Investment Highlights

• Complexities derailed mega-merger discussions. Axiata Group and Telenor Asia, which has a 49% equity stake in Digi.Com, have mutually agreed to end discussions for a merger of their telecommunications and infrastructural assets in Asia after 4 months of due diligence and finalising the transaction details. While this stems from undisclosed complexities in the proposed mega-merger, the parties do not rule out a future deal given the strategic rationale.

Recall that the proposed merger, the largest in Asean, will have pro-forma revenue of over US$12bil (RM50bil) and EBITDA of over US$4.8bil (RM20bil) with operations in 9 countries servicing 300mil customers. Subject to adjustments, Telenor would have been the majority shareholder of the merged entity with an equity stake of 56.5% while Axiata could own 43.5%. The merged entity would emerge as the largest cellular operator in Malaysia, Nepal, Cambodia, Myanmar, Sri Lanka and Bangladesh. It would be ranked second in Indonesia and Pakistan while being the third largest player in Thailand.

• Back to the drawing board. Based on Axiata’s teleconference call on Friday, management aims to continue focusing on profit growth vs. acquisition of revenue market share, and maintain strict costs discipline with a 5-year target to secure opex and capex reductions of RM5bil. The group plans to reprioritise investments with long payback period, fund new growth investments via strategic partnerships and monetise existing investments such as tower company, edotco, which had been planning for an IPO earlier this year.

While the group claims that it is still looking to accelerate structural changes via industry consolidation, management says Axiata is currently not revisiting a potential merger with TM. Axiata is currently exploring partners other than TM in rolling out its fibre broadband services.

• Derating catalysts from earlier expectations of merger’s cost optimisation. As we were earlier positive on this deal, its termination consequently means the reversion to the previous state of intense mobile domestic competition between the 5 existing players – Maxis, Celcom, Digi, U Mobile and Unifi Mobile, excluding mobile virtual network operators (MVNOs) such as REDtone, which are currently offering highly attractive postpaid plans.

Now that Celcom and Digi will no longer be impeded by merger preoccupations over the next 2 years, Maxis may no longer have as much of a free hand to pursue its converged fiberised solutions for its consumer, enterprise and business segments.

• Expect re-emergence of mobile wars. Given that mobile competition will remain just as intense as over the past 4 years, we expect continuing pressure on ARPUs and subscriber trajectory, even though 2Q2019 subscribers have recently flipped to a net sequential accretion of 77K after 4 years of continuous contractions.

As such, we have lowered Digi’s fair value to RM4.80 (from an earlier RM5.45/share) by reducing its terminal growth rate from 2% to 1%. Likewise, we have revised Axiata’s fair value to RM5.00 (from an earlier RM5.40/share) by lowering its FY20F EV/EBITDA target to 5.5x (based on its 3-year average) from an earlier 6x.

• Still negative on the rollout of the National Fiberisation and Connectivity Plan (NFCP) over a 5-year period from this year to 2023. The NFCP rollout could cost RM21.6bil, of which half may be financed by the MCMC's Universal Service Provider fund that currently holds RM8bil.This is in line with the government's objective to recognise access to the internet as a basic right, ensuring equal access to the internet for both urban and rural residents.

Given TM's role as the national broadband provider, the group will likely bear up to half of the NFCP cost, which translates to RM2.2bil over the next 5 years. Besides TM's own capex requirements, the NFCP rollout alone translates to 19% of FY20F revenue – already above management's FY19F capex target of 18% and 8% in 1HFY19. Additionally, the thrust of the NFCP towards connecting the rural population could mean that revenue accretion from these investments will be minimal.

• Downgrade outlook on the sector to NEUTRAL from OVERWEIGHT given the cessation of earlier synergy expectations from sector consolidation and alleviation of price competition that has been eroding the sector’s margins over the past 3 years. Following our lower fair valuation for Axiata and Digi, we have downgraded our calls on the 2 stocks to HOLD.

TM remains burdened by huge capex requirements being the principal operator for the NFCP rollout while Maxis will need to demonstrate a stronger bottom line performance next year under its convergence agenda to catalyse any further rerating.

Source: AmInvest Research - 10 Sept 2019