KT Corporation ADR (KT, Financial) enjoys a strong position in the Korean telecom market. With 18.2 million customers, the company is the incumbent fixed-line telecom operator. Moreover, its 8 million subscribers place the firm as the largest broadband provider, with almost twice the customers its competitor SK Telecom Co. Ltd. (SKM, Financial) possesses. In addition, 16.3 million wireless service users have garnered the firm the second largest base, while 4.7 million pay TV subscribers support a growing business unit.
Diversifying for Growth
However, a 60% market share of the fixed-line segment and a 30.5% share of the wireless business are not sufficient to make revenue bloom in these fields. Thus, in 2013, revenue from fixed-line operations fell 6.7% while its wireless unit gained a lean 0.9%.
In this scenario, KT’s expansion into non-telecom businesses such as payment processing, media and cloud computing plays a key role in the company’s strategy to resume growth. In fact, these businesses increased revenue by 3% in relation to the prior year, with most of this success stemming from pay TV. Furthermore, management’s objective is to generate 45% of total revenue from these units by 2015.
The Outlook
Telecom market is changing. Consequently, as it is happening to most fixed-line operators, KT is losing subscribers who move to VoIP or go wireless only. Although the impact on revenue is significant, some of the losses are offset by the firm’s gaining these changing customers for itself.
On the other hand, the launch of the LTE service made its base of wireless customers double in the last year. And LTE users tend to deliver higher average revenue per user, which is a good sign looking ahead.
However, last year’s less-than- expected revenue decline of only 0.2% was at the expense of heavily hurting margins. The growth of LTE customer base required extra marketing spending, and although this situation has improved, expenditures in this area are still very high compared to other countries.
As for new businesses, they are likely to have lower margins than KT’s traditional operations and they also carry greater execution risk, since they are not the firm’s core competence. Hence, rivals are better positioned to race in these fields since the firm does not have the economic moat it does boast in the telecom arena.
Additional Risks
Apart from TK’s unlikely target of making 45% revenue out of new businesses by 2015, from current 27%, the firm announced it will cut its capital expenditures by 18.5% in 2014, which seems unsustainable.
Following its growth ambitions, the company also has a plan to boost revenues through overseas merges and acquisitions. Thus, although first negotiations to acquire an African Internet service provider from Telkom SA SOC Ltd. (TLKGY, Financial) failed, the company still looks forward to this purchase.
However, a corruption scandal involving CEO Lee Suk-Chae caused the executive to present his resignation in November 2013, thereby putting expansion moves on hold.
Valuation
High uncertainty regarding the results of its non-telecom businesses adds to the concern raised by a dividend cut of 50% due to weak revenue, depicting a blurry horizon for the firm.
TK’s stocks trade at 6.80 its trailing earnings compared to the industry median of 16.70. Its return on equity, however, showcases a dismal -0.47% against its rivals’ 12.49%. Its operating margin, in turn, is at its lowest in a decade with 3.52%, while its revenue growth lags the industry average of 3.90% with 2.90%.
Investment guru Charles Brandes (Trades, Portfolio) sold out his holdings in the company backing my bearish feeling about KT’s potential for growth.
Disclsure: Patricio Kehoe holds no position in any stocks mentioned.
