Daily analyst comments
MTS posts weak 1H 2009 US GAAP financials
12.08.09 10:26
The 1H 2009 US GAAP report from MTS has not offered much to look at: revenue dropped almost 25% y-o-y, and EBITDA margin declined by 3 pp. In addition, the operator did not attempt to reduce investments; on the contrary, it raised them even further, which looked quite amazing against the backdrop of the future acquisition of a controlling stake in Comstar from AFK Sistema. As for the merger itself, it currently looks more profitable for Sistema rather than for MTS.
On August 11, 2009, MTS (RTS: MTSS) announced its 1H 2009 US GAAP financials.
In 6M 2009, MTS revenue denominated in the US dollar, which is the operator’s reporting currency, decreased by 24%, the same value as in 1Q 2009 (see our daily published May 25, 2009).
We are downbeat on the operator’s revenue performance, especially given that MTS underperformed even our most pessimistic forecasts: we expect the company’s USD-denominated revenue to drop only 15% at the end of the year, while our model does not provide for any aggressive development of MTS’s retail business.
MTS’s OIBDA margin declined by 3 pp y-o-y, but grew by 1 pp compared with 1Q 2009. We would rather attribute such robust margin figures to management’s cost-cutting efforts. The operator reported higher OIBDA margin as compared to our end-of-year projection of 40%; however, even such a high margin is unlikely to offset the company’s revenue shortfall from the viewpoint of its net cash flow and estimated stock price.
The operator’s net income decreased by a relatively neutral 60%. On one hand, this was an unavoidable consequence of the US dollar strengthening against the ruble and other currencies of CIS states: the bulk of the MTS debts are denominated in dollars, which resulted in a nearly USD 265 million loss on currency translation differences in 1H 2009 compared with a USD 127 million loss in the year-earlier period. On the other hand, the operator still runs at a profit, which can only be positive. In addition, the ruble has stopped losing ground, which should help the company improve 3Q and 12M 2009 results.
Table. MTS: US GAAP financials 1H 2009, USD million unless otherwise specified
We are extremely downbeat about the company’s massive investment flow: in 1H 2009, it grew by 38%. MTS management estimates the total volume of the operator’s investments in 12M 2009 at USD 1.5 billion: against this background, the current volume of USD 1.3 billion, already invested, looks unreasonably large. All other things equal, an excess of actual investment over that estimated will provoke a downturn in the fundamental value of MTS stock during the update of our financial model.
When announcing the 1H 2009 results, MTS management also substantiated the need to acquire a controlling stake in Comstar (see our daily published August 3, 2009). The following arguments were produced in favor of the acquisition:
Therefore, the key arguments offered by MTS management were, one way or aother, related to manageable growth (1, 2, 5, 6, 7), debt (8, 9) and brand power (4). It is not yet clear how the company is going to exercise the scale advantages: we doubt that equipment for wired and mobile communication services is sufficiently similar to gain MTS any notable discount from equipment manufacturers.
Another important argument offered by the company, which can also be related to manageable growth, is package offers. However, for an overwhelming majority of customers, package offers, especially of the type currently present on the market, are not a weighty argument, either from the economic or technical standpoint. We recall that a few years ago, Sistema was already planning to merge all its subsidiaries into a single billing system (the project was titled "Single Access Point"); however, these plans never came to fruition. In our opinion, MTS is unlikely to cut prices in the package convergence sector, i.e. merged fixed-line and wireless communication services: this does not go in line with the company’s strategy to maintain margins at the current level.
Moreover, the rebranding held in 2006 did not help Sistema boost its market share, though it was actually the first step towards the merger of MTS and Comstar.
In general, we do not see any positive aspects in MTS’s merger with Comstar, from the viewpoint of the companies’ minority shareholders, especially in view of the existing premium to Comstar’s current stock price. Of course, the merger will serve as a driver for MTS’s further business development; however, this growth promises to be inorganic and cost-inefficient, while the synergic effect of the merger looks dubious. In other words, 2+1 does not necessarily give more than 3 in this case.
The only party that will gain from MTS’s merger with Comstar is AFK Sistema: the corporation will receive a lot of sought-after money, and retain control over both companies.
We assign a BUY rating to MTS with a target price of USD 10.80 per share at the end of 2009.