Description

Shares are also available on NYSE:KT at $13.15/share 

The valuation figures above are adjusted for excess real estate and investments  

Description

KT Corp is Korea’s largest incumbent fixed-line telecommunications company.  It is the second largest mobile telecommunications firm in Korea.  KT Corp also owns excess real estate it is in the process of developing. KT Corp also owns a majority of the wireless infrastructure in Korea (90% of the transmitter locations & over 80% of the cable infrastructure) that will be shared for deployment of 5G equipment.  KT Corp will receive compensation for the sharing of there infrastructure with other wireless carriers. KT also owns 50% of KT Skylife, Korea’s only satellite TV provider, BC card, the largest payment card network in Korea with over 40 million cards and 2.6 million merchants and various other firms in the entertainment content, call center, manpower supply, advertising & security monitoring business. 

Thesis

Most analysts have a declining of operating income in their forecast despite the stabilization of KT’s telecom revenue over the past three years.  There is additional upside from IPTV, content and real estate growth which in combination with the stabilization of the telecom revenues can actually increase revenues and cash flows over the next few years.  The CEO is also incentivized (his bonus payments are tied) to increases EBITDA and the KT stock price in excess of the KOSPI average. 

The sum of the parts here is compelling along with the general corporate governance improvements in South Korea.  The telecom business has turned the corner in that the subscriber growth has returned and with the roll out of 5G, KT should be a key player in the next generation of mobile services.  KT’s IPTV offering continues to grow and this in combination with content development & agency business and the ownership of KT Skylife has made KT a key player in Korea media.  BC Card & real estate development are also providing growth opportunities for this legacy Korean telecom player.  KT also owns Korea’s only FSS satellite owner and operator.  For one of the cheapest telecom firms in the world at 1.3x EBITDA, KT has a stabilized telecom customer base and some interesting growth opportunities in content, IPTV and real estate. 

The major portion of KT’s cash flows come from landline telecom, wireless, IPTV and broadband services, the quad play in cable language.  The Korean mobile market has three current players and thus has a better competitive position in the markets with more players.  The government has tried to encourage a fourth player to enter the market but no player has been interested to date.  KT’s wireless subscribers are increasing (6% growth) but ARPUs are declining (3% decline).  KT has gained market share over the past three years from SK Telecom.  KT is the number 2 wireless player with a 31.4% market share (20.0 million subscribers) and is in a good position with largest amount infrastructure locations for the deployment of 5G (over 90% of the telephone poles & 80% of the cable ducts for the existing wireless network).  5G requires more cell locations closer together so KT is in a good position versus SK & LG Uplus to lease these locations to their competitors.

KT is the legacy wireline player in Korea (with 11.2 million lines) and the number 1 wireline player with a 41.3% share.  Korea like all other countries has a declining legacy phone line business with a growing broadband and IPTV business.  Although the combined wireline revenue (phone and broadband) declined year over year it was up slightly quarter over quarter. 

The media (IPTV) & content segment of the business is up significantly as KT has grown IPTV subscribers by 6% in 2016 to 7.4 million subscribers and expanded in the digital media and music and video entertainment content businesses.  The largest part of content business is Nasmedia, a publicly traded digital media representation business, KT (Genie) Music that produces & distributes music in Korea and KT HiTel, a t-commerce and content distribution platform.  The HiTel platform is used by KT and other third-parties like Korean home shopping firms.  T-commerce includes voice and augmented reality shopping and payment processing along with related data analytics.  The media/content segment grew by 16% in 2017.

In other segments, the BC card business is down slightly year over year.  The real estate development business is progressing nicely increasing revenue by 13% over 2016 revenues and management is expected to increase the value of real estate by 6% per year over the next two years.  KT Skytel, KT’s satellite TV business, has increased subscribers by 26,800 over 2016, a 0.6% increase in subscribers.  In summary, overall KT revenues were up modestly for 2017 and is expected to modestly increase revenue over the next few years.

The following are trends in KT’s subscription businesses:

Some key notes here include the improvement in both wireless and broadband revenue growth after the hiring of a new CEO in December 2013, after the previous CEO resigned due to embezzlement who replaced a CEO who resigned in 2008 due to kickbacks.  The new CEO initiated a redundancy program in 2014 which saved ₩700bn annually, sold KT’s capital intensive car rental and leasing businesses in 2015 (which aided in the reducing KT’s debt to the lowest amongst the Korean telecom companies) and focused the company on offering broadband IPTV and other services (such as cloud services) which utilizes KT’s infrastructure advantage over its competitors.  The IPTV division is growing rapidly is at breakeven and has 50% of the market share for IPTV in Korea.  This division along with KT Skylife control 30% of the pay-TV market in Korea, the largest player in Korea.  The cap on pay-TV ownership will be removed later this year which may lead to more consolidation in the pay-TV market.  Finally, KT is looking to grow outside the regulated consumer telecom market in areas such as cloud infrastructure and other B2B markets.

The current CEO, appointed in late 2013, Hwang Chang-Gyu, was the former CEO Samsung Electronics chip division and the former CTO of Korea as the head of Strategic R&D Planning in the Ministry of Knowledge Economy.  His current salary is ₩573m with a 2017 bonus of ₩1500m based upon reaching EBITDA targets along with increases in KT share price in excess of the KOSPI.  This level compensation is comparable to the compensation for the CEO of SK Telecom and LG Uplus.      

Another note here is the equity valuation is the same as when Hwang was hired in December 2013 despite increasing EBITDA by 44% and reducing KT’s debt by 64%.  This has led to KT being the cheapest telecom firm in the world with an EV/EBITDA of less than 1.3x when excess real estate and investments are removed for the EV. 

Valuation

The following is a sum of the parts valuation for KT (including a sensitivity analysis to various EBITDA multiples):

The key sensitivity here is the EBITDA applied to KT’s telecom EBITDA.  The range of possible short-term values range from 3.5x from Asian Incumbent Telecoms to 5 to 6x EBITDA for stabilized US and European Incumbent Telecoms.  If KT can show it has the characteristics of other quad plays over the next few years, a more appropriate multiple may be the quad multiple of 8 to 10x EBITDA.

Comparables

In comparison to other Asian (China, Korea & Japan) integrated telecommunications firms, KT Corp sells at a significant discount:

As a note, there is about ₩431 billion difference between depreciation & amortization (₩3.4 trillion) and capital expenditure & intangibles purchase (₩3.1 trillion) for 2017 which leads to material differences between net income and free cash flow.  Expected 2018 cap-ex is expected to be ₩2.3 trillion down ₩100 billion from 2017 levels.  I believe free cash flow is the correct metric look at here as net income has materially understated free cash flow.

Management & Incentives

Although management does not have large equity stakes in KT Corp, the management has been changed since the kickback & fraud days.  There has been no allegations at KT with the recently departed Park regime like there has been for other Korean chaebols.  Top management compensation (top 11 executives) is ₩4.9 bn (.07% of the current market cap).  Option grants are about 0.1% of market cap per year.

Disclosure

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 issuers securities

Catalyst

Resolution of Korean crisis

Recognition of better governance of Korean companies & KT Corp in particular

Increasing EBITDA due to improving IPTV customer count

Recognition as quad telecom play player

Compensation for use of telephone poles & cable ducts for 5G deployment (equivalent tower value of

13,000 towers is almost ₩1.7 trillion)

Increased value of total real estate holdings (expected to increase value of real estate from ₩8.3 trillion

(currently) to ₩9.3 trillion by 2020).

Potential Korean re‐unification