SingTel - DBS Research 2020-12-07: Digital Banking – Regional Or Singapore Centric?

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SingTel - Digital Banking – Regional Or Singapore Centric?

  • We provide update on SingTel's DFB licence, core business stabilisation and Bharti turnaround.
  • Grab-SingTel consortium could break even in 4-5 years; question remains if SingTel can provide digital financial services outside Singapore. The consortium could be valued at S$1.5-3bn by 2025 based on Singapore-only business if SingTel is not part of the regional story.
  • Maintain BUY on SingTel with a higher target price of S$2.75 on the back of our stronger confidence in Bharti’s outlook.

Grab-SingTel led consortium wins Singapore Digital Banking Licence.

  • On 4th December 2020, the Monetary Authority of Singapore (MAS) announced four successful digital banking applicants. The Grab-SingTel led consortium was awarded the licence to operate as a Digital Full Bank (DFB). Operations are expected to commence by early 2022 and MAS has asked all the successful applicants to meet relevant prudential requirements and licencing pre-conditions before granting the respective banking licences.
  • The following criteria were used by the MAS to assess the applicants;
    1. Use of technology for innovative offerings to fulfil customer requirements and reach underserved segments.
    2. Ability to manage a prudent and sustainable digital banking business.
    3. Growth prospects and other contributions to Singapore’s financial centre.
  • Following the assessment, the Grab-SingTel joint venture (JV) was identified as one of the strongest among the 14 eligible applicants.
  • The other successful DFB applicant was the tech giant, Sea Ltd while the Digital Wholesale Bank (DWB) licences were awarded to two successful applicants;
    1. the consortium comprising Greenland Financial Holdings Group Co. Ltd, Linklogis Hong Kong Ltd, and Beijing Co-operative Equity Investment Fund Management Co. Ltd and,
    2. an entity wholly owned by Ant Group Co. Ltd.

Start of something exciting in the long term for Grab and SingTel led DFB.

  • Grab will own 60% of the JV while the remaining 40% will be held by SingTel (SGX:Z74).
  • The use of innovation in technology, value added services in product offerings and delivering high class financial services are some of the key requirements outlined by the MAS. The Grab and SingTel led JV seems to tick all the boxes. The target market should be digital-first users and small and medium-sized businesses which struggle to obtain funding. Products offered through this consortium are likely to seamlessly integrate into the daily lives of Grab’s and SingTel’s large, highly engaged customer base. SingTel has a subscriber base of 4.3m (as of June 2020) while Grab has over 187m users across Southeast Asia. Furthermore, Grab and SingTel’s consortium is expected to result in several synergies. Grab and SingTel were previously part of several digital innovations and have launched financial technolofgy (fintech) products such as Dash, GrabPay and GrabInsure.
  • Grab’s major advantage is customer data it has acquired through its ride-hailing platform. Grab enjoys an 80% market share in Singapore’s ride-hailing sector. Grab has extended beyond its core business from ride-hailing to digital financial services, food delivery and retail. Grab launched GrabPay wallet in 2016 and incorporated the Grab Financial Group in 2018 which built payment, lending and insurance solutions. This experience has enabled Grab to become well acquainted and understand the unbanked and underbanked segments’ requirements.
  • SingTel is a Temasek-controlled entity and a trusted telecom player. It should be able to build trust among its customers to take bank deposits. SingTel is also investing in its digital business in areas such as cyber security which will add value to the digital banking arm.

Kakao Bank in Korea secured 2.6% share of the consumer market (excluding mortages) in 3-years of its launch and achieved breakeven in 2-years.

  • According to our estimates, Kakao Bank’s loan portfolio of KRW17.3tn in 2Q20 translates to ~2.6% of the South Korean consumer market excluding mortgages. Kakao Bank achieved profit breakeven in 1Q19, secured 9.5% profit before tax margin in 1Q20 which rose to 13.3% in 2Q20. One of the major factors which contributed to the success of Kakao Bank was the presence of an ‘everyday app’ in Kakao Talk which is used by 85% of the South Korean population. Please see our detailed report SingTel - DBS Research 2020-10-27: What Could A Digital Banking Licence Mean?

Grab-SingTel JV could be less successful than Kakao Bank in Korea for three key reasons.

  • First, Kakao Talk along with Kakao Pay are more entrenched as everyday apps compared to Grab and Grab Pay.
  • Second, local banks in Singapore are more digitally advanced than local banks in South Korea.
  • Third, Singapore is a more mature market with Singapore at almost one-tenth of South Korea’s population.
  • As such, the Grab-SingTel consortium could take 5-years to achieve what Kakao Bank has achieved in 2.5-3 years.

A successful DFB in Singapore might grab a market share of 2%-4% in 5-years and achieve profit breakeven in 4-5 years.

  • Ceteris paribus, MAS expects DFBs to meet the minimum paid-up capital of S$1.5bn and become fully functional by the fifth year of operations. Excluding mortgages, we project a successful DFB to secure 2%-4% market share of the consumer market in Singapore by FY25F. This is a reasonable assumption as Kakao Bank achieved 2.5% share within 3-years of its launch.
  • Our back of the envelope numbers assume 10-20% profit before tax (PBT) margins (compared to 50%-plus PBT margins generated by local banks), supported by the fact that Kakao Bank had 13.3% margins in 2Q20. Based on S$1.5bn minimum paid-up capital, it would translate into a return on equity (ROE) of 1%-3.5% comparable to the ROE achieved by Kakao Bank.
  • A successful DFB in Singapore is likely to be valued at ~S$1.5-3.0bn by FY25F. While some of the more successful digital banks such as Kakao Bank in Korea trade at 3-4x book value (BV), we expect less bullish valuations of 1-2x BV for a successful DFB in Singapore depending on the market share and PBT margins.
  • Assuming 1-2x price-to-book value (PBV) on equity paid-up capital of S$1.5bn, we estimate that DFB could secure a S$1.5-3.0bn valuation by FY25F.

Update on Bharti Airtel

Bharti Airtel’s stellar 2Q21 performance exceeded street’s EBITDA estimates.

  • In 2Q21, Bharti Airtel reported EBITDA of Rs 118.5bn (+32% y-o-y, +11% q-o-q), clearly beating consensus expectations of Rs108.7bn. EBITDA margin improved from 44.4% in 1Q21 to 46.0% in 2Q21. Amidst a strong rise in EBITDA primarily led by a resilient operating performance across all segments, Bharti Airtel recorded a net loss of Rs 7.6bn, narrowing from Rs159.3bn in 1Q21.The loss stemmed from
    1. Rs37.6bn in finance expenses which now includes the interest from Rs234bn AGR (Adjusted Gross Revenue) dues,
    2. write-off of Rs 1.8bn for the Airtel Ghana stake and,
    3. higher taxes of Rs5.5bn.

Strong subscriber addition driven by market share gains and migration to 4G services from 2G.

  • In 2Q21, Bharti Airtel’s net subscriber addition was 13.9m reaching a mobile subscriber base of 293.7mn (+5.0% q-o-q). Moreover, the 4G customers in Bharti Airtel stood at 152.7m (+14% q-o-q) and as a percentage of the overall customer base, 4G customers represented 55.2% (from 53.3% in 1Q21), implying an increase in the conversion from 2G to 4G network.
  • Net additions of 4G customer base in Bharti Airtel was at 14.4m vs. 7.3m in Reliance Jio and 1.5m in Vodafone Idea. Bharti Airtel’s 4G coverage is now ~94.5% of the country’s population.

A second increase in tariffs is inevitable for the survival of Vodafone Idea.

  • The market’s perceived uncertainty regarding the next tariff hike due to the COVID-19 general economic downturn, unfounded concerns over an impending war on postpaid plans and fears of an early 5G launch have led to a ~20% drop in Bharti Airtel’s share price over the last five months. However, a second increase in tariffs is inevitable for the survival of Vodafone Idea. Consensus estimates that a 15-20% hike in tariffs is needed in the immediate term for Vodafone Idea to survive. The other concerns do not carry much merit either. Bharti Airtel’s corporate postpaid subscribers are quite sticky and less price sensitive, and India’s 5G network launch is 18-24 months away.
  • We expect tariff hikes to continue to translate into incremental increases in average revenue per user (ARPU) over FY21/22F. The telco is open for further price increases and its management has indicated that ARPU needs to grow to ~Rs 200 and eventually to ~Rs 300 for a sustainable business model. However, Bharti Airtel will not be the first to opt for hiking tariffs. The industry still has faint hopes that the
  • Telecom Regulatory Authority of India (TRAI) will announce a regulation fixing floor price for tariffs which would take care of the hikes despite the lack of any concrete indication to date. Failing which, the dilemma facing Vodafone Idea is that the telco is not sure that if it takes the first step towards announcing a tariff hike, the other two operators would follow suit.
  • Even if we assume that a second tariff hike does not takes place, we are of the opinion that Bharti Airtel can still reach ARPU of Rs 200 by eventually shifting most of its customers from 2G to 4G. The basic entry plans for 4G subscribers are from ~Rs 200 upwards. Bharti Airtel’s performance over the last year suggests that the telco is actively working on migrating subscribers from 2G to 4G.

Despite a weaker network, Vodafone Idea has taken the lead in tariff hike on a couple of its least popular postpaid plans.

  • The tariff increase was expected, and we view this as a symbolic move by Vodafone Idea that do not wish to risk losing its postpaid subscribers. In September 2020, Reliance Jio enhanced its value proposition of its postpaid plans by adding subscriptions to popular OTT (over the top) platforms.
  • Compared to Bharti Airtel’s similar postpaid plans, Reliance Jio’s latest offerings are much lower and the number of platforms is also much higher. However, we believe postpaid subscribers are sticky and less price sensitive since Bharti Airtel has a higher percentage of corporate clients. Instead, it is likely that Reliance Jio’s own prepaid customers may opt to convert to postpaid plans to benefit from the higher data quota and entertainment plans.

In the absence of AGR dues during the quarter, losses in 2Q21 narrowed to Rs 7.6bn; remaining payments to be staggered over ten years.

  • On 01 September 2020, the Supreme Court requested telco players to make 10% of the upfront payment of their dues before 31 March 2021 to the Department of Telecommunications (DoT), with the remaining to be paid over 10 years starting 1 April 2021.
  • Bharti Airtel has paid US$2.4bn to date on AGR dues, versus overall unpaid dues of USD6.4bn. Compared to the heavy burden of immediate payment as per previous rulings, this is an immense relief for Bharti Airtel. This is much-anticipated good news for SingTel since the telco holds a 31.9% stake in Bharti Airtel.

Worst should be over in FY21F for SingTel's core telecom business in Singapore and Australia

We project SingTel's FY21F core EBITDA from Singapore and Australia to decline by 23% in FY21F to S$3.5bn but stabilise in FY22F.

  • We project a decline of ~S$700m in Optus’s EBITDA in FY21F (out of a S$1bn decline in core EBITDA) due to;
    • ~A$250m drop in NBN migration fee in FY21F,
    • losses on equipment sales of another ~A$250-300m,
    • ~A$100m rise in traffic costs in FY21F as more customers switch to NBN. However, in FY22F we expect Optus’s EBITDA to stabilise despite another A$360m drop in NBN revenue due to;
    • absence of equipment losses in FY22F and,
    • recovery in roaming revenue, coupled with fast 5G rollout.
  • Many countries are hopeful that a viable COVID-19 vaccine will be available from early FY21F onwards. However, The World Travel and Tourism Council has indicated that once the COVID-19 outbreak is over, it could take up to 10 months for the tourism industry to fully recover. The slow recovery in inbound and outbound travel is likely to prevent mobile service revenues from recovering in FY21F.
  • In FY22F roaming revenue is likely to grow by ~60% compared to FY21F as travel apprehension by both business and leisure tourists slowly lifts. Prepaid mobile revenues too might grow by 10% partly due to some of the foreign workers returning, despite tourism taking longer to recover. As such, as the impact of COVID-19 wanes, we project SingTel’s core EBITDA to stabilise in FY22F.

In 1H21, core EBITDA from Singapore and Australia declined by 19% to S$1903m.

  • Optus was the biggest culprit as its EBITDA dropped by 30% to A$977m. This reflected structural weakness in its Australia fixed line business amid migration to NBN, coupled with lower equipment sales and COVID-19 weakness. Half of Optus’s EBITDA drop can be explained by lower fixed-line margins and a A$73m drop in NBN migration fee. The rest of the drop can be tied to handset losses and COVID’s impact on roaming and prepaid revenue. Optus headed into losses of S$22m in 1H21 compared to a profit of S$239m in 1H20. However, due to operational improvements, we expect EBITDA to stabilise at SingTel’s Australian business in FY22F.
  • EBITDA from Singapore took a hit largely due to COVID-19 weaknesses as roaming revenues and pre-paid revenues plummeted. Apart from that, customer shift to SIM-only packages and weaknesses in non-information and communications technology (ICT) revenues had an impact on its Singapore operations. We do not expect these weaknesses to worsen in FY22F and project FY22F EBITDA from Singapore to stabilise.

5G commercial deployment in FY21F to be the silver lining for the mobile segment; revenues to be buoyed by 5G over the next five years.

  • On 8 October, SingTel launched Singapore’s first 5G standalone (SA) trial network for enterprises. The network, which utilises 3.5GHz spectrum and Massive MIMO (multiple-input multiple-output) technology, provides enterprises with early access to 5G to develop and trial 5G solutions. However, despite the 5G rollout slated to start from end-2020 onwards, Infocomm Media Development Authority (IMDA) states that only ~50% coverage will be possible by 2023 as the key 5G spectrum 3.5GHz will be available for use only by 2021.
  • The 5G rollout will be much more gradual compared to 4G. For example, 4G network coverage requirement for TPG Telecom was 100% nationwide outdoor coverage in just 12 months of spectrum rights commencement. The slower rollout can be explained by a lack of decent revenue opportunity in the consumer space despite high 5G capital expenditure (capex) requirements.
  • In November 2019, Optus launched its 5G network for the home and mobile with 290 5G sites. Optus had rolled out over 900 5G sites by October 2020.

With the dawn of the 5G era, SingTel might not want to continue with 100% payout ratio in FY22F.

  • SingTel’s management has indicated that the Group’s FY21F capex (including 5G networks) will be ~S$2.2bn, comprising A$1.5bn (S$1.5bn) for Optus and S$700m for the rest of the Group. Whilst Singapore’s capex roll-out is expected to be gradual, the same is not expected in Australia.
  • In August 2020, Telstra’s outlined the telco’s 5G rollout and coverage plans with 75% of the Australian population targeted to access its 5G services by June 2021. To achieve this ambitious target, Telstra brought forward A$500m of capex into 2020. Telstra has guided for FY21F capex of A$2.8-3.2bn for FY21F, which is ~2x of Optus’s capex expectations in FY21F.
  • See also recent report: SingTel - DBS Research 2020-11-13: Relief From 100% Payout Ratio In 1HFY21.
  • With Australia’s 5G capex commitment falling due, SingTel is unlikely to pay more than 90% of its underlying profit as dividends. As such, we project FY21F/22F dividend of 10.9 cents/11.5 cents for SingTel based on 100%/90% payout ratio respectively with a scrip dividend scheme in place.

Australian tower, non-core, data centre and digital businesses could be divested.

  • SingTel plans to divest its telco towers in Australia which are worth a total of ~S$1.97bn (A$2.0bn). Plans are underway for a sale and leaseback of Optus’s towers worth ~S$1.97bn. Optus has over 2,500 towers spread across over 1,000 regional towns as per the telco’s website.
  • The funds from the deal is expected to be utilised to improve Optus’s 4G regional coverage and fund its 5G network rollout without further burdening the balance sheet. However, one of the potential risks of a sale and leaseback is the possibility of opening up the towers to external tenants such as Vodafone Hutchison Australia or TPG.

Non-core business is worth S$1.4bn or 8 cents per share.

We value SingTel’s digital businesses, comprising Cyber-Security and Digital Life at S$1.7bn or 10 cents per share.

  • The Cyber-Security segment is valued at S$437m, based on enterprise value/revenue (EV/revenue) of 1.0x, pegged to a 60% discount to peer average to account for the lack of profitability of SingTel’s cyber-security operations.
  • The Digital Life segment, which largely comprises the Ad-Tech firm Amobee group, has been valued at an EV/Revenue of 1.05x, at a 30% discount to the average valuations of recent acquisitions in the Ad-Tech space.

We value SingTel’s data centre business at S$2.0bn or 12 cents per share.

  • Pure-play data centre (DC) operators fetch an average EV/EBITDA valuation of ~20x while telcos fetch a valuation of ~7x, suggesting 60-70% undervaluation of DC assets held by telcos. Pure-play DC operators tend to structure their business in the form of real estate investment trusts (REITs), yielding tax efficiencies and higher distributions for its owners. This creates a natural premium due to higher cash flow transparency boosting the market value. As evident from US telcos Verizon and Century Link divesting their data-centre businesses, telcos are better off divesting their data-centre business at much higher multiples than their core businesses to book significant gains.
  • In terms of gross leasable area (GLA), we estimate that its portfolio stands at over 1.5msf worldwide based on available data. Assuming 45% utilisation of (generally ranges from 30-50%) and mid-point psf (Hong Kong and Singapore: S$3,700 psf, Australia: S$2,400 psf) established from peer comparison, we value SingTel’s portfolio at S$2.0bn.

Maintain BUY on SingTel with an upgraded target price of S$2.75.

Sachin MITTAL DBS Group Research | https://www.dbsvickers.com/ 2020-12-07
SGX Stock Analyst Report BUY MAINTAIN BUY 2.75 UP 2.690