SingTel - DBS Research 2017-10-02: Unsustainable Discount For The Core And The Digital Business

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SINGTEL Z74.SI

SingTel - Unsustainable Discount For The Core And The Digital Business

• Market valuing Singtel core + digital segments at 5.6x EV/EBITDA versus 7x for M1 & 9x for StarHub.
• With Amobee achieving EBITDA breakeven, market is likely to appreciate core business (more resilient than peers) and improving digital business.
• Singtel could potentially pay S$600mn-1.5bn in special dividends with 1H18 results.
• Resume coverage with BUY at S$4.30 Target Price.

20-40% valuation discount versus peers is an opportunity to accumulate. 

• Singtel’s core plus digital business is trading at only 5.6x FY18F EV/EBITDA versus 7x for M1, 9x for StarHub and 7.5x regional telco average. 
• Despite the ~38% rise in the valuation of regional associates over the last three years, the stock has been flattish, due to mounting losses in the digital businesses perhaps. However, with digital advertising arm Amobee achieving an earlier-than-expected EBITDA breakeven in 1Q18, and official guidance for narrower digital losses in FY18F, we expect the valuation discount to disappear.

Where we differ. 

Investors ought to value core and digital business separately with Singtel improving its execution of digital businesses. 

• Currently, investors bundle the core and digital businesses together whereby digital losses dilute the total EBITDA, leading to a lower EV/EBITDA multiple. 
• In our view, robust digital offerings on top of network access will be a major competitive advantage in the Internet of Things (IoT) era. We argue that investors ought to value the core business at 7x and value the digital business separately based on revenue multiple even though it is not profitable yet.

Potential for special dividends with 1H18F results. 

• According to our analysis, Singtel could pay special dividends of S$600mn- 1.5bn (1.0-2.5% yield) taking total FY18F yield to 6.0-7.5% without exceeding 2x net debt-to-EBITDA.

Valuation

• We use a sum-of-the-parts (SOTP) valuation for Singtel to derive a target price of S$4.30. The stock offers ~17% upside potential in addition to 6.0-7.5% yield.

Key Risks to Our View

• Core business EBITDA from FY19F onwards. If core EBITDA were to decline 4% each over FY19-24 due to the new mobile entrants in Singapore and Australia versus our base case projection of stable EBITDA, our TP will be lowered to S$3.40.

WHAT’S NEW

Special dividends and improving digital businesses 

Potential special dividend post Net Link Trust IPO could be a catalyst for share price: 

• Singtel successfully divested 75% stake in Netlink NBN Trust through an IPO in July 2017. The divestment is expected to result in a cash inflow of S$2.2bn in FY18 for Singtel.
• Singtel has committed to make ~S$1bn in spectrum payments on top of S$2.4bn capex in FY18. Singtel has also guided for 60-75% dividend payouts on underlying profits in the near term for its investors. Given the reduction in capex in FY19 due to Optus’s 3-year investment drive winding down and the inflows from the Net Link Trust IPO, we believe Singtel has the ability to issue ~S$600m-1.5bn in special dividends (on top of 75% payout) without hurting its credit metrics. Singtel’s net debt-to-EBITDA should remain ~2.0x, even after the special dividends, according to our calculations.
• If Singtel does not plan to acquire more digital businesses, it could pay S$1.5bn in special dividends. If it plans to invest another S$1bn in digital businesses, it could pay S$500m in special dividends.

With Amobee achieving breakeven, Singtel is ramping up HOOQ and DataSpark. 

• Amobee, Digital Life’s largest contributor, achieved EBITDA breakeven in 1Q18 ahead of its full year target of EBITDA breakeven. 
• With Singtel guiding for narrower EBITDA losses for S$100m, most of the losses are expected to come from HOOQ- over-the-top (OTT) video offering and DataSpark – Advanced analytics offering. HOOQ and DataSpark contributed only S$3mn in revenue in 1Q18 versus S$290mn by Amobee, however these offerings could really differentiate Singtel’s consumer and enterprise telco offerings as well.

Digital business should be awarded a positive valuation.

• Digital business should be valued over S$2bn based on EV to revenue multiple of recent acquisitions. Currently, market is valuing them negatively due to EBITDA losses of S$120m in FY17 and giving lower EV/EBITDA multiple to core plus digital business due to stagnant EBITDA.

Digital Businesses 

Group Digital Life, coupled with Cyber Security, contributed 9% of Singtel’s revenue in 1Q18. 

• Group Digital Life, coupled with Cyber Security, is already contributing over 9% to Singtel’s top line. 
• Singtel has guided for Digital Life segment to more than double its revenues to S$1.2-1.3bn with the acquisition of Turn. The company has guided for Cyber Security division to generate revenues of ~S$550-650m in FY18 versus S$473m in FY17, implying 16-37% growth.

Digital Advertising 

Amobee has moved away from competitive supply side platform business: 

• In October 2016, Amobee shut down its supply side platform business (except for video) to focus on its core ad-network related functions such as ad monitoring and cross platform targeting tools which can be utilised to improve the effectiveness of advertising campaigns. Its Brand Intelligence tool, which analyses digital content engagement trends, is already used by major bands such as IKEA and Lexus to shape their marketing strategies.
• In addition, Amobee INK, Amobee’s cross device audience targeting tool is being used in their media activation strategies. We believe these businesses could be more lucrative for Amobee in the medium to long term as these segments face less direct competition form large tech players such as Google and Facebook.

Amobee achieved EBITDA breakeven following Turn acquisition. 

• Following the acquisition of Turn in February 2017, Amobee is able to perform programmatic buying without relying on third parties which has resulted in improvement of gross margins. Turn operates a demand side platform (DSP) and data management platform. The DSP adds programmatic buying capabilities to Amobee which will automate the process of buying digital ads in real time across multiple platforms. 
• Furthermore, the scale benefits stemming from the acquisition has allowed Amobee to manage costs better, resulting in EBITDA breakeven in 1Q18. With these savings and Amobee focusing on niche areas where it does not face direct competition from large tech players such as Google and Facebook, we should see Amobee improving its financial performance post FY18. 
• In addition to acquisition-led growth, the rising global digital ad spending is expected to drive Amobee’s growth in the near to medium term. Global digital ad spend is expected to grow by 13.5% in 2017 according to MAGNA, IPG Mediabrands' research arm.

Turn remains a market leader in multi-channel DSP. 

• Turn was recognised as a leader in the 2017 Omnichannel demand-side platform evaluation for 2Q17 by market research firm, Forrester, primarily for the platform’s ability to provide extensive analytics both at a granular and a modular level.
• Technology research firm, Gartner also upgraded Turn from been a “Visionary” to a “Challenger” in an evaluation of digital marketing hubs, signifying that the platform’s capabilities are becoming more in line with customer needs.
• Gartner also recognised the strong eco-system of over 200 partners and customised advisory services provided by the firm to be some of the key strengths of the company.

Amobee is gaining traction in leveraging Singtel’s presence in Asia. 

• Amobee faces direct competition from a range of adtech companies such as AppNexus, Sizmek and market leaders like Google and Facebook. However, Amobee’s key strength lies in its ability to leverage Singtel’s regional presence to gain traction in Asia, where SMEs remain hesitant on partnering with big names in digital advertising due to hefty fee structures and the lack of an understanding of the regional market. 
• Amobee, on the other hand, is capable of utilising Singtel’s regional networks, reputation and clientele to offer more attractive and customised solutions to local firms. For example, last year Amobee, in partnership with Optus, launched “Optus Xtra” an app that provides free data quotas and credit to users in return for allowing ads to be displayed on their phones. Securing this level of collaboration with regional telcos remains a challenge even for the biggest names in digital advertising.

Other digital business ex Amobee 

Subscription Video on Demand (SVOD) OTT market hot in the APAC region. 

• According to Research and Markets, SVOD revenue in APAC region is expected to reach US$18bn by 2021 with a CAGR of 22% over 2015-2021. Though the bulk of the revenue will be generated by markets such as China and Japan, India and Indonesia are expected to see some of the fastest growth. 
• According to Digital TV research forecasts, Indonesia and India are expected to see SVOD subscriber CAGRs of 87% and 31% respectively from 2016-2021, well above the regional average.

HOOQ expanding its operations: 

• HOOQ, Singtel’s OTT video platform targeting emerging markets, has already started operating in the fast-growing markets of India, Indonesia, Thailand and Philippines, in addition to Singtel’s home market Singapore. The management considers HOOQ’s operations to be still at a startup level and is investing on ramping it up.
• Similar to its peer iflix, HOOQ is looking to partner with potential telcos in its markets to increase subscriber penetration with HOOQ provided by Singtel (Singapore), Globe (Phillipines) and Vodafone (India). Further, HOOQ has been able to capture exclusive content from media producers such as Disney while it has already started to invest in its own content, albeit at a relatively small scale.

DataSpark growth driven by unique data repository of Singtel. 

• DataSpark is Singtel’s data analytics business created to provide business and government agencies insights leveraging SingTel's anonymised geolocation data. Given Singtel’s unique ability to capture location data from its subscribers, the company is able to provide insights that are difficult to be matched by external players. 
• In addition, with Singapore government’s investment in smart nation initiatives, Singtel may see opportunities to use its knowledge in more varied contexts.

Digital Life initiatives (ex Amobee) still in early days. 

• Given the relative immature nature of its operations, we believe that it is too early to comment on HOOQ and DataSpark’s profitability.
• However, the segment could yield significant growth in the medium to long term for Singtel and remain strategic investments for the firm.

Digital Life is worth S$1.1bn. 

• We have valued Singtel’s Digital Life business at S$1.1bn using a mix of Singtel’s ad-tech acquisition prices and EV/Revenue multiples of recent industry acquisitions. 
• To be conservative, we have used a 25% discount to account for any valuation premium for Singtel’s ad tech acquisition prices. Similarly, we apply 25% discount to EV/revenue multiple of 1.31x for recent industry acquisitions in order to be conservative. Using the average value of the two methods, we have arrived at an enterprise value of S$1.1bn for Singtel’s Digital Life business.  

Cyber Security 

Business Managed security services providers (MSSPs) are on an upward growth trajectory: 

• Singtel strengthened its managed security services with the acquisition of Trustwave in 2Q16, a leading MSSP based in the US. 
• The global demand for MSSPs is expected to grow robustly at a CAGR of 13% from 2014-2018, according to research firm Frost & Sullivan, backed by the increasing complexities of cyber-attacks, shortage of cyber-security professionals and rising demand from Small and Medium Enterprises. 
• Demand from the APAC region is set to outpace global growth with a CAGR of 15% reaching US$ 3.77bn by 2018. Singtel would be able to capitalise on this trend by combining its position as a leading network service provider in the region with the capabilities of Trustwave. 
• As a likely provider of network infrastructure facilitating the Smart Nation programme, which is expected to be data intensive, Singtel would naturally be among the favorite candidates for monitoring and managing the cyber-security assets of the Smart Nation programme, further boosting growth prospects for the telco’s cyber-security division.

Singtel is expanding cybersecurity operations: 

• Singtel and Trustwave are expanding their cybersecurity operations with new Security Operations Centres in selected countries. Trustwave announced an Advanced Security Operations Centre in Japan and Australia in late 2016 and expanded its facilities in Chicago in 2017. In addition, the company started operations of a new Security Operations Centre with Globe telecom in Philippines in 2017. 
• The expansions offer Singtel the ability to drive cybersecurity revenues, supported by regional partners such as Globe (Philippines) and TIS (Japan). However, the increased headcount from the expansions have also resulted in higher costs and EBITDA losses, especially in seasonally low revenue quarters such as 1Q18. To minimise the losses, Singtel is looking to improve cost savings by shifting work offshore to its low-cost bases in Manila and Warsaw where possible, and by increasing automation, thereby saving on manpower costs. 
• Further, the management expects better costing for third-party solutions to be achieved as the cybersecurity business scales up. As a result, as these investments mature and cybersecurity revenues expand, we are likely to see these investments turning EBITDA positive.

Peer trajectory suggests Cyber Security could achieve ~10% EBITDA margin in the medium term. 

• Trustwave’s slightly larger peer in the MSSP space, SecureWorks has been less successful in achieving positive EBITDAs. We believe this is mostly due to the higher sales and marketing expenses the company incurs (25-35% of revenue). However, Singtel (& Trustwave) is unlikely to maintain such high marketing costs in the near to medium term due to its higher reliance on the upcoming Smart Nation projects and regional partners such as Globe and TIS. As a result, Singtel’s Cyber Security business is likely to achieve a similar growth trend with much lower sales and marketing costs, in our view.
• Adjusting for a more reasonable sales and marketing costs (~5-10% of revenue), SecureWorks’s trends indicate MSSP operations could reach a 10% EBITDA margin as investments mature.

Singtel cybersecurity business is worth S$1.1bn. 

• We have valued Singtel’s cybersecurity business at S$1.1bn using a mix of Trustwave acquisition price and Industry EV/Revenue multiples. 
• To be conservative, we have used a 25% discount to account for any valuation premium for Trustwave’s acquisition price. Similarly, we have used a 10% liquidity discount on the industry EV/revenue multiple of 2.51x to be conservative. Using the average value of the two methods, we have arrived at an enterprise value of S$1.1bn for Singtel’s cybersecurity business 

Core Business in Singapore and Australia 

Singapore core business is more resilient than peers, which should be reflected in its valuations. 

• Singapore’s mobile sector is expected to face headwinds in 2018 with the entry of TPG. Hence, telcos have already increased data prices to reduce customer churn and maintain market share. However, Singtel’s Singapore operations generate over 50% of revenues from the enterprise segment which should enable it to fair better in the near term compared to its peers M1 and StarHub. 
• Even with the competition heating up in the recent quarters, EBITDA from Singtel’s Singapore operations had shown much better resilience in the first half of 2017, declining only 3% compared to its peers M1 and StarHub which saw declines of 8% and 9% respectively. 
• Singapore telcos M1 and StarHub are currently trading at FY18F EV/EBITDA of 7x and 9x respectively, despite their higher exposure to the declining mobile markets. However, considering this, we have conservatively valued Singtel’s Singapore operations at FY18F EV/EBITDA of 7.5x.

Optus is on a much better footing than Telstra which should be reflected in at least 20% premium versus Telstra. 

• Telstra is facing headwinds due to the implementation of National Broadband Network (NBN) as the market expects NBN to change the way broadband is delivered and priced. Telstra faces pressure from lost wholesale revenue, access fees it will have to pay NBN, and competition pressures that will reduce the premium it can charge for retail mobile services. Optus, on the other hand, is able to gain access to more homes via NBN as it did not have the required infrastructure to compete with Telstra previously.
• In the mobile space, Optus has been investing in networks to narrow its gap with Telstra who charges a premium price which we estimate is 10-30% premium for SIM only plans.
• Optus has poured over A$3.7bn in network infrastructure since 2015 increasing 4G coverage from 75% of metro population to 96% total population coverage by 2017 versus 98% for Telstra. 
• Optus also plans to invest A$1bn on rural coverage to improve its market share outside metro areas over the next 12 months in reducing coverage gaps and upgrading existing 3G sites to 4G. While TPG’s entry in the mobile space in mid-2019 is a concern for the sector, Optus’s redced coverage gap with Telstra places it in a positon to gain market share.
• Consensus expects Telstra to see ~10% EBITDA drop in FY20 and gradual EBITDA decline thereafter once NBN rollout is completed in 2020. Recently after cutting it payout ratio to 75% from 100%, Telstra’s stock price took a hit and is trading at only 5.4x FY18F EV/EBITDA. 
• On the other hand, we expect Optus to register stable to low-single digit growth in EBITDA over the next couple of years, which justifies at least 20% premium versus Telstra, leading to 6.5x FY18F EV/EBITDA.

Sachin MITTAL DBS Vickers | http://www.dbsvickers.com/ 2017-10-02

DBS Vickers SGX Stock Analyst Report BUY Maintain BUY 4.30 Down 4.460