Singapore Telcos - Maybank Kim Eng 2017-09-13: Game Of Phones

Telecom Sector Outlook Singapore Telcos Comparison M1 vs Singtel vs Starhub. SINGTEL Z74.SI M1 LIMITED B2F.SI STARHUB LTD CC3.SI

Singapore Telcos - Game Of Phones

We initiate coverage with a negative view

The Singapore telecom sector has not fully priced in the impending entry of new competition into the market.
Our baseline assumption of competition leading to higher retention costs, partly through new smartphone launches leading to a higher rate of recontracting, and modest ARPU pressure results in FY18/FY19 core profit expectations that are 11-38% lower than FactSet consensus for FY18E-FY19E.
We initiate with SELL on StarHub (STH SP, Target Price SGD2.17) and M1 (M1 SP, Target Price SGD1.59) and HOLD on SingTel (ST SP, Target Price SGD3.83).

It’s not over until it’s over

Share price underperformance is indicative of fear partly being priced in for TPG Telecom’s future entry but there are no foregone conclusions until the actual launch and promotions are unveiled, in our view.
Our base case suggests there is room for TPG based on its 5%-6% market share guidance but how incumbents react or whether targets change is not cast in stone. Our sensitivity analysis shows that every 1% further cut in 2018E Singapore wireless revenue assumptions would reduce our DCF-based and SOTP-based target prices by 0.4%, 1.6% and 3.1% for SingTel, StarHub and M1.

An enterprising solution?

All the telco incumbents have eyes set on the enterprise and government market segments to create buffers and new growth opportunities against the backdrop of potential warfare in the retail segment.
SmartNation initiatives and increasing demand for efficiency enhancing enterprise solutions may provide medium-term reprieve for the sector, which is more positive than what we currently forecast.
Larger capex and a historical head start in relationships and network build out favours SingTel but low-base effect means StarHub and M1 have more to gain than lose.

Valuing an unprecedented event

We used DCF as the basis for our target prices to capture the impact of the unprecedented event of a new full operator competing in Singapore, which could defy previous historical cycles.
Based on our forecasts, if the three stocks traded down to our target prices they would be showing FY18E and FY19E P/Es of 17.2x and 18.4x for SingTel, 20.5x and 16.6x for StarHub, and 20.4x and 17.9x for M1. This implies a continued premium valuation for SingTel against its 5-year and 10-year historical means. We believe this is merited given SingTel’s geographical risk diversification that lessens its Singapore competition risk exposure.

REALITY WILL BITE

The worst is yet to come

The fact that new entrant TPG Telecom has won 70Mhz of spectrum on the 900Mhz, 2.3Ghz and 2.5Ghz bands to compete in the Singapore wireless space by 2018 is not new news. The underperformance of the three Singapore telcos against the Straits Times Index (STI) on a 1-, 3- and 12-month basis is testament to that.
The relatively worse drop for M1 (M1 SP, TP SGD1.59) followed by StarHub (STH SP, TP SGD2.17) is indicative of the market’s view regarding their hierarchy of exposure to Singapore competition risk. We believe, however, there is more consensus-earnings-forecast and share-price risk to come in the short to medium term. We are thus initiating coverage of the Singapore telecom sector with a NEGATIVE view.
With the market, and even telco operators, still making educated guesses at TPG’s commercial launch strategy, it is difficult to imagine that the event is fully priced in. For our forecasts, we have assumed that the incumbents will resort to more aggressive retention strategies (e.g. a 10% increase in average cost of sales) by using the traditional handset subsidy promotions that the largely postpaid Singapore market has been accustomed to. The new Samsung Note 8, and the launch of the iPhone 7S and 7S+, and the tenth anniversary iPhone (8 or X) in the coming weeks are likely to be used as a hook to re-sign subscribers to new two-year contracts and at least temporarily dampen the popularity of SIM-only (no contract) plans.
We note that early re-contracting promotions have commenced with penalty-free contract renewals for subscribers (including corporate individual schemes [CIS]) whose existing contracts still have 6-month validity. We would not discount the possibility of even earlier contract renewal fee waivers taking place closer to TPG’s launch date as this would be the easiest barrier to entry incumbents can use.
On what we believe is primarily due to our more aggressive retention strategy assumption, our FY18E total revenue forecasts are 2-9% higher than consensus for the three telcos resulting from handset sales.
- Our service revenue forecasts, however, showcase a continued decline across the incumbents due to wireless data cannibalization impact. We have assumed that new players (Circles.Life, MyRepublic and TPG) will gather a 6% market share by calendar year 2019 with TPG representing half of that share given it will be a full network operator, while the other two are leasing frequency and networks as mobile virtual network operators (MVNOs).
- We forecast an industry revenue rebound as subscribers try out the new operators by buying extra SIM cards while under contract with the incumbents on their primary lines. A price war could easily turn recovery into further downside but our base case is that aggressive recontracting using subsidies rather than price will keep that prospect away.
However, our FY18E EBITDA (-13% to -24%) and core profit (-11% to -38%) forecasts are significantly lower than consensus as a result of acquisition and retention subsidies.
We believe consensus forecasts that currently show slow erosion in margins during a period of theoretically heightened competition do not factor in higher subsidies and/or a price war.

How bad can it get?

With a new player eager to take market share (5-6% as per TPG;) and with wireless data plans today more expensive than during the years of heightened 3G data plan competition in 2009 to 2012, there is room for downside to existing plans.
We do not see a reason why history cannot repeat itself given a new player with land-grab intentions is coming in along with potential new MNVOs like MyRepublic. StarHub and M1’s unlimited data plan options and more generous data packages launched on 31 Aug 2017 are a harbinger of things to come.
For our base-case scenario, however, we have assumed that recontracting efforts will build a great wall preventing significant revenue and ARPU erosion as subscribers on two-year contracts would only be trying out TPG and any new MVNOs that sprout in the coming quarters.
With the bulk (c88% in the Jun 2017 quarter) of wireless industry revenues sourced from postpaid plans and with the Singapore market keen on handset subsidies over SIM only or bring your own (BYO) phone plans, there is a measure of revenue downside protection for the incumbents in the short to medium term. This is because even if a subscriber opts for a new operator’s plan they are still committed to their monthly fees for the contract duration.
We are essentially assuming that TPG will carve its niche from revenues of subscribers who are exceeding their data plan caps which is currently more than 30% of those on tiered postpaid plans. Note that wireless data adoption and cannibalization, and more recently share taken by MVNO Circles.Life (Not Listed), have resulted in a continued decline in wireless service revenues for the incumbents since calendar year 2015.
In the event of a price war in FY18E, whether started pre-emptively or reactively, our sensitivity analyses of 1% wireless revenue downside show massive downside risk for the incumbents to the tune of 1-4% reduction in FY17E-FY19E net profits and 0.4-3.1% risk to target prices.
SingTel, with its diversified revenue base locally and regionally, is naturally the least impacted on a relative basis while M1, with a more wireless focused local business, is exposed to the most risk from wireless competition.

CARVING OUT NEW TERRITORY

Enterprise upside

The incumbents have made no secret of plans to tap the growing fixed network enterprise market segment, internet of things (IoT) and the various projects under Singapore’s Smart Nation initiatives. An increased push towards more cost and process efficiency and cyber security by large corporates, and moves by SMEs to remain asset light are creating increased demand for telcos to provide more than just access (aka “dumb pipe”) services. Tailor fitting a suite of services to a specific enterprise’s needs provides a potentially higher margin than plain vanilla access.
The enterprise segment carries lower margins than the wireless segment but it utilizes the existing fixed and data network and backbone and thus makes efficient use of existing capacity. As such, additional revenues generated from this segment, which is seeing increasing demand, will help cushion the pressure on the traditional wireless cash cow segment. As a consequence of being a lower margin segment, it will lower telcos’ overall EBITDA margins but given usage of largely sunk-in capex it’s theoretically neutral or beneficial to overall return on invested capital (ROIC).
With the incumbents all spouting the enterprise segment mantra, the risk lies in margins being competed away. SingTel’s head start, large network capex spend and legacy in corporate relationships are both a boon and a bane as on the one hand it’s a virtual de facto candidate for any work but on the flipside have a high-base effect and it’s defending an existing revenue base against StarHub and M1, etc. Both StarHub and M1 have been preparing networks and human resources to gain more share in the enterprise segment.
Having said that, the growth prospects of managed services, business solutions and cyber security do seem to leave room for more players to crowd the space in the medium to long term. IDC estimates that IT services spending in Asia Pacific will reach USD150b by 2019E from USD124b in 2015. With Singapore having a robust nationwide fibre broadband penetration rate relative to ASEAN counterparts, and with its positioning as a finance centre, we would opine that the pace of local IT services demand should be accelerating.
With companies increasingly relying on data and business analytics to know the customer and create products and services based on profiling them, the 151% wireless penetration in Singapore implicitly provides a backdrop of the entire population. Data is homogenized to protect privacy but the potential uses of these are ripe for monetization. IDC forecasts big data and analytics revenues will reach USD203b globally by 2020E from USD122b in 2015.
The increasing demand for cyber security services is evidenced by the fact that the Asia Pacific region was ranked second globally in malicious data breach incidents in 2015. With hacking, phishing and other security and privacy threats a daily challenge on the corporate and personal levels, the telcos owning the infrastructure theoretically provide some advantages and expertise in defending against such attacks.
SingTel’s exposure to the local and global enterprise markets, which include USD1.87b acquisitions by its Digital Life division, leads to its significant revenue scale relative to its competitors. These businesses dilute margins but are not as capex intensive as the wireless division; partly as they run operations and systems off the existing fixed-line network. With scale still being built, however, the division is capital intensive due to past acquisitions. As StarHub and M1 target the segment we could see a similar margin dilution and acquisition mode; with the latter having potential impact on payout commitments.

More than enough for everyone?

The Singapore government’s Smart Nation programme, ie, to have private and public sectors join up to use digital technology to improve the way of life in the country, has been providing a wellspring of contracts for the telcos that have rolled out infrastructure nationwide and to office buildings and households. The telcos’ reach and capabilities do encompass the five key domains identified by the plan:
1. transport;
2. home & environment;
3. business productivity;
4. health and enabled ageing; and
5. public sector services.
For the fiscal year 2017, the Singapore government announced up to SGD2.4b of information and communications technology (ICT) contracts would be put up for tender, with 22% set for “data analytics and digital citizen systems” and the same percentage set for cyber security applications. This year’s budget is lower than the SGD2.8b in 2016 but the prior year had more emphasis on physical infrastructure such as data centres and cabling.
On 24 May 2017, Channel NewsAsia reported that about two-thirds of the 2016 ICT contracts awarded were to SMEs but it did not reveal what this translated to in terms of contract value. We believe that in terms of contract value the incumbents, particularly SingTel, were probably front-runners.
Due to the high-base effect on SingTel, increased competition and the continued slide of the traditional fixed-line voice and international call markets, our revenue forecasts for the enterprise segment only ascribe a 2%, 3-year CAGR for the market leader against the 10% of StarHub and 13% for M1. This is based on calendarizing SingTel’s end-March financials. The combined revenue growth from the three incumbents translates to a 3% CAGR over the same period.
As reflected by our profit forecast declines for calendar year 2017 and onwards, we do not assume that the enterprise and fixed network revenues will be enough to compensate for the impending increased costs and tepid wireless revenue growth.

VALUATIONS & RATINGS

No historical (valuation) precedent

With the three-player market being relatively rational even during periods of increased competitive intensity (e.g. 2009 unlimited 3G data plans), we believe applying a DCF methodology rather than one based on a historical trading valuation is more appropriate for the three telcos. This not only captures the cashflow impact of our more-bearish-than-consensus basecase scenario, but also for the periods of recovery and stabilisation afterwards.
It is worth noting that even at our target prices, the implied valuations are not particularly attractive vs history either, save for dividend yields.
Based on our core EPS forecasts of a steep margin decline, if the three stocks traded down to our target prices they would be showing FY18E P/E valuations of 15.9x for SingTel, 20.5x for StarHub, and 20.4x for M1, which are all premiums to their 5- and 10- year historical means.
- For SingTel in FY19E it would still be one standard deviation above either its 5- or 10-year mean P/E but we believe this is warranted by its diversified earnings base outside the risks of Singapore and Australia thanks to its regional associates.
- For StarHub, it would imply the stock for FY19E would trade below either its 5-year mean P/E or at close to its 10- year mean.
- For M1, it would still trade one standard deviation above the 5-year mean and still above its 10-year mean but not by one standard deviation.
Given the risks and uncertainty for their more Singapore-centric businesses exposed to competition risk, we believe the StarHub and M1 implied valuations from our DCF-based targets are justified.
We would note that payout ratios, which we have maintained at current management guidance levels, could be at risk once competition heats up. StarHub’s fixed SGD0.16 per share annual payout in particular would imply well over 100% payout over FY18E and onwards. The balance sheet and loan covenants can tolerate this based on our forecasts but the prudence that led to the 2016 payout reduction from SGD0.20 per share may prevail anew.
Whether the turnover and payments for the 90Mhz at the 700Mhz frequency bands the three telcos won during the Apr 2017 general spectrum auctions (GSA) will take place in FY19E, as we have assumed for our forecasts, could also play a role in medium-term payout decisions for the smaller operators. This is particularly true if this coincides with competitive intensity that is higher than what we expect.
The three operators in total would be shelling out SGD846m for the 15-year use of the frequency. All three telcos’ management teams have expressed that the frequency costs will not hinder their balance sheets or payout capabilities but this likely relies on the assumption of a relatively rational competitive environment.
With StarHub trading at a premium on both a P/E and EV/EBITDA basis against SingTel and M1 on FY19E this compliments our DCF-based target price expectations that it has the most share price downside risk. At our target prices, StarHub would trade similarly to SingTel on an EV/EBITDA basis and M1 would be at a discount to both; intuitively due to its higher income exposure to the wireless market.
Against regional peers, and on an EV/EBITDA basis (to lessen depreciation and amortization and tax accounting differences across countries), the Singapore telcos do not stack up well even against the already competition-stressed India telcos. Even versus historically high valuation Malaysia and Taiwan telcos they are not looking cheap.
Furthermore, we are forecasting EBITDA declines for Singapore telcos against growth for Malaysia and Taiwan. The greatest value gap is with Chinese telcos. It is only in dividend yields that the Singapore telcos appear fairly priced relative to peers.

COMPANY REPORTS

Luis Hilado Maybank Kim Eng | http://www.maybank-ke.com.sg/ 2017-09-13

Maybank Kim Eng SGX Stock Analyst Report HOLD Maintain HOLD 3.83 Up 3.700

SELL Maintain SELL 1.59 Same 1.59

SELL Maintain SELL 2.17 Down 2.360

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