After probe dust settles, will Bezeq be able to regain investors’ confidence?

Shares of Bezeq Israel Telecom have advanced some 2 percent since the start of the year, outperforming the wider benchmark index, as investors start to look beyond the fraud and bribery allegations that have dogged the controlling shareholder and key managers of the country’s largest telecommunications firm, to focus instead on the new board structure and ownership that loom ahead.

Bezeq controlling shareholder Shaul Elovitch, members of his family, Bezeq CEO Stella Handler and another official at the firm were arrested last week as part of a probe by the Israel Securities Authority (ISA) and the police into connections between Prime Minister Benjamin Netanyahu and Elovitch, who controls Bezeq via his Eurocom Ltd. unit. They all deny wrongdoing.

“The market is already looking beyond the case, and is pricing in the fact that Shaul Elovitch and Stella Handler won’t be connected to the company anymore, and that there will be new directors appointed to the board,” Saar Golan, an equity trader at Meitav Dash Brokerage in Tel Aviv, said by phone. “The investigations are seen as relating to the past of Bezeq and not to the future.”

The case, known as Case 4000, involves suspicions that controlling shareholder Elovitch ordered the Walla news site, which he owns, to grant positive coverage to Netanyahu and his family in exchange for the prime minister advancing regulations benefiting Elovitch. The director of the Communications Ministry, Shlomo Filber, has become a state witness in the case.

On Sunday, Bezeq said that an offer to buy Eurocom by a group of investors led by US-Israeli businessman Naty Saidoff has been accepted by creditors and was awaiting a court ruling, reportedly expected on March 20. If the deal is approved, Saidoff and the investors would take ownership of Eurocom and of Bezeq via the units of Eurocom. The arrangement is subject to other regulatory approvals as well, including a permit by the Communications Ministry, the Israel Tax Authority and Israel Securities Authority.

Subject to obtaining the required regulatory approvals, the Saidoff Group is expected to eventually become the controlling shareholder of Bezeq, parent company B Communications Ltd. (BCom), a unit of Eurocom Ltd., said in a letter to Bezeq dated February 25.

In addition, on Monday, Bezeq said in a filing to the Tel Aviv Stock exchange BCom is seeking to convene an urgent board of directors meeting to appoint new members to the board to replace three outgoing directors — Shaul Elovitch, his son Or, and his son’s wife Orna — who said they would resign amid the ongoing investigations. The proposed three directors were Shlomo Rodav, Doron Turgeman, and Tamir Cohen, who is a representative of the Saidoff Group.

On Wednesday, Bezeq said its board had decided to appoint Yaakov Paz as interim CEO, replacing Stella Handler temporarily. She is under house arrest.

So, will a change in ownership, board and management bring investors flocking back to Bezeq — once an investor darling, mainly because it paid out 100 percent of its profits in dividends? Will Bezeq be able to rise above the investigations to reclaim its status as one of Israel’s blue chip favorites?

Feelings in the market are mixed, and much will depend on how quickly the new owner will be able to regenerate investor trust and what the firm’s dividend policy will be going forward, analysts say.

Let’s take a step back

Bezeq is a diversified telecom operator active in a variety of sectors in the Israeli market: Bezeq Fixed-Line provides internet and telephony services; Bezeq International provides international call services; Pelephone provides cellular services; Yes provides satellite pay TV services; Walla runs an internet news portal service; and there is also an online call center. All of these units are fully owned by Bezeq, but because the firm was historically a monopoly, and because it is still a dominant player in the market, regulatory curbs compel these units to operate as separate businesses, leading to higher costs for Bezeq and restricting it from offering the kinds of bundled service packages that its competitors can offer.

Bezeq’s controlling shareholder is communications mogul Shaul Elovitch, who was also its chairman until the start of the ISA investigation. He owns a stake in Bezeq via a pyramidal company structure: his firm Eurocom Communications Ltd. controls Internet Gold-Golden Lines Ltd., which in turns controls B Communications Ltd. B Communications holds a 26% stake in Bezeq, and the rest of Bezeq, 74%, is held by the public via shares traded on the Tel Aviv Stock Exchange.

According to a Bezeq investor presentation, at the end of 2016 Bezeq held 55 percent of the private sector telephony market and 73% of the business sector telephony market, with 2.1 million fixed line customers. Bezeq also held a 69% percent market share in broadband lines; its Pelephone subsidiary held a 23% stake in the cellular market, with 2.4 million subscribers; and satellite broadcaster’s Yes’s market share in the pay TV sector was 40%.

When the cellular market opened to competition in 2010, the advent of newcomers like Golan Telecom and Rami Levy Hashikma Marketing led to a price war that slashed costs for consumers by as much as 90 percent and reduced market stakes and revenues for the incumbent cellular firms, including Pelephone, Cellcom Israel Ltd., and Partner Telecommunications Co.

Because of the diversified nature of its business, however, Bezeq could count on its other activities — mainly its domination of the fixed line market — to prop up its revenues, and its policy of paying out high dividends over the years helped maintain its status as the darling of many foreign investors.

But then the Communications Ministry turned its attention to Bezeq’s lucrative fixed line business — telephony and broadband — and set out a roadmap for the creation of a wholesale market, requiring Bezeq to lease its infrastructure to competitors who would lower prices for internet, phone and digital TV services. The proposed reform said that once competition in the fixed line market was in place, Bezeq would be finally allowed to merge with its units, allowing for the firm to trade market share for cost savings that are estimated to amount to millions of dollars a year.

Prime Minister Benjamin Netanyahu, however, took over the post of communications minister in 2014, firing incumbent director Avi Berger and replacing him with Shlomo Filber, who has now turned state witness. The move was perceived by analysts as a signal Netanyahu was looking for a less confrontational stance vis a vis Bezeq. According to suspicions, Bezeq’s controlling shareholder Elovitch, ordered the Walla news site, which he owns, to grant positive coverage to Netanyahu and his family in exchange for the prime minister advancing regulations benefiting Elovitch.

Chugging along

Amid all of this turmoil, Bezeq has been chugging along. Its shares have dropped 18% since investigators from the Israel Securities Authority (ISA) raided its offices on June 20. They have declined 11% in the past 12 months. Teva Pharmaceutical Industries Ltd., also a one-time investor favorite, now seeing increased competition in its generics business, has plunged 46% in the same time frame. The TA-35 benchmark index has declined 0.6% since the start of the year, as of end of day Wednesday.

The spread of Bezeq’s bonds, meanwhile, has remained virtually unchanged, indicating that investors do not perceive increased risk to Bezeq’s financial stability. Bezeq’s current policy of paying out 100% of its net profit in dividends provides a yield of around 9% to investors, compared to an average yield of some 4.5% for investors from telecommunications firms in Europe, according to company data.

“Bezeq is such a strong company — its fixed line telephony business is so strong — that it is possibly the only Israeli company that could have survived this management turmoil with so little damage in practice,” said Yaniv Pagot, an economist and head of strategy for the Ayalon Group, an Israeli institutional investor.

“A company that would not have had the monopoly in the fixed line telephony market would have been significantly more damaged due to this management paralysis,” he said. “I believe the company results for the fourth quarter won’t be very different from the previous ones, despite all this management upheaval. As long as Israel has just two main fixed line infrastructures laid — those of Bezeq and Hot Telecommunication Systems Ltd. — the situation for these companies will continue to be good. So those same investors who liked Bezeq before are likely to return to the company, once the investigation dust is settled.”

Bezeq forecast in November that its full year 2017 net profit would be NIS 1.4 billion, compared to a profit of NIS 1.2 billion for 2016. The company is expected to publish its fourth quarter and full year 2017 results by the end of March.

“The Group companies continue to post strong financial results over the competition, and our year-to-date results are in line with the guidance we provided the market,” Yali Rothenberg, Bezeq Group’s chief financial officer, said in a statement announcing the company’s third quarter results.

Even so, David Granot, the company’s acting chairman – who replaced Elovitch at the post – said that the data reflects the ongoing competition seen in the Israeli telecom market, and called for the removal of the structural separation imposed on the firm. “Such removal will clear barriers currently preventing full operational efficiency,” he said.

A dark shadow over corporate governance

Despite its apparent financial health, the upheaval at Bezeq has cast a dark shadow over the firm’s corporate governanc and faith will need to be restored quickly by any new owner who takes control of the firm, analysts and investors say. Activist investor Elliot Advisors (UK), which has a 4.8% stake in Bezeq, is likely to play a key part in bringing, or at least trying to bring, Bezeq’s corporate governance back in line. Elliott Advisors is an affiliate of Elliot Management Corporation, founded by US billionaire Paul Singer.

In a letter dated February 27, Elliott said it opposed an attempt by BCom, Bezeq’s parent company, to appoint new directors in lieu of the outgoing Elovitch, his son Or and Or’s wife Orna.

“The demands made by BCom have no legal basis” and their sole purpose is to cause the board of directors of Bezeq “to act for the benefit of the controlling shareholder, against the best interests of the company, its shareholders and the law, through a false representation of the legal situation, and, yet again, in complete disregard for proper corporate governance,” the letter said.

Any new controlling shareholder at Bezeq, whether Saidoff or another, “will have to win back the faith of investors in Bezeq’s management,” Meitav’s Golan said.

But even if Bezeq gets its house in order, there are concerns about the firm’s long-term business prospects.

“Bezeq is a company of the past which is living off a business — fixed line telephony — which is diminishing globally,” said Eldad Tamir, the founder and CEO of Tamir Fishman, an Israeli investment house with $3 billion under management. “In 10 years no one will be using fixed line phones anymore. So the investment is not attractive for the long term.”

Tamir Fishman has not held Bezeq shares for the past two years, and Tamir said he does not see the ownership and directors shakeup at the firm as a reason to go back in and buy shares now. The firm does hold Bezeq bonds, however, he said.

“Bezeq is still enjoying its monopolistic status in fixed line telephony,” Ayalon’s Pagot said. But eventually, a third fixed line infrastructure will turn up to compete with Bezeq and Hot, he said.

“It won’t happen tomorrow morning and until then, the hen will continue to lay its golden eggs,” he said. “But in the long run, it is clear Bezeq will see greater competition in its fixed line business, and we are already seeing signs of that.”

Cellcom and Partner have already started offering fixed line telephone services on the Bezeq infrastructure as part of the wholesale market reform, but because of the investigation, there has been no progress on the abolition of the structural separation long desired by Bezeq. Some investors fear that because of the increased public scrutiny on all things Bezeq, that day won’t come anytime soon.

Fixed line revenues in the third quarter 2017 declined 2.6% to NIS 1.06 billion, mainly due to an 8% decrease in telephony services which were offset by a 3.5% rise in revenues from broadband internet services. In addition, the company said that it lost some 6,000 subscribers at its Yes Satellite TV service. Third quarter 2017 revenues for the Bezeq group declined 3.8 percent to NIS 2.4 billion and net profit was down 18.3% to NIS 322 million

Dividend policy may need to be changed to reduce debt

On Thursday, credit rating agency S&P Maalot put Bezeq and its units Pelephone and Yes on credit watch, with negative implications, because of the “management instability” at the firm. The step reflects the lack of clarity surrounding the control of the firm and may have negative effects on Bezeq’s ability to withstand, in the near future, “the various challenges in the communications market,” the agency said.

Last month, Midroog, a credit rating agency, said that Bezeq’s challenging business environment, and in particular the increased price competition in its multi-channel TV business, increases its credit risk. “The ability of the company to stand up to these pressures is limited because of regulatory barriers,” Midroog wrote in a note, referring to the structural separation of its units imposed by the regulator which is still in place.

“In view of the regulatory limitations,” and in particular the inability of Bezeq to offer bundled packages to customers at competitive prices, unlike its main competitors, the firm’s “ability to maintain a financial profile that is appropriate to the rating level depends on its ability to reduce leverage,” Midroog said.

“Without a change in the financial policy, and in particular the dividend policy, that will contribute to reducing the debt, negative pressure will be created” on the company’s credit rating, Midroog said.

And that dividend policy is what investors will be looking at, going forward.

“Bezeq has had a policy of distributing dividends of 100% of its profits,” Pagot said. “If the new owners will continue with that policy, or even cut it to 70% or 80% of profits, then that will still be a huge draw for investors. But if the dividend payments are cut to 50% of profits, even if it is still considered a good return, it may deter investors’ appetite for the share.”

“The changes to the board of directors and ownership of the firm should lead to better corporate governance, improve the image of the firm and the faith of investors,” Roni Biron, co-head of research at Excellence Nessuah, a Petah-Tikva based brokerage, said by phone. “That said, Bezeq’s competitive pressures coupled with a possible reduction of the 100% dividend payout policy remain a consideration for many investors.”

Other players are more upbeat about the company: regulation regarding the structural separation is bound to change, and the barriers that hinder Bezeq’s operations will have to come down, allowing Bezeq to play in the same field as its competitors, they say.

Indeed, on February 27, acting director general at the Communications Ministry Maimon Shmila said that the cancellation of the structural separation at Bezeq is “definitely on the table,” according to an interview he gave to the financial website Calcalist.

Steven Schoenfeld, founder and chief investment officer of BlueStar Indexes, a financial firm that has developed indices and exchange traded funds (ETFs) with a focus on the Israeli capital markets, said for investors seeking a piece of Israel’s strong economy, Bezeq is still a good buy.

“Despite current management uncertainty, Bezeq is a dominant participant in Israel’s telecommunications sector, with strong franchises in fixed-line and business data and communications services and internet access,” he said. “For investors who want exposure to Israel’s robust and growing economy, Bezeq can be a core holding within a broader portfolio, and it currently has a weight of 1.9% in BlueStar’s flagship benchmark.”

What Bezeq says

“Bezeq is currently going through numerous processes that will lead to increased certainty and better corporate governance,” said Yali Rothenberg, Bezeq Group’s chief financial officer, said in a phone interview.

Regarding dividend payments, Rothenberg said the board would study the matter closely. “After 10 years with the same policy, Bezeq is a steady dividend paying company, but it is only natural we should take a close look at our dividend policy in light of the competitive changes in the market, and the long term financial stability of the company,” he said.

Rothenberg said the company was diversified enough to be able to maintain its market leadership despite the increased competition it is facing in all of its businesses, reacting with special offers to keep and increase its customer base, he said. “Bezeq is a very strong company that has a very long term view.”

He noted that the company was in continuous dialogue with the Communications Ministry on the structural separation it seeks to eliminate, and he hopes there will be some decisions “in the coming months.”

“The state’s position regarding the structural separation is set out in its work plan,” he said. “Everyone knows that it makes absolutely no sense to keep the structural separation: not for the competition, not for the market and not for the consumers.”