Talk is over - time for data

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1 Tupras, 28 Mayıs 2012 Turkcell, Ulker Biskuvi, 06 November 4 December Turkcell, 06 November 2008 Re-Initiation of Coverage Turkish Telecommunications Talk is over - time for data May 28, 2012 Re-Initiation of coverage of Turkish telecommunications We reinitiate coverage of the Turkish telecommunications sector with our sector report. We prefer Turk Telekom over Turkcell based on our valuation and its respective upside potential. We think that Turk Telekom offers a sound investment case with a determined and proven strategy. Turkcell which is the leader in the mobile market will have to nourish investor sentiment by providing a resolution to the board disputes, which have disrupted the company s performance. Internet will be the driving force for the sector Voice revenues have reached a point where substantial growth now appears unlikely as penetration has approached saturation, both in fixed line and mobile telephony. Thus the growth in the sector lies in internet and data communications, as opposed to voice. The ability to monetise on cloud technologies that provide remote access to data will generate new revenues in the sector. Turkcell and Turk Telekom have been active in launching services for consumers and corporate clients creating demand for cloud technology services. Mobile competition looks set to continue in 2012 Competition looks set to continue to be price based as mobile operators challenging Turkcell for market share have started offering luring packages. The most competitive of these is Avea s offer of TRY19/month for 1,000 minutes to fixed lines, followed by Vodafone with its TRY19/month package for 500 minutes and Turkcell s post-paid package offer of TRY25/month for 200 minutes. Turk Telekom stands out as a resilient investment theme We like Turk Telekom as its main business is not yet challenged by competition. The company has consistently delivered profitable results distributing dividends coupled with high cash flow. Due to its market position, Turk Telekom has the ability to adjust tariffs and packages in the fixed line segment to maintain secure revenue generation, despite declining fixed line subscriptions. We forecast Turk Telekom will secure an EBITDA margin of around 40% in Turkcell- Looking for clarity on board disputes The board disputes, which have disrupted Turkcell s operational performance, will need to be resolved in order to establish investor confidence. Clarity on board issues such as the appointment of independent members as required by the CMB will have to be determined. A more efficient capital structure would also be welcomed; to this end, share buybacks with the cash on hand as well as delayed dividend payments would gain the respect of investors. Another area in need of improvement is the international operations in Belarus and Ukraine where losses were incurred during the midst of the economic crisis. Telecommunication Sector Summary Company Ticker Recommendation Target Price Upside Potential Turk Telekom TTKOM IS Outperform % Turkcell TCELL IS Market Perform % Duygu Kalfaoglu Phone: duygu.kalfaoglu@yfas.com.tr Source: YF Securities Research estimates

2 TABLE OF CONTENTS Turkish Telecommunications Investment Summary 3 Valuation Summary 4 Telecommunications Market in Turkey 8 Turk Telekom 16 Turkcell 30 Contacts 47 2

3 INVESTMENT SUMMARY Little room for subscriber growth in telecommunications Limited subscriber growth Penetration levels have reached near saturation levels in the telecommunication market in Turkey. Fixed line penetration is declining due to the convergence from fixed to mobile while household penetration stood at 83% at the end of Mobile penetration of 89% on the other hand has reached saturation levels as the number of mobile subscribers reached 65mn at the end of If the population below the age of 10 is excluded the penetration rate is in fact over saturated at 105%. The introduction of mobile number portability (MNP) at the end of 2008 disrupted mobile subscriber growth as double SIM card subscribers decided to forgo one line, when off net tariffs decreased post MNP implementation. New growth will come from data services Internet will be the new growth domain The telecommunications market will depend on data growth rather than voice growth to generate additional revenues going forward. Internet services, including mobile internet will be the new source of revenue growth in the medium term. The growth in fixed line ADSL also boasts potential as fiber network rollouts will offer internet service products to high end clients at premium prices with faster speeds. We expect internet subscribers, currently 6mn to grow with a 5 year CAGR of 11%. The upgraded internet networks will also provide value added services to be marketed such as IPTV. The ADSL subscribers which currently stand at 6mn imply a household penetration of 33% in Turkey. We think fiber network products will gain popularity with their higher speeds starting from 20 Mbytes in a market where the average ADSL speed is 8 Mbps. The wholesale provider of internet services Turk Telekom looks set to benefit from the potential growth of faster internet services, through subscriber acquisitions as well as leased lines to other broadband companies. Superonline, Turkcell s fiber optic internet service provider is also ambitious in expanding its internet subscriber base which currently stands at 260,000 subscribers. Overall a balanced market expected in mobile telephony as margins decline Profitability in mobile voice services have been on a declining trend as competition which has become increasingly price based following the introduction of MNP in November 2008 has eroded margins. The market leader Turkcell which has seen its subscriber market share decline from 65% at the end of 2008 declined to 53% by the end of 1Q12. Nevertheless the market share loss for Turkcell decelerated considerably over the past three quarters as the market share hovered around 53%. We expect Avea and Vodafone to concentrate on gaining market share from Turkcell for the remainder of Regulation will continue to determine market dynamics Taxes on telecommunication continue to hinder growth Turkey has the highest taxes on mobile and fixed line telecommunication in the world, and the government has no intention of foregoing a steady source of revenue anytime soon. The special communication tax of 25%, which was levied on mobile telephony in the wake of the 1999 earthquake, became permanent despite objections from sector players since then. A future cut in tax rates would unlock revenue generation for telecommunication companies in the future. 3

4 VALUATION SUMMARY We think the strong cash flow generation of Turk Telekom will continue throughout 2012 as the leader in fixed line while opening new frontiers in fiber broadband. We predict that Turkcell will have to monetise on the value added services which include mobile internet in order to compensate for the decelerating growth in voice revenues. Estimates Summary Ticker Sales TRYmn EBITDA margin % Net profit margin % E 2013E E 2013E E 2013E TCELL 9,370 9,868 10, % 31.5% 31.6% 12.6% 14.0% 14.1% TTKOM 11,941 12,714 13, % 39.8% 40.5% 17.3% 18.8% 19.7% Source: ISE data, YF Securities research estimates The Turkish telecommunications index (comprised of TCELL and TTKOM) has outperformed the ISE over the past year. The gap has increased in May 2012 as the outlook for telecoms became more favourable as a defensive investment theme. Telecommunications index vs ISE100 relative performance Source: ISE data 4

5 Turk Telekom stands out in stock performance Turk Telekom has outperformed the market in the past 3 months and lost momentum in the past 1 month. Year to date Relative Price Performances Source: ISE data Peer Group Comparison The telecommunications peer group analysed for multiple based valuations consists of emerging market and European telecommunication companies. We present the weighted average multiples of each group. We choose to use the multiples of the European telcos for Turk Telekom as the companies in this group which offer both fixed line and mobile services are more comparable. We chose to use the emerging market peer group multiples for Turkcell as the companies in the group were similar in operations and geographical presence. Figure 6: Peer group summary Company Country Market Cap US$mn EV/Sales EV/EBITDA P/E E 2013E E 2013E E 2013E Emerging Market Weighted Average Telekomunikacja Polska SA Poland 6, Telefonica Czech Rep. 6, Egyptian Co for Mobile Serv. Egypt 2, nm Magyar Telecom Hungary 2, Orascom Telecom Egypt 2, Vimpel-Com. Russia 11, MTN Group Ltd S.Afrıca 29, Europe Weighted Average Deutsche Telekom AG Germany 44, France Telecom SA France 34, Mobistar SA Belgium 1, Telefonica SA Spain 56, Telenor ASA Norway 24, TeliaSonera AB Sweden 26, Vodafone Group PLC Britain 133, Turkey Weighted Average Turk Telekom Turkey 13, Turkcell Turkey 10, Source: YF Securities research, Bloomberg IBES estimates 5

6 Comparative stock performance Both TTKOM and TCELL are trading above the MSCI Index average forward looking P/E multiple. TTKOM is currently trading at a lower P/E multiple compared to TCELL. P/E comparison of Turkish telco stocks Source: Market data Comparative analysis We provide a comparison of TCELL and TTKOM with other emerging market and developed telecom companies. The 3 year average ROE figures highlight the strength of Turk Telekom which has a 3-yr average ROE of 37%. Turk Telekom also recorded a high EBITDA margin of 39.7% in 2011 which is one of the highest in the focus group. Comparative financial ratios 3 yr average ROE EBITDA margin 2011 Source: Bloomberg, YF Securities research 6

7 Key financial measures ROCE Free cash flow yield Source: Bloomberg, YF Securities research 7

8 TELECOMMUNICATION MARKET IN TURKEY Fixed line penetration in Turkey stands at 20.6% at the end of The population per household in Turkey is around 4, thus the household penetration is above 80% and is at a saturated level. Mobile subscribers on the other hand have peaked from 35mn in 2004 to 65mn at the end of The mobile subscriber growth stalled at the end of 2008 when mobile number portability was introduced as double SIM card usage declined as cheaper off net tariffs became available. The mobile penetration which stands at 87% at the end of 2011 is expected to reach above 100% levels as mobile internet subscriptions become popular in Turkey by Mobile market Fixed line subscribers Mobile subscribers Source: Telecommunications Authority We expect the declining trend in fixed line subscribers to continue and level at 13mn in 5 years. The mobile market is at a near saturated level in terms of voice only subscriptions and growth is expected to be generated from mobile internet subscriptions in the medium term. Market forecasts E 2013 E 2014 E 2015 E 2016 E Population (mn) Mobile market subscribers (mn) Turkcell Vodafone Avea Mobile penetration 83.8% 87.4% 88.2% 89.1% 90.0% 90.9% 91.8% Fixed line subscribers (mn) Turk Telekom subscribers Fixed line penetration 22.0% 20.4% 19.5% 18.8% 18.0% 17.3% 16.6% Source: Telecommunications Authority Turk Telekom is the leader in fixed line services having a dominant share of 97% by subscribers. Other fixed line service providers are small in business scale and do not have the ability to challenge Turk Telekom s leading position. There are 940K subscribers enrolled in fixed line services provided by alternative operators which use the backbone of Turk Telekom s fixed line network 8

9 Alternative fixed line service providers by revenue market share, 2011YE Source: Telecommunications Authority Turkcell has a 35% share of revenues in the Turkish telecommunications market at the end of 2011 followed by Turk Telekom with a 32% market share. Vodafone and Avea have been consistently increasing their share of revenues while Turk Telekom and Turkcell have maintained flat revenue growth. Vodafone has been successful in revenue growth with a 5 year CAGR of 26% followed by Avea which recorded a 5 year CAGR growth of 20%. Revenue distribution in the telecommunications market* * Revenues generated only in Turkey Source: Telecommunications Authority Voice traffic dominated by mobile networks The share of traffic on mobile networks reached 82.6% at the end of 2011 while the share of traffic on fixed line networks was 9.9%. The diminishing fixed line traffic is an eventual 9

10 consequence of the declining fixed line subscribers as well as the reduction in mobile tariffs. Going forward we expect the share of mobile traffic to stabilise at around 90% levels within five years time. Voice traffic share Source: Telecommunications Authority Communication spending growth in tandem with economic growth Communication expenditures in Turkey have increased as disposable income increased in line with GDP growth. Communication expenditures amount to above 4% of total spending in Turkey which we expect to be maintained and to grow further as internet penetration increases. Communication expenditures Source: State Institute of Statistics 10

11 Turkey has the highest taxes on mobile telephony A special telecommunications tax (SCT) of 25% was applied on mobile telephony while 15% was applied to fixed line subscriptions to raise funds for recovery efforts post the 1999 earthquake in Turkey. SCT was initially introduced as a temporary tax item on communication services which eventually became permanent and a secure source of tax revenue for the government which amounts to TRY 4.5bn per year. The mobile operators have long been arguing that the SCT on mobile telephony should at least be equal to the rate applied for fixed line. However the campaigning by the side-lines was not effective in producing a result. The tax on internet services on the other hand was reduced to 5% from 15% as an incentive to promote 3G licenses in Telecommuncation taxes Paid by Tax Item Mobile Fixed Subscriber Special Communication Tax on voice 25% 15% Subscriber Special Communication Tax on broadband 5% 5% Subscriber VAT 18% 18% Subscriber Communication Tax - 1% Subscriber New subscription Special Communication Tax TRY Subscriber Wireless license fees (per acquisition) TRY Subscriber Wireless usage fees (per acquisition) TRY Operator Treasury share 15% 1% Operator Contribution Share to Telecom Authority 0.35% 0.35% Source: Telecommunications Authority Mobile market structure Turkcell is the leading operator in the mobile market with a market share of 53% at the end of 4Q11. The subscriber distribution follows a trend towards a balanced market as Vodafone and Avea gain market share from Turkcell. Post paid subscribers constitute 33% of total subscribers while Avea has the highest share of post-paid subscribers at 44%. Mobile market Mobile subscribers Mobile subscribers market share Source: Telecommunications Authority Mobile ARPU development for all three operators seemed to be achieved through offering more voice minutes. ARPU levels of all three operators reached similar levels at the end of 11

12 2011 as Vodafone and Avea caught up with Turkcell. Avea has the highest MoU of 304 minutes among all three mobile operators. Mobile market ARPU figures MoU- Minutes Source: Telecommunications Authority The impact of mobile number portability on the market The number of ported lines per quarter is on the average 3mn. The impact that MNP had on the mobile market was that as portability was made available in order to maintain subscribers, off-net tariffs were reduced. Thus the demand for double sim-cards declined, reducing the number of subscriptions. Mobile operators have restructured pricing to include package deals offering bundled minutes and messaging quotas at cheaper tariffs for off net calls. The average number of ported lines exceeds 3mn per quarter and the ported subscribers in 1Q12 totalled 3.6mn. Mobile market Monthly churn rates Net changes through MNP Source: Telecommunications Authority The bundle packages eventually led to the increase in average minutes of usage to 250 minutes in the mobile market which is above the EU average of 185 minutes. 12

13 Mobile MoU comparison Source: Telecommunications Authority Interconnection rates have been reduced, to the disadvantage of Turkcell The Telecommunications Authority has the power to determine interconnection rates between operators taking into consideration their market position. The most recent termination tariff rate was announced in April The reductions in termination rates have increased marketing of off net call bundles especially by Avea and Vodafone, thereby acting as a base for more aggressive competition. Mobile interconnection rates Source: Telecommunications Authority 13

14 ARPU data Post-paid ARPU Pre-paid ARPU Source: Telecommunications Authority KPI s EBITDA margins Post-paid subscriber % Source: Telecommunications Authority, company disclosures, YF Securities research Internet and broadband will be the driving growth in the future The number of internet subscribers expanded rapidly since 2003 when the total market amounted to 18,000 subscribers. The introduction of smart phones and tablets increased internet subscriptions as mobility was the driving demand. Currently smart phones account for nearly 40% of total phone sales in the market. Mobile operators are marketing smart phone and tablet campaigns that allow subscribers to sign up for subscriptions for a determined period of time. There are 1.8mn laptop internet and 7.1mn mobile internet subscriptions at the end of 1Q12. The internet penetration stands at 19% at the end of 2011 which is relatively low when compared to the European average of 25.6%. 14

15 Internet subscribers (cable, fiber, broadband, mobile internet) Source: Telecommunications Authority Internet market xdsl subscribers Internet market shares YE Source: Telecommunications Authority 15

16 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Telecommunications, May 28, 2012 Initiation of Coverage Turk Telekom Outperform Initiation of coverage with an Outperform recommendation We initiate coverage of Turk Telekom with an Outperform recommendation. Our target price of TRY8.80 per share implies an upside potential of 26%. Turk Telekom is the leading telecommunications company in Turkey with a market share of 97% in fixed line and 86% in fixed broadband. Turk Telekom s mobile arm, Avea is the third mobile operator with a market share of 20%. We expect Turk Telekom to maintain an EBITDA margin of 40% levels in 2012, one of the highest in the global telecommunication peer group coupled with a sales growth of 6.5%. Strong cash flow generation set to continue We expect a cash flow yield near 10% in 2012 for Turk Telekom and forecast an improvement of 2pp in 2013 as the bulk of the infrastructure investments including the fiber network are completed. The high dividend yield of 8% for this year will continue going forward as TTKOM will be one of the highest dividend paying stocks on the ISE. Fixed line will remain a secure revenue generating segment in 2012 Despite declining subscriber numbers Turk Telekom was able to defend its fixed line revenues through effective cost control and its success in marketing bundled packages that secure a fixed fee tariff. Management expects that an inflationary adjustment in tariffs can be applied in the remainder of We expect fixed line revenues to remain flat in 2012 as we project the subscriber base to contract 5% y/y to 14.7mn. Growth potential locked in broadband As fixed line subscribers continues to decline, Turk Telekom will have to focus on the growth in data services through the upselling of products such as fiber internet and IPTV. We expect a 5 year CAGR growth of 9% in the ADSL segment supported by the fiber internet which offers speeds over 20Mbps. We expect the share of subscribers on an unlimited tariff to increase from the current 66% as fibre optic broadband options become more attractive and start to eke out a stable revenue base. Avea will continue to grow with focus on gaining market share We expect the migration of prepaid subscribers to post paid to continue throughout 2012 while bundled on-net and off-net offers entice subscribers to port to Avea. The TRY 19 per month campaign, the most aggressive in the market launched in 2Q12, offering 1000 off-net minutes to fixed line subscribers will definitely contribute to market share gains. We expect revenue growth of 11% coupled with an EBITDA margin of 12% remaining level y/y in 2012 for Avea. Key Financials & Ratios 2010A 2011A 2012E 2013E 2014E Net Sales (TL mn) 10,852 11,941 12,714 13,685 14,624 EBITDA (TL mn) 4,412 4,736 5,064 5,542 5,803 Net Profit (TL mn) 2,451 2,069 2,386 2,694 2,851 EBITDA Margin (%) 40.7% 39.7% 39.8% 40.5% 39.7% Dividend yield (%) 11.3% 7.2% 8.6% 9.7% 10.3% P/E(x) EV/EBITDA (x) EV/Sales(x) Source: Company data, YF Securities estimates Trading Data Sector Telecommunications Bloomberg TTKOM.TI Reuters TTKOM.IS EV (TRYm) 29,433 Mkt cap (TRYm) 24,500 Free float (%) 13% # of shares (m) 3,500 Av e. Daily Vol. (TRYm) 18.2 ISE-100 (TRY) 54,810 Ownership Stake (%) Oger Telecom 55.0% Turkish Treasury 30.0% Free Float 15.0% Share Price Current Target USD TRY Upside Potential (TRY) 26% Price Data (TRY) 1M 3M 12M ISE ,941 59,738 63,609 Share Price Absolute -7% -4% -6% Relativ e 2% 4% 10% 2009/ /12 Price Chart (TRY) Price (TRY) Price Chart (USD) Volume (USDmn) Duygu Kalfaoglu Phone: duygu.kalfaoglu@yfas.com.tr Relative to ISE (RHS) Price (USD) (RHS)

17 INVESTMENT SUMMARY Valuation implies an upside, justifying an Outperform recommendation Upside potential attractive As the leading fixed line operator and wholesale broadband provider Turk Telekom offers exposure to Turkey s fast moving telecommunications market. The company provides a full range of services including mobile telecommunication services through Avea, the third in the market by subscriber share. We determine a fair value of TRY8.80 per share which implies an upside of 26% in TRY terms. We expect revenues to reach TRY 12.7bn in 2012, marking growth of 6.5% while the EBITDA margin will be 39.8%. Fixed line dominance to continue with revenue stabilization Strong cash flow generation through determined revenue stream Turk Telekom has the power to determine prices by offering bundle packages in fixed line segment, and as the share of fixed fees increased to over 70% in 1Q12, revenue losses due to the transformation of subscribers from fixed to mobile will be mitigated. We estimate a CAGR of 2% in fixed line revenues over the next 5 years as tariffs are adjusted to inflation. Turk Telekom dominant market position will continue to empower the company in pricing, which will be reflected in the high EBITDA margins of over 50% in the fixed line segment. Data services to transcend voice with a growth of 16% Fixed broadband household penetration in Turkey which reached 41% is still behind the European average of 61%. We expect revenue growth to reach TRY 3.4bn with a growth of 16% y/y while we expect a 5 year CAGR growth of 9.2% in the broadband segment. We expect the current TTNet market share of 85% to remain above 80% levels as the market expands. Fiber optic network rollout to benefit from operating in an unregulated market The fiber optic broadband network launched in February 2012 will support subscriber growth as well as the improvement in ARPU in the internet segment. In October 2011, the Telecommunications Authority decided to exclude the fiber connections to the home segment from its market analysis process until fiber optic subscriptions account to 25% of total internet subscriptions or after 5 years. Thus, the unregulated environment will act as a catalyst for fiber optic broadband growth. Avea to contribute to revenues in 2012 We expect Avea to record revenues of TRY3.2bn (accounting for 25% of Turk Telekom revenues) with a growth of 5.4% in 2012 as its subscribers reach 13.2mn. We forecast an EBITDA margin of 12% in The price based competition in the mobile market has suppressed margins in 1Q12 as promotional campaigns took a toll on profitability. Turk Telekom stake in Avea reaches 90% after capital increase without any cash outflow Avea stake to increase without any cash outflow A capital increase for Avea was announced on February 28, 2012 in which Isbank Group public companies did not participate. Turk Telekom participated in the capital increase and as of March 30, 2012 its stake in Avea increased from 81% to 90% while Isbank Group s share declined from 18.63% to 10%. Turk Telekom has not incurred any cash outflow due to this transaction as the credit used by Avea provided by Turk Telekom was credited for the capital increase. 17

18 The legal case against Lokum The Council of State suspended the telecommunications regulator s (BTK) decision allowing Turk Telekom to market retail internet services. The case was filed by Telkoder (Turkish Competitive Telco Operators Association) against the BTK for allowing Turk Telekom to offer the Lokum internet bundles to fixed line subscribers. Turk Telekom discontinued the Lokum offering following the ruling. The Lokum product was offered to fixed line subscribers that do not have an ADSL connection for a fee of TRY2 per day or TRY 1 per hour for a speed of 1 Mbps. The package was intended as an incentive offered to increase internet penetration. Lokum was offered for a brief period thus we do not expect this development to disrupt revenue generation in the future. Turk Telekom has started initiatives to launch a new retail Lokum product model which will enable retail sales through ISP s. Risks to our valuation Aggressive price competition in the market led by alternative fixed line and mobile operators may lead to some market share loss in the fixed line segment or accelerate the migration from fixed to mobile. Any change in the macro environment which would result in the depreciation of the TRY would be a downside risk to our valuation. Any regulatory changes could also damage revenues going forward in the form of price caps or restrictions. 18

19 SWOT Analysis Strengths - The leader in fixed line and fixed broadband with an unthreatening wholesale competition. - Pricing power in fixed line reflected in strong profitability of an EBITDA margin of over 50%. - Completed major capex requirements. - Effective distribution network for Turk Telekom, Avea and TTNet. Weaknesses - Convergence from fixed to mobile will decrease fixed revenues going forward. - Vulnerable to fx volatility due to USD and EUR denominated financial loans. Opportunities - Fiber internet rollout which started in February 2012 will serve high end subscribers. - Unsaturated broad band market with a population penetration of 10% presents growth opportunities. Threats - An SPO possibility for the stake held by the Treasury creates an overhang risk. - Increased competition from mobile operators as well as ISP s. - Price based competition in the mobile market will delay profitability improvement for Avea. - Regulatory environment could impose constraints on TT s activities and margins. 19

20 VALUATION We value Turk Telekom through a blended valuation of DCF and multiple based analysis. We find a 12 month target price per share of TRY 8.80 with a potential upside of 26% which supports our Outperform recommendation for the stock. Valuation summary Method Weight Target equity price (TRY mn) DCF 50% 8.79 Multiple comparison 50% 8.84 Blended target price per share (TRY) 8.80 Current price (TRY) 7.00 Upside potential 26% Source: YF Securities A. DCF Analysis We find a 2012 YE ex-div price target of TRY 8.79 per share using a 5-year detailed USD based DCF analysis. WACC assumptions Risk free rate 6.1% Cost of debt 6.1% Equity risk premium 5.9% Effective tax rate 20.0% Beta 1.0 Equity weight 4.9% Cost of equity 12.0% WACC 11.2% Source: YF Securities Figure 5: DCF Valuation DCF Valuation (USD mn) 2012E 2013E 2014E 2015E 2016E TV Sales growth -1.7% 8.2% 6.2% 6.5% 5.5% 2.0% Sales 7,015 7,591 8,065 8,592 9,067 9,248 EBIT 1,882 2,087 2,152 2,357 2,315 1,850 EBIT margin 26.8% 27.5% 26.7% 27.4% 25.5% 20.0% Tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% Taxes on EBIT NOPLAT 1,506 1,670 1,722 1,886 1,852 1,480 + Depreciation 982 1,055 1,119 1,190 1,259 1,239 +/- Change in working capital Capital expenditures -1,333-1,518-1,613-1,718-1,813-1,239 Free cash flow to the firm 1,150 1,141 1,203 1,331 1,271 1,426 Terminal value growth 2.0% Terminal value 25,891 Discount factor Discounted free cash flow 1, ,971 Enterprise value 22,867 Net debt 4,933 Other adjustments -1,897 Equity value 16,038 Cost of equity 12.0% Target equity value (USD) 17,134 Target equity value (TRY) 30,763 Target price per share (TRY) 8.79 Source: YF Securities estimates 20

21 B. Peer Group Valuation We used peer group multiples of global telecom companies to find a fair value for Turk Telekom. We find a fair value of TRY 31bn or TRY 8.84 per share for Turk Telekom using an average of implied values derived by using multiples of EV/Sales, EV/EBITDA and P/E for 2012 and 2013 for the European Telco Group. Figure 6: Peer group summary a. EV/Sales b. EV/EBITDA c. P/E E 2013E E 2013E E 2013E European Average TTKOM multiples Premium/-Disc. 30% 13% 4% 8% -9% -17% 31% 2% -5% Implied value (TRY mn) 30,175 31,868 35,834 37,852 24,035 25,902 Average value (2012&2013 average) 30,984 37,459 24,869 Average of a., b., c. (TRY mn) 30,940 Source: YF Securities, Bloomberg Main Assumptions used in our model Revenue - estimates detail - Revenues (TRY mn) E 2013E 2014E 2015E Total revenues 10,568 10,852 11,941 12,714 13,685 14,624 15,615 Total revenue growth % 3.7% 2.7% 10.0% 6.5% 7.6% 6.9% 6.8% Fixed line revenues 4,581 4,255 4,114 4,159 4,276 4,395 4,504 Fixed line revenue growth % -12.2% -7.1% -3.3% 1.1% 2.8% 2.8% 2.5% ADSL revenues 2,140 2,473 2,925 3,394 3,882 4,321 4,786 ADSL revenue growth % 28.2% 15.6% 18.3% 16.0% 14.4% 11.3% 10.8% Mobile revenues 2,504 2,646 3,080 3,246 3,478 3,703 3,940 Mobile revenue growth 18.5% 5.7% 16.4% 5.4% 7.1% 6.5% 6.4% Revenue breakdown Fixed line 43.3% 39.2% 34.5% 32.7% 31.2% 30.1% 28.8% ADSL 20.3% 22.8% 24.5% 26.7% 28.4% 29.5% 30.7% Mobile 23.7% 24.4% 25.8% 25.5% 25.4% 25.3% 25.2% Source: Company data, YF research estimates 21

22 FINANCIAL ANALYSIS AND ESTIMATES Sales growth to be generated from ADSL and value added services Fixed line revenues have lagged behind in growth as the number of subscribers has deteriorated in the past few years. We estimate a sales CAGR ( ) growth of 7% which will mainly be generated by the ADSL and mobile segments. We expect revenue growth to reach 6.5% in 2012, slightly above the lower guidance limit of 6% provided by management. Turk Telekom sale progression Source: Company data, YF Securities research estimates The decline in fixed line subscribers is expected to continue in 2012 while revenues are to be generated by higher ARPU in this segment which will be adjusted in line with inflation. We expect revenue growth to be flat in this segment going forward with a five year CAGR of 2%. The ADSL subscriber growth will continue coupled with improved ARPU as the fiber network rollout will span the scope of upsell schemes. Turk Telekom key performance data E 2013E 2014E 2015E Fixed line Subscribers (mn) PSTN Naked ADSL ADSL subscribers ARPU (TRY) PSTN ADSL Mobile Subscribers (mn) Pre-paid Post Paid Mobile ARPU (TRY) Pre-paid Post Paid Source: YF Securities research estimates 22

23 Profitability generated by fixed line segment The fierce price based competition in the mobile market has depressed profitability margins for Avea, the mobile arm of Turk Telekom. Going forward we do not think an immediate recovery will be soon and we expect mobile EBITDA margin to remain around 12.5% levels. The fixed line segment is to generate a higher portion of EBITDA mainly stemming from ADSL services which include value added products such as IPTV and fiber internet. EBITDA generation Source: YF Securities research estimates Turk Telekom was able to mitigate the loss in fixed line subscribers through increasing the portion of fixed fees in total PSTN revenues through promoting bundle packages to subscribers. Thus profitability was maintained coupled with cost control which is reflected in the sustained fixed line EBITDA margin of over 50%. PSTN revenues Source: YF Securities research estimates Mobile margins offset by the increase in bundled packages Avea ARMU (average revenue per minute used) has dropped more than 30% since 2008 when the price war 23

24 TRY Telecommunications, May 28, 2012 began with the introduction of MNP. Revenue generation in the mobile segment depends on value added services and more on data and mobile internet subscriptions which will be supported by smartphone and tablet usage which reached 30% of subscribers at the end of 1Q12. The portion of mobile voice revenues have decreased to 85% in 1Q12 from 90% a year ago as value added service and data revenues started to account for a larger share of service revenues. The fact that bundled packages which offer off net voice minutes also increased interconnection costs which rose to 20% of revenues in 2011 as opposed to 19% of revenues a year ago. Mobile ARMU vs. Mobile EBITDA margin % % % 10% % % Q08 3Q08 1Q09 3Q09 1Q10 3Q10 1Q11 3Q11 1Q12-5% ARMU EBITDA margin (rhs) Source: YF Securities research estimates Robust cash flow generation to continue Turk Telekom has an average high cash flow yield of over 10% and going forward we expect strong cash flow to continue with an average cash flow yield of over 10% in the coming three years. The strong cash flow will also support dividend payments as well as debt repayments. Cash flow generation Source: YF Securities research estimates 24

25 Payout ratio of 100% is maintained as dividend policy Turk Telekom has a policy to distribute 100% of distributable income. A dividend payment of TRY 1.9bn or TRY 0.54 per share will be distributed on May 29, 2012 which corresponds to a dividend yield of 8%. Dividend progression Source: YF Securities research estimates 1Q12 financial results were better than expected due to the positive fx impact Net income beat expectations in 1Q12 as the TRY appreciated 6% in 1Q12 compared to 4Q11 against the USD. Turk Telekom has a net debt of USD 2.8bn at the end of 1Q12 which makes it vulnerable to fx losses in the event that the TRY depreciates. Company guidance for 2012 year end - Management expects to reach a sales growth of 6-8% in Consolidated EBITDA margin in the low 40% levels. - Capex to be around TRY 2.4bn. 25

26 COMPANY BACKGROUND Turk Telekom is Turkey s leading fixed line and wholesale internet operator. The company was originally formed when the postal and telecommunication services were separated in In November 2005 a 55% stake was acquired by Saudi Oger Telecom for USD 6.55bn at a total valuation of USD 11.9bn, while the remaining 45% continued to be held by the Turkish treasury. On May 15, 2008, a 15% of Turk Telekom belonging to the Turkish Treasury was floated on the ISE through an IPO. There are a total of 10 members at the board 6 represented by Oger Telecom and 4 members by the Turkish Treasury. There is one golden share held by the Turkish Treasury. Turk Telekom Shareholding Structure Board of Directors Oger Telecom Turkish Treasury 6 members 4 members (including 1 golden share) Mohammed Hariri Chairman Oger Telecom Ibrahim Sahin Vice Chairman Turkish Treasury Source: Company data Board structure could change Turk Telekom BoD currently consists of 10 members with 6 members from Oger Telecommunication AS and 4 members from the Turkish treasury. The new CMB regulation requires at least 1/3rd of the board members to be independent, which implies that at least four members will be independent. The CMB will determine how many and if there needs to be independent members on the board. The CMB decision will finalize the board structure by the end of June We do not think that the board structure post the CMB regulation change will have an adverse impact on Turk Telekom s performance in the future. Oger Telecom is owned mainly by Saudi Telecom Company (35% stake) and Saudi Oger Limited (47% stake). Oger Telecom also manages the third license in South Africa, Cell C Ltd. Oger Telecom also has a controlling stake in Cyberia, a regional ISP with operations in Saudi Arabia, Lebanon and Jordan. Oger Telecom Shareholding Structure 26

27 Source: Company data Turk Telekom has a 90% stake in Avea the third mobile operator by market share. In February 2012 a capital increase was announced for Avea in which Turk Telekom increased its stake in Avea without incurring any cash outflow as the debt owed to Turk Telekom by Avea was accounted for the capital increase. Turk Telekom will participate in the capital increase of other shareholders, namely Isbank Group companies, if they decide not to participate in the capital increase. Isbank holds the right to have an IPO of Avea which is provided through the put option Isbank holds until December However we think that Turk Telekom would rather buyout the Isbank stake as opposed to an IPO given the complication and the disadvantage of such a listing in terms of a possibly low valuation. Turk Telekom Subsidiaries Company TT Stake Year established Core business Avea 90% 2004 Mobile communications TTNET 100% 2006 Internet service provider Pantel 100% 2010 Internet/data services, fiber optic infrastructure Assistt 100% 2007 Guidance and customer services Innova 100% 1999 Information technologies Argela 100% 2004 Telecommunications infrastructure and services Sebit 100% 1988 Education & information technologies Sobee 100% 2001 Interactive, multi-player, 3-D games Source: Company data Turk Telekom generates its revenues from fixed voice services. The share of fixed voice services has declined over the years from 57% in 2007 to 34% at the end of ADSL services and mobile on the other hand increased their share in total revenues from 13% and 18% respectively in 2007 to 25% and 26% in The share of EBITDA is dominated by fixed services which include fixed voice and ADSL. The company does not disclose separate EBITDA data for fixed voice and ADSL and groups these two segments under the fixed line business. Performance breakdown, 2011 YE Revenue breakdown EBITDA breakdown Source: Company data 27

28 Cloud technologies will be the future growth portal for Turk Telekom TT has broadened the scope of its product offerings through the application of cloud technologies. TT offers internet-based voice and data communications to organizations and corporate clients where telecommunications applications, switching and storage are hosted by TT infrastructure. TT has two products in cloud technology applications: 1. BEL-BIM- a direct product offered to municipalities that do not have the necessary infrastructure to manage corporate data. 2. Fiber to the corporate- Data centers management and maintenance for corporate clients Broadband leadership will continue to be a core asset The available ADSL capacity is sufficient to serve over 30mn subscribers without additional investment requirement. There are currently 7mn ADSL subscribers and 3.5mn are fiber-to-the-cabinet subscribers. Unlimited subscribers account for 66% of TTNet total subscribers and as of April 1, 2012 the price of the unlimited offer has increased from TRY 55 to TRY 59 per month. Pantel acquisition led to revenue growth in 2011 In October 2010, Turk Telekom acquired Pantel, wholesale data and capacity services provider active in Central and Southeastern Europe. Pantel is the first landline fiber optic network operator capable of wholesellling between the Middle East and Europe with over 27,000 optic fiber cables across 16 nations as of 2011 year-end. Pantel revenues made a contribution of an additional 2.5% in 2011 in which total revenue growth was 8%. Value added service offerings will have limited impact on growth Tivibu, the IPTV portal increased subscribers to nearly 100,000 in 1Q12 while Tivibu Web has reached 850,000 subscribers. Digiturk, a subscription based satellite tv provider is the leader in the pay tv market in Turkey and it will be difficult for Turk Telekom to market Tivibu in such an environment. Turk Telekom also offers web tv applications at TRY 4mn per month to TTNet subscribers of which 1mn are subscribed to this service. Fiber connections to improve upsell in ADSL There are currently 1mn home passes at the end of 1Q12 and this figure is expected to reach 3mn at the end of Turk Telekom launched the fiber to the home service in February 2012 and products are offered at higher speeds with higher fixed fees. Turk Telekom currently has 70K fiber broadband subscriptions at the end of 1Q12. 28

29 SUMMARY FINANCIALS Balance Sheet E 2013E 2014E Current Assets 2,845 3,712 4,031 4,569 5,116 5,716 Cash and Cash Equivalents 754 1, ,358 1,659 2,022 Short-Term Trade Receivables 1,487 1,721 1,993 2,090 2,250 2,404 Other Short-Term Receivables Inventories Other Current Assets ,024 Long Term Assets 10,557 11,388 12,143 12,851 13,841 14,898 Long-Term Trade Receivables Other Long-Term Receivables Long-Term Financial Assets Tangible Fixed Assets 6,629 7,161 7,899 8,541 9,212 9,928 Intangible Fixed Assets 3,286 3,517 3,540 3,660 3,948 4,255 Other Long-Term Assets Total Assets 13,401 15,100 16,174 17,420 18,956 20,614 Short Term Liabilities 4,665 4,821 5,607 6,036 6,559 7,009 Short-Term Financial Loans 2,160 1,869 2,302 2,416 2,737 2,925 Short-Term Trade Payables 882 1,311 1,551 1,637 1,687 1,803 Other Short-Term Payables 1,374 1,358 1,514 1,653 1,779 1,901 Other Short-Term Liabilities Long Term Liabilities 3,314 4,105 4,798 4,422 4,088 3,870 Long-Term Financial Loans 1,814 2,330 3,044 2,769 2,309 1,968 Long-Term Trade Payables Other Long-Term Payables 1,494 1,684 1,654 1,653 1,779 1,901 Other Long-Term Liabilities Shareholders' Equity 5,422 6,175 5,769 6,962 8,309 9,735 Total Liabilities and SHE 13,401 15,100 16,174 17,420 18,956 20,614 Income Statement E 2013E 2013E Net Sales 10,568 10,852 11,941 12,714 13,685 14,624 Net Operating Profit 2,460 2,889 3,159 3,411 3,763 3,902 Other Income (Net) Financial income/expense (net) Profit before tax from continuing operations 2,360 3,127 2,609 3,446 3,878 4,108 Tax expense ,049 Minority interests NET PROFIT AFTER TAXES 1,501 2,451 2,069 2,386 2,694 2,851 Cash Flow Statement E 2013E 2014E Cash flow from operations 3,235 3,844 3,970 4,942 5,701 5,984 Cash flow from investing activities -2,079-1,761-2,060-2,416-2,737-2,925 Cash flow from financing -1,444-1,618-2,151-2,061-2,471-2,489 Change in cash and cash equivalents Key Financial Metrics E 2013E 2014E Sales growth 19.5% 2.7% 10.0% 6.5% 7.6% 6.9% EBITDA 4,017 4,412 4,736 1,210 2,400 3,643 EBITDA margin % 38.0% 40.7% 39.7% 9.5% 17.5% 24.9% ROE 34.3% 39.7% 35.9% 39.4% 37.1% 33.5% ROCE 20.5% 21.8% 21.8% 21.6% 21.7% 20.7% Free cash flow yield 8.5% 10.5% 7.3% 10.3% 12.1% 12.5% Source: Company data, YF Securities estimates 29

30 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Jul-11 Aug-11 Sep-11 Oct-11 Nov-11 Dec-11 Jan-12 Feb-12 Mar-12 Apr-12 May-12 Telecommunications, May 28, 2012 Initiation of Coverage Turkcell Market Perform Initiation of coverage with a Market Perform recommendation We initiate coverage of Turkcell with a Market Perform recommendation. Our target price of TRY9.20 per share implies 9.5% upside potential. We employ a sum of the parts valuation methodology and account for the 41.45% stake in Fintur in our total valuation. Turkcell trades at a premium in P/E multiples and at a discount in EV/EBITDA multiples compared to its peer telecom group. Expect slight improvement in margins in 2012 We expect an EBITDA margin of 31.5% in 2012 with a slight improvement compared to the 2011 EBITDA margin of 31.3%. The competition in the mobile market seems set to continue on price driven dynamics which will not improve profitability in We think the fiber optic network rollout through Superonline will improve revenue growth as well as margins as Turkcell will save on transmission service it receives which is currently provided by Superonline with a ratio of 74%. Resolution to board disputes now vital Turkcell s board divided between Cukurova Holding, TeliaSonera and Alfa has been unable to function effectively due to legal disputes. Turkcell has still not announced the date of the ordinary general assembly which remains a concern as independent members, as required by the new CMB rules have to be determined by the end of June. Dividend decision expected to be finalized Turkcell did not distribute dividends from 2010 earnings due to board disputes and investors have long awaited a clarification on the dividends. There is a slim possibility of a double dividend payment in 2012 which would be a combined amount of 2010 and 2011 dividends. However, the date of the General Assembly has still not been announced. The Bulgarian telecom sale process terminated Turkcell submitted a bid for the Bulgarian telecom operator, Vivacom, the sale process of which was terminated on May 4, The news is positive for Turkcell as there will now be a larger reserve for dividends. We think that Turkcell will be cautious in embarking on new international investments given the losses incurred in Ukraine and Belarus. Key Financials & Ratios 2010A 2011A 2012E 2013E 2014E Net Sales (TL mn) 9,004 9,370 9,868 10,249 10,590 EBITDA (TL mn)* 2,948 2,913 3,108 3,237 3,357 Net Profit (TL mn) 1,772 1,183 1,381 1,441 1,499 EBITDA Margin (%) 32.7% 31.1% 31.5% 31.6% 31.7% Dividend yield (%) 4.8% 0.0% 3.7% 3.9% 4.1% P/E(x) EV/EBITDA (x) EV/Sales(x) Turkcell, YF Securities Research estimates Trading Data Sector Telecommunications Bloomberg TCELL.TI Reuters TCELL.IS EV (TRYm) 15,801 Mkt cap (TRYm) 18,480 Free float (%) 25% # of shares (m) 2,200 Av e. Daily Vol. (TRYm) 27.7 ISE-100 (TRY) 54,810 Ownership Stake (%) Turkcell Holding 51.0% Cukurov a Holding 0.1% Sonera Holding 13.1% MV Holding 1.2% Free Float 34.7% Share Price Current Target USD TRY Upside Potential 10% Price Data (TRY) 1M 3M 12M ISE ,941 59,738 63,609 Share Price Absolute -3% -12% -7% Relativ e 6% -4% 8% 2009/ /12 TCELL 2012/ P/E Price/Sales EV/Sales EV/EBITDA P/BV Price Chart (TRY) Price (TRY) Price Chart (USD) Volume (USDmn) Relative to ISE (RHS) Price (USD) (RHS) Duygu Kalfaoglu Phone: duygu.kalfaoglu@yfas.com.tr

31 INVESTMENT SUMMARY Valuation points at limited upside Market perform recommendation Our 12 month price target for Turkcell of TRY 9.20 per share implies an upside of 9.5% which justifies our Market Perform recommendation. Turkcell trades at varying multiples compared to its peers; its EV/Sales and EV/EBITDA multiples imply a discount to the peer group while the P/E multiples imply a premium. Note that Turkcell has a net cash position of TRY 2.7bn at the end of 1Q12 improving its EV based multiples. We expect revenues to reach TRY 9.9bn with a growth of 5.8% coupled with an EBITDA of TRY 3.1bn implying an EBITDA margin of 31.5% for Competition looks set to be price based in 2012 The price based competition is set to continue in Turkcell has already provided guidance on its strategy to employ preemptive marketing in order to establish a strong customer base starting as of 1Q12. Rivals Vodafone and Avea have announced aggressive bundle plans in 2Q12 which will raise subscriber retention costs. Telecom services will focus on data communicaiton Turkcell believes that the future of growth is in data, as voice has reached a penetration rate approaching saturation. Turkcell has focused on products that promote data usage through smart phones or tablets. One such offer enables subscribers to enroll on a package that is limited to Facebook for approximately USD2 a month. The strategy aims to limit dead weight loss by offering products affordable for all income levels. The sale of smarphones which use data more than 5 times compare dto regular mobile phones account to 61% of Turkcell s phone sales whereas this figure is 38% for the market. Turkcell s smartphone base comprises 20% of subscriptions at the end of Lack of clarity on boardroom disputes weighing on Turkcell Clarity on disputes needed The boardroom conundrums which have dominated the headlines will need to be settled in order to achieve favourable investor sentiment. It is not clear on how the CMB would react if Turkcell failed to meet its obligations regarding the new CMB rules on independent candidates, and if the General Assembly does not meet in time. There is a possibility that an extension could be granted but an official confirmation has not been provided regarding such an option. The appointment of independent members will eventually be resolved as mandated through CMB regulation by end of June. The possibility for the number of board members to increase seems likely, in order to establish a fair representation among Cukurova, Teliasonera and Alfa Group. The board currently consists of seven members; according to the new CMB regulation a third of the board must be represented by independent members, which implies that there will be three independent members appointed for CMB approval leaving only four spots for the other three stakeholders. We thus think the number of board members could be increased to 9 in order to leave each group two seats on the board. Undistributed dividends...as well as undistributed dividends Dividend distribution from 2010 earnings was blocked as the board failed to agree on the issue of the assignment of the independent member. This led to expectations for a double dividend payment to be distributed in However we think a double 31

32 dividend payment possibility is slim given that Turkcell would want to maintain cash reserves for other future transactions like share buybacks or acquisitions. The Privy Council to announce its final ruling on the legal dispute between Altimo and Cukurova Group The Privy Council in London ruled that Cukurova Group was not required to deposit a total of USD 1.45bn to an escrow account due to the allegations presented by Altimo claiming that Cukurova Group did not meet its obligations arising from a deal in 2005 and that it failed to pay back its loan owed to Altimo. The Privy Council is expected to announce its final verdict at the end of the year regarding the ownership claim of Altimo for the 51% stake of Cukurova Telekom Holding, which will eventually allow full control of Turkcell. Meanwhile Alfa Group senior officials based in Turkey were reported to have expressed their intent of maintaining Turkcell s Turkish identity, and that an exit would only be possible at a company value of over USD 30bn. Legal action taken against MTN looks set to be long term initiative In April 2012, Turkcell announced that legal action against MTN, the South African telecom company and that a lawsuit had been filed in the US. Recall that Turkcell was awarded the first private GSM tender in Iran in However Turkcell was not allowed to conclude the terms of the license and the government of Iran entered an agreement with MTN instead. Turkcell claims that MTN s actions did not abide by internationally accepted legal norms and eventually led to the cancellation of Turkcell s license. We think the unfolding of the case will be a long term procedure and we thus have not included any proceeds from this case in our valuation. Risks/ upside challenges to our valuation A possible resolution to the board issues, whereby the dividend distribution or share buy-back strategy is clarified, would present an upside challenge to our valuation. Any change in the macro environment resulting in a depreciation of the TRY would be a downside risk to our valuation. Outstanding results from international subsidiaries would be an upside challenge to our valuation. 32

33 SWOT Analysis Strengths - Leader in the mobile market with a share of over 53% by subscriber numbers. - Strong cash flow generation - Completed major investments - Strong balance sheet- the company has a net cash position Weaknesses - Board disputes impeding operational performance - Bound by regulated MTR tariffs - Exposed to FX risk in Ukraine and Belarus Opportunities - Delayed dividend payment in 2010 expected to be distributed in a combined payout with 2011 dividends. - Well positioned to benefit from broadband growth through Superonline - Potential to benefit from the growth in mobile data revenue and in smartphone penetration. - Turnaround in Astelit and Best Threats - Price based competition limiting profitability - Possible deadlock at the boardroom level 33

34 VALUATION We use sum of the parts methodology to find a fair value for Turkcell s main business in Turkey, Ukraine and Belarus and for Fintur, which has mobile operations in Kazakstan, Azerbaijan, Georgia and Moldova. We value Turkcell s main businesses through a blended valuation of DCF and peer group multiple based valuation. We value Fintur in which Turkcell has a 41.45% stake and which is consolidated through the equity pick up method using a multiple based valuation. Our blended valuation is comprised of an average of DCF and peer group multiples analysis. We find a 12 month target price per share of TRY9.20 with a potential upside of 9.5% which supports our Market Perform recommendation for the stock. Figure 3: Valuation summary Asset Valuation Method Value Turkcell stake Contribution (TRY mn) Turkcell main business Blended valuation (Avg of A & B) 17, % 17,749 A. DCF 19,011 B. Peer multiple 16,487 Fintur contribution Peer multiple 6, % 2,587 Total valuation (TRY mn) 20,336 Target price (TRY/share) 9.20 Current price (TRY/share) 8.40 Upside/(Downside) potential 9.5% Source: YF Securities 34

35 B. DCF Analysis We find a 12 month target equity value of TRY19bn using a 5-year detailed USD based free cash flow schedule. We did not assume any dividend payments in our cash flow model. WACC assumptions Risk free rate 6.1% Cost of debt 6.1% Equity risk premium 5.9% Effective tax rate 20.0% Beta 1.0 Equity weight 4.9% Cost of equity 12.0% WACC 11.2% Source: YF Securities Figure 5: DCF Valuation DCF Valution (USD mn) 2012E 2013E 2014E 2015E 2016E TV Sales growth -2.8% 4.4% 2.7% 2.9% 2.2% 2.0% Sales 5,445 5,685 5,840 6,010 6,141 6,263 EBIT ,034 1,072 1,103 1,002 EBIT margin 17.5% 17.6% 17.7% 17.8% 18.0% 16.0% Tax rate 20.0% 20.0% 20.0% 20.0% 20.0% 20.0% Taxes on EBIT NOPLAT Depreciation /- Change in working capital Capital expenditures Free cash flow to the firm Terminal value growth 2.0% Terminal value 9,693 Discount factor Discounted free cash flow ,690 Enterprise value 8,403 Net debt -1,511 Equity value 9,914 Cost of equity 12.0% 12M target equity value (USD) 10,588 12M target equity value (TRY) 19,011 Source: YF Securities 35

36 B. Peer Group Valuation We used peer group multiples of global telecom companies to find a fair value for Turkcell. We find an average value of TRY 16.5bn for Turkcell using EV/Sales, EV/EBITDA and P/E multiples for 2012 and Turkcell trades at a discount compared to its emerging market and European peer group in EV/Sales and EV/EBITDA multiples, while trading at a premium in P/E expected multiples. Peer group summary a. EV/Sales b. EV/EBITDA c. P/E E 2013E E 2013E E 2013E Emerging Market Weighted Avg TCELL multiples Premium/-Disc. -23% -26% -29% 7% 0% -5% 32% -9% -1% Implied value (TRY mn) 17,685 17,526 12,285 12,421 20,272 18,732 Average value (2012&2013 average) 17,605 12,353 19,502 Average of a., b., c. (TRY mn) 16,487 Source: YF Securities, Bloomberg IBES estimates C. Fintur Valuation Turkcell has a 41.45% stake in Fintur, which is consolidated using the equity pick up method and proceeds from the venture are reported directly below the EBITDA line as earnings. We used 2012 and 2013 P/E multiples to derive a fair value for Fintur of TRY 6.2bn and Turkcell s share generates a contribution of TRY 2.6bn. Fintur valuation summary P/E based valuation 24,081 23,596 Implied valuation (SEK mn) (Avg of 2012 & 2013) 23,838 Implied valuation (TRY mn) 6,198 Turkcell's 41.45% stake (TRY mn) 2,569 Source: YF Securities Research estimates Fintur Subsidiaries Country Brand Fintur stake Kazakhstan Kcell 51.0% Azerbaijan Azercell 51.3% Georgia Geocell 100.0% Modovia Moldcell 100.0% Source: Company data 36

37 Fintur data summary Fintur Key Data E 2013E 2014E Mobile subscriptions ('000) 13,564 15,866 18,171 19,080 20,034 21,035 Kcell Kazakhstan 51% 7,165 8,921 10,850 11,393 11,962 12,560 Pre-paid subscribers 5,923 7,574 9,353 9,821 10,312 10,827 MoU Azercell Azerbaijan 51.3% 3,847 3,994 4,166 4,374 4,593 4,823 Pre-paid subscribers 3,733 3,828 3,927 4,123 4,330 4,546 MoU Geocell Georgia 100% 1,892 2,044 2,066 2,169 2,278 2,392 Pre-paid subscribers 1,711 1,743 1,735 1,822 1,913 2,008 MoU Moldcell Moldova 100% ,089 1,143 1,201 1,261 Pre-paid subscribers MoU Net sales (SEK mn) 12,649 12,889 12,806 13,446 14,119 14,825 Kazakhstan 6,762 7,450 7,913 8,309 8,724 9,160 Azerbaijan 4,016 3,817 3,449 3,621 3,803 3,993 Georgia 1,380 1, ,021 1,072 Moldova Fintur income 1,994 2,237 2,420 2,286 2,259 2,372 Source: Teliasonera, YF Securities Research estimates 37

38 FINANCIAL ANALYSIS Subscriber retention and increasing market share will be the focus for 2012 The company targets to acquire subscribers in the post-paid segment and thus we estimate that the number of total subscribers will reach 35mn at the end of We expect post paid subscribers to reach 12.3mn and pre-paid subscribers to reach 22.7mn at the end of Subscriber and ARPU estimates Source: Company data, YF Securities research estimates Turkcell management has posted a guidance of TRY bn for expected sales in We estimate sales of TRY 9.9bn for 2012 implying a y/y increase of 5%. We estimate communication revenues to account for 93% of revenues. Turkcell revenues Source: Company data, YF Securities research estimates 38

39 Turkcell key revenue drivers for the mobile business in Turkey E 2013E 2014E 2015E 2016E Subscribers (EOY) Post paid Pre paid ARPU blended (TRY) Post paid Pre paid Source: Company data, YF Securities research estimates Turkcell revenue breakdown projections TRY mn 2012E 2013E 2014E 2015E 2016E Domestic revenues 8,648 8,966 9,242 9,505 9,778 Communication revenues 8,004 8,291 8,536 8,768 9,007 Monthly fixed fees Commision fees on betting business Call center revenues Simcard sales Other revenues International revenues 1,320 1,386 1,455 1,528 1,604 Communication revenues 1,282 1,346 1,413 1,484 1,558 Commission fees on betting business Plant and fixed fees Simcard sales Other revenues/eliminations Eliminations/discounts Total revenues 9,868 10,249 10,590 10,923 11,269 Source: Company data, YF Securities research estimates Turkcell cost of goods sold projections TRY mn 2012E 2013E 2014E 2015E 2016E Cost of goods sold Treasury share -1,201-1,244-1,280-1,315-1,351 Amortisation and depreciation -1,382-1,435-1,483-1,529-1,578 Interconnection fees -1,121-1,161-1,195-1,227-1,261 Radio expenses Employee costs Trans, base station rent & maint.costs Global service fund Roaming costs Billing costs Cost of simcards sold Other Total COGS -5,922-6,141-6,333-6,518-6,709 Source: Company data, YF Securities research estimates 39

40 Profitability margins Margins followed a declining trend post the introduction of MNP in November The EBITDA margin slipped from 37% levels in 2008 to 31% in 2011 as marketing and promotional campaigns took a toll on profitability. The fact that other operators namely Vodafone and Avea strengthened their distribution networks by adding more exclusive shops also led subscriber additions to lose momentum. We expect the deterioration in the EBITDA margin to lose momentum and stabilize above 30% levels going forward. The marketing of mobile data and internet services will improve profitability as the company will not incur additional costs. EBITDA and EBITDA margin Source: Company data, YF Securities research estimates Cash flow generation to pick up Turkcell recorded an all-time low cash flow yield of 2.5% based on an average Mcap in We expect the yield to improve in 2012 as revenues from value added services will improve revenue growth as well as profitability. Turkcell guidance on Capex for 2012 is around 17% of sales for We expect the cash flow yield to approach to 8% in 2012 up from the 2% level in Cash flow generation Source: YF Securities research estimates 40