• Axiata has signed a definitive agreement with Sinar Mas to proceed with the merger of PT XL Axiata Tbk, PT Smartfren Telecom Tbk and Smartfren’s subsidiary PT Smart Telcom in Indonesia.

• Post-merger, Axiata’s stake will be reduced to 34.8% from 66.5%. Positively, the deconsolidation of XL Axiata will reduce its gearing level to 0.7x from 1.2x.

• The company expects to recognize a pro forma gain of RM445mn from the transaction. However, the merger itself is not expected to be earnings accretive in near term as Smartfren is loss-making.

• Maintain a HOLD call with an unchanged TP of RM2.50. Our TP is based on sum-of-part valuation with each of the operating company valued using EV/EBITDA metric.

XLSmart: Axiata and Sinar Mas Join Forces

Axiata announced the signing of a definitive agreement with Sinar Mas to advance the proposed merger of PT XL Axiata Tbk (XL Axiata), PT Smartfren Telecom Tbk (Smartfren) and Smartfren’s subsidiary, PT Smart Telcom (SmartTel), in Indonesia. This announcement comes as no surprise, given that discussions have been ongoing since 2021. To recap in May 2024, the group had entered into a non-binding agreement with Sinar Mas to explore merging their Indonesian units, XL Axiata and Smartfren. The merger aligns with the Indonesian government’s goal of reducing the number of telecom operators to three to enhance efficiency and foster healthier competition. The new entity will operate under the name PT XLSmart Telecom Sejahtera Tbk (XLSmart). With a combined mobile subscriber base of approximately 94.51mn (27% of the local market share), XLSmart aims to deliver seamless connectivity, innovative digital solutions, and strategic investments in advanced technologies such as 5G, artificial intelligence, cloud services and cyber resilience. The merger is expected to result in pro forma revenues of IDR45.41tn (USD2bn) and EBITDA of IDR22.42tn (USD1bn). The transaction is anticipated to be completed by 1H25.

Axiata's Stake Reduces to 34.8%

In terms of the shareholding structure, the merger will result in a 72:28 equity value split between XL Axiata and Smartfren, with XL Axiata being the surviving entity and remaining listed on the IDX. As part of the merger, XL Axiata will issue new shares to Smartfren shareholders based on the agreed ratio. Following the merger, Sinar Mas will hold a 21.7% stake in XLSmart, while Axiata will retain 47.9%. Concurrently, Sinar Mas will acquire an additional 13.1% stake in XLSmart from Axiata for a cash consideration of USD 400mn (RM2bn) upon completion of the merger, and USD 75 million (RM351mn) on the first anniversary, subject to certain conditions. After the transaction, both Axiata and Sinar Mas will each own a 34.8% stake in XLSmart, becoming joint controlling shareholders with equal influence over the company’s strategic direction (see Chart 2). Note that pre-merger, Axiata held a 66.5% stake in XL Axiata (see Chart 1) Axiata's Stake Reduces to 34.8%

XLSmart Merger to Tap Broadband Growth Potential

Axiata guided several key rationales for the merger:

i) XLSmart will gain enhanced scale and strength, transforming Indonesia’s mobile sector into a three-player market

ii) Expected to realize annual pre-tax synergies of USD 300–400mn postintegration.

iii) The partnership leverages Axiata’s regional telco expertise and Sinar Mas’s local market knowledge, providing strong ecosystem support.

iv) The merger is anticipated to drive ARPU growth, as Indonesia’s ARPU currently lags behind regional peers, following trends observed in previous consolidations.

v) XLSmart will be better positioned to capture growth opportunities in the Home and Enterprise segments, further strengthening its financial resilience and market competitiveness.

Note that Indonesia’s broadband penetration, currently at 21%, lags behind regional counterparts such as Malaysia (52%), Thailand (52%), the Philippines (30%) and Cambodia (21%), reflecting significant growth potential. According to Opensignal data, one in five Indonesian mobile users did not connect to the internet via Wi-Fi last year, while 22.5% connected rarely (less than 10% of the time). However, access to Wi-Fi services has been increasing, with mobile users spending more time on fixed broadband services, rising from 33% in Q1 2022 to 37% in Q3 2024. Wi-Fi usage varies significantly across regions, with some kabupatens (regencies) in Sumatra, Sulawesi, and the Maluku Islands spending less than 30% of their time on Wi-Fi, while kabupatens in East Java often exceed 50%. This highlights the growing importance of reliable fixed broadband connectivity in Indonesia and we believe the merger will support better revenue contributions in the broadband segment.

In terms of compatibility, XL Axiata with a substantial subscriber base of 59bn (16% market share) and is transitioning into a converged mobile, fixed, and content service provider. Meanwhile, Smartfren, with 36bn subscribers (10% market share), specializes in data services and affordable plans, catering to a distinct market segment. We believe the merger of XL Axiata and Smartfren has the potential to create a more comprehensive service provider, delivering a diverse range of services and effectively addressing various market needs. However, even with a combined market share of 27%, XLSmart will still trail behind Indonesia’s two leading telco players, Telkomsel (45%) and Indosat (27%) (refer to Chart 7). Hence we think that Telkomsel continues to hold the largest pricing power, bolstered by its dominant mobile subscriber base.

Earnings Dilution Expected but Stronger Market Position Ahead

Note that the transaction is expected to result in a value accretion of approximately USD 0.2bn (RM 0.9bn) for Axiata, with further upside anticipated once synergies are realized. Pre-merger, the value of Axiata’s stake in XL Axiata was USD 1.2bn (RM 5.3bn) (see Chart 9). Post-merger and equalization, the value of Axiata’s stake in XLSmart will be USD 0.9bn (RM 4.0bn), supplemented by an equalization payment of USD 400mn (RM 1.8bn) upon completion of the merger and USD 75mn (RM 331.8mn) on the first anniversary, subject to certain conditions. This brings the total value to Axiata to USD 1.4bn (RM 5.2bn), reflecting the accretive nature of the transaction.

Based on our calculations, the deconsolidation of XL Axiata will lead to a 40.1% decline in revenue (see Table 1). Furthermore, the equalization payment of USD400mn (circa RM2.1bn) at completion of the proposed merger will be channeled towards debt repayment. We estimate this will result in a 7.1% or RM143mn reduction in finance costs. However, this will be offset by (i) XL Axiata earnings dilution impact as the share of profit will decline in proportion to the decline in Axiata’s stake in the merged entity, and (ii) immediate earnings impact to XLSmart (as a result of the merger) as Smartfren is loss-making.

Looking at the gearing level, the deconsolidation of XL Axiata will also lead to a lower gearing ratio to 0.7x from 1.2x (Table 3). Overall, we are neutral on the merger due to the anticipated earnings dilution, though we see potential for XLSmart to create a more comprehensive service provider offering a broader range of services to meet diverse market needs.

Maintain a HOLD Call with TP of RM2.50.

We make no adjustments to our earnings estimates at this juncture. We maintain a HOLD call with an unchanged TP of RM2.50, based on sum-of-part valuation with each of the operating company valued using EV/EBITDA metric. We remain cautious due to external risks, including regulatory challenges, geopolitical tensions, execution risks, and unfavorable forex translation, particularly given the macroeconomic conditions in Sri Lanka and Bangladesh. Nevertheless, we believe the company is on track to achieve its FY24 KPIs, targeting midsingle-digit revenue growth, mid-teens EBIT growth, and a capital expenditure of RM6.1bn.

Source: BIMB Securities Research - 12 Dec 2024