Telecom Sector - OCBC Investment 2017-03-17: Time For A Switch

Telecom Sector - OCBC Investment 2017-03-17: Time For A Switch Singapore Telcos Sector Outlook M1 LIMITED B2F.SI SINGTEL Z74.SI STARHUB LTD CC3.SI

Telecom Sector - Time For A Switch

  • Competitive pressures a drag on earnings.
  • Maintain NEUTRAL on sector.
  • Singtel our only BUY.

i. Sector Recap 

2016 financial performance recap 

  • All three telecommunications service providers (telcos) reported weaker performances from their Singapore’s mobile segment as a result of intensifying competition (i.e. pressures on ARPU) and the increasing usage of over-the-top (OTT) services that led to lower usage revenue from traditional voice services, IDD and roaming services. 
  • Only Singtel delivered in-line results on diversified earnings base while Starhub and M1 both missed due to significant exposure to Singapore’s mobile segment. 
  • Singtel’s weaker Australia’s contributions were offset by stronger Singapore consumer performance as well as growth in contributions from regional mobile associates. Starhub’s revenue growth from broadband and enterprise fixed segments were offset by weakness from mobile and pay TV segments, drop in equipment sales as well as lower income grant. For M1, FY16 EBITDA declined mainly due to lower handset sales and weaker mobile revenue, but offset by growth from its fixed services segment (i.e. fibre broadband).

Uninspiring outlook 

  • For Singtel (31 Mar year-end), in view of the intense competition faced in Australian market, it maintained its FY17 guidance for consolidated revenue to decline by low single digit level but EBITDA to be stable. Mobile service revenue from Australia is also expected to decline by mid-teens while Singapore’s mobile revenue is expected to be stable.
  • Singtel’s capex guidance remained unchanged: S$2.8b on an accrual basis and S$2.4b on a cash basis. Guidance on ordinary dividends from regional mobile associates remained unchanged at S$1.2b for FY17.
  • Starhub guided for FY17 service revenue to be flat but expects service EBITDA margin to decline from 31.2% in FY16 to 26%-28% in FY17 as it continues to incur expenses to improve customer service levels so as to compete more effectively. More notably, it has cut its dividend from S$0.05 per quarter in FY16 to S$0.04 per quarter in FY17.
  • M1 did not give specific guidance on revenue but noted that market conditions are challenging and uncertain. That said, it guided for capex to be S$170m for FY17, which excludes any new spectrum payments and kept its dividend payout ratio of at least 80% in FY17.

Underperforming the broader market 

  • Since the beginning of CY17, the telecom sector has been tracking STI index performance closely until recently in Mar 17, where performances of both STI Index and FTSE Straits Times Telecommunications Index (FSTTC) started to diverge. We believe the underperformance reflects the ongoing challenges the Singapore telcos face with the impending entry of TPG as well as increasing pressures from the mobile virtual network operator (MVNO), Circles.Life. 
  • We continue to see further downside to Starhub and M1 but expect Singtel to stay resilient given the minimal impact from its limited Singapore mobile segment exposure. As at 8 Mar 17, the forward P/E of FSTTC index is trading slightly above its 5-year mean.

ii. Mobile Segment 

Weak ARPU on declining roaming revenue 

  • For CY2016, the three telcos cumulatively added 142k in net new postpaid subscribers, and proportion of 4G users has risen to around 83% of the total 3G and 4G subscriber base as at 31 Dec 16.
  • Average revenue per user (ARPU) continues to be under pressure with the three telcos citing lower roaming revenue (both inbound and outbound) as the main reason for the overall fall in revenue.
  • We expect this trend to continue with the increasing adoption of over-the-top services (OTT), as subscribers switch to using data for calls instead of using the traditional call services.

TPG is the 4th telco in Singapore 

  • Singapore’s IMDA announced on 14 Dec 16 that TPG Telecom (TPG) made the winning bid of S$105m to become Singapore’s 4th telco. Recall that MyRepublic and TPG were both pre-qualified to participate in the New Entrant Spectrum Auction (NESA), which was held between 13 and 14 Dec 16. The total spectrum available for bidding at the NESA was 60MHz (2x10MHz of 900MHz and 40MHz of 2.3GHz) at a reserve price of S$35m, and TPG’s winning bid represents 3x the reserve price.
  • TPG announced that it expects to incur an additional S$200-300m in capex to achieve nationwide mobile network coverage by Sep CY18. With this timeline, TPG targets to launch mobile services in CY18 and forecasts that it will become EBITDA positive when it reaches a market share of 5-6%, which it believes can be achieved within a short period of time. 
  • Given TPG’s intention, we believe it will offer low-cost plan offerings that will likely undercut the incumbents in terms of pricing to attract customers to switch out from incumbents to them, given the lack of quality coverage at the start.

Aggressive move by Circles.Life worsens ARPU outlook 

  • With TPG’s impending entry, we believe competition within Singapore’s mobile industry is set to intensify as incumbents will likely take actions to gain market share (i.e. to lock-in as many new customers on a two-year contract as possible) during this period. Even Singapore’s only MVNO, Circles.Life, recently stepped up their marketing campaign with aggressive data-focused plan offerings at prices significantly lower than the incumbents. 

Data usage on the rise 

  • We believe the telcos’ longer-term strategy is to find more effective ways to monetize data usage and their current data upsize offerings are part of the efforts to first encourage users to increase their data usage. These efforts seem to be bearing fruit, as average monthly data usage has been steadily increasing across all three telcos. 
  • For M1 and Starhub, average monthly smartphone post-paid data usage has increased from 3.4GB and 3.5GB in 3Q16 to 3.6GB and 3.7GB in 4Q16, respectively. For Singtel, post-paid data usage increased from 2.8GB in 3QCY16 (or 2QFY17) to 3.2GB in 4QCY16 (or 3QFY17). 
  • With the increasing data usage, Circles.Life recent promotion of S$20 for extra 20GB of data on their contract will likely heighten the already intense competitive landscape of Singapore’s mobile industry.

Expects 11%-16% decline in post-paid ARPU over next five years 

  • On the back of falling roaming revenue and intensifying competition in Singapore mobile industry, we believe there will be increased level of marketing and promotional activities, that will continue to put pressures on the industry ARPU. Hence, on aforementioned reasons, we further cut our ARPU assumptions for the incumbents. 
  • For the period CY16 to CY21, we forecast for post-paid mobile ARPUs of Singtel, Starhub and M1 to register CAGR of -2.1%, -3.2% and -3.4%, respectively.

Singapore mobile market is highly saturated 

  • With Singapore’s mobile penetration rate already at ~150%, growth in number of subscribers going forward will be limited and slow, if any.
  • Coupled with falling ARPU amid intensifying competitive environment, we forecast for total mobile revenue to decline ~12.4% between CY16 and CY21 (FY22 for Singtel). In our base case assumption, we also forecast for TPG to achieve ~6% mobile revenue share by CY21.

Not ruling out the second MVNO in Singapore 

  • We highlighted in our 9 Dec 16 sector report not to take Circles.Life too lightly, and rightly so, especially given the recent launch of its aggressive data plan offering priced significantly lower that the incumbents, which we believe will put further pressure on ARPU even before TPG’s launch.
  • Looking ahead, we believe MyRepublic, having lost the NESA to TPG, may potentially launch a MVNO mobile service in Singapore even before TPG launches its mobile services. If this happens, we see further downside to our forecasts as mobile revenue decline will likely accelerate on the back of a greater fall in ARPU. 
  • In short, as the market gets more crowded with players offering the similar services, pricing power will fall, and given limited growth in subscribers, the revenue pie will shrink as a result.

General Spectrum Auction in 1QCY17 

  • With the conclusion of NESA, industry focus has now shifted to the upcoming General Spectrum Auction (GSA) in this quarter. That said, TPG has also said that it will join the GSA to bid for an additional 15MHz of spectrum to reach a total spectrum holding of 75MHz, which is the maximum allowed. 
  • Note that IMDA has set certain spectrum caps to prevent the monopolization of scare spectrum resources and to facilitate efficient allocation of spectrum as much as possible to ensure operators obtain sufficient spectrum to deliver viable mobile services in Singapore.
  • As TPG has been allocated 2x10MHz of 900MHz and 40MHz of 2.3GHz having won the NESA, it will not be allowed to participate to bid for the 900MHz spectrum available for bidding in GSA. Hence, based on the spectrum available for GSA, TPG may only bid for: 
    1. 2x5MHz of 700MHz and 5MHz of 2.5GHz, or 
    2. 15MHz of 2.5GHz. 
  • Lower frequency spectrum has longer propagation properties, which helps achieve larger radius coverage and is better at penetrating obstacles such as walls and windows in urban regions with the same resources (e.g. power usage, base stations etc.), as compared to higher frequency spectrum. Hence, we believe TPG will likely bid for 2x5MHz of 700MHz and 5MHz of 2.5GHz.
  • Of the 2x20MHz of 900MHz available for GSA, Singtel, Starhub and M1 each has the right of first refusal (ROFR) for 2x5MHz of 900MHz.  On above-mentioned reason, we expect all three telcos to exercise their ROFR at the reserve price of S$20m per pair, with one pair of 900MHz remaining for GSA. 
  • While we expect the incumbents to bid for the last remaining pair of 900MHz available, we forecast for this pair to be priced at 1.5x reserve price (i.e. S$20m x 1.5 = S$30m) as TPG is not allowed to participate in the bidding for this spectrum band.
  • For 700MHz and 2.5GHz spectrum bands, we expect all four telcos to participate and forecast for final pricing to be 1.5x the reserve price of S$20m per pair (2x5MHz) and S$3m per 5MHz, respectively. As 900MHz and 2.5GHz spectrum license rights are expected to commence 1 Apr 17, we forecast for the respective spectrum payments to be made in 2QCY17.
  • As for 700MHz, we forecast for the spectrum payments to be made only in 1QCY18 given that the expected license start date is from 1 Jan 18.
  • Consequently, we adjust our forecasts for Singtel, Starhub, and M1 based on the assumptions shown in Exhibit 14.

iii. Broadband Segment Competition set to intensify 

  • Residential broadband market remains stable as Singtel and M1 added a total of 11k in new customers between 3QCY16 and 4QCY16 but Starhub’s broadband subscriber base fell by 2k during the same period. As at end-4QCY16, total broadband subscriber base of the three telcos was 1.24m subscribers, which represent ~92.7% of the overall Singapore broadband market. 
  • While Starhub’s subscriber base fell, retaining the higher value customers helped keep its ARPU stable. For M1, we believe the 5.7% QoQ drop in ARPU was a key reason for the 5.3% increase in subscriber base. Singtel recorded stronger broadband revenue as subscriber base grew 0.5% QoQ on the back of higher ARPU.
  • All said, looking ahead, we expect competition within Singapore’s broadband industry to intensify with the entry of TPG. 
  • Leveraging on Singapore’s Next Generation Nationwide Broadband Network (NGNBN), we expect TPG to launch fibre broadband services even before the launch of mobile services, possibly by CY17. 
  • By establishing a presence in the broadband market before mobile services launch, we believe TPG will be able to offer better value proposition by having bundling option (mobile + broadband), which is similar to M1’s strategy. Note that TPG is already an established fixed service provider and will likely be able to keep its cost structure lean to compete effectively.

iv. Pay TV Segment 

  • Pay TV market impacted by OTT content services Singapore’s Pay TV market continued its decline as the total number of Pay TV subscribers fell 1.3% QoQ to 907k as at end-4QCY16.
  • Starhub fell by a greater 1.8% QoQ to 498k subscribers while Singtel’s subscriber base declined at a slower pace of 0.7% to 409k. ARPU remained largely stable as both Singtel and Starhub cited focus continues to be on retaining higher-value customers.
  • In our view, the key reason for the fall in Pay TV subscribers is mainly due to the increasing adoption by consumers in using OTT content service providers (e.g. Netflix etc.). While both Singtel and Starhub continue to make efforts to manage the contents offered on their Pay TV platforms, we are expecting the downwards trend to persist ahead with more subscribers switching to OTT service providers. 
  • We believe the increasing number of OTT options at affordable pricing will continue to pressure the Pay TV segment.

v. Recommendations 

Dividend yields still the key focus for sector 

  • Based the FY16 results, 59% and 84% of Starhub and M1 revenues are derived from Singapore’s mobile segment, and we expect the impending TPG entry to erode their earnings, which leads to further downside on their dividend outlook. Starhub has guided that it will cut its dividend from S$0.05/quarter in FY16 to S$0.04/quarter in FY17 while M1 maintained its guidance of 80% payout ratio.
  • Given declining earnings outlook, we expect Starhub and M1 dividend yields to fall over the next few years. Hence, we believe there will further pullbacks on the share prices of Starhub and M1, especially coupled with the rising interest rate environment. FSTTC index forward dividend yield is trading at ~0.5SD below the 5-year average, which could suggest that given a muted dividend outlook, there may be further downside to share prices.
  • However, for Singtel, we like its diversified portfolio and it helps that its effective exposure to Singapore’s mobile segment is only 5% and 4% of its 9MFY17 total group revenue and EBITDA, respectively. Hence, we believe TPG’s entry has minimal impact on Singtel’s group earnings, and in turn expect dividend outlook to remain stable in the near-term but to grow over the longer-term.

Maintain NEUTRAL on Singapore Telecom Sector 

  • Amid muted economic environment coupled with the impending 4th Telco entry, we are maintaining our NEUTRAL rating on the sector. We believe investors may continue to stay exposed to the telecom sector, but it is now a time for a switch from Starhub and M1 into Singtel shares.
  • On aforementioned reasons, we further cut our ARPU assumptions for all three telcos, revise upwards TPG’s market share to reach 6% by CY21 from the previous assumption of 5%, and incorporate forecasts on the GSA spectrum capex.
  • Consequently, with more downside risks and limited upside potential to its forward earnings, we maintain SELL on Starhub with 12-month fair value estimate of S$2.50, and downgrade M1 from HOLD to SELL with 12-month fair value estimate of S$1.75.
  • Within the sector, we continue to reiterate Singtel [BUY; FV: S$4.25] as our top pick. 
  • We are positive on Singtel’s longer-term outlook for its strong enterprise segment especially in the growing cyber security segment, as well as the growth potential of its regional associates. Therefore, we recommend investors to switch their Singapore telecom sector exposures from Starhub and M1 into Singtel.

Eugene Chua OCBC Investment | http://www.ocbcresearch.com/ 2017-03-17
OCBC Investment SGX Stock Analyst Report SELL Downgrade HOLD 1.750 Down 2.03
BUY Maintain BUY 4.250 Down 4.270
SELL Maintain SELL 2.500 Down 2.65