SK Telecom in Holding Pattern

 SK Telecom (SKM) recently reported Q1 2008 results (all results KRW unless noted):

Financial Results

• The company did not release cash flow figures, only the income statement & balance sheet figures. However, they did show a 60% capex reduction to 278M KRW which should improve free cash flow.
• The balance sheet was mostly stable, with the exception of a huge bump up in accounts payable, up to 2.8T(rillion) KRW from 1.1T KRW at YE 2007. This lowered the current ratio to 1.09, down from 1.65 from Q4 07. Long-term debt also increased 26% to 2.9T KRW. There were no obvious net increases on the assets side of the balance sheet and I did not find an explanation for the increases in liabilities so it will be interesting to see upcoming Q2 figures.
• Operating income fell 16% YOY to 554M KRW. On a sequential basis from Q4 07, this figure looked much better, up 78%. The big story here was the reduction in marketing expenses.

Other Items

• SK Telecom added 403K net subscribers, with an uptick in the churn rate to 3.1%, up from 2.6% and 2.7% YoY/QoQ respectively.
• ARPU is down to 42,654 KRW, down 3% and 4% YoY/QoQ respectively. This will be a number to watch as management is targeting ARPU as part of their growth strategy and mentioned 43,100 KRW as a baseline target number.
• Management also broke out loss figures for several of their affiliates in Q1 2008:
  • Helio [US]: -27.3B KRW
  • S-Fone (Vietnam): -3.8B KRW
  • total: -49.3B KRW compared to -75.4B KRW in Q4 2007

SKM is still coping with a shifting competitive and regulatory environment, which is reflected in their operating results as well as the share price. Once again, the conference call was filled with vague generalities about the company’s strategy as Asian management simply have different accountability standards than we are used to. But there were a few interesting tidbits.

The hanarotelecom acquisition closed and while there may be some legacy issues with misuse of customer data, management talked about some aspects of the transaction and the benefits it may bring. The obvious benefits are the ability to offer bundled services on their own networks and combined distribution and marketing systems for both entities. But they also mentioned new access to what were previously hanaro-only subscribers so post-acquisition strategy and execution will be important to watch.

The company also discussed some aspects of the Chinese telecom shake-up. The recent developments were troublesome for SKM in several ways. First, China Unicom’s CDMA network is being sold to China Telecom. SKM had been positioning for a strategic relationship with C. Unicom and hence, SK has a good-sized stake in them. Second, most Chinese telecom stocks sold off on the announced realignment, which hurts the book value of SKM’s stake. Some analysts broached the topic of a joint venture with China Telecom but management rebuffed such talk as premature and has denied any plans to take a stake in China Telecom. I was skeptical of SKM’s China strategy in my initial write-up and remain so.

To take that last point further, I was originally skeptical of all the company’s non-domestic ventures. The opportunity with the most potential in my view was S-Fone, the Vietnamese venture. There, management mentioned an upcoming round of 3G licensing as well as nearly 4M subscribers at the end of Q1 2008. Helio is still hemorrhaging money and I wouldn’t expect that to change anytime soon. Profitability was targeted for 2010 but I wouldn’t bet on it. I also am unimpressed by the news that Virgin Mobile USA and SK Telecom are in strategic talks. Any transaction that lowers SK’s exposure to the US market is a plus but as of now, there’s little indication as to whether SKM is looking to increase or reduce US activity.

In the meantime, we will watch domestic results carefully. Management warned of further price wars but sent a very strong message that they intend to maintain 50.5% market share. There is also some talk about KTF (KTC) making a deal with Apple (AAPL) for the iPhone, which could be disruptive to current market share. Here are the performance measurements I’m watching going forward:

2008 Guidance

• Revenue 11.7T KRW
• CapEx 1.75T KRW
• ~1M net adds

Performance Measurements

• 2008 FCF ~1.7T KRW
• ARPU ~ 42k - 43k KRW
• Marketing expenses increased but as a result, I’d expect to see SKT match or exceed KTF’s 3G subscriber numbers.
• Keep market share stable ~50.5%.
• Clarify China strategy.
• Vietnam venture:
  • 3G licensing
  • currently 4M subs, toward target of 5M
  • improve on Q1 08 loss of 3.8B KRW (2007 = 17.6B KRW share of equity losses)
• No further entry into the US market:
  • Best case scenario would be selling Helios to Virgin Mobile USA
  • Stay out of any bidding for Sprint Nextel

Disclosure: Author has a long position in SKM