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MICC - The short case

|Includes: Millicom International Cellular S.A. (MIICF)
At today's stock price of $79, MICC's enterprise value is $9.9 billion and its 31 million subscribers are valued at $320/sub. Is that cheap, fair or expensive? Let's take a look.
Their ARPU (average revenue per user) is $10/month and monthly churn rate is 5%, implying that the average customer lasts 20 months i.e. providing a cumulative gross revenue of $200 before the customer goes away. Even if they had zero operating costs, zero corporate overhead and zero customer acquisition costs, just the gross revenue number makes them look overvalued today. But of course the aforementioned costs are nowhere near zero. My estimate is that their average subscriber should be worth less than $100, implying the aggregate value of their current subscribers to be no more than $3.1 billion, which backs out to $15/share.
So the next question is: Could they significantly grow their subscriber base or improve the value of their existing subscribers to justify the $320/sub tag? Let's look at key factors that will impact the answer.
1. Could MICC increase the ARPU (say from $10 to $20 per month) by providing 3G, value add services etc.? This would have been thinkable if they were providing services in the developed world or even India/China. But the bulk of their upgrade opportunity lies in African and Central American countries where per capita income is on the average $125 per month. I don't think the masses will spend 16% of their income on their cellular bill. My verdict: Very difficult for them to double their ARPU across the board.
2. Could MICC reduce churn rate (say from 5% to 2.5%) effectively doubling the life of each customer? Reduction of churn rate could add a lot more value to their subscriber base. However, most of their subscribers use prepaid cards, which is the norm in most less developing countries. Such subscribers shop for the lowest price and have zero loyalty. There are multiple service providers in each of their markets - in some they are one of six providers. It is possible they could score a slight improvement in their churn rate but I don't see it halving given the customer behavior. My verdict: Customer churn will remain an issue.
3. Could MICC grow the subscriber base by increasing penetration and/or gaining market share? The short answer is yes. However, their relatively wealthier Central and South American markets already have a 60-80% penetration and stiff competition which is primarily based on pricing. There is limited growth opportunity in those markets. Current penetration is lower in African markets. There is a lot more room to add subscribers in African markets but given the demographic makeup, new users are likely to be at $5 per month ARPU rather than $20. Their new subscribers will be worth even less than their current subscribers.
My belief is that the business will have a best case valuation of $6 billion in a couple of years assuming they add another 10 million subscribers and somehow improve their ARPU and churn rates to accomplish a $150 per subscriber valuation. This would also be consistent with a 10x 600 mm free cash flow valuation, which is my best case estimate of their stabilized free cash flow net of capex, assuming MICC grows to 40 million subs and significantly cuts down on growth capex. This backs into a share price of $40-$45.
Why pay $79 for this today?
Don't just take my word for it. Their website has a 3Q 2009 investor presentation which provides very detailed information by market (full credit to them for this) and do the math yourself.

Disclosure: I own in the money puts on MICC.