VimpelCom (VIP) is the holding company for telecommunications operators, providing voice and data services through mobile, fixed and broadband technologies. VIP has a lot of wholly-owned operating subsidiaries in different developed and emerging countries such as Russia, Ukraine, Armenia, Cambodia, Laos, Pakistan, Italy, etc. VIP has 49% of the operators in Vietnam and it recently acquired WIND mobile in Canada. For mobile operators, growth depends on the population and its penetration into the markets it is exposed to. In the annual report of 2010, VIP is reported to cover a territory with a total population of 843 million.
In the Q2 2011 earnings conference call, Jo Lunder, the CEO of Vimpel, who has been with the company for 10 years in the role of CEO, board member and Chairman of the board, discussed the operating performance for the quarter. Revenue increased 9% year on year to $6 billion with the growth in all business units in all regions. This quarter's result was actually influenced by Kyivstar in the full quarter and the Wind Telecom acquisition as of April 15. Compared with the second quarter, the 2010 result has only Kyivstar included as of April 21.
EBITDA jumped 73% to 2.2 billion, representing a large cash flow into the business. Nevertheless, net income declined roughly by 29% because of higher interest expenses and higher depreciation and amortization charges with Wind Telecom transactions. Net income increased by 42% year-on-year resulting from the favorable currency movements offset by increased depreciation and tax expenses. The capital expenditure rose 41% to $1 billion, taking around 21% expected revenue for the year in 2011. Based on the TTM, the second quarter is currently in line with full year 2010; CAPEX to revenue would be at the level of around 20%.
The CEO discussed that the company should be viewed in the essence of three strategic clusters, with different approaches, different strategies for different clusters. The first cluster is the large and mature market such as Italy and Russia, where it focuses on increasing profits and generating more cash flows. Those markets would be potential for broadband growth in both fixed and mobile. The second cluster is the growth area consisting of Ukraine, CIS, Bangladesh, Pakistan and Algeria. Those would have large potential addressable markets with high revenue growth, low penetration and untapped growth potential for mobile data. The third is the area for growth opportunities. This cluster includes early-stage operations that would need more investment for it to reach the full potential.
Over the past 15 years, the market price of VIP has grown gradually. Especially super growth in the share price happened during the period of 2003 – 2007, where the share price jumped from $2 to $42. And now it’s hovering around $9/share. In terms of fundamentals, the revenue, operating income, net income and return on equity is good with the data taken from 2009. The return on equity stays around 22-25%. In addition, it generates a lot of operating cash flow and free cash flow. TTM operating cash flow and free cash flow of VIP are $4.1 and $1.7 billion respectively. For financial health, the WIND merger has pushed the debt load of VIP to more than double, and now the Debt/Asset ratio is at nearly 73%, quite a high figure. That is why even the market cap is staying at $14.8 billion; the actual enterprise value of VIP is more than $39 billion. The cash flow operating ratio to debt is only 16%, not a comfortable level for any conservative investor like me.
With the valuation of 7.6x earnings, and 3.3x cash flows, VIP seems to be quite cheap when compared with the industry average of 12x and 4.4x respectively. However, with the debt load currently a burden on VIP, the valuation on enterprise value is actually 20x earnings and 8.7x cash flow. It doesn’t seem to be cheap anymore.
With the potential growth in the future and stable operating and free cash flow that VIP is expected to generate, VIP fundamentals are no doubt very promising. However, I would rather see its level of debt decreasing for me to establish the position.