M1 (M1 SP) - Maybank Kim Eng 2017-09-13: An Unenviable Position

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M1 LIMITED B2F.SI

M1 (M1 SP) - An Unenviable Position

We initiate coverage with a SELL rating 

• M1 is the most exposed to Singapore wireless competition risk.
• Management is not standing still and has been building a fixed broadband and enterprise segment franchise but we nonetheless forecast a painful transition period. 
• M1's share price has de-rated but there is reason to believe there is still downside from here. A healthy balance sheet will support payout, partially through debt, offsetting returns risk temporarily. 
• On TP of SGD1.59, M1 trades on a FY18E dividend yield of 3.4%.

Building a wall will come at a cost 

• M1 and the incumbents are likely to use the upcoming release of new smartphones to accelerate recontracting postpaid subscribers to 2-year contracts. We have assumed this will come at the cost of unprecedented, elevated subsidies and depressed profits for the next two years. 
• We assume wireless service revenues will only decline at a 1%, 3-year CAGR due to the industry wide defensive manoeuvre.

Making the adjustments 

• We forecast fixed network revenues led by fibre broadband and enterprise services will grow at a 13%, 3-year CAGR as management focuses on building scale and relationships to tap growth opportunities in the face of wireless sector risks. 
• With enterprise in particular coming from a low base, contract wins in the corporate space and/or Smart Nation initiative projects can make a material impact on earnings and outlook.

Looks can be deceiving 

• Despite undergoing a substantial de-rating over the past 12 months, M1 will trade at a premium to its 5-year and 10-year mean P/E valuations even if it trades down to our lower-than-consensus, DCF-based target price of SGD1.59 per share. 
• In our view, it is too early to say that the negatives are all priced in. 
• Successful recontracting without a material increase in costs with no tariff war is the upside risk to our target price and forecast.

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INVESTMENT THESIS

Between a rock and a hard place 

• The legacy of being Singapore’s purest play in the wireless space is a crutch to bear in the face of upcoming increased competition from new MVNOs and from a full-fledged rollout by TPG in 2018 and onwards. It has already been challenging with SingTel and StarHub using a three to four service bundle for acquisition and retention but the ante is set to be raised further. 
• A unique accounting methodology for postpaid iPhone plans buffers margin shocks relative to its peers but we assume volume and higher subsidies will squeeze overall EBITDA margins to 21% in FY18E from 29% in FY16.
• Since getting into the fibre broadband game in FY10, M1 has built up and sustained a subscriber market share of 15-16% and thus created mobile and fixed broadband bundles to counter the traditional bundles of SingTel and StarHub. Just like the wireless segment, however, the high fixed broadband household penetration (98% as of May 2017), makes organic growth challenging. 
• The enterprise segment is thus M1’s potential source of new growth and the company has been building fixed and human networks towards this goal. It faces the headwinds of SingTel’s legacy corporate relationships and StarHub’s similar concentration in the segment. 
• Nonetheless, it is the primary driver for our forecast that fixed network revenues will grow at a 13%, 3-year CAGR. The weight borne by the larger wireless services segment, however, should lead to a fall in core profits, which we anticipate will decline at a 3-year CAGR of 18%. Although we assume pressure will ease in FY19E and onwards, we assume higher subsidies vs historical averages.

Not cheap despite de-rating 

• Although the stock has dropped 28% on a 12-month basis and underperformed the STI, we believe share price downside risk remains.
• Aside from risk to consensus forecasts, valuations at 18.7x and 23.1x P/E for FY17E and FY18E on profit decline is not deep enough value despite a 4.3% dividend yield. Even if the stock trades down to our DCF (WACC 4.1%, TG -1%, beta 0.6) based target price of SGD1.59 per share, M1 would still trade above its 5-year and 10-year P/E means.
• Even on our more bearish than consensus forecasts, M1’s balance sheet remains healthy with a peak net debt to EBITDA of 2.1x in FY19E. Free cashflow is envisaged to be less than dividend distribution during our forecast horizon despite lower DPS from the FY16 peak. 
• But the 80% minimum payout commitment is sustainable; as long as management is willing to tolerate the medium-term higher leverage.

Risk 

• If M1 and the industry manage to recontract subscribers without significant subsidy escalation as we forecast, there is upside risk to our target price and outlook since M1 is potentially the most sensitive to this.
• Managed subsidy costs but without significant recontracting would, however, be a medium-term risk instead of providing TPG et al with easier targets.
• Better-than-expected enterprise revenue growth is an upside risk we cannot discount given management has been building relationships with corporate accounts and government agencies.
• Meanwhile, although the shareholder review has been rescinded, given M1’s significant and profitable market share and healthy cashflow, we could see takeover interest once again.

VALUATION

Still some downside to DCF-based target 

• We set our target price of SGD1.59 per share for M1 using a DCF methodology. We believe such methodology captures the impact of the period of heightened competition coming to Singapore which may not be adequately reflected in historical valuations. It also covers the recovery and normalization period thereafter.
• Thus despite significant share price downside over the past 12 months we believe there is still risk which could be triggered by margin erosion from heightened subsidy costs industry wide and / or indications of either TPG or MyRepublic’s new wireless offers in the market. 
• If TPG also obtains a fibre broadband retail service provider (RSP) license, which is something it is aiming to have according to news reports, then other telcos — including M1 — could experience a negative share-price catalyst in the short term.

Trading valuations are expensive 

• At current levels on FY18E prospects, M1 trades one standard deviation above its 5-year and 10-year historical P/E means. This is still expensive especially since for FY18E, we anticipate margin deterioration will peak for the company and its peers. 
• In theory the 10-year average seems appropriate as this would capture the period where M1 and StarHub were more aggressively fighting for share as the new entrants against SingTel and also capture the unlimited 3G data plan competition period before end-2012 when 4G tiered data plans were introduced into the market.
• On a cash dividend yield basis, the stock has traded at an average of 5.4% and 6.4% over a 5-year and 10-year period, respectively. Trading currently at 3.4% and 3.9% yields for FY17E and FY18E, these levels do not look compelling despite the sustainability of the 80% payout given the healthy balance sheet.
• M1 trades at a premium valuation to SingTel on a P/E, EV/EBITDA and yield basis which we believe is not sustainable unless the negative outlook on the Singapore wireless market reverses. Stock has de-rated significantly relative to its peers but the relative risk profile remains and the valuation gap with SingTel stands out.

Not deep value even at our target price 

• If the stock trades at our target price, this would still imply premium valuations against the 5-year and 10-year P/E averages and still a discount to average yields during both periods. As such, if and when our base scenario of a significant fall in margins takes place, the risk of share price downside overshooting exists as using valuation screens on downgraded assumptions would still not make the stock look like it offers deep value.

Significantly below consensus 

• Our EBITDA and core profit forecasts for the next three calendar years are materially below consensus on the back of our aggressive subsidy assumptions. The equipment sales entailed in such active recontracting efforts is one possible reason our total revenues are higher than consensus despite falling wireless revenue assumptions. Our fixed network revenue growth driven by enterprise could be another reason.
• Part of the profit fall in FY19E despite a slowdown in EBITDA decline is our assumption of the amortization and finance costs related to the payment for the 700Mhz spectrum fees. 
• We are unsure whether consensus has baked in such costs by that time or earlier.

Risks 

• Upside risk to our forecasts and view is if wireless revenues see actual growth and rebound from wireless data cannibalization of other wireless revenue segments. Without the factor of new competition, such may have been possible given Singapore’s relatively advanced stage of wireless data adoption in ASEAN, but with new entrants this would seem unlikely. 
• With M1’s larger exposure to wireless than its peers, every 1% change in wireless revenue for 2017E would result in a 4% change in our core profit forecasts and 3% change to our target price. We note that recent unlimited wireless data plans carry a higher monthly fee price tag that could create additional ARPU, if competition does not escalate. Also, a high level of network usage could pressure capex upwards in the medium term.
• Meanwhile, if M1 generates 5% more fixed network revenues than our current assumptions from 2017E onwards, that would boost FY17E and FY18E core profits by 3% and 4% respectively. Our DCF-based target price would be enhanced by 5% under such scenario. 
• Although all the telcos are targeting the enterprise segment and Smart Nation projects, the organic growth prospects — relative to wireless data still cannibalizing traditional voice, SMS and roaming revenues — make this upside risk more probable than wireless ARPUs rising, in our view.
• The other upside scenario that we believe consensus is counting on is that demand for upcoming smartphone models will be so strong that subsidies can be controlled on an absolute basis, implying potential reduction on a per unit basis. This could be particularly true for the iPhone which M1 accounts for two year accounts by bringing forward the net present value of the contract to match against the subsidy.
• Faster-than-expected market share gains from the enterprise segment to help offset wireless competition pressure would also be an upside risk that we cannot discount. It is also possible that takeover interest in the telco remains even though its major shareholders have set aside a recent strategic review that left their stakes open for sale.

COMPANY BACKGROUND

• M1 is the third largest wireless operator in Singapore with c16% of the wireless revenue market. We believe that the market share position relative to competitors is a function of SingTel and StarHub having telco and media service bundles much earlier and thus creating a recruitment advantage early and retention later. 
• Thanks to the open access network provided by Singapore’s next generation nationwide broadband network (NGNBN) and the formation of its own operating company (OpCo) utilizing the backbone, M1 has since entered the fibre broadband arena and offers its own bundled packages.
• The head start of its two competitors in running their own backbones and building relationships from these coupled with their bundled pay TV content has been a challenge to surmount. Although pay TV and content are turning into an increasing burden due to piracy, ergo its value in the bundle is diminished, the three service bundle packages and discounts from these remain a strong hook to households.
• As with most telcos, M1 is working on monetizing wireless data while trying to minimize or slow down the attrition of traditional voice, SMS and roaming revenues. The introduction of tiered data pricing plans in FY12 has seen a steady increase of subscribers exceeding their data caps (32% in 2Q17) and thus providing additional ARPU beyond the monthly fee.
• A steady decline in postpaid ARPU since FY14 is indicative that such a segment may not be substantial, however.

EARNINGS / FORECASTS

• We forecast a continued decline in ARPU and a minor decline in subscribers in the face of increased competition. A significant decline in both categories is being mitigated by our assumption that recontracting efforts are successful. 
• We forecast M1 will take some wireless revenue market share relative to the current incumbents as we forecast SingTel will bear the brunt of cannibalization of roaming and voice revenues by wireless data and pervasive nationwide WiFi availability. Likewise, we believe multi-SIM ownership is likely more prevalent in SingTel’s subscriber base.
• As is a global trend for integrated operators, M1 is more aggressively targeting the enterprise market segment. 
• M1 has also been actively participating in various Smart Nation and government service trials for local communities to build its experience and relationships in winning projects. For example, the company has been participating in the smart signboard trials being undertaken at certain Housing and Development Board (HDB) buildings. The main challenge is SingTel’s legacy relationships and its formidable build up in assets and capabilities on a global scale as well as StarHub’s experience in managing a nationwide data network. With the volume of available work expected to rise as companies and the government seek to improve efficiency, we forecast M1’s fixed network revenues will be its only growing segment in service revenues. Part of the growth is held back by slower growth in the fixed broadband component due to high household penetration.
• M1 has deliberately shied away from pay TV and directly investing in content. This is a prudent move, in our view, given that over-the-top apps on mobile devices are changing the viewing behaviour for content and piracy is devaluing its efficacy as a currency to acquire or retain subscribers on a bundled platform. Furthermore with Singapore’s cross carriage rules effectively nullifying exclusive content contracts, M1 can carry its competitors’ exclusive content if it chose to do so.
• Our consolidated opex forecasts assume a +3% CAGR over three years but with FY17E and FY18E having a significant bump up due to handset cost escalation before easing off in FY19E. However, the start of amortization of the 700Mhz frequency license (SGD188m total cost) that we have assumed in FY19E dampens part of the relief.
• We forecast M1 will see capex to sales rise to 14-15% of revenues in FY17E-19E in anticipation of network enhancements to support superior quality to new wireless competitors and to increase its viability as an enterprise service provider. Admittedly, instead of network capex this could take the form of acquisitions to build scale in the enterprise services space. Our capex forecasts do not include the cost of the upfront license fee, which we account for in cashflows through costs of intangible assets. 
• Despite such assumptions M1’s balance sheet will remain healthy enough to support the 80% dividend payout commitment, in our view. With the payout being based on earnings rather than a fixed DPS like StarHub, this enables an automatic adjustment for earnings swings.

Luis Hilado Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-09-13

Maybank Kim Eng SGX Stock Analyst Report SELL Maintain SELL 1.59 Down 1.750