Axiata and Telenor are in a non-binding discussion to merge their 11 OpCos in 9 countries to be largest in the region. The rationales include (1) stronger balance sheet; (2) operational synergies; (3) solid cash flow; and (4) digitalization. We opine that this is a positive development for the sector but not without regulatory risks and business conflicts. Axiata is expected to gain more although this will beneficial to Digi as well over the long term. Maintain NEUTRAL with TIME (BUY, TP: RM10.14) as our sole top pick.

NEWSBREAK

Axiata and Telenor are in discussions to establish a new merged global entity by combining their ASEAN and South Asia footprint markets. There is no certainty that this will results in any binding agreement of obligations on the parties to proceed with any acquisition, merger or divestment.

11 OpCos in 9 countries. From Axiata’s stable, Celcom (Malaysia), Ncell (Nepal), XL (Indonesia), Smart (Cambodia), Dialog (Sri Lanka) and edotco are involved. Meanwhile, Telenor offers Digi (Malaysia), Grameenphone (Bangladesh), Telenor Pakistan, dtac (Thailand) and Telenor Myanmar. Axiata will exclude Idea (India), Robi (Bangladesh) and Axiata Digital from the deal.

A global champion. The intention is to list the MergedCo on Bursa Malaysia and another major international exchange within the next few years. MergedCo will include a Malaysian champion, a global towerco and the largest innovation in the region, all to be headquartered in Malaysia. MergedCo’s proforma: RM50bn revenue, RM20bn EBITDA and 300m subscribers.

Rationale. (1) Strengthen balance sheet to support aggressive growth; (2) RM 15- 20bn incremental value in synergies; (3) strong cash flow generation; and (4) accelerating vision of digital champion.

The split. Telenor will own 56.5% of MergedCo while Axiata’s stake is the balance of 43.5%, subject to adjustments and due diligence. Target to achieve a binding agreement by end of 3Q19.

HLIB’s VIEW

A good move. Despite the scarcity of information, we are pleasantly surprised by this development. Market consolidation usually leads to (1) healthier market rivalry; (2) improved operational leverage; (3) effective capex spending (no duplication); (4) more procurement bargaining power; and (5) hostility in spectrum auctions will be greatly reduced.

Regulation risk. Malaysia is the only overlapping market in this proposed deal. The combination of Celcom and Digi will lead to a largest telco with revenue and subs market share of 35% and 47%, respectively and potentially attract scrutiny from the perspective of anti-competition. Together, they will also hold 43% of the operating TDD airwave in the market and there are uncertainties surrounding how MCMC will handle spectrum distribution upon M&A.

Conflicting interests? Axiata may end up with conflicting stakes in Grameenphone (via MergedCo) and Robi who are top 1 and 2 competitors in Bangladesh. Other Robi shareholders, namely Bharti (25% stake) and NTT Docomo (6.3% stake), may not favour this scenario.

Who has a better deal? We think that Axiata is better positioned and this proposed corporate exercise allows it to crystalize the true value of its assets. Besides, those OpCos will be better-managed going forward under the combined experience and knowledge from the parent companies. As for Digi, the consolidation with Celcom may lead to short term indigestion due to the huge duplications in terms of assets (towers, infrastructure, etc) as well as human capital. We do not discount that the merger may lead to asset impairments and one-off restructuring costs. However, we are still positive on the amalgamated Digi-Celcom over the long run.

Forecast. Unchanged for now pending further guidance from companies.

Maintain NEUTRAL. Telco sector remains stable supported by resilient domestic demand. Their dependable dividend yield will be a plus point in a volatile market.

Top pick is TIME (BUY, TP: RM10.21). Although our call and TP are unchanged, we remove Digi (BUY, TP: RM5.00) as top pick for now due to the concerns as mentioned above.

Source: Hong Leong Investment Bank Research - 7 May 2019