Research By Elixir Securities Pakistan Private Limited

Pakistan Telecom Company (PTC) with a HOLD stance. Our neutral stance on the stock emanates from constrained earnings growth for the company on account of

1) maturing traditional telephony revenue stream,
2) growth attrition of data segment (EvDO); by cellular broadband characterized by a highly competitive landscape,
3) constrained ARPU accretion as data led growth in the segment is insufficient to compensate for cannibalization of EvDO and
4) reduction of LDI rate which is unlikely to be compensated by increase in LDI traffic due to proliferation smart phones compatible with VoIP services like Skype, Whatsapp and Viber.

We opine that meaningful bottom-line enhancement on sustainable basis wouldn’t be possible in the current competitive landscape in the absence of restructuring of industry through mergers acquisition and withdrawals. After an initial surge in earnings due to uptick in ARPUs and decrease in finance cost, bottom line growth is likely to remain constrained, while EBITDA generation should remain high on account of hefty depreciation and amortization charge. However, elevated capex requirement would continue to weigh in on FCFE. Among the key upside risk, we flag progress on real estate issue between the sponsor and GoP or M&A deal in the telecom space as potential triggers for price performance.

Inflection point in the industry with data set to dominate revenue mix…

Despite the maturing traditional revenue streams i.e. voice and texts, which we believe are related more to the paradigm shift towards VoIP, the growth opportunity remains potent with broadband penetration at a mere 87% in the country. With the proliferation of smart phones (from 13% in Jan13, market share increased to 31% in Jan15), the telecom regulatory authority estimates the subscriber base to grow at a 5yr CAGR of 26% and data to be an increasing part of the sales mix of telecom revenues.

…however shift towards competitive cellular platform to limit gains

However cellular ARPU (Average Revenue Per User) enhancement through broadband, which was expected to allay the competitive pressure, has failed to play out in the cellular market with ARPUs failing to register growth despite addition of 13mn 3G/4G subscribers (i.e. 11% of cellular subscribers at par with India after 4 years of 3G rollout).

Cannibalization of EvDO to be a dampener for unconsolidated earnings

Broadband (EvDO and DSL) accounts for ~2/3rd (i.e. in CY14) of standalone revenue of PTC and revenue grew 34% compensating for lack of growth in voice segment, with growth primarily emanating from wireless EvDO technology. This segment would be cannibalized by cellular broadband which has disappointed in terms of its contribution to blended ARPUs due to competitive landscape in the cellular market. This is in sharp contrast to non-cellular segment in which PTC had hegemony with 80% market share. We estimate that every 100k reduction in broadband users would chip off earnings by PKR0.19/sh.

Valuation Initiate with HOLD

We have valued PTC using DCF methodology, incorporating a cost of equity of 14% and terminal growth rate of 3%. Our Jun-16 PT of PKR21/sh offers an upside of 1% from last closing price along with a 12-month leading dividend yield of 7.2%; relative to 9-12% offered in the IPP space and 8.7% of 5 yr PIBs. At current levels, the stock is trading at a CY15 P/E of 13.2x relative to a 9.5x for the broader market, with our Jun16 PT offering an exit multiple of 11.3x. An EV/EBITDA of 2.5x seems undemanding as the depreciation and amortization charge of ~PKR6.2/sh is hefty, though normalized capex (~PKR5/sh) is likely to limit FCFE, as the company would continue to invest in cellular infrastructure to maintain its market share.

Also at current price, the stock is trading at P/B of ~1.02x; however an average ROE of ~9% along with 6% p.a. earnings growth in our view does not justify a premium. Our assumptions vis-à-vis growth in cellular segment remains fairly optimistic with ARPU growth of 8% over the next 3 years driven by increase in broadband penetration to 18% (Mobile + Fixed Line) in 3 years from ~9% at current levels, which would primarily be driven by cellular broadband. However we highlight that any transactions in telecom space can result in rerating of PTC as well on account of its fully owned subsidiary (PTML/Ufone).

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