KUALA LUMPUR (May 9): Malaysia’s largest telecom company by revenue Axiata Group Bhd (KL:AXIATA) may face earnings pressure from a potential merger of its unit PT XL Axiata with PT Smartfren Telecom in Indonesia, and investors should sell the stock, said MIDF Amanah Investment Bank.

Smartfren is loss-making, which may affect XL Axiata’s profitability, especially in the near term, MIDF said. The research house downgraded Axiata from ‘hold’ to ‘trading sell’, a rating that MIDF says means that the stock price is expected to fall by more than 10% within three months due to negative newsflow.

“While the transaction may strengthen XL Axiata’s subscriber market share, our immediate concern will be on Smartfren’s loss-making position,” MIDF flagged. “Also, should the funding involve cash, it would further burden the group’s balance sheet.”

The downgrade follows a news report that Axiata and Smartfren’s owner PT Sinar Mas are seeking permission from the Indonesian government to merge their units following years of talks. The merger also comes on the heels of the acquisition of Link Net, another Indonesian mobile telecom company.

For months now, analysts have been broadly cautious on Axiata’s prospects even as the stock racked up 20% year-to-date gains.

Out of 25 analysts covering the stock, nine recommend ‘hold’, and six have Axiata on ‘sell’ rating, while the remaining 10 tell investors to ‘buy’ the stock. The consensus 12-month target price is RM2.74, according to Bloomberg.

Smartfren suffered a net loss in 2023 totalling 108.9 billion rupiah (RM32.2 million), and the merger with Smartfren “would create more pressure for the management to improve the profitability of XL Axiata, MIDF said.

Further, the merged entity — which would command 94 million subscribers — would still not be large enough to dethrone the top two telcos in Indonesia — Telkomsel that has 153 million subscribers and Indosat with 100 million subscribers, MIDF said.

Axiata, controlled by sovereign wealth fund Khazanah Nasional Bhd, has been shedding assets and acquiring new ones as part of an effort to boost its profitability. The company has announced the sale of its businesses in Myanmar and Nepal.

Further, Axiata is now combining its Sri Lankan unit with India’s Bharti Airtel Ltd in a deal that has also raised earnings concerns among analysts.

The transaction in Indonesia, coupled with that in Sri Lanka, “may create earnings volatility for the group in the near term”, MIDF warned. “We do not favour the potential earnings uncertainty for the Axiata group, which may lead to a lower dividend payout.”