Heavy regulatory and competitive pressure on CEE telecom sector, Turkey faring considerably better

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1 Erste Group Research Erste Sector Telecom TELECOMMUNICATIONS Erste Sector Telecom Heavy regulatory and competitive pressure on CEE telecom sector, Turkey faring considerably better Vera Sutedja, CFA, MBA +43 (0) Contents Executive summary 2 Recommendation 3 Valuation 5 Shrinking telecom market 8 EU single telecoms market 10 Phasing out roaming premiums 14 Competitive landscape 16 Individual company reports Individual company reports Magyar Telekom 21 Netia 27 T-Hrvatski Telekom 33 Telefónica Czech Republic 37 Telekom Austria 41 Telekom Slovenije 48 TPSA 52 Turk Telekom 57 Turkcell 62 Contacts 68 Disclosures 69 We expect CEE telecom sector to remain under regulatory and competitive pressure in 2013e and 2014e. Regulatory pressure includes a reduction in mobile termination rates and roaming tariffs. Furthermore, the spectrum auction in the Czech Republic, Hungary and Austria allows possible new mobile entrants. Special telecom taxes continue to be implemented in Hungary. Competitive pressure leads to further falling average mobile tariffs, despite a growing subscriber base. In addition, it leads to higher mobile subscriber retention and acquisition costs for some operators. We see the proposal from the EU Commission on an EU single telecoms market as a mix of good and bad news for our coverage universe. Positives include single EU authorization and coordinated spectrum assignment. Negatives include removal of roaming premiums and fixed inter-eu call premiums, new customer rights to cancel contracts after six months and reluctance to promote market consolidation. The Turkish telecoms fare much better than their CEE peers. This is because of their growth profile and supportive regulation. Recommendation. Our top pick is Turkcell, followed by Turk Telekom. We do not have any top pick among our covered CEE companies. We assign TLSG an Accumulate recommendation, but its liquidity is far below that of its CEE peers. We have a neutral recommendation on TPSA, Netia and T-HT. We give MTel, TCR and TKA Reduce calls. Erste Group Research Sector Report Page 1

2 Executive summary Strong regulatory pressure Large CAPEX for spectrum EU single telecoms market a mix of good and bad news Competitive pressure remains high We expect the CEE telecom sector to remain under regulatory and competitive pressure in 2013e and 2014e. The regulatory pressure includes a reduction in mobile termination rates and roaming tariffs. Furthermore, the spectrum auction in the Czech Republic, Hungary and Austria allows possible new mobile entrants. We only see PPF in the Czech Republic as a credible candidate for a new mobile entrant. We do not expect any new entrant in Hungary, following the state-owned and failed MPVI Mobile. We also do not expect any new entrant in Austria, considering the recent Orange acquisition by Drei and the intense competition. MTel is burdened by a higher telecom usage tax for corporates and will continue to see such telecom taxes indefinitely. Spectrum auction would lead to higher CAPEX for TPSA (our estimate: PLN 2bn), MTel (our estimate: HUF 31bn), TCR (our estimate: CZK 3bn) and TKA (our estimate: EUR 320mn). We expect MTel to drop its dividend from HUF 50 to HUF 10, due to the high spectrum CAPEX and higher telecom taxes. MTel recently announced an early extension to its existing spectrum, which would cost HUF 34bn in 4Q13e. The spectrum price in Hungary is the highest in our coverage universe. We see the proposal from the EU Commission on a EU single telecoms market as a mix of good and bad news for our covered companies. Positives: o Single EU authorization should ease expansion to other EU countries. o Coordinated spectrum assignment in terms of timing, duration and conditions would support mobile operators in network planning. Network and spectrum sharing is encouraged. Negatives: o Removing roaming premiums. The EU Commission gives mobile operators two choices: 1) Provide roam-like-at-home (RLAH) voluntarily or; 2) Provide roaming at the usual regulated prices. We do not expect many operators to choose RLAH, considering that domestic prices are far lower than the regulated roaming prices. o No more fixed inter-eu call premiums. As of July 2016, such calls should be charged at long-distance local calls, meaning calling Bucharest from Vienna should cost the same as calling Tyrol from Vienna. This would be negative for most operators, though the implementation time is still sometime away. o New customer rights: Most of our CEE companies offer tariffs with a 24-month binding period. The EU proposal would allow customers to terminate contracts after six months without penalties. This would lead to a higher churn rate. o Consolidation? The EU Commission sees no reason to change competition rules because they pose few problems for cross-border mergers. We therefore expect domestic market consolidation to remain difficult in terms of gaining EU approval. Competitive pressure leads to further falling average mobile tariffs, despite a growing subscriber base. We saw unlimited tariffs launched by TCR in 2Q13. TPSA launched no-frill NJU Mobile tariffs to attract low-end clients. Drei in Austria keeps its popular SIM-only tariff for EUR 7.5. Nevertheless, Drei also launched unlimited tariffs with a pricing level similar to other competitors, which might indicate price stabilization in Austria. Erste Group Research Sector Report Page 2

3 Competitive pressure also leads to higher mobile subscriber retention and acquisition costs. This is highly visible at TKA, as it wants to retain and acquire high-value subscribers. Higher handset subsidies squeezed its Austria segment s comparable EBITDA margin to below 30% for the first time. Turkish telecoms perform much better than CEE peers The Turkish telecoms fare much better than their CEE peers. This is because of their growth profile. Fixed broadband is still growing, albeit at a slower pace. There is a five-year regulatory holiday for FTTH network rollout. Pay TV penetration is still low in Turkey at ~35% of households (vs. Western Europe s ~55%), giving ample potential for IPTV and web-tv. Mobile broadband is growing rapidly and operators generate handsome revenues from it. TCELL Turkey generated almost 15% of its revenues from mobile broadband, which grew 41.7% in 2Q13. Avea (the mobile subsidiary of TTKOM) generated 17% of its service revenues from non-sms data, which grew 42% y/y. There is no roaming tariff regulation. CAPEX is high, but this is due to 3G coverage expansion, which should support mobile broadband growth. It is therefore unsurprising that our top picks are TCELL and TTKOM. Recommendation Top pick Turkcell, followed by Turk Telekom Our top pick is Turkcell, due to its combination of high growth and stable margins. Its large USD 1bn cash position provides a natural hedge against TRY devaluation. The dividend is highly uncertain, depending on the outcome of the shareholder dispute. We do not consider dividends part of TCELL s investment story. We assign TTKOM an Accumulate recommendation, due to its dividend and growth combination. We do not have any top pick among our CEE companies. MTel faces high CAPEX spending, which consists of HUF 34bn for extension of existing spectrums and possible HUF 31bn for new spectrums. We think that the large spending will lead to a dividend cut. TCR might face high CAPEX spending (auction to start in October 2013), a possible fourth mobile operator and a possibly higher corporate income tax rate, from 19% to 25-30%. We have a Reduce recommendation for TKA. The Austrian mobile market remains highly competitive, but prices seem to be stabilizing. Roaming premiums will eventually be eliminated after TKA generated EUR 285mn in revenues and EUR 225mn in EBITDA in 2012 from roaming premiums. If TKA makes a large acquisition on the scale of Serbia Broadband, it would need a capital increase for financing. We give TLSG an Accumulate call, due to the looming privatization. However, its liquidity is far below that of its CEE peers. We have a neutral recommendation on TPSA, Netia and T-HT. TPSA is bottoming out. We expect that the DPS of PLN 0.5 would be sustainable if Wirtualna Polska could be sold. Netia performed better than expected in terms of OPEX savings, leading to an FCF upgrade. The neutral call on T-HT reflects the balance between the strong regulatory pressure post EU accession for Croatia, the Optima bankruptcy risk, T-HT s strong balance sheet, the possible acquisition of TLSG as well as high margins. Erste Group Research Sector Report Page 3

4 Overview of target price and recommendations Companies Currency Current Price Target price Potential upside New Recommendation Previous recommendation Turkcell TRY % Buy Accumulate Turk Telekom TRY % Accumulate Accumulate Telekom Slovenije EUR % Accumulate Hold T-Hrvatski Telekom HRK % Hold Hold Netia PLN % Hold Reduce TP SA PLN % Hold Hold Telekom Austria EUR % Reduce Sell Magyar Telekom HUF % Reduce Reduce Telefónica CR CZK % Reduce Reduce Source: Erste Group estimates Erste Group Research Sector Report Page 4

5 Valuation Share price change in 12M Share price % 12M TPSA Magyar Telekom Telefónica CR Netia Telekom Austria Turk Telekom -1.1 T-Hrvatski Telekom -9.7 Turkcell 4.9 Telekom Slovenije 73.8 Source: Factset The share prices of our covered telecoms have been very weak in the past 12 months, as seen in the side table. This performance could be explained by: Dividend reduction: TPSA, TCR, TKA Special telecom tax: MTel Threat of new mobile entrant: TCR Lower outlook: TPSA, MTel Large FX losses: TTKOM Corporate governance issue: Turkcell (2x failed AGM, further dividend delay) Telekom Slovenije s share price rose sharply, due to progress in the privatization process, which could trigger a mandatory takeover bid. Dividend is a crucial investment story for the telecom sector. The past reduction in dividends was driven by the following factors: Falling revenues: Strong price competition, regulatory pressure, such as the MTR and roaming reductions, weak consumer and corporate spending leading to falling revenues for CEE telecoms. MTel is an exception, thanks to its low-to-negative-margin energy business. Turkish telecoms are also growing, due to much better market dynamics (growing subscribers, not heavily regulated). OPEX reduction could not compensate for lower revenues, leading to falling EBITDA. CAPEX is expected to rise, due to LTE spectrum purchases in Austria, the Czech Republic, Poland and Hungary. Pressure to maintain a certain credit rating level. Companies such as TKA and TPSA lowered their dividends in order to preserve their credit ratings. DPS cut expected in 2013e for MTel (large spectrum costs) and TTKOM (falling EPS, due to FX losses) Dividend development in local currency Dividend Incumbents e 2014e 2015e Magyar Telekom T-Hrvatski Telekom Telefónica CR Telekom Austria Telekom Slovenije TPSA Turkcell Turk Telekom Netia Source: Erste Group Research, companies data TCELL dividends for 2010 to 2012 are based on a 50% payout ratio. TCELL has not been able to pay dividends so far, due to a severe shareholder dispute. We assume that TCELL will pay a dividend in 2014, with the precondition that the shareholder dispute is resolved. Otherwise, TCELL should pay a dividend by Netia will start paying dividends in 2014, with the precondition that it will not book such large impairments in 4Q13e that lead to any FY13 net loss. Erste Group Research Sector Report Page 5

6 TCR, T-HT and Netia will have highest dividend yield for 2013e Strong CAPEX requirement for LTE spectrum in 2012/13 for MTel, TCR, TKA and TPSA Most CEE telecoms show revenue decline, due to competition, regulatory and macroeconomic pressure Dividend yield: historical* vs. Forecast Dividend yield Incumbents e 2014e 2015e Magyar Telekom 9.7% 9.6% 13.3% 3.2% 3.2% 3.2% T-Hrvatski Telekom 7.9% 9.1% 10.4% 9.1% 8.6% 7.7% Telefónica CR 10.5% 10.4% 9.3% 10.1% 10.1% 10.1% Telekom Austria 7.1% 4.1% 0.9% 0.9% 0.9% 0.9% Telekom Slovenije 4.0% 8.2% 5.4% 5.4% 6.1% 7.0% TPSA 9.2% 8.7% 4.1% 6.4% 6.4% 6.4% Turkcell 0.0% 0.0% 0.0% 13.9% 4.5% 4.7% Turk Telekom 9.9% 7.7% 10.0% 7.1% 8.8% 8.7% Netia 0.0% 0.0% 0.0% 8.7% 9.0% 9.3% Median CEE 7.9% 8.7% 5.4% 6.4% 6.4% 7.0% Median all 7.9% 8.2% 5.4% 7.1% 6.4% 7.0% Source: Erste Group Research. *) Based on end-of-period stock price. CAPEX development CAPEX/sales Incumbents e 2014e 2015e Magyar Telekom 15.3% 14.5% 17.4% 24.4% 13.5% 13.0% T-Hrvatski Telekom 15.9% 10.9% 15.8% 13.1% 13.0% 13.0% Telefónica CR 9.9% 11.3% 11.2% 18.4% 12.5% 12.6% Telekom Austria 16.3% 19.6% 16.8% 33.7% 17.0% 17.1% Telekom Slovenije 15.1% 9.7% 12.8% 16.8% 16.7% 15.4% TPSA 17.3% 17.5% 16.5% 30.6% 14.3% 12.6% Turkcell 15.7% 13.3% 12.9% 15.0% 14.1% 13.8% Turk Telekom 16.6% 19.5% 18.5% 16.5% 14.9% 14.2% Netia 13.3% 77.9% 13.2% 13.7% 12.0% 12.0% Median CEE 15.3% 14.5% 15.8% 18.4% 13.5% 13.0% Median all 15.7% 14.5% 15.8% 16.8% 14.1% 13.0% Source: Erste Group Research, companies data Revenue growth? Revenue growth Incumbents e 2014e 2015e Magyar Telekom -5.3% -2.0% 1.6% 3.0% 0.7% 1.2% T-Hrvatski Telekom -1.7% -3.7% -7.6% -7.9% -5.5% -4.5% Telefónica CR -7.0% -5.7% -3.5% -5.6% -3.2% -0.5% Telekom Austria -3.1% -4.2% -2.8% -3.4% -1.8% -0.5% Telekom Slovenije -1.0% -2.9% -3.7% -1.2% 0.1% 0.1% TPSA -5.1% -5.0% -5.2% -9.8% -4.2% -0.2% Turkcell 0.8% 4.1% 12.1% 8.2% 5.8% 5.8% Turk Telekom 2.7% 10.0% 6.4% 5.0% 5.5% 5.2% Netia 4.2% 3.2% 31.0% -10.4% -6.5% -4.2% Median CEE -3.1% -3.7% -3.5% -5.6% -3.2% -0.5% Median all -1.7% -2.9% -2.8% -3.4% -1.8% -0.2% Source: Erste Group Research. Companies with strong balance sheets can afford to maintain their dividend level, in contrast with their indebted peers. Among our covered companies, TCELL and T-HT have net cash, while TKA is the most indebted. Erste Group Research Sector Report Page 6

7 Balance sheet comparison Net debt/equity Net debt/ebitda Telecoms e 2014e 2015e e 2014e 2015e Magyar Telekom 54% 83% 87% 92% T-Hrvatski Telekom -32% -30% -31% -31% Telefónica O2 CR 0% 8% 8% 8% Telekom Austria 398% 211% 187% 165% Telekom Slovenije 47% 39% 32% 25% TPSA 44% 57% 53% 45% Turkcell -27% -33% -25% -29% Turk Telekom 98% 124% 107% 105% Netia 18% 15% 11% 7% Average 67% 53% 48% 43% Source: Erste Group Research TPSA has highest P/E, followed at distance by Netia; Turkish telecoms have high EV/EBITDA, due to large communication tax Peer group comparison CEE, Turkey Cur Price M Cap P/E EV/EBITDA EURmn 2013e 2014e 2015e 2013e 2014e 2015e Magyar Telekom HUF , T-Hrvatski Telekom HRK , Telefónica CR CZK , Telekom Austria EUR 5.5 2, Telekom Slovenije EUR TPSA PLN 7.8 2, Turkcell TRY , Turk Telekom TRY 7.0 9, Netia PLN Median Source: Erste Group Research Within our CEE coverage universe, we see T-HT and TLSG as having the most attractive valuations. TTKOM and TCELL have lower P/E ratios than their CEE peers. TCELL, TTKOM and T-HT have attractive valuations and above-average margins Margin comparison CEE, Turkey EBITDA margin Net margin 2013e 2014e 2015e 2013e 2014e 2015e Magyar Telekom 26.9% 25.7% 24.9% 3.7% 2.5% 2.4% T-Hrvatski Telekom 42.0% 41.1% 39.6% 19.3% 19.1% 18.1% Telefónica CR 37.1% 36.9% 36.1% 11.2% 10.7% 10.4% Telekom Austria 30.5% 29.9% 29.8% 3.2% 3.3% 3.3% Telekom Slovenije 31.6% 32.0% 32.6% 6.5% 7.2% 8.4% TPSA 30.5% 31.3% 31.0% 1.6% 1.7% 2.1% Turkcell 29.9% 30.3% 30.4% 18.8% 19.3% 19.2% Turk Telekom 38.2% 36.5% 35.2% 14.1% 16.8% 16.0% Netia 28.4% 28.5% 28.3% 2.4% 3.2% 3.6% Median 30.5% 31.3% 31.0% 6.5% 7.2% 8.4% Source: Erste Group Research T-HT, TTKOM and TCR have the highest EBITDA margins in our coverage universe. The net margin of TCELL is high, due to high interest income from the net cash position. Margins of MTel have fallen from around 33% to the lowest in the peer group. This is due to special telecom taxes as well as the higher contribution from low-margin energy and equipment sales. Erste Group Research Sector Report Page 7

8 Shrinking telecom market EU telecom revenues down 2.2% in 2011 and 1.1% in 2012 in real terms The EU telecom sector shrank in revenue terms by 1.1% in 2012, driven by falling fixed and mobile voice revenues. Telecom service revenues were estimated at EUR 234.5bn (source: EU Commission). Within our coverage universe, the revenue decline has been persistent until now. Both fixed and mobile revenues are declining. The fixed-line revenue decline can be attributed to fixed-to-mobile substitution and cheaper bundled products. The mobile revenue decline, despite the rising number of subscriber cases, can be explained by: Price war o Austria: H3G tariff of EUR 10 for 1000 min, 1000 SMS and 1GB data is the cheapest tariff in the country and among our coverage universe o Czech Republic: Telefónica CR introduced unlimited tariffs in 2Q13 that are more than 50% cheaper than its existing tariffs. Unlimited voice and SMS plus 1GB is offered at CZK 749 (EUR 29) o Poland: TPSA introduced no-frill NJU mobile in 2Q13, whose tariffs at PLN 57 (EUR 13.6) for unlimited voice and SMS plus 1 GB data are the cheapest in the country Special taxes o The budget deficit has led the Hungarian government to levy special taxes on mobile revenues. Initiated in 2010, the special taxes have changed names and the amount has increased. Moreover, they are valid indefinitely. The case was brought by the EU Commission to the EU Court of Justice, but a similar case in France was already ruled out. As a result, the EU Commission dropped its case. Special telecom taxes for Magyar Telekom HUFbn Robin Hood Usage tax Duct km tax Total onwards Source: MTel, Erste Group estimate o o Croatia: 6% mobile fee based on revenues implemented from 2010 to July 2012 Czech Republic: There is a plan by the Social Democrats to raise the corporate income tax for telecoms, banks and utilities from 19% to 25-30% if the party wins the election in late October 2013; the party is leading polls with around 28% of votes MTR reduction: There is no doubt that the EU recommendation to cut MTR to eurocents by the end of 2012 led to falling interconnection revenues. The MTR reduction also encourages lower retail prices and enables unlimited tariffs to flourish. Erste Group Research Sector Report Page 8

9 Mobile Termination Rate glide path EUR cent/minute 1H12 2H12 1H13 2H13 Austria Slovenia Bulgaria Croatia Hungary Poland Serbia Macedonia Czech Republic Turkey Turkcell Source: National telecom regulators Roaming reduction: This topic will be thoroughly discussed in a later chapter. Weak macroeconomic situation. Consumer and corporate spending continues to decline, leading to a higher churn rate, renegotiation of existing tariffs and optimization of usage. Private consumption growth y/y in % Private Consumption (grow 2009th y/y 2010 %) Croatia Czech Republic Hungary Poland Turkey Austria Source: Erste Group Research Corporate investments y/y in % Fixed Capital Formation (growth 2009 y/y %) Croatia Czech Republic Hungary Poland Turkey Austria Source: Erste Group Research Technology development: Applications such as Whats App are replacing the once-popular SMS. Voice-over IP applications such as Skype and Viber for smartphones are replacing traditional voice minutes. Erste Group Research Sector Report Page 9

10 EU single telecoms market Aware of the sector being in difficulty, the EU Commission adopts regulatory proposals for a Connected Continent, which is about faster connections, easier business, simpler life, single market, net neutrality, no roaming premiums and no red tape. Reducing red tape Single EU authorization There are more than 200 operators in the EU (28 Member States), of which more than 100 are mobile operators. None is active in all Member States. The EU Commission will introduce a single EU authorization that enables the operator to provide services in more than one Member State by using only one notification from the reference regulator. Coordinated spectrum assignment The stronger coordination of timing, duration and conditions of assignments of spectrum is encouraged. Member States would remain in charge. The EU Commission explicitly endorses spectrum trading and sharing, as well as promoting infrastructure sharing. An operator can even include the shared network in its coverage calculation to fulfill the criteria of spectrum purchase, which is positive for operators. Spectrum price EUR/population/MHz Mobile market in AT 800 MHz 2600 MHz Germany France Spain Italy Netherlands Portugal UK Croatia 0.26 Source: EU Commission, T-HT Spectrum auction allows new mobile entrants Within our coverage universe, Poland, Austria, Hungary and the Czech Republic have yet to conclude their LTE spectrum auctions this year. PL and HU have not started any public consultation process, while AT and CZ are on track to complete the auction by the end of Some spectrum is reserved for new entrants in AT and CZ. We see PPF as a credible candidate for a new entrant in CZ, as we have heard that it has started hiring employees and negotiating with equipment suppliers. We do not expect any new entrant in AT, considering its low price level and strong competition. We do not expect any new entrant in PL, as it already has four operators/mno and plenty of MVNOs. The fourth mobile operator in HU, MPVI Mobile, is dissolving, after the initial LTE spectrum auction was annulled. We therefore do not expect any new entrant in Hungary. Removing roaming premiums Incoming call charges while travelling in the EU would be banned from July 1, There are two options for a mobile operator: 1. Roam like home: The operator could voluntarily offer domestic rates throughout the EU. In order to do so, the operator should create bilateral or multilateral roaming agreements with roaming providers in other Member States. A reasonable use criterion will be applied, in order to avoid usage abuse or roaming arbitrage. For example, a Erste Group Research Sector Report Page 10

11 German could not buy cheaper Austrian domestic tariffs from A1 to be used in Germany. This would lead to almost complete roaming traffic for the user. Such abuse could be avoided by the reasonable use criterion. Nevertheless, it is unclear how the reasonable use criterion would be calculated. According to the EU Commission, the reasonable use criterion will be applied in such a way that consumers are able to confidently replicate their domestic consumption pattern while travelling in the EU. How many minutes/sms/gb would that be? 2. Apply the regulated roaming tariffs, but allow customers to decouple. The customer could choose a separate roaming provider when travelling in the EU, without having to buy a new SIM card. The EU Commission provides an estimate of annual loss in revenues at the EU level resulting from the implementation of roam like home with fixed roaming volumes. The annual revenue loss is seen by the EU Commission as a wealth transfer from the mobile sector to end-users. Annual revenue loss EURmn Remove incoming roaming call charges 300 Roaming calls at domestic price 580 Roaming data at domestic price 540 Roaming SMS at domestic price 230 Total loss in revenues 1,650 Source: EU Commission EU Commission estimated annual revenue loss at ~EUR 600mn from removing fixed international call premium within EU No more international call premiums within EU Fixed intra EU calls cannot be charged more than long-distance local calls as of July The extension of the roaming price cap to the fixed-line calls is new. The likely impact is difficult to quantify. Positives: Lower charges are likely to be followed by higher volumes, as demand for international call is more elastic, near -1. Intra EU international fixed calls represent only a tiny fraction of all fixed calls, estimated at around 1.1% (source: ARCEP, CMT). Corporate clients who are the majority user of fixed intra EU calling probably have package rates. Usage of VoIP such as Skype and Viber has already reduced the fixed intra EU call market. Negatives: The price difference between intra EU international fixed call and longdistance local call is significant. The following table shows how big such a price difference is for Telekom Austria. Telekom Austria s exposure to this segment was EUR 150mn in FY12, or below 3.6% of group revenues. Erste Group Research Sector Report Page 11

12 Telekom Austria fixed line tariffs Eurocents Peak Off Peak Fixed domestic calls Fixed international calls Zone 1* Zone 2* Zone 3* Mobile roaming calls Source: A1. *) Zone 1: DE, IT, FR, GB, SK, SI, CZ, HU, UK Zone 2: BE, BG, DK, ES, PT, FI, EE, IE, HR, LU, NL, PL, SE, EL, MT, LT, LV, CY Zone 3: RO Net neutrality Blocking and throttling of Internet content such as Whats App or Skype would be banned. Customers can cancel their contracts after 6M without penalties New harmonized consumer rights These include the right to have a 12-month contract, the right to walk away from a contract if commitments are not fulfilled, and the right to cancel contracts after six months without any penalties. As most current mobile contracts have a 24-month binding period, we expect such a regulation to lead to a more rapid churn rate. Harmonizing network access cost methodology The price of wholesale copper unbundled local loop ranges from EUR 4 to 14 per month. Such a cost should be harmonized and based on bottom-up long-run incremental costs plus (BU LRIC+): incremental capital (including sunk) plus operating costs borne by efficient operators plus mark-up for recovery of common costs. o Since no operator would today build any pure copper network, the BU LRIC+ calculates the current costs of deploying a modern efficient next generation network (NGA). o When modeling an NGA network, a national regulator should not assume the construction of an entirely new civil infrastructure NGA network. Wholesale access to NGA networks should not be regulated if some criteria are met, such as a competitive retail price resulting from infrastructurebased competition. We see that it is far from straightforward as to how access to an NGA network could be excluded from the regulated price. Still no pro-consolidation Consolidation? In this sensitive topic, the EU Commission refuses to back down from its current position. The EU Commission sees no reason to change competition rules, because those rules pose few problems for cross-border mergers. Consolidation, on its own, cannot be a policy objective. Creating a single telecoms market would allow operators to expand more easily to other EU markets and change the way in which consolidation is looked at under applicable EU competition rules. We therefore would expect domestic market consolidation to remain difficult to gain EU approval. The following table shows recent transaction in the telecom sector. Most transactions involved mobile and cable companies. Orange sold its Switzerland and Austrian operations. Telefónica sold its Germany and Irish operations. Erste Group Research Sector Report Page 12

13 Recent privatization and acquisition deals in telecom market Privatisation/ acquisition target Country Additional information Buyer Telekom Austria AMX acquires 20.97% stake of TA from Ronny Pecik. Price undisclosed. AMX Austria Orange Switzerland 100% stake for EUR 1.5bn or CHF 1.83bn. EV of CHF 2bn. EV/EBITDA 2011 of 6.4x APAX Telefonica Germany IPO for 23.2% of stake for around EUR 1.5bn, range , IPO 5.6, EV/EBITDA 2011 of 5.8 to 5.9x Megafon Russia IPO for 15.2% of stake for USD 1.7bn, range USD, IPO 20, EV/EBITDA 2013 of 4.2x Yesss! Austria EUR 390mn, EV/Sales 6.9x Telekom Austria Orange Austria EUR 1.3bn, EV/EBITDA 6.9x H3G Globul Bulgaria EUR 717mn, EV/EBITDA x, EV/EBITDA 2013e of 6x. Seller: OTE. Stake 100%. Telenor Kabel Germany EUR 7.7bn, EV/EBITDA x Vodafone Deutschland Telefonica Ireland EUR 780mn plus EUR 70mn deferred payment, EV/EBITDA 2013e 7.1x Hutchison Verizon Wireless Source: Erste Group Research USA USD 130.1bn for 45% stake, EV/EBITDA LTM of 9.4x Verizon Communications Erste Group Research Sector Report Page 13

14 Phasing out roaming premiums Option 1: Roam like home Operators offer roaming at the domestic rate. The roaming provider could provide such tariffs by using its own network or using a bilateral/multilateral roaming agreement. Target coverage o July 1, 2014: at least 10 Member States, representing 30% of EU population o July 1, 2015: at least 15 Member States, representing 50% of EU population o July 1, 2016: at least 17 Member States, representing 70% of EU population Benefits for operators: 1. If a provider could cover at least 17 Member States (70% of EU population) with its roam like home tariffs, it may add 50% roaming surcharges to the domestic rate. 2. The operator does not need to offer decoupling, i.e. allowing a customer to choose their own roaming provider when abroad. 3. The operator does not need to apply the regulated retail roaming charges. However, the regulated retail roaming should be treated as a ceiling. Analysis: It is difficult to imagine how an operator would voluntarily lower its roaming price to the domestic rate when it can continue to charge the higher regulated retail roaming price. We can imagine that the operator would charge lower prices due to competition. However, the roaming market is still far from competitive. All operators (existing mobile network operators in the visited country) are charging almost the same price, i.e. the regulated retail price. Furthermore, demand for voice roaming was proven in the past to be inelastic. Demand elasticity for data roaming could potentially be high, though. In our opinion, the benefit would only be valuable if there are enough numbers of alternative roaming providers to make the roaming market competitive. We have yet to see this development. At the moment, there is rarely any alternative roaming provider in the EU. Large operators such as DT, FT, Telefónica and Vodafone could implement such agreements more easily and quickly at their own subsidiaries. However, we are doubtful as to whether they would do so in a timely manner, rather than waiting until July Smaller operators would even find it challenging or time consuming to conclude such agreements. Again, there is no motivation to reduce their prices voluntarily in an uncompetitive market before July Erste Group Research Sector Report Page 14

15 Option 2: Existing regulated roaming prices Roaming glide path Roaming, EURc Before July 2012 July 2013 July 2014 Retail Data per MB none Voice calls made Voice calls received SMS Wholesale Data per MB Voice per minute SMS Source: EU Commission. Valid until June 30, 2017 In addition to applying the aforementioned rates, providers must as of July 2014 offer their customers the possibility to roam with competitors, such as a local company in the visited country or a rival company in the home country. At the moment, alternative roaming providers are still hard to find. According to the EU Commission, European mobile users paid 9.1 eurocents per voice minute in This domestic rate is considerably lower than the regulated roaming tariffs Average revenue per minute (EUR cents) in mobile calls, BG PL HU IT AT EU UK CZ SI FR NL Source: EU Commission Analysis: This is probably the better option for any mobile operators, large or small. Given the limited competition in roaming, the lower domestic rate vs. the roaming rate, as well as the certainty that the roaming premium will eventually be eliminated, operators would make use of this use as long as they can. Erste Group Research Sector Report Page 15

16 Competitive landscape The telecom sector market in the EU shrank 1.1% in real terms in The industry is dominated by mobile, as seen in the following table. Revenue split Segment 2011 Fixed 44.0% Mobile 46.0% Pay TV 6.0% Other 6.0% Source: EU Commission Mobile revenues continued to decline until 3Q12, despite a higher subscriber base and mobile Internet usage. The decline was driven by price competition and regulatory pressures such as MTR and roaming reduction. Mobile revenue growth e Telefonica CR -6.10% % Magyar Telekom -1.20% -0.20% TPSA -9.30% % T-Hrvatski Tel -6.20% % Turk Telekom 12.80% 18.60% Turkcell 8.40% 5.30% Source: Companies data, Erste Group Research Mobile penetration in the EU reached 130% in Oct. 2012, up from 127.3% in Oct (source: EU Commission). In Turkey, the low mobile penetration is caused by the considerable size of the young population. Excluding kids between 0 and 9 years old, the penetration rate amounted to 107.5% in 2Q13. Mobile penetration 2Q13 vs. 2Q12 160% 140% 120% 100% 80% 60% 40% 20% 0% Austria Bulgaria Poland Czech Republic Croatia Hungary Slovenia Turkey Source: Erste Group Research 2Q12 2Q13 Mobile broadband penetration in EU reached 54%, of which 45% from handheld devices Growing mobile penetration has been driven by mobile data connections. The mobile broadband penetration in the EU reached 54.5% per 100 inhabitants in Jan Some countries even have more than 100%, Erste Group Research Sector Report Page 16

17 implying one user has more than one mobile broadband device (smartphones, tablets, notebook). Mobile broadband penetration in selected EU Members and Turkey, Jan % 84.0% 107.1% 105.9% 97.6% 16.5% 23.0% 36.9% 41.1%43.6%44.9% 53.5%54.1%54.5% TR HU SI DE FR CZ AT ES EU PL UK DK SE FI Source: EU Commission. *) Turkey: as of June 2013 Mobile Internet revenues continue to grow rapidly, supported by higher smartphone penetration and growing 3G coverage. The 3G coverage in the EU stood at 96.3% of the population as of Dec The LTE coverage stood at 26.2% of the EU population in Turkcell Turkey generated 14.8% of its revenues from mobile broadband, which grew by 41.7% y/y. TCR posted 20.5% y/y growth of non-messaging data, mainly due to mobile Internet. Non-messaging data contributed 15.4% to TCR s domestic mobile revenues in 2Q13. Mobile broadband revenues of Turkcell (TRY mn) Q09 2Q10 2Q11 2Q12 2Q13 Source: TCELL Erste Group Research Sector Report Page 17

18 Smartphone penetration as % mobile user Countries Oct 2011 Oct 2012 Spain 48.4% 63.2% UK 48.1% 62.3% France 38.1% 51.4% Italy 42.1% 51.2% Germany 34.2% 48.4% Austria 40.0% 63.0% Covered operators 2Q12 2Q13 TPSA Poland 17.5% 23.6% Telefonica Czech Rep 23.0% 30.0% Avea Turkey 19.0% 30.0% Turkcell 15.0% 24.0% Magyar Telekom 31.3% 37.1% T-Hrvatski Telekom 21.0% 27.0% Source: comscore MobiLens, companies data, RTR Fixed broadband penetration continues to grow, albeit at a slower rate. The number of fixed broadband lines grew by 3.9% y/y to 144.8mn as of Jan. 2013, according to the EU Commission. The penetration rate reached 28.8% as of Jan. 2013, up from 27.7% a year before. All of the countries in our coverage universe showed fixed broadband penetration below the EU average. xdsl remains the dominant method with 74%, followed by cable modem with 17%, as of Jan Fixed broadband penetration in selected EU Members and Turkey, Jan % 19.0% 22.5% 22.9% 24.7% 24.8% 25.3% 39.8% 36.7% 33.6%34.2% 30.6% 28.8% 10.6% TR PL BG IT HU AT ES CZ EU FI UK DE FR DK Source: EU Commission. *) Turkey: as of June 2013 Revenues from fixed broadband products have either stopped growing or are growing only slowly in our CEE coverage universe. Competition with cable operators and mobile Internet, as well as lower average prices due to bundled products, contributed to such a development. The Turkish peers posted higher growth, thanks to the lower penetration rate. Erste Group Research Sector Report Page 18

19 Fixed broadband revenue growth y/y in 2Q13 for our coverage universe 37.3% 1.8% 6.6% 9.3% Netia TCR MTel T-HT TPSA TTKOM TCELL -6.5% -3.9% -2.0% Source: Companies data Fixed lines (excluding broadband) continue to decline, as proven in the following diagram. MTel reduced the rate of the access decline considerably, from around 10% in early 2011 to just 3% in 2Q13. This was due to the launch of the Hoppa tariff, a flat tariff with unlimited minutes to on-net mobile and fixed at a 30% lower ARPU. We think that the rapid churn at Netia, TPSA and TKA could be attributed to the strong mobile price competition in Poland and Austria, which encouraged fixed to mobile substitution. Fixed access y/y decline in our covered telecoms, 2Q13 Netia TPSA TKA TLSG TCR TTKOM MTEL T-HT -3.1% -3.0% -6.7% -6.6% -5.4% -8.6% -8.0% -7.9% Pay TV is crucial in driving fixed broadband growth and maintaining competitiveness against cable operators. It is normally sold together with fixed broadband access, as a bundle. Some operators such as MTel and T-HT are highly successful in the pay TV market. T-HT is the market leader with a 59.3% market share in 2Q13, while MTel is the second largest provider with 25.7% in 2Q13. Turk Telekom is catching up fast with its web TV and IPTV offers. Erste Group Research Sector Report Page 19

20 Fixed broadband and pay TV access development Fixed broadband access (000) TV (000) TV as % of fixed BB 2Q12 2Q13 % y/y 2Q12 2Q13 % y/y 2Q12 2Q13 Magyar Telekom % % 93.6% 94.4% T-Hrvatski Telekom % % 53.1% 56.3% Turk Telekom % % 1.4% 18.3% TPSA % % 15.2% 16.7% Telefonica CR % % 15.6% 15.4% Netia % % 1.0% 1.1% Telekom Austria % Source: Companies data Erste Group Research Sector Report Page 20

21 TEST Erste Gr oup R esearch C ompany R eport Magyar T elekom Integrated Tel ecoms Hungar y 24 September 2013 All prices are those current at the end of the previ ous tr adi ng session unl ess other wise indicated and ar e sourced fr om local exchanges vi a Reuters, Bl oomberg and other vendors. Erste Group Research Erste Sector Telecom Magyar Telekom Integrated Telecoms Hungary Magyar Telekom Reduce HUF mn e 2014e 2015e Net sales 607, , , ,818.3 EBITDA 194, , , ,034.6 EBIT 87, , , ,080.3 Net result after min. 36, , , ,050.3 EPS (HUF) CEPS (HUF) BVPS (HUF) Div./share (HUF) EV/EBITDA (x) P/E (x) P/CE (x) Dividend Yield 13.3% 3.2% 3.2% 3.2% weeks Magyar Telekom BUX Performance 12M 6M 3M 1M in HUF -27.1% -23.3% -1.9% 2.6% Share price (HUF) close as of 23/09/ Reuters MTEL.BU Free float 40.7% Number of shares (mn) 1,040.3 Bloomberg MTEL HB Shareholders Deutsche Tel. (59.2%) Market capitalization (HUF mn / EUR mn) 324,580 / 1,086 Div. Ex-date 07/05/13 Treasury (0.14%) Enterprise value (HUF mn / EUR mn) 759,678 / 2,541 Target price Homepage: Dividend drop anticipated Analyst: Vera Sutedja, MBA, CFA +43 (0) We confirm our Reduce recommendation and lower our target price from HUF 330 to HUF 285. The lower target price is driven by higher estimates for spectrum CAPEX. MTel announced that it would pay HUF 34bn for early extension of its existing spectrums. In addition, there will be an auction for new spectrums by the end of 2013, which we estimate to cost MTel HUF 31bn. As a result, we expect net debt to increase considerably and to lead to a significant dividend cut. We run several scenarios for DPS level. According to our calculation, DPS of HUF 10 would lead to net gearing of around 40% on a sustainable level. Parent company Deutsche Telekom provides more than 80% of MTel s financing and receives each year 59.21% of the dividends from MTel. We are doubtful that DT would approve a significant increase in leverage at MTel and leave the dividends unchanged. MTel is heavily burdened by large special communication taxes (~5% of sales) and the high price for spectrum renewal and purchases (in total HUF 75.9bn, or 12.1% of sales), negatively affecting EBITDA down to net profit. The company s EBITDA to net margin is now the lowest in our peer group. Erste Group Research Sector Report Page 21

22 Magyar Telekom Integrated Telecoms Hungary Large CAPEX for spectrum. MTel will spend HUF 34bn on early extension of its existing spectrums in the 900 MHz and 1800 MHz bands. In addition, there will be an auction for new spectrums as follows: Frequencies that had belonged to failed mobile entrant MPVI Mobile before: o 5 MHz on 900 MHz band o 15 MHz on 1800 MHz band o 15 MHz on 2100 MHz band The telecom regulator has said that the auction would enable a new mobile entrant. Therefore, we assume that the aforementioned 900 MHz band would be reserved for a new entrant. New frequencies for all mobile operators: o 30 MHz of 800 MHz band o 70 MHz of 2600 MHz band We assume that MTel would bid for roughly a third of these available frequencies. The total CAPEX estimate for spectrum would be HUF 65bn, as seen in the following table. CAPEX estimate for spectrums New spectrums Size (MHz) Price HUFbn Price/pop/MHz in EUR Auction time 800 MHz Q13e 2600 MHz Q13e Renewal of existing spectrums* 900 MHz Q MHz Q13 Total 65.0 Source: Erste Group estimates. *) Individual spectrum price is estimated Debt goes up, dividend goes...? We estimate that MTel would have to increase its debt by 27% y/y to HUF 454.7bn, as seen in the following table. If we assume that the dividend of HUF 50 would be maintained, net gearing would exceed 50% next year and even 70% in five years. MTel receives more than 80% of its debt from parent company Deutsche Telekom. We are doubtful that DT would allow leverage to go up considerably while dividends remain unchanged. After all, DT only receives 59.21% of the annual dividend. We can therefore conclude that MTel can no longer afford its HUF 50 dividend. Debt estimates with DPS of HUF e 2014e 2015e 2016e 2017e Debt % y/y -7% 27.0% 10.3% 9.9% 8.8% 8.0% Net debt EBITDA Debt/EBITDA Net debt/ebitda Net gearing 34.3% 44.6% 51.1% 58.4% 66.1% 74.2% Source: Erste Group Research *) Debt excludes pension obligations Erste Group Research Sector Report Page 22

23 Magyar Telekom Integrated Telecoms Hungary Even our current DPS of HUF 30 looks unaffordable, as seen in the following table. Net gearing would exceed 40% next year and 50% the year after. Debt estimates with DPS of HUF e 2014e 2015e 2016e 2017e Debt % y/y -5% 27.0% 5.3% 5.3% 4.5% 3.9% Net debt EBITDA Debt/EBITDA Net debt/ebitda Net gearing 34.3% 44.6% 48.5% 52.8% 57.2% 61.5% Source: Erste Group Research *) Debt excludes pension obligations According to our estimates, if the dividends are reduced to HUF 10, then net gearing could be within the 40% range. In fact, dividends could be eliminated and net gearing would still be between 40% and 50%. Debt estimates with DPS of HUF e 2014e 2015e 2016e 2017e Debt % y/y -7% 27.0% -2.2% -2.5% -3.7% -5.1% Net debt EBITDA Debt/EBITDA Net debt/ebitda Net gearing 34.3% 44.6% 44.5% 44.4% 43.7% 42.4% Source: Erste Group Research *) Debt excludes pension obligations We therefore reduce our DPS 2013e and onward estimate from HUF 30 to HUF 10. Update on taxes. The Hungarian government levied a large amount of special taxes on the telecom industry. This was contested by the EU Commission, but a precedent case in France was already decided favorably. Therefore, the EU Commission has withdrawn its case from the EU Court of Justice. We summarize the amount of special taxes below. Special telecom taxes for Magyar Telekom HUFbn Robin Hood Usage tax Duct km tax Total onw ards Source: Company data and estimate Erste Group Research Sector Report Page 23

24 Magyar Telekom Integrated Telecoms Hungary Change in estimates. We lower our EPS 2013 and 2014 estimates by 25% and 40%, respectively, mainly due to our higher financial expenses estimate. We increase our CAPEX estimate from HUF 87.8bn to HUF 152.8bn, due to actual spectrum renewal (HUF 34bn) and expected new spectrum (HUF 31bn). This leads to a considerably higher net debt and, consequently, higher financial expenses. We also lower our DPS 2013 and onward estimate from HUF 30 to HUF 10, as discussed earlier. Change in estimates HUF mn 2013e 2014e New Old +/-% New Old +/-% Revenues 625, ,131 3% 629, ,861 3% EBITDA 168, ,827-2% 161, ,784-3% EBIT 60,928 68,303-11% 55,969 63,809-12% Net income 18,554 24,787-25% 12,676 21,242-40% EPS % % DPS % % Source: Erste Group estimates Valuation and recommendation. We confirm our Reduce recommendation and lower our target price from HUF 330 to HUF 285. The lower target price is largely driven by much higher net debt, resulting in higher than expected spectrum costs. We expect dividends to fall from HUF 50 in 2012 to HUF 10 in 2013e and onward. This would lead to a yield of 3-4%, well below the government bond yield of around 6% and peer group average of 6-7%. CEE and Turkey dividend yield CEE, Turkey Dividend Yield 2013e 2014e 2015e Magyar Telekom 3.2% 3.2% 3.2% T-Hrvatski Telekom 9.1% 8.6% 7.7% Telefónica CR 10.1% 10.1% 10.1% Telekom Austria 0.9% 0.9% 0.9% Telekom Slovenije 5.4% 6.1% 7.0% TPSA 6.4% 6.4% 6.4% Turkcell 13.9% 4.5% 4.7% Turk Telekom 7.1% 8.8% 8.7% Netia 8.7% 9.0% 9.3% Median 7.1% 6.4% 7.0% Source: Erste Group Research Erste Group Research Sector Report Page 24

25 WACC WACC Erste Group Research Erste Sector Telecom Magyar Telekom Integrated Telecoms Hungary WACC calculation 2014e 2015e 2016e 2017e 2018e Terminal Risk free rate 5.8% 5.8% 5.8% 5.8% 5.8% 6.5% Equity risk premium 7.6% 7.6% 7.6% 7.6% 7.6% 7.0% Beta Cost of equity 13.4% 13.4% 13.4% 13.4% 13.4% 13.5% Cost of debt 8.3% 8.3% 8.3% 8.3% 8.3% 9.0% Effective tax rate 23.0% 23.0% 23.0% 23.0% 23.0% 23.0% After-tax cost of debt 6.4% 6.4% 6.4% 6.4% 6.4% 6.9% Equity weight 50% 50% 50% 50% 50% 50% WACC 9.9% 9.9% 9.9% 9.9% 9.9% 10.2% DCF valuation (HUF mn) 2014e 2015e 2016e 2017e 2018e Terminal Sales growth 0.7% 1.2% 2.5% 2.4% 2.4% 2.0% EBIT 55,969 55,080 58,508 63,525 67,208 75,298 EBIT margin 8.9% 8.6% 8.9% 9.5% 9.8% 10.8% Tax rate 23.0% 23.0% 23.0% 23.0% 23.0% 23.0% Taxes on EBIT -12,873-12,668-13,457-14,611-15,458-17,319 NOPLAT 43,096 42,412 45,051 48,914 51,750 57,979 + Depreciation 105, , , , ,237 80,000 Capital expenditures / Depreciation 80.6% 79.5% 77.9% 78.0% 78.2% 100.0% +/- Change in working capital Chg. working capital / chg. Sales 1.6% 1.6% 1.6% 1.6% 1.6% 0.0% - Capital expenditures -85,166-82,611-80,133-80,000-80,000-80,000 Free cash flow to the firm 63,706 63,880 68,035 71,674 74,239 57,979 Terminal value growth 1.0% Terminal value 635,476 Discounted free cash flow - Dec ,983 52,918 51,297 49,186 46, ,912 Enterprise value - Dec ,664 Minorities 0 Non-operating assets 0 Net debt 385,142 Other adjustments 0 Equity value - Dec ,521 Number of shares outstanding (mn) 1,040 Cost of equity 13.4% 12M target price per share (HUF) 285 Current share price (HUF) 312 Up/Downside -8.8% Enterprise value breakdown PV of terminal value 61% PV of detailed period 39% Sensitivity (per share) Terminal value EBIT margin % 9.8% 10.8% 11.8% 12.8% 9.2% % % % % Terminal value growth % 0.5% 1.0% 1.5% 2.0% 9.2% % % % Source: Factset, Erste Group Research 11.2% Erste Group Research Sector Report Page 25

26 Magyar Telekom Integrated Telecoms Hungary Income Statement e 2014e 2015e (IAS, HUF mn, 31/12) 31/12/ /12/ /12/ /12/ /12/ /12/2015 Net sales 609, , , , , , Invent. changes + capitalized costs Total revenues 609, , , , , , Other operating revenues Material costs -63, , , , , , Personnel costs -93, , , , , , Other operating expenses -239, , , , , , EBITDA 212, , , , , , Depreciation/amortization -100, , , , , , EBIT 112, , , , , , Financial result -28, , , , , , Extraordinary result EBT 83, , , , , , Income taxes -6, , , , , , Result from discontinued operations Minorities and cost of hybrid capital -12, , , , , , Net result after minorities 64, , , , , , Balance Sheet e 2014e 2015e (IAS, HUF mn, 31/12) Intangible assets 332, , , , , , Tangible assets 549, , , , , , Financial assets 26, , , , , , Total fixed assets 909, , , , , , Inventories 9, , , , , , Receivables and other current assets 117, , , , , , Other assets Cash and cash equivalents 72, , , , , , Total current assets 199, , , , , , TOTAL ASSETS 1,109, ,098, ,057, ,098, ,078, ,059, Shareholders'equity 531, , , , , , Minorities 63, , , , , , Hybrid capital and other reserves Pension and other LT personnel accruals 12, , , , , , LT provisions 7, , , , , , Interest-bearing LT debts 242, , , , , , Other LT liabilities 12, , , , , , Total long-term liabilities 255, , , , , , Interest-bearing ST debts 118, , , , , , Other ST liabilities 120, , , , , , Total short-term liabilities 239, , , , , , TOTAL LIAB., EQUITY 1,109, ,098, ,057, ,098, ,078, ,059, Cash Flow Statement e 2014e 2015e (IAS,HUF mn, 31/12) Cash flow from operating activities 164, , , , , , Cash flow from investing activities -52, , , , , , Cash flow from financing activities -161, , , , , , CHANGE IN CASH, CASH EQU. -49, , , , Margins & Ratios e 2014e 2015e Sales growth -5.3% -2.0% 1.6% 3.0% 0.7% 1.2% EBITDA margin 34.9% 32.8% 32.1% 26.9% 25.7% 24.9% EBIT margin 18.4% 10.6% 14.5% 9.7% 8.9% 8.6% Net profit margin 12.7% 0.5% 7.6% 3.7% 2.5% 2.4% ROE 12.0% -1.5% 7.8% 4.2% 3.1% 3.0% ROCE 11.0% 0.5% 8.7% 5.5% 5.0% 5.1% Equity ratio 53.6% 50.6% 49.4% 42.4% 41.1% 39.8% Net debt 301, , , , , ,606.2 Working capital -40, , , , , ,778.2 Capital employed 916, , , , , ,874.6 Inventory turnover Source: Company data, Erste Group estimates Erste Group Research Sector Report Page 26

27 TEST Erste Gr oup R esearch C ompany R eport Netia Integrated T elecoms Pol and 24 September 2013 All prices are those current at the end of the previ ous tr adi ng session unl ess other wise indicated and ar e sourced fr om local exchanges vi a Reuters, Bl oomberg and other vendors. Erste Group Research Erste Sector Telecom Netia Integrated Telecoms Poland Netia from Reduce to Hold PLN mn e 2014e 2015e Net sales 2, , , ,701.9 EBITDA EBIT Net result after min EPS (PLN) CEPS (PLN) BVPS (PLN) Div./share (PLN) EV/EBITDA (x) P/E (x) nm P/CE (x) Dividend Yield 0.0% 8.7% 9.0% 9.3% weeks Netia WIG 20 Performance 12M 6M 3M 1M in PLN -20.6% 10.4% 15.2% -6.1% Share price (PLN) close as of 23/09/ Reuters NTIA.WA Free float 53.0% Number of shares (mn) Bloomberg NET PW Shareholders Third Avenue M (15.0%) Market capitalization (PLN mn / EUR mn) 1,846 / 437 Div. Ex-date ING OFE (15.29%) Enterprise value (PLN mn / EUR mn) 1,994 / 472 Target price 5.00 Homepage: Better than expected OPEX control Analyst: Vera Sutedja, MBA, CFA +43 (0) We upgrade Netia from Reduce to Hold, while raising our target price from PLN 4.0 to PLN 5.0. The higher target price is driven by a higher profitability assumption. We had expected worse profitability due to declining RGUs and revenues. However, the rapid decline in off-net services, such as bitstream access and wholesale line rental, has led to a correspondingly rapid decline in direct costs, which we had underestimated. Netia recently upgraded its FY13 adjusted EBITDA and FCF, due to strong OPEX reductions from integration projects, lower off-net sales and a lower interconnection rate. Netia s upside potential should come mainly from acquisitions and OPEX reduction. Shareholder remuneration as support for share price. Netia will distribute PLN 145mn or PLN 0.42 per share next year. If Netia posts net profit after impairment tests in 4Q13e, it will distribute dividends. Otherwise, Netia will conduct a share buyback instead. Erste Group Research Sector Report Page 27

28 Netia Integrated Telecoms Poland Update on 2013 targets. Netia lowered its RGU and revenues targets for 2013, as we had expected. However, it unexpectedly upgraded its adjusted EBITDA, adjusted EBIT and FCF targets. The CAPEX target remained unchanged. Lower RGU target from 2.65mn to 2.525mn, mainly due to the weak residential segment. Rapidly falling voice and - especially - wholesale line rental should contribute to 80% of the decline, while slower than expected on-net and TV additions 20%. Lower revenue target from PLN 1.925bn to PLN 1.9bn, mainly due to weak RGU. Double MTR cuts this year are already included. Raise adjusted EBITDA target from PLN 525mn to PLN 550mn, as 1H13 adjusted EBITDA reached PLN 282mn. Lower interconnection costs post MTR reductions, a relatively faster decline in off-net services and synergies from Crowley and Dialog integration were the main drivers of cost reduction. Raise adjusted EBIT from PLN 65mn to PLN 100mn. Raise adjusted FCF from PLN 300mn to PLN 325mn (CAPEX unchanged). Update on Crowley and Dialog integration. Netia acquired Crowley Data Poland and Telefonia Dialog in December The integration process is well on track. The synergy target is PLN 130mn by the end of 2014, of which PLN 120mn from cost synergies and PLN 10mn from CAPEX synergies. Synergy realization delivered in 1H13 alone amounted to PLN 72.3mn on OPEX and PLN 11.9mn on CAPEX. The development can be seen as follows. Synergy effects and realization (PLNmn) Synergies e 2014e OPEX CAPEX Special costs e 2014e OPEX CAPEX Total synergies Source: Erste Group Research, company data Shareholder remuneration. Netia is committed to distributing PLN 145mn or PLN 0.42/share in 2014e to shareholders. Netia does impairment tests every 4Q. If there is still net profit after any impairment, Netia distributes dividends. If Netia turns into a net loss, then it will conduct a share buyback instead. Acquisition of UPC network. Netia bought cable networks in Warsaw and Krakow (excluding the customer base) from UPC Polska for PLN 5.8mn in May As a result, Netia s next generation access (NGA) will increase from 1.172mn to 1.715mn (12% of households). Netia is connecting the cable networks to its backbone network. A commercial launch in these new networks is expected in early This would support the provision of triple play service (IPTV, fixed broadband, fixed voice). CIT tax refund. The Supreme Administrative Court overruled the judgment of the Voivodship Administrative Court and remanded the case for reconsideration to the court of first instance. It will probably take the whole next year for the court of first instance to reach a decision. Netia claims PLN Erste Group Research Sector Report Page 28

29 Netia Integrated Telecoms Poland 51.9mn plus interest. Overall, there is a greater likelihood than not that Netia will receive its claim, but the timing is unknown. Possible claim damages against TPSA. The EU Commission imposed on TPSA a EUR 127.6mn (PLN 508mn) fine for abuse of its dominant position in the wholesale broadband access market before October TPSA is appealing against the decision to the General Court of the EU and a decision can be expected this year. If TPSA is proven guilty, Netia might sue TPSA and claim damages for abusing its dominant position. A claim of PLN mn might be considered. Change in estimates. We raise our 2013 earnings estimate, mainly due to better than expected OPEX savings. Netia lowered its OPEX 11.4% y/y in 1H13, thanks to strong cost control from integration projects and lower customer acquisition costs, due to lower off-net sales. We assume a dividend of PLN 0.42, rather than a share buyback. Change in estimates 2013e 2014e PLN mn New Old % New Old % Revenues 1, , % 1, , % EBITDA % % Adjusted EBITDA % % EBIT % % Net income % % EPS in PLN % % DPS in PLN % % Source: Erste Group Research Regulated access to decline by a 13% CAGR in e Revenue decline is driven by falling RGUs Revenue generating units of Netia Thousands e 2014e 2015e CAGR Fixed voice 1,745 1,644 1,460 1,292 1,143-11% own network % regulated access 1, % Fixed broadband % own network % regulated access % Mobile broadband % Mobile voice % TV % Total 2,789 2,688 2,500 2,342 2,215-6% % y/y organic -3.6% -7.0% -6.3% -5.4% % own network 40.3% 41.9% 46.0% 50.2% 54.4% Source: Netia, Erste Group estimates. Revenue breakdown by service e 2013e 2014e 2015e CAGR Voice % Data (internet) % Others* % Total 1,619 2,121 1,900 1,777 1,702-7% % y/y 3.2% 31.0% -10.4% -6.5% -4.2% Source: Netia, Erste Group estimates.*)interconnection, wholesale, TV, mobile Erste Group Research Sector Report Page 29

30 Netia Integrated Telecoms Poland Acquisitions? According to the media, Deutsche Telekom is close to completing due diligence on GTS Central Europe. Netia is only interested in the Polish operation of GTS. It depends on DT whether it will acquire GTS Central Europe and then sell the PL operation to Netia. Exatel and TK Telekom are also potential targets. Upgrade to Hold Attractive peer group comparison Valuation and recommendation. We upgrade Netia from Reduce to Hold, while increasing our target price from PLN 4.0 to PLN 5.0. The higher target price is driven mainly by a higher profitability assumption. We had assumed that the fall in RGUs and revenues would lead to a worse decline in EBITDA. The rapid decline in sales of off-net services, such as bitstream access and wholesale line rental, has led to a correspondingly rapid decline in direct costs, which we had underestimated. Netia s upside potential should come mainly from acquisitions and OPEX reduction. Netia is traded at discounts to peers in terms of EV/EBITDA. Its FCF and dividend yield is above the peers. The shareholder remuneration of PLN 0.42/share should provide decent support to the share price. Peer group comparison CEE, Turkey Cur Price P/E EV/EBITDA FCF yield Dividend Yield 2013e 2014e 2015e 2013e 2014e 2015e 2013e 2014e 2015e 2013e 2014e 2015e Magyar Telekom HUF % 10.2% 10.3% 3.2% 3.2% 3.2% T-Hrvatski Telekom HRK % 16.2% 14.6% 9.1% 8.6% 7.7% Telefónica CR CZK % 11.7% 11.3% 10.1% 10.1% 10.1% Telekom Austria EUR % 8.7% 8.9% 0.9% 0.9% 0.9% Telekom Slovenije EUR % 11.7% 14.0% 5.4% 6.1% 7.0% TPSA PLN % 12.4% 14.4% 6.4% 6.4% 6.4% Turkcell TRY % 8.6% 9.9% 13.9% 4.5% 4.7% Turk Telekom TRY % 9.6% 9.8% 7.1% 8.8% 8.7% Netia PLN % 15.5% 15.3% 8.7% 9.0% 9.3% Median % 11.7% 11.3% 7.1% 6.4% 7.0% Source: Erste Group Research Erste Group Research Sector Report Page 30

31 WACC WACC Erste Group Research Erste Sector Telecom Netia Integrated Telecoms Poland WACC calculation 2014e 2015e 2016e 2017e 2018e Terminal Risk free rate 4.4% 4.4% 4.4% 4.4% 4.4% 5.0% Equity risk premium 6.0% 6.0% 6.0% 6.0% 6.0% 5.7% Beta levered Cost of equity 10.4% 10.4% 10.4% 10.4% 10.4% 10.7% Cost of debt 6.4% 6.4% 6.4% 6.4% 6.4% 7.0% Effective tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% After-tax cost of debt 5.1% 5.1% 5.1% 5.1% 5.1% 5.6% Equity weight 70% 70% 70% 70% 70% 70% WACC 8.8% 8.8% 8.8% 8.8% 8.8% 9.2% DCF valuation (PLN thousands) 2014e 2015e 2016e 2017e 2018e Terminal Sales growth -6.5% -4.2% -3.6% -3.2% -2.8% -2.5% EBIT 99, ,415 96, , , ,297 EBIT margin 5.6% 5.9% 5.9% 6.7% 7.6% 7.6% Tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% Taxes on EBIT -19,898-20,083-19,351-21,267-23,446-22,859 NOPLAT 79,593 80,332 77,404 85,069 93,782 91,438 + Depreciation 406, , , , , ,000 Capital expenditures / Depreciation 52.4% 53.7% 54.7% 58.1% 61.7% 70.0% +/- Change in working capital -4,131-1,739-1,444-1,229-1,039 0 Chg. working capital / chg. Sales 3.3% 2.3% 2.3% 2.3% 2.3% 0.0% - Capital expenditures -213, , , , , ,000 Free cash flow to the firm 269, , , , , ,438 Terminal value growth 0.0% Terminal value 1,520,587 Discounted free cash flow - Dec , , , , , ,661 Enterprise value - Dec ,938,504 Minorities 0 Non-operating assets 0 Net debt including pension obligations 331,271 Equity value - Dec ,607,233 Number of shares outstanding (mn) 347,911 Cost of equity 10.4% 12M target price per share (PLN) 5.0 Current share price (PLN) 4.8 Up/Downside 4.1% Enterprise value breakdown PV of terminal value 51% PV of detailed period 49% Sensitivity (per share) Terminal value EBIT margin 5 5.6% 6.6% 7.6% 8.6% 9.6% 8.2% % % % % Terminal value growth 5-1.0% -0.5% 0.0% 0.5% 1.0% 8.2% % % % Source: Factset, Erste Group Research 10.2% Erste Group Research Sector Report Page 31

32 Netia Integrated Telecoms Poland Income Statement e 2014e 2015e (IAS, PLN mn, 31/12) 31/12/ /12/ /12/ /12/ /12/ /12/2015 Net sales 1, , , , , , Cost of goods sold -1, , , , , , Gross profit SG&A Other operating revenues Other operating expenses EBITDA Depreciation/amortization EBIT Financial result Extraordinary result EBT Income taxes Result from discontinued operations Minorities and cost of hybrid capital Net result after minorities Balance Sheet e 2014e 2015e (IAS, PLN mn, 31/12) Intangible assets Tangible assets 1, , , , , , Financial assets Total fixed assets 1, , , , , , Inventories Receivables and other current assets Other assets Cash and cash equivalents Total current assets TOTAL ASSETS 2, , , , , , Shareholders'equity 2, , , , , , Minorities Hybrid capital and other reserves Pension and other LT personnel accruals LT provisions Interest-bearing LT debts Other LT liabilities Total long-term liabilities Interest-bearing ST debts Other ST liabilities Total short-term liabilities TOTAL LIAB., EQUITY 2, , , , , , Cash Flow Statement e 2014e 2015e (IAS,PLN mn, 31/12) Cash flow from operating activities Cash flow from investing activities , Cash flow from financing activities CHANGE IN CASH, CASH EQU Margins & Ratios e 2014e 2015e Sales growth 4.2% 3.2% 31.0% -10.4% -6.5% -4.2% EBITDA margin 37.4% 37.8% 21.8% 28.4% 28.5% 28.3% EBIT margin 18.2% 18.7% -1.0% 5.3% 5.6% 5.9% Net profit margin 16.8% 15.4% -4.1% 2.4% 3.2% 3.6% ROE 12.2% 10.4% -3.7% 2.0% 2.7% 3.0% ROCE 13.1% 9.2% -1.0% 2.5% 3.2% 3.5% Equity ratio 89.4% 70.4% 71.0% 72.7% 74.5% 74.0% Net debt Working capital Capital employed 2, , , , , ,202.8 Inventory turnover Source: Company data, Erste Group estimates Erste Group Research Sector Report Page 32

33 TEST Erste Gr oup R esearch C ompany R eport T-Hrvatski T elekom Integrated T elecoms Croati a 24 September 2013 All prices are those current at the end of the previ ous tr adi ng session unl ess other wise indicated and ar e sourced fr om local exchanges vi a Reuters, Bl oomberg and other vendors. Erste Group Research Erste Sector Telecom T-Hrvatski Telekom Integrated Telecoms Croatia T-Hrvatski Telekom Hold HRK mn e 2014e 2015e Net sales 7, , , ,202.1 EBITDA 3, , , ,456.4 EBIT 2, , , ,322.3 Net result after min. 1, , , ,121.8 EPS (HRK) CEPS (HRK) BVPS (HRK) Div./share (HRK) EV/EBITDA (x) P/E (x) P/CE (x) Dividend Yield 10.4% 9.1% 8.6% 7.7% weeks T-Hrvatski Telekom CROBEX Performance 12M 6M 3M 1M in HRK -9.7% -18.1% -0.6% -0.4% Share price (HRK) close as of 23/09/ Reuters HT.ZA Free float 38.5% Number of shares (mn) 81.9 Bloomberg HTRA CZ ShareholdersDeutsche Telekom (51.0%) Market capitalization (HRK mn / EUR mn) 14,494 / 1,903 Div. Ex-date 13/06/13 Enterprise value (HRK mn / EUR mn) 11,303 / 1,484 Target price Homepage: Regulatory pressure Analyst: Vera Sutedja, MBA, CFA +43 (0) We confirm our Hold recommendation and lower our target price from HRK 220 to HRK 190. The lower target price is driven by higher risk free rate and lower profitability estimates resulting from regulatory pressure. The neutral rating reflects the balance between strong regulatory pressure, Optima bankruptcy risk, and T-HT s strong balance sheet, possible acquisition as well as high margins. We expect regulatory pressure to increase, as Croatia is now part of the European Union. There is a steep mobile termination rate (MTR) glide path. Current MTR at 19.3 lipas should come down to 6.3 lipas as of T-HT is also now bound by the EU roaming regulation to reduce roaming premiums accordingly and eventually eliminate them. Ample cash. T-HT had HRK 5.15bn (~EUR 677.6mn) cash and financial assets as of 2Q13, and no debt at all. LTE spectrum was already bought at very reasonable price. CAPEX to sales ratio should remain at around 16-17% of sales. Dividend policy is 100% payout ratio. T-HT has the highest FCF yield in our coverage at around 14-17%. T-HT management said that they would prefer investment opportunities, rather than an extraordinary dividend. Acquisitions? T-HT is interested in the privatisation of Telekom Slovenije (TLSG) with a market capitalisation of ~EUR 930mn. The Slovenian government is expected to announce the privatisation time table by the end of Sept Locating in a neighbouring country, TLSG would provide synergy to T-HT s existing business. Erste Group Research Sector Report Page 33

34 T-Hrvatski Telekom Integrated Telecoms Croatia The share price of TLSG has come down so much from above EUR 300 during the first privatisation attempt in 2008 to currently around EUR 110. Legal risk is, however, high as TLSG has more than EUR 400mn litigation claims, mostly from its mobile competitors. We cannot assess whether an acquisition of TLSG would be positive for T-HT without knowing the bid price. Change in estimates. We lower our 2013 earnings estimate, due to lower than expected mobile revenues and net financial income in 1H13. Furthermore, we also raise our OPEX estimates, as savings in 1H13 were lower than anticipated. The transformation program which should improve efficiency and competitiveness has yet to demonstrate its effects. Change in estimates Consolidated, IFRS 2013e 2014e (HRK, mn) Now Old Change Now Old Change Revenues 6,867 6, % 6,491 6, % EBITDA 2,886 2, % 2,671 2, % EBIT 1,625 1, % 1,492 1, % Net income 1,325 1, % 1,241 1, % EPS (HRK) % % Dividend (HRK) % % Source: Erste Group Research Optima Telekom 1H13: Sales: HRK 277mn (-4.5%) EBITDA: HRK 41mn (-8.8%) Optima pre-bankruptcy settlement. Optima Telekom is the largest alternative operator in Croatia and is now preparing a pre-bankruptcy and debt restructuring process. Its largest creditors are Zagrebacka Banka (ZABA) with around HRK 600mn outstanding claims and T-HT with around HRK 120mn outstanding receivables. The market capitalisation of Optima is HRK 19.6mn. T-HT is conducting a pre-bankruptcy settlement process, which should lead to debt-to-equity swap giving T-HT a minority stake in Optima. ZABA would transfer its future management rights to T-HT. The whole deal is subject to the Competition Regulator (AZTN) approval. This might not be easy; as such takeover would further increase T-HT s dominance in the fixed line market. The new deadline is beginning of November If a solution is not reached by then, Optima will go into bankruptcy and T-HT would face potentially large receivables impairment. Erste Group Research Sector Report Page 34

35 WACC WACC Erste Group Research Erste Sector Telecom T-Hrvatski Telekom Integrated Telecoms Croatia WACC calculation 2014e 2015e 2016e 2017e 2018e Terminal Risk free rate 5.3% 5.3% 5.3% 5.3% 5.3% 5.0% Equity risk premium 7.2% 7.2% 7.2% 7.2% 7.2% 6.7% Beta Cost of equity 12.5% 12.5% 12.5% 12.5% 12.5% 11.7% Cost of debt 6.8% 6.8% 6.8% 6.8% 6.8% 6.5% Effective tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% After-tax cost of debt 5.4% 5.4% 5.4% 5.4% 5.4% 5.2% Equity weight 100% 100% 100% 100% 100% 100% WACC 12.5% 12.5% 12.5% 12.5% 12.5% 11.7% DCF valuation (HRK mn) 2014e 2015e 2016e 2017e 2018e Terminal Sales growth -5.5% -4.5% -2.3% -1.5% 0.6% 0.5% EBIT 1, , , , , ,533.2 EBIT margin 23.0% 21.3% 20.2% 20.4% 21.1% 25.4% Tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% Taxes on EBIT NOPLAT 1, , , , Depreciation 1, , , , , ,000.0 Capital expenditures / Depreciation 93.3% 92.1% 88.7% 88.9% 87.6% 100.0% +/- Change in working capital Chg. working capital / chg. Sales -7.6% -8.7% -5.8% -7.2% 8.2% 0.0% - Capital expenditures -1, , ,000.0 Free cash flow to the firm 1, , , , , ,226.6 Terminal value growth 1.0% Terminal value 11,632.3 Discounted free cash flow - Dec , ,469.4 Enterprise value - Dec ,659.8 Minorities 0.0 Non-operating assets: HT Mostar Net debt -3,191.0 Other adjustments 0.0 Equity value - Dec ,248.8 Number of shares outstanding (mn) 81.9 Cost of equity 12.5% 12M target price per share (HRK) Current share price (HRK) Up/Downside 7.3% Enterprise value breakdown PV of terminal value 61% PV of detailed period 39% Sensitivity (per share) Terminal value EBIT margin % 23.4% 25.4% 27.4% 29.4% 10.7% % % % % Terminal value growth % 0.5% 1.0% 1.5% 2.0% 10.7% % % % Source: Factset, Erste Group Research 12.7% Erste Group Research Sector Report Page 35

36 T-Hrvatski Telekom Integrated Telecoms Croatia Income Statement e 2014e 2015e (IAS, HRK mn, 31/12) 31/12/ /12/ /12/ /12/ /12/ /12/2015 Net sales 8, , , , , , Invent. changes + capitalized costs Total revenues 8, , , , , , Other operating revenues Material costs -2, , , , , , Personnel costs -1, , , , , , Other operating expenses -1, , , , , , EBITDA 3, , , , , , Depreciation/amortization -1, , , , , , EBIT 2, , , , , , Financial result Extraordinary result EBT 2, , , , , , Income taxes Result from discontinued operations Minorities and cost of hybrid capital Net result after minorities 1, , , , , , Balance Sheet e 2014e 2015e (IAS, HRK mn, 31/12) Intangible assets 1, , , , Tangible assets 6, , , , , , Financial assets Total fixed assets 7, , , , , , Inventories Receivables and other current assets 1, , , , , , Other assets Cash and cash equivalents 3, , , , , , Total current assets 5, , , , , , TOTAL ASSETS 13, , , , , , Shareholders'equity 11, , , , , , Minorities Hybrid capital and other reserves Pension and other LT personnel accruals LT provisions Interest-bearing LT debts Other LT liabilities Total long-term liabilities Interest-bearing ST debts Other ST liabilities 2, , , , , , Total short-term liabilities 1, , , , , , TOTAL LIAB., EQUITY 13, , , , , , Cash Flow Statement e 2014e 2015e (IAS,HRK mn, 31/12) Cash flow from operating activities 3, , , , , , Cash flow from investing activities -1, , , , , Cash flow from financing activities -2, , , , , , CHANGE IN CASH, CASH EQU Margins & Ratios e 2014e 2015e Sales growth -1.7% -3.7% -7.6% -7.9% -5.5% -4.5% EBITDA margin 43.7% 44.9% 45.3% 42.0% 41.1% 39.6% EBIT margin 26.8% 27.3% 27.5% 23.7% 23.0% 21.3% Net profit margin 21.7% 22.6% 22.6% 19.3% 19.1% 18.1% ROE 15.8% 16.5% 15.4% 12.3% 11.8% 10.7% ROCE 22.8% 23.9% 22.7% 17.9% 16.6% 15.0% Equity ratio 81.4% 83.9% 83.1% 82.7% 83.0% 83.1% Net debt -3, , , , , ,209.5 Working capital 3, , , , , ,999.4 Capital employed 7, , , , , ,214.8 Inventory turnover Source: Company data, Erste Group estimates Erste Group Research Sector Report Page 36

37 TEST Erste Gr oup R esearch C ompany R eport Telefónica CR Integrated Tel ecoms Czech R epublic 24 September 2013 All prices are those current at the end of the previ ous tr adi ng session unl ess other wise indicated and ar e sourced fr om local exchanges vi a Reuters, Bl oomberg and other vendors. Erste Group Research Erste Sector Telecom Telefónica CR Integrated Telecoms Czech Republic Telefónica CR Reduce CZK mn e 2014e 2015e Net sales 50, , , ,026.4 EBITDA 19, , , ,628.1 EBIT 8, , , ,089.3 Net result after min. 6, , , ,790.4 EPS (CZK) CEPS (CZK) BVPS (CZK) Div./share (CZK) EV/EBITDA (x) P/E (x) P/CE (x) Dividend Yield 9.3% 10.1% 10.1% 10.1% weeks Telefónica CR Performance 12M 6M 3M 1M in CZK -22.5% -2.5% 12.6% 3.7% Share price (CZK) close as of 23/09/ Reuters SPTT.Pr Free float 28.6% Number of shares (mn) Bloomberg SPTT CP Shareholders Telefónica (69.4%) Market capitalization (CZK mn / EUR mn) 95,182 / 3,665 Div. Ex-date 10/10/13 Treasury (2%) Enterprise value (CZK mn / EUR mn) 96,543 / 3,717 Target price Homepage: PX Threat of new entrant and higher CIT Analyst: Vera Sutedja, MBA, CFA +43 (0) We confirm our Reduce recommendation and target price of CZK 280. We expect the share price to remain stable in the short term, due to the exdividend date on October 10, However, two important developments should also take place in October that might negatively influence the share price. The first is the LTE spectrum auction. The spectrum auction should pave the way for a new entrant. We see PPF as a credible candidate and we have heard that the company is hiring employees and talking with equipment suppliers. The second is the early legislative election, scheduled for Oct , The Social Democrats, who led the polls in September with 28%, have announced plans to increase the corporate income tax rate (CIT) for utilities, banks and telecoms from 19% to 25%-30%. We estimate the tax hike impact on our valuation at around CZK 30 per share. Price competition has heated up since April 2013, when TCR launched the unlimited tariffs called FREE. Competitors immediately matched the tariffs. T-Mobile showed the highest sequential net additions in 2Q13 with 9,700, followed by TCR with 3,400. TCR s market share remained unchanged sequentially in 2Q13, despite launching the aggressive tariffs. The initial idea of the tariff was to deter a new mobile player from entering CZ and locking in customers with 24-month contracts. However, the new EU single telecom market proposal, if it is approved and becomes law in 2Q14, would allow customers to cancel contract after six months without any penalty. Catalysts include the potential sale of TCR by its parent company Telefónica SA to reduce debts. PPF denied that it would buy TCR. We are not aware of any potential buyer. However, we think that a buyer would Erste Group Research Sector Report Page 37

38 Telefónica CR Integrated Telecoms Czech Republic rather wait until the spectrum auction is completed to know the number of players in the mobile market and/or until the CIT rate is decided. Initial impact of FREE tariff. The launch of the FREE tariff did not boost the customer base as much as we had expected. In fact, T-Mobile gathered the most net adds in the market in 2Q13. The revenue impact in the quarter was also negative, as there were more customers migrating from higher tariffs to cheaper FREE tariffs, rather than customers from lower tariffs. The impact on EBITDA was not significant. Interconnection costs rose by 7% sequentially, despite a 34% reduction in the mobile termination rate. However, there should be savings coming from lower mobile subsidy, e-bill and simpler customer service. We have yet to see whether the impact of FREE tariffs on revenues and EBITDA would improve in the coming quarters. Czech mobile market Subscriber (mn) 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 T-Mobile growth%yoy -1.7% -0.9% 0.3% 2.2% 4.0% 5.4% market share 39.4% 39.3% 39.2% 39.4% 39.9% 40.2% Vodafone growth%yoy 3.3% 2.8% 2.0% 1.9% 1.8% 0.4% market share 24.3% 24.3% 24.4% 24.2% 24.0% 23.7% Telefónica CR growth%yoy 2.3% 2.0% 2.9% 2.9% 2.2% 2.3% Telefonica O2 36.3% 36.4% 36.4% 36.4% 36.1% 36.1% Market subscribers growth%yoy 0.9% 1.1% 1.6% 2.3% 2.8% 3.1% Penetration rate 133.2% 134.0% 135.3% 136.8% 137.0% 138.1% Contract customer 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 T-Mobile 54.1% 54.8% 55.5% 55.9% 56.3% 56.6% Vodafone 55.0% 55.5% 55.6% 55.9% 56.1% 56.6% Telefónica CR 62.3% 62.7% 62.5% 62.8% 61.8% 62.4% Market 57.3% 57.9% 58.1% 58.4% 58.3% 58.7% ARPU monthly (CZK) 1Q12 2Q12 3Q12 4Q12 1Q13 2Q13 T-Mobile growth%yoy -3.9% -3.4% -3.6% -13.7% -12.7% -18.2% Telefonica O growth%yoy -7.3% -7.5% -6.7% -12.2% -14.1% Source: Company data -15.2% Change in estimates We lower our 2014 earnings estimate slightly, mainly due to a higher OPEX assumption. We maintain our CAPEX for LTE spectrum estimate at CZK 3bn. Change in estimates Consolidated, IFRS 2013e 2014e (CZK, mn) Now Before Change Now Before Change Revenues 47,820 47, % 46,274 46, % OIBDA 17,756 17, % 17,057 17, % EBIT 6,719 6, % 6,284 6, % Net profit 5,333 5, % 4,936 5, % EPS % % Dividend/share % % Source: Erste Group Research Erste Group Research Sector Report Page 38

39 WACC WACC Erste Group Research Erste Sector Telecom Telefónica CR Integrated Telecoms Czech Republic WACC calculation 2014e 2015e 2016e 2017e 2018e 2019e (TV) Risk free rate 2.5% 2.5% 2.5% 2.5% 2.5% 4.0% Equity risk premium 5.3% 5.3% 5.3% 5.3% 5.3% 5.1% Beta Cost of equity 7.8% 7.8% 7.8% 7.8% 7.8% 9.1% Cost of debt 3.8% 3.8% 3.8% 3.8% 3.8% 5.3% Effective tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% After-tax cost of debt 3.0% 3.0% 3.0% 3.0% 3.0% 4.2% Equity weight 90% 90% 90% 90% 90% 90% WACC 7.3% 7.3% 7.3% 7.3% 7.3% 8.6% DCF valuation (CZK mn) 2014e 2015e 2016e 2017e 2018e 2019e (TV) Sales growth -3.2% -0.5% -0.2% 0.1% 0.4% 0.0% EBIT 6, , , , , ,390.2 EBIT margin 13.6% 13.2% 12.9% 13.2% 14.2% 13.8% Tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% Taxes on EBIT -1, , , , , ,278.0 NOPLAT 5, , , , , , Depreciation 10, , , , , ,000.0 Capital expenditures / Depreciation 53.8% 55.0% 55.7% 57.8% 60.5% 100.0% +/- Change in working capital Chg. working capital / chg. Sales 7.8% 9.7% 11.9% 2.7% 7.8% - Capital expenditures -5, , , , , ,000.0 Free cash flow to the firm 9, , , , , ,112.1 Terminal value growth 1.0% Terminal value 67,848.2 Discounted free cash flow - Dec , , , , , ,758.0 Enterprise value - Dec ,107.7 Minorities 0.0 Non-operating assets 0.0 Net debt 4,244.8 Other adjustments 0.0 Equity value - Dec ,862.9 Number of shares outstanding (mn) Cost of equity 7.8% 12M target price per share (CZK) Current share price (CZK) Up/Downside -6.2% Enterprise value breakdown PV of terminal value 55% PV of detailed period 45% Sensitivity (per share) Terminal value EBIT margin % 12.8% 13.8% 14.8% 15.8% 7.6% % % % % Terminal value growth % 0.5% 1.0% 1.5% 2.0% 7.6% % % % Source: Factset, Erste Group Research 9.6% Erste Group Research Sector Report Page 39

40 Telefónica CR Integrated Telecoms Czech Republic Income Statement e 2014e 2015e (IAS, CZK mn, 31/12) 31/12/ /12/ /12/ /12/ /12/ /12/2015 Net sales 55, , , , , , Invent. changes + capitalized costs Total revenues 55, , , , , , Other operating revenues Material costs -13, , , , , , Personnel costs -6, , , , , , Other operating expenses -8, , , , , , EBITDA 27, , , , , , Depreciation/amortization -11, , , , , , EBIT 15, , , , , , Financial result Extraordinary result EBT 15, , , , , , Income taxes -3, , , , , , Result from discontinued operations Minorities and cost of hybrid capital Net result after minorities 12, , , , , , Balance Sheet e 2014e 2015e (IAS, CZK mn, 31/12) Intangible assets 21, , , , , , Tangible assets 56, , , , , , Financial assets Total fixed assets 78, , , , , , Inventories Receivables and other current assets 9, , , , , , Other assets Cash and cash equivalents 4, , , Total current assets 14, , , , , , TOTAL ASSETS 92, , , , , , Shareholders'equity 73, , , , , , Minorities Hybrid capital and other reserves Pension and other LT personnel accruals LT provisions Interest-bearing LT debts 2, , , , , Other LT liabilities 4, , , , , , Total long-term liabilities 6, , , , , , Interest-bearing ST debts , , , , Other ST liabilities 12, , , , , , Total short-term liabilities 12, , , , , , TOTAL LIAB., EQUITY 92, , , , , , Cash Flow Statement e 2014e 2015e (IAS,CZK mn, 31/12) Cash flow from operating activities 21, , , , , , Cash flow from investing activities -5, , , , , , Cash flow from financing activities -12, , , , , , CHANGE IN CASH, CASH EQU. 3, , , , Margins & Ratios e 2014e 2015e Sales growth -7.0% -5.7% -3.5% -5.6% -3.2% -0.5% EBITDA margin 49.2% 41.5% 39.1% 37.1% 36.9% 36.1% EBIT margin 27.9% 19.3% 16.5% 14.1% 13.6% 13.2% Net profit margin 22.1% 16.6% 13.4% 11.2% 10.7% 10.4% ROE 16.7% 12.2% 10.5% 9.3% 9.4% 10.0% ROCE 16.1% 12.2% 10.4% 8.7% 8.6% 9.0% Equity ratio 78.9% 77.7% 76.5% 73.7% 73.0% 71.5% Net debt -1, , , , ,618.1 Working capital 1, , , ,185.9 Capital employed 75, , , , , ,290.7 Inventory turnover Source: Company data, Erste Group estimates Erste Group Research Sector Report Page 40

41 TEST Erste Gr oup R esearch C ompany R eport Telekom Austria Integrated T elecoms Austri a 24 September 2013 All prices are those current at the end of the previ ous tr adi ng session unl ess other wise indicated and ar e sourced fr om local exchanges vi a Reuters, Bl oomberg and other vendors. Erste Group Research Erste Sector Telecom Telekom Austria Integrated Telecoms Austria Telekom Austria from Sell to Reduce EUR mn e 2014e 2015e 52 weeks Net sales 4, , , , EBITDA 1, , , , EBIT Net result after min EPS (EUR) CEPS (EUR) BVPS (EUR) Div./share (EUR) Telekom Austria ATX EV/EBITDA (x) P/E (x) Performance 12M 6M 3M 1M P/CE (x) in EUR -13.4% 4.1% 11.0% -3.1% Dividend Yield 0.9% 0.9% 0.9% 0.9% Share price (EUR) close as of 23/09/ Reuters TELA.VI Free float 45.7% Number of shares (mn) Bloomberg TKA AV Shareholders ÖIAG (28.4%) Market capitalization (EUR mn) 2,447.4 Div. Ex-date 03/06/13 America Movil (22.76%) Enterprise value (EUR mn) 6,256.2 Target price 5.00 Homepage: Uncertainties ahead Analyst: Vera Sutedja, MBA, CFA +43 (0) We upgrade Telekom Austria from Sell to Reduce, while raising our target price from EUR 4.5 to EUR 5.0. We believe that the Austrian mobile market remains competitive post consolidation, but prices seem to be stabilizing. It is clear that the roaming premium will eventually be eliminated. The new EU single telecom market proposal allows a voluntary roam-like-at-home (RLAH) option or the usual regulated roaming tariff option. Operators have been given until mid-2016 to show their initiatives. We do not expect TKA to adopt RLAH anytime soon. EU roaming. Revenue exposure to EU roaming amounted to EUR 285mn or 6.6% of 2012 group revenues. The respective EBITDA exposure amounted to EUR 225mn, or 15.8% of 2012 group EBITDA. According to our estimate, we expect a EUR 180mn loss in revenues and EUR 145mn in EBITDA, spread over four years between 2012 and Uncertainties. TKA confirmed that it re-joined the bidding process for Serbia Broadband. The financing of such a large acquisition would need a capital increase. If core shareholders ÖIAG and AMX were to participate accordingly to maintain their stake, then large dilution should be expected. If AMX were to participate more than its stake so as to breach the 30% threshold and the Austrian government would approve of such move, a mandatory takeover bid would be triggered. Erste Group Research Sector Report Page 41

42 Telekom Austria Integrated Telecoms Austria TKA maintains price premium; existing fixedline clients get better deal Austrian competition post consolidation Drei launched its new tariffs in August 2013, following the acquisition of Orange. The cheapest and very popular EUR 7.5 SIM-only tariff is retained. Drei introduced unlimited tariffs, the prices of which are comparable to T- Mobile. Unlimited data is back in all tariffs, with speed slowed down after a certain number of GB. A1 s tariffs are the highest in the market. In our example below, one can see that A1 charges 33% more than the next competitor. However, existing fixed-line or internet clients receive a EUR 10/month discount. A1 s tariffs are thus only attractive for them. We have observed that Drei is less aggressive than before. Its unlimited tariffs are priced much closer to those of T-Mobile. iphone 5 (retail price EUR 679) as of Voice SMS Data GB Tariff Name Handset Total in 24M Drei unlimited unlimited unlimited/ Hallo XL T-Mobile* unlimited unlimited unlimited/ Smart net unlimited M A1** unlimited unlimited A1 GO M Drei unlimited/1 7.5 HalloSIM M Source: Erste Group Research. *) Promotional price, otherwise EUR 29.9 **) Price for existing fixed line/internet client EUR 29.9 Roaming exposure We have devised a roaming model based on available information from the company, as seen in the following table. Close to 40% of roaming revenue losses should come from the elimination of the retail roaming calls received tariff as of July Roaming model of Telekom Austria Roaming e 2014e 2015e Change Revenues Retail Wholesale EBITDA Retail Wholesale Margin 78.9% 79.1% 80.1% 78.6% -0.4% Retail 71.9% 73.0% 74.5% 72.1% 0.1% Wholesale 100.0% 100.0% 100.0% 100.0% 0.0% Source: Erste Group Research We assume that TKA would apply the usual regulated roaming tariffs, rather than RLAH, because: Most of TKA s roaming revenues come from customer roaming, i.e. own TKA customers who travel abroad within the EU and make use of roaming calls/sms/data. Domestic prices remain lower than the retail regulated prices. Regulated retail roaming price > domestic price According to the EU Commission, European mobile users paid 9.1 eurocents per voice minute in 2011 (-12.1% y/y). We think that users are likely to pay an even lower price/voice minute in 2012, thanks to a lower mobile termination rate and competition. This domestic price is considerably lower than the current retail roaming call of 24 eurocents or next year s 19 eurocents. It is therefore very economically challenging to offer domestic rates for roaming. Erste Group Research Sector Report Page 42

43 Telekom Austria Integrated Telecoms Austria Roaming glide path EUR cents Before July 2012July 2013July 2014 Retail Data/MB none Voice calls made Voice calls received SMS Wholesale Data/MB Voice per minute SMS Source: EU Commission. Valid until June 30, 2017 Average revenue per minute (EUR cents) in mobile calls, 2011 Source: EU Commission Fixed intra EU calls. The EU Commission proposed the reduction of fixed intra-eu calls to the level of long-distance domestic calls. For example, an Austrian calling Bucharest is currently charged 35 eurocents/minute. As of July 2016, the same call should be charged 5.4 eurocents/minute. Calling Bucharest should not cost more than calling Tyrol. Telekom Austria fixed line tariffs Eurocents Peak Off Peak Fixed domestic calls Fixed international calls Zone 1* Zone 2* Zone 3* Mobile roaming calls Source: A1. *) Zone 1: DE, IT, FR, GB, SK, SI, CZ, HU, UK Zone 2: BE, BG, DK, ES, PT, FI, EE, IE, HR, LU, NL, PL, SE, EL, MT, LT, LV, CY Zone 3: RO TKA s revenue exposure to this segment was roughly EUR 150mn or 3.4% of 2012 group revenues. If such a proposal is implemented, we would expect considerable revenue decline from July Our rough estimate indicates revenue decline of more than 70%, or more than EUR 100mn on an annual basis. Erste Group Research Sector Report Page 43

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