M1 - DBS Research 2017-07-19: Taking Off M&A Premium

M1 - DBS Vickers 2017-07-19: Taking Off M&A Premium M1 LIMITED B2F.SI

M1 - Taking Off M&A Premium

  • M1'S 2Q17 net profit of S$32.5m (-21% y-o-y) was 10-12% below consensus expectations.
  • Costs rise despite lower mobile service revenue due to high handset subsidies and other operating costs.
  • Major shareholders are not disposing off their stake in M1; downgrade to FULLY VALUED with revised Target Price of S$1.78.



Downgrade to FULLY VALUED with a lower Target Price of S$1.78. 

  • We have removed the 25% M&A premium from our DCF valuation as M1’s major shareholders (with combined stake of 61%) have announced that they are not going ahead with a strategic review to dispose of their stake. 
  • In addition, due to higher-than expected handset subsidy costs and other operating costs, we have cut our FY17F/18F earnings forecasts by 12%/11%.
  • MyRepublic’s intention to enter as an MVNO (Mobile Virtual Network Operator), on top of TPG’s entry as Singapore’s fourth mobile-network operator, further adds to the sector’s woes.


WHAT’S NEW - Cost escalation hurts bottomline 


Net profit below our expectations due to handset subsidies and higher costs: 

  • Net profit of S$32.5m (-21% y-o-y, -10% q-o-q) was ~10% below our expectations. Profitability was impacted by higher handset subsidies and increased project related costs. 
  • Handset subsidies increased due to M1 looking to sign up and re-contract higher-end customers and increased competition for subscribers. Handset subsidies are likely to remain relatively high, according to the company’s management, as telcos will look to retain and add to their high-end customer base.

Growth in the fixed-line segment helps revenues: 

  • Service revenue benefitted from the growth in the fixed-line segment’s revenue as well as stable mobile and IDD revenues.
  • The fixed segment added ~8,000 subscribers in 2Q17 while posting revenue of S$31.1m (+21% y-o-y, +4% q-o-q).
  • Mobile revenue held steady q-o-q as growth in data offset declines in legacy revenues. In addition, mobile’s ARPU continued to decline, with postpaid ARPU declining 6% y-o-y.


WHERE WE DIFFER? 

  • The market seems to have over-estimated M1’s ability to control operating costs in tandem with a decline in service revenue. High customer acquisition costs and the lack of a strategic cost-cutting programme are our key concerns.
  • Dividend payment has been the most critical factor for M1’s share price performance in the past. However, earnings and hence dividends (80% payout ratio for FY17) are set to decline sharply in FY19F due to high price tag of S$188m for 700MHz spectrum (yet to be paid), resulting in high amortization costs. 


POTENTIAL CATALYST

  • Weak 2Q17 and 3Q17F results even before the actual launch of operations by TPG (expected in late 2017) could lead to further downward revision in consensus earnings and the valuation of M1, in our view.


VALUATION

  • Revised Target Price of S$1.78. Our valuation is based on DCF (WACC 6.3%, terminal growth 0%). Despite an 18% decline in M1's share price over the last one year, M1 is not cheap at FY18F EV/EBITDA of 8.5x versus the Asian telco average of 7.3x. 
  • A potential dividend yield of 5% is clearly not enough to compensate for annual earnings decline of 12% over FY17F- 19F in our view.


KEY RISKS TO OUR VIEW

  • Strategic cost-cutting programme at M1 or TPG struggling to roll out a network. Any potential big cuts in M1’s operating costs could result in better-than-expected earnings.
  • Alternatively, any potential delay in TPG’s rollout due to operational challenges could also boost M1’s stock price.




Sachin MITTAL DBS Vickers | http://www.dbsvickers.com/ 2017-07-19
DBS Vickers SGX Stock Analyst Report FULLY VALUED Downgrade BUY 1.78 Down 2.540



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