SK Telecom: Moat Rating Downgraded to None, Fair Value Estimate Decreased on Currency

We downgrade SK Telecom’s SKM, or SKT’s, moat rating from narrow to none and reduce our fair value estimate for SKT to USD 28.50 per ADR from USD 29.00 per ADR previously due to the moat rating downgrade and a slightly weaker KRW. The moat downgrade is based on SKT’s inability to earn above cost of capital returns consistently over the past 10 years and therefore our uncertainty around its ability to do so over the next 10 years. This is largely due to the competitive nature of the Korean telecom market and the penchant of SKT for investing in noncore telecom activities such as Metaverse platforms, urban air mobility, and a global AI assistant that we see as having no moat. The company recently announced its intention to triple its investment in AI with the aim of increasing its own efficiency of operating and producing a global AI assistant product. We find it difficult to see how SKT’s domestic-focused telecom business will help with the later. Despite the moat and fair value downgrade, we continue to see SKT as a decent value, trading on a 2024 price/earnings ratio of only 12 times with a 6.4% dividend yield.

While the Korean government has attempted to attract new entrants into the Korean telecom market at least three times during the period from 2010 to 2020, no new licenses were awarded. Some small companies did make bids for licenses but were rejected by the regulators. Korean regulators are expected to announce policy changes to allocate a 28 GHz mobile network to a new entrant, and the government has indicated that it will provide incentives to the newcomer in the form of tax cuts and loans. We do not expect much interest in this license from serious mobile operators. If the three telecom operators can curb their competitive instincts enough to allow the generation of returns above cost of capital, this would look like a classic narrow-moat market based on efficient scale, but until we can get some confidence that this can happen it will remain no-moat.