We reiterate our NEUTRAL call for the telecommunication sector. The recent launch of several entry-level bundling packages suggested that Celcos have started to adopt more aggressive market approaches to spur data usage and more importantly, data revenue going forward. Telekom Malaysia (TM) is expected to transform into a full-suite integrated communications service provider by 3Q14 should the group received approvals from the authority to implement a new business plan for P1. The move is not expected to pose an immediate threat to the mobile incumbents, given that TM would continue to focus on its strength in the fixed-line services rather than the mobile segment. Meanwhile, we understand that P1 has some long overdue tax allowance yet to be approved by the authorities. There is no indication provided by the management; however, should P1 receive any form of tax allowances in the future, this will allow TM to reduce its investment cost in P1. There is no change in our FY14-FY15 earnings forecast for all the sector players. TM is our top pick for the sector in 3Q14. Its near-term catalysts include: (i) more traction from HSBB2 project and (ii) potential better-than-expected synergies from its recent acquisition in P1. We continue to have MARKET PERFORM rating on Maxis (TP: RM6.92), Axiata (TP: RM6.96) and Digi (TP: RM5.40). Meanwhile, we reiterate our OUTPERFORM call on small cap telco player, Redtone, with an unchanged target price of RM0.81. We believe the group will continue to gain synergetic benefits created under the NSA agreement with Maxis and may potentially seal more data projects from the government.

Finding ways to drive data revenue. The recent launch of several entry-level bundling packages suggested that Celcos have started to adopt more aggressive market approaches to spur data usage and more importantly, data revenue going forward. With the current low smartphone penetration rate of c.38% in contrast to more than 50% recorded in advanced countries in the region, this suggests plenty of room for Celcos to improve the penetration rate should: (i) more affordable smart devices are available in the market, (ii) lower mobile data plan pricing, (iii) new killer apps/functions emerging to spur users to convert their feature phones to smartphones, and (iv) faster and more reliable network. Data revenue is expected to contribute more significantly (from the current 19%-22% to mobile incumbent’s total revenue) should Celcos implement aggressive strategies in its data segment.

A new integrated communications service's provider in the making? The recent partnership and collaboration between TM, Green Packet and SK Telecom is expected to enable TM to offer a full-suite integrated communications service in Malaysia should the fixed-line giant received a green-light on its new business plan in P1. We understand that TM remains hopeful to complete the exercise by 3Q14.

Potential tax allowances from P1? We understand that P1 has submitted its tax allowance application (related to the qualifying last mile broadband assets) to the authorities but has yet to receive any response so far. While management remains muted on the abovementioned issue (given the application is still under review by the authorities), we understand that the benefits of these tax allowances, if any, can only be utilised if the relevant subsidiaries derive future assessable income. Any tax allowance being granted in the future will help TM to reduce its investment cost in P1.

Threat from TM wireless ambition? Mobile incumbents are generally not overly concerned on the partnership and collaboration agreement between TM, Green Packet and Korea-based SK Telecom. While TM is able to offer a full-suite converged communications service through P1’s LTE technology platform in coming months, mobile operators believe TM strength is still in the fixed-line services and thus, the company would likely to leverage its strength and competitiveness in the mobile segment and target certain sectors as well as geographical areas. Nevertheless, Celcos believe the actual impact can only be accessed after TM unveils its business plan in P1.

1QCY14 result's snapshot. All the local telco players posted respective 1QCY14’s results that came in within our expectations. Similar to the prior quarters, the industry trend generally remains unchanged, where Voice and SMS revenues continued to deteriorate while Data revenue continued to record a strong growth on a year-on-year basis. Maxis’ operational environment remains demanding in view of the current on-going business transformation plan. The group has lowered its service revenue (total revenue minus hubbing and device sales) target to c.RM8.5b (a similar revenue that recorded in FY13), down from the earlier low-single digit annual growth target. Axiata’s short-term outlook remains challenging due to the XL-Axis integration costs and continued currency fluctuation in all its regional key operation companies. Digi and TM, meanwhile, continue to post decent results. The former was mainly driven by better operational efficiency as well as higher market share at the expense of its peers while the latter was mainly led by its data and broadband businesses.

Plenty of rooms to growth in the smartphone penetration rate. Despite Malaysia recording one of the highest mobile penetration rates (CY13: 157.6%) in the region, its smartphone penetration rate merely stood at 37.6% as compared to more than 50% recorded in advanced countries (figure: 1), according to Frost & Sullivan. The low rate suggested that Malaysia could experience a strong growth in the smartphone penetration rate, should: (i) more affordable smart devices (especially in the mid-price range (i.e. c.RM1k/unit) but with premium features) are available in the market, (ii) lower mobile data plan pricing, (iii) new killer apps/functions emerging to spur users to convert their feature phones to smartphones, and (iv) faster and more reliable network.

Introduce more affordable bundled/data plans. Of late, the country’s mobile incumbents have launched several lower entries and innovative bundled service plans (i.e. Maxis’ ONE plan; Digi’s SurfMore 30; and Digi’s YouTube Internet Top Up Package) to spur data usage. With the current deterioration in both the Voice and SMS revenue, mobile incumbents are finding ways to improve its data usage and hence, data revenue. Meanwhile, we also observed that the recently introduced service plans were more focused on bundling with low-to-mid range smartphones rather than the premium devices (i.e. > RM2k/unit). This is not a surprise, given the country’s smartphone penetration rate which has reached 37.6% as of end-FY13, which we believe majority was dominated by the premium smartphones, thus any growth going forward will likely be driven by the low-to-mid range smart devices. As of end-1QCY14, data revenue accounted about 19%-22% of mobile incumbents’ total revenue.

TM - A new integrated communications service's provider. The recent partnership and collaboration between TM, Green Packet and SK Telecom is expected to enable TM to offer a full-suite integrated communications service in Malaysia should the fixed-line giant received a green-light on its new business plan. TM has submitted the detailed business plan in relation to the requisite spectrum to MCMC in late-May for its approval. Management remains hopeful to complete the exercise by 3Q14 and believe through P1, TM can expand its capabilities into wireless broadband space more efficiently and enabling the group to provide a complete portfolio of services to its valued customers. Meanwhile, the group also believes the partnership has laid the foundation for the development of a new LTE platform and opening up possibilities for TM to deliver fully integrated high-quality Internet, data and application across all market segments. We concurred with the management’s view and believe TM is capable to deliver should the group received all the approvals from the authority. Note that, P1 currently has c.2,000 WiMax sites (of which more than 50% are scalable to the next generation (i.e. LTE)) and valuable spectrum assets in both the 2.3GHz and 2.6GHz frequency.

Potential tax allowance from P1? The industry players have generally enjoyed a lower tax rate that falls below the statutory rate (i.e. 25%) over the past few years due to the tax allowances received related to mobile broadband network facilities and qualifying last mile broadband assets. Similar to the industry peers, Packet One Network S/B (P1), an ex-subsidiary of Green Packet Berhad, has also submitted its tax allowance applications to the authorities but has yet to receive any response so far. Based on our observation, Green Packet has spent an average RM200m-RM250m annual capex (on both the operational and network coverage) over the past two years with an accumulated capex spent in WiMax services of more than RM1b. While TM’s management remains hopeful on the tax allowance submission, the group is reluctant to provide any details or guidance at this juncture given that the application is still under review by the authorities.

Note that, TM had on 27 of March entered into an Investment Agreement with Green Packet and SK Telecom to acquire 57% stake in P1 with an initial capital injection of RM350m followed by a series of bond subscriptions and capex allocation of c.RM1.2b over the next three years. Should P1 managed to receive any forms of tax allowance in the future, TM will be able to lower its investment cost in P1 indirectly.

No solid progress in HSBB 2 yet. There is no solid progress on the HSBB2 project given that the discussion with the authority is still on-going. Nevertheless, we understand that TM will be focused on building its coverage in state capitals under the HSBB 2 project. To recap, the government has announced a combination of RM3.4b broadband investment to roll out fibre links (HSBB) for both the urban and suburban areas under the Budget 2014. For the urban areas, we understand that the authority intends to collaborate with the private sector, involving an investment of RM1.8b to increase the internet speed to 10 Mbps, which will benefit up to 2.8m households nationwide. Meanwhile, the HSBB network will also be expanded to suburban areas with internet access speed increased to between 4-10 Mbps, and benefiting 2m consumers at a cost of RM1.6b.

Source: Kenanga