We are maintaining our NEUTRAL call on the telecommunication sector call in view of: (i) intensifying competition, especially in the prepaid segment, (ii) potential margins pressure as a result of the higher customer acquisition costs (via heavy handset's subsidies), and (iii) higher marketing costs to retain market share which may further pressure profitability. The continued growth of the tier-2 celcos as well as the entry of two muscular MVNO players could lead to the big telcos facing intensifying competition in the prepaid segment. While celcos believe the upcoming GST implementation could allow players to execute the prepaid tax pass-through scheme, there is a possibility that the authority may request the incumbents to continue the subsidies, in our view, given the rising cost of living, hence neutralising the earnings impact. Valuation-wise, there is no change in our telecommunication companies FY13-FY14 earnings forecasts. Telekom Malaysia (OP, TP: RM5.94) is our top pick for the sector due to: (i) its solid presence in the FTTH market, (ii) lesser competition in its wholesale and fixed-line segment, and (iii) it is a key lagging index mover YTD. We are maintaining our MARKET PERFORM calls on Maxis (TP: RM7.32); Axiata (TP:RM6.70) and Digi (TP: RM5.24). Meanwhile, we reiterated our OUTPERFORM rating on Redtone with unchanged fair value of RM0.81.

The availability of LTE-FDD/TDD network convergence could provide opportunities for spectrum starved players, especially Digi, to improve and balance their spectrum portfolio. We believe mobile incumbents are likely to enter smart partnership/network sharing agreement, if any, instead of outright acquisitions of spectrums from rivals.

Neutral impact on GST implementation. At first glance, the upcoming GST implementation could benefit the Celcos (if the subscribers' usage behaviour remains unchanged) given that the mobile incumbents would be able to pass through the prepaid service tax to the prepaid users. Nevertheless, we are neutral on the potential impact given the possibility for the government requesting celcos to continue subsidising the prepaid service tax in view of the rising cost of living. Note that, the authority had previously been using a similar reason to deny the tax transfer to prepaid users in late 2011.

Newbies in MVNO set to compete with big telco. Telin, a subsidiary of Indonesia largest telco operator – Telkom Indonesia, has recently entered into a MVNO agreement with Maxis to provide prepaid services for the foreign immigrant market, especially the Indonesian community in Malaysia. Meanwhile, Altel Communications S/B (or formerly know as Puncak Semangat S/B), is another MVNO player via a partnership with Celcom Axiata. The group was reportedly aiming to become a full-fledged telco once its own infrastructure is in place to roll out 4G broadband services.

Intensifying competition in the prepaid market. The aggregate of the total tier-1 local celco companies (i.e Maxis, Celcom Axiata, and Digi) subscribers’ net adds have continued to shrink for the two consecutive quarters. To a certain extent, we believe the drop was mainly led by the migration of the lower prepaid subscribers to U Mobile and other MVNO players. Going forward, the segment competition is expected to heat up in view of more muscular MVNO players (i.e. Telin & Altel) entering into the prepaid market, albeit the impact should be minimal during the initial stage.

Digi’s Business Trust listing may be a neutral affair after all. While Digi continues to remain silent on its BT feasibility study progress, the proposed structure could turn out to be a double-edged sword, in our view. Although the move could improve its dividend payout via its strong operating cash flow, the impact could be neutralised should Digi intends to raise fresh funds from the capital market. Under the above scenario, existing shareholder's interest are likely to be diluted (should the share dilution impact is higher than the dividend improvement), thus positioning Digi for a de-rating over the long term. 

Source: Kenanga