If you think Americans have a lot of cell phones, consider this: Israels wireless penetration rate is 117%.
If that sounds impossible, well, thats because people with more than one wireless device get double counted. Analysts estimate that about 80% of Israelis have at least one mobile phone.
The biggest share of this densely populated market belongs to Cellcom Israel (NYSE:CEL - News). Currently, it has about 3 million customers or about 34% of the total market. And its still growing.
Americans first got to know Cellcom in February when it came out on the NYSE. The stock priced at 20 and then cruised up to near 35 by December. It put on 40% in November alone when most of the U.S. market was tanking.
A Home Run?
Jefferies analyst Jonathan Schildkraut calls it a "home-run stock."
"Its listed in the U.S., but it has no relationship to the U.S. market," he said. "The results go up in the face of the weak dollar."
But the results arent just an artifact of exchange rates. Cellcom turned around its finances after a difficult 2005, when Israel Discount Bank bought a majority share and installed new management. Amos Shapira, former head of the Israeli division of Kimberly-Clark (NYSE:KMB - News), became chief executive.
The new team focused on tightening operations, and also on improving customer service. Schildkraut says the latter is a key differentiator, since Israeli mobile phone companies dont compete on price the same way American providers do.
"Everybodys paying on a per-minute rate, and based on who you call, the rates change," he said. "So theres not much visibility into what your bill will look like at the end of the month. Price is not really the ground in which they compete. Its wrapped around branding."
Since the market is so mature, competition is also less about revenue growth than about margin and free cash flow. In that field, Cellcom also leads. According to Goldman Sachs, Cellcoms EBITDA margin is running 300 basis points ahead of its main rival Partner Communications (NasdaqGS:PTNR - News) in the year so far.
The last four quarters have shown especially strong profit growth. In the third quarter, earnings jumped 113% over the prior year to 66 cents a share. Sales gained 15% to $391.3 million.
Aiding this growth is the fact that while Israel is well-stocked with cell phones, its only just starting to use them for nonvoice services like text messaging. Cellcom has rapidly been ramping this up. In the third quarter, data services revenue jumped 47% over the prior year, rising to 8.9% of total revenue vs. 6.9% last year.
"In select geographies in Western Europe, data is 20% of revenue, suggesting data is highly underpenetrated in Israel," wrote Goldman Sachs analysts in a Nov. 9 note. "Accordingly, we believe Cellcom (and other Israeli wireless carriers) still have significant opportunity to continue to grow data and forecast a 20%-plus CAGR over the next three years."
The main hazard at this point, analysts agree, is regulatory. The Israeli Ministry of Communications has been promoting efforts to increase competition in the field and has already mandated several changes in billing methods.
In 2004, it ordered a series of cuts in "interconnect" rates charged for calls between wireless and landline phones. A 10% cut went through on Mar. 1, and a 15% cut is slated for this coming Mar. 1. Cellcom managed to grow fine through the first round, but analysts have shaved their profit forecasts to account for the loss.
Another change going into effect this month is local number portability. This lets customers transfer their phone numbers when they move from one provider to another. Analysts expect this to increase customer turnover, or churn, and boost marketing costs aimed at keeping those customers. Cellcoms current churn is running at 3.6%, but William Blair expects that to rise to 4.4%.
Charging By Seconds
Starting in 2009, phone carriers also will have to start charging by second-long increments, instead of the 12-second increments they use now. This will trim the number of units that Cellcom can charge.
Dicier still, on Dec. 6 a petition arrived in Israels high court arguing that this billing change should be applied retroactively to September 2007, when both Cellcom and Partners most recent licenses started. That could make things even more complicated, but at this early stage its unclear what will happen. In its press release on the subject, Cellcom says it is "unable to assess the petitions chances of success." (Executives did not respond to requests for comment.)
Also uncertain of success is a class-action lawsuit filed on Dec. 18 charging that some of Cellcoms towers were unlawfully built and create environmental hazards.
Because of all this, analysts see steady but not explosive growth after this year.
Those polled by Thomson Financial expect earnings per share in the full 2007 to reach $2.12, up 67% from last year. But they expect only 6% growth in each of the next two years.
