By Todd Rosenbluth, CFRA
Last week, the index providers behind the widely followed GICS structure, used for the S&P 500 index, the MSCI ACWI index and many others, began a public review of the telecommunications services sector. The index has shrunk by a third in size to just 2.1% as of mid-July, down from 3.2% in 2011. Among the proposed changes, which we think would not be implemented until 2018, include moving certain information technology and consumer discretionary stocks, along with the telecom companies, into a new Communications Services sector.
S&P Global (SPGI) and MSCI (MSCI) are in early stages of a consultation for GICS changes and CFRA expects a formal announcement later this year. However, based on public information and our analytical expertise, the below reflects CFRA’s take on what this means for the key companies our team is qualitatively with proprietary STARS recommendations. CFRA acquired the S&P Global’s Equity and Fund Research business in October 2016.
While CFRA analysts highlight that companies likely to be impacted are increasingly competing and collaborating despite residing in different GICS sectors, they do not expect to see changes in capital deployment or how they value the stocks. For example, current telecom carriers use part of their operating cash flow to support dividend payments, while Internet-focused tech and consumer discretionary companies generally do not offer such pay-outs. However, CFRA thinks the greater impact of the potential GICS changes on our research is for ETFs. Sector ETFs, such as Technology Select Sector SPDR (XLK) and iShares Global Telecom (IXP) are dependent on the GICS structure.
According to Angelo Zino, an equity analyst for CFRA, “communications companies have been converging in recent years, with the distributors AT&T (T) and Verizon Communications (VZ) looking to acquire content providers. T’s proposed acquisition of TWC and Verizon’s recent acquisitions of AOL and Yahoo’s core assets are good example.” Zino’s see further consolidation and vertical integration by the big telecom providers as they look to diversify their business amid a no growth wireless environment. Meanwhile, Charter Communications and Comcast recently announced initiatives to offer wireless services to its customers, another example of convergence occurring in the communications space.
While telecom and cable providers have long battled for share of communications spending in the household, increasingly social media companies Facebook and Twitter, as well as Google/YouTube, have been increasingly competing with media companies, not only for advertising dollars, but also for content from licensing to developing premium content. Meanwhile, according to CFRA equity analyst Scott Kessler, Akamai Technologies develops and provides solutions that accelerate and secure content and application delivery via the Internet and mobile. Key partners have included media and telecom companies. Further Kessler notes that Video game developers license content from media companies for games, and increasingly have been using their own intellectual property for more traditional media. For example, a Candy Crush TV show recently debuted on CBS.
CFRA thinks that ETF investors will need to understand the exposure of their sector ETFs are not as simple as the name suggests. For example, while Guggenheim S&P 500 Equal Weight Information Technology (RYT) holds only tech stocks such as Facebook and Twitter, XLK also includes telecom stocks such as AT&T and Verizon.