Haaretz 6-8-2012

Bruised and battered now, Bezeq destined to survive
Competition is brutal, but it has infrastructure, marketing power, strong management.
By Amir Teig | Aug.06, 2012 | 4:14 AM

Bezeq’s core business suffered serious setbacks in the second quarter, and competition is expected to heat up later this year. But the company’s landline operations weren’t hit as badly as expected, and Bezeq’s key competitors probably did worse.
As reported in TheMarker on Friday, Bezeq’s second-quarter net profit dropped more than 29% to NIS 415 million.
Taking a closer look, it’s clear that the biggest blow at landline was a sharp drop in cash flow. The group’s main cash generator provided between NIS 210 million and NIS 430 million during each of the last six quarters in free cash flow.
In the second quarter, cash from operating activities less net investments fell to just NIS 160 million. The reason is clear: A net attrition of 33,000 subscribers.
In broadband Internet, the company actually added 15,000 subscribers, but average revenue per user dropped NIS 4 to NIS 80. Although Bezeq invested heavily in new infrastructure and Internet speed upgrades, mounting competition from HOT is apparently forcing rates down.
Last week TheMarker reported that Bezeq is close to finalizing a deal for selling landlines to Partner Communications at wholesale rates. This is expected to be the opening volley in fierce competition in the landline market, which will put added pressure on Bezeq’s profitability.
Back to basics for Pelephone
Cell phone unit Pelephone preceded Bezeq into the wholesale market for infrastructure; it was the first cell-phone company to host virtual operators. Pelephone provides infrastructure to HOT Mobile and Rami Levi, the top two new challengers in terms of subscribers signed up.
Pelephone thus softened the blow on May 14, when more competitors were allowed in the industry. Although Bezeq’s second-quarter results were poor, Partner and Cellcom have probably done worse.
Pelephone’s operating results still don’t fully reflect the cutthroat competition. Airtime sales fell just 7.3% from the same quarter last year and were even a bit higher than in the first quarter this year, with average revenue per user climbing NIS 2 to NIS 99.
But in the second half of the last quarter, price competition stiffened against HOT Mobile and Golan Telecom. Still, by registering a bit of profit from every customer signed up by HOT Mobile and Rami Levi, Pelephone can at least weather some of the storm.
Over the past year and a half, Pelephone spearheaded the industry’s dubious strategy of focusing more on marketing cell-phone handsets. This strategy at its peak brought in more than NIS 500 million a quarter – 36% of the company’s sales. But those halcyon days are apparently over: In the second quarter handset sales fell to NIS 291 million, just 25% of total revenues.
Elovitch’s debts
Bezeq faces brutal competition these days but has immense infrastructure, tremendous marketing power and strong management. Bezeq will survive the tsunami rocking the industry.
While the business pyramids of competitors Ilan Ben-Dov at Partner and Nochi Dankner at Cellcom are falling apart, the pyramid of controlling Bezeq owner Shaul Elovitch is still intact. Still, if Bezeq comes through, it doesn’t necessarily mean he will.
The long-term 6.6-year bonds of B Communications, which holds a 31% controlling stake in Bezeq, are already trading at a 12.2% net yield to maturity. This doesn’t mean the market expects the company to fold, but such a yield is high.
But up one rung to the top of Elovitch’s pyramid, long-term 3.9-year bonds of Internet Gold, trade at a worrisome net yield to maturity of 26%. Internet Gold owns 80% of B Comm stock. The situation got worse at the beginning of July when Midroog downgraded Bezeq and Internet Gold while giving the entire group a negative outlook.
B Comm’s net financial debt totals NIS 3.7 billion – NIS 700 million in bonds and the rest in bank loans. The company expects NIS 465 million in dividends from Bezeq this quarter to reduce the debt load. But the key question is whether Bezeq can generate enough dividends for both B Comm and Internet Gold, which owes NIS 840 million to bondholders, to meet their payments.
Elovitch needs to redeem NIS 460 million of Internet Gold’s bonds by the end of 2015 and will probably need to raise at least part of it in the market. His ability to do so will rest directly on the rate of Bezeq’s dividend payments and competitiveness, now entering a period of uncertainty.