Karachi Stock Exchange - Pakistan
Our channel checks suggest that the much touted International Clearing House (ICH) mechanism is very close to implementation. The only concerns at the moment are the objections raised by the Competition Commission of Pakistan (CCP), where we expect the Ministry of Information and Technology (MoIT) to amicably address the concerns of CCP. ICH will lead to the revival of the LDI sector in our view and should result in multiple rerating for the sector. While the market has today partially priced in the optimism from ICH as far as PTC is concerned (forward EPS could jump to PkR7.2 ex-VSS), we believe that the smaller telco players (TELE, WTL and WTCL) should also be in for a sustained bull run.
ICH key terms: In order to enhance the understanding of our readers, we have provided definitions/explanations of some of the telecom jargon (Source: Access Promotion Rules 2004):
i) Approved Settlement Rate (ASR): Half of the Approved Accounting Rate (AAR), which is the rate that a license negotiates with a foreign service provider for handling of one minute of international telephony.
ii) Access Promotion Charge (APC): Payments made by LDI licensees to LL (Local Loop) licensees or to the Universal Service Fund. It is the charge which an LDI operator pays to LL operator for termination of calls on the LL system. Recall that PTCL is the main LL operator in the country, so unlike other LDI’s, it will not have to pay APC, instead it will receive APC payments from other LDI operators.
The market dynamics: Total market size for incoming calls inclusive of the grey traffic is ~2bn minutes per month. Presently, the incoming traffic is mostly coming through legal channels owing to extremely low incoming rates. Post ICH we do see a significant fall in incoming traffic due to i) higher ASR will encourage grey traffic as well as shift towards VoIP platforms like SKYPE, ii) lower demand (demand elasticity), and iii) increase in outgoing traffic where currently outgoing traffic represents ~23% of total international traffic in Pakistan. Despite the said changes, we believe that incoming traffic through the legal channel should still average at around ~1bn min/month, where stricter monitoring, investment in infrastructure to prevent illegal traffic and need for greater voice quality should help curb grey minutes. VoIP is a concern for telcos globally and as per ‘TeleGeography’, VoIP accounted for ~30% of global international traffic.
Earnings impact: ICH will be a game changer for the listed telecom sector, particularly PTC, as the company will have 50% share in revenues from ICH, furthermore, unlike other LDI operators, PTC will actually receive APC and will not have to pay 15% of its LDI margin towards the settlement of USF dues. We estimate incremental per minute revenue of Usc7.5/min for PTC and Usc5.0/min for the other LDI operators. Post creation of ICH, the bargaining power of PTC would be enhanced as it will be the only LDI operator, making it easy for PTC to negotiate the higher ASR rates with foreign operators. Below we have provided earning sensitivity to incoming traffic, where assuming 1bn min/month, the incremental revenue of PTC will amount to PkR42.75bn, resulting in an annualized EPS impact of PkR5.45. The earnings sensitivity of the Telecom sector provided on the previous page assumes a market share of 50% for PTC, ~3.5% for WTL, ~6% for WTCL and ~3% for TELE.
Recommendation: We highlight PTC as the major gainer from the ICH. Assuming recurring consolidated EPS of PTC of PkR1.75, forward EPS under ICH at monthly traffic of 1bn min could go up to PkR7.2 (ex-VSS), which in turn could conceivably bump up our target price to PkR50/share (assuming market P/E multiple of 7.0x). Similarly, TELE would also be a key beneficiary of the development (second highest EPS impact) followed by WTCL and WTL which should lead to multiple re-rating of these scrips in our view. We recommend a BUY stance on the sector with PTC being our conviction pick.
Risks to our call: CCP presents the biggest road block to our call, however we expect MoIT to amicably address the concerns of CCP, where the government itself would be a major beneficiary of the ICH in the form of higher foreign exchange earnings as well as improving the marketability of the telecom sector for 3G license auction. Another risk would be a huge jump in grey traffic, which could force PTA to reduce ASR in order for the sector to remain competitive. In this regard, a Usc1/min change in ASR will lead to a 13% reduction in our earnings estimates for PTC and 20% for other LDI operators.