Description

SKM ($23.41) SK Telecom ($ in millions of US dollars)

Wouldn’t it be great to own a market leader in a growing market, with a rock-solid balance sheet, generating tons of cash, with a continuously increasing dividend pay-out, earning high returns on equity, all of this and more at a basement-bargain price? Furthermore, it is a highly liquid multibillion dollar market cap name. Interested? Read further (also, you may want to read a previous VIC write-up by molly747 about two years ago).

First, some numbers (for orthodox value investors):
Market cap $15700
Net debt $1000
EV $16700

EV/ltm Rev 1.7x
EV/ltm Ebit 6.5x
EV/ltm Ebitda 4.0x
EV/ltm Ebitda-Capex 6.1x
EV/ltm Net income 9.2x

P/Book 1.9x
ROE, ltm 25% (avg ROE for last 5 years 25%)

On any valuation metric, SKM is very cheap on an absolute basis. It is also very cheap on a relative basis:

EV/ltm Ebitda-capex
SKM 6.1x
DCM 7.6x
VOD 9.5x
CHL 11.8x
AMX 22.9x

EV/ltm Ebit
SKM 6.5x
DCM 10.0x
VOD 11.1x
CHL 9.5x
AMX 22.5x

EV/ltm Net income
SKM 9.2x
DCM 14.5x
VOD 16.4x
CHL 13.6x
AMX 23.8x

Before going into a discussion on the market and the business, allow me to address an obvious question. Is SKM in a worse position than other leading mobile operators around the world? I think the answer is clearly, no. Let’s look at a few angles. First, competition, while we can debate the market of each of the comparables shown should there be interest, I believe SKM’s position in its market is as solid as that of any other of the leaders show above. Second, capital intensity (or the ability to generate tons of cash), SKM being in one of the most developed mobile markets; it is past the high capital intensity associated with this business. On the other hand, companies like AMX, and CHL have yet to spend the money necessary to upgrade their networks to the next generation of mobile technology. Third growth potential, an argument can be made that, similar to DCM and VOD, the Korean mobile market has less growth potential than the Chinese and Mexican mobile markets. True, however the Korean mobile market is more profitable than either of those markets, especially AMX’s market:

Ltm (Ebitda-capex)/rev
SKM 28%
VOD 27%
CHL 25%
DCM 20%
AMX 9%

Finally, on comparables, and while not necessarily the domain of value investors, the strength of its home economy. Other than China, Korea has a much stronger economy than the home market of the comparables shown. This means that it is more likely than not that the dividend stream coming from SKM will be worth a lot more dollars than that of the comparables.

To conclude this first section, SKM is a bargain on an absolute and relative basis.

SKM is the dominant service provider of mobile telecommunication in South Korea. This market has three operators: SKM with a 50% market share, Freetel with 33%, and LG with 17%. In Korea, SKM is widely recognized as the best operator with the best network. As such, its subscribers willingly pay a premium. Consequently, in addition to its larger scale to absorb operating costs, it is more profitable that it’s two competitors. For example, in 2005 its ebitda margin was 42%, which compares favorably to the 39% of Freetel and the 27% of LG.

The total market consistently grows at a nice pace. The total number of subscribers as of the end of 2005 is around 38 million, which represents a penetration rate of about 79%. Together with Japan, Korea is one of the most developed and advanced mobile markets in the world. Being a leader in this market, SKM not only has the strength to maintain its leadership position at home but also penetrate selected international markets (more on this below).

SKM grows through both increasing its subscribers and increasing ARPU. To illustrate, over the last five years, its subscriber base has increased from 14.5 million to 19.5 million. ARPU has increased from 33 thousand Won to 45 thousand Won. Aided by a strong currency, in turn, its revenues have grown from US$6.5 billion to US$10 billion over the same period. Similarly, the amount of cash generated (ebitda-capex) has increased substantially form less than US$1 billion to over $2.7 billion.

The future looks bright. First, SKM stands to further benefit from continuous fixed to mobile substitution and other long term trends favoring mobile telecommunication services. Second, SKM will likely continue increasing its ARPU by providing incremental data services, which have and continue to grow in the double-digits. Third, SKM is strongly positioned to succeed in its three new initiatives for its home market: satellite DMB, telematics, and home network. And Fourth, it has two international (US and Vietnam) initiatives that could become major winners. The US initiative, in particular, strikes me as a relatively minor capital commitment with a potentially very large payoff.

On top of its dominant position, SKM possesses some valuable assets in related fields. First, it owns the leading (number 1) music download site Melon –the “itunes” of Korea. It also owns the leading (and I believe, unrivaled) community website Cyworld –the “myspace” of Korea. While it is hard to value these properties, and also the magnitude of the numbers would probably not be completely relevant to the total market capitalization of SKM, they add to the strength of SKM in its market.

What should be the fair value of a company that currently generates about $2.5 billion of ebitda-capex, grows at a nice clip (say 5% per year), has a rock-solid balance sheet, is the market leader, and distributes an increasingly larger amount of cash to its shareholders? I believe that SKM is worth no less than $35/share (ADR).

Ok, $35/share is about a 50% upside, what is the downside? Let’s see, the current dividend yield is about 5% and SKM has mentioned an increased payout and a share repurchase for 2006. The effect of these actions would be a forward dividend yield of around 6% at the current price and excluding any further currency appreciation (a very conservative exclusion). If SKM were a (Canadian) income trust, it would have a yield of 16%! Hmm, so under a status-quo with no success in any of its growth initiatives, SKM will generate tons of cash and distribute a large amount of it to its shareholders. It is hard to see a reasonable scenario were SKM could be worth less than its current price. Consequently, in SKM, we have a security with substantial upside and minimal downside.

Catalyst

Increased cash flow generation
Increased dividends and share repurchases
Continued appreciation of the Korean Won