John Genovese

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• John Genovese
• Edward Mui
• Ram Narayanan
• Mitesh Patel
• Sachin Patel
• Aric Schachner

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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 Telecoms Business
• Current Market Situation
• Investment Outlook
• Financial Analysis
• Final Recommendation

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(No Transcript)
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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 1980s 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 Koreas 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 Koreas 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 Koreas 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 SKs 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 RD 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 worlds 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 Contd

• 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 TeleComs first Korean wireless Internet
  service (1999)
• Over 8,000 options
• Commercialized the worlds 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 Koreas 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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Cell Tech Evolution
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3rd Generation Wireless Technology Capabilities
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3G Network Standards
cdma2000 1X EV-DO cdma2000 1X EV-DV W-CDMA
Wireless access method Synchronous Synchronous Asynchronous
Speed of data transmission 2.4Mpbs (high) 307Kbps (average) 5.2Mpbs (high) 1.2Mbps (average) 2Mpbs (high) 384Kpbs (average)
Applications MMS, VOD, mobile broadcasting MMS, VOD, mobile broadcasting, visual telephone MMS, VOD, mobile broadcasting, visual telephone
Cases SKT, KTF N/A NTT DoCoMo of Japan
Features 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 Unlike EV-DO, provides both data and voice services, high efficiency of networks Not commercialized Compatible with existing networks under synchronous method 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
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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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A New Focus
THE TRANSITION
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New Growth Drivers

• The Industrys 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 RD within the
  communications sector

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Tariffs

• MIC regulates tariff rates for SKT
• Regulation of tariff causes ripple effect in
  industry
• Tariffs 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 Whats the Deal

• WHATS 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 SP500

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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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Ratio Analysis
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Ratio Analysis Contd
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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/VRE D/VRD(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 Calculations
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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 LGTs lower
• ROIC
• Earnings Growth Rate
• Premium P/E multiple

LGT Phone Home
Needs help to survive!
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Scenario 1
X

• 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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Scenario 2
X

• 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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Scenario 3
X

• 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 LGTs trade secrets
• Sharing of profits
• If you cant beat em, join em

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• QA