GO internet — Full speed ahead on 5G

GO internet has recently implemented plans to roll out its 5G network more rapidly to upgrade customers to ultra-high-speed (up to 1Gbps) 5G services. Management intends to increase base station roll-out from the previously planned 75 to 95 in 2019 and to continue with seven to eight new base stations per month in 2020, compared with its previous schedule of six per month. This will give the group the option to shut down the WiMax network in 2020 and migrate all existing WiMax subscribers to the 5G network a year earlier than planned.

Advantages of the plan are firstly that the construction of the 5G network can be carried out over existing WiMax infrastructure, which will speed the roll-out and reduce build costs. The roll-out to existing WiMax service areas also enables GO to exploit existing brand awareness in the area. The group also intends to exploit new online channels to accelerate sign-ups.

The frequency sharing agreement with Linkem, Italy’s largest supplier of fixed wireless broadband with networks covering 60% of Italy’s population, also transforms the ROI picture. New 5G base stations using both GO’s and Linkem’s 5G frequencies will double the capacity of the existing WiMax base stations for only marginally more outlay and GO will benefit from Linkem’s marketing to generate wholesale as well as retail revenues from the base stations. The resulting ability to offer unlimited data packages, as well as higher speeds, should also put it on a firmer footing when competing against other offerings, including fibre to the cabinet.

Migrating WiMax subscribers to 5G more rapidly should also have a positive impact on residential churn. GO currently offers most of its WiMax subscribers speeds of up to 12Mbps, which is similar to the speed offered by ADSL fixed lines. Nevertheless, a high proportion of GO’s WiMax customers switch to other networks at the end of their promotional period, so the boost to either up to the 100–300Mbps speed provided by LTE or up to 1Gbps speed offered by 5G will present a powerful incentive to remain with GO and pay higher subscription fees.

Linkem has also helped fund GO’s investment with a (pre-costs) €4m equity investment in H118. The deal also provides the potential for GO to generate significant wholesale revenues. Under the agreement, each company will pay the other €10 per customer, per month for hosting the other’s customers on their networks. GO sees the potential to gain as many as 5,000 new wholesale subscribers from Linkem in 2019, representing a c €0.6m pa boost to revenues.

Despite the new 5G strategy, GO remains committed to further the expansion of its LTE fixed wireless network, which is currently growing at the rate of 500 (net) new subscribers a month. The LTE network offers substantially higher speeds than the now-obsolete WiMax system and provides the ability to attract customers in areas outside the 5G network. Recently, the revenue generation potential of the network has been affected by churn in business subscribers to faster networks. Nevertheless, with speeds of 100–300Mbps, the network remains attractive to residential subscribers, particularly in rural areas, so migrating some subscribers from WiMax to LTE and recruiting new LTE subscribers remains an attractive proposition.

Management now also expects slower growth in fibre subscribers as a result of the new 5G strategy. The deal with Enel Open Fiber enables GO to add subscribers to the Enel network in return for a wholesale line rental charge, giving rise to an EBITDA margin in the mid-30s in percentage terms. The economics of the 5G roll-out, including the absence of wholesale line costs and the added incentive to fill capacity rapidly means the group will focus its marketing spend more heavily in that area.

The 5G frequency auctions in Italy that were completed in early October resulted in higher than expected sale prices for frequencies in the 3.4–3.6GHz spectrum range. GO’s 3.5GHz frequencies are part of the same band of frequencies being used to launch 5G as the 3.7GHz frequencies sold at auction, and can be considered functionally equivalent.

TIM and Vodafone each paid €1.69bn for Italy-wide 80MHz blocks of 3.7GHz frequencies for a term of 19 years. Adjusting for differences arising from population coverage and duration1 (see Exhibit 1), we calculate that these sales imply a potential value of €20.8m for GO’s current rights to 42MHz in the 3.5GHz spectrum, which run until 30 June 2023.2 We calculate a further value of €30.0m for the use of the frequencies, which was recently granted by the Italian government under the extension for a further 6.5 years to end-2029.

We calculate the implied value of GO’s existing frequencies (ie excluding the planned extension) at €20.8m or €1.54 per share. If we include the extension to 2029, this rises to €50.8m, or €3.77 per share. Assuming that the extension fee remains at the €2.7m set by the government (see below), the implied value of the group’s frequencies to 2029 net of debt rises to €46.4m or €3.45 per share. These values do not take into account the value of the operations and other non-frequency related parts of the business, including the group’s fixed wireless infrastructure and customer base.

GO’s licence extension was approved this summer, a few months before the auction, with the government writing to GO stating that the charge for the 6.5-year extension to end-2029 would be €2.7m.

The procedure to extend the licence as undertaken by the company included the following steps.

Despite the significant gap between this price and the amounts raised at auction for similar frequencies, GO has obtained a legal opinion that this letter should bind the government to charging no more than this sum. A recent compact with the government to bring forward the licence payment to end January 2019 looks set to further secure the agreement.

However, it does appear that the government will face pressure from the participants in the frequency auction in the summer to bring the charge to extend the frequencies in line with the prices achieved in the auction. On 13 November, TeleGeography reported that TIM had joined Vodafone and Iliad Italy in threatening legal action against the Italian telecoms regulator (Agcom) in Italy’s regional courts if it proceeded with its plans to extend the 3.5GHz wireless licences held by Tiscali, GO internet, Linkem and Mandarin.

We believe that the Italian government has a strong interest in enabling Italy’s regional broadband operators to continue to use 5G frequencies to provide the population with high speed broadband services in rural areas. As such, we believe that there is a will within the government to continue with the issue of licence extensions at the agreed price.

Nevertheless, in view of these announcements by TIM, Vodafone and Iliad, it is not possible to rule out a period of uncertainty regarding the licence fee payment or the risk of the government being required to increase the renewal fee charged to GO, potentially to the figures shown in Exhibit 1, under pressure from the courts.

GO reported a 2% decline in H118 revenues to €3.4m and a 9.8% decline in EBITDA to €1.4m, leading to a widening in reported pre-tax losses to €0.7m from €26k in H117.

Revenues were hit by a slowdown in annual subscriber growth from 9.5% in 2017 to 5.8% and a 10.5% decline in ARPU to €13.1. The decline in subscriber growth was principally due to ongoing subscriber churn from the obsolete WiMax network with net subscriber losses recorded at 137 per month during H118. The group nevertheless achieved overall subscriber numbers due to average net monthly additions of 345 in the 4G LTE network.

The decline in revenue was in part offset by cost efficiencies and a reduction in the use of consultants, which led to an 8% reduction in personnel costs. As a result the decline in EBITDA, margin was held at 3.5pp (to 40.8%) and the EBITDA decline was kept at 9.8%.

Capex rose 8.6% y-o-y to €1.7m as the group intensified spending on the LTE and 5G networks to take full advantage of the Linkem frequency sharing agreement. With the help of the €4m equity investment from Linkem in H118, net debt was reduced 66% to €1.6m at end-June.

D&A expenses rose 15% in H1 to €1.5m, reflecting the increase in network capex since the start of 2017, resulting in a normalised operating loss of €87k (H117: €262k profit). Pre-tax losses increased further to €709k (H117: €26k) as a result of doubtful debt and other provisions rising from €103k in H117 to €356k, reflecting the difficult economic climate in Italy.

Subscriber development: We forecast 7.0% growth in total subscriber numbers to 45.2k at the end of 2018. This reflects the expectation of 56% growth in LTE subscribers, with H2 numbers assumed to be boosted by the recruitment of c 500 subscribers in 5G areas in the last quarter of this year, which will be included with LTE network subscribers ahead of the roll-out of 5G base stations at the start of 2019.

With the new accelerated 5G strategy in place, we forecast a sharp build-up in 5G subscribers during 2019 from zero to 15.1k. This arises from the assumed migration of 7.5k subscribers from the WiMax network, the recruitment of 2.5k new retail 5G subscribers and the addition of 5.1k wholesale subscribers from Linkem. This leaves 20.0k subscribers in the WiMax network at YE19 after applying a 10% churn estimate.

We forecast LTE subscribers to grow 32% during 2019 to reach 17.3k at YE19. We forecast a further 44% increase in fibre broadband subscribers to 1.3 million in 2019, but this is sharply down from previous forecasts. This reflects management’s increased focus on 5G, in part driven by the higher EBITDA margins that can be achieved from own network operations that do not incur wholesale rental costs.

ARPU outlook: We forecast FY19 blended ARPU to grow by 0.7% to €13.2 from our estimate of €12.9 in 2018. As the 5G network rolls out, we expect GO to offer discounted rates to WiMax subscribers to incentivise them to switch to the 5G network. As a result of this ARPU dilution, we assume that initial 5G ARPUs in 2019 will average c €15.7 compared with the c €18 charged to completely new subscribers. Over time, the average ARPU should revert back to c €18 as the discounts are eliminated. Despite this, we expect growth in LTE subscribers and further shrinkage in WiMax subscribers to have a positive overall impact on blended ARPU going forward.

We summarise our revised earnings forecasts in Exhibit 3. For 2018 we forecast 2.7% revenue growth y-o-y to €6.8m, down from €7.5m. This principally reflects reduced expectations of LTE subscriber numbers arising from high churn and lower blended ARPUs arising from the reduced proportion of LTE business subscribers lost to competing higher-speed networks.

We have reduced our FY18 EBITDA margin estimate by 0.4pp to 39.6% on lower revenue growth/fixed-cost coverage, resulting in a 2.9% y-o-y reduction in FY18e EBITDA to €2.7m. With doubtful/bad debts likely to remain high, we forecast normalised FY18 PBT losses of €670k vs €269k in H1.

In 2019, we forecast a 16.5% y-o-y increase in revenue to €7.9m on the back of strong growth in the 5G network helped by migration of WiMax customers to 5G, as well as the addition of 5G wholesale revenues from Linkem.

We forecast EBITDA margins to rise 0.2pp from 2018 to 39.8% as double-digit revenue growth increases fixed-cost cover, although higher marketing costs will cap the extent of the increase. Overall, we forecast a 17.0% increase in EBITDA to €3.1m, translating to a normalised PBT loss of €583k.

FY18: The net €4.0m equity issue by Linkem in the first half of the year enabled GO to cut net debt by €3.1m in H118 to €1.6m. For the full year, we expect operating cash flow (as we calculate it) to reach €2.8m (€2.5m as reported by the company). We have trimmed our capex forecast from €3.7m to €3.3m to reflect management’s expectation of a continuation of the H1 rate of capital investment in H2. As a result, we forecast year-end net debt of €2.4m, equating to a 0.9x net debt to EBITDA multiple.

FY19: Our 2019 forecast now assumes that GO pays a €2.7m 5G licence fee to the state in January 2019, funded by a new €5.0m equity issue in Q119. We assume underlying capex, excluding the licence fee, to rise to €5.6m to accommodate the accelerated 5G roll-out strategy. Including the assumption of the completion of the €5.0m capital increase in early 2019, we forecast net debt to rise to €3.4m by YE19. This equates to a 1.1x YE19 net debt/EBITDA multiple, which we expect to peak at 1.2x in 2020 before falling back below 1.0x in 2021. This forecast reflects our expectation that the benefits of the increase in operating cash flows in 2020 arising from the accelerated 5G roll-outs will be augmented by reduced discounting of 5G subscriptions to WiMax subscribers.

GO internet is attractively valued on a multiple comparison with its Italian broadband peers. On EV/EBITDA, it is priced at a 9% discount to the prospective 2018 peer multiples, rising to 11% in 2019. We believe that the stock’s in-line EV/sales multiple in 2018 of 2.8x is supportive of the stock in view of GO’s above-average EBITDA margins.

We have reduced our DCF valuation for GO from €2.20 to €1.67 per share. This reflects the reduction in earnings forecasts discussed above and high forecasts of near-term capex due to the accelerated 5G strategy and the incorporation in our forecasts of the expected €2.7m 5G licence payment in 2019.

With regard to the group’s valuation, we note the potential strategic value of GO’s frequencies to competing players and mobile operators. This can be seen in the €3.45 per share implied value of the recent 5G frequency auctions, assuming that the fee for the extension of 5G frequencies is levied at the already agreed rate.

We also note the implied €1.41 per share strategic valuation placed on the group by fellow Italian broadband supplier Linkem’s recent purchase of a 21% stake in GO internet for €4.0m, as part of the 5G frequency sharing agreement between the two companies.

As mentioned above, we note the risk to the share price of the threat of legal action against the Italian government over the issue of 5G licence fee extensions to Go Internet and the other regional broadband operators.