Taking Advantage of Telecom Sector Consolidation

NEW YORK (TheStreet) -- The telecommunications sector has been heating up lately with merger and acquisition news as Verizon (VZ) has reached a deal to buy out Vodafone (VOD) from their partnership in Verizon Wireless.

Separately, Vodafone is in the process of taking over Kabel Deutschland, Germany's largest cable company. Latin American giant America Movil ( AMX) is embroiled in a so-far unsuccessful attempt to take over KPN from the Netherlands. The latest news has AT&T ( T) interested in bidding for Vodafone.

M&A activity often comes in waves within a sector or industry, and the telecom sector has historically seen a lot of M&A activity, although not recently. The original AT&T was split into seven regional bell operating companies, or "baby bells," in 1984. In subsequent years the seven have become three.

The investment opportunity is that increased M&A activity has the effect of reducing the supply of telecom stocks even on a global scale. If supply goes down and demand for telecom stocks remains constant, which seems reasonable given the sector's high dividend yields, then prices should go up.

There are several ETFs in the space that would generally benefit from this trend without having to specifically pick individual stocks that eventually become takeover targets.

The largest domestic sector ETF is the Vanguard Telecommunication Services ETF ( VOX) at $515 million in assets, followed closely by the iShares US Telecom ETF ( IYZ) with $464 million. VOX allocates a whopping combined 44% to Verizon and AT&T compared to a combined 18% in IYZ. The funds' trailing dividend yields are 3.49% and 2.75%, respectively.

Investors interested in capturing a potential global wave of merger transactions could consider iShares Global Telecom ETF ( IXP), which allocates 69% to foreign companies. AT&T, VZ and Vodafone combine to add up to 40% of this fund. AMX and China Mobile ( CHL) also feature prominently in the fund as well. Japan has a 10% weighting in IXP and euro countries also account for 10% of the fund. IXP has a trailing 4.1% yield and is the largest telecom ETF with $527 million in assets.

The SPDR S&P international Telecommunications Sector ETF ( IST) has no domestic exposure. Not surprisingly, Vodafone is largest holding at 20% followed by Softbank from Japan and Spain's Telefonica ( TEF), each with 8% weightings. The UK is the largest country in the fund at 27% followed by Japan at 19%. Euro countries account for 30% of the fund. IST has been trading for five years but despite yielding almost 4% the fund has only attracted $32 million in assets.

One final fund to consider is the EG Shares Telecom GEMS ( TGEM), which invests exclusively in emerging market stocks. TGEM has struggled to attract assets since launching two years ago which is surprising given it is the only emerging market fund.

Its two largest holdings are AMX and CHL, each at 10%. China is the largest country in the fund at 17% followed by Malaysia at 12% and Mexico and South Africa, which each have 10%. Emerging markets are important in the industry. The recent renaissance in the stock price for Apple ( AAPL) has been partially attributable to a possible deal for CHL to make iPhones available to its customers.

Each of the funds, by virtue of what they target, will offer exposure to some parts of the industry will avoiding others. The domestic funds obviously avoid Europe and Japan which is a potential positive if those markets revert back to underperforming domestic markets but would be a negative attribute if those markets continue to do well.

TGEM has been the worst performer by far year to date because emerging markets in general have had a terrible year but when emerging markets next rotate into favor then TGEM will likely be the top performer. IXP is likely to be the least volatile of the group because it is the broadest fund in the group.

The biggest risk confronting all of the funds is the threat of higher interest rates. As rates on fixed income products move higher then investors will be less likely to seek higher yielding equities like telecom stocks if they can get decent yields without having to take on equity market risk.

At the time of publication the author had no position in any of the stocks mentioned.

This article was written by an independent contributor, separate from TheStreet's regular news coverage.

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