Singapore Telecom Sector - DBS Research 2019-04-18: Singtel For Recovery & NetLink For Yield

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

Singapore Telecom Sector - Singtel For Recovery & Netlink For Yield

  • 2018 was full of surprises - enterprise sector and cyber-security - were key disappointments. Mobile sector to weaken further in 2019 with recovery in 2021 possibly.
  • We like NetLink NBN Trust (SGX:CJLU) for 6.1% yield versus ~5.7% offered by large-cap industrial S-REITs.
  • Prefer SingTel (SGX:Z74) for projected earnings recovery in FY20F, narrowing of holding company (HoldCo) discount and 5.5% yield.

What took us by surprise so far?

  • The much-talked about 5.3% decline in Singapore’s mobile services revenue in 2018 was in line with our 5% decline projections. The big reason for SingTel’s core EBITDA decline of ~8% over 9MFY19F (Mar YE) was
    1. weak enterprise business from slow Smart Nation contracts and lower carriage revenue
    2. ~A$83m drop in National Broadband Network (NBN) migration fee and
    3. ~7% depreciation of AUD/SGD.
  • The biggest surprise to us was sharp rise in costs at StarHub (SGX:CC3) from newly acquired cyber-security business.

Revise Singapore mobile revenue contraction to 6.5% (vs 5% earlier) for 2019 with possible recovery in 2021.

  • We expect revenue in the mobile services industry to contract ~6.5% in 2019 (vs 5% earlier) on the back of newly revamped SIM-only plans.
  • Potential industry consolidation in 2020/21 with 5G launch, primarily targeting enterprises, could lead to re-pricing of consumer services and recovery in the industry perhaps.

In 2019, core EBITDA may stablize for Singtel but remain lackluster for StarHub.

  • SingTel’s core EBITDA may in stabilize FY20F (Mar YE) despite weakness in the enterprise business due to ~A$50m rise in NBN migration fee, stronger Optus and a relatively stable AUD/SGD.
  • Meanwhile, we see a potential decline in StarHub’s EBITDA with the accelerated migration of Hybrid fibre cable (HFC) customers to fibre which will benefit NetLink Trust.

Netlink Trust (NLT) is our top pick for 6.1% yield, prefer Singtel for projected earnings recovery at associates and further narrowing of HoldCo discount.

  • NetLink Trust should trade at a lower yield than large-cap industrial S-REITs’ yield of ~5.7% as
    1. NetLink Trust’s distributions are largely independent of the economic cycle
    2. gearing is less than half of industrial S-REITs’
    3. asset life is much longer than industrial SREITs.
  • We like SingTel for a projected rebound in associates’ contributions in FY20F, after two years of decline, which may lead to narrowing of HoldCo discount from 27%.
  • We think that StarHub should offer 6.0%-6.3% yield, 50- 80 basis points higher than SingTel’s 5.5% yield due to its muted growth prospects.

Mobile Sector

Singapore mobile services revenue contracted 5.3% in FY18 - in line with our forecast.

  • Singapore’s mobile services revenue contracted 5.3% in 2018, with the drag from accelerating migration of postpaid subscribers towards SIM-only plans and lower excess data usage revenue with the uptake of unlimited data plans and data add-ons that were introduced towards the latter part of 2017. Based on our estimates, SIM-only plans yield ~40-50% lesser revenues in comparison to bundled plans, impacting service revenue of operators with accelerating migration towards SIM-only plans.
  • The introduction of unlimited data plans by StarHub and other operators towards the latter part of 2017, along with a suite of data add-on offerings, further exacerbated the decline in mobile revenue, with fewer subscribers exceeding their data allowances.

Despite intact mobile revenues, EBITDA of Singapore operators fell short of our expectations.

  • SingTel recorded a core EBITDA of S$3,526m in 9MFY19 (March YE), 7.7% short of its 9MFY18 core EBITDA of S$3,820m. This was primarily to the slowdown in enterprise segment arising from a temporary stop in smart nation orders from the Singapore government following the cybersecurity breach at SingHealth, pricing pressures from aggressive competition, and absence of contribution of a few large scale Infocomm Technology (ICT) contracts that were completed. The 5% depreciation of AUD/SGD and the absence of ~A$83m in National Broadband Network (NBN) migration revenues from Australia also led to SingTel missing our EBITDA projections.
  • StarHub’s EBITDA fell by 11.8% in FY18 (including one-offs), mainly due to ramping up of StarHub’s cybersecurity venture and migration of its broadband and pay TV users to Next Generation Nationwide Broadband Network (Next Gen NBN) from Hybrid Fibre Coaxial (HFC) network. These eroded the bulk of the cost savings that StarHub had realised through its workforce reduction exercise, which formed part of StarHub’s S$210m cost transformation program. Other factors that weighed on EBITDA was a 7% y-o-y increase in marketing expenses for fibre migration and the revamped SIM-only plans, and 3.8% increase in cost of services.

TPG trials continue; commercial launch yet to be confirmed.

  • TPG launched mobile trials in late December 2018, offering unlimited data plans free for 12 months to the first 20,000 subscribers, expanding to 200,000 subscribers. Subscribers are eligible for 2GB of mobile data at 4G speeds daily with any excess usage capped at 1Mbps. Feedback from TPG users reveal decent 4G speeds outdoors but coverage in underground tunnels and within buildings remain weak. Online user reviews also indicate that TPG has managed to secure interconnection deals with all three operators, allowing users to make calls over 4G-VoLTE (Voice over LTE) and use SMS services with other operators.
  • TPG also confirmed that it has achieved 99% island-wide outdoor coverage since 12 March 2019. We believe this could be an indication of TPG having ramped up its capex significantly over the past few months. TPG is required to meet 99% coverage in road tunnels and 85% coverage in buildings by 1 January 2020, which will be quite a task given the weak in-building and tunnel coverage of its existing network that would require significant expansion. TPG is expected to launch commercial services in late 2019.

SIM-only plans: the new battleground for incumbents.

  • StarHub revamped its SIM-only offerings in early December 2018, cutting down the number of plans and bumping up data allowance on mid-high-end SIM-only plans. StarHub also introduced a range of add-on data offerings such as 10GB extra data quota for S$10/month, unlimited data over weekends for S$6/month and unlimited monthly access passes to social media apps. SingTel and other operators countered StarHub’s plans by offering additional data quotas for limited time periods as promotions.
  • StarHub recently launched a data add-on, offering subscribers 50GB of data for an additional S$20 a month. For a limited time, the add-on was offered free of charge to SIM-only subscribers willing to enter into a two-year contract. This was on-top of free unlimited data during weekends and a promotional offering of 10GB of data per month.
  • SingTel responded to StarHub’s latest SIM-only offerings with “Gomo” plans, which offers 20GB of data for S$20 per month the cheapest SIM-only plan among incumbents and second only to Circles.Life’s SIM-only plan of 20GB for S$18. Other incumbent operators have also responded to StarHub’s revamped offerings with the introduction of unlimited data over weekends and 25GB data add-ons for just S$5 per month.
  • We believe incumbents would increasingly focus on SIM-only plans going forward amid lengthening smartphone replacement cycles and SIM-only subscribers forming a double digit proportion of the postpaid subscriber base. A price war by incumbents on the SIM-only front is also likely to heavily impact TPG, - TPG may have an even tougher time in gaining sufficient revenue market share to reach breakeven EBITDA in light of the new SIM-only offerings of incumbents.

Mobile service revenue likely to shrink a further ~6.5% in 2019.

  • We project that mobile service revenue in Singapore will shrink by a deeper 6.5% in 2019 compared to our previous forecast of 5%. Our forecast factors in the on-going migration of postpaid subscribers from handset-bundled plans to SIM-only plans, on-going price competition among incumbents on the SIM-only front, and projected commercial launch of services by TPG by 2Q19.
    1. Migration to SIM-only plans– Under our base case, we project that ~7% of the postpaid subscriber base will migrate to SIM-only plans, causing a severe dilution of ARPUs of these subscribers. SIM-only subscribers already represent >20% of the total postpaid subscriber base telecom operators, which saw the proportion of SIM-only subscribers grow by almost 5% to 17% over 2Q18. With the incumbents targeting SIM- only plans as a centerpiece of their pricing strategy, and offering attractive data allowances at significant discounts to bundled plans, we believe migration to SIM-only plans would accelerate during 2019. We estimate that SIM-only plans yield ~40-50% lesser service revenues than handset bundled plans although margin profiles tend to be similar with the absence of handset subsidies. We project SIM-only plan migration to contribute 3.15% to the industry decline of 6.5%, assuming ~7% of the postpaid subscriber base would migrate to SIM- only plans this year.
    2. Price cuts on SIM-only plans – All three incumbent operators have revamped their SIM-only offerings to include bigger data bundles at the same or marginally higher prices. The telcos have also introduced an array of data add-on plans, offering significant data allowances at very attractive prices. Taking into account the attractive data bundles on offer with SIM-only plans, we believe the uptake of data add-on plans would be relatively limited. Factoring in the lower ARPU on the revamped plans, lower likelihood of subscribers exceeding their data allowances, and a growing proportion of SIM-only subscribers, we project the industry topline will fall by ~2.7% arising from a higher take-up of the revamped SIM-only offerings.
    3. Entry of TPG – While the projected entry of TPG during 2Q19 is unlikely to cause major ripples to the incumbents, we believe the revenue flow from MVNOs to incumbents would be disrupted with the entry of TPG. All three incumbents have tied up with at least one MVNO, with SingTel partnering two operators. Successful implementation and revenue flow from the MVNOs have allowed smaller operators to stabilise the decline of mobile revenue in the recent past. We believe the entry of TPG could cause a severe disruption in the MVNO segment, as subscribers opt for TPG as their secondary SIM card replacing the MVNOs, given the free or nominally priced data services TPG is likely to offer in the early days of its launch. This could disrupt the revenue flow from MVNOs to incumbents to weigh on the industry topline. Assuming ~65% of e revenues of MVNOs flow back to their partners, we project -0.7% net negative impact on the topline of telcos, with a projected decline of 1% in net revenues of MVNOs with the commercial launch of services by TPG in 2Q19.

2020 likely to witness even steeper declines.

  • We project ~7.6% decline in mobile service revenue in 2020 as a result of disruption caused by TPG. Provided that TPG meets the set guidelines for in-building and tunnel coverage by the beginning of January 2020, we believe TPG’s network would be good enough to be a threat to incumbent operators in 2020.
  • Price wars could emerge between incumbents and TPG, as TPG battles hard to gain a strong foothold in the SIM-only segment of the market through heavily discounted data bundles offered at nominal price points. We believe this would heavily weigh down industry growth as
    1. attractive SIM-only offerings would further accelerate postpaid subscriber migration to SIM-only offerings,
    2. price war between the incumbents and TPG could significantly lower subscriber spend on data services, weighing down on industry ARPUs,
    3. disruption to revenue flow from MVNOs to incumbent operators as TPG battles hard at the lower end segment of the market.
  • Potential industry consolidation and/or launch of 5G services during 2020/21 to stymie declines in mobile revenue. We believe the business case for TPG remains challenging with the incumbents aggressively revamping their offerings in the SIM-only segment that TPG is likely to be active in.
  • Continued steep declines in the industry’s topline and lack of clarity on the path towards positive EBITDA for TPG could prompt the telco to consider the option of ceasing its operations in Singapore, which would help the industry stymie further declines and work towards restoration.
  • Launch of 5G services in 2020/2021, primarily targeting enterprises, could also allow operators to stem declines in mobile revenues through re-pricing of services and the introduction of new use cases, potentially paving way for recovery in the industry.

Singapore government eyeing 2020 for 5G launch.

  • The Singapore government announced plans to launch 5G services in the country by 2020, with a public consultation to be held over the next few months to decide on the regulatory framework and spectrum allocation guidelines. All three operators have conducted initial trials on 5G but have yet to detail their 5G strategy or provide guidance on projected 5G capex. We believe that the 5G roll-out would be a collaborative exercise by the mobile operators, with extensive network sharing arrangements, taking in to account substantially higher capex requirements for 5G networks.
  • Operators have also raised concerns over the lack of use cases that can be served via 5G networks, which could potentially delay a commercial roll-out of the network beyond the government’s target of 2020.

Lackluster EBITDA outlook for Singapore operators for 2019.

  • We project marginal decline in EBITDA for SingTel in FY20F (FYE March) with weakness in Singapore largely mitigated by cost savings initiatives and a stronger Optus equipped with higher contributions from NBN migration fees.
  • SingTel’s Singapore operations are likely to dip ~4% in FY20F, driven by pressure on the Singapore mobile segment along with potential declines in Singapore enterprise division, driven by slow growth in smart nation orders after the cyber-attack, pricing pressure from StarHub which continues to expand its cyber-security portfolio aggressively, and continued decline of its legacy carriage business, which is unlikely to be adequately offset by growth in the ICT business.
  • However, Optus is likely to see ~3% growth in EBITDA supported by contribution of ~A$50m higher NBN fees coupled with stronger performance in the mobile segment, the impact of which would be partially offset by a weaker AUD/SGD. A stronger Optus should largely offset declines from Singapore operations, allowing SingTel to report a marginal decline of 0.3% in core EBITDA in FY20F (March YE).

StarHub likely to post lower EBITDA in FY19F.

  • StarHub is likely to report lower EBITDA in FY19F, with higher cost of services and marketing expenses in 1H19 arising from the on-going migration of subscribers from HFC to Next Gen NBN, weighing down on EBITDA. Potential savings on content costs in the Pay-TV segment with the renegotiation of contracts to a variable cost base however, could partially offset higher cost of services.
  • StarHub is also likely to record higher overheads in FY19F with the on-going expansion of cybersecurity and managed services segments, both of which tend to be labour and opex intensive businesses and carry lower margin profiles than traditional mobile and legacy IT services. We believe the net effect of cost savings announced by StarHub in 2018 would be minimal in FY19, as bulk of the cost savings StarHub is likely to accrue in FY19F would likely be reinvested in the business during the year. This coupled with lower revenues from Pay-TV and mobile would further exacerbate the decline in EBITDA in FY19F.
  • With the adoption of SFRS 16 in FY19, StarHub would be capitalising some of its operating leases as right-of-use (ROU) assets, allowing for a reduction in opex relating to operating lease expenses with a subsequent increase in StarHub’s depreciation and amortization expense. Post-SFRS 16, we expect StarHub’s EBITDA in FY19 to decrease by 1.3%.

Pay-TV and Broadband segment

Pay-TV revenue growth plunges deeper into negative territory.

  • The loss of subscribers with the on-going migration to OTT services has led to major woes in the Pay-TV segment, with revenues plunging deeper into negative territory in 2018.
  • Approximately 17,000 subscribers have left Pay-TV services since January 2016 when Netflix entered the Singapore market, with ~75% coming from StarHub, the largest provider of Pay-TV services in Singapore.
  • Pay-TV revenues are likely to witness further declines in 2019, with potential loss of subscribers from the on-going migration of StarHub’s customers to fibre network, which could push users to exit Pay-TV services. We believe subscriber losses in the Pay-TV segment would stabilise during 2020, with a potential shift in the Pay-TV business model of SingTel and StarHub in favour of a more variable content model.

Pay-TV business model evolving towards variable cost structure.

  • Telcos are subisidising Pay-TV content providers as Pay-TV services are often bundled with broadband services, which are usually more profitable for telcos. However, with a growing number of Pay-TV subscribers cutting cables in favour of OTT services and broadband penetration in Singapore nearing 100%, Singaporean operators are striving to evolve towards a variable cost model for Pay-TV content.
  • StarHub’s Pay-TV business has not been profitable for some years now and StarHub indicated that it is re-negotiating contracts to make payments based on the number of subscribers as and when they come up for renewal. According to StarHub’s management, content providers are more open to variable-cost contracts than in the past. As SingTel’s Pay-TV segment remains under similar topline and cost pressures, we believe SingTel would also welcome such a change. The move towards a variable cost structure could significantly lower the cost of services for operators and lessen the pace of subscriber loss, as subscribers would have greater freedom in choosing the content they want to see and pay only for such content, as opposed to the bundled content packages currently available in the market.

Broadband segment remains competitive.

  • Broadband revenue growth has been positive over the last 4 years supported by stable ARPUs despite tight competition in the sector.
  • Competition in the broadband segment could intensify over the next 1-2 years with penetration nearing 100%. Fixed broadband market penetration stood at 93.2% in December 2018, with SingTel enjoying a market share of 42.5%. We expect competition in the sector to intensify in 1H19 with StarHub’s migration of broadband subscribers from HFC to NBN, which offers smaller players like MyRepublic and ViewQwest an opportunity to snatch StarHub’s subscriber base.

StarHub’s migration to HFC progressing as planned.

  • In November 2018, StarHub announced plans to cease providing broadband and Pay-TV services on HFC network by June 2019, ahead of its earlier proposed discontinuation in 2020. Accordingly, all existing Pay TV and broadband subscribers on the HFC network would be transitioned to Next Gen NBN by June 2019. Based on 4Q18 results, StarHub had 482,000 residential broadband customers, out of which 425,000 are already on fibre. We expect the remaining 57,000 broadband users to be migrated within 1H19 along with Pay TV users who are still on HFC. According to the management, the migration is progressing as planned and uptake from existing subscribers has been satisfactory.
  • We expect StarHub’s cost of services to rise in FY19F with the on-going migration to Next Gen NBN. Assuming StarHub pays S$13.80 per month (cost of Residential connection charges as per Netlink NBN) for each fibre line of its ~60,000 to 70,000 broadband and pay TV residential subscribers, StarHub is likely to incur S$10-11.5m in annual Next Gen NBN fibre leasing costs in FY19. Once the migration is complete, StarHub is likely to accrue savings of ~S$30m in lease expenses on the HFC network it currently leases from SingTel, likely to be recognised in FY20.

Enterprise service

Singtel’s Enterprise segment unlikely to show signs of stabilisation in FY20.

  • SingTel’s Enterprise segment in Singapore, which contributes 60% of Singapore operations, has been facing headwinds from the accelerating pace of decline in legacy services and a recent slow-down in the ICT segment. SingTel’s ICT revenue expanded by only 1% in CY2018 (Jan-Dec), vs. 4%/18% in 2017/2016. The slower growth in the ICT segment was affected by weaker growth in Smart nation orders from the Singapore government following the cybersecurity breach at SingHealth and completion of major IT implementation projects.
  • Declines in legacy voice and data business coupled with a slow-down in ICT led to 1%/6% decline in revenue/EBITDA y-o-y in the enterprise segment in 2018. The mix of low-margin ICT services and price competition for new ICT orders probably led to a contraction of EBITDA margins in the enterprise segment, which dipped by160bps from 32.6% in 2017 to 31% in 2018 (December YE). SingTel’s managed services segment (~35% of Singapore Enterprise) including cybersecurity has recently come under heavy pricing pressure from StarHub which has been aggressively investing to expand its managed services portfolio.
  • We believe the Singapore enterprise segment would continue to remain under pressure over FY20 with slow growth in smart nation orders from the government as the government undertakes a more cautious approach in expanding smart nation projects following the cyber-security breach. Pricing pressure from StarHub, which continues to expand its cyber-security portfolio aggressively, and continued decline of the legacy carriage business, which is unlikely to be adequately offset by growth in the ICT business would further weigh on the growth of the Singapore enterprise segment

StarHub getting aggressive on the enterprise services front.

  • StarHub is expanding its managed services portfolio with a heavy focus on cybersecurity. With the acquisition of D’Crypt in FY17 and formation of a joint venture with Certis Cisco in FY18, 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, StarHub has been challenging the managed services arm of SingTel. The joint venture is poised to augment StarHub’s ICT service portfolio, which continues to drive the telco’s enterprise segment. Certis Cisco also maintains close relationships with government entities, which should pave the way for StarHub to compete strongly with SingTel to clinch major government cybersecurity tenders pertaining to the ongoing Smart City projects. As such, we believe the enterprise segment would remain a key driver of StarHub’s top line going forward.
  • However, increasing contribution from low margin ICT (low-mid teens) business is likely to weigh on StarHub’s EBITDA margins in the future.

Stock picks and valuations

Netlink Trust (NLT) should trade at lower yield than industrial S-REITS.

  • We argue that NetLink Trust should trade at a lower yield than S- REITs as
    1. NetLink Trust’s distributions, due to the regulated nature of its business, are largely independent of the economic cycle;
    2. NetLink Trust’s gearing is less than half of S-REITs’ with an ample debt-headroom to fund future growth; and
    3. NetLink Trust’s asset life is much longer than SREITs as NetLink Trust incurs annual capex to replenish its regulated asset base.

Key risk for Netlink’s share price will be regulatory changes and technology risk.

  • As ~80% of revenue is regulated under the Regulated Asset Base (RAB) model, any changes in nominal pre-tax WACC from 2022 onwards may lead to changes in Interconnection Offer (ICO) pricing. We further note that NetLink Trust’s unique “ring” and “star” topology schemes are considered highly future-proof passive infrastructure but wired fibre broadband remains susceptible to technology obsolescence with new technologies.

Singtel looks interesting on the back of regional associates.

  • After two successive years of declines, regional associate earnings (critical success factor for Singtel’s share price) is likely to start growing in FY20F, led by potential narrower losses at Bharti, supported by Bharti’s debt re-financing exercises. Meanwhile, SingTel offers an assured DPS of 17.5 Scts (5.5% yield) compensating investors for the wait.
  • In terms of valuation, SingTel is trading at a 27% holding company discount (vs 12% historically) which ironically attaches almost zero value to Bharti’s stake worth S$10.6bn.

Key risks for Singtel is a delay in earnings recovery beyond FY20F.

  • Adverse market conditions in India continues to be the norm, delaying Bharti Airtel’s recovery, and further weakness in Singapore operations owing to tight competition in the mobile and enterprise segments coupled with the weaker Australian Dollar, leading to a sharp fall in core EBITDA which could further delay a rebound in earnings of SingTel beyond FY20F.

Not the apt time to enter StarHub yet.

  • StarHub’s share price performance has remained weak, with a 13% YTD contraction in 2019 amid concerns over losses from StarHub’s cybersecurity segment eroding savings from StarHub’s cost transformation efforts, leading to steeper declines in EBITDA, which has been a critical factor driving StarHub’s share price.
  • While the counter is seemingly cheap at current price levels, trading near -2SD on forward PE and EV/EBITDA multiples and a dividend yield of 5.9%, we believe investors should wait for better clarity on StarHub’s cybersecurity segment and for signs of tangible savings from cost transformation initiatives before entry. Besides, SingTel and NetLink Trust, trading at 5.5%/6% FY20F (March YE) yields respectively offer much better prospects of earnings growth and stable dividends than StarHub in our view.
  • We believe StarHub should offer 6.0%-6.3% yield, 50- 80 basis points higher than SingTel’s 5.5% yield due to its muted growth prospects to look attractive.

Key risk for StarHub is deeper losses from cybersecurity and severe disruption from TPG.

  • StarHub could witness steeper declines in EBITDA, if the ramp-up of its cybersecurity operations result in sharp losses in the cybersecurity segment, eating away cost savings accrued through the on-going cost transformation program.
  • Faster than expected declines in mobile service revenue, with a very aggressive TPG severely disrupting the current status-quo in the market, could also result in steeper than expected declines in EBITDA and earnings of StarHub, potentially weighing down dividends ven further.

Sachin MITTAL DBS Group Research | https://www.dbsvickers.com/ 2019-04-18
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