The world of business can be a rather strange place over a prolonged period of time. Certainly, ideas to expand or contract the size, reach and diversity of a business can make sense in the moment and during their execution. However, over a prolonged period, the decision to do one or the other seems to contradict that which was just done. In other words, businesses seem to go from an expansionary phase to a period of contraction and back again at very regular intervals.
Take, for example, BT (LSE: BT-A) (NYSE: BT.US). Its focus at the present time is on expanding its product offering so as to be a provider of mobile, broadband, pay-tv and landline and, by doing so, it is hoping to increase customer numbers, sales and, ultimately, profitability. And, to BT’s credit, the investment world seems to be on board with the idea, since BT’s share price has risen by 260% in the last five years.
However, just a decade or so ago, the focus for BT was on shrinking its business so as to become more efficient and more focused on providing a niche offering. For example, it sold its mobile offering and instead focused on broadband and landline offerings, with pay-tv not being a focus. And, while that has been successful, BT is now doing the opposite and has purchased the mobile network, EE, as well as various sports rights which are eating away at its margins in the short run.
The problem with expanding quickly and offering more products in new and different spaces is that companies can quickly become inefficient. That’s not to say that BT is a poorly run business, but rather that juggling too many balls inevitably leads to higher than required costs, a lower return on investment and difficulty in outperforming the wider index in terms of profitability growth. And, with all of the initial investment required, it can cause greater risk as well as a potentially disappointing return.
That’s a key reason why stocks other than BT in the fixed line telecoms sector seem to have more appeal. For example, the likes of Cable & Wireless (LSE: CWC), Colt (LSE: COLT) and Telecom Plus (LSE: TEP) may lack the size and scale of BT, but they have far stronger growth prospects and a much clearer catalyst for future share price growth.
In fact, all three companies are expected to increase their bottom lines at double digit rates next year. In the case of Cable & Wireless and Colt, this equates to a price to earnings growth (PEG) ratios of just 0.7, which indicates that their shares are undervalued and could move significantly higher. And, while Telecom Plus has a PEG ratio of more than double that at 1.5, it is still far more appealing than BT’s PEG ratio of 2.9.
Furthermore, Cable & Wireless and Telecom Plus yield 3.9% and 4.6% respectively, which indicates that they could be better income plays than BT, which has a yield of 3.2%. And, while Colt posted a loss last year, its anticipated shift to profitability this year could be another reason for investors to bid up its share price over the medium term.
Of course, BT’s foray into quad play may prove to be a major success, but the market clearly has high expectations for the business and, with vast initial costs, a pension liability that remains a drag on performance and the risk of inefficiencies due to a greater breadth of services, Cable & Wireless, Colt and Telecom Plus hold more appeal at the present time.
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Peter Stephens has no position in any shares mentioned. The Motley Fool UK has no position in any of the shares mentioned. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors.