The merger of Idea with Vodafone India should be completed by Aug 18, and Axiata will book in a non-cash impairment of RM3b (either 50% or RM1.5b by 2Q18 or RM3b by 3Q18). We cut target price to RM4.85 to factor in a RM2.5b residual value for Idea, which will cease to be an associate. All in all, we expect the stock to trade sideways given a lack of re-rating catalysts. Downside will be supported by undemanding valuation (- 1SD) and 3% dividend yield. Maintain HOLD. Entry price: RM4.00.

WHAT’S NEW

Merger expected to be completed by Aug-18... Idea (a 16.33%-owned associate of Axiata in India) has been given the approval by the Department of Telecommunications, Ministry of Communications, Government of India (DOT) to merge with Vodafone India. Pending approval by the National Company Law Tribunal (for the dissolution of Vodafone India), the merger is expected to be completed by Aug 18.

...and Axiata will book in an impairment of RM1.5b-3b over 2Q-3Q18. Upon completion of the merger, Axiata’s stake in Idea will be diluted to 8.17% from 16.33%. Thereafter, Axiata will de-recognise and reclassify its investment in Idea from associate to financial investment. A non-cash impairment of RM1.5b (50% impact if merger is completed after Axiata announces 2Q18 results) to RM3b (full impact if merger is completed when Axiata announces 2Q18 results) will be booked in 2Q-3Q18. This is the difference between the carrying value and market value of the Idea stake.

STOCK IMPACT

Keen competition erodes ROIC. Note that: a) the non-cash impairment will not affect Axiata’s ability to pay out at least 50% of net profit as dividends, and b) 2019 earnings would improve vastly in the absence of Idea losses, but the keen competition has eroded ROIC in India. Book value is about RM5.5b and Axiata has only recognised RM1b in associate share of profit since 2009. This pales in comparison to the RM3b merger impairment.

We expect the stock to trade sideways in the near term. Axiata has retraced 21% ytd, and we believe this has partly factored in: a) weak 1Q18 earnings as a result of Idea’s widening losses and Celcom’s higher-than-expected network cost, and b) Idea’s impairment. From hereon, we expect the stock to trade sideways given the lack of key re-rating catalysts. Downside will be supported by undemanding valuation – the stock currently trades at -1SD from its mean 5-year PE of 32x and offers a net dividend yield of 3.3% (based on a 80% dividend payout vs mandate to pay at least 50% of core net profit as dividends).

The deconsolidation of Idea. Post merger, Idea will cease to be equity accounted and will be deemed a financial investment until such time Axiata sees an opportunity to exit. Idea is no longer deemed a strategic investment for the group. Importantly, post merger, quarterly markto-market adjustment on gain/loss on Idea investment will be reflected in the balance sheet and not via profit and loss.

Potential longer-term value creation from the merger entity? Axiata believes that the merger will be in a stronger position to compete effectively in the fast growing market and provides a platform for long-term value creation. As a financial investment, Axiata may exit when the India telco operating landscape improves. In the meantime, the mergeco is expected to have > US$10b in revenue and command a 38% revenue market share in India. This will give the mergeco a #1 or #2 position with strong spectrum position and 3G and 4G footprint.

EARNINGS REVISION/RISK

No change to earnings estimates.

Our 2019 forecast net profit will jump almost 50% to RM1,623m in the absence of Idea losses as we expect the merger to be completed by 3Q18.

Key risks includes: a) prolonged price war in Indonesia, b) international long distance (ILH) revenues falling faster than expected in NCell, and c) regulatory/tax issues cropping up in Sri Lanka, Malaysia and Bangladesh.

VALUATION/RECOMMENDATION

Maintain HOLD with a lower target price of RM4.85 as we factor in the residual Idea book value of RM2.5b (post RM3b impairment to be booked in between 2Q-3Q18). At our target price, the stock trades at 27x 2019F PE and 6x EV/EBITDA. We would accumulate Axiata on price weakness (entry level: RM4.00) on the medium-term turnaround in Celcom and XL Axiata as well as the potential listing of edotco.

Source: UOB Kay Hian Research - 31 Jul 2018