Description

NTT DoCoMo is the largest wireless telecommunications provider in Japan with a 56% market share and a subscriber base of approximately 50 million. The company offers a wide variety of leading-edge mobile multimedia services, including i-mode®, which provides e-mail and Internet access to over 44 million subscribers as the world's most popular mobile Internet service, and FOMA®, launched in 2001 as the world's first 3G mobile service based on W-CDMA. DoCoMo’s largest shareholder is Nippon Telegraph and Telephone (NTT).

It is not often that a company with very good management, over 50% market share and a sterling balance sheet trades at such a low valuation. DoCoMo is trading near its all time low of $14.50 per US ADR since becoming public. DoCoMo’s book value is $7.70 per US ADR.

DoCoMo has a current market cap of $74 billion with no net debt. EBITDA for the year ending 3/05 was $14.5 billion. On a trailing basis DoCoMo is trading at an EBITDA multiple of 5.1X. DoCoMo’s peak EBITDA was $16.6 billion in the fiscal year ending 3/04 giving it a multiple of 4.5X its peak EBITDA. Not many large cap companies trade at this type of multiple unless they are highly cyclical or reside in some banana republic.

So why is DoCoMo so cheap? 1) Revenues declined 4.0% in the year ending 3/05 and are forecast to decline 0.8% in the current year due to price pressures. 2) The perception that higher marketing costs and falling revenue per user would dent earnings growth. 3) The carriers are offering cheaper handsets and services such as full song downloads on their 3G networks to help retain subscribers and generate more sales.

DoCoMo just released its first quarter numbers ending 6/05. What was most surprising was the level of expense reduction and the growth in FOMA high-speed service revenues. Overall, revenue fell by 2.8% but EBITDA increased by 2.0% to $4.038 billion compared with the first quarter of fiscal 2005. Annualizing the first quarter yields $16.2 in EBITDA an 11.7% increase over 2005 and a current multiple to EV of 4.6X. Sequentially, EBITDA increased 39% from fiscal fourth quarter EBITDA of $2.9 billion. Voice revenues from FOMA services increased 201% to $2 billion and FOMA services from packet communications rose 180% to $1 billion. In other words, more customers are using phones and plans with additional services other than just voice phone calls.

DoCoMo, in the most recent quarter, added 605,000 net users compared with 505,000 for the same period last year. DoCoMo’s share of net adds in the market rose to 56.1%. Customer churn fell from 1.06% to 0.8%, a record low. In fact churn has been on a declining trend for the past three years. In a recent customer survey 95% rated DoCoMo’s service satisfactory or higher.

Vodafone Group, the world's biggest wireless service provider, said on July 26 it lost 72,000 customers in Japan during the April to June period. Vodafone is struggling in Japan. KDDI DoCoMo’s strongest competitor also recently announced numbers that were better than forecast due to growth in high speed services. KDDI also appears to be a trading at a very attractive valuation.


So while DoCoMo’s total revenue is being hurt by current competitive factors, cash flow is growing after a decline in fiscal 2004. At some point price pressure should ease, especially in a market dominated by only three companies (DoCoMo, KDDI/au, and Vodafone). That combined with the strong growth in high speed services like video, wallet in a phone, international calling, email, i mode, etc. could lead to sales growth once again. I think DoCoMo is mis-priced and deserves a higher EBITDA multiple than 4.6X. If the top line starts to grow again I think it may someday get a multiple of 8 or more. Taking free cash flow for the next three years plus a 7 multiple on fiscal 2005 estimated EBITDA gets you to an EV of $130 billion and a stock price of $28 (a 75% increase). At a multiple of 8 the stock trades at $32 or a 100% increase in price. So three years out I look for a 75% to 100% total return. US domestic cellular companies are trading in the range of 7X to 10X EBITDA.

I like situations where I see little downside and the potential to double my money in three years or less. Here the gold plated balance sheet, recurring revenue steam business model and low current EBITDA multiple (or high operating cash flow relative to enterprise value) provide downside protection.

Some additional data:


Japan Mobile Customers by Carrier (millions)

DoCoMo 49
KDDI/au 20
Vodafone 14
TU-KA 4

3G Subscribers by Carrier (millions)

DoCoMo 14
KDDI/au 19
Vodafone 1




DoCoMo (billions) 2003 2004 2005 *


Revenue $42.7 $43.0 $42.7

EBITDA $16.3 $14.5 $14.0


CAPX $ 7.2 $ 7.6 $ 7.5

Free Cash Flow $ 6.3 $ 7.6 $ 5.4

Free Cash Flow
Yield on $74 billion
EV 8.5% 10.3% 7.3%

Dividend per
Share .13 .19 .38

Yield at current
stock price of
$16.06 .8% 1.2% 2.4%


* Company estimate released in May prior to 1st quarter results ending 6/05. Actual 1st quarter annualized EBITDA equals $16.2 billion, which would increase free cash flow yield to 9.5%.

Additionally, it is possible that free cash flow could grow through reductions in capx spending once all the new 3G and high speed services are built out. Capx is currently running at 15% of revenue. Cutting Capx in by one third would add another 3.3% to free cash flow.


Caveat – All numbers have been converted from Yen to US Dollars by me so it’s possible that there is a typo or two.

Catalyst

Time

Mr. Market decides to weigh this company rather than vote on it.

Results that continue to exceed forecast