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 Telecommunications Sector LG Telecom’s Business Current Market Situation Investment Outlook Financial Analysis Final Recommendation

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

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.

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…”

Asian Financial Crisis

     Exposed weaknesses in South Korea’s developmental model including    H igh 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

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

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

4 Tigers Singapore Taiwan Hong Kong South Korea

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

CPI RANK

5 14 30 43

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”

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

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

LG Telecom Brands

    

Ez-i Khai Khai Holeman Btob IMT (International Mobile Telecommunication) 2000

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.

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.

Khai Holeman

   Incorporates teenage interests:   Invitations to various events and discounts Animated characters Highly diverse marketing techniques High demand among teenagers

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

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.

Competition



SK Telecom



Korea Telecom Freetel

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

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

South Korean Mobile Phone Market

     2001 South Korea 1 st 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

Market Share 2002

SKT KTF LGT Total 15% 32% 53% 2002 Korean mobile sector ended with 32.34 million subscribers up 11.4% from 2001 and a penetration rate of 67.7% SKT KTF LGT Subscribers 17,329,252 10,277,333 4,755,155 32,342,040 Net Adds 145,000 (55,437) (15,006) 74,557 Activiations Deactivations Market Share (%) 315,155 120,278 53.60% 160,273 55,128 530,556 215,710 70,134 406,122 31.72% 14.68% 100.00%

Cell Tech Evolution

3rd Generation Wireless Technology Capabilities

3G Network Standards

cdma2000 1X EV-DO cdma2000 1X EV-DV W-CDMA

Wireless access method Speed of data transmission Applications Cases Features Synchronous Synchronous Asynchronous 2.4Mpbs (high) 307Kbps (average)     MMS, VOD, mobile broadcasting SKT, KTF Dedicated data services Commercialized in frequency band of 2G Channels can be dominated by users that have high capacity date transmission Compatible with existing network    5.2Mpbs (high) 1.2Mbps (average) 2Mpbs (high) 384Kpbs (average) MMS, VOD, mobile broadcasting, visual telephone N/A Unlike EV-DO, provides both data and voice services, high efficiency of networks Not commercialized Compatible with existing networks under synchronous method     NTT DoCoMo of Japan No difference with EV DO, if excluding visual telephone services Stability with speed of 384Kbps Incompatible with existing networks; massive CAPEX required, problems related to handoff High growth potential relative to cdma2000

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

Mobile Phone Industry

   Declining ARPU (Average Revenue per User)  Decrease in Service Revenue Market Saturation  Increase in Subscriber Base 3G Technology

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%

A New Focus

THE TRANSITION

High Customer Growth -Voice Centric Customer Focus -Portfolio of voice and data services

New Growth Drivers

 The Industry’s Solution   Decrease in Prices for Voice Calls New Focus on VAS and Data Services

Issues Relating to Growth

   Target new demographics  Corporate clients  Youth 3G technology   New applications What to market Expensive development  Infrastructure  Engineering

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

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

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

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

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

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

NO 3G!



LG TELECOM DID NOT INVEST IN 3G…

Current Market Situation



SK Telecom KTF LG Telecom – S&P500

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

Ratio Analysis

Activity Ratios

A/R Turnover Net Fixed Asset Turnover Asset Year Change

Total Cap Exp Growth

Depreciation Change

Profitability Ratios

Sales Yearly Change Operating margin Pretax margin

Profit margin Return on assets Return on cap. Return on equity

Interest burden

2002

7.86

1.39

12.49

4.26

21.52

LG 2001

8.24

1.40

22.41

-18.17

-30.00

2000

8.83

1.32

3.52

7.52

113.83

6.82

7.84

4.56

3.2

2.47

6.13

8.59

58.14

14.65

17.43

10.51

7.28

6.14

13.76

30.42

60.32

28.66

-14.53

-20.34

-23.90

-19.91

-13.83

-94.40

139.97

SKT 2001

7.46

1.92

20.66

-38.33

19.45

2000

7.76

2.13

76.32

99.41

91.28

12.78

27.77

23.61

13.69

9.41

13.02

20.19

85.04

67.11

20.15

17.35

13.1

11.23

15.01

20.08

86.11

KTF 2001

5.66

1.38

95.87

21.95

115.99

2000

6.9

1.46

33.08

52.58

39.06

61.66

16.59

12.48

9.63

8.83

14.94

27.59

75.25

23.08

9.01

6.06

4.17

3.99

7.29

11.05

67.24

Ratio Analysis Cont’d

Per Share Data

Op income per share Book value/share

P/E Liquidity Ratios

Current ratio

Debt Factors

T debt/Com equity Total debt

Leverage Analysis

Assets/Equity Debt to assets

2002

850.16

3159.32

16.6

LG 2001 2000

1,770.43 -1,410.22

2,936.39

11.15

1,052.86

NA 0.46

0.50

0.33

188.72

1,653.20

169.63

1,381.14

735.85

1,477.43

3.55

53.13

3.40

49.93

11.26

65.38

SKT 2001 2000

26859.01 17144.63

64916.67

17.82

66937 22.84

1.16

0.87

84.02

4,526.73

50.02

2,982.37

2.19

33.97

1.81

27.00

KTF 2001

4420.35

11089.5

11.26

2000

1756.1

7762.34

20.33

0.69

0.48

171.63

3487.6

140.73

1558.24

3.2

53.69

3 46.98

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 R e = R f + SYS + B(R m – R f ) = 19.13% Weighted average return of debt of 10.5%

WACC / DCF

  WACC = 12.13%     E/V*R E + D/V*R D *(1-T C ) Debt = 1,181,582m Equity = 876,009m T C = 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

DCF Calculations

LG Telecom Discounted Cash Flow Analysis ( KRW Billions)

EBIT Net Income + Depreciation & Amortiztion + (Inc) / Dec in net working capital - Capex Free Cash Flow

2002

230 161 314 (99) 359 17

2003E

276 194 322 (16) 321 178

2004E

368 258 324 (26) 391 165

2005E

412 289 332 (9) 350 262

2006E

444 312 332 (11) 359 264

2007E

472 332 314 (13) 347 286

Discount Rate 8% 9% 10% 11% 12% 13% 14% 15% 16% Terminal EBITDA Multiple 2x

2826 2553 2294 2047 1812 1589 1377 1174 981

3x

4834 4471 4126 3798 3486 3190 2909 2641 2386

4x

6842 6388 5957 5549

5160

4792 4441 4108 3790

5x

8850 8305 7789 7299 6834 6393 5973 5574 5195

6x

10857 10223 9621 9050 8508 7994 7505 7041 6599

7x

12865 12140 11453 10801 10182 9595 9038 8508 8004

8x

14873 14057 13284 12552 11856 11196 10570 9974 9409

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!

Divest LG Telecom

  Pros   Cash generated could be used towards more profitable projects Concentrate on other businesses Cons  Lost opportunity in 3G technology

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!!!”

“Do Nothing”

 Pros   Second mover advantage No Capex required  Cons   Loss of Subscribers to new technology Obsolete technology

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”

Q&A