Israel’s telecoms industry is in crisis, but can mergers save it? That’s what at last some of the players are counting on.
Two weeks ago Hot Telecommunications said it wanted to buy Partner Communications and on Monday reports surfaced that Cellcom Israel is eyeing Golan Telecom. Others may follow.
But even before the companies involved turn to the Communications Ministry and Competition Authority for approval, regulators will need to ask themselves which problems they think a merger would solve. Is it to enable them to upgrade their infrastructure to 5G service and fiber optics? Or is it, as appears to be the case right now, they only aim to stave off collapse? Do regulators see their main concern as preserving Israel’s super-low cellphone rates?
In any event, everyone involved, whether they are the companies themselves, the shareholders who have sustained big losses and market analysts, say the number of players in the market has to shrink.
The latest merger news lifted the price of Cellcom shares on the Tel Aviv Stock Exchange 4.1% to close at 14.38 shekels ($4.20). Golan’s parent company, Electra Consumer, rose 4.9% to close at 72 shekels.
With so many companies offering telecoms services, the competition has grown too intense. There’s no business case for why subscribers should be paying every month as little as 17 shekels for mobile, 29 shekels for multichannel television and 59 for fast internet.
As a result, Cellcom, the biggest of the mobile operators, had revenues of 2.8 billion shekels in the first nine months of 2019, but it earned an operating profit of just 47 million shekels and posted a net loss attributable to shareholders of 52 million. Partner had revenues of 2.4 billion shekels, an operating profit of 57 million and eked out a net profit of just 15 million.
Altice, the European parent company of Hot, which as of the end of 2018 had written down 143 million euros ($160 million) on its subsidiary, generated 13.5 million euros in operating profit and 87.9 million in free cash flow on revenues of 712 million euros for the first three quarters of 2019. Bezeq, meanwhile, had revenues of 6.72 billion shekels, with an operating profit of 876 million and a net loss of 1.08 billion (a giant loss mainly due to write-downs in its Yes satellite TV unit).
The only telco to earn a decent profit, if any at all, was tiny Golan Telecom, which unlike the others offers only mobile telephony service. From its 923,000 subscribers, it captured 398 million shekels in revenue and posted a 198 million profit for the nine months.
Faced with so much red ink, regulators will have to decide how the big the risk is that one or more of these companies is at risk of insolvency. Cellcom’s parent, Discount Investment Corporation, itself is coping with other financial problems in its group of companies and faces 2.2 billion shekels in debt coming due. Partner meanwhile has to contend with net debt of 1 billion shekels and Bezeq debt of no less than 8.1 billion.
The companies looking to merge also face a considerable obstacle in the fact that to date Israeli regulators have never countenanced one.
“The odds are poor that any regulator will every say, ‘I made a mistake – mergers are the right way to solve the problem of competition that is hurting the quality of Israeli infrastructure,” said one source in the capital markets.
Ilanit Sherf, who is head of research at Psagot brokerage, agrees. “While a merger between Partner and Hot seems natural because they share cellular infrastructure, I think regulators will find it difficult to approve deal between two telecom companies that will create a duopoly,” she said.
If approved it would leave two big players in the market (Bezeq and Hot) and two smaller ones (Cellcom and Golan) – and the latter would have difficulty surviving.
If the Hot-Partner merger were approved, Cellcom would fight hard for the right to complete its own merger or mergers with smaller players like Golan and Xfone, added Lublin. Partner CEO Isaac Benbenisti, who isn’t anxious to lose his job in a Hot takeover, has hinted his company might make a bid to buy Golan, which would make Partner a less attractive target.
Sherf said a Cellcom-Golan tie-up made sense because their shared infrastructure would make it easier and cheaper to retain and service Golan subscribers.
But is Golan ready to be bought? It’s a very low cost operation that hasn’t followed the other telcos into segments like television and landline internet, which haven’t yet proven themselves to be profitable.
“If the two companies [Cellcom and Partner] weren’t burning so much money on new growth engines, they would today be a lot more profitable,” said one capital markets source who asked not to be identified. “
Sherf thinks Golan’s controlling shareholder, Electra Consumer, is interested in selling. “When it bought Golan at the start of 2017, Electra’s management thought that cellular rates had hit bottom, that the market was in equilibrium, and that they would start to go up. But since then, rates have continued to fall, among other reasons because Xfone entered the market,” she said.
That still leaves the question how financially ailing Cellcom can hope to finance an acquisition. Sherf said the deal doesn’t have to be in cash – the two sides can merge via a share swap.
“This is the easiest deal for regulators to accept,” she said. “In the past, when there were only five telecommunications companies, they rejected it. But Xfone’s entry has further upset rates. Regulators have already internalized the idea that if it wants companies to invest in infrastructure, it needs to reduce the number of players. Merging a big and small player is easier to digest than merging two giants, like Partner and Hot.”
Not everyone is buys the logic. One capital markets source, speaking on condition of anonymity, said that the cooperative agreement between Cellcom and Golan meant that Cellcom was already capturing some of Golan’s profits.
“Golan’s profits aren’t enough for it to go ahead with the acquisition. Spending hundreds of millions of shekels … so that profits will improve a little isn’t financially worthwhile,” he explained.
In any case, he noted, mergers cost money – severance pay for fired employees and merging information systems – none of which shows any payback for years to come.
At least one industry figure thinks that even one of the players goes belly up in the absence of mergers, the consequences will be minimal.
“Customers won’t be harmed if one of the companies collapses. In the worst case, they’ll have to change providers and the company will have to negotiate a debt rescheduling that will involve writing down some of its obligations. It will get new shareholders and then its financial situation will improve,” said one industry executive, who asked not to be named
“The main damage will be to the employees, creditors and current shareholders, among them the provident funds and pension funds that hold Israeli’s savings. But it’s not a big drama,” he said.
In any case, the loss of one competitor won’t necessarily lead to increase phone rates. Quite to the contrary, it might set off a new round of rate cuts as those remaining compete to capture the subscribers of the failed company.
But Liran Lublin, the head of research at IBI Investment House, said it would a losing battle because merger or no merger the leading players can’t match the lowest prices prevailing the market.
“The ones who today pace the competition are the virtual providers, like Rami Levy, We4G and Golan Telecom,” he said. “These players don’t care if anyone else is making profits or not. Their cost of sales is fixed and relatively low. ... I believe that if there’s a merger, consumers will buy the services of the market pacesetters with the lowest rates. They won’t be liking for brands like Cellcom, Partner, Hot or [Bezeq subsidiary] Pelephone.”