CFA Institute Research Challenge hosted by Local Challenge CFA Society Poland Wroclaw University of Economics CFA Institute Research Challenge 4 Feb 2014 WSE Ticker: NET Recommendation: HOLD Current price 5.00 (as of 24-01-2014) NETIA SA 12 M target price 5.50 (upside 10%) Telecommunications Industry Market profile Netia: Wire up to cash flow Highlights 52-week price range 3.91 – 5.65 [PLN] We issue a HOLD recommendation with a target price of PLN 5.50. It implies 10% upside potential including dividend payout. Netia is the biggest alternative fixed-line market operator in Poland with one of the highest dividend yields on WSE. Average daily volume 407 221 Main price growth drivers: (1) Growing EBITDA margin as an effect of shift from regulated access network to own infrastructure, average margin growth of 1.5% YoY in the forecast As % of shares period, from 15.2% in 2008 up to 31.3% in 2018E. (2) Profit distribution to shareholders, 0.12% outstanding annual dividend yield 8.0%. Main price decline drivers: (1) -2.5% CAGR revenues decline driven by fixed-to-mobile substitution effect at. (2) -2.6% CAGR ARPU decrease resulting from fierce price war on 2013 dividend yield 7.87% telecom market. (3) Dominant market position of incumbent operator in fixed-line sector. Sound financial position: low leverage and cash sufficiency. We believe Netia to maintain Shares outstanding 348m healthy financial standing: (1) D/E equal to 17.2% in the forecast period; (2) CFO/CAPEX; 202% in 2012, 207% in 2018E; (3) Cash ratio; 2013E; 0.4, 2018E; 1.9. Market capitalization Main risk issues: (1) Strong telecom market consolidation may develop two scenarios: 1 740 [PLNm] development opportunities by further acquisitions, or by becoming an acquisition target, (not incl. in valuation). (2) Recent legal regulatory changes in Poland concerning pension funds impose significant risk of influence on capital market and forthcoming Institutional holdings 60.34% undervaluation of stocks listed on WSE. BV per share 6.3 Figure no. 1 Netia price last 52 weeks P/BV 0.79 3.91Valuation – 5.65 DCF Multipliers Estimated price 5.50 - Weights407 221 100% 0% Target Price 5.50 0.12% 7.87% 348m 1 740 60.34% 2 6.3 CFA Institute Research Challenge 4 Feb 2014 Figure no. 2 Business Description Ownership Structure in 2013 Netia S.A. is the largest alternative provider of fixed-line telecommunication services in Poland. Company was established in 1990; it provides range of telephony and data transmission services, offered on Company’s own copper or fiber optic backbone ING PTE S.A. structure and on the network infrastructure leased selectively from the incumbent 17% operator (IO), Orange. The company’s ownership structure consists mostly (60%) of institutional holdings. Others Netia management is stable and comprise of four professionals members, realizing 40% Third Avenue successfully development strategy by organic grow and acquisitions. (See appendix 15) Management LLC Company strategic goals 17% Netia announced its development strategy until 2020. The main goals are: Broadband market share increase to 20% by the way of both organic SISU Capital development and acquisitions. Limited Increase in RGU from the level 1.3 to 2.0 per client. 13% Continue client switch from regulated access network to own infrastructure. Provision integrated solutions for home & business customers, extending TV OFE PZU services and multimedia solutions to three screens (TV, PC, and Mobile). "Złota AVIVA OFE Jesień" Aviva BZ Key events 5% WBK The milestone in the company’s development was introduction of new 8% telecommunication market legal regulations, forcing IO to allow alternative operators Source: Company data access to its network infrastructure. In order to take advantage of the arising provision of broadband internet access services based on IO network facilities, starting January 2007. Figure no. 3 Netia Group has been expanding over the time by the way of organic growth as well as Netia Group structure intense acquisition program. The Company acquired Tele2 Polska for PLN 148m, a company providing broadband and voice services on a country-wide scale based on Internetia Holdings regulated access to IO infrastructure, in September 2008 and exceeded 1m of RGU. Netia Sp. z o.o. Group has also been enlarging its customer base by acquiring vast number of local fast Ethernet operators. Since the beginning of 2007, the Company managed to acquire 37 Net 2 Net Poland Sp. z o.o. operators with total number of over 129k active customers. Netia Brand Following the acquisitions strategy, Netia acquired Telefonia Dialog, along with its Management subsidiaries Avista Media, Petrotel as well as Crowley Data Poland for cumulative amount of PLN 1.07bn, in 2011. Dialog and Petrotel provided a similar range of Telefonia Dialog telecommunication services and serve business and residential customers. Crowley was Sp. z o.o. NetiaS.A. Group providing telecommunication services exclusively to business customers. Those acquisitions materially increased the size of Netia operations from 1.95m to 2.79m RGU. Centrina Sp. z o.o. Over the last two years, Netia has conducted internal consolidation associated with previous large acquisitions. In order to broaden Netia product offer even further, the Dianthus Sp. z o.o. Company started offering IPTV services since 2011. Besides, the company bought from the UPC cable network with access to 446k households in Warsaw and Cracow, constantly seeking the access to new customers and gradually upgrade its copper and Ethernet Source: Company data access networks to meet the NGA transfer (up to 30Mb/s) standards. Netia covered 1,240k households in NGA at the end Q3 2013. Figure no. 4 Netia market price (January 2008 - January 2014) 8 USA government 7.5 announces Deutsche Telekom acquires 7 Acquisition of TELE2 S.A. contradictionary fiscal GTS CE 6.5 policy introduction 2.3bn 6 148m 5.5 5 4.5 4 3.5 3 2.5 101m 2 Acquisition of CDT S.A. 1.5 1 Acquisition of 0.5 Telefonia Dialog S.A. 969m 0 Jan/08 Jul/08 Jan/09 Jul/09 Jan/10 Jul/10 Jan/11 Jul/11 Jan/12 Jul/12 Jan/13 Jul/13 Jan/14 Source: Stooq.pl 3 CFA Institute Research Challenge 4 Feb 2014 Figure no. 5 Industry Overview & Competitive Positioning Revenues on Telecom market in 2012 [bn] Netia operates on fixed-line voice and broadband, PayTV and wholesale 20 19 telecommunication market. The market is highly regulated by the Office of Electronic 18 Communications – UKE, which realizes its strategy of market competition development in 16 line with European Commission guidelines described in Digital Agenda and National 14 Development Strategy 2020. UKE regulates the market by the way of Mobile and Fixed 12 Termination Rate level control, frequency license tender offers announcements, regulated 10 access restrictions and penalties imposition based on the SOR16 regulations. Due to 8 approximate decrease of 2.4% YoY, the total value of telecommunication industry in 6 4 5 Poland amounted to PLN 41.7bn in 2012. Market decrease has been mainly driven by 4 13.5% YoY decline of fixed-line telephony segment. In 2012, first time since the beginning 2 of market operations in Poland, mobile telephony segment decreased on a yearly basis, 0 by 1% in terms of revenues. Internet Mobile Fixed-line telephony telephony Fixed-line telephony market value amounted to PLN 4.5bn in 2012 and its performance is Source: UKE strongly correlated with the mobile telephony sector due to worldwide observed fixed-to- Figure no. 6 mobile substitution effect. We forecast further market shrinking at pace of -5% a year. Revenues on fixed-line broadband segment [m] Segment is dominated by Orange with revenues of over 60% of market value, and Netia, the largest alternative operator, 20.4%. Main features of the segment are constantly Multimedia Polska diminishing number of subscribers, 1.8m over last 4 years, (-5.3% YoY), to the level of 7.4m, along with successively declining ARPU by PLN 14.1 over last 4 years to the level of Vectra PLN 51.1 per month. Due to stronger competitiveness, the ARPU of Netia has been gradually declining. ARPU declined by PLN 5 to PLN 45 on regulated access network and UPC Polska by PLN 21 to PLN 43 over own network, since 2009. 19.5% of all fixed-line telephony subscribers (1.4m) were provided the service over WLR, 54.8% of which was offered by Netia Netia. The cost of WLR, determined by the telecom regulator UKE, is set at the level of PLN 20 monthly per subscriber, unchanged since 2007. Main determinant of service PTK Centertel provider choice is price. Operators tend to combat churn rates by combining fixed-line telephony, broadband and Pay TV into bundle services. Orange Internet services sector is growing steadily in terms of popularity and availability. As a pozostaliOthers result, at the end of 2012, the penetration of broadband services reached the level of 83.5% for households and 29.3 per 100 inhabitants. The number of subscribers has grown 0 400 800 1200 to 11m, 7.4% in terms of CAGR in 2010-2012. Market value of broadband services 2012 2011 amounted to PLN 4.4bn, 10.7% increase compared to 2011. Despite increasing total Source: UKE income, ARPU was successively declining, due to price cuts caused by fierce competition. The fixed-line broadband is steadily growing and according to our forecast it will Figure no. 7 continue to increase 1.5% YoY in terms of CAGR, and is foreseen to reach 7.8m until Broadband penetration in Poland, Dec 2012 2018. PLN 3.4bn (76.7%) revenues was generated by fixed-line connections, of which 120% 17.6% was covered by Netia.