Two Years of Cellphone Competition Leave Veterans Bruised but Trimmer

Cellcom, Partner, Pelephone are still losing customers but cost-cutting has saved their profit margins. 4G, new services give them hope for growth.

Tali Mayer

It’s been two years since then-Communications Minister Moshe Kahlon shook up Israel’s mobile market in one fell swoop. A comfortable oligarchy of three big companies was replaced within weeks by a cacophony of carriers offering flat-rate monthly plans for just tens of shekels.

The big three wireless service providers — Cellcom Israel, Partner Communications (Orange) and Bezeq’s Pelephone unit — are still reeling from the shock. But, as their second-quarter financial reports released this week and last show, they have begun learning how to survive in the jungle that Kahlon planted.

All three companies continue to show falling revenues, as they lose customers and business to upstarts like Golan Telecom and Hot Mobile. But thanks to deep cost-cutting they have managed to retain their pre-Kahlon profit margins.

Each company’s relative success is reflect in its share price. Cellcom climbed almost 71% in the past two years to close at 42.70 shekels ($12.30) yesterday, while Partner shares nearly doubled, to 26.61 shekels. Still, both shares are down this year by 3% and 16%, respectively.

All three are poised for a big spending program to launch their fourth-generation networks, offering smartphone users faster Internet. They are bullish enough about the future to use their accumulated cash to invest in their networks and reduce debt rather than paying out shareholder dividends.

Their shareholders, then, must ask whether they can squeeze out new growth for 4G services.

Partner, the last of the big three to report, saw its second-quarter revenues fall 4% from a year earlier, to 1 billion shekels. Cellcom suffered an even bigger decline, of 6%, to 1.1 billion shekels, while Pelephone revenues plunged 8%, to 843 million shekels.

Two years after the industry shake-up, competition remains grueling. Despite repeated price cuts, the Big Three are still bleeding users to the new rivals. Golan and Hot are determined to keep growing their subscriber bases, and are constantly coming up with new discounts.

That’s created a revolving door in the market, as customers sign up with and cancel one carrier, only to repeat the process, sometimes multiple times, depending on who’s offering the best terms at the moment. That comes at a double cost to the companies, who not only have to lure callers with better and better deals but have to invest in marketing and sales to do so.

As a result, average revenue per user, a key industry benchmark, keeps falling. For Partner, ARPU in the second quarter was down 8% from a year ago, for Pelephone 7.1% and Cellcom 5.4%. (Cellcom even succeeding in raising its ARPU from the first quarter.)

One bright spot there is for the big three is in revenue from customer sales, of devices and accessories. That came to 221 million shekels in the second quarter for Pelephone, a 1% increase, while Cellcom boosted its sales 4%.

Partner saw its sales soar 27%, to 218 million shekels, after a slow start in the segment and was the only one of the three to show a profit from it, albeit a slim one. The company reported an operating profit of 58 million shekels on device and peripherals sales alone, a 25% increase from a year ago. Having said that, however, many analysts doubt Partner can continue that pace in coming quarters.

Cutting back

To offset declining revenues, the three veteran carriers continued to cut back. All three have cut their workforces significantly since the start of the year.

Partner reported that it had trimmed its sales costs in the quarter by 6%, to 824 million shekels.

Such efficiency measures have enabled all three companies to keep their profit margins steady, in fact higher than in most industries even if they are down from the pre-Kahlon era. Earnings before interest, taxes, depreciation and amortization, or EBITDA, are around 27% for all three companies.

Another bright spot in their financial report is their balance sheets. The companies have stopped paying dividends and have labored to reduce their debt.

At Partner, for instance, net debt at the end of the second quarter was 2.7 billion shekels, down from 3.4 billion shekels a year earlier. In April, the company reported that it had repaid early a 100-million-shekel bank loan.

The big three are still struggling, but they have at least one joker up their sleeve, namely 4G. Strictly speaking there isn’t a huge difference between the customer experience of a phone operating on 3G versus 4G, but 4G gives the companies a big marketing advantage over their newer rivals: Against the low-price come-ons of the upstarts, the veterans can brand themselves as the fastest, most reliable networks.

Getting their networks 4G-ready requires a lot of capital spending, but not enough to make life difficult for the big three. Pelephone, for instance, said it increased capital spending just 7% in the quarter, to 90 million shekels. Cellcom invested 104 million shekels, a 25% increase from 83 million a year earlier. Only Partner cut back investment, a sharp 20% drop to 98 million shekels.

The other great hope for the big three is new services, most notably Cellcom’s plan to enter the broadcast television segment. Its board approved plans a year ago in June, and sources at the company say everything is in place to launch multichannnel television — agreements for buying content, equipment and other investments — and is simply waiting for the green light from management to go ahead.

Cellcom is expecting to go ahead with the plan sometime in the next few months, with the costs related to it appearing on its financial statements in the final quarter of this year and early in 2015.

Meanwhile, Kahlon is long gone, but regulators continue to create headaches for the veteran wireless carriers. They face hearings on the issue of roaming services overseas, on the fees they charge virtual providers like Golan to be hosted on their networks and another on the requirement they provide universal service all over the country.

Uri Lich, an analyst at IBI Israel Brokerage and Investments who follows the industry, says these issues could give the companies serious trouble.

“Their big problem for the companies is that the communications minister doesn’t let go of them,:” says Licht. “Instead of moving forward with the most important reform of all, which is establishing a wholesale market [for mobile services] and encouraging competition in areas like television, Internet and landline telephony, he keeps pressuring for more competition in cellular. Today it’s one of the most competitive in the world, certainly relative to its size.”