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Morningstar | Tele2 Reports Flat 1Q Revenue Growth, Though Better EBITDA Margins; Shares Still Overvalued

Tele2 reported first-quarter results, with stronger EBITDA margin improvement than we expected as the benefits of last year’s acquisition of Swedish cable operator Com Hem appear to be accruing faster than we anticipated. Tele2 reported revenue was flat on a pro forma basis, as if the Com Hem acquisition occurred at the beginning of 2018. We model actual results, which puts our revenue growth estimate at 24.5%, generating 2019 revenue in line with 2018’s pro forma result. While we expect to increase our estimate for 2019 EBITDA margin, we don’t expect to raise our long-term projection and don’t anticipate any significant changes to our SEK 91 fair value estimate. We continue to believe the company has no economic moat and the shares are overvalued.

Revenue fell 1.6% year over year in Sweden, which accounts for 79% of the company’s revenue. On the consumer side, which generates 76% of Sweden’s revenue, revenue declined 1.5%. The unit saw slight subscriber growth in postpaid wireless and broadband, but larger customer losses in most other segments, particularly prepaid wireless. We believe the Swedish market has become more competitive and Telia is not going to easily give up market share to Tele2, especially in higher-value segments.

On the Swedish business side, revenue dropped 1.8% as the slight growth in mobile and solutions was more than offset by a 9% decline in fixed telecom services, primarily legacy services. This is a problem for most telecom operators that have divisions serving businesses. We expect this scenario will continue until newer services gain enough scale to offset the ongoing decline in legacy products.

While the Com Hem acquisition hasn’t generated much organic growth, it has provided significant cost-cutting opportunities, which allowed the firm to generate an adjusted EBITDA margin, excluding leases, of 32.4%, ahead of our full-year projection of 31.7%. However, we have already modeled in two more years of strong EBITDA margin expansion.

Weakness in Sweden was offset by continued strong revenue growth in the Baltic countries. The fastest revenue growth was in Lithuania, where revenue grew 11% year over year, followed by Latvia at 4% and Estonia at 3%. However, almost all of this revenue growth was driven by increases in average revenue per user as the wireless subscriber base declined in all three countries. We don’t believe this is a sustainable scenario.

We expect Tele2 will struggle to grow revenue consistently much above 1%. Yet, its stock trades at a 2018 EV/EBITDA multiple of 12.5 times. This is high for a pure cable company, but cable only makes up about 25% of the company. Even with higher projected EBITDA margins, its 2019 estimated EV/EBITDA multiple is close to 10 times. We think this is way too high for a company with low revenue growth prospects and average EBITDA margins for a communications company.