From  recent  meetings  in  Hong  Kong  and  Malaysia,  we  gather  that  investors  are increasingly  pricing  in  a  potential  downside  in  TM's earnings. The group faces headwinds from: i) new IPTV entrants, ii) margin pressure from higher content cost &  the  expiry  of  equipment  warranties,  and  iii)  potentially  unfavorable  regulatory developments.  We  lower  our  FV  to  RM6.20  (from  RM7.00)  after  cutting  our  core earnings  estimates  for  FY12/13  to  build  in  higher  opex  and  lower  subscriber growth  for  Unifi  in  2013.  The  upside  risks  to  our  forecast  are  the  stronger-than-expected EBITDA margin and earnings going forward. TM's share pricehas fallen by 14% over the past month on the back of the sector's de-rating. At current levels, there is still more than 10% upside to our revised FV. Maintain BUY.  

Investor meetings. We recently brought TM to Hon Kong as part of the Invest Malaysia Hong  Kong  (IMHK) corporate  series.  The  telco  met  up  with  a  good  number  of  investors, comprising both long and hedge funds. The discussions were centered on i) M&A plans, ii) the  procurement  of  additional  content,  and  iii)  dividend  prospects.  While  TM  has  denied submitting  a  bid  for  a  WiMAX  provider,  it  is  open  to  strategic  collaborations  and acquisitions that could add value to its fixed broadband business. We expect TM to tread M&A  opportunities  carefully  as  not  to  compromise  on  its  balance  sheet  and  capital management  headroom.  On  the  Barclays  Premier League  (BPL),  TM  was  keen  to  lodge an  independent  bid  but  decided  otherwise  after  evaluating  other  content  options  on  the table. There was no specific guidance on special dividend payouts although we think TM may re-guide the market post the announcement of its FY12 results in Feb 2013, where it will also unveil a new set of KPIs.  

Unifi  growth  to  decelerate further in  3Q.  TM  conducted a  clean-up  of  its  Unifi  base in 2Q/3Q2012,  which  would  crimp  subscriber  growth  in  3Q12.  The  exercise  is  intended  to expunge  delinquent  customers.  We  estimate  subscriber  net-add  decelerated  further  to 45k-50k in 3Q2012 from 68k in 2Q12 and 79k in 1Q12, with August being a shorter month due to festive closures and the school holidays. That said, gross add number continued to be strong at 900-1000/day despite competition from Maxis. TM should be on track to meet its  target  of  500k  Unifi customers  by  year-end.  On  the  33k customers coming  to  the  tail-end  of  their  24  month  contracts,  TM  said  it  has  good loyalty  benefits  to  retain  these customers.

Business  trust  and  regulatory  developments.  TM  do  not  discount  the  possibility  of transferring related network assets to a business trust to unlock their values but we think this may not be high on its agenda compared to the mobile operators where benefits are more  discernible.  We  believe  the  eventual  revelation  of  the  wholesale  access  pricing framework  by  the  regulator  could  impact  TM  as  it  is  the  incumbent  fixed  broadband operator and the government is keen to promote further competition.

KEY HIGHLIGHTS 

We  recently  brought  TM  to  Hong  Kong  as  part  of  Invest  Malaysia  Hong  Kong  (IMHK)  and  also  hosted  a  few other  group  meetings  with  local  investors.  TM  was  represented  by  Datuk  Bazlan  Osman,  its  Executive Director/Group CFO and Head of Investor Relations, Rohaila Basir. The group met over 15 fund managers and investors in Hong Kong over a full day of meetings.   

Open to M&As. TM said it is open to strategic collaborations and potential acquisitions should they add value to its  overall  fixed  broadband  business.  The  group  is  likely  to  tread  M&A  opportunities  carefully  as  not  to compromise  on  its  balance  sheet  and  capital  management  headroom.  While  TM  recently  dismissed  media reports of a bid for P1, a WiMAX operator, we do not rule out the possibility as P1 would provide access to the valuable 2.3GHz and 2.6GHz/LTE spectrum which would further complement TM's triple play aspirations. In our view, the acquisition would also circumvent additional competition from mobile operators. We note with interest the  P1  CEO  was also formerly the CEO of TM Net, TM's subsidiary overlooking its broadband business. P1 would benefit from TM's stronger branding, marketing, distribution platform and access to content while TM would be able to capitalize on P1's expanding nomadic coverage and its strength within the SME market. 

Vying  for  content  that  is  not  value  destructive.  We  believe  TM  has  explored  the  submission  of  an independent  bid  for  the  2013-2016  BPL  rights.  However,  it  decided  against  making  a  bid  after  taking  into account  commercial  considerations  and  evaluating  other  content  options. We  would  have  viewed  it  negatively should  TM  put  in  a  value  destructive  bid.  The  number  of  Unifi  customers  and  the  modest  take-up  of  premium content (25% of its base) may not justify an iconic investment just yet in our view. TM is also mindful of Astro, the  incumbent  holder  of  the  rights,  which  it  believes  will  go  all  out  to  defend  the  exclusivity.  Astro  reportedly coughed out RM1bn for the rights, a substantial sum considering that TM had budgeted less than RM200m for content in FY12. Content spending totaled RM43m in 1HFY12. 

BPL  for  Unifi  subscribers  if  TM  has  its  way.  We  think  TM  may  be  able  to  procure  the  rights  to  air  BPL matches  if  the  Malaysian  Communications  and  Multimedia  Commission  (MCMC)  decides  to  introduce  a  more cohesive form of content sharing. The government may be compelled to level the access to popular content after receiving complaints from Unifi subscribers who felt shortchanged from the recent 'black-out' of the Piala Malaysia final match on TM's HyppTV by another pay-tv  provider.  The  action  was  perceived  as  an  attempt  to prevent viewers from watching the match via Unifi.

The MCMC had earlier this year ruled that certain sports content of national significance be offered to other pay-tv  providers  on  reasonablecommercial  terms  if  they  are  not  taken  up  by  free-to-air  (FTA)  operators  who  shall have the first rights of refusal. We think TM could also be looking to ring-fence other sports content to preempt competition from Maxis, which is set to roll out its IPTV in 1Q2013 with Astro. TM recently added Fox Sports and three Chinese channels, bringing its total channel line up to 100, which includes 42 pay per view channels and 17  video-on-demand  channels.  We  are  not  overly  concerned  about  the  entry  of  Asian  Broadcasting  Network (ABN) as we think its coverage will be limited in the initial years as most compelling content already procured by Astro and TM.

Unifi growth to slow further in 3Q. TM conducted a clean-up of its Unifi base, which would have a negative impact  on  its  subscriber  growth  in  3QFY12.  The  exercise  is  intended  to  address  delinquent  customers.  We estimate subscriber net-add decelerated further to 45k-50k in 3Q2012 from 68k in 2Q12 and 79k in 1Q12, with August  being  a  short  month  due  to  festive  closures  and  the  school  holidays.  It  has  signed  up  close  to  460k subscribers as at mid-November. We understand Unifi gross subscriber adds remained robust at 900-1000/day despite competition from Maxis.

Our on the ground checks indicate that some users are holding out for better packages to be unveiled by Maxis (bundled  IPTV  content  from  Astro),  which  will  pit  its  plans  directly  with  Unifi. We  think  TM  is  watching  Maxis closely now that the pricing gap on equivalent packages has narrowed (see our report on Maxis dated 22 Oct titled 'Narrowing the Pricing Gap'). TM believes in giving out more for the same price and will continue to place strong emphasis on customer service. On the potential churn arising from subscribers (totaling 33k) reaching the  tail-end  of  their  24  month  contracts,  TM  said  it  intends  to  further  lock-in  these  subscribers  via  attractive retention benefits. 

Moving  up  the  dividend  curve.  After  monetizing  various  non-core  assets  over  the  past  three  years  and actively managing its working capital, TM's ability to pay out special dividends going forward would now be based upon a more effective management of its capex given that HSSB (high speed serial bus) spending will start to level off from FY13. While management has maintained its dividend policy of 'RM700m or 90% of core PATAMI,  whichever is higher' in place since 2008, we believe  TM  would  have  to  re-guide  investors  on  its dividend outlook as its FCF yield is building up, increasing to 7%-8% in FY13/14 from under 5% in FY11. We believe there is still headroom for capital management given that TM's gross debt/EBITDA of 2.1x is still below its longer-term target of 2.5x. 
 
Vast ICT potential. TM sees strong potential within the business process outsourcing (BPO) space in Malaysia and will be looking to increase its revenue contribution from this segment, which currently accounts for <10% of revenue. The BPO business is undertaken by its wholly-owned subsidiary, VADS. It aspires to be a medium for exchange,  being  an  enabler  and  information  aggregation  point  for  customers.  TM  indicated  it  would  provide more details on the potential of the ICT business when its 2013 business plans are finalized.

Playing  an  indirect  role  in  DTTB.  We  understand  that  TM  did  not  submit  a  bid  for  the  digital  terrestrial television  broadcasting  (DTTB)  project  as  it  sees  more  value  as  a  service  provider  as  opposed  to  taking  the lead role as a turnkey contractor to manage the country's migration to digital broadcasting. The project involves the  construction  of  a  common  integrated  infrastructure  comprising  transmission,  network  and  multimedia broadcasting  hub,  for  which  TM  may  not  want  to  commit  unnecessary  resources.  We  expect  TM  to  play  an indirect role in the project as the owner of transmission towers which would be utilized for the broadcasting of digital content. The DTTB contract specifications also include the provision of set-top boxes to consumers. 

3Q12  results  preview. TM will announce its 9MFY12 results on 30 Nov to be followed by an investors' conference call. We expect its revenue to grow 2%-4% q-o-q (+6%-9% y-o-y), driven by its internet and data segments,  while voiced revenue should stay relatively subdued. Although likely to see a deceleration, TM's YTD  revenue  growth  should  still  tracked  ahead  of  its  low-balled  2012  revenue  growth  KPI  of  5%  (1HFY12 revenue  growth  of  9.8%). We  expect  the  group  to  report  flattish  EBITDA on  higher content  and maintenance costs, which allude to slightly weaker EBITDA margin. TM's reported PATAMI should continue to be boosted by the broadband tax incentive (1HFY12: RM188m) which partially offsets its tax expense.   

 
VALUATION & RECOMMENDATION 

Maintain BUY but FV revised to RM6.20. We cut our FY12/13 forecasts for TM by 2%-12% as we factor in higher  opex  assumptions  from  the  expiration  of  warranties  on  Unifi  equipment  and  building  in  higher  content cost. Although TM has decided to give BPL a miss, we expect it to procure more compelling content over the next  few  quarters  to  improve  its  IPTV  franchise  and  to  compete  with  Maxis,  which  is  set  to  roll  out  its  IPTV service bundled with Astro's content in 1Q2013. Our revised forecast models in EBITDA margin of 33.7% for FY12 and 34.2% for FY13.
 
We lower our FV on the stock to RM6.20 from RM7.00 previously on incorporating the revised estimates and pegging a slight lower FY13 EV/EBITDA multiple of 6.5x vs 7x. TM remains a BUY as there is still more than 10% upside to our revised FV, after the recent sell-down.

Source: OSK