VEON - VEON: Solid Q3 Report But Kyivstar-Related Risks Persist

2023-11-21 01:21:49 ET

Summary

• VEON's Q3 report shows promising financials with revenue and EBITDA growth, reduced debt, and improved leverage ratio.
• The potential nationalization of VEON's Ukrainian subsidiary, Kyivstar, and macro risks in emerging markets remain concerns for investors.
• The situation around Kyivstar needs to be resolved before the stock will be able to unleash its value.

Back in October, I discussed VEON ( VEON ) in the context of its Russian business sale and potential serious regulation risks in Ukraine. Thankfully for investors, the recent Q3 report has clarified the post-sale financials of the company, and they look very promising. VEON has also managed to attract a notable individual to the board of directors of its Ukrainian subsidiary, who may assist in negotiations with the authorities in the foreseeable future.

Nevertheless, the Ukrainian authorities seem very determined in their intention to nationalize the Ukrainian telecom operator, Kyivstar, which is currently owned by VEON. Additionally, the macro perspective doesn't look particularly encouraging for the emerging markets where VEON primarily operates.

VEON appears compelling in terms of valuation, but the market's muted reaction after the Q3 report clearly indicates that investors continue to be cautious about the company. I remain cautious as well, maintaining my "hold" rating until the situation around Kyivstar fully resolves.

Q3 2023 Financial Highlights

VEON's revenue in Q3 is up 6.1% year-over-year (y-o-y) in USD terms and 19.3% in local currency terms. Service revenues grew 6.9% y-o-y in USD terms.

EBITDA went up 17% y-o-y in reported currency and 30.6% in local currency. EBITDA margin expanded to 47% from 42.7% in Q3 2022.

Net debt excluding leases declined 75.1% y-o-y to $1.3 billion. Leverage ratio improved to just 0.86x net debt/EBITDA from 3.30x a year ago.

Capex decreased 29.8% y-o-y to $131 million, with LTM capex intensity of 17.8%.

The lower debt and capex are two key positive outcomes from the recent sale of the Russian business unit. With significantly reduced debt, VEON will be able to focus on expanding its operations and distributing yield to shareholders in the form of dividends and buybacks.

Recent Developments

• VEON's subsidiary in Bangladesh, Banglalink, signed a $70 million loan facility for network expansion and reached a $100 million deal to sell around a third of its tower portfolio.
• VEON proactively addressed upcoming debt maturities of 2023 and 2024 bonds in September through early redemption.
• The company's overall mobile customer base is down 0.7 y-o-y to 156.1 million, while 4G users grew 12.9% to 91.8 million.
• VEON raised full-year revenue growth guidance to 18-20% in local currency, from the prior 16-19% range. EBITDA growth guidance increased to 18-20% in local currency.

Regulation Risks Are Still Here, Macro Concerns Remain Intact

As previously mentioned in my article about VEON, the main risk for the company's investment case is the potential nationalization of Kyivstar, VEON's Ukrainian subsidiary. Kyivstar represents around a third of VEON's EBITDA, which implies a potentially serious asset loss for the company.

On November 20th, Ukrainian news media "Ukrainska Pravda" published an interview with Deputy Head of the Presidential Office, Rostislav Shurma. Discussing Kyivstar, he mentioned that there is a “high probability” of sanctions against Kyivstar with the subsequent confiscation of the company.

Just a week earlier, VEON welcomed former U.S. Secretary of State Mike Pompeo to Kyivstar's Board of Directors. Appointing Pompeo as a board director seems like a strategic move to ensure smooth communication between Kyivstar and the Ukrainian authorities.

While it's evident that the Ukrainian government wants full control over Kyivstar, the alienation of Ukrainian assets from VEON seems quite problematic. Ukrainian experts recognize this:

In Ukraine, there is a formal bilateral agreement on the mutual protection of investments with the Netherlands, which protects the expropriation of assets, except for losses, as long as such expropriation is legally binding procedures to protect public interest on a non-discriminatory basis by ensuring reliable and fair compensation for the value of the asset,” explains Analyst at the Kyiv School of Economics, member of the Yermak-McFaul sanctions group Anna Vlasyuk.

Simply put, the nationalization of Kyivstar poses not only reputational risks for the Ukrainian government but also implies full compensation for all losses incurred during the nationalization. Therefore, a loss of Kyivstar would be akin to a forced sale, though the timeline for the Ukrainian authorities to pay compensation to VEON remains uncertain.

Now to macro risks. VEON operates in countries experiencing regular depreciation of their local currencies: Bangladesh, Kazakhstan, Kyrgyzstan, Pakistan, Ukraine, and Uzbekistan. This year, only the Kazakhstani tenge and Ukrainian hryvnia managed to withstand growing pressure from the US dollar amid the Fed's hiking cycle.

Since October, the National Bank of Ukraine has shifted from a fixed currency rate to a "flexible" one, which ultimately means the Ukrainian Hryvnia may continue to weaken against the US dollar.

Pakistan is stuck in a "debt trap" that continues to harm its economy. If oil prices keep declining amid global economic concerns , the Kazakhstani Tenge will likely depreciate further. Bangladesh's economy also appears extremely fragile , suffering from the long-term economic fallout of the COVID-19 pandemic and Russian aggression in Ukraine. Due to currency depreciation, growing business in emerging markets remains a constant challenge for VEON.

The Bottom Line

The valuation metrics for VEON suggest that the stock is very attractively priced:

It's hard to deny that VEON has significant growth potential in the long term, though I don't anticipate an immediate revaluation of the stock. After the sale of the Russian business, all eyes are now on the fate of Kyivstar.

Long-term investors may start accumulating a position at the current share price, though they should be aware of a potentially significant drop in the share price if the Ukrainian government ultimately nationalizes Kyivstar.

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