NTT Docomo (NYSE: DCM; 100 ADR’s represent one share at TSE; market capitalization 71.9 billion USD) is one of the world’s largest mobile communications operators. With more than 59 million customers in Japan, the company holds a share of around 48.5 percent of its home market. Main competitors are KDDI au (27.6 percent) and Softbank Mobile (21.2 percent). The company follows the fiscal year schedule starting April 1 and ending March 31, which is common in Japan.
DCM is a technology leader, launching i-mode mobile internet services in 1999 and introducing the world’s first commercial 3G service in 2001. 4G LTE was first proposed by DCM as an international standard in 2004, and launched as the first 4G service in Japan in October 2010. As most mobile phone users in Japan have migrated to 3G or 4G, the firm will end operations of its 2G network in 2012. This will free up capital to broaden DCM’s domestic lead in 4G services.
DCM believes that increasing use of smartphones and tablet devices is driving a rapid demand for large volume data communications, and plans to attract around 15 million LTE subscriptions by 2014.
At the same time the company is investing in Asian growth markets. The most notable holding is a stake of 26 percent in India’s Tata Teleservices, which has been growing steadily and currently holds 11 percent market share in one of the fastest growing mobile communications markets worldwide.
DCM has consistently delivered strong EBITDA margins of around 35 percent over the last 10 years. This may indicate the existence of an economic moat of some sorts.
Taking into account the company’s very low churn rate at around 0.5 percent, which points to very loyal customers, I believe that DCM owns an economic moat built on high switching costs.
Handsets are generally sim-locked in Japan, which means that switching operators also implies the purchase of a new handset. Prepaid plans are of marginal relevance at best in the country, and customers are commonly locked into 2-year plans with high penalties for early release.
Number portability has been introduced in Japan a few years back, but customers still have to change their email addresses when switching mobile phone operators. This constitutes an actual inconvenience, as Japanese consumers almost exclusively use push-email instead of SMS/MMS message services that are popular in other countries.
I also believe that the company’s structural competitive advantage is strengthened by its market leading position, which makes various billing plans that offer discounts for calls to other DCM subscribers more valuable than similar plans by KDDI or Softbank. Examples include discount plans to family members or friends, but also wider groups, such as the newly launched LTE ‘Xi Talk 24’ plan with a flat-rate for 24-hour unlimited domestic voice calls to all DCM users.
A possible danger to the company’s economic moat may be that KDDI recently joined Softbank in supplying the widely popular Apple iPhone, but considering high switching costs; Japanese consumer preference towards domestic brands, recent strong Android sales, and DCM’s lead in LTE services, the future impact is not clear and would need to be regularly monitored.
DCM pays an interim dividend in mid-November and a year-end dividend in early April. The company has not cut its dividend for over ten years and has delivered average annual dividend growth of 27.3 percent to its shareholders, although growth rates have slowed down in the second half of the last decade. I would expect future annual dividend growth around 5 percent.
The dividend is well covered, as DCM maintains a comfortably low payout ratio below 50 percent and has a very strong balance sheet. The company has continuously reduced its debt ratio from 28 percent ten years ago to currently around 8 percent, which is very rare in a telecommunications company.
Based on an exchange rate of around 82 Japanese yen for 1 US-dollar at the time of writing, DCM trades at around 140,000 JPY per share or around 17 USD per ADR. The stock yields around 4 percent, which is high for a Japanese company. I estimate fair value at 175,000 JPY per share or 21.30 USD per ADR, assuming free cash flow growth of 8.5 percent and a discount rate of 10 percent, which would provide a reasonable safety margin of around 20 percent. DCM is attractively valued at 13 times earnings, and 1.14 times book value.
Based on its attractive current valuation, economic moat and strong balance sheet, I would consider adding DCM to my portfolio, expecting sustainable high yield growing in the low to mid-single-digits. US-based investors would have to be aware however, that the Japanese yen is close to its 20-year high against the US-dollar and that the investment will be negatively affected should the dollar strengthen.
Full disclosure: I do not own stock in DCM at the time of writing.
DCM is a technology leader, launching i-mode mobile internet services in 1999 and introducing the world’s first commercial 3G service in 2001. 4G LTE was first proposed by DCM as an international standard in 2004, and launched as the first 4G service in Japan in October 2010. As most mobile phone users in Japan have migrated to 3G or 4G, the firm will end operations of its 2G network in 2012. This will free up capital to broaden DCM’s domestic lead in 4G services.
DCM believes that increasing use of smartphones and tablet devices is driving a rapid demand for large volume data communications, and plans to attract around 15 million LTE subscriptions by 2014.
At the same time the company is investing in Asian growth markets. The most notable holding is a stake of 26 percent in India’s Tata Teleservices, which has been growing steadily and currently holds 11 percent market share in one of the fastest growing mobile communications markets worldwide.
| Year | 2002 | 2003 | 2004 | 2005 | 2006 | 2007 | 2008 | 2009 | 2010 | 2011 (est.) |
| EBITDA margin | 38.2% | 36.8% | 33.6% | 33.7% | 32.9% | 34.8% | 37.7% | 36.6% | 37.1% | 37.3% |
| Debt ratio | 28% | 22.8% | 19.5% | 16.4% | 12.7% | 10.1% | 12.8% | 11.6% | 8.1% | 8.1% |
| Dividend (JPY) | 500 | 1,500 | 2,000 | 4,000 | 4,000 | 4,800 | 4,800 | 5,200 | 5,200 | 5,600 |
| Payout ratio | 38.5% | 42.1% | 43% | 43.8% | 44.1% | 45% |
DCM has consistently delivered strong EBITDA margins of around 35 percent over the last 10 years. This may indicate the existence of an economic moat of some sorts.
Taking into account the company’s very low churn rate at around 0.5 percent, which points to very loyal customers, I believe that DCM owns an economic moat built on high switching costs.
Handsets are generally sim-locked in Japan, which means that switching operators also implies the purchase of a new handset. Prepaid plans are of marginal relevance at best in the country, and customers are commonly locked into 2-year plans with high penalties for early release.
Number portability has been introduced in Japan a few years back, but customers still have to change their email addresses when switching mobile phone operators. This constitutes an actual inconvenience, as Japanese consumers almost exclusively use push-email instead of SMS/MMS message services that are popular in other countries.
I also believe that the company’s structural competitive advantage is strengthened by its market leading position, which makes various billing plans that offer discounts for calls to other DCM subscribers more valuable than similar plans by KDDI or Softbank. Examples include discount plans to family members or friends, but also wider groups, such as the newly launched LTE ‘Xi Talk 24’ plan with a flat-rate for 24-hour unlimited domestic voice calls to all DCM users.
A possible danger to the company’s economic moat may be that KDDI recently joined Softbank in supplying the widely popular Apple iPhone, but considering high switching costs; Japanese consumer preference towards domestic brands, recent strong Android sales, and DCM’s lead in LTE services, the future impact is not clear and would need to be regularly monitored.
DCM pays an interim dividend in mid-November and a year-end dividend in early April. The company has not cut its dividend for over ten years and has delivered average annual dividend growth of 27.3 percent to its shareholders, although growth rates have slowed down in the second half of the last decade. I would expect future annual dividend growth around 5 percent.
The dividend is well covered, as DCM maintains a comfortably low payout ratio below 50 percent and has a very strong balance sheet. The company has continuously reduced its debt ratio from 28 percent ten years ago to currently around 8 percent, which is very rare in a telecommunications company.
Based on an exchange rate of around 82 Japanese yen for 1 US-dollar at the time of writing, DCM trades at around 140,000 JPY per share or around 17 USD per ADR. The stock yields around 4 percent, which is high for a Japanese company. I estimate fair value at 175,000 JPY per share or 21.30 USD per ADR, assuming free cash flow growth of 8.5 percent and a discount rate of 10 percent, which would provide a reasonable safety margin of around 20 percent. DCM is attractively valued at 13 times earnings, and 1.14 times book value.
Based on its attractive current valuation, economic moat and strong balance sheet, I would consider adding DCM to my portfolio, expecting sustainable high yield growing in the low to mid-single-digits. US-based investors would have to be aware however, that the Japanese yen is close to its 20-year high against the US-dollar and that the investment will be negatively affected should the dollar strengthen.
Full disclosure: I do not own stock in DCM at the time of writing.
