M1 (M1 SP) - UOB Kay Hian 2017-08-18: Near-term Headwinds Priced In

SGinvestors.io

M1 LIMITED B2F.SI

M1 (M1 SP) - Near-term Headwinds Priced In

• M1 has to contend with higher handset subsidies caused by the launch of iPhone 8 and 8 Plus in Sep 17 as well as stiffer competition with the impending entry of TPG Telecom in 2018. These near-term headwinds have been priced in with the stock correcting 25% over the past three months. 
• M1 remains a takeover target should the industry consolidate from four to three players. 
• Maintain BUY and cut target price to S$1.98 (S$1.55 if the network sharing with StarHub fails to materialise).

WHAT’S NEW

• We resume coverage of M1 with a BUY recommendation.

Strategic review unravelled. 

• Major shareholders - Axiata, Keppel T&T and SPH - have ended their strategic review on the divestment of their stakes in M1. Their announcement stated that proposals from potential investors “did not meet the minimum criteria and parameters determined by the majority of shareholders”. 
• We understand that the potential investors did not pull out. However, the three largest shareholders failed to reach a consensus on selecting the preferred bidder. Recent intense scrutiny on overseas deals by the authorities in China could have also made the decision more complicated than usual.

Strategic review could resurrect in the future. 

• Axiata, Keppel T&T and SPH remain potential sellers. Axiata could raise funds by divesting its stake in M1 for re-investment in high-growth emerging markets, such as India. 
• Keppel T&T, as part of conglomerate Keppel Corp, could undergo restructuring. The telecommunications business is not a core business for SPH. Thus, the need for a strategic review could resurface again. We would not rule out an industry consolidation over the longer term as well.

iPhone 8 escalates the rise in handset subsidies. 

• iPhone 8 and 8 Plus are expected to launch in Sep 17, coinciding with the 10th anniversary of iPhone. The new smartphones look stunningly beautiful and have various exciting new features:
  1. curved edge-to-edge display with 2K resolution (iPhone 8: 5.15-inch LCD screen, iPhone 8 Plus: 5.8-inch OLED screen),
  2. stainless steel and glass body in black, silver and gold (copper) colours, including reflective and mirror-like finishing,
  3. a virtual home button,
  4. facial recognition security,
  5. fast charging and wireless charging, also known as inductive charging, 
  6. 16-megapixel dual-lens camera with 3D-sensing capabilities, 
  7. augmented reality capabilities, 
  8. iOS 11 operating system, and
  9. Apple A11 processor.
• There is a lot of pent-up demand for iPhone 8 and 8 Plus, given the uninspiring reception for iPhone 7 and 7 Plus. iPhone 8 and 8 Plus are expected to be wildly popular but would be positioned at higher price points due to the many new features that have inflated the cost of production. We expect iPhone 8 and 8 Plus with storage capacity of 128GB to be priced at US$799 (iPhone 7: US$749) and US$1,099 (iPhone 7: US$869) respectively.
• We expect M1 to be eager to sign up new customers and to attract existing customers to re-contract earlier, so as to lock-in customers with new 2-year contracts ahead of the entry of the fourth mobile operator, TPG Telecom, in 2018. Unfortunately, doing so would substantially increase M1’s handset subsidies in 4Q17 and 1H18. 
• We estimated handset subsidies would increase 38% and 29% yoy for 4Q17 and 1H18 respectively.

Expansion into digital solutions. 

• M1 has steadily added 8,000 fibre broadband customers over seven consecutive quarters. Revenue contributions from Fixed Services has increased 21.5% yoy and accounted for 15.2% of service revenue in 2Q17. 
• M1 is an approved vendor and has secured a few contracts from government ministries involving leased circuits, WiFi, managed services and analytics. These new projects incur upfront capex to roll out infrastructure in 1H17 and require a gestation period of 5-6 months before making full impact starting 2H17.

Expansion into IoT. 

• M1 has launched its nation-wide narrowband Internet-of-Things (NB IoT) network in Aug 17, the first commercial NB IoT network in Southeast Asia. The NB IoT network delivers enhanced performance for machine-to-machine (M2M) communications, including sensors, CCTVs etc. 
• Management envisage contributions from enterprise customers for smart metering (electricity and water meters), environmental monitoring, asset tracking and fleet management (taxis, buses and delivery trucks) applications starting 4Q17.

STOCK IMPACT

An issue of timing. 

• The industry could consolidate from four to three players over the next 3-5 years. 
• Unfortunately, in the near term, M1 has to contend with higher handset subsidies caused by the launch of iPhone 8 and 8 Plus in Sep 17 as well as heightened competition with the impending entry of TPG Telecom in 2018.

Resumed negotiation on network sharing. 

• M1 and StarHub had suspended their negotiation on network sharing when the strategic review by M1’s shareholders was ongoing. Negotiation with StarHub has resumed now that M1’s shareholders have decided not to proceed with the strategic review. While the savings in capex are irrefutable, there are many implementation details to iron out. The negotiation is protracted but management hopes to finalise the deal by end-17.
• We believe the probability of M1 and StarHub entering a deal on network sharing is high as both companies share the same equipment vendors, namely Huawei and Nokia.

EARNINGS REVISION/RISK

• We cut our 2017-18 net profit forecasts by 11% and 24% respectively due to below-par performance in 1H17 and the increase in handset subsidies.

VALUATION/RECOMMENDATION

Maintain BUY. 

• Our new target price of S$1.98 is based on DCF (COE: 7.5%, terminal growth: 1.5%), assuming M1 and StarHub embark on network sharing. 
• However, our target price would drop to S$1.55 if the network sharing with StarHub fails to materialise.

SHARE PRICE CATALYST

• M1’s dividend yield has improved to 6.1% for 2017 after the recent steep price correction.
• Valuations are near levels during the aftermath of the global financial crisis in 2009.
• Damage from the impending entry of TPG Telecom in 2018.
• Savings in capex from sharing of mobile infrastructure with StarHub.
• Potential industry consolidation from four to three mobile operators over the next 3-5 years.

Jonathan Koh CFA UOB Kay Hian | http://research.uobkayhian.com/ 2017-08-18

UOB Kay Hian SGX Stock Analyst Report BUY Maintain BUY 1.98 Down 2.520