TELECOMMUNICATION SECTOR: The Telecommunication Shield Remains a Good Defence

In this report we initiate coverage of Russian mobile companies MTS, VimpelCom and MegaFon and reinitiate coverage of major Russian telecommunication company Rostelecom. We assign BUY ratings to Rostelecom’s ordinary and preferred shares and HOLD ratings to the mobile operators.
Mobiles are priced fairly… We believe that the market is correctly pricing the shares of MTS, VimpelCom and MegaFon. All three stocks have outperformed the market YtD, largely attributable to their defensive nature. However, our view is that further upside potential is limited by the companies’ high valuations and, furthermore, should the market direction shift upwards, there is a risk of underperformance. The mobile Big Three’s dividend yields all fall in the 6-7% range and their valuation ratios as well as our DCF-derived target prices support our view that they are currently fairly priced.
...But Rostelecom unfairly punished. Rostelecom’s 2013 share-price plunge (-12% YtD) is not based on its fundamentals, in our view, but mostly related to its reorganisation and the ambiguous future of Marshal Capital’s 10.7% stake. The company’s own managers have also been selling its shares, which cannot have helped its performance. We believe that the partial buyout of shareholders voting against the company’s reorganisation or abstaining from voting presents a good opportunity for investors to sell some of their shares at prices higher than the market. Furthermore, Rostelecom has several potential triggers which may have a very strong impact on the share price. These include a London listing, the conversion of preferred shares into ordinaries, and privatisation. Nonetheless, it is Rostelecom’s fundamental undervaluation based on our DCF model that is the main reason for our BUY rating.
In focus this year: LTE and Tele2. We believe that the two major events in the telecommunication market this year are likely to be the creation of a Long Term Evolution (LTE) network and the further development of Tele2 in Russia. The sector is transforming rapidly, with the likely outcome being increased revenues from mobile data services and Value-Added Services (VAS) and a simultaneous decline in revenue from voice services. All four companies on which we initiate coverage have been granted licences for the construction of LTE networks in Russia. We believe that the companies able to develop their LTE networks fastest and with superior quality will have a market advantage and therefore be able to demonstrate greater growth in total revenues.
Fourth operator? In Mar 2013 VTB purchased Swedish mobile operator Tele2’s Russian assets. The deal came as a total surprise to investors and to Russian mobile operators that were ready to offer significantly higher prices for the asset. Although VTB has stated that it will consider all offers for potential collaboration, we believe that the only real candidate for the alliance is Rostelecom. The shape of the potential association is not clear and we do not expect any respective progress until Rostelecom finalises its reorganisation (Oct 2013). However, the potential creation of a fourth mobile operator presents a major threat to our valuation of the existing mobile companies.

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