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Resume with Underweight as mobile pricing strategy compromises value

TE’s foray into mobile, as a fourth entrant, relinquishing value. We resume coverage on Telecom Egypt (TE) with an Underweight rating based on a 12M TP of EGP12.0/share. Our valuation is impeded by loss-making margins for TE’s newly launched mobile segment branded “WE”, as well as falling EBITDA margins (-249 bps y-o-y in 2018 on a recurring basis), along with rising net debt (to 2x EBITDA), which we expect the company will need by end-2018. Vodafone Egypt (VFE) alone represents 71.7% of our TP, which is based on a 3.5x 2018e EV/EBITDA multiple, derived using relative industry valuation, based on a 2017-19e EBITDA CAGR of -3.2% for VFE.

Betting on data is risky. WE’s launch on 20 September 2017 came at prices discounted to incumbents’ by up to 48% on some bundles, with a focus on the underpenetrated data market. However, such aggressive discounts will attract price-sensitive subs (ARPU assumed to be 27% lower vs. the market) whom we expect will consume more voice. We view this as loss making since TE relies on national roaming (it does not own 2G and 3G licenses).

Higher debt, lower DPS. Due to negative mobile margins, high capex, elevated interest rates, and lack of dividend inflow from VFE, we believe TE will not be able sustain the same DPS or finance its operations internally. In our view, the company will lower its 2017 DPS to EGP0.5 (40% DPO, in line with latest guidance) from EGP1.0 in 2016. We expect TE will resort to external funding, with net debt reaching EGP10.2bn in 2018, 2.0x EBITDA up from 1.5x in 2017e.

Company risks are skewed to the downside. Potential biometric SIM verification, and a lack of other national roaming agreements could hamper TE’s growth. Higher-than-expected subs’ usage of loss-making voice services could add more pressure on cash flow. Management’s efforts to enhance efficiencies have yet to yield results; any failure to do so would also pose a downside risk to our TP.