Investment Highlights

• Makes sense. Media reports quoted Michael Kuehner, the CEO of Axiata Group’s wholly-owned Celcom Axiata, as saying that it makes sense to merge Axiata Group and Telekom Malaysia as “a lot of synergy” can be generated with both companies operating large nationwide networks. However, he added that the final decision hinged on their shareholders, of which the major stakeholder Khazanah Nasional owns 38% in Axiata and 26% in TM.

• Swap or SPV? One option could be to inject Celcom into TM through a share swap so that a single company directly owns all the Malaysian-based operations. Hence, Axiata could resume its focus on regional businesses. In the past, sensitivities on security were raised when foreign-based management were involved in the pre-demerged Telekom, operator of the national network, back in 2008. Another option could be the formation of special purpose vehicle (SPV) to acquire Celcom from Axiata and TM’s mobile service unit.

• Reaffirms our conviction call. Recall that we have upgraded our recommendation on both Axiata and TM based on our conviction that a merger between Axiata and Celcom was a value-enhancing proposition, way back on 17 March last year. The driving factors for the re-integration stem from TM's own convergence drive amid a slowdown in the sector's revenues compounded by the difficulties in monetising rapidly increasing mobile data demand.

• Still the fastest path to convergence. Main synergistic benefits from a merger are the complementary suite of services which Axiata's mobile services can integrate into TM's fixed line operations, rendering the domestic roaming arrangement signed between the two parties in February last year irrelevant. With TM’s unifi mobile (formerly webe)) still bearing operating losses and struggling to make a significant dent in mobile market share, Axiata's regional presence will provide a much faster path to TM's convergence strategy to offer a unified suite of services to customers.

• Stronger platform to edge out peers. By offering a converged suite of products, the merged entity is on a stronger platform, poised to draw further mobile market share from the other players Maxis, Digi and U Mobile. Even though such fast revenue growth is only likely to materialise in 2-3 years after the merger (as a 1% revenue improvement translates to a relatively slight RM337mil), we expect improving clarity to top-line prospects to re-catalyse market excitement.

• Low-lying fruits from cost efficiencies. The more immediate earnings impact from a merger will be cost efficiencies from the reduction in redundancies for head office expenses, marketing costs and procurement management. These cost efficiencies can be further augmented by the sharing of facilities and resources. Assuming a 10% cost reduction would mean substantial annual savings of RM2.1bil, 3% of the combined group's market capitalisation.

• No easing in mobile data pricing intensity. We expect further repackaging formulations by the industry against the backdrop of U Mobile’s Hero P78 plan, which offers unlimited data with speeds up to 5Mbps for RM78/month and P99 for unlimited data with no speed caps at RM99/month. In our view, near- to medium-term revenue growth outlook remains weak given the likelihood of further intensification in the mobile wars, with Digi and Celcom likely to raise the ante against both U Mobile’s plan and webe’s unlimited mobile data/voice/SMS pricing plans, currently priced at RM79/month for the first SIM, RM69/month-RM49/month for second to fourth SIM. As U Mobile and unifi mobile wrestle for new customers on the unlimited mobile data arena, we do not discount the possibility of sector earnings cuts if incumbents up the ante to further exacerbate the already intense competition for market share.

• Declining risks from new spectrum offerings early this year. The huge capex speculated earlier on spectrum costs appear to be declining as the 2600MHz spectrum, used for 4G connectivity, which expired on December 2017 has been extended to December 2019. Also, we understand that the MCMC may be extending the 2100MHz band, used for 3G deployment under the spectrum assignment structure, from March 2018 until 2034.

• Sector upgrades only if prospects for stronger earnings momentum materialise. A sector re-rating requires catalysts for stronger earnings growth prospects demonstrated in subscriber, ARPU and margin expansions. As the global landscape for rapid data trajectory is driven by lower price plans and increasingly expensive capex rollouts to provide 4G capabilities, coverage and service quality, any significant organic revenue or margin growth improvement is unlikely over the next 12 months.

• Maintain NEUTRAL call given the continued intense competition in the cellular telecommunications segment while the fixed broadband segment could face rising pressure from the government to cut tariffs to drive a knowledge and IT-driven economy. Our Top BUYs remain Axiata and TM due to the game-changing merger prospect which will significantly enhance their earnings and market share trajectory while Maxis and Digi are HOLDs due to the resistance in gaining traction in revenue growth amid potential loss in competitive advantage under a re-energised Axiata-TM brand.

Source: AmInvest Research - 26 Jan 2018