BCommunication Ltd. (BCOM.IT - NIS Buy) Investment Summary:

Transcription

1 Initiating Coverage Telecom Services BCommunication Ltd. (BCOM.IT - NIS Buy) COMPANY NOTE Lena Rogovin, Senior Research Analyst, lrogovin@chardancm.com Sales and trading 7 a.m. to 7 p.m. ET, (646) Sales and trading 7 p.m. to 7 a.m. ET, (646) Stock Data 11/06/15 Price NIS Week Range (NIS NIS99.20) Price Target NIS Exchange rate 1US$ = NaN NIS Market Cap (mil) NIS2, Shares out (mil) Mo Avg Vol 32,914 One year price history BCOM.IT 1 Year Price History for BCOM/IT Created by BlueMatrix BCOM: Undervalued leveraged play on Bezeq We initiate coverage on BCOM with BUY rating and ILS112 PT. The only controlling shareholder in Bezeq with 30.7% share, BCOM is trading at a 38% discount to NAV vs. an average discount over the last 2 years of 30% and and average discount for Israeli holding companies of 10-31%. We believe this high discount is not justified, as BEZQ is the only asset of BCOM, and the risk of investing in the holding company has decreased dramatically following its recent deleveraging, in addition to the refinancing of its remaining debt into longer maturities. BCOM started to pay dividends in 1Q15 as a part of its commitment to return cash to shareholders. BCOM is a leveraged play on BEZQ, which is an efficiency improvement (cost cutting) and dividend play. Bezeq is the Israeli fixed-line telecom incumbent with a leading presence in mobile, ISP and Pay TV segments. BEZQ has weathered the storm through recent years of increased competition in the local market as well as a hostile regulatory environment. Through it all, the company has succeeded in maintaining strong margins, and has a dividend policy of distributing 100% of net income. Despite continuing competition in the mobile segment, BEZQ should be able to reap the benefit of significant cost savings as a result of the gradual end to the mandated structural separation between Bezeq and its subsidiaries. Dividends from BEZQ, further deleveraging, and an increase in the dividend payout ratio are drivers of share price performance. BCOM might buy back part of its debt from the market, reduce interest payments, and thus have leeway to increase its dividend payout ratio. We value BCOM applying a 25% discount to its spot NAV, derived from the value of BCOM s 30.7% stake in BEZQ current market cap and BCOM s stand alone net debt adjusted for dividends received from BEZQ after 2Q15 report. Investment Summary: With a 30.7% stake, BCOM is the only controlling shareholder of Bezeq, an Israeli fixed-line incumbent. BCOM has significantly improved its financial position recently. BCOM s total debt has almost halved from ILS5bn in April 2010 to ILS2.6bn as of June, In addition to that, the company s management has refinanced almost the entire amount of the remaining debt in February, The company pays quarterly dividends starting from 1Q15 and plans to increase dividend amounts going forward. There is no established dividend policy in BCOM at this stage. The stock is trading at 38% discount to NAV, which hasn t shrunk after a deleveraging and an announcement of dividend payments. We believe such a high discount is not justified as the risks of investing in BCOM are much lower now. Please refer to important disclosure information and Regulation Analyst Certification found on pages of this report.

2 Bezeq is an operational savings story. While top line continues to be affected by competition and regulation, margins stay high, and stronger results are expected from , when structural separation between BCOM and its subsidiaries is removed and the subsidiaries operations are fully integrated. This should save BEZQ hundreds of millions of ILS. Catalysts for BCOM stock price are: Bezeq results above consensus, especially on a net income line, which would mean higher dividend payments. Two major sources of potential upside are structural separation removal earlier than the market expects and stabilization of pricing in Israeli mobile market following sector consolidation. Bezeq is going to report 3Q15 results on November, 10. Further deleveraging of BCOM. The company may come back to the market to buy back a part of the debt, which will lead to lower interest payments. Increase in BCOM dividend payout ratio and establishing of dividend policy. Improvement in BCOM stock liquidity. Valuation: Our ILS112 price target for BCOM is based on a target discount to spot NAV of 25%, vs a 38% current discount and a 30% average historical discount for the last 2 years. Risks to achievement of target price: Deterioration in Bezeq fundamentals and lower dividends by Bezeq Unfavorable regulatory changes Bezeq poor stock price performance BCOM dividend payments below market expectations Interest rate increases leading to higher interest payments by BCOM Company description: B Communications is a 67% owned subsidiary of Internet Gold, a publicly traded company, which is 70% owned by Eurocom Group (see Appendix I for Eurocom organizational chart). BCOM is traded on TASE and NASDAQ. BCOM holds a 30.7% stake in Israeli telecom incumbent Bezeq and is its only controlling shareholder. BCOM acquired the controlling interest in BEZQ in 2010 from Apax-Saban-Arkin, and is the only BEZQ shareholder, which has a permit from the Israeli Prime Minister and the Ministry of Communications to direct BEZQ activities, and controls BEZQ Board. The company's founder and Chairman is Mr. Shaul Elovitch, who also serves as a Chairman of Bezeq Board. The company's CEO since 2011 is Mr. Doron Turgeman, who served as the CFO of the company since Page 2 of 15

3 Contents BCOM High discount to NAV is not justified... 2 Bezeq in a Nutshell... 3 Bezeq revenue segments overview... 4 Fixed-line 47% of revenue, 68% of EBITDA... 4 Mobile 38% of revenue, 13% of EBITDA... 5 Bezeq International 17% of revenue, 7% of EBITDA... 5 YES 19% of revenue, 12% of EBITDA... 5 Structural separation removal... 5 Bezeq financials... 5 BCOM financial position... 7 Appendix I Eurocom Group Structure... 8 Page 3 of 15

4 BCOM High discount to NAV is not justified In our view, the BCOM stock price is not just a function of BEZQ stock price, but should also reflect processes, which take place on a holding company level. Over the last 2 years, BCOM stock has been trading at 30% discount to NAV on average, while recently the discount has widened to around 40%, despite fundamental improvements in BCOM s financial position. The company s interest expenses have decreased following paying back a part of the debt and refinancing the remaining debt to longer maturities and at lower interest rate. In addition, BCOM itself is now paying dividends. These changes, combined with almost ILS 1bn accumulated liquidity, provide further potential for debt buyback and an increase in BCOM s own dividend payments. BCOM MCap and NAV vs. Bezeq MCap since BEZQ acquisition Israeli holding companies average discount to NAVs Sources: FactSet, company reports, Chardan estimates Sources: TASE, Companies reports, Chardan estimates BCOM s almost 40% discount to NAV is in the upper end of Israeli holding companies average discounts, while it has only one asset with pretty stable cash flows and a clear cash distribution policy. Page 4 of 15

5 Bezeq in a Nutshell Bezeq structure chart Source: Company presentation Bezeq is Israeli fixed line incumbent with 45% share of $6.1bn Israeli telecoms market. It has 2.2 mn fixed-line subscribers and 1.4 mn broadband Internet subscribers (65% fixed-line and broadband infrastructure market share). It owns 100% in Pelephone, an Israeli 3rd mobile operator with 2.6mn subscribers (26% mobile market share) and YES, the 2nd largest pay-tv provider with 638k subscribers. Via its 100%-owned subsidiary Bezeq International, the company controls 42% of the Israeli ISP market. Israeli Telecom Market, 2014 Partner, 18% HOT, 17% Cellcom, 19% Bezeq, 45% Source: Company reports Bezeq receives 85% of revenue from fixed line (48%) and mobile (38%) segments, both of which have been under pressure from the regulation and increased competition for the last 5 years. The company sees churn rates and ARPU stabilizing over recent quarters, which likely indicates that the bulk of the downside, at least in broadband infrastructure access and mobile segments, is already reflected in the Page 5 of 15

6 company s results. There is still some downside in the fixed line telephony segment, as providing an access to other operators is a next step of a wholesale market establishing by the Communications Ministry, however in our view a potential damage is unlikely to be dramatic given already low ARPU from fixed-line telephony. That said, Bezeq is a value story, with cost savings potential from a gradual removal of the structural separation which was in place for 20 years, which means a merger of the subsidiaries and integration of their operations. Bezeq revenue segments overview Bezeq operates in four main segments: Fixed-Line Communications, which includes providing access to infrastructure; Mobile Communications, Pay TV and International Communications. Bezeq revenue breakdown by segment, , % Dec '10 Dec '11 Dec '12 Dec '13 Dec '14 International Communications & Internet Services Multi-channel Television Cellular Communications Domestic Fixed-line Communication Source: FactSet, Company reports Fixed-line 47% of revenue, 68% of EBITDA There is a duopoly in Israeli infrastructure market Bezeq controls 65% and HOT the remaining 35%. Israel s Communication Ministry is in the process of changing this situation by creating a wholesale telecoms market, via obliging Bezeq and Hot to provide an access to their infrastructure to all telecoms players. This has already been done in the broadband Internet segment, and still to be done in fixed-line telephony segment, the biggest Bezeq business segment, which brings the company 39% of revenue. Bezeq was supposed to provide access to its fixed-line telephony network starting from May, 2014, but it hasn t happened yet. The bulk of 100k broadband customers added by BEZQ during 12M ended June, 2015, are wholesale customers. All in all, broadband subscribers churn was modest relative to regulator expectations, with only 170k subs out of 2mn switched to other infrastructure providers. Page 6 of 15

7 Fixed-line segment enjoys high EBITDA margins of above 60%. Mobile 38% of revenue, 13% of EBITDA BEZQ mobile subsidiary Pelephone is the 3 rd largest operator in Israel with 2.56mn subscribers. Pelephone has suffered from tight competition, however ARPU has stabilized over the last 2 quarters. Margins have also been under pressure on lower revenues, but have started to stabilize at around 22% level in 2Q15 and 20% for 1H15, 2 p.p. higher than peers. Bezeq International 17% of revenue, 7% of EBITDA This segment includes ISP, which has 42% Israeli market share, ILD and business solutions. Bezeq International revenue has been growing, mostly on business communications and data services, which combined account for 74% of the segment revenue, while ILD revenue continues to decline. EBITDA margin is relatively stable at 22-24%. YES 19% of revenue, 12% of EBITDA Bezeq 100% owned pay-tv subsidiary YES had 638k subscribers (43% market share) as of the end of 2Q15, ARPU of ILS230/month and churn of 3.1%. Bezeq bought a remaining 50.2% stake from Eurocom in 2Q15 to strengthen competitive position in the market via inter-segment revenue synergies. YES revenue has been relatively stable over the last 4 quarters, growing at low single digits in 2Q15 y-o-y on new subscribers additions despite more and more people switching to Internet-TV. EBITDA margin was 34% in 2Q15. Structural separation removal The biggest theme in BEZQ story is a removal of structural separation, which should lead to material cost savings from elimination of overlapping functions. There is still no clear time frame for a merger between BEZQ and its subsidiaries, however the market expects them to fully come into effect only in The timing of elimination of structural separation is the biggest catalyst for BEZQ stock, however it should be taken into account that a merger and integration is a long and complicated process, which will take not less than months. For example, the merger with YES, which has been already approved by the Telecoms Ministry, is planned before 2016 YE and should lead to cost savings of ILS 155mn, mostly from SG&A. A merger with Bezeq International may save the company ILS300mn annually, according to media reports. When fully integrated, operational savings could reach ILS 600mn - ILS 1bn according to various market estimates. Bezeq financials BEZQ s top line has been affected by increased competition as a result of telecoms industry reform in Israel, however the company managed to keep high margins. Revenue in the fixed-line and mobile segment has been declining since , and the consolidated top line has been supported by YES Page 7 of 15

8 and Bezeq International growth. Gross margin has remained at above 40%, EBITDA margin has stayed at 42% in and operating margin at 27% and higher. BEZQ revenue growth by segment, , % Dec '10 Dec '11 Dec '12 Dec '13 Dec '14 Domestic Fixed-line Communication Pelephone YES Bezeq International BEZQ Margins, , % Dec '10 Dec '11 Dec '12 Dec '13 Dec '14 Gross Margin EBITDA Margin Operating Margin Net Margin Sources: FactSet, company reports Sources: FactSet, company reports The market doesn t expect any dramatic changes in BEZQ financials in the coming years, but expects revenue to stabilize.10% y-o-y revenue growth expected in 2015 is mostly from a full consolidation of YES. BEZQ Sales and Net Income Consensus expectations 10% 3% 2% 0% FY '15E FY '16E FY '17E -2% -3% Sales growth Net income growth Source: FactSet There is an upside for margins on operational savings from elimination of structural segments separation, which according to BCOM s management and market participants estimates should save ILS 600mn - 1bn annually. Bezeq has a dividend policy of distributing 100% of net income. Page 8 of 15

9 BCOM financial position Dividend from BEZQ is the only source of BCOM revenue, and debt servicing costs is a core costs item. BCOM Solo P&L, ILS mn 2Q2014 3Q2014 4Q2014 1Q2015 2Q2015 G&A Tax expenses -12 Financing expenses, net Total expenses Interest in BEZQ net income PPA amortization, net Net Income Sources: Company reports BCOM s financial position has improved significantly over recent years. The company decreased net debt from above ILS5bn at the time of BEZQ stake acquisition in April, 2010 to ILS 2.6bn as of 2Q15. In addition, it has refinanced the remaining debt via issuing $800mn of senior secured notes in February, As of the end of 1H16, the company has accumulated liquidity of almost ILS1bn. BCOM debt repayment schedule BCOM net debt and leverage 3,000 2,842 2,500 2,000 1,500 2,842 1, Senior Secured Notes Source:Company reports Series B Debentures Source: Company reports BCOM coverage ratio has improved from 1.51x in the beginning of 2014 to 2.33x in the end of 1H15. The company is paying dividends for 2 quarters and despite the company not having a dividend policy in place, it says it is committed to return cash to shareholders. It has paid ILS 67 mn in dividends for 1Q15 and a part of 4Q14, and ILS 22mn for 2Q15. Page 9 of 15

10 Appendix I Eurocom Group Structure Eurocom Group Structure Source: Company reports Page 10 of 15

11 B Communications Ltd. Consolidated Income Statement All figures in millions of Israeli Shekel, except per share items Year/Year growth Income Statement Jun '15 Dec '14 Dec '13 Dec '12 LTM 365 DAYS 365 DAYS 366 DAYS Sales 9,271 9,055 9,563 10,278 Cost of Goods Sold (COGS) incl. D&A 5,215 5,661 5,556 6,100 COGS excluding D&A 3,272 3,788 3,542 3,733 Depreciation & Amortization Expense 1,943 1,873 2,014 2,367 Gross Income 4,056 3,394 4,007 4,178 SG&A Expense -- 1,350 2,005 2,278 Other Operating Expense (17) EBIT (Operating Income) 1,867 1,891 1,934 1,917 Nonoperating Income - Net Nonoperating Interest Income Other Income (Expense) Interest Expense Unusual Expense - Net (252) (240) (53) (75) Unrealized Investment Loss (Gain) -- (240) (53) (75) Other Unusual Expense (252) Pretax Income 1,679 1,968 1,715 1,590 Income Taxes Income Taxes - Current Domestic Income Taxes - Deferred Domestic -- (126) (55) 60 Equity in Earnings of Affiliates (56) (170) (252) (245) Consolidated Net Income 1,094 1, Minority Interest 950 1, Net Income 144 (21) Net Income available to Common 144 (21) EPS (recurring) -- (6) 3 (0) EPS (diluted) 5 (1) 5 1 Diluted Shares Outstanding Total Shares Outstanding EBITDA 3,810 3,764 3,948 4,284 EBIT 1,867 1,891 1,934 1,917 Depreciation & Amortization Expense 1,943 1,873 2,014 2,367 Source: FactSet Page 11 of 15

12 B Communications Ltd. Consolidated Balance Sheet All figures in millions of Israeli Shekel, except per share items Balance Sheet Assets Dec '14 Dec '13 Dec ' DAYS 365 DAYS 366 DAYS Cash & Short-Term Investments 3,880 2,406 2,241 Short-Term Receivables 2,117 2,873 3,147 Inventories Other Current Assets Total Current Assets 6,498 5,740 5,785 Net Property, Plant & Equipment 6,572 6,541 6,911 Total Investments and Advances 1,328 1,096 1,095 Long-Term Note Receivable ,074 Intangible Assets 5,908 6,613 7,252 Deferred Tax Assets Other Assets Total Assets 21,236 21,083 22,627 Liabilities & Shareholders' Equity ST Debt & Curr. Portion LT Debt 1,501 1,451 1,582 Accounts Payable Income Tax Payable Other Current Liabilities 1,062 1,118 1,757 Total Current Liabilities 3,898 3,949 4,768 Long-Term Debt 12,357 11,798 11,980 Provision for Risks & Charges Deferred Tax Liabilities 835 1,032 1,159 Other Liabilities Total Liabilities 17,648 17,171 18,286 Common Equity Total Shareholders' Equity Accumulated Minority Interest 2,627 2,917 3,380 Total Equity 3,588 3,912 4,341 Total Liabilities & Shareholders' Equity 21,236 21,083 22,627 Source: FactSet Page 12 of 15

13 B Communications Ltd. Consolidated Statement of Cash Flows All figures in millions of Israeli Shekel, except per share items Cash Flow Operating Activities Dec '14 Dec '13 Dec ' DAYS 365 DAYS 366 DAYS Net Income / Starting Line 1, Depreciation, Depletion & Amortization 1,873 2,014 2,367 Other Funds (399) (148) (19) Funds from Operations 2,605 2,805 3,138 Changes in Working Capital Net Operating Cash Flow 3,085 3,485 3,299 Investing Activities Capital Expenditures (1,275) (1,228) (1,540) Sale of Fixed Assets & Businesses Purchase/Sale of Investments (1,404) (148) (82) Other Funds (43) Net Investing Cash Flow (1,896) (1,014) (1,273) Financing Activities Cash Dividends Paid - (102) - Issuance/Reduction of Debt, Net 213 (381) (452) Other Funds (1,428) (2,006) (2,186) Net Financing Cash Flow (1,215) (2,489) (2,638) Net Change in Cash (26) (18) (612) Free Cash Flow 2,004 2,443 2,028 Free Cash Flow per Share Source: FactSet Page 13 of 15

14 Important Research Disclosures Rating and Price Target History for: BCommunication Ltd. (BCOM/IT) as of ,600 9,300 9,000 8,700 8,400 Q3 Q1 Q2 Q3 Q1 Q2 Q3 Q1 Q2 Q3 8, Created by BlueMatrix Distribution of Ratings/IB Services Chardan Capital Markets IB Serv./Past 12 Mos. Rating Count Percent Count Percent BUY [BUY] HOLD [NEUTRAL] SELL [SELL] NOT RATED [NR] Regulation Analyst Certification ("Reg AC") Lena Rogovin ANALYST(s) CERTIFICATION: The analyst(s) responsible for covering the securities in this report certify that the views expressed in this research report accurately reflect their personal views about Company and its securities. The analyst(s) responsible for covering the securities in this report certify that no part of their compensation was, is, or will be directly or indirectly related to the specific recommendation or view contained in this research report. DISCLOSURES Chardan Capital Markets intends to seek compensation for investment banking services from all companies under research coverage. Chardan Capital Markets or its officers, employees or affiliates may execute transactions in securities mentioned in this report that may not be consistent with the report s conclusions. RATINGS Buy: Expected to materially outperform sector average over 12 months and indicates total return of at least 10% over the next 12 months. Neutral: Returns expected to be in line with sector average over 12 months and indicates total return between negative 10% and 10% over the next 12 months. Sell: Returns expected to be materially below sector average over 12 months and indicates total price decline of at least 10% over the next 12 months. FORWARD-LOOKING STATEMENTS: This Report contains forward-looking statements, which involve risks and uncertainties. Actual results may differ significantly from such forward-looking statements. Factors that might cause such a difference include, but are not limited to, those discussed in the Risk Factors section in the SEC filings available in electronic format through SEC Edgar filings at on the Internet. GENERAL: Chardan Capital Markets ( Chardan ) a FINRA member firm with offices in New York City NY, Palo Alto, CA and Beijing, China is an investment banking and institutional brokerage firm providing corporate finance, merger and acquisitions, brokerage, and investment opportunities for institutional, corporate, and private clients. The analyst(s) are employed by Chardan. Our research professionals provide important input into our investment banking and other business selection processes. Our proprietary trading and investing businesses may make investment decisions that are inconsistent with the recommendations expressed herein. Chardan may from time to time perform corporate finance or other services for some companies described herein and may occasionally possess material, nonpublic information regarding such companies. This information is not used in preparation of the opinions and estimates herein. While the information contained in this report and the opinions contained herein are based on sources believed Page 14 of 15

15 to be reliable, Chardan has not independently verified the facts, assumptions and estimates contained in this report. Accordingly, no representation or warranty, express or implied, is made as to, and no reliance should be placed on, the fairness, accuracy, completeness or correctness of the information and opinions contained in this report. The information contained herein is not a complete analysis of every material fact in respect to any company, industry or security. This material should not be construed as an offer to sell or the solicitation of an offer to buy any security in any jurisdiction where such an offer or solicitation would be illegal. We are not soliciting any action based on this material. It is for the general information of clients of Chardan. It does not take into account the particular investment objectives, financial situations, or needs of individual clients. Before acting on any advice or recommendation in this material, clients should consider whether it is suitable for their particular circumstances and, if necessary, seek professional advice. Certain transactions - including those involving futures, options, and other derivatives as well as non-investment-grade securities - give rise to substantial risk and are not suitable for all investors. The material is based on information that we consider reliable, but we do not represent that it is accurate or complete, and it should not be relied on as such. The information contained in this report is subject to change without notice and Chardan assumes no responsibility to update the report. In addition, regulatory, compliance, or other reasons may prevent us from providing updates. COMPENSATION OR SECURITIES OWNERSHIP: The analyst(s) responsible for covering the securities in this report receives compensation based upon, among other factors, the overall profitability of Chardan Capital Markets including profits derived from investment banking revenue and securities trading and market making revenue. The analyst(s) that prepared the research report did not receive any compensation from the Company or any other companies mentioned in this report in connection with the preparation of this report. The analysts responsible for covering the securities in this report currently do not own common stock in the Company, but in the future may from time to time engage in transactions with respect to the Company or other companies mentioned in the report. Chardan expects to receive, or intends to seek, compensation for investment banking services from the Company in the next three months. Page 15 of 15