December 30, 2015 - 11:00pm EST by
2015 2016
Price: 8.41 EPS 0.59 0.62
Shares Out. (in M): 2,762 P/E 14.3 13.5
Market Cap (in $M): 5,956 P/FCF 12.6 11.7
Net Debt (in $M): 2,553 EBIT 2,966 3,133
TEV (in $M): 8,509 TEV/EBIT 11.2 10.6

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  • Telecommunications
  • Israel
  • Broadband
  • telephony
  • Industry Consolidation
  • Regulatory Change
  • Dividend


Executive Summary

Bezeq Israeli Telecommunication Corporation Ltd. (“Bezeq”) is Israel’s largest telecom provider based on revenue and subscribers. Bezeq operates the most comprehensive telecom infrastructure in Israel with market-leading positions in fixed line, mobile, ISP, and pay TV businesses. Bezeq is a top player in each of its core markets with ~65% market share in fixed line telephony and broadband internet, 27% market share in mobile, 40% market share in Israel’s ISP market (which is separate from the provision of broadband internet access) and 40% market share in pay TV.



Bezeq is publicly traded on the Tel Aviv Stock Exchange and is included in the TA-25 index, which includes 25 traded companies with the highest market value in the TASE. Bezeq is a subsidiary of B Communications Ltd. (BCOM), which is a public company in Israel whose only asset is its ~30% stake in Bezeq). BCOM is a subsidiary of Internet Gold Golden Lines (Nasdaq: IGLD), which is a subsidiary of Eurocom Communications, a member of the Eurocom Group. Eurocom was established in 1979 by Shaul Elovitch and has investments in telecommunications, satellite services, media, real estate, consumer electronics, and financial services.

Source: BCOM investor presentation



Bezeq is an attractive event-driven play with multiple catalysts to drive substantial increases in EBITDA over the next 2-3 years. We believe the following catalysts are not fully appreciated by investors and discounted in today’s closing stock price of ILS 8.41 per share.

  1. Full implementation of fixed line voice and broadband wholesale markets: Media outlets and research analysts have routinely and significantly overestimated the ultimate negative impact to Bezeq as Israel implements a wholesale pricing regime that allows upstarts to piggyback on Bezeq’s infrastructure.

  2. Removal of structural separation: Israeli law mandates that Bezeq’s four subsidiaries must be held in separate legal entities and must be outfitted with heavily duplicate back office, management, and other general and administrative infrastructure. In conjunction with the implementation of wholesale markets in fixed voice and broadband, the government is expected to permit the removal of structural separation over the next few years. We expect significant cost savings as these barriers to full legal integration are removed and believe these savings, while sometimes discussed, are not included in analyst estimates.

  3. Wireless market consolidation: After years as a three-player market the Israeli government opened the wireless market to competition in 2011 on terms highly favorable to new competitors. At one point the market swelled to 10 competitors for a population of ~8 million people and new competitors led a brutally competitive race to the bottom in mobile pricing, which cost incumbents hundreds of millions of shekels in EBITDA. We believe that mobile consolidation will occur near term and that mobile ARPUs could conservatively recover ILS 20/month, a roughly one third increase from current levels.


Bezeq stock could be worth 10 shekels (ILS) per share in one year, representing a 25% total return inclusive of the 7% dividend yield on the current stock price of ILS 8.41. In a reasonably conservative upside scenario, Bezeq could be worth ILS 12 per share one year from today, representing a 48% total return from today’s stock price.


Bezeq's market cap is ILS 23.2bn, or ~USD 6.0bn at the latest USD/ILS exchange rate of 3.9 shekels to the dollar. Bezeq trades only in Tel Aviv but is fairly liquid, trading roughly ILS 30mm, or USD 7.8mm, worth of stock per day.


Bezeq Company Overview

Bezeq had 2.2 million active fixed telephone lines, 1.5 million fixed line broadband internet subscribers, 2.6 million mobile telephony subscribers and 639 thousand pay TV subscribers as of September 30, 2015. For calendar year 2015, we expect Bezeq to generate ILS 10.6bn in revenue and ILS 4.3bn in EBITDA. Bezeq’s services are provided by the following company segments:


Domestic Fixed Line Telephony and Broadband (ILS 4.4bn in revenue, ILS 2.9bn in EBITDA): Bezeq is the incumbent and largest provider of fixed line telephony and fixed line broadband internet access services in Israel. Products and services include basic telephony services on domestic telephone lines and fixed line broadband internet access services through Bezeq’s nationally deployed, high quality infrastructure. Bezeq’s next generation network is the most advanced fixed line communications network in Israel and covers 98% of Israel’s population. Bezeq is in the middle of a fiber rollout that is expected to reach 1.3mm households by the end of 2015.

Bezeq has consistently increased its market share in the broadband infrastructure market since 2012, with market share increasing to 67.6% in September 2015 from 60.3% in December 2012. Broadband ARPU has continued to rise, reaching ILS 87/month for LTM September 2015, up from ILS 81/month in 2012. Over the same time frame, HOT, Bezeq’s main broadband competitor, saw ARPU fall from ILS 62/month to ILS 51/month.


Mobile Telephony (Pelephone) (ILS 2.9bn in revenue, ILS 592mm in EBITDA): Pelephone is among the leading mobile telephony service providers in Israel. Pelephone’s nationwide 3.5G network supports download speeds of up to 42 Mbps and upload speeds of 5.7 Mbps, making it one of the fastest, highest quality and most advanced networks in Israel.

Since the Israeli government opened the mobile market up to wholesale competitors in 2012, Bezeq’s Pelephone subsidiary has done an admirable job stemming subscriber losses and mitigating EBITDA losses. Pelephone has lost only 73k subscribers since 2013, while competitors Partner and Cellcom have lost 260k and 216k subscribers, respectively, from similar beginning subscriber bases. Additionally, Pelephone cut almost ILS 800mm in operating expenses since 2012, supporting EBITDA margins of 21% in 9M 2015 (down 10% since 2012) vs. 19% at Cellcom (down 11%) and 14% at Partner (down 15%).


ISP, ILD, Data Services and ICT (Bezeq International) (ILS 1.6bn in revenue, ILS 377mm in EBITDA): Bezeq International is the leading provider of ISP services in Israel and one of Israel’s leading providers of international and domestic data transfer and network services. Israeli law mandates a separation in the provision of internet service and internet infrastructure; thus customers pay for the connection (in Bezeq fixed line) and for the ISP through which they access the internet (can be through Bezeq’s ISP or through a wholesale competitor). Bezeq’s ISP segment deployed the JONAH high-speed submarine optical fiber communications cable system connecting Israel and Europe in January 2012, providing increased bandwidth and positioning Bezeq International as Israel’s only ISP to own and operate an advanced international network. 


Multi-Channel Pay Television (YES) (ILS 1.8bn in revenue, ILS 595mm in EBITDA): YES offers nationwide coverage through its DTH technology and is the only company in Israel licensed to provide multi-channel pay TV broadcasts via satellite and is one of only two companies in Israel licensed to provide multi-channel television services. YES is differentiated from its main competitor, HOT, through its wide range of high quality content on 178 channels, including 20 HD channels, and approximately 23,000 VOD titles. Of 220 new theatrical releases that aired in Israel in 2012, 60% were broadcast only by YES during 2013.

Bezeq’s YES has grown market share by 2 percentage points vs. its main competitor HOT since Q1 2014 despite maintaining stable ARPU at a premium to HOT.


The Telecom Industry in Israel

Israel has high penetration rates across all telecom services that are in line with developed economies in the European Union and the U.S. High levels of penetration are attributed to rapid adoption rates of new technologies, significant expenditures on telecom services by consumers and businesses and a relatively young population. Fixed line losses in aggregate have been lower than in other developed countries. Bezeq IR believes this is due to larger family sizes (doesn’t make sense to give each kid a cell phone) and general security considerations (families feel there is a need to have a fixed line in the home given enduring regional conflict).

The broader communication market is dominated by four players: Bezeq, the HOT Group, the Cellcom Group and the Partner Group, each of which have interests in some or all of the main telecom segments in Israel.

  • HOT (Altice subsidiary): HOT is the only competitor that matches Bezeq’s full offering of fixed line telephony, broadband internet access, mobile telephony, pay TV and ISP services. HOT had 19% market share in fixed line telephony, 38% market share in broadband, 8% market share in mobile and 60% market share in pay TV. HOT is owned by Patrick Drahi’s Altice.

  • Cellcom (TASE:CEL; ILS 2.5bn market cap): Cellcom provides fixed line telephony, mobile telephony and ISP services through its Cellcom and Netvision brands. Cellcom had 8% market share in fixed line telephony and 32% market share in mobile telephony as of 2013. Cellcom is publicly traded in Israel.

  • Partner Group (TASE:PTNR; ILS 2.7bn market cap): Partner provides fixed line telephony, mobile telephony and ISP services through its Orange and O12 Smile brands. Partner had 8% market share in fixed line telephony and 30% market share in mobile telephony as of 2013. Partner is publicly traded in Israel and is ~30% owned by Haim Saban, who was until a few years ago a large shareholder in Bezeq along with Apax Partners.

  • Golan Telecom (private): Privately owned by French entrepreneur Xavier Niel. Much of Golan’s success has been enabled by its ability to convert network rollout with a fixed payment to Cellcom, practically removing its variable hosting cost and capex needs. The Israeli Ministry of Communications (“MoC”) has recently opposed the inclusion of 4G within the scope of the agreement, calling for more active participation by Golan.









Full Implementation of Fixed Line Voice and Broadband Wholesale Markets

There are currently just two companies that own their infrastructure: Bezeq and HOT. While head of Israel’s MoC, Moshe Kahlon initiated a wholesale market freeform process through that would enable Cellcom, Partner, and other operators to access Bezeq’s and HOT’s networks and offer fixed telephony and broadband services on a wholesale basis. In January 2014, the ministry set a wholesale broadband price of ILS 50/month, a steep discount to the ~ILS 90/month ARPU that Bezeq realized in 2015.

Following initial details of the wholesale market, local news outlet Globes published a stream of articles suggesting Bezeq could lose hundreds of millions of shekels as telephony ARPU goes as low as ILS 10/month (from current levels of ~ILS 45/month) and wholesale broadband ARPU goes as low as ILS 30/month (from current levels of ~ILS 85/month). More recently, the MoC published wholesale broadband ARPU rates of ILS 51/month, well above prior worst case scenarios.

Most importantly, HOT’s infrastructure is also being opened up to wholesale market competition, and Bezeq management believes it is likely that Bezeq will gain a portion of HOT’s churned subscribers. If Bezeq attracts 30% of HOT’s churned subs, we believe Bezeq EBITDA will be positively impacted by the new wholesale market regime. Similar assumptions in wholesale telephony yield a relatively small EBITDA loss of ~ILS 100mm, much less than the ILS 500mm to ILS 1bn of EBITDA that many analysts assumed Bezeq could suffer when the idea of the wholesale market was first discussed.

Please see below for a reconciliation of EBITDA gain and loss associated with wholesale market pricing.



Removal of Structural Separation

In return for opening up its infrastructure to the fixed telephony and broadband markets, the MoC will gradually remove structural separation that forces Bezeq to spend hundreds of millions of shekels per year in duplicative back office infrastructure and other G&A. We believe that after wholesale pricing is implemented in the fixed telephony market, the MoC will begin steps to remove structural separation at Bezeq International, Bezeq’s ISP. G&A savings from the removal of structural separation at Bezeq International are expected to total ILS 250mm per year by 2018. Following the merger of YES into Bezeq (until earlier this year Shaul Elovitch controlled 51% of the company directly), Bezeq should be able to collapse YES into Bezeq, saving ~ILS 210mm by 2018. Finally, Bezeq expects to be able to collapse Pelephone by 2019, ultimately saving ILS 200mm (assumed ILS 100mm in 2018). Altogether, the removal of structural separation should save Bezeq ~ILS 560mm by 2018 and in excess of ILS 600mm by 2019.

While a few analysts covering Bezeq have recognized the potential for substantial savings, none appear to explicitly include these savings in their 2017-2018 estimates.


Wireless Market Consolidation

After years of a profitable three-player market in mobile, Communications Minister Moshe Kahlon opened the Israeli mobile market to competition in 2011. The market swelled to ten players and is now one of the most competitive globally with six MNOs and several MVNOs in a country with a population of just eight million. The market reform began with a 73% cut in mobile termination rates and the cancellation of exit fines and accelerated in May 2012 with two new 3G MNOs, Golan Telecom and HOT Mobile. A sixth MNO, Xfone, acquired 5 MHz of spectrum in the latest LTE auction. Increased competition has led to aggressive price competition and sub €10/month packages. At Bezeq’s Pelephone, ARPU went from ILS 111/month in 2010 to ILS 65/month in Q2 2015. A recent slide from Partner Communications below shows the substantial increase in competition from 2011-2015 and the subsequent negative impact on mobile ARPU in Israel.

Source: Partner Communications investor presentation


Golan has grown to ~900k subscribers through aggressive promotional pricing, offering second lines for a little as ILS 2/month earlier this year. Golan committed to investing in a full service nationwide network when it received its license to operate in Israel but was allowed to sign a shorter-term agreement with Cellcom to share Cellcom’s network infrastructure before beginning to invest in its own network.

In March, new MoC Director General Shlomo Filber shifted emphasis from maximizing competition to encouraging investment in infrastructure and creating a more balanced competitive environment. Consistent with this approach, the MoC rejected the hosting agreement between Golan and Cellcom and is looking to enforce network sharing criteria whereby the two entities share the cost and ownership of the network. As of January 1, 2016, Golan will be in violation of its license if it doesn’t commence network investment, and analysts estimate Golan would have to invest up to ~ILS 250mm per year if independent.

Filber spoke with Bloomberg in October and said that mobile prices were too low and that there should be fewer operators in the market. Shares of predominantly mobile operators Cellcom and Partner jumped on the news as investors anticipated consolidation, and in November Cellcom announced it would buy Golan for ILS 1.5bn. Much ink has been spilled around whether the deal will be approved as Israel’s Ministry of Finance (now chaired by Moshe Kahlon, who led mobile market reform a few years ago) has voiced opposition to mobile consolidation, but we believe consolidation is imminent, deal or no deal. Without a sale, we believe Golan is likely to exit the market as it owes ILS 400mm to Cellcom and it will have to invest ~ILS 250 per year in its network following the expiration of its current network sharing deal with Cellcom.

We believe that ARPUs in mobile are likely to rebound to at least ILS 85/month over the next 2-3 years if Golan enters the market, up from ~ILS 65 in Q3 2015. Note that we have modeled only a modest rebound in mobile pricing to ILS 72/month by 2018.


Political Considerations

An at least elementary understanding of Israeli politics is key to an investment in Bezeq. Shaul Elovitch has been close to Israeli Prime Minister Benjamin Netanyahu and Netanyahu has in the past been supportive of Bezeq specifically and of the telecom sector generally. Bezeq owns an online news outlet, Walla (not included in our valuation), which has provided favorable coverage to Netanyahu.

As MoC Director, Moshe Kahlon’s main goal was to reduce the cost of living in Israel, and he was hugely successful with mobile ARPUs declining from ~ILS 120/month to less than ILS 60/month earlier this summer. Kahlon got a lot of traction politically, which bothered Netanyahu.

Earlier this year, Kahlon was forced out of the MoC. Netanyahu himself headed the MoC until Shlomo Filber, whom Israeli news outlet Globes called a Netanyahu “puppet,” took over as Director in May 2015. Filber has given a number of interviews in the last six months in which he telegraphed his support for consolidation in general and, later, for the Cellcom/Golan deal. Both the MoC and antitrust department must approve the Cellcom/Golan deal. David Gilot, the former antitrust commissioner, resigned this summer in protest over a gas deal he opposed (Netanyahu found a solution that allowed the deal to go through over Gilot’s opposition), leaving Netanyahu as acting antitrust commissioner. Kahlon, now the head of the Ministry of Finance, has given interviews in which he opposes the Cellcom/Golan deal, but our understanding is that neither the Ministry of Finance nor the Ministry of Economics have veto power over a deal.

If a deal is not approved, we believe Golan will exit the market rather than repay an estimated ~ILS 300mm in guarantees it won from the Israeli government when it received its provisional license. Remember, Golan would also be on the hook for ~ILS 250mm per year in network investments, rendering it unprofitable.  



We believe that Bezeq should trade at 7.5x forward EBITDA and use 2018E EBITDA (valuation as of 12/31/17, discounted at 10% to year-end 2016) to account for a close to full realization of the substantial savings associated with the removal of structural separation. At 7.5x our base case EBITDA, Bezeq could trade at ILS 10 by 12/31/16 and ILS 11 by 12/31/17, representing a two-year IRR of 22% including Bezeq’s 7% dividend yield. At ILS 11 by 12/31/17, Bezeq would trade at a 7.5% forward dividend yield (Bezeq’s policy is to pay 100% of net income as dividends) and an 8.6% forward FCF yield, well wide of European telecom comparables that trade at 5-6% one-year forward FCF yields.

Please see the table below for downside case and upside case sensitivities.



I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


* Implementation of fixed line telephony and broadband wholesale markets and clarity on rate structures

* Continued progress on removal of structural separation

* Closure of Cellcom/Golan deal or Golan market exit

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