5 Telecom Stocks With Double-Digit Upside: Frontier Markets

NEW YORK (TheStreet) -- We have identified the top five telecom stocks that investors should consider adding to their portfolios. These frontier market stocks have market caps of at least $1 billion and offer returns ranging from 12% to 57%. In the frontier markets arena, you'll find stocks like Vodafone Qatar (VFQS), with its 16% upside, and more.

Many of the stocks identified below are from the Middle East. Overall, Middle East companies have larger operations and are trading relatively cheap, compared to other geographies. In fact, we had to exclude prominent companies like Hrvatski Telekom and Jordan Telecom with market caps of $4 billion and $2 billion, respectively, from the list as valuations were not in favor.

The companies included in the list have some distinct advantages. Firstly, these companies benefit from higher tariff advantage. As per the Telecommunication Regulatory Authority, the average mobile tariff rate in the Mideast countries is 80%-100% higher than in the Organization of Economic Co-operation and Development (OECD) countries including Australia, Canada, U.K. and the U.S.

Secondly, the Middle East market is characterized by a strong demand for value-added services. Increasing mobile penetration, higher per capita income and improving lifestyles have led to the massive explosion of mobile telephony services. Most companies compiled in our list are focusing on niche areas to improve their margin profiles. For instance, the penetration of broadband and related services in these markets is relatively low; in Oman, the use of digital broadband is about 2%. In addition, the price of broadband in this region is three times higher than the European average. Indisputably, the companies we have listed here will benefit from future demand growth.

U.S. players operating in relatively mature markets and in regions associated with higher tele-density, are trading at a premium compared to their counterparts in the frontier markets. China and India, which are home to companies like China Mobile ( CHL), China Unicom ( CHU) and Tata Communications ( TCL) are relatively under-penetrated, offering opportunities for expansion.

Integrated communications companies, like Century Link ( CTL), are trading at lower valuations, relative to companies like Windstream ( WIN) and Qwest Communications International ( Q), which provide niche services. We have not considered SBA Communications ( SBAC) and Crown Castle International ( CCI), with negative return on equity and net profit margins.

Frontier market telecom companies like Bahrain Telecommunications and Oman Telecommunications are trading at enterprise value per earnings before interest tax depreciation of 4.7 and 4.3, respectively, offering maximum upside for investors from the present levels. In comparison, AT&T ( T), Verizon Communications ( VZ), and Sprint Nextel ( S) are trading at EV to EBITDA ratios of 5.6, 5.4 and 4.9, respectively.

Qatar Telecom (QTEL) is a Qatar-based diversified telecommunications company offering services in Qatar and wireless telecommunication services in Asia, the Middle East and North Africa (MENA) region. The stock trades on the Doha Stock Exchange.

Qtel is planning to expand its operations in Saudi Arabia and Tunisia through its subsidiary Wataniya Telecom. The company operates in 17 countries and is planning to expand into other markets to mitigate the loss of its domination after Vodafone Qatar, a unit of the Vodafone Group ( VOD), entered the Qatari market.

Recently, Qatar Telecom raised $2.75 billion in bonds to refinance its existing $3 billion term loan due in 2012, which will improve its profitability. In a conference call after the third-quarter results, the company said that it would meet its revenue and EBITDA guidance of 5% to 10% for the full year.

Vodafone Qatar (VFQS) is a Qatar-based telecommunications company engaged in the cellular mobile telecommunication services and the sale of mobile-related equipment and accessories. The stock trades on the Doha Stock Exchange.

The company has a 19% market share and a customer base of half a million subscribers. A unit of telecom major Vodafone Group, the company stands to gain from the parent company's experience, expertise and discount rates provided by suppliers on network equipment, IT services and handsets.

The introduction of mobile number portability is expected to benefit Vodafone Qatar in terms of market share, subject to enhancing its network quality. Analysts at JP Morgan Cazenove expect the company to turn earnings before interest, tax, depreciation and amortization positive in the second quarter of fiscal 2011, on a 21% revenue growth.

Safaricom (SCOM), one of the biggest brand names in Kenya, is a provider of mobile telecommunications services. The stock trades on the Nairobi Stock Exchange.

The company's market share in Kenya is about 78% with a subscriber base of 15.8 million. Safaricom has consistently generated positive cash flows from operating activities despite higher investments for developing its network infrastructure.

Regulations and lower competitor tariff could compel Safaricom to restructure its calling tariffs, according to analysts. However, the company enjoys the first-mover advantage in data. Its 3G set up and efforts to install a Wimax network would help increased its share of data revenues, which are more profitable. Analysts expect the share of data and other value-added services to contribute 30% of revenue in fiscal 2011, compared to 8% in fiscal 2008.

Oman Telecommunications Company (OTEL), or Omantel, is the largest telecom service provider in Oman, covering over 90% of the populated areas and serving more than 2.3 million subscribers. The stock trades on the Muscat Security Market.

Despite strong competition in the Omani telecom market, analysts are optimistic about Omantel as the demand for value-added services will drive growth. Further, broadband and related services are likely to witness strong growth. To capture a market share in this segment, the company is offering a suite of products and services targeting both retail and corporate consumers. Omantel has pioneered the launch of innovative services such as mobile TV and multi-player mobile gaming, in the domestic market.

Notwithstanding its recent entry in the 3.5G space, the company is targeting to install around 900 base stations by the end of this year. Furthermore, the company has demonstrated its 4G network, supported by Long Term Evolution technology. Omantel is among the first few telecoms in the world to introduce this network. Analysts foresee the company experiencing strong growth in subscriber base as well as average revenue per user in the VAS segment, supported by its aggressive expansion plans, relatively low broadband penetration and the projected uptake of VAS. The company's stock is trading at a price-to-earnings multiple of 7.1 to 7.2 times on estimated 2011 earnings.

Bahrain Telecommunications Company, or Batelco, is the leading telecommunications operator in Bahrain, Jordan, Yemen and Kuwait. The stock trades on the Bahrain Stock Exchange under the ticker "BATELCO".

The Bahraini telecom market is well developed and highly competitive, with mobile penetration higher than 140%. There is strong competition in the domestic market. Batelco's overseas expansion, through strategic acquisitions and joint ventures, is helping it sustain top-line and bottom-line growth.

A key long-term growth driver will be its focus on growth opportunities through acquisitions in the North African and Asian markets. Given the higher per capita income in the regions Batelco operates, the increased uptake of value-added services (such as broadband and mobile content) will power growth going forward. During the first half of 2010, the company's active mobile subscriber base expanded 47% to 6.9 million, and broadband Internet users jumped 54% to 230,600. The stock is trading at over 8 times its estimated 2010 earnings.

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