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Lehman Sees Takeover by France Telecom in Partner's Future

Partner's losses are mounting, but so is its revenue.

Losses are still mounting for

Partner Communications

(PTNR) - Get Partner Communications Company Ltd. Report

but its revenue is climbing, too. Meanwhile,

Lehman Brothers

speculates that the Israeli cellular carrier could be in for a takeover bid by

France Telecom



Partner, the youngest of Israel's three major cellular operators, lost $56 million in the third quarter compared with $44 million in the second quarter. However, Partner's losses have shrunk by $20 million since the third quarter of 1999. Analysts had predicted losses of 27 cents per share for the third quarter. But the company's loss came to 30 cents per share.

But its losses aren't the only thing growing -- so is its revenue. Partner, which operates under the


brand, reported third-quarter revenue of $145 million, compared with $117 million in the second quarter.

For the first time in its history, the young cellular carrier's EBITDA (earnings before interest, taxes, depreciation and amortization) turned positive. Its EBITDA came in at $1.1 million, compared with a negative $7 million in the previous quarter. Dan Eldar, Partner's VP carrier of international and investor relations, called the EBITDA the most important item in the report. It shows the company is on the right track to profits, he says.

Partner's operating losses shrank by $200,000 to $34.4 million. Its accrued loss over the first nine months of 2000 was $144 million.

Expensive New Subscribers

Eldar said the growing net losses were due to the company's addition of new subscribers who were not committed to staying with the company for a fixed amount of time. Therefore, the cost of their recruitment enters the books all in one quarter. When a subscriber commits to a given period, recruitment costs can be spread over that period. Usually new subscribers join for a minimum of three years, meaning the cost can be dispersed over 36 months. This, he explains, is why operating losses decreased so slightly. Today 40% of the company's subscribers belong to the prepaid program, another 40% to Orange To Go and only 20% are committed to the company. Most of these committed subscribers are business customers.

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The above figures were arrived at by American accounting methods. If Israeli accounting methods are used, then Partner lost $50 million instead of $56 million. The Israeli method distributes costs differently.

"We expect losses to resume shrinking in the next quarter as they did in the second quarter," Eldar said. Analysts expect a positive cash flow in 2002 and the company shifting to profits in 2004.

Partner published its operating results a month ago, revealing that during the first three quarters of 2000 it added 129,000 subscribers. Its subscriber base therefore came to 633,000 people, boosting its share of Israel's cellular market to 17%. In the second quarter, its share was 15%.

Viva la France!?


rated Partner stock a buy and set it a target price of $12, about 92% above the company's Friday closing price on Wall Street. The target prices Partner at $2.15 billion, compared with its market capitalization of $1.15 billion.

The investment bank bases its conjecture on the fact that Partner's controlling shareholder, the Hong Kong group

Hutchison Whampoa

, sold its holdings in Orange Europe. But it retained its holdings in Partner, leaving the Israeli company with the Orange brand name, but without its infrastructural and informational backing.

Lehman says that on one hand, Hutchison Whampoa is trying to become a leading player in third-generation wireless services provider, which would be helpful to Partner. But the Hong Kong outfit is no longer affiliated with any major European cellular operators, which does not help Partner.

80% Penetration in Three Years

Lehman says that it doesn't know of any talks between the companies involved. But it says that a takeover by Orange-France Telecom would be good for Partner, as it would enable it to access a range of technologies and services via Orange-France Telecom.

Partner's Dan Eldar says he doesn't know about any contacts with Orange-France Telecom either. If there are negotiations, they are at the shareholder level. The Partner executive, headed by CEO Amikam Cohen, is currently in Hong Kong on a visit to Hutchison Whampoa.

The Lehman analysts say that the Israeli cellular market is established by European standards. But it still growing strong. The investment bank believes that the Israeli cellular market will sustain high growth in the coming three years, at the end of which cellular providers will have attained 80% market penetration compared to 60% today. The bank opines that Partner is likely to win 33% of all new subscribers in the coming two years.

Lehman says Partner's commitment to taking over a market segment, whose penetration is expected to come to 90% in the long term, even at the price of immediate financial results. The bank commends this strategy in light of the possible introduction of a new wireless provider in 2001.

Penetration and Growth

A 22% Market Segment Target in 2001

The investment bank predicts that Partner will control 18% of the market by the end of 2000 and 22% in 2001. Assuming a fourth wireless provider enters the market in 2001, Lehman believes that in 2010, Partner will control 25% of the Israeli cellular market.

The Israeli government is expected to publish the tender for a fourth wireless provider in 2001. Lehman believes that the Israeli government will find it difficult to attract companies to participate in the tender, given the required investment. In fact, the bank thinks it will be status quo for the three cellular companies.

Lehman does not see a need for a fourth wireless provider and doesn't deem it economically viable. It says the market is highly competitive with high penetration rates, and the three existing providers are aggressively competing with one another for market segments.

In addition, the bank says that the current violence in the

Middle East

could put off leading communications companies from participating in the tender.

The Status of Israel's Cellular Companies

European Telcos Shares Expected to Rise

Despite Lehman's position on a fourth Israeli wireless provider, the bank believes that a fourth cellular provider could enter the market in the second half of 2001. It could win a license to provide third-generation mobile Web services, out of a total of four such licenses to be allocated by the Israeli government. This provider will serve as both a second- and third-generation wireless provider.

Lehman believes that Partner is going to win a third-generation wireless license. The fourth provider will find it hard to obtain a substantial market segment and will operate mainly as a niche third-generation player, attaining 10% of the market by 2010, Lehman's report says.

The investment bank points out that today the stocks of European telecom companies are slumping and trading at a steep discount against their economic value.

Based on the high correlation that has been observed between Partner and European telecom companies in the past, Lehman predicts that a recovery in the European telecom market will positively affect Partner stock.

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