TELECOM EGYPT … MASSIVE CAPEX OVER THE SHORT TERM … THE COST TO REGAIN AN UPWARD ACCELERATING PERFORMANCE …
We downgrade TE fair value to EGP 10.58/share down from EGP 11.34/share as we account for massive investments to be incurred over the short run. We shift the previous base case valuation (assuming 2015 lines of business dynamics continuance) to our previously assumed scenario 2 (mobile operator + VFE stake sale in 2017 + Wholesale liberalization – International gateway) which previously yielded EGP 7.88/share. After accounting for the new updates that took place, it resulted in an upgrade to such scenario`s assumptions taking the value up to EGP 10.58/share, due to …
1- Telecom Egypt becoming Egypt`s first 4G operator after signing the agreement with the National Telecommunications Regulatory Authority (NTRA), with services promised within 6-months. The 4G license is valued at EGP 7.08bn, 50% of which will be settled in USD, while EGP 5.2bn was settled up front utilizing the company`s cash balance and a bank short term overdraft of EGP 2-3bn which we account for at EGP 2.5bn. Leading to an upgrade in 2017-2020 estimated mobile operations earnings, to accommodate the recent indications of a 6-months competition break to be granted for TE to build its client base (launching 4G first). Hence smoothing the discounts we assumed over the average market ARPU previously. to only account for a first year discount and to move with the market average thereafter.
2- Adding an overdraft facility of EGP 2.5bn to 2016 debt weight, to reach 14.6% of capital up from c.2.3% in 2015, hence contributing directly to smoothing the year`s WACC, and heavily adding more value as we previously assumed 2015`s minor debt level to prevail.
3- Updating VFE stake value to EGP 33.9bn up from EGP 31.1bn thanks to the group`s enhancement in top line and Ebitda in contrary to our previous expectations, which led to an increase in Telecom Egypt`s estimated capital gain post tax to EGP 5bn up from EGP 2.5bn thanks to the stake`s book value drop due to the EGP 9.5bn in 1H2016 and estimated to reach c. EGP 9bn by the year end.
4- We anticipate EGP 1,285.3mn of investment income from VFE in 2016 full year after the EGP 716.3mn received in 1H2016 (c. 68% Y-o-Y), on the back of VFE 33.7% Y-o-Y increase in net profits to stand at EGP 766mn in 1Q-FY2016/17.
5- Updating 2016E earnings and profitability after the company was able to surpass our bottom line impressively in 1H2016 mainly due to the increase in deposits and t-bills investments at more favorable returns which created a massive interest income account, supported by regaining the company`s historically strong cash balances as the BoD approved channeling funds from reserves. And also after accounting for the new dividends anticipated from VFE.
6- Telecom Egypt control over its cost structure in 1H2016 through reevaluating some assets expected life, while benefiting from a drop in connectivity costs.
7- The anticipated wholesale division liberalization, would result in the loss of revenues as orange and VFE operate their international gateway licenses, below the expected additions from the mobile segment as we reach 2019, while help smoothing the group`s cost structure especially the FX-denominated portion.
8- We smoothed down the SG&A expenses` increases as we now believe in a better utilization for the 50k+ employees.
The cost TE will have to incur for launching its services through other MNOs was not announced yet, but we abide by the unified license guidelines assuming it as the recent adopted case, with EGP 2.5bn accounted for in our model to take place by early 2017, until further clarification takes place. As we believe there will be a new round of high noise and struggles until an agreement is reached directly between TE and the MNOs that if failed NTRA will be intervening for setting the pricing or leading the negotiations.
We believe after the recent overdraft raised, the mobile operations launch and 2016`s interest income balance, expected dividends and reserves additions to retained earnings added to VFE stake sale proceeds will lead to enough cash to absorb the upcoming massive investments (CAPEX) needed, so we did not assume TE`s CEO recent indication of raising an EGP 5bn of debt from a syndicated loan in our base case scenario. And added the EGP 5bn of new debt anticipated by 2017 beginning as another scenario yielding EGP 11.59/share in case it materialized as the average debt weight rises to 18.28% during 2017-to-2020.
The recent developments were welcomed by the market as we saw the stock positively reacting to the news, as most market participants were in skepticism about TE`s path to take after the unified license and the 4G long talks and extended delays.
However, we believe TE is now in the middle of a new fight where it is not dominant any more. As apparently Vodafone, Orange and Etisalat Egypt are demanding to set a mandatory minimum fees/payment to welcome TE`s services on board. In order to be able to use their 2G & 3G networks until an independent 4G infrastructure is built. The operators stated before that the high connectivity fees imposed by TE on Orange and VFE led them to suffer from high costs for the inbound and outbound capacities` transmission in addition to the ADSL high connectivity fees the 3 operators suffered from over the past period which led TE to easily maintain the market dominant position, while limiting all others` competitive ability in pricing their services.
… however, offering Orange and Vodafone Egypt their international gateway licenses at favorable conditions, facilitated payments and more frequencies might be the keys for smoothing negotiations. Currently Vodafone and Orange are offered to pay EGP 3.6bn for receiving their international gateway licenses, but set by 2018, which we see as a new hurdle against reaching an agreement, as TE will gain more powers over them. We account for the liberalization to take place by 2017 in correspondence with TE mobile operations launch and VFE stake sale. VFE, Orange and Etisalat Egypt are also offered to pay EGP 12bn for the 4G licenses, divided as EGP 3.54bn for each of VFE and Orange, and EGP 5bn for Etisalat Egypt. However, the licenses are conditioned by a clause demanding 50% of the licenses value to be settled in foreign currencies, with September 22nd set as the deadline for signing or rejecting the 4G license contracts.