A Tale of Two Telecoms Markets in Israel: As Landline Thrives, Mobile Dives

If the cellular losses continue and grow deeper, the result is inevitable: At least one player will end up dropping out, merging or going bankrupt.

The offices of Golan Telecom.
Eyal Toueg

The financial reporting period of the country’s communications companies ended a week ago and it reveals that 2015 was a particularly turbulent one for the sector.

This time around, it could be that the telecommunications companies’ financial results might influence government policy. The results also raise the question as to whether the data they provide can enable us to draw conclusions regarding the degree of competition in the market and what aspects of the market are healthy or not. Is it now clearer what effect a merger between Golan Telecom and Cellcom would have? Is there enough money in the sector to invest in network infrastructure? And what will the country’s communications infrastructure look like, for example, in two years?

One major conclusion is that there is a major disparity between the cellular service market and the landline market. Other than the fact that both purportedly belong to one telecommunications market, they have nothing in common.

The cellular sector features five networks and genuine competition; all of the cellular firms reported sharp overall revenue declines. At 15%, Pelephone reported the sharpest drop, followed by Cellcom’s 9% and Partner’s 6% (figures that only relate to the cellular business). Pelephone is also the company with the lowest revenues: 2.9 billion shekels ($755 million) compared to about 3.3 billion among the competition.

The reason for the steep revenue decline at Pelephone is that it is no longer hosting another service provider on its network for a fee whereas Cellcom has an important “customer” in the form of Golan Telecom and Partner has a major client named Hot Mobile. That shows why it would be wise for Pelephone to team up with a new potential player in the sector, Xfone, and either host it or go into partnership with it.

The important point is that this market is bleeding by all measures, with sharp declines over the prior year. In 2015, Partner, which used to do business as Orange, lost 40 million shekels, which was also dragged down by a one-time write-off. Even offsetting that, however, Partner would have finished the year with a net profit of just 32 million shekels, down 80% from 2014, and its final quarter net profit was just 7 million shekels.

Cellcom’s earnings are no less interesting. A look at its operations excluding its Netvision division shows it would have had an 18 million shekel net profit for the first nine months of the year, but for the whole year that was down to 11 million shekels, meaning that it lost 7 million shekels in the final quarter.

Hot Mobile was also in the red. Its parent company does not provide a net profit or loss figure, but Hot Mobile reported a 2015 operating loss of 356 million shekels. In practice, what is saving this cellular firm is the sale of actual phones, tablets and accessories. At Pelephone and Partner, such sales already constitute 31% of all of their cellular operations. But it’s a segment with stiff competition and low profit margins, and it also requires the companies to finance their customers’ payments, which depresses cash flow.

And what will happen if the companies continue to show losses over the long term or if the losses deepen? It’s rather simple. One of the competitors will drop out of the market, probably Golan Telecom, or there could be a merger, which Golan is in fact trying to accomplish. Bankruptcy is another scenario.

In contrast to the cutthroat atmosphere in the cellular service sector, the landline sector is continuing to thrive. The Bezeq group reported annual revenues of 10 billion shekels, up 10% over the previous year. Its landline revenues were up 2%, despite reforms in the broadband business that were supposed to stiffen competition. The landline division had 4.4 billion shekels in revenues. It had an 8% increase in EBITDA earnings, earnings before interest, taxes, depreciation and amortization, of 2.8 billion and an EBITDA to revenue ratio of 65%, which has no parallel, even outside Israel.

At Hot, the landline business alone is similar. The company did report a 4% decline in cable revenues, to 3.1 billion shekels, and a 2.5% decline in EBITDA to 1.6 billion shekels, but that left it with an EBITDA-revenue ratio of 53% in the sector, which is much higher than what the cellular firms have reported, even in their heyday.

The landline sector is also the only one that is distributing dividends. Bezeq distributed a whopping 1.7 billion shekels this year. Although Hot Telecommunications Systems is purportedly not paying a dividend, it is in fact doing so indirectly in the form of a management fee of 60 million shekels to its controlling shareholder, Patrick Drahi. Without the payment, it would have had a net profit of 67 million shekels.

And it looks like the revelry isn’t about to end. Bezeq has issued a forecast for 2016 in which it predicts a certain amount of erosion in its net profits, but stability in EBITDA-revenue ratios and its cash flow.

Reforms are not affecting Bezeq

One conclusion that can be drawn from the results is that landline reform isn’t affecting Bezeq at all, meaning that it is not reducing the excessive profits that the Bezeq group has been enjoying, and no portion of those profits is being shifted to the consumers or even to competitors.

Ilanit Scharf of the Psagot investment house estimated the total damage to Bezeq at 23 million shekels, with an additional 13 million shekels for every 100,000 customers who take advantage of the reform and get their Internet service provider and Internet infrastructure bundled through a single source. That’s small change for Bezeq. The Halman Aldubi Investment House put it plainly: “The wholesale market is not delivering the goods.”

Amir Adar of the Meitav Dash investment firm observed, “Cellcom’s report exemplifies the cellular companies’ problem working in fields beyond the mobile market and the urgent need for regulatory clarity in the communications market in general and on the subject of Golan in particular.”

Bezeq’s financial results show that it has been trying in vain to minimize the importance of the good old version of the telephone. Despite the constant erosion, it is still at the center of an annual market of 1.6 billion shekels. Bezeq’s largest operations are still the landline sector (and 36% of its revenues compared to 35% for its Internet business) and it is certainly its most profitable business.

The investment in infrastructure is the lifeblood of the telecom industry and its development and should therefore interest everyone, but here, too, the differences between the cellular and landline sector are like day and night. In the cellular sector, Partner cut its investment by 17% over the past year to 354 million shekels. Cellcom reduced its investment in its network by 19% to 396 million shekels (despite a substantial investment in transformers in connection with its television service). Of the cellular providers, only Pelephone boosted investment in its network, by 33% to 426 million shekels. These figure are particularly disturbing if one recalls that this year the cellular firms bought 4th generation frequencies for tens of millions of shekels, so they should have been in the midst of a wave of investment in new networks.

The combined investment by the cellular firms dropped by 5% in 2015 compared to 2014 despite the investment in 4G technology. The aggregate investment in networks in the cellular market was 1.1 billion shekels. To provide some perspective, that figure was 1.7 billion in 2009 and 1.4 billion shekels in 2012.

When it comes to landlines, Bezeq’s landline division increased investment in its network by 3%, to 849 million shekels, and the entire group raised investment in networks by 28% to 1.64 billion shekels. If Bezeq and its subsidiaries continue to be capable of investing more than the competition, over time it will develop an advantage that will be difficult for its competitors to overcome.

The investment momentum at Bezeq, it appears, will continue over the next several years. Comments by its CEO, Stella Handler, around the time of the release of Bezeq’s financial results indicate the company’s intention to broaden the scope of its operations. “Thanks to our entry into new areas of activity, Bezeq has managed to create a new revenue stream," she said. "In 2016, Bezeq will work to expand its operations in the fields of cyber, electronic commerce, smart cities and telemedicine.”

Handler added: “We have begun field testing of G.fast technology [ultra-wide band technology for copper telephone lines, which has been tested in the city of Modi’in], as well as other advanced technology, making ultra-fast Internet speeds of 100 mega and even 1 giga possible. As a first step, we are looking at 500 mega Internet speeds for individual customers. The field testing is aimed at looking at the investment necessary to operate the network from a technological and financial standpoint. As of the end of the year [2015], Bezeq had installed fiber optic lines in about 1.3 million homes in Israel.”

Hot has also increased its rate of investment in its network by 7% to 956 million shekels (which includes its cellular operations). All told, Bezeq’s landline division’s rate of investment in its network is 19% of its revenues (the highest in the industry), while at the cellular firms, it is much lower – 9.5% at Cellcom and 8.5% at Partner.

Those are worrying figures compared to the telecom industry's global average of 16%-17% of revenues. Here, too, the Bezeq group’s cellular firm, Pelephone, is also the exception, with a 15% investment rate. The financial reports show that the cellular firms are beginning to use up their oxygen while Bezeq and Hot will have no problem continuing to invest in their networks this year and beyond.