StarHub - DBS Research 2018-09-06: Positive Direction; Wait For The Impact

StarHub - DBS Group Research 2018-09-06: Positive Direction; Wait For The Impact STARHUB LTD SGX:CC3

StarHub - Positive Direction; Wait For The Impact

  • StarHub and Temasek’s wholly owned subsidiary merge to form a cybersecurity entity, Ensign.
  • Deep cybersecurity expertise and close ties with the government would fuel future growth for Ensign.
  • Cybersecurity venture is positive; unlikely to offset declines in the Mobile and Pay-TV business over the next 2-3 years.

What’s New

StarHub and Certis Cisco to pool cybersecurity assets to form cybersecurity firm, Ensign.

~ SGinvestors.io ~ Where SG investors share
  • StarHub has entered into a Joint Venture Agreement with Certis Cisco, a wholly owned subsidiary of the Temasek Group, through Leone Investments, to pool the cybersecurity assets of StarHub and Certis to create Ensign, a pure play cybersecurity service provider, touted to become one of the biggest in the region.
  • According to the agreement, StarHub will transfer all of its cybersecurity assets, including the assets and personnel of its cybersecurity centre of excellence and a 100% stake in its cybersecurity subsidiary, Accel Systems & Technologies (ASTL), to Ensign in return for a 40% stake in Ensign and S$16m cash consideration. Leone will inject a 100% ownership stake in Quann, the managed security service arm of Certis Cisco, for 60% ownership in Ensign and ~S$16m cash consideration. At completion Leone will also transfer an additional 20% economic interest in Ensign to StarHub for five years (with clauses for prior termination) for S$52m cash, making Ensign a subsidiary of the StarHub group (see more details on the deal structure below).
  • The deal is expected to be completed by the end of October. StarHub’s net cash outlay for the transaction would be ~S$46m, comprising S$9.8m for the acquisition of the remaining 19.6% stake in ASTL along with a net outlay of S$36m for Ensign.
  • Maintain HOLD with an unrevised Target Price of S$1.42.

Ensign is expected to have an annual revenue run rate of ~S$100m with low mid-teen profit margins.

  • Excluding the current contribution of StarHub’s cybersecurity assets including ASTL, we estimate that the new entity would add ~S$5-10m to StarHub’s earnings over FY19F. Growing contributions from cybersecurity businesses, which inherently carry low margins, would also further weigh on 
  • StarHub’s service EBITDA margins. While we believe cybersecurity would be a key driver of growth for StarHub’s enterprise segment over the medium term, we await further clarity to incorporate the potential medium-term impact of Ensign to our models.

With roots dating back to 2000, Quann has strong ties with the government.

  • Quann is one of the very few homegrown Managed Security Service Providers (MSSP) in Singapore, formed in 2000 by the name “e-Cop”. Certis Cisco, a wholly owned subsidiary of Temasek Holdings, acquired e-Cop in 2012. Quann is a leading provider of MSSP services in Asia and currently operates over 10 Security Operation Centres across the region, including Singapore, India, Thailand, Malaysia, Hong Kong, and Japan. Quann has also developed strong ties with leading cybersecurity vendors such as CISCO, Palo Alto, Checkpoint, Google and FIreeye, among others.
  • Over the years, Quann has developed strong ties with the Singapore government, with its executive team comprising several former government officials from the Ministry of Home Affairs and Singapore Armed Forces. The company has also managed the Cyber-Watch Centre of the Singapore government since 2007, providing round-the-clock monitoring of the government's IT systems and networks.

Promising outlook for Ensign.

  • The management expects Ensign to differentiate its service offerings through its deep expertise in cybersecurity. We believe the combined cybersecurity technology and the talent pool of the two entities, with years of experience and training, would help Ensign effectively compete with the leading cybersecurity players in the region.
    • Ensign would be one of the few pure play cybersecurity entities in Singapore and the ASEAN region. This, combined with Quann’s history of handling cybersecurity contracts for the Singapore government, places Ensign in a strong position to compete with the likes of Singtel for smart nation contracts pertaining to cybersecurity from Singapore and other regional governments
    • Ensign’s deep expertise in cybersecurity would further strengthen StarHub’s enterprise service portfolio. The ability to gain visibility in StarHub’s network traffic would further augment Ensign’s value proposition to enterprise customers.
  • We believe with Ensign, StarHub would be in a strong position to capitalise on the growing demand for cybersecurity in the APAC region in the long run.

Unfolding the deal structure.

  • According to the deal, over the life of Ensign, the ownership stake of StarHub and Leone would remain unchanged at 40%/60% respectively.
  • However, StarHub would acquire a 20% economic interest in Ensign from Leone, for a limited span of five years for S$52m cash to leverage Starhub’s operational networks and go-to-market capabilities to augment Ensign’s ability to create value. The 20% economic interest would be transferred back to Leone at the end of five years for a consideration equivalent to its fair market value but both parties have provisions to terminate this assignment at the agreed consideration below. Over the 5-year term, Ensign would be consolidated with StarHub’s financials.

Consideration for early terminations.

  • If StarHub initiates the termination – Lower of the fair market value of 20% interest in Ensign or S$52m (consideration for the 20% stake) compounded at 6% annually.
  • If Leone initiates the termination – Higher of the fair market value of 20% interest in Ensign or S$52m (consideration for the 20% stake) compounded at 6% annually.

We continue to expect cut in dividends in FY19F.

  • StarHub has committed to pay out S$277m in annual dividends in FY18. With the Ensign deal resulting in a cash outlay of S$46m for StarHub along with ~S$282m in spectrum payments over the next two years for the 700MHz spectrum, we believe StarHub’s equity value will be wiped out by 2020 if it maintains similar dividend payments. As such, we project StarHub to bring its dividends to match its net profit level.
  • While we have assumed 100% payout ratio from FY19F onwards, StarHub should ideally retain some earnings to invest in new business opportunities, in our view.

Dim outlook warrants a valuation discount.

  • StarHub is likely to see an annual EBITDA contraction of 4.4% from FY17A- 20F vs. 2.7% for M1, owing to a contracting pay-TV business, heavy competition from M1 in the broadband segment and a lack of support for mobile revenues from an MVNO. While StarHub has struck an MVNO partnership with MyRepublic, which could support the telco’s contracting mobile business, we believe it could take at least 1-2 years before StarHub records any meaningful contributions from MyRepublic.
  • Excluding the current contribution of StarHub’s cybersecurity operations and ASTL, we estimate that Ensign would add ~S$5-10m over FY19F to StarHub’s earnings which we believe would not be material enough to compensate for the losses in the mobile and pay-TV segments.
  • We argue that StarHub should trade at 12-month forward EV/EBITDA of 5.6x vs. its current valuation of 6.3x, reflecting StarHub’s weak business model and its likelihood to be the most affected over the medium term from the impending contraction of the mobile industry.

Maintain HOLD with an unrevised Target Price of S$1.42.

  • Due to a lack of clarity on future free cash flows, we switch to peer multiple-based valuation.
  • We value StarHub at a 12-month forward EV/EBITDA of 5.6x which is at a ~20% discount to the 7x regional average.
  • StarHub offers a decent FY18F dividend yield of ~9.8%.

Sachin MITTAL DBS Group Research | https://www.dbsvickers.com/ 2018-09-06
SGX Stock Analyst Report HOLD Maintain HOLD 1.420 Same 1.420