BUY

SLRs.18.00
Sri Lanka Telecom
Sector: Telecommunication The Communication Powerhouse!
Date: 01 June 2006

Financials
CSE Code: SLTL
Year to Dec (SLRs.mn) FY03A FY04A FY05FC FY06FC FY07FC FY08FC
Index Level: 2221.45 Revenue 25553 29,516 32,515 39,553 47,229 56,011
Revenue Growth (%) n/a 15.51% 10.16% 21.65% 19.41% 18.59%
EBITDA 14,346 12,645 16,263 20,804 24,675 30,093

Key Data: PAT 2,249 1,293 3,093 5,648 7,977 11,221

EPS (SLRs.) 1.25 0.72 1.71 3.13 4.42 6.22
12m Price Range: SLRs 27-14.70
EPS growth (%) n/a -42.4% 137.5% 83% 41.2% 40.7%

Market Cap (SLRs.mn/ US$m): PER (x) 14.65 21.98 10.50 5.75 4.07 2.90
Sri Lanka Telecom (SLT), with a market cap over US$300mn is one
32487/318.5
of the top companies on the Colombo Bourse with a substantial
Shares in Issue (m): 1804.86 foreign demand. Being the market leader of Sri Lanka’s fixed
telephony market, SLT is a company with a steady income stream
Book value / shares (SLRs): 19.44 expecting rapid growths through its mobile arm, Mobitel which has
Price / Book value (x): 0.93 already captured 19% of the mobile market since acquisition in 2003.

Forecasted PE (X): 5.75 Industry Outlook The telecommunication industry is regarded as one of
the fastest growing industries in Sri Lanka, with an average growth rate of
30% to 35% each year. The now fully liberalized industry is poised to
Price chart: thrive as it could be identified by the latest statistics showing 77 licensed
operators at the end of 2004 as against 40, two years ago. These
10,000,000 30 companies offer numerous services in line with the latest communication
8,000,000
25 technology and the available services include, fixed access telephones, as
20
both wire and wireless connections, cellular connections, internet and e-
6,000,000 mail, pay phones, radio paging etc. The mobile network of the country has
4,000,000
15
been in the forefront of the recent telecommunication boom with 73% of
10 the telecom market being dominated by the mobile operators. The mobile
2,000,000 5 subscribers increased by more than 1.5 times during 2005 reaching
0 0
3.36mn while the total telephone subscriber base in the country grew by
44% over 2004.
1-Jun-05
7-Jul-05

10-Jan-06
12-Aug-05
19-Sep-05
25-Oct-05
2-Dec-05

20-Feb-06
28-Mar-06
9-May-06

Industry Analysis
5,000,000
Fixed Access Wire Line

Analysts: 4,000,000 Fixed Access Wire Less

Cellular
Sonali Ratnayake 3,000,000 Total telephone Subscriber
Lauren Chang base

Bimanee Meepagala 2,000,000

Tel: 94 5 576757 1,000,000

research@lankasec.com
0
2000

2001

2002

2003

2005
2004

LSL Research - SLT – June 2006 1

 The growth in the industry had been primarily due to the timely
liberalization, which enabled the country to attract a number of
international telecommunication giants to invest in the necessary telecom
infrastructure. In addition, this assisted the local industry in obtaining
latest technology at the same time expanding communication facilities
through out the island. GPRS and 3G technology in mobile telephony are
two examples for such technology obtained and Sri Lanka was the first
country to introduce these to the South Asian region. Some of the
companies, which invested in Sri Lanka after the liberalization in 1996,
include some well-known names such as, NTT-Japan, Telecom Malaysia,
Telstra – Australia, Hutchison Whampoa– Hong Kong and Telia, the
national telecom operator of Sweden.
Sri Lanka Profile
The tele-density of the country increased by 4.1% during 2005 as against
Location: Southern Asia, island in the previous year and is now standing at 23.4%. The breakdown of this
the Indian Ocean, south of India comes as 6.3% in fixed lines and 17% in mobile connections. This is the
Area: total: 65,610 sq km
land: 64,740 sq km highest in the South Asian region and is well above the 8% overall density
water: 870 sq km of India and 3% to 4% of Pakistan. The market penetration level in mobile
Natural resources: limestone, telephony is 5% in India which is again far below the 10% in Sri Lanka.
graphite, mineral sands, gems,
phosphates, clay, hydropower Though this is the case, it should be noted that the tele -density of Sri
Natural hazards: occasional Lanka is still much lower than the average of the developed countries,
cyclones and tornadoes which is around 50%. Similarly, it is the same with mobile penetration, in
Population: 20,222,240
(July 2006 est.) which the world average is around 25% while the average in developed
Population growth rate: 0.78% countries hovers around 70%. However it should be accepted that low
(2006 est.) penetration levels and density on the other hand means more growth
Literacy: definition: age 15 and over
can read and write opportunities. There is still much potential for telecommunication
Total population: 92.3% investments within the country, especially in rural areas. Confirming this
male: 94.8% fact, through out the past decade Sri Lanka has been a prime choice among
female: 90% (2003 est.)
GDP (purchasing power parity): many global telecom operators as a comparatively better investment
$87.15 billion (2005 est.) opportunity.
GDP (official exchange rate):
$21.5 billion (2005 est.)
GDP - real growth rate:
History of the company SLT was the pioneering telecom company in the
5% (2005 est.) country, which was then fully owned by the government and was known
GDP - per capita (PPP): as ‘Sri Lanka Telecom Corporation’ (SLC). In 1996 the local telecom
$4,300 (2005 est.)
GDP - composition by sector:
industry was liberalized ending the monopoly status of SLC. During the
agriculture: 17.7% same year ‘Sri Lanka Telecom Limited’ was created and in 1997, NTT of
industry: 27.1% Japan invested in a 35% stake of the company’s capital apart from taking
services: 55.2% (2005 est.)
Labor force: 8.08 million
over the management. In 2003, licenses were granted to other private
(2005 est.) telecom operators to handle international call traffic, thus reducing SLT’s
Inflation rate (consumer prices): international call revenue from 60% to 30% of the total income. However
11.2% (2005 est.)
Investment (gross fixed): 27% of
SLT is still considered as the largest telecom company in the country in
GDP (2005 est.) terms of infrastructure, being the sole provider of fixed cable connections.
Public debt: 98.5% of GDP The company is regarded as the telecom operator with the highest income
(2005 est.)
Exchange Rate: SLRs per US$-
as well. The growth of the customer base and the revenue stream of SLT
100.498 (2005) was fuelled by its 100% stake in Mobitel, a leading mobile operator.

LSL Research - SLT – June 2006 2

Valuation SLT is currently trading at a considerable discount which is
50% of its estimated counter price of SLRs.36 based on their closest
comparator, Dialog GSM’s PE of 11.6x. On a forecasted EPS of 3.13 and
an expected market PE of 13x, the fair value of SLT is SLRs40. Based on
our Price to Book Value computation we derived a counter price of
SLRs.35 per SLT share.

Overall financial Performance SLT consolidated itself as the Number

One Sri Lankan Company by yet again showing strong performance in the
financial year ended December 2005. Both its local and international call
segments recorded revenue growths of 9% as a result of increased
customer base during the year and further contribution from data oriented
services, value added services and inclusion of new businesses (i.e.
telephone directory) enabled the group to record an overall revenue of
SLRs.32.5bn, which was a 10% increase over the previous year.

Revenue composition of SLT Local

International
Mobitel

11%

24%

65%

The group having retired some of its high interest rate bearing loans
during 2004 reduced its finance cost by 7% negating the increase in
operating costs of 7%. This together with the International Operator’s
Levy reducing by SLRs.924mn compared to a year ago and Interest
Income recording a growth of 221% enabled the group to gain a massive
139% increase in net profits to SLRs.3093mn.
The first quarter profit of SLT for the year 2006 was SLRs.1.3bn posting
an increase of 42% compared to the previous year. The group was able to
achieve this due to a revenue increase of 28% whilst maintaining modest
increases in operating costs and depreciation.

Market Performance of SLT The fixed line telephony maintains its

position as the highest contributor to SLT’s growth. In 2005, SLT
captured 93,592 new subscriber lines to retain its position as Market
Leader enjoying as high as 77% of the total market. The Customer base as
at the end of the year stood at 954,060 lines. It was significant to note that
10,923 of these lines were supplied to the North and East despite rising
political upheaval. The tele-density of the country still being at 6.32
telephone lines per 100 persons, will enable the company to penetrate
more into this segment possibly maintaining its compound annual growth
rate of 7% in its subscriber base.

LSL Research - SLT – June 2006 3

 Customer Base

1,000,000

800,000

600,000

400,000

200,000

0
2001 2002 2003 2004 2005

Source: SLT Annual Report

Predominant Infrastructure and Technology SLT’s microwave copper
based network is based on a technology that is superior to any other
network in the country. But in understanding the future need, this fiber
network is being enhanced to a more high-speed island wide optical fiber
network to ensure high transport capacity and seamless connectivity
region wide.

Further, SLT will be introducing IP transport technology which will

support the convergence of broadband services such as Next Generation
Network (NGN), AII-IP CDMA, ADSL, Wi-Fi island-wide and by 2009
include an additional fibre ring, the high speed Optical Fibre Super
Highway (STM-64). This will enable SLT to offer a standards-based
wireless technology called WiMAX to provide high throughput broadband
connections over long distances through the use of the above mentioned
microwave links. WiMAX will support voice, high-speed Internet
connectivity, email, fax, and data services.

The undersea fiber optic cables SEA-ME-WE 3 and SEA-ME-WE 4 has

been able to elevate the group’s global connectivity in par with
international levels. SEA-ME-WE 4 been built on DWDM technology
will enable performance to be at tetrabit per second as well as support
connectivity across the East and West, link South East Asia to the sub
continent as well as the Middle east and Europe. SLT will be looking at
selling excess capacity on this cable to other operators.

The Bharat Lanka cable system, expected to start operating by July 2006,
will enable both SLT and Bharat Sancher Nigam (BSNL), the seventh
largest telecommunication operator in the world, to access foreign
countries using each others existing and future cable networks such as
SEA-ME-WE 3, SEA-ME-WE 4 and the internal terrestrial networks of
BSNL. At first, the system will be running at a capacity of 10 gigabits per
Second, targeting up to 160 gigabits per seconds to benefit corporate and
personal customers of both India and Sri Lanka with Competitive
International Private Leased Circuits (IPLCs), broad band internet, direct
and transit international direct dialing (IDD) traffic, Internet protocol (IP)
backbone networks and multimedia content services.

LSL Research - SLT – June 2006 4

CDMA technology Code Division Multiple Access (CDMA) technology
will aid SLT in their objective of eliminating existing disadvantages to
citizens of Sri Lanka in terms of their access to communication. Whilst
providing such access to remote locations in the North, East and the Deep
South of the island, CDMA connections are of superior quality granting
users already in city limits a range of services. Hence, SLT can deploy
this technology at a reduced cost and at a faster rate in comparison to
connecting via the present wired access technology. Currently servicing a
CDMA subscriber base of 120,000 customers, SLT will target to increase
its subscriber capacity by 150,000 year on year.

Internet Services SLT’s ADSL (Asymmetric Digital Subscriber Line)

technology serves more than 13,312 domestic and corporate users island
wide enabling them to browse and use telephone lines at the same time for
communication purposes. In the overall market of Internet users, SLT
again places itself in a dominant position, seizing 64% share.

Internet Subscriber Base

200,000
180,000 Total Internet Subscribers
160,000 SLT Internet Subscribers
140,000
120,000
100,000
80,000
60,000
40,000
20,000
0
2001 2002 2003 2004 2005

Aggressive Mobile Coverage Mobitel the wholly owned subsidiary of

SLT is only second to Dialog, the largest mobile operator in Sri Lanka.
Possessing the only network in the island that provides pre-paid roaming,
Mobitel boasts of a comprehensive roaming coverage and is continuously
looking to expanding coverage and value added services offered to its
invaluable and expanding customer base. As at the year-end 2005, its
subscriber base had grown by 48% to 420,062 compared to the previous
years’ 284,430 and thus capturing 19% of the mobile telecommunication
market of Sri Lanka. The company’s operating profit grew by a massive
382% to SLR.806mn in 2005 reaping benefits from aggressive
investments in technology and network expansion. Despite a strong
operating performance recorded, the company was only able to relieve its
previous year’s loss by only 6% registering a year end net loss of
SLRs.1.1bn. However it is expected to breakeven by the 2nd Quarter of
2006. The reason for this was the high depreciating costs of heavy
investments and interest charges from the company being highly geared.

LSL Research - SLT – June 2006 5

The company’s expansion plans include increasing its subscriber capacity
from its current 400,000 to 1,000,000 by the end of this year and adding
more than 350 new base stations to provide wider coverage and
uninterrupted connectivity.

Way Forward Currently the industry thrives on coverage and players in

with expanded networks are reaping benefits from their investments in
infrastructure. In the years to come, with rising competitiveness in the
industry and the market reaching its saturation we expect the competence
to shift towards supplying a more sophisticated customer demanding rich
and ready to use latest of technologies. Hence, consumers will demand
more choice, flexibility and greater control, urging the telecommunication
providers to innovate new products of superior quality and reliability at a
faster delivery time.

SLT raising itself to the challenge, will be rolling out a modern IP based
platform that will enable SLT’s network to evolve into an ultra modern
Next Generation Network (NGN) providing multiple services on a single
platform. This facility will amalgamate voice, data, and Internet
connectivity together with application services to both the local and global
markets.

Relative performance

SLT Price Vs. Adj ASPI SLT Price Vs. 200Day MA

30
60
Price 25
50
Adjusted Index
40 20

30 15

20 10

Price
10 5
200day Avg

0 0
12-May-04

12-May-05

12-May-06
12-Nov-03

12-Nov-04

12-Nov-05
14-Jul-03

14-Jul-04

14-Jul-05

12-Aug-04

12-Aug-05
14-Jan-03

14-Jan-04

14-Jan-05

14-Jan-06

12-Feb-04

12-Feb-05

12-Feb-06
14-Apr-03

14-Oct-03

14-Apr-04

14-Oct-04

14-Apr-05

14-Oct-05

14-Apr-06

The information contained in this report, researched and compiled for purposes of
information do not purport to be complete description of the subject matter referred to
herein. In preparing this report care has been exercised to collect information from
sources which we believe to be reliable although we do not guarantee the accuracy and
completeness thereof. Lanka Securities (Pvt.) Ltd. And/or its affiliates and/or its
directors, officers and employees shall not in any way be responsible or liable for loss or
damage which any person or party may sustain or incur by relying on the contents of this
report and acting directly or in directly in any manner whatsoever.

LSL Research - SLT – June 2006 6

Earnings Model Growth Rates (%)

Yr to Dec (SLRsmn) 2004A 2005A 2006F 2007F 2008F Yr to Dec 2004A 2005A 2006F 2007F 2008F

Domestic revenue
Total Revenue 29,516 32,515 39,553 47,229 56,011 growth 10.11% 6.55% 22.00% 18.00% 15.00%
International revenue
domestic revenue 19,726 21,019 25,643 30,259 34,798 growth 28.17% 17.43% 21.00% 22.00% 25.00%
Total Revenue
Int'l revenue 9,790 11,496 13,910 16,970 21,213 Growth 15.51% 10.16% 21.65% 19.41% 18.59%
Operational Expense
Margin 49.08% 47.71% 45.00% 46.00% 45.00%
Total Operating
Expenses 14,485 15,512 17,799 21,725 25,205 Depreciation 8.63% 4.62% 10.00% 2.00% 4.00%
Growth in long term
Operating profit 15,031 17,003 21,754 25,504 30,806 debt 54.59% -8.45% -5.30% -5.00% -8.00%

EBITDA 12,645 16,263 20,804 24,675 30,093

Ratio Analysis

EBIT 3,693 6,897 10,502 14,166 19,164

Financial charges 2,252 2,085 1,812 1,894 1,901 Yr to Dec 2004A 2005A 2006F 2007F 2008F

EBT 1,441 4,812 8,689 12,272 17,263

taxation 148 1719 3041 4295 6042 Liquidity (x)
PAT 1293 3093 5648 7977 11221 Current Ratio 1.95 1.72 2.53 2.40 2.25

Price to Earnings Valuation Solvency (x)

Long term debt to
total assets 0.27 0.23 0.22 0.19 0.16
Long term debt to
Market price 18.00 equity 0.67 0.55 0.46 0.38 0.29

EPS (Expected) 3.13 Interest cover 1.64 3.31 5.79 7.48 10.08

Dialog P/E (Expected) 11.60 Assets to equity 2.54 2.32 2.11 1.96 1.81
Price based on Sector
P/E(SLRs) 36.30

Market Measures

Price to Earnings Valuation EPS (SLRs) 0.72 1.71 3.13 4.42 6.22

BV (SLRs) 17.21 19.44 21.67 25.01 29.93

Market price 18.00 Price to Book (x) 0.92 0.93 0.83 0.72 0.60

EPS (Expected) 3.13 PE(x) 21.98 10.50 5.75 4.07 2.90

Market P/E (Expected) 13.00

Price based on Market
P/E(SLRs) 40.68 Profitability

EBITDA margins 42.84% 50.02% 52.60% 52.25% 53.73%

Price to Book
Valuation EBIT margins 12.51% 21.21% 26.55% 29.99% 34.21%
Pre-tax margins 4.88% 14.80% 21.97% 25.98% 30.82%
Market price 18.00 Net Profit Margin 4.38% 9.51% 14.28% 16.89% 20.03%
-
BVPS (Historical) 19.44 Net Profit Growth 42.51% 139.21% 82.61% 41.23% 40.67%
P/B Ratio 0.93 ROE 4.16% 8.82% 14.44% 17.67% 20.77%
Market P/B Ratio
(Expected) 1.80 ROA 1.64% 3.73% 6.85% 9.02% 11.47%
Price based on Sector
P/B(SLRs) 34.99

LSL Research– SLTL– Jun 2006 7