SK Telecom (017670 KS, ADR: SKM) Market Cap: $10.43 bn

SK Telecom is South Korea's leading wireless service provider with 50% market share. KT and LG have approximately 30% and 20% respectively. It is 23% owned by the SK Group. This is a well covered company and has been written up before. Please refer to those write-ups for further detailed description of the business and competitive position.

This will not be a promotional write-up. The main premise is clearly that the current valuation amply discounts all the major concerns that are well known in the market.

Talking points:

1. Valuation: On a EV/EBIDTA basis it is trading at 2.45x ’11 company estimates. (EV includes marketable securities fully taxed and at a 20% discount). It trades at 7.0x ’11 consensus EPS and has a FCF yield of 15.6% incorporating the companies Cap. Ex. guidance. (This FCF estimate does not include a potential 3.5 trn won reduction in working capital from transferring accounts receivable to an affiliate…this is equivalent to 30% of the market cap). With no increase in the dividend in 2011 it yields 5.9%. The stock is on a 6 year low and has never traded cheaper on all valuation ratios. On a comparative basis other wireless carries in penetrated markets sell for 5x+ EBITDA.

1. Smartphone growth: Smartphone’s account for 15% of the subscriber base or 3.9m users, the company expects this to increase to 10m+ by the end of ’11. This will drive data ARPU growth (it should be up 12%), there is an offset as voice ARPU declines, but this will be the main factor in driving sales for the next number of years.

1. Minimal increases in capital expenditure: Cap ex was only increased 8% for 2011, SK telecom should be able to handle data growth without any major capital expenditures,  earnings approximate FCF.

1. Capital allocation: While management has reiterated that they will pay a dividend at a minimum the same level as last year, they said on the year end call that they have not yet decided on a dividend raise or the level of share buybacks for this year (they bought back 1.25% of the stock last year). They have hinted that the increased financial strength of the company would be a factor in returning more to shareholders. (The company can be debt free by 2012). The payout ratio has averaged 47% over the last 3 years. An improvement in capital allocation is clearly going to be the major catalyst for the stock.

1. Acquisition strategy. The strong balance sheet and high penetration of the local market leads to constant concerns that they will do a value destroying international acquisition. The company has had a track record of dipping their toes into international markets with relatively small amounts of capital and then finding an exit if things are not going well or they cannot justify it strategically. They made a successful investment in China Unicom and sold it citing no strategic benefit. They pulled out of being the 3^rd operator in Vietnam when they could not be dominant. They had an unsuccessful partnership with EarthLink in the US (Heilo) that they shut down. They were a low bidder for Indian assets that Vodafone paid up. They recently bid for the assets of Blockbuster, but were low bidder (there was some strategic rational). Most other major Wireless companies around the world did value destroying acquisitions and still trade at twice the EBITDA multiple.

1. iPhone: KT did benefit from having the iPhone. SKT since March has been selling it as well. This was a much touted reason last year for not owning SKT, which no longer applies even though  SK telecom sells the ‘Galaxy S’ from Samsung which has outsold the iPhone last year..

1. The Korean government interferes on pricing and general running of the business. Now that KT and LG are established competitors the asymmetric regulation is largely a thing of the past. The government has also decreed that the level of marketing spend should not exceed 22% of sales. This should be a tailwind in 2011 as irrational competition had driven up marketing spend to 27% of sales in ’09. The ability to raise prices freely is not an option in S. Korea, it is widely expected that the government will ask for some price reductions this year, this has been well flagged and should be discounted at this stage.

1. North Korea discount: This is a constant worry and should be lead to a discount. I can however paint a positive picture if the North Korean regime rolls over quietly. I am sure that SK Telecom would be given a license to rapidly build out a wireless infrastructure and hence increase its potential market by 50%+.

1.  The analysts nearly without exception ignore the treasury stock (which accounts for 12% of the shares outstanding…the correct figure is 71.1m shares out). They also tend to ignore the marketable securities and investments made in various funds. They account for 27% of the market cap.

1. The ADR is very liquid, average trading volume $22m per day. However, it trades at a 13% premium due to the 50% foreign ownership restriction being reached on the local stock. It is possible to buy the local share if you can find foreigners who are selling in the local market. I largely own local stock, any Korean broker or major international broker can walk you thru how to bid for local stock. This is a hit and miss proposition, I mainly own the local stock.