A Telecom Monopoly in Russia

It’s no secret I’m bullish on Russia. I know this isn’t an easy stance to take given the tensions between the United States and Russia right now, but I don’t care. I try to find value where value resides. To me, there’s tremendous asymmetric value to be found in Russia. The bad part of Russia is their government structure. The Russian government is still a quasi communist operation with the KGB running the show. However, I don’t want to get too deep into the woods with the politics. One of the companies that I really like is Mobile TeleSystems PJSC (MBT).

Mobile TeleSystems is a monopolistic powerhouse in the telecommunications industry. MBT is the largest telecommunications company in Russia. The company provides fixed – line broadband and pay-TV services. Russia contributes over 90% of its sales, but MBT is also one of the largest wireless operators in Ukraine, Armenia, and Turkmenistan. Also, MBT recently acquired a 49% stake in the largest telecom operator in Belarus.

Company History

Mobile TeleSystems was founded in 1993 by Moscow City Telephone. MBT was the first company to launch GSM services in the Moscow region in 1994. Shortly after, the company expanded rapidly into Russia through acquisition of smaller independent telecom companies. After capturing nearly all of the mobile telecom market in Russia, the company set their sights abroad.

Monopoly Through Acquisition

In 2002, the company established a JV with Beltelecom, the national fixed line operator in Belarus. A year later (2003), the company acquired the leading telecom operator in the Ukraine, which remains the biggest CIS market outside of the Mother Land. Two years later (2005), the company acquired Barash Communications Technologies, Inc, the number one operator in Turkmenistan. In September 2007, the company acquired the leading mobile operator in Armenia, K-Telecom. A little over a year later (2008), the company branched outside of its direct Eastern European neighbor with the joint agreement between MBT and Shyam Telelink Limited (Indian telecommunications company) for the Indian company to use the MBT brand.

History on the Exchange

MBT has been listed on the NYSE since July 2000. The company’s shares are also listed locally on the Moscow Exchange since November 2003. Their bran “MTS” launched in 2006 in which the company built on its reputation as the leader and highest quality operator in Russia. This brand was developed to attract customers from a variety of cultural, socio-geographic, and income groups. This determination to rebrand themselves paid off handsomely, as the company has been internationally recognized for seven straight years. In 2008, MBT became the first and only Russian company to enter BRANDZ Top 100 Most Powerful Brands.

From Expansion to Internal Growth

The company took a break from their “Alexander The Great” conquest of the mobile telecom industry and looked inwards to develop the internal infrastructure needed to successfully operate a business of that reach. Their first internal initiative was titled ‘3i’, which focused on integration, internet, and innovation. To accomplish this, the company acquired Cornstar-UTS, the leading supplier of integrated telecom solutions in Russia. The acquisition provided access to important growth markets in commercial and residential broadband, which allowed the company to realize value-accretive synergies in capital and operational expenditures.

Four years later, MBT acquired 25.1% of MTS Bank OJSC. Before 2013, the company already owned a small stake in MTS Bank through MTS’s majority-owned subsidiary Moscow City Telephone Network. MBT and MTS Bank have also concluded a profit-sharing agreement where MBT and MTS would realize 70% and 30% of the proceeds from its MTS Dengi (India) project.

In order to further its presence online, the company acquired a 10.82% stake in OZON Holdings, Russia’s leading e-commerce company. This investment complements MBT’s core mobile and retail businesses by aligning MBT with Russia’s largest e-commerce company. The company leverages OZON’s logistical infrastructure, its proprietary delivery services, IT capabilities, and industry expertise to improve MBT’s own online store.

In 2014, the company took a controlling stake in the Russian-Uzbek entity Universal Mobile Systems LLC (UMS). UMS was granted 2G, 3G, and LTE licenses, and received frequencies, numbering capacity and other permits for various operations. This is huge because Russia is a bit behind the curve when it comes to mobile telecom technology. Nevertheless, MBT has those capabilities.

Current Business Strategy

The company is focused on its ‘3D’ initiative: Data, Digital, and Dividends. The data segment of the initiative is to provide its customers with the fastest, most reliable mobile and fixed line networks in the region. Think of it like the Verizon Wireless of Russia (note this is not an endorsement to VZ as an investment, merely a comparison of business models and initiative).

The digital component of the strategy signifies the company’s effort to expand in other areas beyond the telecom industry through development of various digital products such as: fintech, IoT, BigData, system integration, and e-commerce.

Finally the Dividends segment of the strategy. One of the aspects of the company that drew me into further investigation was this category of their current business strategy. Although the capital I deploy is via a paper trading account, I treat it like I would real money in my own fund. Due to this, there is an inherent risk in risking capital in Russian business ventures. However, if management’s goals are streamlined to reward their shareholders, it doesn’t really matter to me if that company is in the US, Russia, or Tim-buck-two. The company, through prudent operational approaches, stable investment programs, and opportunistic debt management, the company has been able to steadily grow its cash flows while reducing its balance sheet obligations. As a result, the company has had more cash available in which they will return to their shareholders.

Balance Sheet Analysis

The company expanded its total assets by nearly $1.1B over the last quarter coming in at $9.46B. It’s total liabilities are $7.35B $4.02B of which is composed of long-term debt. Cash to debt sits at 0.29, better than 45% of its competitors. The company has significant debt, yes, but its debt that can be overcome if management continues to operate like they have been. Debt levels are actually declining since their 2015 peak of $6.01B.

Leverage is something to worry about with this company, but a current ratio of 0.93 and a quick ratio of 0.86 isn’t something that would necessarily keep me up all night, that is, if the company can continue to fund its operations. The company is currently 3.8x levered, which is above the 2.6x average.

How Well Are Operations Funded?

The company reported $2.1B in total operating expenses for Sept. 2017. During the same time period the company brought in $5.7B in cash from operations, more than enough to cover its operating costs into the forseeable. In fact, the company has managed to reduce its total operating expenses over the last three-quarters while simultaneously increase its cash from operations.

Overall, I am confident that the business will continue to fund 100% of its operating expenses from its cash from operations. It has no need to debt finance when it’s bringing in more than 2x cash than expenditures.

Valuations (Cash-Flow is King)

The company is trading 1.6x sales, exactly average for the industry. Taking a look at Enterprise Value to FCF, the company trades at roughly 12x, well below the sector average of 24.3x, a 51% discount to sector averages. Finally, the company trades only 9.3x its EV/EBIT, a 40% discount to the sector average of 15.6x. These valuations are relatively low in all areas compared to its peers and sector, which you don’t often see coming from one of the largest players in the field.

Show Me The Yields

The company has an earnings yield of 8.2%, 26% higher than the sector average of 6.5%. FCF Yield comes in at 10.6%, that is good for 200% greater than sector average of 3.5%. The company also sports an Earnings Yield of 11.48%, better than 89% of its competitors. Finally, the company pays a dividend of 7.2%, much greater than the 3% yield of its peers, and the 3.5% yield of the sector as a whole.

Current Business Operations

To go along with its size, the company also leads its industry in most profitability and growth metrics. Their operating margin is better than 86% of industry at 21.60%, and net margin of 13.14%, better than 82% of competitors. The company sports a ROE of 43.74% and an ROA of 10.36%, better than 96% and 87% respectively. Return on Capital comes in at 36.39%, that’s 78% better than competitors.

Let’s dive into their most recent quarterly earnings report. Total Group Revenue increased 7.2% to $114.6 RUB bln, while adjusted OIBDA (Operating Income Before Depreciation & Amortization) increased 10.9%. Since the company generates revenue from its five separate locations throughout Eastern Europe, we can break down revenues to see where the lions share is coming from. The company generated 93% of its revenues last quarter from Russia, which is consistent over the last three quarters. Revenue from Armenia increased 9.5% to $1.8 RUB bln. Turkmenistan revenue declined over the recent quarter 10.8% to $990MM RUB. Belarus revenue increased 8% to $5.8 RUB bln. Finally, revenue from the Ukraine increased 1.7% to $6B RUB bln.

Margins across countries were (for the most part) healthy. Russian OIBDA margins increased 10.7% to 46.6, Armenia increased 14.2% to 47.2, Ukraine decreased margins by 3.2% to 41.4, Belarus increased margins 12.5% to 49.4, and finally Turkmenistan reduced margins 60.6% to 15.7. Net Profit and profit margin both increased over last quarter. Net profit increased 22% with margins increasing close to 3%. The company’s been able to grow net profit at quarterly clip of 16.3% over the last 6 quarters.

Taking a Look at Debt

The company is expected to pay 13.8 RUB bln of its debt in Q4 2017, 54.1 RUB bln in 2018, 74.3 RUB bln in 2019, 65.5 RUB bln in 2020, and then 69.3 RUB bln until debt is paid off. Over the last six quarters, the company has kept its Net Debt / Adjusted OIBDA at about 1.1 – 1.3.

Retail & Service Side Business

Over the last 11 quarters MBT has expanded its retail store presence at a 3.12% quarterly clip, and 34% total growth since Q1 2015. Over its most recent quarter, the company opened 18 new stores. Handsets & Accessories grew 34.78% over the most recent quarter, with gross margins increasing 5% in that category to 14.7%. The company has also grown its MyMTS (the company’s mobile app) users to 11.0 million, a near 2 million increase since last quarter, and 15.49% growth over the last six quarters.

Outlook for 2018

Currently the company expects revenues to grow about 2%, which makes sense given the tremendous size of the business. Tailwinds for revenue growth include service revenue growth in Russia as a whole, competitive factors in Russia & tariff policies, handset sales due to overall optimization of the company’s retail business, and developments within the company’s foreign subsidiaries. The one major potential headwind could also be the valuation and volatility of the Russian ruble. The company is expecting a 5% increased in OIBDA, and a reduction of capex spending of 75 RUB bln.

The company also plans to continue its share repurchase program as long as business operations remain profitable. Since the launch of the repurchase plan back in Sept. 2017, the company has acquired 64,581,020 shares or 3.23% of total shares outstanding.

The Market’s Take

The market is assuming that because this company is so large, it will compound a return of around 3 – 4% per annum like any other giant utilities company would in the United States. Utilities aren’t a sexy investment, and nobody on Wall Street likes pitching them, and you can bet you won’t hear any talking heads on CNBC rave about their “next hot utility stock” about to rip higher!

Because of this, the market isn’t looking deeper into this company and seeing the tremendous margin superiority, the virtual monopoly, and the FCF yield of 10.6%. Share prices over the last year appreciated 20%, but if you look over the last five years you get a different picture, a 37% decline in share value. If you bought this stock even 10 years ago you would have 63% less of your initial investment. The PHLX Utility Sector Index is down roughly 11% since Nov. 2017, which is a stark contrast to the S&P 500’s rise of 7% (11% before early February). Finally, it cannot be overstated the impact this “Russian Collusion” with the Trump campaign and administration has had on the United States’ outlook on Russia. The fact of the matter is these Russian businesses almost certainly didn’t have anything to do with these political strifes. However, negative news is like a low tide, it lowers all the ships.

Finding A Fair Value Range

In an effort to find a range of fair business value I used a 10YR DCF Terminal Growth model with the following inputs: A discount rate of 8.5%, Revenue 10YR CAGR, 42.4% 10YR Avg EBITDA Margin, and a 2.3% unlevered FCF 10YR CAGR. Revenue projections were (in millions) $7,232 by Dec 2021, or 10.6% growth cumulative over the next 4 years. The company’s historical 5-yr average CAPEX spending as a percentage of revenues is 16.9%, so I chose 17.1% for Dec 17 – Dec 18, and 16.2% after that.

In order to come up with a price range of fair value, I used a low, medium, and high perpetuity growth rate of 0%, 1.5%, and 2%. Using those growth rates I came to a Terminal Value range of 16,595 – 25,390 with an implied fair value range of $15.04 – $20.71, or about a 46% upside from current market price. The implied revenue multiples are between 2.3x and 3.5x, and EBITDA multiples range from 5.3x to 8.1x. These multiples aren’t far off from the companies average EBITDA multiple of 5.2x.

Variant Perception

This company is a growth machine disguised as a slow-growing utility player. Because of this false premise, I believe the mis-pricing of market value to intrinsic business value is valid. The company dominates the mobile telecom space in one of the most populated areas on Earth, and is still expanding into different industries. Last week the company announced a 100% stake in Ticketland.ru, and a 78% stake in Ponominalu.ru, both are leading businesses in the event ticketing industry in Russia. Moreover, MBT signed a deal with the tech giant Nokia to launch a 5G network in Russia, this could be a huge driver of growth as more and more countries are starting the switch to 5G.

I almost don’t want to make this comparison, but I’m going to anyways. It looks and feels like MBT is the Amazon of the Russian mobile telecom business. By saying that, I mean the company is extremely large, has broad reach across multiple domains and platforms, and is actively looking to expand through acquisition. Yet for some reason this company is only trading 13x FCF.

Getting Technical

To top it all off, the charts look extremely constructive. Price has formed a symmetrical triangle with horizontal price resistance at $12.08. I am long currently at $12.61 with my stop-loss set at $9.00. I put the stop-loss significantly back in order to give price room to move around before legging higher (hopefully). As of today (2/24) I am risking 50bps, but I might add another 25bps of open risk before it’s all said and done and I start moving stop-losses up.

Where is My Fallibility?

Here are the top reasons why I my thesis could fail:

  1. Debt, debt, debt. The company could either leverage itself over its historical normal of 1.1x – 1.3x, or it could simply decide to shut-down its long – term debt reduction plan in favor of more leverage.
  2. Cash from operations could decrease due to increased operating costs that come with a broad reach and global initiative in multiple business sectors.
  3. Instead of continuing its Share Repurchase program, the company could start issuing shares to debt finance its operations.
  4. A slash in dividend.
  5. Political tensions between the US and Russia could become so intense and polarizing that no matter how good the business, the market will do anything it can to bring down Russian based businesses.


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