StarHub - DBS Research 2018-10-16: What Is The Street Missing Out?

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STARHUB LTD (SGX:CC3)

StarHub - What Is The Street Missing Out?

• The street is factoring underestimating the cost savings over FY19-20; overly concerned about TPG’s entry and profitability of Cybersecurity business.
• We expect consensus to raise FY19F/20F EPS by 10/20%; attractive valuation at -2SD of its historic EV/EBITDA and PE average.
• Maintain BUY with an unrevised Target Price of S$2.45.

Street FY19F/20F earnings projections have bottomed out.

• The street is overly concerned about profitability of new businesses and under estimating the magnitude of cost savings over FY18- 20. The street is also missing out on an annual cost savings of ~S$30m due to shutdown of StarHub’s co-axial cable network after 2020.
• Besides, the street is not paying attention to potential network sharing which may further boost free cash flow. 
• StarHub is attractive near -2SD of its historical EV/EBITDA and PE average and offers sustainable yield exceeding ~5.5%.

Where We Differ: We expect the street to raise FY19F/20F EPS by 10%/20% over the next few months.

• FY19F street earnings are likely to be raised S$20m from
  1. an absence of S$10-15m amortisation cost for 700MHz spectrum
  2. additional S$10- 15m savings from staff and procurement costs.
• StarHub may ramp up hiring in the Cybersecurity business but the impact should be low given smaller size of the business.
• FY20F street earnings are likely to benefit from
  1. digitisation of marketing & distribution, and
  2. lower maintenance & repair costs. We have not factored the impact of potential network sharing yet.

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Potential catalyst:

• News on TPG’s launch, updates on network sharing and the transformation programme. Official confirmation of delay in TPG’s commercial launch from late 2018 to early 2019, more clarity on network sharing and quarterly updates on the transformation programme.

Valuation:

• Maintain BUY with an unrevised Target Price of S$2.45. 
• We use DFC (WACC 7%, terminal growth 0.5%) to drive our Target Price and project FY19F dividend yield of 5.6%.

Key Risks to Our View:

• Bear-case valuation is S$1.75 if TPG causes severe disruption. StarHub could see a 3% drop in FY19F EBITDA under this scenario vs our base case of stable EBITDA.
• Network sharing among existing telcos could lead to bull-case valuation of S$2.92. StarHub could save ~20% of the projected capex from FY19F onwards under this scenario.

WHAT’S NEW - Deep dive into StarHub’s cost savings

700MHz spectrum unlikely to be available until 2H19.

• StarHub acquired 30MHz of the 700MHz spectrum in the general spectrum auction held in 2017 for S$282m. However, we do not think the 700MHz spectrum will be available before 2019 as Malaysia and Indonesia use this spectrum for Analogue TV, which will cause interference. 
• To be conservative, we have modelled StarHub to pay half the auction fee in 2H19 and 2020 although this spectrum may not be available till 2020. As such, we have not factored in any amortisation of the 700MHz spectrum for FY19F.

Staff cost reduction could save ~S$30m annually from FY19F onwards but the street is factoring only S$15m-20m. 

• Total staff expenses stood at S$282m in 2017. Workforce reductions will primarily affect backroom functions, with approximately 300 full-time employees out of an estimated 2,500. We estimate almost S$30-35m in annual savings from staff reduction. There will be one-off cost of S$25m in FY18.
  • New businesses may not have a significant adverse impact on staff cost savings. StarHub is striving to expand its enterprise service portfolio, to compensate for declines in mobile and pay-TV businesses, with the addition of new ICT services such as Managed Security. The telco entered into a joint venture agreement with Certis Cisco in September 2018 to pool the duo's cybersecurity assets and expand their cybersecurity businesses together, leveraging the enterprise and government networks of both parties. While the addition of low-margin ICT services like cybersecurity should weigh on StarHub’s margins, the new cybersecurity business has been profitable so far.
  • Even under a bear-case scenario where StarHub must ramp up the hiring of cybersecurity professionals much before the actual revenue kicks in, the magnitude of such losses would not be material in our view. We take cues from Singtel’s cybersecurity business, which has an annual revenue run rate of ~ S$500m, almost 5x the projected revenues of StarHub’s cybersecurity venture. Singtel’s cybersecurity arm generated a negative EBITDA of S$28m in FY18. StarHub’s cybersecurity is quite regional in nature with just one monitoring centre versus multiple global monitoring centres for Singtel, implying low-cost structure. Assuming a similar margin profile, the losses of StarHub’s cybersecurity venture are likely to be limited to S$5-10m in the initial years of operation even in the worst case scenario.
  • We already project StarHub’s mobile revenue to contract 5% annually over 2018-22 due to TPG’s entry. TPG, the fourth Mobile Network Operator (MNO) set to enter Singapore in 2H18 is speculated to delay the commercial launch to 1H19 due to integration issues. We project that the Singapore mobile industry would contract ~4% annually over 2018-22 under our base-case scenario with growing adoption of SIM-only plans and potential price wars between TPG and MVNOs.
  • TPG faces an uphill battle, amid the myriad of Mobile Virtual Network Operators (MVNO) the incumbents have partnered with. Each incumbent has partnered with at least one MVNO (StarHub with MyRepublic), with the market leader Singtel joining hands with two, taking the total number of mobile service providers in the country to seven from just three players at the end of 2015. By partnering with MVNOs, the incumbents are
    1. making it difficult for TPG to succeed by stirring up competition in the SIM-only segments, which TPG is likely to target first, and
    2. generating wholesale mobile revenues, offsetting any potential revenue impact in the low-end segments that is likely to be caused by TPG.
  • TPG has already announced plans to offer unlimited voice and 3GB of data free of charge for 24 months to senior citizens in Singapore. The telco is also offering free unlimited data for six months (A$9.99 thereafter) in Australia, where TPG entered as an MNO. We believe that TPG will likely adopt a similar strategy of offering free services at the initial stages of its entry into Singapore as well, possibly leading to price wars between operators.
  • However, under our base-case scenario of TPG grabbing ~4% mobile revenue market share, TPG could remain cash- flow negative till 2022, four years after its entry. Negative cash flow generation in Singapore, coupled with TPG’s ongoing investments in deploying a mobile network in Australia, could weigh heavily on the telco’s balance sheet, making TPG a potential acquisition target.

~S$30m savings annually in operating lease expenses from 2021 onwards. 

• StarHub presently leases part of its Hybrid Fibre Coaxial (HFC) network used to provide broadband and pay-TV services, from Singtel. The agreement, which is set to expire in FY20, is not expected to be renewed by either of the parties. StarHub is expected to migrate its co-axial customer base to National Broadband Network by 2020 (~83% of StarHub’s broadband subscriber base is already on the fibre network). Hence, we do not expect the agreement to be renewed after FY20 and this should allow StarHub to save an estimated S$30m in operating lease expenses from FY21 onwards. Conservatively, we have projected cost savings of ~S$23m in operating lease expenses from FY21F onwards.
  • Rising cost of Fibre-broadband and enterprise services to be partially offset by lower content costs. StarHub is likely to record rising cost of services as the telco continues to migrate its broadband customers to its fibre network and expand its enterprise services portfolio. However, on the Pay-TV front, amidst heavy pressure from OTT services and continued loss of subscribers, StarHub is cutting down its investments in content. The suite of channels from Discovery Networks’ and Scripps Networks' Channels was discontinued in two phases, in June and August 2018 following unsuccessful negotiations between StarHub and the vendors on content licensing costs. StarHub is also powering up its Asian content line-up which commands a significantly lower cost compared to Western content.
  • While content costs contributed to the 11% y-o-y growth in cost of services StarHub recorded in 1H18, we believe the rise was primarily attributable to the Football World Cup that took place in 2Q18 and is not representative of the long-term trend of StarHub’s content strategy. We believe the cost savings on content would partially offset the rising expenses attached to broadband and other managed enterprise services.

Digitisation efforts to result in ~S$20m annual cost savings. 

• Under the recently launched strategic transformation plan, StarHub will embark on digitisation initiatives to transform customer experience and slice sales and distribution costs. We believe digitising customer care and improvements in digital distribution channels such as the deployment of online shops should allow StarHub to save ~S$20m annually in marketing and distribution costs with the savings kicking in from FY20 onwards.
• Our research on digitisation of the telecom industry reveals that on the customer service front, the costs of implementing digital chats as a customer care tool is just ~56% of the cost of maintaining a call centre. As such we believe that with the use of digital chat as a customer care tool, there could be 30-40% savings in customer care costs for StarHub. Investing in digital distribution channels such as online shops and effective offline- to-online model, coupled with the use of data analytics, could lead to a 10-15% reduction in distribution costs for StarHub by our estimate.
• Our research also indicates that fully digitising internal processes could help telcos save ~18% of their current operating expenses, supported by lower expenses in customer service and distribution, reduced marketing spend supported by data analytics, and efficiency gains realised through automation.

StarHub is expected to expedite infrastructure sharing. 

• StarHub signed a MOU with a major operator in Singapore in 2017 to study potential collaboration in mobile infrastructure sharing, with a focus on sharing radio access network, backhaul and access assets. 
• While progress has been slow over the past year due to the challenging operating conditions, StarHub's new management plans to ink a commercial agreement for network sharing by 2019, if not earlier. The management expects financial benefits from the network sharing agreement to flow through from end-FY19.
• Based on the previous MOU, StarHub was exploring the sharing mobile network radio elements (MORAN), which is the simplest form of network sharing where the operators share the RAN – including towers and base stations that are responsible for connecting individual devices to the network, while keeping Spectrum and other core networking infrastructure separate.

Considerable benefits in network sharing: 

• A higher level of network sharing could eliminate significant amounts of equipment and installation cost duplication, thereby reducing overall capex, while achieving similar levels of coverage and capacity for multiple service providers. 
• In addition, overall running costs of the networks can be reduced by removing certain operational costs relating to staff, maintenance, security, etc.

Expect capex to drop by 20% once network sharing kicks in:

• According to Groupe Spéciale Mobile Association (GSMA), sharing part, or all, of the radio access network (RAN) could result in up to 20% increase in free cashflows for a typical European operator. Similarly, according to TMG, a consultancy specialising in telecommunications, RAN sharing can save 30–40% in costs.
• Given the considerable synergies, especially in capital expenditure, we believe network capex could reduce by 20% as network sharing takes hold. However, we await better clarity on the prospective agreement to model in potential savings of capex from network sharing.

Sachin MITTAL DBS Group Research | https://www.dbsvickers.com/ 2018-10-16

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