Back on track

The lack of clarity over funding during the first nine months of 2016 (refer to our report Rights issue for accelerated network roll-out for more detail) meant that GO had to slow the pace at which it rolled out its network to conserve liquidity. Subscriber growth tends to track base station installations and, consequently, while subscriber numbers have continued to increase (as GO back-filled its existing capacity), net additions during 2016 of 6.4k were not as strong as in FY15 (8.4k). Nevertheless, the full year results show continued solid financial progress.

Revenues increased by 21% to €6.4m, in line with our forecast, tracking the 20% year-on-year increase in subscribers to 37,749 at the year end. EBITDA of €2.5m (40% margin – flat on the interim) was 11% below our estimates, which we attribute to a higher level of marketing spend in relation to the launch of the new fibre service in Perugia in partnership with Enel Open Fibre. At the operating level, this was offset by a lower than forecast depreciation charge (due to a slower roll-out of the network in H216) leaving operating profits of €0.7k (+25% y-o-y), broadly in line with our expectations. However, a slightly higher tax charge meant that net profit of €0.3m was slightly short of our forecast.

Following the €4.0m October 2016 capital raise, management is accelerating the roll-out of the network and has taken advantage of favourable terms offered by Huawei to purchase approximately €2m of base stations just before the year end. Consequently, capital expenditure of €5.7m was considerably above our estimate of €3.2m, as was the year-end net debt of €3.0m.

In October 2016, GO announced the successful completion of its 77-for-100 rights issue at 0.86 per share (raising €4.0m via issuing 4.6m shares in total). In addition, in January 2017 it secured an additional €1.75m loan from Banca Intesa.

With this funding in place, GO has the resources to reaccelerate the roll-out of its 4G LTE high-speed wireless broadband network, targeting approximately 100-120 new base station installations in FY17 (compared to c 30 installed in FY16).

Additionally, in July 2016 GO announced that it had partnered with Enel Open Fibre in Perugia to market its ultra-wideband, fibre-to-the-home network. The additional funds will also enable it to widen the scope of its marketing for the promotion of this high-speed wireline network. Take-up in the first few months has been encouraging and the offer will be extended to another city in Q217, potentially adding other cities in Italy as the year progresses.

We assume GO maintains a higher level of marketing spend in FY17 to support the new wireline services and a faster pace of deployment for its wireless network which leads to a reduction in our FY17 EBITDA forecast by 7%. The additional cost of financing the €1.75m loan leads to a reduction in our EPS forecast by 26% in FY17. We view the increase in capital expenditure as an acceleration of plans rather than an uplift and consequently we leave our FY18 forecasts largely unchanged at the operating level.

GO reported FY16 year-end net debt of €3.0m, with cash of €2.4m. Debt comprises two bank loans of approximately €2.3m (c 3.5% interest) repayable in annual instalments by 2019 and 2023 respectively, and sale and leaseback arrangements mainly with Huawei for €2.1m, the outstanding payments due on the licence acquisition for the Emilia-Romagna region of €0.3m (repayable in annual instalments to 2024) and other credit lines (€0.6m).

We are increasing our FY17 capital expenditure forecast from €4.0m to €4.5m, and again in FY18 from €3.4m to €4.1m. Despite this increase and the higher than forecast FY16 year-end debt level, we raise our FY17 forecast net debt by only 9% to €3.7m. GO’s strong relationship with Huawei has enabled it to secure favourable payment terms on the procurement of its base stations, which we expect to result in a significant working capital inflow in the current year. Provided this is the case, GO is adequately funded to execute a more aggressive roll-out plan in the forecast period, although it may seek to add to its facilities to provide additional flexibility in the event these payment terms are not repeated in for future equipment purchases.

The commercialisation of its wireless network in the in the Marche and Emilia-Romagna regions of Italy is the primary driver of forecasts and underpins our base case DCF valuation of €2.8 per share (down from €3.1 following the reduction in our EBITDA forecast). Along with the pace of expansion of this wireless network, there are a number of other initiatives that could have a significant impact on GO’s valuation. In summary:

Since our last update it is the value of GO’s spectrum in a wider context that requires greater attention given wider developments in the industry. When GO first acquired its spectrum, there was little interest by the industry in the 3.5GHz frequencies and GO secured 42MHz of spectrum in this frequency band for a relatively low price. However, with the explosion of mobile data, the lower frequencies currently used by mobile service providers are rapidly becoming saturated and mobile operators are looking to higher frequencies to satisfy capacity demands as the industry moves towards the gigabit technologies offered in a 5G environment.

Intel, Qualcomm and Huawei have all started producing chipsets that support 3.5GHz frequency for tablet and smartphone reception, which are now being incorporated across a spectrum of equipment, including smartphones (Sony, Samsung and ZTE phones using Qualcomm Snapdragon 835 chipset are expected to be on the market in the coming months). Furthermore, regulators across Europe (Ofcom, ITU) have now identified three key bands that will enable 5G in Europe – 700MHz, 24.5-27.5Ghz and, critically for GO, 3.4-3.8GHz.

This opens up a number of new possibilities for GO longer term, from wholesaling its spectrum to telecoms operators, to potentially even adding its own mobile offering to its fixed wireless broadband services. It also makes GO a more attractive target for one of the larger operators looking to secure 5G spectrum.

Assessing the actual value of GO’s spectrum is at this stage highly speculative. However, there is an interesting reference case in the UK. Hutchinson 3’s UK arm recently acquired UK Broadband for €350m (£250m plus £50m deferred investment). At an implied value per subscriber of €23k (UK Broadband has only 15k subscribers, mainly in London), the acquisition is largely ascribed to its ownership of 208MHz of nationwide spectrum holdings between 3.5 and 3.7HGz range, giving a significant boost to 3UK’s capacity in this band. Hutchinson’s acquisition is a lower-risk and cheaper route to securing spectrum than relying on the spectrum auctions – scheduled for later in 2017 in the UK. Via UK Broadband, Hutchinson secures the spectrum for only 3c per MHz per population compared to the 43c it paid for its 800MHz of 4G spectrum in 2013. As a benchmark, this indicates a potential spectrum value of €8m (assuming the UK Broadband takeover value per MHz per population), up to €122m (using the price Hutchinson paid for its spectrum in 2013). This is in addition to the value of GO’s wireless subscriber network and installed base of 37.7k subscribers.

For GO, the question has now become how and when, rather than if it can leverage its frequencies beyond wireless broadband services with a mobile offer. Irrespective of its eventual commercial strategy, owning exclusive access to these frequencies in the valuable Marche and Emilia-Romagna regions in Italy has put GO on the map of mobile operators looking to secure capacity for 5G mobile services.

On the other hand, it complicates GO’s own plans to bid for additional 3.5GHz spectrum to widen its wireless footprint to other regions, as these auctions are likely to be hotly contended now. In early 2015, AGCOM announced its intention to release an additional 200MHz of spectrum in the 3.6GHz frequency band. The government was keen to add services in areas of the country that currently have poor or no reception (digital divide areas). The auctions, which have already been subject to delays (they were originally expected last year), are likely to be delayed further as the regulator reassesses its strategy in light of the 5G standards that are being recommended.

With funding in place, GO is in a strong position to reaccelerate the deployment of its network, both within and beyond its existing regions. Our base case DCF valuation, which factors in our forecasts to FY18 followed by stable subscriber additions for a further five years (and assumes an 11.5% WACC and a 2% terminal growth rate), returns a valuation of €2.8 per share, 35% above the current share price. Investors should also consider the following:

GO competes with a number of much larger, well-funded operators. Our forecasts assume, a stable pricing environment and steady progression in subscribers. However, the market is highly competitive and GO needs to react to market trends.

While we do not consider our subscriber forecasts for the new Enel service to be aggressive (peaking at 200 new subscribers a month), they are fairly speculative. The financial impact could be significantly higher or lower than we assume.