Starhub - DBS Research 2017-05-04: Entering a Lower Earnings Phase

Starhub - DBS Vickers 2017-05-04: Entering a Lower Earnings Phase STARHUB LTD CC3.SI

Starhub - Entering a Lower Earnings Phase

  • Starhub faces declining earnings in FY17.
  • Will need to lever up to fund S$350m of spectrum payments due in 2017/18.
  • Dividends can then be maintained at 16 Scts p.a.
  • Downgrade to FULLY VALUED, lowered TP to S$2.33.

Few positives other than yield. 

  • Starhub’s profitability has been affected by lower grant income, higher customer acquisition and retention costs in recent quarters. 
  • We have revised down our FY17F/18F earnings by ~17%/20% after removing adoption grant from our model and projecting lower EBITDA margins. 
  • Our key concern is continued loss of pay TV subscribers as it hurts Starhub's hubbing strategy. 
  • While StarHub will maintain annual DPS of 16 Scts in 2017, sustaining 16 Scts in the long term will require the company to gear up higher in our estimates.

1Q17 results 

  • 1Q17 net profit of S$73.1m (-21% y-o-y, +35% q-o-q) was 10% below our estimate. While service revenue declined slightly (-1% y-o-y), the bottom line was hurt more by an absence of adoption grant and higher operating expenses.
  • Other income declined by S$12m versus 1Q16, due to the absence of adoption grant for fibre broadband as StarHub has fully amortised the grant. Meanwhile, operating expenses rose by S$13m versus 1Q16 due to 
    1. an increased mix of high-end smartphones, coupled with higher volumes, and 
    2. higher TV content costs, coupled with higher costs from more fibre broadband sign-ups.

Pay TV and broadband subscriber loss is a key concern. 

  • Pay TV subscriber base declined by 11,000 during 1Q17 or ~2% of its subscriber base. This brought 12-month subscriber loss to 41,000 as customers churned to the cheaper alternatives. 
  • Broadband subscriber base also declined, by 3,000 during 1Q17 or ~1% of its subscriber base after being stable for a while. 
  • Pay TV revenue declined 7% y-o-y while broadband revenue was flat on an annual basis.

Mobile business was relatively stable as subscriber gains offset the ARPU decline. 

  • Mobile revenue at S$296m declined 1% yo-y.
  • The pre-paid and post-paid customer base grew by 43,000 and 48,000 y-o-y respectively. Compared to a year ago, both the pre-paid and post-paid ARPUs decreased by S$2 to S$15 and S$67 respectively.

Trade-off between leveraging up and sustaining dividends.

  • Against the backdrop of projected declining earnings due to competition in the mobile space and structural shifts in the pay TV business, as well as potential competition from TPG in the broadband space, we believe Starhub has to decide between leveraging up and the possibility of cutting dividends as it needs cash for the spectrum rights payment.

Leveraging up more likely. 

  • Starhub has an existing S$1bn multi-currency medium-term note programme and it has issued S$520m in the two years leading up to 31 December 2016, leveraging up from 0.57x net debt/EBITDA in FY14 to 1.02x in FY16, keeping below its comfortable level of 1.5x net debt/EBITDA. 
  • After cutting its dividend guidance for FY2017 in February 2017, we think it is less likely that Starhub would want to cut its guidance again in the short term. Hence, we assume that Starhub will borrow another c.S$250m by FY18, due to its projected cash needs for spectrum rights payment. 
  • We project net debt/EBITDA to move up to 1.9x by FY18.

Spectrum auctions and new entrant market share scenarios 

  • What will payment schedule for newly acquired spectrum be like? We note that previous payments for the 2013 spectrum auction were due on a lump-sum basis. TPG also paid for its spectrums in the New Entrant Spectrum Auction conducted in December 2016 on a lump-sum basis, according to its filing with the Australian Securities Exchange. 
  • While a conservative payment schedule will benefit the incumbents’ cash flows, we project lump-sum payment to be on the conservative side.

Spectrum payment for 700 MHz spectrum could be delayed.

  • Prior to the auction, the 700 MHz was initially removed due to uncertainty over the switch-over date from analogue TV transmission to digital. It was subsequently added back. While analogue broadcasting is due to be phased-out by end-2017, there may be potential delays. 
  • According to the Infocomm Media Development Authority (IMDA), while the 2G network is due for closure from 1 April 2017, there were reportedly ~100,000 mobile subscribers still registered on 2G network as of 31 March 2017. As a result, telcos will only progressively wind down the 2G network after 1 April. 
  • Reportedly, the shutdown process will be completed by 18 April 2017. There may be similar delays for the transition from analogue TV transmission to digital, although the official commencement date for the 700 MHz lots is 1 January 2018. Thus, we believe that the S$188m spectrum payment may be due only in early 2018, though further clarity from the regulator is awaited.

Valuation: Downgrade to FULLY VALUED with a lower TP of S$2.33. 

  • Our revised DCF-based (WACC 5.6%, terminal growth 0.3%) TP is S$2.33, as we factor in the contraction of earnings in the near future, as well as higher interest expense from higher debt levels.
  • The counter offers around 5.8% yield currently.

Key Risks to Our View

Limited uptake of TPG’s services could reduce the threat to mobile market share. 

  • In this scenario, we expect TPG to capture only 3.5% of the revenue share from the incumbents over the next 4-5 years, by 2022. Under this bull-case scenario for incumbents, our TP for StarHub is S$2.66.

Network sharing may not go through. 

  • We currently project a 10% capex savings from network sharing from FY18 onwards. If it does not go through, our TP for StarHub would be S$2.09.

Suvro SARKAR DBS Vickers | Singapore Research Team DBS Vickers | Sachin MITTAL DBS Vickers | 2017-05-04
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