• MBT is a telecommunications company with more than 100,000,000 subscribers and is Russia’s largest mobile operator and has high payout ratio close to their Free Cash Flow– which warrant the use of dividend discount model (DDM) to value it
  • H Dividend Discount Model (DDM) is more relevant to value MBT as compared to Gordon Growth Model and Two-Stage DDM
  • Using the H DDM, I would come up with a value of $10.95 for MBT’s common shares
  • Taking the average of relative valuation from my previous article using Entreprise Value (EV) to Earnings Before Interest, Tax, and Depreciation (EBITDA) and the current H DDM, it will yield an average of $12.98 (undervalued as of June 22, 2016)

Introduction To H Dividend Discount Model

Technically, the only cash that we receive when we buy common shares of a stock from the stock market is the dividends. This basically says that the value of a stock is the present value of expected dividends on it.

There are three types of dividend discount model (DDM) that analyst normally use; Gordon Growth Model, Two-stage DDM or the H DDM. In this article, I will shed light on why MBT is suitable to be valued using DDM– more specifically the H DDM as compared to the other two…

About Mobile TeleSystems (NYSE: MBT)

Mobile Telesystems

Mobile TeleSystems Logo

Image source: Google

I have talked quite substantially about MBT– which is segmented into 3 articles– and at the end, I valued it using a simple relative valuation on EV to EBITDA. You may read it here.

For the benefit of you who have not read it, MBT is a telecommunications company with more than 100,000,000 subscribers and is Russia’s largest mobile operator as well as the largest in Eastern and Central Europe.

It provides mobile network not only to Russia but also to other countries of the Commonwealth of Independent States.

Why I Bought MBT Back Then?

It was primarily due to the strong competitive advantage MBT has over its competitors in terms of the quality of their business evident through their significantly lower churn rate that I decided to be vested in MBT close to 1.5 year back.

I have conviction back then, and I still do now.

Why to Use H Dividend Discount Model 

MBT is a company that is relatively stable, due to the nature of their business– telecommunications. Despite the fact that it is mainly operating in Russia, it has proved to be resilient despite the oil price and Ruble meltdown– with their share price appreciating 40 over percent year to date (YTD).

Key Is To Have A Well-Established Dividend Policies

More importantly, they have a well-established dividend payout policies that they intend to continue into the future and they pay out nearly all of their free cash flows as dividends– this is key to accurately value companies using the dividend discount model– if the company consistently pay out much less than they can afford to and accumulate cash in the process, this model will underestimate the value of MBT.

“Our dividend policy for the years 2013, 2014 and 2015 was aimed to make dividend payments to our shareholders in the amount of at least 75% of Mobile Telesystems (MTS)’ free cash flow, but not less than RUB 40 billion. For the purposes of dividend calculation we utilized a simplified form of free cash flow—which we define as Operating Cash Flow less capital expenditures. On April 8, 2016, our Board of Directors approved new dividend policy which sets a target payout of RUB 25.0 – 26.0 per ordinary MTS share (RUB 50.0 – 52.0 per ADR) per calendar year. The policy guarantees a minimum payout of RUB 20.0 per ordinary MTS share (or RUB 40.0 per ADR). The new policy will cover 2016 – 2018. Payments will continue to be made on a semi-annual basis.”- 2015 MBT Annual Report under dividend distribution policy section

With that, we ascertained that DDM model is suitable for MBT. However which DDM model shall we use?

There are three choices– Gordon Growth dividend discount model, two stage dividend discount model or the H dividend discount model?

Now, to answer that, the first step is to decide the assumptions relating to their dividend growth rate and cost of equity for MBT and answers the logic behind the use and flaws of different dividend discount model.,sg,,

Image source: 2015 MBT Annual Report

When we look at the big picture, we would realise that most of MBT’s revenue comes from Russia. Although one would say that the telecommunications  business is stable, one cannot say the same with the country it is operating in– Russia.

Should We Input Macro Economic Factors?

Personally I try not to input macroeconomic factors into my valuation as I would like to focus more on the competitive advantage of the business itself– however, it would be naive to ignore the current state Russia is in– really bad state– due to the drastic fall in oil price and the devaluation of their Ruble– not mentioning the sanctions that the United States had placed on them.

MBT Compounded Annual Growth Rate For Their Free Cash Flows For The Past 9 Years,sg,,

Image Source: My Excel Sheet

Still, to be on the conservative side, taking into account the compounded annual growth of MBT’s FCF over the past 9 years to be 9.95%, I would expect and input in the model for MBT’s dividend to grow at only 7%  annually for the next ten years and grow 4% perpetually.

Why an initial higher growth?

That is because Russia is one of the leading countries for internet use in Eastern Europe; it is still ranked fairly low compared to some of the world’s most developed economies and therefore I forecasted that in the next ten years, there is still room for it to grow till it becomes really matured (albeit not as high as the last 9 years at 9.95%). Thereafter, it would converge to a more stable growth rate.

Using The Above Assumptions To Value MBT

To value the stock using this assumption, only H DDM is able to value a stock with an initial higher growth rate in the first stage and converge to a more stable growth rate in a linear downward fashion to the second stage growth rate which is perpetual.

Gordon Growth DDM expects the dividend growth rate to be positive and increasing from the start while the two-stage DDM only allows a positive extraordinary growth during the first stage and then move on suddenly to a more stable rate perpetually.

Based on the current dividend policy, common shareholders are poised to receive a dividend of $0.62- $0.82 per share per year for the next two years– using the current Ruble to USD exchange rate of 1 to 0.02. To be conservative, let us input 3/4 of the maximum dividend range it could go to this year– which is $0.77 (the reason I put 3/4 instead of 1/2 is because of the potential upside of Ruble to USD exchange rate due to my expected rise in the price of oil).

Inputting A Cost Of Equity Into MBT Is Tricky

The cost of equity is calculated by adding the riskless rate to the multiplication of beta and risk premium.

I will make the assumption here that since MBT is listed on the New York Stock Exchange (NYSE), I will use the risk-free rate of US 10 year treasury bonds– which is 1.67% as of June 20, 2016.

The Beta of MBT is 1.34 using the historical beta provided by Google Finance while the risk premium would be placed at 5%– which is also on a conservative side.

That would equate to an equity premium of [(1.67%+ 1.34(5%)= 8.37%)}. I would add another 4% because it is operating in Russia– to a total cost of equity of 12.37%.

Using H DDM Valuation Tool,sg,,

MBT H Model Valuation as of June 20, 2016

Image source: My Excel Sheet

Using the H DDM, I would come up with a value of $10.95. As of June 20, 2016, the current price is $8.79– that represents a 24.57% upside. My average buying price of MBT is at $9.7– including the dividends I had received so far, it would be averaged out to $9.1.

There Are Always Caveats In Every Financial Model And No One Model Is Perfect

The limitations of the H DDM is that it assumes that the payout ratio is constant in both the growth phase as well as the infinite growth phase (which is to calculate the terminal value)– which is unlikely because as growth rates decline, the payout ratio usually increases.

Still, the H DDM warrants a good use especially for a company like MBT that focuses on dividend payments.

In Conclusion

Based on my previous valuation for MBT using relative valuation of EV/EBITDA, I came out with a valuation of $15.

So, if you take the average of the two valuation type, we will get a value of $12.9.

Disclosure: I am long on MBT. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article. 
Disclaimer: The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.
Important: Please read my full disclaimer.
Further Reading: 

Do You Know How To Value Dividend Stocks?

[Part 2 of 2] Do You Know How To Find The Discount Rates For Stocks’ Valuation?




Hi, my name is Chris and I am the founder of Re-ThinkWealth. A blog that focuses on personal finance self-improvement, investments, and investor psychology.

Since early 2015, I manage money for my family and invests it in Singapore and United States equities and options achieving above market return.

I use Value Investing and Options Selling strategies used by Warren Buffett (World’s richest investor) coupled with the core theory of inversion. Inversion meaning that in every investing idea, we have to scrutinise on why it would fail.

This will result in us being more conservative, and being conservative is the key to protecting and growing wealth in the long run.

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