Kazakhtelecom applies for approval of the purchase of 75% of Kcell shares by Antimonopoly Committee

Andrey KozhokaruJanuary 24, 2018

The Committee for Regulation of Natural Monopolies of Kazakhstan began the review of Kazakhtelecom's application for the purchase of a 75% stake in Kcell

The Committee for Regulation of Natural Monopolies of Kazakhstan began the review of Kazakhtelecom's application for the purchase of a 75% stake in Kcell. Previously, the main shareholder of Kcell, Telia Company? several times announced its intentions to sell its stake in Kazakhstani Company. As of 01.01.2018, 60.4% of Kcell's shares belonged to Telia Company, 14.6% to Turkcell, about 9% to Freedom Finance and 16% to other institutional and private investors. Most likely, Kazakhtelecom intends to acquire shares of Telia Company and Turkcell, representing 75% of Kcell's total equity. As of the end of 3Q2017, the subscriber base of JV Tele2-Altel totaled 6.8mn. The subscriber base of Kcell was 10mn. Taking into account the Company's plans to increase the market share of the JV Tele2-Altel, the potential number of Kazakhtelecom's user contracts after the acquisition of Kcell may reach 17mn, which would exceed 65% of the total market.

Our opinion:

The main component for the acquisition is the obtainment of the permission from the Antimonopoly Authorities of the Republic of Kazakhstan. Despite the fact that this transaction would allow Kazakhtelecom to dominate in the mobile segment of Kazakhstani market, we do not exclude the possibility of the Antimonopoly Committee approving this transaction. The main factors to consider will be the structure of the transaction and further strategic plans of the Company.

As of the end of 2016, the Kazakhstani mobile communications market was divided among Kcell, Beeline and JV Tele2-Altel in proportions of 39.2%, 35.5%, and 25.3%, respectively. Assuming proposed acquisition would take place and Beeline will maintain its market share held in 2016, of 35.5%, the combined market share of Kazakhtelecom could reach 64.5%. Given the specifics of the telecommunications sector, the oligopoly may be the standard, but in the case of this deal, one can assume without any detailed estimations that Kazakhtelecom will be able to occupy a dominant position in the mobile segment. Consequently, the Company will have the leading positions in almost all major segments of the telecommunications industry. (Kazakhtelecom's market shares as of December 31, 2016: broadband 72%, fixed line 93%, data transmission 73%)

Another main factor in the proposed transaction is its financing. As of September 30, 2017, Kazakhtelecom had 99.8bn KZT on its balance, of which bank deposits with maturities of 3-12 months represented 62%, the Company's debt was 55bn KZT. According to our estimates, after 30bn KZT bonds buyback in 4Q2017, Kazakhtelecom should have around 70bn KZT in cash and cash equivalents and the total debt of 26bn KZT at the beginning of 2018. The current market value of Kcell is 333.8bn, considering yesterday’s closing price of 1 669 KZT per share. Therefore, Kazakhtelecom should pay around 250bn KZT for 75% stake in Kcell, which will require over 180bn KZT of the additional financing.

Kazakhtelecom has sufficient reserves relative to its stipulated covenants and could increase the debt burden for the amount needed to purchase Kcell, excluding the realization cost of option for the stake of Tele2 AB in JV. (the threshold Debt/EBITDA is not more than 3.5 versus 0.38 at the end of 2017, the Debt/Equity ratio is no more than 1.00 versus 0.07 at the end of 2017). The reduction of debt, strong financial results from core operations and a significant decrease in the loss from the JV in 2017 are the main factors, which ensured the improvement of the above credit metrics.

According to the agreement concluded with the Swedish Company, Kazakhtelecom has obligations to finance JV Tele2-Altel until the share of debt will equal to the Company's economic share in the JV (51%). As a result, in the medium term, Kazakhtelecom will bear all the necessary financing costs associated with the JV. Meanwhile, the Company has an option to buy out the stake of Tele2 AB. The realization of the option will be available in 1Q2019. The option will be valued at fair value at the time of the exercise. In case of the option realization, Kazakhtelecom will have to return the Tele2 AB shareholder loan (101bn KZT including interest), net of Tele2 AB debt to the Company (around 4.6bn, discounted to the option date).

Kazakhtelecom will need a significant increase in the debt burden to finance the acquisition of 75% of Kcell, which is possible from the point of view of its financial stability coefficients. The exercise of the option to buy out the Tele2 AB stake in the JV may also require additional financing, the amount of which will depend on the dynamics of the financial performance of the JV. The issue of sources and costs of funding for the implementation of the proposed transaction remains in place.

In order to effectively evaluate the financial and operational effects of the proposed acquisition of Kcell, additional information on the structure of the transaction is required, including the main financial and legal aspects. Our recommendation on Kazakhtelecom’s shares is under review.