Telecom Service

Telecom Service The age of constant connectivity

The age of constant connectivity; Going beyond the frontier

Overweight (Initiate) Initiation Report June 11, 2013

Daewoo Securities Co., Ltd. Media/Telecom Service Jee-hyun Moon 02-768-3615 [email protected]

We believe we are transitioning from The Age of Access to The New Digital Age. The days of intermittent connectivity are over, and constant high-speed connectivity has become the norm. Amid qualitative changes in communication methods and systems, we believe the telecom service industry is now at a major inflection point for renewed growth. One notable change is that people nowadays are not only generating traffic on networks, but are also creating data at the same time. In response, telecom companies are transforming themselves from simple network and data providers into more comprehensive service providers focused on the user experience.

Dividend plays with earnings growth potential We have been witnessing some positive changes in the fundamentals of Korean telcos. On top of attractive dividends, we believe earnings growth is also gaining momentum, making telcos increasingly appealing. Domestic telcos have been seeing improving earnings as well as valuation re-ratings on the back of LTE subscriber growth and rising ARPU. Moreover, new and non-telecom businesses are expected to make increasing earnings contributions going forward. Externally, several favorable developments are also fueling investor interest in the telecom sector. The macroeconomic outlook is currently clouded by uncertainties, and the low-growth, low-interest-rate environment is likely to continue. Against this backdrop, the subscriber-based earnings stability of telcos, coupled with the continued growth of dividend payouts, have sparked a reevaluation of the sector.

Initiate coverage with Overweight; Top picks are LG Uplus ,SK Telecom, and KT We initiate our coverage on the telecom sector with an Overweight recommendation. From a long-term perspective, the Korean telecom index has moved broadly in line with the industry’s ARPU, which we expect will continue to grow in 2H. We think telcos have increasing room to improve their ARPUs via data plans and marketing strategies. We recommend LG Uplus (032640 KS/Buy), SK Telecom (017670 KS/Buy), and KT (030200 KS/Buy) as our top picks for the sector, given their earnings potential and attractive dividends.

Telecom service sector: Overweight

Economic uncertainty External factors (industry environment) Defensive investment strategies Telecom S ervice < O verweight > Attractive dividends Internal factors (company fundamentals) Earnings improvement

Source: KDB Daewoo Securities Research

Analysts who prepared this report are registered as research analysts in Korea but not in any other jurisdiction, including the U.S.

C O N T E N T S Investment summary 1. Initiate coverage with Overweight 2. Top picks: Dividend plays with earnings growth potential

Industry analysis 1. The age of constant connectivity 2. Earnings variables of telcos 3. The LTE era

Telecom industry outlook 1. Expect structural growth 2. Stable nature of the telecom service industry 3. Non-telecom and new businesses generating revenue full swing 4. Financial analysis and outlook 5. Risk analysis

Industry issues 1. Paradigm shift in handset distribution 2. Tariff system 3. Government regulations

Investment strategy 1. Initiate coverage with an Overweight rating 2. Telcos’ high dividend yields gaining traction

Valuation 1. Case studies 2. Valuation comparison with global peers

3 3 4

5 5 11 19

23 23 33 35 44 45

46 47 52 63

71 71 72

77 77 81

LG Uplus (032640 KS)

83

SK Telecom (017670 KS)

92

KT (030200 KS)

101

SK Broadband (033630 KQ)

111

KDB Daewoo Securities Research

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Investment summary 1. Initiate coverage with Overweight We initiate our coverage of the telecom sector with an Overweight recommendation. We have been witnessing some positive changes in the fundamentals of Korean telcos. On top of attractive dividends, we believe earnings growth is also gaining momentum, making telcos increasingly appealing. Domestic telcos have been seeing improving earnings as well as valuation re-ratings on the back of LTE subscriber growth and rising ARPU. Moreover, new and non-telecom businesses are expected to make increasing earnings contributions going forward. Externally, several favorable developments are also fueling investor interest in the telecom sector. The macroeconomic outlook is currently clouded by uncertainties, and the low-growth, lowinterest-rate environment is likely to continue. Against this backdrop, the subscriber-based earnings stability of telcos, coupled with the continued growth of dividend payouts, have sparked a reevaluation of the sector. Korean telcos operate in a market in which mobile telecom penetration has surpassed 100%. As such, the upside of quantitative growth (number of subscribers) is limited. However, a generational transition to 4G services is occurring, with LTE subscribers acting as a short-term variable that can drive earnings. Over the long term, however, we expect ARPU to become a more sustainable earnings driver. The Korean telecom index has largely moved in line with the industry’s ARPU. 4G data usage is on the rise as constant connectivity is the norm in the digital era, and the emergence of high-quality content and services (aided by hardware and network upgrades) should further boost data traffic. We think telcos have increasing room to improve their ARPU via data plans and marketing strategies. In the earlier stages of the mobile data market, when 3G smartphones were used and services were not stable, telcos compiled a large volume of information related to data plans (including unlimited data plans), frequency auctions, and declining ARPU for voice calls. Korean telcos are utilizing this information and feedback to increase their ARPUs. Figure 1. ARPU and FTSE Korea telecom index over the past decade (W) 36,000

(p) 60

Three major telcos' average ARPU (L) FTSE Korea telecom price index (R)

LTE penetration 34,000

50

32,000

40

30,000

30

28,000

20 1Q04

1Q05

1Q06

1Q07

1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Note: ARPU is based on SK Telecom, KT, and LG Uplus’ average monthly charges Source: Company data, Thomson Reuters, KDB Daewoo Securities Research


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2. Top picks: Dividend plays with earnings growth potential We advise investors to closely follow telcos that pay out large dividends and generate robust earnings momentum. In order of investment attractiveness, our top picks are LG Uplus, SK Telecom, and KT. We also believe SK Broadband is worth attention. LG Uplus: Improvements in fundamentals and dividends. LG Uplus’s net profit figure is expected to swing to positive this year. The wireless telecom unit, the company’s core business, is experiencing improvements in fundamentals, and the fixed-line unit is also gaining market share thanks to service bundling. The company has recorded the fastest rise in LTE subscribers (quantitative growth) in Korea, and its ARPU (qualitative) is expected to improve. Dividend payments are also scheduled this year, unlike last year. SK Telecom: Earnings improvements and high dividend yields. SK Telecom’s market power in wireless telecommunications is starting to be felt in wireless LTE and network media. The company’s proportion of LTE subscribers is steadily increasing, and net profit is forecast to climb thanks to greater earnings contributions from major subsidiaries including SK Hynix. KT: Steady earnings growth and the highest dividend yields in the sector. KT’s ARPU growth has been relatively slow due to its late entry onto the wireless LTE market. However, earnings growth should accelerate on the back of increases in LTE subscribers and network media profits. SK Broadband: Improvements in operating results and financials. SK Broadband’s positioning within the SK Telecom Group is improving. The ongoing nationwide switch to digital broadcasting and the spread of LTE services are benefiting the company’s IPTV business. Investors should find themselves increasingly drawn to dividend plays in 2H. Unlike in the past, more and more investors are acknowledging telcos as long-term investments due to their attractive dividend yields. All three Korean telcos are planning to pay dividends this year (KT and SK Telecom: 4-5%; LG Uplus: 2% (estimate based on the company’s 30% dividend payout ratio). SK Broadband is not projected to pay dividends given its ongoing efforts to strengthen its financial position. Table 1. Ratings of major telco stocks Rating

(W, %, x)

Company

Ticker.

Target price Upside P/E P/B EV/EBITDA EPS growth ROE Dividend yield

LG Uplus

032640 KS Buy 017670 KS Buy

15,000

29.3 15.4 1.5

4.4

TTB

8.4

2.2

SK Telecom

270,000

28.0 10.0 1.7

5.0

47.8 14.0

4.5

KT

030200 KS Buy

50,000

31.1

8.1 0.9

3.9

15.8

9.7

5.2

21.3 19.5 1.5

4.0

233.6

6.6

0.0

SK Broadband 033630 KQ Trading Buy

6,000

Note: 12-month target price; valuations are based on 2013 estimates Source: KDB Daewoo Securities Research

Figure 2. Telecom service sector: Overweight

Economic uncertainty External factors (industry environment) Defensive investment strategies Telec om S ervice < O v erweight > Attractive dividends Internal factors (company fundamentals) Earnings improvement



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Industry analysis 1. The age of constant connectivity From the end of ownership to a new digital age In 2000, Jeremy Rifkin predicted in his book The Age of Access that ownership will soon be rendered meaningless and time and experience will become the ultimate commodities. In the earlier days of capitalism, possession of property was considered the most sacred tenet. As industrialization progressed, it became increasingly important to accumulate capital and increase production. But Rifkin argued that, in the 21st century, the importance of ownership will be displaced by sharing and access. In other words, people will prefer temporary access over permanent ownership. In his 2013 book The New Digital Age, Google’s founder Eric Schmidt states that the amount of data coursing through an optical fiber cable doubles every nine months. Put simply, the advance of communication technology is exponentially increasing the possibilities of the virtual world. He also stresses that innovation is presenting both opportunities and challenges for technology, industry, culture, and society. Putting this into context for the telecom industry, we note that consumers nowadays indeed prefer streaming, a type of temporary access, over downloading, a means of acquiring ownership. Intermittent communication like voice calls has been replaced by constant real-time communication. Indeed, we are transitioning from temporary to constant connectivity. The amount of traffic and quality of data available depend on networks. As communication is undergoing qualitative changes, we believe the telecom service industry is now at a major inflection point of renewed growth. Figure 3. Age of constant connectivity

Source: DevCentral

Figure 4. Nomophobia

Figure 5. Survey of domestic smartphone users 63%

Feels anxiety without smartphone

Takes smartphone to the bathroom

59%

Searches for answers via smartphone rather than asking nearby person

57%

54%

Smartphone is most important digital devices

46%

Sleeps with smartphone nearby Smartphone is more useful for web surfing than PC

Note: Nomophobia is short for “no-mobile-phone-phobia” Source: CuboiArt


0%

Note: Survey of 1,000 Korean adults aged 19-44 Source: Trend Monitor, KDB Daewoo Securities Research

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Growing importance of networks brings communication costs to the fore Telecom services allow people to technologically overcome certain limitations. The advance of the internet has paved the way for interconnectivity and increased the economic importance of networks. Against this backdrop, governments and consumers have been increasingly taking notice of rising communication costs. Indeed, communication costs as a percentage of household spending has steadily grown over the years. The percentages in Korea, Mexico, and Japan are relatively high compared to the OECD average. In Korea, the percentage of communication services out of household expenditures peaked in 2011 and has been on a steady downtrend ever since. In the early 2000s, the Korean government began to pressure on telcos to lower communication charges. Figure 6. Telecom expenses as a % of household expenditure (%)

Korea

Japan

US

6

UK

Mexico

OECD average

5

4

3

2

1 95

97

99

01

03

05

07

09

Notes: GDP per capita – South Korea: US$20,000; Japan and US: US$40,000, UK: US$37,000; Mexico: US$9,000 Source: OECD Communication Outlook (2011), KDB Daewoo Securities Research

Figure 7. Mobile telecom service charge comparison (US$ PPP) 200

150

Korea

Japan

US

UK

Mexico

OECD average

100

50

0 30 times

100 times

300 times

900 times

Note: Average fee is based on number of calls; as of August 2010 Source: OECD Communication Outlook (2011), KDB Daewoo Securities Research


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In the past, the proportion of telecom costs in household spending appears to have risen due to increasing usage rather than rate hikes. Indeed, rates have fallen by 1.4% per year since 1995, while electricity, gas, and sewage treatment rates have climbed steadily. Meanwhile, household debt and credit card delinquency rates are increasing, but telecom delinquency is falling. We believe that this points to the growing importance of telecom services in modern life. Figure 8. Comparison of price index trends in Korea (2010=100)

Communication charges

Electricity

Gas

150

Water and sewage

CPI

2010=100

100

CAGR from 1995-2012 Communicat ion charges: -1. 4% Electricity: +0.9% Gas: +7.0% Water and sewage: +7.7% CP I : + 3. 2%

50

0 95

97

99

01

03

05

07

09

11

Note: 100 = 2010 levels Source: Statistics Korea, Bank of Korea, KDB Daewoo Securities Research

Figure 9. Gradual decline in telecom expense delinquency 3.0%

SK Telecom's mobile delinquency rate Credit card delinquency rate

Household debt delinquency rate

2.5% 2.0%

1.5% 1.0% 0.5%

0.0% 2008

2009

2010

2011

2012

Note: Based on annual average Source: SK Telecom, Financial Statistics Information System, KDB Daewoo Securities Research


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A new digital era is dawning The development of telecom networks has reshaped politics and culture. Modems opened the era of PC-based communications. Personal IDs, rather than real names, were used, and text-based communication reigned supreme. As high-speed connections were introduced, the impact of the internet grew much bigger. Online communities and online games started to gain popularity, and internet-based media and digital content began to influence public opinion. P2P file sharing and web hard services completely changed content demand and supply dynamics. During this period, the emergence of digital cameras gave rise to image-based communication. Mobile internet started with 2G feature phones. Despite limited hardware functions and slow network speeds, 2G phones created a new culture characterized by personal electronic devices and services. At the time, handset makers focused on improving their designs to stimulate replacement demand. Apple made the first 3G smartphone and the App Store, creating a new ecosystem for digital content. Social network services spread around the globe, and the emergence of mobile messengers caused telcos’ text and voice revenue to contract. 4G smartphones feature larger screens and faster network speeds. As users can view and transmit high-quality videos using smartphones, content demand and supply are rising. We believe that a new digital era is dawning. Data traffic growth is accelerating, and interconnectivity, personalization and Big Data are taking globalization to the next level. Interactions between the virtual world and the real world are also gaining traction. Figure 10. Developments in telecom service affect culture and politics Modem

High-speed internet

2G feature phone

3G smartphone

Age of PC Use of IDs Online-based clubs Online slang

Online community Internal portals Online chatting Online public opinion MMORPG

Form over function Texting

iPhone App Store platform Content innovation Social networks Mobile messengers

Dawn of a new digit al age

4G phablet

Data traffic continues to grow Interconnectivity strengthens New globalization Increasing personalization Big Data: A new game changer?

"Screenager" N-screen service Rising demand for high-quality content

Note: “Screenager” was coined by Richard Watson; The New Digital Age is the title of Eric Schmidt’s recent book Source: KDB Daewoo Securities Research


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Linking different industries Telecom services allow different industries to connect with one another. In the past, handset makers and equipment makers were the main participants. But nowadays, semiconductor, internet, OS, and media firms have also joined the fray. As the number of participants has grown and the level of interconnectivity has increased, issues such as network neutrality have emerged due to conflicts of interest. A content-platform-network-device (C-P-N-D) ecosystem has taken root in the telecom industry. C - Content demand is rising, as increasingly diversified platforms require different content. P - The platform business is growing, led by global platform providers including Google and Apple. N - The network segment is weakening, as telcos are losing ground in content, platforms, and devices. The closed ecosystem created by telcos is being replaced with the open ecosystems of smartphones. But the traditional role of networks is becoming increasingly important, because content, platforms, and handsets require constant connectivity. D - The device market is picking up along with the global expansion of SEC and Apple. Their revenue growth has been impressive. Figure 11. Diversification of market participants in the telecom service industry

Source: SK Economic Management Institute

Figure 12. Global players rely on telecom networks Apple

Amazon

Google

SEC

X

O

O

O

Apps, digital music

Books, items, content

Websites, content

O

O

O

iOS, App Store

Amazon.com

Android OS, Google

X

X

X

O

O

O

O

Android devices

Tablets and smartphones

C: Content

X

P: Platform

N: Network

X

D: Device iPhone/iPad

Kindle



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Telcos lose ground in ICT industry The position of telcos in the information and communications technology (ICT) industry has steadily weakened over the past three years. Telcos’ revenue and operating profit contributions have declined, while those of handset makers have visibly expanded since 2012. Given the domestic focus of telecom services, telcos’ revenue share in the ICT industry should continue to fall. However, their operating profit contribution has been gradually recovering since 3Q12 (after LTE marketing competition peaked). Figure 13. Revenue breakdown of Korean ICT industry by segment (Wtr)

Internet (L)

Telecom service (L)

60

Handset (L)

Proportion of telecom service (R)

(%) 52

45

44

30

36

15

28

0

20 1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

Notes: Internet - NHN, Daum; telecom service - SK Telecom, KT, LG Uplus; handsets – SEC’s and LGE’s handset divisions Source: Company data, KDB Daewoo Securities Research

Figure 14. Operating profit breakdown of Korean ICT industry by segment (Wtr)

Internet (L)

Telecom service (L)

10

Handset (L)

Proportion of telecom service (R)

(%) 80

8

60

6 40 4 20

2

0

0 1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

Notes: Internet - NHN, Daum; telecom service - SK Telecom, KT, LG Uplus; handsets – SEC’s and LGE’s handset divisions handset division, Source: Company data, KDB Daewoo Securities Research


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2. Earnings variables of telcos Number of subscribers (quantitative)

1) Demographics A key metric of the telecom industry is subscriber base. In fact, an increase in subscribers is essential to growth. As telecom services are focused on the domestic front, population and demographics dictate the overall size of the industry’s subscriber base. Korea’s population growth is stagnating due to low birth rates, and population aging is accelerating. Generally speaking, low population growth bodes ill for industries such as telecom that rely on subscriber growth. When volume growth is limited, marketing becomes important. Ironically, however, the efficiency of marketing tends to fall under such circumstances. In Korea, mobile phone penetration exceeded 100% in 2010, but we believe there is still a bit of upside, given the case in Taiwan (whose population and per-capita GDP are similar to those of Korea). Korea’s mobile phone penetration level is somewhere between the US’ and Japan’s. Figure 15. Korea's population growth and mobile subscriber trends (mn persons) 60

Mobile subscribers (L)

(%) 120

Mobile penetration (R)

Penetration rate: 100% (R) 45

100

30

80

15

60

0

40 00

01

02

03

04

05

06

07

08

09

10

11

12

Source: Statistics Korea, KDB Daewoo Securities Research

Figure 16. Key countries’ mobile penetration rate (%) 200 160 160 121 110

120

109

103

80

73

72

China

India

40

0 Russia

Singapore

Vietnam

Taiwan

England

US

South Korea

Japan Philippines

Source: Bloomberg, Wireless Intelligence, KDB Daewoo Securities Research


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2) Subscriber market share When population growth is slow, subscriber market share is a more important metric than the absolute number of subscribers. Subscriber market share has also traditionally served as one of the key determinants of companies’ share performance. In Korea, LG Uplus saw its subscriber market share, which had stood below 18%, rise to over 19% after it launched LTE services ahead of its peers. The company’s share price is also on the rise in line with an increase in its subscriber market share. In Japan, Softbank expanded its mobile telecom subscriber market share following its iPhone 3G launch. The company’s market share growth has also driven up its share price. In the US, Verizon and AT&T are widening their leads over second-tier players. Of note, Verizon’s shares have been trading at a premium since 2009, when the company surpassed AT&T to claim the largest subscriber market share in the US. Figure 17. LG Uplus’ subscriber market share and share price (%)

Subscriber market share (L)

19.2

Share price (R)

(W) 12,000

LTE service launch

18.6

10,000

18.0

8,000

17.4

6,000

16.8

4,000 1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Source: Company data, KCC, Thomson Reuters, KDB Daewoo Securities Research

Figure 18. Softbank’s subscriber market share and share price

Figure 19. Verizon’s subscriber market share and share price Subscriber market share (L) (US$) Share price (R) 50


(JPY)

(%)

Share price (R)

4,000

36

3,000

32

40

20

2,000

28

30

17

1,000

24

20

0

20

(%) 26

23

Release of iPhone 3G

14 1Q08

1Q09

1Q10

1Q11

1Q12

Source: Company data, Bloomberg, KDB Daewoo Securities Research


Became top telco in US

10 1Q08

1Q09

1Q10

1Q11

1Q12

Source: Company data, Bloomberg, KDB Daewoo Securities Research

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3) New services and technologies stimulate subscriber movements In a market with limited quantitative growth potential, the introduction of new services and technologies often stimulates the movements of subscribers. Currently, in the Korean telecom space, LTE technology is sparking such movements. Differences in the timing of service launches and marketing strategies are leading to changes in companies’ market shares (in terms of subscribers) In particular, LTE subscribers tend to be high-ARPU, long-term customers. Thus, the LTE subscriber market should have a significant impact on telcos’ overall mobile phone subscriber market shares and the quality and direction of their revenue. Figure 20. Telcos’ LTE market performance and share price trends (%p) 50

SK Telecom's LTE market share - overall share (L) LG Uplus' LTE market share - overall share (L)

KT's LTE market share - overall share (L) SK Telecom's share price (R)

KT's share price (R)

LG Uplus' share price (R) LG Uplus' LTE strength boosts share price

25

(10/11=100) 200

150

0

100

-25

50

-50

0 10/11

12/11

2/12

4/12

6/12

8/12

10/12

12/12

2/13

4/13

Source: Company data, KCC, Thomson Reuters, KDB Daewoo Securities Research


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In our view, the share performances of telcos are more sensitive to subscribers’ movements toward new technologies and services than to the number of total subscribers. The number of subscribers to new services is significant in that it indicates telcos’ current competitiveness and future subscriber trends. Figure 21. KT’s share price and net growth in subscribers to 3G and advanced services Net growth in subscribers to 3G and more adv. technologies (R) Share price (L)

(W) 50,000

('000 persons) 1,800

45,000

1,200

40,000

600

35,000

0

30,000

-600 1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Note: 2Q13 earnings are estimates Source: Company data, KCC, Thomson Reuters, KDB Daewoo Securities Research

Figure 22. LG Uplus’ share price and net LTE subscriber growth Monthly net growth in LTE subscribers (R)

(W) 12,000

('000 persons) 480

Share price (L)

10,000

360

8,000

240

6,000

120 Operation suspended for 24days

4,000

0 11/11

2/12

5/12

8/12

11/12

2/13

5/13

Source: Company data, Thomson Reuters, KDB Daewoo Securities Research


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When new technologies are first introduced, the telecom market sees net subscriber growth on the back of companies’ aggressive marketing activities. However, long-term trends indicate that the impact of new services on quantitative variables like total subscriber growth appears to be weakening, as Korea’s mobile phone penetration has already exceeded 100% (in 2010). Given that the net increase in total subscribers after the launch of LTE in 2012 was significantly weaker than the increases after the launches of new services in the past, the launch of 4G LTE is unlikely to boost telcos’ overall customer base significantly. Figure 23. Penetration after the introduction of new services (%) 60

3G penetration

Smartphone penetration

LTE penetration

45

30

15

0 1Q06

1Q07

1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Note: 3G subscriber data = total of SK Telecom and KT Source: KCC, KDB Daewoo Securities Research

Figure 24. Net mobile subscriber additions and mobile phone penetration ('000 persons) 1,400

Mobile phone net subscriber additions (L)

(%) 110

Mobile phone penetration (R)

1,050

100

700

90

350

80

0

70 1Q06

1Q07

1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Source: KCC, KDB Daewoo Securities Research


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ARPU (qualitative) As the quantitative growth of subscribers is displaying structural deceleration, qualitative growth (e.g., rising ARPU) is gaining in importance. During the early and middle stages of 3G growth, telcos’ ARPU stayed flat. The launch of smartphones also failed to drive up ARPU as telcos introduced unlimited data plans to boost mobile internet use. However, ARPU has grown markedly since the launch of LTE phones in 2012 on the back of a larger proportion of subscribers using high-rate plans and a structural increase in data usage volume in line with an improvement in internet speeds. Telcos’ LTE-driven ARPU growth is unfolding in two stages. First, an increase in the percentage of high-rate plan subscribers has driven up telcos’ ARPU. Second, growth in subscribers’ data usage should further push up revenue. In our view, LG Uplus is going through the first stage of LTE-driven ARPU growth. Currently, the company’s LTE subscribers account for 50% of its total mobile phone subscribers. Further ARPU growth, combined with an increase in subscribers’ data usage should lead to revenue growth. Accordingly, new services, content, and rate plans for LTE subscribers are expected to determine the company’s ARPU growth going forward. Figure 25. Penetration and ARPU trends (%) 80

3G penetration Smartphone penetration

Spread of smartphone

Spread of LTE

LTE penetration 60

40

20

0 1Q08

(W)

1Q09

SK Telecom ARPU KT ARPU LG Uplus ARPU

40,000

1Q10

1Q11

ARPU declines due to 3G unlimited data plans

1Q12

1Q13

ARPU growth due to LTE rate plans

36,000

32,000

28,000

24,000 1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Notes: 3G subscriber data = total of SK Telecom and KT; SK Telecom’s ARPU after 1Q11 is based on billings, Source: Company data, KDB Daewoo Securities Research


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Softbank’s share price was on the rise until end-2010 as the introduction of the iPhone 3G in end2008 had driven up ARPU growth. Verizon is displaying typical two-stage ARPU growth after the launch of its LTE service. Figure 26. LG Uplus’ ARPU and share price ARPU (L)

(W)

(W)

Share price (R)

34,000

12,000

31,500

10,000 LTE service launch

29,000

8,000

26,500

6,000

24,000

4,000 1Q08

1Q09

1Q10

1Q11

1Q12

1Q13


Figure 27. Softbank’s ARPU and share price (US$)

ARPU (L)

(JPY)

50

Share price (R)

4,000

47

Release of iPhone 3G

3,000

44 2,000 41

38

1,000 1Q08

3Q08

1Q09

3Q09

1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

Source: Wireless Intelligence, company data, Thomson Reuters, KDB Daewoo Securities Research

Figure 28. Verizon’s ARPU and share price (US$)

ARPU (L)

58

Share price (R)

New data plans

56

(US$) 52

44

LTE service launch

54

36

52

28

50

20 1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Source: Wireless Intelligence, company data, Thomson Reuters, KDB Daewoo Securities Research


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Usage of telecom services It should be noted that price hikes are typically limited due to intense competition, resistance from customers, and price-cutting pressure from the government. Against this backdrop, we believe that the engine of the telecom services industry is an increase in usage arising from qualitative changes in communication. Voice calls (a traditional telecom service) are on the decline. However, data usage is on the rise, backed by: 1) a trend toward constant connectivity resulting from the proliferation of smart devices and 2) the high transmission speeds of LTE. Going forward, data usage will likely exceed voice call usage. Figure 29. Data usage trends (TB) 100,000

LG Uplus was the first to introduce LTE

SK Telecom KT LG Uplus

75ï

80,000

60,000

40,000

20,000

SK Telecom launched an unlimited data plan

KT introduced the iPhone

28ï 68ï

0 1H10

2H10

1H11

2H11

1H12

Source: SK Research Institute for SUPEX Management, KDB Daewoo Securities Research

Figure 30. Per-capita average data usage of mobile services (MB) 2,000

3G smartphone LTE

1,500

1,000

500

0 12/10

3/11

6/11

9/11

12/11

3/12

6/12

9/12

12/12

Source: SK Telecom, KCC, Ministry of Science, KDB Daewoo Securities


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3. The LTE era Differentiating factors of LTE The key differentiating factor for 4G LTE technology (vs. previous network technologies) is its rapid transmission speeds. Technically speaking, the current LTE technology should be considered 3.9G. In 2H, a true 4G technology, LTE-Advanced, will likely be commercialized. As mobile internet speeds have become as fast as wired speeds, subscribers are now able to enjoy high-quality content on their mobile devices, significantly boosting customer satisfaction. Table 2. Telecom technologies by generation Generation

1G

2G

Key features

Analog

Digital

Data download speed

-

Technology

CDMA

3G

WCDMA Video calls available 14.4-64Kbps 14.4Mbps

4G (3.9G)

4G

LTE LTE-Advanced Wireless high-speed Exceeds current wired internet internet speeds 100Mbps 1Gbps


Figure 31. Higher speeds: Shorter download times due to improvements in telecom services Download time for a 700MB movie

1,806 sec

2G (CDMA)

389 sec

3G (WCDMA)

4G (LTE)

75sec

Faciliates the development of a mobile content ecosystem

Content big bang!

Source: Media reports, KDB Daewoo Securities Research

Business models LTE technology was initially designed to transmit data. Previously, telcos had used circuit switching for voice transmission and packet switching for data transmission. However, with LTE technology, telcos use packet switching for both voice and data transmission. This technological change is also facilitating business model changes. Under the circuit switching method, two network nodes establish a dedicated communication channel (circuit) through the network before the start of communication. This method requires the full usage of a channel’s bandwidth and connectivity for the duration of a communication session. Therefore, although this method ensures the safe transmission of information, it does not use the network efficiently. Packet switching groups all transmitted data—regardless of content, type, or structure—into suitably sized blocks, called packets. The packet switching method has the advantage of utilizing the network efficiently. However, it also risks information loss in the process of grouping transmitted data. The characteristics of circuit and packet switching also affect the tariff system. With circuit switching, subscribers are charged by the minute, as an entire channel is occupied throughout a single communication session. For packet switching, however, they are charged by data transmission volume.


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As such, telcos’ business models are changing to promote packet growth, increasing the importance of: 1) structural changes in telcos’ tariff systems, 2) content supply, and 3) the expansion of supplementary services. Figure 32. Change in major revenue source: Voice  data Voice-centric

Data-centric

Source: Google, KDB Daewoo Securities Research

Table 3. Changes to major global telcos’ plans Country

Company

US

AT&T

June: Subscription to unlimited data plan suspended

US

Verizon

October: Usage-based data plan was launched

July: Subscription to unlimited data plan suspended

UK

O2

June: Existing unlimited data plan abolished with the release of iPhone 4

December: Existing unlimited data plan abolished

UK

EE (Everything Everywhere)

Sweden

TeliaSonera

Austria

Telekom Austria

Japan

NTT Docomo

2010

2011

2012 August: Mobile Share (a data-centric voice-text integrated plan) was launched; existing separate-type plan was kept in place June: Share Everything plan (a data-centric voice-text integrated plan) was launched; existing separatetype plan was kept in place

Fall: A joint venture between EE, Deutsche Telekom, and France Telecom) launched LTE for the first time in the UK September: Data rate hike announced

July: LTE rates hiked

2013

Phase-out of existing unlimited data plans; usagebased data plans in the pipeline; LTE subscription fee hiked

March: LTE data plan hiked December: Existing unlimited data plan was abolished

September: LTE rates cut by 8% thanks to the announcement of a new LTE plan

Source: Company data, KDB Daewoo Securities Research


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LTE prompting changes in the industry landscape LTE technology is stimulating changes in the landscape of the Korean telecom service market. We compared the performances of Korean telcos one year before and one year after the introduction of LTE. LG Uplus, which launched Korea’s first LTE services, exhibited the most notable quantitative and qualitative improvements. Although there was no change in telcos’ subscriber share rankings, LG Uplus saw its subscriber share rise notably, while the shares of SK Telecom and KT fell modestly. With regard to wireless telecom ARPU, LG Uplus caught up with KT one year after the launch of LTE thanks to a rapid rise in its LTE subscriber proportion. Past examples of instances in which a trailblazing company displayed robust share performance after introducing a revolutionary new technology or service include: 1) the introduction of internet telephony by LG Dacom and 2) the launch of the iPhone by KT. Figure 33. Changes in mobile subscriber market share before and after the introduction of LTE SK Telecom

KT

50.6%

LG Uplus

50.6%

31.6%

50.3%

31.5%

17.8%

30.8% 18.9%

17.9%

One year prior

Introduction of LTE

One year after

4Q10

4Q11

4Q12


Figure 34. Changes in wireless ARPU before and after introduction of LTE SK Telecom

KT

LG Uplus

W36,676 W33,761 W32,587

W31,281

W30,697

W31,085

W28,826 W26,060

W26,213

One year prior

Introduction of LTE

One year after

4Q10

4Q11

4Q12



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June 11, 2013

Figure 35. LG Dacom’s broadband internet subscriber share surged on the introduction of internet telephony (%) 18

(W) 28,000

LG Dacom's internet subscriber market share (L) LG Dacom's share price (R)

14

21,000

9

14,000

5

7,000

0

0 Four years prior

Introduction of internet telephony

2002

2003

2004

2005

2006

Four years after 2007

2008

2009

2010

Notes: LG Dacom was merged into LG Uplus in 2010; subscriber share is LG Uplus’ following the merger Source: KCC, KDB Daewoo Securities Research

Figure 36. 3G: KT’s subscriber share rose after the introduction of the iPhone (W)

(%) 32.4

48,000

KT's wireless subscriber market share (L) KT's share price (R)

32.2

43,000

32.0

38,000

31.8

33,000

31.6

28,000 One year prior 4Q08

Introduction of iPhone 1Q09

2Q09

3Q09

4Q09

One year after 1Q10

2Q10

3Q10

4Q10


Figure 37. 4G: LG Uplus’ subscriber share climbed after introducing Korea’s first LTE service (%) 19.0

(W) 9,000

LG Uplus' wireless subscriber market share (L) LG Uplus' share price (R)

8,000

18.5

7,000 18.0 6,000 17.5

5,000

17.0

4,000 FALSE One year prior 4Q10

Introduction of LTE 1Q11

2Q11

3Q11

4Q11

One year after 1Q12

2Q12

3Q12

4Q12



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Telecom industry outlook 1. Expect structural growth Qualitative growth has begun We are witnessing improvements in traditional telecom businesses. These improvements are particularly notable in that they are structural rather than temporary, and are the results of a series of developments, including technological developments and changes in business models. Wireless telecom ARPU has shown visible growth (QoQ) for the first time in ten years. Although the pace of growth is varied among telcos due to differences in the timing of LTE service launches and subscriber bases, the industry is surely recovering overall. In the wired telecommunications segment, network media businesses are anticipated to offset structural declines in overall revenue growth. Across the industry, IPTV, which started as a component in bundled services, is expected to soon show break–even results on the back of subscriber growth. In 2013, we expect media to account for almost 20% of the combined wired telecommunication revenues of the three Korean telcos. Figure 38. Wireless communication: Recent increase in mobile ARPU (W) 34,000

Average ARPU of top three telcos

32,000

30,000

28,000

26,000 1Q04

1Q05

1Q06

1Q07

1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Note: Average monthly ARPU is based on SK Telecom, KT, and LG Uplus’ billings Source: Company data, KDB Daewoo Securities Research

Figure 39. Wired communication: Steady increase in media segment’s revenue contribution (Wbn) 600

(%) 20

Top three telcos' combined media revenues (L) Top three telcos' combined media proportion within wired revenue (R)

450

15

300

10

150

5

0

0 1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

3Q13F

Note: Combined data of KT, LG Uplus, and SK Broadband Source: Company data, KDB Daewoo Securities Research


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We are particularly upbeat on the wireless segment. In the early stages of the mobile data market, when 3G smartphones were released, telcos tested various types of call plans and marketing strategies, collected feedback from customers and the government, and accumulated business know-how via trial and error. Indeed, during this nascent period, telcos made adjustments to data plans, participated in frequency auctions, and introduced unlimited data plans. Drawing upon their vast experience, telcos now seem to be efficiently responding to the market’s shift to LTE services, which is leading to ARPU increases. We believe that LTE’s ARPU growth will happen in two stages: 1) average ARPU will rise as the number of LTE subscribers increases, and then, 2) individual ARPU will rise as the data consumption of each LTE user increases. The first stage should continue until LTE penetration reaches 70% (i.e., until the end of this year in Korea), and the second stage of growth should begin sometime in 2H and pick up full swing next year. As telcos are planning to offer LTE-Advanced services starting in 2H, and demand for supplementary services and content are rising, average and individual ARPU may also grow in tandem. Figure 40. LTE subscribers and total ARPU rise in tandem (W) 34,000

('000 persons) 25,000

Subscribers number of LTE (R) Average ARPU of top three telcos

20,000 32,500 Start of LTE 15,000 31,000 10,000 29,500 5,000

28,000

0 1Q04

1Q05

1Q06

1Q07

1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Notes: ARPU is based on monthly average of SK Telecom, KT, and LG Uplus’ billings Source: Company data, KCC, KDB Daewoo Securities Research

Figure 41. LTE subscribers’ data usage per capita is much higher than 2G and 3G subscribers’’ (MB) 2,500

3G 4G (LTE) Total

2,000

1,500

1,000

500

0 1/12

2/12

3/12

4/12

5/12

6/12

7/12

8/12

9/12

10/12 11/12 12/12

1/13

2/13

3/13

4/13

Source: KCC, MSIP , KDB Daewoo Securities Research


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June 11, 2013

Telecom investments to decrease steadily Earnings at telcos largely hinge on their investments in networks. Before migrating to a new network technology, they need to preemptively make investments and engage in marketing activities (prior to generating related revenue). This should increase investment burdens and drag down profitability. Looking at the capex, marketing spend, and annual operating profit figures of domestic telcos, it is clear that they experienced tough times in 2012, burdened with heavy investments, heated marketing competition, and the resulting OP margin deterioration. More specifically, last year, telcos switched from 3G to 4G LTE networks, incurring significant investment burdens. And transitioning from circuit switching to packet switching resulted in heavy equipment expenses. However, we do not expect any big investments for the next three to four years. We think that telcos could transition to LTE-Advanced technology just by upgrading their existing LTE networks. Taking into account annual capex trends and guidance figures, we also project that telecom capex will gradually decrease from the peak level seen in 2012. Figure 42. Profitability declined due to LTE investments and marketing efforts in 2012 (Wbn) 18,000

(%)

Combined capex and marketing expenses (L)

12

Average OP margin (R)

16,000

10

14,000

8

12,000

6

Capex and marketing expenses expected to decline after hitting a peak

10,000

4 2010

2011

2012

2013F

2014F


Figure 43. Annual capex (Wbn) 10,000

LG Uplus KT

Expected to decline after intensive LTE investments in 2012

SK Broadband SK Telecom (parent)

7,500

5,000

2,500

0 2009

2010

2011

2012

2013F

2014F



25

June 11, 2013

Telecom Service

In the short term, telcos’ investments will be focused on LTE-Advanced technology (for mobile) and gigabit internet technology (for wired). 1) We anticipate telcos’ to switch to LTE-Advanced in 2H in order to meet growing mobile traffic demand. LTE-Advanced increases the efficiency of LTE-based frequencies using technologies such as carrier aggregation (CA) and enhanced inter-cell interference coordination (eICIC). This technology should make wireless internet much faster than wired connections. Telcos are stressing that a transition to LTE-Advanced technology can be achieved by upgrading existing networks. Meanwhile, telcos are scheduled to participate in additional frequency auctions in order to ensure their medium- and long-term growth. And, as related expenses should be amortized over the long term, they are unlikely to hurt financials in the near term. 2) Gigabit internet makes connections ten times faster than the current wired level. For now, the development of this technology remains only in the pilot stage (with no government support as of yet), and few companies have made any massive investment plans. However, the MSIP aims to help establish gigabit internet networks in 90% of Korea by 2017. Recently, consortiums led by five providers (i.e., KT, SK Broadband, LG Uplus, CJ Hellovision, and T-broad) were selected to participate in this project. Each consortium will receive a maximum of W800mn in financial support from the government.


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Government regulations moving away from restrictions on subsidization

Marketing expenses to decline in 2H We think that marketing competition has been easing. With the government toughening regulations, telecom subsidies have drastically decreased since early 2Q. And companies are switching their marketing focus from subsidies to the introduction of competitive plans and services. External factors influencing marketing competition include the emergence of new network technologies and handsets, seasonality, and regulations. Internal factors include strategies designed to attract subscribers and expand market share. In March 2007, after SK Telecom and KT both adopted the WCDMA standard, the telecom market experienced cutthroat competition. And, with the introduction of contract plans after March 2008, telcos’ marketing burdens grew sharply. Smartphones began to proliferate after 4Q09, thanks in large part to the fact that KT introduced the iPhone in Korea in November 2009. Still, marketing burdens remained almost flat, compared to during the initial phase of 3G phones. After 4Q11, as LTE networks emerged, LG Uplus launched an aggressive marketing campaign. And this year, new handsets have been rolled out more frequently. When new handsets are released, consumers tend to voluntarily change their handsets, even with just minor subsidies. As this year’s new models are upgraded versions of existing models, we think that manufacturers’ promotion policies should have a greater influence on sales (than telcos’ marketing). Although the penetration rate of LTE networks has reached 30-50%, telcos do not seem to be engaging in heated marketing battles. They are changing their focus to subscriber retention. In addition, as mentioned earlier, they are switching their marketing focus from subsidies to the introduction of competitive plans and services. Additionally, telcos’ marketing expenses have drastically fallen in 2Q, partially due to restrictions imposed by the Korea Communications Commission (KCC). Furthermore, manufacturers are offering a cut in ex-factory prices. Figure 44. Marketing expenses relative to service revenue: Marketing battles are easing (%)

SK Telecom

45

LG Telecom-LG Uplus

KTF-KT

Spread of smartphones

Introduction of 3G

Introduction of LTE

35

25

15

5 1Q05

1Q06

1Q07

1Q08

1Q09

1Q10

1Q11

1Q12

1Q13

Notes: Based on KT data from 2009 and LG Uplus data from 2010; 1Q13 data reflect suspensions Source: Company data, KDB Daewoo Securities Research


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Government regulations moving away from restrictions on subsidies The government is increasingly moving away from pressuring telcos to cut subsidies. Instead, the government is relying more on a variety of policies, such as efforts to improve handset distribution networks, and expense restrictions on telcos. It should be noted that, historically, rate cuts have not proven effective. The government forced telcos to cut the base rate by W1,000 in September 2011, which was unsatisfactory for both companies and consumers. Companies suffered revenue declines, and consumers were unhappy with the limited cut. In 2012, mobile phones provided by mobile virtual network operators (MVNO) and offered under the blacklist system emerged. In particular, MVNO phones are on the upswing, with new large companies (with extensive customer bases or big retail networks) entering the market. The current government plans to gradually abolish telcos’ subscription fees. However, we think this would have only s limited impact on telecom earnings, since subscription fees are only onetime revenue that the company spreads out over the contract period. Table 4. Major intervention measures related to telecom rates Year

Comments

2004

Reduced monthly base rates by W1,000

2008

Reduced texting rates

2010

Introduced per-second billing of voice calls

2011

Reduced monthly base rates by W1,000; 50 texts free of charge every month

2012

Introduced MVNO and implemented full-scale blacklist system; discussions about mVoIP began Subscription fees are scheduled to be phased out Planning to reduce mobile telecom subscription fees by 40% in August 2013

2013-2015

Source: KCC, MSIP, media reports, KDB Daewoo Securities Research

Figure 45. Subscriber trends after introduction of MVNO (000 person) 1,600

MVNO subscribers

1,200

Permit of mobile number portability

800

400

0 11.11

12.2

12.5

12.8

12.11

13.2

Source: KCC, MSIP, KDB Daewoo Securities Research


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June 11, 2013

Despite focus on qualitative growth, some opportunities for quantitative growth exist Telcos’ major markets include B2C, households (fixed line), and individual subscribers (mobile). With the saturation of certain markets, however, companies are shifting their focus to: 1) further penetration into the B2C market, 2) the corporate market, and 3) machine-to machine (M2M) or the Internet of Things (IoT).

1) Companies appear to be having some success in further penetrating the B2C market, as evidenced by an increase in multi-device subscribers. Going forward, average revenue per account (ARPA) is expected to replace average revenue per user (ARPU) as a major earnings indicator for telcos in line with an increase in people using multiple devices. Telcos are also making efforts to increase service subscriptions per account, including the introduction of data-sharing tariff plans. Currently, Verizon, a leading US telecom operator, is presenting ARPA as one of its key earnings indicators. The company’s average device per account figure stands at 2.7. In Korea, customers owning multiple devices are expected to increase in light of the spread of smart devices (e.g., tablet PCs), growth in service usage thanks to accelerating mobile data speeds, and an increase in data-based tariff plans. 2) Sales from the B2B segment are also on the rise. In particular, sales related to telecom services, including leased lines, and convergence solutions are growing. Recently, companies’ demand for cloud server services to manage mobile traffic growth and volatility is expanding in line with the development of mobile games and video services. Figure 46. Percentage of multi-device users Multi-device subscribers One-device subscribers 100%

0.08

0.12

0.15

0.19

0.22

0.25

2013F

2014F

2015F

2016F

80%

60%

40%

20%

0% 2011

2012

Source: Cisco, KDB Daewoo Securities Research

Figure 47. Growth in B2B at telcos (Wbn) 6,000

SK Telecom

SK Broadband

KT

LG Uplus

5,000 4,000 3,000 2,000 1,000 0 2010

2011

2012

2013F



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June 11, 2013

3) The M2M (or IoT) segment could also present opportunities for quantitative growth. The emergence of various smart products such as glasses, watches, and cars, combined with the spread of existing mobile devices, is expanding the business scopes and targets of telcos. Telcos have traditionally confined their service targets individual users. With the rise of machine– machine internet connections, however, accounts (vs. subscribers) appear to be gaining growing importance for companies’ earnings. On the overseas front, Vodafone is leading the industrial M2M platform segment. In February 2010, the company commercially launched M2M services with Verizon and nPhase (a subsidiary of Qualcomm). In Korea, the three major telcos are aiming to provide commercial M2M services by building their own M2M platforms. Recently, the Ministry of Environment’s implementation of a volume-based food waste disposal system is giving rise to a new 3G-based smart waste disposal business. Figure 48. Scope of Internet of Things

Source: Beecham Research

Figure 49. 3G-based smart waste disposal system

Source: Chosun Ilbo


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June 11, 2013

Verizon is displaying structural profitability improvement Verizon is solidifying its dominant leadership of the US telecom service market. The company’s 1Q results exceeded analysts’ expectations on the back of steady net subscriber growth and new tariff plans. In addition, the company’s efforts to improve its profit structure are accelerating margin growth. A closer look at Verizon’s path to success could help us better understand what may lie ahead for Korean companies.. The percentage of subscribers to Verizon’s “Share Everything” plan, which was launched in June of last year, stands at 30% of total subscribers, similar to the company’s LTE subscriber percentage. Smartphone subscribers as a percentage of total subscribers stand at 61%. Looking ahead, the company is expected to see further growth in ARPU with users’ shift from 3G to LTE. We attribute the company’s profitability improvement to three factors. Mobile data sales are growing. An increase in LTE subscribers, who tend to consume large amounts of data, and growth in individual subscribers’ data usage are driving up the company’s sales volume. Tariff hikes have fueled its data sales growth. In addition, a change in tariff structures for data-based plans has sharply boosted profitability. The company’s mobile service unit’s margin jumped from around 40% in 2012 to 50.4% in 2013. 2) Marketing expenses are on a structural decline. Growth in new smartphone subscribers is slowing as smartphone penetration has already passed the early stages of growth. Thus, marketing expenses for attracting smartphone subscribers appear to be decreasing. In addition, the company does not need to carry out aggressive marketing campaigns as the US telecom services market is currently divided among two leading operators, Verizon and AT&T (Sprint is a distant third). The two companies are executing similar business strategies. 3) Verizon is also cutting expenses. This year, the company is scaling down operating expenses as well as facility investments. Recently, analysts have been revising up their investment ratings and target prices for Verizon. The shares of the company are trading at a 2013F P/E of 18x, which represents a premium to the market. Despite Verizon’s rising valuation, investors are still bullish on the company, as they believe that earnings growth is being driven by a structural improvement. Table 5. US analysts’ earnings estimates for Verizon

(US$, no.)

2Q13F

3Q13F

2013F

2014F

0.73

0.75

2.80

3.23

EPS estimate average (-1M)

0.73

0.75

2.80

3.22

EPS estimate average (-3M) EPS (-1Y)

0.72 0.64

0.75 0.64

2.77 2.31

3.14 2.79

29.82bn

30.18bn

120.49bn

125.12bn

28.55bn Current share price 50.24

29.0bn

115.85bn

120.39bn

Avg.

Minimum

Maximum

EPS estimate average

Revenue estimate average Revenue (-1Y)

Target price No. of securities firms

54.02

47

59

Strong buy 8

Buy 11

Hold 15

Note: As of June 10, 2013 Source: Yahoo Finance, KDB Daewoo Securities Research

Table 6. Verizon’s profitability and valuation Fiscal year

12

13F

14F

(%, x) 12

OP margin 11.4

20.8 5.9

14F

12

P/E 22.2

16.8

EV/EBITDA 7.9

13F 18.0

3.3

18.8

14F

P/B 15.6

ROE 5.5

13F

4.3

3.9

3.6

Dividend yield 22.8

3.8

4.1

-

Source: Bloomberg, KDB Daewoo Securities Research


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Figure 50. Verizon’s subscriber share and share price (%)


Became top telco in US

36

(US$)

Share price (R)

50

32

40

28

30

24

20

20

10 1Q08

1Q09

1Q10

1Q11

1Q12

Source: Thomson Reuters, KDB Daewoo Securities Research

Figure 51. Verizon’s EPS and valuation multiple are rising simultaneously (x)

Verizon - 12MF P/E (L)

MSCI US - 12MF P/E (L)

($)

Verizon - 12MF EPS (R)

28

3.6 EPS and P/E are rising simultaneously

23

3.2

P/E increase with earnings growth 18

2.8

13

2.4

8

2.0 2Q98

2Q01

2Q04

2Q07

2Q10

2Q13



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2. Stable nature of the telecom service industry Growing importance of telecom services in the smart environment Telcos are evolving from simple data and network service providers into providers of comprehensive customized services focused on user experience. With the spread of smart devices and real-time device updates, the importance of telecom services is growing. Indeed, digital services and devices are growing more and more reliant on network connections. Users’ activities on telecom networks are generating traffic and data. As the industry is currently more focused on traffic, network neutrality has become a huge issue. However, the focus is expected to shift to data going forward. Opportunities to effectively collect data could serve as a game changer for the industry. Figure 52. Growing importance of telecom services

TRAFFIC

DATA

Source: Mankind Unplugged, KDB Daewoo Securities Research

Solid business model based on paid subscribers The telecom services industry boasts a stable business model based on paid subscribers. The tariff structure breaks down into two parts: a fixed fee and a usage-based fee. Companies see a steady and predictable inflow of cash on a monthly basis. They also pay dividends out of the cash that steadily flows in. Such a business model has boosted investors’ confidence in telcos. US media stocks have been trending upward since 2H11 on the back of the economic recovery. In particular, cable system operators (SO) and satellite broadcasters with business models based on paid subscribers have displayed outstanding share performances. Robust earnings indicators, including subscriber figures and ARPU, as well as strong dividend payout ratios, have differentiated these companies from other media firms Figure 53. Strong share performances of media companies with paid subscription-based business models

Source: Bloomberg


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Churn rate is steadily falling The churn rate for mobile subscribers has been steadily falling since 2010. We believe that this steady decline points to the increasing stability of the subscriber-based model of the telecom services industry. Indeed, telcos have recently started introducing additional subscriber retention policies, including benefits for long-term subscribers. The narrowing gaps in the types and quality of services among telcos are also driving down the churn rate. Figure 54. Monthly average mobile subscriber termination trends (%)

SK Telecom KT LG Uplus

4.0

3.5

3.0

2.5

2.0 2010

2011

2012

1Q13


Stable nature of the telecom service industry also reflected in the bond market The stable nature of the telecom service industry is also being recognized in the bond market. Telecom service providers typically display high credit ratings. SK Telecom’s and KT’s corporate bonds are rated AAA by Korea Ratings, while LG Uplus’ corporate bond rating has steadily improved since 2007, climbing to AA-. Receivables arising from handset installment sales have been weighing on the financials of telcos since the emergence of smartphones, as smartphones are more expensive and have a shorter replacement cycle than feature phones. In 2009, SK Telecom became the first Korean telco to securitize its handset installment receivables. The combined securitization of the three major Korean telecom firms has surged since 2011. Asset-backed securities (ABS) that are based on a pool of handset installment receivables are popular among investors thanks to their relatively low–risk nature and high yields. Indeed, these ABS are: 1) secured by collateral as opposed to bank debentures and corporate bonds and 2) guaranteed by telcos, which boast high credit ratings. Figure 56. Issuance of ABS based on handset installment receivables is rising

Figure 55. Corporate credit ratings of major telcos SK Telecom

KT

(Wtr) 12

LG Uplus

Three telcos' combined ABS (based on handset installment receivables) (L)

(%) 80

% of three telcos' combined ABS out of receivables (R) AAA

9

% of three telcos' combined ABS out of total ABS (R)

Proliferation of smartphones

60

AA+ 6

40

3

20

AA-

A

0 07

08

09

10

11

Source: Korea Ratings, KDB Daewoo Securities Research


12

0 2009

2010

2011

2012

Source: Financial Supervisory Service, KDB Daewoo Securities Research

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June 11, 2013

3. Non-telecom and new businesses generating revenue full swing Media businesses expanding Among the non-telecom businesses of telcos, media is generating the most tangible results. For example, IPTV services, which telcos initially offered as part of bundled products in order to prevent a fixed-line decline, has been taking on greater importance due to the: 1) ongoing nationwide conversion to digital broadcasting and 2) consumers’ increased preference for digital features, including VOD. The number of IPTV subscribers exceeded 7mn in April. For KT, its subsidiary KT Skylife operates digital satellite broadcasting. The number of subscribers to media services offered by telcos accounts for more than 40% of total domestic pay TV subscribers. Given that the digital conversion ratio of cable TV stands at only 36%, the status of telcos is rising in the digital media market, in our view. The combined number of IPTV and satellite TV subscribers is nearing the number of cable TV subscribers. IPTV and satellite TV subscribers grew by 32.2% and 16.9% YoY in 1Q, while cable TV subscribers remained flat. We believe that rapid IPTV and satellite TV subscriber growth is attributable to: 1) strong marketing, including bundled product offers, and 2) consumers’ preference for digital broadcasting. Telcos are currently enjoying a period of quantitative growth (subscriber growth) in non-telecom segments. Going forward, they will likely reach a subscriber level that will allow them to generate economies of scale, and profitability should improve on increases in supplementary service revenue. Furthermore, we are encouraged that telcos are expanding their non-telecom business areas, evolving from broadband internet service providers to IT-based comprehensive service providers. Figure 57. Number of IPTV subscribers has exceeded the 7mn mark ('000 persons) 8,000

LG Uplus SK Broadband

7,000

KT

6,000 5,000 4,000 3,000 2,000 4/11

7/11

10/11

1/12

4/12

7/12

10/12

1/13

4/13

Source: Company data, KDB Daewoo Securities

Figure 59. YoY growth of pay-TV subscribers by platform (1Q13)

Figure 58. Pay-TV subscribers by platform (1Q13) (mn persons) 30

(%) 40 25.8

32.2 30

23

20

14.9

16.9

15 9.6

10 7.0

8

-0.04 0

3.9

0

-10 Cable SO

IPTV

Satellite

Total pay TV

Notes: Cable SO subscribers are based on aggregate data; IPTV and satellite TV services include those offered by telcos Source: ICTI, KCTA, KDB Daewoo Securities Research KDB Daewoo Securities Research

Cable SO

IPTV

Satellite

Total pay TV

Notes: Cable SO subscribers are based on aggregate data; IPTV and satellite TV services include those offered by telcos Source: ICTI, KCTA, KDB Daewoo Securities Research

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Figure 60. Subscribers to media services offered by telcos account for more than 40% of total domestic pay-TV subscribers (mn persons) 30

50%

No. of cable TV subscribers (L) No. of subscribers to media services offered by telcos (L) Share of subscribers to media services offered by telcos (R)

23

40%

15

30%

8

20%

0

10% 1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

Note: Three major telcos’ IPTV subscribers and KT Skylife’s satellite subscribers combined Source: Company data, KCTA, KDB Daewoo Securities Research

Figure 61. Rising contribution of media revenue to wired telecom revenues Top three telcos' combined media revenue (L)

(Wbn) 600

(%) 20

Top three telcos' media proportion within wired revenue (R)

450

15

300

10

150

5

0

0 1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

3Q13F

Note: Based on the combined revenue of KT, LG Uplus, and SK Broadband Source: Company data, KDB Daewoo Securities Research

Figure 62. Rising contribution of media revenue to total revenue (Wbn) 500

(%) 4

Three telcos' combined media revenue (L) % of three telcos' combined media revenue out of their total consolidated revenue (R)

400 3 300 2 200 1

100

0

0 1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

Note: Media revenue from KT Skylife has been recognized in KT’s consolidated revenue since 2011 Source: Company data, KDB Daewoo Securities Research


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Figure 63. Domestic pay-TV market share breakdown (1Q12)

Figure 64. Share of IPTV rose markedly (1Q13)

1Q 12

Satellite 14.2%

1Q 13 Satellite 15.1% (+0.9%p YoY)

IPTV 22.4%

Cable SO 57.8% (-5.6%p YoY)

IPTV 27.1% (+4.6%p YoY)

Cable SO 63.4%

Source: Company data, ICTI, KCTA, KDB Daewoo Securities Research

Figure 65. Subscribers of domestic pay-TV companies (1Q13) 0

500

1,000

1,500

KT (IPTV)

2,000

2,500

3,000

3,500

4,000

Figure 66. Telco subscribers showed the biggest YoY increase in 1Q13 -15

4,500 ('000)

0

15

30

KT (IPTV)

Skylife

Skylife

CJ Hellovision

CJ Hellovision

T-broad

T-broad

CNM

CNM

SK Broadband

SK Broadband

Hyundai HCN

Hyundai HCN

CMB

CMB

LG Uplus

LG Uplus

45

60

27.5

(%)

16.9 8.2 -0.9 -8.7 47.0 8.9 -0.4 32.0

Note: Cable SO subscribers are based on aggregate data; Blue indicates telcos, while gray indicates cable SOs, Source: Company data, ICTI, KCTA, KDB Daewoo Securities Research


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Figure 67. Media industry’s value chain Distribution

Production

Production Terrestrial broadcasting

Programming

DMB

Distribution

Terminal/handset

Cable broadcasting companies (SO)

TV

Network operators (NO) PP

Independent production companies

IPTV

Over-the-top (OTT)

Service providers Terrestrial broadcasters

Terrestrial broadcasters

Cable TV

Satellite TV

Content consumption

Broadcasting equipment providers

Satellite broadcasting

Wireless DMB,

DMB broadcasters

IPTV content providers

IPTV broadcastets

OTT carriers

OTT carriers

#NAME?

Handset TV, Handset TV Everywhere website, mobile web, smart TV


Figure 68. KT holds the most media subsidiaries among telcos Distribution

Production

Production

Programming

Content consumption

Service providers

Distribution

Terminal/handset

Terrestrial broadcasting Cable TV Korea HD Broadcasting

Satellite TV

KT Skylife

DMB

IPTV

KTH

KT Media Hub, KTH

KT (Olleh TV)

Over-the-top (OTT)

Olleh TV Now

Notes: Korea HD Broadcasting, KT Skylife’s subsidiary, operates a PP business; KTH, KT’s subsidiary, holds intellectual property for films and operates a T-commerce business Source: KDB Daewoo Securities Research

Figure 69. SK Broadband and LG Uplus engage mainly in IPTV and OTT services Distribution

Production

Production

Programming

Service providers

Content consumption

Distribution

Terminal/handset

Terrestrial broadcasting Cable TV Satellite TV

DMB

IPTV

SK Broadband, LG Uplus (IPTV)

Over-the-top (OTT)

Btv Mobile, Hoppin (SK Telekom) U+ HDTV (LG Uplus)



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Overseas telecom firms are also expanding their media businesses. Indeed, their media business strategies and activities should have significant implications for domestic telecom firms. In the US, AT&T is the largest IPTV operator. During the company’s 1Q earnings announcement, the IPTV business, which is headlined by its U-verse brand, attracted keen attention from investors due to the fact that IPTV subscribers exceeded broadband internet subscribers in the quarter. In 1Q, the company, which currently has 4.8mn IPTV subscribers, recorded its highest new subscriber increase in two years. Notably, household fixed-line revenues climbed by 2% YoY in 1Q, as IPTV revenues expanded by 31.5% YoY during the quarter, offsetting a fall in revenue from traditional fixed-line services, including voice calls and broadband internet. The company has recently revamped its VOD functions and user interface in order to promote further IPTV revenue growth. Verizon also engages in the IPTV business with the brand FiOS. The company recently mounted a VOD promotion campaign called “Free On Demand Marathon,” which allowed its subscribers to watch VOD for free on Memorial Day. This campaign was aimed at taking advantage of the fact that, statistically speaking, those who watch free VODs tend to also use paid VOD services. In Korea, VOD revenue is rising rapidly. For KT, VOD revenue exceeded W120bn (+70% YoY) last year. SK Broadband and LG Uplus are estimated to have recorded 40% YoY rises in VOD revenue last year. Each company has recently launched a fixed monthly payment plan for terrestrial VOD. As such, we expect the popularity of VOD to increase. Figure 70. AT&T overhauled the features and UI of its IPTV service, U-verse

Figure 71. Verizon’s VOD promotion, Free On Demand Marathon

Source: Company data


Figure 72. Spain’s Telefonica offers Terra in 18 countries

Figure 73. Orange of France acquired a video-sharing site and forged partnerships with broadcasters Acquired a stake in a video sharing site



Forged partnerships with broadcasteres


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For media platform services, including IPTV and over-the-top (OTT), it is key to secure content. Therefore, for service providers, it is necessary to have massive financial resources in order to secure killer content through alliances with content providers. Furthermore, media platform providers need to cooperate with network service companies to ensure high quality delivery of content to subscribers. In Spain, Telefonica launched a media distribution platform called Terra in 2010 and currently offers it in 18 countries. In 2012, the company released an OTT service called SundayTV. The company links these services with advertising and online rental services. KT of Korea is also endeavoring to expand TV business-related revenue. In addition to VOD, the company is working on a variety of projects related to TV subscribers, including advertising, Tcommerce, and mobile IPTV. In France, Orange, which also started an OTT service, is securing content through acquisitions and alliances. The company acquired a 51% stake in the video sharing site Dailymotion in 2011 and bought the remaining 49% stake this year. In addition, the company has strengthened its premium content, including movies, by forging an alliance with the TV channel Canal+. In Canada, Rogers Communications is a comprehensive telecom/media firm, engaging in the wireless telecom, cable (cable SO, fixed-line telecom), and media (broadcasting PP, printing, internet, etc.) businesses. Of note, Rogers is both a telco and a cable SO, as the company, which was engaging in the media and cable businesses, expanded its business areas to include wireless telecom. Currently, the wireless telecom unit contributes more to the company’s earnings than the media unit. In 2012, however, the wireless telecom unit posted low single-digit revenue growth, while the growth of the cable and media units stagnated. AT&T has experienced failure in its cable business. The company, which was engaging in the fixedline telecom business, expanded into the cable SO market. However, the company faced a crisis due to weak profitability arising from massive investments in the media business in the early 2000s. As such, the company went through restructuring and sold the cable business unit to Comcast in 2002. The Korean cable SO market is likely to undergo consolidation amid deregulation and conversion to digital broadcasting. Indeed, some cable multiple system operators are already up for sale in the market. Given the overseas examples and the domestic conditions mentioned above, domestic telcos are unlikely to acquire cable multiple system operators. Figure 74. Business divisions and earnings of Canada’s Rogers

Source: Company data KDB Daewoo Securities Research

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Mobile platform segment Korean telcos run their own application stores for smartphones. The relatively late entries of global mobile platform providers into the Korean market allowed domestic brand names such as SK Telecom’s T store to secure footing without much competition. However, things have changed, as Apple and Google have started to provide mobile platform services in Korea, and domestic players such as KakaoTalk and LINE have also joined the fray. As such, despite the continued expansion of the mobile platform market, telcos’ revenue growth in the segment may slow, given their rivals’ strong positions in highly profitable mobile games. For telcos to continue to expand their mobile platform businesses, they need to strengthen their competitiveness in mobile games. Given the significant number of mobile games available (700,000 on Google Play and 800,000 in Apple’s App Store), “search” and “suggest” functions are becoming increasingly important. KakaoTalk is planning to feature games of global developers in addition to their in-house developed games. Telcos can also secure growth by focusing on providing domestic content (movies, dramas, etc.) where global rivals and MMS cannot have competitive advantages. Telcos already own related licenses thanks to their IPTV businesses.


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Commerce platform business Telcos are expanding their positions in the commerce platform segment. Among the various types of commerce platforms, TV and smartphone platforms appear to hold the highest growth potential. The TV platform has been widely favored by home shopping companies, but mobile commerce is just beginning to grow. SK Telecom is betting on the growth of mobile commerce. 11th Street, run by SK Telecom’s subsidiary SK Planet, is Korea’s second-largest online shopping site, just behind eBay Korea (Gmarket and Auction), and the largest mobile commerce vendor in terms of transaction volume. Its growth has been driven by aggressive promotions, advertisements, and brand marketing, which have all been enabled by SK Telecom’s strong market power (i.e., large subscriber base and capital). KT is likely to focus on the TV platform, as the company has the largest digital TV subscriber base in Korea. The Sky T Shopping channel, owned by the company’s subsidiary KTH, airs on KT’s IPTV and KT Skylife. The transaction value of Sky T Shopping has increased since its channel number on KT Skylife changed from 43 to 17. Payments via smartphones are now available (introduced in April), and channel upgrades are scheduled for July. The company decided on a W13.2bn rights offering in May, which will be used to expand its TV commerce business. Figure 75. Domestic platform usage hours and commerce market: TVs and smartphones have room for growth (%) 80

Average daily usage time GMS - commerce

60

40

20 ?

0 TV

Internet

Smartphone

Notes: Average usage time per day; based on the value of 2012 commerce transactions Source: KT Economic Management Institute, KDB Daewoo Securities Research

Figure 76. Domestic mobile shopping market (Wbn) 1,500

Transaction value of mobile shopping market 1,300

1,200

900 600 600

300

200 2

3

14

08

09

10

0 11

12

13F

Source: Korea Online Shopping Association, KT Economic Management Institute, KDB Daewoo Securities Research

.


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Hardware business – rising semiconductor demand SK Hynix accounts for the lion’s share of SK Telecom’s equity-method gains. As SK Hynix is a semiconductor maker, the so-called “Big Cycle” of the semiconductor industry, characterized by falling supply and rising mobile demand, should greatly benefit the company. Memory content grew steadily during the PC period, but as smartphones started to replace PCs, mobile DRAM content growth has picked up speed. Indeed, smartphones’ mobile DRAM content doubled YoY to 2GB in 2Q, and some products are even expected to adopt 3GB DRAM in 2H. Memory chip makers are ramping up mobile DRAM production, but demand should still outgrow supply in 2H, resulting in supply shortages, which should benefit SK Hynix. Figure 77. Semiconductor industry entering a “Big Cycle” on increased demand for mobile memory

Industry restructuring

Growth of mobile devices

Conservative capex

Rapid growth of DRAM content Big cycle has begun in 2013

Delays to tech migration

Surge in SSD demand


Figure 78. Mobile DRAM content surges on increased demand for mobile devices (GB/system)

(bn GB)

2.5

3.5

Mobile DRAM adoption in smartphones (L) Mobile DRAM demand from smartphones (R)

3.0

1.93

2.0

2.5

Mobile DRA M adopt ion t o increase rapidly 1.25

1.5

2.0 1.5

1.0 0.70

1.0

0.37

0.5 0.13

0.5

0.21

0.0

0.0 09

10

11

12

13F

14F

15F

Source: Gartner, IDC, KDB Daewoo Securities Research


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4. Financial analysis and outlook Telcos have faced growing financial burdens since 2H11. Operating profits have contracted due to the costly introduction of LTE services (capex and marketing expense). Growth in receivables related to installment-based purchases of smartphones has resulted in increased liabilities. Spinoffs, acquisitions, and new businesses have also fueled fund outflow and borrowings. However, financial burdens started to ease in 2012. Telcos’ combined EBITDA started to recover, and borrowings seem to have peaked in the year. We expect these positive trends to continue in 2013 and beyond. As the LTE market takes root, marketing and capex spending should decrease, and profitability and operating cash flow should improve. Receivables (related to installment buying) will be securitized and sold, and net borrowings should decline as a result. SK Telecom and KT should be able to maintain their financial flexibility, given their strong non-operating assets and healthy credit. Figure 79. Telcos’ annual EBITDA has been recovering since 2012 (Wtr) 14

EBITDA

11

7

4

0 2008

2009

2010

2011

2012

2013F

2014F

2013F

2014F

Note: Combined data of SK Telecom, KT and LG Uplus (consolidated basis) Source: Company data, KDB Daewoo Securities Research

Figure 80. Annual borrowings of telcos likely to fall going forward (Wtn)

Total debt

24

Net debt

18

12

6

0 2008

2009

2010

2011

2012

Note: Combined data of SK Telecom, KT and LG Uplus (consolidated basis) Source: Company data, KDB Daewoo Securities Research


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5. Risk analysis The government regulates the telecom business as it is considered a form of infrastructure. We expect regulatory and policy risks to heighten in July-August, as the KCC plans to announce sanctions against telcos (penalties, etc.) for offering illegal handset subsidies (July), and the MSIP will re-allocate frequencies (August). Both issues are likely to greatly influence telecommunication businesses in the short and long term. Competition in the telecom market is likely to intensify. As service quality, LTE network coverage, and types of services/plans have become increasingly difficult to differentiate, telcos tend to focus on marketing. The government also promotes competition, as it leads to greater benefits for customers (lower rates, etc.). With regard to handset subsidies, however, the government has shown a strong commitment to regulate excessive competition. Thus, telcos are focusing on providing a diverse array of services and content, and attractive call/data plans. The biggest risk that may threaten the telecom industry is a widening gap between revenue and data traffic. Mobile traffic has been growing rapidly, outpacing KCC’s forecast from two years ago. If revenue fails to catch up with traffic growth, telcos’ profitability should deteriorate structurally. Thus, telcos will need to come up with effective strategies (call plans, etc.), and the government will need to take caution in making policy decisions. Figure 81. Growth of mobile data traffic after the introduction of LTE is forecast at the top of the 2011 scenario ('000 TB) 200

Wire-free world Projected future Worst-case scenario

150

Actual traffic growth

100

50 (year) 0 12

13

14

15

16

17

18

19

20

Note: Actual usage trends compared to mobile traffic forecasts before the introduction of LTE in 2011 Source: KCC, National Assembly, Kyung Hee University, KDB Daewoo Securities Research

Figure 82. Revenue growth may fail to match capex expansion Revenue

Traffic

Voice era: Capex and revenue synchronization Predictable traffic growth Stable revenue from voice-centric plans

Data era: Capex and revenue desynchronization Solutions: - Builing bypass network - Network technology upgrades - Spectrum additions - Data-centric plans

Source: Atlas, KDB Daewoo Securities Research


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Industry issues The major issues of the telecom service industry relate to: 1) the distribution structure of handsets, 2) call/data plans, and 3) government regulations and policies. 1) Telcos play a key role in distributing mobile handsets, providing phone subsidies to customers. However, this distribution structure burdens carriers financially (subsidies and receivables related to installment buying), and often puts consumers in disadvantageous positions due to information asymmetry (unequal subsidies). As a result, carriers are increasingly seeking ways to enhance their competitiveness in areas other than subsidies, such as call plans and services. The government is also making efforts to diversify distribution channels, tightening subsidy regulations and fostering MVNOs and introducing and the mobile phone blacklist system, which allows users to purchase cell phones at large supermarkets and discount stores. 2) Advances in telecom technologies and shifts in consumers’ service usage patterns have brought about changes in carriers’ major profit sources and charging methods. Indeed, cell phones are now used more for data than for calls. As such, carriers have introduced data-based call plans, which include unlimited voice minutes (as voice calls are no longer a major source of profit). Meanwhile, carriers are reviewing a scheme to allow users to choose between subsidies and service rate discounts, in essence separating phone prices from service rates. 3) In a sustained low growth environment, the government is hoping to create jobs in new industries. Thus, we expect that a series of favorable policies, including frequency reallocation for wireless companies to deal with surging mobile data traffic, will continue to benefit the telecom industry. On a macro scale, measures to improve frequency efficiency and secure new frequencies will be needed. On a micro level, policy efforts should continue to find ways to reduce communications costs, as mobile phones have become an essential part of everyday life. Figure 83. Key issues of telecom service industry

Carrier-oriented handset distribution system Distribution paradigm

Supplement 1: MVNO (bargain phone) Supplement 2: Blacklist system (handset payout) Voice  data

Issue

Call plans

Unlimited plans Separate pricing (subsidies/rate discounts)

Macro: Economic development driven by ICT industry Government regulation/policies

Micro: Reduction of communication costs Frequency allocation



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1. Paradigm shift in handset distribution The unique distribution structure of the telecom industry—installment buying and the interconnected nature of handset prices and call plans—has created many issues, such as unequal subsidies, long-term contracts, and the general perception that telecom rates are excessively high. While these problems originate from telcos’ dual role as a service provider and handset distributor, telcos are unlikely to give up their position in handset distribution. Since the network quality, customer service, and call plans of telcos have become increasingly difficult to differentiate from one another, phone subsidies have become the most effective means of customer acquisition. As such, carriers are anticipated to continue to pay subsidies under the current distribution structure. The good news is that carriers are making efforts to improve their service quality and provide customers with more competitive call plans, rather than relying solely on subsidies. As mentioned above, the government is also making efforts to diversify distribution channels, applying stricter regulations on phone subsidies and introducing MVNO services and the mobile phone blacklist system.


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MVNO service providers borrow virtual networks from mobile network operators (MNO). As such, their rates are cheaper than those of MNOs such as SK Telecom, KT and LG Uplus, which make profits through the direct operation of telecom networks. In exchange for access to MNO’s virtual networks, MVNOs pay wholesale rates (fixed costs). The government suggested that the reasonable discount rate for MVNO services (2010) should be 31% for pure MVNOs and 33-44% for those that are not fully reliant on borrowed networks. MVNO services are attracting some users thanks to their reasonable rates. As of April 2013, the number of MVNO subscribers reached 830,000 for KT, 600,000 for SK Telecom, and 220,000 for LG Uplus. Collectively, MVNO subscribers account for 3% of total mobile phone subscribers. The number of service providers is also climbing, as MNO subsidiaries, pay-TV channels, and network providers expand into MVNO. MVNO is attractive for pay-TV companies because of possibilities related to service bundling. By offering MVNO services, CJ HelloVision is aiming to compete with telcos’ IPTV services. Network providers can also easily enter the MVNO market thanks to their existing network infrastructure, but they will need to offer new products due to regulations. For handset makers, the rise of MVNOs should boost low-end handset sales. And it will allow MNOs to attract subscribers and gain market share without significant marketing spend. Figure 84. MVNO subscriber market trends ('000 persons) 2,000

4%

MVNO subscribers (L) Telecom market share (R)

1,500

3% Start of mobile number portability

1,000

2%

500

1%

0

0% 11/11

1/12

3/12

5/12

7/12

9/12

11/12

1/13

3/13

Notes: KT and LG Uplus have allowed carrier switches since January 2012; SK Telecom has allowed switches since April 2012 Source: KCC, MSIP, KDB Daewoo Securities Research

Table 7. Major domestic MVNOs MNO carriers

SK Telecom

KT

LG Uplus

MVNO carriers

Korea Cable Telecom SK Telink Korea Post

CJ Hellovision FreeC Annex Telecom Evergreen Mobile C& Communications Winnerstel KT Powertel Homeplus

Monty Star Telecom CN MVNO B&S Solution EDD Company Fitel Leaders Telecom

Source: Company data, media reports, KDB Daewoo Securities Research


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However, growth of the domestic MVNO market is expected to be limited due to an unfavorable environment. 1) The domestic telecom market has already been saturated. In Europe, MVNOs were able to achieve meaningful penetration when mobile phone penetration was below 100%. 2) In foreign countries, MVNOs offering pre-paid billing systems are popular. However, the postpaid billing system has already taken firm root in Korea. 3) The introduction of various unlimited rate plans by MNOs and approval for mVoIP services are weakening the competitiveness of MVNOs. Meanwhile, the government plans to utilize MVNOs in an effort to improve the distribution structure of the telecom service industry. Korea Post plans to launch an MVNO business with over 3,600 post offices nationwide serving as distribution channels. The government believes the dismal performance of MVNOs is attributable to the small number of related retail outlets (just 400). It remains to be seen whether increased sales outlets for MVNO services will improve the current distribution system. Figure 85. Major European countries’ mobile phone penetration rates when MVNOs were introduced (%) 125

Mobile phone penetration 109%

100

91% 81%

75

50

58%

59%

Denmark ('00)

Germany ('00)

41%

25

0 England ('99)

Finland ('02)

Sweden ('03)

Korea ('12)

Source: Bloomberg, OECD, KDB Daewoo Securities Research

Figure 86. Major countries’ pre-paid plan subscription rates (%)

Prepaid-plan subscription rate

100

75

50

Korea

Japan

Finland

US

Taiwan

Denmark

Canada

Austria

Norway

France

Spain

England

Netherlands

Greece

Portugal

Italy

China

Vietnam

Thailand

Indonesia

0

Philippines

25

Note: As of 2009 Source: Bloomberg, OECD, KDB Daewoo Securities Research


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Implementation of the blacklist policy As mentioned above, a so-called blacklist policy for mobile phone distribution was introduced recently. The new system allows consumers to purchase phones at supermarkets, online shopping malls, and other stores operated by phone manufacturers. Under the blacklist system, consumers will be able to subscribe to mobile phone services with any phone, even those purchased from retail outlets not run by telcos (with the exception of blacklisted phones registered as stolen or lost). It should be noted that, In the past, telecom companies held control of international mobile equipment identity (IMEI). However, since the implementation of the blacklist policy in May 2012, telcos no longer manage IMEI. The new policy has resulted in a clear separation between mobile phone purchases and service plans. Thus, telcos are likely to concentrate on improving services going forward. In addition, an increase in the distribution of foreign mobile phones should lead to a decline in the prices of phones made by Korean companies. The blacklist policy is also likely to give rise to a robust used phone market. In our view, the blacklist policy should complement the current mobile phone distribution system. Consumers are likely to continue to buy mobile phones at telco-run stores to receive subsidies. As for mobile phone manufacturers, selling products/services at the highest possible prices is their foremost goal regardless of what distribution channels are in use. Thus, the current mobile phone distribution system is unlikely to change significantly. Figure 87. Mobile phone replacement trend (mn phones) 40 Net subscriber growth (R)

Mobile phone replacement (L)

Used phones (L)

(mn persons) 4

30

3

20

2

10

1

0

0 02

03

04

05

06

07

08

09

10

11

12

Note: Based on 2012 estimates, Source: National Assembly, KDB Daewoo Securities Research


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Government plans to enact mobile phone distribution system improvement measures In May 2013, the MSIP plans to put forth a bill to improve the mobile phone distribution structure. The bill includes measures to improve newly introduced systems, including the MVNO and blacklist systems, and plans to strengthen regulations on telcos’ phone subsidies. In addition, the bill stipulates the following regulations on telcos’, manufacturers, and distributors. 1) According to the bill, the subsidies of mobile phone manufacturers like SEC and LGE will be subject to investigation and regulation. Currently, only telcos are subject to such regulation. In addition, the practice of giving subsidies to mobile phone stores and providing unfair support to certain telecom operators will also be restricted. 2) The bill also proposes fines for mobile phone stores that give misleading information to customers. In addition, sales outlets will no longer be able to be considered official stores without the approval of telcos. 3) Telcos will be banned from basing subsidies on services, tariff plans, and subscribers’ location. 4) The bill aims to force telcos to post the wholesale and retail prices of phones--and relevant subsidies—on their websites on a weekly basis. Each model will have a standard subsidy level. Meanwhile, agents and sales outlets will be allowed to provide extra subsidies (less than 15% of official subsidies) to subscribers. 5). Subscribers who do not receive subsidies will receive discounts on rates. If the bill is passed, a new rate system that separates discounts on mobile phone prices (subsidies) and service subscription fees (rate discounts) is expected to be introduced. 6) Telcos’ sales agents will be banned from forcing customers to subscribe to high-rate plans and additional services in order to receive subsidies. They will also be restricted from charging penalties to customers who terminate their plans before their contracts expire. 7) Telcos driving excessive competition will be subject to suspension.


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2. Tariff system Changes in the tariff system underway Recently, Korean telcos have been introducing new tariff plans more frequently than before. They are overhauling their tariff plans to account for the fact that voice call and text message usage is decreasing globally. Indeed, telcos’ traditional revenue sources are being eroded by similar services offered by non-telcos. Meanwhile, data usage is on the rise. Higher download speeds and the proliferation of phablets are leading to a surge in the size of content files, increasing the need to invest in telecom networks. Against this backdrop, a shift to a data-oriented tariff system will likely boost revenue at telcos. The technological characteristics of LTE are also facilitating changes in the tariff system. LTE technology was designed to transmit data. Previously, telcos used circuit switching for voice transmission and packet switching for data transmission. However, with LTE technology, telcos use packet switching for both voice and data transmission. Under the circuit switching method, two network nodes establish a dedicated communication channel (circuit) through the network before the start of communication. This method requires the full usage of a channel’s bandwidth and connectivity for the duration of a communication session. Packet switching groups all transmitted data—regardless of content, type, or structure— into suitably sized blocks, called packets. The characteristics of circuit and packet switching also affect the tariff system. With circuit switching, subscribers are charged by the minute, as an entire channel is occupied throughout a single communication session. For packet switching, however, they are charged by data transmission volume. Figure 88. Global mobile communication voice traffic (tr min.) 30

Figure 89. Global mobile communication voice revenue (%) 16

V oice traffic (L)

(US$bn) 800

(%) 2

V oice revenue (L)

V oice YoY growth (R)

V oice YoY growth (R)

23

12

600

0

15

8

400

-2

8

4

200

-3

0

0

0 11

12

13F

14F

15F

16F

Figure 90. Global mobile data traffic (M onthly exabyte) 12

-5 11

12

13F

14F

15F

16F

Figure 91. Global mobile data revenue (%) 140

Data traffic (L)

(US$bn) 600

(%) 16

Data revenue (L) Data Y oY growth (R)

Data Y oY growth (R)

9

105

6

70

3

35

0

0 11

12

13F

14F

15F

16F

Note: Monthly averages Source: KISDI, KDB Daewoo Securities Research


450

12

300

8

150

4

0

0 11

12

13F

14F

15F

16F

Source: KISDI, KDB Daewoo Securities Research

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Global telcos are increasingly switching to data-oriented tariff plans. A case in point is Verizon of the US. The company launched its “Share Everything” plan, an LTE data sharing plan, in June 2012. With the introduction of the data-oriented tariff plan, Verizon has seen changes in its revenue structure. The company has started to offer free unlimited voice calls and text messages. In addition, the company has broken down its tariff plan by: 1) data allowance and 2) number of communication lines. And, notably, Verizon has hiked its monthly fixed rates. In addition, the company has allowed data sharing among family members, which has led to reduced marketing expenses and a lower churn rate. Subscribers to the “Share Everything” plan account for 30% of Verizon’s total subscribers, similar to the company’s LTE subscriber proportion. The percentage of smartphone subscribers out of the company’s total subscribers stands at 61%. The company’s ARPU is likely to continue to rise on the shift from 3G to LTE services. Following the success of Verizon’s “Share Everything” plan, KT rolled out Korea’s first data sharing plan in November 2012. However, KT’s plan offered only limited voice calls and text messages at that time. In April 2013, KT launched a new data sharing plan with free unlimited voice calls and text messages (similar to Verizon’s plan). This plan also offers the option of free data sharing between two mobile devices. Figure 92. Verizon’s data-centric plan



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Focus of data plans also shifting from data allowance to service/product quality Conventional data plans were designed based on data allowance. However, now, telcos, particularly LG Uplus, are considering the introduction of new data plans that offer a variety of options to subscribers, rather than a one-size-fits-all fixed-rate data plan based on data allowance. If these new data plans come to fruition, they could be differentiated based on data transmission speeds. As such, consumers would have more options to choose from. Meanwhile, telcos could make efficient use of bandwidth by enhancing the efficiency of network management—at a time when bandwidth management is taking on increasing importance due to rising data usage. In the long term, a data-based supplementary service model could emerge. Telcos’ current revenue models are designed based on their data allowances to customers. However, higher data transmission speeds could create new business opportunities. In addition, mobile service providers other than telcos could pay data fees for their customers in order to promote their services. Table 8. Analysis of tariff plans by data speed Carrier

TeliaSonera Korea KT

Plan

Basic fee

Data limit

Delivery speed

Total

US$97.08

30GB

80Mbps

Grand

US$59.79

20GB

20Mbps

In the event of exceeding data limit Data speed reduced to 120Kbps

Medium

US$48.44

10GB

10Mbps

LTE-1300

W130,000

Unlimited

Up to 75Mbps

No speed limit

LTE-650

W65,000

6GB

Up to 75Mbps

LTE-550

W55,000

2GB

Up to 75Mbps

Data speed reduced to 400Kbps

Source: Company data, ConnectingLab, KDB Daewoo Securities Research


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Introduction of unlimited service plans Since early this year, domestic telcos have introduced new service plans. LG Uplus launched unlimited LTE data plans for the first time in Korea in an attempt to promote LTE services. And SK Telecom was the first to offer unlimited voice call plans. As of mid-2013, SK Telecom, KT, and Uplus are now offering similar service plans—though they were introduced in different time frames. Initially, this competition was heated. However, now that all of them have come to provide similar plans, telcos ironically appear to be somewhat cooperative with one another. Generally speaking, given that unlimited service plans are based on fixed rates, they should dilute chances for additional revenue. However, telcos seem capable of boosting an ARPU by adjusting voice call and data rates. During the early stages of 3G smartphone proliferation, telcos accumulated experience in terms of service rates and marketing strategies. Consumer complaints during the initial phases of technologies (about product defects and unsatisfactory service) often helped produce better results. We believe that this broad experience and feedback from consumers and the government should boost the growth of 4G technologies. Telcos launched unlimited service plans in order to give subscribers more access to LTE services. On a positive note, service rates have increased. And telcos switched their marketing focus from one-off subsidies to diversified service plans. Unlimited LTE data plans are meant to promote the budding of LTE service businesses. And we see the introduction of unlimited voice plans as a timely move, considering decreasing voice call usage. Figure 93. Introduction of LG Uplus’ unlimited data plan

Figure 94. Introduction of SK Telecom’s unlimited data plan

Notes : Announcement on 1/25/2013; In place from Feb. to Apr. Source: Company data

Note: Launched on 3/22/2013; data as of May 30th Source: Company data


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1) Introduction of unlimited LTE data plans LG Uplus launched unlimited LTE data plans for the first time in Korea in order to: 1) solidify its second-place position in terms of LTE subscribers (KT is quickly catching up), and 2) expand its subscriber base (the company resumed promotion activities on January 31st, following the end of its suspension). And we think LG Uplus needed to further differentiate itself from competitors, which have launched LTE services and other similar plans. We also believe that, by offering unlimited LTE plans, LG Uplus was targeting iPhone owners and wired internet subscribers to SK Telecom’s and KT’s services. Before introducing LTE services, LG Uplus recorded the lowest ARPU among the three major carriers. Furthermore, LG Uplus needed to switch from subsidies to profitable plans so as to improve its deteriorating earnings. Just a few hours after LG Uplus launched unlimited LTE data plans, KT and SK Telecom also launched similar plans. This development appeared unavoidable, given that: 1) KT and SK Telecom were scheduled to suspend marketing operations, and 2) LG Uplus’ plans looked attractive enough to lure subscribers. LG Uplus and KT stopped offering unlimited LTE data plans at end-April, and SK Telecom followed suit at end-May. As such, the proportion of such plans is limited. Considering unlimited LTE plans were offered only via indirect marketing, we believe they should have limited impacts on carriers. Table 9. Unlimited LTE data plans SK Telecom Plan Monthly charge (including VAT) Voice calls

KT LTE-950

LTE-1100 LTE-1300

Unlimited 95

W119,900

W104,500

W121,000 W143,000

W104,500

W121,000

W143,000

1,050 min. 1,250 min.

650 min.

1,200 min.

1,500 min.

650

1,000

1,000

1,050 min.

650 min.

1,050

650

Data

Unlimited

Speed limit

Unlimited 130

LTE109

Text Standard data Additional allowance per day

LG Uplus Unlimited 110

18GB

1,050

2,500

Unlimited 14GB

20GB

Unlimited 25GB

14GB

20GB

3GB

3GB

3GB

Limitations available

2Mbps

2Mbps

24GB

Notes: KT and LG Uplus plans were terminated by the end of Apr.; SK Telecom extended its plans until end-May Source: Company data

It should be noted that telcos’ 1Q unlimited data plan launches dampened investor sentiment, raising concerns that the positives related to LTE services might dissipate. Indeed, KT shares experienced corrections for two months. If unlimited data plans revive or expand, this should trigger concerns such as: 1) potential slowdown of ARPU growth, and 2) weak revenue related to heavy investments. In particular, given that an increasing number of users are accessing mobile services more frequently, unlimited data plans might prove to be self-destructive for carriers. In addition, carriers might need to accelerate investments in post-LTE technologies. And increased unlimited LTE data services might take a bite out the wired internet market. With the opening of the 4G era, the difference in speed between wired and mobile connections is narrowing. In the US, some second-tier carriers offer unlimited LTE data plans. However, only a few carriers do so, and these carriers do not cover the entire nation. However, major Korean carriers’ LTE services cover the entire nation. And the number of LTE subscribers is quickly increasing. And we believe that domestic carriers should not consider additional unlimited data plans to protect data usage-based charges.


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2) Introduction of unlimited voice plans On March 22nd, SK Telecom announced it was offering unlimited voice calls among SK Telecom subscribers. In the near term, we expect this plan to erode earnings, considering: 1) the plan applies to 3G handsets as well as 4G handsets, and 2) existing voice call and text message revenue still account for a significant portion of the company’s overall mobile service revenues. However, this plan indicates SK Telecom’s drive to reinforce its leadership (market share of 50%). And the plan comes with a way to make up for revenue erosion. First, the base rate for the new unlimited voice call plan are higher than those for existing plans. Second, the company is maintaining its limits on data usage. Meanwhile, unlimited 3G data, which was previously provided for users of specific fixed-rate plans (W55,000 or more per month), is no longer available. Figure 95. SK Telecom’s wireless service revenue breakdown Data revenues increased 11% YoY

Data V oice

29%

32%

Figure 96. Subscriber market share

LG Uplus 19%

Subscription fee

68%

65%

About 50% of voice revenues to be affected by unlimited voie call plan

SK Telecom 50%

KT 31% 3%

3%

2011

2012




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Table 10. First unlimited voice call plans (within network): SK Telecom and KT

W35,000

SK Telecom - “Plan Between Ts “ Out of Data Rate discount network 80 min. 550MB W7,200

Out of network 130 min.

750MB

W7,000

W45,000 W55,000

130 min. 180 min.

1.1GB 2GB

W11,250 W14,250

185 min. 250 min.

1.5GB 2.5GB

W11,000 W14,000

W65,000 W75,000

280 min. 380 min.

5GB 8GB

W16,750 W18,750

350 min. 450 min.

6GB 10GB

W16,000 W18,000

W85,000 W100,000

500 min. 800 min.

12GB 16GB

W20,000 W24,000

650 min. 1,050 min.

14GB 20GB

W20,000 W24,000

1,250 min.

25GB

W30,000

Rate

W125,000

KT - “Everybody Ole” Data

Rate discount


Table 11. Follow-up unlimited voice plans of Korea’s top-three telcos SK Telecom

Monthly charge

Voice

Nationwide Unlimited 75

W75,000

Wireless unlimited

Nationwide Unlimited 85

W85,000

Nationwide 100

W100,000

KT

Monthly charge

Full Unlimited 67

W67,000

Full Unlimited 77 Full Unlimited 97

W77,000 W97,000

Full Unlimited 129

W129,000

LG Uplus

Monthly charge

Unlimited Freedom 69

W69,000


W79,000


W89,000


W99,000

Unlimited Freedom124

W124,000

Note: Excluding VAT

Wired and wireless unlimited

Voice

Text

Data

Unlimited

12GB

8GB 16GB Text

Data 5GB


Unlimited

9GB 17GB Unlimited

Voice

Text

5GB

Wireless unlimited

8GB Unlimited


Data

12GB 16GB Unlimited


Introducing heftier penalties for early termination of contracts With population growth slowing, mobile phone penetration has reached 100%, new subscriber growth has fallen, and marketing to attract new customers (including customer poaching) has become increasingly less effective. As such, telcos are focusing now on improving customer retention. Indeed, in 2H12, Korean telcos introduced new early termination penalty schemes aimed at discouraging customers from switching carriers. Early termination penalties used to be applied to phone subsidies only. Under this system, a customer who received phone subsidies when he/she signed a fixed-term contract would be obliged to pay penalties related to these subsidies if the contract were terminated early. Now, under the new schemes, customers are also penalized for any rate discounts that they received. In the US and Europe, penalties are still applied in relation to phone subsidies only. Meanwhile, in Japan, as in Korea, penalties are charged for both phone subsidies and discounted rates. However, the penalty schemes in Korea and Japan are different in that, under Japan’s call plan structure (where customers can choose between handset subsidies and service rate discounts), only one type of penalty is applied. Early termination penalties scale downward as the contract term approaches expiry (no penalties after the fixed term). This penalty structure is intended to discourage early termination and at the same time prevent the imposition of excessive penalties. Table 12. New early termination schemes Telco

Effective date

SK Telecom

November 1, 2012

KT

January 7, 2013

LG Uplus

March 14, 2013

Source: Company data, media reports, KDB Daewoo Securities Research KDB Daewoo Securities Research

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Figure 97. New early termination penalty structure Handset subsidies Discounts

(W) 400,000

Early termination penalties Penalty rate

300,000

200,000

100,000

0 1month

4month

7month

10month

13month

16month

19month

22month


Figure 98. Decline in mobile phone termination rates (%) 4.5

SK Telecom KT

4.0

LG Uplus

3.5

3.0

2.5

2.0 1Q10

2Q10

3Q10

4Q10

1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13



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Separation between phone subsidies and service rates 1) Introduction of separate pricing system In May, the Korea Information Society Development Institute (KISDI) put forth a proposal to separate phone subsidies from service rates, as part of industry-wide efforts to improve the distribution structure of mobile handsets. The new pricing scheme would allow customers to choose between either phone subsidies or rate discounts at the time the contract is signed. The desired effects for telcos are: 1) reduced reliance on handset subsidies and enhanced competitiveness in other areas including call plans, and 2) an easing of regulatory risks related to subsidies. Japan has separated phone subsidies from service rates since 2007 (NTT Docomo and au by KDDI). Gemany’s T-Mobile, Australia’s Telstra and France’s Orange also use separate pricing systems; their discounted-rate call plans are roughly W12,000 cheaper per month than call plans for subsidized phones. Since November 2007, Japan’s NTT Docomo, one of the world’s largest mobile carriers, has allowed customers to choose between Basic Course (phone subsidy) and Value Course (rate discounts) plans. Since then, over 90% of new subscribers have chosen Value Course, leading to improvements in the company’s financials and average service years of subscribers. On the downside, however, ARPU and handset revenue have visibly declined. Marketing spend decreased as subsidy payments fell, but voice call revenue has fallen faster. In addition, customers subscribing to discount-rate call plans have more leeway in choosing cell phones, as they do not need to buy phones from telcos. KT introduced the separate pricing system back in 2009, but it failed to attract customers. Given the examples in other countries, we believe that more aggressive rate cuts (relative to phone subsidies) will be needed for the system to successfully take root. However, it is doubtful whether telcos will be willing to adopt separate pricing, given it may lead to declines in ARPU and handset sales.


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Table 13. LTE fee structure of Japan’s NTT Docomo Basic fee

(JPY) Basic

Value

1,560

1,560

Two-year contract ISP

-780 315

-780 315

Fixed data charge Monthly discount

5,985 -

5,985 -3,000

Monthly charge

7,080

4,080

Handset price

52,800

52,800

Handset discount

15,000

-

Monthly installment

1,575

2,200

Monthly contribution

8,655

6,280

Note: JPY9,975 penalty for early termination (before expiry of two-year contract) Source: NTT Docomo, KISDI, KDB Daewoo Securities Research

Figure 99. NTT Docomo’s subscription duration and OP margin rose after the introduction of the separate pricing system Average subscription duration (R)

(%) 22

(months)

OP margin (L)

Introduction of separate-type plan

40

19

30

16

20

13

10

10

0 2005

2006

2007

2008

2009

2010

2011

2012


Figure 100. NTT Docomo’s ARPU and handset revenue declined after the introduction of the separate pricing system (Yen)

Handset revenue (R) ARPU (L)

Introduction of separate-type plan

8,000

(Wbn) 650

6,500 500 5,000 350 3,500

2,000

200 2005

2006

2007

2008

2009

2010

2011

2012



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2) Elimination of subsidies US telcos (except T-Mobile) do not offer service rate discounts or installment buying. Customers buy phones at full price or under revolving payment conditions. However, as mobile data has become a major source of profit, US telcos are considering introducing installment buying schemes and eliminating phone subsidies. Early this year, T-Mobile completely overhauled its call plans, eliminating phone subsidies and offering rate discounts under its Value Plan. By removing phone subsidies, the company was aiming to attract customers with differentiated marketing and prop up profits. Roughly 30 European carriers (including Vodafone and O2) have also eliminated subsidies or are considering doing so. Nevertheless, we expect many telcos to continue to provide subsidies, because: 1) customers are highly resistant to the idea of no-subsidy phones due to the devices’ short product life cycles and high prices, and 2) telcos that completely give up subsidies will be put at a disadvantage if only a few players join the trend. Indeed, Spain’s Telefonica lost 830,000 subscribers in April-August after it stopped providing subsidies. Vodafone reintroduced subsidized phones in July after its subscriber number fell by a whopping 639,000 in 2Q alone. Subsidies have proven to be the most effective method of attracting customers, and, thus, giving up the practice completely will not be easy for telcos. Figure 101. T-Mobile introduces Value Plan without subsidies

Source: Company data, TmoNews

Figure 102. Vodafone’s subsidy-free plan

Source: Company


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3. Government regulations Policy goals of new government The new Korean government is taking a two-pronged approach to promoting and regulating the ICT industry, with the MSIP promoting growth, and the KCC focusing on the regulatory side. The MSIP aims to creating jobs in ICT and science. Its action plans include stimulating growth in cloud computing, Big Data, IoT, etc., increasing investments in wired and wireless networks, and cutting telecoms costs for households. The KCC’s goal is creating a fair and creative telecom environment. The commission is planning to apply tighter rules to control subsidy payment practices. Table 14. MSIP’s telecom road map Targets

Action plans

Related stocks

Build an ecosystem for a creative economy Support for new technologies - Create new industries and new demand - Nurture new internet-based industries: Cloud computing, Big Data, IoT

- Undertake ten projects by 2017 - Enact a new law to promote development of KT, SK Telecom cloud computing

- Facilitate informatization of the nation Upgrade wired/wireless networks Establish the world’s best network to support the content-platform-networkdevice (C-P-N-D) ecosystem - Strengthen network infrastructure: Gigabit Internet (wired network) and free - Extend coverage of gigabit internet to 90% WiFi zones of the country by 2017 - Develop faster wireless Internet (40 times - Improve wireless internet speeds faster than LTE) - Allocate the 140MHz bandwidth to LTE - Auction the 1.8/2.6GHz bandwidth - Secure 1GHz or wider bandwidth

KT, SK Broadband, CJ HelloVision SK Telecom, KT, LG Uplus SKT, KT, LG Uplus

- Establish Mobile Gwanggaeto Plan 2.0

Serve the interest of the populace Ease telecom cost burdens for households - Promote competition in call rates/services

SK Telecom, KT, LG Uplus - Phase out mobile phone subscription fees - Offer customized call plans

- Encourage the use of MVNOs - Ban unequal subsidy practices

- Allow mobile VoIP for all smartphone call plans - Allow the entries of new service provider and cut wholesale rates for network access - Improve transparency in handset distribution

Source: MSIP, KDB Daewoo Securities Research

Table 15. KCC’s telecom road map Targets

Action plans

Related stocks

Improve the operational environment of broadcasting Tighten regulations - Review overall subscription/usage/termination conditions of broadcast communication services - Identify and remedy practices that undermine the interests of users

- Enact a law to protect broadcasting communication service users

Regulate subsidy-based competition

SK Telecom, KT, LG Uplus

- Work to secure trust in subsidy probes

- Step up probes into subsidies

- Identify companies that abuse their market power and enact measures to impose punitive sanctions

- Impose stricter sanctions if subsidy-based competition intensifies

Promote fair competition - Improve transactions between pay-TV platform providers and program providers - Review/improve the profit sharing structures of wired/wireless companies and content providers - Identify/remedy unfair transactions between wireless companies and MVNOs

CJ HelloVision



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Failures of the government We believe that a series of government regulations on the telecom industry have contributed to steady declines in service rates. Indeed, the proportion of telecom costs in household spending has been falling steadily after peaking in 2001. Such regulations have not always been successful, however, especially in the short term. For instance, starting in 1Q13, the government suspended telcos from signing new customers due to excessive subsidies in 3Q12. However, marketing competition intensified during the suspension period, as evidenced by an increased number of carrier switches. As a result, the government decided to impose fines after the telcos resumed operations. Although regulatory measures may fail to achieve the desired effects, we believe that the market will learn from experience, and the frequency of failure will decrease over time. Table 16. Recent government sanctions and market conditions Telco

Penalties (Dec)

Suspension period

Penalties (Mar)

SK Telecom

68.9 1/31-2/21, 22 days

31.4

KT

28.5 2/22-3/13, 20 days

16.1

LG Uplus Total

21.5 1/07-1/30, 24 days

5.6

118.9 1/07-3/13, 66 days

53.1

(Wbn)

Number of carrier switches in 4Q12

Number of carrier switches in 1Q13

2,735,225

2,905,823

Notes: Carrier switches before suspension - 4Q12; carrier switches during suspension - 1Q13 Source: KCC, media reports, KDB Daewoo Securities Research

Table 17. Regulations on subsidies

Date

Detail

2000

A ban on subsidies was included in the terms of use.

Dec. 2002

The Telecommunications Business Act was revised, banning subsidy payments by law

Mar. 2003

The revised Telecommunications Business Act took effect, but an expiry date (2006) was added to the subsidy provision (a sunset clause).

2006

The expiration date of the sunset clause was extended to 2008; Users with 18-month-or-longer subscriptions (at a single carrier) were allowed to receive subsidies (one time only); Imposed a total of W73.2bn in penalties on three telcos (June).

2008

The sunset clause expired; The KCC released a guideline on subsidies (banning subsidies in excess of W270,000) .

2012

The KCC launched an investigation in September as subsidy-based competition intensified (triggered by the launch of Samsung’s Galaxy S3); The KCC imposed a total of W11.89bn in penalties on three telcos, and banned the signing of new contracts (suspension of operations).

2013

Three telcos were banned from signing new customers for 66 days (between January and March) , In March, the KCC imposed a fine of W5.3bn on three telcos after the suspension period was over. In May, MSIP held a discussion with the KISDI on measures to improve the handset distribution structure. The KCC launched a probe into telcos’ subsidy practices in May. In July, the KCC plans to impose a fine on or suspend the operations of a telco that stoked subsidy competition.

Source: KCC, media reports, KDB Daewoo Securities Research


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Micro-level objective: Reduction in households’ telecom bills 1) Gov’t aims to reduce burdens on households The government has made continuous efforts to reduce households’ telecom cost burdens. Recently, the government’s policy direction is shifting from pressing telcos to cut telecom rates toward expanding the choices of customers. While previous administrations put direct pressure on telcos to cut base rates and to change billing units, the current government is introducing indirect measures, including the phase-out of up-front subscription fees, the expansion of MVNOs, the introduction of the blacklist system, and approving mVoIP. In Korea, the percentage of telecom costs in the final consumption expenditure of households has been on the decline since peaking at 5.6% in 2001. Currently, the proportion of telecom costs is similar to the proportions of spending on medical/healthcare (6.7%), education (6.2%), and restaurants/hotels (7.9%). Households’ telecom spending includes fixed-line and mobile phone fees as well as broadband internet fees. As only a limited number of players operate in the domestic telecom space, the government’s regulations are expected to deliver meaningful results, in our view. Table 18. Major government efforts to reduce households’ telecom expenditure Year

Measure

2004

Cut base rates by W1,000

2010

Introduction of the per-second billing system

2011

Cut base rates by W1,000; 50 free SMS per month

2012

Introduction of MVNOs; full-scale implementation of the blacklist policy; discussion on mVoIP

2013~2015

To cut subscription fees by 40% in August 2013 in an effort to phase out up-front subscription fees

Source: KCC, MSIP, media reports, KDB Daewoo Securities Research

Figure 103. Domestic gross consumption and proportion of telecom costs (Wtr) 750

(%) 6

Gross domestic consumption expenditure (L) % of telecom spending (R)

600

5

450

4

300

2

150

1

0

0 70

75

80

85

90

95

00

05

10

Note: Nominal base Source: Statistics Korea, KDB Daewoo Securities Research


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2) Case study: Mexico Mexico has historically recorded the highest proportion of telecom spending in household consumption expenditure among OECD member countries, as its telecom market has been monopolized for several decades. America Movil dominates the Mexican telecom market (75% of the fixed-line; 70% of mobile). The telco’s stranglehold on the industry has led to rises in prices and deteriorating service quality. OECD estimates that the monopolistic structure of the Mexican telecom market has stripped about 2%p off the country’s annual GDP growth. In an effort to end the monopoly and promote free competition in the telecom services market, Mexican lawmakers passed the Telecom Reform Bill in March 2013. America Movil’s share price had been stagnant but steady since 2009, trading at a P/E of around 15x. However, regulatory issues have weighed down the company’s share performance in 2013, dragging down its P/E to around 10x. Mexico’s case well demonstrates that telcos, as providers of essential consumer services, cannot stay immune from the government regulations. In Korea, the possibility of new regulations is gaining traction amid the economic slowdown and increases in household telecom costs due to the introduction of LTE. Figure 104. Mexico’s telecom spending in total household expenditure (%) 5

Mexico OECD average

4

3

2

1

0 95

96

97

98

99

00

01

02

03

04

05

06

07

08

09

Source: OECD, KDB Daewoo Securities Research

Figure 105. Share performance of America Movil ADR (US$) 29

America Movil share price (L)

(x)

America Movil P/E (R)

Politicians discussed telecom market reform in Feb. 26

14

Telecom market refom bill was passed by the lower house on March 21st

Passed by the upper house on April 30th

13

12 23 11 20 10

17

9 1/13

2/13

3/13

4/13

5/13

6/13



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Macro-level regulations: Telecom frequency policies 1) Short-term event: Frequency auction and redistribution In April, the MSIP revealed a plan to push for the enactment of a pay-TV digital conversion act in order to accelerate the transition to digital broadcasting. In addition, the MSIP announced a plan to allocate the 1.8GHz and 2.6GHz frequencies (140MHz bandwidth) to LTE services with the aim of accommodating increasing mobile traffic. If everything goes smoothly, the MSIP is scheduled to allocate frequency resources to telcos in 3Q. The ministry is currently considering four options in relation to frequency allocation. Korean telcos are currently developing LTE-Advanced technology to deal with rising mobile traffic. However, we believe that additional frequency allocation is necessary to tackle an increase in traffic in the medium term, given that: 1) 2G and 3G subscribers are steadily switching to LTE services, and 2) existing LTE subscribers are increasing their data usage. Table 19. Government’s frequency allocation plan Details

Conditions for allocation

Auctions for blocks A, B, and C (excluding block D) Limit the bidding of KT and SK Telecom for block C 1) If LG Uplus wins block C, existing 2G spectrum will be withdrawn after the end No.1 Minimum bid prices: W498bn for 2.6GHz (40MHz); W700.8bn for of 2G service. 1.8GHz (35MHz) 2) Allow 2.4GHz low-power wireless devices to use the 2.6GHz spectrum.  SK Telecom and LG Uplus favor the most; KT opposes 1) If SK Telecom and KT win bands in block C, they should return existing 1.8GHz Auctions for blocks A, B, and C (excluding block D) holdings within six months. No limitations on participation 2) If SK Telecom or KT secures a band in the1.8GHz spectrum, conditions will be No.2 Minimum bid prices: W498bn for 2.6GHz (40MHz); W700.8bn for attached for service launch. 1.8GHz (35MHz) 3) If LG Uplus wins a band in block, existing 2G spectrum will be withdrawn after  Second-best choices for SK Telecom and LG Uplus; KT opposes the end of 2G service. 4) Allow 2.4GHz low-power wireless devices to use the 2.6GHz spectrum.

Auctions for blocks A,B,C, an d D Minimum bid prices: W478.8bn for 2.6GHz (40MHz); W673.8bn No.3 for 1.8GHz (5MHz); W288.8bn for 1.8GHz (15MHz)  Favors KT

1) If SK Telecom and KT wins blocks, they should return existing 1.8GHz holdings within six months. 2) If SK Telecom or KT secures a band (block C) in 1.8GHz, conditions will be attached for service launch. 3) If LG Uplus wins a band in block C, existing 2G spectrum will be withdrawn after the end of 2G service. 4) If KT wins a bid for a band in block D, conditions will be attached to the company’s service launch. 5) Allow 2.4GHz low-power wireless devices to use the 2.6GHz spectrum (if existing radio stations are protected).

Present plans 1 and 3 Decide band plans and winners for each block through bidding Minimum bid prices: W478.8bn for 2.6GHz (40MHz); W673.8bn No.4 for 1.8GHz (35MHz), W288.8bn for 1.8GHz (15MHz)  SK Telecom and LG Uplus are opposed; KT is concerned about bid prices

1) Limit the participation of SK Telecom and KT in the bid for the block C1 2) If SK Telecom and KT win a bid for the block C2, they should return the existing 1.8GHz within six months 3) If SK Telecom or KT secures a broadband (block C) in the 1.8GHz, conditions will be attached for the company’s service launch. 4) If LG Uplus wins block C1 or C2, existing 2G spectrum will be withdrawn after the end of 2G service. 5) If KT wins a band in block D2, conditions will be attached to the company’s service launch. 6) Allow 2.4GHz low-power wireless devices to use the 2.6GHz spectrum (if existing radio stations are protected). 1) LG Uplus is allowed to win two blocks (maximum). 2) SK Telecom and KT are allowed to win just one block each; If SK Telecom or KT wins the Cb block, the company can request an exchange of its existing 1.8GHz band with the Ca block.

Auctions for three1.8GHz blocks (sealed bid combinatorial auctions) Minimum bid prices: W478.8bn for 2.6GHz (40MHz); W385bn for No.5 1.8GHz (35MHz); W288.8bn for 1.8GHz (15MHz)  Second-best choice for KT; SK Telecom is opposed; LG Uplus claims this options grants unfair preference to KT

3) Rebidding will take place if no 1.8GHz bands are secured. 4) If SK Telecom or KT secures a band (blocks Ca and Cb) in the 1.8GHz spectrum, conditions will be attached for service launch. 5) If LG Uplus wins a 1.8GHz band (Ca+Cb or Cb+D), existing 2G spectrum to be withdrawn after the end of 2G service. 6) If KT wins a band in block D, conditions will be attached to the company’s service launch. 7) Allow 2.4GHz low-power wireless devices to use the 2.6GHz spectrum (if existing radio stations are protected)

Note: MSIP announced No.4 plan as a final plan on June 28. Source: Korea Communications Commission, MSIP, media reports, KDB Daewoo Securities Research


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2) Government’s long-term plan to secure radio frequency bands In 2012, the KCC announced its Mobile Broadband Plan, which is aimed at securing combined bandwidth of up to 650MHz by 2020. Then, the KCC handed over this project to the MSIP, which is planning to implement Mobile Broadband Plan 2.0, which targets the procurement of combined bandwidth of 1GHz. Furthermore, the government is also considering a plan to secure additional frequency bands for unlicensed communication (to be used by individuals and small companies), as usage of unlicensed communication devices is on the rise. In this new age of constant connectivity, it will be important to take note of which industries and companies are likely to benefit from frequency band additions.


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3) Dealing with the radio frequency band drought Countries around the world are currently transitioning to digital broadcasting. This is because radio frequencies necessary for wireless broadband services are in short supply. As mentioned earlier in this report, Korea is among those nations switching to digital. Last year, terrestrial broadcasters turned off their analog broadcasting. Currently, fee-based platforms are following suit. As of end-2012, 46% of fee-based platform subscribers (approximately 25mn) had converted to digital broadcasting. And 35% of cable SOs have gone digital. Meanwhile, the number of Korean LTE mobile service subscribers now exceeds 20mn, 37% of overall mobile service subscribers and 58% of overall smartphone users. In particular, mobile traffic has substantially increased since the introduction of LTE services. Figure 106. Digital conversion is a global trend: Aimed at solving the frequency shortage issue

Source: Wikipedia

Figure 107. Frequency shortages caused by increasing mobile data usage

Source: FCC, ETRI


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4) Case study: Frequency policy in the US Despite recent improvements, the US government is struggling with a slow economy and unemployment. A decade ago, the country launched a Federal Communications Commission (FCC)-led project aimed at creating jobs through ICT policies. We think that these efforts are bearing fruit, given the rise of Silicon Valley companies (e.g., Google and Facebook), as well as the mobile revolution. The FCC has taken several measures to expand wireless networks and acquire sufficient radio frequencies. These measures have been aimed at creating jobs, supporting ailing industries, and nurturing the infrastructure, education, health, and clean energy segments. Of note, the mobile revolution caused a frequency shortage. The US government attributed this issue to political reasons, rather than to a shortage of resources. Thus, it took actions to support the new ICT industry, which drove economic growth. Furthermore, the US government allowed TV broadcasters to use white spaces. This innovative policy allowed new start-ups to access frequencies, which led to the growth of the ICT industry and job creation. Figure 108. US government is trying to stimulate an IT revolution and create jobs by boosting the ICT industries Government Analog TV shutdown Digital TV

Permit telcos to use white spaces for TV Frequency sharing policies

Industry Creation of new industies and new jobs Emergence of new economic drivers

Establishing new IT platform

Collapse of previous industrial structure

Source: Gatech.edu, KDB Daewoo Securities Research

Figure 109. Frequency war in US between Silicon Valley’s Wireless Innovation Alliance and the National Association of Broadcasters

Source: Gatech.edu


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Investment strategy 1. Initiate coverage with an Overweight rating We initiate our coverage on the telecom sector with an Overweight recommendation. We have been witnessing some positive changes in the fundamentals of Korean telcos. On top of attractive dividends, we believe earnings growth is also gaining momentum, making telcos increasingly appealing investment options. Domestic telcos have been seeing improving earnings as well as valuation re-ratings on the back of LTE subscriber growth and rising ARPU. Moreover, new and non-telecom businesses are expected to make increasing earnings contributions going forward. Externally, several favorable developments are also fueling investor interest in the telecom sector. The macroeconomic outlook is currently clouded by uncertainties, and the low-growth, lowinterest-rate environment is likely to continue. Against this backdrop, the subscriber-based earnings stability of telcos, coupled with the continued growth of dividend payouts, has sparked a reevaluation of the sector. We select LG Uplus,SK Telecom, and KT as our top picks for the sector. We expect LG Uplus to show structural earnings growth on the back of a rise in ARPU and a decline in marketing spend. And the company’s fundamentals are quickly improving thanks to its improved market standing. Meanwhile, SK Telecom continues to maintain its leadership in terms of subscriber base. And SK Telecom’s efforts to enhance the fundamentals of its telecom operations and its subsidiaries seem noteworthy. We believe these efforts should boost earnings improvement at the parent company and subsidiaries. And investors should take note of the company’s stellar dividend payouts. Table 20. Ratings of major telecom stocks

(W, %, x) 12-month target price 15,000

Company

Ticker

Rating

LG Uplus

032640 KS

SK Telecom

017670 KS

Buy Buy

KT

030200 KS

Buy

SK Broadband

033630 KQ

Trading Buy

29.3

15.4

1.5

4.4

EPS growth TTB

8.4

Dividend yield 2.2

270,000

28.0

10.0

1.7

5.0

47.8

14.0

4.5

50,000

31.1

8.1

0.9

3.9

15.8

9.7

5.2

6,000

21.3

19.5

1.5

4.0

233.6

6.6

0.0

Upside

P/E

P/B

EV/EBITDA

ROE

Note: Valuation indicators based on 2013 estimates Source: KDB Daewoo Securities Research

Figure 110. Investment points for the telecom service sector

Economic uncertainty External factors (industry environment) Defensive investment strategies Telecom S ervice < O verweight > Attractive dividends Internal factors (company fundamentals) Earnings improvement



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2. Telcos’ high dividend yields gaining traction High dividend yields appear attractive in a low-interest-rate era The real economy has been picking up slowly since the 2008 global crisis. In light of low bond yields in Korea and abroad, as well as a fragile economy, investors are increasingly turning to safe assets. This persistently low-interest rate situation has prompted investors to turn to dividend stocks. Previously, investors had seen dividend stocks as: 1) defensive plays, 2) solid investments during marked corrections, and 3) good year-end investments. However, currently, telcos’ dividend yields are higher than interest rates on deposits at savings banks. As such, an increasing number of investors are looking at dividend stocks as long-term and stable investments. Figure 111. Major domestic telcos’ dividend yields, vs. major domestic savings banks’ interest rates (%) 6 5.2 5 4.5 4

3.6 3.2

3.1

3

2 Savings banks' average interest rate

Savings banks' highest rate (Charm, Chohung)

Interest rate of no. 1 savings bank (Hyundai Swiss)

KT's dividend yield

SK Telecom's dividend yield

Note: Based on June 10, 2013 data, Source: Korea Federation of Savings Banks, company data, KDB Daewoo Securities Research


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Indeed, since the global crisis, dividends yields have been steadily higher than government bond yields. Of note, the average dividend yields of US and Japan have outstripped 10-year government bond yields since 2008. As for Korea, after comparing the dividend yield of SK Telecom with the 3-year KTB yield, we found that the dividend yield has surpassed the 3-year yield due to the low interest rate trend. Figure 112. S&P 500 dividend yield > 10-year UST yield (%) 10

S&P 500 dividend yield 10-year UST yield

8

6

4

2

0 1Q80

1Q84

1Q88

1Q92

1Q96

1Q00

1Q04

1Q08

1Q12


Figure 113. Japanese dividend yield > 10-year Japanese bond yield (%) 4 10-y ear bond yield

Dividend yield

3

2

1

0 00

02

04

06

08

10

12


Figure 114. SK Telecom’s dividend yield > 3-year KTB yield SK Telecom dividend yield

(%) 10

3-year KTB yield

8

5

3

0 1Q00

1Q02

1Q04

1Q06

1Q08

1Q10

1Q12



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Stability amid growing economic uncertainty Korea’s potential GDP growth rate has been on the downswing. The average annual growth rate has fallen from 9.4% in the 1970s, to 9.1% in the 1980s, and to 7.4% in 1990 through the Asian financial crisis. The figure plunged to 4.7% during 1998-2007 and 3.8% during 2008-2012. In this era of economic sluggishness, companies’ shareholder return policies should determine their long-term share prices. These policies include share buybacks and dividend payouts. In Korea, share buyback programs are difficult to predict, as companies tend to carry out share buybacks only intermittently. By contrast, dividend payouts are relatively predictable, as: 1) financial resources for dividends stem from balance sheet stability, and 2) corporate dividend policies tend to be consistent. In the US, shares have stagnated amid the economic slowdown. If shares remain range-bound, investors should pay more attention to shares yielding high dividends. Figure 115. US telcos have outperformed the market for the last three years (-3Y=100) 225

AT&T

Verizon

Figure 116. Dividend yields of US telcos were higher than the market average (%) 8

S&P 500

AT&T dividend yield S&P 500 - dividend yield

Verizon dividend yield

200 6 175 150

4

125 2 100 75

0 5/10

1/11

9/11

5/12



1/13

5/10

1/11

9/11

5/12

1/13


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It should be noted that the number of long-term investors (e.g., NPS) is growing, which should increase demand for dividend plays. For long-term investors, dividend yields are an important determinant of their portfolio yields. Indeed, in the US, dividend yields have been a key determinant of the performances of long-term investments. Comparing the S&P 500 with the S&P 500 Total Return (which reflects cash distributions), we conclude that, since 2000, dividends have been a determinant of investment results when share prices have remained persistently range-bound. Korean investors are also paying more attention to dividend shares, as they have become increasingly bullish (as shown in the Korea Dividend Stock Price Index (KODI)). Figure 117. Dividend yields became an important factor as US equities remained range-bound in the 2000s (88.1 = 100) S&P500 Total Return Index

1,200

1,083

S&P500 1,000 800

614

600 400 200 0 88

91

94

97

00

03

06

09

12


Figure 118. Relative strength of KODI rebounded compared to lows set in 2002 and 2007 (1/02=100)

(%p) Relative performance of KODI vs. KOSPI (L)

130

2

Dividend yield of Korea's stock market - 3-year KTB yield (R) 120

0

110

-2

100

-4

90

-6 01

02

03

04

05

06

07

08

09

10

11

12

13

Source: WiseFn, KDB Daewoo Securities Research


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Focus on the rapid growth of income funds Lately, the growth of income funds has been outstanding. Income funds focus on dividend stocks and high-yielding overseas bonds. They pursue medium-risk, medium-gain investments by emphasizing regular gains (e.g., interest income and dividend gains) over capital appreciation. Income funds have grown remarkably since 2012, as more investors are now seeking stable profits, affected by heightened economic risks (caused by US and European fiscal issues), low global bond yields, and population aging. As baby boomers (born between 1955 and 1963) are retiring, and population aging is accelerating, income funds are likely to grow further. In 2011, Koreans in their 50s accounted for 14.9% of the overall population, vs. 13.6% for those in their 20s. If retirees incur losses on financial investments, their post-retirement lives could be financially troubled. As such, they tend to become increasingly risk-averse over time. However, the low interest rate situation should prompt baby boomers to lean toward income funds to achieve stable profits and capital gains, rather than only relying on safe assets such as bank deposits. We estimate that dividend stocks represent a significant portion of income funds’ holdings. Figure 119. Percentage of people in their 20s and 50s in Korea’s overall population (%) 25

People in their 20s

People in their 50s

20

15

10

5

0 80

84

88

92

96

00

04

08

12

Source: CEIC, KDB Daewoo Securities Research

Figure 120. Net assets and number of income funds (Wtr)

(unit)

3

Net as s et (L)

80

Number of funds (R)

67 55

60

2 37

1

23

25

40 2.6

24

2.1 20

1.3 0.6

0.7

0.6

2009

2010

2011

0

0 2012

M ar. 2013

Apr. 2013

Source: Korea Financial Investment Association, KDB Daewoo Securities Research


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Valuation 1. Case studies Telecom stocks undergoing valuation re-ratings Currently, telecom stocks are experiencing valuation re-ratings on the back of improvements in earnings indicators, including ARPU. In particular, companies displaying earnings growth while maintaining attractive dividend payout ratios are attracting investors’ attention. Among listed telcos worldwide, we compared the valuations of LTE service providers. Globally, the number of LTE subscribers is estimated at 100mn with 90% of them being in the US, Canada, Japan, Korea, and Australia. Verizon has the largest number of LTE subscribers in the world, followed by AT&T and NTT Docomo. In Korea, SK Telecom, KT, and LG Uplus are seeing rapid increases in LTE subscribers. In light of ongoing subscriber and business strategy trends, taking a closer look at the earnings and valuations of leading global LTE service providers (i.e., Verizon, AT&T, and NTT Docomo) should offer us meaningful takeaways regarding Korean telcos. Figure 121. Global LTE penetration

Source: GSA

Table 21. Earnings and valuation metrics of leading LTE providers Company

13F

14F

12

13F

14F

12

13F 14F

12

SK Telecom

17,037 10.8 12.4 14.6 10.7 10.0

8.0

1.3

1.7

1.5

4.5

5.0

4.4

9.8 14.0 16.3

4.5

6.9

0.9

0.9

0.9

4.4

3.9

3.5

8.8

9.7 10.8

5.2

- 15.4 11.9

1.2

1.5

1.4

5.2

4.4

3.9

-1.6

8.4 10.1

2.2

OP margin 12

Korea

(Wbn, %, x)

Market Cap.

P/E

13F 14F

KT

9,961

5.1

6.0

6.9

LG Uplus

5,065

1.2

5.2

5.6

12 8.8

8.1

P/B

EV/EBITDA

ROE 13F

Dividend yield 14F 13F

US

AT&T

215,505 10.2 18.2 19.1 15.0 14.2 13.1

2.2

2.2

2.1

8.7

6.3

6.0

7.7 15.6 16.7

5.1

US

Verizon

162,415 11.4 20.8 22.2 16.8 18.0 15.6

4.3

3.9

3.6

7.9

5.9

5.5

3.3 18.8 22.8

4.1

Japan

NTT Docomo

75,053 18.7 18.1 18.4 12.5 12.2 11.8

1.1

1.1

1.0

3.7

4.0

4.0

9.4

4.0

9.1

8.8



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Cases of telecom stocks exceeding market valuations Currently, telcos are trading at a premium to the market. We believe that, in the US and Taiwan as well as in Korea, telecom shares are significantly overvalued relative to their respective markets. In Japan, however, telecom shares are underperforming the market due to yen depreciation. There are two cases in which telcos’ P/E levels can exceed the market P/E: 1) periods during which earnings growth boosts telcos’ P/Es and 2) when telcos’ attractiveness as defensive and dividend plays gains attention amid market corrections. Currently, the first reason is driving up valuation.s However, the second reason is also appealing to investors amid slowing economic growth. Companies’ 12-month forward P/Es are usually higher in the first case than in the second case. We took a look at the valuation trends of major global telecom stocks based on companies’ 12month forward P/Es since 2000 and found the following: 1) In the US, telecom stocks saw their P/Es surpass the market P/E in 2004 and 2006, and have been outperforming the market since 2010. Japan’s NTT Docomo outperformed the market in 2003 and 2005, and Softbank in 2009. Taiwan’s Chunghwa Telecom experienced such valuation growth in 2005 and 2011. Major telecom companies in Korea are all outperforming the market now. In the past, SK Telecom’s P/E grew higher than the market P/E in 2002 and 2007. KT experienced the same phenomenon in 2002 and 2010, while LG Uplus did so in 2005. 2) Most of the global major telecom stocks saw their defensive nature and solid dividends boost valuations in 2008 (US companies in 2003). Figure 122. Verizon: Rise in P/E on earnings growth (x)

Verizon - 12MF P/E (L)

28

Verizon - 12MF EPS (R)

Figure 123. Verizon: Rise in P/E on attractive dividends

MSCI US - 12MF P/E (L) (US$) 3.6

(x) 24

(%)

Verizon - 12MF P/E (L) Verizon - Dividend yield ratio (R)

8

Received attention due to emergence of defensive stock theme 3.2

20

7

18

2.8

16

5

13

2.4

12

4

2.0

8

23

12MF P/E range: 14-18x P/E increase with earning growth

8 2Q98

2Q01

2Q04

2Q07

2Q10

2 2Q98

2Q13

2Q01

2Q04

2Q07

2Q10



Figure 124. AT&T: Rise in P/E on earnings growth

Figure 125. AT&T: Rise in P/E on attractive dividends

(x)

AT&T - 12MF P/E (L)

25

AT&T - 12MF EPS (R)

MSCI US - 12MF P/E (L) (US$)

(x)

AT&T - 12MF P/E (L)

4.0

25

AT&T - Dividend yield ratio (R)

P/E increase with earnings growth

3.4

20

2Q13

(%) 8

20

6

15

4

2.8 15 2.2 2

10

10

1.6 Received attention due to emergence of defensive stock theme

12MF P/E range : 12-15x 5

1.0 2Q98

2Q01

2Q04

2Q07

2Q10



2Q13

5

0 2Q98

2Q01

2Q04

2Q07

2Q10

2Q13


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Figure 126. NTT Docomo: Rise in P/E on earnings growth NTT Docomo - 12MF P/E (L) MSCI Japan - 12MF P/E (L) NTT Docomo - 12MF EPS (R)

Figure 127. NTT Docomo: Rise in P/E on attractive dividends (x)

NTT Docomo - 12MF P/E (L)

16,000

30

NTT Docomo - Dividend yield ratio (R)

24

13,000

23

5

18

10,000

15

3

7,000

8

2

4,000

0

(x) 30

(JPY)

12

(%) 6

12MF P/E range: 17-22x 6 2Q98

2Q01

2Q04

2Q07

2Q10

0 2Q98

2Q13

2Q01

2Q04

2Q07

2Q10

2Q13



Figure 128. Softbank: Rise in P/E on earnings growth

Figure 129. Softbank: Rise in P/E on attractive dividends

(x)

Softbank - 12MF P/E (L) MSCI Japan - 12MF P/E (L) Softbank - 12MF EPS (R)

(JPY)

(x)

Softbank - 12MF P/E (L) Softbank - Dividend yield ratio (R)

(%)

400

40

30

300

30

1.8

20

200

20

1.2

10

100

10

0.6

40

2.4

12MF P/E range: 13-16x 0

0 2Q98

2Q01

2Q04

2Q07

2Q10

0

2Q13

0.0 2Q98

2Q01

2Q04

2Q07

2Q10

2Q13


Note: Low correlation due to the small dividend Source: Thomson Reuters, KDB Daewoo Securities Research

Figure 130. Chunghwa Tel.: Rise in P/E on earnings growth

Figure 131. Chunghwa Tel.: Rise in P/E on attractive dividends

(x)

Chunghwa Telecom - 12MF P/E (L) MSCI Taiwan - 12MF P/E (L) Chunghwa Telecom - 12MF EPS (R)

(NT$)

(x)

(%)

7.2

20

17

6.4

17

12

14

5.6

14

8

4.8

11

4

4.0

8

20

12MF P/E range: 13-18x

11

8 1Q99

1Q02

1Q05

1Q08



1Q11

16

Chunghwa Telecom - 12MF P/E (L) Chunghwa Telecom - Dividend yield ratio (R)

0 1Q99

1Q02

1Q05

1Q08

1Q11


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Figure 132. SK Telecom: Rise in P/E on earnings growth

Figure 133. SK Telecom: Rise in P/E on attractive dividends (W)

(x)

SK Telecom - 12M F P/E (L)

30,000

15

SK Telecom - Dividend yield ratio (R)

12

24,000

12

6

9

18,000

9

4

6

12,000

6

2

6,000

3 1Q99

(x)

SK Telecom - 12MF P/E (L)

15

SK Telecom - 12MF EPS (R)

MSCI Korea - 12MF P/E (L)

(%) 8


3 1Q99

1Q02

1Q05

1Q08

1Q11

0 1Q02

1Q05

1Q08

1Q11



Figure 134. KT: Rise in P/E on earnings growth

Figure 135. KT: Rise in P/E on attractive dividends (W) 6,800

(x) 20

16

5,600

16

6

12

4,400

12

4

8

3,200

8

2

2,000

4

(x) 20

KT - 12MF P/E (L) KT - 12MF EPS (R)


KT - 12MF P/E (L) KT - Dividend yield ratio (R)

(%) 8

12MF P/E range: 11-16x 4 1Q99

1Q02

1Q05

1Q08

1Q11

0 1Q99

1Q02

1Q05

1Q08

1Q11



Figure 136. LG Uplus: Rise in P/E on earnings growth

Figure 137. LG Uplus: Rise in P/E on attractive dividends

(x)

LG Uplus - 12MF P/E (L) MSCI Korea - 12MF P/E (L) LG Uplus - 12MF EPS (R)

(W)

(x)

1,800

16

16

1,200

12

6

12

600

8

4

0

4

2

-600

0

20


8

4 1Q99

1Q02

1Q05

1Q08

1Q11



(%)

LG Uplus - 12MF P/E (L) LG Uplus - Dividend yield ratio (R)

8

0 1Q99

1Q02

1Q05

1Q08

1Q11


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2. Valuation comparison with global peers Korean telcos are displaying strong OP margin growth relative to their peers in Asia. Although their dividend yield ratios are similar to the average global peer level, they are experiencing the fastest LTE subscriber growth. In light of their aggressive investments and marketing efforts, Korean companies are delivering healthy dividend yield ratios, in our view. Table 22. Earnings and valuation metrics of major global telcos Company

13F

14F

12

13F

14F

12

13F 14F

12

14F

Dividend yield 13F

SK Telecom

17,037 10.8 12.4 14.6 10.7 10.0

8.0

1.3

1.7

1.5

4.5

5.0

4.4

9.8 14.0 16.3

4.5

6.9

0.9

0.9

0.9

4.4

3.9

3.5

8.8

9.7 10.8

5.2

- 15.4 11.9

1.2

1.5

1.4

5.2

4.4

3.9

-1.6

8.4 10.1

2.2

75,053 18.7 18.1 18.4 12.5 12.2 11.8

1.1

1.1

1.0

3.7

4.0

4.0

9.4

9.1

8.8

4.0

76,124 22.1 21.7 21.1 21.3 15.6 14.9

4.2

3.3

2.8

6.2

5.9

5.5 23.1 24.3 21.2

-

35,916

5.0

6.0

7.6 24.5 18.2 13.2

0.9

0.9

0.8

4.2

3.8

3.4

3.8

4.9

6.5

1.5

14,058

4.4

4.9

6.6 28.6 20.5 14.9

1.0

1.0

1.0

-

4.4

3.9

3.7

4.3

6.3

1.1

14.8 15.7 16.1

4.6

OP margin 12

Korea

Japan

(Wbn, %, x)

Market cap.

P/E

13F 14F

KT

9,961

5.1

6.0

6.9

LG Uplus

5,065

1.2

5.2

5.6

NTT Docomo

Softbank China Unicom Hong China Kong China United Network Communications Hong Kong PCCW

12 8.8

8.1

P/B

EV/EBITDA

ROE 13F

52,853 16.7 17.4 17.7 16.8 15.2 13.9

2.5

2.3

2.2 12.3 12.9 12.7

Taiwan

Far EasTone Telecom

3,769 13.4 13.9 15.0 15.6 15.1 12.9

2.9

2.9

2.8

6.0

5.9

5.6

19.3 20.8

5.4

Singapore

Singapore Telecom Philippine Long Distance Telephone Maxis

8,972 16.5 17.5 18.2 22.4 19.3 17.4

3.3

3.1

3.0 12.0

8.4

7.8 14.6 16.3 19.7

4.0

17,675 30.6 29.9 31.2 19.9 17.3 16.3

5.1

4.6

4.6

9.0

8.6 25.9 25.4 26.0

3.9

18,329 34.3 33.7 34.1 28.9 23.5 22.1

7.3

8.2

9.2 12.7 12.6 12.2 23.4 32.7 39.6

4.7

Axiata Group

20,749 23.2 23.1 23.7 22.5 20.5 18.6

2.8

2.7

2.7

9.4

8.3

7.8 12.5 13.5 14.4

3.4

AT&T

215,505 10.2 18.2 19.1 15.0 14.2 13.1

2.2

2.2

2.1

8.7

6.3

6.0

7.7 15.6 16.7

5.1

Verizon

162,415 11.4 20.8 22.2 16.8 18.0 15.6

4.3

3.9

3.6

7.9

5.9

5.5

3.3 18.8 22.8

4.1

Sprint Nextel CenturyL Level 3 Communications Frontier Communications BCE

24,690 -5.1 -0.5 4.4 24,383 14.8 16.6 16.3 21.1 12.8 12.8

3.4 1.2

4.2 1.2

6.1 1.2

7.3 5.6

7.0 5.6

5.7 -48.1 -47.3 -63.6 5.7 4.4 6.8 6.2

6.1

- 34.1

4.3

3.8

3.0

9.0

7.9

7.2

4,690 21.3 21.5 21.6 18.2 18.5 18.8

1.0

1.0

1.1

5.0

5.2

5.4

5.1

9.6

39,050 22.5 22.9 23.4 14.4 15.0 14.5

3.3

2.6

2.6

7.2

7.0

6.8 24.6 17.9 17.7

5.1

Telus Rogers

25,079 19.3 19.4 20.3 17.2 16.6 14.9 26,220 23.5 26.6 26.9 12.9 13.0 12.4

2.8 5.9

2.8 5.2

2.7 4.8

7.4 7.7

7.1 6.9

6.8 17.1 17.1 17.9 6.7 45.3 43.7 40.8

3.9 3.8

Telefonica

70,851 17.3 16.4 16.4 11.5

9.2

2.2

2.0

1.9

5.3

5.5

5.5 19.0 21.4 20.4

3.3

Deutsche Telekom France Telecom

57,606 11.6 12.5 12.9 - 12.7 11.9 30,071 13.9 15.6 15.0 24.6 7.1 7.4

1.5 0.8

1.4 0.8

1.3 0.8

4.4 4.4

4.7 4.1

4.6 -16.0 10.7 11.1 4.3 3.2 10.9 10.2

7.8 6.6

TeliaSonera Tele2

32,794 13.8 23.7 24.9 9.5 10.7 10.2 6,286 12.9 18.4 9.8 13.0 17.9 15.0

1.8 1.7

1.7 1.6

1.6 1.6

7.6 6.6

7.2 7.1

7.0 18.3 15.2 15.8 6.6 15.8 38.7 12.4

6.5 8.8

Belgacom Telenor

8,707 16.2 14.7 13.8 8.0 9.0 9.9 37,062 17.3 21.2 22.6 15.1 12.1 10.8

1.9 2.4

1.9 2.4

1.9 2.3

4.8 6.6

4.5 6.5

4.6 21.6 20.3 19.2 6.1 15.6 19.7 21.0

12.6 4.9

Telecom Italia Koninklijke KPN NV

15,774 21.4 20.1 19.8 9,873 14.7 13.8 13.6

Philippine Malaysia US

Canada

Europe

Korea Japan China South East Asia US Europe Total

Avg. Avg. Avg.

5,334

9.6 11.1 13.1

7.9

9.0

6.6

9.5

-5.1 10.2 3.7

6.1

-

5.1 7.7

5.0 8.6

0.6 1.5

0.5 0.9

0.4 0.9

4.0 3.8

4.1 4.9

4.1 -8.7 10.0 9.3 4.9 20.0 15.5 11.1

3.4 -

9.8 11.2

8.9

1.1

1.4

1.3

4.7

4.4

3.9

5.7 10.7 12.4

4.0

20.4 19.9 19.7 16.9 13.9 13.3 4.7 5.5 7.1 26.5 19.3 14.1

2.7 1.0

2.2 0.9

1.9 0.9

5.0 4.2

5.0 4.1

4.7 16.3 16.7 15.0 3.6 3.8 4.6 6.4

4.0 1.3

26.2 26.0 26.7 22.0 19.1 17.7

4.4

4.5

4.7 10.7 10.7 10.3 19.1 21.8 24.0

4.1

Avg. Avg.

10.3 14.6 16.1 17.8 15.9 18.9 15.4 17.4 16.5 12.6 10.2 9.8

2.7 1.6

2.7 1.5

2.8 1.4

7.2 5.3

6.3 5.4

5.9 5.3

4.8 8.4 12.2 9.9 18.0 14.5

6.2 6.8

Avg.

15.1 16.9 17.3 16.8 14.2 13.6

2.5

2.4

2.4

6.7

6.3

6.0 10.2 14.0 13.6

5.0

Avg.

5.7

-

8.5



81

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June 11, 2013

Table 23. Earnings and valuation metrics of major global fixed-line telcos Company

Market cap.

OP margin 12 13F 14F

Korea Japan China Europe

SK Broadband Nippon Telegraph & Telephone China Telecom BT Group

P/E

P/B

ROE

Dividend yield 13F

12 13F 14F

12 13F 14F

12 13F 14F

1.5

1.5

1.4

4.7

4.0

4.0

2.0

6.6

7.3

0.0

78,422 11.2 11.2 11.6 12.0 10.5 10.1

0.7

0.7

0.7

3.3

3.8

3.8

6.5

6.7

6.5

3.1

42,764 7.5 9.0 9.7 15.5 12.7 10.5 42,841 17.0 18.0 19.1 11.6 12.0 11.0

0.9 -

0.8 9.8

0.8 6.9

4.9 5.1

3.1 5.5

2.9 5.3

5.7 -

6.6 -

7.6 -

2.3 3.4

5,285 15.9 16.0 16.8 20.0 19.5 16.3 6,800 14.0 15.6 17.7 29.0 24.1 19.7

4.6 1.5

5.7 1.6

8.2 1.6

6.0 9.3

5.9 8.6

5.8 13.9 28.1 42.2 8.3 5.2 6.5 7.9

12.7 5.7

11.5 12.4 13.3 24.9 16.3 13.9

1.8

3.3

3.2

5.6

5.2

5.0

Avg.

3.3

4.6

12 13F 14F

EV/EBITDA

4.7 61.4 19.5 16.4

1,464

US Windstream Hong Kong HKT Trust Total

(Wbn, %, x)

6.7 10.9 14.3

4.5


Table 24. Earnings and valuation metrics of major global mobile telcos

(Wbn, %, x)

13F

14F

12 13F 14F

12 13F 14F

Dividend yield 12 13F 14F 13F

17,037 10.8 12.4 14.6 10.7 10.0

8.0

1.3

1.7

1.5

4.5

5.0

4.4

9.8 14.0 16.3

4.5

9.9 10.3

1.7

1.6

1.4

4.2

3.4

3.4 18.8 16.6 14.7

4.3

162,307 13.4 21.8 22.5 - 11.6 10.9 46,309 14.0 15.3 16.2 14.2 11.2 9.5

1.3 1.5

1.2 1.4

1.2 1.3

9.5 4.2

9.3 4.4

9.2 0.6 10.2 10.6 4.1 11.2 14.0 14.6

5.9 2.7

Advanced Info Service Taiwan Mobile

29,486 32.2 32.5 36.3 22.4 20.7 17.7 20.9 16.9 15.9 11.3 11.8 10.3 14,361 16.0 18.5 18.0 20.3 18.6 17.3 6.0 7.2 - 16.5 13.6 13.7 29.8 27.9 29.4

4.0 5.0

Malaysia US

DiGI US Cellular

13,386 25.0 32.0 33.8 30.5 22.3 20.6 3,166 4.4 -1.6 -1.8 32.5 -

0.8

0.7

- 12.5 12.2 11.6 0.7 2.8 5.0 5.7

1.4 -0.1 -0.2

3.4 -

Total

Avg.

17.9 19.5 20.2 20.0 14.9 13.5

4.8

4.4

3.7

7.8 11.9 13.8 14.2

4.3

Company

Market cap.

OP margin 12

P/E

13F 14F

Korea

SK Telecom

China

China Mobile

230,417 27.8 24.8 21.9

England Japan

Vodafone KDDI

Thailand Taiwan

12 9.7

P/B

EV/EBITDA

8.2

8.1

ROE


Figure 138. 2013F P/E-EPS growth

Figure 139. 2013F P/B-ROE

P/E (x)

P/B (x) 5

25

Verizon

SK Broadband 4

20

Softbank

Verizon LG Uplus (TTB)

Softbank

15

AT&T NTT Docomo

SK Broadband LG Uplus

SK Telecom

10

AT&T

2

1

SK Telecom

NTT Docomo KT

KT EPS growth (%)

ROE (%) 0

5 -250

0

250

500



750

1000

0

10

20

30

40


82

Telecom Service

June 11, 2013

LG Uplus (032640 KS) Riding the LTE wave

Telecom Service

Initiate coverage with Buy and TP of W15,000

Buy

(Initiate) Target Price (12M, W)

15,000

Share Price (06/10/13, W)

11,600 29%

Expected Return OP (13F, Wbn)

619

Consensus OP (13F, Wbn)

582

EPS Growth (13F, %)

TTB

Market EPS Growth (13F, %)

22.0

P/E (13F, x)

15.4

Market P/E (13F, x)

9.3

KOSPI

1,932.70

Market Cap (Wbn)

5,065

Shares Outstanding (mn)

437

Free Float (%)

63.9

Foreign Ownership (%)

23.8

Beta (12M)

0.05

52-Week Low (W)

5,220

52-Week High (W)

12,850

(%)

1M

6M

12M

Absolute

-4.1

58.0

107.9

Relative

-3.5

59.3

102.6

180 130 80 9/12

As the first mover into the domestic LTE market, LG Uplus currently has the highest proportion of LTE subscribers among domestic telcos. ARPU growth has also been the fastest in the industry; ARPU jumped 20% YoY from W26,677 in 1Q12 (post-LTE rollout) to W31,963 in 1Q13. We estimate ARPU in April was over W32,500, boding well for second quarter performance. We believe the firm is currently in the midst of its first stage of ARPU growth, driven by the rising percentage of LTE subscribers (who pay higher rates), and will soon enter the second stage earlier than rivals, thanks to increasing usage by LTE subscribers and data plan adjustments.

Investment point 2: Continued net subscriber additions In 1Q12, LG Uplus’ share of net subscriber additions in total mobile number portability (MNP) increased to the upper-20% range. We believe such gains were largely due to a narrowing of the mobile carrier’s service gap with top-tier rivals on the back of its successful LTE rollout, and the resulting brand reputation improvement. In 1Q13, the company’s wireless and wired service subscribers climbed 8% YoY and 13% YoY, respectively.

LG Uplus’ successful positioning in the LTE market has been narrowing the stock’s discount. We expect the company to resume its dividend payouts this year, supported by an improving balance sheet (we forecast a swing to net profit in 2013).

KOSPI

230

5/12

Investment point 1: Highest ARPU growth among domestic telcos

Investment point 3: Improving fundamentals, and better market positioning

Share price 280

We initiate our coverage on LG Uplus with a Buy rating and a target price of W15,000. Our target price is based on a P/E of 19x, which represents a 30% premium to the stock’s historic-high 12-month forward multiple. The company has displayed the fastest growth among domestic telcos across a wide range of earnings indicators, and also offers strong earnings visibility. It has bolstered its market position following its entry into the LTE market. We also expect the company to resume dividend payments in 2013 after last year’s suspension.

1/13

5/13

For 2Q, we forecast revenue to grow 7% QoQ and operating profit to surge 44% QoQ. For the full year, we see revenue and operating profit rise 9% YoY and 388% YoY, respectively. LTE subscribers represented around half of LG Uplus’ overall wireless subscribers at end-1Q; we expect the percentage to rise to 72% by year-end.

FY (Dec.)

12/10

12/11

12/12

12/13F

12/14F

12/15F

Revenue (Wbn) OP (Wbn) OP Margin (%) NP (Wbn) EPS (W) ROE (%) P/E (x) P/B (x)

7,975 655 8.2 570 1,113 19.2 6.4 0.9

9,186 279 3.0 85 164 2.2 45.0 1.3

10,905 127 1.2 -60 -122 -1.6 1.2

11,952 619 5.2 329 754 8.4 15.4 1.5

12,920 729 5.6 426 975 10.1 11.9 1.4

13,316 837 6.3 521 1,193 11.5 9.7 1.2

Notes: All figures are based on consolidated K-IFRS; NP refers to profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates


83

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June 11, 2013

Figure 140. Quarterly ARPU and share price

Figure 141. P/B band

(W)

(W)

36,000

20,000

LG Uplus ARPU (L)

(W) 20,000

LG Uplus share price (R)

2.1x

32,000

15,000

16,000 1.6x

28,000

10,000

12,000 1.3x

24,000

5,000

8,000 0.8x

20,000

4,000

0 1Q04

1Q06

1Q08

1Q10

06

1Q12

07

08

09

10

11





P/E (x)

P/B (x)

25

5

12

13 13F

1414F

Verizon

SK Broadband 20

4

Verizon

Softbank

LG Uplus Softbank AT&T

15

(TTB)

2

SK Broadband

NTT Docomo 10

LG Uplus 1

SK Telecom

NTT Docomo

EPS growth (%)

5 0

SK Telecom

KT

KT

-250

AT&T

250

500

750

ROE (%) 0

/// 1000

0

10

20

30

40



Figure 144. Rise in P/E driven by improvements in fundamentals and earnings

Figure 145. Rise in P/E driven by attractive dividend yield

(x)

LG Uplus - 12MF P/E (L) MSCI Korea - 12MF P/E (L) LG Uplus - 12MF EPS (R)

(W)

(x)

1,800

16

16

1,200

12

6

12

600

8

4

0

4

2

-600

0

20


8

4 1Q99

1Q02

1Q05

1Q08

1Q11



(%)

LG Uplus - 12MF P/E (L) LG Uplus - Dividend yield ratio (R)

8

0 1Q99

1Q02

1Q05

1Q08

1Q11


84

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June 11, 2013

LG Uplus has displayed the fastest growth among domestic telcos across a wide range of earnings indicators and also offers strong earnings visibility. It has bolstered its market position following its entry into the LTE market. We also expect the company to resume dividend payments in 2013 after last year’s suspension. Figure 146. Investment point 1: Wireless ARPU climbing rapidly (W'000) 36

LG Uplus

SK Telecom

KT

33

30

27

24 1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13


Figure 147. Investment point 2: Increasing subscribers ('000 persons)

(mn persons) 12

9,000

Cable (R) Wireless (L)

8,500

11

8,000 10 7,500 9

7,000

8

6,500 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F


Figure 148. Investment point 3: Strengthening fundamentals and improving market position (%)

(%)

32

Proportion of LG Uplus' net MNP subscriber additions (L)

3.9

Churn rate (R)

29

3.5

26

3.1

23

2.7

20

2.3 1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13



85

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June 11, 2013

In 2Q, we forecast LG Uplus’ revenue and operating profit to climb by 7% QoQ and 44% QoQ, respectively. We expect the telecom service industry to see an overall decrease in marketing expenses during the quarter, as MNP is likely to stabilize compared to in 1Q. The monthly average number of MNP subscribers will likely fall by 6% QoQ in 2Q, while LG Uplus’ monthly average net MNP subscriber additions is likely to reach 50,000, higher than its competitors’ levels. Furthermore, the company’s ARPU in April rose from both its monthly average in 1Q and the level in March. Table 25. Quarterly and annual earnings breakdown

(Wbn, %, ‘000 persons)

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F

2011

2012

2013F

2,552

2,799

2,821

2,755

2,860

3,079

3,041

2,973

9,186

10,905

11,952

Operating revenue

1,647

1,748

1,804

1,811

1,848

1,935

1,993

2,040

6,419

7,013

7,817

Wireless revenue

894

988

1,057

1,039

1,107

1,172

1,221

1,244

3,413

3,980

4,744

Wired revenue

750

760

748

772

740

763

772

796

3,067

3,030

3,071

Terminal revenue

889

1,035

1,013

940

1,006

1,138

1,043

928

2,753

3,878

4,115

Operating profit

68

3

-10

72

123

177

153

166

279

127

619

OP margin

2.7

0.1

-0.4

2.6

4.3

5.8

5.0

5.6

3.0

1.2

5.2

22

-32

-38

-11

74

91

72

92

85

-60

329

0.9

-1.1

-1.4

-0.4

2.6

3.0

2.4

3.1

0.9

-0.5

2.8

Revenue

Net profit NP margin YoY growth Revenue

20.6

21.5

18.4

12.9

12.0

10.0

7.8

7.9

15.2

18.7

9.6

Operating revenue

6.6

9.6

11.7

8.8

12.2

10.7

10.5

12.7

1.6

9.2

11.5

Wireless revenue

8.7

16.6

22.8

17.8

23.8

18.7

15.5

19.8

-1.9

16.6

19.2

Wired revenue

3.8

1.3

-1.1

-0.8

-1.3

0.4

3.3

3.1

8.5

-1.2

1.4

Terminal revenue

58.4

50.7

38.4

21.8

13.2

10.0

2.9

-1.4

67.0

40.9

6.1

Operating profit

-24.1

80.7

130.7 TTB

388.6

236.6

TTB TTB

-54.6

-82.5

5540.5 TTB

36.3

-61.3

TTR TTR

7.8

Net profit

-94.8 TTR

-85.1

TTR

TTB

QoQ growth Revenue

4.6

9.7

0.8

-2.3

3.8

7.7

-1.2

-2.2

Operating revenue

-1.0

6.1

3.2

0.3

2.1

4.7

3.0

2.4

Wireless revenue

1.4

10.5

7.0

-1.7

6.6

5.9

4.2

1.9

Wired revenue

-3.7

1.4

-1.6

3.2

-4.2

3.2

1.2

3.0

Terminal revenue

15.2

16.4

-2.2

-7.2

7.0

13.1

-8.4

-11.0

Operating profit

2.0

-95.4

TTR

TTB

70.8

44.0

-14.0

9.0

TTB

TTR

RR

RR

TTB

22.6

-21.5

29.0

Wireless subscribers

9,554

9,852

10,020

10,162

10,363

10,670

10,924

11,178

9,391

10,162

11,178

LTE subscribers

1,484

2,576

3,564

4,380

5,202

6,190

7,095

8,000

557

4,380

8,000

7,317

7,467

7,605

7,905

8,292

8,336

8,552

8,767

7,260

7,905

8,767

893

938

980

1,054

1,179

1,289

1,406

1,524

862

1,054

1,524

Net profit Key indicators

Wired subscribers Media subscribers

Note: Under consolidated K-IFRS Source: Company data, KDB Daewoo Securities Research

Figure 149. Quarterly earnings

Figure 150. Annual earnings

Revenue (L) OP margin (R)

(Wbn) 3,200

(%)

(Wtr)

(Wbn)

9

16

2,400

6

12

600

1,600

3

8

300

800

0

4

0

-3

0

NP margin (R)

0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F



3Q13F

4Q13F

900

Revenue (L) Operating profit (R) Net profit (R)

-300 2010

2011

2012

2013F

2014F


86

Telecom Service

June 11, 2013

LG Uplus engages in a variety of businesses, including mobile telecom services, telephone services, triple-play services (TPS: broadband internet, VoIP, and IPTV services), eBiz, IDC, and solutions. In 2008, LG Telecom launched a 3G data service under the OZ brand. In January 2010, LG Telecom merged with LG Dacom and LG Powercom. The company changed its name to LG Uplus in June of that year. The company’s mobile service subscriber figure climbed to 8mn in 2008 and 10mn in 2010. In July 2011, the company rolled out Korea’s first commercial 4G LTE service. The company’s share of wireless service subscribers, which stood at 19.2% in 1Q, has been steadily rising since the launch of the LTE service. In October 2012, the company launched U+TV G which combines Google Smart TV technology and IPTV. The company’s IPTV and internet subscribers are also on the rise, backed by an increase in marketing/promotions (bundled packages). Figure 151. Market share: Wireless service subscribers (1Q13)

Figure 152. Market share: Broadband internet subscribers (2012) Others 17%

LG Uplus 19. 2%

SK Telecom 50.2%

KT 44%

LG Uplus 15%

KT 30.5% SK Broadband 24%




87

Telecom Service

June 11, 2013

LG Uplus has been generating positive momentum by marrying LTE technology with mobile services. The company plans to make additional investments in LTE-Advanced technology in 2H. When it comes to non-telecom operations, the company is focusing on individual services, service convergence, and sharing. Specific services include mobile IPTV services (U+HDTV), cloud services (U+Box, and cloud games), navigation, music, and shopping services. Over the medium to long term, we expect LG Uplus to expand into mobile and wired convergence as well as B2B solutions. Figure 153. Revenue breakdown and outlook (Wbn) 3,200

Wireless communication services

Wired communication services

Terminal revenue

2,400

1,600

800

0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F


Figure 154. LTE investment road map


Figure 155. New LTE services

Source: Company data KDB Daewoo Securities Research

88

Telecom Service

June 11, 2013

LG Uplus operates under the LG Group umbrella. The company's largest shareholder is LG Corp., and, as a result, it has under its arms many small subsidiaries (CS Leader). Unlike SK Group and KT Group, LG Group includes both IT manufacturers and telcos. It should be noted that smartphones, TVs, home electronics, and telecom services all target “picky” consumers. LG Electronics (LGE), one of two largest IT companies in the country, is an affiliate of LG Uplus. This relationship has allowed LG Uplus could roll out its U+TV G service. LGE’s improving competitiveness should positively affect LG Uplus. Indeed, the telco should have no issues acquiring and distributing handsets in the near term. And, over the medium to long term, its market standing should improve on the back of LGE’s improving brand reputation. Figure 156. Corporate governance JI Heung

100%

Koo Bon-moo & affiliates

LG International (001120 KS)

28.0% 51.0%

48.6%

33.5%

37.9%

LG Hausys (108670 KS) Housys Interpane TOSTEM BM

47.9%

100%

Housys ENG

Nanumnuri

LG Innotek (011070 KS) 100%

The Face Shop CleanSoul

100%

HiBusiness Logistics

100% 51.0%

100%

Hiteleservice

64.8%

100%

90.0%

Ace R&A

Coca-Cola Korea 100%

50.0%

100%

Hientech

100%

LG Hitachi Water Solution

100%

100% 100%

Ucess Partners 61.3%

Serveone

BNE 75.0%

LG Sports

EverOn

LG Solar Energy LG Siltron Lusem

70.0%

LG-Toyo Engineering 90.0%

Konjiam Yewon LG MMA LG Pure Cell Systems

Hankook Beverage 51.0% 30.4%

L Best

V-ENS 100%

100%

Bugs Com Ad

Korea Elecom 100%

100%

100% 100%

83.7%

51.0%

CS ONE partner

100%

Haitai Beverage

LG N-Sys

A-in Teleservice

Himsolutek Fuser

100%

88.1%

Dacom Crossing

HS Ad

LG CNS

Media Log

Innowid Hiplaza

100%

100%

CS Leader

Image & Materials

100%

LG H&H (051900 KS)

100%

G2R (035000 KS)

100%

LG Display (034220 KS)

100%

50.0%

50.0%

7.5%

Global Digest Foreign Support

35.0%

LG UPlus (032640 KS)

100%

80.0%

100%

33.3%

Sladaebidi Korae

85%

SeeTec

34.0%

100%

PixDix

36.0%

LG Electronics (066570 KS)

50.0% 33.5%

LG (003550 KS)

33.7%

LG Chem (051910 KS)

Kumah Steel

LG MDI

LG Life Sciences (068870 KS)

Note: As of 1Q13 Source: KDB Daewoo Securities Research


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June 11, 2013

LG Uplus’ financials have been steadily improving. The company’s profitability has been enhanced on the back of: 1) increased operational efficiency following M&As, 2) subscriber base expansion, 3) the government’s restriction on subsidies, and 4) a rise in ARPU resulting from LTE subscriber growth. Despite steady investments, LG Uplus’ financial burden does not appear heavy, as the company’s annual cash flow from operating activities should almost match capex. LG Uplus’ financial leverage level also seems manageable, considering the aforementioned securitization of its handset installment sales receivables as well as the company’s stable business structure and healthy cash flow. Meanwhile, the company is facing several risk factors. 1) LG Uplus valuation might look burdensome, given the company’s relatively low ROE and dividend payouts. However, we believe that the company’s valuation premium should be justifiable in light of its 2012 earnings turnaround and resumption of dividend payouts this year. 2) The company’s ARPU outlook seems unclear, given that LTE services have just begun to spread. Currently, companies and governments are making public monthly new subscriber figures and mobile data usage figures. This should help to better clarify the company’s earnings outlook. 3) LG Uplus is showing the fastest progress among domestic telcos in migrating to LTE technology. The stock’s upward momentum could weaken once the initial hyper growth phase comes to an end. We believe the company needs to acquire medium- to long-term growth drivers like mobile/wired convergence and non-telecom operations. 4) Meanwhile, KEPCO is working to dispose of its 8.8% LG Uplus stake (38.4mn shares) via KEMCO, increasing overhang risks. However, given that the telecom industry has improved, this overhang risk should be offset by the recent increase in free float.


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June 11, 2013

LG Uplus (03264KS/Buy/TP: W15,000) Comprehensive Income Statement (Summarized)

Statement of Financial Condition (Summarized)

(Wbn)

(Wbn)

12/12 12/13F 12/14F 12/15F

Current Assets

2,573

4,296

5,789

7,126

341

1,855

3,153

4,410

1,731

1,897

2,051

2,114

Revenue Cost of Sales

12/12 12/13F 12/14F 12/15F 10,905 11,952 12,920 13,316 0

0

0

0

Cash and Cash Equivalents

Gross Profit

10,905 11,952 12,920 13,316

AR & Other Receivables

SG&A Expenses

10,778 11,332 12,191 12,478

Inventories

346

380

410

423

837

Other Current Assets

114

125

135

139

8,516

7,473

6,640

5,930

13

13

14

15

6,079

5,112

4,320

3,671

Operating Profit (Adj)

127

619

729

Operating Profit

127

619

729

837

Non-Current Assets

Non-Operating Profit

-256

-228

-224

-219

Investments in Associates

Net Financial Income

143

122

107

74

Net Gain from Inv in Associates Pretax Profit

1

1

1

1

-129

391

505

619

Property, Plant and Equipment Intangible Assets

891

733

611

518

11,089

11,769

12,429

13,056

Current Liabilities

3,538

3,779

4,002

4,094

AP & Other Payables

1,735

1,901

2,055

2,118

Short-Term Financial Liabilities

1,022

1,022

1,022

1,022

Total Assets

Income Tax

-70

62

80

98

Profit from Continuing Operations

-60

329

426

521

0

0

0

0

Net Profit

-60

329

426

521

Other Current Liabilities

781

856

925

954

Controlling Interests

-60

329

426

521

Non-Current Liabilities

3,803

3,930

4,067

4,231

Long-Term Financial Liabilities

3,276

3,276

3,276

3,276

466

593

730

894

Profit from Discontinued Operations

Non-Controlling Interests

0

0

0

0

Total Comprehensive Profit

-77

312

408

503

Other Non-Current Liabilities


-77

312

408

503

Total Liabilities

7,340

7,709

8,069

8,325

Non-Controlling Interests EBITDA FCF (Free Cash Flow) EBITDA Margin (%)

0

0

0

0


3,747

4,059

4,357

4,730

1,520

1,798

1,696

1,634

Capital Stock

2,574

2,574

2,574

2,574

-82

1,599

1,479

1,428

Capital Surplus

837

837

837

837

13.9

15.0

13.1

12.3

Retained Earnings

347

677

993

1,383

Operating Profit Margin (%)

1.2

5.2

5.6

6.3


Net Profit Margin (%)

-0.6

2.8

3.3

3.9

Stockholders' Equity

Cash Flows (Summarized) 12/12 12/13F 12/14F 12/15F

Cash Flows from Op Activities

2,060

1,689

1,569

1,516

-60

329

426

521

1,703

1,469

1,271

1,113

1,097

967

792

649

Non-Cash Income and Expense Depreciation

2

2

2

4,060

4,359

4,732

Forecasts/Valuations (Summarized)

(Wbn) Net Profit

2 3,749

12/12 12/13F 12/14F 12/15F P/E (x)

-

15.4

11.9

9.7

P/CF (x)

2.9

3.3

3.6

3.9

P/B (x)

1.2

1.5

1.4

1.2

EV/EBITDA (x)

5.2

4.4

3.9

3.3

Amortization

296

212

176

147

EPS (W)

-122

754

975

1,193

Others

-168

-108

-118

-146

CFPS (W)

2,730

3,454

3,190

3,017 9,646

Chg in Working Capital

441

-47

-48

-20

BPS (W)

6,541

7,618

8,580

452

-166

-154

-63

DPS (W)

0

250

300

400

21

-33

-31

-13

Payout ratio (%)

0.0

33.2

30.8

33.5

-181

167

154

63

Dividend Yield (%)

-23

-62

-80

-98

Revenue Growth (%)

Cash Flows from Inv Activities

-1,974

26

41

74

Chg in PP&E

-1,921

0

0

0

Chg in Intangible Assets

-54

-54

-54

-54

Chg in Financial Assets

-5

0

0

0

Others

7

80

95

128

Cash Flows from Fin Activities

136

-202

-311

-333

Chg in Financial Liabilities

368

0

0

0

30

0

0

0

Chg in AR & Other Receivables Chg in Inventories Chg in AP & Other Payables Income Tax Paid

Chg in Equity Dividends Paid

EBITDA Growth (%)

0.0

2.2

2.7

3.5

18.7

9.6

8.1

3.1

3.5

18.3

-5.7

-3.7

-54.6

388.6

17.7

14.9

TTR

TTB

29.3

22.4

6.3

7.3

7.2

7.1

Inventory Turnover (x)

30.4

32.9

32.7

32.0

Accounts Payable Turnover (x)

19.9

25.0

24.8

24.2

ROA (%)

-0.5

2.9

3.5

4.1

ROE (%)

-1.6

8.4

10.1

11.5

Operating Profit Growth (%) EPS Growth (%) Accounts Receivable Turnover (x)

-65

0

-109

-131

ROIC (%)

Others

-198

-202

-202

-202

Liability to Equity Ratio (%)

Increase (Decrease) in Cash

223

1,513

1,298

1,257

Current Ratio (%)

Beginning Balance

119

341

1,855

3,153

Net Debt to Equity Ratio (%)

Ending Balance

341

1,855

3,153

4,410

Interest Coverage Ratio (x)

1.7

7.5

10.2

13.5

195.8

189.9

185.1

175.9

72.7

113.7

144.6

174.1

104.5

59.2

25.3

-3.2

0.6

3.1

3.6

4.1

Source: Company data, KDB Daewoo Securities Research estimates


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June 11, 2013

SK Telecom (017670 KS) Cementing market leadership

Telecom Service


Buy

(Initiate)

270,000

Target Price (12M, W)

Share Price (06/10/13, W) 211,000

28%


2,146


2,101

EPS Growth (13F, %)

47.8


22.0

P/E (13F, x)

10.0

Market P/E (13F, x)

9.3

KOSPI

1,932.70

Market Cap (Wbn)

81

Free Float (%)

61.1


44.4

Beta (12M)

0.00

52-Week Low (W)

120,000

52-Week High (W)

230,500

(%)

1M

6M

12M

Absolute

-1.9

34.8

72.2

Relative

-1.2

36.1

67.0

Share price KOSPI

180

Investment point 1: Continued market leadership SK Telecom remains the top industry player in the LTE market. As LTE coverage has become more widespread, the firm has widened its lead over its rivals in terms of LTE subscribers. The company has also seen success with its marketing strategies for pricing and data usage. It was the first to introduce an intra-network unlimited voice plan, which should help drive up rates. The firm’s LTE Noot app campaign has encouraged LTE subscriber data usage and has helped consumers become more accustomed to data payments.

Investment point 2: Improving fundamentals of subsidiaries We have seen several signs indicating SK Telecom’s non-telecom subsidiary earnings are starting to turn around. The earnings growth of subsidiaries should add momentum to the firm’s traditionally telecom-oriented operating value. Also encouraging is the improving business environment and strengthening fundamentals of major subsidiaries. SK Broadband has been seeing improvements in its balance sheet and positive changes in its wired business fundamentals amid a more favorable media industry environment. SK Hynix is also expected to benefit from improving semiconductor industry conditions. All of these factors point to further upside to SK Telecom’s EPS.

Investment point 3: Accelerating earnings growth, superior dividend yield

160 140 120 100 80 5/12

In addition to existing markets, SK Telecom has extended its leadership to new markets. Furthermore, the fundamentals of the firm’s major subsidiaries have been improving, providing a strong boost to SK Telecom’s value. In light of its high dividend yield, we believe SK Telecom is an attractive play on both dividends and earnings growth.

17,037


200

We initiate our coverage on SK Telecom with a Buy recommendation and a target price of W270,000. Our target price implies a P/E of 13x, which marks the upper end of the average 12-month forward P/E band of domestic telcos during the post-2000 earnings growth period.

9/12

1/13

5/13

Regarding top line, the simultaneous growth of LTE subscribers and more expensive pricing plans have led to increasing ARPU. As for costs, we look for a QoQ decline due to the government’s subsidy regulations and the company’s shift to data plan-driven marketing campaigns. For 2013, we forecast revenue, operating profit and net profit to rise 6%, 22%, and 49% YoY, respectively. As of June, dividend yield stood at around 4%.

FY (Dec.)

12/10

12/11

12/12

12/13F

12/14F

12/15F


15,519 2,286 14.7 1,842 22,808 16.4 7.6 1.4

15,927 2,296 14.4 1,613 19,975 14.0 7.1 1.2

16,301 1,760 10.8 1,152 14,263 9.8 10.7 1.3

17,287 2,146 12.4 1,702 21,077 14.0 10.0 1.7

18,675 2,717 14.6 2,125 26,319 16.3 8.0 1.5

19,305 2,815 14.6 2,209 27,356 15.6 7.7 1.4



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Figure 158. P/B band (W)

(W)

280,000

300,000

36,000

235,000

250,000

34,000

190,000

200,000

(W) SK Telecom ARPU (L)

38,000

SK Telecom share price (R)

14.1x

10.0x

8.0x

6.6x 32,000

30,000 1Q04

1Q06

1Q08

1Q10

145,000

150,000

100,000

100,000

1Q12

06

07

08

09

10

11





P/E (x)

P/B (x)

25

5

20

4 LG Uplus (TTB)

Softbank AT&T

SK Broadband

2

NTT Docomo

LG Uplus 1

S K Telecom

S K Telecom

NTT Docomo

EPS growth (%)

5 250

500

750

ROE (%) 0

/// 0

AT&T

KT

KT

-250

14 14F

Softbank

Verizon

10

13 13F

Verizon

SK Broadband

15

12

1000

0

10

20

30

40



Figure 161. Rise in P/E driven by strong fundamentals and earnings

Figure 162. Rise in P/E driven by attractive dividend yields

(W)

(x)

SK Telecom - 12M F P/E (L)

30,000

15

SK Telecom - Dividend yield ratio (R)

12

24,000

12

6

9

18,000

9

4

6

12,000

6

2

6,000

3 1Q99

(x)

SK Telecom - 12MF P/E (L)

15

SK Telecom - 12MF EPS (R)


(%) 8


3 1Q99

1Q02

1Q05

1Q08

1Q11



0 1Q02

1Q05

1Q08

1Q11


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June 11, 2013

Figure 163. Investment point 1: Widening gap with rivals in terms of LTE subscribers (mn persons) 12

SK Telecom LTE KT LTE LG Uplus LTE

9

6

3

0 1/12

4/12

7/12

10/12

1/13

4/13


Figure 164. Investment point 2: Revenue growth (Wbn) 1,600

Consolidated subsidiaries New businesses of parent company

1,200

800

400

0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F


Figure 165. Investment point 3: Earnings recovery and high dividend yields (W) 24,000

(%) 8

12-month forward EPS consensus (L) Dividend yield (R)

22,500

6

21,000

4

19,500

2

0

18,000 1/13

2/13

3/13

4/13

5/13


. KDB Daewoo Securities Research

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June 11, 2013

Table 26. Quarterly and annual earnings breakdown

(Wbn, %, 000’ persons)

1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F

Revenue

3,970

4,008

4,126

4,197

4,113

4,194

4,367

4,613

15,926 16,300 17,287

Parent

3,007

3,069

3,098

3,159

3,112

3,208

3,288

3,471

12,551 12,333 13,079

2,875

2,930

2,941

2,948

2,937

3,025

3,080

3,191

11,903 11,695 12,233

132

138

157

211

175

183

208

280

648

638

846

963

939

1,028

1,038

1,001

986

1,079

1,142

3,375

3,967

4,207 2,146

Wireless business New businesses Consolidated subsidiaries Operating profit

2011

2012

2013F

499

416

301

545

411

560

525

650

2,296

1,760

12.6

10.4

7.3

13.0

10.0

13.4

12.0

14.1

14.4

10.8

12.4

323

121

176

519

346

435

415

469

1,582

1,116

1,666

8.1

3.0

4.3

12.4

8.4

10.4

9.5

10.2

9.9

6.8

9.6

Revenue

1.9

-0.4

2.0

6.0

3.6

4.6

5.9

9.9

2.1

2.3

6.0

Parent

-3.9

-3.8

-3.2

4.3

3.5

4.5

6.1

9.9

0.0

-1.7

6.1

-3.3

-3.0

-2.4

1.9

2.2

3.2

4.7

8.3

-1.0

-1.7

4.6

-15.4

-17.4

-17.4

56.3

32.6

32.6

32.6

32.6

24.1

-1.5

32.6

OP margin Net profit NP margin YoY growth

Wireless business New businesses

25.5

12.3

21.8

11.7

3.9

5.0

5.0

10.0

10.7

17.5

6.0

Operating profit

Consolidated subsidiaries

-23.1

-39.8

-46.4

37.6

-17.8

34.8

74.6

19.4

0.8

-23.3

21.9

Net profit

-39.9

-74.1

-54.2

164.8

7.1

261.2

136.5

-9.6

-10.5

-29.5

49.3

Revenue

0.3

1.0

2.9

1.7

-2.0

2.0

4.1

5.6

Parent

-0.7

2.1

0.9

2.0

-1.5

3.1

2.5

5.6

Wireless business

-0.7

1.9

0.4

0.2

-0.4

3.0

1.8

3.6

New businesses

-2.2

4.5

13.8

34.4

-17.1

4.5

13.8

34.4

QoQ growth

3.6

-2.5

9.4

1.0

-3.6

-1.5

9.4

5.8

Operating profit

Consolidated subsidiaries

26.1

-16.8

-27.6

81.1

-24.6

36.5

-6.3

23.9

Net profit

64.8

-62.7

45.7

195.6

-33.3

25.8

-4.6

12.9

Wireless subscribers

25,989

26,269

26,421

26,553

26,556 26,659 26,778 26,961

LTE subscribers

1,766

3,344

5,666

7,530

9,334 11,265 13,133 15,000

Key indicators 25,705 26,553 26,961 634

7,530 15,000

Note: Based on consolidated K-IFRS Source: Company data, KDB Daewoo Securities Research

Figure 166. Quarterly earnings


Revenue (L) OP margin (R) NP margin (R)

(Wbn) 4,800


(%) 16

(Wtr) 20

3,600

12

15

2,250

2,400

8

10

1,500

1,200

4

5

0

0

0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

Note: Under consolidated K-IFRS Source: company data, KDB Daewoo Securities Research


3Q13F

4Q13F

(Wbn) 3,000

750

0 2010

2011

2012

2013F

2014F


95

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June 11, 2013

SK Telecom’s business areas (including those of consolidated subsidiaries) can be broken down into the following: 1) Wireless communications (mobile telecom, wireless data, and information and communications): SK Telecom, PS&Marketing and Network O&S fall under this group. SK Telecom is primarily oriented towards wireless communications and has controlled roughly half of the market in terms of subscribers since 2006. 2) Fixed-line communication businesses (telephony, high-speed internet, and data and network rentals), which are run by SK Broadband and SK Telink. 3) Other businesses (platform service, online portal, music streaming services, etc.), which include SK Planet, SK Comms, LOEN Entertainment, YTK Investment and Atlas Investment. SK Telecom acquired an additional stake in SK Broadband (previously Hanaro Telecom) in 2008 and took over SK Networks’ leased-line business in 2009. The company bought a stake in Hana Card in 2010 and spun off SK Planet in 2011. In February 2012, the firm acquired SK Hynix (previously Hynix Semiconductor) and, in January 2013, merged SK Planet and SK Marketing & Company. Figure 168. Market share breakdown in wireless telecom (1Q13) LG Uplus 19.2%

SK Telecom 50.2%

KT 30.5%

Source: MSIP


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Telecom Service

June 11, 2013

SK Telecom’s new businesses are geared toward solutions, including smart healthcare, smart learning, cloud computing, and green IT. In early 2012, the company established Health Connect, a joint venture with Seoul National University Hospital that combines healthcare with information technology to provide medical services at any time or place. In June 2012, a healthcare service called Health-On was launched. SK Telecom has also released T Smart Learning, a platform that allows uses to access a wide range of educational content via smartphones and tablets. The company is also working with the Ministry of Education to develop learning solutions and launched a smart-learning service in Indonesia with the local carrier Telkom. In the B2B area, the company is pushing for small merchant services, cloud services and energy management. It is also believed that the firm is considering expanding into other areas like smart work, mobile ads, and payment solutions. Figure 169. Revenue breakdown and outlook (Wbn) 5,000

Consolidated subsidiaries New businesses of parent company Wireless business of parent company

4,000

3,000

2,000

1,000

0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F



97

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June 11, 2013

Within the SK Group, SK Telecom is in charge of the telecommunication and media business. The group’s energy units, SK Innovation and SK E&S, have been playing an increasing role in driving the share performance and enterprise value of SK Holdings. SK Telecom still holds a dominating position in the domestic telecom market. However, there continues to be worries that stiffer industry competition and the emergence of similar services outside the industry are eating into profits. In response, the company spun off its non-telecom units (SK Planet) to focus on telecom. Also, it acquired SK Hynix, a move we believe was aimed at offsetting any potential weakness of the telecom business. In the past, SK Telecom had several affiliates that had overlapping or conflicting businesses with the company. This led to delays in decision-making, which in turn resulted in ill-timed entries into new markets. A major example is the NateOn service of SK Communications, a subsidiary of SK Planet. NateOn, already a leading service in the online messenger market, was looking to advance into the mobile messenger market in response to the growing penetration of smartphones. However, concerns over the potential impact of such a move on SK Telecom’s SMS profits prolonged the decision-making and development processes and, in the end, the mobile version of NateOn came out too late. Going forward, SK Group’s business convergence trend is likely to continue. As such, we believe the group needs to further overhaul affiliates’ business structures in order to facilitate efficient decision-making. Figure 170. Corporate governance 99.0%

Bizen

100%

Infosec Encar Networks

0.1%

25.2%

100% 50.0%

100%

Netruck Jeju United FC SK Global Chemical

100%

SK Lubricants 41.0%

100%

Daehan Oil Pipeline SK Mobile Energy

42.5%

SK SKTelecom Telecom (017670 (017670KS) KS) 50.6%

SK SKBroadband Broadband (033630 (033630KQ) KQ)

100% 21.1% 83.5%

72.2%

80.0%

SK Hynix

46.3%

SK Forest

50.0%

10.0%

SKC Lighting SKC Airgas SKC Solmics SK Telesys

5.0% 86.5%

65.0%

SK-W

PS& Marketing F&U Credit Information

100%

Happy Narae

100%

Service Ace

100%

42.5% 100% 100%

Network ONS 100%

27.9%

SK Planet

67.6%

Loen LoenEntertainment Entertainment (016170 (016170KQ) KQ)

64.6%

SK SKCommunications Communications (066270 (066270KQ) KQ)

100%

Commerce Planet

51.0%

100% 100%

SK Networks Service

100%

100% 100%

Silicon SiliconFile FileTech. Tech. (082930 (082930KQ) KQ)

100%

Chonnam City Gas

32.0%

Daejeon Clean Water

42.0%

Gwangju Clean Water

Kangwon City Gas

LCNC

100%

Chungcheong Energy Service

100%

Jeonbuk Energy Service

100%

Yeongnam Energy Service

100%

Pyeongtaek Energy Service

99.7%

Ko-one Energy Service

71.0%

Wirye Energy Service

SK Hystec

Ami Power

40.4%

PMP

100%

Hynix Engineering

SK E&C

Busan BusanCity CityGas Gas (015350 (015350KS) KS)

SK Pinx

Speed Motors

13.7% 25.4%

100%

79.6%

83.1%

40.0%

SK E&S 40.0%

SK SKSecurities Securities (001510 (001510KS) KS)

Choi Chang-won & affiliates

SK Shipping

100% 94.1%

SK SKNetworks Networks (001740 (001740KS) KS)

SK Wyverns

100%

42.5%

SK Biopharm

39.1%

SKC SKC (011790 (011790KS) KS)

Service Top

SK Telink

100%

50.0%

SK SK (003600 (003600KS) KS)

100%

33.4%

SK Energy

31.8%

5.0%

Happy Narae

SK SKInnovation Innovation (096770 (096770KS) KS)

Choi Tae-won & 54.5% affiliates

5.9%

SK E&S

100%

48.5%

SK SKC&C C&C (034730 (034730KS) KS)

100%

SK D&D

45.5%

SK SKChemical Chemical (006120 (006120KS) KS) SK SKGas Gas (018670 (018670KS) KS) 5.0%

Leviathan Asset

10.0%

Happy Narae 50.0%

44.0%

100%

SK Cytec

UB UBCare Care (032620 (032620KQ) KQ) SK Syntec

50.0%

Kimcheon Energy

Television Media Korea Madsmart M & Service

Note: As of 1Q13 Source: SK Holdings, KDB Daewoo Securities Research


98

Telecom Service

June 11, 2013

SK Telecom has among highest profitability and financial flexibility in the industry. The firm enjoys high margins thanks to its extensive subscriber base (giving it the advantage of economies of scale) and high ARPU relative to competitors. The company’s annual EBITDA of W4tr suggests it has enough room to raise capital without outside help. Although large dividend payments have led to persistent cash outflows, the company has still managed to maintain stable cash flow. After 2H11, the firm’s spinoff of SK Planet and takeover of Hynix Semiconductor resulted in significant cash outflows and higher debt. However, we expect the company’s debt burden will gradually subside, given the firm’s solid cash generation from operating activities and sizeable non-operating assets (POSCO stake, etc.). Furthermore, the company should continue to enjoy a sound balance sheet, considering its important position within the SK Group and solid credit (thanks to its stable earnings stream). Key downside risks are as follows: 1) SK Telecom’s position in the telecom industry exposes it to regulatory risks. The firm also lacks flexibility within the market. In particular, the rollout of LTE has narrowed its service gap with rivals, which could potentially undercut its market leadership. 2) Despite having the largest number of LTE subscribers, the company also still has a high percentage of 2G subscribers. As a result, its overall ARPU growth has been slower than that of its rivals. 3) Another key risk is the poor margins of its platform business (SK Planet). Major platform services, such as SK Communications’ Cyworld, Hoppin, 11th Street and T Store, are online-oriented. Therefore, the advance of mobile services presents a threat (as well as an opportunity) to these platform businesses. Looking forward, as the company expands the boundaries of its telecom business, we believe the platform business will assume increasing importance. SK Planet’s growth and profit trends will likely have a significant impact on the operating value of SK Telecom over the medium to long term. 4) Capex pressures are another potential risk. SK Telecom’s mobile data usage figure is growing rapidly due to its large LTE subscriber base. This suggests that the company will need to spend more on communication networks than other industry players. SK Hynix also faces constant capex pressures given the capital-intensive nature of the semiconductor industry.


99

Telecom Service

June 11, 2013

SK Telecom (17670 KS/Buy/TP: W270,000) Comprehensive Income Statement (Summarized)


(Wbn)

(Wbn)

12/12 12/13F 12/14F 12/15F

Current Assets

5,294

7,972

10,749

13,064

920

3,420

5,948

8,150

2,537

2,691

2,907

3,005


12/12 12/13F 12/14F 12/15F 16,301 17,287 18,675 19,305 0

0

0

0


Gross Profit

16,301 17,287 18,675 19,305


SG&A Expenses

14,540 15,140 15,958 16,490

Inventories

242

257

277

287

926

935

948

954 16,123


1,760

2,146

2,717

2,815


Operating Profit

Non-Current Assets

1,760

2,146

2,717

2,815

20,301

18,480

17,129


-209

168

184

203


4,633

4,633

4,633

4,633


312

374

264

153

Property, Plant and Equipment

9,713

7,506

5,893

4,713

Net Gain from Inv in Associates Pretax Profit Income Tax

-24

0

0

0

1,551

2,314

2,902

3,018

Intangible Assets

4,434

4,559

4,685

4,810

25,596

26,452

27,878

29,187

Current Liabilities

6,175

6,440

6,813

6,982

AP & Other Payables

2,065

2,190

2,366

2,446


1,493

1,493

1,493

1,493

Total Assets

296

648

812

845

1,255

1,666

2,089

2,173

-139

0

0

0

Net Profit

1,116

1,666

2,089

2,173


2,617

2,757

2,954

3,044


1,152

1,702

2,125

2,209


6,566

6,605

6,613

6,625 5,434

Profit from Continuing Operations Profit from Discontinued Operations


-36

-36

-36

-36


5,434

5,434

5,434


796

1,346

1,770

1,853


1,045

1,085

1,093

1,104


852

1,402

1,825

1,909

Total Liabilities

12,741

13,045

13,426

13,607


11,855

12,462

13,562

14,746

45

45

45

45

2,916

2,916

2,916

2,916

12,125

13,032

14,432

15,916

1,000

945

889

834

12,855

13,407

14,451

15,580


-55

-55

-55

-55

EBITDA

4,373

4,353

4,330

3,994

Capital Stock

FCF (Free Cash Flow)

1,527

3,715

3,568

3,137

Capital Surplus

EBITDA Margin (%)

26.8

25.2

23.2

20.7

Retained Earnings


10.8

12.4

14.6

14.6


7.1

9.8

11.4

11.4



Cash Flows (Summarized)


(Wbn)

12/12 12/13F 12/14F 12/15F


4,247

3,793

3,642

3,206

P/E (x)

10.7

10.0

8.0

7.7

Net Profit

1,116

1,666

2,089

2,173

P/CF (x)

3.3

4.4

4.6

5.0

Non-Cash Income and Expense

3,290

2,687

2,241

1,822

P/B (x)

1.3

1.7

1.5

1.4

2,613

2,207

1,613

1,179

EV/EBITDA (x)

4.5

5.0

4.4

4.2

EPS (W)

14,263

21,077

26,319

27,356

CFPS (W)

46,625

48,408

46,297

41,960

Depreciation Amortization Others Chg in Working Capital

0

0

0

0

-90

542

449

357

12/12 12/13F 12/14F 12/15F

204

88

124

56

BPS (W)

Chg in AR & Other Receivables

111

-154

-216

-98

DPS (W)

Chg in Inventories

-109

-15

-21

-9

Payout ratio (%)

Chg in AP & Other Payables

335

125

176

80

-363

-648

-812

-845


-5,193

-56

54

165

Chg in PP&E

-3,123

0

0

0

-125

-125

-125

-125

Income Tax Paid

Chg in Intangible Assets Chg in Financial Assets Others Cash Flows from Fin Activities Chg in Financial Liabilities Chg in Equity Dividends Paid

575

0

0

0

-2,520

70

179

290

121,754 127,723 139,798 152,910 9,400

9,400

9,400

9,400

56.9

38.5

30.8

29.7

Dividend Yield (%)

6.2

4.5

4.5

4.5

Revenue Growth (%)

2.4

6.1

8.0

3.4 -7.8

-8.5

-0.5

-0.5

Operating Profit Growth (%)

EBITDA Growth (%)

-23.3

21.9

26.6

3.6

EPS Growth (%)

-28.6

47.8

24.9

3.9

8.6

8.6

8.7

8.5


Accounts Receivable Turnover (x)

70.6

69.3

69.9

68.4


65.3

222

-1,238

-1,168

-1,168

72.6

66.1

66.7

1,166

0

0

0

ROA (%)

4.5

6.4

7.7

7.6

0

0

0

0

ROE (%)

9.8

14.0

16.3

15.6 24.3

-655

-725

-725

-725

ROIC (%)

11.1

13.3

20.1

Others

-290

-443

-443

-443


99.1

97.3

92.9

87.3


-731

2,500

2,528

2,202

Current Ratio (%)

85.7

123.8

157.8

187.1

41.5

21.2

2.2

-12.1

4.3

4.8

6.1

6.4

Beginning Balance Ending Balance

1,651

920

3,420

5,948


920

3,420

5,948

8,150




100

Telecom Service

June 11, 2013

KT (030200 KS) An attractive play on broadcast and telecom convergence Telecom Service


Buy

(Initiate)

50,000

Target Price (12M, W) Share Price (06/10/13, W)

38,150 31%


1,494


1,543

EPS Growth (13F, %)

15.8


22.0

P/E (13F, x)

8.1

Market P/E (13F, x)

9.3

KOSPI

1,932.70

Market Cap (Wbn)

9,961


261

Free Float (%)

85.7


45.5

Beta (12M)

0.08

52-Week Low (W)

27,900

52-Week High (W)

41,250

(%)

1M

6M

Absolute

-1.7

0.7

12M 30.0

Relative

-1.1

1.9

24.7

Share price 160

KOSPI

120 100 80 9/12

A latecomer to the LTE market, KT has seen the slowest growth among domestic telcos in terms of wireless ARPU and subscriber share. Taking this into account, we relied on SK Telecom’s historical trajectory (in which gradual earnings growth led to multiple expansion even though its market share remained largely unchanged) in making our projections.

Investment point 1: ARPU on the rise after the completion of LTE network In order to efficiently use its existing frequencies, KT had to shut down its 2G network before rolling out LTE in 1Q12. As such it arrived later to the party than LG Uplus, which launched its LTE services in 4Q11. And KT has been one step behind in completing a nationwide LTE network, and, as a result, the company has seen its subscriber base and ARPU growth lag behind rivals’. Although KT’s decision to shut down its 2G network before deploying LTE resulted in some tardiness, we believe the shutdown removed potential risks down the road. ARPU has been on an uptrend since 2Q12 thanks to the LTE rollout. Some of KT’s high-ARPU subscribers, who came to the company during the initial iPhone 3G launch, also appear to be migrating to LTE.

Investment point 2: Fixed-line & media expansion to restore market position KT is the largest fixed-line operator in Korea, a fact that has worked to its disadvantage over the years in a wireless-oriented industry. However, we believe the company’s expansion into the media business will compensate for its struggling fixed-line business and help restore KT’s market position. Growing revenue from pay-TV platforms (IPTV and KT Skylife), content businesses (KT Media Hub’s VOD and video content investments), KTH’s motion picture distribution business, and T-commerce are all contributing to the growth of KT’s media segment.

Investment point 3: Growing non-telecom earnings, high dividend yield

140

5/12

We initiate our coverage on KT with a Buy rating and a target price of W50,000. Our target price is based on a P/E of 11x, the 12-month forward peak multiple during SK Telecom’s earnings growth period.

1/13

5/13

Non-telecom subsidiaries are expected to make growing contributions to consolidated operating profit, from 10% in 1Q12 to 36% in 2013. Non-telecom earnings should partly offset the margin erosion and earnings volatility of the telecom business. As earnings volatility declines, this could trigger a stock re-rating. Also worth noting is KT’s dividend yield, which is the highest among domestic telcos. Target price is based on a P/E of 11x, the 12-month forward peak multiple during SK Telecom’s earnings growth period. FY (Dec.)

12/10

12/11

12/12

12/13F

12/14F

12/15F


20,009 2,008 10.0 1,477 5,655 13.7 8.2 1.1

21,258 1,748 8.2 1,435 5,497 12.6 6.5 0.9

23,790 1,214 5.1 1,057 4,048 8.8 8.8 0.9

24,839 1,494 6.0 1,224 4,689 9.7 8.1 0.9

25,860 1,779 6.9 1,444 5,531 10.8 6.9 0.9

26,903 2,100 7.8 1,700 6,512 11.9 5.9 0.8

Note: All figures are based on consolidated K-IFRS; NP refers to profit attributable to controlling interests Source: Company data, KDB Daewoo Securities Research estimates


101

Telecom Service

June 11, 2013


Figure 172. P/E band (W)

(W)

56,000

60,000

(W) KT ARPU (L)

34,000

22.0x

KT share price (R)

10.0x

32,000

48,000

50,000

30,000

40,000

40,000

28,000

32,000

30,000

24,000

20,000

7.8x

26,000 1Q04

1Q06

1Q08

1Q10

1Q12

5.5x

06

07

08

09

10

11





P/E (x)

P/B (x)

25

5

4

20 LG Uplus (TTB)

Softbank AT&T

2

SK Broadband

NTT Docomo

LG Uplus 1

SK Telecom KT

250

500

750

SK Telecom

NTT Docomo ROE (%)

0

/// 0

AT&T

KT

EPS growth (%)

5 -250

14 14F

Softbank

Verizon

10

13 13F

Verizon

SK Broadband

15

12

0

1000

10

20

30

40



Figure 175. Rise in P/E driven by strong fundamentals and earnings

Figure 176. Rise in P/E driven by attractive dividend yields

(W) 6,800

(x) 20

16

5,600

16

6

12

4,400

12

4

3,200

8

2

2,000

4

(x) 20

KT - 12MF P/E (L) KT - 12MF EPS (R)


8

KT - 12MF P/E (L) KT - Dividend yield ratio (R)

(%) 8

12MF P/E range: 11-16x 4 1Q99

1Q02

1Q05

1Q08

1Q11



0 1Q99

1Q02

1Q05

1Q08

1Q11


102

Telecom Service

June 11, 2013

We believe KT has the most compelling LTE story in the telecom sector. The firm completed the rollout of nationwide LTE coverage in 2Q12 after terminating its 2G services. Since then, ARPU has been on an uptrend. In our view, KT’s decision to shut down its 2G services could serve as a key differentiating factor during the LTE mid-cycle. Looking ahead, the switch of 3G smartphone and iPhone users to LTE could trigger a faster rise in ARPU. Figure 177. Investment point 1: Wireless ARPU on an uptrend (Won) 32,000

KT LTE ef f ect

30,000

28,000

26,000

24,000 1Q11

2Q11

3Q11

4Q11

1Q12

2Q12

3Q12

4Q12

1Q13


Figure 178. Wireless service subscribers (mn persons) 20

2G (CDMA)

3G (WCDMA)

4G (LTE)

15

10

5

0 1Q10

3Q10

1Q11

3Q11

1Q12

3Q12

1Q13

3Q13F


Figure 179. Revenue breakdown and outlook (Wbn)

Wireless communication services

Wireline communication services

Media/content services

6,800

Finance/rental services

Other services

Product revenues

5,100

3,400

1,700

0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F



103

Telecom Service

June 11, 2013

We believe KT’s expansion into the media business will help the firm’s dominating the fixed-line business regain its footing. The decline in fixed-line revenue has been moderating thanks to the bundling of media products. Going forward, KT should see more ancillary revenue streams on the back of a growing subscriber base. The firm’s digital pay-TV platform businesses (IPTV and KT Skylife) also remain well on track. With the expansion of its subscriber base, KT’s ancillary revenue (VOD, home shopping transmission commissions, etc.) has been gaining momentum. In 2012, KT Media Hub’s VOD revenue exceeded the combined VOD revenue of cable operators on the back of the growth of IPTV. The company is also planning to make investments in a variety of content, including videos, music, and new media services. KTH currently holds one of the most extensive movie distribution rights in Korea and has launched a T-commerce business using KT IPTV and KT Skylife channels. Non-telecom subsidiaries’ contribution to consolidated operating profit is expected to grow from 10% in 1Q12 to 36% in 2013. Non-telecom earnings should partly offset the margin erosion and earnings volatility of the telecom business. As earnings volatility declines, this could trigger a stock re-rating. We believe real estate and other asset holdings could serve as additional revenue streams, providing room for dividend growth. This bodes well for KT’s dividend yield, which is already the highest among domestic telcos. Figure 180. Investment point 2: KT’s media subscriber numbers on the rise 20%

KT IPTV

KT Skylife satellite

15%

10%

5%

0% 2010

2011

2012

1Q13

Source: Company data, KT Skylife, KDB Daewoo Securities Research

Figure 181. Investment point 3: Earnings contribution from non-telecom units climbing (%) 60

Contribution of subsidiaries to consolidated operating profit

50 40 30 20 10 0 1Q12

2Q12

3Q12

4Q12

1Q13



104

Telecom Service

June 11, 2013

We expect 2Q revenue and operating profit to rise 1.3% QoQ and 16.6% QoQ, respectively. For wireless communication, the increasing mix of LTE subscribers should push ARPU higher. In the media unit, additional revenue streams and subscriber expansion should prop up top-line growth. For the full year, we see revenue and operating profit growing 4.4% YoY and 23.1% YoY, respectively. The wireless communication unit is expected to deliver its first top-line growth in years. In the media and content unit, robust growth should continue, driven by net subscriber additions and more meaningful growth in ancillary revenues. As for the fixed-line business, we expect the pace of revenue decline to slow on the back of falling churn rates (due to more bundling services) and discount adjustments for high-speed internet bundled products. In the medium to long run, we believe the growth of the non-telecom business (media & content, financing & leasing, miscellaneous services, real estate, etc.) will have a defining impact on KT’s consolidated revenue. Table 27. Quarterly and annual earnings breakdown Revenue Service revenue


1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F

2011

2012

2013F

5,706

5,709

6,173

6,203

6,104

6,184

6,168

6,382

21,258

23,790

24,839

4,708

4,736

4,860

4,885

4,941

4,905

5,016

5,116

16,947

19,189

19,977

Wireless communication

1,716

1,740

1,754

1,703

1,757

1,785

1,822

1,858

6,969

6,913

7,222

Wired communication

1,664

1,611

1,568

1,549

1,522

1,508

1,472

1,468

6,951

6,392

5,970

Media/content

231

248

266

323

314

341

356

371

803

1,068

1,381

Finance/rental

836

844

939

955

917

925

1,030

1,047

997

3,574

3,919

Other services

262

293

332

355

432

345

337

372

1,227

1,242

1,485

Product revenue

998

973

1,312

1,318

1,163

1,280

1,152

1,267

4,311

4,601

4,861

Operating profit OP margin

580 10.2

346 6.1

227 3.7

61 1.0

367 6.0

428 6.9

500 8.1

199 3.1

1,737 8.2

1,214 5.1

1,494 6.0

Net profit

405

235

370

101

213

314

485

268

1,441

1,111

1,279

7.1

4.1

6.0

1.6

3.5

5.1

7.9

4.2

6.8

4.7

5.1

12.7

8.2

24.9

3.8

7.0

8.3

-0.1

2.9

6.2

11.9

4.4

18.0

15.8

19.4

1.8

4.9

3.6

3.2

4.7

3.2

13.2

4.1


-1.4

-1.9

1.0

-1.0

2.4

2.6

3.9

9.1

-1.3

-0.8

4.5

Wired communication

-5.1

-8.5

-10.2

-8.4

-8.5

-6.4

-6.1

-5.2

-7.7

-8.0

-6.6 29.3

NP margin YoY growth Revenue Service revenue

Media/content

23.9

32.2

24.4

50.0

36.2

37.7

33.5

14.7

195.5

33.0

Finance/rental

1460.8

1327.4

1730.7

14.7

9.6

9.6

9.6

9.6

467.5

258.7

9.6

Other services

2.2

-5.1

3.5

3.9

65.1

17.7

1.5

4.7

-10.7

1.2

19.6

Product revenue

-7.2

-18.1

50.6

12.0

16.6

31.5

-12.2

-3.9

19.9

6.7

5.7

6.0

-22.8

-57.6

-70.4

-36.7

23.9

120.5

224.2

-20.6

-30.1

23.1

-28.0

-44.9

45.1

-48.4

-47.5

33.3

31.1

163.9

7.7

-22.9

15.1

-4.5

0.1

8.1

0.5

-1.6

1.3

-0.3

3.5

-1.9

0.6

2.6

0.5

1.1

-0.7

2.3

2.0


-0.2

1.4

0.8

-2.9

3.1

1.6

2.0

2.0

Wired communication

-1.6

-3.2

-2.7

-1.2

-1.8

-0.9

-2.4

-0.3

Media/content

7.0

7.4

7.6

21.3

-2.8

8.5

4.3

4.3

Finance/rental

0.4

0.9

11.3

1.7

-4.0

0.9

11.3

1.7

Other services

-23.4

12.0

13.5

6.8

21.7

-20.2

-2.2

10.2

17,616

Operating profit Net profit QoQ growth Revenue Service revenue

-15.2

-2.5

34.9

0.4

-11.8

10.0

-10.0

10.0

Operating profit

Product revenue

179.8

-40.4

-34.4

-73.0

499.1

16.6

16.8

-60.2

Net profit

106.1

-41.9

57.1

-72.6

109.8

47.6

54.6

-44.8

17,435

17,389

17,416

17,436

17,371

17,494

17,555

17,616

17,307

17,436

351

1,170

2,488

3,900

5,070

6,763

7,609

8,456

-

3,900

8,456

29,331

29,523

29,794

30,058

30,303

30,494

30,629

30,733

28,867

30,058

30,733

4,547

4,710

4,900

5,125

5,341

5,593

5,796

6,039

4,275

5,125

6,039

Key indicators Wireless communication subscribers LTE subscribers Wired communication subscribers Media subscribers

Notes: Under consolidated K-IFRS; net profit is comprehensive net profit attributable to controlling and minority shareholders Source: Company data, KDB Daewoo Securities Research


105

Telecom Service

June 11, 2013

KT is the largest fixed-line operator in Korea and has the second largest number of mobile subscribers. Its key business area is telecom services, including fixed-line and wireless telephony and high-speed internet. The company also offers IPTV, VoIP and WiBro services, in line with telecom-broadcasting and wired-wireless convergence trends. In 2008, KT merged with its mobile unit KTF. In November 2009, the firm became the first mobile carrier in Korea to introduce the iPhone 3G. The satellite operator Skylife became KT’s subsidiary in April 2010, as did Kumho Rental in May and KT Estate in September of that year. In September 2010, KT released the iPhone 4 alongside a 3G unlimited data plan. In 2011, the firm merged its fixed-line brand QOOK and mobile brand SHOW into a single brand named Olleh. In November 2011, BC Card joined the KT Group. In the following month, the company’s IPTV subscribers hit 3mn. KT rolled out LTE services in January 2012. Smartphone users accounted for more than half of the carrier’s subscribers in February 2012. In October 2012, KT announced its decision to establish a real estate investment company and a media/content provider and approved spin-offs in November. KT Estate, KT Media Hub and KT Sat were subsequently established. Figure 182. Quarterly earnings


(Wbn)

(%)

(Wtr)

12

30

6,500

9

23

6,000

6

15

7,000

Revenue (L)

OP margin (R)

NP margin (R)

(Wbn) Revenue (L)

Operating profit (R)

Net profit (R)

2,500

2,000

1,500

1,000 5,500

3

5,000

0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F

8

500

0

0 2010

2011

2012

2013F

2014F

Note: Under consolidated K-IFRS Source: company data, KDB Daewoo Securities Research


Figure 184. Market share breakdown: Wireless service subscribers (1Q13)

Figure 185. Market share breakdown: High-speed Internet subscribers (2012) Other 17%

LG Uplus 19.2%

SK Telecom 50.2%

KT 44%

LG Uplus 15%

KT 30. 5% SK Broadband 24%




106

Telecom Service

June 11, 2013

KT’s new businesses are centered on the group’s vision of selling virtual goods. KT is also working to promote shared growth among its affiliates. By blending telecom and non-telecom businesses, the company targets to raise its proportion of non-telecom revenue from 27% in 2010 to 45% in 2015. Furthermore, the company is making efforts to expand its global footprint, especially in the distribution of virtual goods. As part of such efforts, KT has launched several platform companies including Ustream Korea, Genie, and Soompi, and is considering such options as equity investments, joint ventures, and partnerships with global carriers. Figure 186. Affiliates of KT Group

T elcom

Media

C onver gence



107

Telecom Service

June 11, 2013

KT’s major subsidiaries can be broadly broken down into the telecom, IT, media and convergence sectors. The following is a list of KT’s consolidated subsidiaries. KT Sat; KT Networks and KT Powertel (telecom); BC Card (credit card); KT Skylife (satellite TV); KT Hitel (online content); KT Commerce (e-commerce); KT Music (database and online data); Nasmedia (advertising); KT Rental (rental car); KT Auto Lease (auto leasing and used car financing); KT Estate (real estate development, leasing, and management); KT Capital (corporate credit); KT Submarine (submarine cable); KT Telecop (private security); KT M&S (wholesale machinery and equipment); KTDS (software development and distribution); KT Linkus (payphone maintenance); HNC Network (HR consulting); Initech (security); Initech Smartro Holdings (business consulting); and Smartro (financial services). Given the sheer number of KT’s subsidiaries, we believe there is a possibility that KT will reorganize its corporate structure in order to ensure more efficient management and clearer, quicker decision making and to enhance corporate value. Figure 187. Corporate governance KT KT (030200 (030200KS) KS) 65.9%

83.6%

KTH KTH

(036030 (036030KQ) KQ)

KT Commerce 81.0%

16.4% 19.0%

KTis KTis (058860 (058860KS) KS)

17.8%

KT KTMusic Music (043610 (043610KQ) KQ)

57.8%

KT KTSubmarine Submarine (060370 (060370KQ) KQ)

36.9%

17.8%

1.0%

KT Capital

99.0%

69.5%

BC Card KT KTCS CS (030210 (030210KS) KS)

28.0%

Vanguard Private Equity Fund

57.0%

H&C Network 50.9%

100%

VP

Initech Smartro Holdings

44.9%

KTP 35.5%

9.0%

Initech Initech

(053350 (053350KQ) KQ)

KT-LIG ACE Private Equity Fund

61.2%

Enswers

19.9%

Smartro 100%

KT Networks 51.4%

100%

Nasmedia

KT M&S 93.8%

74.2%

KT Telecop 86.2%

48.0%

Korea HD Broadcasting

Animax Broadcasting Korea

26.2% 72.4%

KT Cloudware

WIC

Sidus FNH 100%

KT KTSkylife Skylife (053210 (053210KS) KS)

50.0% 14.2%

86.8%

KT Linkus

0.1%

77.4%

51.0%

T-on Telecom

Sofnics

KT Mhows 100% 65.0%

91.1%

Smart Channel

KT Estate

KT DS 58.0% 82.8%

50.0%

Centios

KT Rental

Kan

100%

KT Autolease

100%

KT AMC

Communications 100%

100% 48.4%

51.0%

51.0%

79.2%

KT Innoedu

Best Partners

KT-SB Data Service

100%

100%

U-stream Korea

KT OIC 100%

KT Sports

KT Rental Autocare Kumho Rent-a-car

100%

KT Sat

KT Media Hub

Note: As of 1Q13 Source: Company data, KDB Daewoo Securities Research


108

Telecom Service

June 11, 2013

KT has a healthy balance sheet. In the telecom segment, improved operational efficiency through mergers and marketing spend regulations have contributed to higher margins. Despite heavy capital spending and dividend payouts, the company has managed to generate free cash flow every year. Overall debt remains at manageable levels, with debt-to-asset ratio currently standing at around 28%, Since 2012, financial stress has eased with the sale of bonds and the conclusion of LTE investments. Looking forward, we could see better cash flow from the monetization of the firm’s idle assets (e.g., real estate and copper wire). Key risks facing KT are as follows: 1) Due to KT’s belated LTE rollout, major earnings indicators have been improving at a slower pace than its rivals’ indicators. Furthermore, its high exposure to fixed-line earnings has often overshadowed the performance of its wireless business. Such factors have weighed on KT’s share momentum. 2) The government’s tighter control over telecom subsidies, which have been creeping up to attract LTE subscribers, could slow the pace of subscriber and ARPU growth. 3) The MSIP is set to redistribute wireless frequencies this year. If KT fails to gain broadband frequency, this could darken the outlook for the company’s LTE business. 4) The company’s rising market share in pay TV makes it increasingly vulnerable to potential media industry regulations. Also, KT’s growing dominance in the media market implies less upside room for subscriber growth. That said, once the initial phase of high subscriber growth come to an end, we believe KT will be able to generate additional revenue streams by capitalizing on its large media subscriber base. Over time, we think the company’s priority will shift from growth to profit. 5) It also remains unclear whether BC Card and KT Rental, two of KT’s largest acquisitions, will be able to create synergy with its telecom business.


109

Telecom Service

June 11, 2013

KT (030200 KS/Buy/TP: W50,000) Comprehensive Income Statement (Summarized)


(Wbn)

(Wbn)


12/12 12/13F 12/14F 12/15F 23,790 24,839 25,860 26,903 0

0

0

0

Current Assets

13,685

16,797

20,019


2,055

4,941

7,745

10,652

5,878

6,137

6,389

6,646

935

976

1,016

1,057

Gross Profit

23,790 24,839 25,860 26,903


SG&A Expenses

22,577 23,344 24,081 24,803

Inventories


1,214

1,494

1,779

2,100


Operating Profit

1,214

1,494

1,779

2,100

Non-Current Assets


209

104

94

94


264

247

71

-101


13

0

0

0

1,423

1,599

1,873

2,194

Property, Plant and Equipment Intangible Assets

394

410

19,993

18,286

411

411

411

411

15,734

13,203

11,142

9,462

3,213

3,266

3,310

3,347

34,480

35,526

36,790

38,305

Current Liabilities

12,291

320

375

439

1,279

1,499

1,755

-32

0

0

0

Net Profit

1,112

1,279

1,499

1,755



1,057

1,224

1,444

1,700



379 21,842

Total Assets

280

Profit from Discontinued Operations

363 23,997


1,143

Profit from Continuing Operations

12/12 12/13F 12/14F 12/15F 10,483

11,247

11,599

11,941

AP & Other Payables

7,216

7,534

7,844

8,160


3,273

3,273

3,273

3,273

758

792

824

858

10,068

10,085

10,109

10,121 8,334

54

54

54

54


8,334

8,334

8,334


998

1,165

1,385

1,641


1,185

1,202

1,227

1,238


938

1,105

1,325

1,581

Total Liabilities

21,315

21,684

22,050

22,411



60

60

60

60

12,309

12,927

13,764

14,857

EBITDA

4,521

4,492

4,316

4,262

Capital Stock

1,565

1,565

1,565

1,565


3,182

3,641

3,382

3,313

Capital Surplus

1,440

1,440

1,440

1,440

19.0

18.1

16.7

15.8

10,646

11,383

12,340

13,553


5.1

6.0

6.9

7.8



4.4

4.9

5.6

6.3


EBITDA Margin (%)

Cash Flows (Summarized)

Retained Earnings

855

916

976

1,037

13,165

13,842

14,740

15,894


(Wbn)

12/12 12/13F 12/14F 12/15F


5,925

4,140

3,883

3,814

P/E (x)

12/12 12/13F 12/14F 12/15F 8.8

8.1

6.9

5.9

Net Profit

1,112

1,279

1,499

1,755

P/CF (x)

2.1

2.4

2.5

2.6

Non-Cash Income and Expense

3,473

3,213

2,818

2,507

P/B (x)

0.9

0.9

0.9

0.8

Depreciation

2,919

2,531

2,062

1,679

EV/EBITDA (x)

4.4

3.9

3.5

2.8

Amortization

389

467

476

483

EPS (W)

4,048

4,689

5,531

6,512

Others

-92

345

159

-13

CFPS (W)

16,715

16,171

15,247

14,792

Chg in Working Capital

1,720

-33

-59

-9

BPS (W)

38,404

40,566

43,602

47,648

1,840

-259

-252

-258

DPS (W)

2,000

2,000

2,000

2,000

Chg in Inventories

-288

-41

-40

-41

Payout ratio (%)

46.1

39.8

33.8

28.7

Chg in AP & Other Payables

178

318

310

316

Dividend Yield (%)

5.6

5.2

5.2

5.2

-379

-320

-375

-439

Revenue Growth (%)

11.9

4.4

4.1

4.0


-3,487

-318

-142

30

Chg in PP&E

-2,602

0

0

0

Chg in Intangible Assets

-520

-520

-520

-520

Chg in Financial Assets

-548

0

0

0

Others

183

202

378

549


-1,827

-936

-936

-936

-512

0

0

0

Chg in AR & Other Receivables

Income Tax Paid

Cash Flows from Fin Activities Chg in Financial Liabilities Chg in Equity Dividends Paid

-4.4

-0.7

-3.9

-1.3


EBITDA Growth (%)

-30.6

23.1

19.1

18.0

EPS Growth (%)

-26.4

15.8

17.9

17.8

4.0

4.1

4.1

4.1

29.6

26.0

26.0

26.0


3.6

3.4

3.4

3.4

ROA (%)

3.3

3.7

4.1

4.7

Accounts Receivable Turnover (x)

11

0

0

0

ROE (%)

8.8

9.7

10.8

11.9

-497

-487

-487

-487

ROIC (%)

5.1

6.7

9.1

12.1


Others

-830

-449

-449

-449

161.9

156.7

149.6

141.0


610

2,886

2,805

2,907

Current Ratio (%)

93.2

118.0

140.7

162.9

7,745


63.0

39.1

17.7

-1.9

2.7

3.3

4.0

4.7

Beginning Balance

1,445

2,055

4,941

Ending Balance

2,055

4,941

7,745 10,652




110

Telecom Service

June 11, 2013

SK Broadband (033630 KQ) Growth drivers and improving financial health Telecom Service

Initiate coverage with Trading Buy rating and TP of W6,000

Trading Buy

(Initiate) Target Price (12M, W)

6,000

Share Price (06/10/13, W)

4,945 21%


121


114

EPS Growth (13F, %)

233.6


22.5

P/E (13F, x)

19.5

Market P/E (13F, x)

9.3

KOSDAQ

547.00

Market Cap (Wbn)

1,464


296

Free Float (%)

49.4


3.9

Beta (12M)

-0.05

52-Week Low (W)

2,830

52-Week High (W)

5,660

(%)

1M

6M

Absolute

-6.7

3.5

12M 73.5

Relative

-6.1

4.7

68.2

Share price 200

KOSDAQ

We initiate our coverage of SK Broadband with a Trading Buy rating and a target price of W6,000 (target P/E multiple of 24x). The company’s financial position is strengthening, and IPTV and business services are driving growth. However, we applied a 10% discount to the company’s historical average 12-month forward P/E, in light of the stagnant growth of the wired telecom industry (compared to that of the wireless industry), the company’s low ROE, and a negative dividend outlook.

Investment point 1: Partnership with SK Telecom to fuel growth The IPTV business (B2C) of SK Broadband is picking up thanks to the introduction of digital broadcasting and the company’s marketing partnership with SK Telecom. Digital broadcasting subscribers now account for 63% of domestic pay-TV subscribers, and 36% of cable SOs have switched to digital broadcasting. We are seeing sufficient upside to IPTV penetration. Just as is the case with KT’s partnership with its subsidiary KT Skylife, a digital satellite network company, SK Broadband’s cooperation with SK Telecom is boosting subscriber numbers. Meanwhile, since the introduction of LTE services in the wireless telecom market, demand for high-quality videos has been rising. At the initial stage of smartphone market growth, SK Telecom, which has the largest mobile phone subscriber base in Korea, benefited greatly from its ties to its subsidiary LOEN Entertainment (digital music service). In the wireless LTE age, SK Broadband’s IPTV business (Btv and Btv Mobile) should become a new growth driver. In the business services segment, group service sales (wired network service) are expanding quickly.

Investment point 2: Improvements in fundamentals and financial position SK Broadband has seen its earnings turn around and its financial position improve. In 2013, we expect the company’s operating profit and net profit to soar 48% and 233%, respectively

180

The company’s IPTV service termination rate has stayed below 2% since 2012. In addition, net borrowings are steadily declining, with the average cost of borrowing dipping from over 6% in 2010 to around 4% in 2012.

160 140 120 100 80 5/12

9/12

1/13

5/13

FY (Dec.)

12/10

12/11

12/12

12/13F

12/14F

12/15F


2,123 -23 -1.1 -120 -405 -10.2 1.7

2,295 65 2.8 -14 -48 -1.3 1.1

2,492 82 3.3 23 76 2.0 61.4 1.5

2,639 121 4.6 75 254 6.6 19.5 1.5

2,740 130 4.7 89 301 7.3 16.4 1.4

2,866 146 5.1 111 374 8.4 13.2 1.3


.


111

Telecom Service

June 11, 2013

Figure 188. Quarterly net subscriber growth and share performance

Figure 189. P/B band

(W)

(W)

12,000

16,000

200

9,500

12,000

100

7,000

8,000

(000' persons) 300

SK Broadband internet + IPTV net subscriber additions (L) SK Broadband share price (R)

2.2x 1.6x

0

-100 1Q08

1Q09

1Q10

1Q11

1Q12

4,500

4,000

2,000

0

1Q13

1.3x 0.9x

06

07

08

09

10

11





P/E (x)

P/B (x)

25

5

12

13 13F

14 14F

Verizon

S K B roadband 4

20

Softbank

Verizon LG Uplus (TTB)

Softbank AT&T

15

2

LG Uplus

NTT Docomo 10

SK Telecom

S K B roadband 1

SK Telecom

AT&T

NTT Docomo KT

KT EPS growth (%) 5

/// -250

0

250

500



750

1000

ROE (%) 0 0

10

20

30

40


112

Telecom Service

June 11, 2013

SK Broadband’s partnership with SK Telecom is widely anticipated to fuel the growth of its IPTV business. Since 2Q12, the company’s IPTV net subscriber growth has exceeded 30,000 per month. In 1Q13, the company’s subscriber growth was the highest in the pay-TV market. Figure 192. Investment point 1: IPTV business is picking up ('000 subscribers) 2,000

IPTV subscribers

Over 10,000 monthly net additions

Over 30,000 monthly net additions

1,500

1,000

500

0 1/11

7/11

1/12

7/12

1/13


Figure 193. Strongest subscriber growth among pay-TV platform providers -15

0

15

30

60

27.5

KT (IPTV)

(%)

16.9

KT Skylife 8.2

CJ HelloVision -0.9

T-broad C&M

45

-8.7

SK Broadband

47.0 8.9

Hyundai HCN -0.4

CMB

32.0

LG Uplus


Figure 194. Investment point 2: Earnings turnaround and recovering financial health (Wbn)

Operating profit (L)

(Wbn)

200

Net profit (L)

1,600

Net debt (R) 100

1,400

0

1,200

-100

1,000

-200

800 2010

2011

2012

2013F



113

Telecom Service

June 11, 2013

SK Broadband’s earnings are improving on strengthening fundamentals. These improvements are being driven by the IPTV and business services segments. We expect the company’s 2Q revenue and operating profit to jump 6.5% QoQ and 98.5% QoQ, respectively. On a full-year basis, operating profit and net profit are projected to soar 48% YoY and 233% YoY, respectively. Table 28. Quarterly and annual earnings breakdown


1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F

3Q13F

4Q13F

2011

2012

2013F

559

606

648

688

605

644

676

713

2,295

2,492

2,639

236

239

234

231

230

229

228

228

962

935

914

IPTV

47

52

59

67

73

83

91

99

152

220

347

Home phone

68

67

61

62

56

57

57

57

281

257

227

207

224

241

250

242

253

261

271

772

928

1,027

Revenue Broadband

Corporate Other

1

23

54

78

4

23

38

58

129

153

123

Operating profit

16

17

20

30

17

33

43

28

65

82

121

OP margin

2.9

2.8

3.0

4.3

2.7

5.1

6.4

4.0

2.8

3.3

4.6

1

3

6

12

5

22

33

15

-14

23

75

0.2

0.5

1.0

1.7

0.9

3.5

4.9

2.1

-0.6

0.9

2.8

7.4

8.6

11.2

5.6

8.3

6.4

4.3

3.6

7.4

8.6

5.9

-3.6

-1.9

-2.6

-6.4

-2.7

-4.5

-2.6

-1.4

-2.5

-2.8

-2.2

Net profit NP margin YoY growth Revenue Broadband IPTV

40.7

43.3

47.0

60.6

54.9

58.9

54.2

47.6

26.6

44.6

58.0

Home phone

-10.4

-10.1

-6.9

-10.1

-17.3

-14.6

-5.9

-7.3

-10.8

-8.7

-11.4

Corporate

29.6

22.2

17.6

-12.4

17.3

12.7

8.6

8.1

13.1

20.2

10.7

Other

-84.3

19.1

64.4

802.3

263.6

0.0

-28.5

-25.3

280.2

19.3

-19.5

Operating profit

6.6 TTB

-9.6 TTB

0.5

168.5

3.1

93.8

120.2

-4.9

TTB

25.7

48.4

966.7

TTB

420.0

597.2

413.4

23.4

RR

TTB

233.6

Net profit QoQ growth Revenue

-14.3

8.4

7.1

6.2

-12.1

6.5

4.9

5.5

Broadband

-4.5

1.5

-2.1

-1.4

-0.7

-0.4

-0.2

-0.2

IPTV

13.1

10.3

13.0

13.9

9.1

13.2

9.7

9.0

Home phone

-1.7

-1.9

-8.7

2.1

-9.5

1.2

0.6

0.6

Corporate

-27.7

8.6

7.3

4.0

-3.2

4.4

3.4

3.5

Other

-87.2

2000.0

132.0

44.8

-94.8

477.5

66.0

51.2

Operating profit

45.0

5.6

15.3

52.0

-44.3

98.5

31.0

-34.3

Net profit

TTB

220.0

100.0

85.9

-56.3

329.0

47.3

-55.3

Broadband subscribers

4,242

4,302

4,348

4,394

4,436

4,487

4,512

4,538

4,192

4,394

4,538

IPTV subscribers

1,067

1,187

1,307

1,445

1,569

1,723

1,861

2,000

981

1,445

2,000

Phone (home, corporate) subscribers

4,326

4,415

4,480

4,510

4,528

4,612

4,654

4,696

4,204

4,510

4,696

Key indicators


Figure 195. Quarterly earnings (Wbn)

Revenue (L)

800

OP margin (R)

Figure 196. Annual earnings (%)


(Wbn)

(Wbn)

8

3,000

600

6

2,250

80

400

4

1,500

0

200

2

750

0

0

NP margin (R)

0 1Q12

2Q12

3Q12

4Q12

1Q13

2Q13F



3Q13F

4Q13F

160

-80

-160 2010

2011

2012

2013F

2014F


114

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SK Broadband was established in September 1997 as Hanaro Telecom, a provider of local call, telecom circuit rental, and telecom network deployment services. After being listed on the KOSDAQ in November 1998, the company acquired Dreamline in 2001 and merged with Thrunet in 2006. In 2H06, the company launched the VOD service Hana TV. In 2008, the Ministry of Information and Communication approved SK Telecom’s acquisition of Hanaro Telecom. SK Broadband (the company was renamed following the acquisition) launched real-time IPTV services in 2009 and introduced a new fixed-line brand. Currently, SK Broadband focuses on fixed-line telecom services, including broadband internet, telephone, IPTV, and corporate data. SK Telecom holds a 50.56% stake in the company. SK Broadband is the second-largest company (market share of 24%) in the Korean broadband internet market behind KT. Although its revenue is stagnating, revenue from IPTV and corporate data businesses is expected to increase steadily. Figure 197. Market share breakdown: High-speed Internet subscribers (2012)

Figure 198. Revenue breakdown and outlook (Wbn)

Others 17%

800

Broadband

IPTV

PSTN

B2B

Other

4Q12

1Q13

2Q13F

600 KT 44%

LG Uplus 15%

400

200

S K B roadband 24%



0 1Q12

2Q12

3Q12

3Q13F

4Q13F


115

Telecom Service

June 11, 2013

In the medium to long term, the mobile IPTV and B2B businesses are expected to display marked growth. Since the introduction of LTE services, demand for high-quality video content has been rising. During the initial stages of smartphone market growth, SK Telecom, which has the largest mobile phone subscriber base in Korea, greatly benefited from its relationship with its subsidiary LOEN Entertainment. In the wireless LTE era, SK Broadband’s IPTV business should serve as a new growth driver for the company. In addition, the company is improving its market share in the B2B segment in line with the expansion of its customer base. The telecom unit engages in PSTN, internet phone, and leased-line businesses. General phone number services for corporate customers are also an important business for the unit. The IDC unit’s major customers include Koscom, Daum, IBM, and EBS. The CDN unit is expanding marketing activities for solutions and preparing for an expected increase in media traffic. Currently, the CDN unit is providing services to EBS, SBS Contents Hub, KakaoTalk, and Nexon. We also note that cooperation and synergies with SK Telecom are boosting SK Broadband’s competitiveness. Figure 199. Corporate governance 99.0%

Bizen

100%

Infosec

48.5%

SK C&C (034730 KS)

100%

Choi Tae-won & 54.5% affiliates

Encar Networks

0.1% 5.9%

SK E&S

25.2%

SK Energy 100% 50.0%

100%

Netruck Jeju United FC SK Global Chemical

100%

SK Lubricants 41.0%

100%

Daehan Oil Pipeline SK Mobile Energy

42.5%

SK Telecom (017670 KS) 50.6%

SK Broadband (033630 KQ)

100% 21.1% 83.5%

72.2%

80.0%

SK Hynix

46.3%

10.0%

SKC Lighting SKC Airgas SKC Solmics

50.0%

SK Telesys

5.0% 86.5%

65.0%

SK-W

PS& Marketing F&U Credit Information

42.5% 100%

100%

Happy Narae

100%

Service Ace

100%

100%

Network ONS 100%

27.9%

SK Planet

67.6% Loen Entertainment (016170 KQ)

51.0%

64.6% SK Communications (066270 KQ)

100%

100%

100%

Commerce Planet

SK Networks Service

100% 100%

100%

SK Pinx 79.6% 100%

LCNC Speed Motors

Ami Power Silicon File Tech. (082930 KQ)

13.7%

SK E&C

Busan City Gas (015350 KS)

40.4%

PMP

100%

Chonnam City Gas

32.0%

Daejeon Clean Water

42.0%

Gwangju Clean Water

100%

Kangwon City Gas

100%

Chungcheong Energy Service

100%

Jeonbuk Energy Service

100%

Yeongnam Energy Service

100%

Pyeongtaek Energy Service

99.7%

Ko-one Energy Service

71.0%

Wirye Energy Service

Hynix Engineering SK Hystec

83.1%

40.0%

SK E&S 40.0%

SK Securities (001510 KS)

Choi Chang-won & affiliates

SK Shipping

100%

25.4%

SK Networks (001740 KS)

SK Wyverns

100%

42.5%

SK Forest

94.1%

39.1%

SKC (011790 KS)

Service Top

SK Telink

100%

50.0%

SK Biopharm 100%

33.4%

SK Innovation (096770 KS)

SK (003600 KS)

5.0%

Happy Narae

100%

31.8%

SK D&D

45.5%

SK Chemical (006120 KS) SK Gas (018670 KS) 5.0%

Leviathan Asset

10.0%

Happy Narae 50.0%

SK Cytec 44.0%

100%

UB Care (032620 KQ)

SK Syntec

50.0%

Kimcheon Energy

Television Media Korea Madsmart M & Service

Note: As of 1Q13 Source: Company data, KDB Daewoo Securities Research


116

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SK Broadband is seeing an improvement in profitability and cash flow in line with its sales growth. We expect the company’s profitability to continue to improve on the back of customer base expansion, sales growth in the IPTV and corporate businesses, and an increased revenue contribution from the high-margin B2B business. Annual net debt is on a steady decline, and the company’s average borrowing rate slid from 6% in 2010 to around 4% in 2012. Risks for SK Broadband are as follows: 1) The company’s earnings growth is largely driven by orders from SK Telecom. When SK Telecom was ordered to suspend certain operations in 1Q13, SK Broadband witnessed a slowdown in net IPTV subscriber growth. Accordingly, investors are concerned about the company’s dependence on its parent company. And a merger with SK Telecom is also likely to be a looming possibility. In addition, the B2B business might be subject to government regulations on the related-party transactions of large conglomerates. 2) Marketing expenses are likely to increase in line with intensifying competition in the pay-TV market. Furthermore, content costs could increase for structural reasons, including competition between IPTV operators to attract subscribers and the increasing influence of terrestrial broadcasters. 3) The company’s low ROE and high debt ratio might raise concerns about valuation.


117

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June 11, 2013

SK Broadband (033630 KQ/Trading Buy/TP: W6,000) Comprehensive Income Statement (Summarized)


(Wbn)

12/12 12/13F 12/14F 12/15F

(Wbn)

Revenue

2,492

2,639

2,740

2,866

Current Assets

0

0

0

0

Gross Profit

2,492

2,639

2,740

2,866


SG&A Expenses

2,411

2,518

2,610

2,720

82

121

130

Operating Profit

82

121


-59

-45


57

55

Cost of Sales



12/12 12/13F 12/14F 12/15F 685

1,185

1,608

1,995

87

561

966

1,330

385

407

423

442

Inventories

41

43

45

47

146


17

18

18

19

130

146

Non-Current Assets

2,394

1,996

1,683

1,451

-40

-35


23

24

25

26

35

18

Property, Plant and Equipment

2,057

1,626

1,294

1,039

1

1

1

1

23

76

90

112


Intangible Assets

172

189

206

224

3,079

3,180

3,292

3,445

Current Liabilities

907

934

952

976

AP & Other Payables

202

214

222

233


450

450

450

450

Total Assets

0

1

1

1

23

75

89

111

0

0

0

0

Net Profit

23

75

89

111


255

270

280

293


23

75

89

111


1,062

1,066

1,075

1,099


1,000

1,000

1,000

1,000

32

36

45

70

1,969

2,000

2,027

2,075

Profit from Continuing Operations Profit from Discontinued Operations


0

0

0

0


17

70

84

106



17

70

84

106

Total Liabilities

Non-Controlling Interests EBITDA

0

0

0

0


1,111

1,181

1,265

1,370

556

552

461

402

Capital Stock

1,480

1,480

1,480

1,480


215

529

441

381

Capital Surplus

306

306

306

306

EBITDA Margin (%)

22.3

20.9

16.8

14.0

Retained Earnings

-684

-609

-520

-409


3.3

4.6

4.7

5.1



0.9

2.8

3.3

3.9


Cash Flows (Summarized) (Wbn) Cash Flows from Op Activities Net Profit Non-Cash Income and Expense Depreciation Amortization Others Chg in Working Capital

0

0

0

0

1,111

1,181

1,265

1,370

Forecasts/Valuations (Summarized) 12/12 12/13F 12/14F 12/15F

12/12 12/13F 12/14F 12/15F

436

546

458

399

P/E (x)

61.4

19.0

16.4

13.2

23

75

89

111

P/CF (x)

2.8

2.9

3.5

4.0

577

477

372

291

P/B (x)

1.5

1.5

1.4

1.3

474

431

332

255

EV/EBITDA (x)

4.7

4.0

4.0

3.6

0

0

0

0

-60

-5

-19

-31

EPS (W)

76

254

301

374

CFPS (W)

1,678

1,710

1,421

1,236 3,874

-163

-5

-2

-2

BPS (W)

3,173

3,351

3,576

6

-23

-16

-20

DPS (W)

0

0

0

0

-100

-2

-2

-2

0.0

0.0

0.0

0.0

-53

12

8

10

Dividend Yield (%)

0.0

0.0

0.0

0.0

0

-1

-1

-1

Revenue Growth (%)

8.6

5.9

3.8

4.6


-273

-7

13

30

-12.9

Chg in PP&E

-317

0

0

0

-17

-17

-17

-17

Chg in AR & Other Receivables Chg in Inventories Chg in AP & Other Payables Income Tax Paid

Chg in Intangible Assets Chg in Financial Assets

Payout ratio (%)

3.6

-0.7

-16.5


EBITDA Growth (%)

25.7

48.4

7.0

13.1

EPS Growth (%)

TTB

233.6

18.7

24.4

8

0

0

0

53

10

31

48

Cash Flows from Fin Activities

-300

-66

-66

-66

Chg in Financial Liabilities

-225

0

0

0

ROA (%)

0.7

2.4

2.8

3.3

0

0

0

0

ROE (%)

2.0

6.6

7.3

8.4

Others

Chg in Equity Dividends Paid Others Increase (Decrease) in Cash Beginning Balance Ending Balance

Accounts Receivable Turnover (x) Inventory Turnover (x)

6.5

6.7

6.6

6.6

73.1

62.8

62.2

62.5


0

0

0

0

-75

-66

-66

-66


ROIC (%)

-137

474

406

364

Current Ratio (%)

224

87

561

966


87

561

966

1,330


3.6

5.9

7.6

10.2

177.3

169.4

160.3

151.4

75.5

126.9

168.9

204.5

108.7

62.1

25.9

-2.6

1.1

1.8

2.0

2.2



118

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June 11, 2013

Important Disclosures & Disclaimers Disclosures As of the publication date, Daewoo Securities Co., Ltd. has acted as a liquidity provider for equity-linked warrants backed by shares of SK Telecom and KT as an underlying asset, and other than this, Daewoo Securities has no other special interests in the covered companies. As of the publication date, Daewoo Securities Co., Ltd. issued equity-linked warrants with SK Telecom and KT as an underlying asset, and other than this, Daewoo Securities has no other special interests in the covered companies.

Stock Ratings

Industry Ratings

Buy

Relative performance of 20% or greater

Overweight

Fundamentals are favorable or improving

Trading Buy

Relative performance of 10% or greater, but with volatility

Neutral

Fundamentals are steady without any material changes

Hold

Relative performance of -10% and 10%

Underweight

Fundamentals are unfavorable or worsening

Sell

Relative performance of -10%

* Ratings and Target Price History (Share price (----), Target price (----), Not covered (■), Buy (▲), Trading Buy (■), Hold (●), Sell (◆)) * Our investment rating is a guide to the relative return of the stock versus the market over the next 12 months. * Although it is not part of the official ratings at Daewoo Securities, we may call a trading opportunity in case there is a technical or short-term material development. * The target price was determined by the research analyst through valuation methods discussed in this report, in part based on the analyst’s estimate of future earnings. The achievement of the target price may be impeded by risks related to the subject securities and companies, as well as general market and economic conditions. (W) 20,000

LG Uplus

(W) 300,000

15,000

SK Telecom

(W) 60,000

200,000

40,000

100,000

20,000

KT

(W)

10,000 5,000 0

0 6/11

12/11

6/12

12/12

6/13

0 6/11

12/11

6/12

12/12

6/13

SK broadband

10,000 8,000 6,000 4,000 2,000 0 6/11

12/11

6/12

12/12

6/13

6/11

12/11

6/12

12/12

6/13

Analyst Certification The research analysts who prepared this report (the “Analysts”) are registered with the Korea Financial Investment Association and are subject to Korean securities regulations. They are neither registered as research analysts in any other jurisdiction nor subject to the laws and regulations thereof. Opinions expressed in this publication about the subject securities and companies accurately reflect the personal views of the Analysts primarily responsible for this report. Daewoo Securities Co., Ltd. policy prohibits its Analysts and members of their households from owning securities of any company in the Analyst’s area of coverage, and the Analysts do not serve as an officer, director or advisory board member of the subject companies. Except as otherwise specified herein, the Analysts have not received any compensation or any other benefits from the subject companies in the past 12 months and have not been promised the same in connection with this report. No part of the compensation of the Analysts was, is, or will be directly or indirectly related to the specific recommendations or views contained in this report but, like all employees of Daewoo Securities, the Analysts receive compensation that is impacted by overall firm profitability, which includes revenues from, among other business units, the institutional equities, investment banking, proprietary trading and private client division. At the time of publication of this report, the Analysts do not know or have reason to know of any actual, material conflict of interest of the Analyst or Daewoo Securities Co., Ltd. except as otherwise stated herein. Disclaimers This report is published by Daewoo Securities Co., Ltd. (“Daewoo”), a broker-dealer registered in the Republic of Korea and a member of the Korea Exchange. Information and opinions contained herein have been compiled from sources believed to be reliable and in good faith, but such information has not been independently verified and Daewoo makes no guarantee, representation or warranty, express or implied, as to the fairness, accuracy, completeness or correctness of the information and opinions contained herein or of any translation into English from the Korean language. If this report is an English translation of a report prepared in the Korean language, the original Korean language report may have been made available to investors in advance of this report. Daewoo, its affiliates and their directors, officers, employees and agents do not accept any liability for any loss arising from the use hereof. This report is for general information purposes only and it is not and should not be construed as an offer or a solicitation of an offer to effect transactions in any securities or other financial instruments. The intended recipients of this report are sophisticated institutional investors who have substantial knowledge of the local business environment, its common practices, laws and accounting principles and no person whose receipt or use of this report would violate any laws and regulations or subject Daewoo and its affiliates to registration or licensing requirements in any jurisdiction should receive or make any use hereof. Information and opinions contained herein are subject to change without notice and no part of this document may be copied or reproduced in any manner or form or redistributed or published, in whole or in part, without the prior written consent of Daewoo. Daewoo, its affiliates and their directors, officers, employees and agents may have long or short positions in any of the subject securities at any time and may make a purchase or sale, or offer to make a purchase or sale, of any such securities or other financial instruments from time to time in the open market or otherwise, in each case either as principals or agents. Daewoo and its affiliates may have had, or may be expecting to enter into, business relationships with the subject companies to provide investment banking, market-making or other financial services as are permitted under applicable laws and regulations. The price and value of the investments referred to in this report and the income from them may go down as well as up, and investors may realize losses on any investments. Past performance is not a guide to future performance. Future returns are not guaranteed, and a loss of original capital may occur.


119

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Distribution United Kingdom: This report is being distributed by Daewoo Securities (Europe) Ltd. in the United Kingdom only to (i) investment professionals falling within Article 19(5) of the Financial Services and Markets Act 2000 (Financial Promotion) Order 2005 (the “Order”), and (ii) high net worth companies and other persons to whom it may lawfully be communicated, falling within Article 49(2)(A) to (E) of the Order (all such persons together being referred to as “Relevant Persons”). This report is directed only at Relevant Persons. Any person who is not a Relevant Person should not act or rely on this report or any of its contents. United States: This report is distributed in the U.S. by Daewoo Securities (America) Inc., a member of FINRA/SIPC, and is only intended for major institutional investors as defined in Rule 15a-6(b)(4) under the U.S. Securities Exchange Act of 1934. All U.S. persons that receive this document by their acceptance thereof represent and warrant that they are a major institutional investor and have not received this report under any express or implied understanding that they will direct commission income to Daewoo or its affiliates. Any U.S. recipient of this document wishing to effect a transaction in any securities discussed herein should contact and place orders with Daewoo Securities (America) Inc., which accepts responsibility for the contents of this report in the U.S. The securities described in this report may not have been registered under the U.S. Securities Act of 1933, as amended, and, in such case, may not be offered or sold in the U.S. or to U.S. persons absent registration or an applicable exemption from the registration requirements. Hong Kong: This document has been approved for distribution in Hong Kong by Daewoo Securities (Hong Kong) Ltd., which is regulated by the Hong Kong Securities and Futures Commission. The contents of this report have not been reviewed by any regulatory authority in Hong Kong. This report is for distribution only to professional investors within the meaning of Part I of Schedule 1 to the Securities and Futures Ordinance of Hong Kong (Cap. 571, Laws of Hong Kong) and any rules made thereunder and may not be redistributed in whole or in part in Hong Kong to any person. All Other Jurisdictions: Customers in all other countries who wish to effect a transaction in any securities referenced in this report should contact Daewoo or its affiliates only if distribution to or use by such customer of this report would not violate applicable laws and regulations and not subject Daewoo and its affiliates to any registration or licensing requirement within such jurisdiction.

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Tel: 65-6671-9845

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120

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Telecom Service

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