Description

(TKA is listed in Austria, I put Germany in the dropdown box above as there was no Austria)
 

Telekom Austria AG (TKA VI) - compelling risk/reward 

Telekom Austria (TKA VI) represents an attractive risk/reward with a probability adjusted 20%+ IRR over the next 12 to 24 months

TKA is a telecom provider that is supported by stable free cash flow from TKA’s Austrian business, growing earnings in the company’s Central & Eastern European markets, and significant hidden asset value in the form of passive tower assets that should be unlocked in the near-term.   

Key thesis points

• Telekom Austria has hidden asset value in the form of its passive infrastructure (towers) that the Company will likely monetize in the next 12 to 24 months
• Like many telecom operators, Telekom Austria has a portfolio of wireless towers. Similar to peers in Europe, TKA recently formed a towerco and put most of its tower assets into the structure with a dedicated management team with the intention of increasing the efficiency / tenancy of its portfolio.
• We believe the company will eventually monetize these assets given the passive nature of the assets (at least from TKA’s perspective) coupled with the market valuations being ascribed to towers.
• Furthermore, America Movil (TKA’s parent) recently announced plans to monetize their towers and they will likely use a tower monetization to partially monetize their stake in TKA.
• Additionally, there was a report over the summer (https://kurier.at/wirtschaft/telekom-austria-will-15000-funktuerme-ausgliedern/401466913) that confirmed TKA was looking to monetize the assets and that meetings between AMX and the Austrian government were occurring in both Mexico and Austria.
• Given the smaller size of TKA (~€7.5bn EV) and the size of its tower assets portfolio that could be monetized (16,000+ per AMX), we estimate the towers value at 30% to 50% of TKA’s EV, which would effectively create the remaining wireless business at a 3-4.5x EV/EBITDA multiple.

• TKA is a stable telecom provider that generates healthy amounts of FCF that will likely increase shareholder returns in the near-term
• TKA operates in attractive markets in mostly 2 or 3 player markets that leads to rational competition and sustainable earnings / free cash flow. TKA currently trades at a 9.5% FCF yield (after adjusting for leases, restructuring costs and spectrum auctions) before taking into consideration the tower assets which is attractive given the competitive position and recurring cash flows. 
• Additionally, as the Company just reached its target leverage ratio in 2Q’21 (1.5x net), increased shareholder returns via a growing dividend is most likely. With most peers having a 70%+ payout ratio, TKA cold more than double its dividend and still have cash to invest in any fiber buildout. This will support double digit long-term growth of its dividend over the near-term. 

Business description

·       Telekom Austria (TKA) is a telecom provider in Austria and 6 Central & Eastern European (CEE) countries: Bulgaria, Croatia, Belarus, Slovenia, Serbia and North Macedonia. The Company generates most of its revenue (84%) from services: wireless services (46% of revenues) & fixed line (38% of revenues). The remaining revenue is largely from equipment revenue.

·       TKA generates ~57% of its revenue & profits in Austria. Other large markets for the company include Bulgaria (~11% of EBITDA), Croatia (~9% of EBITDA) and Belarus (~11% of EBITDA).

·       Wireless services (46% of revenue) comprise digital mobile communications services including value-added services, such as text and multimedia messaging, m-commerce, information and entertainment services (for example mobile television, streaming of music, etc.).

o   2% of wireless service revenue in 2020 was from roaming of travelers (lower due to COVID; was 3% in 2019) but shrinking as part of reduced roaming fee regulation via Euro

§  Was 4% impact to EBITDA in 2020 given lack of travel and high margin nature of roaming fees. Some upside to margin from reopening / travel return as roaming fees return and flow directly to earnings

o   9% of wireless service revenue was from interconnection fees

·       Fixed-line services (38% of revenue) include access fees, domestic and long distance services including Internet services, fixed-to-mobile calls, international traffic, voice value-added services, interconnection, call center services, data and ICT solutions, television services, IPTV and smart home services.

o   Of its ~6mn RGUs (as of 12/31/20), 2.55mn are broadband and 1.68mn are TV with presumably the remaining being largely telephony 

Valuation & Return Analysis

·       TKA currently trades at ~5.1x EV/FWD EBITDA (9.5% normalized FCF yield), which is at the low-end of telecom peers.

·        In the base case, with the Company monetizing their tower assets, we ascribe a 5x multiple as such a stable telecom company, even with higher lease payments, is worth at least 5x and this seems conservative. We assume the €2.7bn in tower assets are unlocked either through a spin to shareholders or sale with cash then distributed to shareholders. With a growing dividend in the near-term and a YE’23 price target of €11.30, it represents an IRR of ~24%.   

·       In the bull case, we assume the Company monetized their assets at a higher valuation (€3.4bn) and the Company repurchases ~40% of its float at a 65% premium to today’s price. In addition, revenue growth modestly accelerates with margins expanding as service revenue grows due to 5G and TKA benefits from operational leverage coupled with the return of roaming fees and the impact of its restructuring program over time. As a result, the Company commands a higher multiple than the base case at 5.25x, resulting in an IRR of 41%.

·       In the bear case, the Company does not monetize their assets and faces declining top-line results in the LSD as fixed-line losses accelerate, particularly in Austria and wireless competition increases, reducing the 5G opportunity and seeing margins decline. However, the tower assets help put a floor on valuation and any weakness in operations likely increases the odds of an eventual sale/spin. Putting a 5x multiple on the business with tower assets seems conservative and results in a -10% IRR.

Tower Valuation

·       The value of the towers was determined using a SoTP between the company’s Austrian towers and its CEE towers where we would expect the Austrian towers to command a higher premium. In the base case valuation, we use a €20k per rent for the Austrian towers and €16.8k in annual rent for the CEE towers. We then use a 60% margin and a 20x multiple on the Austrian business and a 55% margin and a 12x multiple on the CEE business, resulting in a total value of ~€2.7bn in tower value. 

§  For comparison, Cellnex acquired ~5,000 (4,500 towers + intention to build 500 more) Austrian towers from CK Hutchison as part of a larger transaction. In its financials, Cellnex ascribed a purchase price of ~€1.2bn for the assets. (Source: Cellnex 10-K)

§  At the same value per tower, this would imply TK’s Austrian towers are alone worth ~€2bn.

§  The €240,000 valuation for tower is also roughly in line with precedent transactions in price per tower in Europe

For the non-Austrian towers, the best comp is a pulled IPO in 2016 of Global Tower, which owns towers in Turkey and Ukraine. According to TowerXchange, the company had ~4,574 revenue generating at a revenue of ~$14,000 per year and was seeking a 12-15 EV/EBITDA multiple (~52% EBITDA margins). Using the ~$14,000 (~€16,800 in annual revenue, which is likely conservative since these were based on 2016 numbers), similar 55% EBITDA margins and the low end of the EBITDA range implies a conservative €1.1bn valuation for the non-Austrian towers.

 

Austrian Market

• The Austrian Telecom market is ~€3.8bn with mobile accounting for ~63% of the market and broadband 26%

• The Austrian telecom industry is unique as the wireless market is one of the most economically developed and mature markets whereas the fixed market is significantly less developed and in ‘pre-disruption.’
• The Austrian telecom market is effectively a 3-player market with a large tail of MVNOs and regional broadband providers.
• The 3 players are: Telekom Austria, T-Mobile/Magenta, and Hutchison Drei. TKA and T-Mobile both offer wireless and wireline solutions while Hutchison Drei relies exclusively on wireless to offer both mobile and broadband solutions.

• TKA is roughly double the size of T-Mobile in terms of total Austria revenue although its EBITDA margins after leases lag T-Mobile following T-Mobile’s acquisition of UPC (cable in 2018). This seems mostly due to TKA effectively paying employees not to work through its restructuring program. Although even adjusting for TKA’s restructuring, they still lag likely due to TKA’s incumbent status and the fact that ~40% of its employees are still considered civil servants.
• Austria Wireless Market

• The Austrian wireless market is a 3 player MNO market with a growing MVNO side.
• The 3-player market followed a merger between Hutchison and Orange in 2012
• As a result of that merger, the combined company was required to provide a third of its network capacity to MVNOs
• A1 is the incumbent legacy player and holds the #1 position
• According to primary research, A1 is seen as having the best network but as we’ve seen around the world, with networks being commoditized, Magenta has been catching up
• The market share amongst the big 3 has been relatively stable over the past few years
• MVNO penetration has increased due to regulatory concessions when Hutchison merged. The top competitor is HoT which is the Aldi grocery chain in Austria
• The MVNO competition is largely in the lower-value plans which is not where TKA is focused.
• Austria Fixed Line Market

• The Austria fixed line market is largely a duopoly between A1 (TKA) and Magenta (DT/T-Mobile) with a tail of hyper local providers that are usually backed by local utilities. 

• TKA is the incumbent and dominant player but its broadband largely consists of the inferior DSL (upgraded VDSL). So while it remains the market leader, it has been losing share to Magenta which is largely HFC in higher density areas.
• Magenta purchased cable operator (UPC) in 2017 which at the time passed 36% of Austrian households (1.4mn)
• As the regulated incumbent, TKA has to alert regulators/competitors when it is going to do promotions and has to offer wholesale prices to competitors.
• There is a proposal to de-regulate part of the market that is in front of the EU and likely will be resolved by mid-2022 which should allow TKA to become more competitive in the fixed business.
• Fiber is growing but small and both companies are making very targeted investments in fiber
• Government has struggled to incentivize fiber investments and market was characterized as ‘stuck.’
• TKA said they wanted to keep customer base stable but have been losing subs. Said low bandwidth is churning while high andwidth is increasing
• Did highlight that customers are actually churning from fixed to mobile broadband subs. 
• Despite fixed access line losses due to losses across all of its RGUs, TKA has been able to keep fixed line ARPL revenue relatively flat through increases in ARPL which appear aided by higher bandwidth.
• Have been able to grow overall fixed-line revenue through ancillary services, notably business connectivity which has seen solid growth
• Business connectivity revenue is ~80% recurring and remainder is project based

CEE

• While our main focus was to understand the tower valuation and the Austrian market, given its outsized impact on the business, we were pleasantly surprised by the CEE market (with the very real exception of one market).
• In the CEE markets, TKA is often the lean, more agile disruptor competing with legacy incumbents. These markets are also often less mature so there is more growth potential from both overall market growth and potential share gains.
• Slovenia (3.5% of EBITDA) – Very stable market and TKA is in an excellent position. Market is operating in integrated way with stable competitors. TKA is #2 in mobile and #4 in broadband.
• Croatia (9.6% of EBITDA) – Very stable with TKA in a great operating position with stable competitors. TKA is the #2 player in both markets, trailing Magenta (T-Mobile’s operator).
• Serbia (5.8% of EBITDA) – TKA’s only non-integrated market (mobile-only). Stable market but better growth prospects than some other markets. TKA is the #3 operator in the market.   
• Macedonia (2.7% of EBITDA) – Another growth hero for TKA where the company operates from a strong position but market still has room for growth. TKA is #1 in mobile and #2 in broadband.
• Bulgaria (12.9% of EBITDA) – Has some growth potential but TKA needs to figure out cable side of business as entered market at a later stage. TKA is #1 in mobile and #2 in broadband.
• Belarus (9.3% of EBITDA) – Massive political risk and recent results have been impacted by this uncertainty and currency depreciation which has dragged on performance but also seen Belarus become less important for TKA’s results. #2 in mobile and broadband.

Capital Allocation

• Given state ownership percentage, TKA is run fairly conservatively. Target net leverage of 1.5x which is at low-end of peers.
• Unlikely to increase leverage given ownership / management
• Just hit 1.5x net leverage target so would expect an update to capital allocation policy (read dividend increase).

o   Had small dividend in 2015/2016 (0.05 Euro) that was increased to 0.20 EUR in 2017 and since grown to 0.25 EUR

• Historically did some small tuck-in M&A in existing markets as part of a cable / telco convergence.
• Unlikely to do transformative M&A or even enter a new country given ownership and current market trends

Capital Expenditures

• TKA has guided to capex (ex-spectrum) of €800mn for 2021. This follows 2020 where non-spectrum capex was delayed as most telecoms ramped down capex
• Capex has been elevated due to transition from 4G to 5G. Notably, the acquisition of spectrum has created several one-off capex purchases. However, most spectrum purchases are largely complete and remaining countries are unlikely to have large spectrum auctions in terms of Euros.
• Completed multi-band auction in Austria. Spent €65.6mn. Remaining band open is 26GHz which shouldn’t be less costly
• Slovenia -finished multi-band auction (acquired 700MHz, 1.4GHz, 2.1GHz, 3.6GHz, 26 GHz) for €43.6mn
• Bulgaria – acquired 3.6 Ghz for €2.4mn (700 MHz not open yet b/c still used by military)
• Croatia – in the middle of 5G auction
• Macedonia & Serbia are still left
• Belarus – no idea what is going on with recent political turmoil
• Spending ~€100mn on fiber in Austria. Cautious about doing fiber only where it is economical but just announced that it will increase fiber spending along with expected deregulation of the Austrian market
• Deregulation of certain parts of the Austrian market has been proposed to the EU and a likely ruling is due in 2022 which could see TKA increase capex to build out fiber in Austria.

Restructuring Program Overview

• TKA has an ongoing restructuring program. However, some of the employees (civil servants) cannot be laid off due to their status so the restructuring provision includes future compensation of employees who will no longer provide services. The restructuring program also includes social plans for employees whose employment will be terminated in a socially responsible way.
• The liability has come down over time as the restructuring program pace lessened coupled with the release of employees. Over time, this will gradually come down as more employees roll off.
• Additionally, the company has ~€170mn in short-term investments which are held as deposits to offset some of the liability
• Historically, the restructuring charge has been extremely volatile but the Company expects something in the €85mn context going forward for a run-rate of restructuring ~80 employees per quarter (~320 per year).
• The Company attempts to market itself on adjusted EBITDA adding back this restructuring charge; however, this seems a bit misleading since unlike in the US, these restructuring costs are recurring and the average age in the restructuring program is ~51 vs the retirement age of 62 (upon which citizens roll into the government sponsored retirement program).
• That said, as existing employees in the restructuring program roll off, that should aid margins and cash flow.
• We estimate that this should result in ~€10-€15mn benefit per year.

Why this opportunity exists

• Relatively low float and liquidity given ~79% of the Company is owned by a combination of AMX and the Austrian Government
• Company does not broadly distribute earnings calls or have transcripts
• Has minimal European sell-side and all based in Europe so they don’t follow AMX and their strategic priorities. Does not appear like market has put together AMX’s monetization priorities with TKA
• Concern over Central & Eastern Europe exposure provides an overhang on the stock, particularly Belarus

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Catalyst

• As TKA’s announcement of the creation of a separate towerco anniversaries, we would expect some clarity around the Company’s intentions for their tower profile in the next 6-12 months. Additionally, the shareholder agreement between AMX and the Austrian government expires in early 2024 so we would expect this to serve as a likely deadline to determine a solution that satisfies both parties.
• We would expect that tower monetization will serve as a bargaining chip and that AMX would prefer some type of monetization of their own stake. While TKA could use it to buy back some of America Movil’s stake, we think AMX prefers consolidating TKA’s earnings and would be unwilling to go below 50%. Therefore, we would expect either a spin-off with shareholders getting equity in the new towerco or a sale with TKA giving shareholders a special dividend. In either scenario, this would give the company capital, along with its low leverage to invest in fiber while also generating an attractive return to AMX and existing shareholders.  
• In the interim, following TKA’s recent beat & raise coupled with their already low payout ratio, we would expect that the Company will continue to grow its dividend in the low-double digit context. Given TKA is already below their net leverage target, we would also expect the Company will look to deploy capital either through more capital returns or smaller tuck-in acquisitions that should further support future earnings growth.