April 06, 2022
Fifth-generation (5G) networks are set to roll out across the U.S. this year. As fixed income investors, we are cautious about technology and digital media companies.
Although they may well continue to capture most of the value from 5G (as they did with the rollout of 4G), their debt already tends to be high-quality and is trading at high valuations. We see more value in wireless telecoms and cell tower operators; their credit profiles should improve as carriers expand 5G coverage and monetize this service.
Technology and digital media are high-quality sectors that already trade at elevated valuations, leading to an asymmetric risk-return profile (that is, limited upside and comparatively greater downside risk).
Tech companies may use their fortress balance sheets to pursue new market opportunities through mergers and acquisitions (M&A), to the detriment of creditors. The recently announced Oracle-Cerner transaction is a good example.
5G is contributing to high demand for semiconductors today, but we are concerned that the massive supply response will overshoot demand and lead to an inventory-led correction.
Today’s dominant technology companies won’t necessarily be the winners in 5G applications. Asian markets have a head start and will be more competitive during this cycle.
Regulatory scrutiny is elevated. In the 5G era, tech incumbents will have less latitude to buy rising threats (such as Facebook/Instagram and Alphabet/YouTube).
If regulatory curbs, global competition, and excess capacity slow growth, firms may resort to using their balance sheets to drive earnings-per-share growth, which would entail moving down in credit quality.
We see better fixed income value in wireless telecoms such as Verizon and T-Mobile US and towers including Crown Castle and American Tower. Driven by M&A, the U.S. wireless sector dropped in credit quality during the 4G era. “In the U.S., wireless telecoms migrated from single-A to triple-B credit ratings,” said Scott Miles, senior credit analyst. “That wasn’t a great outcome for fixed income investors, but, as a result, they offer more value today.” Additionally, North American wireless networks have invested heavily recently in capital equipment and wireless spectrum. Balance sheets are stretched, but we expect credit profiles to improve as carriers expand 5G coverage and monetize this service. Carriers should use the current inflationary environment to push up pricing while touting increased network capability.
Wireless earnings growth should shift from low single digits today to mid-single digits or better, accelerating the recovery of credit profiles.
Although the mobile market is saturated, we see major growth opportunities opening for fixed wireless. The drivers will be population growth, pricing, and fixed wireless expansion.
Regulatory oversight will increase as wireless networks displace landlines in some underserved areas, limiting margin growth but also suppressing volatility.
“We expect credit profiles in this sector to be broadly stable to slightly improving,” said Miles. “There are, however, differences among telecom credits, and we will deploy our global research capabilities to identify which companies in each region may have better prospects for improving their credit profiles and select securities that offer attractive risk-adjusted returns.”
By investing in a Vanguard active global credit fund, you get access to this expertise and can benefit from attractive investment opportunities globally.
This is an abridged version of research published recently by Vanguard Fixed Income Group.
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