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WE Detailed Report
May 2013

Pakistan Telecommunication Company Ltd

PTCL - Play on Pakistan's Telecom potential
We initiate the coverage of Pakistan Telecommunication Company Ltd. (PTCL) with a Dec'13 Target Price of Rs 28.10/share, offers an upside of +34% -BUY! Our bullish view is mainly on back of implied ICH implementation by the players as a result company's EPS to show massive upside in CY13 by +265% YoY resulting in better cash flows and dividend payout, 2) Broadband segment expansion still going on, 3) Property issue expected to resolve and 5) finally UFONE to add value in longer run post 3G license announcement. We expect 1) topline average growth of 9% (2013-2015), 2) gross margins to average at 37% (2013-2015), 3) average market share of ICH to remain 50% (2013-2015) and 4) incoming international traffic to average at 650mn min/month. The key risks to our estimates are 1) ICH is terminated, 2) Upsurge in discount rate, 3) More than expected decline in incoming minutes and 4) No dividend payout in CY13.

KEY DATA KATS Code PTC Reuters Code PTCA.KA Current Price (Rs) 20.97 Year High, Low (Rs) 24.59, 15.39 Market Cap (Rs' bn) 107 Market Cap (US$ mn) 1,069 Shares Outstanding (mn) 5,100 Free Float (%) 15.5% Source: KSE, Reuters & WE Research

PTC Financial Snapshot CY12A CY13E Net Sales (Rs mn) 67,838 77,495 Profit after Taxation (Rs mn) 3,641 13,302 EPS (Rs) 0.71 2.61 Book Value (Rs/share) 20.55 23.14 DPS (Rs) 1.50 P/E (x) 29.37 8.04 P/BV (x) 1.02 0.91 P/EBITDA (x) 4.89 3.19 ROE (%) 3.47 11.27 ROA (%) 2.21 7.47 Source: Company Reports & WE Research CY14F 82,487 14,482 2.84 24.48 1.75 7.39 0.86 2.97 11.60 7.70 CY15F 87,812 15,762 3.09 25.82 2.00 6.79 0.81 2.77 11.97 8.06

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WE Detailed Report
May 2013

Valuation: BUY with a Target Price of Rs 28.1

In order to compute the target price of PTCL we have used Sum of Parts Valuation Technique. We have applied discounted cash flow valuation method to arrive at the target price of Rs 22.04 for PTCL. While PTCL subsidiary UFONE valuation has been carried out from estimated book value and its projected value is Rs 6.06. We have assumed Risk Free Rate of 11.1% and 5% market premium where as terminal growth rate of 3%. The SOTP based Dec'13 TP for the stock is Rs 28.10/share.
DCF based Value of PTC (Rs in million) CY12E Net Income 13,302 Non Cash Expense 12,787 Change in working cap (3,077) CAPEX (13,664) Free Cash Flow to Equity 9,347 Discounted Free Cash Flow 9,347 PV of Terminal Value 79,014 EV 112,389 Shares Outstanding 5,100 PTC Value 22.04 Ufone Value 6.06 Target Price Dec'13 (Rs) 28.10 Source: WE Estimates CY13F 14,482 13,404 1,873 (14,351) 15,407 13,147 CY14F 15,762 14,052 199 (15,072) 14,941 10,880

We have applied discounted cash flow valuation method to arrive at the target price of Rs 22.04 for PTCL. While PTCL subsidiary UFONE valuation has been carried out from estimated book value and its projected value is Rs 6.06. Thus SOTP based Dec'13 TP for the stock is Rs 28.10/share.

ICH changed the fundamentals Firstly we should know what is ICH? ICH exchange was established for international incoming calls for long distance, fixed-line local loops, wireless local loops and mobile operators. Rate notification was signed by each LDI operator complying with PTA notified Approved Settlement Rate (ASR) and with the approval of the government shall be conveyed to foreign operators through the designated consortium leader. It was in Oct'12 that ICH was formed by the previous govt, despite reservations by CCP. Financial benefit of ICH As per PTA the Approved Settlement Rate (ASR) for PTC is USc 8.8/min as against previous rates ranging around USc 1.25-2.0/ min. The other LDI players in the telecom sector to benefit as well as they will get USc5.9/min. PTC's market share is 50% of total incoming calls and to enjoy the highest benefit whereas rest is distributed among other LDI operators.
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WE Detailed Report
May 2013

Recent fruits of ICH to PTCL PTCL's standalone revenue made history on quarterly basis and in 4QCY12 company reported revenue of Rs 21,493 million upside of +37.4% QoQ translating into PAT of Rs 7,081 million (EPS: Rs 1.39) ex VSS advantage. Company's gross margins traded at 43% highest since FY08 period. In 1QCY13 company's revenue dipped slightly due to seasonal downtick in calls and recorded revenue of Rs 19,425 million and PAT of Rs 2,916 million (EPS: Rs 0.57). One other listed player TELE also has performed well and has reported profitability in period (Oct-Dec'12) which reflects that ICH is the gamechanger for the sector and would result in revival of loss-making entities of the industry. What's the chance of ICH to survive? Before we go into details we present events since ICH came into existence. Month Event Aug 13, 2012 Oct 01, 2012 Oct 30, 2012 Dec 2012 Dec 2012 Feb 21, 2013 Mar 05, 2013 PTA approved implementation of ICH ICH formed LHC suspends ICH PTA withdraws from ICH All LDIs were ordered to revert to pre-ICH prices Supreme Court clears ICH Federal Communication Commission ordered not to pay ASR above USC 2/min to operators in Pakistan Source: PTA, NEWS, WE Research There are two issues currently on ICH, 1) CCP is investigating the matter as per SC which is not a good sign because CCP since pre-formation of ICH was against it, and now the ball is in CCP's court. However, penalty was imposed by CCP to all Long Distance International (LDI) operators at 7.5% of their annual turnover which was turned down by Sindh High Court. Though, uncertainty is looming on future of ICH, we believe two possible outcomes. First, total rejection of ICH this will have negative impact on the share price of PTC and other listed telecom players. But keeping in view the CCP's penalty or decisions in past a stay order is an option for Telecom players that this will be beneficial. Second option can be cut down in ASR rates or set some range to establish free market environment which is not against the customer's point of view. We believe minimum of ASR USc 3.5/min to maximum USc8.8/min can be set. We have assumed USc6.5/min for PTC and still the company would be in handsome profit under last scenario, moreover other players will also be satisfied as well, which creates a win-win situation for all stakeholders. Consequently average minutes to hover at 700-800mn min/ month rather fear of breaching below 600mn min /month.
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PTCL's standalone revenue made history on quarterly basis and in 4QCY12 company reported revenue of Rs 21,493 million upside of +37.4% QoQ translating into PAT of Rs 7,081 million (EPS: Rs 1.39) ex VSS advantage. Company's gross margins traded at 43% highest since FY08 period. In 1QCY13 company's revenue dipped slightly due to seasonal downtick in calls and recorded revenue of Rs 19,425 million and PAT of Rs 2,916 million (EPS: Rs 0.57).

WE Detailed Report
May 2013

VSS - to contain fixed cost PTC management announced Voluntary Separate Scheme (VSS), and as a result employees of the company opted finding it lucrative, the one-off impact on P&L witnessed in 2HCY12 amounting to Rs 9,467million or (per share impact: Rs 1.86). We believe the increment in admin cost would be slower as ~30% of the staff took benefit of this scheme. Ufone to add value post 3G auction Ufone is PTC's 100% owned subsidiary and 3rd largest cellular company in Pakistan. Ufone's revenue contribution on consolidated basis would be around 35-40% where as dividend income from it supports the bottom line. We believe Ufone is poised to go for 3G licence due to strong backing of Etisalat-PTC compared to other players like Warid/Telenor/Zong. The revenue and bottom line to improve post this service and would add value to PTC's profitability. Likely Scenario for CY13 PTC has reported 1QCY13 earnings of Rs 2,916 million (EPS: Rs 0.57) revenue improved by +31% YoY and gross margins clockedin at 36% versus 25.2% in same period last year. We expect flat earnings for 2QCY13 as incoming minutes for whole sector dipped by -25% QoQ to 600mn min/month and same would continue for 3QCY13. However we see seasonal uptick in incoming minutes due to Umra season in Ramadan and Eid followed by 4QCY13 Hajj season where incoming minutes likely to average above 800mn min/month. Quarterly Trend We expect full year earn- 4,000 0.80 ings after tax of Rs 13,302 0.60 million (EPS: Rs 2.61) up by 3,500 0.40 265% and anticipate the 3,000 0.20 profitability for CY13 would be the highest since 2,500 FY07. We expect gross PAT EPS (Rs) margins to average at 37% Source: WE Research & Company Report vs 30% in CY12.
1QCY13A 2QCY13E 3QCY13E 4QCY13E

PTC has reported 1QCY13 earnings of Rs 2,916 million (EPS: Rs 0.57) revenue improved by +31% YoY and gross margins clocked-in at 36% versus 25.2% in same period last year. We expect full year earnings after tax of Rs 13,302 million (EPS: Rs 2.61) up by 265% and anticipate the profitability for CY13 would be the highest since FY07.

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WE Detailed Report
May 2013

We anticipate dividend payout to remain stable in CY14-CY15 as 3G license auction to start either in late CY13 or in CY14 but for CY13 we expect DPS of Rs 1.5.

What's beyond CY13? We expect PTC top line to expand at an average of 9% (CY14ECY15E) assuming decline in incoming minutes by 8% annually to settle at 600mn min/month by CY15. Firstly stiff competition from cellular companies as they are offering very cheap rates as a result outgoing calls are increasing month on month basis, secondly people are moving towards skype/viber and other softwares which are in android / smart sets which are free of cost and just require internet connection, and thirdly high incoming call rates will open gray trafficking as well so all these factors to reduce the telecom sectors incoming minutes. Company's bottom line to expand at an average rate of 9% from (CY14E-CY15E), moreover gross margins to average at 37%, and EBITDA margins at 23%. We believe in CY15 company is expected to post highest net profit since FY06. We anticipate dividend payout to remain stable in CY14-CY15 as 3G license auction to start either in late CY13 or in CY14 but for CY13 we expect DPS of Rs 1.5. PTC's broadband business is expanding rapidly but margins in this business is still on lower side although we believe the larger expansion in small cities would support top line consequently operating profitability from this segment to improve significantly. Broadband flying higher Broadband connections have grown considerably to reach 2.43 million by January 2013. Digital subscriber Line (DSL) technology continues to hold 38.6% share in the total subscriber's base. However, more growth was seen in other broadband wireless segments i.e. EvDo, which is considered future of broadband because of their efficient and technological advancement. Being the largest and the fastest growing broadband service provider in Pakistan and has more Broadband Subscribers (000's) than 60% market share, 3,000 PTCL launched several new broadband packages, 2,000 both for wireline and wireless customers, which 1,000 resulted in an increased subscribers' base. We expect company to surpass FY08 FY09 FY10 FY11 FY12 FY13E by over 2.5 million broadband subscribers by CY13. Source: WE Research & PTA

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WE Detailed Report
May 2013

Etisalat withheld US$ 800mn due to non-transfer of more than 3,300 properties. According to Market channels, new government would satisfy Etisalat with transfer of remaining properties.

Cellular performance remain stable Ufone the third largest cellular company in Pakistan has crossed 23 million subscribers at the end of CY12. The total number of cellular subscribers has now reached up to 23.35 million capturing the market share of 19.5%. We expect annual cellular subscriber to remain at same level in next two years as cellular teledensity has reached to 68%. Ufone now need to focus on increasing revenue from value added services and target towards increasing average revenue per user (ARPU). Wireless local Loop-Picking the pace The subscribers of wireless segment of local loop service are continuously increasing since 2005 and at the end of September 2012; the total subscribes reach WLL Subscribers (000's) to 2.92 million. Up till now 3,000 of total WLL subscribes, 2,000 PTCL maintained its market share by 48% followed 1,000 by Telecard and World call of 20% & 18% respectively. FY05 FY06 FY07 FY08 FY09 FY10 FY11 FY12 The WLL teledensity WLL Subscribers PTCL WLL Subscribers stands at 1.8% at the end of Source: WE Research & PTA Feb 13. Property issue expected to resolve before De'13 Etisalat withheld US$ 800mn due to non-transfer of more than 3,300 properties. According to Market channels, new government would satisfy Etisalat with transfer of remaining properties. As Pakistan foreign exchange reserves are depleting, government would resolve the issue to provide breather to Exchange rate. Furthermore, it would also help contain fiscal deficit. Hidden land value - yet to incorporate PTCL has a massive land bank of approx Rs 1.7 billion, which has never been revalued. Once property matter resolved, revaluation of the land would increase PTCL assets. We expect lands worth would be at least 20 times higher which would increase book value and generating profit if it rented out after construction.

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WE Detailed Report
May 2013

Key Risk

ICH case goes unfavored The case is on the desk of CCP if there is complete removal of ICH this would badly hurt future earnings of the company and our Dec'13 Target price would be reduced to Rs16.5/share. Moreover reversal in ASR rates will hit future revenue and margins as well. Decline in international income minutes There is a high possibility of decline in incoming calls due to ICH hiked-rates and consumers are gradually moving to skype/viber and other softwares which are available in latest cell phones. If the decline is rapid it would result in downward revision in our valuations. Dividend estimates We believe 3G technology is expected to enter either by end of 4QCY13 or most probably in 2014 this would result in huge license cost and dividend payout can be omitted by the company.

Company Introduction
PTCL provides telecommunication services in Pakistan. It owns and operates telecommunication facilities and provides domestic and international telephone services and other telecommunication facilities through Pakistan. The company is also licensed to provide such services in Azad Kashmir and Gilgit-Baltistan. It is the market leader in the fixed local line and the broadband segment with approximate market shares of 96% and 60% respectively. It also owns the third largest cellular operator (Ufone) of Pakistan with a market share of 19.6%. UAE based telecom company Etisalat owns 26% of the shareholding of PTC while the Government of Pakistan has a 62% stake in the company.

Shareholding Structure
2% 26% 10%

62%

GoP

Etisalat

Individuals

Others

Source: Company Report

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WE Detailed Report
May 2013

Valuation

PTCL - Financial Highlights

CY12A 0.71 20.55 29.37 1.02 4.89 CY13E 2.61 23.14 1.50 8.04 0.91 3.19 7.15 57.51 CY14F 2.84 24.48 1.75 7.39 0.86 2.97 8.35 61.63 CY15F 3.09 25.82 2.00 6.79 0.81 2.77 9.54 64.71

EPS (Rs) Book Value (Rs/share) DPS (Rs) P/E (x) P/BV (x) P/EBITDA (x) Dividend Yield (%) Dividend Payout (%) Source: WE Research & Company Reports

Key Ratios Analysis

Current Ratio (x) ROE (%) ROA (%) Gross Margin (%) Net Margin (%) Sales Growth (%) PAT Growth (%) Source: WE Research & Company Reports

CY12A 2.03 3.47 2.21 29.68 5.37 22.8 (51.2)

CY13E 2.51 11.27 7.47 36.87 17.16 14.2 265.3

CY14F 2.61 11.60 7.70 36.96 17.56 6.4 8.9

CY15F 2.88 11.97 8.06 36.97 17.95 6.5 8.8

Income Statement

Rs in million Sales Cost of Sales Gross Profit Marketing Expenses Admin. Expense Operating Profit Other Income Finance Cost Profit before taxation Taxation Profit after taxation Source: WE Research & Company Reports

CY12A 67,838 47,704 20,134 2,717 8,257 9,160 6,511 701 5,503 1,862 3,641

CY13E 77,495 48,920 28,575 3,487 10,346 14,742 5,979 351 20,370 7,069 13,302

CY14F 82,487 52,003 30,484 3,712 11,012 15,760 6,842 425 22,177 7,695 14,482

CY15F 87,812 55,349 32,463 3,952 11,723 16,789 7,746 398 24,137 8,376 15,762

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WE Detailed Report
May 2013

Balance Sheet
Rs in million Share Capital Shareholder Equity Non Current Liabilities Current Liabilities Total Liabilities Non Current Assets Current Assets Total Assets Source: Company Reports & WE Research CY12A 51,000 104,783 31,781 28,292 60,072 107,497 57,358 164,856 CY13E 51,000 118,033 33,013 27,123 60,137 109,974 68,196 178,170 CY14F 51,000 124,865 34,311 28,870 63,182 112,640 75,406 188,046 CY15F 51,000 131,702 35,679 28,100 63,778 114,692 80,788 195,480

Cash Flow Statement

Rs in million Cash from Operations Cash from Investing activities Cash from Financing Net change in Cash Beginning Cash balance Ending Cash balance Source: Company Reports & WE Research CY12A 4,921 (4,283) 4,938 5,576 8,372 13,948 CY13E 23,011 (15,264) 1,181 8,929 13,948 22,876 CY14F 29,758 (16,069) (6,352) 7,336 22,876 30,213 CY15F 30,013 (16,104) (7,558) 6,351 30,213 36,564

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