Friday, March 27, 2020 | update Orange Polska: buy (upgraded) OPL PW; OPL.WA | Telco, Poland Defensive Play, Demand For FTTH Might Increase Current Price PLN 5.88 We have revised our outlook on Orange Polska ("Orange") to Target Price PLN 6.90 account for the expected consequences thus far of the current MCap PLN 7.7bn epidemic – obviously, the situation is still developing and Free Float PLN 3.8bn circumstances are subject to change. The key risks we see as facing telecoms at the moment include increased network traffic, potential ADTV (3M) PLN 31.3m customer losses, weaker sales of electronics due to subdued demand, exacerbated by quarantine store closures, reduced use of Shareholders international roaming, and, crucially for Orange, diminished Orange S.A. 50.67% prospects for selling noncore real estate at a good price. Our base- case scenario for Orange assumes that, against the backdrop Others 49.33% described above, we will see a 3% decline in eEBITDAaL, and witness FCFE of PLN 391m, in 2020. The following year, assuming the epidemic is contained, EBITDA could rebound by 5.1%, Business Profile supported by cost savings, and FCFE might increase to PLN 800m Orange Polska is a leading telecommunications provider in Poland with 14.8 million mobile users, (10.4% Yield). On updated estimates, we set our new target price 2.6 million broadband users, and 3.4 million voice for OPL at PLN 6.90, and we upgrade the stock to buy. Below we also users at the end of 2018. This was equivalent to provide a best-case earnings outlook for Orange, which considers respective market shares of 28% in mobile and 49% potential positive effects of price hikes facilitated by increasing data in fixed line. Orange controls 28% of Poland's traffic. In the worst case, we discuss the possibility of an extended broadband Internet market. It is currently in the freeze on dividends. process of buiding FTTx infrastructure. Increased interest in FTTH, possible opportunities for price OPL vs. WIG hikes 8 Web traffic has surged as more and more people join the #stayathome movement and governments introduce increasingly strict social distancing PLN rules, to the point where streaming quality in Europe had to be reduced on 7 an intervention form the European Commission. The cable operator UPC reports a 40% increase in its Polish network traffic relative to weekly pre- epidemic levels, and we see this as an indication of increased demand for 6 broadband Internet where the are no usage caps or speed limitations. A marked rise in wired connections would add legitimacy to Orange's business 5 model, including the current investment in fiber infrastructure. At the same time, increasing phone data use should create an opportunity to raise the prices of mobile plans. 4 OPL Risks WIG There is downside risk to our current forecasts for Orange if the coronavirus 3 quarantine measures extend beyond mid-May. Further, Orange might not be able to generate the assumed profits on planned real-estate deals, which to Jun-19 Mar-19 Mar-20 Dec-19 a large extent determine the size of FCFE. In our worst-case scenario where Sep-19 2020 eEBITDAaL falls 8% to PLN 2,519m, the year-end net debt/eEBITDAaL ratio might be 2.52x (after assumed 5G expenditures of PLN 550m). Under such circumstances, Orange would most likely not restore a regular dividend policy from 2021 even with tailwinds on the way forward – a factor which Target Price Recommendation makes it less attractive than the rival telecom Play. Company new old new old Orange Polska 6.90 7.40 buy accumulate Current Target Company Upside Price Price (PLN m) 2018* 2019 2020P 2021P 2022P Orange Polska 5.88 6.90 +17.3% Revenue 11,087.0 11,405.6 11,150.7 11,322.7 11,523.9 Forecast Update 2020E 2021E 2022E eEBITDAaL ** - 2,735.0 2,644.6 2,780.2 2,912.9 Revenue -3.5% -3.1% -3.0% eEBITDAaL margin - 24.0% 23.7% 24.6% 25.3% EBIT 345.0 416.8 378.4 612.9 823.8 EV/EBITDA under IFRS 16 -3.5% -3.3% +0.5% Net profit 10.0 91.3 62.7 263.3 422.4 Net Profit -75.4% -43.1% -16.0% P/E - 84.5 123.1 29.3 18.3 P/CE 3.0 2.7 2.8 2.6 2.5 P/B 0.7 0.7 0.7 0.7 0.7 EV/EBITDA 5.1 5.0 5.2 4.7 4.6 Analyst: DPS 0.00 0.00 0.00 0.25 0.25 Paweł Szpigiel DYield 0.0% 0.0% 0.0% 4.3% 4.3% +48 22 438 24 06 * ex. IFRS 16 effects; ** EBITDA ex. leases and real-estate profits [email protected] Revising Forecasts For a Recession numbers reported by China Mobile showed a decrease of less than 1%, or 8.1 million users, relative to a subscriber base of 950.3 million at the end of 2019. The decline was Quarantine measures introduced by countries across the attributed mainly to users suspending some of their multiple world have drastically transformed the telecommunications SIM cards during the period of travel restrictions. In the long landscape, disrupting the business activities of hundreds of run, Polish carriers might see some loss of business on the companies. As a result, Polish telecom stocks tracked by the heels of slowing economic activity, however the potential WIG-IT index have shed 13.1% over the past month against declines in subscriber numbers in our view will be cushioned a 22.9% fall the WIG broad market benchmark. To reflect by the price hikes on mobile plans introduced in 2019. this, we have updated our outlook on the Polish mobile sector as a whole, and we have revised our models for In fact, we see potential for mobile ARPU growth driven by Orange Polska to give a comparison of three scenarios users to increasing their data plans. (base, best, and worst case) for how the current epidemic might affect the Company's value and earnings prospects. 3. Store closures Sector Outlook The closure by Poland of large shopping centers to help contain the current epidemic is going to hurt smartphone We see the following top challenges facing the telecom sales. For example, UPC Poland has closed most of its industry in the months ahead: several dozen locations except four stores in Warsaw, Gdańsk, Katowice, and Krakow. Play has opted to keep 1. Increased network traffic stores outside shopping center open for now, but with circumstances changing fast it is advising its customers to Internet traffic has spiked as more and more countries close check its Website for updates on store hours. T-Mobile and schools and encourage firms to allow their employees to Orange have implemented similar policies. Orange operates work from home. As the #stayathome movement grows, about 700 sales locations across Poland, of which about 300 and governments introduce increasingly strict social (43%) are currently closed for business. 500 of the 700 distancing rules, demand for online video streaming is stores are run by partner networks. estimated to have surged 20-30% over the recent weeks, with Europe leading the charge, represented by Austria 4. Reduced demand for international roaming (+44%), Spain (+42%), and Germany (+32%). services The surges in activity have sparked concerns over the ability Polish MNOs earn about PLN 100m a year from international of the European network infrastructure to withstand roaming services – profits which are about to be drastically increasing traffic without outages. With the closure of movie curtailed by the current travel restrictions. theaters, distributors are opting to make new movie releases available on streaming platforms, potentially 5. 5G auction adding to the congestion, alongside live concerts and theatrical streams, and streaming content being created by France has postponed its 5G auction, originally scheduled to museums, cultural institutions, and more. begin in late April, with the local regulator Arcep saying it was not able to move forward with the spectrum sale under Earlier this month, the EU' internal market commissioner, the current circumstances. On the other hand, Arcep's Polish Thierry Breton, called on content providers like Netflix and counterpart, UKE, on 23 March confirmed the 23 April Youtube, to curtail bandwidth usage by reducing the deadline for submitting initial bids for 5G frequencies (3480- streaming quality of their videos. The companies have 3800 MHz band). "The trial auction, followed by the auction, complied, with Nefllix reducing its European service quality will take place no earlier than May 15, 2020, taking into for 30 days, expected to reduce traffic by 25%. account the current external conditions," the regulator said in a post on its Website. It is probable that the trial will get In Poland, CSPs gave assurances after reports of disruptions pushed back if Poland further escalates the current from internet users: quarantine restrictions, however our base-case scenario for . Play disclosed a 30% increase in voice traffic over the Orange assumes that the 2020 5G auction will go ahead as recent days, accompanied by a 40% surge in peak planned, with telecoms paying approximately PLN 550m daytime data traffic, which subsides in the evenings. each per frequency block. T-Mobile Polska is seeing traffic on its network as "stabilized at new, higher levels," and it currently The Base Case handles 40% more voice calls than at the beginning of March. The average call duration has increased by 25% . Mobile revenues: Our base case predictions for on week days and 60% during weekends.