On Friday, Bezeq Israeli Telecommunication Co. Ltd. (TASE: BEZQ) published an ostensibly dramatic report. The company reported that it had received a letter on Thursday from Ministry of Communications director general Shlomo Filber entitled, "Elimination of the structural separation requirement in Bezeq" - no less. The text of the company's announcement stated that the Ministry of Communications was "promoting" (unclear wording, which was probably copied from Filber's letter) in the first stage elimination of corporation separation in exchange for a commitment by Bezeq to bring forward deployment of fiber optic infrastructure and to launch commercial service on it in early 2017. Bezeq said that the deployment obligation would be anchored in the company's license according to the following timetable: a minimum deployment of 76% within three years. The target for completing deployment was not stated.
Publication of the announcement created a storm. Ministry of Finance budget department personnel, who are cooperating with the Ministry of Communications in regulation of the communications sector, played no part in this decision, and announced that they opposed the measure. The other operators in the market also obviously had no idea that such a letter would be sent to Bezeq. A senior Ministry of Communications official, however, who spoke with "Globes" immediately after the report became public, sought to pour water on the flames. "This letter is nothing more than a declaration of intentions," he told "Globes," "and in any case, the Ministry of Communications plans to a hearing for all the concerns in the sectors before anything is done."
When "Globes" asked why such a letter was necessary, since the hearing documents could simply have been published, the official gave a confused answer that failed to explain the peculiar timing.
We will nevertheless attempt to explain here the interests behind the letter and why it was sent at this particular time.
What was in Filber's letter?
At the beginning of Filber's letter to Bezeq, which "Globes" has obtained, he quotes his letter to Bezeq dated June 30, 2016, which already stated that his ministry was willing to begin discussions of regulation to replace the structural separation regime. He lists a series of matters, however, that must be arranged before the structural separation requirement is removed: how wholesale services are provided; ensuring that Bezeq does not discriminate in the quality of the wholesale and retail services it provides; establishing effective transparency, control, and supervisory mechanisms; maintaining the possibility of again separating Bezeq into its components; and maintaining the possibility of continuing to provide wholesale services on the fiber optic network being deployed by the company. The letter also states that any change depends on finding a solution for the question of providing telephony services in the wholesale services framework. This is a long list of arrangements that must be settled before going ahead with the elimination of structural separation. Nevertheless, Filber notes in his letter that in pursuance of the October 13, 2016 meeting between the Ministry of Communications and Bezeq representatives, "You stressed the importance of the merger between Bezeq and Yes before the end of 2016. The ministry is promoting in the first stage the elimination of corporate separation in the Bezeq group." At the same time, Filber writes, "At this stage, all the regulations currently established in (Bezeq's, G.P.) concerning structural separation will be maintained."
What is the difference between structural and corporate separation?
Bezeq has sought to eliminate the structural separation between it and its subsidiaries - Bezeq International Ltd., Pelephone Communications Ltd., and DBS Satellite Services (1998) Ltd. (YES) - which will enable it to merge activities and market service packages that it is currently barred from marketing, for a long time. The Ministry of Communications, however, has so far been unable to make progress with eliminating this structural separation, and Bezeq is being forced to settle for elimination only of corporate separation, subject to a hearing. This different is not merely a matter of semantics. Corporate separation is a legal term that enables Bezeq to use Yes's losses for tax purposes. Yes currently has NIS 5.3 billion in accumulated losses, which in tax terms are worth NIS 1.3 billion spread over 10 years. Bezeq can take advantage of these accumulated losses only if it is legally merged with Yes.
In the framework of a parties at interest deal between Bezeq and Eurocom Group, Bezeq acquired the losses, and paid a lot of money for them: NIS 300 million out of a NIS 680 million cash payment, plus NIS 200 million paid to Eurocom after approval of the arrangement with the Israel Tax Authority. Bezeq also paid NIS 460 million to the Tax Authority under the arrangement. In total, Bezeq paid NIS 960 million for the right to utilize Yes's losses. With the elimination of corporate separation, Bezeq will be able to make use of NIS 1.3 billion in losses over eight years.
Other than that, eliminating corporate separation will not change much in Bezeq's day-to-day life; it is designed solely to promote Bezeq's tax arrangements. Furthermore, such elimination is likely to be bad for Bezeq, because it will perpetuate a specific situation, and de facto elimination of structural separation will be postponed. This is one of the perplexities of the Ministry of Communications' measure: instead of eliminating structural separation, it is working for Bezeq in order to devise solutions that will help it obtain some kind of tax benefits.
For consumers, the important thing is the structure of future competition, and whether they will pay less for products. Elimination of corporate separation is not expected to have such an effect. If structural separation is eventually eliminated, this will enable Bezeq to sell communications service packages without any separation between it and its subsidiaries. For example, Bezeq will be able to sell a package combining Internet, television, and telephony, like the packages currently being marketed by Hot Telecommunication Systems Ltd. (TASE: HOT.B1) and Cellcom Israel Ltd. (NYSE:CEL; TASE:CEL), which is likely to reduce the price of these packages.
Would Bezeq have upgraded its infrastructure without the letter?
Several months ago, Bezeq CEO Stella Handler sent a letter to Filber undertaking to make infrastructure investments. This was important to Filber, because the two sides were preparing a measure in which elimination of structural separation would lead Bezeq to invest in fiber optics, but there is no actual connection between the two questions. Bezeq will invest and upgrade its network, simply because it has no choice; if it does not invest in higher communications speeds, Hot will do it, and the end result will be a race in infrastructure investment, unless the two companies coordinate between them, and we do not believe that this can take place.
Why was the letter sent now?
Filber's letter again confirms a wave of rumors in the market concerning the supreme importance that Bezeq attributes to eliminating structural separation in 2016. As "Globes" has already stated, the enormous pressure being applied by Bezeq to eliminate structural separation by the end of the year, and its failure to complete the process at the time it wants, shed light on the need for the letter, which actually has no real value.
Much was written late last week about why Bezeq so very much wanted to complete the elimination of its structural separation before the end of 2016, and why it was important for Bezeq to obtain this letter of intent from the Ministry of Communications when Bezeq failed to achieve its aim. Most people attributed it to the arrangement reached by Bezeq with the tax authorities concerning Yes's losses. Following much discussion with analysts and experts, however, we can offer a different explanation.
First of all, where the tax matter is concerned, the determining date is the actual merger between Bezeq and Yes, and the fact that some letter was published has no bearing on the date on which Yes's accumulated losses can be utilized. These losses are worth NIS 5.3 billion to Bezeq, spread over years as tax benefits. What will eventually determine the matter is the date on which corporate separation is actually eliminated.
In our opinion, the explanation lies in the parties at interest deal in Yes, in which Bezeq acquired the holdings in Yes of its controlling shareholder. The price in the deal in which Bezeq acquired Eurocom's holdings in Yes was NIS 680 million in cash. The acquisition agreement also stipulated two contingent payments: NIS 200 million if the Tax Authority allows Bezeq to fully utilize Yes's losses, and an additional NIS 170 million payment in 2015-2017, i.e. NIS 57 million a year, to be paid subject to Yes meeting the free cash flow targets set in the agreement.
Bezeq made the first NIS 57 million payment to Eurocom in early 2016 in respect of 2015, and the second payment is scheduled in early 2017 in respect of 2016, insofar as Yes meeting the cash flow target listed in the agreement. The agreement states that final calculation of the amount will take place in 2018 when the 2017 financial statements are signed. At the same time, the agreement states that if the separation between Bezeq and Yes is canceled before the end of 2016, the final accounting will take place as soon as the 2016 financial statements are signed. Similarly, the amount according to which the accounting is made will be both the contingent payment for 2016 and the payment attributed to 2017, in other words, NIS 114 million.
Thus, if the separation between Bezeq and Yes is eliminated by the end of 2016, Eurocom will profit in two ways: Yes will not have to meet the 2017 targets (and in view of Yes's declining results, this is a real benefit), and the amount that was supposed to have been paid in early 2018 will be brought forward by a year, and will be paid in early 2017.
It was recently reported that Eurocom is not meeting the repayment terms for a loan it took from a consortium of lenders headed by Mizrahi Tefahot Bank (TASE:MZTF). Eurocom does not have the NIS 85 million it is due to pay. It is possible that the explanation for the events at the end of last week lies in the Bezeq controlling shareholder's need for cash.
Those with sharp eyes will immediately say that since the separation was not actually eliminated, the clause in the acquisition agreement is invalid. It is possible, however, that the Bezeq controlling shareholder is relying on the company board of directors regarding Filber's letter of intent as a sufficient reason for acting according to this clause and moving the above-mentioned payments forward. It remains only to wait and see whether this is a theoretical conspiracy or a real plan. Bezeq's actions in the coming weeks will settle the matter one way or another. We note only that the Bezeq sources we spoke with told us that more than our wild imagination was involved, and that the matter was definitely on the table.
Bezeq said in response, "Bezeq has had an interest for a very long time in mergers with the group's companies, and the company always intended to carry out these mergers as soon as possible. The assertion that this interest is biased in favor of the controlling shareholder or contrary to Bezeq's interest is completely mistaken and groundless. We note that the mechanism for bringing forward the payment for Yes's performance in 2017 will apply to any merger that takes place by the end of September 2017, and the timing of the merger therefore is of no significance in this context. All of Bezeq's shareholders, including its controlling shareholder, will benefit to the same degree from the elimination of structural separation and the merging of the group's companies."
Published by Globes [online], Israel business news - www.globes-online.com - on December 28, 2016
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