Singapore Telecommunications (ST SP) - Maybank Kim Eng 2017-09-13: Too Perfectly Balanced?

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SINGTEL Z74.SI

Singapore Telecommunications (ST SP) - Too Perfectly Balanced?

Initiate coverage with HOLD 

• SingTel’s geographically-diversified but telco-focussed portfolio should insulate it from Singapore-centric risks. That said, TPG’s entry will likely intensify competition in Australia while India remains a hot bed of competition. 
• An expected special cash dividend from Netlink Trust’s (NLT SP, Not Rated) IPO proceeds provides share-price support in the short term, but medium-term investor interest may require the majority of SingTel’s parts to go in the right direction. 
• Our SOTP-based TP is SGD3.83. We prefer direct exposure to two of its parts: AIS (ADVANC TB, BUY) and Intouch (INTUCH TB, BUY).

Fire vs Ice 

• We believe that heated competition in Singapore and Australia will manifest in higher handset subsidies rather than wireless-revenue erosion, which is more aggressive than market assumptions. However, if wireless revenue in both countries takes a 1% hit in FY18E, our core EPS forecasts would take a 0.5% hit. 
• Cooler competition in Indonesia, Thailand and the Philippines, which make up a combined 41% of our SOTP, may help offset these pressures; with unlisted Telkomsel having the largest impact.

Un-priced swing factors 

• Aside from the wireless space, competition for Singapore enterprise contracts is also rising, from StarHub (STH SP, SELL) and M1 (M1 SP, SELL). These are gunning for their shares of the pie. Thankfully, an increasing volume of work in local IT services and from SGD2.4b worth of Smart Nation contracts could provide growth for all players, in our estimation. 
• SingTel’s Digital Life division and cyber security outfit, Trustwave, are also gaining global/regional scale, which could accelerate profit contributions.

Neither cheap nor expensive 

• SingTel trades at 1SD above its 5- and 10-year P/E means of 15x and 12x, respectively. This is fair, in our view, given its greater diversification than Singapore-centric peers, it trades near our SOTP TP of SGD3.83.
• Successful subscriber re-contracting without cost jumps may offer upside risk while tariff wars are a downside risk.

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INVESTMENT THESIS

Worst and best of the times 

• SingTel is one of the most successful regional telco players with significant, if not leading, presence in five countries outside Singapore.
• However, the low-penetration, high-growth phase of the wireless sector in all its markets has come to pass, with well over 100% penetration in most places. Increased adoption of smartphones by developing countries such as India, Thailand and the Philippines should propel wireless-data growth, likely at the expense of traditional voice, SMS and roaming services. This could dilute revenue growth.
• With the Singapore and Australia wireless markets set to be besieged by competition in the next 12-18 months, SingTel will be relying on the enterprise and digital space to provide future sources of growth vertical integration and evolution of its traditional fixed network services, amid demand by companies and government agencies for more efficient systems and solutions. 
• In cyber security, digital marketing, online video on demand and data analytics, it is aiming for regional and global scale. To achieve this, its bottom line has been sacrificed during its investment phase. This may not quite be over, though its new endeavours are approaching EBITDA breakeven.
• Meanwhile, regional associates, which account for over 60% of our SOTP valuation, are propelling earnings growth. They are a mixed bag, with 35%-owned Telkomsel in Indonesia leading the way with its dominant market position. Thirty-six-percent-owned Bharti in India (BHARTI IN, INR402.95, SELL, TP INR320) is struggling with intense competition.
• Elsewhere, AIS and Intouch in Thailand, 36% and 21% owned, and 47%- owned Globe (GLO PM, Not Rated) in the Philippines are coming out of competitive intensity.

Halo-effects valuation 

• With its geographical diversification providing alternating business cycles to balance out risks, SingTel’s current premium FY18E P/E of 16.6x to its 5- and 10-year P/E means of 15x and 12x, respectively are deserved, in our view. 
• On the other hand, it trades near our SOTP TP, which suggests the market has priced in the oncoming tougher competitive environment in Singapore and Australia. With our FY18-19E core EPS being 9% and 20% lower than consensus, there may be some share-price risks during its adjustment period.
• Anticipation of special cash dividends from the divestment of its Netlink Trust (NLT) stake is likely to support its share price in the near term. We forecast a FY18E dividend yield of 7.5%, assuming half its NLT gains are declared as dividends.

Balanced portfolio a double-edged sword 

• Downside to SingTel’s diversification at this stage of the wireless growth cycle is that it would take several parts moving in the right direction to provide major upside to our earnings and SOTP. This may happen when data cannibalisation troughs and / or Enterprise and Digital Life generate economies of scale. Those ends are not yet in sight. 
• Meanwhile, exposure to regional currency risks is well known, so it would take major currency volatility to move its share price in either direction, in our view.

VALUATION

SOTP-based 

• We derive our TP of SGD3.83 based on SOTP, largely using the DCF valuations of its various parts by MKE country analysts. We believe DCF captures the impact of current or coming competition in the wireless space more adequately than other methodologies.
• SingTel’s value is fairly spread across its parts. Associates account for over 60% of its valuation. ASEAN forms over two-thirds of this. SingTel’s telco portfolio provided growth exposure in the past when wireless penetration was low. It now offers risk diversification with its parts in various stages of the competition cycle.
• We initiate coverage with a HOLD, given our negative view on Singapore’s telco sector. We have SELL ratings for its competitors StarHub and M1.
• Among its listed associates, our Thai telco team has positive views and BUYs on AIS and Intouch. These may provide investment alternatives for regional investors until the uncertainty in Singapore lifts.

Trading at premium to historical mean 

• Based on the 12M forward P/E valuation, SingTel currently trades around 16.6x, which is above its 5-year average P/E and 1SD above its 10-year average. The 10-year period captures a more intense competitive environment when StarHub and M1 were building up their respective market shares. It also covers the period when 3G unlimited wireless data plans suppressed industry yields.
• On a cash dividend yield basis, the stock traded at an average of 4.9% and 4.8% over five and 10 years respectively. An estimated 7.5% yield for FY18E would appear to offer value but this assumes exceptional gains and special dividends. Yields drop to 4.1% for FY19E in the absence of such gains. We have assumed that half its SGD2b gains from its NLT stake sale will be declared as special dividends this fiscal year. We think management may announce this during its 2QFY18E results release.
• SingTel trades at P/E and EV/EBITDA discounts to its local peers for FY18E and at superior yields due to its prospective exceptional payout for the year.

Premium likely to stick 

• Our TP implies premium P/E valuations for FY18-19E over its historical averages and the same relative to its FY19E yield. We believe the market will continue to ascribe premiums for SingTel’s unique business structure and diversification. 
• That said, we think outperforming the STI and regional telco peers - including its listed associates - will require a confluence of positive events for most of its parts in an overall challenging environment.

Core EPS below consensus 

• Our core profit forecasts are below consensus from FY18E onwards because of our assumption of higher equipment sales and subsidies as SingTel and the industry aim to re-contract postpaid subscribers for new 2-year contracts. We have made similar assumptions for Optus in its preemptive moves ahead of TPG’s full network launch in 2018, as reported by Mobile World Live. On the other hand, higher equipment sales account for our higher revenue forecasts than consensus.
• Our FY18E forecasts for reported profits are 22% higher than consensus, most likely as we included SGD1.9b of exceptional gains from its NLT stake sale in 2QFY18. Our TP of SGD3.83 is 9% lower than consensus TP of SGD4.20.
• As for its associates, MKE analysts value them at an average 14% discount to consensus. This implies SGD0.17/share or a 4% addition to our SOTP.
• If we use the last traded share prices of its listed associates, our SingTel SOTP would be 2% or SGD0.09 higher, primarily due to a higher valuation for Bharti.

Risks 

• Downside risks to our call include any SingTel failure to stem its revenue decline with its re-contracting efforts in Singapore and Australia. SingTel’s own associates have experienced irrational competition, which subjected their markets to quarters of painful adjustments. The first domino this time around, which is TPG’s launch, must fall before a new reality takes place, in our view. 
• The recent re-emergence of unlimited wireless data packages may be that first drop. Assuming consolidated wireless revenue declines 1% worse than our estimates, FY18E core EPS could dip 0.5% in each of the next three fiscal years. Our SOTP TP would correspondingly drop by 0.4%. Irrational competition in any of its major markets remains a risk.
• On the flipside, an influx of next-generation smartphones, particularly iPhone X aka the 10th anniversary iPhone, may be in such demand that operators have the opportunity to slash their unit subsidies. Still, we think absolute subsidies may remain high due to unit sales.
• With geographical diversification comes FX risks. As 78% of SingTel’s value is derived outside Singapore, it is heavily exposed to such risks and volatility. SingTel and its associates hedge their currency exposure but operational streams are not.
• Additional acquisitions for its enterprise division, particularly cyber security, Digital Life and in existing associates, are not part of our forecasts. Management is open to such options though no opportunities are imminent or guaranteed. Future asset sales such as its SingPost stake or any further NLT stake sales are also not part of our assumptions.

CORPORATE INFORMATION

Singapore leadership here to stay but… 

• SingTel is the wireless market leader in Singapore. This is based more on its legacy head-start, in our view. Aspirational and premium branding has likely kept higher-end, retail postpaid subscribers sticky despite the availability of mobile number portability since 1997. With wireless penetration at 151% in May 2017, the scope for organic growth seems limited.
• Converting more subscribers to smartphones, thereby increasing wireless data usage, is both a strategy and an inevitability, in our view. Right now, 65% of its postpaid subscribers use smartphones. Upcoming launches of new Samsung and Apple smartphones could boost adoption in the near term, as existing users sell or hand down their old units. Wireless data usage growth, however, cannibalises voice, SMS and roaming revenue, potentially stifling revenue growth.
• Upcoming competition from TPG will likely erode SingTel’s revenue market share, including those of its peers. The degree of erosion is tied to the extent of buffers generated by re-contracting efforts and the domino effects of tariff promotions on all the players. We currently assume that SingTel’s wireless service revenue will decline by a 4% CAGR over the next two years.
• SingTel’s local enterprise leadership is a function of its head-start in fixed network deployment and its competitors’ greater focus on the retail market during the segment’s growth years. The creation of an open-access, next-generation nationwide broadband network (NGNBN) since 2013 and more recently, challenges in the wireless market have forced its competitors to target this segment increasingly. Nevertheless, organic growth prospects of managed services, business solutions and cyber security leave room for more players to crowd the space. IDC estimates that IT service spending in the Asia Pacific will reach USD150b by 2019E, from USD124b in 2015.
• Meanwhile, SingTel’s acquisition and integration of Trustwave with its enterprise division since 2015 has enabled it to tap global, regional and local cyber security demand. After North America, the Asia Pacific ranked second globally in malicious data breaches in 2016. These are the two key markets among the 96 that Trustwave has customers in.
• As a result of growing demand, we forecast growth for SingTel’s enterprise-related services, unlike wireless. We believe SingTel will still take the lion’s share of revenue from incumbents in its associate markets, though by incrementally smaller quantums. For example, on a calendarised basis, we forecast a fixed network revenue CAGR of 2% for the next two years, with a 2019E revenue share of 88%, down from 90% in 2016. Fixed network includes its slower-growing fibre broadband business and structurally-declining national and international call businesses.
• As part of its expansion into digital services, enabled by its telco assets, Digital Life continues to focus on digital marketing (Amobee), regional premium video services (Hooq) and advanced data analytics (Dataspark) regionally and globally. SingTel’s acquisition of Turn Inc. in Apr 2017 to augment Amobee’s capabilities was mainly responsible for a 122% QoQ leap in its 1Q18 Singapore digital business revenue and guidance of lower negative EBITDA for the division.
• With digital marketing turning the corner, what remain for Digital Life are challenges for its two other focuses. 
• Increasing corporate usage of data analytics for both internal and external purposes does support the viability of its target segment. IDC forecasts that global big data and analytics revenue will reach USD203b by 2020E, from USD122b in 2015. As with Amobee, scaling up Dataspark will be key. There is no guidance for potential acquisitions to accelerate this process.
• Although on-the-go content demand has been lifting demand for premium video services, piracy issues are hobbling SingTel’s content initiatives such as Hooq and mioTV, its pay-TV offering. Although such risks are shared with content creators such as Sony Pictures and Warner Bros in the case of Hooq and should be reflected in their pricing, take-up rates for paid services are naturally hampered by “free” options. In May 2017, a Channel NewsAsia article cited a Muso Global Piracy report that Singapore ranks ninth globally in visits to piracy sites as a ratio of the country's Internet population.

Optus 

• Optus in Australia is a wholly-owned subsidiary of SingTel. It is the second largest wireless operator in a highly penetrated market - 138% in Dec 2016 - with an estimated 27% revenue market share. Optus is the challenger to incumbent, Telstra (TLS AU, Not Rated) in Australia. In Apr 2017, TPG won a nearly-11-year licence with 20Mhz of frequency at the 700Mhz band for AUD1.26b or USD994m to compete as a full-fledged operator in Australia as early as Apr 2018. A 3-year AUD600m or USD473m capex budget for 80% population coverage was guided in a 12 Apr 2017 article in the Sydney Morning Herald.
• Unlike in Singapore, TPG is an existing MVNO and known brand in wireless and fixed broadband in Australia. Therefore, we think it can more easily convert its subscribers to its full mobility network. 
• As with Singapore, we have assumed that equipment subsidy contract walls will be erected by incumbents in Australia to prepare for increased competition from TPG. We also assume that APRUs and subscribers will not dive dramatically. With wireless revenue recovering from FY17 lows, we forecast a 2-year CAGR of 5%.
• The migration of cable broadband subscribers to and new subscriber signups for NBN fibre services could fuel a similar 5% 2-year CAGR for data and internet revenue. This should mitigate declines in traditional fixed-line and pay-TV services.

Associates 

• SingTel’s regional associates are now all wireless market leaders. Globe is the most recent to climb the podium in the Philippines against PLDT (TEL PM, Not Rated). However, wireless penetration is already high. As such, revenue growth is no longer a low-hanging fruit.
• Each market is in a different stage of smartphone and 3G vs 4G adoption. Hindsight from faster-adoption markets suggests that adoption eventually mutes revenue growth as voice and SMS components are replaced by wireless data over-the-top app substitutes for them.
• Its associates’ markets are in different stages of competition, with India and Indonesia in contrasting circumstances. Meanwhile, competitive heat in Thailand and the Philippines has cooled off after several quarters of intensity.

Indonesia leads the pack 

• Telkomsel is the largest associate contributor to profits and our SOTP. This reflects Indonesia’s most rational market among SingTel’s associate countries. Telkomsel also has the balance sheet and network to support its market position.
• Telkomsel defied a revenue slowdown in Indonesia, which has the highest mobile penetration among SingTel’s associate markets, to post a 13% YoY increase in operating revenue in 1QFY18. This was backed by a 31% YoY jump in its data and digital service revenue growth and 6% increase in its voice revenue.

India / South Asia still under siege 

• Bharti is the second-largest contributor, after Telkomsel, despite India’s dire competitive landscape. Our Indian telco analyst, Neerav Dalal, continues to see risks for Bharti from Reliance Jio’s (Not Listed) continued aggression. Furthermore, capex intensity for network capacity could remain elevated and affect Bharti’s FCF and balance sheet.
• Bharti’s 1Q18 consolidated revenue slipped 14% YoY despite the addition of 7m wireless subscribers. This was due to disruptive data pricing and free voice promotions in India. Voice realisation per minute fell 34% YoY and data realisation per MB, 73% YoY.

Thailand heading in right direction 

• Through its direct stake in AIS and indirect stake via Intouch, SingTel’s Thai exposure has a material impact on its profitability and valuation. Our Thai telco team, Maria Lapiz and Sittichai Duangrattanachaya, highlights that the sector and AIS should benefit from waning hyper-competition this year, particularly with well-targeted handset subsidies. Going forward, with True Corp (TRUE TB, HOLD) catching up with DTAC (DTAC TB, BUY) in revenue and subscriber market shares, there is less incentive for marketshare grabbing in the industry.
• In the recent June quarter, service revenue climbed 7% YoY as data revenue growth of 21% YoY overwhelmed a 14% drop in voice revenue.
• Likewise, fixed broadband continued to grow strongly, further aiding growth.

Globe in Philippines joins top of the podium 

• SingTel’s largest interest among its associates is its 47% holding in Globe.
• Globe recently overtook PLDT in wireless market leadership in the Philippines as it took prepaid market share and branded itself a wireless data innovator. Mirroring Thailand, the Philippines is coming off a period of intense competition in 2016. In its case, this not only involved handset subsidies but also aggressive wireless data packages, such as PHP50/USD1.10 for 1GB data over three days for prepaid.
• Globe’s wireless service revenue grew 8% YoY in 1QFY18, as wireless data revenue grew 21% YoY. Even its SMS revenue increased 5% YoY as subscriber usage remained healthy despite the end of promotions such as free Facebook access. This was in stark contrast to PLDT, whose wireless revenue declined YoY and QoQ.

Other stakes: future special payouts? 

• In line with its commitment to the IMDA, SingTel recently sold down its stake in NetlinkTrust NLT from 100% to 25% less one unit in the latter’s July IPO. NLT operates, expands and leases out passive infrastructure such as ducts, manholes, fibre cables and central offices to Singapore’s nationwide fibre broadband network. 
• By regulation, SingTel has no control over NLT’s operations. NLT is an independent, open-access network. As such, further stake reductions cannot be ruled out. SingTel has indicated that part of its SGD2b IPO gain will be booked in 2QFY18. This may be declared as exceptional cash dividends. We have assumed that 50% will be declared.
• SingPost (SPOST SP, HOLD) is Singapore’s national postal provider that has branched into global ecommerce and fulfilment logistics. It is under transformation from a highly-cash-generative but declining mail business to high-volume, high-growth ecommerce logistics. 
• SingTel previously guided that its 25.8% stake represents a non-core asset. If there is an opportunity, it could be divested and parts of its proceeds be declared as special dividends. There is no time table for such disposal as yet.

Opex swings largely from subsidies and marketing 

• Our consolidated cash opex forecasts grow by a 5% CAGR over three years, primarily dictated by higher equipment subsidies and selling & administration costs in most of SingTel’s markets. Our forecasts for depreciation and amortisation assume that the SGD376m for 700Mhz frequency slots SingTel won during a recent auction will be paid by FY20E.
• We forecast that consolidated capex to sales will range from 13% to 15% in FY18-20E. The bulk should be spent on Optus’ further 4G expansion into Australian states to improve ARPU among existing metro subscribers and SME customers who travel domestically. Our capex forecasts do not include spectrum fees.

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

Maybank Kim Eng SGX Stock Analyst Report HOLD Maintain HOLD 3.83 Up 3.700