grow by 2% to 3% annually over the next few years, with earnings and cash-flow growth of 5% to 7% a year.

Deutsche Telekom isn’t as respected as it once was, making its shares relatively inexpensive today. The company's overseas wireless businesses make it a good candidate to exceed expectations in the coming quarters, and the yield is both high and safe. I recommend DT for all but the most conservative income investors. (The ADRs closed above $17 Tuesday—Editor.)

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