ROGERS COMMUNICATIONS -CL B RCI.B S
July 05, 2012 - 4:24pm EST by
Ragnar0307
2012 2013
Price: 37.13 EPS $2.92 $2.78
Shares Out. (in M): 528 P/E 12.9x 13.5x
Market Cap (in $M): 19,816 P/FCF 16.1x 14.9x
Net Debt (in $M): 10,238 EBIT 2,804 2,628
TEV ($): 29,015 TEV/EBIT 10.3x 11.0x
Borrow Cost: NA

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  • Canada
  • Wireless
  • Multi System Operator (MSO), CATV, Cable
  • Competition short
 

Description

Rogers Communications Inc. - SHORT IDEA
 
Business Description

Rogers is the largest provider of wireless and cable services in Canada.  As of 1Q12, Rogers had 9.3 million wireless subs and 2.3 million basic cable subs.  Rogers also operates a media division, which owns TV stations, radio stations, and sports teams.  Rogers’ EBITDA is roughly 2/3rds wireless and 1/3rd cable.

Short Thesis

1. Wireless competition is intensifying.

  • Canadian ARPU is the highest in the developed world.  Penetration is also the lowest.
  • The regulator is hard-set on increasing competition to increase wireless penetration and has awarded spectrum to 4 new entrants (Wind, Moblicity, Videotron, and Public).
  • Bell and Telus (the other two incumbents) are also taking share by investing in their networks/handset portfolios.
  • If Rogers’ ARPU falls to Verizon’s level, EBITDA will decline by 20%.  I am not advocating that this will happen overnight, but it should happen over the next two years, which will provide a constant EBITDA headwind.

Back-of-the-Envelope Math Illustrating the Above

2011 Post-paid Wireless ARPU                   $70.26  
x Average Subs                       7,450  
2011 Wireless Network Revenue                 $6,281  
         
Contribution Margin %                   80.0%  
         
Verizon Post-paid APRU                   $55.43  
         
Implied EBITDA Hit                 $(1,061)  
         
2011 EBITDA                     $4,716               100.0%
Less: ARPU Hit                     (1,061)               (22.5)%
PF EBITDA                     $3,655                 77.5%

Why haven’t we seen it yet?  We have.

  • The new entrants are now taking 35-40% of net adds!
  • Bad ARPU and churn trends have been masked by increased smart phone penetration.  This will change in 2012.
    • In 2011, the underlying ARPU decline was masked by large increases in smart phone penetration (37% to 52%).  Even if 100% of adds take smart phones, penetration won’t increase by another 15%.  This will make for a very tough ARPU comp in 2012.
    • The underlying churn trend has also been masked by smart phone penetration gains.  Churn increased this year even though smart phone penetration increased.  This means underlying churn spiked a lot.  Note that smart phone churn will also rise as the base ages.  Current smart phone churn is around 1%, which is much lower than overall post-paid churn.
2. Cable competition is intensifying.
  • Bell is rolling out IPTV in 70-80% of Rogers footprint.  Assuming similar penetration rates as U-verse, Fios, and Optik (~25% penetration), Rogers could lose several hundred thousand video subs assuming the bulk of this penetration comes from Rogers.  In addition to the sub loss, ARPU will likely be pressured by a few percent due to increased competition.  All together, EBITDA could decline by another 3-5%.
Back-of-the-Envelope Math Illustrating the Above
 
Video ARPU                     $68.34      
x Cable Subs Lost                      (388) Assumes 25% IPTV penetration and 60% of this comes from Rogers
Video Revenue Lost                    $(318)      
Video Incremental Margin                   30.0%  Low incremental margins due to high variable programming costs 
EBITDA Lost                        $(95)      
             
Video ARPU Price                   $68.34      
Price Hit                     (5.0)%      
PF Video ARPU                   $64.92      
             
Lost ARPU                     $(3.42)      
x PF Cable Subs                     2,691      
Video Revenue Lost                    $(110)      
Contribution Margin                 100.0%      
Total EBITDA Lost                    $(110)      
             
Adj. EBITDA                     $4,716               100.0%    
EBITDA Lost                        (206)                 (4.4)%    
PF EBITDA                     $4,510                 95.6%    
 
Valuation
  • EV / EBITDA = 6.2x
  • P/E = 13.1x
  • Dividend yield = 3.8%
  • Pure play NA wireless (S, PCS, LEAP) trade at 3-5x EBITDA
  • NA telecom (T, VZ, BCE, CTL, Telus,BellAlliant,Manitoba) trade at ~6x EBITDA
  • NA telecom dividend yield ~4.5-5%
Downside
  • 5x EBITDA (slight premium to pure play wireless and discount to telco peers due to competitive headwinds and overexposure to wireless) implies $25 or -29% downside including dividend. 
2012 Adj. EBITDA          $4,656
Multiple                  5.0
Enterprise Value        $23,280
Less: Total Debt         (11,078)
Plus: Cash and Cash Equivalents                  -
Plus: Cogeco Cable Inc.             502
Plus: Cogeco Inc.               267
Plus: Other Investments             269
Market Cap        $13,240
Shares                 528
Price per Share          $25.08
Plus: Dividend              1.42
Adj. Price per Share          $26.50
       
Current Price          $37.53
% Upside / (Downside)          (29)%

Estimates vs. Consensus

      12/31/09 12/31/10 12/31/11 12/31/12 12/31/13
               
Revenue          $11,731      $12,142      $12,428      $12,310      $12,294
Consensus                12,499        12,709
% Above / (Below)                 (1.5)%         (3.3)%
               
EBITDA            $4,370        $4,635        $4,716        $4,656        $4,480
Consensus                  4,716          4,802
% Above / (Below)                 (1.3)%         (6.7)%

I only included my consolidated revenue and EBITDA projections, but if you want detailed stats for wireless (post-paid ARPU, churn, gross adds, pre-paid stats, EBITDA, etc.) and cable (basic subs, HSD subs, VoIP subs, etc.), please let me know in the comments and I will post.  In general, I was much more conservative than the above BOTE analyses so I think there is further downside to my estimates if my thesis plays out.

Why now?  Rumblings of increased competition from new entrants has been around for years…

  • It’s timely.  Smartphone penetration gains have been masking underlying trends.  As smartphone penetration gains slow this year, the underlying trends will become more apparent.
  • Capital allocation is shifting.  Historically,Rogers has aggressively bought back stock.  These buybacks will slow this year due to higher cash taxes (NOLs are exhausted), increased capex for LTE, upcoming spectrum auctions, and cash funding of the Maple Leafs transaction.
  • IPTV roll-out is happening now.  In 1Q, Bell’s IPTV roll-out in Toronto already started negatively impacting results. This will likely continue throughout the year.


Catalyst

  • Smart phones won’t mask the underlying trends as much this year i.e. 2012 comps are hard.
  • Rogers already missed in 1Q and will likely have to lower full year guidance.
  • Upcoming spectrum auction.  New rules (set asides, caps, forced roaming) announced in February favor new entrants.
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    Description

    Rogers Communications Inc. - SHORT IDEA
     
    Business Description

    Rogers is the largest provider of wireless and cable services in Canada.  As of 1Q12, Rogers had 9.3 million wireless subs and 2.3 million basic cable subs.  Rogers also operates a media division, which owns TV stations, radio stations, and sports teams.  Rogers’ EBITDA is roughly 2/3rds wireless and 1/3rd cable.

    Short Thesis

    1. Wireless competition is intensifying.

    • Canadian ARPU is the highest in the developed world.  Penetration is also the lowest.
    • The regulator is hard-set on increasing competition to increase wireless penetration and has awarded spectrum to 4 new entrants (Wind, Moblicity, Videotron, and Public).
    • Bell and Telus (the other two incumbents) are also taking share by investing in their networks/handset portfolios.
    • If Rogers’ ARPU falls to Verizon’s level, EBITDA will decline by 20%.  I am not advocating that this will happen overnight, but it should happen over the next two years, which will provide a constant EBITDA headwind.

    Back-of-the-Envelope Math Illustrating the Above

    2011 Post-paid Wireless ARPU                   $70.26  
    x Average Subs                       7,450  
    2011 Wireless Network Revenue                 $6,281  
             
    Contribution Margin %                   80.0%  
             
    Verizon Post-paid APRU                   $55.43  
             
    Implied EBITDA Hit                 $(1,061)  
             
    2011 EBITDA                     $4,716               100.0%
    Less: ARPU Hit                     (1,061)               (22.5)%
    PF EBITDA                     $3,655                 77.5%

    Why haven’t we seen it yet?  We have.

    • The new entrants are now taking 35-40% of net adds!
    • Bad ARPU and churn trends have been masked by increased smart phone penetration.  This will change in 2012.
      • In 2011, the underlying ARPU decline was masked by large increases in smart phone penetration (37% to 52%).  Even if 100% of adds take smart phones, penetration won’t increase by another 15%.  This will make for a very tough ARPU comp in 2012.
      • The underlying churn trend has also been masked by smart phone penetration gains.  Churn increased this year even though smart phone penetration increased.  This means underlying churn spiked a lot.  Note that smart phone churn will also rise as the base ages.  Current smart phone churn is around 1%, which is much lower than overall post-paid churn.
    2. Cable competition is intensifying.
    • Bell is rolling out IPTV in 70-80% of Rogers footprint.  Assuming similar penetration rates as U-verse, Fios, and Optik (~25% penetration), Rogers could lose several hundred thousand video subs assuming the bulk of this penetration comes from Rogers.  In addition to the sub loss, ARPU will likely be pressured by a few percent due to increased competition.  All together, EBITDA could decline by another 3-5%.
    Back-of-the-Envelope Math Illustrating the Above
     
    Video ARPU                     $68.34      
    x Cable Subs Lost                      (388) Assumes 25% IPTV penetration and 60% of this comes from Rogers
    Video Revenue Lost                    $(318)      
    Video Incremental Margin                   30.0%  Low incremental margins due to high variable programming costs 
    EBITDA Lost                        $(95)      
                 
    Video ARPU Price                   $68.34      
    Price Hit                     (5.0)%      
    PF Video ARPU                   $64.92      
                 
    Lost ARPU                     $(3.42)      
    x PF Cable Subs                     2,691      
    Video Revenue Lost                    $(110)      
    Contribution Margin                 100.0%      
    Total EBITDA Lost                    $(110)      
                 
    Adj. EBITDA                     $4,716               100.0%    
    EBITDA Lost                        (206)                 (4.4)%    
    PF EBITDA                     $4,510                 95.6%    
     
    Valuation
    • EV / EBITDA = 6.2x
    • P/E = 13.1x
    • Dividend yield = 3.8%
    • Pure play NA wireless (S, PCS, LEAP) trade at 3-5x EBITDA
    • NA telecom (T, VZ, BCE, CTL, Telus,BellAlliant,Manitoba) trade at ~6x EBITDA
    • NA telecom dividend yield ~4.5-5%
    Downside
    • 5x EBITDA (slight premium to pure play wireless and discount to telco peers due to competitive headwinds and overexposure to wireless) implies $25 or -29% downside including dividend. 
    2012 Adj. EBITDA          $4,656
    Multiple                  5.0
    Enterprise Value        $23,280
    Less: Total Debt         (11,078)
    Plus: Cash and Cash Equivalents                  -
    Plus: Cogeco Cable Inc.             502
    Plus: Cogeco Inc.               267
    Plus: Other Investments             269
    Market Cap        $13,240
    Shares                 528
    Price per Share          $25.08
    Plus: Dividend              1.42
    Adj. Price per Share          $26.50
           
    Current Price          $37.53
    % Upside / (Downside)          (29)%

    Estimates vs. Consensus

          12/31/09 12/31/10 12/31/11 12/31/12 12/31/13
                   
    Revenue          $11,731      $12,142      $12,428      $12,310      $12,294
    Consensus                12,499        12,709
    % Above / (Below)                 (1.5)%         (3.3)%
                   
    EBITDA            $4,370        $4,635        $4,716        $4,656        $4,480
    Consensus                  4,716          4,802
    % Above / (Below)                 (1.3)%         (6.7)%

    I only included my consolidated revenue and EBITDA projections, but if you want detailed stats for wireless (post-paid ARPU, churn, gross adds, pre-paid stats, EBITDA, etc.) and cable (basic subs, HSD subs, VoIP subs, etc.), please let me know in the comments and I will post.  In general, I was much more conservative than the above BOTE analyses so I think there is further downside to my estimates if my thesis plays out.

    Why now?  Rumblings of increased competition from new entrants has been around for years…

    • It’s timely.  Smartphone penetration gains have been masking underlying trends.  As smartphone penetration gains slow this year, the underlying trends will become more apparent.
    • Capital allocation is shifting.  Historically,Rogers has aggressively bought back stock.  These buybacks will slow this year due to higher cash taxes (NOLs are exhausted), increased capex for LTE, upcoming spectrum auctions, and cash funding of the Maple Leafs transaction.
    • IPTV roll-out is happening now.  In 1Q, Bell’s IPTV roll-out in Toronto already started negatively impacting results. This will likely continue throughout the year.


    Catalyst

    Messages


    SubjectRE: thoughts
    Entry07/06/2012 11:39 AM
    MemberRagnar0307
    gocanucks97,
     
    I like Rogers better than Bell and Telus mainly because of its higher exposure to wireless.  Wireless as a % of EBITDA is 64% for Rogers vs. 25% for Bell and 56% for Telus.  In my mind, the core of the short thesis is around wireless and the cable part of the thesis is just extra juice for the short.  That's why I picked the company with the most wireless exposure.  Also, Rogers has the highest ARPU and highest wireless EBITDA margins of the three incumbents i.e. it has the most to lose.
     
    I think there is a lot more juice in the short than people think.  I tried to lay out some simple math on the wireless economics to show what happens when ARPU declines due to price pressures.  I think there is way more operating leverage than people think.  Just look what happened to Sprint.  Its EBITDA has been cut in half due to ARPU price pressure (subs have basically been flat).  If EBITDA really takes a 15-20% hit over the next two years, it will be way lower than consensus which has EBITDA growing.
     
    greenshoes93,
     
    I agree with all your points.  Between the set asides, spectrum caps, and forced roaming, the new auction rules definitely favor the new entrants.  I heard the same thing about Vimpelcom being more aggressive through Wind.  Honestly, it makes sense.  The Canadian market is probably the most lucrative market in the developed world (low penetration/high ARPUs/limited competition) so why not invest more and be more aggressive if you are Vimpelcom/Wind??

    SubjectShaw Communications
    Entry07/06/2012 12:30 PM
    Memberspike945

    Thanks for the idea – I think it’s a good one.   But I think that Shaw Communications (SJR/B) is an even better short.  Unlike Rogers, Shaw Communications has no wireless to help stem the tide of increased cable competition.  Telus is aggressively rolling out their IPTV product (Optik TV) in western Canada with no slowdown in sight.  There is little Shaw can do to defend themselves.  Telus has been so successful that in addition to falling video subs, Shaw actually posted falling Broadband subscribers in their most recent quarter (nearly unheard of and an ominous sign).  Why? When customers switch from Shaw to Telus, they switch more than just video.   Yet somehow sell-side managed to applaud the latest results. 

    80% of Shaw’s EBITDA is at risk from Telus and Telus has made it clear that they want their “fair share” of the TV market in western Canada.  Shaw’s management seems confused with their strategy on price discounting appearing to change each quarter.  Shaw is aggressively paying out 95% of their FCF in dividends – a risky move given the decline in their earnings power coupled with financial leverage.   Valuation is high.

    Finally, the housing bubble in Vancouver is finally coming undone, which should be negative for overall industry growth.


    SubjectRE: lots o questions...
    Entry07/10/2012 05:14 PM
    MemberRagnar0307

    1. Agreed. I think consolidation will actually lead to a stronger competitor that will be better positioned to directly compete with the incumbents and go after the post-paid market. To date, the new entrants have been more focused on the pre-paid market.

    2. The BCE IPTV build-out is still early stages. I think BCE has built out ~1.5MM homes and is targeting 4MM homes by 2013. They will have 80% overlap with Rogers' footprint when they are done. Bottom line, 2012 is the big year for the build-out. We started seeing the negative impact of the build-out in 1Q at Rogers leading to a miss for its cable segment, and I think we'll continue to see pressure throughout the year.

    I agree about the potential cannibalization. In my back-of-the-envelope analysis, I assumed that BCE gets only 60% of their subs from cable, 25% from their own satellite customers, and the rest are new to the market.

    3. IPTV definitely has an advantage with their guide and set-top box. People in Canada perceive IPTV as a better offering than cable because of the better guide experience. Even if Rogers is successful retaining customers, upgrading boxes will negatively impact margins and cost capex.

    4. Agreed. I think there could be risk here to this changing, which would be negative for Rogers.

    5. Agreed. That sounds unsustainable to me. Just look at what happened in the U.S...

    6. I haven't thought about this threat much. I think the increased competition from IPTV will be much more meaningful near-term.

    7. I think it makes some sense for Rogers to buy this exclusive content to be more than just a dumb pipe, but not sure it will ultimately help with the increased competition. They will still likely be forced to sell this content to the other providers. Also, spending all this money will pressure FCF which will limit future buybacks.

    8. I still think there is some left to play out. Check out the recent comments from the past two transcripts about data roaming ARPU being a source of pressure.

    9. At 4.2%, Rogers' yield is not too high relative to other NA telecoms (AT&T=5.0%, VZ=4.5%, BCE=5.1%, CTL=7.3%, Telus=3.9%, Bell Aliant=7.4%, and Manitoba=5.1%). Given the competitive pressures and likely decline in EBITDA at Rogers, I could see the stock yielding closer to 6% which would equate to $26 or -30% downside. However, I hear your point. If I didn't see risk to consensus numbers, I do not think the short would be as interesting.

    10. The amount of spectrum the incumbents can buy is capped at 10MHZ. One block has also been set aside for the new entrants, which will make it much cheaper to acquire since the new entrants won't have to compete against the incumbents. Also, BCE/Telus are actually at an advantage vs. Rogers because they share a network and will be able to acquire 20MHZ of spectrum combined.


    SubjectRE: variant perception
    Entry07/10/2012 09:50 PM
    MemberRagnar0307

    What's the variant view?

    At a very high level, Rogers is a company that has consistently grown EBITDA for the past several years. It's also a company where consensus/mgmt guidance assume that EBITDA will continue to grow. Because of increased wireless and cable competition, I think EBITDA will decline (not grow) over the next 2 years.

    Digging in a little deeper, most of my variant view is centered around the wireless business. Bulls say that this short thesis (increased competition from new entrants / other incumbents) has been around for awhile and that Rogers' metrics have held up. So why now? What's changed? I'm arguing that nothing has changed, but that the true underlying trends in ARPU and churn have been masked by the massive increase in smartphone penetration. Smartphone ARPU is double traditional ARPU and smartphone churn is ~1% vs. blended churn of 1.3%. Smartphone penetration has gone from 31% at the end of 2009 to nearly 60% at the end of 2011. This massive postive mix shift has greatly benefitted ARPU and churn. Without this massive mix shift, Rogers' post-paid wireless metrics would have deteriorated significantly i.e. the underlying trends are much worse than they appear.

    The Street assumes that the ARPU decline and high churn will moderate in 2012. I disagree. The Street models the post-paid business without splitting out the smartphone business. When I model the smartphone business separately, it becomes clear that the positive mix shift that ARPU and churn have been benefitting from will slow in 2012. Why? Mainly becase the rate of smartphone penetration gain will slow. This will cause the ARPU decline and churn to get worse, not better. This is the main driver of why my EBITDA is below the Street and why I model EBITDA declines for the next 2 years.

    Bottom line, if there is one analysis that I recommend you do, it is to model the post-paid business in two segments - smartphone and non-smartphone. Once you do this, it becomes clear that the thesis has been playing out for awhile and that ARPU/churn trends will not moderate like the Street thinks, they will become worse.


    SubjectRE: Sellside Coverage
    Entry07/11/2012 03:23 PM
    MemberRagnar0307
    I have not seen a recent industry primer or initiation piece, but BofA has a ton of good data in spreadsheet form on the telecom and cable industries in Canada that I found useful.

    SubjectRE: RE: Sellside Coverage
    Entry07/11/2012 03:33 PM
    Memberjdr907
    RBC has a pretty good industry report titled "Shelter from the storm" from Dec 13, 2011.  I've been searching for a Canadian media/telco conference to meet w the companies, but have yet to find anything. 

    SubjectRE: smartphone penetration
    Entry07/24/2012 07:08 PM
    MemberRagnar0307
    katana,
     
    Smartphone penetration increased an average of 4% per quarter last year for a total of 15%.  This year, I assume that smartphone penetration will increase ~3% per quarter for a total of 12%.  Increased smartphone penetration this year will still be a tailwind, but the tailwind will be a lot smaller.  Also, it will be very tough to get smartphone penetration above 70% when only 70% of your gross adds take smartphones.  For the past several quarters, the percent of gross adds taking smartphones has stabilized at 70%.  As long as it stays around here (I actually assume it will increase slightly), it will be tough for smartphone penetration to increase materially above 70%.
     
    Also, another important part of the thesis is that not all smartphone penetration is the same.  The incremental smartphone growth comes in at lower ARPUs (see quotes below from last earnings call).  This makes sense.  The early adopters are willing to pay $100+ ARPUs, but prices will have to come down to achieve incremental penetration.  Maybe think about flat screen TVs as a proxy.  When they were expensive, only a few people bought them.  But as prices came down, everyone started buying them.
     
    Quote #1 from President of Rogers (Rob Bruce)

    "Yes, let me start off and then maybe I will hand it over to -- for Tony and Nadir for further comment. So there is no question -- and Nadir highlighted -- we are obviously excited about our success on smartphones. I think the one thing that is important to say is the smartphone market, as we penetrate 60% of our base, and the market in general starting to be penetrated with smartphones, the kind of customers that are going to be getting on smartphones more and more are not going to be customers that are willing to spend north of CAD100 to get on smartphones.

    So it's incumbent upon all of us as we figure out how to intelligently penetrate this market, to figure out how to put offerings in front of a customer that will bring on those smartphone customers that have slightly lower ARPU, and find devices and combinations of plans that will actually let us get it that revenue and that magic. Because in the long run people really want smartphones."

    Quote #2 from CEO of Rogers (Nadir Mohamed)

    "Whereas I think to be fair, in the early days of smartphones we were getting customers with much higher ARPUs than today. So the level of subsidy you could warrant in that case is different from what we will be doing going forward. And I think that will play out in the market."


    SubjectRE: This may sound naive...
    Entry07/24/2012 07:22 PM
    MemberRagnar0307
    cross310,
     
    Rogers is the best operator and will likely remain dominant in Canada.  I just think that they are over-earning and that earnings will be negatively impacted as competition intensifies.  I'm basically assuming that a similar story plays out in Canada that played out in the U.S.  In the U.S., competition from S, T-Mobile, LEAP, PCS, etc. pressured ARPU at VZ/T.  In Canada, I think that competition from the new entrants and the other incumbents will pressure ARPU for Rogers.  Rogers' post-paid ARPU is $68.  Verizon's is $55.  If Rogers' ARPU was closer to VZ's ARPU, the short would not be nearly as compelling.
     
    I don't follow T/VZ super closely, but I think this business is about scale.  The player with the most scale is best positioned to compete.  However, unfortunately, this is a commodity type business so if there is price competition, everyone gets hurt.

    SubjectRE: Any thoughts on the quarter?
    Entry07/24/2012 07:31 PM
    MemberRagnar0307
    jdr907,
     
    I agree with your assessment.  Post-paid results were better than expected (ARPU+churn), while pre-paid and cable were worse.  In general, I thought Rogers cost cut themselves into a good quarter.  This marks the second quarter in a row that total revenues declined.  Longer term, it will be tough to grow EBITDA without revenue growth.  There is only so much cost you can cut...
     
    I also think there was a lot of short covering.  The short interest was ~10% and close to 20 days to cover going into earnings.  I think there was probably a lot of fast money in the short hoping for lower guidance, which did not happen.

    SubjectRE: RE: RE: This may sound naive...
    Entry07/25/2012 04:51 PM
    MemberRagnar0307

    Throughout most of the 2000s, the market was dominated by Rogers, Bell, and Telus.  In 2008, the government auctioned off additional spectrum and set aside some for new entrants.  Four new companies entered the market and are now taking 30-40% of net adds.  There is another auction next year and the government has set aside more spectrum for the new entrants.  Bell and Telus share a network so they actually have more scale than Rogers.  Bell and Telus are also relatively new to GSM.  Before 2010, Rogers was the only GSM network in Canada so they got the majority of the roaming revenue and had access to the best handsets.

    Is this helpful?  Are you looking for something specific?

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