Value searching after turmoil
Korean telecoms have underperformed the broader market
throughout this year, which many investors may consider
cheap entry. While earnings should improve from eased
marketing competition throughout 2H09, lack of new
catalysts will limit large upside momentum, in our view. We
rate the sector Neutral on unexciting but better earnings
heading into 2H09, and assume coverage on the Korean
telecom sector with KT and LG Dacom our only BUYs.
» Mature, saturated, and soon declining market
Even with the Korean telecoms market having 90%-plus maturity,
competition has remained high, and market value has declined
significantly. While mobile may see limited opportunities to grow ARPU
qualitatively through increased use of consumer friendly smartphones,
fixed-line services value is likely to continue decline amidst more
competition and less net adds. With this in mind, operators may venture
outside of their core businesses and market for growth.
» Consolidation themes and cost savings opportunities
The Korean telecoms sector has been an underperformer to the broader
market for most of its public history. But in the past three-to-four years,
with consolidation themes, excitement over new services (IPTV, VoIP),
and recession, the sector traded within market ranges. From now, with
hopes on significant top-line growth subsiding, we believe companies
with consolidation themes and better cost management will outperform.
» 2Q lower than consensus, but likely the earnings bottom
Reckless competition after pleasant 1Q earnings is likely to drive a
weak 2Q earnings season for Korean telcos. We believe the market is
underestimating the downward impact on 2Q earnings (we are 11%
below consensus 2Q OP). 2H is likely to see relative easing of
competition, and earnings should improve.
» Prefer KT and LG Dacom
We prefer KT for post-merger efficiencies and LG Dacom for growth
execution and likely merger. KT’s management has shown solid
direction and has executed cost-savings. Also, the company’s mobile
division may see ARPU growth following launch of the iPhone.
LG Dacom, continues resilient earnings with a solid growth profile, and
the Powercom merger can act a price catalyst once executed.
Executive summary
Even with the Korean telecoms market having 90%-plus maturity in its core services,
competition has remained high, and market value has declined significantly. Heavy
competition within the sector has lead to price competition and huge bundle discounts, which
we estimate to have lowered mobile ARPU by 5% YoY and broadband ARPU by 12% YoY in
the past year alone. The search for value-accretive (high-ARPU) subscribers in mobile, longterm
contracted bundle subscribers in broadband, and subscriber bases to jumpstart VoIP
and IPTV have lead to large price cuts and upfront costs to these operators, but they have yet
to realize any longer-term benefits as they have continued heavy competition.
While mobile may have a few opportunities to grow ARPU qualitatively through increased use
of consumer friendly smartphones, fixed-line services value is likely to continue to decline
with undifferentiated services, more competition, and fewer net adds. Even though earnings
should improve from eased marketing competition throughout 2H09, the lack of excitement in
Korean telcos without growth catalysts will limit large upside momentum, and we cannot
picture the sector outperforming. We reassume coverage on the Korean Telecom sector
with a Neutral rating on unexciting but better earnings heading into 2H09.
Reckless competition after pleasant 1Q earnings is likely to contribute to a weak 2Q earnings
season for Korean telcos. As total MNP subscribers reached 3.3mn subs in the quarter
(up 12% YoY, up 131% QoQ), net marketing costs in mobile likely grew to over 30% of
mobile service revenue. Company-specific, we believe SKT (2.5% OP decline YoY) and LGT
(17.9% OP decline YoY), who displayed the heaviest mobile marketing and MNP
aggressiveness, will see the biggest OP disappointments. Moreover, we believe aggregate
mobile service revenues grew 0.8% YoY, and aggregate broadband revenues fell 2.8% YoY
in a quarter full of continued price discounts. We believe the market is underestimating the
downward impact on 2Q earnings (we are 11% below consensus 2Q OP).
For 2H09, with hopes on top-line growth subsiding, we believe telecom operators with
consolidation stories or ones that can execute well on cost-savings offer the strongest
investment cases over a 12-month horizon. This is the reason why we prefer KT for postmerger
efficiencies and LG Dacom for growth execution and likely merger. KT’s
management has shown solid direction and has executed as promised to date.
While the telecom services sector underperformed the market most of its public history, in the
past three-to-four years, the themes that offered telecom outperformances were consolidation
themes, excitement over new services (IPTV, VoIP), and a recession. From now, with hopes
on significant top-line growth subsiding, we believe companies with consolidation stories and
better cost management will outperform.
Against this backdrop, another key risk remains in that these operators may venture outside
their core competencies and familiar markets in order to find growth drivers. This strategy has
been unfruitful for Korean telecom operators to date, and recent advertisements and
movements by SKT suggest that another try for overseas growth may be possible.