Nippon Telegraph & Telephone: Hidden Value In Broadband Assets

Nippon Telegraph & Telephone Corp. (NYSE:NTT) is the dominant telephone and broadband company in Japan. Using a sum-of-the-parts valuation, the stock is attractively valued especially when one considers the opportunity of growing broadband usage opportunity in Japan and the surprisingly strong balance sheet.

Telecom

The largest part of the valuation puzzle regarding NTT is NTT DoCoMo (NYSE:DCM), Japan’s largest telecommunications company with 73 million customers and a market share of 46%. Its primary competitors are KDDI (OTCPK:KDDIF) with 30% share and Softbank (OTCPK:SFTBY) with 24%. With only three main players, competition is limited and all players are profitable.

NTT DoCoMo is trading at a reasonable P/E of 16 while cash flow from operations minus capex is 20% higher than net income. NTT has a rock-solid balance sheet. Cash increased to 838B yen, of which up to 300B yen will be used for share repurchases while debt is only 222B yen. In addition to share repurchases, the company pays a decent dividend with a 3.74% yield. These valuation numbers compare quite favorably to US telecom companies like AT&T (NYSE:T) and Verizon (NYSE:VZ) which have huge debt loads and are burdened by expensive tower lease contracts from American Tower (NYSE:AMT) and Crown Castle International (NYSE:CCI).

The market value of NTT DoCoMo is currently 10.43T yen and NTT holds 66.7% of the company giving its share a value of 6.95T yen. Given the operational results and balance sheet I would consider NTT DoCoMo reasonably valued or even attractive, thus using a 6.95T yen for this sum-of-parts analysis is defensible.

Broadband

While the mobile market is very strongly developed in Japan with 164.1 million customers, the fixed market is not that strong with only 39 million customers. Only 29.7M of those customers use the fastest FTTH connections which have access speeds of 2 Gbps. In the FTTH market, NTT holds a 68% market share through its subsidiaries NTT West and NTT East. Since 2015, NTT is collaborating with the strong telecommunication companies to sell its fixed broadband connections. This has been an intelligent move since it allows NTT to cut its sales and marketing expenditures in this field while increasing subscriptions and profitability. Total FTTH subscriptions increased from 18.7M in 2015 to 20.9M currently, a meagre growth of 11.7%. Profits before taxes increased from 20.9B yen at NTT West to 81.2B yen while at NTT East it grew from 83.5B yen to 148.9B yen. The combined profit thus increased from 104.4B yen to 230.1B yen, an increase of 120%.

Profits however are not the best way to measure the value of a broadband network; that honour goes to free cash flow. Both entities have been turned into free cash flow machines. NTT West delivered 145.2B yen in free cash flow last year while NTT East contributed 214.9B yen which together is 360.1B yen in annual free cash flow.

While most broadband companies have borrowed heavily and have burdened balance sheets to match their stable cash flows, this is not the case in Japan. NTT East had 297B yen in cash and cash equivalents while having 365.8B in debt, resulting in a net debt of 68.8B yen. NTT West is considerably more leveraged with 66.3B in cash and equivalents while having 701.7B yen in debt. The combined debt load however is very manageable since net total combined debt at 704.2B yen is less than two years of the generated free cash flow.

Given the uncertain growth prospects and lack of peers, I propose two values to the broadband business. One, which is very conservative, values the business at 12 times free cash flow, which assumes basically no growth whatsoever or credit for its steady predictable income stream in a low interest rate environment. Using 12 times free cash flow results in a valuation of 4.32T yen.

Another scenario allows for a higher valuation given the under penetration of fiber customers in Japan, its growth prospects, low debt levels, and its stable subscription revenue stream. Using a modest value of 16 times free cash flow results in a valuation of 5.76T yen.

Both scenarios above use more conservative valuation multiples compared to US broadband companies with market positions like Comcast (NASDAQ:CMCSA) which trades at a P/E of 19.4.

NTT Data

NTT Data (OTC:NTTDF) is a provider of system integrations and IT solutions. While this sounds promising and revenues have increased steadily, profits are rather low and free cash flow even lower. I think it is a very competitive market constantly disrupted by technological change. Some of its business might be fairly sticky and repetitive, but in such fast changing landscape nothing can be taken for granted. NTT Data generated 1.73T yen in revenue and net income of 66B yen. The balance sheet used to be in good shape but was weakened by the acquisition of Dell Services for $3.05B. Cash is 198B yen while debt amounts to 574.3B yen resulting in a net debt position of 376.3B. The cash flow from operations was 238.5B yen while capital expenditures amounted to 158B yen, resulting in CFO – capex of 80.5B yen.

The market value of NTT Data is 1.9T yen, which means it has a P/E of 28.7. Personally, I have insufficient knowledge or confidence to give this business such a valuation and therefore value the company at a 50% discount to its market value. If somebody has more knowledge about IT services companies and their growth potential, please leave some insightful comments in the comment section.

NTT Data is 54.2% owned by NTT, which means that the market value of its ownership share is 1.03T yen while I will be using 515B yen.

NTT Communications

Historically provided long distance communication services but has expanded into related applications like enterprise mail and solution services but also more attractive areas with growth potential like data centers and undersea cables. While voice communications seems to be in a slow terminal decline, this business is quite valuable since it helps the world cope with increasing data flows. A company which in some regards is doing a similar job is Level 3 Communications (NASDAQ:LVLT). NTT Communications is hardly a growth stock due to all its legacy business but still managed to increase revenues from 1.26T yen in 2014 to a forecasted 1.33T yen in 2017.

NTT Communications has a decent balance sheet. Debt is 257B yen while cash amounts to 10.7B yen resulting in a net debt of 246.3B yen. This is a reasonable amount of debt and something which can be easily paid back.

Net income from the last 12-month period amounted to 93B yen. Cash flow from operations was 211.2B yen while capital expenditures were 120B yen. This results in a free cash flow of 91.2B yen. Given that NTT Communications is trying to actively grow certain parts of its business but also still relies for 22.2% of its revenues on voice communications, it is difficult to value this business within this conglomerate. My best estimate for a conservative valuation is 11 times the free cash flow or 10 times last 12 months’ earnings. The average leads to a valuation of 966B yen.

Other businesses

Next to all its business units which are grouped around communication and data transfer, NTT has various other businesses. Some like vendor finance are pretty common but NTT has quite a diverse set of other businesses. NTT is active in real estate as an owner/operator of commercial and residential real estate. In addition it also builds and manages energy efficient buildings, solar power solutions and data centers through NTT Facilities. Other activities grouped together in this group are system development, NTT advanced technologies, and advertising. While one can argue that those businesses are a distraction, they are at least producing profits fairly consistently. Operating profit is expected to be 75B yen. Given the large uncertainties around these business units and the distraction they provide for management, I think a fair conservative valuation would be 8 times expected operating income of 75B yen, resulting in a value of 600B yen.

Sum of the parts

While, as expected, the shares in NTT DoCoMo are still responsible for the majority of the value at 6.95T yen, what is surprising though is that because of its strong cash flow generation, the broadband assets might be a lot more valuable than most people give it credit for. This hidden gem has a value between 4.32T yen and 5.76T yen. NTT Data is a risky proposition; because of its low profitability, it is valued at 515B yen, a 50% discount to its market value. NTT Communications is a decent business, which is transforming to cope with the decline in voice communication revenue and worth 966B yen. While the other businesses are valued at a combined 600B yen, this leads to a value for the entire NTT conglomerate of 6.95 + 5.76 + 0.515 + 0.966 + 0.6 = 14.79T yen or for more conservative investors 6.95 + 5.76 + 0.515 + 0.966 + 0.6 = 14.35T yen.

Both are significantly above the current market value of 11.22T yen and do not take into account the low levels of debt on the balance sheet.

Conclusion

Nippon Telegraph & Telephone is a strong Japanese telecom conglomerate with strong market positions, strong cash generation, and low debt levels. The company is trading at a discount on a conservative sum-of-the-parts analysis and has a P/E ratio of only 12.5. The dividend yield is currently 2.83%, but the payout ratio is only around 30%, and significant sums are invested in share buybacks. The company has clearly become more focused on shareholders, and shareholder remuneration is a clear management goal.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in NTT over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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