EQUITIES TELECOMS / EEMEA March 2017
By: Hervé Drouet, Ziyad Joosub and Eric Chang https://www.research.hsbc.com EEMEA telecoms EEMEA EEMEA telecoms 5G: Threats or Opportunities?
5G will be evolutionary rather than revolutionary, but the impact will be significant for EEMEA telcos, bringing new challenges and opportunities
Long term, diversified operators Equities // Telecoms / EEMEA Telecoms // Equities might be advantaged but the benefit will hinge mostly on regulation, substitution and competitive risks
Short term, the drivers are likely to remain dividend, currency impact and data monetisation/affordability March 2017 March
Disclaimer & Disclosures: This report must be read with the disclosures and the analyst certifications in the Disclosure appendix, and with the Disclaimer, which forms part of it EQUITIES ● TELECOMS / EEMEA 16 March 2017
Contents
Executive Summary 2 Potential winners and losers 42 Short-term drivers in 2017: Affordability, Short-term drivers 42 FX and dividend 2 Long-term driver: 5G 44 Long-term driver: 5G: threat or Conclusion 46 opportunities for 2020 4 Winners and losers 7 Companies section 48 Changes to our target prices and Etisalat (ETISALAT UH) 49 summary tables 9 Global Telecom Holding (GTHE EY) 54 Magyar Telekom (MTELEKOM HB) 59 Affordability and telecom Megafon (MFON RX) 63 spending dynamic in EEMEA 10 Mobile Telesystems (MTSS RX) 67 The costs of mobile data ‘access’ Mobily (EEC AB) 71 across EEMEA 10 MTN Group (MTN SJ) 76 Handset affordability drives O2 CZ (TELEC CP) 82 smartphone penetration 10 Ooredoo (ORDS QD) 86 Level of data pricing correlated to mobile Orange Polska (OPL PW) 92 spend as a percentage of GDP 13 Rostelecom (RTKM RM) 96 Macro and economic momentum also Saudi Telecom Co (STC AB) 100 has an impact on elasticity and Telkom Group (TKG SJ) 106 competition intensity 15 Turk Telekom (TTKOM TI) 111 Conclusion 16 Turkcell (TCELL TI) 115 VimpelCom (VIP US) 119 Currency swings still impact telcos 18 Viva Kuwait (VIVA KK) 124 Vodacom Group (VOD SJ) 129 Selective currency swing still to Vodafone Qatar (VFQS QD) 136 impact telcos 18 Zain Group (ZAIN KK) 140 Zain KSA (ZAINKSA AB) 146 Dividend sustainability and trends 25
5G: threat or opportunity? 28 Disclosure appendix 153 5G is round the corner – even in EEMEA 28 Disclaimer 156 5G will need handling with care by EEMEA telcos 29
EEMEA telcos will need to overcome
challenges to monetise 5G 30 5G may introduce new risks 34 5G can nevertheless offer significant opportunities in some areas 36
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Executive Summary
5G is just round the corner with commercial launch likely to have started in some EEMEA emerging markets by 2020, bringing opportunities (higher speed, better latency, fixed wireless radio access), challenges (densification of network, regulation, software skills) and risks (use of unlicensed spectrum, network slicing, OTT). We look at which operators will be at a natural advantage. Short term, we would expect investors to concentrate on dividend trend, data monetisation, affordability and currency impact.
Short-term drivers in 2017: Affordability, FX and dividend
Are micro drivers more relevant than macro in 2017? Over the past few years, cyclical and macro considerations have been the prevalent drivers of EEMEA telecom sector performance but this macro correlation seems to have declined significantly in recent months. We now see a new scenario unfolding in which emerging market macro and currency volatility have stabilised and secular and fundamental telecoms drivers demand greater consideration.
In his multi-asset research report (A game-changer for equities: Diversification is back, 16 February 2017), HSBC’s strategist Daniel Grosvenor highlights the sharp declines in equity- market correlations since Donald Trump's US presidential election win which surprised the markets. At the sector level, correlations between long and short duration names have turned negative for the first time since the 2008 financial crisis, while emerging markets are again moving independently from developed, with greater variation between countries within these blocs. The market, previously highly macro-driven, is likely to be much more responsive to micro themes. This increased fragmentation of equity markets suggests greater scope for diversification and greater opportunities to outperform, making country and sector calls increasingly important.
Affordability and data monetisation, regulatory and currency impact, dividend outlook In our previous thematics report (When the going gets tough, 6 April 2016), we showed that ROIC for EEMEA operators was under pressure from challenging macros and currency woes. Regulatory and tax risks have increased and data monetisation is becoming crucial. We also discussed how macro factors are exerting pressure on operators to become more rational and to protect margins through leaner business models. In order to limit ROIC erosion companies are increasingly optimising capital expenditure. If the regulator allows, a more collaborative approach (consolidation, network sharing) would also help preserve ROIC. Sale and lease back of tower businesses in an attempt to bring cash upfront and help strengthen balance sheet has been temporarily thwarted by FX movements where debt has largely been in hard currency.
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With EM macros and currency starting to stabilise and potentially even strengthening in some cases, we think the key short-term drivers to consider in EEMEA telcos are:
Data monetisation and affordability Currency impact Regulation trends OpFCF and Dividend outlook On data monetisation and affordability, we look at current affordability a local level and whether there is room for catch up. The idea is to look at how the telecoms sector and telecoms prices are affordable for local users. Is pricing stretched versus average consumer spending or is it cheap? Is consumer telecom spending sensitive to or correlated with the state of the economy?
Our analysis shows that even adjusted for the economy, smartphone penetration in South Africa and Africa lags EEMEA. The lag in South Africa could be explained, in our view, by a lower urbanisation rate and less spread of wealth across the population (gini index). As smart phone prices gradually fall, penetration should catch up with the sector average. Smartphone penetration is driven more by low end affordability (as GDP per capita PPP adjusted, or as a percentage of disposable income) and should continue to improve as emerging market currencies stabilise and cheaper Asia-produced smartphones flow into EEMEA markets. Compared with their per capita wealth levels, we think South Africa, Africa and Russia have the most room to grow smartphone penetration.
Mobile data pricing (adjusted to GDP PPP) varies considerably in EEMEA with the cheapest in Russia and Poland and the most expensive in Algeria, Nigeria and South Africa. Data pricing in Turkey, Czech Republic and Hungary looks well balanced. Aggressive competition keeps data pricing low in Poland while aggressive independent retailers in Russia keep churn high and tariffs low. We believe a switch to monobrand retailers could be a catalyst for enhanced data monetisation in Russia while we think it might take consolidation in Poland to see more rational pricing competition.
Mobile spending appears quite resilient during a macro recession but high elasticity is generally seen in countries where there is rational competition or market repair through consolidation. This is the case for Turkey, Czech Republic (rational competition) and Pakistan (consolidation). With most EEMEA countries seeing GDP growth, a rational competitive environment or a consolidating market could unlock elasticity for countries such as Russia or Poland.
Countries with stable and rational competition, like Turkey, are well placed to monetise data further.
On currency, we look at which operators are more exposed to currency movements and which are most likely to benefit or not. The overall impact of currency is the highest for companies most exposed to countries whose currencies are under pressure, and which are most exposed through their capex and debt. This is the case Turk Telekom, MTN and to a lesser extent, Russian telcos. With most GCC currencies pegged to the USD, GCC domestic telcos are by default the least impacted by currency exposure to USD. For the other operators the least sensitive to low gearing and local currency financing rather than hard currency is O2CZ.
On regulation, we look at regulatory change happening in the region and in particular the impact of the removal of European international mobile roaming (we estimate a c2% impact on average revenues for the CE3 telcos).
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Dividend trends and sustainability remain key criteria for EEMEA Telecom investors in the short term. We analyse the dividend outlook for EEMEA telecoms based on the attractiveness of dividend yields and the ability to maintain the dividend. Companies offering high dividends and high dividend yield spreads over the 10-year sovereign yield with improving trends score highest in our model. To determine the sustainability of dividends, we look at the FCF yield and current leverage ratio (net debt/EBITDA). By analysing the FCF-dividend yield spread, we can gauge a company’s ability to pay dividends without affecting gearing.
Companies with lower dividend yield vs FCF yield and leverage ratios are considered less at risk of cutting existing dividends. Zain Group, O2CZ, Magyar, Etisalat score well from that perspective, while Zain KSA and Etihad Etisalat score much less well. Companies set to improve their dividend the most in the next two years are VimpelCom and the Turkish telcos (ie Turkcell, Turk Telekom) – assuming TRY and RUB stability.
MTS and Megafon offer high dividend yields, albeit room to increase these further is limited due to most surplus cash flow already being returned shareholders. Significant changes in company fundamentals would be needed to improve dividends, such as a shift from independent retailers towards monobrand shops.
Long-term driver: 5G: threat or opportunities for 2020
HSBC’s European telecoms team recently published a detailed report on 5G and its impact on the European telecom sector in FT5G – What the telecoms sector need is a new acronym (16 January 2017). In this report, we analyse the impact of 5G on EEMEA telecom operators.
5G could come sooner than you think We believe the technological lag between EEMEA and developed markets is shrinking and that 5G roll-out may come to EEMEA markets sooner than investors expect. Turkey and Russia are due some pre-commercial launches and some city coverage in H2 2018, with full commercial launch nationwide in 2020 in both countries. 5G is not only about linking machine to machine devices, but bringing higher speed, better latency and better spectrum efficiencies. In fact, 5G could come relatively quickly to EEMEA emerging markets for the following reasons:
A shorter technological and investment cycle for EEMEA telcos: technology is becoming cheaper, sooner, thanks to key telecoms equipment manufacturers in emerging Asia (particularly China) such as Huawei; A potential wireless capacity crunch driven by a sharp increase in data services while capacity will start to become inadequate in some countries. This effect could be amplified by the lack of home fibre broadband in emerging markets where the main means of data access is via smartphones (smartphone penetration is above 50% in most EEMEA countries). 5G will provide substantial improvements in speed, latency and capacity – if we consider the additional spectrum to be delivered; The benefit of 5G Fixed Radio Access (FRA), enabling efficient and fast fixed wireless broadband access to smaller cities and rural urban areas where current broadband provisioning is poor in emerging markets;
The evolutionary technology upgrade path of 5G, enabling relatively fast adoption by EEMEA telcos operators. Network operators do not always need all of the capacity on day one but are more likely to adopt a phased approach.
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5G will bring threats and opportunities From a sector perspective:
1. 5G is unlikely to directly boost sector revenue but it could impact business models via base station densification. The technology would increasingly move towards the software layer, an area in which not all telcos have strong skills or expertise. 5G could also promote Fixed Radio Access (FRA), however, which could be an interesting technology with which to provide broadband in some emerging markets, especially for mid-size towns in rural areas.
2. Converged players have the advantage in backhaul and cross-selling, which could have significant implications for EEMEA telcos, where diversified operators could have an advantage over pure mobile where they are present.
3. With potential new high frequencies allocated which might be unlicensed, 5G could introduce new risks to the telcos sector in terms of new entrants taking customers away. The process of attributing new frequencies by the regulators could also have a significant impact on future sector profitability.
In EEMEA, some applications could be monetised due to a lack of alternatives, but this would require telcos to acquire a great deal of software development skills and sufficient knowledge of the requirements of individual industries to be able to devise solutions for them. Overall, we think monetisation for operators in EEMEA will still come mostly from increased connectivity needs and data usage.
Data monetisation has become more critical, with operators gradually expanding their offers and integrated operators gradually benefiting from customers shifting to bundles and convergence services. Smartphone penetration in the EEMEA region has lagged developed regions because of currency headwinds and affordability, but penetration should gradually catch up as currency stabilises. 5G FRA could be also an attractive proposition for fixed wireless broadband where there is no fixed-line last-mile connection. There are risks. The 5G shift towards greater importance of the software control layer could be taken up more by the tech giants to the detriment of telcos’ data monetisation. Google’s Project Fi and Facebook’s project ARIES could be threats – even for EEMEA telcos operators if they do not rapidly enhance their software capabilities and engage more aggressively with digital services. With 5G, Wifi and Mobile networks are used simultaneously; thus unlicensed frequencies could also threaten telcos’ ability to monetise data.
Who is at a natural advantage? Diversified operators could benefit through bundles versus pure mobile competitors as they are likely to see a cost advantage. With simultaneous use of 5G with Wifi, the value of a fixed asset is likely to increase for pure mobile operators. EEMEA telecoms operators might be able to monetise and/or improve margin in countries where: Access to spectrum is cheap and channelled to existing operators instead of disruptors or new entrants (eg Russia, GCC) Licenses and frequencies are tech-neutral (eg most EEMEA countries) Net neutrality is not required and zero rating pricing of content is accepted by the regulators (Russia, GCC) Disruptive new entrants or technology (eg Google’s Project Fi) is limited for security reasons (eg Russia, GCC) There are opportunities for broadband in rural mid-size cities through 5G Fixed Radio Access where there is a lack of fixed alternatives (Cable, Fibre, xDSL) (eg some regions in Russia, Turkey, SSA, South Africa) Competition is limited to three players with no small players (ie that can create danger of layering) (eg Turkey, GCC, South Africa).
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We believe countries and regions such as Russia, GCC and South Africa can provide a relatively good environment via which to monetise 5G opportunities while limiting potential disruptive risks.
EEMEA telcos operators more likely to succeed are those with: diversified fixed and mobile operations (where 5G fuses with Wifi, wireless automatic offload) that compete with pure mobile operators;
the ability to invest and which have deep pockets (densification of cells) superior tech-neutral spectrum strong innovation skill sets in service layers, and strong software skills sets Based on our scorecard analysis, companies that are naturally well placed are those that have:
The most room to monetise 5G: Operators scoring highly in this category have a high potential for data and connectivity growth, strong opportunities in 5G Fixed Radio Access, good levels of investment to meet demand and are ready for bundles. Integrated operators (ie those with fixed and mobile operations) with access to premium content also have an advantage if they compete versus pure mobile operators. Low level of services substitutes or rational competition. Companies that operate in markets where consolidation is taking place tend to score highly. Competition generally becomes more rational post-consolidation as the number of players and substitutes diminishes. Conversely, operators in markets with potential new entrants score worst as smaller players tend to be the most irrational or aggressive on tariffs, so as to gain market share and reach critical mass. With 5G, small players may introduce the risk of a significant discount through layering. Markets with two or three players generally rank more highly than those with four or five. Security concerns (telecoms are perceived as strategic assets) could be an inhibiting factor for deep pocket international new entrants.
Accommodating regulation on 5G. A regulatory environment with few constraints generally enables operators to access spectrum at more advantageous prices (eg through beauty contests instead of auctions). Tech-neutral licenses are also advantageous as existing spectrum could be used for 5G. Not having net neutrality could also be an advantage for existing telcos, helping monetise data traffic through prioritisation. Zero pricing data content could benefit operators that provide content. Finally, companies operating in countries with a more lenient regulator tend to score highly. A business model that is adequate for 5G dynamics. Companies with superior networks and spectrum, strong innovation and software skills (digital agenda) and which are diversified rank highly, as do those with adequate strategies to limit cannibalisation of voice by data through data-tiered packages, convergence services and strong brand positioning. In more mature markets, we like to see site-sharing and a more cooperative approach among players – as long as it is a passive network element. We view business models that relinquish control of the company’s own active network as unfavourable, as we see this as a risk at times of new technology roll-out cycles such as 5G.
Overall Russian telcos (MTS, Megafon, VIP), Turkcell and MTN score well. In MENA, Ooredoo and Saudi Telecom have the highest scores in their regional group.
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Winners and losers
Short-term drivers in 2017: Currency, data monetisation, dividend trend In the very short term, key share price drivers for EEMEA telcos are:
Data monetisation and affordability, as data becomes the most significant growth engine Currency impact, as there is much more dislocation between countries, and exposure sensitivity varies significantly among EEMEA telcos OpFCF and dividend outlook, as investors still mostly tend to perceive telcos as a dividend yield play.
We rank operators in quintiles to get a net short-term criteria score, then overlay our thematic scoring with our valuation matrix. We look at the upside implied by our fair value target prices, 2018e multiples (EV/EBITDA, EV/OPFCF, PE) and dividend yield spread. The higher the score, the cheaper a stock looks. We summarise our analysis with the bubble chart below. The companies in the top right-hand quadrant rank the highest on both short-term criteria and valuation, with those in the bottom left-hand quadrant ranking lowest.
Short-term thematic score vs valuation relative 6 Key : VIP Zain Buy = 5 Hold = GTH Reduce = TTKOM (size = mkt cap) MFON Magyar 4 RTKM MTS TCELL Telkom SA 3 Viva STC ORDS ValuationRelative OPL MTN Etisalat O2 CZ 2 Vod Qatar Mobily Zain KSA Vodacom 1 1 2 3 4 5 Short term thematic Relative
Source: HSBC
On both valuation and short-term drivers, Zain Group ranks well in GCC, with VIP, Magyar Telekom in EEMEA. In South Africa, the scoring does not highlight any significant difference between operators. The picture partly reflects the negative view HSBC’s FX strategists have on most EEMEA currencies versus USD. This has a greater negative effect on operators with higher sensitivity to currency movements due to their hard currency debt levels or a high portion of capex paid in USD (eg Russian telcos, Turk Telekom, MTN). Should the RUB, Naira and TRY appreciate, those companies would score significantly higher.
Long-term driver: 5G impact The potential long-term impact is more fundamental for the operators, in our view. We have updated our traditional thematic scoring methodology to include the potential opportunities and threats 5G brings to EEMEA telecoms. We rank operators in quintiles to get a net thematic long- term 5G score based on data monetisation ability, competitive threats and risks faced, 5G regulation, and each company’s model. A high long-term net thematic score indicates a company is well placed for 5G and a high net valuation score indicates the stock looks cheap relative to peers. On both valuation and 5G drivers, Turkcell and the Russian telecoms score well, and STC in MENA. MTN scores relatively well overall in South Africa. Those that rank
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poorly include Zain KSA, Vodafone Qatar. Despite being diversified, CE3 telcos only rank in the medium range due to heavy competition from cable, high OTT penetration, which could become a greater risk with 5G, and a much less supportive regulatory environment with a potentially high spectrum cost.
Net long-term thematic score vs net valuation score
Zain VIP Key : Buy = GTH MFON Hold = Magyar TTKOM Reduce = RTKM (size = mkt cap) STC Telkom SA TCELL Viva MTS ORDS
OPL Vod Qatar Mobily MTN ValuationRelative O2 CZ Etisalat Zain KSA Vodacom
1 2 3 4 5 Thematic Relative
Source: HSBC
The table below summarises our overall analysis. Those more likely to benefit from 5G are operators that rank well on our key criteria for the short term drivers related to affordability, currency impact, dividend trend; and on more long-term key criteria related to 5G (eg data monetisation, competitive threats and risks, 5G regulation, having a company model that is able to cope with 5G dynamics and its coming challenges).
Stock ranking based on scorecard High ranked Low ranked ST score Magyar Telekom, O2Cz , ZAIN, TCELL, Etisalat ZAINKSA, VIVA, VFQS
5G positioning score MTS, MFON, TCELL, MTN, VIP VIVA, VFQS, OPL
Valuation Score (high=Cheap) ZAIN, GTH, TTKOM, TCELL, VIP, MFON, RTKM VFQS, VOD, O2Cz Source: HSBC
Taking into consideration both the thematic and valuation scores, we highlight our Buy-rated companies: Turkcell, VimpelCom and MTN look strong on long-term factors, while Magyar Telekom and Turkcell look strong on short-term metrics.
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Changes to our target prices and summary tables
Rating and target price changes in this report Company Currency Old TP New TP Old Rating New Rating Reason Ooredoo QAR 78 91 Reduce Reduce Change in estimates GTH EGP 8.7 8.0 Hold Hold Change in estimates VimpelCom USD 5.4 5.2 Buy Buy Change in estimates Rostelecom RUB 88 84 Hold Hold Change in estimates Vodacom ZAR 172 160 Hold Hold Change in estimates Source: HSBC estimates
Rating and target price summary table ______Buy ______Hold ______Reduce ______Company Curr TP Price Company Curr TP Price Company Curr TP Price Mobily (Etihad Etisalat) SAR 27.20 21.65 MTS RUB 250 270 Etisalat AED 14.9 17.85 MTN ZAR 141.5 122.9 STC SAR 71 65.75 Zain KSA SAR 7.1 8.75 Turkcell TRY 14.2 12.2 Vodacom ZAR 160 149 Ooredoo QAR 91 99 VimpelCom Ltd USD 5.20 3.98 GTH EGP 8.0 7.0 Viva Kuwait KWD 0.74 0.82 Magyar T. HUF 580 500 O2 CZ CZK 270 272 Vodafone Qatar QAR 8.1 9.04 Megafon RUB 700 628.7 OPL PLN 5.0 4.67 Zain Group KWD 0.49 0.48 RTKM RUB 84.0 76.5 Telkom SA ZAR 77 69.8 Turk Telekom TRY 6.0 5.7 Source: HSBC estimates, priced as of 8 March 2017
Valuation Summary Table Company Currency Ticker Rating CMP TP Up(down)side EV/EBITDA EV/OP FCF PE Etisalat AED ETEL.AD Reduce 17.85 14.90 -16.5% 5.7 9.0 18.9 Global Telecom USD GTHE.CA Hold 7.0 8.0 14.3% 2.9 4.8 9.5 Magyar Telekom HUF MTEL.BU Buy 500 580 16.0% 4.7 8.7 14.6 Megafon RUB MFON.MM Buy 628.7 700 11.3% 4.4 9.0 11.3 Mobile Telesystems RUB MTSS.MM Hold 270 250 -7.4% 4.4 8.1 9.3 Mobily (Etihad Etisalat) SAR 7020.SE Buy 21.65 27.20 25.6% 7.6 53.8 182.0 MTN Group ZAR MTNJ.J Buy 122.87 141.5 15.2% 6.3 11.8 16.8 O2 CZ CZK SPTT.PR Hold 272 270 -0.7% 8.3 9.4 16.4 Ooredoo QAR ORDS.QA Reduce 99 91 -8.1% 5.0 10.1 14.4 Orange Polska PLN OPL.WA Hold 4.67 5 7.1% 4.5 14.9 -34.2 Rostelecom RUB RTKM.MM Hold 76.5 84 10.0% 2.8 7.6 14.1 Saudi Telecom Company SAR 7010.SE Hold 65.75 71 8.0% 5.9 13.2 14.9 Telkom SA ZAR TKHJ.J Hold 69.8 77 10.3% 2.8 7.7 10.4 Turk Telekom TRY TTKOM.IS Hold 5.7 6 5.3% 4.5 8.9 10.3 Turkcell TRY TCELL.IS Buy 12.18 14.2 16.6% 5.4 13.9 12.0 VimpelCom Ltd USD VIP.OQ Buy 3.98 5.2 30.7% 3.2 5.2 4.4 Viva Kuwait KWD VIVA.KW Reduce 0.82 0.74 -9.8% 3.0 13.2 10.1 Vodacom Group ZAR VODJ.J Hold 149 160 7.0% 7.2 11.5 14.4 Vodafone Qatar QAR VFQS.QA Reduce 9.04 8.1 -10.4% 13.7 33.3 -42.0 Zain Group KWD ZAIN.KW Hold 0.48 0.49 2.1% 3.7 5.4 7.2 Zain KSA SAR 7030.SE Reduce 8.75 7.1 -18.9% 9.9 99.2 -7.8 Median 4.7 9.4 11.3 Source: HSBC, prices are as of 8 March, FY17e for multiples
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Affordability and telecom spending dynamic in EEMEA
Smartphone penetration is correlated to the affordability of the cheapest smartphone relative to disposable income: Africa has room to catch up EEMEA mobile spend accounts for low single digits of disposable income. For greater share of customer wallet, operators must ramp up monetisation of data connectivity and develop faster digital services Data pricing is cheapest in Russia, rational competition could allow prices increase. Sensitivity to macro is highest in Turkey, Pakistan and Czech Republic
The costs of mobile data ‘access’ across EEMEA
We look at wealth, affordability and consumer spending dynamics across EEMEA to establish which markets hold the most upside and downside risks in terms of (1) smartphone penetration and affordability, (2) mobile data pricing and (3) consumer ability to increase spend on mobile data.
Handset affordability drives smartphone penetration
Smartphone penetration varies across the EEMEA region. Penetration rates vary from In EEMEA, South Africa is the laggard in terms of 70%+ in GCC, to below 40% in Sub-Saharan Africa (South Africa, Nigeria). Handset adoption smartphone penetration remains a key enabler for effective data monetisation in conjunction with absolute data pricing. South Africa and Africa may be characterised by lower smartphone adoption levels due to the prevalence of dual-sim usage in these markets; Russia exhibits similar levels. Therefore, we believe South Africa is currently still lagging the EEMEA telcos sector, due, possibly, to a lower urbanisation rate and greater wealth disparity (as measured by the gini index). As handset prices decrease, we expect smartphone penetration in these countries to converge to the regional sector average.
Relative pricing of smartphones varies considerably across markets. Differences in duties, Retail pricing difference in high end smartphones is not taxes, VAT, wealth and cost of living dynamics are likely to explain the variance across explained by affordability due smartphone pricing in EEMEA markets. to absence of subsidies
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USD price of iPhone 7 (LHS) versus GDP per capita PPP-adj (RHS)
Source: Company data, Worldbank, Numbeo, GDP PPP for FY15 taken from World bank
PPP-adjusted GDP per capita or monthly disposable income differences do not explain Smartphone penetration more driven by low end the variance in pricing. We have not observed any relationship between GDP per capita and smartphone affordability handset pricing. Therefore handset pricing appears not to follow a subsidisation model to cater for lower-income markets.
Lowest wealth barrier in USD price of iPhone 7 (lhs) versus average monthly disposable income (rhs) GCC, highest in Algeria
Source: Company data, Worldbank, Numbeo
Smartphone penetration driven by wealth dynamics. Based on monthly disposable income, the UAE, Saudi Arabia and Qatar are the markets with the lowest wealth barrier to smartphone adoption. Algeria and Turkey have the highest barriers from an affordability perspective.
Most affordable smartphone as % of GDP per capita (lhs) versus smartphone penetration (rhs) 15% Price of most affordable smartphone as % of monthly PPP-adj GDP per capita LHS 100% Smartphone penetration 80% 9.8% 10% 60% 6.8% 5.8% 40% 5% 3.9% 4.0% 3.2% 3.6% 20% 1.3% 1.6% 0.7% 0% 0% Saudi Russia South UAE Qatar Hungary Czech Poland Turkey Algeria Arabia Africa Republic
Source: Company data, Worldbank, Numbeo
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In the EEMEA region, Turkey and Poland have the highest smartphone penetration Turkey and Poland have the relative to GDP per capita dynamics. Algeria and Poland are characterised by high retail highest smartphone handset prices, partially offset in Poland by moderate subsidies from telcos operators and in penetration relative to GDP per capita PPP adjusted Turkey, by a more aggressive marketing campaign to push data services, helped by consumer financing services put in place by operators such as Turkcell. Smartphone penetration in South Africa, Russia and Saudi has the most room to grow based on GDP per capita wealth levels. Saudi, Russia and South Africa wealth dynamics are likely to be overstated when using GDP per capita metrics given their respective commodity- driven wealth.
Price of most affordable smartphones
Source: Company data FY16, Worldbank, Numbeo
Monthly disposable income (after tax and finance costs) is a more appropriate metric with which to gauge smartphone affordability across the region. This data is provided by Numbeo and also takes into account cost of living criteria. Using monthly disposable income yields a more accurate comparison. On a monthly The more affordable a disposable income basis, results are more in line with reality, in our view, but correlation smartphone is versus between disposable income and smartphone penetration is evident. disposable income, the higher the penetration Turkey and Hungary appear to have disproportionately higher smartphone penetration relative to monthly income dynamics, while UAE, Saudi and Qatar have significant room to grow smartphone penetration, based on monthly income levels.
The more affordable the smartphone versus disposable income (LHS), the higher the penetration (RHS)
50% Price of most affordable as % of monthly disposable income 100% Smartphone penetration 40% 40% 80% 29% 30% 60%
20% 40% 14% 14% 15% 9% 11% 10% 7% 20% 2% 2% 0% 0% UAE Qatar South Czech Poland Russia Turkey Hungary Nigeria Algeria Africa Republic
Source: Company data, Worldbank, Numbeo
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Smartphone penetration in South Africa is overstated (dual-SIMs are prevalent) while monthly income levels explain the high penetration rate in Nigeria In South Africa, the pre-paid segment represents 80% of the subscriber base and is characterised by customers holding multiple SIMs (which we believe to be at c1.67x). If we adjust for that factor, smartphone penetration per capita is closer to 55%. We therefore see scope for growth as the market is not as penetrated as headline figures suggest. Nigeria appears highly over-penetrated given monthly income levels. This is a function of cheap handsets as well as the lack of alternative communication/entertainment/connectivity options (other than mobile).
In general, markets that are heavily skewed towards prepaid subscribers tend to have higher multiple SIMs. This is the case in most markets in Africa and to a certain extent Russia.
Level of data pricing correlated to mobile spend as a percentage of GDP
Mobile data pricing varies considerably across EEMEA. Nigeria, Poland and Russia are The cheapest mobile data pricing is in Poland and characterised by the lowest spend levels whilst the UAE, Algeria and South Africa are the most Russia; the most expensive expensive markets. is in Algeria and UAE Average price per GB of data (USD)
Source: Ofcom
Mobile data pricing as a percentage of GDP. Nigeria, South Africa and Algeria appear the most expensive on this basis, whilst Qatar, Russia and Poland are cheapest.
Average mobile data (per GB) price as a percentage of monthly GDP PPP adj (basis points)
Source: Ofcom
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Mobile data pricing as a percentage of monthly disposable income. Nigeria, Czech Republic and South Africa are the most expensive on this basis, while Qatar, Russia and Poland are the cheapest.
Average mobile data (per GB) price as a percentage of monthly disposable income (basis points)
Source: Ofcom
Mobile data spend as a percentage of GDP per capita (PPP) versus ARPU as a Russia, Turkey and Czech Republic have lower mobile percentage of GDP (PPP). On this metric, the more expensive the mobile data, the greater the ARPU as a percentage of proportion of mobile telecom spend in PPP-adjusted GDP per capita. South Africa, Hungary and monthly GDP per capita the UAE exhibit higher mobile ARPUs relative to GDP per capita levels. Russia, Poland appear to have structurally low ARPUs relative to GDP per capita levels.
Comparing data pricing, wealth and total mobile spend dynamics for EEMEA operators
Source: Ofcom
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Mobile ARPU constant Mobile data spend as a percentage of monthly disposable income, versus ARPU as a across countries at 1-2% of percentage of monthly disposable income. We think some of the disparity can be explained by disposable income multiple SIM card usage, which can understate the real ARPU by unique subscriber. This would be the case for markets with a relatively high prepaid level (eg Africa, Russia). In reality, we believe mobile spending in Nigeria is closer to c2% of disposable income and c1.5% in Russia. We note with interest that mobile telecom spend (as a percentage of monthly disposable income) is relatively uniform across the EEMEA region. We find that mobile data pricing has no bearing on monthly There is more room to monetise data and digital mobile spend. There is scope for this ratio to improve. The key for mobile operators is to monetise services data services but also introduce digital services and content.
Comparing data pricing, income and total mobile spend dynamics for EEMEA operators
Source: Ofcom
Macro and economic momentum also has an impact on elasticity and competition intensity
Mobile spending is resilient We look now at how ARPU has been impacted by GDP per capita in the past three years. The unless there is a steep macro impact varies across operators, with some markets showing a completely negative correlation to downturn or mobile services economic conditions (Middle East, Turkey and Czech) whilst others show a very strong are priced at a premium correlation (Ukraine, South Africa, Russia and Poland). The countries with the highest correlation to macro factors have recently been in recession, such as Ukraine, Nigeria and Russia or, in South Africa’s case, have higher mobile service pricing. This shows that mobile spending has been somewhat resilient to macro economic downside, in that it is a way of providing cheap entertainment as well as communications. In steep economic downturns however, or in a high pricing environment, mobile service revenue growth is highly correlated to macro factors.
The lowest correlation is in Turkey, Pakistan and Czech Republic have shown the lowest correlation to macro conditions – countries where there is whether positive or negative. These countries have seen a more rational competitive rational competition or environment through less aggressive competition (eg Turkey, Czech Republic) or consolidation consolidation and market repair (Pakistan).
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Mobile spend correlation to GDP ______GDP per capita (USD) ______ARPU (USD) / GDP per capita (USD) ______Country Operator 2014 2015 2016 3 year CAGR 2014 2015 2016 3 year CAGR Correlation
Algeria ORDS 5 459 4 175 4 129 -13.0% 1.6% 1.9% 1.9% 9.2% -1.00 Qatar ORDS 93 990 68 940 60 733 -19.6% 0.4% 0.6% 0.7% 22.9% -1.00 Kuwait ORDS 40 689 27 756 26 146 -19.8% 0.6% 0.8% 0.9% 22.8% -1.00 Saudi Arabia STC 24 499 20 583 19 922 -9.8% 1.0% 1.4% 1.5% 24.9% -0.99 UAE Etisalat 43 213 38 650 38 050 -6.2% 0.9% 1.0% 0.9% 4.5% -0.98 Kuwait VIVA 40 689 27 756 26 146 -19.8% 0.9% 1.3% 1.5% 29.1% -0.98 Qatar VFQS 93 990 68 940 60 733 -19.6% 0.4% 0.5% 0.6% 17.7% -0.98 Kuwait ZAIN 40 689 27 756 26 146 -19.8% 1.2% 1.4% 1.4% 6.4% -0.98 Saudi Arabia EEC 24 499 20 583 19 922 -9.8% 0.7% 1.0% 1.2% 30.1% -0.94 Turkey TTKOM 11 102 11 245 11 522 1.9% 1.1% 0.9% 0.9% -10.8% -0.90 Czech republic O2 17 001 17 636 18 454 4.2% 1.0% 0.8% 0.8% -11.1% -0.88 Saudi Arabia ZAINKSA 24 499 20 583 19 922 -9.8% 0.8% 0.8% 0.8% 3.9% -0.88 Turkey TKCEL Turkey 11 102 11 245 11 522 1.9% 1.1% 1.0% 0.9% -8.9% -0.87 Pakistan GTH 1 312 1 428 1 289 -0.9% 1.9% 1.8% 2.1% 5.1% -0.79 Pakistan PTCL 1 312 1 428 1 289 -0.9% 2.7% 2.0% 2.1% -11.5% -0.53 Algeria GTH 5 459 4 175 4 129 -13.0% 1.7% 1.7% 1.5% -6.8% 0.58 Russia MFON 14 160 9 243 8 838 -21.0% 0.7% 0.6% 0.6% -9.4% 0.87 Poland OPL 14 332 12 492 12 309 -7.3% 0.8% 0.8% 0.7% -8.4% 0.89 Russia MTS Russia 14 160 9 243 8 838 -21.0% 0.7% 0.7% 0.6% -7.1% 0.90 Nigeria MTN 3 268 2 763 2 260 -16.8% 2.5% 2.2% 2.2% -6.6% 0.91 Russia VIP Russia 14 160 9 243 8 838 -21.0% 0.7% 0.7% 0.6% -6.6% 0.92 South Africa VODSJ 6 503 5 727 5 018 -12.2% 2.1% 1.9% 1.8% -7.2% 0.92 Ukraine TKCEL Ukraine 3 095 2 125 2 052 -18.6% 0.8% 0.7% 0.7% -7.4% 0.98 Ukraine VIP Ukraine 3 095 2 125 2 052 -18.6% 1.2% 1.0% 1.0% -6.2% 0.99 South Africa MTN 6 503 5 727 5 018 -12.2% 1.6% 1.6% 1.5% -4.4% 1.00 Ukraine MTS Ukraine 3 095 2 125 2 052 -18.6% 1.3% 1.0% 1.0% -12.7% 1.00 Source: HSBC, World bank, IMF
Conclusion
Even adjusted for the economy, smartphone penetration in South Africa and Africa lags EEMEA. South Africa lagging the EEMEA telcos sector might be explained by its lower urbanisation rate and lesser spread of wealth within the population (gini index). As smart phone prices gradually decrease, penetration should catching up with the sector average, driven as it is by low end smartphone affordability (as GDP per capita PPP adjusted, or as a percentage of disposable income), and we expect this to continue to improve as emerging market currencies stabilise and cheaper Asian smartphones flow into EEMEA markets. Compared with their per capita wealth levels, South Africa, Africa and Russia have the most room to grow smartphone penetration in our view.
Mobile data pricing (adjusted to GDP PPP) varies considerably in EEMEA with the cheapest in Russia and Poland and the most expensive in Algeria, Nigeria and South Africa. Data pricing in Turkey, Czech Republic and Hungary looks well balanced.
Aggressive competition keeps data pricing low in Poland while aggressive independent retailers in Russia have prevented tariffs from adjusting for inflation. We believe a switch to monobrand retailers could catalyse enhanced data monetisation in Russia while consolidation in Poland might be required to see more rational pricing competition.
Mobile spending appears quite resilient during a macro recession but high elasticity is generally in countries where there is rational competition or market repair through consolidation. This is the case for Turkey and Czech Republic (rational competition) and Pakistan (consolidation). With most EEMEA countries seeing GDP growth, being in a rational competitive environment or consolidating market could unlock elasticity for countries such as Russia or Poland.
Countries like Turkey, with stable and rational competition, are well placed to further monetise data.
16 EQUITIES ● TELECOMS / EEMEA 16 March 2017
The countries with the highest correlation to macro conditions have been recently in recession, such as Ukraine, Nigeria and Russia or, in South Africa’s case, have higher mobile service pricing. Turkey, Pakistan and Czech Republic have shown the lowest correlation to macro conditions – whether positive or negative. These countries have seen a more rational competitive environment through less aggressive competition (eg Turkey, Czech Republic) or consolidation and market repair (Pakistan).
The countries with the highest mobile spend as a percentage of GDP are Nigeria, Pakistan, Algeria, South Africa and Saudi Arabia. We believe the high level of mobile spend in Nigeria, Pakistan and Algeria can be explained by low wealth dynamics; in South Africa it is driven by higher pricing and gini-coefficient, while in Saudi Arabia is driven by a high propensity to consume mobile services. Poland, Russia and Qatar have scope to increase mobile spending more than other countries across EEMEA.
EEMEA biggest spenders on mobile services ______GDP per capita (USD) ______ARPU (USD) / GDP per capita (USD) ___ Country Operator 2014 2015 2016 3 year CAGR 2014 2015 2016
Nigeria MTN 3 268 2 763 2 260 -16.8% 2.5% 2.2% 2.2% Pakistan PTCL 1 312 1 428 1 289 -0.9% 2.7% 2.0% 2.1% Pakistan GTH 1 312 1 428 1 289 -0.9% 1.9% 1.8% 2.1% Algeria ORDS 5 459 4 175 4 129 -13.0% 1.6% 1.9% 1.9% South Africa VODSJ 6 503 5 727 5 018 -12.2% 2.1% 1.9% 1.8% Saudi Arabia STC 24 499 20 583 19 922 -9.8% 1.0% 1.4% 1.5% Algeria GTH 5 459 4 175 4 129 -13.0% 1.7% 1.7% 1.5% South Africa MTN 6 503 5 727 5 018 -12.2% 1.6% 1.6% 1.5% Kuwait VIVA 40 689 27 756 26 146 -19.8% 0.9% 1.3% 1.5% Kuwait ZAIN 40 689 27 756 26 146 -19.8% 1.2% 1.4% 1.4% Saudi Arabia EEC 24 499 20 583 19 922 -9.8% 0.7% 1.0% 1.2% Hungary MAGYAR 14 007 12 240 11 903 -7.8% 1.3% 1.2% 1.2% Ukraine VIP Ukraine 3 095 2 125 2 052 -18.6% 1.2% 1.0% 1.0% Ukraine MTS Ukraine 3 095 2 125 2 052 -18.6% 1.3% 1.0% 1.0% UAE Etisalat 43 213 38 650 38 050 -6.2% 0.9% 1.0% 0.9% Turkey TKCEL Turkey 11 102 11 245 11 522 1.9% 1.1% 1.0% 0.9% Kuwait ORDS 40 689 27 756 26 146 -19.8% 0.6% 0.8% 0.9% Turkey TTKOM 11 102 11 245 11 522 1.9% 1.1% 0.9% 0.9% Saudi Arabia ZAINKSA 24 499 20 583 19 922 -9.8% 0.8% 0.8% 0.8% Czech republic O2 17 001 17 636 18 454 4.2% 1.0% 0.8% 0.8% Ukraine TKCEL Ukraine 3 095 2 125 2 052 -18.6% 0.8% 0.7% 0.7% Poland OPL 14 332 12 492 12 309 -7.3% 0.8% 0.8% 0.7% Qatar ORDS 93 990 68 940 60 733 -19.6% 0.4% 0.6% 0.7% Russia MTS Russia 14 160 9 243 8 838 -21.0% 0.7% 0.7% 0.6% Russia VIP Russia 14 160 9 243 8 838 -21.0% 0.7% 0.7% 0.6% Russia MFON 14 160 9 243 8 838 -21.0% 0.7% 0.6% 0.6% Qatar VFQS 93 990 68 940 60 733 -19.6% 0.4% 0.5% 0.6%
Source: HSBC
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Currency swings still impact telcos
Operators with the highest debt in hard currency, gearing and capex are the most sensitive to currency swings Sensitivity should decline as currencies stabilise and capex falls due to network sharing Turk Telekom is the most sensitive, STC the least
Selective currency swing still to impact telcos
In our previous thematic report (EEMEA telcos: when the going gets tough, 6 April 2016), we Headwinds in currency and macro have pushed EEMEA highlighted that secular and fundamental drivers would gain prominence when emerging market telcos towards a more macro and currency volatility stabilised, and the EEMEA telecoms valuation gap relative to collaborative approach European peers would narrow. Since then, emerging markets currencies and macro conditions have somewhat stabilised. The valuation gap has reduced albeit this is mostly attributable to de- rating of the European companies. There is a positive aspect to the historical pressure EEMEA telecom operators have had to contend with, in that it has pushed them gradually to react more rationally to economic factors. They have sought to protect margins through leaner business models and have found ways to limit ROIC erosion by optimising costs and – to a certain extent – capex. A more collaborative approach (consolidation, network sharing) can also help stem ROIC declines – if the regulator allows it. Tower assets spin-offs could also bring cash up-front and crystallise higher valuations.
However currency movements have widely diverged within the region. During 2016, RUB has EEMEA currency are now diverging significantly sharply appreciated against USD while TRY has been under significant pressure. between countries HSBC End of the Year Exchange rate estimates for EEMEA currencies 2016 2017e Change RUB 61.2 65.0 -6% TRY 3.5 4.0 -12% ZAR 13.7 14.0 -2% CZK 27.0 26.2 3% PLN 4.4 4.6 -4% HUF 309.0 310.0 0% Source: HSBC FX Strategist forecasts
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Capex exposure and Sensitivity for EEMEA Telecoms Companies capex/ebidta % of capex in HCY Capex exposure to FX FX YoY in 2017 FX effect on Capex FX sensitivity score
MTS 45% 55% 25% -6% -1.5% 2 VIP 38% 55% 21% -6% -1.2% 2 MFON 51% 55% 28% -6% -1.6% 2 RTKM 56% 55% 31% -6% -1.8% 2 OPL 58% 28% 16% -4% -0.7% 2 O2 CZ 21% 21% 4% 3% 0.1% 5 MAGYAR 46% 67% 31% 0% -0.1% 3 TTKOM 49% 50% 25% -12% -2.9% 1 TCELL 61% 50% 31% -12% -3.6% 1 GTH 40% 50% 20% 0% 0.0% 4 ORDS 51% 33% 17% 0% 0.0% 4 VFQS 59% 100% 59% 0% 0.0% 4 ETISALAT 37% 46% 17% 0% 0.0% 3 ZAIN 31% 21% 7% 8% 0.5% 5 ZAINKSA 74% 100% 74% 0% 0.1% 4 STC 55% 100% 55% 0% 0.1% 4 EEC 86% 100% 86% 0% 0.1% 5 VIVA 77% 100% 77% 8% 6.1% 5 MTN 46% 50% 23% -2% -0.4% 3 VODSJ 37% 45% 16% -2% -0.3% 3 TKG 64% 40% 26% -2% -0.5% 3 Source: HSBC estimates
Telecoms are like importers
EEMEA currencies vs USD over FY15, FY16 and FY17e
30% A significant part of their capex and debt is in hard 20% currency (EUR, USD)
10%
0%
-10%
-20%
-30%
-40% RUB UAH PLN CZK HUF TRY DZD PKR MAD KWD QAR SAR AED NRA ZAR
2015 2016 2017e
Source: Company data, HSBC estimates
We have likened telecom operators to importers because a proportion of their capex, debt and costs is denominated in hard currency. That has translated into a significant divergence in FCF and thus EEMEA telcos’ total return performance.
The EEMEA telecoms sector is feels a negative impacted from local currency devaluation versus hard currency (USD, EUR). Many EM operators could be partly seen as importers through capex, some raw materials and international traffic. Part of their capex is in hard currency, as is part of the operating cost (indirectly from energy costs, for example, or directly from potential subsidies on handsets). This would directly impact cash flow in local currency. The capital structure also impacts their equity valuation in local currency as a part of their debt is often in hard currencies, while most of their operations generate local currency cash flow (only international roaming revenues are USD-driven).
19 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Sensitivity of capex to currency For each operator, we analyse capex relative to EBITDA and the proportion of capex in hard currency to determine the capex impact on cash flow. We then assess the capex exposure.
Although capex is still relatively significant in EM versus DM, the ratio has come down significantly from five years ago as markets have matured. The proportion of hard currency capex has also fallen significantly. The most sensitive operators are those with high capex spending and a high proportion of capex spend in hard currency. GCC companies are the least sensitive due to their USD peg, with the most sensitive (by decreasing order) being Turk Telekom, Turkcell, the Russian operators and MTN.
Capital expenditure in hard currency (%)
Most sensitive Turkish 100% telcos, least sensitive GCC 90% telcos 80% 70% 60% 50% 40% 30% 20% 10% 0% MTS OPL O2 CZ MAGYAR TTKOM ORDS VFQS ETISALAT ZAIN VODSJ
Source: HSBC estimates, Based on FY16
Capex/EBITDA over FY16 and FY17e
140% 120% 100% 80% 60% 40% 20% 0%
16 17e
Source: Company data, HSBC estimates
Move from capex-heavy to asset-light likely to continue As ROIC remain under pressure, the key question is to what extent EEMEA operators should The optimum level of network asset ownership depends on adapt their models and reduce their asset bases. The diagram below shows the various options market maturity, regulation related to network sharing. It can begin with site sharing and even involve the disposal of active and competition network equipment.
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From Asset heavy to Asset light
Active Active Network Passive Site sharing SpectrumSpectrums networkNetwork spin sharingnetwork Networknetwork spin sharingsharing offspin off sharing off
- Heavy capex - Asset light/Low Capex - High control - Low control - Higher margins - Lower margins
Source: HSBC
Historically, the length of regulatory cycles seems twice that of technological cycles
Europe trying to regain early 2000s technology leadership – lightening regulation to stimulate capex…
1
0.8
0.6 Tougher regulation may cost US its capex lead – sowing seeds of future lightening of regulation…
0.4
0.2 Europe
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
-0.2
Capex US -0.4
-0.6
-0.8 Lower Higher Lower
-1
1
0.8
0.6
0.4
0.2
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20
-0.2
-0.4
-0.6 Regulation
-0.8 LighterHeavier
-1
c2000 c2012-13 c2025? c2040?? Technological cycle: eg 3G Technological cycle: eg 4G Technological cycle
Regulatory cycle: peak to trough to peak, or trough to peak to trough Regulatory cycle
Source: HSBC
We argue the optimum level of assets depends on a variety of factors. What is the market Turkish and Russian companies may be tempted position of the operator (ie is it dominant)? How mature/developed is the market? How stringent to further share capex and is the regulation? And how long can a market sustain irrational competition? even active network In mature markets with heavy regulation and stable competition, an operator would likely pursue a more extensive asset-light model. However, we believe the logic/rationale would stop at the spin-off of the active network. We remain sceptical of operators (like O2 CZ) which spin-off the entire network (i.e. inclusive of the active electronic components). This heightens the risks of losing control on the next technology roll-out (for example, 5G expected after 2020). Turk Telekom has, for example, signalled it will be actively pursuing sites and capex sharing with competitors and would even consider some active equipment sharing.
Tower assets – sales and lease back valuation getting more difficult to monetise We believe the monetisation of tower assets is gradually becoming more challenging. Valuation Turkcell seeking to IPO tower business, VimpelCom to sale of TowerCos have somewhat de-rated since H2 2016. Some IPOs have also been postponed: and lease back towers in Telefonica/Telxius and Turkcell/Global Tower are notable cases. However, we believe Russia, Pakistan and opportunities remain in Pakistan, Bangladesh and potentially Russia. VimpelCom, with Bangladesh. operations in the three countries, would be a beneficiary. Turkcell is still considering listing its Tower business in 2017. The willingness of Turk Telekom to pursue capex sharing and colocation may help boost the tenancy ratio. Our previous analysis shows towers becomes profitable when the tenancy ratio exceeds 1.4x.
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Currency impact on debt could remain significant Local currency depreciation would negatively impact equity valuations (in local currency) of Equity value is impacted by a combination of gearing and telecoms operators that have significant amounts of debt in hard currency and/or significant proportion of debt in hard international assets. currency In the table below, we have identified each company’s exposure on their capital structure to potential currency movements. The equity value would in theory be proportionally impacted by the combination of their gearing and portion of debt in hard currency, assuming the enterprise value in local currency stays the same. Reported net profit would also be impacted by FX losses and so would dividends, assuming the dividend policy is based on a payout ratio of reported net earnings.
Turk Telekom and VimpelCom are the most exposed while GCC companies are the least.
Debt exposure and sensitivity for EEMEA Telecoms Companies net debt/market cap % gross debt in HCY Net Debt exposure to FX FX YoY in 2017 FX effect on Net Debt FX sensitivity on Debt MTS 44% 27% 12% -6% -0.701% 2 VIP 108% 73% 79% -6% -4.592% 1 MFON 52% 23% 12% -6% -0.695% 2 RTKM 89% 0% 0% -6% 0.000% 4 OPL 115% 0% 0% -4% 0.000% 4 O2 CZ 4% 0% 0% 3% 0.000% 4 MAGYAR 77% 0% 0% 0% 0.000% 4 TTKOM 42% 82% 35% -12% -4.074% 1 TCELL 14% 75% 11% -12% -1.257% 2 GTH 114% 0% 0% 0.000% 4 ORDS 74% 78% 58% 0% 0.022% 5 VFQS 10% 100% 10% 0% 0.004% 4 ETISALAT 0% 70% 0% 0% 0.000% 3 ZAIN 30% 98% 30% 8% 2.332% 5 ZAINKSA 263% 100% 263% 0% 0.407% 5 STC -14% 100% -14% 0% -0.022% 2 EEC 86% 100% 86% 0% 0.133% 5 VIVA 0% 100% 0% 8% -0.001% 3 MTN 21% 45% 10% -2% -0.185% 2 VODSJ 11% 5% 1% -2% -0.011% 3 TKG 9% 4% 0% -2% -0.007% 3 Source: HSBCe
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Proportion of debt in hard currency (%)
100% 90% 80% 70% 60% 50% 40% 30% 20% 10%
0%
O2 O2 CZ MAGYAR MTS VIP TCELL TTKOM ZAIN ZAINKSA STC VIVA OPL MFON ETISALAT ORDS VFQS EEC
Source: Company data, Based on FY16
Net debt/Market cap over FY16 and FY17e
140% 120% 100% 80% 60% 40% 20% 0% -20% -40%
16 17e
Source: company data, HSBC estimates
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FX Sensitivity FX Sensitivity on Capex FX Sensitivity on Debt Overall FX sensitivity MTS 2 2 2 VIP 2 1 2 MFON 2 2 2 RTKM 2 4 3 OPL 2 4 3 O2 CZ 5 4 5 MAGYAR 3 4 4 TTKOM 1 1 1 TCELL 1 2 2 GTH 4 4 4 ORDS 4 5 5 VFQS 4 4 4 ETISALAT 3 3 3 ZAIN 5 5 5 ZAINKSA 4 5 5 STC 4 2 3 EEC 5 5 5 VIVA 5 3 4 MTN 3 2 3 VODSJ 3 3 3 TKG 3 3 3 Source: HSBC estimates, Rounded up to the nearest integer
We calculate overall FX sensitivity by considering FX sensitivity on capital expenditure and debt.
More limited impact of currency swing on opex Currency swings have some bearing on the cost structure of EEMEA operators, including Removal of European roaming will negatively international interconnect costs. However, operators also receive international interconnect impact CE3 telcos margin revenue in hard currency. The net impact will depend on whether the operator is a net exporter of international voice minutes and data traffic or an importer. Countries popular with tourists (Turkey, CE3) are generally importers of minutes and would be the least impacted by interconnect costs but would benefit from increased revenues. However, as EU roaming fees are removed this summer, the CE3 telecom companies are likely to see a greater impact on EBITDA mobile margins in 2017. MTN also has significant hard currency exposure in its Nigerian subsidiary: we estimate c33% of opex is in USD and relates to tower leasing agreements and managed service contracts. The company has guided that for every 10% weakening of the Naira, 2% of EBITDA is lost. We expect this level of dilution to moderate over the medium term as tower lease contracts are renegotiated into Naira.
Overall currency impact The overall impact of currency movements is highest for those companies most exposed to Turkish telcos most sensitive to FX, GCC telcos the least countries whose currencies are under pressure, and which are most sensitive on their capex and debt. This is the case for Turkish companies (Turk Telekom), MTN and to a lesser extent Russian operators. GCC domestic operators are by default the least impacted as their currencies are in some way pegged to the USD. O2CZ stands out because its low gearing and local currency financing blunts the impact of currency swings.
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Dividend sustainability and trends
Dividend outlook score is based on the attractiveness of dividend yield and the company’s ability to increase it Sustainability of dividends is driven by a low capital expenditure requirement and strong balance sheet Zain, O2 CZ and Etisalat screen well based on dividend outlook
EEMEA Telecom investors still regard dividend outlook as a key criterion. In this section, we look at each company’s dividend ‘attractiveness’ and sustainability.
We measure attractiveness by looking at the dividend yield and its spread over the 10-year Improving sustainable dividend remains key for sovereign bond yield. Companies with high dividends and high dividend yield spreads over their EEMEA telcos respective country 10-year sovereign yield with improving trends rank highest on our scorecard. To gauge the sustainability of dividends, we look at the FCF yield and current leverage ratio (as measured by net debt/EBITDA). The FCF-dividend yield spread serves to measure a company’s ability to pay dividends without impacting gearing. The companies with lower dividend yield vs FCF yield and leverage ratios are considered less likely to cut dividends.
Dividend outlook score
Source: HSBC estimates
25 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Higher score overall for Zain We take into consideration the dividend estimates for the next two years (2017e and 2018e) to group, O2 CZ, Magyar, determine the score on each parameter. We assign higher scores for companies with better Etisalat dividend yields, higher dividend-sovereign spreads, better FCF yields and lower leverage. We also assign higher scores for companies with increasing trend of paying higher dividends. A higher overall score implies better dividend outlook.
Zain Group, O2 CZ and Magyar Telekom rank highest due to high dividend yield spread, good High score for high dividend free cash-flow generation and reasonable leverage. yields and spread over sovereign, high FCF yield, Russian telecoms offer high dividend yield but sovereign bond yields cap the spread. A steady and lower leverage decline in sovereign Russian yield will increase the spread and improve the overall valuation scoring.
Zain Group ranks highest on strong dividend yield, spread over sovereign yield, robust free cash-flow yield and an increasing dividends trend.
O2 CZ ranks highly on its high spread over sovereign yield and increasing trend of dividends. Zain KSA and Mobily still low Etisalat ranks high on dividend outlook mainly driven by high spread over sovereign bond yield. on dividend score with high leverage We are most optimistic about the dividend outlook for Magyar Telekom. We believe Magyar Telekom has room to increase dividends. Its dividend policy is based on a net debt/total capital ratio cap of 40%, which we expect to decline further over the next year. We forecast dividends increasing to HUF30 per share in FY17 (compared to HUF25 per share in FY16).
Zain KSA and Mobily’s poor rankings are mainly driven by their leveraged balance sheets, and poor dividend and FCF yields.
For South African telecoms MTN has the most scope for absolute dividend transformation on a medium-term view, while short term is likely to see muted dividend growth performance from MTN; once capex-intensity normalisation commences in FY18e and FX dilution is in the base we expect a multi-year earnings and dividend growth profile to play-out at MTN. We expect MTN to progressively delever as FCF margin expansion cycle commence in conjunction with steep capex reductions off a high base. Vodacom is also likely to exhibit strong acceleration (high single digits) in FY18e (March year end) as the impact on earnings of one-off BEE charges and FX translation losses cease (Vodacom has a fixed dividend pay-out of 90% of HEPS). Telkom SA is likely to
Dividend trend and Dividend policy for EEMEA Telecoms ______Div Yield ______FCF Yield ______Company 15a 16a/e 17e 15a 16a/e One offs Dividend Policy Mobily 0.0% 0.0% 0.0% 9.8% (20.2%) Etisalat 4.5% 4.8% 5.1% 11.2% 10.9% GTH 0.0% 0.0% 0.0% (0.7%) 17.1% Magyar 3.0% 5.0% 6.0% 7.4% 11.1% Net Debt/Total Capital under 40% MFON 8.6% 12.2% 12.2% 8.7% 6.5% MTS 7.1% 9.3% 9.3% 8.3% 9.4% Potential fine related to Uzbekistan Minimum RUB20 per share MTN 10.5% 5.6% 6.2% 29.3% 14.1% ZAR7 unless there is some unforeseen deterioration in key markets O2 CZ 5.8% 6.2% 6.0% 6.3% 7.3% 90-110% of Net Profit Ooredoo 2.8% 2.8% 3.0% 6.6% 9.3% OPL 5.3% 5.3% 5.3% 17.8% 14.2% EU Fine around EUR127m RTKM 7.6% 7.6% 7.6% 9.1% 9.2% Lower of 75% of FCF or RUB45bn over FY16-18 STC 6.1% 6.1% 6.5% 9.4% 6.9% Minimum SAR1 per quarter valid until Q3 2018 Telkom SA 3.9% 5.2% 5.8% 8.1% 8.8% 60% of headline earnings TTKOM 4.2% 0.0% 6.0% 11.2% 6.4% 92% of Net Profit Turkcell 0.0% 0.0% 4.1% 6.8% 5.1% At least 50% of Net Profit VIP 0.9% 0.9% 2.4% (17.3%) 6.3% Progressive Dividend Policy Viva 0.0% 1.2% 1.2% 0.7% 5.6% Vodacom 5.3% 5.8% 6.4% 4.1% 4.7% At least 90% of headline earnings Vod Qatar 0.6% 0.0% 1.7% 0.6% 0.8% Zain 6.3% 7.4% 8.4% 12.1% 14.1% 70-80% of EPS Zain KSA 0.0% 0.0% 0.0% 9.9% 35.7% Source: HSBC estimates
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exhibit pedestrian dividend growth in the medium term, with growth dynamics for Enterprise/IT impacted by public sector budget cuts in South Africa. While scope for margin expansion is limited, with higher finance costs and D&A we forecast low-single digit earnings and dividend growth for Telkom SA (established a fixed pay-out of 60% of HEPS).
Despite a strong growth outlook (in terms of revenue and EBITDA), we estimate Turkcell’s FCF Turkish telcos have one of the highest dividend trends yield is under pressure from 4.5G-related expenditure (capital expenditure needed for network as currency stabilises and rollout and the remaining instalment on the license). However, we believe the dividend outlook the shareholder dispute at remains positive. We expect the shareholder dispute to be resolved this year and assume TCELL is resolved regular dividends related to the current fiscal period will be paid. We remain conservative and do not factor any extraordinary dividends related to the cumulative unpaid dividends from the past two years. This may represent an upside risk to our score for Turkcell.
Turk Telekom’s dividend outlook score is mainly driven by increasing dividends. 2016 dividends were impacted by TRY volatility last year. We assume the TRY/USD stabilises over the next few quarters, with negligible forex loss in FY18e. This will have a positive y-o-y impact on net profit; thus we forecast an increase in dividends as pay-out is linked directly to net profit.
Russian telecoms operators present high dividend yields but have limited scope for Russian telecoms offer high dividend yield but limited improvement. The upside risk is concomitant to a significant shift in fundamentals and concerns room for improvement specifically the independent retail distribution network (eg split of Euroset). The dividend yield spread is capped by still-high Russian sovereign yield and by much of the free cash-flow already being returned to the dividend. Investors are nevertheless being paid to wait for a potential shift in fundamentals.
VimpelCom’s fast growing cash flow offers one of the most attractive dividend positive trend. VimpelCom offers strong improvement of dividend outlook Breakdown of Dividend outlook score Spread over Dividend yield sovereign FCF yield Dividend trend Total score Company score yield score score Leverage scre score Total score Rebased to 5 Mobily 1.2 2.3 1.2 0.4 2.4 7.5 1 Etisalat 3.6 4.3 2.9 3.6 3.0 17.4 5 Global Telecom 1.2 0.8 4.8 2.1 2.4 11.3 2 Magyar Telekom 2.4 3.6 4.4 1.6 5.0 17.0 5 Megafon 4.8 3.4 2.5 0.9 2.4 14.0 3 MTS 4.4 2.6 3.2 1.8 2.4 14.4 4 MTN Group 3.1 1.8 3.6 2.2 3.4 14.1 3 O2 CZ 3.8 4.5 2.5 3.4 2.8 17.0 5 Ooredoo 2.3 3.9 3.9 1.4 4.2 15.7 4 Orange Polska 2.2 3.2 2.8 0.6 2.4 11.2 3 Rostelecom 4.0 1.7 3.4 1.2 2.4 12.7 3 STC 3.4 4.1 1.3 4.2 3.2 16.2 4 Telkom SA 2.7 1.3 2.0 4.0 2.6 12.6 3 Turk Telekom 4.0 1.9 3.9 2.3 4.6 16.7 4 Turkcell 1.9 1.0 2.0 3.2 4.0 12.1 3 VimpelCom Ltd 2.8 3.6 4.3 0.9 4.8 16.4 4 Viva Kuwait 1.4 2.9 1.1 3.8 2.4 11.6 2 Vodacom Group 2.9 1.6 1.8 2.8 3.8 12.9 3 Vodafone Qatar 1.7 3.4 0.9 2.7 3.6 12.3 2 Zain Group 4.4 4.8 4.5 2.9 4.4 21.0 5 Zain KSA 1.2 2.3 1.8 0.2 2.4 7.9 1 Source: HSBC estimates, Higher score implies better outlook for the company
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5G: threat or opportunity?
A 5G roll-out from 2020 will have significant implications with opportunities (FRA, data usage, connectivity) and risks (unlicensed spectrum, layering, OTT WIFI) We rank companies highly that are i) tech neutral, ii) spectrum rich, iii) operate in markets with low probability of new entrants. Network densification will advantage diversified/converged operators relative to pure mobile Russian telcos, Turkcell and MTN score highly. CE3 telcos, despite their diversified network, are penalised by regulation and competition. In MENA, STC scores relatively highly
HSBC’s European telcoms team recently published a report on 5G and its impact on the European telecom sector in FT5G: What the telecoms sector need is a new acronym. Here, we analyse the impact of 5G on EEMEA telecom operators.
5G is round the corner – even in EEMEA
Characteristics of emerging EEMEA markets The emerging markets presents significant specific characteristics relative to developed Emerging markets have strong characteristics with markets. They have a majority low-ARPU multi-SIM subscriber base, which combines low subscale wireline networks density rural areas and rapidly expanding urban environments. In some African countries, the power grid is unreliable at best and mobile towers require back-up diesel generators. In addition, given geographical size and population spread, wired networks are not prevalent so the provision of telecom services is heavily reliant on mobile networks. Lastly, regulatory frameworks vary significantly within the EEMEA region as regulatory bodies take different views on net neutrality; tech neutrality and competitive dynamics within domestic markets.
5G is coming to EEMEA sooner than you think 5G is expected to be launched commercially in developed market around 2020. The question is Technological lag between EEMEA and developed when it will be implemented in most EEMEA markets. New technologies roll out on average markets is shrinking every ten years in mobile (1G, 2G, 3G, 4G, and now 5G) with an average five-year lag between devoloped markets’ roll out and emerging markets. Using GDP/PPP/capita figures and assuming a 10% per year decline in telecom equipment prices, it takes on average five years after rollout in DMs for it to be affordable in EMs.
Popular wisdom would see emerging markets rolling out 5G at a late stage, well after developed markets but we beg to differ. 5G is not only about linking machine-machine devices. In fact, we believe 5G could come relatively quickly in the EEMEA region for the following reasons:
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A shorter technological and investment cycle for EEMEA telcos: technology is becoming cheaper, sooner, thanks to key telecoms equipment manufacturers in emerging Asia (particularly China) such as Huawei; A potential wireless capacity crunch driven by a sharp increase in data services while capacity will start to become inadequate in some countries. This effect could be amplified by the lack of home fibre broadband in emerging markets where the main means of data access is via smartphones (smartphone penetration is above 50% in most EEMEA countries). 5G will provide substantial improvements in speed, latency and capacity – if we consider the additional spectrum to be delivered; The benefit of 5G Fixed Radio Access (FRA), enabling efficient and fast fixed wireless broadband access to smaller cities in rural urban areas where current broadband provisioning is poor in emerging markets; The evolutionary technology upgrade path of 5G, enabling relatively fast adoption by EEMEA telcos operators. Network operators do not always need all of the capacity on day one but are more likely to adopt a phased approach.
Although 5G technology is not yet officially standardised, emerging market telecoms operators 5G already been tested in some Emerging markets with have expressed significant interest. a possible roll out from 2020 The Turkish government has signalled its intention to be one of the first countries globally to use 5G. In January 2017, Ericsson said it had completed the first “5G” technology trial in Turkey, achieving transmission speeds in excess of 22 gigabits per second and paving the way for commercial 5G deployment in 2020.
In Russia, MTS is working with Nokia and Ericsson on developing a 5G test network in time for the 2018 football world cup. MegaFon is planning a similar exercise with Huawei. In February 2017 Rostelecom signed a strategic partnership agreement with Gazprom Neft on the industrial internet of things (IIoT) development. The key goal of the agreement is to establish long-term and effective cooperation between the two companies to form new business models, as well as to develop and implement innovative IT technologies.
We expect GCC countries to be among the first globally to commercialise 5G services due to their oil wealth and populations with high disposable income. In the UAE, Etisalat had 5G in late 2016. Both UAE operators aim to launch 5G services in time for the Expo 2020 in Dubai. Similarly in Qatar, Ooredoo held 5G trials with vendors Huawei and Nokia and in January STC announced it achieved data transmission speed of 70Gbps.
We doubt the industry can agree completely on a new standard this year and produce the 5G standard still not completely defined relevant equipment in scale before the next decade. However, because of the increasingly modular nature of mobile technology, platforms can continue to benefit from ongoing incremental technological improvements long before ‘official’ 5G infrastructures are completely unveiled’ and start to be implemented with a later version of 4G LTE.
5G will need handling with care by EEMEA telcos
In our European Telecoms team’s recent global telecom thematic FT5G: What the telecoms sector 5G could introduce new risks but also new opportunities need is a new acronym, three key outcomes for the global telecoms sector are highlighted. 1. 5G is unlikely to directly boost revenues but it may disrupt business models due to the required base station densification. In addition, the technology will increasingly focus on the software layer, a skillset which is not always associated with telecom operators. On the other hand, 5G could also help establish Fixed Radio Access (FRA) as a broadband access technology. FRA may be particularly useful in emerging markets, mid-size towns in rural areas.
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2. Converged players have the advantage on backhaul and cross-selling. In the EEMEA region, this has significant implications: diversified operators could be advantaged relative to pure mobile operators.
3. The process of attribution of new frequencies could have a significant impact on the sector’s profit outlook. 5G will require the allocation of new high frequencies spectrum, some of which might be unlicensed. This could introduce new risk to the telecoms sector.
EEMEA telcos will need to overcome challenges to monetise 5G
We are sceptical about the 5G Internet of Things (IoT) revenue proposition Expectations for 5G are unrealistic, in our view. Equipment manufacturers are claiming 5G improves Latency and exponential improvements in coverage, latency, capacity and speed. We are somewhat Speed; much less so Coverage and Capacity cautious about 5G’s vaunted coverage and capacity capabilities, while we acknowledge latency and speed could significantly improve.
5G promises substantial improvements along four dimensions
Source: HSBC
If we look at the demand side of the equation, Gartner predicts there will be more than twenty billion connected objects (the Internet of Things, IoT) by 2020. IDC predicts each individual will own five devices within the next year.
We explain in detail why we are sceptical about the 5G revenue proposition later in the report.
4G LTE networks are capable of serving many applications often cited as necessary for IoT 4G LTE can currently handle usage. 4G technology incorporates a pair of standards that address machine-machine IoT communications communications: LTE-Machine (LTE-M) and narrowband IoT (NB-IoT). Both standards have already been deployed. We also note LoRa and Sigfox are complementary initiatives. These standards operate in the 868MHz band and at low speeds (a few kbps) but with much lower energy consumption than 4G standards. We fail to understand in what aspect 5G might be truly ground-breaking. By adding further standards, 5G might merely further fragment the situation.
As wireless technology becomes increasingly modular and flexible, technical progress will be 5G more an evolutionary than revolutionary evolutionary rather than revolutionary. Unlike previous technologies, we think technical enhancement will be incremental and less of a step change. We view 5G more as an optimiser
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in the sense that will it enable networks to manage applications more efficiently. Each application requires very different features from the network. 5G should be able to handle “heterogeneous demand”. Some applications (e-health is one example) will require high reliability but modest latency and bandwidth. Others may demand extremely low bandwidth and can potentially fit around more demanding services (many IoT sensors). But it is unclear whether 5G delivers new applications for which there is real demand (i.e. for which consumers are willing to pay).
So far, monetisation of machine-machine communication (which was originally discussed in So far, operators have found it difficult to monetise conjunction with 3G) has been very slow and revenues have been insignificant, representing machine-machine only 1% of Vodafone group revenues, for example. In the EEMEA region, the short-term communications potential for machine-machine communication appears even smaller. Firstly, there is a smaller installed base of machines and sensors. Secondly, we think relatively cheaper labour cost and lower affordability will negate the demand in the short term within emerging markets.
Most applications do not require double-digit Mbps. In mobility applications, customers are Most IoT applications do not require high speed or high likely viewing one screen at a time. In the instances where separate ‘screens’ are available (for capacity example a Virtual Reality (VR) headset), the customer’s focus will be on one display area at a time. Specifically in a mobility context, there are also likely clear limits as to what resolution is required. The vast majority of videos are watched on a smartphone or tablet. A single-digit mbps bandwidth is sufficient to watch a video at the highest video resolution adapted to these devices’ screen size. In the same fashion, most IoT applications would not require high speeds. We think it is unlikely these applications would impose an extraordinary burden on networks. For most, the capacity requirements will be limited, often in the order of a few kbps.
There are nevertheless some revenue opportunities for 5G in EEMEA On the other hand, 5G may further enable a complete range of applications, even in emerging Some applications could be monetised thanks to lack of markets, from monitoring to control, automation of industrial process in manufacturing or substitutes in emerging resource extraction, mobile banking, mobile health, or mobile education. These services might markets be still in their infancy (m-banking is already significant in some African countries) but could have a promising future due to the lack of alternatives. 5G combined with some relevant applications delivery could offer new services that are in demand but are currently not fulfilled, bringing a technological leap at a relatively affordable cost in a significant number of emerging market countries.
But monetising those services would require telecom companies to have a great deal of skills in Telcos are generally not good in software and innovations, software development and sufficient knowledge of the requirements of individual industries to but would need to develop be able to devise solutions for them. The difficulties for operators in monetising purely data those skills very quickly connections is the lack of strong tangible differentiation between them on just connectivity. Operators who are investing further in their software development skills and moving towards digital applications will be at a greater advantage (eg 02CZ, MTS, Megafon, VimpelCom, Turkcell). Network operators are de facto not immediately qualified in the software domain, as demonstrated by the rise of OTT apps. Operators have continued to provide the underlying connectivity, but have – for understandable reasons – failed to keep up with the degree and pace of innovation that is possible in the software domain.
Overall, we believe monetisation for EEMEA operators would still mostly originate from the Data monetisation still to come from increased increased need for connectivity and data usage. Data monetisation has become more critical. connectivity and data usage Operators have gradually expanded their offers. Integrated operators are gradually benefiting from the consumer shift to bundles and convergence services. Smartphone penetration in the region lags the developed world because of currency headwinds but should gradually catch up when currency stabilises.
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Within the EEMEA region, Cisco, the networking equipment manufacturer, forecasts a 60% 2015-20 CAGR in mobile data traffic (based on Cisco’s VNI Mobile Forecast Highlights, 2015- 2020). Companies that can monetise this data growth and improve (or at least minimise dilution of) ROIC rank better on our scorecard. We therefore look for operators with access to affordable spectrum auction.
EEMEA region to see strong jump in data Mobile data traffic generated by an traffic average smartphone to rise significantly
80% 71% Mobile data traffic 2015-20 CAGR 5000 Mobile data traffic per month generated by a smartphone (MB) 54% 53% 52% 60% 50% 4000 45% 42% 40% 3000
20% 2000 37% CAGR 4406
0% 1000
929 CEE
MEA 0
Global LatAm
AsiaPac 2015 2020 W Europe W N N America Source: Cisco, HSBC Source: Cisco, HSBC
We believe 5G can provide significant revenue opportunities in emerging market mid-size cities 5G FRA could provide fixed wireless broadband more in rural areas where fixed broadband or other alternatives are unavailable. 5G would be an cheaply if fixed broadband economical and efficient way of provisioning Fixed Radio Access for fixed broadband services was non existent through beamed firming technologies. Countries with relatively high numbers of rural mid-size cities with very limited fixed broadband network infrastructure (e.g Turkey, Poland, Russia, African countries) should benefit.
In our 2012 report CEEMEA telecoms, voice versus data: price it right, we highlighted that Operators in countries where net neutrality is not enforced network neutrality would also be a key element that may help monetisation of data access are more likely to be able to potentially through data prioritisation. Current networks tend to throw all applications together monetise versus their return instead of prioritising those that are time-sensitive. This tendency is aggravated by the impact of restrictive net neutrality regulation. A 5G network may be able to stratify its service further into different classes tailored to the precise needs of each application. In turn, this may enable the mobile industry to actively remediate large problems such as network congestion or capacity crunch. In our view, operators in countries where net neutrality is not enforced are more likely to be able to monetise versus their return. Whereas net neutrality is an ingrained concept in CE3 countries, South Africa and to an extent Turkey, its interpretation is more fluid in Russia, the Middle East and some African countries.
5G will accelerate the process of base station densification
Our previous thematic reports have consistently highlighted how improvements in mobile 5G High frequencies short range and the Shannon limit technologies appear to be subject to diminishing returns. The transition from 2G to 3G provided will lead to network for very substantial gains in spectral efficiency (i.e., the amount of data that can be densification accommodated in a given Hertz of radio frequency), but the shift to 4G afforded much more modest gains. Succinctly, we are already close to the physical limit (defined as the “Shannon limit”) of spectral efficiency. As such, capacity increase can only be achieved through high frequency spectrum. The limiting factor of this spectrum is their shorter range. Therefore, operators would need more base stations to increase capacity.
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This only leaves a handful of levers to improve bandwidth:
MIMO (multiple-input multiple-output antennae) Additional spectrum Small cells Potentially, enhancements to prioritisation via network slicing/network virtualisation Off-load traffic to alternatives, e.g., WiFi
The “Shannon Limit” will confine 5G to modest spectral efficiency gains 6
Shannon limit 5 Shannon limit with 3dB offset OFDMA
CDMA (HSPA) 4
3 Inaccessible Region 2
Lower interference Achievable Achievable rate (bps/Hz) Achievable Achievable rate (bps/Hz) environments e.g. 1 isolated hotspots, femtocells 0 -15 -10 -5 0 5 10 15 20 Required SNR (dB) Typical loaded mobile network (outdoors)
Source: HSBC
Base stations with small cells cover a smaller area (than a macrocell). The main benefit is increased bandwidth: available radio frequencies are shared between fewer users and as a result more spectrum can be allocated to each user. However, small cells sites have limitations that are not automatically a desirable outcome. In practice they tend to interfere with macrocells, thus eroding their efficiencies and capacity. A poorly placed small cell may only penetrate into buildings beyond the first floors. In addition, each small cell would require power and backhaul. We note securing additional sites could be problematic in certain locations.
The existing process of network densification will be intensified with 5G
1 mile
4 miles
Source: HSBC
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With the expected densification of cells, operators that have a strong balance sheet, good ability to Diversified Operators with good ability to invest will be invest and a dense network will have a natural advantage. We also highlight the competitive edge at an advantage diversified operators have over pure mobile operators due to their greater backhaul capacities.
5G may introduce new risks
5G Network virtualisation may introduce new risks 5G will accelerate the current trend of shifting network functions away from specialised 5G shift towards software control layer could help tech hardware kits into software running on servers. Features that once required specific hardware giants limit telcos data may instead be carried out by software running on standard servers. The ‘network slicing’ monetisation functionality in 5G specifically gives operators the flexibility to slice their network into different strata to provide services to different categories of customer. In the long term, and as 5G matures, this could enable tech giants such as Google to increasingly take control of the software layer and out-manoeuvre telcos on monetising data connectivity (think how WhatsApp cannibalised SMS revenues).
We can already picture a virtual network that would run on top of the network infrastructure. The virtual network would be controlled by a software layer, an area where traditional telecoms operators might find themselves rapidly out-innovated. There is therefore a risk of the sector being further disrupted by OTT and internet companies.
We highlight the potential threat from Project Fi, a Google MVNO in the US. The key feature is Google Project Fi will first seek to connect via WiFi, and that connectivity is assured by WiFi and cellular networks. For the purpose of this venture, if that is unavailable, will go Google leases cellular capacity from traditional network operators. The service switches through MVNOs seamlessly between WiFi and cellular networks according to signal strength and speed. Google has a pre-eminent position thanks to its Android operating system which has the potential to give it much greater reach than any individual telecom operators.
We reiterate that software has historically not been telecom operators’ core competency; thus Core software competencies for telcos needed to keep those with strong software skills are more likely to resist the onslaught of tech companies. internet companies at bay Use of Unlicensed spectrum could bring new players and more fragmentation 5G spectrum plans Range Band Description <1GHZ 470-694MHz ITU aims to identify bands for 5G usage 600MHz US plans for 5G usage 700MHz EC plans for 5G usage
1-6GHz 3.3-3.8GHz Likely band for initial 5G services globally 3.85GHz FCC has already signed off plans for 5G usage 4.8-4.99GHz Being explored by several countries for 5G usage
>6Ghz 6-24GHz 24Ghz EC plans for 5G usage 28Ghz FCC has already signed off plans for 5G usage; Japan and Korea examining etc Many more higher bands are being explored Source: GSMA 5G Public Policy Position, November 2016
5G brings WiFi with Mobile to create the heterogeneous network (hetnet) The 5G standard is designed to integrate a variety of alternative approaches in a concept With 5G, WiFi and Mobile network are used referred to as heterogeneous networks (and so the ‘hetnet’). It offers the prospect of greater simultaneously integration of WiFi into wireless. For example, a smartphone could simultaneously use the wireless network and WiFi. This could help significantly through offload and especially in areas where there is data congestion during peak hours. As a result, improved end-user experience is a positive outcome.
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Operators with a fixed broadband and mobile network infrastructure would be at a more natural Divesified telcos would benefit from WiFi offload advantage and we believe WiFi offload will remain a powerful tool. While it is already a widely used option today, 5G offers the prospect of improved integration into cellular platforms.
Carrier aggregation technology is already a feature of 4G networks, but the technology has so Unlicensed frequencies could be a threat for telcos data far focused on enabling customers to access multiple bands of licensed spectrum – all owned monetisation by the relevant network operator. The next step is to permit subscribers to use the available bandwidth in unlicensed spectrum (i.e., WiFi) in addition to cellular. There has been considerable progress made on getting WiFi/unlicensed capacity to work seamlessly with cellular/licensed networks. We would therefore anticipate seeing the importance of unlicensed spectrum made available to customers continuing to increase. There are larger blocks of spectrum available at higher frequencies. Some of this (spare) spectrum will likely be allocated on an unlicensed basis. However the unlicensed spectrums are short range and would somewhat limit cannibalisation.
On a final note, one of the problems with unlicensed spectrum is that operators cannot control the availability of the associated frequencies (since they do not own them). Furthermore, although additional unlicensed spectrum is being added at 5GHz, its poor propagation characteristics will make its availability highly variable on the top of the crowded nature of 2.4GHz WiFi spectrum. The most likely scenario is one where the ‘base’ connection would use licensed spectrum (which the operator controls) while the unlicensed spectrum would be utilised when and where available to boost data throughput.
Proposed 5G spectrum above 6GHZ
Source: World Radiocommunications Conference 2015
Within EEMEA emerging markets, operators with greater spectrum in the low bands should be EEMEA telcos with higher bandwidth spectrum in low advantaged as the service will be provided deeper in the buildings through a larger cell. bands will be at an advantage
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Spectrum holdings Total spectrum 800 Total Mobile subs Hz/Mobile Company MHz 900 MHz 1800 MHz 2100 MHz 2600 MHz spectrum (m) subs O2 CZ 20 22.8 30 39.6 40 152.4 5 31.0 Vodafone Qatar 0 11 20 15 0 46 1.5 31.0 Magyar Telekom 20 0 50 30 60 160 5 29.2 Viva 0 10.2 14.6 15 0 39.8 2.4 16.6 Zain 0 13.8 14.2 15 0 43 2.9 14.8 Ooredoo 0 11 20 15 0 46 3.1 14.8 Turk Telekom 20 20 70 30 35 175 17 10.3 Etisalat 0 24.6 40 15 0 79.6 9.7 8.2 Orange Polska 20 13.6 19.2 29.6 30 112.4 16 7.2 Turkcell 20 24.8 59.6 70 60 234.4 34 6.9 Megafon 15 40.4 88.8 30 80 254.2 74 3.4 VIP 15 30.8 87.2 30 20 183 59 3.1 MTN 0 22 24 30 0 76 29 2.6 MTS 15 28.8 83.6 30 20 177.4 77 2.3 Vodacom 0 22 24 30 0 76 34 2.2 Source: Company data
Our preference is for countries where: We prefer countries that allocate cheap spectrum to Access to spectrum is cheap and channelled to existing operators instead of disruptors or existing operators rather than new entrants (this is generally the case for Russia and GCC countries). to new entrants Licenses and frequencies are technology-neutral. Attributed spectrum can be used in the future for 5G. This is generally the case for Russia and Turkey. Potential entry of disruptive new entrants (Google Fi) or technology (VoIP, messaging apps) is limited. This could be for strategic reasons (Russia) or national security (GCC). Competition is balanced, generally where limited to three players with no small players (danger of layering and heavy discount).
5G can nevertheless offer significant opportunities in some areas
5G may also accelerate take-up of fixed broadband as IT (and ICT) increasingly move from a desktop/centralised architecture to a webtop/ centralised cloud architecture HSBC recently used a new acronym: FT5G = Fibre-to-5G (FT5G: What the telecoms sector 5G is likely to accelerate the shift from desktop to need is a new acronym). FT refers to the fact data packets tend to begin their journey in the WebTop, which in turn will core network on fibre. 5G refers to fact that they tend to end their journey on wireless: cellular or increase the need for data (more often) WiFi. Inbetween there lies a series of intermediary technologies: FTTP, G.fast, consumption and DOCSIS3.1, etc. connectivity in EEMEA 5G introduces a new architecture within networks with a direct link to the cloud. In addition to providing wireless connection (IoT = Internet of Things), 5G is likely to accelerate the shift from desktop to webtop. In the latter ‘domain’, most applications and documents are centralised in the cloud and desktop computers are increasingly used as terminals. We wrote on this transformational shift in Cloud burst (October 2011). One of our conclusions was that it decreases the Total Cost of Ownership of PCs and their application, which could have a significant impact on affordability and potentially push for further adoption in emerging markets. A significant outcome of this transition will likely be increasing data consumption and connectivity, in particular in Emerging markets.
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Full circle: cloud involves return to The cloud provides a more efficient way of centralised processing doing processing
Distributed Centralised Distributed
<1980s: 1990s-2000s: Future: the Processing on desktops Processing in the cloud mainframe client/server cloud
Source: HSBC Source: HSBC
5G may open a significant opportunities in fixed radio access (FRA) for emerging markets As discussed previously, WiFi would remain a best-efforts service. It lacks scalability and cannot Interesting development and monetisation opportunities of substitute for mobile. However, 5G might be a substitute for fixed-line connections with FRA in 5G FRA in EEMEA certain contexts. There could be an interesting development for FRA in EEMEA markets as a substitute for satellite broadband (like in Nigeria), providing cheaper backhaul capabilities in rural areas and fixed wireless broadband services in rural urban areas (some parts of Russia, Turkey, North Africa and Africa) where no fixed line infrastructure really exists. FRA could play a key role in areas where the balance of population density, the value of the available market and the practicability of deployment are right.
5G use: FRA and IoT
Source: HSBC
What is FRA? Proposed FRA solutions work over mmWave frequencies exploiting beam-forming techniques. One drawback of such high frequencies is their limited range, perhaps 100-200 metres as a base-case and up to 500 metres when working with line-of-sight.
5G FRA could open opportunities in Emerging EMEA We believe FRA could be an interesting technology to provide fixed broadband with line of sight 5G FRA would provide cheap backhaul and fixed wireless into medium cities or villages where there are currently no alternatives (such as cable, fibre, or broadband in rural urban even VDSL or G fast). We see an application in regions and countries such as Africa, North areas Africa or in rural areas in Russia, Turkey and even Poland.
In the US, Verizon and AT&T have publicly disclosed their plans for 5G, placing particular emphasis on its capabilities in a fixed-line context. One solution being trialled by AT&T involves using millimetre wave to send a multi-Gbps signal from one central building (which is connected directly by fibre) to its neighbours via rooftop-mounted antennae. Each individual apartment in the block served by this wireless signal is then connected to the building’s existing (copper) wiring. It was trialling a point-to-point millimetre wave wireless technology coupled with in- building wiring to provide 100Mbps bandwidths to individual households.
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We believe 5G FRA could be an economical way of providing fixed broadband in areas where it 5G FRA could be a strong substitute for satellite is unavailable. G fast would probably be a better solution economically if a fixed line connection broadband existed. We believe 5G FRA could be a solid alternative to satellite broadband delivery with 5G FRA bringing a much better latency and higher capacity to the end user, at perhaps a lower cost.
Facebook has signalled its interest in wireless solutions, with two development projects Facebook is already targeting rural emerging markets underway: Terragraph and Project ARIES (Antenna Radio Integration for Efficiency in through project ARIES Spectrum). Project ARIES involves base stations with 96 antennae capable of supporting 24 simultaneous communications streams. It uses massive MIMO (i.e., spatial multiplexing) to deliver a claimed 71bits/Hz. MIMO can be used to improve bandwidth or to provide wider coverage, and it is the latter that is the focus for Project ARIES, which seems aimed at rural areas in emerging markets.
At 20Mbps+ speeds, the end-user cannot really discern any difference in webpage download Attractive proposition for fixed wireless broadband time (see following chart). A 20Mbps connection should also offer sufficient capacity to transmit where there are no fixed lines 4K TV. The transmission speed requirement is likely to decrease with the introduction of new coding and compression algorithms. At the same time, we would expect 5G FRA equipment to be cheap as it would be designed for the mass-market and for integration into smartphone chipsets. In our view, this should ensure 5G FRA becomes an attractive proposition to deliver fixed wireless broadband where there is no fixed line alternative.
Average webpage download time, by advertised download speed Cable DSL Fibre Satellite Multiple 9 8 7 6 5 4 (seconds) 3 2
1 Average webpage download time webpage Average 0 0 25 50 75 100 125 150 Advertised download speed (Mbps)
Source:FCC report, 2016 Measuring Broadband America Fixed Broadband Report
Convergence could be accelerated through 5G In our global telecom thematic FT5G: What the telecoms sector need is a new acronym, we Diversified operators at an advantage through bundles demonstrated that fixed and mobile networks are more compliments than substitutes. Our analysis versus pure mobile shows that triple-play (Fixed, TVoIP, Broadband) is accretive but quad-play has a greater risk of a competitors negative-sum game due to more significant discount expected for taking mobile as an add-on service. In theory, convergence can provide a means of cross-selling and up-selling. However, this may be at the expense of other providers if the new services are not incremental, therefore becoming a zero-sum game. In this case, mobile-only players will have to fight back via price discounting (since they lack the relevant fixed-line infrastructure to counter by other means), and hence the revenue picture is liable to become a negative-sum game. The graphs below illustrates that discount is still the most important criteria for the end consumer in taking a bundle.
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Reasons for taking a bundle (Proportion of respondents)
80% 70% 60% 50% 40% 30% 20% 10% 0% Cheaper Convenience - one Convenience - one bill Easier to budget Good experience with supplier previous supplier
Source: Plum Consulting, Ofcom (2010)
Diversified/Converged operators likely to get a cost advantage While quad-play may not be revenue accretive, bundles can significantly improve margins. With 5G, value of fixed lines / backhaul set to increase for Operators such as Magyar Telekom have demonstrated that converged bundles can pure mobile operators significantly decrease churn and increase customer loyalty. 5G will mean more convergence all round as backhaul and density of sites will increase. Associated backhaul costs will be cheaper if the operator owns the network. In this case converged operators are likely to enjoy cost advantage over pure-play competitors. If quad-play is required in selling broadband in the bundle or 5G as a new product, operators will not incur wholesale costs if they own their network and in particular their backhaul and backbones. On the other side, it will be difficult for pure-play mobile players to be credible bundlers of broadband/payTV or have a cost advantage over their competitors if they themselves do not own the fixed lines infrastructure. Even if incumbents are obliged to resell infrastructure, they will earn a return in excess of capital cost. The value of fixed lines assets/backhaul infrastructure is likely to increase for pure mobile operators and the transition to 5G is likely to accelerate that trend.
5G impact for EEMEA telcos
In the previous sections, we have highlighted the 5G opportunities and threats to EEMEA telecom operators. We believe EEMEA telecoms operators will have a greater chance of monetising and/or improving margins if they operating in countries where:
Access to spectrum is cheap and channelled to existing operators instead of disruptors on new entrants (e.g. Russia, GCC)
License and frequencies are tech neutral (most EEMEA countries) Net neutrality is not required and zero rating pricing of content is accepted by regulators (Russia, GCC) Disruptive new entrants (Google Fi) or technology (VoIP) are limited for national security reasons (Russia, GCC)
There are opportunities for broadband to Rural urban mid size cities through 5G Fixed Radio Access with a lack of fixed alternatives (Cable, Fiber, xDSL) in those regions (some regions in Russia, Turkey, Sub-saharan Africa, South Africa)
Competition is limited to three players with no small players (danger of layering) (e.g. Turkey, GCC, South Africa)
We believe countries like Russia, those in GCC and and South Africa should provide a relatively good environment with which to monetise 5G opportunities while limiting potentially disruptive risks.
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In our view, EEMEA telecom operators are more likely to succeed if they present the following characteristics:
Diversified fixed and mobile operations (5G fusioning with WiFi, wireless automatic offload) competing with pure mobile operators
Are able to invest and deep pocket (densification of cells) Superior tech neutral spectrum Strong innovation skillsets in service layers Strong software skillsets How do EEMEA telcos scores on 5G monetisation The following table ranks each EEMEA telecoms operator we cover according to four key criteria. The scores range from 1 (least positive) to 5 (most positive).
The companies that rate highest are those with:
The most room to monetise 5G. Operators with a high potential for data and connectivity growth; strong opportunities in 5G Fixed Radio Access, have investment capacity to meet demand and are ready for bundles. We think integrated operators (i.e. those with fixed and mobile operations) with access to premium content are better positioned against pure mobile operators. Low level of services substitutes or rational competition. Countries where there is in-market consolidation fare better. We have observed more rational competition post-merger as the number of players and substitutes diminishes. Conversely, markets with potential new entrants score worst. The objective of smaller players is to gain market share and reach critical mass. In pursuit of that goal, they can become aggressive on tariffs (and in some cases irrational). With 5G, small players may introduce a risk of significant discount through layering. Two- or three-player markets generally rank higher than four- or five-operator markets. Security concerns (telecoms are perceived as strategic assets) could inhibit deep pocketed international new entrants. Accommodating regulation on 5G. We like markets that present fewer regulatory constraints and companies operating in such countries rank highly. We prefer beauty contests to auctions as it enables operators to buy spectrum at more advantageous prices. We favour technology-neutral licenses because existing spectrum can be used for 5G. The absence of net neutrality policy also helps existing telcos monetise data traffic through prioritisation. Zero-rating data content could also advantage operators with content. An adequate business model with 5G dynamics. Companies that have superior network, superior spectrum and strong innovation and software skills (digital agenda) and are diversified rank higher, as do those with adequate strategies that address cannibalisation of voice by data. These plans can be in the form of data-tiered packages, convergence services and strong brand positioning. In more mature markets, we welcome site-sharing and a more cooperative approach among players as long as it is limited to the passive network element. Companies with business models that relinquish control of the active network rank low: this presents a risk at times of new technology roll-out cycles such as 5G.
We summarise the score for each company in the table below. Overall Russian telcos (MTS, Megafon), Turkcell and MTN score well. In MENA, Ooredoo and Saudi Telecom have the highest scores in their regional group.
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Thematic Score (Long Term) higher points for countries higher point for higher point for tech neutral higher point for diversified with strong opportunities in consolidation and low licenses, no net neutrality operators, with superior FRA with low substitutes, competition and substitute, (+1), light regulation, cheap spectrum, superior network diversified and ready for lower points for new spectrum, zero pricing with strong balance sheet bundles, with still high entrants, more than 3 players content accepted and strong software and potential for data and with a weak players innovation skills connectectivity growth 5G Company data Competitive threats and risk 5G regulation Company model adequate to Overall score monetisation ability 5G drivers Companies (high=5, low=1) (Good=5, Bad=1) (low=5, high=1) (excellent=5, bad =1)
Etihad Etisalat(Mobily) 3 3 4 2 12 Etisalat 4 3 4 4 15 Global Telecom 4 4 4 3 15 Magyar Telekom 3 3 3 3 12 Megafon 5 4 4 3 16 Mobile Telesystems 5 4 4 4 17 MTN Group 4 4 4 4 16 O2 CZ 3 3 2 3 11 Ooredoo 4 3 3 3 13 Orange Polska 2 2 2 3 9 Rostelecom 2 3 3 3 11 STC 4 3 3 4 14 Telkom SA 3 2 3 3 11 Turk Telekom 4 4 3 4 15 Turkcell 4 4 4 4 16 VimpelCom Ltd 3 4 4 5 16 Viva Kuwait 2 2 3 3 10 Vodacom Group 3 3 3 3 12 Vodafone Qatar 2 3 2 3 10 Zain Group 3 3 3 3 12 Zain KSA 2 3 4 1 10 Source: HSBC estimates
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Potential winners and losers
ZAIN, MAGYAR, O2 CZ, TCELL rank favourably on short-term drivers Russian/Turkish telcos and MTN are well positioned for the long-term impact of 5G Key Buys: TCELL, VIP, MTN and MAGYAR on short-term drivers
Short-term drivers
We look at what we see as the three key drivers of short-term share price performance for EEMEA telcos. We acknowledge the fact data is becoming the most significant growth driver and have analysed data monetisation and affordability. We quantify the impact of currency fluctuation: there is much more dislocation between countries and significant disparity among EEMEA telcos. Lastly, we analyse each company’s OpFCF and dividend outlook because investors still perceive the sector as a dividend yield play.
The table below ranks each company under our coverage relative to the above-mentioned factors. The scores range from 1 (least positive or negative) to 5 (most positive). The scoring methodology is detailed in the previous sections.
The valuation score is based on: the target price upside; 2018e EV/EBITDA, EV/OPFCF; dividend yield relative to the sector average.
Short-term drivers Data affordability and FX sensitivity Dividend outlook Overall score monetisation Etihad Etisalat(Mobily) 3 5 1 9 Etisalat 4 3 5 12 Global Telecom 2 4 2 8 Magyar Telekom 3 4 5 12 Megafon 3 2 3 8 Mobile Telesystems 3 2 4 9 MTN Group 3 3 3 9 O2 CZ 3 5 5 13 Ooredoo 3 5 4 12 Orange Polska 1 3 3 7 Rostelecom 3 3 3 9 Saudi Telecom Company 4 3 4 11 Telkom SA 3 3 3 9 Turk Telekom 4 1 4 9 Turkcell 5 2 2 9 VimpelCom Ltd 3 2 4 9 Viva Kuwait 2 4 2 8 Vodacom Group 3 3 3 9 Vodafone Qatar 2 4 2 8 Zain Group 3 5 5 13 Zain KSA 1 5 1 7 Source: HSBCe
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Valuation score Average Company EV/EBITDA EV/OPFCF PE DCF upside Yield valuation score Etihad Etisalat(Mobily) 6 4 3 20 9 8 Etisalat 9 12 4 3 18 9 Global Telecom 22 22 18 19 1 16 Magyar Telekom 12 16 10 16 16 14 Megafon 13 15 14 12 15 14 MTS 14 17 16 7 8 12 MTN Group 8 9 7 14 7 9 O2 CZ 4 8 6 6 19 9 Ooredoo 10 11 9 1 17 10 Orange Polska 15 13 1 11 14 11 Rostelecom 21 19 15 8 4 13 Saudi Telecom Company 7 6 8 13 20 11 Telkom SA 18 14 12 15 5 13 Turk Telekom 16 18 17 10 12 15 Turkcell 11 10 13 17 3 11 VimpelCom Ltd 19 21 20 21 21 20 Viva Kuwait 20 5 11 5 11 10 Vodacom Group 5 7 5 18 6 8 Vodafone Qatar 2 3 21 4 13 9 Zain Group 17 20 19 9 22 17 Zain KSA 3 2 21 2 9 7 Source: HSBC estimates
We then rank operators in quintiles to get a net thematic long-term 5G score. We do the same for our valuation scoring. A high net valuation score means a stock looks cheap relative to its peers based on the four selected valuation criteria. We compare this with our valuation score in the bubble chart overleaf. On both valuation and ST drivers, Zain Group ranks best in GCC, VIP, Magyar Telekom and TCELL in EEMEA. In South Africa, the scoring does not highlight any significant difference between operators.
Net ST Thematic score vs Net Valuation score Company Net thematic score Net valuation score Etihad Etisalat(Mobily) 2.6 1.9 Etisalat 3.2 2.6 Global Telecom 2.5 4.6 Magyar Telekom 3.2 4.1 Megafon 2.5 4.5 Mobile Telesystems 2.6 3.5 MTN Group 2.6 2.3 O2 CZ 3.4 2.1 Ooredoo 3.2 2.8 Orange Polska 2.3 2.3 Rostelecom 2.6 3.9 Saudi Telecom Company 3.0 3.0 Telkom SA 2.6 3.5 Turk Telekom 2.6 4.3 Turkcell 2.8 3.4 VimpelCom Ltd 2.6 5.0 Viva Kuwait 2.5 3.0 Vodacom Group 2.6 1.5 Vodafone Qatar 2.5 1.9 Zain Group 3.4 4.8 Zain KSA 2.3 1.4 Source: HSBCe
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Short-term thematic score vs Valuation relative 6 Key : VIP Zain Buy = 5 Hold = GTH Reduce = TTKOM (size = mkt cap) MFON Magyar 4 RTKM MTS TCELL Telkom SA 3 Viva STC ORDS ValuationRelative OPL MTN Etisalat O2 CZ 2 Vod Qatar Mobily Zain KSA Vodacom 1 1 2 3 4 5 Short term thematic Relative
Source: HSBC
Long-term driver: 5G
5G brings opportunities as well as threats that will have a long-term impact on the fundamental drivers of EEMEA telcos. We think the more successful operators are those with:
diversified fixed and mobile operations (5G fusionning with WiFi, wireless automatic offload) or those who are not competing against diversified operators;
the ability to invest in the densification of cells, superior spectrum which is technology-neutral improving innovation and software skillsets The companies with the highest scores present the following characteristics:
Most room to monetise 5G Low level of services substitutes or rational competition Accommodating regulation on 5G A business model adequate with 5G dynamics We summarise the score for each company in the table below. Overall, Russian telcos Turkcell and MTN score best. In MENA, Ooredoo and STC have the highest scores in their region.
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Thematic LT score breakdown Company model 5G data Competitive threats adequate to 5G monetisation ability and risks 5G Regulation dynamics Total Score Mobily 3 3 4 2 12 Etisalat 4 3 4 4 15 Global Telecom 4 4 4 3 15 Magyar Telekom 3 3 3 3 12 Megafon 5 4 4 3 16 MTS 5 4 4 4 17 MTN Group 4 4 4 4 16 O2 CZ 3 3 2 3 11 Ooredoo 4 3 3 3 13 Orange Polska 2 2 2 3 9 Rostelecom 2 3 3 3 11 STC 4 3 3 4 14 Telkom SA 3 2 3 3 11 Turk Telekom 4 4 3 4 15 Turkcell 4 4 4 4 16 VimpelCom Ltd 3 4 4 5 16 Viva Kuwait 2 2 3 3 10 Vodacom Group 3 3 3 3 12 Vodafone Qatar 2 3 2 3 10 Zain Group 3 3 3 3 12 Source: HSBC estimates
We then rank operators by quintiles to get a net thematic long-term 5G score. We do the same for the valuation scoring. A high net valuation score means a stock looks cheap versus peers based on the 4 selected valuation criteria. We compare this with our valuation score in the bubble chart overleaf.
Our analysis shows Turkcell and Russian telecoms score best on valuation and 5G long-term drivers. MTN perform wells in Africa and so does STC in the Gulf. The lowest ranked are Zain KSA, Vodafone Qatar and Viva. In spite of its diversified network infrastructure, CE3 operators rank in the medium quintile due to a combination of factors: heavy competition from cable operators, large penetration of OTT (which can become a larger risk with 5G) and unhelpful regulation (potential high spectrum cost).
Net long-term thematic score vs net valuation score Company Net thematic score Net valuation score Etihad Etisalat(Mobily) 2.3 1.9 Etisalat 3.4 2.6 Global Telecom 3.4 4.6 Magyar Telekom 2.3 4.1 Megafon 3.9 4.5 Mobile Telesystems 4.6 3.5 MTN Group 3.9 2.3 O2 CZ 1.7 2.1 Ooredoo 3.0 2.8 Orange Polska 1.2 2.3 Rostelecom 1.7 3.9 Saudi Telecom Company 3.2 3.0 Telkom SA 1.7 3.5 Turk Telekom 3.4 4.3 Turkcell 3.9 3.4 VimpelCom Ltd 3.9 5.0 Viva Kuwait 1.4 3.0 Vodacom Group 2.3 1.5 Vodafone Qatar 1.4 1.9 Zain Group 2.3 4.8 Zain KSA 1.4 1.4 Source: HSBCe
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Net long-term thematic score vs net valuation score
Zain VIP Key : Buy = GTH MFON Hold = Magyar TTKOM Reduce = RTKM (size = mkt cap) STC Telkom SA TCELL Viva MTS ORDS
OPL Vod Qatar Mobily MTN ValuationRelative O2 CZ Etisalat Zain KSA Vodacom
1 2 3 4 5 Thematic Relative
Source: HSBC
Conclusion
We highlight operators that score well on short-term drivers (affordability, currency impact, dividend trend) as well as long-term factors (5G data monetisation, competitive threat and risks, 5G regulation, company model adequate to 5G dynamics and upcoming challenges). The table below summarises our overall analysis.
ST scoring vs LT 5G scoring vs Valuation scoring Highly ranked Lowly ranked ST score Magyar Telekom, 02Cz , ZAIN, TCELL, Etisalat ZAINKSA, VIVA, VFQS
5G positioning score MTS, MFON, TCELL, MTN, VIP, VIVA, VFQS, OPL,
Valuation Score (high=Cheap) ZAIN, GTH, TTKOM, TCELL, VIP, MFON, RTKM VFQS, VOD, 02Cz Bold = Buy-rated Source: HSBC estimates
In consideration of the thematic scores and valuation score, we highlight our Buy-rated companies: Turkcell, VimpelCom, MTN over the long-term and Magyar Telekom, Turkcell in the short-term.
Turkcell: Our bullish view on Turkcell is driven mainly by significant improvements in operational trends. We expect Turkcell’s digital strategy to lead to an improvement in ARPUs, lower churn rates and higher EBITDA margins. Given its infrastructure in mobile and fixed line segments, we think Turkcell is successful in executing a convergence strategy. We expect the FCF outlook to improve over the next few years driven by improving margins and declining capital spending. We believe Turkcell’s capital spending cycle will reverse from FY17e. Capital expenditure peaked in FY16, mainly driven by accelerated 4.5G rollout and volatility in TRY/ USD. Given the robust growth outlook, we think Turkcell is attractive based on relative valuation.
VimpelCom: Our positive view on VimpelCom is driven mainly by improving dividend outlook on the back of improving free cash flows. VimpelCom guides for equity free cash flow of more than USD1bn for FY18 (compared to USD588m in FY16 and guidance of USD700-800m in FY17). Management guides for low single digit growth in revenue and EBITDA. The growth in equity free cash flows will be driven mainly by improvement in capital efficiency. VimpelCom’s emphasis on disposing non-strategic assets will help it to reduce the capex/sales to c15% over the medium term (currently 17-18%). Given the robust free cash flows over next few years, we see significant scope for dividend improvement at VimpelCom.
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MTN: MTN finds itself in a unique ‘capex hike’ and ‘FX headwind’ cycle, which is contracting FY17e FCF margins. We believe the base is suitably low for FCF/dividend delivery to exceed expectations over the next 12-24 months, despite higher Iranian repatriation and ZAR concerns recently. Over the past three to five years the coefficient of variation (std dev/mean) for MTN’s FCF yield and dividend yield has been significantly lower than that for EV/EBITDA and PE. Cash-earnings and yield dynamics still drive MTN’s rating, and valuation is attractive on a current forward FCF yield of 7.4% (1.8 std deviations above mean). Operational progress, specifically data/VAS monetisation, will be significant over the medium term. All three engines are growing strongly and are set to come off elevated-capex bases. Dividend transformation on a two-year basis is meaningful with additional optionality if Nigeria repatriation can commence. FY18e will be a transformational FCF/EBITDA period; we expect investors to start positioning for this in 2017. In FY18e the effects of Naira depreciation will hit and the SA/Nigeria capex bump-up will be in the base; we expect FY18e proportionate FCF to grow 31% y-o-y and proportionate EBITDA to grow 10.2% y-o-y. Given the initiation of a progressive dividend theme and new CEO/CFO placements in March/April 2017, we expect the market to price in the FY18e recovery beforehand.
Magyar Telekom: Our bullish view on Magyar Telekom is based on an improving dividend outlook supported by growth in FCF. We expect FCF to grow significantly on lower near-term capex. We expect capital spending to decline by over10% y-o-y in FY17e and FY18e and operating margins to be roughly stable in FY17e. Our cautious view on margins is mainly driven by the entry of Digi and potential competitive pressures in Hungary, but we expect the impact of Digi to be limited due to the lack of a mandatory national roaming agreement in Hungary. Margin improvement should continue gradually and we expect EBITDA margin to reach c35% over the next five years (compared with 32.7% in FY16). Based on improving margins and declining capex, FCF yield looks robust over the next few years. The leverage ratio should decline significantly, leaving significant scope for improving dividend: we have FY17e dps at HUF30 (vs FY16 dps of HUF25). Magyar Telekom’s dividend policy is to maintain leverage ratio (net debt/total capital) under 40%.
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Companies section
Valuation methodology and assumptions for EEMEA telcos Company Valuation Methodology Assumptions Etisalat Relative valuation based SOTP EV/EBITDA 17e of 6x times for UAE, EV/EBITDA 17e of 5x for Maroc Telecom Global Telecom DCF based SOTP WACC of 14%, 12.6% and 12.2% for Algeria, Pakistan and Bangladesh respectively Magyar Telekom DCF COE of 10.9%, RFR of 4.8%, Beta of 1.1 and MRP of 5.5% Megafon DCF COE of 14.6%, RFR of 8.5%, Beta of 1.1 and MRP of 5.5% Mobile Telesystems DCF COE of 14.6%, RFR of 8.5%, Beta of 1.1 and MRP of 5.5% Mobily (Etihad Etisalat) DCF WACC of 8.1%, COE of 9.4%, RFR of 2.5%, MRP of 7%, Beta of 1 MTN Group DCF based SOTP and DCF COE of 18.1%, RFR of 12%, Beta of 1, MRP of 6% O2 CZ DCF COE of 8%, RFR of 2.5%, Beta of 1 and MRP of 5.5% Ooredoo Relative valuation based SOTP EV/EBITDA 17e of 5.5x for Qatar, EV/EBITDA 17e of 3x for Iraq Orange Polska DCF COE of 9%, RFR of 3.5%, Beta of 1 and MRP of 5.5% Rostelecom DCF COE of 14.6%, RFR of 8.5%, Beta of 1.1 and MRP of 5.5% Saudi Telecom Company DCF and SOTP WACC of 6.6%, RFR of 2.5%, MRP of 7%, Beta of 0.73 Telkom SA DCF and SOTP COE of 13.5%, RFR of 8.5%, MRP of 5%, Beta of 1 Turk Telekom DCF COE of 16%, RFR of 10.5%, Beta of 1 and MRP of 5.5% Turkcell DCF COE of 16%, RFR of 10.5%, Beta of 1 and MRP of 5.5% VimpelCom Ltd DCF COE of 14.6%, RFR of 8.0%, Beta of 1.1 and MRP of 5.5% Viva Kuwait DCF WACC of 6.5%, RFR of 2.5%, MRP of 4.5%, beta of 1 Vodacom Group Discounted medium term Terminal FCF Yield of 7.5% terminal value Vodafone Qatar DCF WACC of 8.9%, COE of 13.2%, RFR of 2.5%, MRP of 7%, Beta of 1.53 Zain Group Relative valuation based SOTP EV/EBITDA 17e of 5x for Kuwait, EV/EBITDA 17e of 3x for Iraq and Sudan Zain KSA DCF WACC of 9%, COE of 12.1%, RFR of 2.5%, MRP of 7%, Beta of 1.4 Source: HSBC
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Etisalat (ETISALAT UH)
Cash generation suggests scope for dividend increase Etisalat ranks best among GCC operators for 5G on our scorecard… …however, rich valuation means we rate the stock Reduce with a AED14.9 TP
Company description
Etisalat is the incumbent telecom operator in the UAE with leadership positions in the fixed and Eric Chang* mobile segments. It expanded internationally through a series of acquisitions and greenfield Analyst HSBC Bank Middle East Limited projects and today is an integrated telecoms operator focused on the Middle East, Africa and [email protected] +971 4 423 6554 South Asia. It has built a portfolio of assets primarily focused on MENA (KSA, UAE, Egypt, Morocco) and Africa (Benin, Burkina Faso, the Central African Republic, Gabon, the Ivory Nikhil Mishra* EEMEA Telecom Associate Coast, Mali, Mauritania, Nigeria, Niger, Togo). It also owns operations in South Asia Bangalore (Afghanistan, Pakistan, Sri Lanka). The UAE still represents half of group revenues and EBITDA
while Maroc Telecom (IAM MC, MAD142.80, Not rated) represents the bulk of the balance. For * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ the purpose of this thematic report, we only consider Etisalat’s key markets: UAE, Morocco, qualified pursuant to FINRA regulations Pakistan and Egypt.
Short-term drivers
Affordability, spend dynamics and potential for data monetisation We expect Etisalat to continue to monetise data in the UAE relatively unimpeded. The UAE telecom sector is characterised by high smartphone penetration (c. 70%), high average smartphone selling price (USD300+) and pricing that is commensurate with income levels. The UAE is a two-player market and perhaps the only GCC market where there is a modicum of pricing rationality. Both operators have so far eschewed unlimited data pricing plans or free handset bundles. Instead, they have been using data allowance as a retention tool whereby a longer contractual commitment boosts monthly data allowance.
Instead, we think the challenge lies more in the international operations (Egypt, Morocco, Pakistan and Western Africa), which in aggregate represent nearly 40% of group revenues. We think competitive intensity – the majority of these markets have three or four players – as well as significantly lower GDP/per capita, may inhibit Etisalat’s capacity to monetise data.
Currency impact We expect negligible currency impact over the short term. We estimate the group has 70% of debt and capital expenditure denominated in either USD or EUR.
Etisalat has no currency exposure from its UAE domestic operations (just over 50% of group revenues) given that the AED is pegged to the USD. Instead, exposure lies in the domestic operations of Maroc Telecom, and Egypt and Pakistan. These three markets contribute a third of group revenues.
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The MAD has weakened over the past three years and is now trading around 10 (to the USD). HSBC expects the USD:EGP to settle around the 18 level by year-end. The PKR has been stable for the past year and a half. We highlight that Maroc Telecom has significant operations in Western Africa but currency fluctuation will have minimal impact on Etisalat because the XFA is pegged to EUR.
Dividend outlook Etisalat has maintained a prudent balance sheet, alternating between net cash and minimal net debt positions. We do not expect management to deviate from that. The company does not have a defined dividend policy other than an interim and final dividend payment. We therefore expect an annual dividends increase of AED 0.05 per share from FY2017e. Current dividend yield at half the free cash-flow yield suggest the UAE incumbent has significant room to increase pay-out.
Long-term driver: 5G expected impact
Monetisation We see Etisalat as be well placed to capitalise on the 5G opportunity. It has leading positions as an integrated operator in the UAE and Morocco. We note that it does not offer any converged bundles that include mobile services in either market.
We see opportunity where the topography allows FRA to substitute or even complement a fixed network. For example, the technology could be being rolled out outside the Nile delta or in Pakistan’s mountainous regions.
Competition We discount the risk of new entrants. The markets in which Etisalat has a presence would struggle to support an additional operator that might not be wholly driven by profit motives.
In the UAE, competition remains rational. Both operators have so far eschewed unlimited data pricing plans or free handset bundles. Instead, they have been using data allowance as a retention tool whereby a longer contractual commitment boosts the monthly data allowance. The UAE government has limited the array of services offered by OTT players (example VoIP) in the interests of national security; thus we see limited threat from Google or Facebook.
Competition is somewhat more elevated in the international operations. We note the Moroccan regulator has designated Maroc Telecom a dominant operator which may level the playing field. In Egypt, we expect Telecom Egypt’s entry into the mobile segment to disrupt the market although there is no clarity on the commercial launch of services. We note however that its mobile license (obtained in summer 2016) required it to “make the services available within six months”, which has since lapsed. In Pakistan, PTCL lags its mobile competitors.
Regulation On this metric, Etisalat scores highly due to the regulatory landscape in the UAE. In its domestic market, the telecom license is independent of the transmission technology. The regulator’s influence has so far been relatively benign.
We have not attributed the highest score due to increasing regulatory headwinds in the international markets. Often, as in the case of Egypt and Morocco, operators need to bid separately for a 4G mobile license and the relevant spectrum. In addition, we note the Moroccan regulator has designated Maroc Telecom a dominant operator but has yet to impose any regulation or constraints on it.
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Business model From its experience as an integrated telecom operator in the UAE, Etisalat has deployed data-enabled mobile networks in record time in Egypt and Saudi Arabia. Its 2014 acquisition of Maroc Telecom adds to that knowledge base.
We see the case for 5G roll-out and adoption in the UAE but are circumspect about the potential in its international markets. Competition and low GDP per capita conspire against an extensive roll-out.
Investment thesis
Despite its high relative ranking in our scorecard, we note that on a fundamental valuation Etisalat trades at a significant premium to the EEMEA telecom sector average: 2017e EV/EBITDA of 5.7x (EEMEA average 4.7x) and P/E of 18.9x (EEMEA average 11.1x). This highlights its strong competitive positions (as the incumbent) in the UAE and Morocco, also reflected in EBITDA margins in excess of 50% and its high cash generation. Nevertheless, current multiples would presume that turnaround of its international operations (West Africa, Egypt and Pakistan) is imminent and these subsidiaries’ EBITDA margins would converge with those in the UAE and Morocco.
Valuation and Risks
Etisalat: ETISALAT UH, AED17.85, Reduce, TP AED14.90 We value Etisalat on a sum-of-the-parts methodology. We continue to value the UAE operations on 6x 2017e EBITDA and Maroc Telecom (IAM MC, NR) at 5x 2017e EBITDA. We update the current market value of PTCL (PTC PK, PKR 16.87, Not Rated). We value Egypt on 5.5x 2017e EBITDA. We value Mobily at its TP of SAR27.20. We roll-forward net debt to 2017e year-end. Our estimates are broadly unchanged. We have a AED14.90 TP, which implies 16.5% downside. We rate the stock Reduce because valuation continues to look rich despite its strong cash generating assets.
Etisalat SOTP EBITDA EV % EV % (AEDm) 2017e /EBITDA stake (current) of EV UAE 16,192 6.0x 100.0% 97,150 76.6% Maroc Telecom 6,957 5.0x 48.4% 16,838 13.3% Egypt 1,026 5.5x 66.0% 3,726 2.9% Pakistan 1,594 2.9x 23.4% 1,018 0.8% Asia 322 3.0x 100.0% 965 0.8% Subsidiaries 119,697 Mobily 4,043 27.0% 5,536 4.4% Nigeria 658 5.0x 40.0% 1,316 1.0% Associates 6,852 Other interests 296 0.2% EV 126,845 Debt 22,389 Cash -22,464 Adj. for minority's share in debt -3,315 Net debt -3,390
Equity value 130,235 Issued shares (m) 8,696.75 FV 14.90 Source: HSBC estimates
Key upside risks include: Competition easing in Morocco, Egypt and Pakistan; Mobily achieving a quicker-than-expected turnaround; a formal dividend policy; any further easing of foreign ownership for the company; a weakening of the USD, which would have a positive FX impact on Etisalat's earnings as almost half its revenues are non-dollar pegged.
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Relative valuation Etisalat trades ahead of the sector average on a forward EV/EBITDA multiple. The share price re-rating started when foreign ownership rules were relaxed in the summer of 2015. Looking at estimates revision, it appears the consensus has become more prudent. Etisalat’s dividend yield remains respectable at 5% for 2017e vs the peer average of 6x.
ETISALAT: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 1.4% 0.3% -3.0% -10.1% -5.3% Total return 1.4% 0.3% -3.0% -10.1% -1.2% Total return vs EEMEA index (USD) 2.6% 0.2% -7.9% -12.0% -18.7% Total return vs MSCI EEMEA Telecom (USD) 0.7% -1.7% -8.2% -12.9% -8.9% Price return vs ADX 1.0% -0.1% -4.6% -11.7% -5.4% Price Return (USD) 1.4% 0.3% -3.0% -10.1% -5.4% Total Return (USD) 1.4% 0.3% -3.0% -10.1% -1.2% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 67,460 7 64,310
6 61,160 58,010 5 54,860 51,710 4 48,560 45,410 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
12 30,910 10 29,700 8 28,490 27,280 6 26,070 4 24,860 2 23,650 0 22,440 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
8.0% 31,220 26,760 6.0% 22,300
4.0% 17,840 13,380 2.0% 8,920 4,460 0.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
52 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Financials & valuation: Etisalat Reduce
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (AEDm) EV/sales 2.8 2.8 2.7 2.6 Revenue 52,360 52,591 54,778 57,358 EV/EBITDA 5.8 5.7 5.5 5.2 EBITDA 25,298 26,091 27,064 28,184 EV/IC 2.9 2.6 2.5 2.4 Depreciation & amortisation -7,543 -7,580 -7,869 -8,163 PE* 15.6 18.9 18.0 17.1 Operating profit/EBIT 17,755 18,511 19,195 20,021 PB 3.6 3.4 3.4 3.3 Net interest -442 -176 -149 -152 FCF yield (%) 9.7 10.5 10.6 11.1 PBT 10,693 10,677 11,302 12,006 Dividend yield (%) 4.8 5.0 5.3 5.3 HSBC PBT 12,202 10,677 11,302 12,006 * Based on HSBC EPS (diluted) Taxation -1,206 -801 -848 -900 Net profit 8,421 8,207 8,619 9,080 HSBC net profit 9,930 8,207 8,619 9,080 Issuer information Cash flow summary (AEDm) Share price (AED) 17.85 Free float 40% Cash flow from operations 23,254 26,174 26,652 28,031 Target price (AED) 14.90 Sector Diversified Telecoms Capex -7,092 -9,636 -9,995 -10,704 Reuters (Equity) ETEL.AD Country United Arab Emirates Cash flow from investment -7,092 -9,636 -9,995 -10,704 Bloomberg (Equity) ETISALAT UH Analyst Eric Chang Dividends -8,708 -7,827 -8,262 -8,262 Market cap (USDm) 42,260 Contact +971 4 423 6554 Change in net debt -2,075 1,322 615 354
FCF equity 14,515 15,562 15,660 16,275 Balance sheet summary (AEDm) Price relative Intangible fixed assets 28,808 29,450 28,822 28,323 Tangible fixed assets 42,450 48,574 51,328 54,367 Current assets 44,358 41,951 41,562 38,192 24.00 24.00 Cash & others 23,676 22,464 21,849 18,188 22.00 22.00 Total assets 122,546 128,627 130,634 130,309 20.00 20.00 Operating liabilities 40,143 41,464 41,278 41,416 18.00 18.00 Gross debt 22,279 22,389 22,389 19,082 16.00 16.00 Net debt -1,398 -75 540 894 14.00 14.00 Shareholders' funds 42,701 45,184 45,541 46,360 12.00 12.00 Invested capital 51,796 56,047 58,585 61,278 10.00 10.00 8.00 8.00 2015 2016 2017 Ratio, growth and per share analysis Etisalat Rel to DUBAI FINANCIAL MARKET INDEX
Year to 12/2016a 12/2017e 12/2018e 12/2019e S ource: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 1.2 0.4 4.2 4.7 EBITDA -4.6 3.1 3.7 4.1 Operating profit -6.3 4.3 3.7 4.3 PBT -0.9 -0.2 5.9 6.2 HSBC EPS 1.8 -17.4 5.0 5.3 Ratios (%) Revenue/IC (x) 1.0 1.0 1.0 1.0 ROIC 32.7 34.5 33.5 33.2 ROE 23.0 18.7 19.0 19.8 ROA 8.6 8.1 8.3 8.7 EBITDA margin 48.3 49.6 49.4 49.1 Operating profit margin 33.9 35.2 35.0 34.9 EBITDA/net interest (x) 57.3 148.4 181.4 185.1 Net debt/equity -2.5 -0.1 0.8 1.3 Net debt/EBITDA (x) -0.1 0.0 0.0 0.0 CF from operations/net debt 4932.6 3134.7 Per share data (AED) EPS Rep (diluted) 0.97 0.94 0.99 1.04 HSBC EPS (diluted) 1.14 0.94 0.99 1.04 DPS 0.85 0.90 0.95 0.95 Book value 4.91 5.20 5.24 5.33
53 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Global Telecom Holding (GTHE EY)
Short term: Competitive intensity in Algeria and Bangladesh likely to impede growth Long term: Focus on turning asset-light in key operating markets is positive Maintain Hold, cut TP to EGP8(from EGP8.7)
Company description
Global Telecom is a diversified telecom operator with a presence in Algeria, Pakistan and Herve Drouet* Head of EEMEA TMT Equity Bangladesh. Algeria contributes c35% of total group revenue, Pakistan contributes c44% and Research Bangladesh contributes c21%. Global Telecom holding recently cancelled its GDR programme HSBC Bank plc [email protected] and is now listed solely on the Egypt stock exchange. +44 20 7991 6827
Venkata Velagapudi*, CFA EEMEA Telecom Associate Short-term drivers Bangalore
Affordability, spent dynamics and potential for data monetisation * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ Smartphone and mobile data affordability is very low in Algeria, with currently around 40% of qualified pursuant to FINRA regulations mobile users there using mobile data services. Despite a significant untapped data usage market we think further growth in mobile data penetration will be slower than other EEMEA markets. Currently the price of the most affordable smartphone in Algeria represents around 40% of average monthly disposable income. Moreover high competitive intensity and tough macroeconomic conditions lead to high churn rates and ARPU erosion in Algeria in the short term.
The data monetisation opportunity in Bangladesh is impacted by aggressive competition, which increased post the SIM-verification. The 3G network gap in semi-rural and urban areas will also impact data growth in Bangladesh in the near term.
However, Pakistan should partially offset the slowdown in Algeria and Bangladesh. The recent merger of Mobilink and Warid will impact mobile data growth in Pakistan further.
Dividend outlook Global Telecom scores poorly on this parameter. It has not paid a dividend since 2009 and we do not see any change in the company’s stance over dividends in the short term. The high competitive intensity and tough macro in Algeria will lead to high churn rates and ARPU erosion. Post the recent SIM verification programme competition appears to have grown more intense in Pakistan.
54 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Long-term driver: 5G expected impact
GTH is in a reasonably good position in Pakistan and Bangladesh to capitalise on a 5G launch and we expect rational competition to help sustain strong margins over the medium term. However, we are conservative about the prospects of GTH post a 5G launch in Algeria due to the intense price competition there.
Spectrum prices should remain reasonable in our view. The strategic focus of the parent company (VimpelCom) to turn asset light and dispose of non-strategic assets like towers may be positive over medium term.
Investment thesis
We expect Bangladesh to be the key driver of growth for GTH. The recent consolidation of Mobilink (GTH’s Pakistan segment) and Warid will help to improve margins further. However growth outlook could be impacted by the Algeria and Pakistan segments. We expect revenue and EBITDA to grow at c8% in the near term. GTH’s valuation looks attractive on our estimates, trading at a 1 year forward EV/EBITDA multiple of less than 3x compared with the EEMEA average of c5x. However, the company may prefer to deleverage rather than pay dividends to shareholders over near term. We view the delisting of the GDR negatively as it will reduce liquidity and limit investor access to the local listing in Egypt, with the potential associated risks (cash repatriation constraints).
Change in estimates We cut our estimates based on lower than expected Q4 2016 results and our revised expectations.
Old vs New estimates Old 2017e 2018e 2019e Revenue 3,370 3,559 3,759 EBITDA 1,488 1,567 1,651 Net profit 189 247 345 New 2017e 2018e 2019e Revenue 3,208 3,270 3,370 EBITDA 1,397 1,494 1,531 Net profit 180 225 286 Old vs New 2017e 2018e 2019e Revenue -5% -8% -10% EBITDA -6% -5% -7% Net profit -5% -9% -17% Source: HSBCe
Valuation and Risks
Global Telecom Holding, GTHE EY, EGP7, Hold, TP EGP8 We cut our DCF-based SOTP target price to EGP8 from EGP8.7 for the local shares, driven by our reduced estimates. We use a WACC of 14% (Previously 12.3%) to value the business in Algeria, 12.6% for Pakistan and 12.2% (Previously 10.8%) for Bangladesh. We use a USD: EGP spot exchange rate of 17.5 (18.7 previously). Our TP implies upside of 14.3% and we rate the stock Hold as we anticipate short-term selling pressure from the GDR programme cancellation.
55 EQUITIES ● TELECOMS / EEMEA 16 March 2017
GTH sum of the parts valuation EV Stake GTH's share in EV Algeria 2044 49% 2044 Pakistan 2058 100% 2058 Bangladesh 891 100% 891
Total EV 4993 4993 Group net debt -1995 -1995 Minorities -693 -693 Non-Core assets 481 100% 481 Contingent Liability -67 -67 Equity value 2786 2719 Shares (fully diluted) (in millions) 5246 5246
Value per share(USD) at 2017 end 0.52 Current Fair value 0.46 USD-EGP exch rate 17.5 Target price (EGP) 8.0 Source: HSBCe
Main upside risks: higher market share gain and margin recovery in Algeria from the recent 4G launch and superior cash return from potential sale and lease back of tower businesses in Pakistan and Bangladesh.
Main downside risks: continuous erosion of the Algerian telecom markets due to increased competitive pricing, increasing competitive pressure in key operating markets like Pakistan, Bangladesh and Algeria.
56 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Valuation Relative
One of the cheapest on most relative ratios versus the EEMEA telecoms sector but no dividend yield Back to historical valuation relative after strong share price performance Relatively stable consensus trend in particular on opFCF
Global Telecom Holding: Valuation Benchmark Chart Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 10.2% -4.9% 18.6% 69.1% 218.2% Total return 10.2% -4.9% 18.6% 69.1% 218.2% Total return vs EEMEA index (USD) 1.8% -3.1% 16.6% -17.1% 23.3% Total return vs MSCI EEMEA Telecom (USD) 9.6% -6.9% 13.4% 66.3% 210.6% Price return vs EGX 4.1% -1.2% 5.9% 13.6% 117.3% Price Return (USD) 0.6% -3.0% 21.5% -15.2% 40.6% Total Return (USD) 0.6% -3.0% 21.5% -15.2% 40.8% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 4,160 5 3,940 4 3,720 3,500 3 3,280 2 3,060 1 2,840 2,620 0 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2014 2015 2016 2017 2018 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
70 1,900 60 1,790 50 1,680 40 1,570 30 1,460 20 1,350 10 1,240 0 1,130 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2014 2015 2016 2017 2018
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
0.7% 2,520 0.6% 2,160 0.5% 1,800 0.4% 1,440 0.3% 1,080 0.2% 720 0.1% 360 0.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2014 2015 2016 2017 2018
Source: Thomson Reuters Datastream, HSBCe
57 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Financials & valuation: Global Telecom Hold
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (USDm) EV/sales 1.4 1.2 1.1 0.9 Revenue 2,957 3,208 3,270 3,370 EV/EBITDA 3.3 2.8 2.4 2.0 EBITDA 1,294 1,397 1,494 1,531 EV/IC 1.8 1.7 1.6 1.4 Depreciation & amortisation -667 -669 -659 -649 PE* 16.5 11.5 9.2 7.2 Operating profit/EBIT 627 727 834 881 PB 5.1 3.5 2.6 1.9 Net interest -258 -269 -277 -264 FCF yield (%) 18.5 16.6 18.3 19.0 PBT 436 459 544 633 Dividend yield (%) 0.0 0.0 0.0 0.0 HSBC PBT 406 459 544 633 * Based on HSBC EPS (diluted) Taxation -147 -166 -204 -226 Net profit 155 180 225 286 HSBC net profit 126 180 225 286 Issuer information Cash flow summary (USDm) Share price (EGP) 7.00 Free float 48% Cash flow from operations 913 973 1,051 1,064 Target price (EGP) 8.00 Sector Wireless Telecoms Capex -465 -583 -596 -608 Reuters (Equity) GTHE.CA Country Egypt Cash flow from investment -473 -583 -596 -608 Bloomberg (Equity) GTHE EY Analyst Herve Drouet Dividends 0 0 0 0 Market cap (USDm) 2,074 Contact 44 20 7991 6827 Change in net debt 13 -321 -439 -449
FCF equity 424 378 418 433 Balance sheet summary (USDm) Price relative Intangible fixed assets 1,806 1,806 1,806 1,806 Tangible fixed assets 2,146 2,060 1,997 1,955 Current assets 1,165 2,173 2,621 3,085 7.77 7.77 Cash & others 606 1,608 2,047 2,496 6.77 6.77 Total assets 5,598 6,520 6,892 7,329 5.77 5.77 Operating liabilities 2,097 2,113 2,143 2,174 Gross debt 2,602 3,283 3,283 3,283 4.77 4.77 Net debt 1,995 1,675 1,236 787 3.77 3.77 Shareholders' funds 404 584 809 1,095 2.77 2.77 Invested capital 2,414 2,318 2,234 2,176 1.77 1.77 0.77 0.77 2015 2016 2017 Ratio, growth and per share analysis Global Telecom Rel to EGYPT HERMES INDEX
Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 0.9 8.5 1.9 3.1 EBITDA 1.1 7.9 6.9 2.5 Operating profit 25.1 16.1 14.7 5.6 PBT 206.9 5.3 18.7 16.2 HSBC EPS 435.2 43.3 24.7 27.5 Ratios (%) Revenue/IC (x) 1.2 1.4 1.4 1.5 ROIC 16.9 19.6 23.0 25.7 ROE 33.6 36.4 32.2 30.1 ROA 8.9 8.1 8.1 8.7 EBITDA margin 43.8 43.5 45.7 45.4 Operating profit margin 21.2 22.7 25.5 26.2 EBITDA/net interest (x) 5.0 5.2 5.4 5.8 Net debt/equity 374.3 202.9 106.0 50.0 Net debt/EBITDA (x) 1.5 1.2 0.8 0.5 CF from operations/net debt 45.8 58.1 85.0 135.2 Per share data (USD) EPS Rep (diluted) 0.03 0.03 0.04 0.05 HSBC EPS (diluted) 0.02 0.03 0.04 0.05 DPS 0.00 0.00 0.00 0.00 Book value 0.08 0.11 0.15 0.21
58 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Magyar Telekom (MTELEKOM HB)
Short-term drivers look encouraging, mainly due to dividend outlook Moderately placed to benefit from 5G.Convergence strategy and network sharing will help but completion and regulation challenging Attractive based on valuation score; Maintain Buy and HUF580 TP
Company description
Magyar Telekom is a diversified telecom operator in Hungary, Montenegro and Macedonia. The Herve Drouet* Hungary segment contributes c87% of group revenue, of which mobile represents c53% and Head of EEMEA TMT Equity Research fixed line, c33%. HSBC Bank plc [email protected] +44 20 7991 6827 Short-term drivers Venkata Velagapudi*, CFA EEMEA Telecom Associate Bangalore Affordability, spent dynamics and potential for data monetisation
Currently, mobile data users comprise 48% of the total mobile subscriber base for Magyar * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ Telekom, and mobile data revenue constitutes c26% of mobile service revenue. The improving qualified pursuant to FINRA regulations macro in Hungary should lead to increased smartphone penetration enabling the mobile data revenue to grow further. Smartphone penetration is at 61% for Magyar Telekom. The most affordable smartphone costs less than 4% of monthly PPP-adj GDR per capita in Hungary and the average mobile data price per GB accounts for 0.34% of PPP adjusted GDP per capita.
Currency impact We expect the currency impact to be negligible for Magyar Telekom short-term as USD:HUF exchange rate is forecast flat over 2017, as per HSBC’s FX strategists. Roughly 20% of Magyar’s debt comprises EUR-denominated debt; however there is a cross currency swap that completely hedges this. Around 67% of Magyar Telekom’s capital expenditure is in hard currency for FY16.
Dividend outlook We looked at Magyar Telekom’s dividend outlook based on the attractiveness of dividends and its ability to maintain them. We are encouraged by a reduction in leverage over the past few quarters, with Q4 2016 leverage ratio (net debt/ (net debt + equity)) falling to below 40% (39.3%). Magyar Telekom announced a dividend of HUF25 per share for FY16. We estimate DPS of HUF30 in FY2017 .Magyar Telekom’s dividend policy is to keep the leverage ratio (net debt/total capital) under 40%. We forecast this falling to 33.2% by end-FY18 and 29.2% by end- FY18, which implies significant room for further dividend improvement.
59 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Long-term driver: 5G expected impact
We expect Magyar Telekom to be moderately well placed to capitalise on the benefit of 5G. Given its mobile and fixed operations, we think it is well placed to offer bundled services and would be at an advantage as a diversified incumbent with a strong presence in fixed broadband. Currently, its Magenta1 offer is being well received by the customers in Hungary, with over 113k subscribers using Multi play Magenta1. Over 50% of Magenta1 subscribers have at least 30Mbps fixed broadband, with the share of plans including unlimited mobile voice and SMS at close to 50%.
Although, there is a potential four mobile operator (Digi, NR) in Hungary in FY17, we believe the competitive challenge will be limited by the lack of a mandatory national roaming agreement and limited quantity of spectrum available to Digi. With potential 5G fusion with WiFi, cable operators such as Liberty Global (LBTYA.OQ, USD, Buy) could play a role as well as some OTT players such as Facebook (FB.OQ, USD137.7, Not rated) or Google (GOOGL.OQ, USD853, Not rated) This could be potential threat to 5G monetisation.
The regulatory framework is unlikely to be supportive with net neutrality in place and additional spectrum likely to be auctioned at a significant price. We do not see any major changes to the existing regulatory environment in Hungary in the medium term. We think Magyar Telekom’s business model can deal with 5G dynamics as it has a strong balance sheet, continues to invest and is developing its software skills. The company has a 4G network sharing agreement with Telenor, which is one reason for its reduced capital spending over recent quarters. We expect Magyar Telekom to continue to collaborate with other players to reduce the capital expenditure required for 5G roll out as well.
Investment thesis
Our bullish view on Magyar Telekom is based on improving dividend outlook supported by growth in FCF, which we expect to grow significantly owing to lower capex in the near term. We expect capital spending to decline by over 10% y-o-y in FY17e and FY18e and operating margins to be roughly stable in FY17e. Our cautious view on margins is mainly driven by the potential entry of Digi and competitive pressures in Hungary. However, we would expect Digi’s impact to be limited due to the lack of a mandatory national roaming agreement in Hungary. We expect gradual margin improvement to continue, with EBITDA margin reaching c35% over the next five years (vs 32.7% in FY16).
Based on improving margins and declining capex, we expect FCF yield to be robust over the next few years, with the leverage ratio declining significantly. This leaves significant scope for improving the dividend: we estimate HUF30 FY17 dps (vs HUF25 in FY16). Magyar Telekom’s dividend policy is to keep the leverage ratio (net debt/total capital) under 40%: we expect this to fall to 33.2% by end- FY17e and 29.2% by end-FY18e, implying significant room for further dividend improvement.
Based on an improving FCF outlook, Magyar Telekom looks attractive based on 1 year forward EV/Operating FCF. It trades at a 1 year forward EV/Op FCF of 8.7x (compared to the EEMEA average of 11.8x).
Valuation and Risks
Magyar Telekom: MTELEKOM HB, HUF500, Buy, TP HUF580 Our fair value TP of HF580 for Magyar Telekom is based on DCF model assuming a COE of 10.9%, RFR of 4.8% (based on the historical Hungarian long-term sovereign yield average), MRP of 5.5% and a beta of 1.1. Our fair value target price of HUF580 implies upside of 16.0% and we rate the stock Buy, mainly driven by its improving cash flow and dividend outlook.
Downside risks include more aggressive competition in the domestic mobile segment, a weaker than expected recovery in the EBITDA margin, a slowdown in the Hungarian economy and lower than expected dividends.
60 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Valuation Relatives
Attractive valuation on EV/OPFCF 17e versus EEMEA telecom sector High Dividend yield with significant spread Rising EBITDA consensus estimates and stable OpFCF expectation
Magyar Telekom: Valuation Benchmark Chart Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -0.4% -2.4% 2.6% 10.7% 12.6% Total return -0.4% -2.3% 2.7% 10.9% 16.3% Total return vs EEMEA index (USD) -0.3% -4.5% -1.8% 1.3% -5.4% Total return vs MSCI EEMEA Telecom (USD) -1.1% -4.4% -2.6% 8.0% 8.7% Price return vs Budapest exchange 1.9% -2.3% -3.7% -3.4% -16.3% Price Return (USD) 0.0% 0.0% 0.0% 0.0% 0.0% Total Return (USD) -1.5% -4.4% 3.2% 3.2% 12.1% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 650,170 6 638,380 5 626,590 614,800 5 603,010 4 591,220 4 579,430 567,640 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
60 198,850 194,940 40 191,030 20 187,120 0 183,210 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 179,300 -20 175,390 -40 171,480 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
8.0% 178,570 6.0% 153,060 4.0% 127,550 2.0% 0.0% 102,040 -2.0% 76,530 -4.0% 51,020 -6.0% 25,510 -8.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
61 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Financials & valuation: Magyar Telekom Buy
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (HUFm) EV/sales 1.6 1.5 1.4 1.3 Revenue 602,651 560,555 557,559 564,365 EV/EBITDA 4.8 4.7 4.4 4.0 EBITDA 197,039 182,562 184,906 190,296 EV/IC 0.7 0.6 0.6 0.6 Depreciation & amortisation -117,476 -111,913 -109,430 -101,728 PE* 15.0 14.6 13.3 10.5 Operating profit/EBIT 79,563 70,648 75,475 88,568 PB 1.0 1.0 0.9 0.9 Net interest -23,574 -18,522 -17,713 -16,805 FCF yield (%) 13.9 11.3 13.5 14.3 PBT 52,748 52,126 57,762 71,763 Dividend yield (%) 5.0 6.0 6.0 6.0 HSBC PBT 50,967 52,126 57,762 71,763 * Based on HSBC EPS (diluted) Taxation 4,397 -13,553 -15,018 -18,658 Net profit 54,201 35,600 39,192 49,518 HSBC net profit 34,772 35,600 39,192 49,518 Issuer information
+ 1 6 Cash flow summary (HUFm) . Share price (HUF) 500.00 Target price (HUF) 580.00 0 % Cash flow from operations 154,825 168,371 152,283 155,540 Capex -98,000 -84,699 -75,577 -72,112 Reuters (Equity) MTEL.BU Bloomberg (Equity) MTELEKOM HB Cash flow from investment -100,283 -84,699 -75,577 -72,112 Market cap (USDm) 1,767 Market cap (HUFm) 521,371 Dividends -22,686 -31,282 -31,282 -31,282 Free float (%) 41% Enterprise value (HUFm) 854,420 Change in net debt -32,836 -83,671 -45,424 -52,146 Country Hungary Sector Diversified Telecoms FCF equity 78,848 63,521 75,241 79,788 Analyst Herve Drouet Contact 44 20 7991 6827 Balance sheet summary (HUFm)
Intangible fixed assets 479,356 479,356 479,356 479,356 Tangible fixed assets 483,174 455,960 422,106 392,490 Price relative Current assets 193,978 277,485 322,309 375,816 Cash & others 15,909 102,303 147,727 199,873 550.00 550.00 Total assets 1,175,529 1,231,822 1,242,792 1,266,683 Operating liabilities -182,372 -228,650 -228,160 -230,228 500.00 500.00 Gross debt 392,466 395,189 395,189 395,189 450.00 450.00 Net debt 376,557 292,886 247,462 195,316 400.00 400.00 Shareholders' funds 538,490 542,808 550,718 568,953 350.00 350.00 Invested capital 1,322,971 1,339,148 1,304,204 1,278,018 300.00 300.00 250.00 250.00 Ratio, growth and per share analysis 200.00 200.00 Year to 12/2016a 12/2017e 12/2018e 12/2019e 2015 2016 2017 Magyar Telekom Rel to BUDAPEST SE Y-o-y % change Source: HSBC Revenue -8.2 -7.0 -0.5 1.2 Note: Priced at close of 08 Mar 2017 EBITDA 5.2 -7.3 1.3 2.9 Operating profit 8.2 -11.2 6.8 17.3 PBT 16.3 -1.2 10.8 24.2 HSBC EPS 4.0 2.4 10.1 26.3 Ratios (%) Revenue/IC (x) 0.5 0.4 0.4 0.4 ROIC 4.4 3.9 4.2 5.1 ROE 6.7 6.6 7.2 8.8 ROA 6.3 4.4 4.6 5.4 EBITDA margin 32.7 32.6 33.2 33.7 Operating profit margin 13.2 12.6 13.5 15.7 EBITDA/net interest (x) 8.4 9.9 10.4 11.3 Net debt/equity 64.8 49.8 41.2 31.4 Net debt/EBITDA (x) 1.9 1.6 1.3 1.0 CF from operations/net debt 41.1 57.5 61.5 79.6 Per share data (HUF) EPS Rep (diluted) 51.98 34.14 37.59 47.49 HSBC EPS (diluted) 33.35 34.14 37.59 47.49 DPS 25.00 30.00 30.00 30.00 Book value 516.42 520.56 528.14 545.63
62 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Megafon (MFON RX)
Short term: Dividend outlook seems attractive Long term: Benign regulation in Russia and focus on diversifying the operations will help Maintain Buy and RUB700 TP
Company description
Megafon is a diversified telecom operator with a presence mainly in Russia. More than 98% of Herve Drouet* Head of EEMEA TMT Equity revenue comes from Russia, with the mobile segment contributes c92% of revenue from Research Russia. Fixed line segment contributes c8% of revenue from Russia. HSBC Bank plc [email protected] +44 20 7991 6827
Venkata Velagapudi*, CFA Short-term drivers EEMEA Telecom Associate Bangalore Affordability, spent dynamics and potential for data monetisation The cost of the most affordable smartphone in Russia represents c14% of monthly disposable * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ income. Mobile data prices are very low in Russian relative to EEMEA peers, with competitive qualified pursuant to FINRA regulations retailers incentivising mobile users to churn. We would like to see less aggressive promotion, which could be driven by a shift of the Russian mobile operators towards more monobrand shops. The split of Euroset shops between Megafon and VimpelCom will be a key catalyst in our view. The tough macro in Russia may impede the ability to monetise data in the near term but this could improve medium-term.
Currency impact We expect Megafon to be at moderate risk from currency impact due to exchange rate movement. A significant portion of capital expenditure is denominated in hard currency and 23% of gross debt is in hard currency. HSBC FX strategists forecast RUB depreciating c6% y-o-y in FY17 relative to USD. This may be a downside risk to Megafon as it may limit the capital spending capability.
Dividend outlook Megafon has the highest dividend yield among EEMEA telecoms, at c12%. Given robust free cash flows and lower leverage, we expect the high dividend yield to be sustainable over next few years.
Long-term driver: 5G expected impact
We expect Megafon to be well placed to benefit from the launch of 5G in the medium term. The recent acquisition of mail.ru will enable Megafon to diversify sources of revenue for Megafon and reflects its intention to become a diversified player rather than being a conventional telecom operator. Given that mail.ru is one of largest internet service providers in Russia, the collaboration could create significant opportunities after 5G launch.
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We expect competition to turn rational gradually. The potential entry of disruptive new entrants or technology players is limited in Russia due to security concerns. The Russian telecom regulator is benign in terms of spectrum allocation as the mobile operators are allocated spectrum at a low cost and the frequencies allocated are tech neutral. A lack of strict enforcement of net neutrality is also positive for Russian telecoms.
Based on these factors we view Megafon to be well placed to capitalise on the 5G launch.
Investment thesis
Our bullish view on Megafon is mainly driven by the strong dividend outlook and robust cash flow generation that will sustain it. We expect Megafon to offer the highest dividend yield among EEMEA telecoms. FCF yield will be supported by declining capital spending, supported in the near term by factors such as investment project prioritisation and optimisation of technical solutions. We see Megafon as being at least risk among the Russian telecoms from the potential cost of data storage units in the next few years.
The growth outlook for Russian telecoms is weak over the next few years driven by a saturated market and tough macro-economic conditions in Russia. The recent acquisition of mail.ru implies Megafon’s intention to shift away from being a traditional telecom service provider. We expect Megafon to grow at low single digit over the next two to three years. However, free cash flows are strong as low growth should be offset by limited capital spending.
Valuation and Risks
Megafon: MFON RX, RUB628.7, Buy, TP RUB700 We value Megafon GDR using a DCF model assuming a COE of 14.6%, RFR of 8.5%(based on the sovereign yield of Russia), MRP of 5.5% and a beta of 1.1. Our TP remains unchanged at RUB700. Our TP implies upside of 11.3%, and we rate the stock Buy given the attractive valuation and dividend outlook. For Megafon ADR (MFON LI), we maintain our fair value TP of USD10.80 using an exchange rate of USD1/RUB65.
Key downside risks to our rating and estimates include: increased competition and aggressive entry of T2RTK in the Moscow region; a more-aggressive-than-expected decline in data pricing; a sustained weakening economic outlook; and regulatory uncertainties.
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Valuation relatives
Looks attractive on EV/opFCF and EV/EBITDA versus sector Consensus estimates on sales and EBITDA has increased recently due to the consolidation of Mail.ru. Attractive dividend yield but spread reduced by high Russian sovereign yield
Megafon: Valuation Benchmark Chart Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -6.6% -1.2% 5.6% -7.8% -27.4% Total return -6.6% -1.1% 9.9% -4.0% -18.0% Total return vs EEMEA index (USD) -5.1% 0.4% 14.5% 2.9% -14.9% Total return vs MSCI EEMEA Telecom (USD) -7.3% -3.2% 4.7% -6.8% -25.6% Price return vs MICEX -4.9% 6.3% 13.9% -6.5% -33.5% Price Return (USD) -5.6% 0.0% 13.3% 0.0% -10.5% Total Return (USD) -6.3% 0.4% 19.4% 4.8% 2.6% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 352,010 7 345,350 6 338,690 5 332,030 4 325,370 3 318,710 2 312,050 1 305,390 0 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2014 2015 2016 2017 2018 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
14 155,300 12 149,630 10 143,960 8 138,290 6 132,620 4 126,950 2 121,280 0 115,610 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2014 2015 2016 2017 2018
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
20.0% 127,610 15.0% 109,380 10.0% 91,150 5.0% 72,920 0.0% 54,690 -5.0% 36,460 -10.0% 18,230 -15.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2014 2015 2016 2017 2018
Source: Thomson Reuters Datastream, HSBCe
65 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Financials & valuation: Megafon Buy
Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (RUBm) EV/sales 1.7 1.7 1.7 1.7 Revenue 313,383 316,356 318,382 330,020 EV/EBITDA 3.9 4.5 4.4 4.2 EBITDA 132,357 120,516 125,666 135,261 EV/IC 1.7 1.7 1.8 1.8 Depreciation & amortisation -56,399 -60,415 -62,766 -62,316 PE* 8.4 12.4 11.3 9.3 Operating profit/EBIT 75,958 60,100 62,900 72,945 PB 2.6 3.0 3.5 3.7 Net interest -13,192 -16,230 -16,923 -18,190 FCF yield (%) 10.6 7.9 10.2 11.9 PBT 51,550 40,389 44,977 54,754 Dividend yield (%) 9.0 12.8 12.8 12.8 HSBC PBT 60,665 40,866 44,977 54,754 * Based on HSBC EPS (diluted) Taxation -12,334 -10,327 -10,575 -12,593 Net profit 39,016 30,042 34,381 42,140 HSBC net profit 46,512 31,446 34,381 42,140 Issuer information Cash flow summary (RUBm) Share price (RUB) 628.70 Free float 15% Cash flow from operations 103,798 89,498 97,996 104,989 Target price (RUB) 700.00 Sector Diversified Telecoms Capex -72,267 -67,748 -63,832 -63,461 Reuters (Equity) MFON.MM Country Russian Federation Cash flow from investment -59,108 -77,559 -63,832 -63,461 Bloomberg (Equity) MFON RX Analyst Herve Drouet Dividends -48,038 -48,625 -50,003 -50,003 Market cap (USDm) 6,675 Contact 44 20 7991 6827 Change in net debt -3,214 26,385 15,839 8,475
FCF equity 35,568 26,482 33,916 39,509 Balance sheet summary (RUBm) Price relative Intangible fixed assets 95,709 94,802 94,802 94,802 Tangible fixed assets 234,417 241,408 242,475 243,620 Current assets 83,552 62,701 63,005 64,751 1080.00 1080.00 Cash & others 37,649 25,000 25,000 25,000 Total assets 454,536 439,554 455,994 457,805 880.00 880.00 Operating liabilities 69,531 58,848 58,980 61,238 Gross debt 219,680 233,416 249,255 257,730 680.00 680.00 Net debt 182,031 208,416 224,255 232,730 Shareholders' funds 147,898 128,552 112,930 105,066 480.00 480.00 Invested capital 306,498 315,064 316,302 316,935 280.00 280.00 2015 2016 2017 Megafon Rel to RTS INDEX Ratio, growth and per share analysis Year to 12/2015a 12/2016e 12/2017e 12/2018e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue -0.4 0.9 0.6 3.7 EBITDA -4.4 -8.9 4.3 7.6 Operating profit -8.8 -20.9 4.7 16.0 PBT 2.3 -21.7 11.4 21.7 HSBC EPS -10.2 -32.4 9.3 22.6 Ratios (%) Revenue/IC (x) 1.0 1.0 1.0 1.0 ROIC 18.4 14.9 15.2 17.7 ROE 30.4 22.7 28.5 38.7 ROA 11.1 9.9 10.9 12.6 EBITDA margin 42.2 38.1 39.5 41.0 Operating profit margin 24.2 19.0 19.8 22.1 EBITDA/net interest (x) 10.0 7.4 7.4 7.4 Net debt/equity 123.2 162.2 198.6 221.5 Net debt/EBITDA (x) 1.4 1.7 1.8 1.7 CF from operations/net debt 57.0 42.9 43.7 45.1 Per share data (RUB) EPS Rep (diluted) 62.93 48.45 55.45 67.97 HSBC EPS (diluted) 75.02 50.72 55.45 67.97 DPS 56.45 80.65 80.65 80.65 Book value 238.55 207.34 182.14 169.46
66 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Mobile Telesystems (MTSS RX)
Short term: Moderate currency risk and potential fine from Uzbekistan may impact the dividend outlook Long term: Diversified operations and supportive regulation will help Maintain Hold and RUB250 TP
Company description
Mobile Telesystems (MTS) is a diversified telecom operator with a presence in Russia, Ukraine, Herve Drouet* Head of EEMEA TMT Equity Turkmenistan, Armenia and Belarus. MTS Russia contributes c91% of overall group revenue Research and MTS Ukraine contributes c7%. The mobile segment contributes c86% of MTS Russia’s HSBC Bank plc [email protected] overall revenue and fixed line contributes c14%. +44 20 7991 6827
Venkata Velagapudi*, CFA EEMEA Telecom Associate Bangalore Short-term drivers
* Employed by a non-US affiliate of HSBC Affordability, spent dynamics and potential for data monetisation Securities (USA) Inc, and is not registered/ We estimate almost half of mobile users in Russia have a smartphone, with the price of the qualified pursuant to FINRA regulations most affordable smartphone representing around 14% of monthly disposable income in Russia. Mobile data prices are very low in Russia relative to EEMEA peers, with competitive retailers incentivising mobile users to churn. We would like to see less aggressive promotion, which could be driven by a shift of the Russian mobile operators towards more monobrand shops. The split of Euroset shops between Megafon and VimpelCom is a key catalyst in our view. The tough macro in Russia may impede the ability to monetise data in the near term but this could improve medium term.
Currency impact We expect MTS to be at a moderate risk of a currency impact due to exchange rate movement, with 50-60% of capital expenditure denominated in hard currency and 27% of gross debt in hard currency. HSBC FX strategists forecast RUB depreciating c6% y-o-y in FY17 relative to USD, thus MTS is likely to be vulnerable to currency risk to some extent over the short term.
Dividend outlook We expect a near-term dividend yield of c10%. Currently we do not factor any potential fine related to Uzbekistan spectrum allocation into our estimates. However, this may be a downside risk to free cash flow generation, which may impact the dividend outlook. However, the dividend yield spread over sovereign yield is limited for MTS.
Long-term driver: 5G expected impact
We expect MTS to be well placed to benefit from the launch of 5G. Given the infrastructure in both mobile and fixed line segments MTS is in a good position to offer convergence services. We expect competition to turn rational gradually and the potential entry of disruptive new
67 EQUITIES ● TELECOMS / EEMEA 16 March 2017
entrants or technology players is limited in Russia due to security concerns. The Russian telecom regulator is benign in terms of spectrum allocation as mobile operators are allocated spectrum at a low cost, and the frequencies allocated are tech neutral. A lack of strict enforcement of net neutrality is also positive for Russian telecoms’ further monetisation.
MTS’s intention to lease its towers in Russia will be positive over medium term and should be a key revenue source as operators look to rent towers to lower the burden of capital spending.
The company’s execution skill is one of the strongest within the Russian telecoms operators in our view, and it is gradually increasing its skills in software and in developing digital services. MTS has developed and launch mobile payment services, e-commerce platform and is developing ICT activities for corporates.
Based on these factors MTS looks well placed to capitalise on the 5G launch.
Investment thesis
The outlook for growth is limited in the near term for Russian telecoms, with MTS’s revenue growing at under 2% y-o-y over the next two years on our estimates. Operating margins are under pressure due to a higher proportion of revenue coming from equipment sales. The volatile currency may impact the capital spending capability for MTS.
Free cash flow should be strong for MTS, although there are potential risks, such as a fine related to Uzbekistan and data storage costs. These costs could compel MTS to stay conservative while paying dividends in the short term.
Valuation and Risks
Mobile Telesystems: MTSS RX, RUB270, Hold, RUB250 Our fair value TP of RUB250 is DCF-based, assuming a COE of 14.6%, RFR of 8.5% (based on the Russian sovereign bond yield) and beta of 1.1 and MRP of 5.5%.
Our TP of RUB250 implies a downside of 7.4%, and we reiterate Hold rating due to its better than average dividend outlook relative to most of the EEMEA peers.
For the MTS ADR (MBT US), we maintain our TP of USD7.70 using USD/RUB exchange rate of 65 (unchanged) and one ADR equaling two shares.
Key downside risks include potential legal penalties related to Uzbekistan, increased competition and aggressive entry of T2RTK in the Moscow region, a decline in data pricing, sustained weakening economic outlook and regulatory uncertainties.
Key upside risks include no fine payment for Uzbekistan operations, RUB appreciation relative to USD and better-than-expected growth in key markets such as Russia and Ukraine.
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Valuation relatives
Looks attractive on EV/opFCF but fairly priced on EV/EBITDA versus sector and history due to good recent share price performance Consensus estimates on sales and EBITDA declining but stable on OpFCF Attractive dividend yield but spread limited due to high Russian sovereign yield
MTS: Valuation Benchmark Chart Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -1.2% -0.4% 6.3% 9.6% 12.7% Total return -1.2% -0.4% 6.3% 15.5% 25.8% Total return vs EEMEA index (USD) 0.0% 0.8% 10.3% 24.1% 39.4% Total return vs MSCI EEMEA Telecom (USD) -1.9% -2.4% 1.1% 12.7% 18.2% Price return vs MICEX 0.5% 7.1% 14.5% 10.8% 6.6% Price Return (USD) -2.7% 0.0% 16.1% 20.0% 38.5% Total Return (USD) -1.2% 0.8% 15.2% 26.0% 56.9% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 492,830 5 479,190 4 465,550 451,910 3 438,270 2 424,630 1 410,990 397,350 0 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2014 2015 2016 2017 2018 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
20 194,270 190,220 15 186,170 182,120 10 178,070 5 174,020 169,970 0 165,920 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2014 2015 2016 2017 2018
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
20.0% 145,670 15.0% 124,860 10.0% 104,050 5.0% 83,240 62,430 0.0% 41,620 -5.0% 20,810 -10.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2014 2015 2016 2017 2018
Source: Datastream, HSBCe
69 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Financials & valuation: Mobile Telesystems Hold
Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (RUBm) EV/sales 1.8 1.8 1.7 1.7 Revenue 426,639 435,053 442,891 448,938 EV/EBITDA 4.5 4.5 4.4 4.2 EBITDA 175,665 171,319 171,896 176,806 EV/IC 2.0 2.3 2.3 2.3 Depreciation & amortisation -82,472 -82,332 -79,124 -79,133 PE* 9.3 10.4 9.3 8.7 Operating profit/EBIT 93,193 88,988 92,772 97,673 PB 3.4 4.5 4.3 3.9 Net interest -20,973 -23,535 -19,283 -18,667 FCF yield (%) 8.7 9.5 10.9 12.4 PBT 62,491 66,128 73,489 79,006 Dividend yield (%) 7.3 9.4 9.4 9.4 HSBC PBT 72,220 65,452 73,489 79,006 * Based on HSBC EPS (diluted) Taxation -13,269 -15,377 -16,902 -18,171 Net profit 51,307 51,726 57,672 62,003 HSBC net profit 57,694 51,372 57,672 62,003 Issuer information Cash flow summary (RUBm) Share price (RUB) 270.00 Free float 49% Cash flow from operations 144,088 135,822 136,669 140,502 Target price (RUB) 250.00 Sector Diversified Telecoms Capex -96,111 -83,563 -78,150 -74,307 Reuters (Equity) MTSS.MM Country Russian Federation Cash flow from investment -145,356 -83,563 -78,150 -74,307 Bloomberg (Equity) MTSS RX Analyst Herve Drouet Dividends -50,704 -50,715 -50,715 -50,715 Market cap (USDm) 9,240 Contact 44 20 7991 6827 Change in net debt 31,584 -17,969 -7,804 -15,479
FCF equity 45,432 49,475 56,993 64,926 Balance sheet summary (RUBm) Price relative Intangible fixed assets 109,064 106,728 106,728 106,728 Tangible fixed assets 302,662 282,586 281,611 276,786 300.00 300.00 Current assets 159,017 102,512 103,688 104,595 280.00 280.00 Cash & others 83,304 40,000 40,000 40,000 260.00 260.00 Total assets 653,378 561,958 562,159 558,241 240.00 240.00 Operating liabilities 104,209 118,769 120,902 122,343 Gross debt 345,869 284,596 276,792 261,313 220.00 220.00 Net debt 262,565 244,596 236,792 221,313 200.00 200.00 Shareholders' funds 160,115 119,344 126,301 137,589 180.00 180.00 Invested capital 383,230 333,058 331,125 325,765 160.00 160.00 140.00 140.00 2015 2016 2017 Ratio, growth and per share analysis Mobile Telesystems Rel to RTS INDEX
Year to 12/2015a 12/2016e 12/2017e 12/2018e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 3.9 2.0 1.8 1.4 EBITDA 0.1 -2.5 0.3 2.9 Operating profit -7.5 -4.5 4.3 5.3 PBT -9.1 5.8 11.1 7.5 HSBC EPS -20.4 -11.0 12.3 7.5 Ratios (%) Revenue/IC (x) 1.1 1.2 1.3 1.4 ROIC 18.5 19.1 21.5 22.9 ROE 35.4 36.8 47.0 47.0 ROA 11.4 12.0 13.1 13.9 EBITDA margin 41.2 39.4 38.8 39.4 Operating profit margin 21.8 20.5 20.9 21.8 EBITDA/net interest (x) 8.4 7.3 8.9 9.5 Net debt/equity 155.9 198.7 183.6 159.1 Net debt/EBITDA (x) 1.5 1.4 1.4 1.3 CF from operations/net debt 54.9 55.5 57.7 63.5 Per share data (RUB) EPS Rep (diluted) 25.81 26.02 29.01 31.19 HSBC EPS (diluted) 29.02 25.84 29.01 31.19 DPS 19.62 25.50 25.50 25.50 Book value 80.54 60.03 63.53 69.21
70 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Mobily (EEC AB)
Mobily is still in turnaround phase Long-term drivers moderately supportive Maintain Buy and TP SAR27.20
Company description
Mobily is a Saudi mobile operator with an extensive fibre network in the Kingdom. It was Eric Chang* Analyst established in 2004, shortly after the Etisalat-led consortium won a GSM and 3G license (for HSBC Bank Middle East Limited [email protected] SAR13bn). The following year the company listed on the Saudi Exchange and built a 3G network +971 4 423 6554 with 79% population coverage at launch. Nikhil Mishra* EEMEA Telecom Associate From the outset, Mobily decided network investments and marketing would be key to its Bangalore commercial success. 1m subscribers joined Mobily within 90 days of launch. The second
entrant was EBITDA-positive in Q4 2005 and turned profitable by Q1 2006. Free cash flow * Employed by a non-US affiliate of HSBC generation started in Q3 2006. Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations In 2012, as growth in mobile voice services slowed, Mobily shifted its focus towards the Information and Communication Technologies (ICT) segment. It began directly challenging the incumbent STC on the Enterprise client segment.
With this transition, the company pursued lofty financial targets and aggressive accounting policies. The strategy unravelled and the accounting problems were disclosed in Q3 2014. The problem was revenue recognition related to: i) one of its promotional programmes as well as ii) non-readiness of FTTH (Fibre-To-The-Home) ports related to a lease contract signed with one of its approved distributors. The restatements were significant. Cumulatively, SAR3.8bn of profits was restated from the 2013 and 2014 financials. Market reaction was unequivocal and Mobily’s share price contracted by two-thirds.
Short-term drivers
Affordability, spent dynamics and potential for data monetisation We do not view affordability (handsets or services) as an issue given Saudi Arabia’s oil wealth. However, telecom spending may be under pressure as the Saudi government’s efficiency drive reduces allowances and subsidies.
We see data as a key driver of revenue growth. Mobile penetration in the Kingdom is in excess of 150% whereas smartphone penetration is estimated to be 60%. Data monetisation is hence correlated to the intensity of competition. We think Zain KSA and Mobily are unlikely to indulge in value-destructive price wars as both need to resolve their high leverage.
Currency impact We do not see any currency impact because the company only operates in Saudi Arabia where the currency is pegged to the dollar.
71 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Dividend outlook We do not factor any dividend payments in the forecast period. We think management would consider dividend payments once the operator returns to net profit and deleverages to a sustainable level.
Mobily has been in discussion with STC to share telecom towers. An agreement would allow opex and capex savings and should improve cash flow generation.
Long-term driver: 5G expected impact
According to our scorecard, Mobily is in a moderate position to benefit from the 5G opportunity.
Monetisation On this criteria, we rate Mobily one notch lower than STC given the latter’s extensive fixed infrastructure (and, crucially, the link to the last mile). We acknowledge Mobily’s significant network capex spend (although there is no disclosure on the proportion allocated to mobile or fixed). We think the unified license introduced late last year will help the Etisalat affiliate target the high value consumer and corporate segments.
Competition We expect competition to remain rational and support 5G monetisation. We do not envisage Zain KSA or Mobily engaging in value-destructive price wars because both companies need to resolve their high leverage. In addition, we discount the risk of new mobile entrants given the penetration rates and the fact that two out of three network operators struggle with profitability.
Regulation In Saudi Arabia, the regulator has not introduced any regulation on net neutrality and the practice of zero-rating. The introduction of a unified license has brought some respite to Mobily and Zain KSA.
Business model We think Mobily has a reasonable opportunity to monetise the 5G opportunity. It has invested heavily in mobile and fixed infrastructure; it has adequate spectrum for the provisioning of 4G services; the unified license may be a stepping stone to offering convergence services; and Mobily benefits from a technical services agreement with its main shareholder Etisalat.
We have written at length in the thematic section of this report about the network densification that 5G technology will impose. In that context, current discussions with STC to form a TowerCo joint-venture would allow all parties to achieve lower capex and opex. Talks have so far focused on the sharing of passive network element.
Investment thesis
Mobily has lost market share in the past two years and needs at least to stem the decline if not reverse it. However, we think it is more likely to focus on improving ARPU growth (better for profitability) rather than market share in order to drive up revenue.
The unified license should open up revenue streams and, most importantly allow the Etisalat affiliate to monetise its extensive fibre infrastructure. We see profit potential but find it difficult to quantify given lack of disclosure.
We do not see Mobily’s debt load and low profitability as insurmountable challenges. Management has been effective with cost control and negotiations with various stakeholders: it now needs to show its mettle with revenue growth.
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Valuation and Risks
Etihad Etisalat (Mobily), EEC AB, SAR21.65, Buy, TP SAR27.20 We value Mobily on a DCF, using a WACC of 8.1% based on following assumptions: cost of equity of 9.4%, risk-free rate of 2.5% and equity risk premium of 7%. We use a beta of 1 and long-term growth rate of 2%.
Our target price of SAR27.20 implies 25.6% upside and we rate the stock Buy as we see an improvement in the regulatory environment and competitive landscape. We think the unified license will open up new revenue and profit streams.
Downside risks include: Zain KSA pursuing market share instead of profitability; failure to secure additional spectrum to facilitate continued broadband growth.
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Relative valuation Mobily trades at a forward EV/EBITDA multiple that is significantly ahead of its peers. This is a reflection of its turnaround phase where high debt and low profitability lead to higher multiples. Estimates revisions suggest consensus remains sceptical of Mobily’s turnaround story. We do not expect dividend payments to resume. The company remains in turnaround mode and its priority is to deleverage.
Mobily: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 1.3% 0.8% -12.3% -3.6% -14.7% Total return 1.2% 0.7% -12.2% -3.4% -14.8% Total return vs EEMEA index (USD) 2.5% 0.6% -17.1% -5.2% -32.1% Total return vs MSCI EEMEA Telecom (USD) 0.5% -1.3% -17.4% -6.2% -22.4% Price return vs Tadawul 1.2% 0.8% -10.2% -16.4% -23.1% Price Return (USD) 1.6% 1.6% -12.2% -3.0% -14.5% Total Return (USD) 1.3% 0.7% -12.1% -3.3% -14.7% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 22,690 13 21,070 11 19,450 17,830 9 16,210 7 14,590 5 12,970 11,350 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
70 9,080 60 8,060 50 7,040 40 6,020 30 20 5,000 10 3,980 0 2,960 -10Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 1,940 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
15.0% 50
10.0% 40
30 5.0% 20 0.0% 10 -5.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
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Financials & valuation: Etihad Etisalat(Mobily) Buy
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) EV/sales 2.4 2.4 2.1 1.9 Revenue 12,569 12,990 14,657 16,298 EV/EBITDA 7.6 7.6 6.2 5.4 EBITDA 4,009 4,130 4,938 5,726 EV/IC 1.0 1.0 1.0 1.0 Depreciation & amortisation -3,775 -3,511 -3,543 -3,605 PE* 182.0 20.4 11.0 Operating profit/EBIT 235 619 1,395 2,121 PB 1.1 1.1 1.0 0.9 Net interest -481 -525 -558 -562 FCF yield (%) -22.9 -2.9 2.2 -0.6 PBT -246 94 837 1,559 Dividend yield (%) 0.0 0.0 0.0 0.0 HSBC PBT -246 94 837 1,559 * Based on HSBC EPS (diluted) Taxation 43 -2 -21 -39 Net profit -203 92 816 1,520 HSBC net profit -203 92 816 1,520 Issuer information Cash flow summary (SARm) Share price (SAR) 21.65 Free float 61% Cash flow from operations 1,739 3,591 4,749 5,605 Target price (SAR) 27.20 Sector Wireless Telecoms Capex -5,112 -3,551 -3,801 -5,101 Reuters (Equity) 7020.SE Country Saudi Arabia Cash flow from investment -4,704 -3,551 -3,801 -5,101 Bloomberg (Equity) EEC AB Analyst Eric Chang Dividends 0 0 0 0 Market cap (USDm) 4,444 Contact +971 4 423 6554 Change in net debt 1,465 542 -369 96
FCF equity -3,810 -487 369 -96 Balance sheet summary (SARm) Price relative Intangible fixed assets 8,987 8,658 8,347 8,043 Tangible fixed assets 24,406 24,408 24,976 26,775 Current assets 7,780 7,841 8,409 8,807 52.00 52.00 Cash & others 1,216 755 831 728 47.00 47.00 Total assets 41,193 40,926 41,751 43,644 42.00 42.00 Operating liabilities 10,626 10,199 10,502 10,882 37.00 37.00 Gross debt 15,209 15,290 14,997 14,990 32.00 32.00 Net debt 13,993 14,535 14,166 14,262 27.00 27.00 Shareholders' funds 15,356 15,435 16,251 17,771 22.00 22.00 Invested capital 29,331 29,953 30,399 32,015 17.00 17.00 12.00 12.00 2015 2016 2017 Ratio, growth and per share analysis Etihad Etisalat(Mobily) Rel to TADAWUL ALL SHARE INDEX
Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue -12.9 3.3 12.8 11.2 EBITDA 36.3 3.0 19.6 16.0 Operating profit 163.7 125.3 52.0 PBT 790.4 86.3 HSBC EPS 790.4 86.3 Ratios (%) Revenue/IC (x) 0.4 0.4 0.5 0.5 ROIC 2.2 3.1 5.5 7.6 ROE -1.3 0.6 5.1 8.9 ROA 0.6 1.5 3.3 4.9 EBITDA margin 31.9 31.8 33.7 35.1 Operating profit margin 1.9 4.8 9.5 13.0 EBITDA/net interest (x) 8.3 7.9 8.8 10.2 Net debt/equity 91.1 94.2 87.2 80.2 Net debt/EBITDA (x) 3.5 3.5 2.9 2.5 CF from operations/net debt 12.4 24.7 33.5 39.3 Per share data (SAR) EPS Rep (diluted) -0.26 0.12 1.06 1.97 HSBC EPS (diluted) -0.26 0.12 1.06 1.97 DPS 0.00 0.00 0.00 0.00 Book value 19.94 20.05 21.10 23.08
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MTN Group (MTN SJ)
FY18e should be a transformational FCF/EBITDA period for MTN; multiples are likely to start reflecting this in 2017e Well placed to benefit from 5G in Iran, Ghana and Nigeria – regulatory/spectrum/competition makes SA more uncertain Attractive based on data/VAS/dividend transformation. Maintain Buy and ZAR141.5 TP
Company description
MTN Group is the largest mobile telecom operator across Sub Saharan Africa and the Middle Ziyad Joosub* Analyst East. The company’s four largest markets account for c67% of total revenue – SA 30%, Nigeria HSBC Securities (South Africa) (Pty) Ltd 19%, Iran 11% (proportionately consolidated) and Ghana 7%. The remaining 17 markets [email protected] account for roughly one third of revenue. The data theme has significant scope to grow: +27 (0)11 676 4223 currently 26.9% of total revenue is through data and we highlight half of MTN Nigeria’s data Ramesh Pantagolusula* EEMEA Telecom Associate revenue relates to digital and VAS – thus data connectivity revenue remains at relative low Bangalore levels in comparison to other EEMEA markets.
* Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Short-term drivers
Affordability, spent dynamics and potential for data monetisation The data theme has significant scope to grow across MTN’s footprint: currently 26.9% of total revenue is through data: we highlight half of MTN Nigeria’s data revenue relates to digital and VAS – thus data connectivity revenue remains at relative low levels in comparison to other EEMEA markets. MTN Iran (Irancell), MTN Ghana and MTN SA are more developed in terms of data monetisation, with approximately 42% of revenue being derived from data services. Nigeria data monetisation is more in line with the rest of MTN’s footprint, with data revenue only accounting for 21.1% of revenues. MTN is investing at a high rate into 3G/LTE network capability across its footprint, recent spectrum purchases in Nigeria and Ghana will also support greater data monetisation in these markets over the medium term. In 2016 data traffic grew 143% y-o-y at MTN Group, whilst effective data tariffs declined 56% y-o-y (in constant FX terms). Handset procurement is predominantly driven by the unofficial market (no tax and duties), thus handset pricing across sub-Saharan Africa (SSA) is cheaper than other EEMEA markets. Smartphone penetration in Nigeria, at 32%, is relatively high given low wealth dynamics in this market – the cheapest handset in Nigeria accounts for 2.24% of annual GDP per capita (PPP adj) versus EEMEA average of 0.34%. However no alternative entertainment, connectivity and communication exists for consumers. Data pricing at USD3.2 per GB remains elevated in Nigeria compared to other EEMEA markets, at 0.64% of PPP adjusted GDP per capita.
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Currency impact Around half of MTN Group’s NAV is based in SSA, whilst approximately 33% of MTN’s debt comprises USD-denominated debt. Due to extensive tower leasing agreements and managed service contracts, opex in SSA markets for mobile network operators is 20-33% dollarised. Around 50-60% of SSA mobile operator’s capital expenditure is in hard currency for FY16. MTN’s fundamentals and FCF margin will likely continue to be impacted by Naira/Cedi weakness and ZAR strength over the next 12 months. MTN SA, which accounts for 30% of revenue and 40% of NAV, will benefit from a FCF and margin perspective due to the recent rally in the ZAR currency. Iran on the other hand will also have a moderate negative impact from a weaker Iranian Rial as Central Bank administrators’ medium-term target is for a convergence of the official and unofficial market FX rates. Overall FX will serve as a significant dilutor for MTN near-term; however we believe this is priced in and we expect report growth metrics to accelerate meaningfully in FY18e once a weaker Naira and stronger ZAR are in the base.
Dividend outlook MTN Group will continue its aggressive investment cycle in key markets through 2017e, capex intensity across the Group is anticipated to be around c23-25%, whilst key markets of South Africa, Iran and Nigeria will all likely have capex intensity in excess of 26%. Given the high investment cycle, management has maintained a minimum dividend of ZAR7 for FY17e – unless a substantial FX/macro change occurs over the next 12 months. Thus dividend will serve to underpin the valuation near-term rather driving share price upside. Once MTN starts normalising capex in FY18e, we anticipate substantial FCF growth and dividend transformation. Given the capex normalisation cycle will take two to three years and be accompanied with accelerating growth trends (low FX-induced base, higher data monetisation and network leadership) we expect FCF and dividend growth to be multi-year theme at MTN from FY18e. We expect the market to start positioning for better organic growth, FCF margin expansion and progressive dividend in 2017e.
Long-term driver: 5G expected impact
MTN looks relatively well placed to capitalise on the benefit of 5G, specifically in markets outside of South Africa, where the recent investment cycle in addition to spectrum acquisitions will likely place MTN in a leadership position in transmission, fibre and 4G across key markets (Nigeria, Iran and Ghana). Africa remains underpenetrated from a fixed-line perspective, whilst spectrum allocation is structurally low compared with other regions globally. For South Africa specifically, we believe Vodacom (VOD SJ, ZAR149, Hold) is best positioned for 5G but only moderately. MTN has front loaded capex into its South African operations over the past two years and has made meaningful steps in closing the network gap with Vodacom. Thus the South African operation has room to monetise 5G given ongoing network progression; however unless there is clear evidence of MTN capturing higher ARPU subscribers from Vodacom SA (unlikely in our view), MTN will monetise 5G at a lower quantum than Vodacom given our expectations for relatively equal spectrum holdings over the medium term for both operators.
Consolidation a theme in SSA, whilst South Africa and Iran will only see new entrants in the form of MVNOs. Nigeria, Ghana and other SSA opcos are likely to exhibit ongoing consolidation given (1) the higher capex required for mobile data proliferation and monetisation in addition to (2) lower ROICs across SSA post FX depreciation across the landscape. This could be a moderate risk for MTN as smaller players combine to drive scale and balance sheet benefits: given its leadership position in key markets we do not expect MTN to participate in any in-market consolidation initiatives over the medium term. Overall, we believe lower fragmentation across countries in SSA will drive better unit economics and incremental returns on capital for operators, thus from a market structure perspective we believe 5G economics will increasingly become more attractive as SSA mobile markets progressively consolidate. For SA
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and Iran, we do not expect a new entrant of scale to enter the market given relative levels of maturity and existent scale of incumbent operators, the launch of multiple MVNOs will be more thematic in these markets. In Iran every operator needs to support 2 MVNO’s, according to MTN management MTN Iran is close to finalizing the launch of two MVNOs on its network. For both South Africa and Iran we expect MVNO launches to be characterized by differentiated services in data provision and/or fintech to capture consumer incremental spend, rather than aggressive market share gain initiatives that look to replicate all of incumbent operator services.
Regulatory bottlenecks remain a constraint to technology evolution and spectrum allocation in South Africa; however we expect the regulatory environment to be supportive in Nigeria, Ghana and Iran. The allocation of spectrum, specifically the digital dividend, in South Africa and Nigeria has continuously been held up and/or delayed due to administrative/macro and legal issues. Whilst the regulator’s intention is to support the private sector to drive broadband transformation, spectrum allocation and analogue switch-over ambitions have continually been delayed due to administrative and regulatory complexities. The NCC in Nigeria has been more forthcoming recently on making spectrum expeditiously available to operators; more importantly recent spectrum allocation to MTN (2600MHz in June 2016) was completed at a relatively attractive price of USD67m. We believe MTN Nigeria is well positioned to secure the requisite spectrum for 4G/5G initiatives given its FCF margin and balance sheet advantages relative to peers in Nigeria. In South Africa spectrum allocation and the structure it will take remains opaque given the Ministry of Telecommunications’ recent ICT white paper recommending a wholesale model be followed for spectrum access in South Africa; nevertheless we believe all operators are equally impacted by the regulations and on a relative basis MTN has a marginal advantage given its new BEE deal is already complete (level 4 BEE rating needed in order to participate in spectrum auctions). In Iran, we expect Regulators to be supportive of new technology launches. According to the Research Center of Communications and Information Technology in Iran, by 2025, 5G Internet access is targeted to have 100% penetration in Iran. The Ministry of Telecommunications in Iran has established a 5 year roadmap where they aim to ensure the 5G experience and roll-out in Iran is to be executed more successfully than was 4G and 3G, the five year roadmap also emphasizes enhancing the role of the private sector in launching 5G.
Investment thesis
Our positive thesis on MTN is based on three key themes: (1) wide-scale organic operational progression and higher incremental returns on capital over the medium term; (2) capex normalisation post FY17e will create a multi-year FCF and EBITDA margin expansion cycle; and (3) revenue share gains will be achieved in key markets due to digital/VAS/data leadership. Solid medium-term growth, yield, and capital return outlook. Macro and FX pressures have driven a moderation in competitor/regulator intensity and an in-market consolidation theme across MTN’s footprint. This was evident in MTN’s FY16 results where all major markets are exhibiting strong sequential accelerations in revenue growth. In our view, the market is clearly questioning MTN’s capital allocation ability and macro stability of its footprint. Whilst a harsh macro and FX environment has driven steep declines in MTN’s value over the past two years, we believe the next 2 years at MTN will be characterised by organic execution and strong secular trends (data/VAS/digital monetisation) driving progressively higher incremental yield and returns on capital.
FY18e will be a transformational FCF/EBITDA period; we expect investors to start positioning for this in 2017. In FY18e, the impact of the expected depreciation of the Nigerian Naira and Iranian Rial, and elevated big-market capex bump-up will be reflected in the base; we expect FY18e proportionate FCF and EBITDA to grow 138.5% y-o-y and 7.8% y-o-y.
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Given that: (1) ZAR7 dividend guidance should underpin valuation near term; (2) CEO/CFO placement should ensure a refinement of strategy and communication thereof; and (3) operational progression and potential revenue/EBITDA upgrades over the next 12 months, we expect the market to progressively start pricing in the FY18e recovery this year. Data/VAS leadership indicates progressive revenue share gains in key markets. Incremental growth in Africa mobile is concentrated in data, with substantially higher network and/or spectrum investment into key markets (Nigeria, Iran and Ghana) relative to competitors and data/VAS/digital leadership. We struggle to see a scenario where MTN does not secure disproportionate service revenue share over the medium term.
Valuation and Risks
MTN Group: MTN SJ, ZAR122.87, Buy, ZAR141.5 DCF-based SOTP valuation. Our target price is based on an equal weighting of our DCF valuation of ZAR142 and a DCF-based SOTP valuation of ZAR141, from which we subtract the PV of periodic regulatory fines that MTN Nigeria must pay over the next 3.5 years (-ZAR3.80). Our DCF-based SOTP makes use of a cost of capital ranging between 12% and 20.5%, depending on the region that we value. For our DCF, we use a cost of equity of 18.1% derived from a country-weighted risk-free rate of 12%, beta of 1.0 and a market risk premium of 6.0%. Our ZAR141.5 TP implies 15.2% upside and we rate the stock Buy as we see organic operational progression and higher incremental returns on capital, FCF and EBITDA margin expansion and revenue share gains.
Key downside risks include: (1) macro, political and FX volatility – particularly unforeseen ZAR strength; (2) negative regulatory or competitive evolution in Nigeria and South Africa; (3) imposition of higher telecom taxes/VAT rates; (4) sanction evolution in Iran that might impact cash repatriation; and (5) unforeseen extension of capex bump-up cycle into FY18e, large-scale M&A and operational disappointments.
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Relative valuation
Valuation relatively cheap versus the sector Improving EV/EBITDA multiple Low div yield relative to G Sec10 year bond yield
MTN Group: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 5.0% 6.2% 4.2% 5.2% -17.0% Total return 5.0% 6.2% 4.2% 5.2% -9.8% Total return vs EEMEA index (USD) 5.9% 8.7% 4.0% 10.4% -10.9% Total return vs MSCI EEMEA Telecom (USD) 4.3% 4.1% -1.0% 2.4% -17.4% Total return vs JSE 5.5% 6.9% 2.4% 7.7% -10.8% Price return vs JSE 5.7% 7.1% 2.7% 8.9% -15.2% Price Return (USD) 4.8% 8.7% 8.9% 12.3% -2.0% 2017e 2018e 2017e 2018e 2017e 2018e Total Return (USD) 4.8% 8.7% 8.9% 12.3% 6.5% EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 180,210 8 173,220 7 166,230 159,240 6 152,250 5 145,260 4 138,270 131,280 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
15 83,380 78,000
10 72,620 67,240 61,860 5 56,480 51,100 0 45,720 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
15.0% 71,890 61,620 10.0% 51,350
5.0% 41,080 30,810 0.0% 20,540 10,270 -5.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBCe
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Financials & valuation: MTN Group Buy
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (ZARm) EV/sales 1.9 2.1 2.1 1.9 Revenue 147,920 134,148 140,070 150,344 EV/EBITDA 5.5 6.2 5.8 5.3 EBITDA 51,981 46,640 50,175 55,159 EV/IC 1.6 1.5 1.4 1.3 Depreciation & amortisation -25,736 -24,147 -23,812 -24,807 PE* 26.2 17.6 14.8 12.6 Operating profit/EBIT 26,245 22,493 26,363 30,352 PB 2.2 1.9 1.8 1.7 Net interest -2,339 -2,166 -4,505 -2,827 FCF yield (%) 6.0 3.5 5.3 7.7 PBT 7,409 22,825 24,786 31,166 Dividend yield (%) 5.7 5.7 6.6 7.2 HSBC PBT 5,243 22,164 26,347 30,999 * Based on HSBC EPS (diluted) Taxation -8,346 -7,092 -8,431 -9,920 Net profit -937 15,732 16,355 21,246 HSBC net profit 8,730 13,037 15,498 18,234 Issuer information Cash flow summary (ZARm) Share price (ZAR) 122.87 Free float 75% Cash flow from operations 54,724 47,034 49,189 54,576 Target price (ZAR) 141.50 Sector Wireless Telecoms Capex -29,899 -29,647 -23,824 -23,737 Reuters (Equity) MTNJ.J Country South Africa Cash flow from investment -29,899 -29,647 -23,824 -23,737 Bloomberg (Equity) MTN SJ Analyst Ziyad Joosub Dividends -19,792 2,616 -12,619 -13,948 Market cap (USDm) 17,704 Contact +27 (0)11 676 4223 Change in net debt 39,594 -610 1,682 594
FCF equity 14,140 8,129 12,429 18,092 Balance sheet summary (ZARm) Price relative Intangible fixed assets 46,473 46,473 46,473 46,473 Tangible fixed assets 142,616 161,290 171,654 181,106 Current assets 79,611 77,484 78,058 82,206 Cash & others 28,395 27,850 27,633 29,585 235.00 235.00 Total assets 268,700 285,248 296,186 309,785 Operating liabilities 58,091 59,253 60,438 61,647 185.00 185.00 Gross debt 86,954 85,799 87,265 89,811 Net debt 53,731 53,121 54,804 55,398 Shareholders' funds 102,380 118,473 126,535 136,113 135.00 135.00 Invested capital 182,214 198,145 208,115 218,553 85.00 85.00 2015 2016 2017 Ratio, growth and per share analysis MTN Group Rel to JSE ALL SHARE
Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 0.6 -9.3 4.4 7.3 EBITDA -24.0 -10.3 7.6 9.9 Operating profit -41.8 -14.3 17.2 15.1 PBT -79.6 208.1 8.6 25.7 HSBC EPS -62.6 49.3 18.9 17.7 Ratios (%) Revenue/IC (x) 0.8 0.7 0.7 0.7 ROIC -1.7 8.2 8.6 9.7 ROE 7.0 11.8 12.7 13.9 ROA -0.4 6.2 6.6 7.6 EBITDA margin 35.1 34.8 35.8 36.7 Operating profit margin 17.7 16.8 18.8 20.2 EBITDA/net interest (x) 22.2 21.5 11.1 19.5 Net debt/equity 51.1 43.6 42.1 39.6 Net debt/EBITDA (x) 1.0 1.1 1.1 1.0 CF from operations/net debt 101.8 88.5 89.8 98.5 Per share data (ZAR) EPS Rep (diluted) -0.50 8.44 8.78 11.40 HSBC EPS (diluted) 4.68 7.00 8.32 9.78 DPS 7.00 7.00 8.05 8.86 Book value 55.53 64.26 68.63 73.83
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O2 CZ (TELEC CP)
Dividend outlook looks attractive; moderate potential to monetise data due to regulation risk on retail data services Competition in the B2B segment may be the key barrier to benefiting from 5G launch, structural separation is also a risk Maintain Hold and CZK270 TP
Company description
O2 CZ is a diversified telecom operator with a presence in Czech Republic and Slovakia. O2 CZ Herve Drouet* Head of EEMEA TMT Equity span off the infrastructure assets into a separate company (CETIN) in 2015. Research HSBC Bank plc [email protected] +44 20 7991 6827 Short-term drivers Venkata Velagapudi*, CFA EEMEA Telecom Associate Affordability, spent dynamics and potential for data monetisation Bangalore We estimate Smartphone penetration for O2 CZ to be above 50%. We observe the price of the
* Employed by a non-US affiliate of HSBC most affordable smartphone to be around 9% of the average monthly disposable income in Securities (USA) Inc, and is not registered/ Czech Republic. The average price of mobile data as a percentage of GDP (PPP) also looks qualified pursuant to FINRA regulations low for O2 CZ, but data monetisation will be limited by competitive pressures in the B2B segment. In February 2017 the regulator made some comments about the potential regulation of data services retail prices (Source: Reuters), which could limit data monetisation further.
Currency impact We expect the currency risk to be insignificant for O2 CZ, with around 21% of its capital spending in hard currency and debt is completely denominated in local currency. HSBC’s FX strategists forecast the CZK to appreciate by c3% y-o-y relative to USD by end-2017e, which should benefit capital spending slightly.
Dividend outlook We assume a dividend pay-out ratio of 100% for O2 CZ given its policy to maintain a 90-110% pay-out ratio. Given robust FCF generation and low leverage we expect O2 CZ to be able to comfortably maintain the high dividend pay-out ratio over next few years. O2 CZ intends to distribute CZK4 per share from the share premium. DPS of FY16 is CZK17 per share (excluding the share premium). We expect the dividends to remain at the same level assuming a pay-out ratio of 100% based on historical track record, implying a regular dividend yield of c6%. The distribution of share premium adds another 1.5% to the yield. The spread of the dividend yield over the sovereign yield is one of the highest among the peer group, enabling O2 CZ to score well on this metric.
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Long-term driver: 5G expected impact
We see competition in the B2B segment as a key barrier to benefiting from the launch of 5G. O2 CZ span off its infrastructure assets into a separate entity in 2015; and lack of infrastructure assets may limit the extent of 5G rollout.
With 5G potentially being combined with Wifi, cable operators such as Liberty Global could play a role, as could some OTT players such as Facebook or Google, and this could pose a threat to 5G monetisation in CE3.The regulatory framework would unlikely be very supportive with net neutrality in place and spectrum pricing could get expensive in Czech Republic, based on history. We do not see any major changes to the existing regulatory environment in Czech Republic in the medium term, while there is likely to be some political pressure to regulate and reduce retail data pricing.
O2 CZ is gradually developing its software skills, proposing more media content and venturing into digital services (through a startup accelerator). It is gradually shifting its skills into software development and is looking at expansion into new services such as insurance for hardware or travel.
Based on these factors we expect the long-term impact of 5G on Czech Republic to be moderate.
Investment thesis
We see O2 CZ’s revenue and EBITDA growing at low single digits over the next few years. Mobile data revenue should see strong growth, partially offset, however, by intense B2B competition. In the fixed line segment, the structural decline of fixed voice will be offset by growth in the fixed BB segment, while B2B remains under pressure in fixed line segment as well. We view the potential for operating margin improvement at O2 CZ as limited, with operating margin at around c27% over the next few years.
Although the growth prospects for revenue and EBITDA look limited for O2 CZ, a lower capital spending requirement should drive free cash flow. Given the completion of spectrum payments and spectrum rollout costs in FY15 and FY16, we expect capital expenditure to decline over the next few years. We factor capex/sales of c7% in FY17e (compared to c9% in FY15 and c8% in FY16). We estimate the FCF yield to be c7% and c8% for FY17e and FY18e respectively.
We are bullish about the dividend outlook for O2 CZ, which offers the highest spread over sovereign yield among EEMEA telecoms.
Valuation and Risks
O2 CZ: TELEC CP, CZK272, Hold, TP CZK270 We value O2 CZ using a DCF model, assuming a COE of 8%, a RFR of 2.5%, a beta of 1 and MRP of 5.5% (all unchanged). Our RFR corresponds to the 5-year market average of the Czech 10-year Sovereign yield. Our TP of CZK270 implies 0.7% downside and we rate the stock Hold.
Upside risks include better than expected margin expansion and higher than expected revenue growth. Higher than expected dividend may be another upside risk.
Downside risks include a decline in margins, the risk of exclusion from MSCI CZ index, and a stake sale by PPF (major shareholder) to increase free float
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Valuation relatives
Above EEMEA telcos average on EV/EBITDA but in line with sector average on EV/OPFCF High dividend yield and spread versus Czech sovereign bond No significant change in consensus estimates
O2 CZ: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -0.6% 1.6% 16.3% 15.8% 11.1% Total return -0.6% 1.6% 16.3% 15.9% 18.9% Total return vs EEMEA index (USD) 0.6% 0.1% 10.7% 6.6% -3.9% Total return vs MSCI EEMEA Telecom (USD) -1.2% -0.4% 11.0% 13.1% 11.2% Price Return (USD) -0.6% 0.2% 15.6% 8.5% 6.1% Total Return (USD) -0.6% 0.2% 15.6% 8.5% 13.5% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 44,980 12 43,660 10 42,340 8 41,020 6 39,700 4 38,380 37,060 2 35,740 0 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
20 17,560 16,180 15 14,800 13,420 10 12,040 5 10,660 9,280 0 7,900 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
50.0% 14,630
40.0% 12,540 10,450 30.0% 8,360 20.0% 6,270
10.0% 4,180 2,090 0.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBCe
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Financials & valuation: O2 CZ Hold
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (CZKm) EV/sales 2.3 2.3 2.2 2.1 Revenue 37,593 38,076 39,101 40,011 EV/EBITDA 8.3 8.3 8.0 7.7 EBITDA 10,451 10,348 10,639 10,899 EV/IC 2.3 2.4 2.3 2.3 Depreciation & amortisation -3,442 -3,476 -3,492 -3,453 PE* 16.1 16.4 15.6 14.9 Operating profit/EBIT 7,009 6,872 7,146 7,446 PB 4.9 4.9 4.9 4.9 Net interest -90 -323 -279 -219 FCF yield (%) 7.1 7.0 7.6 8.1 PBT 6,742 6,550 6,867 7,227 Dividend yield (%) 6.3 6.1 6.4 6.7 HSBC PBT 6,662 6,550 6,867 7,227 * Based on HSBC EPS (diluted) Taxation -1,485 -1,310 -1,373 -1,445 Net profit 5,257 5,240 5,494 5,781 HSBC net profit 5,330 5,240 5,494 5,781 Issuer information Cash flow summary (CZKm) Share price (CZK) 272.00 Free float 22% Cash flow from operations 9,192 8,641 9,070 9,307 Target price (CZK) 270.00 Sector Diversified Telecoms Capex -2,936 -2,822 -2,631 -2,474 Reuters (Equity) SPTT.PR Country Czech Republic Cash flow from investment -4,501 -2,822 -2,631 -2,474 Bloomberg (Equity) TELEC CP Analyst Herve Drouet Dividends -4,946 -5,366 -5,240 -5,494 Market cap (USDm) 3,297 Contact 44 20 7991 6827 Change in net debt 1,828 -453 -1,199 -1,340
FCF equity 5,949 5,868 6,375 6,761 Balance sheet summary (CZKm) Price relative Intangible fixed assets 16,515 16,515 16,515 16,515 Tangible fixed assets 5,075 4,421 3,559 2,581 Current assets 11,235 11,141 11,346 11,528 278.00 278.00 Cash & others 4,137 4,000 4,000 4,000 Total assets 33,306 32,558 31,902 31,105 228.00 228.00 Operating liabilities -8,419 -8,261 -8,804 -9,347 178.00 178.00 Gross debt 6,976 6,386 5,187 3,847 Net debt 2,839 2,386 1,187 -153 128.00 128.00 Shareholders' funds 17,505 17,505 17,505 17,505 78.00 78.00 Invested capital 37,107 36,339 36,225 35,971 28.00 28.00 2015 2016 2017 O2 CZ Rel to PRAGUE SE-50 Ratio, growth and per share analysis Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 0.3 1.3 2.7 2.3 EBITDA 1.4 -1.0 2.8 2.4 Operating profit 3.3 -1.9 4.0 4.2 PBT 2.1 -2.9 4.8 5.2 HSBC EPS 5.7 -1.7 4.8 5.2 Ratios (%) Revenue/IC (x) 1.0 1.0 1.1 1.1 ROIC 15.2 15.0 15.8 16.5 ROE 29.7 29.9 31.4 33.0 ROA 16.8 16.8 17.8 19.0 EBITDA margin 27.8 27.2 27.2 27.2 Operating profit margin 18.6 18.0 18.3 18.6 EBITDA/net interest (x) 116.1 32.1 38.1 49.7 Net debt/equity 16.2 13.6 6.8 -0.9 Net debt/EBITDA (x) 0.3 0.2 0.1 0.0 CF from operations/net debt 323.8 362.2 764.3 Per share data (CZK) EPS Rep (diluted) 16.65 16.60 17.40 18.32 HSBC EPS (diluted) 16.88 16.60 17.40 18.32 DPS 17.00 16.60 17.40 18.32 Book value 55.46 55.46 55.46 55.46
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Ooredoo (ORDS QD)
Dividend outlook is improving… …but competition intensity will prevent Ooredoo from fully monetising data and 5G opportunities Maintain Reduce; increase TP from QAR78 to QAR91 as we bring in its stake in Asia Mobile Holding at book value
Company description
Ooredoo is the incumbent telecom operator in Qatar. It has international operations in the Eric Chang* Analyst Middle East (Kuwait, Oman, Iraq and Palestine), North Africa (Algeria and Tunisia) and Asia HSBC Bank Middle East Limited (Indonesia and the Maldives). [email protected] +971 4 423 6554 Ooredoo Group (ORDS QD) is the holding company for the Qatari operations as well as listed Nikhil Mishra* entities in Kuwait, Oman, Indonesia and Iraq. EEMEA Telecom Associate Bangalore Ooredoo Kuwait (OOREDOO KK, KWD 1.18, Not Rated). Ooredoo acquired a controlling stake in 2007 and increased its ownership to 92.1% in 2012. This entity includes its namesake * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ operation as well as mobile subsidiaries in Algeria, Tunisia, Palestine and the Maldives. The qualified pursuant to FINRA regulations unit remains listed on the Kuwaiti exchange despite its limited free-float (7.3%). Ooredoo Oman (ORDS OM, OMR 0.58, Not Rated) started as a mobile operator but eventually expanded to fixed services. The company listed on the Muscat Securities Exchange in 2011 and the Ooredoo group owns a 55% stake. Indosat (ISAT IJ, IDR7000, Buy, TP IDR7,800). Ooredoo initiated its investment in the Indonesian mobile operator in 2008. The following year, Ooredoo obtained control by increasing its stake to 65%. Asiacell (TASC IQ, IQD 5.81, Not Rated). Ooredoo owns 64% of the Iraqi mobile operator. It is second to Zain in this market. 3G services were launched in 2016.
Short-term drivers
Affordability, spent dynamics and potential for data monetisation In Qatar, Ooredoo remains the dominant mobile operator with two-thirds share of the overall market and, more importantly, 62% of the high-value post-paid segment.
We think the challenge lies more in its overseas markets that in aggregate represent nearly 75% of group revenues. We think competitive intensity – the majority of these markets have either three or four players – as well as significantly lower GDP/per capita may inhibit Ooredoo’s capacity to monetise data.
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Currency impact GCC markets (Qatar, Kuwait, Oman) represent 40% of group revenues. Ooredoo’s greatest local currency exposure is in Indonesia (Indosat contributes 25% of group revenues), Iraq (13% of group revenues) and Algeria (11% of group revenues). All three currencies have been stable relative to USD.
From a debt perspective, we see little impact from currency fluctuations: 78% of group debt is denominated in USD and QAR, the majority of which is at the parent level. In Indonesia, we see minimal risk of currency mismatch given Indosat has largely refinanced debt in IDR.
Dividend outlook Ooredoo appears to be winding down its high-investment phase, with management guiding to lower capex in 2017. We expect free cash flow to improve, which will allow Ooredoo significant headroom to increase dividends. For 2016, the Board recommended a dividend of QAR3.50, a 17% y-o-y increase.
Long-term driver: 5G expected impact
Monetisation We think Ooredoo’s prospects are greatest in Qatar due to its market structure. We see larger challenges overseas where most markets comprise three to four players. Indonesia and Algeria remain highly competitive: the introduction of 3G and 4G services has not prevented ARPU from declining. Kuwait would be a structurally attractive market: wireless broadband is the preferred internet access for residential customers. Instead all three mobile operators have competed on price to gain or maintain market share, thus eroding market value.
Competition Despite market liberalisation in 2009, Ooredoo remains the dominant operator in Qatar with a near- monopoly on fixed services and two-thirds market share in mobile. In all international markets, we expect competition to remain elevated or even intensify. The government of Oman has invited bids for a third mobile license. In Burma, a fourth entrant is expected to launch this year.
Regulation The Qatari regulator has so far been quite supportive of the incumbent and we expect it to extend this support in an effort to ensure the country is 5G ready before the 2022 FIFA World Cup. Internationally, we believe regulation will be relatively benign. In Indonesia, our Asia telecoms team thinks the regulator may even be supportive of Indosat (ISAT IJ, IDR7,000, Buy) and XL Axiata (EXCL IJ, IDR2,830, Hold) to enable a more balanced competitive environment.
Business model Ooredoo has been focusing on data, which represents 40% of group revenues and has rolled out 4G in eight of its ten markets. In Qatar, the business model is quite supportive as it is the only well-integrated player in the market. In Kuwait, Iraq and Algeria, Ooredoo is a pure-mobile operator as fixed line services are either under-developed or a state monopoly.
Investment thesis
We have had three investment concerns over the past year: competition, currency risk and capital intensity. Only one – competition – remains material, with Algeria, Kuwait, Iraq remaining highly competitive with little prospect of rationality.
We see risks of a new entrant in Burma and potentially in Oman. In Burma, a fourth mobile operator is expected to start operations later this year. In Oman, the regulator has invited bids
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for a third mobile license despite near-saturation of the market. We see a risk of Ooredoo repeating its Kuwait experience, where it saw revenues and profits pressure, and where its Kuwaiti subsidiary even ceded its market position to the new entrant. We think Burma is most at risk given that Ooredoo’s operating and financial performance lag that of Telenor’s (TEL NO, NOK136.30, Hold).
Changes to our estimates
We increase our EBITDA margin estimates by 1.4ppt for both 2017e and 2018e. The company was able to improve its EBITDA margins by 1ppt during 2016, despite revenue growth of only 1%. The company guides for EBITDA growth in the range of 0% to 3%, while we estimate 2017e EBITDA growth at c2%.
Ooredoo: change in estimates ______New ______Previous ______Change ______2017e 2018e 2019e 2017e 2018e 2017e 2018e Revenue 33,759 34,810 35,706 33,582 35,360 0.5% -1.6% EBITDA 13,695 14,030 14,332 13,162 13,772 4.0% 1.9% margin 40.6% 40.3% 40.1% 39.2% 38.9% 1.4% 1.4% Net profit 2,604 2,584 2,666 2,207 2,799 18.0% -7.7% DPS 3.75 3.75 3.75 3.25 4.25 15.4% -11.8% Capex -7,512 -7,867 -8,114 -6,670 -6,755 12.6% 16.5% % revenue 22.3% 22.6% 22.7% 19.9% 19.1% 2.4% 3.5% Source: HSBC estimates
Valuation and risks
Ooredoo: ORDS QD, QAR99, Reduce, TP QAR91 (from QAR78) We value Ooredoo using a sum-of-the-parts approach.
In Qatar, Ooredoo’s market leadership is uncontested and we use a target multiple of 5.5x 2017e EBITDA. We value the Indosat stake at HSBC’s target price of IDR7,800 (ISAT IJ, Buy, TP IDR7,800, covered by Neale Anderson).
We value Algeria, Kuwait, Oman, Palestine and Tunisia on 4x 2017e EBITDA reflecting the competitive intensity. For Ooredoo’s operations in Iraq, Burma, and the Maldives we assign a multiple of 3x 2017e EBITDA. This low multiple reflects: geopolitical instability in Iraq, greenfield operations in Burma and limited growth prospects in Maldives.
We increase our TP to QAR91 (from QAR78) as we bring in Ooredoo’s stake in Asia Mobile Holdings at book value. Our new TP implies downside of 8.1% and we rate the stock Reduce as the intensity of the competition may not afford an improvement in margin or lower capital intensity.
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Ooredoo SOTP EBITDA EV % EV % (QARm) 2017e /EBITDA stake New of EV Qatar 4,105 5.5x 100.0% 22,579 44.8% Oman 1,527 4.0x 55.0% 3,359 6.7% Iraq 1,954 3.0x 64.1% 3,758 7.5% Indosat 3,738 3.7x 65.0% 8,984 17.8% Burma 94 3.0x 100.0% 283 0.6% Kuwait 528 4.0x 92.1% 1,946 3.9% Algeria 1,341 4.0x 73.7% 3,953 7.8% Tunisia 714 4.0x 84.1% 2,401 4.8% Maldives 217 3.0x 92.1% 601 1.2% Subsidiaries 47,852 Palestine 97 4.0x 44.6% 174 0.3% Asia Mobile Holdings 25.0% 2,326 4.6% Associates 2,500
EV 50,362
Debt 2017e 45,485 Cash 2017e -23,997 Adjustment for minority's share in debt -363 Net debt 2017e 21,126
Equity value 30,358 Issued shares (m) 320.32 FV (QAR) 91.00 Source: HSBC estimates
Key upside risks include: favourable FX movements; maintaining market share in Qatar especially in (the high-value) post-paid segment; positive geopolitical developments particularly in Iraq and Tunisia; easing of competitive intensity in some of the key markets.
Valuation and risks Indosat (ISAT IJ, IDR7,000, Buy, TP IDR7,800)
Neale Anderson* We calculate a fair value target price of IDR7,800 for Indosat using a DCF-based Analyst methodology. We apply: a cost of equity of 9%; a debt/capital ratio of 50%, a terminal The Hongkong and Shanghai Banking Corporation Limited growth rate of 1%. This returns a WACC of 7.5%. [email protected] +852 2996 6716 Downside risks: Key downside risks are higher competition than expected, and foreign
exchange-related weakness. * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations
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Relative valuation Ooredoo trades in line with the sector. We highlight that it has reversed to its average forward EV/EBITDA multiple. While consensus revenue estimates have been relatively stable, we note consensus has been more sanguine on Ooredoo’s profit outlook. We highlight a significant increase in 2018 EBITDA estimates over the last six months. We do not share that optimism as long as competition remains elevated in its international markets. The dividend yield has seen an uptick after the announcement of a dividend increase for fiscal 2016.
Ooredoo: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -7.8% -5.7% 1.2% 2.6% 13.7% Total return -7.7% -5.7% 1.2% 2.6% 17.8% Total return vs EEMEA index (USD) -6.6% -5.8% -3.7% 0.7% 0.4% Total return vs MSCI EEMEA Telecom (USD) -8.4% -7.7% -4.0% -0.2% 10.2% Total return vs QE -4.9% -4.7% -3.8% 2.7% 14.7% Price Return (USD) -7.9% -5.7% 1.1% 2.6% 13.5% Total Return (USD) -7.7% -5.7% 1.2% 2.6% 17.8% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 39,020 5 37,920
5 36,820 35,720 4 34,620 33,520 4 32,420 31,320 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
25 15,880 15,300 20 14,720 15 14,140 10 13,560 12,980 5 12,400 0 11,820 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
8.0% 12,670
6.0% 10,860 9,050 4.0% 7,240 2.0% 5,430
0.0% 3,620 1,810 -2.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
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Financials & valuation: Ooredoo Reduce
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (QARm) EV/sales 1.8 1.7 1.6 1.5 Revenue 32,503 33,759 34,810 35,706 EV/EBITDA 4.4 4.2 3.9 3.7 EBITDA 13,365 13,695 14,030 14,332 EV/IC 1.1 1.1 1.1 1.0 Depreciation & amortisation -8,364 -7,808 -7,820 -7,897 PE* 17.2 12.2 12.3 11.9 Operating profit/EBIT 5,001 5,886 6,209 6,436 PB 1.4 1.3 1.3 1.2 Net interest -1,809 -1,753 -1,887 -1,832 FCF yield (%) 6.6 10.6 9.7 9.7 PBT 3,570 4,148 4,338 4,620 Dividend yield (%) 3.5 3.8 3.8 3.8 HSBC PBT 3,221 4,148 4,338 4,620 * Based on HSBC EPS (diluted) Taxation -823 -956 -1,000 -1,065 Net profit 2,193 2,604 2,584 2,666 HSBC net profit 1,843 2,604 2,584 2,666 Issuer information Cash flow summary (QARm) Share price (QAR) 99.00 Free float 36% Cash flow from operations 9,417 10,891 10,957 11,323 Target price (QAR) 91.00 Sector Wireless Telecoms Capex -8,359 -7,012 -7,367 -7,614 Reuters (Equity) ORDS.QA Country Qatar Cash flow from investment -11,030 -8,012 -8,367 -8,614 Bloomberg (Equity) ORDS QD Analyst Eric Chang Dividends -961 -1,121 -1,201 -1,281 Market cap (USDm) 8,708 Contact +971 4 423 6554 Change in net debt -367 -2,758 -2,389 -2,428
FCF equity 2,315 3,746 3,505 3,581 Balance sheet summary (QARm) Price relative Intangible fixed assets 29,827 28,826 27,825 26,825 Tangible fixed assets 32,240 32,445 32,992 33,710 Current assets 24,747 32,393 33,658 34,593 133.00 133.00 Cash & others 16,502 23,997 25,136 25,963 123.00 123.00 Total assets 90,515 97,380 98,207 98,875 113.00 113.00 Operating liabilities 17,134 17,270 17,258 17,277 103.00 103.00 Gross debt 40,748 45,485 44,235 42,635 93.00 93.00 Net debt 24,246 21,488 19,100 16,672 83.00 83.00 Shareholders' funds 22,184 23,587 24,920 26,281 73.00 73.00 Invested capital 53,178 52,396 52,081 51,888 63.00 63.00 53.00 53.00 2015 2016 2017 Ratio, growth and per share analysis Ooredoo Rel to DSM 20 INDEX
Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 1.1 3.9 3.1 2.6 EBITDA 2.8 2.5 2.4 2.2 Operating profit -1.1 17.7 5.5 3.6 PBT 17.7 16.2 4.6 6.5 HSBC EPS -14.5 41.3 -0.8 3.2 Ratios (%) Revenue/IC (x) 0.6 0.6 0.7 0.7 ROIC 9.9 11.5 12.1 12.5 ROE 8.4 11.4 10.7 10.4 ROA 4.7 5.1 5.2 5.4 EBITDA margin 41.1 40.6 40.3 40.1 Operating profit margin 15.4 17.4 17.8 18.0 EBITDA/net interest (x) 7.4 7.8 7.4 7.8 Net debt/equity 83.6 69.3 57.7 47.2 Net debt/EBITDA (x) 1.8 1.6 1.4 1.2 CF from operations/net debt 38.8 50.7 57.4 67.9 Per share data (QAR) EPS Rep (diluted) 6.84 8.13 8.07 8.32 HSBC EPS (diluted) 5.75 8.13 8.07 8.32 DPS 3.50 3.75 3.75 3.75 Book value 69.26 73.63 77.80 82.05
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Orange Polska (OPL PW)
Most affordable data pricing but limited scope to monetise; dividend suspended in 2016 Tough competition and regulation is the key barrier to capitalising on 5G launch Valuation score attractive; Maintain Hold and PLN5 TP
Company description
Orange Polska is a diversified telecom operator in Poland. The mobile segment contributes Herve Drouet* Head of EEMEA TMT Equity c56% of group revenue and fixed line contributes c44%. Research HSBC Bank plc [email protected] +44 20 7991 6827 Short-term drivers Venkata Velagapudi*, CFA EEMEA Telecom Associate Affordability, spent dynamics and potential for data monetisation Bangalore Currently, we estimate smartphone penetration to be above 50% in Poland with the price of the
* Employed by a non-US affiliate of HSBC most affordable smartphone accounting for c11% of monthly disposable income. We expect this Securities (USA) Inc, and is not registered/ to drive rapid smartphone penetration over the next few years. Poland has the most affordable qualified pursuant to FINRA regulations data pricing in EEMEA, with 1GB of mobile data costing less than USD1 on average; thus mobile data usage in Poland is increasing rapidly. The opportunity for data monetisation is likely limited, however, due to the intensity of competition in the country.
Currency impact We expect the currency impact for Orange Polska to be limited, with an estimated c28% of capital spending in hard currency. Around 20% of debt is in hard currency, but is fully hedged by a cross currency swap. HSBC’s FX strategists forecast PLN depreciation of c4% y-o-y in FY17; thus Orange Polska’s capital spending could be at moderate risk due to potential PLN depreciation.
Dividend outlook Orange Polska decided not to pay a dividend for FY16 in order to maximise cash allocation to strategic investment projects like fibre rollout; however we are a bit sceptical about this strategy to skip dividends. We expect dividends to resume from FY17e and factor DPS of PLN0.25 for FY17 implying c5% yield.
Long-term driver: 5G expected impact
We are conservative about Orange Polska’s capability to monetise data by offering bundled services because of the tough competitive environment in Poland, where competitive risks remain high for the medium term. Spectrum payments were very high in the latest spectrum auctions relative to those in other EEMEA markets. High spectrum payments for 5G may limit Orange Polska’s capital spending capabilities.
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Investment thesis
Operational conditions remain tough for Orange Polska, with revenue growth likely impacted by declines in fixed and infrastructure projects, and mobile revenue growth facing competitive pressures post 4G launch. Mobile service revenue will be impacted by new roaming regulations and uncertainty in the prepaid segment. Orange Polska’s corporate segment is likely to continue to suffer from low tariffs in mobile broadband, leading to cannibalisation. It has also signaled it wants to defend market share, and pricing could remain aggressive. Mobile equipment sales growth will be lower than in FY16 according to management. Cable operators such as UPC, are upgrading their networks with docsis 3.1 which will remain competitive against Orange Polska’s G-fast offering in fixed line broadband. We expect revenue to decline by c4% in FY17e driven by a c5% decline in fixed line revenue.
Despite our conservative view on the fundamentals, Orange Polska looks attractive on valuation. The share price has declined 15% y-t-d (vs Index at -14%) and valuation is now less expensive – 4.5x 2017e EV/EBITDA, giving dividend yield for FY16e of 4.6%.
Valuation and Risks
Orange Polska: OPL PW, PLN4.67, Hold, TP PLN5.0 We value Orange Polska using a DCF model assuming a COE of 9%, RFR of 3.5% based on the sovereign bond yield of Poland, MRP of 5.5% and a beta of 1 (all unchanged). Our fair value target price of PLN5 implies 7.1% upside and we rate the stock Hold as we see a possible catalyst in the form of accelerated real estate sales that have been freed by the company, and there is room to improve working capital by selling handsets client receivables.
Upside risks include less competition than expected in the mobile segment, consolidation in Polish telecom sector and a better-than-expected macro and regulatory environment.
Downside risks include more aggressive competition in the domestic mobile and fixed segment, lower than expected dividend, worsening of macro in Poland.
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Relative valuation Orange Polska is currently trading in the lower half of the EV/EBITDA and EV/OPFCF 1 year forward multiple range. It is trading in line with its historical valuation relative Consensus estimates have been revised down due to continuing decline in the legacy business, and headwinds from competition and European mobile roaming regulation. Consensus expect stabilisation in 2018 Dividend yield expectations have been reduced post the 2016 dividend suspension
Orange Polska: Valuation Benchmark chart Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -1.1% -10.4% -14.6% -18.8% -24.6% Total return -0.9% -10.2% -14.5% -18.8% -20.8% Total return vs EEMEA index (USD) 0.0% -11.4% -17.3% -25.7% -41.5% Total return vs MSCI EEMEA Telecom (USD) -1.5% -12.2% -19.7% -21.6% -28.4% Total return vs Poland index 1.0% -15.4% -29.0% -40.5% -46.6% Price Return (USD) -1.4% -10.5% -11.7% -23.6% -26.9% Total Return (USD) -1.2% -11.3% -12.4% -23.8% -24.1% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 12,060 6 11,900 6 11,740 5 11,580 5 11,420 4 11,260 11,100 4 10,940 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
100 3,900 3,730 50 3,560 3,390 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 3,220 -50 3,050 2,880 -100 2,710 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
8.0% 4,060 6.0% 3,480 4.0% 2,900 2.0% 2,320 1,740 0.0% 1,160 -2.0% 580 -4.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters DataStream, HSBCe
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Financials & valuation: Orange Polska Hold
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (PLNm) EV/sales 1.2 1.2 1.1 1.1 Revenue 11,538 11,115 11,082 11,182 EV/EBITDA 4.3 4.5 4.2 3.8 EBITDA 3,163 2,920 3,038 3,154 EV/IC 0.5 0.5 0.5 0.5 Depreciation & amortisation -2,725 -2,782 -2,684 -2,765 PE* NM NM NM NM Operating profit/EBIT 438 138 354 390 PB 0.6 0.6 0.7 0.8 Net interest -359 -310 -306 -290 FCF yield (%) 12.0 8.2 10.4 13.8 PBT -1,713 -172 48 100 Dividend yield (%) 0.0 5.4 5.4 21.4 HSBC PBT 9 -172 48 100 * Based on HSBC EPS (diluted) Taxation -33 -8 -10 -20 Net profit -1,746 -179 38 80 HSBC net profit -24 -179 38 80 Issuer information Cash flow summary (PLNm) Share price (PLN) 4.67 Free float 50% Cash flow from operations 2,549 2,632 2,656 2,854 Target price (PLN) 5.00 Sector Diversified Telecoms Capex -1,989 -2,045 -1,959 -1,920 Reuters (Equity) OPL.WA Country Poland Cash flow from investment -5,382 -2,045 -1,959 -1,920 Bloomberg (Equity) OPL PW Analyst Herve Drouet Dividends -328 -328 -328 -328 Market cap (USDm) 1,501 Contact 44 20 7991 6827 Change in net debt 2,950 -588 -369 -606
FCF equity 807 550 695 923 Balance sheet summary (PLNm) Price relative Intangible fixed assets 8,798 8,798 8,798 8,798 Tangible fixed assets 10,678 9,941 9,216 8,372 11.90 11.90 Current assets 2,418 2,740 2,733 2,753 10.90 10.90 Cash & others 262 600 600 600 9.90 9.90 Total assets 22,588 22,172 21,441 20,617 8.90 8.90 Operating liabilities -4,107 -4,448 -4,376 -5,389 Gross debt 7,194 6,944 6,575 5,970 7.90 7.90 Net debt 6,932 6,344 5,975 5,370 6.90 6.90 Shareholders' funds 10,009 9,502 9,212 7,980 5.90 5.90 Invested capital 25,739 25,327 24,522 24,712 4.90 4.90 3.90 3.90 2015 2016 2017 Orange Polska Rel to WIG 20 Ratio, growth and per share analysis Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue -2.6 -3.7 -0.3 0.9 EBITDA -7.8 -7.7 4.0 3.8 Operating profit -23.4 -68.4 155.8 10.0 PBT -709.6 109.1 HSBC EPS -111.6 109.1 Ratios (%) Revenue/IC (x) 0.5 0.4 0.4 0.5 ROIC -4.6 0.6 1.1 1.3 ROE -0.2 -1.8 0.4 0.9 ROA -12.3 0.7 1.3 1.5 EBITDA margin 27.4 26.3 27.4 28.2 Operating profit margin 3.8 1.2 3.2 3.5 EBITDA/net interest (x) 8.8 9.4 9.9 10.9 Net debt/equity 69.3 66.8 64.9 67.3 Net debt/EBITDA (x) 2.2 2.2 2.0 1.7 CF from operations/net debt 36.8 41.5 44.4 53.2 Per share data (PLN) EPS Rep (diluted) -1.33 -0.14 0.03 0.06 HSBC EPS (diluted) -0.02 -0.14 0.03 0.06 DPS 0.00 0.25 0.25 1.00 Book value 7.63 7.24 7.02 6.08
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Rostelecom (RTKM RM)
Short term: Dividend outlook looks healthy assuming no M&A Long term: Lack of mobile infrastructure may impact the data monetisation capability post 5G launch We switch our primary coverage from the ADR to the local listing. Hold, cut TP to RUB84 (from RUB88)
Company description
Rostelecom is a wireline operator composed of a nationwide backbone transport network, local Herve Drouet* Head of EEMEA TMT Equity telephony services, and adjunct wireline services such as broadband and IPTV. It owns a 45% Research stake in mobile operator T2RTK (Joint venture of Rostelecom and Tele2) in Russia HSBC Bank plc [email protected] +44 20 7991 6827
Venkata Velagapudi*, CFA Short-term drivers EEMEA Telecom Associate Bangalore Affordability, spent dynamics and potential for data monetisation We expect growth in fixed broadband data to drive growth for Rostelecom. The tough macro * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ and intense competition in Russia may impede data monetisation capability short-term. qualified pursuant to FINRA regulations Currency impact Almost all group debt is in denominated in local currency (RUB), as is a significant portion of capex, which makes Rostelecom to be resilient to currency risk in our view.
Dividend outlook Rostelecom has a dividend policy to pay 75% of FCF or at least RUB45bn over 2016-18, whichever is lower. Based on our estimates Rostelecom’s dividend yield will be around c8% short-term. Given the robust FCF yield and healthy leverage ratios, we see this as sustainable, assuming there is no significant M&A activity.
Long-term driver: 5G expected impact
Rostelecom is moderately well placed to benefit from the 5G launch, with a lack of mobile infrastructure the key hurdle. We expect competition to turn rational gradually, while the potential entry of disruptive new entrants or technology players is limited in Russia due to security concerns. According to news reported by Reuters on 6 March 2017, Rostelecom is considering the need to have a controlling stake in mobile operator T2RTKM (the fourth mobile operator in Russia).
The key question is whether Rostelecom will acquire the remaining 55% stake in T2RTKM from VTB (VTBR.MM, RUB0.066, Reduce). The mobile operation is highly leveraged and there could have a negative impact on the balance sheet, with a possible transfer of value to VTB if there were to be an acquisition.
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Investment thesis
We have a conservative outlook regarding Rostelecom’s medium-term growth. The tough macro in Russia and competitive pressures in the B2B segment will limit the growth of revenue and EBITDA in our view. But we view dividends and valuation as attractive. One potential issue is the lower and delayed public investment in the BDD project. Another risk is the possible acquisition of the remaining 55% stake in the mobile associate tele2RTK: acquiring a controlling stake could be at a large premium, with an impact on dividend and ROIC. We estimate around c8% dividend yield for Rostelecom near-term. The stock trades at c3x 2017e EV/EBITDA (compared to EEMEA average of c5x).
Change in estimates
Change in estimates Old 2017e 2018e 2019e Revenue 301,128 312,415 - EBITDA 100,242 104,756 - Net Profit 15,419 22,155 - New Revenue 300,171 310,189 318,116 EBITDA 98,003 102,422 105,982 Net Profit 13,987 19,890 21,386 Old vs New Revenue 0% -1% - EBITDA -2% -2% - Net Profit -9% -10% - Source: HSBC
We revise our estimates post Q4 2016 results, slightly lowering operational and capital spending estimates to be in line with the management guidance.
Valuation and Risks
Rostelecom: RTKM.MM, RUB76.5, Hold, TP RUB84 (from RUB88) We switch our primary coverage from the ADR to the local listing. We value Rostelecom using a DCF model assuming a COE of 14.6%, RFR of 8.5% (based on sovereign yield of Russia), and MRP of 5.5% and a beta of 1.1 (unchanged). We reduce our TP to RUB84 from RUB88. Lower TP is due to lower estimates partially offset by lower capex estimates. Our TP implies an upside of 9.8% and we rate the stock Hold due to the weak growth outlook. For the ADR (RKMD LI, USD7.86 as of 14 Mar), Our TP is unchanged at USD8.10 (using an exchange rate of 62 (65 earlier) for RUB/USD and 1 ADR= 6 shares.
Key downside risks to our view include liberalisation of the fixed-line market, fixed-to mobile substitution, and accelerated adoption of new internet communication technologies, changes to fixed-line licensing and other developments in the competitive environment.
Key upside risks to our valuation include a better-than-expected Russian macro environment, as well as a better-than-expected performance from T2RTK.
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Relative valuation
Looks cheap on V/EBITDA and EV/OPFCF But estimates consensus continue to erode with fear of potential M&A Dividend spread still negative and at risk if M&A activity
Rostelecom: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -2.8% -9.7% -13.0% -7.2% -19.3% Total return -2.8% -9.7% -13.0% -7.2% -13.9% Total return vs EEMEA index (USD) -1.5% -8.5% -10.6% -0.6% -9.8% Total return vs MSCI EEMEA Telecom (USD) -3.5% -11.7% -18.2% -10.0% -21.5% Price return vs MICEX -1.1% -2.2% -4.7% -6.0% -25.3% Price Return (USD) -2.4% -8.0% -5.8% 1.3% 1.3% Total Return (USD) -2.7% -8.5% -5.6% 1.3% 7.6% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 314,240 5 311,570
5 308,900 306,230 4 303,560 300,890 4 298,220 295,550 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2014 2015 2016 2017 2018 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
14 112,230 12 109,420 10 106,610 8 103,800 6 100,990 4 98,180 2 95,370 0 92,560 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2014 2015 2016 2017 2018
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
20.0% 74,060 15.0% 63,480 10.0% 52,900 5.0% 42,320 0.0% 31,740 -5.0% 21,160 -10.0% 10,580 -15.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2014 2015 2016 2017 2018
Source: Thomson Reuters Datastream, HSBCe
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Financials & valuation: Rostelecom Hold
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (RUBm) EV/sales 0.9 0.9 0.9 0.8 Revenue 297,446 300,171 310,189 318,116 EV/EBITDA 2.9 2.8 2.6 2.5 EBITDA 95,207 98,003 102,422 105,982 EV/IC 0.7 0.7 0.7 0.7 Depreciation & amortisation -55,589 -58,315 -62,411 -65,419 PE* 15.3 14.1 9.9 9.2 Operating profit/EBIT 39,618 39,688 40,011 40,562 PB 0.8 0.8 0.8 0.8 Net interest -17,175 -15,524 -15,909 -15,501 FCF yield (%) 12.1 17.6 20.2 23.8 PBT 16,723 18,164 25,433 27,150 Dividend yield (%) 7.7 7.7 7.7 7.7 HSBC PBT 16,712 18,164 25,433 27,150 * Based on HSBC EPS (diluted) Taxation -4,693 -4,178 -5,543 -5,764 Net profit 12,030 13,987 19,890 21,386 HSBC net profit 12,868 13,987 19,890 21,386 Issuer information Cash flow summary (RUBm) Share price (RUB) 76.50 Free float 44% Cash flow from operations 61,177 78,401 82,286 84,855 Target price (RUB) 84.00 Sector Diversified Telecoms Capex -61,857 -61,924 -61,739 -61,469 Reuters (Equity) RTKM.MM Country Russian Federation Cash flow from investment -56,950 -61,924 -61,739 -61,469 Bloomberg (Equity) RTKM RM Analyst Herve Drouet Dividends -13,295 -15,243 -15,243 -15,243 Market cap (USDm) 3,275 Contact 44 20 7991 6827 Change in net debt 3,459 -1,234 -5,304 -8,142
FCF equity 11,279 16,477 19,182 23,164 Balance sheet summary (RUBm) Price relative Intangible fixed assets 61,209 61,209 61,209 61,209 Tangible fixed assets 343,667 347,277 346,605 342,655 108.00 108.00 Current assets 68,872 89,554 91,057 92,246 Cash & others 4,257 25,000 25,000 25,000 98.00 98.00 Total assets 555,682 573,974 576,136 575,463 88.00 88.00 Operating liabilities 71,465 71,504 74,324 75,651 Gross debt 187,105 206,614 201,310 193,169 78.00 78.00 Net debt 182,848 181,614 176,310 168,169 68.00 68.00 Shareholders' funds 244,316 243,059 247,705 253,848 Invested capital 398,026 401,536 399,547 395,459 58.00 58.00 48.00 48.00 2015 2016 2017 Ratio, growth and per share analysis Rostelecom Rel to RTS INDEX
Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 0.0 0.9 3.3 2.6 EBITDA -5.6 2.9 4.5 3.5 Operating profit -1.5 0.2 0.8 1.4 PBT -14.2 8.6 40.0 6.7 HSBC EPS -16.4 8.7 42.2 7.5 Ratios (%) Revenue/IC (x) 0.8 0.8 0.8 0.8 ROIC 7.7 7.6 7.8 8.0 ROE 5.3 5.7 8.1 8.5 ROA 4.6 4.6 5.6 5.8 EBITDA margin 32.0 32.6 33.0 33.3 Operating profit margin 13.3 13.2 12.9 12.8 EBITDA/net interest (x) 5.5 6.3 6.4 6.8 Net debt/equity 73.5 73.4 70.0 65.1 Net debt/EBITDA (x) 1.9 1.9 1.7 1.6 CF from operations/net debt 33.5 43.2 46.7 50.5 Per share data (RUB) EPS Rep (diluted) 4.67 5.43 7.72 8.31 HSBC EPS (diluted) 5.00 5.43 7.72 8.31 DPS 5.92 5.92 5.92 5.92 Book value 94.88 94.40 96.20 98.59
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Saudi Telecom Co (STC AB)
STC has a solid base from which to deliver on 5G monetisation Unleveraged balance sheet is supportive of the dividend policy over the medium term Maintain Hold and SAR71 TP
Company description
Saudi Telecom Company (STC) is the incumbent telecom operator in Saudi Arabia where it Eric Chang* Analyst remains the only integrated telecom company. Liberalisation of the Saudi telecoms market took HSBC Bank Middle East Limited place in stages. In 2004, the CITC awarded the second mobile license to Mobily and the fixed-line [email protected] +971 4 423 6554 market was liberalised in 2007 with the award of three new fixed-line licenses. Nikhil Mishra* Despite the competitive pressure from market liberalisation, STC was late in seeking international EEMEA Telecom Associate Bangalore diversification, deploying capital by acquiring minority stakes with mixed results. Currently, the company is limiting its expansion ambitions to the Middle East. Its subsidiaries in Kuwait and * Employed by a non-US affiliate of HSBC Bahrain have performed well despite being the third entrant in these small markets. Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations The rationalisation of STC’s international operations has resulted in a positive impact on its financials and on investor sentiment. In terms of revenue contribution, Saudi Arabia represents 90% of the group while Kuwait and Bahrain contribute the balance. Domestic operations remain the key driver as the size of the Kuwaiti and Bahraini markets limits upside potential. For the purpose of this thematic report, we focus on STC’s operations in Saudi Arabia and Kuwait.
Short-term drivers
Affordability, spent dynamics and potential for data monetisation We do not view affordability (handsets or services) as an issue given Saudi Arabia’s oil wealth, but telecom spending may be under pressure as the Saudi government’s efficiency drive reduces allowances and subsidies.
We see data as key driver of revenue growth. Mobile penetration in the Kingdom is in excess of 150% whereas smartphone penetration is estimated to be 60%. Data monetisation is hence correlated to the competition intensity. We think Zain KSA and Mobily are unlikely to indulge in value-destructive price wars as both need to resolve their high leverage. We do not award STC the highest score in our ranking on this metric on account of Viva Kuwait’s low data monetisation.
Currency impact We do not see any currency impact because the company only operates in the Gulf where the currencies are pegged (in one form or another) to the USD.
100 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Dividend outlook The incumbent established a dividend policy in November 2015 that calls for the payment of a minimum of SAR1 per share per quarter. The policy is valid until Q3 2018. We forecast an annual increase of SAR0.25: STC should be able to meet our expectations based on its cash- rich balance sheet. However, we see limited scope for a marked increase because our dividend estimate is significantly higher than free cash-flow.
Long-term driver: 5G expected impact
Monetisation Overall, we believe STC has reasonable opportunities for monetisation. In its domestic market, we believe the incumbent’s extensive fixed infrastructure (and crucially the link to the last mile) is a significant competitive advantage.
Monetisation can improve if competition in Saudi Arabia and Kuwait becomes rational (see also the Viva Kuwait company section). The unified license in Saudi Arabia will allow competitors to chip away at its near-monopoly on fixed and data services.
Competition In the Saudi mobile segment, we expect competition to remain rational. We do not envisage Zain KSA or Mobily engaging in value destructive price wars because both companies need to resolve their high leverage. In addition, we discount the risk of new mobile entrants given the penetration rates and the fact that two out of three network operators are struggling with profitability. However, Mobily may pose some threat to STC’s monopoly on fixed and data services.
In our opinion, Kuwait is by far the most competitive telecoms market in the Gulf. The three operators have nearly a third of market share, with Zain preserving its leadership. In 2016, Ooredoo was the only operator that managed to grow revenues (+5% y-o-y). Revenues for Zain and Viva were flat and Viva’s subscriber base stagnated in 2016, showing the limits of an aggressive pricing strategy. We would like to see greater rationality in the pricing strategy but think it is unlikely.
Regulation In Saudi Arabia, the regulator has not introduced any regulation on net neutrality and the practice of zero-rating. The introduction of a unified license increases competition on fixed and data services.
Kuwait established a regulator last year but its format and strategy are yet to become apparent and at this stage, its role and function remains unclear. We note the provisions of international gateways and fixed line services are the sole prerogative of the Ministry of Communications. There have been talks about privatising these services but nothing has transpired to date.
Business model As the incumbent, STC has a structural advantage over its Saudi competitors: it is the only integrated network operator in the Kingdom, and its network allows it to dominate the corporate and government segments. We also presume STC has the best mobile network and greater spectrum. Discussions with Mobily to form a TowerCo joint-venture would allow all parties to achieve lower capex and opex in our view.
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Investment thesis
STC is currently by far the biggest telecom operator in Saudi Arabia – it has the highest market share in the mobile segment and is the dominant player in the fixed line segment. Broadband, especially mobile, has been the driver of growth for telecoms in the region. STC’s leadership in Saudi Arabia has been a key competitive advantage as it was a net beneficiary of data growth.
This has translated into high cash generation and a solid balance sheet. We still think its high cash balance will lead – over time – to increased dividend pay-out (we forecast an annual increase of SAR0.25). However, we see limited scope for a marked increase as our dividend estimate is significantly higher than free cash flow. In light of deteriorating financial performance, de-regulation of the Saudi telecoms market and challenging economic conditions, we think STC may be more prudent with its net cash position. Moreover, STC’s trade receivables have nearly doubled, from SAR8.2bn (63 days) in Q4 2014 to SAR18.5bn (140 days) in Q4 2016. We think this could be related to STC’s government-related accounts and highlights the possibility of receivables write-downs.
Valuation and risks
STC: STC AB, SAR65.75, Hold, TP SAR71 We value STC on equal weighting of DCF (cSAR75/share) and a multiples-based SOTP (cSAR67/share). Our TP of SAR71 implies 8.0% upside and we rate the stock Hold in light of deteriorating financial performance, de-regulation of the Saudi telecoms market and challenging economic conditions.
STC Valuation (SAR) Weight Fair value Target price calculation DCF 50% 75.45 37.73 SOTP 50% 67.12 33.56 TP 71.29 (rounded to 71.00) Source: HSBC estimates
DCF
We calculate a DCF fair value of SAR75.45. The key assumptions remain the same: WACC 6.6%, risk free rate of 2.5%, equity risk premium of 7% and beta of 0.73 (as calculated by FactSet).
Sum-of-the-parts
Core Saudi operations are valued at 5.5x 2017e EBITDA Viva Kuwait (VIVA KK, Reduce) stake at our target price of KWD0.74. Viva Bahrain operations are valued at 4x 2017e EBITDA We assign no value for STC’s 35% stake in Oger Telecom We value Maxis (MAXIS MK, MYR 6.40, Reduce, covered by Piyush Choudhary) at HSBC’s target price of MYR5.15. This is based on a cost of equity of 6.5%, cost of debt of c5.0% and terminal growth rate of 0.5%
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STC SOTP SARm EBITDA EV % EV % 2017e /EBITDA stake of EV Saudi Arabia 19,471 5.5x 100.0% 107,091 91.7% Viva Kuwait 1,598 51.8% 2,357 2.0% Viva Bahrain 520 4.0x 100.0% 2,079 1.8% Subsidiaries 111,527
Oger Telecom 35.0% 0 0.0% Maxis 16.2% 5,308 4.5% Associates 5,308
EV 116,835
Debt 5,881 Cash -24,858 Minority's share in net debt 1,566 Net debt -17,410
Equity value 134,245 Issued shares (m) 2,000.0 FV (SAR) 67.12 Source: HSBC estimates
Upside risks: higher dividend in the coming quarters; Viva Kuwait focusing on profitability instead of market share; Oger Telecom (of which STC owns 35%) solving its debt problem in an equity accretive manner
Downside risks: we highlight the possibility of receivables write-downs. Trade receivables continue to go up and now exceed SAR18bn; an extended period of low oil prices would have a deeper impact on the Saudi economy and telecom spending; higher competition in the mobile segment (from Zain KSA and the MVNOs) and in the ICT segment (Mobily); a further cut in termination rates in Saudi Arabia would impact revenue and margins as STC is the leading operator in the country; given its significant net cash position, STC could take part in dilutive M&A activity. We believe the possibility is lower as the company seemed to have learnt from its past experience.
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Relative valuation STC trades at the higher range of sector multiples. We observe an interesting trend in consensus estimates. The consensus is becoming sanguine on revenue growth prospects but has been more cautious on profit as seen in the recent EBITDA estimates downgrades.
The dividend yield, while attractive, has compressed as the share price lost some steam during Q4 2016.
STC: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 1.2% 1.2% -8.9% 14.3% -3.0% Total return 1.1% 1.2% -9.0% 16.3% 3.6% Total return vs EEMEA index (USD) 2.3% 1.2% -13.9% 14.4% -13.8% Total return vs MSCI EEMEA Telecom (USD) 0.5% -0.8% -14.2% 13.4% -4.0% Price return vs Tadawul 1.2% 1.2% -6.9% 1.4% -11.4% Price Return (USD) 0.8% 0.8% -9.1% 14.0% -3.0% Total Return (USD) 1.1% 1.2% -8.9% 16.3% 3.6% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 57,280 8 55,540 7 53,800 52,060 6 50,320 5 48,580 4 46,840 45,100 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
20 22,660 21,990 15 21,320 20,650 10 19,980 5 19,310 18,640 0 17,970 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
10.0% 21,210
8.0% 18,180 15,150 6.0% 12,120 4.0% 9,090
2.0% 6,060 3,030 0.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
104 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Financials & valuation: Saudi Telecom Company Hold
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) EV/sales 2.0 2.0 2.0 2.0 Revenue 51,845 52,952 55,456 57,567 EV/EBITDA 5.8 5.9 5.9 6.0 EBITDA 18,256 18,213 18,538 18,848 EV/IC 3.0 2.9 2.7 2.5 Depreciation & amortisation -8,063 -8,595 -8,368 -8,364 PE* 13.7 14.9 13.6 13.1 Operating profit/EBIT 10,193 9,618 10,170 10,484 PB 2.2 2.2 2.1 2.1 Net interest 561 175 283 233 FCF yield (%) 7.1 5.1 4.7 5.3 PBT 9,510 9,870 10,797 11,215 Dividend yield (%) 6.1 6.5 6.8 7.2 HSBC PBT 9,803 9,081 9,934 10,318 * Based on HSBC EPS (diluted) Taxation -751 -789 -863 -897 Net profit 8,539 8,835 9,686 10,070 HSBC net profit 9,583 8,835 9,686 10,070 Issuer information Cash flow summary (SARm) Share price (SAR) 65.75 Free float 16% Cash flow from operations 19,606 17,000 16,818 17,773 Target price (SAR) 71.00 Sector Diversified Telecoms Capex -10,561 -10,100 -10,371 -10,608 Reuters (Equity) 7010.SE Country Saudi Arabia Cash flow from investment -11,424 -10,100 -10,371 -10,608 Bloomberg (Equity) STC AB Analyst Eric Chang Dividends -8,031 -8,375 -8,875 -9,375 Market cap (USDm) 35,057 Contact +971 4 423 6554 Change in net debt 1,157 1,624 3,498 3,356
FCF equity 8,855 6,287 5,868 6,502 Balance sheet summary (SARm) Price relative Intangible fixed assets 4,394 4,194 4,383 4,790 Tangible fixed assets 43,023 44,728 46,542 48,379 107.00 107.00 Current assets 46,899 46,425 41,415 38,272 Cash & others 24,858 21,834 16,936 12,498 97.00 97.00 Total assets 101,854 102,851 100,187 99,787 87.00 87.00 Operating liabilities 34,899 36,468 34,517 34,629 Gross debt 5,881 4,481 3,081 2,000 77.00 77.00 Net debt -18,976 -17,353 -13,854 -10,498 67.00 67.00 Shareholders' funds 59,743 60,571 61,258 61,827 Invested capital 34,559 37,044 40,886 44,314 57.00 57.00 47.00 47.00 2015 2016 2017 Ratio, growth and per share analysis Saudi Telecom Company Rel to TADAWUL ALL SHARE INDEX
Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 8 Mar 2017 Revenue 2.4 2.1 4.7 3.8 EBITDA -5.4 -0.2 1.8 1.7 Operating profit -14.0 -5.6 5.7 3.1 PBT -9.3 3.8 9.4 3.9 HSBC EPS -8.4 -7.8 9.6 4.0 Ratios (%) Revenue/IC (x) 1.5 1.5 1.4 1.4 ROIC 30.7 28.1 25.9 23.7 ROE 15.9 14.7 15.9 16.4 ROA 9.0 9.0 9.9 10.4 EBITDA margin 35.2 34.4 33.4 32.7 Operating profit margin 19.7 18.2 18.3 18.2 EBITDA/net interest (x) Net debt/equity -31.1 -28.0 -22.1 -16.6 Net debt/EBITDA (x) -1.0 -1.0 -0.7 -0.6 CF from operations/net debt Per share data (SAR) EPS Rep (diluted) 4.27 4.42 4.84 5.03 HSBC EPS (diluted) 4.79 4.42 4.84 5.03 DPS 4.00 4.25 4.50 4.75 Book value 29.87 30.29 30.63 30.91
105 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Telkom Group (TKG SJ)
With growth uncertainty around BCX/Enterprise and higher capex/D&A, we expect benign growth in FCF/EBITDA/HEPS Moderately placed to benefit from 5G. Convergence strategy and network sharing will help but completion and regulation challenging No compelling growth/rating drivers exist near-term. Maintain Hold and ZAR77.0 TP
Company description
Telkom is a diversified telecom operator in South Africa. The fixed-line segment contributes Ziyad Joosub* Analyst 66% to revenue, the mobile segment 14% and BCX (Telkom’s IT arm) c17.5%. Enterprise HSBC Securities (South Africa) (Pty) Ltd services account for c50% of revenue, consumer services 30% and wholesale services 20%. [email protected] +27 (0)11 676 4223 Ramesh Pantagolusula* Short-term drivers EEMEA Telecom Associate Bangalore Affordability, spent dynamics and potential for data monetisation
* Employed by a non-US affiliate of HSBC Through price leadership, Telkom Mobile has been very successful in the 4G mifi router space Securities (USA) Inc, and is not registered/ and is now looking to monetise the smartphone segment more efficiently with its FreeMe qualified pursuant to FINRA regulations packages; initial indications are that FreeMe is generally being used as a secondary SIM by subscribers – nevertheless uptake of both 4G mifi router’s and FreeMe continues to be robust, with mobile broadband subscribers increasing 44.5% to 2.28m in H1 2017. South Africa fares well against EEMEA peers with the cheapest smartphone representing 1.6% of PPP-adj GDP per capita and c7% of monthly disposable income (adjusted for cost of living). Data pricing remains elevated in South Africa at USD10.7 per GB on a blended basis, forming 0.99% of PPP adjusted GDP per capita – however we note Telkom Mobile prices data at a discount. Mobile data remains a key driver for Telkom, and this is likely to continue near-term due to spectrum allocation delays in South Africa, as it has spectrum advantages in the 1800/2300MHz bands. On the fixed-line data side Telkom continues to price at a premium (20-40%) to competitors, with only 0.3% growth in fixed broadband subscribers in H1 2017 and c19,000 FTTH subscribers, ADSL subscriber numbers are falling at Telkom with FTTH net-adds not making up for the decline. Given this growth drag and that only 13-14% homes passed have FTTH connectivity (high competitive intensity), we do not see FTTH as a transformational growth driver near-term. Approximately 65% of fixed-line data revenue is driven by connectivity; while (1) competition in FTTH; (2) pricing in Enterprise; and (3) LTE cannibalisation of ADSL limit growth prospects we expect data connectivity revenue to improve to 2-3% in the medium term (from 0.3% in H1 2017) as Enterprise pricing pressure eases and migration from legacy leased lines to Megalines and Metro Ethernet accelerates.
106 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Currency impact We expect the currency impact to be negligible for Telkom over the short term given its low exposure to dollarised debt of only 3.8% and that the ZAR has strengthened c15% against the USD over the past 4-6 months. Savings on capex through the recent strengthening of the ZAR are likely to drive better investment yields as the company can invest a greater USD amount of capex: we note capex is guided for in ZAR terms; hence we do not expect any reduced guidance on this front given recent ZAR strength and heightened capex guidance by competitors (MTN South Africa specifically).
Dividend outlook We believe Telkom will continually invest in greater 3G/4G/LTE capability in order to (1) facilitate optimal growth and market share gains; (2) support greater business scale; (3) maintain price leadership; and (4) avert network congestion issues due to traffic/revenue concentration of BTS’s in key metropolitan areas. Management has stated that Telkom will push ahead aggressively with fibre rollouts over the next 12 months. Whilst we foresee no dividend transformation at Telkom, outside of any unforeseen M&A, we believe the dividend is secure and will largely underpin current valuations as it is fully covered by internal FCF generation (80% of FCF), while Telkom’s balance sheet (0.3x 2017e net debt to EBITDA) also remains unlevered. We see little scope for extraordinary cash returns at Telkom (buyback, special or higher payouts) with the balance sheet being used for spectrum and potential bolt-on acquisitions (IT, FTTH retail ISPs) and “higher-capex/flat-FCF” is set to be a multi-year theme in our view.
Long-term driver: 5G expected impact
Fixed-line infrastructure and fibre advantage to erode overtime, 5G will be a competitive and level playing field; key advantage will be in the IT software for Enterprise. In theory Telkom, due to its spectrum and extensive fibre and wifi advantages, is the best positioned operator to monetise 5G relative to Vodacom SA and MTN SA– also given its scale, 5G provides Telkom with the highest growth optionality of listed MNOs in South Africa. While the incumbent fixed-line operator lacks appropriate mobile scale and penetration into high ARPU smartphone, nevertheless Telkom should benefit from 5G mifi-like products and establish a strong position in the second data-SIM market. Telkom’s ability to sustain its balance sheet capacity longer-term is debatable given it needs to invest for growth, which could be through M&A, whilst defending its dividend pay-out level as well (80%+ of FCF). No operator in South Africa has “excess” low frequency spectrum except Neotel (not listed), which has no mobile infrastructure – thus low-frequency spectrum advantages until the digital-dividend spectrum allocation is finalised appear minimal. We believe most of the 4G/5G wallet will reside in key metropolitan areas in South Africa; whilst Telkom has extensive fixed-line infrastructure nationwide-wide, we believe that by 2020 its fibre density advantage to MTN and Vodacom will reduce meaningfully in key metropolitan areas. Independent fibre provider rollouts (where transmission can be leased from) and higher fibre investment by MTN, Vodacom and Cell C is likely to erode Telkom’s fixed-line advantage in key urban centres and business parks. A key advantage for Telkom will be its IT scale post its acquisition of BCX and its existing Enterprise segment scale, Telkom’s ability to drive 5G as an agile software-defined network infrastructure for IOT Applications will be a key determinant to how successful it is in 5G.
107 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Investment thesis
We forecast 2H17/FY18 revenue growth of only 0.4%/1.7% y-o-y, while mobile (data/voice) dynamics remain relatively robust and Openserve/wholesale revenue appears to be stabilising (greater demand seen from MNOs and FTTH ISPs) – we remain concerned on revenue dynamics at BCX/Enterprise. These segments have high public-sector exposure on the back of slumping tax revenue and benign growth – the South Africa government’s robust fiscal consolidation agenda looks likely to continue. We see little scope for immediate cost transformation, as employee annual attrition of 3% (1% organic and 2% outsourcing) is offset by a 5% average annual salary increase. Overall, we expect 20-40bps margin expansion a year at Telkom, which combined with a subdued 3-year revenue CAGR of 2.3% drives our FY17-20 EBITDA CAGR forecast of 3.2%.
1 year forward FCF-yield and PE of 6.4% and 11.0x are 2.2 and 1.0 standard deviations above their means; the initiation of a fixed dividend-policy has driven a structural re-rating of Telkom. We believe the dividend is secure and will largely underpin current valuations as it is fully covered by internal FCF generation (80% of FCF), while Telkom’s balance sheet (0.3x 2017e net debt to EBITDA) also remains unlevered. An outlook for “slow-growth” + slow “multiple- contraction” underpins our Hold rating. Asset-base/invested-capital build-up due to higher-capex cycle will drive a slow reduction of ROE/ROIC over the medium term; we thus expect multiples to gradually contract. HSBCe EBITDA/FCF/HEPS 3 year CAGR of 3.2%/3.6%/5.2% will not be sufficient to offset the de-rating in our view.
Valuation and Risks
Telkom SA, TKG SJ, ZAR69.8 Hold, TP ZAR77 We value Telkom South Africa on a 50/50 split between our SOTP valuation of ZAR77.0 and our DCF for the company as a whole of ZAR76.5 to arrive at a final fair value target price of ZAR77. Our DCF valuation is based on explicit cash flow forecasts for six years to FY2022e and assumes a second-stage growth into perpetuity of 1.0% for the fixed-line business and 2% for the mobile segment. Our DCF based SoTP valuation for the whole company is based on a COE of 13.5%, RFR of 8.5%, equity risk premium of 5% and a beta of 1.0. Our ZAR77 TP implies 10.3% upside and we rate the stock Hold based on our expectation for slow-growth plus slow multiple contraction.
Key upside risks include: (1) Completion of BCX/Enterprise integration drives greater than expected synergies; (2) stabilisation in public sector ICT contract pricing and competition; (3) faster than expected mobile FCF break-even and growth; (4) value accretive M&A; and (5) higher ordinary payout or initiation of buybacks and/or special dividends.
Key downside risks include: (1) Higher competitive intensity for South Africa mobile; (2) greater than expected regulatory risk; and (3) unforeseen telecom taxes or operational surprises.
108 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Relative valuation
Valuation relatively premium versus history Higher sales growth estimation Consensus EBITDA estimates rising
Telkom South Africa: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 3.3% -1.6% -4.4% 15.0% 22.2% Total return 3.3% -1.6% -4.4% 17.1% 29.9% Total return vs EEMEA index (USD) 4.3% 0.8% -5.0% 23.2% 36.0% Total return vs MSCI EEMEA Telecom (USD) 2.7% -3.6% -9.6% 14.3% 22.3% Price return vs JSE 4.1% -0.6% -5.9% 18.6% 24.0% Price Return (USD) 3.0% 0.8% -0.2% 22.6% 44.3% Total Return (USD) 3.1% 0.8% -0.1% 25.1% 53.4% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 45,880 6 43,690 6 41,500 5 39,310 5 37,120 4 34,930 32,740 4 30,550 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
14 12,970 12 12,260 10 11,550 8 10,840 6 10,130 4 9,420 2 8,710 0 8,000 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
15.0% 8,190
10.0% 7,020 5,850 5.0% 4,680 0.0% 3,510
-5.0% 2,340 1,170 -10.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Datastream, HSBCe
109 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Financials & valuation: Telkom SA Reduce
Financial statements Key forecast drivers Year to 03/2016a 03/2017e 03/2018e 03/2019e Year to 03/2016a 03/2017e 03/2018e 03/2019e Profit & loss summary (ZARm) Access lines (000s) 3,288 3,150 2,994 0 Revenue 36,044 40,867 41,544 42,794 ADSL subscribers (000s) 970 971 984 0 EBITDA 10,954 10,599 10,794 11,298 Fixed line EBITDA margin (%) 37.2 37.4 37.7 0.0
Depreciation & amortisation -5,272 -5,599 -5,860 -6,063 Operating profit/EBIT 5,682 4,999 4,934 5,235 Net interest -318 -341 -305 -267 Valuation data PBT 5,263 4,518 4,630 4,968 Year to 03/2016a 03/2017e 03/2018e 03/2019e HSBC PBT 5,263 4,518 4,630 4,968 EV/sales 0.9 0.8 0.8 0.8 Taxation -942 -994 -1,019 -1,143 EV/EBITDA 3.1 3.3 3.2 3.0 Net profit 4,557 3,577 3,489 3,702 EV/IC 1.3 1.3 1.2 1.1 HSBC net profit 3,351 3,407 3,558 3,768 PE* 10.6 10.7 10.3 9.7 Cash flow summary (ZARm) PB 1.4 1.4 1.2 1.1 Cash flow from operations 8,153 9,487 8,726 9,152 FCF yield (%) 9.5 10.6 7.7 9.2 Capex -5,851 -6,895 -6,887 -6,848 Dividend yield (%) 3.9 5.6 5.8 6.2 Cash flow from investment -8,106 -6,895 -6,887 -6,848 * Based on HSBC EPS (diluted) Dividends -1,402 -2,040 -2,135 -2,261 Change in net debt 2,929 619 -330 -362 FCF equity 2,930 3,291 2,425 2,910 Issuer information Balance sheet summary (ZARm) Share price (ZAR) 69.80 Free float 36% Intangible fixed assets 4,584 4,584 4,584 4,584 Target price (ZAR) 77.00 Sector Diversified Telecoms Tangible fixed assets 25,357 27,609 29,650 31,509 Reuters (Equity) TKGJ.J Country South Africa Current assets 12,912 10,519 10,486 10,587 Bloomberg (Equity) TKG SJ Analyst Ziyad Joosub Cash & others 2,548 1,635 1,662 1,712 Market cap (USDm) 2,813 Contact +27 (0)11 676 4223 Total assets 46,787 46,256 48,284 50,283
Operating liabilities 14,738 14,222 14,042 14,037 Gross debt 5,269 4,975 4,672 4,359 Net debt 2,721 3,340 3,010 2,648 Price relative Shareholders' funds 26,134 26,367 28,825 31,084 Invested capital 25,567 26,856 29,016 30,932 86.00 86.00
81.00 81.00 76.00 76.00 Ratio, growth and per share analysis 71.00 71.00 Year to 03/2016a 03/2017e 03/2018e 03/2019e 66.00 66.00 Y-o-y % change 61.00 61.00 Revenue 13.8 13.4 1.7 3.0 56.00 56.00 EBITDA 22.0 -3.2 1.8 4.7 51.00 51.00 Operating profit 95.3 -12.0 -1.3 6.1 46.00 46.00 PBT 93.4 -14.1 2.5 7.3 2015 2016 2017 Telkom SA Rel to JSE ALL SHARE HSBC EPS 54.2 -1.0 4.4 5.9 Ratios (%) Source: HSBC Revenue/IC (x) 1.5 1.6 1.5 1.4 Note: Priced at close of 08 Mar 2017 ROIC 18.7 13.7 12.7 12.6 ROE 12.9 13.0 12.9 12.6 ROA 10.8 8.5 8.5 8.5 EBITDA margin 30.4 25.9 26.0 26.4 Operating profit margin 15.8 12.2 11.9 12.2 EBITDA/net interest (x) 34.4 31.1 35.4 42.3 Net debt/equity 10.2 12.4 10.2 8.3 Net debt/EBITDA (x) 0.2 0.3 0.3 0.2 CF from operations/net debt 299.6 284.0 289.9 345.7 Per share data (ZAR) EPS Rep (diluted) 8.93 6.82 6.66 7.06 HSBC EPS (diluted) 6.56 6.50 6.79 7.19 DPS 2.73 3.89 4.07 4.31 Book value 50.14 50.04 56.45 60.87
110 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Turk Telekom (TTKOM TI)
Vulnerable to exchange rate risk, which may impact dividend outlook over short term Well placed to benefit from 5G given the ability to execute convergence strategy Maintain Hold and TRY6 TP
Company description
Turk Telekom is a diversified telecom operator in Turkey. The fixed line segment contributes Herve Drouet* Head of EEMEA TMT Equity c64% of group revenue and mobile contributes c36%. Turk Telekom’s mobile segment Avea is Research HSBC Bank plc the third largest operator in Turkey with a subscriber market share of c25%. [email protected] +44 20 7991 6827 Venkata Velagapudi*, CFA Short-term drivers EEMEA Telecom Associate Bangalore Affordability, spent dynamics and potential for data monetisation
* Employed by a non-US affiliate of HSBC We are moderately optimistic about Turk Telekom’s ability to monetise data. Currently c75% of Securities (USA) Inc, and is not registered/ its mobile subscribers use data services. The price of the most affordable smartphone accounts qualified pursuant to FINRA regulations for c14% of monthly disposable income in Turkey; for EEMEA peers, the median value of the most affordable smartphone accounts for 10% of monthly disposable income. The average price of mobile data at Turk Telekom is low relative to Turkcell and EEMEA peers.
Mobile data revenue has grown over 30% y-o-y in the past four quarters. Given the nationwide fibre network and good quality spectrum to enhance the LTE experience, Turk Telekom looks well placed to execute a convergence strategy. In the 4.5G spectrum auction concluded last year, it acquired the 900MHz spectrum, thus eliminating its earlier disadvantage.
Currency impact Turk Telekom looks the most vulnerable to currency risk among the EEMEA telecom operators. Roughly 50% of its capital expenditure is in hard currency, and hard currency debt accounted for around 82% of total gross debt. Moreover, HSBC’s FX strategists forecast TRY depreciating by 12% y-o-y in FY17.
Dividend outlook Dividend yield is dependent mainly on the USD/TRY exchange rate. In FY16, dividends were not paid because of a net loss at group level due to sharp TRY depreciation. We expect dividends to resume in FY17, with estimated dividend yield of c6%. Although we are conservative about the actual dividend pay-out due to the volatile exchange rate (TRY/USD and TRY/EUR), the company’s ability to pay a dividend should be good, driven by healthy FCF yield and leverage. We expect FCF yield to be above 12% over the next two years, with leverage (Net debt/EBITDA) at 1.3x by end-FY17e and 1x by end-FY18e.
111 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Long-term driver: 5G expected impact
Turk Telekom looks well placed to benefit from 5G in the medium term, with its diversified infrastructure in both fixed and mobile. Data is gradually becoming the key driver in the Turkish telecoms market and multi-play and convergence services are seeing significant traction, which will change the way existing players compete. Turk Telekom has a natural advantage with strong offers in both mobile and fixed lines services for residential and corporate customers. It is the only operator in Turkey with nationwide fibre coverage and eliminated its disadvantage in 900MHz spectrum at the spectrum auctions, concluded last year.
We expect the Turkey market to gradually become rational in the medium term. Turk Telekom’s mobile segment and the third largest mobile operator, Avea, has a c25% subscriber market share and we believe it would make more economic sense to adopt rational pricing going forward. Given the intention of operators in Turkey to collaborate at the capital spending level in the medium term, the pricing environment should become more rational in the medium term. Telecom assets are increasingly perceived politically as a strategic asset. Regulation is relatively accommodating with tech neutral frequency already acquired for 4G and 5G although spectrum price has been relatively expensive.
Turk Telekom’s business model still has a legacy as the national incumbent. However the company has become leaner and more agile as it has restructured its organisation, and now uses a common brand. It can also benefit from some premium media content it has acquired (European football rights).
Investment thesis
Turk Telekom’s operational level estimates look healthy, with Mobile data and Fixed Broadband the key drivers of revenue and EBITDA over the next few years. We are optimistic about Turk Telekom’s strategy of focusing on operating free cash flow over FY17. It should comfortably achieve its EBITDA guidance (TRY5.6-6bn) in FY17. Despite a volatile exchange rate, Turk Telekom managed to limit capital spending in FY16 and we expect it to be able to continue doing so in FY17, keeping it under TRY3bn. Over the medium term, Turk Telekom intends to sharing capital spending with other operators in Turkey.
However, we remain conservative on Turk Telekom as the exchange rate (TRY/USD and TRY/EUR) is likely to be volatile over the near term. Given its high proportion of debt and capex in hard currency, Turk Telekom looks vulnerable to the currency risk. Net profit may be impacted by the forex loss, which will in turn lead to a lower dividend pay-out.
Valuation and Risks
Turk Telekom: TTKOM TI, TRY5.7, Hold, TP TRY6.0 We assume a cost of equity of 16% and a risk-free rate of 10.5% (based on Turkey’s long-term bond yield), with a market risk premium of 5.5% and beta of 1.0 (all unchanged). Our fair value target price of TRY6.0 implies upside of 5.3% and we rate the stock Hold as we remain concerned about potential TRY weakness, which could affect reported net profit in 2017. The stock currently trades on an EV/EBITDA multiple for 2017e of 4.5x and adjusted PE for 2017e of 10.3x versus the EEMEA telcos sector average of EV/EBITDA of 4.7x and adjusted PE of 11.2x.
Upside risks include: a quicker recovery of the TRY; a change in the dividend policy so that it is not based purely on reported net income and also considers cash flow generation; and a more favorable regulatory environment. Downside risks include: increased competition; a more aggressive-than-expected decline in data pricing; a sustained weakening economic outlook; a higher-than-expected forex loss; and a lower-than-expected dividend.
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Valuation relatives
Attractive on EV/opFCF Consensus has stabilised and may now increase No Dividend in 2016 due to TRY currency but should resume in 2017
Turk Telekom: Valuation Benchmark Chart Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -1.7% 2.7% 9.2% -2.4% -4.3% Total return -1.7% 2.7% 9.2% -2.4% -0.5% Total return vs EEMEA index (USD) -2.2% 2.2% -3.8% -24.9% -39.8% Total return vs MSCI EEMEA Telecom (USD) -2.4% 0.7% 4.0% -5.2% -8.1% Price return vs Borsa Istanbul -1.8% 1.2% -9.0% -17.2% -19.5% Price Return (USD) -3.5% 2.2% 1.2% -23.0% -25.3% Total Return (USD) -3.4% 2.3% 1.2% -23.0% -22.3% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 21,460 7 20,250
6 19,040 17,830 5 16,620 15,410 4 14,200 12,990 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
30 7,390 25 7,030 20 6,670 6,310 15 5,950 10 5,590 5 5,230 0 4,870 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
15.0% 5,250
10.0% 4,500 3,750 5.0% 3,000 0.0% 2,250
-5.0% 1,500 750 -10.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: HSBCe , Datastream
113 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Financials & valuation: Turk Telekom Hold
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (TRYm) EV/sales 1.7 1.6 1.4 1.2 Revenue 16,109 17,402 19,041 20,738 EV/EBITDA 5.1 4.5 3.8 3.3 EBITDA 5,470 6,049 6,872 7,688 EV/IC 0.9 0.9 0.8 0.7 Depreciation & amortisation -2,848 -3,071 -3,033 -2,933 PE* 10.7 10.3 7.9 6.1 Operating profit/EBIT 2,622 2,979 3,839 4,756 PB 5.9 5.7 5.4 5.0 Net interest -504 -566 -529 -454 FCF yield (%) 8.5 10.3 12.1 14.7 PBT -394 1,786 3,310 4,302 Dividend yield (%) 0.0 6.1 11.6 15.1 HSBC PBT 2,220 2,413 3,310 4,302 * Based on HSBC EPS (diluted) Taxation -329 -470 -794 -1,032 Net profit -723 1,316 2,516 3,269 HSBC net profit 1,871 1,943 2,516 3,269 Issuer information Cash flow summary (TRYm) Share price (TRY) 5.70 Free float 13% Cash flow from operations 4,932 4,675 5,739 6,296 Target price (TRY) 6.00 Sector Diversified Telecoms Capex -3,026 -2,989 -3,067 -3,201 Reuters (Equity) TTKOM.IS Country Turkey Cash flow from investment -4,609 -3,972 -3,272 -3,406 Bloomberg (Equity) TTKOM TI Analyst Herve Drouet Dividends -841 -1,211 -1,211 -2,315 Market cap (USDm) 5,350 Contact 44 20 7991 6827 Change in net debt 2,447 -703 -1,257 -575
FCF equity 1,650 2,000 2,348 2,857 Balance sheet summary (TRYm) Price relative Intangible fixed assets 8,386 9,164 9,164 9,164 Tangible fixed assets 8,686 8,605 8,639 8,907 8.10 8.10 Current assets 9,236 9,280 9,608 9,947 Cash & others 3,016 3,000 3,000 3,000 7.60 7.60 Total assets 26,874 27,820 28,388 29,200 7.10 7.10 Operating liabilities -6,381 -7,941 -9,564 -10,690 6.60 6.60 Gross debt 11,540 10,820 9,564 8,988 6.10 6.10 Net debt 8,523 7,820 6,564 5,988 Shareholders' funds 3,387 3,492 3,693 3,955 5.60 5.60 Invested capital 29,672 31,989 33,975 35,708 5.10 5.10 4.60 4.60 2015 2016 2017 Turk Telekom Rel to ISTANBUL COMP Ratio, growth and per share analysis Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 11.2 8.0 9.4 8.9 EBITDA 2.6 10.6 13.6 11.9 Operating profit -14.5 13.6 28.9 23.9 PBT -131.2 85.3 30.0 HSBC EPS -38.4 3.8 29.5 30.0 Ratios (%) Revenue/IC (x) 0.6 0.6 0.6 0.6 ROIC 7.6 7.8 8.8 10.4 ROE 44.7 56.5 70.0 85.5 ROA -1.6 6.8 10.7 12.9 EBITDA margin 34.0 34.8 36.1 37.1 Operating profit margin 16.3 17.1 20.2 22.9 EBITDA/net interest (x) 10.9 10.7 13.0 16.9 Net debt/equity 251.7 224.0 177.7 151.4 Net debt/EBITDA (x) 1.6 1.3 1.0 0.8 CF from operations/net debt 57.9 59.8 87.4 105.1 Per share data (TRY) EPS Rep (diluted) -0.21 0.38 0.72 0.93 HSBC EPS (diluted) 0.53 0.56 0.72 0.93 DPS 0.00 0.35 0.66 0.86 Book value 0.97 1.00 1.06 1.13
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Turkcell (TCELL TI)
Potential for data monetisation strong driven by focus on digital strategy; Dividend outlook to improve Well placed to capitalise on 5G launch driven by the ability to execute convergence strategy and rational competition Maintain Buy and TRY14.2 TP
Company description
Turkcell is a diversified telecom operator with presence in Turkey, Ukraine and Belarus. Turkey Herve Drouet* Head of EEMEA TMT Equity contributes c90% of group revenue, with c4% from Ukraine. Turkcell is the market leader in the Research mobile segment in Turkey with a subscriber market share of c48%. HSBC Bank plc [email protected] +44 20 7991 6827
Venkata Velagapudi*, CFA Short-term drivers EEMEA Telecom Associate Bangalore Affordability, spent dynamics and potential for data monetisation
* Employed by a non-US affiliate of HSBC We are optimistic about Turkcell’s ability to monetise data. Currently a majority of subscribers Securities (USA) Inc, and is not registered/ use a smartphone, with the most affordable smartphone accounting for around 14% of monthly qualified pursuant to FINRA regulations disposable income in Turkey. Through its consumer financing unit, Turkcell aims to enable easier smartphone purchase. For EEMEA peers, the median value of the most affordable smartphone accounts for 10% of monthly disposable income. Turkcell is able to charge higher prices for mobile data in Turkey than its peers. It intends to focus on selling digital services rather than selling raw data. Given the better quality and quantity of spectrum we are bullish about Turkcell’s digital strategy.
Currency impact Turkcell looks moderately vulnerable to currency risk among EEMEA telecom operators. Roughly 50% of its capital expenditure is in hard currency, and hard currency debt forms around 75% of total gross debt. Moreover, HSBC FX strategists forecast 12% y-o-y TRY depreciation in FY17. After considering hedging and cash reserves in hard currency, Turkcell has a net FX exposure of USD125m as of end-FY16.
Dividend outlook For Turkcell, the dividend payment hinges on the resolution of the shareholder dispute. Dividend payments over the past two years (FY15 and FY16) have been cancelled due to the deadlock. We assume a resolution in 2017. We therefore see a dividend of TRY0.50 per share (based on a 50% pay-out ratio) for FY17e, to be paid and approved in 2018. If the shareholder dispute is resolved, we cannot rule out the possibility of extraordinary shareholder dividends in FY17 related to the unpaid dividends over the past two years. We do not factor any extraordinary dividends into our model in order to stay conservative.
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Long-term driver: 5G expected impact
Turkcell is well placed to benefit from 5G over medium term in our view and data and digital services will play a crucial role in driving growth. Superior infrastructure in mobile and good infrastructure in fibre through superonline should enable it to offer multi-play and convergence services. Turkcell’s position in the mobile segment is further strengthened since the recently concluded spectrum auction. Increasing the fibre network across the nation will be the key for Turkcell before the launch of 5G in Turkey and we see it improving its fibre coverage gradually over the next few years. Currently Turkcell has fibre networks in 15 cities (vs Turk Telekom’s presence in 81 cities) and is exploring options to share capital expenditure with other players, such as Vodafone Turkey and Turksat, to build the infrastructure.
We expect competition to become more rational in Turkey over the medium term. Given the intention of operators in Turkey to collaborate at a capital spending level, pricing should also turn more rational.
Telecom assets are increasingly perceived politically as a strategic asset. Regulation is relatively accommodating with tech neutral frequency already acquired for 4G and 5G, although spectrum price has been relatively expensive.
Turkcell’s business model is increasingly turning towards digital applications, and there is already a relatively well developed digital platform with significant premium contact.
Investment thesis
Our bullish view on Turkcell is mainly driven by significant improvement in operational trends. We expect Turkcell’s digital strategy to lead to an improvement in ARPUs, lower churn rates and higher EBITDA margins. Given its infrastructure in mobile and fixed line segments, we expect Turkcell to be successful in executing a convergence strategy.
We expect the FCF outlook to improve over the next few years driven by improving margins and declining capital spending. Turkcell’s capital spending cycle should reverse from FY17e: capital expenditure peaked in FY16 mainly driven by the accelerated 4.5G rollout and volatility in TRY/USD.
Given its robust growth outlook, Turkcell looks attractive on a relative valuation, trading at 4.5x 2018e EV/EBITDA (a 12% discount to EEMEA average of 5x).We expect Turkcell to rerate to a higher multiple given its accelerating growth, margin and FCF improvement. Other catalysts could be the potential sale of Fintur and monetisation of the tower business through a stake sale.
Valuation and Risks
Turkcell: TCELL TI, TRY12.18, Buy, TP TRY14.2 We maintain our DCF-based fair value target price of TRY14.2. We assume a cost of equity of 16% and a risk-free rate of 10.5% (based on Turkey sovereign bond yield), with a market risk premium of 5.5% and beta of 1.
Our TRY14.2 fair value target price implies upside of 16.6% and we rate the stock Buy based on a robust growth outlook and improvement in margin and FCF outlook. Our target price for Turkcell’s ADRs (TKC US, USD8.21) is USD9.70, using the equation of 1 ADR equaling 2.5 shares and USD/TRY of 3.66.
Downside risks relate to the regulatory environment and domestic competition, which may put pressure on Turkcell’s margins and growth prospects. Weak macroeconomic prospects for Turkey and Ukraine are other downside risks, together with a more aggressive-than-expected decline in data pricing. Any potential sale of TeliaSonera’s stake in Turkcell may put the share price under pressure.
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Relative valuation
Valuation relatively cheap versus the sector and history Superior growth Consensus estimates rising
Turkcell: Valuation Benchmark Chart Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -0.2% 9.2% 33.9% 22.3% 3.0% Total return -0.2% 9.2% 33.8% 22.3% 3.0% Total return vs EEMEA index (USD) -0.7% 8.7% 19.1% -5.4% -37.0% Total return vs MSCI EEMEA Telecom (USD) -0.8% 7.2% 28.6% 19.5% -4.6% Price return vs Borsa Istanbul -0.3% 7.7% 15.7% 7.4% -12.1% Price Return (USD) -1.9% 8.8% 24.0% -3.6% -19.6% Total Return (USD) -1.9% 8.8% 24.0% -3.5% -19.6% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 20,700 9 19,350 8 18,000 7 16,650 6 15,300 5 13,950 12,600 4 11,250 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
150 7,040 100 6,530 50 6,020 5,510 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 5,000 -50 4,490 -100 3,980 -150 3,470 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
25.0% 5,670 20.0% 4,860 15.0% 4,050 10.0% 5.0% 3,240 0.0% 2,430 -5.0% 1,620 -10.0% 810 -15.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBCe
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Financials & valuation: Turkcell Buy
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (TRYm) EV/sales 2.0 1.8 1.5 1.3 Revenue 14,286 16,079 17,974 20,085 EV/EBITDA 6.2 5.4 4.5 3.8 EBITDA 4,620 5,257 5,995 6,805 EV/IC 1.5 1.4 1.3 1.3 Depreciation & amortisation -2,203 -2,416 -2,428 -2,501 PE* 9.8 12.0 9.5 7.7 Operating profit/EBIT 2,416 2,841 3,567 4,304 PB 1.7 1.6 1.4 1.3 Net interest 617 22 75 155 FCF yield (%) 5.5 5.9 9.1 11.4 PBT 1,967 2,845 3,643 4,460 Dividend yield (%) 0.0 4.1 5.3 6.5 HSBC PBT 2,991 2,863 3,643 4,460 * Based on HSBC EPS (diluted) Taxation -423 -626 -801 -981 Net profit 1,492 2,212 2,834 3,470 HSBC net profit 2,738 2,230 2,834 3,470 Issuer information Cash flow summary (TRYm) Share price (TRY) 12.18 Free float 35% Cash flow from operations 607 4,746 5,492 6,234 Target price (TRY) 14.20 Sector Wireless Telecoms Capex -3,495 -3,212 -3,055 -3,214 Reuters (Equity) TCELL.IS Country Turkey Cash flow from investment -2,977 -4,536 -3,055 -3,214 Bloomberg (Equity) TCELL TI Analyst Herve Drouet Dividends 0 -1,106 -1,106 -1,417 Market cap (USDm) 7,186 Contact 44 20 7991 6827 Change in net debt 2,431 -211 -1,330 -1,603
FCF equity 1,374 1,458 2,261 2,840 Balance sheet summary (TRYm) Price relative Intangible fixed assets 8,236 9,560 9,560 9,560 Tangible fixed assets 8,196 8,991 9,619 10,332 17.00 17.00 Current assets 13,351 10,877 11,180 11,518 16.00 16.00 Cash & others 6,052 3,500 3,500 3,500 15.00 15.00 Total assets 31,600 31,246 32,177 33,227 14.00 14.00 Operating liabilities 4,513 5,809 6,645 7,556 13.00 13.00 Gross debt 9,781 7,018 5,688 4,085 12.00 12.00 Net debt 3,729 3,518 2,188 585 11.00 11.00 Shareholders' funds 16,012 17,118 18,535 20,270 10.00 10.00 Invested capital 19,217 20,120 20,214 20,354 9.00 9.00 8.00 8.00 2015 2016 2017 Turkcell Rel to ISTANBUL COMP Ratio, growth and per share analysis Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 11.9 12.6 11.8 11.7 EBITDA 11.6 13.8 14.0 13.5 Operating profit 19.7 17.6 25.6 20.7 PBT -7.0 44.6 28.1 22.4 HSBC EPS -4.2 -18.6 27.1 22.5 Ratios (%) Revenue/IC (x) 0.8 0.8 0.9 1.0 ROIC 13.0 11.3 13.8 16.6 ROE 18.0 13.5 15.9 17.9 ROA 6.8 8.2 10.0 11.5 EBITDA margin 32.3 32.7 33.4 33.9 Operating profit margin 16.9 17.7 19.8 21.4 EBITDA/net interest (x) Net debt/equity 23.2 20.5 11.8 2.9 Net debt/EBITDA (x) 0.8 0.7 0.4 0.1 CF from operations/net debt 16.3 134.9 251.0 1066.1 Per share data (TRY) EPS Rep (diluted) 0.68 1.01 1.29 1.58 HSBC EPS (diluted) 1.24 1.01 1.29 1.58 DPS 0.00 0.50 0.64 0.79 Book value 7.28 7.78 8.42 9.21
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VimpelCom (VIP US)
Short term: Significant scope for dividend improvement Long term: Change of business model to technology company will be positive ahead of 5G launch Maintain Buy, cut TP to USD5.2 (from USD5.4)
Company description
VimpelCom is a diversified telecom operator with presence in Russia, Italy, North Africa, Asia Herve Drouet* and CIS. VimpelCom Russia contributes 46% of group revenue, with Africa and Asia Head of EEMEA TMT Equity Research contributing 34% and CIS contributing 14%. VimpelCom has announced its intention to list in HSBC Bank plc [email protected] Amsterdam as well (expected in Q2 2017). +44 20 7991 6827
Venkata Velagapudi*, CFA EEMEA Telecom Associate Short-term drivers Bangalore
Affordability, spent dynamics and potential for data monetisation * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ Currently c62% of VimpelCom mobile subscribers use some kind of mobile data services, with qualified pursuant to FINRA regulations the price of the most affordable smartphone representing c14% of monthly disposable income in Russia. Given the tough macro in Russia, monetisation has been limited recently. Data pricing is also cheap and competitive retailers incentivise mobile users to churn. We would like to see less aggressive promotion, which could be driven by a shift of the Russian mobile operators towards more monobrand shops. The split of Euroset shops between Megafon and VimpelCom is a key catalyst in our view. However, we expect VimpelCom’s voice and data monetisation to be driven by key segments such as Pakistan, Bangladesh and Ukraine. In Algeria, we expect VimpelCom’s market share to gradually stabilise.
Currency impact VimpelCom looks at moderate risk of a currency impact due to exchange rate movement in Russia and Ukraine. A significant portion of its capital expenditure is in hard currency, with 73% of group debt in hard currency. HSBC FX strategists forecast RUB depreciating c6% y-o-y in FY17 relative to USD. Therefore we expect VimpelCom to be vulnerable to currency risk to some extent over the short term.
Dividend outlook The dividend outlook at VimpelCom improved significantly in FY16. The company announced total dividends of USDc23 (including the regular USDc3.5 paid in December 2016), with USDc19.5 paid in April 2017. The improvement in leverage ratio post the deconsolidation of Wind (Italy segment) is in our view the key factor behind the improved dividends. We expect the current dividend yield to be sustainable over the near term given the good FCF yield and controlled leverage and we see scope for further improvement in dividends over the next two years.
119 EQUITIES ● TELECOMS / EEMEA 16 March 2017
Long-term driver: 5G expected impact
VimpelCom reiterated the group strategy to transform into a technology company from a conventional telecom company post the Q4 2016 results, which we think will be a benefit post the launch of 5G, by creating new revenue streams and optimising capital spending.
It is a diversified operator in two of its key markets – Russia and Ukraine – which is also a positive, putting it in a good position to offer convergence services. We expect competition in Russia to become rational gradually.
The potential entry of disruptive new entrants or technology players is limited in Russia due to security concerns. Consolidation in key markets like Bangladesh and Pakistan will help VimpelCom. The Russian telecom regulator is benign in terms of spectrum allocation as the mobile operators are allocated spectrum at a low cost. Spectrum prices may go higher in other markets like Africa and Asia.
Lack of strict enforcement of net neutrality is a positive for the Russian segment. However, in other Asian markets like Bangladesh and Pakistan net neutrality may be strictly enforced.
VimpelCom has been actively pursuing network sharing to reduce capital expenditure and, to some extent, operating expenses. We expect this to continue post 5G launch.
Investment thesis
Our positive view on VimpelCom is mainly driven by an improving dividend outlook on the back of improving free cash flows. VimpelCom guides for equity free cash flow of more than USD1bn for FY18 (compared to USD588m in FY16 and guidance of USD700-800m in FY17). Management guides for low single digit growth in revenue and EBITDA. The growth in equity free cash flows will be mainly driven by improvement in capital efficiency. VimpelCom’s emphasis on disposing non-strategic assets will help it to reduce capex/sales to c15% in the medium term (currently 17-18%). Given the robust free cash flows we expect over the next few years, we see significant scope for dividend improvement.
Change in estimates
We revise our model post Q4 2016 results, cutting our estimates as the Q4 2016 results were lower than our expectations.
Old vs New estimates Old 2017e 2018e 2019e Revenue 9,107 9,431 - EBITDA 3,605 3,721 - Net Profit 1,444 1,781 - New Revenue 9,443 9,531 9,859 EBITDA 3,804 3,927 4,075 Net Profit 775 968 1,192 Old vs New Revenue 4% 1% - EBITDA 6% 6% - Net Profit -47% -46% - Source: HSBCe
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Valuation and Risks
VimpelCom: VIP US, USD3.98, Buy, TP USD5.2 (from USD5.4) We value VimpelCom based on DCF valuation. We assume a COE of 14.6%, RFR of 8% (based on the sovereign yield of key operating markets), and MRP of 6% and a beta of 1.1 (all unchanged). Our TP decreases to USD5.2 from USD5.40 due to lower estimates. Our target price of USD5.2 implies 30.7% upside from current levels and we rate the stock Buy.
Key downside risks include RUB and EUR fluctuations with the USD, macroeconomic volatility and M&A activities or share overhang of the Telenor stake coming to the market. Other risks include regulatory uncertainties related to deal approval, increased competition, weak economic outlook, exposure to Ukraine and tougher-than-expected competition with Iliad’s entry in Italy.
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Relative valuation
Looks attractive on EV/EBITDA and EV/OPFCF versus peers Dividend yield rising significantly Consensus estimates rising since deconsolidation of Wind Italy.
VimpelCom: Benchmark Valuation chart Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -4.0% -2.7% 8.6% -4.9% 5.4% Total return -4.1% -2.7% 8.4% -4.0% 6.4% Total return vs EEMEA index (USD) -2.9% -2.7% 3.5% -5.9% -11.0% Total return vs MSCI EEMEA Telecom (USD) -4.8% -4.7% 3.2% -6.8% -1.2% Total return vs NYSE -2.3% -4.7% 5.1% -10.5% -12.7% Price return vs NYSE -2.2% -4.5% 5.9% -10.1% -10.6% Price Return (USD) -4.0% -2.7% 8.6% -4.9% 5.4% 2017e 2018e 2017e 2018e 2017e 2018e Total Return (USD) -4.1% -2.7% 8.4% -4.0% 6.4% EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 17,830 8 16,320 7 14,810 13,300 6 11,790 5 10,280 4 8,770 7,260 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
20 7,770 7,040 15 6,310 5,580 10 4,850 5 4,120 3,390 0 2,660 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
20.0% 5,040 15.0% 4,320 10.0% 3,600 5.0% 0.0% 2,880 -5.0% 2,160 -10.0% 1,440 -15.0% 720 -20.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBCe
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Financials & valuation: VimpelCom Ltd Buy
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (USDm) EV/sales 1.3 1.2 1.1 1.0 Revenue 8,905 9,443 9,531 9,859 EV/EBITDA 3.7 3.0 2.8 2.5 EBITDA 3,232 3,804 3,927 4,075 EV/IC 1.0 1.0 1.0 1.0 Depreciation & amortisation -2,147 -1,973 -1,922 -1,911 PE* 13.2 7.2 6.5 5.8 Operating profit/EBIT 1,085 1,831 2,005 2,164 PB 1.1 1.1 1.0 0.9 Net interest -761 -690 -687 -640 FCF yield (%) -6.2 21.9 25.0 28.5 PBT 434 1,477 1,669 1,896 Dividend yield (%) 5.8 5.8 7.0 8.6 HSBC PBT 936 1,477 1,669 1,896 * Based on HSBC EPS (diluted) Taxation -635 -608 -575 -549 Net profit 2,415 775 968 1,192 HSBC net profit 525 968 1,068 1,192 Issuer information Cash flow summary (USDm) Share price (USD) 3.98 Free float 11% Cash flow from operations 1,875 2,485 2,606 2,836 Target price (USD) 5.20 Sector Diversified Telecoms Capex -2,104 -1,517 -1,496 -1,523 Reuters (Equity) VIP.N Country Russian Federation Cash flow from investment -2,610 -1,517 -1,496 -1,523 Bloomberg (Equity) VIP US Analyst Herve Drouet Dividends -60 -402 -443 -540 Market cap (USDm) 6,961 Contact 44 20 7991 6827 Change in net debt 1,616 -566 -667 -773
FCF equity -267 975 1,144 1,339 Balance sheet summary (USDm) Price relative Intangible fixed assets 6,953 6,433 5,949 5,500 Tangible fixed assets 6,719 6,783 6,841 6,903 6.90 6.90 Current assets 4,550 5,210 5,223 5,272 Cash & others 2,942 3,600 3,600 3,600 5.90 5.90 Total assets 21,279 21,818 21,756 21,790 Operating liabilities 3,701 3,689 3,683 3,739 4.90 4.90 Gross debt 10,488 10,580 9,913 9,140 3.90 3.90 Net debt 7,546 6,980 6,313 5,540 Shareholders' funds 6,047 6,413 6,897 7,493 2.90 2.90 Invested capital 11,579 11,137 10,730 10,336 1.90 1.90 2015 2016 2017 VimpelCom Ltd Rel to RTS INDEX Ratio, growth and per share analysis Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue -7.5 6.0 0.9 3.4 EBITDA 13.1 17.7 3.2 3.8 Operating profit 114.4 68.8 9.5 7.9 PBT 240.3 13.0 13.6 HSBC EPS -9.7 84.5 10.3 11.6 Ratios (%) Revenue/IC (x) 0.8 0.8 0.9 0.9 ROIC 10.8 15.0 16.3 17.6 ROE 10.7 15.5 16.0 16.6 ROA 1.3 6.5 7.5 8.5 EBITDA margin 36.3 40.3 41.2 41.3 Operating profit margin 12.2 19.4 21.0 21.9 EBITDA/net interest (x) 4.2 5.5 5.7 6.4 Net debt/equity 123.1 105.9 87.7 69.7 Net debt/EBITDA (x) 2.3 1.8 1.6 1.4 CF from operations/net debt 24.8 35.6 41.3 51.2 Per share data (USD) EPS Rep (diluted) 1.38 0.44 0.55 0.68 HSBC EPS (diluted) 0.30 0.55 0.61 0.68 DPS 0.23 0.23 0.28 0.34 Book value 3.46 3.67 3.95 4.29
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Viva Kuwait (VIVA KK)
Aggressive marketing strategy weighs on dividend outlook Moderate scope to seize any 5G opportunity Maintain Reduce and KWD0.74 TP
Company description
In 2007, the government of Kuwait established the Kuwait Telecommunications Company to Eric Chang* Analyst launch the third mobile operator in the country. STC bid and won a 26% stake for KWD248.7m HSBC Bank Middle East Limited (USD931.4m). Commercial operations were launched in Q4 2008 under the ‘Viva’ brand. [email protected] +971 4 423 6554 Viva was listed on the Kuwait Stock Exchange in late 2014. In December 2015, STC initiated a Nikhil Mishra* EEMEA Telecom Associate voluntary tender offer at KWD1/share for the remaining 74% stake in Viva. The transaction Bangalore completed in January 2016 as STC secured enough shares to increase its stake to 51.8%.
Since operations started in 2008, the new entrant has disrupted the Zain/Ooredoo duopoly in * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ Kuwait and initiated a phase of heightened market competition. In a very short period of time, qualified pursuant to FINRA regulations Viva has carved itself nearly one-third of the mobile subscriber market. The STC subsidiary overtook Ooredoo as the second largest player in 2013. Competition has been fierce and is reflected in the ARPUs, which have nearly halved.
Short-term drivers
Affordability, spent dynamics and potential for data monetisation In Kuwait, affordability is not the issue preventing data monetisation given the country’s oil wealth. In fact, we would argue that Kuwait is the most consumer-friendly market in the Gulf. Operators significantly subsidise premium handsets in bundles, which include generous voice and data allowances at a fraction of the cost seen in other GCC markets. This may partly explain a mobile and smartphone penetration rate approaching 200%.
Currency impact We do not see any currency impact because the company only operates in Kuwait where the currency is pegged to a basket of undisclosed currencies.
Dividend outlook Viva announced a maiden dividend of KWD0.01 in 2016. We believe its aggressive marketing (handset subsidies, generous voice and data allowance) will require sustained capital intensity in the near term. The combination of these two factors will dampen free cash flow generation and limits the scope for increased dividends; hence we forecast dividends remaining at current levels.
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Long-term driver: 5G expected impact
Monetisation We ascribe a low score to Viva on data monetisation. We estimate Kuwait has the highest data consumption among the GCC countries, yet, increased traffic has not translated into higher revenue growth. Overall, the Kuwaiti telecoms market has been growing at low single-digits while Viva’s revenue growth flattened out in 2016.
Competition In our opinion, Kuwait is by far the most competitive telecoms market in the Gulf. The three operators have nearly a third market share while Zain has preserved its leadership. In 2016, Ooredoo was the only operator that grew revenues (+5% y-o-y). Revenues for Zain and Viva were flat. Viva’s subscriber base stagnated in 2016, showing the limits of an aggressive pricing strategy. We would like to see greater rationality in the pricing strategy but think it is unlikely.
Regulation Kuwait established a regulator last year but its format and strategy are yet to become apparent and at this stage, there is no clarity as to its role or function. We note the provisions of international gateways and fixed line services are the sole prerogative of the Ministry of Communications. There have been talks about privatising these services but nothing has transpired so far.
Business model In our opinion, Viva’s marketing strategy is not sustainable as it stimulates usage while revenues are not growing at a higher pace. We believe high data traffic may require sustained network investments to keep pace. As a result, cash generation will likely remain sub optimal.
Investment thesis
We see limits to subscriber growth as the Kuwaiti market is fairly saturated and the market has stopped expanding (in terms of subscribers), with penetration at nearly 200%. Viva has not been spared the market’s woes. Subscriber numbers stagnated during 2016 (2.4m throughout the year) – the company’s strategy of promotion-driven subscriber growth seems to have run its course.
In addition, cash generation remains sub-optimal due to its aggressive marketing strategy and high capital intensity. We do not expect the situation to change much in the near future. Moreover, in the absence of subscriber growth, revenues can only be driven by higher ARPU, especially data ARPU. However, this would require higher data usage and hence continued investments to make sure capacity keeps pace with usage. Viva was able to achieve a net cash position in 2016 despite lower operating cash-flow y-o-y. But this appears to be largely on the back of lower capex, which may not be sustainable. Both Zain Group and Ooredoo ramped up capex spend q-o-q in Q3 16. To remain competitive, Viva will also have to continue its network spending.
We think Viva has limited potential to increase dividends. The STC subsidiary announced a maiden dividend of KWD0.01 in 2016 (current yield at 1%). Given the low free cash flow yield, we do not think there is scope for the company to increase dividends to interesting levels for the equity investor. As discussed above, capex intensity should remain high near-term, allowing the company limited room to push up its dividend.
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Valuation and Risks
Viva Kuwait: VIVA KK, KWD0.82, Reduce, TP KWD0.74 We value the company on a DCF using the following assumptions for the WACC calculation of 6.5%: risk-free rate of 2.5%, an equity risk premium of 4.5% and owing to its short trading history (listing in December 2014) we use a beta of 1. Our assumptions for the terminal value are EBITDA margin 48%, capital intensity of 40.5% and 2.5% terminal growth rate.
Our target price of KWD0.74 implies 9.8% downside and a 2017e PE of 10.1x (EEMEA average 11.1x) on a 0.8% 2016-18e EPS CAGR. We rate the stock Reduce as the operator’s strategy of handset subsidies is not supportive of greater cash generation.
Risks
Key upside risks include: further market share gains particularly on the lucrative post-paid segment; ARPU improvement could yield better-than-expected margin increase; STC launching another voluntary tender offer at a premium to its previous offer
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Relative valuation Viva Kuwait appears cheap on forward EV/EBITDA. That is because the STC subsidiary expenses subscriber acquisition cost. When factoring capex, it trades at a premium (EV/OpFCF) to the sector but offers a lower dividend yield. The consensus estimates support our investment thesis. There has been no significant EBITDA and OpFCF upwards revisions. In fact, estimates for both metrics are expected to be flat for the next three years. The dividend yield (based on consensus estimates) suggest our dividend estimates may be too conservative. We offer the following explanation: its capital intensive strategy does not lend itself to further dividend increase.
Viva Kuwait: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 0.0% -5.7% -8.9% -9.9% -16.3% Total return 0.0% -5.8% -8.9% -9.9% -16.3% Total return vs EEMEA index (USD) 1.2% -6.0% -14.2% -13.1% -35.2% Total return vs MSCI EEMEA Telecom (USD) -0.7% -7.8% -14.1% -12.7% -24.0% Price return vs Kuwait index 1.3% -5.6% -27.9% -32.4% -42.2% Price Return (USD) 0.0% -6.0% -9.2% -11.2% -17.7% Total Return (USD) 0.0% -6.0% -9.2% -11.2% -17.7% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 320 10 310 9 300 8 290 7 280 6 270 5 260 4 250 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
30 220 25 200 20 180 160 15 140 10 120 5 100 0 80 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
6.0% 140 5.0% 120 4.0% 100 3.0% 80 60 2.0% 40 1.0% 20 0.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
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Financials & valuation: VIVA KUWAIT Reduce
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (KWDm) EV/sales 1.5 1.4 1.3 1.2 Revenue 279 278 279 283 EV/EBITDA 3.1 3.0 2.8 2.6 EBITDA 132 130 131 134 EV/IC 3.1 2.5 2.0 1.7 Depreciation & amortisation -88 -86 -87 -90 PE* 10.3 10.1 10.0 9.8 Operating profit/EBIT 43 43 44 44 PB 3.1 2.3 1.8 1.5 Net interest -2 -1 -1 0 FCF yield (%) 4.7 3.7 3.7 4.0 PBT 42 42 43 44 Dividend yield (%) 1.2 1.2 1.2 1.2 HSBC PBT 42 42 43 44 * Based on HSBC EPS (diluted) Taxation -2 -2 -2 -2 Net profit 40 40 41 42 HSBC net profit 40 40 41 42 Issuer information Cash flow summary (KWDm) Share price (KWD) 0.82 Free float 50% Cash flow from operations 121 119 123 128 Target price (KWD) 0.74 Sector Wireless Telecoms Capex -98 -101 -105 -110 Reuters (Equity) VIVA.KW Country Kuwait Cash flow from investment -92 -101 -105 -110 Bloomberg (Equity) VIVA KK Analyst Eric Chang Dividends -5 -5 -5 -5 Market cap (USDm) 1,340 Contact +971 4 423 6554 Change in net debt -21 -20 -21 -22
FCF equity 19 15 15 16 Balance sheet summary (KWDm) Price relative Intangible fixed assets 47 47 47 47 Tangible fixed assets 138 152 170 189 Current assets 82 90 96 120 Cash & others 47 46 44 62 1.33 1.33 Total assets 267 290 313 356 1.13 1.13 Operating liabilities 88 86 85 86 Gross debt 47 25 4 -1 0.93 0.93 Net debt 0 -20 -41 -63 Shareholders' funds 133 178 224 271 0.73 0.73 Invested capital 133 158 183 208 0.53 0.53 2015 2016 2017 Ratio, growth and per share analysis VIVA KUWAIT Rel to KUWAIT SE PRICE INDEX
Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 0.8 -0.4 0.3 1.6 EBITDA 0.7 -1.5 1.0 2.1 Operating profit -10.8 -0.1 0.7 0.7 PBT -7.3 1.4 1.2 2.6 HSBC EPS -9.3 1.1 1.1 2.6 Ratios (%) Revenue/IC (x) 2.3 1.9 1.6 1.5 ROIC 37.2 68.4 25.6 21.8 ROE 35.4 26.0 20.3 16.9 ROA 15.6 14.9 13.8 12.6 EBITDA margin 47.3 46.7 47.1 47.3 Operating profit margin 15.6 15.6 15.7 15.6 EBITDA/net interest (x) 82.9 117.5 149.6 1820.6 Net debt/equity -0.1 -11.5 -18.3 -23.2 Net debt/EBITDA (x) 0.0 -0.2 -0.3 -0.5 CF from operations/net debt Per share data (KWD) EPS Rep (diluted) 0.08 0.08 0.08 0.08 HSBC EPS (diluted) 0.08 0.08 0.08 0.08 DPS 0.01 0.01 0.01 0.01 Book value 0.27 0.36 0.45 0.54
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Vodacom Group (VOD SJ)
Operational strength in South Africa encouraging, EPS/dividend growth muted near-term due to FX, International weakness and one- off costs Well positioned to benefit from 5G monetisation given leading 3G/4G network and fibre initiatives; however regulatory risk is significant Looks fairly priced on valuation; Maintain Hold and cut TP to ZAR160 (from ZAR172)
Company description
Vodacom is primarily a mobile network operator with operations in South Africa, Tanzania, Ziyad Joosub* Analyst Mozambique, Democratic Republic of Congo (DRC) and Lesotho. The South Africa unit HSBC Securities (South Africa) dominates, accounting for 81% of Group revenue and 86% of Group EBITDA in H1 2017. (Pty) Ltd [email protected] +27 (0)11 676 4223
Ramesh Pantagolusula* Short-term drivers EEMEA Telecom Associate Bangalore Affordability, spent dynamics and potential for data monetisation Currently, mobile data and Enterprise services accounts for 41% and 24.5% of service revenue * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ at Vodacom South Africa. Active data customers of 19.3m represents 53% of the total active qualified pursuant to FINRA regulations subscriber base in South Africa. Data bundle sales in South Africa are growing 49% y-o-y in 3Q17 whilst effective price per MB is declining at 15.4% y-o-y, underpinning healthy data conversions. Active smartphone penetration for Vodacom in South Africa stands at 45.6% with average monthly data usage of 667MB. 4G economics are attractive at Vodacom; however spectrum delays are hampering near-term effective monetisation of 4G infrastructure. Whilst smartphone pricing has been hampered recently by a weaker ZAR, pricing transformation should become more apparent given strong ZAR and availability of cheaper handsets. South Africa fares well against EEMEA peers with the cheapest smartphone representing 1.6% of PPP-adj GDP per capita and c7% of monthly disposable income (adjusted for cost of living). Data pricing remains elevated in South Africa at USD10.7 per GB on a blended basis, forming 0.99% of PPP adjusted GDP per capita.
Currency impact Near-term currency impacts for Vodacom are divergent across its International footprint and its core South Africa operations. The South Africa business has c10% of opex in hard currency excluding handset sales, whilst approximately 40% of capex is in hard currency. The recent strengthening of the ZAR versus the USD (c15%) will drive better EBITDA/FCF margins at Vodacom South Africa. However International Mobile continues to be impacted by FX volatility in certain markets, thus FX translation losses on dollarised cash and debt facilities (which are non-cash in nature) will dilute headline earnings and thus dividend progression.
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Dividend outlook Vodacom’s dividend outlook is progressive given our expectation of acceleration in HEPS commencing FY18e (March end); Vodacom’s dividend policy is to pay-out 90% of headline earnings at least. H1 2017 results were characterised by flat earnings and dividend growth as 4.1% revenue growth was diluted by FX translation losses, tax and lower profitability of its International opcos. Whilst H2 2017e should see better earnings/dividend progression we expect attractive dividend growth of high single digits to only transpire in FY18e, once diluting factors are in the base. With net debt to EBITDA of 0.8x and HSBCe proportionate FCF growth of 15.1% FY16-19e CAGR – balance sheet capacity is sufficient to support 90% pay-outs. Dividend progression is a function of earnings growth momentum, which in our view will only be compelling relative to valuations in FY18e – if we also takes into account the high spectrum and regulatory uncertainty in the key market of South Africa.
Long-term driver: 5G expected impact
We expect Vodacom Group to be moderately well placed to capitalise on the benefits of 5G, although it be may be lacking in terms of low frequency spectrum reserves and fixed broadband scale – however we believe these limitations apply to all operators in South Africa. All MNOs in South Africa have been limited in rolling out LTE coverage and have resorted to re-farming spectrum because of the failure of ICASA and Governmental bodies to effectively initiate the digital migration and allocation of the digital dividend to operators.
We do not expect Vodacom to maintain its 3G/4G revenue share in terms of 5G economics, as we believe WBS will be a “new” and “key” player in the space – the company is already leveraging off its existing spectrum assignments in the 1 800MHz and 2 600MHz bands for LTE Advanced Pro (LTE-A) or 4.5G connectivity. WBS (Wireless Business Solutions, an independent broadband service provider in South Africa) believes this will be a precursor to 5G, which will enable WBS to be at the forefront of 5G adoption globally when it occurs. Vodacom should nevertheless be a key player in the 5G space, due to its strong balance sheet and leadership in 3G/4G, high ARPU subscriber base and software/content development. We also think it will have adequate fixed-line/wifi capabilities by 2020e in key metropolitan centres where the majority of mobile data spend is concentrated in South Africa – for example, Telkom has noted 4% of its network coverage accounts for c70% of revenue.
If 4G/LTE-A is the foundation of 5G then Vodacom is better positioned than MNO peers to launch 5G. Its entire network is 4G ready and 86% of base stations (thus all metro base stations) are fiberised or connected to high-speed fibre. Transmission backhaul is strong already, with 80% of traffic being carried on its own backhaul. With the initiation of a fibre JV and access to WBO 4G spectrum, Vodacom’s network is relatively well positioned for 5G. Vodacom has the requisite network leadership and innovation levels (be it for content/software driven services and or product commerciality), whilst spectrum remains an issue – on a relative basis we do not see it having any form of spectrum deficit relative to competitors.
BEE a level playing field for 5G. In South Africa the requirement for spectrum application is at least level 4 BEE scoring under the new BEE ICT charter – we believe all larger operators are on an even footing on this front. Thus we do not expect asymmetric regulations between MTN, Vodacom, Cell C (not listed) and Telkom when it comes to spectrum allocation – potentially new entrants will have more favourable terms but as mentioned above they will work in conjunction with incumbents: (1) leasing excess spectrum, (2) leasing transmission/fibre, (3) proliferation of MVNO license issues form “light” to “full-service” models. Thus economics for 4G/5G will be shared to some extent in South Africa. Given that tougher/uncertain regulations on spectrum/BEE will impact all operators relatively equally, we do not believe regulatory risk for Vodacom/MTN is substantially different to that for Telkom.
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Consolidation remains a key theme but regulatory, pricing and/or funding hurdles have muted large scale in-market consolidation in South Africa. Whilst fragmentation could occur in South Africa, we believe this will take the form of smaller scale MVNO launches focused on a key service or product (fintech, eCommerce, online video/content). We will likely also see more infrastructure-spend and spectrum-sharing initiatives between operators over the medium term, such as Vodacom's spectrum leasing deal with WBS and Vodacom's proposed fibre build-out JV. Thus whilst operators may not own specific spectrum, access to spectrum and fixed-line infrastructure will follow a more "open-platform" approach between operators. The Ministry of Telecommunications’ recent ICT White Paper proposal for all spectrum to be housed in a single WOAN (wireless opex access network) SPV from where all operators can lease capacity, indicates the that new technology launches – such as 5G – could follow a leasing rather than purchase arrangement between MNOs and Regulators (ICASA Africa and Ministry of Telecommunications).
Investment thesis
Solid execution in South Africa not enough to offset macro/regulatory pressures – legacy share price drivers are now reversing. Despite solid execution in its primary market, South Africa, and a positive medium-term outlook for ROIC, FCF, and dividend expansion, we believe near-term risks will continue to serve as an overhang on Vodacom's share price. More specifically, key legacy share-price drivers are now reversing: these include: (1) multiple expansion on the back of the 5-year "search-for-yield" trade driven by declining DM bond yields; (2) a benign regulatory/competitive landscape in South Africa; and (3) FX tailwinds for the International Mobile segment. We estimate approximately two-thirds of Vodacom's 19% PE multiple de-rating over the past eight months can be explained by higher EU/DM bond yields; given FX-related dilution from the International Mobile segment and still opaque regulatory/spectrum outlook in South Africa, we believe ratings will remain under pressure.
However, BEE and Ministerial complexities with respect to spectrum will inhibit 4G economics being priced in at Vodacom. The full sale of PIC’s 15% stake would move Vodacom Group’s BEE ownership to 21.25% (6.25% BEE deal + 15% stake sale), yet participation in ICASA’s spectrum auction Vodacom requires 30% BEE ownership of the South Africa business or 27% BEE ownership at the group level. Increasing the BEE stake to 27% would require: (1) potential Vodafone sell-down of a portion of its 65% stake; (2) equity issuance; (3) a new BEE deal; or (4) a combination of all three. Whilst management remains confident that BEE requirements will be resolved, we struggle to see investors paying for 4G growth at Vodacom until there is more transparency on: (1) how it can achieve 27% BEE ownership at the group level; and/or (2) how flexible ICASA will be with the BEE requirement. That the Minister of Telecoms and Postal Services, Siyabonga Cwele, plans to take legal action against ICASA for announcing the 4G spectrum auction adds further uncertainty to South Africa MNOs receiving spectrum by early 2017.
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Change to our estimates
Earnings estimate revisions (ZARm) FY17e FY17e FY18e FY18e March ending FY (old) (new) % y-o-y Variance (old) (new) % y-o-y Variance
Revenue 84 279 81 908 2.3% -2.8% 89 174 84 765 3.5% -4.9% South Africa 65 068 64 862 4.1% -0.3% 68 460 67 543 4.1% -1.3% Tanzania 5 766 5 388 -2.8% -6.5% 6 175 5 380 -0.2% -12.9% DRC 6 214 6 004 5.3% -3.4% 6 520 5 936 -1.1% -9.0% Mozambique 3 290 2 684 -16.9% -18.4% 3 733 2 689 0.2% -28.0% Lesotho 924 924 -2.1% 0.0% 940 940 1.7% 0.0% International Mobile other 2 915 1 943 0.0% -33.3% 3 206 2 137 10.0% -33.3% Total International Mobile 19 780 17 614 -1.9% -10.9% 21 299 17 808 1.1% -16.4%
EBITDA 32 232 32 006 5.5% -0.7% 34 408 33 868 5.8% -1.6% South Africa 26 732 27 171 8.6% 1.6% 28 446 28 937 6.5% 1.7% Tanzania 2 364 1 940 6.0% -17.9% 2 532 1 991 2.6% -21.4% DRC 1 740 1 681 7.3% -3.4% 1 858 1 692 0.6% -9.0% Mozambique 987 805 -14.0% -18.4% 1 157 834 3.6% -28.0% Lesotho 457 457 -2.1% 0.0% 465 465 1.7% 0.0%
EBITDA margin 38.6% 39.1% 39.0% 40.0%
Capex 11 498 11 223 -12.8% -2.4% 11 836 11 902 6.0% 0.6%
HEPS 966.3 912.6 6.1% -5.6% 1057.3 1027.5 12.6% -2.8% DPS 878.4 829.7 4.4% -5.6% 961.2 934.1 12.6% -2.8% Source: HSBC estimates
Revenue cuts: Driven by (1) deterioration in FX for International Mobile on ZAR strength, (2) lower Q3 service revenue growth trends for Tanzania and DRC, (3) slower equipment sales in South Africa
EBITDA cuts: (1) lower margin for South Africa data on initiation of WBS spectrum roaming deal, (2) dollarised opex component for International Mobile (c20%) impacts margin in markets where FX has declined.
HEPS cuts: (1) higher FX translation losses for International Mobile, higher tax rate and finance costs.
Valuation and Risks
Vodacom: VOD SJ, ZAR149, Hold, TP ZAR160 (from ZAR172) We set a fair value target price of ZAR160 (from ZAR172) based on our discounted medium-term terminal value calculation. Given the attractive data growth story in South Africa and easing competition, we believe it is appropriate at this juncture to discount 3 years of growth (at an 11% discount rate) for a company such as Vodacom. We also believe it is fair to assume a de-rating to a mature telco multiple, which we see as sustainable at 7.5% free cash flow yield based on more mature EM/DM peers and a more stable South Africa bond yield environment. Our TP adjustment is primarily driven by (1) FX headwinds and slower local currency service revenue growth for International Mobile, (2) trimming our medium-term SA data growth forecasts and (3) marginally higher medium-term capex forecasts.
Our new target price of ZAR160 implies 7.4% upside and we rate the stock Hold given moderate upside and the uncertain regulatory backdrop and rating risk at Vodacom.
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Medium-term terminal multiple derived TP
Terminal Year FY2019e Terminal FCF Yield 7.5% Terminal Value 228 294 Present Value at June-17 (at WACC of 10.5%) 191 181 Per Share 130 Total Discounted Dividends 44 678 Total Value 235 859 Implied Equity Value Per Share at Jun-17 R 160.6 Implied forward PE at TP date 15.1 Implied forward EV/EBITDA at TP date 7.5 Implied forward FCF yield at TP date 6.7% Fair value TP 160.6 Source: Company data, HSBC estimates
Key upside risks include: (1) Strengthening of DM bond yields and South Africa bond yields beyond current expectations; (2) better than expected South Africa mobile data and enterprise growth (3) South Africa margin expansion exceeds our base case expectations, (4) positive regulatory surprises with respect to BEE and spectrum allocation over the medium-term, (5) initiation of higher a higher dividend pay-out ratio by Vodacom (greater than 90% of HEPS).
Key downside risks include: (1) Normalisation of DM bond yield environment through a steep, growth-led interest rate hike cycle; (2) pick-up in competitive intensity in South Africa mobile, (3) operational surprises with respect to the South Africa business, (4) regulatory surprises with respect to BEE implications on spectrum allocation over the medium-term, (5) BEE complexities.
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Relative valuation
Valuation at par versus the sector and history Moderate growth Consensus OpFCF estimates flat
Vodacom Group: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 1.3% 0.5% 5.3% -3.3% 2.7% Total return 1.4% 0.5% 5.3% -0.6% 8.0% Total return vs EEMEA index (USD) 2.3% 2.9% 5.1% 4.2% 10.1% Total return vs MSCI EEMEA Telecom (USD) 0.7% -1.5% 0.1% -3.4% 0.4% Total return vs JSE 1.9% 1.2% 3.4% 1.9% 7.1% Price return vs JSE 2.1% 1.4% 3.8% 0.4% 4.5% Price Return (USD) 0.9% 2.8% 10.1% 3.3% 21.0% 2017e 2018e 2017e 2018e 2017e 2018e Total Return (USD) 1.1% 2.9% 10.0% 6.1% 27.5% EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 101,050 10 97,010 9 92,970 8 88,930 7 84,890 6 80,850 5 76,810 4 72,770 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
20 39,770 37,690 15 35,610 33,530 10 31,450 5 29,370 27,290 0 25,210 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
8.0% 34,790 29,820 6.0% 24,850
4.0% 19,880 14,910 2.0% 9,940 4,970 0.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBCe
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Financials & valuation: Vodacom Group Hold
Financial statements Valuation data Year to 03/2016a 03/2017e 03/2018e 03/2019e Year to 03/2016a 03/2017e 03/2018e 03/2019e Profit & loss summary (ZARm) EV/sales 3.0 3.0 2.9 2.7 Revenue 80,074 81,908 84,765 90,005 EV/EBITDA 7.9 7.6 7.3 6.7 EBITDA 30,345 32,006 33,868 36,670 EV/IC 5.7 5.2 5.0 4.6 Depreciation & amortisation -8,735 -8,914 -8,816 -9,154 PE* 17.3 16.3 14.5 12.8 Operating profit/EBIT 21,610 23,092 25,052 27,516 PB 9.0 8.5 9.0 6.8 Net interest -1,480 -1,945 -2,618 -2,377 FCF yield (%) 4.4 5.0 6.7 7.2 PBT 20,130 21,147 22,434 25,139 Dividend yield (%) 5.3 5.6 6.3 7.1 HSBC PBT 20,130 21,147 22,434 25,139 * Based on HSBC EPS (diluted) Taxation -5,934 -6,861 -7,067 -7,667 Net profit 14,203 14,038 15,094 17,161 HSBC net profit 12,622 13,406 15,094 17,161 Issuer information Cash flow summary (ZARm) Share price (ZAR) 149.00 Free float 15% Cash flow from operations 22,847 22,178 26,528 28,194 Target price (ZAR) 160.00 Sector Wireless Telecoms Capex -13,229 -11,223 -11,902 -12,365 Reuters (Equity) VODJ.J Country South Africa Cash flow from investment -13,229 -11,223 -11,902 -12,365 Bloomberg (Equity) VOD SJ Analyst Ziyad Joosub Dividends -11,830 -13,420 -15,153 -17,127 Market cap (USDm) 16,954 Contact +27 (0)11 676 4223 Change in net debt 4,402 2,828 3,955 -3,945
FCF equity 9,618 10,955 14,626 15,829 Balance sheet summary (ZARm) Price relative Intangible fixed assets 9,517 9,517 10,469 11,516 Tangible fixed assets 39,744 42,984 46,990 51,157 180.00 180.00 Current assets 27,618 25,938 24,635 25,819 170.00 170.00 Cash & others 7,934 6,439 6,615 7,829 Total assets 78,703 80,262 83,918 90,316 160.00 160.00 Operating liabilities 26,554 25,346 26,212 27,750 150.00 150.00 Gross debt 29,125 30,458 34,589 31,857 140.00 140.00 Net debt 21,191 24,019 27,973 24,028 Shareholders' funds 24,158 25,663 24,256 32,221 130.00 130.00 Invested capital 42,391 46,653 49,267 52,912 120.00 120.00 110.00 110.00 2015 2016 2017 Ratio, growth and per share analysis Vodacom Group Rel to JSE ALL SHARE
Year to 03/2016a 03/2017e 03/2018e 03/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue 7.5 2.3 3.5 6.2 EBITDA 12.8 5.5 5.8 8.3 Operating profit 11.8 6.9 8.5 9.8 PBT 12.3 5.1 6.1 12.1 HSBC EPS 3.2 6.1 12.6 13.7 Ratios (%) Revenue/IC (x) 2.4 2.2 2.1 2.0 ROIC 46.9 43.6 44.9 44.5 ROE 59.1 57.7 63.8 63.2 ROA 24.8 23.6 24.0 23.9 EBITDA margin 37.9 39.1 40.0 40.7 Operating profit margin 27.0 28.2 29.6 30.6 EBITDA/net interest (x) 20.5 16.5 12.9 15.4 Net debt/equity 87.7 93.6 115.3 74.6 Net debt/EBITDA (x) 0.7 0.8 0.8 0.7 CF from operations/net debt 107.8 92.3 94.8 117.3 Per share data (ZAR) EPS Rep (diluted) 9.68 9.56 10.27 11.68 HSBC EPS (diluted) 8.60 9.13 10.27 11.68 DPS 7.95 8.30 9.34 10.62 Book value 16.47 17.47 16.51 21.93
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Vodafone Qatar (VFQS QD)
Ooredoo’s leadership appears unassailable… …but 5G potential will be difficult to monetise with the current low- value subscriber base Maintain Reduce and QAR8.10 TP
Company description
In December 2007, Vodafone and the Qatar Foundation consortium won Qatar’s second mobile Eric Chang* Analyst licence, and Vodafone Qatar was established shortly after. During summer 2009, the company HSBC Bank Middle East Limited launched commercial operations and a listing on the Qatar Exchange. It won a fixed license in 2010 [email protected] +971 4 423 6554 and launched commercial services for fixed broadband in 2012.
Nikhil Mishra* Despite market share gains, profitability and cash generation have remained below Vodafone’s EEMEA Telecom Associate Bangalore initial plans as Ooredoo defended its positions. As of Q4 2016 (calendar) Vodafone had 33% market share. 4G services were launched last year and Vodafone has been re-directed its focus * Employed by a non-US affiliate of HSBC to the post-paid segment, Ooredoo’s stronghold. Securities (USA) Inc, and is not registered/ qualified pursuant to FINRA regulations Short-term drivers
Affordability, spent dynamics and potential for data monetisation Similar to all Gulf countries, affordability is not the issue preventing data monetisation and we see reasonable potential for Vodafone Qatar. Currently, the second entrant’s smartphone penetration is about 60% while monthly data consumption is around 1Gb. We think Vodafone Qatar can improve on this metric by increasing its share of high-value customers (white collar expats, Qatari nationals, corporates) in which Ooredoo is currently dominant with a two-thirds market share.
Currency impact We do not see any currency impact because the company only operates in Qatar where the QAR is pegged to the dollar.
Dividend outlook The company paid dividends in FY2014 and FY2015, but they were cancelled in FY2016 when net losses widened. We note dividends have been paid when distributable profits – which the company defines as net profit excluding amortisation charges – are in excess of QAR150m. In FY2017, we forecast distributable profits of QAR153.7m but do not factor in a dividend payment. We expect the company will retain a prudent approach to its balance sheet structure.
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Long-term driver: 5G expected impact
Monetisation We assign a low score on this metric due to its customer base and what we see as an infrastructure disadvantage relative to the incumbent. In light of lower ARPU (relative to Ooredoo) and data consumption, we believe (price-sensitive) expat labourers represent a significant proportion of Vodafone Qatar’s customer base. We think data monetisation will be greater if STC manages to chip away Ooredoo’s dominance of the lucrative post-paid segment.
Competition We expect competition to remain rational. Vodafone Qatar needs to focus on profitability and cash generation and aggressive pricing would not be supportive in that regard. From FY2018e we factor in improving profitability to account for mobile pricing discipline.
Regulation We believe regulation will be benign if not supportive of the smaller player.
Business model Despite a fixed telecom license, Vodafone Qatar is mainly a mobile operator. The lack of a fixed infrastructure (limited to a small area of Doha) puts it at a structural disadvantage. We highlight that Ooredoo’s annual capex spend in Qatar is double that of Vodafone Qatar.
Investment thesis
Revenue growth is key to profitability as cost-optimisation runs through its limits. We see limited upside from further cost reduction. In our view, Vodafone Qatar needs to drive revenue growth to achieve profitability. The most obvious route would be to increase its market share in the post-paid segment, where, since launching a post-paid product in 3Q13, Vodafone Qatar has consistently increased its post-paid subscriber base and market share. This high-value segment is still dominated by Ooredoo, however, with a two-thirds market share. On our estimates, Vodafone Qatar’s post-paid ARPU is c. 50% lower than the incumbent’s.
Valuation and Risks
Vodafone Qatar: VFQS QD, QAR9.04, Reduce, TP QAR8.1 We value Vodafone Qatar on a DCF with the following assumptions underpinning the WACC of 8.9% (unchanged): risk-free rate of 2.5%, an equity risk premium of 7%, beta of 1.53 (as calculated by FactSet). The long-term growth rate assumption of 2.5% is unchanged. Vodafone Qatar’s valuation remains heavily back-ended and is based on the following long-term assumptions: EBITDA margin of 45% and capital intensity of 16.3%.
Our TP of QAR8.10 implies 10.4% downside and we rate the stock Reduce as the operator’s quest for profitability has been consistently delayed.
Key upside risks include: a resilient Qatar economy driving telecom spend; increased market share in mobile (particularly in the post-paid segment) and fixed services; and better-than- expected ARPU improvement would be a fillip to revenue.
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Relative valuation We believe Vodafone Qatar’s share price has sharply de-rated because of a deteriorating profitability outlook. In the past six months, consensus revenue forecast have been stable while EBITDA estimates have marginally increased. We highlight our forecasts err on the side of caution and are more conservative. In the left-hand side chart at the bottom of this page, we see that Vodafone Qatar’s dividend yield do not offer any reward relative to holding a Qatar sovereign bond.
Vodafone Qatar: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -2.2% -1.6% -4.9% -20.4% -25.4% Total return -2.2% -1.6% -4.8% -20.4% -25.4% Total return vs EEMEA index (USD) -1.0% -1.7% -9.8% -22.3% -42.8% Total return vs MSCI EEMEA Telecom (USD) -2.8% -3.6% -10.1% -23.2% -33.0% Total return vs QE 0.7% -0.7% -9.9% -20.2% -28.5% Price Return (USD) -2.1% -1.7% -5.0% -20.4% -25.3% Total Return (USD) -2.2% -1.6% -4.9% -20.4% -25.4% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 3,390 43 3,180
33 2,970 2,760 23 2,550 2,340 13 2,130 1,920 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
60 1,250 50 1,120 40 990 860 30 730 20 600 10 470 0 340 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
4.0% 1,190 1,020 2.0% 850
0.0% 680 510 -2.0% 340 170 -4.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
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Financials & valuation: Vodafone Qatar Reduce
Financial statements Valuation data Year to 03/2016a 03/2017e 03/2018e 03/2019e Year to 03/2016a 03/2017e 03/2018e 03/2019e Profit & loss summary (QARm) EV/sales 4.0 4.0 3.5 3.2 Revenue 2,119 2,099 2,305 2,491 EV/EBITDA 21.3 15.6 13.2 10.6 EBITDA 401 540 619 760 EV/IC 1.5 1.5 1.6 1.7 Depreciation & amortisation -816 -765 -747 -750 PE* nm nm nm nm Operating profit/EBIT -415 -224 -128 10 PB 1.6 1.6 1.7 1.8 Net interest -19 -27 -31 -28 FCF yield (%) -0.9 1.0 3.2 3.9 PBT -466 -251 -159 -18 Dividend yield (%) 0.0 0.0 2.3 2.3 HSBC PBT -466 -251 -159 -18 * Based on HSBC EPS (diluted) Taxation 0 0 0 0 Net profit -466 -251 -159 -18 HSBC net profit -466 -251 -159 -18 Issuer information Cash flow summary (QARm) Share price (QAR) 9.04 Free float 55% Cash flow from operations 345 413 642 733 Target price (QAR) 8.10 Sector Wireless Telecoms Capex -396 -310 -366 -407 Reuters (Equity) VFQS.QA Country Qatar Cash flow from investment -279 -310 -366 -407 Bloomberg (Equity) VFQS QD Analyst Eric Chang Dividends -171 0 -178 -178 Market cap (USDm) 2,099 Contact +971 4 423 6554 Change in net debt 134 -107 -246 -121
FCF equity -70 76 246 298 Balance sheet summary (QARm) Price relative Intangible fixed assets 5,235 4,784 4,355 3,933 Tangible fixed assets 1,249 1,215 1,263 1,343 Current assets 508 657 929 1,077 19.50 19.50 Cash & others 130 255 501 622 17.50 17.50 Total assets 6,992 6,656 6,546 6,352 Operating liabilities 985 881 930 931 15.50 15.50 Gross debt 1,023 1,041 1,041 1,041 13.50 13.50 Net debt 892 786 540 419 11.50 11.50 Shareholders' funds 4,923 4,672 4,513 4,318 Invested capital 5,877 5,520 5,116 4,799 9.50 9.50 7.50 7.50 2015 2016 2017 Ratio, growth and per share analysis Vodafone Qatar Rel to DSM 20 INDEX
Year to 03/2016a 03/2017e 03/2018e 03/2019e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue -8.1 -0.9 9.8 8.1 EBITDA -29.2 34.8 14.6 22.6 Ratios (%) Revenue/IC (x) 0.3 0.4 0.4 0.5 ROIC 1.7 4.9 6.6 9.7 ROE -8.9 -5.2 -3.5 -0.4 ROA -6.2 -3.3 -1.9 0.3 EBITDA margin 18.9 25.7 26.9 30.5 Operating profit margin -19.6 -10.7 -5.5 0.4 EBITDA/net interest (x) 21.0 20.2 20.0 27.5 Net debt/equity 18.1 16.8 12.0 9.7 Net debt/EBITDA (x) 2.2 1.5 0.9 0.6 CF from operations/net debt 38.6 52.6 118.9 174.8 Per share data (QAR) EPS Rep (diluted) -0.55 -0.30 -0.19 -0.02 HSBC EPS (diluted) -0.55 -0.30 -0.19 -0.02 DPS 0.00 0.00 0.21 0.21 Book value 5.82 5.53 5.34 5.11
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Zain Group (ZAIN KK)
Low leverage and potential tower sale in Kuwait brighten dividend outlook Competition and macro factors may limit data or 5G monetisation We maintain our Hold rating and TP of KWD 0.49
Company description
Zain is Kuwait’s first mobile operator and has been the undisputed leader since it was established in Eric Chang* Analyst 1983. Zain also operates subsidiaries in seven countries (Iraq, Bahrain, Jordan, Sudan, South Sudan HSBC Bank Middle East Limited and Lebanon) where it operates under a management contract on behalf of the governments. In [email protected] +971 4 423 6554 many of these countries, Zain is the leading mobile operator with the highest share of post-paid
Nikhil Mishra* subscribers and quality spectrum. In addition, Zain has a 15.5% stake in Moroccan mobile operator EEMEA Telecom Associate inwi, as well as a 37% stake in Zain KSA. Zain’s principal markets are Kuwait, Iraq and Sudan. Bangalore
* Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ Short-term drivers qualified pursuant to FINRA regulations Affordability, spent dynamics and potential for data monetisation Affordability is an issue in Iraq and Sudan, which in aggregate represent nearly 40% of group revenues. We think competitive intensity as well as significantly lower GDP/per capita may inhibit Zain’s capacity to monetise data. Compounding these issues, Iraq is facing political as well as economic difficulties, forcing mobile operators to absorb the 20% tax on mobile services.
In Kuwait, affordability is not the issue preventing data monetisation given the country’s oil wealth. In fact, we would argue that the Kuwait market is the most consumer-friendly in the Gulf. Operators significantly subsidise premium handsets in bundles, which include generous voice and data allowances at a fraction of the cost seen in other GCC markets. This may partly explain a mobile and smartphone penetration rate approaching 200%.
Currency impact The currencies of Kuwait, Bahrain and Jordan are pegged to the USD. These three countries represent 50% of revenues and 70% of profits. The main currency risk lies in Sudan (20% of revenues, 25% of profits). The country is under US sanctions, making repatriating currency nearly impossible. We also highlight Iraq represents 30% of group revenues and 10% of profits. As Zain’s debt is mainly dollar-denominated, we estimate capital expenditure would follow the same proportion.
Dividend outlook The company’s stated dividend policy is to pay out 70-80% of earnings. In light of its low leverage, we would argue there is room for greater flexibility. On numerous occasions, Zain has cut dividends to a greater extent than the EPS decrease and balance sheet warrants. For example, in 2014, dividends were cut by 20% whereas net profit declined 10%. In 2015, dividends were cut by 25% whereas net profit dropped 21%. In our opinion, cutting dividends did not have the desired impact on (reducing) leverage.
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We await a management update on the tower sales process in Kuwait. The company previously guided towards a transaction close in H2 2016. On our estimates, the disposal of its Kuwaiti tower assets could generate proceeds of KWD 90m (based on 1,988 sites valued at USD150k). We think the company would consider using the proceeds to pay a bonus dividend, similar to when it sold its African assets.
Long-term driver: 5G expected impact
Monetisation As long as competition is not rational, we think Zain will have moderate opportunities in 5G. Structurally, Kuwait should be an attractive market: wireless broadband is the preferred internet access for residential customers. Instead all three mobile operators have competed on price to gain or maintain market share, thus eroding market value. Given the geopolitical and economic headwinds, we think Sudan and Iraq are far removed from a 5G reality.
Competition In our opinion, Kuwait is by far the most competitive telecoms market in the Gulf. The three operators have nearly a third market share while Zain has preserved its leadership. Ooredoo was the only operator that managed to grow revenues in 2016 (+5% y-o-y). Revenues for Zain and Viva were flat. We would like to see greater rationality in pricing and competition but think it is unlikely.
In Iraq, revenues and profits have been under pressure due to geopolitical and economic factors. In addition, the operators had to absorb a 20% sales tax on mobile services introduced early last year. Neither Zain nor Ooredoo have been able to pass the added cost on to their customers for fear of losing market share.
Regulation Kuwait established a regulator last year but its format and strategy are yet to become apparent. At this stage, its role and function are unclear. We note that the provisions of international gateways and fixed line services are the sole prerogative of the Ministry of Communications. There have been talks about privatising these services but nothing has transpired to date.
Business model We do not think that Zain’s mobile-only business model is a limiting factor as the markets in which it operates (save for Jordan) have limited fixed broadband infrastructure. Mobile networks are therefore the only reliable internet access points.
Investment thesis
The stock has risen 45% in the past six months and now trades ahead of its 3-year historical average. We believe a key driver of share price performance has been a broad-based market rally in Kuwait. We attribute a significant portion of Zain’s performance to the strength of the Kuwait Stock Exchange Index (+24% in the same period). However, unconfirmed reports of a possible takeover of Zain (Mubasher, No sale offer by Adeptio for Kharafi’s stake in Zain, 22 January 2017) could have also fuelled outperformance over the past six months.
Zain’s key attractions are its market leadership and cash generation capacity in its key markets (Iraq, Jordan, Kuwait, and Sudan). Vodafone, Orange and MTN are global operators with a presence in the Middle East, but we think it unlikely they would look at expanding their footprint further by acquiring Zain because of differing priorities. GCC telecom operators would present the most obvious fit. Etisalat, Ooredoo and STC would be the only companies with enough financial headroom to make an acquisition. But in such a scenario, overlapping operations
141 EQUITIES ● TELECOMS / EEMEA 16 March 2017
would pose a risk as the regulator’s stance on in-market consolidation is untested. We highlight that nearly all of Zain’s markets have three players, which would make consolidation perhaps unlikely from a competition perspective (see M&A would face significant competitive hurdles, 28 February 2017)
Valuation and Risks
Zain Group: ZAIN KK, KWD KWD0.48, Hold, TP KWD0.49 We value Zain using a sum-of the parts approach.
We value Kuwait on 5x 2017e EBITDA as a reflection of its market leadership. We continue to value Jordan and Bahrain on 3x 2017e EBITDA due to competitive pressure. Despite its market leadership in Iraq and Sudan, we value these businesses on 3x 2017e EBITDA to reflect the geopolitical risks We continue to attribute zero value to South Sudan as the operations are marginally EBITDA positive We value Zain KSA at our target price of SAR7.10. We use DCF to value the company based on a WACC of 9.3% (cost of equity of 13.0%, risk-free rate of 2.5%, 7.0% market risk premium).
Our target price of KWD0.49 implies 2.1% upside and we rate the stock Hold.
Zain: sum-of-the-part valuation EBITDA EV % EV % Method (KWDm) 2017e /EBITDA stake of EV Kuwait 163 5.0 100.0% 817 36.7% Multiple Iraq 120 3.0 76.0% 275 12.3% Multiple Sudan 110 3.0 100.0% 330 14.8% Multiple South Sudan 0 0.0 100.0% 0 0.0% Jordan 73 3.0 96.5% 211 9.5% Multiple Bahrain 22 3.0 54.8% 36 1.6% Multiple Lebanon 10 1.0 100.0% 10 0.4% Multiple Subsidiaries 1,679
Zain KSA 37.0% 121 5.5% Target price Other assets 424 19.1% Associates 546
EV 2,225 Adjusted net debt -323 Equity value 1,902 Issued shares (m) 3,901 TP (KWD) 0.49 Source: HSBC estimates
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Upside risks include
Privatisation of the Kuwait government’s fixed line and international gateway assets may generate revenue/opex/ capex upsides if Zain is able to acquire them at a reasonable price Zain is still contemplating the sale of its Kuwaiti tower assets. Given its low leverage, the company may elect to pay a significant portion of proceeds as a special dividend
Geopolitical situation improves considerably in some of its markets like Iraq, Sudan and South Sudan
If competition in Kuwait becomes rational, all three operators could see pricing power and improve their margins
Downside risks include
Geopolitical instability in Iraq and to some extent Sudan and South Sudan; Negative FX movements in some of its markets impacting the group’s financial performance; Press reports (Bloomberg, 19 July 2016; see our report No rationale for a foray into Egypt, 20 July 2016) about the company’s interest in a mobile licence in Egypt, if confirmed, could compromise the balance sheet and the company’s ability to maintain dividends.
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Relative valuation Valuation remains attractive relative to the sector. Zain trades at a marked discount. The consensus’ outlook has become more positive. We observe a step change in 2017-19 EBITDA estimates. Zain Group’s strong share price performance (+44% over the past six months, vs the index at +24%) is the only factor behind the yield compression over the same period.
Zain Group: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return 0.0% -5.0% 13.1% 43.9% 26.7% Total return 0.0% -5.0% 13.1% 43.9% 37.4% Total return vs EEMEA index (USD) 1.2% -5.3% 7.7% 39.9% 17.6% Total return vs MSCI EEMEA Telecom (USD) -0.7% -7.0% 7.9% 41.1% 29.8% Price return vs Kuwait index 1.3% -4.9% -5.9% 21.4% 0.8% Price Return (USD) 0.0% -5.2% 12.7% 41.8% 24.5% Total Return (USD) 0.0% -5.2% 12.7% 41.8% 35.0% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 1,400 7 1,350 6 1,300 6 1,250 5 1,200 5 1,150 4 1,100 4 1,050 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
15 590 570
10 550 530 510 5 490 470 0 450 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
Dividend yield and corresponding Gsec 10yr bond yield OpFCF estimates revision
14.0% 560 12.0% 480 10.0% 400 8.0% 320 6.0% 240 4.0% 160 2.0% 80 0.0% 0 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Yield premium vs GSec D/Y GSec 10Y bond yield 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
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Financials & valuation: Zain Group Hold
Financial statements Valuation data Year to 12/2015a 12/2016e 12/2017e 12/2018e Year to 12/2015a 12/2016e 12/2017e 12/2018e Profit & loss summary (KWDm) EV/sales 1.9 2.0 1.8 1.5 Revenue 1,157 1,094 1,181 1,249 EV/EBITDA 4.4 4.4 3.7 3.2 EBITDA 504 513 557 589 EV/IC 1.3 1.4 1.3 1.3 Depreciation & amortisation -213 -212 -211 -210 PE* 9.8 8.8 7.2 6.3 Operating profit/EBIT 291 301 346 379 PB 1.2 1.3 1.2 1.1 Net interest -21 -21 -18 -10 FCF yield (%) 14.2 18.3 19.4 20.6 PBT 202 223 312 356 Dividend yield (%) 6.3 7.4 8.4 10.5 HSBC PBT 236 246 312 356 * Based on HSBC EPS (diluted) Taxation -36 -31 -47 -53 Net profit 154 188 258 293 HSBC net profit 189 211 258 293 Issuer information Cash flow summary (KWDm) Share price (KWD) 0.48 Free float 50% Cash flow from operations 461 455 508 532 Target price (KWD) 0.49 Sector Wireless Telecoms Capex -217 -166 -174 -183 Reuters (Equity) ZAIN.KW Country Kuwait Cash flow from investment -378 -201 -174 -183 Bloomberg (Equity) ZAIN KK Analyst Eric Chang Dividends -156 -132 -137 -156 Market cap (USDm) 6,724 Contact +971 4 423 6554 Change in net debt 160 22 -191 -187
FCF equity 230 295 318 342 Balance sheet summary (KWDm) Price relative Intangible fixed assets 1,185 1,125 1,125 1,125 Tangible fixed assets 902 904 867 841 0.63 0.63 Current assets 795 820 1,023 1,221 0.58 0.58 Cash & others 360 354 545 732 Total assets 3,495 3,447 3,598 3,757 0.53 0.53 Operating liabilities 762 836 878 929 0.48 0.48 Gross debt 965 982 982 982 0.43 0.43 Net debt 605 627 437 249 0.38 0.38 Shareholders' funds 1,543 1,433 1,535 1,633 Invested capital 1,761 1,658 1,592 1,525 0.33 0.33 0.28 0.28 2015 2016 2017 Ratio, growth and per share analysis Zain Group Rel to KUWAIT SE PRICE INDEX
Year to 12/2015a 12/2016e 12/2017e 12/2018e Source: HSBC Y-o-y % change Note: Priced at close of 08 Mar 2017 Revenue -4.6 -5.5 8.0 5.8 EBITDA -2.6 1.8 8.5 5.8 Operating profit -15.8 3.4 14.8 9.6 PBT -17.6 10.6 39.8 14.1 HSBC EPS -22.3 11.9 22.1 13.6 Ratios (%) Revenue/IC (x) 0.7 0.6 0.7 0.8 ROIC 14.0 15.2 18.1 20.7 ROE 11.9 14.2 17.4 18.5 ROA 5.6 6.3 8.3 9.0 EBITDA margin 43.5 46.9 47.1 47.1 Operating profit margin 25.2 27.5 29.3 30.3 EBITDA/net interest (x) 24.4 23.9 31.4 58.3 Net debt/equity 35.0 39.4 25.7 13.8 Net debt/EBITDA (x) 1.2 1.2 0.8 0.4 CF from operations/net debt 76.1 72.5 116.4 213.2 Per share data (KWD) EPS Rep (diluted) 0.04 0.05 0.07 0.08 HSBC EPS (diluted) 0.05 0.05 0.07 0.08 DPS 0.03 0.04 0.04 0.05 Book value 0.40 0.37 0.39 0.42
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Zain KSA (ZAINKSA AB)
Leverage clouds any discussion about profitability We see significant challenges with 5G Maintain Reduce and SAR7.10 TP
Company description
In 2007, Zain Group led a group of Saudi partners (including Almarai) to bid for the third mobile Eric Chang* Analyst license in Saudi Arabia. The consortium won by paying SAR22.9bn (USD 6.1bn), double the HSBC Bank Middle East Limited amount of Mobily’s license. Zain Group is the largest shareholder in Zain KSA, holding a 37% [email protected] +971 4 423 6554 stake, while a Saudi consortium owns 21% and the remaining 42% is free float. In February
Nikhil Mishra* 2008, Zain KSA was listed on the Saudi stock exchange, Tadawul. The same year, in August, EEMEA Telecom Associate the company launched its commercial operations, breaking the duopoly of STC and Mobily. Bangalore Zain KSA is the smallest of the three mobile network operators in Saudi Arabia and holds a market share of around 22% (as of Q3 2016, source: Zain). It serves around 10.5m customers * Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/ through a network of over 8,000 sites. The company has seen significant management change qualified pursuant to FINRA regulations despite its short history. Peter Kaliaropoulos is the company’s sixth CEO, and Mehdi Khalfaoui is the fourth CFO.
Short-term drivers
Affordability, spent dynamics and potential for data monetisation We do not view affordability (handsets or services) as an issue given Saudi Arabia’s oil wealth. However, telecom spending may be under pressure as the Saudi government’s efficiency drive reduces allowances and subsidies.
We see data as key driver for revenue growth. Mobile penetration in the Kingdom is in excess of 150% whereas smartphone penetration is estimated to be 60%. Data monetisation is hence correlated to the intensity of competition. We think Zain KSA and Mobily are unlikely to indulge in value-destructive price wars as both need to resolve their high leverage.
Currency impact We do not see any currency impact because the company only operates in Saudi Arabia where the currency is pegged to USD.
Dividend outlook Zain KSA has been operating for eight years and has yet to turn a net profit. We do not factor any net profit or dividends in the forecast period. As is the case for Mobily, we think Zain KSA management would consider dividend payments once it becomes profitable and deleverages to a sustainable level. Zain KSA is seeking to sell its tower assets and intends to use proceeds to pare down debt.
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Long-term driver: 5G expected impact
Monetisation On this criteria we rank Zain KSA lowest in Saudi Arabia due to a lack of fixed infrastructure. We note the third entrant is in discussion with fibre network owners for wholesale access. This is most certainly efficient from the perspective of capital allocation (and the denominator in the ROIC equation) but it limits revenue and profit upside.
Competition We expect competition will remain rational and support 5G monetisation. We do not envisage Zain KSA or Mobily engaging in value-destructive price wars because both companies need to resolve their high leverage. In addition, we discount the risk of new mobile entrants given the penetration rates and the fact that two out of three network operators are struggling with profitability.
Regulation The CITC has not introduced any regulation on net neutrality and the practice of zero-rating. The introduction of a unified license has brought some respite to mobile operators. The royal decree extended mobile licenses by 25 years and effectively eliminates any concerns about the cost (zero upfront) of mobile license renewal.
Business model We award Zain KSA the lowest score on this metric for a variety of reasons. As the latest entrant, the company had to rely on a pricing strategy to attract and retain subscribers. We have noticed some evidence of greater pricing discipline: ARPU has been improving but not by the same quantum as voice or data traffic. We think the exorbitant license cost has, in the past, impeded Zain KSA from spending adequately on network infrastructure. Data traffic in a 5G world will originate from fixed infrastructure but will increasingly terminate on a mobile network: lack of a fibre network may be a penalising factor.
Investment thesis
Our Reduce rating is based on the premise that Zain KSA’s debt load is not sustainable and will likely require another recapitalisation, which may be dilutive. Management has confirmed it is considering a variety of options to address this, including the possibility of a recapitalization or a debt-equity swap. The company will present its new strategy to the market in April.
A tower sale remains under consideration. Proceeds from the sale would be go towards debt reduction. In our previous report (Saudi Telecoms: 2016, a year of regulatory upheaval, 6 December 2016), we stated proceeds from a tower sale are unlikely to significantly reduce leverage. Zain KSA has lagged its nearest competitor Mobily (EEC AB, SAR21. 65, Buy) for many years in terms of network investments, which means capital intensity should remain elevated in the medium term to keep pace with competitors’ networks and increasing data usage.
Management has confirmed that no capex will be committed to developing a fixed infrastructure. For the last-mile connectivity, the company is considering using wireless technology or partnering with a network owner (for example Saudi Electricity). As such, we think upside to profitability will be limited.
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Valuation and Risks
Zain KSA: ZAINKSA AB, SAR 8.75, Reduce, TP SAR7.1 We value Zain KSA on a DCF based on a 9.0% WACC. The assumptions behind the cost of capital are as follows: 12.1% cost of equity (risk-free rate of 2.5% and equity risk premium of 7%, beta of 1.4); 7.3% cost of debt (corporate spread of 5.0%).
The target price of SAR7.10 implies 2017e EV/EBITDA of 9.8x (EEMEA average 5.6x) on a 10% 2016-18e EBITDA CAGR, and 18.9% downside: we rate the stock Reduce as we think the company may need to raise further capital given its current balance sheet structure.
Upside risks
Greater penetration of the government and corporate customer segment: Zain KSA’s growing customer base has been price-sensitive consumers (lower income expats, Saudi youths). The government and corporate segment are generally high-value customers which would allow the operator to expand margins
Greater mobile broadband usage could be a catalyst for ARPU increases. As usage increases, customers will start to see the value of data and may be more inclined to pay for it.
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Relative valuation Investors appear willing to discount the possibility/impact of a dilutive capital restructuring. Zain KSA has seen a robust share price performance, returning 30% over the past six months and 24% over the past year. The (stock market) enthusiasm contrasts with the consensus forecasts which remains prudent. We do not expect any dividend during our forecast period. The third entrant remains loss-making and its priority is to deleverage.
ZAIN KSA: Valuation Benchmark relative Recent performance Relative valuation
1W 1M 3M 6M 12M Price return -1.0% 0.0% 5.1% 30.4% 24.1% Total return -1.1% 0.5% 5.0% 30.6% 24.2% Total return vs EEMEA index (USD) 0.1% 0.3% 0.0% 28.4% 6.4% Total return vs MSCI EEMEA Telecom (USD) -1.7% -1.5% -0.2% 27.8% 16.6% Price return vs Tadawul -1.0% 0.0% 7.2% 17.5% 15.7% Price Return (USD) 0.0% 3.7% 7.7% 33.3% 27.3% Total Return (USD) -1.1% 0.4% 5.0% 30.3% 23.9% 2017e 2018e 2017e 2018e 2017e 2018e EV/EBITDA EV/opFCF D/Y
1yr fwd EV/EVITDA Sales estimates revision 8,730 23 8,380
18 8,030 7,680 13 7,330 6,980 8 6,630 6,280 3 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 2015 2016 2017 2018 2019 EV/EBITDA Average -2 SD +2 SD
1yr fwd EV/OpFCF EBITDA estimates revision
150 3,640 3,120 100 2,600 50 2,080 0 1,560 Mar-14 Jul-14 Nov-14 Mar-15 Jul-15 Nov-15 Mar-16 Jul-16 Nov-16 Mar-17 1,040 -50 520 -100 0 Mar-15 May-15 Jul-15 Sep-15 Nov-15 Jan-16 Mar-16 May-16 Jul-16 Sep-16 Nov-16 Jan-17 EV/OpFCF Average -2 SD +2 SD 2015 2016 2017 2018 2019
Capped at +/-50x levels
OpFCF estimates revision
3,850 3,300 2,750 2,200 1,650 1,100 550 0 Mar-15 Jun-15 Sep-15 Dec-15 Mar-16 Jun-16 Sep-16 Dec-16 2015 2016 2017 2018 2019
Source: Thomson Reuters Datastream, HSBC estimates
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Financials & valuation: Zain KSA Reduce
Financial statements Valuation data Year to 12/2016a 12/2017e 12/2018e 12/2019e Year to 12/2016a 12/2017e 12/2018e 12/2019e Profit & loss summary (SARm) EV/sales 2.8 2.7 2.7 2.7 Revenue 6,927 7,178 7,481 7,650 EV/EBITDA 10.6 9.8 9.3 9.1 EBITDA 1,802 1,998 2,178 2,304 EV/IC 1.1 1.1 1.2 1.2 Depreciation & amortisation -1,850 -1,760 -1,836 -1,916 PE* Operating profit/EBIT -48 238 341 387 PB 1.4 1.8 2.2 2.9 Net interest -925 -898 -914 -967 FCF yield (%) 18.6 -10.2 -12.4 -8.7 PBT -973 -659 -573 -580 Dividend yield (%) 0.0 0.0 0.0 0.0 HSBC PBT -973 -659 -573 -580 * Based on HSBC EPS (diluted) Taxation 0 0 0 0 Net profit -973 -659 -573 -580 HSBC net profit -973 -659 -573 -580 Issuer information Cash flow summary (SARm) Share price (SAR) 8.75 Free float 42% Cash flow from operations 4,122 2,185 2,084 2,293 Target price (SAR) 7.10 Sector Wireless Telecoms Capex -2,267 -1,800 -1,791 -1,760 Reuters (Equity) 7030.SE Country Saudi Arabia Cash flow from investment -2,267 -1,800 -1,791 -1,760 Bloomberg (Equity) ZAINKSA AB Analyst Eric Chang Dividends 0 0 0 0 Market cap (USDm) 1,362 Contact +971 4 423 6554 Change in net debt 281 513 662 595
FCF equity 930 -513 -621 -434 Balance sheet summary (SARm) Price relative Intangible fixed assets 16,196 15,751 15,980 15,866 Tangible fixed assets 7,006 7,491 7,258 7,377 Current assets 3,312 3,268 3,481 3,337 14.50 14.50 Cash & others 919 859 1,202 1,098 12.50 12.50 Total assets 26,611 26,607 26,815 26,676 Operating liabilities 7,975 8,177 7,953 7,902 10.50 10.50 Gross debt 15,061 15,514 16,519 17,011 Net debt 14,143 14,656 15,318 15,913 8.50 8.50 Shareholders' funds 3,575 2,915 2,343 1,763 6.50 6.50 Invested capital 17,621 17,475 17,564 17,580 4.50 4.50 2015 2016 2017 Ratio, growth and per share analysis Zain KSA Rel to TADAWUL ALL SHARE INDEX
Year to 12/2016a 12/2017e 12/2018e 12/2019e Source: HSBC Y-o-y % change Note: Priced at close of 8 Mar 2017 Revenue 2.7 3.6 4.2 2.3 EBITDA 10.6 10.9 9.0 5.8 Operating profit 43.2 13.6 Ratios (%) Revenue/IC (x) 0.4 0.4 0.4 0.4 ROIC 5.1 5.0 5.6 6.0 ROE -23.9 -20.3 -21.8 -28.2 ROA -0.1 1.0 1.3 1.5 EBITDA margin 26.0 27.8 29.1 30.1 Operating profit margin -0.7 3.3 4.6 5.1 EBITDA/net interest (x) 1.9 2.2 2.4 2.4 Net debt/equity 395.6 502.7 653.8 902.6 Net debt/EBITDA (x) 7.8 7.3 7.0 6.9 CF from operations/net debt 29.1 14.9 13.6 14.4 Per share data (SAR) EPS Rep (diluted) -1.67 -1.13 -0.98 -0.99 HSBC EPS (diluted) -1.67 -1.13 -0.98 -0.99 DPS 0.00 0.00 0.00 0.00 Book value 6.12 4.99 4.01 3.02
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Notes
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Notes
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Disclosure appendix
Analyst Certification The following analyst(s), economist(s), and/or strategist(s) who is(are) primarily responsible for this report, certifies(y) that the opinion(s) on the subject security(ies) or issuer(s) and/or any other views or forecasts expressed herein accurately reflect their personal view(s) and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation(s) or views contained in this research report: Herve Drouet, Ziyad Joosub and Eric Chang
With respect to the analysis pertaining to the valuation of Indosat in this report, the following analyst certifies that the opinion(s) on the subject security or issuer and/or any other views or forecasts expressed herein accurately reflect their personal view and that no part of their compensation was, is or will be directly or indirectly related to the specific recommendation or views contained in this research report: Neale Anderson
Important disclosures Equities: Stock ratings and basis for financial analysis HSBC believes an investor's decision to buy or sell a stock should depend on individual circumstances such as the investor's existing holdings, risk tolerance and other considerations and that investors utilise various disciplines and investment horizons when making investment decisions. Ratings should not be used or relied on in isolation as investment advice. Different securities firms use a variety of ratings terms as well as different rating systems to describe their recommendations and therefore investors should carefully read the definitions of the ratings used in each research report. Further, investors should carefully read the entire research report and not infer its contents from the rating because research reports contain more complete information concerning the analysts' views and the basis for the rating.
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Rating distribution for long-term investment opportunities As of 15 March 2017, the distribution of all independent ratings published by HSBC is as follows: Buy 45% ( 25% of these provided with Investment Banking Services ) Hold 40% ( 27% of these provided with Investment Banking Services ) Sell 15% ( 17% of these provided with Investment Banking Services )
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HSBC & Analyst disclosures Disclosure checklist
Company Ticker Recent price Price date Disclosure ETIHAD ETISALAT (MOBILY) 7020.SE 21.31 15 Mar 2017 1, 5 ETISALAT ETEL.AD 17.65 15 Mar 2017 1, 5 MAGYAR TELEKOM MTEL.BU 495.00 15 Mar 2017 7 MOBILE TELESYSTEMS MTSS.MM 269.00 15 Mar 2017 5, 6, 7 MTN GROUP MTNJ.J 122.10 15 Mar 2017 4, 7 OOREDOO ORDS.QA 101.00 15 Mar 2017 1, 5, 6, 7 TURK TELEKOMUNIKASYON AS TTKOM.IS 5.68 15 Mar 2017 5, 6, 7 TURKCELL TCELL.IS 12.10 15 Mar 2017 2, 5, 6, 7 VIMPELCOM LTD VIP.N 4.05 15 Mar 2017 5, 7 Source: HSBC
1 HSBC has managed or co-managed a public offering of securities for this company within the past 12 months. 2 HSBC expects to receive or intends to seek compensation for investment banking services from this company in the next 3 months. 3 At the time of publication of this report, HSBC Securities (USA) Inc. is a Market Maker in securities issued by this company. 4 As of 28 February 2017 HSBC beneficially owned 1% or more of a class of common equity securities of this company. 5 As of 31 January 2017, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of investment banking services. 6 As of 31 January 2017, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-investment banking securities-related services. 7 As of 31 January 2017, this company was a client of HSBC or had during the preceding 12 month period been a client of and/or paid compensation to HSBC in respect of non-securities services. 8 A covering analyst/s has received compensation from this company in the past 12 months. 9 A covering analyst/s or a member of his/her household has a financial interest in the securities of this company, as detailed below. 10 A covering analyst/s or a member of his/her household is an officer, director or supervisory board member of this company, as detailed below. 11 At the time of publication of this report, HSBC is a non-US Market Maker in securities issued by this company and/or in securities in respect of this company
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12 As of 10 March 2017, HSBC beneficially held a net long position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. 13 As of 10 March 2017, HSBC beneficially held a net short position of more than 0.5% of this company’s total issued share capital, calculated according to the SSR methodology. HSBC and its affiliates will from time to time sell to and buy from customers the securities/instruments, both equity and debt (including derivatives) of companies covered in HSBC Research on a principal or agency basis.
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Additional disclosures 1. This report is dated as at 16 March 2017.
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5. As of 03 Mar 2017 HSBC owned a significant interest in the debt securities of the following company(ies): SAUDI TELECOM COMPANY
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156 EEMEA telecoms Equities // Telecoms / EEMEA March 2017 HSBC Bank plc
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*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations. HSBC Bank Middle East Ltd +971 4423 6554 | [email protected] Eric Chang rejoined HSBC in as 2015 an equity analyst covering the MENA telecoms sector. Prior to this, he was a MENA-focused buy-sideanalyst at a major UAE bank. Eric started his career at HSBC in 1997 as an equity analyst covering technology and media companies. Eric has a BA in Economics and Political Science from McGill University as well as a Masters in Finance from ESCP Europe. house inJohannesburg for over eight years. He has covered South Africa TMT for over six years and has beenranked a Financial Mail and Institutional Investor analyst consistently over this period. Ziyad also spent two years as an associate inthe consumer (retail) space.Before moving into equity research, Ziyad spent five years as a strategy and corporate finance analyst at a USinvestment bank. Ziyad is an honours graduate in Economic Sciences and Statistics from the University of the Witwatersrand. Chang* Eric Analyst a MBA from London Business School and graduated from Ecole Supérieure d’Ingénieurs en Electrotechnique et Electronique in France. Joosub* Ziyad Analyst HSBC Securities (South Africa) (Pty) Ltd 676 4223+27 11 | [email protected] Ziyad Joosub joined the EEMEA TMT team at HSBC in May 2016. He had previouslybeen an equity research analyst for a US investment Hervé Drouet* Head of EEMEA TMT Equity Research plc Bank HSBC +44 20 7991 6827 | [email protected] Hervé is Head of EEMEA TMT Equity Research. He has covered the sector for more thanyears 14 and has been ranked regularly, and ranked highly in numerous external surveys. He has 20 years’ experience in the media, telecoms and technology sectors, having been asenior management consultant in the TMT practice at Deloitte Consulting and a project manager for Schlumberger Technologies. He holds Main contributors