Starting next year, phone carriers 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.
Legislation was recently passed that will limit new contracts to 18 months -- half of the length previously allowed. The government introduced an option for callers who reach voice mail to hang up within the first three seconds of a call without being charged.
In 2004, the ministry ordered a series of cuts in "interconnect" rates charged for calls between wireless and landline phones. Rates were slashed by 10% last year, and another 15% reduction took hold this year.
Because of all this, analysts see steady but not explosive growth after this year. Analysts polled by Thomson Reuters expect earnings per share in the full 2008 to hit $2.65, up 21% from last year. But they expect only 9% year-over-year growth in 2009.
"Israel is a heavily regulated market, but we've been able to address these challenges and will continue to do so," Cellcom CFO Tal Raz told IBD.
In anticipation of lower interconnect fees, Cellcom has offset the reduction in revenue by raising fees for certain subscribers. The firm is also moving ahead with "bucket" plans that will help negate losses in revenue due to the change in minimum airtime billing units.
Another change that has gone into effect is local number portability. This allows customers to switch providers while keeping the same phone number.
William Blair analyst Jeff Rosenberg expects this to increase customer turnover, or churn, while raising marketing costs to retain those subscribers.
Churn rose 150 basis points to 5.3% in the first quarter from a year ago, due in large part to local number portability and the implementation of shorter contracts.
Cellcom said earnings shot up 53% to 78 cents a share, beating views by 19 cents. A dividend was issued of roughly 74 cents a share, which is a 96% payout of net income.
Revenue increased 11% to $452.2 million, according to Thomson Reuters. Equipment revenue -- handsets and accessories -- grew 47% from a year earlier, while total services revenue was up nearly 6%.
Raz attributed the rise in revenue to a 9% increase in airtime usage. Average monthly subscriber minutes of use rose 3% to 351 minutes, reflecting increased utilization.
Cellcom cut costs by bringing some services, such as the installation of hands-free vehicle devices, in-house, as well as making changes to repair services. Also, the company was effective in reducing handset acquisition costs and handset accessory expenses to sustain margins.
Cost efficiencies as a percentage of revenue dropped from 21.4% last year to 19.4% in the first quarter this year, the company reported.
"The management team has done an excellent job in increasing efficiency in the business, managing regulatory risks and building the Cellcom brand," Rosenberg said.
But it will become increasingly difficult to outperform expectations, he says, given the significant cost savings already achieved, continuing heavy regulation and limited market growth opportunity.
Israel's wireless penetration rate is 120%, mainly because people with more than one wireless device get counted twice. Analysts estimate that out of a population of 7.3 million people, 80% own at least one mobile phone.
There is not a lot of room for increased penetration, and because of this, analysts say the story becomes one about the monthly average revenue per user. ARPU dipped slightly during the first quarter to $40.80, the company said.
"ARPU remained relatively stable year over year," Rosenberg said. "(It) was sustained largely due to an increase in (third-generation) subscribers, data and content value-added services, which helped to offset pricing competition."
Third generation refers to the data transmission capabilities over a cellular network that provide Internet access and real-time video.
Despite stifling regulation and a mature market, Raz says there still remains attractive market fundamentals, especially in data and content services.
"Strong growth can still be achieved because Israel is one of the world's most tech-savvy nations," Raz said.
Cellcom operates a high-speed downlink packet access (HSDPA) 3.5 generation network, which is the fastest high-speed content transmission available in the world.
Last quarter, the company added roughly 104,000 net new 3G subscribers for a total of 523,000. Roughly 17% of Cellcom's total subscriber base already have 3G-capable phones. That leaves plenty of room for growth.
Revenue from data and value-added services grew 41% in the first quarter. Goldman Sachs analyst Albert Kabili expects at least a 20% compound annual growth rate for data and content during the next three years.
"Data remains highly under penetrated in Israel vs. most Western European countries that are 20% or greater," Kabili wrote in a note. "Data shows no immediate signs of deceleration."
While the majority of company's telecommunication services are mobile, Cellcom entered the fixed-line business about 18 months ago. Its landline unit leverages the fiber-optic network used by the company for mobile backhaul.
"The fixed-line business enables us to generate noncellular revenue, and it is a good source of growth going forward," Raz said.