Singapore Telecom Sector - DBS Research 2016-09-22: Too early to bargain hunt

Singapore Telecom Sector - DBS Vickers 2016-09-22: Too early to bargain hunt M1 LIMITED B2F.SI STARHUB LTD CC3.SI

Singapore Telecom Sector - Too early to bargain hunt

  • Despite sharp decline in their share prices, M1 and StarHub may continue to spiral downwards. 
  • Potential new entrant may lead to a contraction in mobile sector revenue and secure 7% revenue share by 2022 at the cost of the existing players. 
  • Recommend FULLY VALUED on M1 and StarHub from HOLD earlier as we switch from 50% probability of a new entrant to 100% and assume adequate funding in place for the new entrant. 

MyRepublic and TPG are front runners. 

  • MyRepublic, TPG Group and airYotta have submitted applications to participate in the upcoming spectrum auction in October 2016. TPG is a surprise applicant with no prior indication of interest. 
  • TPG does not have the experience of operating a mobile network but its strong balance sheet with low gearing could provide an edge. 
  • MyRepublic and TPG should be the front runners and a new mobile player is almost certain, in our view.

Our bear-case scenario seems quite likely. 

  • Both MyRepublic and TPG have a reputation of capturing subscribers through price competition, albeit in the fixed broadband segment.
  • MyRepublic has disclosed its intent to launch unlimited mobile data plans (not offered by existing telcos) at ~S$60 per month, almost 10% lower than existing postpaid ARPU. 
  • With sharp decline in data pricing, we project Singapore mobile revenue to drop by 4% in 2022 versus 2015. 
  • Taking a cue from U Mobile’s experience in Malaysia, we project the new entrant to capture ~7% revenue share by 2022, translating to a decent 18%/11% Return on Investment (ROI) based on an investment of S$300m/SS$500m.

Earnings may decline from next year onwards. 

  • We project StarHub’s and M1’s mobile revenue to drop 12% and 20% in 2022 versus 2015, leading to 12% and 25% earnings decline respectively. 
  • Our FY18F/19F earnings for StarHub and M1 are cut by 6%/16% and 3%/8% leading to our revised TP of S$3.00 and S$2.15 respectively. 
  • In the scenario of earnings decline, we think forward PER multiple could well shrink to 12-13x (below -2SD) versus 14-16x now.

Key risk to our view. 

  • Non-entry of a new mobile player as IDA may disqualify the current candidates due to 
    1. potential lack of funding at MyRepublic and airYotta, 
    2. TPG's inadequate technical expertise and business plan. 
  • This could lead to a relief rally for StarHub and M1. 
  • Under this bull-case scenario, our TP will be S$4.00 for StarHub and S$3.10 for M1.

A four-player mobile market is quite likely now 

Unexpected interest heats up spectrum auction. 

  • Infocomm Development Authority (IDA) has announced that it received Expressions of Interest (EOI) (applications to bid at the new entrant spectrum auction) from three parties – MyRepublic, TPG and airYotta. 
  • TPG, a fixed and mobile virtual network operator (MVNO) operator from Australia, was a surprise applicant with no prior indication of interest in entering the Singapore mobile market. 
  • With three interested players, we believe Singapore is now likely to become a four-player mobile market. 
  • IDA has said it will consider and review other relevant factors such as prospective bidder’s business plans, planned service offerings and track record of operational performance when reviewing EOIs.

Existing infrastructure of MyRepublic versus TPG’s funding advantage 

airYotta’s plans are unknown. 

  • Not much is known about the newly formed airYotta which is led by Mr Michael DeNoma, OMGTel's former chief executive officer. OMGTel, backed by Consistel, has not submitted the EOI. airYotta is backed by a regulated fund supported by a single investor, and it plans to launch Singapore’s first 4.5G LTE Advanced Pro Network.
  • However, neither the company nor the IDA has given any further definitive details on the company’s funding levels, investment plans or competitive strategies. Given the company has no history of operations, we are compelled to consider MyRepublic and TPG as the leading candidates in the race at this point of time.

None of the players has a track record of operating a mobile network. 

  • Neither MyRepublic nor TPG have a history of operating mobile networks. MyRepublic, however, has participated in HetNet trials in Singapore. In addition, the company has received support from foreign mobile operators.
  • In September 2015, DST Communications, a mobile network operator in Brunei, became one of the first outside parties to back MyRepublic’s fourth player bid through an investment of US$16m (~S$23m). 
  • In addition, Sunshine Network, an Indonesian telco and Xavier Niel, the founder of France’s fourth mobile player, Free (a subsidiary of Illiad), are also stakeholders in MyRepublic, which could be a positive in a successful bid. Though TPG provides MVNO services in Australia, the company does not operate its own mobile network.

TPG lacks bundling capabilities compared to MyRepublic.

  • TPG, if successful, will be a pure-play mobile operator in the Singapore market with no prior involvement in the market. As a result, TPG will have to build the needed infrastructure from the ground up, from retail networks, agents, service points, in addition to the mobile network itself. 
  • In comparison, MyRepublic already has most of the infrastructure (except mobile network), in place and would potentially see synergies and cost savings. 
  • In addition, with incumbents offering bundled services (fixed + mobile) to retain data heavy subscribers, MyRepublic will be in a more level playing field to compete compared to TPG.

TPG's stronger balance sheet is an important factor. 

  • We were skeptical on MyRepublic’s ability to raise the necessary funding as the company had not raised a significant amount of equity while only raising S$130m in debt funding as of late June compared to the company’s target capex of S$250- 300m. The company has not provided a recent update on its funding status.
  • In contrast to MyRepublic’s undisclosed funding status, TPG with a guided EBITDA of A$770-775m (S$792-797m at the current forex rate) and FY16 (July year-end) net debt-toEBITDA at 1.6x, has enough room to raise over S$500m to S$1bn required to roll out a mobile network. TPG’s implementation of the network from scratch is likely to require a higher capital outlay than MyRepublic.

TPG could be a more serious threat in our view. 

  • Due to the limited information available, it is difficult to assess which of the two main participants are most likely to pass the IDA review or win spectrum rights. However, due to its stronger balance sheet, we are inclined to think a TPG win would have a higher impact on the overall market and incumbent performance.

Lack of domestic roaming agreement is a big challenge for the new player though. 

  • In the absence of domestic roaming, a new entrant will need to cover the entire island from scratch. While fourth telco, Illiad in France, achieved 15% subscriber share in three years, it was largely due to mandated roaming which allowed it to invest in the most profitable areas. U Mobile in Malaysia managed to capture just 5% revenue share in 2014, almost seven years after its launch as there was no mandatory domestic roaming in Malaysia. 
  • U Mobile did sign roaming agreements with other operators but probably had to pay a steep fee for those agreements. However, it is still possible for the new entrant in Singapore to sign a roaming agreement with one of the existing players.

Potential impact on the existing players 

StarHub has already launched aggressive mobile-fixed broadband plan. 

  • On 18 August, StarHub launched four mobile-fixed broadband plans with data bundles starting at 12GB. We estimate that average revenue per user (ARPU) from these plans would be 10-12% lower than StarHub’s average ARPU although the adoption will be gradual. 
  • M1 has also launched SIM-only plans offering 8GB mobile data at S$45 and 13GB at S$75 per month to defend this segment although existing telcos do not offer unlimited data plans as yet.

Expect 13% ARPU contraction due to data pricing wars. 

  • We would like to remind our readers that in March 2016 MyRepublic had announced plans to launch unlimited data plan for its fixed broadband customers at S$60 per month, if it secures the spectrum.

A cash-rich new entrant could hurt incumbents more. 

  • Both MyRepublic and TPG have a reputation of capturing subscribers through price competition, albeit in the fixed broadband segment. We believe these companies are likely to use similar strategies to capture market share if they win spectrum rights. 
  • The new entrant, if sufficiently funded, could aggressively pursue market share growth and diminish industry-wide revenue generation, making the impact on incumbents even more acute. We project an overall drop of 4% in industry-wide mobile revenue between 2015 and 2022.
  • Overall, data pricing should decline sharply but with rising usage, we expect a 13% drop in average ARPU by 2022 versus 2015. This may contribute to a 4% contraction in mobile sector revenue (assuming 1.2% annual expansion in subscriber base).

New entrant is unlikely to invest anything over S$550m.

  • Considering the substantial risk and technical complexities, any new entrant is likely to expect a minimum 15% return on their investment, in our view. However, we believe even an aggressive new entrant is unlikely to go past S$276m in revenues by 2022 (7% revenue share). 
  • Assuming an EBITDA margin of 20% for the mobile operation (half of 40% at M1), a new entrant can reap an EBITDA of S$55m. If a player invests S$500m in the network and spectrum, given S$55m EBITDA, its TOI is likely to be ~11%. As such, even a cash-rich new entrant is unlikely to invest more than S$550m in order to secure more than 10% ROI.

U Mobile in Malaysia captured 10-11% subscriber share and 6-7% revenue share in seven years. 

  • U Mobile was awarded a 3G licence in March 2006 and officially launched its services in September 2007. In the early days, U Mobile had a 2G domestic roaming agreement with Celcom to provide nationwide coverage, while it focused on rolling out its own 3G network, mainly in key urban cities. 
  • U Mobile is estimated to have close to 5m subscribers in 2014, translating into subscriber market share of about 10-11%. This is a significant jump from 2010 when it had just about 500k subscribers and 1.5% market share. 
  • Nevertheless, U Mobile's revenue market share in 2014 was said to be only 6-7% (meaning lower ARPU subscribers versus peers), while EBITDA was estimated to be still negative in the range of RM100m.

We model 7% revenue share for the new entrant in five years of its launch in end-2017. 

  • While Singapore's small size is a big advantage in rolling out the network, the absence of a domestic roaming agreement is a big obstacle. However, one cannot completely rule out a roaming deal being signed once the new player secures the spectrum.

M1 to be impacted the most. 

  • We believe the entrance of a new player will be most felt by M1 due to its higher exposure to mobile revenue and a more price-sensitive subscriber base.
  • As a result, we expect M1's market share to drop from 18% in 2015 to 15% by 2022. We project M1’s mobile revenues to contract by 20% (16% drop in total revenue) in 2022 from 2015 levels. We expect M1 earnings to drop by 25% during the same timeframe. Hence, we have revised down our TP to S$2.15.

StarHub to be more resilient than M1. 

  • With only c. 50% of revenues coming from mobile and due to more fixed-mobile bundling, StarHub will be less impacted than M1. As a result, we expect StarHub’s mobile revenues to decrease by 12% (6% drop in total revenue) and earnings to contract by 12% in 2022 versus 2015. As a result, we have revised our TP for StarHub to S$3.00. 

Key risk to our view 

Non-entry of a new mobile player. 

  • There would be no new entrant if IDA disqualifies the current candidates due to 
    1. potential lack of funding at MyRepublic and airYotta, 
    2. TPG's inadequate technical expertise and business plan. 
  • This could lead to a relief rally for StarHub and M1. 
  • Under this bull-case scenario, our TP will be S$4.00 for StarHub and S$3.10 for M1.

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