When Cellcom announced its offering, my initial, automatic response was to buy the stock on the offering. I had previously made a 40% return on my purchase of Cellcom’s competitor, Partner (PTNR).
How great it would be to profit from my high phone bills. Cellcom earned 91 million dollars on revenue of 974 million dollars for the first nine months of 2006. It seems that most of the revenue comes from me.
Although not by a wide margin, Cellcom (CEL) is the leading mobile phone operator in Israel. It has a 34.4% market share compared to Partner’s 31.1% and Pelephone’s 28.7%. I like to look at the market leader. My theory being that if they are able to dominate in a competitive marketplace, they will be able to increase their domination.
When I looked to invest in any emerging market country, one of the first industries that I investigate is the phone or mobile phone operator. Usually, in an emerging market country, penetration of phone lines and mobile phone usage increases with the modernization of the country.
With her hi-tech prowess, Israel is not only an exception to that rule, but I am not even sure there is much room for more market penetration in a country where almost every 10 year old has a cell phone. In fact, cell phone usage in Israel only increased 4.6% in 2006.
In a country of 6 million people, there are 7.6 million registered phone users in Israel. In most countries, less than half the population (43%) has a cell phone. According to the prospectus, Israel has the fourth highest cell phone penetration after Italy, Greece, and Portugal. As an added advantage, studies show that Israelis, unlike citizens of other countries, prefer to use their cell phone at home.
Reading the prospectus made me rethink some of my original optimism about the offering. The debt level at Cellcom is a whopping 767 million dollars. In the prospectus, the company said that it is reducing workforce and renegotiating contracts with key suppliers to increase revenue. That is not good enough for me.
As someone who got burned in the previous telecom crash, I am cautious about such high debt levels. Cellcom’s dividend policy of distributing dividends equivalent to 75% of net income seems irresponsibly high with the current debt load. Debt should be pared down before large dividends are paid.
The current regulatory climate in Israel is not favorable to mobile phone operators. The Israeli communications minister, Ariel Atias, is determined to cut prices for mobile phone users.
The thing that disturbed the most was that none of the proceeds of the offering were going to the company. Instead of paying down the company’s debt, all the proceeds went to the selling shareholders, Nochi Danker’s IDB and Goldman Sachs. I almost never buy this kind of offering. I am a communist in a capitalist’s job. I think that offerings should not just line the pockets of the owners, but should also strengthen a company.
At the IPO offering price, Cellcom stock was priced at 17 P/E earnings ratio. I can not see any reason why does Cellcom deserve of a 30% premium in P/E to its nearest competitor Partner? Partner was trading at a 13 P/E at the time of the IPO. It moved up to a 14 P/E recently in response to the Cellcom pricing.
I am passing on Cellcom because it is richly priced and the debt repayment may become a problem in the future.
CEL 10-day chart
Disclosure: Author has no position in CEL.