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John Genovese Edward Mui Ram Narayanan Mitesh Patel Sachin Patel Aric Schachner Agenda Both a quantitative and qualitative analysis will be conducted. These analyses will be composed of: Social Conditions within South Korea Macroeconomic Landscape Political Environment

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John genovese edward mui ram narayanan mitesh patel sachin patel aric schachner l.jpg

John Genovese

Edward Mui

Ram Narayanan

Mitesh Patel

Sachin Patel

Aric Schachner


Agenda l.jpg
Agenda

Both a quantitative and qualitative analysis will be conducted. These analyses will be composed of:

  • Social Conditions within South Korea

  • Macroeconomic Landscape

  • Political Environment

  • Telecommunications Sector

  • LG Telecom’s Business

  • Current Market Situation

  • Investment Outlook

  • Financial Analysis

  • Final Recommendation


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Case Insights

  • As students make the transition from school to the business world, we must be aware of international markets, and how they affect the world economy.

  • Able to use our valuation techniques to evaluate foreign markets in regards to exchange rates, DCF computations, and sovereign risk adjustments.

  • Learn about Emerging Markets (South Korea) and how the volatility in these markets can destroy, or exponentially grow an individuals wealth


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Social Conditions

Population

  • Population of 48,324,000

  • Ethnically homogeneous country- Korean decent.

  • Biggest minority group - Chinese

  • ¼ of population located in Seoul and more than ½ of all South Koreans live in big cities

  • Growth rate dropped from 3% in late 1950s to 0.85% in 2002

  • 297 institutions of higher learning with 2.5mill annual enrollment

  • 99.8% literacy

    Population affects LG Telecom positively because South Korea is a nationalistic, homogenous, urbanized countries. Thus a large concentrated consumer market that is loyal to home country brands.


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Macroeconomic Conditions

Background

  • High growth in 1980’s due to a system of close government/business ties, including directed credit, import restrictions, sponsorship of specific industries, and a strong labor effort

  • Government promoted import of raw materials and technology at the expense of consumer goods

  • Encouraged savings and investment over consumption

    “The Luck would soon run out…”


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Asian Financial Crisis

  • Exposed weaknesses in South Korea’s developmental model including

    • High debt/equity ratios

    • Massive foreign borrowing

    • Undisciplined financial sector

  • Growth fell 6.6% in 1998

  • Rebounded in 1999 to 10%

  • Rebounded again in 2000 to 9%

  • Growth fell back to 3.3% in 2001

    • Slowing Global Economy

    • Falling Exports

    • Corporate and Financial reforms had become stagnant


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Current and Future Macroeconomics

Current Economic Situation

  • Showed great resilience in 2001 with strong GDP growth

  • 2002 GDP grew by 5.9%

    Future Economic Outlook

  • Forecasted South Korea’s real GDP to expand by 4.6% in 2003, to 5.3% in 2004

  • Export volume will slow in 2004, to 9.5% because of won appreciation

  • Will result in smaller foreign trade balance contributions

  • Stable inflation forecast of 2002-2004


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South Korea

  • 1948- Republic of Korea declared below the 38th parallel on the Korean peninsula

  • #43 on Transparency International Corruption Perceptions Index 2002 with a 4.5 CPI score

  • Roh Moo-hyun current president will carry on “sunshine policy”

  • Military Threat from North Korea

    • North Korea’s aggression towards the South is strong

    • Large stockpile of chemical weapons

    • One million strong army

    • Ever present terrorism from North Korea

      • Assassination of four members of SK’s cabinet

      • Bombings Korean Airlines plane

      • 3 Naval disputes

Corruption leads to abnormal market returns, and negatively impacts country risk profile.


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LG Telecom

  • LGT is a subsidiary of the LG Group (Diverse Conglomerate)

  • Provider Personal Communications Services (CDMA)

  • First to commercialize CDMA technology through cellular services

  • Holdings include Dacom Corporation and Hanaro Telecom (Broadband provider)

  • Customer base of 4.8 million wireless subscribers

“Say hello to my little friend”


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History

  • 1996 - LG Telecom established (Opened Main Switching Center)

  • 1997 - Korean Government makes their R&D a national center for industrial research

    • Network Management Center (NMC) established

    • Customer Services Center opens

  • 1998 – Launched PCS service using CDMA

    • Merged with Venezuelan PCS Consortium for better CDMA capabilities

    • Formed Strategic partnership with BT (BT bought 23% stake)

  • 1999 – Launched world’s first broadcasting service for mobile phone

  • 2000 – Launched Btob, first mobile service designed for business

    • Launched EZ-Java, a PCS eMoney service


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History Cont’d

2001

  • Breakthrough year financially

  • Recorded net income of W154 billion compared to loss of W442 billion (2000)

    • Due to ban on handset subsidies and steady ARPU and subscriber growth

  • Raised W343.6 billion in equity to shore up balance sheet

  • Paid over W200 billion in debt by cutting Capital Expenditures


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LG Telecom Brands

  • Ez-i

  • Khai

  • Khai Holeman

  • Btob

  • IMT (International Mobile Telecommunication) 2000


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Ez-i

  • LG TeleCom’s first Korean wireless Internet service (1999)

  • Over 8,000 options

  • Commercialized the world’s 1st Java Station through a strategic alliance with BT Genie.


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Khai

  • Launched February 2000 for the 19-24 age group

  • Access to diverse cultural aspects

    • Fashion, sports, music, performances, and dancing

  • Discount benefits added through their phones.


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Khai Holeman

  • Incorporates teenage interests:

    • Invitations to various events and discounts

    • Animated characters

  • Highly diverse marketing techniques

  • High demand among teenagers


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Btob

  • For effective communication, work, and optimum resource management

  • 1st Korean mobile communication service exclusively for business

  • LG TeleCom has the largest market share in the mobile office market

  • Services include mobile consulting specializing in data solutions


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IMT

  • International Mobile Telecommunication 2000

  • Mobile communication linked up to wire/wireless and global satellite networks

    • Includes Internet, data, fax, video, video communication/conference, TV viewing, and motion picture in real time.


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Competition

  • SK Telecom

  • Korea Telecom Freetel


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Korea Telecom Freetel

  • Established in January 1997 and successfully launched commercial service in October 1997

  • One million subscribers within first six months of operations

  • 1 year later they had more than 3 million subscribers.

  • As of April 2000 there are over 4.7 million subscribers generating $4.3 billion in revenues

  • 1st cellular operator to launch IS-95B wireless Internet service nationwide in February 2002

  • Concluded merger contract with KTICOM in 2002

  • Ranked No.1 in mobile Service on the Business Week's IT 100 in the world

  • Provides 3G services based on W-CDMA


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SK Telecom

  • South Korea’s #1 wireless telecommunication services provider

  • Revenues totaled $6.37 billion in 2001

  • Part of the SK Group which is made up of 60 member companies

    • Includes seven companies listed on the Korean Stock Exchange

  • SK Telecom has a presence on six continents

  • Provides 3G services based on W-CDMA


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South Korean Mobile Phone Market

  • 2001 South Korea 1st to provide CDMA 2000 service

  • LG 0.05 million net subscribers in 2002

  • Wireless internet market as the most successful growth driver

  • Technologically adept culture

  • Importance of the Korean youth


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Market Share 2002

2002 Korean mobile sector ended with 32.34 million subscribers up 11.4% from 2001 and a penetration rate of 67.7%





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3G

  • Benefits of 3G

    • Additional capacity

    • More efficient spectrum management techniques

    • Faster data rates

    • Enhances 2.5G applications

    • Facilitates new applications

    • Continued substitution from fixed to mobile

    • Ensures optimal capital efficiency


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Mobile Phone Industry

  • Declining ARPU (Average Revenue per User)

    • Decrease in Service Revenue

  • Market Saturation

    • Increase in Subscriber Base

  • 3G Technology


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ARPU and MOU

  • ARPU declined 9.5% and was W33.25million in 2002

  • MOU was at 121 minutes for outbound traffic while inbound traffic was 107 minutes, an increase of 2.7%


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High Customer Growth

-Voice Centric

Customer Focus

-Portfolio of voice and data services

A New Focus

THE TRANSITION


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New Growth Drivers

  • The Industry’s Solution

    • Decrease in Prices for Voice Calls

    • New Focus on VAS and Data Services


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Issues Relating to Growth

  • Target new demographics

    • Corporate clients

    • Youth

  • 3G technology

    • New applications

    • What to market

  • Expensive development

    • Infrastructure

    • Engineering


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Increasing ARPU

  • Modest but REAL ARPU movement

  • Improvements arise generally from

    • Increase in data revenues

      • Sustained growth in SMS

      • New applications (e.g. picture messaging)

    • Competitive gain on high spending customers

    • Further increases in active customers

    • Greater usage of new voice services


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Regulatory Environment

  • Ministry of Information and Communication (MIC)

    • Accelerate information

    • Promote the IT industry

    • Facilitate market

    • Deregulation and liberalization

    • Promote venture capital along with R&D within the communications sector


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Tariff’s

  • MIC regulates tariff rates for SKT

  • Regulation of tariff causes ripple effect in industry

  • Tariff’s cut by 8.3% in January 2002 and 7.3% in January 2003

  • Can hinder free market competition


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Mobile Number Portability

  • Wireless subscribers can switch operators without having to change their mobile phone numbers

  • LG customers granted MNP in 2005

  • No need for a new handset

  • Promote competitive environment


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Handset Subsidy & Marketing

  • Handsets are subsidized through customers signing up for contracts

  • MIC limited subsidies to 10-20% of retail handset price

  • MIC imposed limits on marketing activities via membership or royalty programs

  • Reduce marketing costs


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So What’s the Deal…

  • WHAT’S THE BIG PROBLEM?

    • Why not focus on:

      • New types of customers

      • Promoting data and VAS usage

      • Providing new voice services

      • Increasing user spending


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NO 3G!

  • LG TELECOM DID NOT INVEST IN 3G…


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Current Market Situation

  • SK Telecom - KTF - LG Telecom – S&P500


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LGT Revenue Breakdown

  • Moderate growth in PCS service due to tariff rate cuts and lower interconnection rate adjustments in 2002

  • High marketing, customer acquisition costs leading to slower growth in PCS Voice




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Return on Equity

  • Risk Free Rate of 4.75%

  • Company Beta of 1.5

  • Market Risk Premium of 6.25%

  • SYS = 5%

    • 10-Year US yield 3.875

    • 10-Year Korean yield of 8.875

  • Re = Rf + SYS + B(Rm – Rf) = 19.13%

  • Weighted average return of debt of 10.5%


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WACC / DCF

  • WACC = 12.13%

    • E/V*RE + D/V*RD*(1-TC)

    • Debt = 1,181,582m

    • Equity = 876,009m

    • TC = 29%

  • Assumptions

    • 5 years cash flow projections

    • Perpetual growth rate of 4%

    • Terminal EBITDA multiple of 4x

    • 72% of DCF value resides in the terminal value



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DCF Analysis

  • Trading at W4,200

  • 52 week range 3,370 - 5,050

  • DCF Target Price = W5,000

    • 12% Discount Rate

    • 4x Terminal EBITDA Multiple

  • Trading 18.4% below our DCF calculation

  • Investors may feel that LG Group will not increase spending for LG Telecom

  • Exposed to downside risk relative to competitors due to LGT’s lower:

    • ROIC

    • Earnings Growth Rate

    • Premium P/E multiple

“LGT Phone Home”

Needs help to survive!


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X

Scenario 1

Divest LG Telecom

  • Pros

    • Cash generated could be used towards more profitable projects

    • Concentrate on other businesses

  • Cons

    • Lost opportunity in 3G technology


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X

Scenario 2

Implement 3G

  • Pros

    • Increase subscriber base

    • Offer superior service

  • Cons

    • Too expensive for LGT to do alone

    • Not enough cash flow to cover capex

“Show me the money!!!”


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X

Scenario 3

“Do Nothing”

  • Pros

    • Second mover advantage

    • No Capex required

  • Cons

    • Loss of Subscribers to new technology

    • Obsolete technology


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Our Recommendation

Strategic Alliance with KTF

  • Pros

    • Risk and cost of implementation are split

    • Synergies with customer bases and existing technologies

    • Increase in available resources

  • Cons

    • Regulations over mergers

    • Loss of LGT’s trade secrets

    • Sharing of profits

      “If you can’t beat ‘em, join ‘em”



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