Thursday, December 03, 2015 | update Orange Polska: buy (reiterated) OPL PW; OPL.WA | TMT, Poland FCFs Show Rebound Potential Current Price PLN 6.50 Contrary to our expectations with respect to the recently-ended Target Price PLN 9.00 LTE spectrum auction that after speculative bidding by NetNet to MCap PLN 10.66bn drive prices up to a point where the auction would have to be Free Float PLN 5.26bn canceled and redone, in the end the Administration Ministry stepped in and brought the auction to a close by effectively turning ADTV (3M) PLN 34.96m it into a tender process despite numerous protests from the bidder. As a result the total bids placed on the 4G frequencies reached Ownership PLN 9.2bn. As the winner of two of the five frequency blocks in the Orange S.A. 50.67% 800 MHz range put up for auction, Orange Polska is due to pay a (f. France Telecom S.A.) total of PLN 3.2bn for the licenses, prompting adjustments to our valuation model formerly based on the assumption of PLN 1.5bn frequency CAPEX. Orange is currently trading at 4.4x 2016E Others 49.33% EV/EBITDA, showing discounts of 35% to the peer group and 31% to the valuation of rival Polkomtel. This is an attractive ratio in our Sector Outlook view given its high FCF yield at 13.0% (similar to 12.8% poffered The value of the Polish telecommunications market by Cyfrowy Polsat and 6.1% European telecoms), relatively low is estimated at PLN 39 billion, including PLN 26bn in mobile telephony at a penetration rate greater debt even after the pricey spectrum bookings (at 1.9x vs. 2.0x than 153%. Fixed-line penetration in 2014 was European telecoms), and the fact that within a few months from 45% (-2.0ppts y/y), and wholesale line rental and completing LTE800 coverage infrastructure it will be able to offer LLU-based line leasing has been on a decline in the widest range of B2B and B2C telecommunications services in 2015. Poland. What is more Orange's current market valuation does not yet price in the high-speed FTTx infrastructure and its potential to Company Profile take away market share from cable operators. Our new price target Orange Polska is the leader in telecommunications of PLN 9.00 for OPL implies upside potential of 38%. services. It had over 23 million customers at the end of 2014, and in 2015 its mobile and fixed-line Even after cut, dividend potential sill above average market shares (in customer numbers) are 27% After its winning bids on LTE spectrum were confirmed in October, Orange and 52%, respectively. In addition Orange controls 30% of the Polish broadband Internet. Finally announced it was reducing the dividend payout ratio to 50% in light of the Orange is the owner of the largest upcoming expenditures. However in the future, even assuming a fall in telecommunications infrastructure in Poland. EBITDA in 2016, since the Company is aiming to achieve a 2018 target debt ratio of 1.7x, we believe it will restore the payout ratio to a higher OPL vs. WIG level (depending on the new net debt/EBITDA target set to be announced in February 2016). By contrast, the rival telecom Cyfrowy Polsat's stated 12.0 2016 year-end net debt/EBITDA target is <2.5x, and its dividend policy is OPL up for a revision. According to our calculations the telecom will not be able PLN to reduce the debt ratio below 2.7x next year, and as a result it will WIG withhold distributions from shareholders in the following year. 10.5 High-speed infrastructure coming soon Orange Polska lost 4% of its share in the fixed-line broadband market between 2010 and 2014 (mostly to cable providers which control 80% of 9.0 the market for >30 Mpbs speeds compared to Orange's share of 7%), and it needs to start investing in high-speed bandwidth infrastructure if it wants to regain its footing. In the next few years we expect Orange will invest 7.5 over PLN 2 billion in developing FTTH networks, supported by G.Fast, a technology which in test conditions achieved speeds up to 500 Mbps. We anticipate a G.Fast pilot launch still this year. By offering high-speed fixed- line Internet, Orange stands to expand its customer base and maximize the 6.0 cross-sell potential within that base, and consequently stabilize its EBITDA Nov-14 Feb-15 May-15 Aug-15 Nov-15 starting in 2016. Target Price Rating (PLN m) 2013 2014 2015E 2016E 2017E Company new old new old Revenue 12,923 12,212 11,841 11,502 11,457 EBITDA 3,904 4,076 3,535 3,430 3,496 OPL 9.00 10.20 buy buy EBITDA margin 30.2% 33.4% 29.9% 29.8% 30.5% Current Target Company Upside EBIT 788 986 626 718 934 Price Price Net profit 294 535 281 292 474 OPL 6.50 9.00 +38% DPS 0.50 0.50 0.50 0.25 0.25 P/E 29.0 15.9 30.4 29.2 18.0 Analyst: P/CE 0.7 0.7 0.7 0.7 0.7 P/B 0.7 0.7 0.7 0.7 0.7 Paweł Szpigiel EV/EBITDA 3.4 3.1 3.5 4.4 4.3 +48 22 438 24 06 DYield 7.7% 7.7% 7.7% 3.8% 3.8% [email protected] OPL Undervalued Relative to CPS Both Cyfrowy and Orange face modest EBITDA growth in the coming years despite a push into LTE, which may explain the discount at which they are valued relative to Compared to rival Cyfrowy Polsat, Orange Polska has a European telecoms, set for EBITDA growth at average different revenue composition in that 43% of its annual annual rates of 2.5% in 2016 and 4.4% in 2017 according topline comes from the fixed-line business which relies to a to Bloomberg forecasts. Meanwhile our analyses indicate large extent on obsolete copper wire infrastructure. At that the two Polish telecoms are poised for a flat earnings Cyfrowy, 33% of the revenues are provided by the momentum from 2017 on stemming from the fact that the television business (broadcasting and DTH satellite pay- local market for telecommunications services is one of the TV). most competitive in the world. At Cyfrowy the upsell capabilities are limited to the existing customer base, and Cyfrowy Polsat revenue composition they entail significantly reduced prices, and while the television business does show meaningful growth potential its share in the Company's total sales is only 10%. 33% DTH + TV FCF Yield projection for Cyfrowy Polsat and Orange Broadcasting Polska Mobile Telecom 20% 67% 12.9% 15.6% 15.0% 13.5% 15% 13.1% 12.3% 12.9% 12.8% 12.7% 10.2% 10% Source: Dom Maklerski mBanku 5.7% 5% Orange Polska revenue composition 0% -5% 5% -10% Fixed Line 43% -15% Mobile Other -20% 52% -25% 2016P 2017P 2018P 2019P 2020P 2021P OPL PW CPS PW Source: Dom Maklerski mBanku Source: Dom Maklerski mBanku While we agree that the differences in revenue composition should mandate a valuation premium for CPS over OPL, at Cyfrowy is expected to generate higher FCF Yield in 2016 57% on 2016E EV/EBITDA (with OPL’s multiple adjusted and 2017 than Orange, whose cash flows in the period will be affected by the PLN 3.2bn LTE spectrum payment and a for the effects of LTE frequency payments on net debt), fine imposed by the European Commission. In addition the premium is much too high looking at the following Orange is expected to invest PLN 450m per year until 2019 metrics: (1) EBITDA growth, (2) FCF Yield and DivYield, in the development of FTTx technology, and although we and (3) debt. We assign the highest weight to these factored these expenditures out of FCF calculations for metrics as they directly influence the amounts of presentation purposes, note that even with them factored distributions to shareholders. in Orange still generates higher FCF than Cyfrowy. EBITDA growth projection for Cyfrowy Polsat and Orange Polska FCF adjustments Orange Polska 40% 37.3% 8.0% 6.0% 35% 4.0% 30% 2.0% 2.0% 25% 0.5% 0.2% 0.4% 0.6% 0.0% 20% -0.2% -2.0% -0.6% -0.4% 15% -1.5% 10% -4.0% -3.1% -3.1% 6.0% -6.0% 5% -5.6% -8.0% 0% 2016P 2017P 2018P 2019P 2020P 2021P 2016P 2017P 2018P 2019P OPL PW* CPS PW LTE spectrum payment EU fine Source: Dom Maklerski mBanku, * EBITDA adjusted for proceeds of property Source: Dom Maklerski mBanku sales 2 Adjusted FCF Yield projection for Cyfrowy Polsat and Net Debt/EBITDA projection for Cyfrowy Polsat and Orange Polska Orange Polska 18.0% 3.0x 2.7x 15.6% 16.0% 15.0% 2.5x 2.2x 13.5% 2.0x 14.0% 13.1% 12.9% 12.9% 12.8% 12.7% 2.0x 1.9x 2.0x 12.3% 1.7x 1.7x 11.1% 11.7% 1.6x 12.0% 1.4x 1.4x 10.2% 1.5x 1.2x 1.2x 10.0% 1.0x 8.0% 6.0% 0.5x 4.0% 0.0x 2016P 2017P 2018P 2019P 2020P 2021P 2.0% 0.0% OPL PW CPS PW 2016P 2017P 2018P 2019P 2020P 2021P Source: Dom Maklerski mBanku CPS PW OPL PW To reiterate Cyfrowy has less dividend-paying capacity Source: Dom Maklerski mBanku than Orange due to its higher debt and lower FCF yield.