VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 1

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE

A Thesis

Presented to the Faculty

of Finance Programme at

ISM University of Management and Economics

in Partial Fulfilment of the Requirements for the Degree of

Bachelor of Finance

by

Matas Ramanauskas

Advised by

Doc. Dr. Ieva Augutytė - Kvedaravičienė

December 2020

Vilnius

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 2

Summary

Ramanauskas, A., Valuation of Telia Lietuva, AB from an Investor’s Perspective

[Manuscript]: bachelor thesis, finance. Vilnius, ISM University of Management and

Economics, 2020.

The topic of the thesis is Valuation of Telia Lietuva, AB from an Investor’s

Perspective. This work aims to determine the enterprise value of the company and issue recommendations for investors after deriving the company’s stock price. To get the most accurate results, the analysis of the telecommunication industry and the company is prepared, the best-fit methods applied, namely market method, including financial and transactions multiples (EV/Sales and EV/EBITDA), and for income method discounted cash flow valuation model was performed. In the end, both methods provide enterprise value and after subtracting the net debt, it arrived at the equity value and the corresponding stock price derived. The enterprise value for Telia Lietuva using the market method resulted in EUR

985-1002 million with a EUR 1.45-1.48 stock price for financial multiples and EUR 1066-

1096 million with a EUR 1.59-1.64 stock price for transactions multiples, which is usually higher because of the priced-in synergies. Discounted cash flow resulted in EUR 1126 enterprise value and a corresponding EUR 1.69 stock price. The stock price of Telia Lietuva was priced at EUR 1.56 on September 30th, 2020 (valuation date), creating a possible 8.3% upward move to reach the price derived from the DCF method. In the end, the final recommendations were issued for prospective investors willing to invest in Telia Lietuva,

AB. Giving more weight to the DCF method, the final recommendation is to BUY with a long-term investing strategy.

Keywords: Telia Lietuva, telecommunication, relative valuation, discounted cash flow, enterprise value.

Number of words: 13995 VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 3

Table of Contents

Introduction ...... 9

1. Situation analysis ...... 11

1.1 General information about Telia Lietuva, AB ...... 11

1.2 The History of Telia Lietuva, AB ...... 11

1.3 Size and operations ...... 11

1.4 Shareholder structure ...... 13

1.5 Business risk assessment...... 13

1.6 Global industry environment ...... 13

1.7 European industry environment ...... 14

1.8 Lithuanian industry environment ...... 15

1.9 Growth trends...... 17

1.10 Local competition and external factors ...... 19

1.11 Financial situation ...... 22

2. Theory and research methods ...... 27

2.1 Defining valuation ...... 27

2.2 Review of valuation methods...... 28

2.2.1 Income method...... 29

2.2.2 Market method ...... 30

2.3 Discounted Cash Flow Method ...... 30

2.3.1 Discount rates...... 32

2.3.2 Cost of equity ...... 33 VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 4

2.3.3 Risk-free rate ...... 33

2.3.4 Equity beta ...... 34

2.3.5 Market risk premium...... 34

2.3.6 Income tax rate ...... 34

2.3.7 Cost of debt ...... 35

2.3.8 Terminal value ...... 35

2.3.9 Sensitivity analysis...... 35

2.4 Relative valuation ...... 35

2.4.1 Valuation multiples ...... 36

2.4.2 Transaction multiples ...... 36

2.5 Relevant information for an investor ...... 37

3 Empirical research ...... 41

3.1 Discounted Cash Flow (DCF) ...... 41

3.1.1 Cost of equity (CAPM) ...... 41

3.1.2 Risk-free rate ...... 41

3.1.3 Beta coefficient ...... 42

3.1.4 Equity risk premium ...... 42

3.1.5 CAPM ...... 43

3.1.6 Discount rate ...... 43

3.1.7 Cost of debt ...... 43

3.1.8 Revenue forecast ...... 44

3.1.9 Cost of goods sold forecast ...... 47

3.1.10 Operating expenses forecast ...... 47

3.1.11 Other income, gain/loss forecast ...... 48 VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 5

3.1.12 Depreciation, amortization, and CapEx forecast ...... 49

3.1.13 EBIT forecast ...... 50

3.1.14 Change in net working capital forecast ...... 51

3.1.15 FCFF calculation ...... 52

3.1.16 Terminal value ...... 52

3.1.17 Enterprise value of Telia Lietuva ...... 52

3.1.18 Sensitivity analysis...... 53

3.1.19 Scenario analysis ...... 54

3.2 Relative valuation ...... 54

3.2.1 Financial multiples ...... 55

3.2.2 Transactions multiples ...... 56

3.2.3 Findings of the relative valuation ...... 57

3.3 Recommendations ...... 58

3.3.1 Relative valuation ...... 58

3.3.2 Discounted cash flow ...... 59

Conclusions ...... 60

References ...... 63

Appendices ...... 68

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 6

List of figures

Figure 1. Total revenue breakdown of telecommunications services 2014 - 2019...... 16

Figure 2. Total revenue breakdown of data transmission services 2014 - 2019...... 17

Figure 3. Lithuanian Telecommunications market share by revenues in Q3 2020...... 19

Figure 4. Revenue growth and net profit margin 2015 - 2019...... 23

Figure 5. Recent changes in users base 2019-2020...... 24

Figure 6. Telia Lietuva historical stock price and volume 2017 - 2020...... 37

Figure 7. Historical P/E ratio averages of Telia Lietuva and its peers...... 38

Figure 8. 5 years stock chart of Telia Lietuva...... 59

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 7

List of tables

Table 1. PESTEL analysis of the electronic communications sector ...... 20

Table 2. SWOT analysis of Telia Lietuva, AB ...... 22

Table 3. Financial ratios of Telia Lietuva and its peers ...... 24

Table 4. Historical P/E ratio averages of Telia Lietuva and its peers for 2017-2020 ...... 38

Table 5. Telia Lietuva and its peers’ stocks reaction to the pandemic...... 39

Table 6. Telia Lietuva and its peers’ fundamentals...... 40

Table 7. Weighted average of unlevered beta, revenues approach...... 42

Table 8. Book value of equity and debt calculations...... 43

Table 9. Breakdown of revenues by service...... 44

Table 10. Revenues forecast...... 47

Table 11. Cost of goods and services forecast...... 47

Table 12. Operating expenses forecast...... 48

Table 13. Other income, gain/loss forecast...... 48

Table 14. Depreciation, amortization, and CapEx forecast...... 49

Table 15. EBIT forecast...... 50

Table 16. Change in net working capital forecast...... 51

Table 17. Corresponding components’ ratios to revenues, cost of goods, and services...... 51

Table 18. Free cash flows to firm...... 52

Table 19. Discounted cash flow calculations...... 53

Table 20. Sensitivity analysis...... 53

Table 21. Financial multiples of peer companies for September 30, 2020...... 55

Table 22. Financial multiples calculations...... 56

Table 23. Recent M&A transactions and multiples...... 56

Table 24. Transactions multiples share price calculations...... 57 VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 8

Table 25. Enterprise values and stock prices using different methods...... 57

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 9

Introduction

Topic relevance

The valuation of Telia Lietuva, AB is performed as the author is a prospective investor of the company. It is a must to evaluate the fundamentals of a certain firm before considering investing in it, to verify the financial stability, historical growth, margins.

Especially during these days, when the world is shocked by a global pandemic, it is crucial to assess the company’s position and value in the market to know where it is heading and what could be expected. At this moment uncertainty still prevails in the markets and economies, creating a riskier environment for investors. Most equities have plunged considerably and

Telia Lietuva was not an exception. Even though a big part of securities together with OMX

Vilnius Index have retrieved all their losses back in a very short time, it is way too early to state that the distress is over. Now it is even more relevant to see, whether Telia Lietuva is still valued the same or even overvalued after the quick recovery and growth. Certain ratios are used to reflect the company’s historical results and its current standpoint. The value of the company is derived using a couple of different methods, like Discounted Cash Flow model and relative valuation, calculated ratios are compared with peer companies in the industry, to make the interpretation easier, whether a ratio is considered to be acceptable. Also, a lot of new investors were brought in the market after seeing huge drops as an opportunity to jump in, and the trend of gambling hardly beaten-down stocks has started (however, some of the investors being new and unexperienced do not base their choice on fundamentals, instead just jumping on the bandwagon and following trends). After the recovery, a lot of investors felt the psychological pressure of Fear-Of-Missing-Out, thus investing has not stopped, and the market kept increasing surprisingly fast. All in all, from March a lot of companies have seen an increase in the market capitalizations, and as a result market multiples have climbed too, VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 10 thus it is important to evaluate the company and check whether it is overvalued, undervalued, or fairly priced.

Research problem: What is the enterprise value of Telia Lietuva, AB?

Thesis aim: To determine the enterprise value of Telia Lietuva, AB from an investor’s perspective and decide whether the company is undervalued, overvalued, or fairly priced by deriving its stock price.

Thesis objectives:

1. To perform the analysis of the telecommunication industry, internal and financial

analysis of the company.

2. To provide and examine the methods for the company’s value determination.

3. To derive the enterprise value and the stock price of Telia Lietuva, AB.

4. To provide recommendations for investors.

Research methods:

To find the value of Telia Lietuva, income and market methods are used. Discounted cash flow model is carried out to determine the enterprise value of the company considering the earnings growth. Comparable company analysis using equity and enterprise value multiples and precedent M&A transactions in the same industry is executed. PESTEL and

SWOT analyses are used for the external and internal environment examination.

The practical value of the thesis:

The outcome of the thesis is the enterprise value with a derived equity value and the stock price of Telia Lietuva and a recommendation statement. Not only for the company it is important to know its real value but also for investors. Fundamental analysis and valuations are often prepared to make investment decisions for certain companies. VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 11

1. Situation analysis

1.1 General information about Telia Lietuva, AB

For a smart investment decision backed by strong fundamentals it is needed to dig deeper into a company’s financials, find some general information about the industry environment and the company itself. To understand how the company works, it is beneficial knowing its history, what operations it engages in, how, and by who it is managed. Therefore,

Telia’s history, management, operations, and shareholders structure is reviewed in this section.

1.2 The History of Telia Lietuva, AB

The company’s journey has started at the end of the 20th century. Telia Lietuva, a subsidiary of Swedish Telia Company, AB, was formerly known as one of the biggest telecommunication companies in Lithuania, back then it was registered as AB Lietuvos

Telekomas in 1997. After a year, the company was privatised by the Swedish “Telia” and

Finnish “Sonera” and in 2002 the companies merged creating a new joint company under the name TeliaSonera AB. In 2006 Lietuvos Telekomas became TEO LT and only after the merger of TEO LT and Omnitel on February 1st, 2017, the company became Telia Lietuva,

AB. In 2015 TEO LT announced that it will acquire 100% of the stock of the Lithuanian telecommunication company Omnitel from TeliaSonera for EUR 220 million. After the transaction, two companies merged, a joint management team was formed and Telia Lietuva started operating. Since 2000 the company’s equity is listed on the “Nasdaq Vilnius” under the ticker symbol TEL1L and German Deutsche Boerse AG under the ticker symbol ZWS.

1.3 Size and operations

Telia Lietuva is a Lithuanian branch of Telia Company, AB, and is the largest telecommunication provider in Lithuania. It is considered to be a small-cap company in a global context, with the market capitalization reaching 909 million euros on the valuation VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 12 date, September 30th, 2020 (with a closing price of 1.56 EUR). The size of the company could be evaluated using other metrics, too. Based on the Brussels Regional Public Service publication, the size of an enterprise could be measured by three factors: staff, turnover, and balance sheet total (n.d.). Total assets stood at EUR 575 million for 2020Q3 and turnover reached EUR 396.5 million by the end of the last available 2019 financial year. At the end of

2020Q3 it had 2,386 staff members, considering all three factors, Telia Lietuva appears to be a large-sized enterprise (please refer to appendix B). Telia Lietuva is headquartered in

Vilnius, Lithuania and is operating in Lithuania. The company conducts local business, main clients reside in Lithuania, suppliers or creditors base does not step over Europe’s borders.

The company’s operations cover telecommunication, television, and information technology services for both residential customers and businesses. These services are broken down into internet access, mobile and fixed telephony services, television, data communication, and network capacity, music entertainment, mobile signature, and other additional data solutions.

What is more, the company engages in selling electronic equipment, such as mobile phones,

TVs, tablets, computers. Based on the 2020Q3 financial report, the company still serves more individual customers than business ones, revenues from services are split by 60.3% from B2C and 38.9% from B2B activities, 0.8% came from others (p. 6).

The company has an ethical and sustainable business model, it focuses on innovation and customer service, values teamwork and strong execution. Telia Lietuva follows three principles to remain the leaders in the sector: dare, care, and simplify. The goal is to connect people and with the help of technology, to bring the world closer.

The governing bodies of Telia Lietuva are the CEO, the Board of Directors, and the

General Shareholder’s Meeting. Without a doubt, the company has a strong and experienced management team. The CEO is Dan Strömberg, who has more than 25 years of experience in

Telia Company and serves this role since July 4th, 2018. What is more, on August 1st, 2020 he VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 13 was appointed as a senior vice president and Head of Lithuania, Estonia, and Denmark at

Telia Company, AB, confirming his competencies.

1.4 Shareholder structure

The last Annual General Meeting took place on the 28th of April 2020. According to

Telia Lietuva reported “Shares and Shareholders” section (2020), its share capital is made of

583 million ordinary shares and 11,521 shareholders. The parent Telia Company is the largest mobile operator by revenue and customer base in the Nordic and Baltic regions and is the biggest owner of Telia Lietuva, holding 88.15% of the whole stake. The other 11.85% is split among other shareholders in different countries. Lithuanian investors hold 8.75%, from which 7.73% is owned by private individuals, 0.61% and 0.41% belong to financial institutions and legal entities, respectively. The remaining 3.1% is distributed among other investors in different countries, the biggest positions held in Estonia, Latvia, Poland, Canada,

USA. Every owned and registered share of Telia Lietuva grants access to one vote in the

General Meeting of Shareholders.

1.5 Business risk assessment

In this section, the current situation in the selected environment is reviewed using the funnel technique. First of all, the situation is acknowledged in the sector globally, after that, the European market is briefly reviewed, finally, research is narrowed down to the country analysis, focusing on Telia Lietuva, growth trends, and local competitors. Sector analysis helps to understand what the current situation and the standpoint of the company are, whether there is still room to expand operations and grow.

1.6 Global industry environment

Global industry analysis is based on the GSMA Association’s “The Mobile Economy

2020” report. In the last 5 years people continued to connect digitally worldwide, almost one billion new customers joined mobile broadband networks. According to the report, at the end VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 14 of 2019, around 5.2 billion customers were using mobile services, which accounted for 67% of the total population. Mobile services with SIM card connections are not seen to be growing as fast anymore, letting new technologies eventually replace them. GSMA Intelligence projects that by 2025 there will be an increase of 600 million mobile services subscribers

(CAGR of 1.9%) and SIM connections (CAGR of 1.7%) each, and it will reach 5.8 billion users and 8.8 billion connections, respectively. However, the biggest growth is projected for new technologies and trends. Mobile internet users are seen to be growing from 3.8 billion to

5 billion users in 2025 at 4.6% CAGR, while the Internet of Things (IoT) total connections are forecasted to jump from 12 billion total connections to 24.6 billion in 2025. As well, 5G connections are also expected to rise. During the upcoming 5 years, mobile operators worldwide are projected to invest around 1.1 trillion euros in mobile capital expenditures, from which investments in 5G networks should account for around 78% (p. 6). Operators' revenues stood at 1.03 trillion euros in 2019, it is projected to reach 1.14 trillion euros globally in 2025, growing by almost 11% (GSMA, 2020).

1.7 European industry environment

In Europe, subscriber penetration at the end of 2019 took 86% and is expected to reach 87% by 2025, while North America reaches 83% and Greater China stands at 82% in

2019. The growth of penetration in Europe looks slow at the moment, indicating that already almost 90% of the population uses telecommunication services with little room for customers base to grow (from the above-mentioned 600 million new subscribers, only 10 million accounts to the European market). What is more, mobile internet connectivity is very high in

Europe compared to other continents, 76% of the population already using the internet. 5G network is anticipated to account for 20% of total connections globally, with Europe being one of the biggest participants in the field. At the end of 2019 4G was the most used network, constituting 58% of all mobile connections, 3G and 2G corresponding to 28% and 14%, VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 15 respectively. By 2025 it is expected for 5G to take 34% of all mobile connections in Europe, creating additional competition for companies in Europe, however, 4G still grasping the biggest share (GSMA, 2020). According to European Telecommunications Network

Operations Association (ETNO), European customers do not spend much on communication services compared to other companies globally. ETNO states: “Telecom service revenues are stuck at around 165bn EUR for the past 5 years as are mobile and fixed Average Revenue Per

User (ARPU) at 14.9 EUR and 21.5 EUR in 2019 respectively.” (The State of Digital

Communications 2020, p. 5).

1.8 Lithuanian industry environment

Telia Lietuva operates in the communication services sector, telecommunication industry. The Communications Regulatory Authority of the Republic of Lithuania

(hereinafter - RRT), is responsible for regulating the electronic communications sector in the country under Lithuanian law. This institution provides periodical reports about the communication sector, including electronic communication services providers. The latest data, published by the Official Statistics Portal of Lithuania, is available for the end of 2019 which reflects the size of the market. In 2019Q4 there were almost 4.7 million active mobile phone subscribers and almost 3.1 million public mobile network subscribers (please refer to appendix C).

Based on the RRT 2019 communication sectors report, Lithuania saw a decrease in the volume of new companies entering the electronic communications sector. In 2019 121 entities were operating in the country, a 16% decrease from 2014, however, based on the

2020Q3 report, currently, there are 124 entities. Considering revenues, the sector shows a healthy growth year by year. In 2019 revenues in the electronic communication sector reached 713.5 million euros, a 20.1 million euros increase from 2018 or 2.9% and a 17.5% increase from 2014. Out of the 713.5 million, the telecommunication services took a VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 16 substantial 43% part of these revenues, resulting in 308.3 million euros in 2019 and the first three quarters of 2020 look more promising comparing to 2019. However, during the last 3 years (from 2016 to 2019) telecommunication services became less and less able to generate revenue and data transmission took the lead in 2019 outgrowing all the service groups in the electronic communications sector. According to RRT (2019), total revenue from telecommunication services is made of mobile communications services, fixed communications services, and network interconnection services. The biggest part of the revenues is attributed to mobile communications services and network interconnection services, which took 51% and 39% of the total revenues, respectively. However, the total revenue of the Lithuanian telecommunication market has been decreasing and it indicates, that the market might have reached its maturity. There is no main type of service to be blamed for because all three mentioned above were decreasing in the last years (please refer to the figure provided below). Fixed communications services were decreasing straight from

2014 until 2019, and it plunged considerably, from 53.8 million euros in 2014 to 29.7 million euros in 2019, marking a 45% decrease. Based on figure 1, last year's revenues from telecommunication services decreased by 7.7%. According to the latest 2020Q3 report, the mentioned services’ revenues were still decreasing in all three quarters of 2020 (p. 6).

Figure 1. Total revenue breakdown of telecommunications services 2014 - 2019.

Source: Report of Communications Regulatory Authority, 2019 VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 17

Data transmission services look very promising and are already marking some noticeable gains. In the age of technology, internet access became one of the most crucial things and that is what drives the revenues to go up in this field. The biggest part of data transmission revenues was made from retail internet access services, which revenues increased from 141 million euros in 2014 to 290.2 million euros in 2019, growing at 106% percent in 5 years period

(please refer to the figure provided below) and growing even more in the first three quarters of

2020. Comparing Telia Lietuva performance in this field, more than 40% of total data transmission revenues were coming from the company being analysed, leaving UAB Tele2 and

UAB Bitė Lietuva behind with 24.5% and 19.5%, respectively.

Figure 2. Total revenue breakdown of data transmission services 2014 - 2019.

Source: Report of Communications Regulatory Authority, 2019

What is more, the revenue from mobile telephone voice services also saw a considerable drop, from 2014 dropping almost 24%. It could be again linked to the increasing popularity of data transmission alternatives, which gradually replace traditional communication services.

1.9 Growth trends

It is important to evaluate growth opportunities and consider them when forecasting a company’s revenues. Speaking of alternative technology solutions, there is a lot of room for companies to take advantage of new growth trends. Companies are discovering opportunities VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 18 and try to keep up with the innovations and technological trends, otherwise, they would just be outcompeted.

Forbes publication written in 2019 by Bernard Marr indicated several technological trends, the most popular being 5G networks, Internet of Things (IoT), and Artificial

Intelligence (AI). Telecommunication companies process a very large volume of data every day and it becomes harder to operate with an increasing number of users, the complexity of technologies, and new solutions applied by competitors. According to Telia’s annual report of

2019, Telia Company together with Telia Lietuva has already started considering and implementing new products to fulfill their goals and strategic excellence. In November of

2019, Telia Lietuva introduced an artificial intelligence solution to keep up with the volume of customers by employing a chatbot on their websites. At the beginning of 2020, the company presented the potential of narrowband Internet of Things technology and is already taking part in discussing the implementation of 5G technology. Telia Lietuva has serious strategic goals using these opportunities in the future, continue investing in broadband and

5G technology and digitalising as many processes as possible. The company pursuits that by

2022 its customers would already be able to get fully digital support without any need for help from humans. What is more, in 2017 three largest Lithuanian telecommunication companies, namely, Telia Lietuva, Tele2, and Bitė Lietuva acquired 33.3% each in the company called UAB Mobilieji Mokėjimai. It was a move from companies to innovate their technology and to stick up with new payment trends. Instant payments platform MoQ was acquired with it, however in 2018 it was classified as a held for sale item and in March 2020,

UAB Mobilieji Mokėjimai operations were terminated by the decision of its shareholders.

After that, all telecommunication companies sold their stake in the company to SEPAexpress

FS, UAB. VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 19

1.10 Local competition and external factors

There are 3 main electronic communications companies in Lithuania: Telia Lietuva,

AB, UAB Tele2, and UAB Bitė Lietuva. Telia Lietuva has a local competition and remained the leader in the sector, taking almost 39% percent of the market in Lithuania by revenues in

Q3 2020. UAB Tele2 stood at 24.5% and Bitė Lietuva at 19%.

Figure 3. Lithuanian Telecommunications market share by revenues in Q3 2020.

Other 17.6% Telia Lietuva, AB UAB Bitė 38.9% Lietuva 19%

UAB Tele2 24.5%

Source: Telia Lietuva Q3 2020 report

Telia Lietuva stands out from the competitors being not only the leader in the market based on the market share but also the service quality and operations. According to RRT

2019 annual report, Telia Lietuva had an average SMS service delivery time of 3.8 seconds in

2018 and 3.5 seconds in 2019, the competitors are still standing behind by approximately one second. Data speed increased tremendously in 2019, the average speed of receiving data in cities and roads was 43.4 megabytes per second (Mb/s) in 2018 and it jumped by more than

30 Mb/s and stood at 76.2 Mb/s in 2019 marking a 76% increase in data speed. In this field,

Tele2 performs very well and Telia Lietuva should keep up with the high standards to remain the best player in the market (Tele2 marked a 71% increase, from 41.6 Mb/s to 71.3 Mb/s) (p.

60). VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 20

To evaluate and indicate external factors that have an impact on the company,

PESTEL analysis was used.

Table 1. PESTEL analysis of the electronic communications sector

P – Political The change in the government could impose a great risk for the

companies, change in policies could result in lower revenues or

constrained freedom of operations. Taxation and possible changes

should also be taken into account to avoid any future

misunderstandings.

E – Economic Economic influence is a common risk for all companies, especially

now when the economy suffers from the downturn. The sector is

exposed to interest rates, inflation, unemployment, and other risks.

Costs influence profits, on one hand, paying higher interest rates

could be a big risk for a company if the loans are mostly short-term

and the rate is not fixed in the recession but in general, the problem

should be manageable. On the other hand, telecom businesses do not

suffer as much in the current situation, since people shifted to virtual

communication and increased the use of electronic equipment. Also,

higher opportunities in the future with a projected increase in GDP.

S – Social This factor is extremely important for businesses because

management needs to understand what the customer wants and how

their behaviour could change. To have a good product, this is the

first thing to be considered, without demand, there will not be any

revenues. In the technological century, it is extremely relevant to

follow the trends. Also, even though the population in Lithuania has VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 21

decreased a lot since 1990, past years have shown an increase in

immigration and a decrease in emigration, which means more

possible customers for companies.

T – Technological Technological factor also plays one of the most important roles for

telecom business, it is very important to keep up with the technology

changes and innovate products to stay competitive. Automation and

digitalisation make a big impact on companies that process a lot of

data and serves a lot of customers. At the same time, there are more

opportunities for improving technology through acquisitions.

E – Environmental While weather and climate do not have a big impact on the telecom

sector, environmental policies do. Companies must consider the

environment, more people care about “green” solutions as well, so it

is very important to be on the same page with the customers. Also,

there might be pressure from NGOs and various activists that require

to be sustainable and companies must take action, to maintain their

reputation. Lightning has some impact on the telecom business,

according to Telia Lietuva expert Giedrius Žilinskas, network and

equipment malfunctions increase 2-3 times in the “lightning season”

(2020, para. 2).

L - Legal There are a lot of different laws that could have a big influence on

the telecom sector and companies should be aware of it. From

consumer protection and competition laws to copyright and patent

laws, companies are regulated to operate in the way, that the law

requires to and a big change in the law would accordingly have a big

impact on the company. VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 22

At this moment the technological aspect would be the most important one. It is hard to predict the exact impact of deploying 5G, but most of the analysts foresee a bright future- shaping a new disrupting effect on the sector. Technology is the key for the future, knowing that, operators must prepare for additional investments with new technology on their way.

Finally, to capture a better-summarized picture about the internal and external factors of Telia Lietuva, the strengths, weaknesses, opportunities, and threats are identified in the

SWOT analysis below:

Table 2. SWOT analysis of Telia Lietuva, AB

INTERNAL EXTERNAL

Strengths Opportunities

• Strong current management team • To take advantage of social changes • Strong current position in the in the current pandemic situation (IT, market TV, equipment) • Early technologies application (AI, • Technology innovation (5G, AI, IoT) talks about 5G) • Increasing consumer interest in new • Widely diversified products range technology • Strong customer service • Increasing immigration and decreasing emigration • The Bank of Lithuania forecast an increase in the GDP of 3.1% in 2021 Weaknesses Threats

• Frequent executive, management • Big existing competition, strong team changes competitors • Deteriorating turnover ratios • High and complex technological requirements • Economic recession

1.11 Financial situation

Fundamentals are one of the first things to be considered before putting money into a stock. Investors need to make sure that the company is financially stable and well-managed.

Revenue growth and profitability margins are reviewed to make sure that the company is VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 23 managed well turning its products into sales and earnings. The chart below represents Telia

Lietuva revenue growth and its net profit margin for the latest audited years 2015-2019.

Figure 4. Revenue growth and net profit margin 2015 - 2019.

20% 450 378 € 389 € 358 € 15% 17.2% 16.7% 14.1% 14.4% 14.1% 300

10% 198 € 204 €

150 5%

0% 0 2015 2016 2017 2018 2019

Revenues Net profit margin

Source: Telia Lietuva financials and the author’s calculations.

Revenue of Telia Lietuva looks stable with a healthy yearly increase. The merger in

2017 resulted in a big leap in sales, however, from that year net income margin has dropped, since then the company keeps the margin stable at around 14% percent. Since the full 2020- year report is not available, based on the Telia Lietuva 2020 quarterly reports, the first three quarters of 2020 provide revenues higher by 2.9% than the first three quarters of 2019 (2020).

To better understand the reason for increasing revenues, the graph below represents the recent growth of users in services, namely, mobile, IPTV services, broadband internet connections, and number of fixed telephone lines every quarter from 2019Q1 to 2020Q3.

Please note, that the secondary axis depicts mobile service users only to better reflect how the growth changed. There are two very clear trends, mobile services users were increasing rapidly, while fixed telephone lines in service kept falling every quarter. It reflects the structure of Telia Lietuva customers base in thousands and how it is distributed among services. VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 24

Figure 5. Recent changes in users base 2019-2020.

500 1400

425 1350 350 1300 275

200 1250 Q1 Q2 Q3 Q4 Q1 Q2 Q3 2019 2020 Broadband internet connections IPTV service users Fixed telephone lines in service Mobile service users

Source: Telia Lietuva quarterly reports

Four ratios are used to evaluate the company’s solvency, profitability, margin, and

liquidity, which depict the historical and current financial situation of the company (see the

table below). Two European companies were chosen for the comparison, GO p.l.c. and

Orange Belgium, which are similar by their size and operations to Telia Lietuva. All three

companies have similar capital structure and historical revenue growth, therefore they look

fair for the comparison since ratios may vary by industries.

Table 3. Financial ratios of Telia Lietuva and its peers

Unlevered Free Cash Flow Operating Cash Flow to Debt to Equity ROE Margin Current Liabilities

2017 2018 2019 2020* 2017 2018 2019 2020* 2017 2018 2019 2020* 2017 2018 2019 2020* Telia 53% 50% 61% 55% 18% 18% 17% 18% 9% 10% 17% 25% 1.2x 1.0x 1.1x 1.3x Lietuva GO 59% 57% 95% 98% 16% 17% 11% 9% 14% 10% 14% 5% 0.7x 0.7x 0.7x 0.8x p.l.c. Orange 56% 50% 93% 89% 7% 6% 6% 9% -1% 6% 12% 14% 0.5x 0.5x 0.5x 0.4x Belgium *For Telia Lietuva and Orange Belgium, LTM 2020Q3 is provided, for GO p.l.c. the latest available LTM 2020Q2 is presented

Sources: Capital IQ, Telia Lietuva financial statements, and author’s calculations.

The first thing to be noticed is that Telia Lietuva was doing better considering all the

ratios calculated. Debt to equity reflects companies’ capital structure which is important to

keep an eye on. Operating with much leverage might raise the risk for creditworthiness and VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 25 default in hard times, however, debt is considered to be cheaper. One could argue that it is good to have debt since interest payments are tax-deductible, thus reduces taxable income.

On the flipside, a situation of having little debt show prospects for expansion because of more fund-raising possibilities. Most importantly, “If the company's returns are higher than its interest cost, the debt will enhance value. However, if it is not, shareholders will lose," (DK

Aggarwal in Money Today, 2014, para. 12). Telia Lietuva looks the least leveraged from its peers, standing at an average of 55% of debt to equity. It is worth mentioning, that the ratio increased tremendously in 2019 because of the changes in IFRS 16 standards of capitalising lease liabilities, adding almost 54 million euros of additional debt to Telia Lietuva balance

(please note, that Debt-Equity ratio in Telia Lietuva reports appears lower in 2019 because of excluding leases in the calculations) but the company seems to be coming back to its previous rate on 2020Q3. That said, Telia Lietuva is not overleveraged, which is a good sign.

Profitability and activity are reflected by the return-on-equity ratio, which shows how well the management can use capital from equity-financing and turn it into profits or what return investors get from investing in the stock. In this case, Telia Lietuva is doing better than its peers, keeping ROE stable. According to Statista database, the average ROE for telecommunication services in Western Europe for 2020 is 8.39%, while for telecom wireless and equipment it is even negative, thus the ROE of 17%-18% is a very good sign.

Unlevered free cash flow margin and operating cash flow to current liabilities were used after digging deeper into the company’s financials. Both metrics reflect a more realistic situation of the company managing its cash than net income because it excludes non-cash expenses, like depreciation. Telia Lietuva had its unlevered FCF margin increasing considerably, reaching 25% in LTM 2020Q3 being the best among its peers. Keeping this ratio high is important for the investors since Telia Lietuva must payout 80% of free cash flow as dividends (approved by the Board in 2017). It means, the more sales are converted VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 26 into cash, the more dividends are paid out. Increasing ratio creates value for the investors in the long-term and proves the company being capable of generating cash from its sales. The operating cash flow ratio reflects the liquidity and ability to pay off short-term liabilities using cash from main operations. The ratio is reliable since non-cash expenses are added back, it shows the ability to generate cash from core operations and whether a company is solvent for paying back current debts. Telia Lietuva had the best ratio among its peers, reaching 1.3x in LTM 2020Q3. Telia Lietuva increased net cash flows from operating activities by almost 35% from 2018 to 2019 and marked a 21.4 million euros increase in cash and cash equivalents in 2019 (Telia Lietuva Annual report, 2019, p. 11). For additional historical financial analysis, please refer to table 6.

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 27

2. Theory and research methods

Before starting to value the company, it is needed to look at theoretical aspects. In this part an explanation of main terms is provided, valuation methods reviewed, stating their strengths and weaknesses, and the best approach for the company is chosen.

2.1 Defining valuation

Valuation is a way of deriving the value of certain assets using analytical processes, different methods and a bit of subjectivity. According to the Stern School of Business professor Aswath Damodaran (n.d.),

Knowing what an asset is worth and what determines that value is a pre-requisite for

intelligent decision making -- in choosing investments for a portfolio, in deciding on

the appropriate price to pay or receive in a takeover and in making investment,

financing and dividend choices when running a business (para. 1).

There are a plethora of different valuation methods. Some are better for a certain type of asset, others might be better to value a company, therefore it is needed to choose a suitable one. “The problem in valuation is not that there are not enough models for valuation; it is that there are too many.” (Damodaran A., n.d.). Reviewing the literature, some of the experts classify the techniques of valuation into two or three groups. According to Charles M.C. Lee and Henrietta J. Louis, the two groups are relative valuation, which is based on comparing market multiples of peer companies, and direct valuation, covering discounted-cash-flow, balance sheet, and contingency claims approach (2003, p. 5). However, Damodaran sees three valuation groups, namely intrinsic, relative, and contingent claim valuations (An

Introduction to Valuation, 2012). The methods are the same, the difference is how some academics classify them. However, the contingent claim method is mostly used for valuing traded options and is not used for companies as much. The asset-based valuation is useful in valuing non-trading businesses that are primarily asset-based, e.g., property and commodity VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 28 companies, or when other valuation techniques result in a value, which is less than the net asset value.

Both indicated methods will not be performed in this paper since it is relevant to dig deeper into the forecasts, growth opportunities, consider the time value of money and compare the results with industry peers. Also, Telia Lietuva is not primarily asset-based.

The problem is that the markets are considered to be inefficient, i.e., prices might poorly reflect values, therefore it is useful to find the real value of an asset and possibly gain from it. From an investor’s perspective, it is important to make your due diligence, assess company’s growth opportunities and potential in the future. Since there is a lot of bias in the market and not everyone puts effort to find the fundamental value of a company, it is likely to find undervalued equity and make a profitable decision.

2.2 Review of valuation methods

A different asset might require a different method of valuation, some are better than others on special occasions, therefore it is important to pick the ones, which reflect the value the most accurately. According to the International Journal of Academic Research in

Accounting, Finance and Management Sciences, “the literature suggests using more than one theory, mainly because many of them rely on various assumptions and conditions to demonstrate the relationship between the hypothesis and the proposed framework, model or method” (Mohammad, A. N., 2016, p. 68). Therefore, in this work, two main valuation methods are used. The models used in this paper are reviewed, indicating some advantages and limitations.

Income method: Discounted Cash Flow model

Market method: Financial multiples and Transactions multiples approaches

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 29

2.2.1 Income method

The discounted cash flow methodology is included in the work. DCF is based on the anticipated future cash flows and the terminal value. These projected future cash flows are discounted together with the value of the company in perpetuity at a terminal date (assuming that a company will generate cash flows at a certain rate forever), at the company’s cost of capital, taking into account the risks associated with the business. The future forecasted cash flows are discounted back to the Valuation Date to generate present value. In assessing the overall reasonableness of the forecasts and the underlying assumptions, an assessment is made by reference to the historic level of cash flows generated by the business, historical growth rates and their averages, and any change in the prospects. A terminal value at the end of the forecast period is calculated, discounted back to the valuation date and added to the present value of the forecast cash flow stream to give an overall value for the business.

According to this valuation methodology, free cash flows for companies are discounted using the Weighted Average Cost of Capital (WACC), which reflects not only the time value of the cash flows but also the risks associated with the respective business’ future operations.

Advantages: considers existing values and growth expectations by valuing company’s fundamentals that are less sensitive to any market moods and hypes. It is a detailed approach that also allows reflecting how sensitive the value is to some changes applied.

Disadvantages: requires many assumptions and information, which could be not accurate, resulting in overstating/understating of value (assumptions might also be manipulated).

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 30

2.2.2 Market method

This method is also known as the relative valuation method and it uses comparable multiples based on traded multiples of similar companies and specific transactions multiples on M&A deals. Usually, companies from the same industry are taken, in this work’s case, 10 telecommunication sector’s European companies were taken (please refer to appendix D for more detailed information about the peer companies). The companies have to be comparable, which means, similar in size, geography, operations, growth potential, and so on. After calculating the multiples of comparable companies, the average is taken (median, if there are outliers) to evaluate whether the analysed company looks expensive or fair relative to its peers and to determine the price of the stock. According to Damodaran, there are four groups of multiples: earnings, book value or replacement value, revenue, and sector-specific multiples, however, A. Damodaran believes that the latter is a bit risky, “since they cannot be computed for other sectors or for the entire market, sector-specific multiples can result in persistent over or under valuations of sectors relative to the rest of the market.” (n.d.).

Transactions multiples method is another way of finding an average of multiples based on the latest M&A deals in the telecommunications sector, supplementing the traditional multiples approach.

Advantages: a quick way to evaluate a company, also getting to compare it to the industry peers. There are a plethora of different multiples to be assessed and compared and they are easy to comprehend.

Disadvantages: it might be very difficult to find a group of similar companies to compare with, as a result the outcome might be biased.

2.3 Discounted Cash Flow Method

The first method applied in this work is the DCF model. The method involves plenty of different inputs, reflecting cash flows growth and risks. An investor using this method VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 31 usually has a long-term perspective, since the earnings growth are often forecasted for at least

5 years. However, there is a risk of losing accuracy when the forecast approaches the term of

10 years. Since the forecasted period is a finite number, terminal value is calculated at the end which depicts the value of a firm as it would continue operating indefinitely at a certain growth rate. To derive the enterprise value of the company with the DCF model, formula and inputs provided below are used.

푡=푛 퐹퐶퐹퐹 푉푎푙푢푒 = ∑ 푡 (1 + 푟)푡 푡=1

Where:

FCFF = Free Cash Flow of the firm in the given period; r = The discount rate

Inputs for the DCF model

FCFF

For the calculations free cash flows to firm (FCFF) are used to depict the cash flow available to investors. FCFF is also called the unlevered free cash flow because the interest payments are not taken into account. The formula is as follows:

퐹퐶퐹퐹 = 퐸퐵퐼푇 ∗ (1 − 푡) + 퐷푒푝푟푒푐푖푎푡푖표푛 푎푛푑 푎푚표푟푡푖푧푎푡푖표푛 − 퐶푎푝퐸푋 −△ 푁푊퐶

Where:

EBIT = earnings before interest and taxes. CapEx = capital expenditures.

∆NWC = change in net working capital.

The estimation of the future cash flows and picking the inputs take a lot of responsibility, since every mistake might result in a biased value of the enterprise value. For a company new projects, investments in technology in the future would increase the capital expenditures and depreciation cost, thus impacting the FCFE and with new technology trends, telecommunication companies are expected to invest more in research and development for the VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 32 upcoming years. Expanding operations would increase working capital needs, however the corporate tax rate is most likely not going to change.

Damodaran points out three main ways to estimate growth of earnings, which include looking at the past by considering historical growth in earnings, looking at what other analysts are estimating to have an idea of where the earnings could move, and looking at fundamentals, which covers the ideas mentioned before, it is evaluating how much would a firm invest in new projects and possible returns from them (2005). Damodaran (2005) distinguishes three main growth patterns to choose from, namely, stable growth (no high growth is foreseen, stable growth is reached), 2-stage growth (high growth for some period after which the stable growth is reached), and 3-stage growth (high growth is expected for some period after which it will gradually decrease to reach the stable growth).

2.3.1 Discount rates

Discount rate is used to determine the present value of forecasted cash flows. It plays an important role in the model and even small errors calculating the rate could result in big changes for the final result. According to A. Damodaran, “discount rate used should be consistent with both the riskiness and the type of cashflow being discounted.” (n.d.). The cost of capital is used for the valuation of a company since the cash flows of the firm are used.

The cost of equity is used when the discounted cashflows are the cash flows to equity.

However, even though the firm is being valued, the cost of equity is needed for the calculation of the cost of capital. In this work, the weighted average cost of capital (WACC) is used, and it is calculated as follows:

퐸 퐷 푊퐴퐶퐶 = ∗ 푅 + ∗ 푅 ∗ (1 − 푡) 푉 푒 푉 푑

Where:

E = Equity; D = Debt; V = E+D = Firm’s value

Re = Cost of equity; Rd = Cost of debt; t = Corporate tax rate VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 33

2.3.2 Cost of equity

Cost of equity or required return on equity is determined using the Capital Asset

Pricing Model (“CAPM”). The model reflects the relationship between risk and return, higher return is expected with more risk involved. The model is calculated as follows:

푅푒 = 푅푓 + 훽푖 ∗ (푅푚 − 푅푓)

Where:

Re = expected return of investment; Rf = risk-free rate

βi = beta coefficient of the investment; (Rm – Rf) = market risk premium

According to Journal of Economic Perspectives, “the CAPM says that the risk of a stock should be measured relative to a comprehensive “market portfolio” that in principle can include not just traded financial assets, but also consumer durables, real estate and human capital.” (Fama, E.F, French, K.R, 2004, p. 25). In theory, the market portfolio includes all types of assets available, weighing them on their presence in the market.

2.3.3 Risk-free rate

Risk-free rate is the minimum expected return generated by an asset. According to F.

Pacho riskless asset is “for which the investor knows the expected return with certainty for the time horizon of the analysis” (Pacho, F., 2008, p. 193). Also, to be considered risk-free, two conditions must be met, there cannot be any default risk and reinvestment risk.

Governments’ bonds are considered to be the safest securities and usually the risk-free rate is derived from long-term governmental bonds. However, all securities carry risk, therefore risk-free investment is considered to be more a theoretical concept. In the CAPM formula adding Rf indicates that it is expected to get at least the return of the risk-free rate.

Damodaran explains, that long-term government bond should be used for long-term analysis, while short-term bond for short-term analysis, accordingly (n.d.). VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 34

2.3.4 Equity beta

Beta is a measure of volatility, or systematic risk of a particular investment or a portfolio relative to the movements of the average of all share prices in the stock market. The average beta is 1, a beta greater than 1 reflects higher than average risk and increased volatility. If beta equals 1, then the expected return equals the average return of the market portfolio.

퐷 훽 = 훽 (1 + ((1 − 푡) ∗ )) 퐿 푈 퐸

Where:

β(L) = Levered Beta; β(U) = Unlevered Beta;

D/E = Debt/Equity; t = corporate tax rate

2.3.5 Market risk premium

Market risk premium represents the excess return over the risk-free rate an investor requires for investing in market portfolio. Harris and Marston (1999) state that “The most prevalent approach to estimating the market risk premium relies on some average of the historical spread between returns on stocks and bonds.” (p. 6). Simply, it is a difference between the yield on equities and government bonds. The authors of “Principles of

Managerial Finance” state that if the equity beta is greater than 1, then the risk premium of an asset is greater than that of the market, if the beta is lower than 1, the risk premium of an asset is lower than the market’s risk premium (Gitman & Zutter, 2010, p. 335). However, there are country-specific differences in market risk premium, which depends on variance in the underlying economy, political risk or market structure.

2.3.6 Income tax rate

According to the Parliament of the Republic of Lithuania, the main rate of Corporate Income

Tax in Lithuania is 15% (2020). VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 35

2.3.7 Cost of debt

From a company’s point of view, it is simply an interest rate that a firm could currently borrow at. The interest rate could be either the yield to maturity of a company’s traded long-term bonds, or the interest rate of a recent long-term borrowing from a bank.

2.3.8 Terminal value

The concept is introduced after forecasting finite cash flows in the future after the forecasting period, which is usually five years. According to Damodaran, there are three ways of estimating it, namely liquidation value, multiple approach, and stable growth model. The latter is used in this work, the formula is provided below:

푇푉 = 퐹퐶퐹퐹 ∗ (1 − 푔)/(푟 − 푔)

Where:

FCFF = Free cash flow; g = growth rate; r = discount rate

2.3.9 Sensitivity analysis

A sensitivity analysis is an additional tool reflecting how a change in an independent variable affects the dependent variable. For the DCF model it is used at the end to see how sensible the result is to changes in the inputs like WACC, terminal growth rate. Using the approach, the results could reflect different states of a company and provide outputs for creating different scenarios. However, the analysis is based purely on historical data and forecasts, therefore even it provides more flexibility and outcomes, it still cannot be blindly trusted. Seeing a lot of uncertainty in the markets these days, it is important to evaluate different effects on the company’s value.

2.4 Relative valuation

In multiples comparison, it is theoretically assumed that compared assets or companies should be selling at the same price. However, no firms are identical, therefore at some point the result is biased, thus it is needed to find as similar companies as possible. According to the VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 36

Journal of Financial Education, “When similar assets sell at different prices, then arbitrage should cause the prices to converge to a single price.” (Esty, B.C., 2000, p. 24). It means, that we need to assume similar companies to be priced equally and by comparing the averages of multiples of the peer companies, we derive the real price that reflects the true value of the analysed firm. Valuation and transactions multiples are compared with some industry peers that are similar in size by assets, enterprise value, geography, and growth.

2.4.1 Valuation multiples

Valuation multiples help to standardize the market values of peer companies to make the comparison more straightforward. Since the telecommunication sector is considered to be capital-intensive because of large investments in technology, which results in high depreciation expenses, for valuation purposes, EV/EBITDA multiple is used as it eliminates differences in asset base but accounts for the normalized profitability of the companies. In addition to that, the comparison of EV/Sales multiple is applied. To compare the multiples, the average is taken of the selected peer companies and applied to the analysed firm, from which the value is derived.

2.4.2 Transaction multiples

Transaction multiples are used as a supplementary valuation method. In this approach transactions in M&A are taken, that reflect the value of the company plus the premium for acquiring a company or a portion of it. That premium might rise from the bidder’s perspective who thinks that the company will pay off in the future even with a higher price because of the possible growth, created by synergies, lower costs, and overall effectiveness in the long run. For these reasons, transaction multiples might usually look boosted and appear higher than trading multiples. However, as companies are different, deals are also unique in their way and comparing them might also result in some bias. On the flipside, it is more VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 37 realistic since it reflects the premium paid for the company and kind of counts the future benefits in.

2.5 Relevant information for an investor

Before beginning the valuation process, it is important to take a general look at the targeted market, check the main metrics that might help to build an initial opinion about the company, how attractive it is compared to other companies, also to see the stock’s historical performance. These are easier to find and calculate, thus before digging deep into the valuation, some metrics are provided in this section.

The graph below reflects the changes in the stock price of Telia Lietuva and the stock volume. A healthy uptrend is seen after the merger of Omnitel and TEO at the beginning of

2017 (the highest black bar indicates an enormous increase in the volume when two companies merged). Two important points are noted, the stock’s all-time high on September

15th, 2020 standing at EUR 1.60/stock right before the valuation date, after plunging to EUR

1.15/stock March 16th, when the whole market drop was caused by the COVID-19 pandemic.

Figure 6. Telia Lietuva historical stock price and volume 2017 - 2020.

1.80 1.60 1,600 1.60 1,400 1.40 1,200 1.20 1.15 1,000 1.00 0.80 800

0.60 600 Thousands 0.40 400 0.20 200 0.00

Telia Lietuva stock volume Telia Lietuva stock price

Source: Capital IQ database.

However, the stock recovered rapidly, which leads to another metric, the price-to- earnings ratio. P/E is a good measure for mature companies, since growth companies usually VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 38 constitute an inflated one. To interpret it better, historical P/E of a company and its peers’ averages are taken. The table below shows the historical P/E ratio averages of Telia Lietuva and 10 peer companies operating in Europe for 3 years, from the beginning of 2017 until the third quarter of 2020. Based on the calculations, Telia Lietuva has the lowest historical P/E ratio among its peers. Also, the graph below the table indicates Telia Lietuva situation compared to its peers’ P/E averages combined (the graph was created excluding the outliers:

Telekom Slovenije and TalkTalk Telecom Group).

Table 4. Historical P/E ratio averages of Telia Lietuva and its peers for 2017-2020

Telia GO Telekom Orange Company TalkTalk Sonaecom Retelit NOS Netia Gamma Euskaltel Lietuva p.l.c. Slovenije Belgium Average P/E 12,9 25,9 51,2 86,8 16,2 25 29,7 20 33,2 33,5 22,3 Source: Capital IQ database and the author’s calculations

Figure 7. Historical P/E ratio averages of Telia Lietuva and its peers.

Sources: Capital IQ database and author’s calculations.

If we would consider only the P/E ratio, Telia Lietuva stock looks like a decent opportunity, however the stock is still in all-time highs and its P/E ratio is higher than usual, standing at around 15.6. It is always important to compare ratios and multiples with either industry averages or peers to grasp the best picture of the market.

Also, to reflect the reaction of those 10 stock prices to the pandemic, the table below proves that Telia Lietuva is not an exception and the whole telecommunication sector fell into VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 39 a recession raising a need for valuation. The change was calculated from the highest point in

February 2020 to the lowest in March, please see the indicated dates in the table.

Table 5. Telia Lietuva and its peers’ stocks reaction to the pandemic.

Source: Capital IQ database and the author’s calculations

GO p.l.c. is not included, since it did not show the same trend out of all the companies.

Since it is already known that the problem exists and companies have suffered from the downturn, it is important to summarise main things to be considered when picking a stock before the valuation. Telia Lietuva is assessed in relation to its peers. Revenue, earnings growths, and profit margin of 2017-2019 years average was taken to reflect the historical performance for the full financial years, excluding 2020. Red and yellow numbers indicate that fluctuations have been relatively high, thus more risk, however usually higher risk generates higher rewards. Telia Lietuva stands out as a stable company with clear uptrends and low fluctuations. Revenue and earnings growth are not very high, however stable capital gains is an appreciated quality for long-term investors, especially when the company also pays dividends, it is seen that Telia Lietuva offers a pretty high 5.8% yield at the valuation date. Profit margin looks very well compared to the peers, standing between the highest ones that showed a healthy uptrend. For other rows, the newest last twelve months data is used, most of them reflect the valuation date, which is September 30th, 2020. D/EBITDA is especially important when there is a lot of uncertainty in the economy, which throws many challenges for companies, requiring them to be prepared for unexpected outflows. It is crucial VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 40

to stay solvent and D/EBITDA reflects a good position of Telia Lietuva, being the second

lowest of all the peers (Gamma has low debt), indicating that the company’s debt is only 1.3x

higher than its earnings after the direct expenses (like COGS). Also, short-term liquidity is

even more important to cover liabilities and interest expenses when times get difficult.

Considering both cash flow from operations to current liabilities and EBITDA to interest

expenses, the analysed company is in a healthy position once again, generating 1.3x more

cash flows from operations than it has current liabilities and having a great amount of

EBITDA to cover its interest payments, thus being liquid.

Table 6. Telia Lietuva and its peers’ fundamentals.

Telia GO Telekom Orange Company TalkTalk Sonaecom Retelit NOS Netia Gamma Euskaltel Lietuva p.l.c. Slovenije Belgium Revenue 4% 4% -1% -4% 2% 17% 2% 2% -5% 16% 6% growth* Earnings 9% -11% 14% 799% 41% 97% -20% 17% 24% 25% 2% growth* Profit 14% 9% 2% -0,3% 39% 16% 3% 9% 4% 10% 9% margin* D/EBITDA 1,3x 1,8x 2,2x 2,5x - 3,3x 1,5x 2,4x 1,4x 0,3x 5x P/E 15,6 32 - 9,2 23,6 48,3 15,7 18,9 37,4 35,1 22,6 Div. yield 5,8% 4,4% 7,8% 3,1% 5% 1% 3,5% 9,2% - 0,6% 3,7% CFO / CL 1,3x 0,8x 0,8x 0,2x - 0,5x 0,4x 0,7x 1,3x 0,6x 0,8x EBITDA / 34,9x 20,6x 14,7x 7x - 12,4x 51x 24,4x 41,1x 90,4x 6,2,x Int. exp. * 3 years average (2017-2019) Green: healthy uptrend, low fluctuations = low risk; Yellow: positive result, medium fluctuations = medium risk Red: high fluctuations, high uncertainty = high risk Source: Capital IQ database, Telia Lietuva reports, and the author’s calculations

The P/E ratios were calculated by taking the share price on 2020.09.30 and dividing it

by LTM 2020Q3 earnings per share measure, provided by the CapitalIQ database for each

company.

To finally decide whether Telia Lietuva stock is a good buy, a more comprehensive

valuation is conducted in the following section. VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 41

3 Empirical research

In the third chapter, the enterprise, equity values, and the corresponding stock price of

Telia Lietuva is determined based on the methods discussed previously. The results are analysed, and recommendations are issued. Discounted cash flow method and relative valuation, including financial and transactions multiples calculations of EV/Sales and

EV/EBITDA are presented in detail and outcomes interpreted. The valuation date is

September 30th, 2020.

3.1 Discounted Cash Flow (DCF)

The DCF method is the main tool utilised to derive the value of Telia Lietuva. The model considers more assumptions and projects the value of the firm including the future cash flows and discounting them back to the valuation date. Even though the model reflects the value including future growth, thus being more descriptive, it is also easier to create bias with illogical assumptions.

To calculate the value using DCF, a few inputs are considered and analysed below.

3.1.1 Cost of equity (CAPM)

For the cost of equity, CAPM is used and before applying the formula, the inputs are analysed.

3.1.2 Risk-free rate

These days, living in a very low or even negative bond yields’ economy, it is harder to pick the risk-free rate. According to Worldgovernmentbonds website, the yield for the 10- years Lithuanian Government bond for September 30th, 2020 is 0.25%, however, if we would consider other countries’ yields, like Germany, which also has the currency of euro, it is negative, thus the yield of 0.25% is used. VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 42

3.1.3 Beta coefficient

Beta is a volatility measure of the company’s stock. The volatility often changes and by calculating the terminal value, an assumption of generating cash flows forever with a constant beta, might unavoidably create some bias in the future. The earnings beta approach is applied by the sector unlevered betas for Emerging markets, which include Eastern Europe, provided by Damodaran as of January 5th, 2020. The approach is applied since Telia Lietuva provides different services, thus it is the most accurate to find the coefficient by knowing which share of revenues is attributed to each of them. There are three services indicated by

Damodaran, Telecom (Wireless), Telecom Equipment, and Telecom Services. Please refer to the weighted average calculations provided below.

Table 7. Weighted average of unlevered beta.

Share of Sector's Type of service Sector revenues Beta (U) Broadband services Telecom services 45,9% 0,62 Mobile services Telecom wireless 32,8% 0,64 Equipment sales Telecom equipment 21,3% 1,33 Weighted average unlevered beta 0,778 Source: Damodaran database, Telia Lietuva reports, and the author’s calculations

The next step is to lever the beta considering the debt factor. The corporate tax rate in

Lithuania stands at 15%. As of 2020Q3, Telia Lietuva has EUR 172.6 million of debt and

EUR 314.7 million of equity, thus its D/E ratio equals 0.548. Please find the derived levered beta value below.

Beta levered 0.778*(1+(1-0.15)*0.548) 1,14

3.1.4 Equity risk premium

According to Damodaran, the final equity risk premium for a certain country might be derived by adding the country’s risk premium to the risk premium of mature markets (2020).

As of July 1, 2020, the risk premium of mature markets is 5.23%, while the country risk VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 43 premium for Lithuania is 1.76%. Adding both values the equity risk premium of 6.99% is used.

3.1.5 CAPM

An additional risk premium is added to the cost of equity to cover extra risks related to the small size and limited liquidity of the company. In the scope of Lithuania Telia Lietuva is considered one of the biggest companies, however globally it is still a small capitalization company with a higher risk. The small-capitalization company risk premium, according to

Duff&Phelps (2019), is 1.58%. The cost of equity used in this work is provided below.

CAPM 0.25%+1.14*6.99%+1.58% 9,80%

3.1.6 Discount rate

For the discount rate, weighted average cost of capital is used. The WACC consists of different inputs that need to be clarified carefully to get an accurate result, since the final value of a company is usually very sensitive to the changes in the discount rate.

For the value of debt and equity, 2020Q3 book values were retrieved from the latest

Telia Lietuva report. Please refer to the table below for the results.

Table 8. Book value of equity and debt calculations.

In M Eur E D E+D E/(E+D) D/(E+D) 2020.09.30 314,7 172,6 487,3 0,65 0,35 Source: Telia Lietuva reports and the author’s calculations

3.1.7 Cost of debt

The cost of debt for Telia Lietuva is calculated by using weighted average for the two long-term loans granted for the company by Lithuanian commercial banks for the end of the

2019 financial year, since newer information and interest rates are not published. On January

4th, 2016 Telia Lietuva was granted EUR 150 million loan with a 1.02% interest rate, at the beginning of 2019 loan outstanding stood at EUR 67.5 million, a part was repaid and at the end VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 44 of 2019 it was EUR 37.5 million (2019 average was EUR 52.5 million). Also, Telia Lietuva was granted EUR 60 million loan on May 29th, 2017 with an interest rate of 0.82% until 2024.

At the end of 2019 loan outstanding was the same. Please see the cost of debt calculations below.

Cost of debt (52.5*1.02%+60*0.82%)/(52.5+60) 0,913% Taking the tax shield’s effect on the cost of debt, the final after-tax cost of debt of:

After-tax cost of debt 0.913%*(1-0.15) 0,78% Finally, the WACC is calculated used for the forecasts’ model:

WACC 0.65*9.8%+0.35*0.78% 6,60%

3.1.8 Revenue forecast

The table below represents the change in revenue by splitting it into different services from 2017 to 2020 (please note, that 2020 was calculated by taking the first three quarters of

2020 and the fourth quarter of 2019. The same method is applied for other elements calculating financials for 2020 unless otherwise stated). Evaluating the average growth of IT services in 2020, the fourth quarter was calculated by multiplying 2020 Q3 by 1.03 and fixed telephony for the last quarter of 2020 was taken as an average of the first three quarters since a decrease is expected to continue.

Table 9. Breakdown of revenues by service.

EUR'000 2017 2018 2019 2020 F Mobile services 98 130 121 305 127 300 127 062 Voice telephony (fixed) 58 431 58 779 49 517 46 583 Equipment sales 77 440 77 735 88 211 90 319 Broadband services (internet, data, 99 999 93 833 93 481 96 686 IT) TV services 23 809 26 076 30 783 34 213 Total revenues 357 809 377 728 389 292 394 862 Source: Telia Lietuva financial reports, and the author’s calculations

The forecasts for revenue are based on the historical patterns, analysts’ projections for the sector and personal assumptions, subsequent income statement items are mostly based on VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 45 the sales revenues. Based on the GSMA Association report “The Mobile Economy 2020”, revenues for the new 5G network are expected to be modest, since in Europe people still tend to use 4G and not rush to deploy 5G, also the market is highly saturated, making it hard to add new subscribers (2020). By 2025 5G is expected to take 34% of European connections.

GSMA believes, that the increase of the 5G, Internet of Things technology, and data growth, revenues should remain stable and increase 1% each year until 2025 (2020). Telia Lietuva historical revenue change proves that the company can keep its revenue growth relatively stable, with revenues growing by 6% and 3% in 2018 and 2019 and based on the three quarters of 2020 it should be up around 2% at the end of the year. Since no company is the same, Telia Lietuva trends are evaluated and the growth of 1% is adjusted. Considering broadband services, the company’s 2020Q3 report reflects, that FTTH/B (Fibre-to-the-home) internet connections already made more than 70% of all the connections and people are turning from copper DSL (digital subscriber line) to fiber lines which outweigh the losses for

DSL. It is expected for internet revenues to increase by slowly adding customers to FTTH and growing the penetration rate. However, for 2021 roaming services are still assumed to be affected by the traveling restrictions slowing the revenues down. Additionally, internet services decreased in 2017-2020, while IT services have increased, some services’ revenues outweigh each other, thus growth of 1% seems to be fair for the first two years because of the pandemic influence on roaming. The historical trends are assumed to change for the upcoming years based on the increase of customers using fiber networks and IT services, thus the growth is increased 2% for 2023-2025. For the mobile services based on the historical growth, the rate is increased to 1.5% for the first 3 years and in 2024-2025 it returns to 1% because of the high customers saturation in the sector. Equipment sales are expected to grow at 2.3% for 2021, the same as in 2020, since the quarantine should continue increasing sales, knowing that the demand for TVs, computers and other technical equipment has grown. Telia VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 46

Lietuva reported in their 2020Q3 report that the sales of laptops and TV sets have increased exceptionally, and mobile devices’ sales are going back to their pre-covid levels, too (2020).

According to these trends, the growth rate for 2022-2023 will stay at 2% for the post-covid ease on equipment purchases and for 2024-2025 it is increased back to 2.3%, based on the

GSMA report in which the organization believes that 5G will make up to 34% of all technology mix, thus new smartphones supporting 5G will be needed (2020).

Fixed telephone lines have been constantly decreasing from 401 thousand in 2018Q1 to 270 thousand in 2020Q3. Other voice telephony services increased in 2020, however it cannot outweigh the loss from retail voice telephony services. Therefore, a decrease is forecasted to continue. Historical data shows a -15.8% downward leap from 2018 to 2019, the median decrease from 2015-2020 is -1.3%, staying conservative, -3% change is applied for every year until 2025, assuming that a big drop was a one-time event. TV services revenues have been steadily increasing from 2017 when it stood at EUR 24 million, reaching

EUR 34 million in 2020. Three years growth median is 11.1% and it is expected that the revenues will stay higher during 2021 because of the pandemic. Telia Lietuva has added popular HBO shows, which increased the customer’s rate. However, it is hard to keep the growth that high for a long time, since competitors exist and the market will eventually get saturated, thus a more conservative approach is considered, the growth rates are 10%, 8%,

5%, 5%, 5% for five years respectively. The final forecasted yearly average revenue growth is 1.6%.

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 47

Table 10. Revenues forecast.

Source: Telia Lietuva, GLMA reports, and the author’s calculations

3.1.9 Cost of goods sold forecast

A forecasted increase in equipment sales might drive the COGS up, however, the sales were already growing fast years before which was incorporated in the element.

According to K. Fendick “Revenues and Cost of Goods Sold, for example, both depend on the number of units sold and hence both tend to move in a correlated fashion from one accounting period to another.” (2010, p. 2), thus for COGS the historical percentage of sales revenue approach is applied since it was similar for the years 2017-2020, ranging from 40% to 43%. The median of 42.7% is applied.

Table 11. Cost of goods and services forecast.

Source: the author’s calculations

3.1.10 Operating expenses forecast

Operating expenses include two different income statement lines from Telia Lietuva financial reports, namely employee-related expenses and other operating expenses. For this VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 48 line, historical percentage of sales revenue approach is used too, and the median for 2017-

2019 years stood at 24.5%. Even though from January 1st, 2019 Telia Lietuva implemented a new reporting standard IFRS 16 on leases, treating lease on premises and network capacity as assets, reducing operating expenses by excluding the operating leases influence and increasing depreciation, the percentage of total revenues remained very similar even in 2019 and 2020. Also, expenses like marketing are often correlated with revenues, therefore the

24.5% share of revenues is used.

Table 12. Operating expenses forecast.

Source: the author’s calculations

3.1.11 Other income, gain/loss forecast

In this line, gain or loss from selling PP&E, foreign exchange, investments in associates are included. Telia Lietuva has announced to sell their old buildings for more than

EUR 4.9 million. However, it is an auction, and the real value of the upcoming deals is unknown. Being a one-off event, it is hard to forecast the effects of it. Thus, since no exact data is provided, the assumption is made, that there will not be any non-recurring changes. In this way, the percentage share of the total revenues is taken, since it was very similar for the years 2017-2019, 0.4%, 0.1%, and 0.29% respectively. The average of 0.27% is applied for the years 2021-2025.

Table 13. Other income, gain/loss forecast.

Source: the author’s calculations VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 49

3.1.12 Depreciation, amortization, and CapEx forecast

Depreciation, amortization, and capital expenditures were calculated together using a single table. Firstly, beginning balance for tangible and intangible assets of 2018 was taken.

Depreciation expense for historical years was calculated by including land, buildings, telecommunication equipment, ducts, and other tangible fixed assets, while in amortization, licenses and software were included. If the total tangible and intangible assets are divided by the calculated depreciation, the result is the approximate number of years by which assets fully depreciate/amortize. However, dividing depreciation by the assets, the multiplier is derived, and is multiplied by the ending balance of these assets to arrive at the next year’s depreciation/amortization expense. Capital expenditures for 2020 were derived by multiplying the forecasted revenues for 2020 by the previous year’s CapEx/Sales ratio and from 2021 an assumption was made that capital expenditures will account for 115% of the depreciation/amortization, however, decrease to 110% for the terminal year. The amount for

2020Q4 was taken by dividing the total amount for 2020 by four, arriving at EUR 13,551 thousand, indicated in the discounted cash flows calculation.

Table 14. Depreciation, amortization, and CapEx forecast.

Source: Telia Lietuva reports the author’s calculations VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 50

From 2016 capital expenditures of Telia Lietuva were decreasing at a relatively fast pace. In general, the company did not have any large investments, neither invested a lot in software, nor to licenses and other intangible assets. Because of the low capital expenditures, depreciation expense was exceeding CapEx for the last years, however, for the upcoming five years it is expected that Telia Lietuva will ramp up their investments for the future of technological innovations. The management stated in the Telia Lietuva 2020Q2 report:

Also, we are actively participating in discussions regarding the 5G technology

implementation in Lithuania and are await of 5G frequency auction which delayed

due to ongoing state level negotiations with the neighbouring countries. Anyway, we

are preparing for 5G era in Lithuania and are planning to be a front-runner (2020, p.

29).

It reflects that the company is ready for big investments to grab the market share in innovations and new technologies. Even though capex is hard to predict, licenses and roll out of the network are expected to take a large part of it, making the 5G available for the public.

3.1.13 EBIT forecast

Having all the required income statement lines forecasted for EBIT to be calculated, results for the 2020Q4 and years 2021-2025 are indicated in the table below, average yearly growth of 1% is derived.

Table 15. EBIT forecast.

Source: the author’s calculations VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 51

3.1.14 Change in net working capital forecast

For the change in net working capital forecast historical data of 2018-2019 was used, however for the 2020 Q4 the average of three quarters of 2020 was taken of the NWC components to reflect the amount at the year end. Inventories, receivables, and contract asset amounts were divided by revenues for each year accordingly, while payables and contract liability amounts were divided by cost of goods and services. In this way the ratios were calculated for 2018-2020. For 2021-2025 the ratio of 2020 is taken for every year and multiplied by the forecasted revenues and cost of goods and services amounts, arriving at the result for the components of working capital for 2021-2025 (please refer to the tables below).

Table 16. Change in net working capital forecast

Sources: Telia Lietuva financial reports, and the author’s calculations

Table 17. Corresponding components’ ratios to revenues, cost of goods and services.

Sources: Telia Lietuva financial reports, and the author’s calculations VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 52

3.1.15 FCFF calculation

The free cash flows to firm for 2020Q4-2025 were calculated using the forecasted components above. The cashflows do not increase by a lot mostly because of the high capital expenditures, increasing but not exceeding the depreciation. Capital expenditures are expected to be used for new projects, technology, licenses, equipment.

Table 18. Free cash flows to firm.

Source: the author’s calculations

3.1.16 Terminal value

Terminal value represents the company’s value after the projected period. The company is assumed to operate indefinitely at the same terminal growth. Additional terminal year is added, similar to the fifth forecasted year, only the CapEx is decreased to make 110% from depreciation, stable growth model is used. The calculated value is then discounted back to the valuation date and added to the discounted cash flows to arrive at the enterprise value.

The forecasted compound annual growth rate (CAGR) revenue growth of Telia Lietuva during 2021-2025 resulted in 1.66%, thus it is used for the terminal value calculations. With this rate, the terminal value is EUR 876 thousand (please refer to table 19).

3.1.17 Enterprise value of Telia Lietuva

After calculating the free cash flows and terminal value, the last step is to discount the cash flows back to the valuation date using the WACC. The WACC used is 6.60 % and the VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 53 final enterprise value of Telia Lietuva is EUR 1126 million, the equity value stands at EUR

986 thousand with a corresponding EUR 1.69 share price.

Table 19. Discounted cash flow calculations.

Sources: Telia Lietuva financial reports, and the author’s calculations

3.1.18 Sensitivity analysis

Sensitivity analysis is a very common approach to supplement DCF model and provide a view of how the dependent variable would change caused by the change in the independent variables. Also, it provides a picture showing more outcomes which eliminates possible bias of the inputs. The model proved to be significantly sensitive to discount rate and terminal growth rate and a scenario of +-0.5% change in WACC and terminal growth rate were evaluated in the table below. The equity value of Telia Lietuva yields an interval of

EUR 817,815 – 1,239,026 thousand with a corresponding share price of EUR 1,40 – 2,13.

Table 20. Sensitivity analysis.

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 54

Source: the author’s calculations

3.1.19 Scenario analysis

Pessimistic and optimistic analyses are used to reflect how the equity value and share price of Telia Lietuva would change under different factors used in the sensitivity analysis.

The original DCF equity value calculations are used as a base-case scenario from which two additional scenarios are derived. The diagonal of the grey rectangle of the table above indicates 3 scenarios: pessimistic with a lower 1.16% terminal growth rate and higher 7.10%

WACC, the base-case scenario is the original forecasted equity value, and the upper right corner indicates optimistic scenario, with 2.16% terminal growth rate and a lower 6.10%

WACC. It is seen that the changes are quite substantial and small moves in the inputs could result in big changes in the output. Pessimistic scenario for Telia Lietuva would result in EUR

818 million equity value and EUR 1.40 share price (17.2% lower than the base-case), while optimistic scenario indicates EUR 1,239 million equity value with EUR 2.13 share price

(26% higher than the base-case). Adding the net debt, the enterprise value for the company would be EUR 957 million and EUR 1,379 million for pessimistic and optimistic scenarios, respectively.

3.2 Relative valuation

After getting the results for the first method applied in this work, it is also important to see what the value of Telia Lietuva is using relative valuation approach. Two approaches for relative valuation are applied, namely transaction and financial multiples.

First of all, for the financial multiples ten sector peers were chosen (please refer to the table below). The initial assumption is made in this work is that companies in the same sector possess similar growth rates, risk, and cash flows, thus can be compared with Telia Lietuva.

However, because of large discrepancy in growth, Gamma Telecommunications was excluded from the peers’ list and a Finnish telecommunications company Elisa was added. VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 55

The company is bigger than Telia Lietuva, however the growth is similar. In general, all companies have pretty similar revenue growth, margins and cashflows.

3.2.1 Financial multiples

For the financial multiples, EV/EBITDA and EV/Sales were used, the results were retrieved from the Capital IQ database for the valuation date. The multiples were averaged to arrive at the mean used for the calculations.

Table 21. Financial multiples of peer companies for September 30, 2020.

EV/EBITDA EV/Sales GO p.l.c. 6,43 2,45 Telekom Slovenje 3,88 1,03 TalkTalk 4,68 1,18 Sonaecom 7,36 2,37 Retelit 13,3 4,32 Orange Belgium 3,52 0,96 NOS 5,47 1,8 Netia 4,96 1,61 Elisa Oyj 13,78 4,99 Euskaltel 9,65 4,53 AVERAGE 7,30 2,52

Sources: Capital IQ database and the author’s calculations

In the table below the calculations of the enterprise and equity values are shown. Telia

Lietuva financials were taken from the third quarter reports for the valuation date. Based on the financial multiples, the enterprise value of Telia Lietuva is EUR 1,002 million and EUR

985 million using EV/Sales and EV/EBITDA, respectively with share prices reaching EUR

1.48 and EUR 1.45.

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 56

Table 22. Financial multiples calculations.

Source: Capital IQ database, Telia Lietuva financial reports and the author’s calculations

3.2.2 Transactions multiples

For the transactions multiples mergers and acquisitions data for the last three years were taken, with derived EV/Sales and EV/EBITDA multiples calculated by the

Mergermarket database. The multiples were averaged and used for the calculations.

Table 23. Recent M&A transactions and multiples.

Sources: Mergermarket database, and the author’s calculations.

Based on the transaction’s multiples, the enterprise value of Telia Lietuva is EUR

1.096 billion and EUR 1.066 billion using EV/Sales and EV/EBITDA, respectively with share prices reaching EUR 1.64 and EUR 1.59.

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 57

Table 24. Transactions multiples share price calculations.

Sources: Mergermarket database, Telia Lietuva financial reports and the author’s

calculations

3.2.3 Findings of the relative valuation

At the valuation date (September 30th, 2020) the share price stands at EUR 1.56. Two

approaches indicate different results, EV/Sales for financial multiples method results in EUR

1.48 stock price, while EV/EBITDA indicates EUR 1.45. Based on the results, the stock

looks overvalued standing at EUR 1.56 and being higher by 5.4%-7.6% considering both

multiples. However, based on the transaction’s multiples approach it indicates results closer

to the share price at the valuation date making it appear fairly valued with some room to

grow, with an approximate 5% increase to reach EUR 1.64 (please refer to table 25).

Financial multiples reflect book values, thus showing a real picture of the price, however in

M&A transactions bidders evaluate the benefits of synergies like cost savings, increased

market share, or improvements in future revenues, thus paying more to acquire a company,

usually boosting the transaction multiples.

Table 25. Enterprise values and stock prices using different methods.

Current Financial multiples Transactions multiples EUR'000 2020.09.30 EV/Sales EV/EBITDA EV/Sales EV/EBITDA Enterprise value 1 048 396 1 002 462 984 539 1 096 195 1 066 371 Equity value 908 876 862 942 845 019 956 675 926 851 Share price (EUR) 1,56 1,48 1,45 1,64 1,59 VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 58

Sources: Capital IQ, Mergermarket databases, Telia Lietuva financial reports and the author’s calculations

Considering all the share prices derived using relative valuation, the price of EUR

1.56 at the valuation date looks modest. Even though half of the multiples suggest a possible increase, the potential is not too high.

3.3 Recommendations

3.3.1 Relative valuation

First of all, the share price of EUR 1.56 at the valuation date stands almost at the all- time highs, after a very strong upward move from the March lows caused by the COVID-19 pandemic (please refer to the chart provided below). The share price of EUR 1.48 derived by

EV/Sales multiple the last time was recorded around July 25th, 2020, however, it was also on its all-time highs at the time. The highest price until the valuation date was recorded at EUR

1.60. The stock is not very volatile and appears to have a healthy uptrend which makes it look attractive. To reach EUR 1.64 the stock needs to hit a new share price records, which based on the relative valuation is possible, however, the upside potential is not large. Averaging all the share prices derived from the relative valuation, it results in EUR 1.54, in that way it helps to smoothen out the discrepancies of different methods. Considering only the results of the relative valuation and the historical stock chart, the recommendation would be to HOLD the stock and dig deeper in the analysis to verify whether other approaches like discounted cash flow provides similar results.

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 59

Figure 8. 5 years stock chart of Telia Lietuva.

Source: Google charts.

3.3.2 Discounted cash flow

According to Palea, V., “transaction and market multiples perform very poorly at least during financial turmoil, i.e., under the most uncertain information condition, and those relevant firm specific adjustments are necessary.” (2016, May 5, p. 185). For this reason, the

DCF method is assumed to be more reliable in current market conditions. The pessimistic scenario gave a similar result to financial multiples approach results, however for the stock to drop to EUR 1.40 the market sentiment should change a lot, a worsening COVID-19 situation could create the effect again. The base-case scenario looks more realistic, the company is expected to be one of the leaders in Baltics considering the technology innovation, 5G network, high investments are anticipated with some potential to grow. The EUR 1.69 share price derived from the base-case scenario is 8.33% higher than the price at the valuation date.

The optimistic scenario indicates the price of EUR 2.13, considering that the five years of cash flows were priced in and assuming the near end of the pandemic, it is a possibility to reach this target in the long-term, which would result in an upward move of 36.5%. Based on the discounted cash flow method, the recommendation is to BUY.

Giving more weight to the DCF method, the final recommendation for an investor is to BUY the Telia Lietuva stock with a long-term investing strategy. The company gives hopes with its enthusiasm to grasp a big part of the market share being the front-runner of the 5G VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 60 network, it is known that in the long run the customers will transit to a faster network, thus an upward potential is highly possible. During the pandemic some fluctuations might be unavoidable, however pricing five years of possible cash flows in, the investment looks attractive.

Conclusions

1. Telia Lietuva is the biggest and prospectively the most innovative telecommunication

provider in Lithuania. The global industry looks quite saturated, however with room

for 5G network, IoT, and other innovations to grow. GSMA Intelligence projects the

CAGR of 1.9% for mobile subscribers worldwide until 2025, higher growth for new

technologies, investments of EUR 1.1 trillion in mobile CapEx worldwide, 5G

accounting for 78% (GSMA, 2020). Europe has a high customers penetration rate,

however, is expected to be one of the biggest players in 5G network globally.

Lithuanian total telecommunication services were decreasing since 2015, however,

services like data transmission started to outgrow other services, showing the change

of popularity and awareness of new solutions, leaving the primary services like fixed

communications behind, the same is expected to happen when 5G will be

implemented, gaining the popularity at a fast pace.

2. Sector analysis showed that there are three biggest players in Lithuania, namely Bitė,

Telia, and Tele2. Telia is still holding the strongest market share position of 38.9%

with strong mobile services users’ growth in 2019-2020Q3, as well the business looks

strong fundamentally. Calculations reflected that for the last three years Telia Lietuva

held a steady net profit margin around 14% with a 3-years 4% revenue growth

average, healthy liquidity and solvency measures. Capital structure for 2019 has

changed because of the new IFRS 16 standards, boosting the debt of the company. VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 61

3. After undergoing research on valuation methods, income method analysis using

discounted cash flow method was applied and for the market method financial and

transaction multiples approaches were carried out as the most suitable for Telia

Lietuva.

4. Competitors for market method were chosen, analysis proved that all the companies

have suffered from the COVID-19 pandemic, stock prices plummeting from 19% to

the highest of 67%, raising the need to measure the current enterprise and equity

values with a corresponding share price for Telia Lietuva.

5. Relative valuation included financial multiples with ten chosen competitors and

transactions multiples approach included M&A transactions from the last three years

with corresponding multiples. EV/EBITDA and EV/Sales multiples were chosen.

Financial multiples resulted in the enterprise value of EUR 985 million and EUR

1,102 million for EV/EBITDA and EV/Sales, respectively with corresponding EUR

1.45 and EUR 1.48 share prices. Transaction multiples usually result in higher values

because of the priced-in synergies and potential future benefit, the enterprise values

drawn under this method are EUR 1,066 million and EUR 1,096 million for

EV/EBITDA and EV/Sales, respectively with corresponding EUR 1.59 and EUR 1.64

share prices.

6. After all the inputs were calculated and forecasts completed, the discounted cash flow

method indicated the final EUR 1,126 thousand enterprise value, a corresponding

EUR 986 thousand equity value, and EUR 1.69 share price. The inputs used for the

analysis were WACC of 6.60% and the terminal growth rate of 1.66%.

7. Discounted cash flow analysis was supplemented by the sensitivity analysis of the

changes in the discount rate and the terminal growth rate of +-0.5%. Based on that,

two scenarios were derived, pessimistic and optimistic, taking changes of 0.5% in VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 62

each input. Pessimistic scenario indicated changes caused by 0.5% increase in the

discount rate and 0.5% drop in the terminal growth rate, resulting in the equity value

of EUR 818 million and a share price of EUR 1.40, while optimistic scenario was

presented with a 0.5% increase in the terminal growth rate and 0.5% decrease in the

discount rate, deriving EUR 1,239 million equity value with a EUR 2.13 share price,

depending on the economic and market conditions.

8. Concluding all the calculations, forecasts, and methods applied for the valuation of

Telia Lietuva and giving a bigger weight to DCF analysis, the final recommendation

for an investor on the valuation date with a corresponding share price of EUR 1.56

(September 30th, 2020) would be to BUY with a long-term strategy, since the main

method indicated a possible 8.33% upside potential and a similar view was supported

by the transaction multiples results, indicated higher share prices than at the valuation

date.

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 63

References

Brussels Regional Public Service (n.d.). Micro, small, medium or large: how to determine the

size of your enterprise? Retrieved from:

http://werk-economie-emploi.brussels/en/determine-the-size-of-your-business

Businesswire (2020, March 12). Global Telecom Industry Statistics 2020. Retrieved from:

https://www.businesswire.com/news/home/20200312005279/en/Global-Telecom-

Industry-Statistics-2020---CAPEX

Damodaran, A. (2005). Investment Valuation: Second Edition. Retrieved from:

http://easyonlinebooks.weebly.com/uploads/1/1/0/7/11075707/investment_valuation- damodaran.pdf

Damodaran, A. (n.d.). Damodaran Online. Retrieved from:

http://pages.stern.nyu.edu/~adamodar/

Damodaran, A. (n.d.). Estimating Risk Parameters and Costs of Financing. Retrieved from:

http://people.stern.nyu.edu/adamodar/pdfiles/valn2ed/ch8.pdf

Damodaran, A. (n.d.). Relative Valuation. Retrieved from:

http://pages.stern.nyu.edu/~adamodar/pdfiles/DSV2/Ch4.pdf

Damodaran, A. (n.d.). What is Valuation? Retrieved from:

http://pages.stern.nyu.edu/~adamodar/New_Home_Page/background/valintro.htm

Delfi (2020, August 25). Vasara išeina su tranksmu: kaip žaibuojant nelikti be ryšio.

Retrieved from: https://www.delfi.lt/mokslas/technologijos/vasara-iseina-su- trenksmu-kaip-zaibuojant-nelikti-be-rysio.d?id=85074365

Duff&Phelps (2019). Small company risk premium data. Retrieved in 2019, from

Duff&Phelps database.

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 64

Esty, B.C. (2000). What Determines Comparability When Valuing Firms with Multiples?

Retrieved from:

https://www.jstor.org/stable/41948338?refreqid=excelsior%3Ab9ae3287fba3629f545

4a94f5bc4d0c1&seq=1

European Commission (2019, December 17). Electronic Communications Laws. Retrieved

from: https://ec.europa.eu/digital-single-market/en/policies/telecom-laws

Fama, E.F. & French, K.R. (2004). The Capital Asset Pricing Model: Theory and Evidence.

Retrieved from: http://mba.tuck.dartmouth.edu/bespeneckbo/default/AFA611-

Eckbo%20web%20site/AFA611-S6B-FamaFrench-CAPM-JEP04.pdf

Fendick, K. (2010, June 24). Method and System for Forecasting Financial Statements and

Analysis There of. Retrieved from:

https://patentimages.storage.googleapis.com/d0/43/a4/d7db61b6e4d4ab/US20100161

471A1.pdf

Gitman, L.J & Zutter, C.J. (2012). Principles of managerial finance (Global Edition, 13th

ed.). Retrieved from: http://www.mim.ac.mw/books/Principles-of-Managerial-

Finance-13th-Edition_Full.pdf.9Ukgy8w1RYp7U1dls6CxRLDn1i8aezIq

GSM Association (GSMA) (2020). The Mobile Economy. Retrieved from:

https://www.gsma.com/mobileeconomy/wp- content/uploads/2020/03/GSMA_MobileEconomy2020_Global.pdf

Harris, R.S. & Marston, F.C. (1999, October 12). The Market Risk Premium: Expectational

Estimates Using Analysts’ Forecasts. Retrieved from:

https://papers.ssrn.com/sol3/papers.cfm?abstract_id=252671

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 65

Lee, M.C. & Louis, H.J. (2003, April). Choosing the Right Valuation Approach. Retrieved

from:

https://www.researchgate.net/publication/272894294_Choosing_the_Right_Valuation

_Approach

Lietuvos Respublikos Ryšių reguliavimo tarnyba (RRT) (2019). 2019 metų veiklos ataskaita.

Retrieved from: https://www.rrt.lt/wp- content/uploads/2020/04/RRT_2019_veiklos_ataskaita_20200604.pdf

Lietuvos Respublikos Ryšių reguliavimo tarnyba (RRT) (2020Q3). Lietuvos ryšių sektorius.

Retrieved from: https://www.rrt.lt/wp- content/uploads/2020/12/Ataskaita_2020_III_ketvirtis.pdf

Lietuvos Respublikos Ryšių reguliavimo tarnyba (RRT) (2019). Lietuvos ryšių sektorius.

Retrieved from: https://www.rrt.lt/wp-content/uploads/2020/07/Rysiu- sektorius_2019.pdf

Marr, B. (2019, October 14). The 7 Biggest Technology Trends That Will Transform

Telecoms In 2020. Retrieved from:

https://www.forbes.com/sites/bernardmarr/2019/10/14/the-7-biggest-technology- trends-that-will-transform-telecoms-in-2020/#30dea0e60332

Mohammad, A.N. (2016, October). Valuation Tools for Determining the Value of Assets.

Retrieved from: http://oaji.net/articles/2016/1447-1474728283.pdf

Nasdaq Baltic, Morningstar (2020). Company fact sheet. Retrieved from:

https://nasdaqbaltic.com/statistics/en/instrument/LT0000123911/fact_sheet?date=202

0-11-23

Oberoi, R. & Aggarwal DK (2014, September). Between the numbers. Retrieved from:

https://www.businesstoday.in/moneytoday/investment/key-financial-ratios-analyze- company-stock-investment/story/209789.html VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 66

Official Statistics Portal (2018). Main telecommunications indicators. Retrieved from:

https://osp.stat.gov.lt/EN/statistiniu-rodikliu-analize?hash=ed31f2be-5468-4598-89f4- db69e21e04ba#/

Pacho, F. (2014). Capital Asset Pricing Model (CAPM) Testability and its Validity in Stock

Market: Evidence from Previous literatures. Retrieved from:

https://core.ac.uk/download/pdf/234630301.pdf

Palea, V. (2016, May 5). Market and Transaction Multiples’ Accuracy in the European

Equity Market. Retrieved from:

https://ijbssnet.com/journals/Vol_7_No_5_May_2016/17.pdf

S&P Capital IQ. (2020). Telia Lietuva: Public company profile. Retrieved September 30,

2020, from S&P Capital IQ database.

Salman, A., Munir, N. (2012, July). Choice between Debt and Equity and Its Impact on

Business Performance. Retrieved from:

https://www.researchgate.net/publication/281859052_Choice_between_Debt_and_Eq uity_and_Its_Impact_on_Business_Performance

Statista database (2020). Average return on equity (ROE) in the technology and

telecommunications sector in Western Europe 2020, by industry. Retrieved from:

https://www.statista.com/statistics/1044049/return-on-equity-in-the-technology-and- telecommunications-in-europe/

Telia Lietuva, AB (2020). Financial results. Retrieved from:

https://www.telia.lt/eng/investors/financial-results

Telia Lietuva, AB (2020). Shares and shareholders. Retrieved from:

https://www.telia.lt/eng/investors/shares-and-shareholders VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 67

Telia Lietuva, AB (2020). Sustainability report. Retrieved from:

https://www.telia.lt/documents/20184/34947/Telia_Lietuva_Sustainability_Report_20

19.pdf

Worldgovernmentbonds (2020). Lithuania’s governmental bond yield data. Retrieved in

September 30th, 2020, from: http://www.worldgovernmentbonds.com/bond-historical- data/lithuania/10-years/

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 68

Appendices

Appendix A

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 69

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 70

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 71

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 72

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 73

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 74

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 75

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 76

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 77

Appendix B

Appendix C

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 78

Appendix D

VALUATION OF TELIA LIETUVA, AB FROM AN INVESTOR’S PERSPECTIVE 79

Source: CapitalIQ database.