The Special FX of Turkcell's Q2 Shouldn't Discourage Investors

| About: Turkcell Iletisim (TKC)

By “FX,” I’m referring in this case to foreign currency exchange, specifically, the 5.5% drop in the dollar versus the Turkish Lira in the second quarter, which Wednesday had the effect of producing rather surprising results for Turkey’s number one wireless phone operator, Turkcell (NYSE:TKC), the only Turkish stock with American Depository Shares (ADRs).

Turkcell’s ADRs traded down about .6% Wednesday after the company in Istanbul reported sales that were above analysts’ estimates, at $1.5 billion, versus $1.42 billion, on average, and profit that came in well below expectations, with net income of $273.6 million. That was less than the $311 million analysts were expecting, and essentially flat with the prior quarter.

How do sales outperform and profit underperform in the same quarter so dramatically? Turkcell’s sales are reported in dollars for the U.S. audience, but so are its expenses. The Turkish Lira’s rise from 1.38 Lira to the dollar in the first quarter to 1.30 in the second boosts both, and even though sales rose faster than expenses, at 29% year over year versus an 18% rise in expenses, the end result is still lower profit than expected.

To add insult to injury, Turkcell was on the wrong side of some currency trades: The company’s foreign exchange losses jumped to $139.9 million from a $73.4 million a year earlier as its dollar-denominated investments fell against the Lira (in case you’re wondering, Turkcell expects a strong Lira the rest of the year: management Wednesday said it's revising expectations for the closing exchange rate at year-end 2007 from 1.72 Lira to the dollar to 1.45).
But what the foreign exchange rate doesn’t count are some relatively robust statistics about Turkcell’s wireless business that should cheer investors.

For one thing, average revenue per user [ARPU] rose year over year by 13% to $14.1. No doubt that was also a result of the currency boost, but it’s impressive, nonetheless, in comparison to the 1% or so drop in the first quarter. ARPU was helped by a big jump in the average minutes per phone subscriber of 32% year over year — again, much better than the 8.5% rise in the first quarter. That, and the fact that churn was down from the first quarter, at 4.7%, compared to 5.1%.

How long people talk on the phone and how many of them flee the service or stay is not affected by currency accounting. Both stats show Turkcell’s been able to sign up more customers and get them to use their phones more. The company added 1.5 million subscribers in the quarter, 13.4% more than a year earlier.

And, in fact, that progress does show up in the financials if one looks a little deeper.

When all is said and done, the bottom line is not net income, but EBITDA, or earnings before interest, taxes, depreciation and amortization, which more closely approximates cash earnings. With the higher Lira, EBITDA mightily outperformed expectations, coming in at $596 million versus an estimate Tuesday night by Raymond James Securities for $554 million.

Those kind of metrics suggest Turkcell is prospering despite inroads made by #2 operator Telsim, owned by England’s Vodafone (NASDAQ:VOD). We’ll see what kind of response analysts come up with when they talk with management in Istanbul Thursday morning. But I have a feeling the Street will set aside the steeper cost of Turkcell’s expenses given subscriber additions and churn rates that were probably better than hoped for.

In after hours trading Wednesday evening, Turkcell’s ADRs rose 1.27% to $19.10.

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