Will the Data Boom Pay Dividends?

US News

For investors who want certainty in their portfolio--and that includes virtually everyone--there is growing interest in the companies best positioned to cash in on the boom in social media and mobile computing: diversified media companies like AT&T and Verizon that offer broadband in all forms.

Still, the perils of investing in technology have never been better-illustrated than by Apple's slide over the past six months. High-tech products, even those with transformative properties, have a life cycle like the iPhone's apparent march toward middle age.

Meanwhile, providers of multimedia networks are feeling a surge in online demand as more people gobble up data and access social media and video over their smartphones. AT&T estimates demand for its wireless data has grown 20,000 percent over the past five years. Consulting firm Sandvine says data consumption more than doubled in the past year again, much of it from growing use of Netflix and other bandwidth-hogging video.

Not all of the growth hits the bottom line for telephone and cable companies that provide broadband service. They charge set fees under data plans. Still, the integrated network providers have been racing to win more users so they can lock them into monthly fees that can grow moderately over time in the same manner as a traditional utility.

[See 10 'Digital Utilities' You Need Every Day]

"There have been some slight downturns during the severe recessionary down period [in 2008 and 2009] but not a heck of a lot," says Howard Silverblatt, senior index analyst for S&P Dow Jones Indices. "They are becoming more of a basic service."

In the past, Internet service has been a tough way to make money. In the early days, more than 4,000 companies offered dialup service, some with only a few hundred subscribers. The difference now: There are far higher barriers to entry for providing big, integrated services over high bandwidth lines stretching across the entire U.S. geography.

The majority of users subscribe to one of a small handful of providers and get a bundle of mobile phone, home Wi-Fi and television service. The companies have become expert at locking consumers into long-term service contracts by offering cut-rate plans and low-priced smartphones, and churn has declined gradually.

The towers and the traffic boom. One of the purest plays for cashing in on the digital wireless boom is American Tower. Few people know the company's name, but everyone has seen its towers scrabbled over rooftops and high points in the countryside, some disguised as tall pine trees.

More than just antennas for cell phones, the towers also carry much of the data sent over televisions and computers, as well as those increasingly data-hungry mobile devices made by Apple, Samsung and others and bundled with service contracts sold by the broadband providers.

American Towers does not have to offer anything but the communication lines used by the big telecom and cable companies. The revenue is a rare commodity because "over 95 percent of it is recurring," Zacks Investment Research said in a recent report. And the business is growing. "Increased use of smartphones and tablets will create impressive demand for tower leasing." CrownCastle is its main competitor.

American Tower got a head start in the booming business as it borrowed heavily over the years to build or acquire 55,000 towers, twice as many as the nearest competitor. Cash flow turned positive three years ago and with high profit margin on operations, it is posed to start paying investors more of its double-digit profit growth.

Income seekers can be relatively certain dividends will rise since American Tower converted most of its property into a Real Estate Investment Trust (REIT), a move that cuts its own tax payments on income it pays its investors--and unlike dividends, which are voluntary, REITs must pay 90 percent of net profit to shareholders. When profit goes up, payouts also rise. The has stock surged 60 percent since it unveiled its plan to boost payouts by creating the REIT.

Some worry American Tower's shares could be overpriced at 50 times earnings, but as costs related to its conversion and debt pay-down become less onerous, its earnings will rise steadily. Its payout, now only 1.3 percent, will rise in proportion as net profit goes higher--possibly producing those digital-age, utility-like payouts for years to come.

New competition, old problem in tech. A number of diversified communication companies like AT&T, Verizon, Time Warner and Comcast are also benefiting from the data boom. The two largest, AT&T and Verizon, together added one million new accounts in the most recent quarter and reported higher net income that more than made up for any declines in landlines.

"Our view is that they are better than traditional utilities because they are not regulated to the same degree and the growth in demand is stronger," says David Cassese, associate portfolio manager on BlackRock's equity dividend team and a consumer and technology specialist.

The stocks of those companies are rising, many of them faster than the market as a whole, as investors seek out dividends in whatever form they can find them, he says. Surprisingly, the tech sector is now the highest dividend payer as the cash on hand for companies like Apple soars.

[Read: Earnings Drama Grows as Dividend Seekers Put Stock in Payouts.]

"They used to pay almost no dividends but tech companies are actually the biggest payers now," Silverblatt says. Intel and Microsoft, non-payers until they became dominant tech companies, pay out 4 percent and 3 percent, respectively. Apple launched a $50 billion share buyback Tuesday and boosted its dividend 15 percent to $3.05 give shareholders some of its $100 billion-plus in cash. But dividends yields are skimpy for most other tech companies, Silverblatt says, because the stock prices are still valued more highly by investors. The volatility of tech stocks makes them less attractive for income investors.

"You can lose all of your yield in a typical day's trading when the stock goes down," he adds. The big data providers enjoy the protection of high barriers to entry, he says, but Apple looked unassailable not long ago and innovations could alter the communications world, too. "You always have to worry about what's coming down the street," he says.

Telecoms and cable pay the old-fashioned way. The telecoms and cable companies, with their long history of high dividend payouts, are emerging as another way for investors to get steady income with the added bonus of possible stock appreciation if earnings rise.

To be sure, not all of the diversified service providers are steady payers--Sprint has not paid a dividend in five years, and CenturyLink stock was slammed this year when it cut its dividend. But for the most part, the telecom and cable companies are staying true to investors who buy them for income. Their corporate culture and shareholder base virtually require it, says Silverblatt. Even CenturyLink, which is mired in heavy debt and feeling the impact of lost landlines, continues to pay a yield of 6 percent, a figure that is "sustainable," according to a recent JPMorgan report.

Other, more established telecoms like Verizon and AT&T have the financial clout to keep paying dividends, even with steady declines in their traditional landline service keeping a drag on earnings. Other big players, the cable companies like Comcast and Time Warner, generate huge cash flow from a subscriber base that is relatively stable.

[See 10 Golden Parachutes to Make Your Head Spin]

Meanwhile, new competitors are looking more and more like old-line utilities (and could, in theory, structure dividends accordingly in the future). Amazon and Google are pushing more aggressively into data services that could create a steady income stream. Amazon is the dominant player in cloud computing with its 450,000 servers that store and manage data for thousands of companies. Google is starting to offer super-high speed 1 gigabit Internet and television service that is 10 times as fast as existing broadband, though it's limited to a few communities and termed "experimental."

Alternately, over the longer term, existing dividends at telecom and cable firms could be threatened as new technology challenges their networks. Competitive threats could also come through mergers like the one proposed by Dish for Sprint, which could create a big new player in the integrated broadband world. But longer-term, the big data retailers could confront the old problem faced by anyone in the tech world. For now, they offer the both income and growth, Cassese says.

"They are becoming like a utility, yields are growing over time for the high-quality companies, and dividends are playing bigger role," says Cassese. "Individual investors are having a difficult time finding yield. This is a very good place to be focused."



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