Axiata’s Indonesia Unit XL Axiata has entered into a conditional sale and purchase agreement to buy a 95% stake in PT Axis Telekom Indonesia (Axis) for a cash consideration of USD865m, to be funded by a combination of Axiata shareholder’s loan and XL’s external debt. The proposed acquisition is expected to be completed by end-March 2014 or the earliest by the end of CY13. Management expects earnings accretion to materialise in FY15 should the acquisition perform to expectations. We, however, believe the expectation is challenging in view of a short-term transition period. There is no change to our FY13E-FY14E earnings for now. We maintain our MARKET PERFORM call on Axiata with an unchanged target price of RM6.70 based on targeted FY14 EV/forward EBITDA of 8.5x (+1.0 SD).

A spectrum driver deal. Axiata announced that XL Axiata, a 66.5%-owned subsidiary, has entered into a conditional sale and purchase agreement with Saudi Telecom Company and Teleglobal Investments B.V. to purchase a 95% equity stake in Axis for a cash consideration of USD865m (or RM2.8b) to be utilised towards payment for a nominal value for Axis equity and redemption of Axis’ indebtedness; while the remaining 5% will be held by a local Indonesian shareholder. Axis is valued at a 100% enterprise value of USD865m, on cash free and debt-free basis. The proposed acquisition is subject to obtaining (i) all relevant regulatory approvals (includes Ministry of communications and informatics of Indonesia (“MCIT”), Badan Koordinasi Penanaman Model (“BKPM”), and Komisi Pengawas Persaigan Usaha (“KPPU”), (ii) XL shareholders’ approval; and (iii) spectrum retention. The proposed acquisition is expected to be completed by end-March 2014 or the earliest by the end CY13.

Rationale for the proposed acquisition. The propose acquisition is expected to create significant synergies, which include improvement in XL’s 2G and 3G networks quality through the spectrum parity in the 1.8GHz bandwidth, cost savings on capital and operational expenditure through better utilization and redeployment of Axis’ assets. No immediate earnings accretion. Axis recorded net losses of IDR5.48T (or RM1.53b) with a ‘significant’ loss at EBITDA level as at end-CY12. No earnings impact is expected in FY13 given the proposed acquisition is only expected to be completed by end 1Q14. Moving forward, the actual earnings impact will be very much dependent on the successful integration of Axis’ operations and the realisation of synergies from the proposed acquisition. Management indicated that, should the proposed acquisition perform as per expectation, Axis is still expected to incur losses at the EBITDA level in FY14 but expect EPS accretion from FY15 onwards. We, however, believe that it’s a tall order to achieve in view of the short transition period. Meanwhile, the integration costs could potentially eat into XL’s profitability during the initial stage, in our view.

Spectrum retention is THE KEY. While we are generally positive on the proposed acquisition, we believe, the success of the deal will be mainly linked to its spectrum retention issue. Note that, XL currently has a total 7.5MHz in 1.8GHz band and 15MHz in 2.1 GHz band while Axis owns 15MHz and 10Mhz in the above-mentioned spectrums, respectively. The country’s MCIT had previously mentioned that there cannot be two similar companies, which have comparable frequency in one spectrum and thus creating a monopoly situation that is prohibited under the current regulation.

Second largest telco player in making. Upon the completion of the proposed acquisition, the enlarged XL group will have 66.1m subscribers and 22% revenue market share, thus surpassing Indonsat (55.0m subscribers; 18% revenue market share) to become the second largest telco player in Indonesia.

Funding on the proposed USD865m acquisition is expected to be funded by a combination of Axiata shareholder’s loan and XL’s external debt. We understand that XL management intends to use US Dollar as its financing currency tool given the proposed acquisition payment will be settled by US Dollar. While the detail of the funding structure has yet to be finalised, we believe, there is a likelihood for XL to seek funding from Axiata alone given the latter has a strong under-leveraged balance sheet. For illustration purpose, assuming all the acquisition cost is funded by Axiata, its net gearing is expected to increase from 0.22x to 0.34x, on a pro-forma basis, based on the group’s FY12 audited account.

Dividend policy maintained. Both XL Axiata and Axiata group’s dividend policy remains unchanged where XL Axiata is targeting to reward at least 30% of its net profit to shareholders while the latter continuing to have a policy of progressively increasing its dividend payout, subject to the group’s net FCF growth.

Brief background of Axis. AXIS is one of the fastest growing national GSM mobile operator in Indonesia. Since launching its services in April 2008, the company provides 2G, 3G and BlackBerry Services nationwide and covers the world through 382 international roaming partners in 159 countries. Currently, AXIS has more than 80% population coverage in Indonesia, covering Sumatra, Java, Bali, Lombok, Kalimantan and Sulawesi and is also available in more than 400 cities across the country. AXIS HSPA+ Service available in major cities such as Java Island, including Jabodetabek, Serang, Cilegon, Bandung, Semarang, Jogjakarta, and Solo.

Source: Kenanga