Moderate turn around for Sri Lanka Telecom

Sri Lanka Telecom (SLT), the Company with a 1.8 billion shares in issue, is one of the largest market capitalised companies on the Colombo Stock Exchange (CSE).

SLT is by far the biggest player in Sri Lanka among the Fixed Line Telecom service providers, with a base of 860,468 fixed lines(estimated market share 87%) as at end of the December 2004.

The mobile subsidiary, Mobitel, had a subscriber base of 285,000 (estimated 19% market share) as at end 2004. Given the steadily increasing demand (in some cases potential subscribers are expected to be on a waiting list, which can be as long as 12 to 18 months.) and the expansion plans of the Company, the number of lines in operation is estimated to reach 900,000 by the end of FY 2005. We estimate that the number of potential subscribers on the waiting list to be in excess of 350,000.

Tough Times to End?

The group profits for the FY 2004 had declined by 43% Year on Year. This can be mainly attributed to the following:

(a) The Government imposed International Operators Levy that came into operation during FY 2004. The impact on the bottom line was SLRs. 2,474 Mn.

(b) Mobitel continued to make losses. The impact on the Group Profits was a SLRs. 1,328 Mn loss.

(c) The tsunami related loss of SLRs. 330 Mn was another unforeseen charge on the bottom line.

(d) Higher than proportionate increase in Operating Costs compared with Revenue, mainly as a result of promotional expenditure for Mobitel.

The 1Q 2005 results, however, appears to indicate a moderate turnaround for SLT mainly as a result of lower Interest Charges and higher Interest Income. SLT carried out a successful international bond issue amounting to US $ 100 Mn in 2004 and as a result the overall interest cost has declined.

Is Mobitel turning around...?

Mobitel is a fully owned subsidiary of SLT and currently holds a market share of approximately 19% in the mobile telecommunications market, with estimated 285,000 subscribers in its network. The GSM launch was successful and made a significant impact in the industry.

As at end of 1Q 2005, Mobitel's total non-current debt stood at SLRs 4,856 Mn with a retained loss of SLRs 1,670 Mn. The short-term debt of Mobitel as at end of 1Q 2005 was SLRs 1,951 Mn. The loss incurred during the 1Q2005 was SLRs 152 Mn as opposed to a loss of SLRs 341Mn during the same period FY 2004.

The investments made in Mobitel are likely to pay-off in FY 2005. It is our opinion that Mobitel may break-even during the 4Q 2005 and there is a possibility of reporting a marginal profit by the year end.

The contribution from Mobitel is expected to be significant in the medium to long-term. The ability of SLT to offer a complete telecommunication solution to its customers is one of the competitive advantages it has over its rivals.

Internet based services

One of the key growth areas of the future for SLT would be the internet based services. Low penetration likely to change in the future as the government has now made it a priority to develop the Information Communication and Technology (ICT) sector.

SLT has taken an early lead in providing internet based services leveraging on its wide penetration within the country. We estimate that as much as 20% of its gross revenue would accrue from internet based services within the next three years.

The Revenue generated by the Company is forecasted to increase by 6% year on year driven mainly by the increase in domestic call revenue, turnaround in the international call market and the expected performance of Mobitel to SLRs 31,455 million in FY 2005.

Operating Costs are forecast to increase by 15% year on year to SLRs 16,237 million in FY 2005, on account of higher operating expenditure, repairs and maintenance and payments to international network operators.

In addition the International Operators Levy (Levy) would continue to be a burden on the bottom line. However, according to the Company, "..regulations may be made for disbursement of these levies.

The regulations are still under preparation. It is likely that 2/3 of the levy will be refunded ...for rolling out the network in rural areas. Accordingly, the refund to SLT has been estimated at SLRs 1,646 Mn...." The regulations for such refund have not yet been gazetted and if gazetted would be a bonus for the Company.

The bottom-line is likely to get a significant lift from increased interest income and reduced finance charges as the Company's balance sheet is carrying a significant amount of cash and cash equivalents. The decline in overall interest cost as a result of the US $ 100 Mn bond issue is a major factor in reducing interest cost.

We are of the opinion that FY 2005 would be a year of turnaround for SLT. With internet based services and Mobitel expected to contribute positively, the Operating Profit is forecast to grow 6% Year on Year to SLRs 6,824 Mn.

The Profit After Tax is forecast to be SLRs 2,864 Mn in FY 2005. This is a significant recovery from the Net Profit reported in FY 2004. This recovery is primarily because of the Levy being applicable only for a twelve-month period (as opposed to it being charged with retrospective effect from March 2003, during FY 2004).

We are of the opinion that at despite a relatively high forward PE multiple of 11.97 times the stock provides an opportunity for investors to participate in a high-growth industry.