Singapore Telecom Sector - DBS Research 2018-11-21: TPG May Not Disrupt, Attractive Yield & Valuations

Singapore Telecom Sector - DBS Group Research | SGinvestors.io SINGTEL (SGX:Z74) STARHUB LTD (SGX:CC3) NETLINK NBN TRUST (SGX:CJLU)

Singapore Telecom Sector - TPG May Not Disrupt, Attractive Yield & Valuations

  • TPG’s abysmal capex so far implies room for positive surprises in 2019.
  • Netlink Trust is our top pick for 6.6 yield and front-loading of revenue from StarHub’s accelerated fibre migration.
  • We like StarHub for its 5.6% yield, -2SD valuation and potential upside to consensus FY19F/20F earnings.
  • We also like Singtel for its assured DPS of 17.5 Scts (5.7% yield) and -1SD valuation.

Mobile Sector - TPG to launch services in 2Q19 but will it cause major disruption?

TPG’s low capex spend and launch delays bring reprieve to telco incumbents.

  • TPG has so far spent A$66.7m (S$65.7m) in cumulative capex on its Singapore rollout, or ~22-32% of its planned S$200-300 of capex. The telco revealed that its production network covers ~90% of outdoor areas during its FY18 results briefing and mentioned that is on track to meet the nationwide coverage requirement by December 2018, as set forth by IMDA. TPG has delayed the commercial launch of its services to 2Q19 from late-2018, citing delays in negotiating access to the jointly built common antenna systems of the incumbents and network testing. TPG is slated to launch 4G trials in 4Q18, followed by a commercial launch of services in 2Q19.
  • At the current level of capex spend, TPG’s network at commercial launch is unlikely to pose a major threat to the incumbents, in our view. We estimate that StarHub, the second largest operator in Singapore, is likely to have spent over S$600m on its 4G network since 2013, almost 10x of the current capex spend of TPG on its 4G network. We are of the view that to become a disruptive market player in Singapore, TPG would need to significantly ramp up its rollout capex to provide ubiquitous coverage. For instance, Reliance Jio in India, spent almost US$20bn over six years to build its 4G network from ground up before its commercial launch, spending ~US$3.3bn annually. This is nearly 4x the average annual capex Bharti Airtel had spent over the past five years on expanding its mobile coverage in India. (The average 5-year annual capex spend by Bharti on mobile services in India is ~US$900m after assuming 40% of capex is spent on network maintenance. INR/US$ = 60).
  • While TPG is likely to meet the outdoor coverage requirements by 2018, the quality of the outdoor network is likely to be poor with patchy and inadequate coverage inside buildings and MRTs given its current capex spend. This would make it difficult for TPG to lure low-end subscribers, who already enjoy much better network quality and coverage through Mobile Virtual Network operators (MVNOs) that ride on the incumbents’ mobile networks.

Not meeting coverage requirements could lead to penalties or forced industry consolidation.

  • We believe TPG would need to significantly boost its capex spend and network rollout over 2019, in order to meet IMDA’s road tunnel and in-building coverage requirements by December 2019. TPG would also need to negotiate a+ccess to common antenna systems of the incumbents, given the limited availability of space for deploying antennas in key sites.
  • Any potential delays in TPG’s network ramp-up or negotiating access to the incumbents’ network could lead to TPG failing to meet the coverage deadlines set by IMDA. While this is likely to result only a fine (S$5,000-S$50,000) in the first few instances, continued failure to meet coverage requirements, particularly owing to issues in securing funding for capex, could prompt the regulator to mediate a forced consolidation of the industry or push TPG to dispose of its spectrum assets to an incumbent.

TPG is likely to offer unlimited data plans in Singapore to capture subscriber market share.

  • With its forthcoming launch in Singapore, TPG is likely to enter the telco battlefield with aggressive promotions to attract subscribers and drive up scale. We base our argument on TPG’s strategy in Australia where TPG announced plans of this nature before its merger with Vodafone.
  • In Australia, initial subscribers of TPG were entitled to free unlimited mobile data for six months, and customers who stay with the plan after the initial six-month period are to pay A$9.99 per month with no lock-in contract. Under the terms of the daily unlimited data plan, the first 1GB is supplied at 4G LTE speeds, after which speed is capped at 1Mbps for the remainder of the day. It is likely that TPG will follow a similar pattern in Singapore.
  • In March 2018, TPG revealed plans to offer free mobile data plans (3GB, local voice) for the first 24 months to the elderly, a segment largely ignored by the incumbents, when it kicks off its operations. However, given that the greenfield operator is likely to have an inferior network at least till the end of 2021, the unlimited data plans may not be as enticing as it sounds to induce the lower-end subscribers to switch operators.

Mobile Virtual Network Operators (MVNOs) march on with their aggressive expansion plans.

  • Against a backdrop where TPG was expected to enter Singapore in 8H88, each incumbent operator partnered with MVNOs takes the total number of mobile service providers in the country to seven from three players at the end of 8888. 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 ow-end segments that is likely to be caused by TPG.
  • MVNOs such as MyRepublic and Circles.Life, with their low-cost model, superior network quality (as they leverage on the network assets of established players) and convenient customer service (888% app based), may attract a substantial number of customers, especially the low-income segments, in shifting to cheaper SIM-only plans. As the majority of MVNOs’ revenues will flow back to their telco partners, telcos are better off losing revenue share to MVNOs than TPG by offering flexible wholesale pricing to their MVNOs.
  • TPG is likely to compete on cheaper pricing but will be challenged by MVNOs that offer superior network quality and differentiated services. As MVNOs are already disrupting the Singapore telco market, we do not expect a major disruption from TPG in 8H88 when it launches its services in Singapore.

SIM-only plans to continue weighing on ARPU.

  • Both Singtel and StarHub witnessed y-o-y declines of 88% and 8% in postpaid ARPUs over 8Q88, respectively, largely owing to the growing adoption of SIM-only plans. We believe SIM-only plans will rise in popularity over the medium term, with lengthening smartphone replacement cycles, which could further incentivise subscribers to move away from bundled plans.
  • The growing adoption of SIM-only plans presents a challenge to operators, with potential declines in mobile service revenues, dilution of ARPU and profitability. Customer spend over the life of SIM-only contracts tends to be substantially lower than handset plans, and SIM-only plans remain less profitable than handset plans, even after taking handset subsidies into consideration.
  • Our industry checks indicate that SIM-only plan adoption among Singapore postpaid customers grew from 8-8% in 8Q88 to 88-88% by 8Q88. Judging from Australia’s experience, where SIM-only plans constitute ~88% of the total postpaid plans, Singapore is likely to see a leap in these plans. Customer spend on SIM-only plans vis-à-vis handset plans tends to be substantially lower and growing uptake would negatively impact mobile service revenues and dilute industry ARPU going forward.

We project annual contraction of 5% for the mobile sector in FY19F.

  • We estimate that mobile service revenues declined ~8.8% over 8M88 vs our projection of a 8% decline over FY88. Declines were largely driven by postpaid ARPU due to SIM-only plans and contractions in legacy usage.
  • We expect the mobile industry to contract ~8% over 8888, driven by the adoption of SIM-only plans (88-88% of postpaid user base currently vs 88% in 8-8 years) and commercial launch of TPG’s services in 8Q88. However, if TPG faces serious network quality issues, incumbents may not hesitate from raising prices, in our view, thus implying room for positive surprises.

Pay-TV Segment

Pay-TV market should continue to shrink due to the impact of Internet-based distribution.

  • The pay-TV market in Singapore has shrunk by ~8.8% y-o-y YTD with ~88k subscriber losses over 8M88, as subscribers continue to cut the cord, opting for cheaper OTT alternatives. We believe that pay-TV subscriber losses will likely to continue through FY88 with the industry topline contracting ~8-8% over FY88.

Pay-TV business model to change with content-cost to be linked to subscriber base.

  • StarHub’s pay TV business has not been profitable for some years now and the current business model where content-cost is fixed would have to evolve to a variable-cost model. StarHub’s management is re-negotiating contracts to make payments based on the number of subscribers as and when they come up for renewal. Content-providers are reaching subscribers directly and are more open to variable-cost contracts than in the past.

Enterprise Segment

Expansion of StarHub and other operators to the enterprise segment puts pressure on Singtel.

  • StarHub managed to expand revenues from the enterprise segment by 88% y-o-y in 8Q88, largely driven by the consolidation of Accel Systems and D’Crypt. Additionally, in 8Q88, StarHub entered into a joint venture agreement with Certis Cisco, a wholly owned subsidiary of the Temasek Group, to pool the cybersecurity assets of StarHub and Certis to create Ensign, a pure-play cybersecurity service provider. The joint venture should further augment StarHub’s ICT service portfolio, which continues to drive the telco’s enterprise segment. As such, we believe the enterprise segment would remain a key driver of StarHub’s topline going forward.
  • With the entry of StarHub and other mobile operators into the enterprise services segment, Singtel’s pricing premiums in the enterprise segment have come under pressure. The Singapore enterprise segment, which accounts for ~88% of Singtel’s Singapore operations, has continued to contract on a y-o-y basis over the past four consecutive quarters, largely owing to the declining usage of legacy services and contraction of ICT revenues due to the lack of order wins, which in the past had adequately offset any declines in legacy services. Singtel’s management also reiterated that the managed services, is getting crowded due to the aggressive expansions of incumbents. We believe Singtel would continue to remain under pricing pressure in the enterprise segment, as operators like StarHub continue to expand their reach in this segment.

Resumption of Smart Nation contracts to benefit Singtel and StarHub.

  • As the government accelerates new Smart Nations projects, Singtel and StarHub’s investments in fields such as cybersecurity is expected to bear fruit over the next few years. StarHub’s joint venture partner Certis Cisco has 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 8888, providing round-the-clock monitoring of the government's IT systems and networks. This should make StarHub’s cybersecurity division a likely candidate for clinching future government cybersecurity contracts pertaining to Smart Nation projects.
  • Singtel is also set to benefit from the resumption of Smart Nation projects, and might benefit from a rebound in ICT revenue with ~S$888m of additional ICT revenue over 8H88F (March YE) vs 8H88 largely stemming from Smart Nation contracts.

Stock Picks & Valuations

Netlink Trust (NLT) is trading at c.6.6% FY19F yield, similar to large-cap industrial S-REIT’s average yield.

  • We argue that Netlink Trust should trade at a tighter spread than S-REITs as
    1. Netlink Trust’s distributions, due to the regulated nature of its business, are largely independent of the economic cycle, and
    2. Netlink Trust’s gearing is less than half of S-REITs’ with an ample debt-headroom to fund future growth.
  • Netlink Trust has hedged its interest rates till March 8888 and NLT's one unique advantage over REITs and Business Trusts is that the potential rise in the cost of capital might lead to higher regulated returns from 8888 onwards, thus translating into higher distributions.
  • Catalyst for Netlink Trust would be StarHub’s accelerated migration to fibre. StarHub intends to migrate 888% of its subscribers from co-axial cable to fibre by July 8888 vs earlier expectations of 8888. There were ~88,888 co-axial cable broadband subscribers by the end of 8H88 and slightly more cable TV subscribers who will migrate to fibre.
  • Beyond FY88F, Netlink Trust should benefit from ~8% growth in the number of households and Singapore’s household wired broadband penetration rising towards 888% from ~88% in FY88F and ~88% currently.
  • See report: NetLink NBN Trust - Attractive 6.6% Yield Amid Healthy Outlook.

StarHub is attractive for its -2SD valuation and potential upside to the street’s FY19F/20F earnings.

  • The street’s FY88F earnings are likely to be raised by at least S$88m in the absence of S$88-88m amortisation cost for 888MHz spectrum. Consensus is also ignoring ~S$88m savings on operating lease expenses in FY88 with the shutdown of StarHub’s co-axial cable network. The street’s FY88F earnings are edging up and we expect to see more upward revisions going forward.
  • StarHub’s valuation is attractive, trading close to -8SD of its historical EV/EBITDA and PE averages, and offers sustainable yields that exceed ~8.8%. We expect the street to raise FY88F/88F EPS by 8%/88% over the next few months.
  • See report: StarHub - Street FY19F/20F Earnings Set To Rise.

Singtel is attractive for its -1SD valuation and rebound in Singtel’s associate contributions from FY20F (Mar YE) onwards.

  • Associate profit contributions, which have been a critical factor for Singtel’s share price, are expected to rebound in FY88F – led by Telkomsel, AIS and Globe, despite the delay in Bharti’s recovery.
  • Singtel is trading at 88x FY88F PE, 8SDs below its historical average of 88x, despite offering an FY88F-88F EPS CAGR of 8% and an assured annual DPS of 88.8 Scts (8.8% yield) over FY88F-88F.
  • See report: SingTel - Negatives Are In The Price; Safe Dividend.

Sachin MITTAL DBS Group Research | https://www.dbsvickers.com/ 2018-11-21
SGX Stock Analyst Report BUY MAINTAIN BUY 3.590 SAME 3.590