We are keeping our NEUTRAL view on the telecommunication sector. The sector’s service revenue is expected to remain sluggish in view of intensifying competition from both local as well as overseas (i.e. OTT) players. Emerging local partnership with the OTT players could potentially pose some threats to the local incumbents over the mid-to-long term, in our view, should the applications start to offer advanced video/voice functions, bringing mobile VoIP to the mainstream. We expect Digi to benefit the most when GST starts 1st of April 2015, should the country’s prepaid subscribers’ usage behaviour remains unchanged. Meanwhile, Telekom Malaysia (TM) is expected to transform into a full-suite integrated communications service provider in 1Q15. The move, however, is not expected to pose any 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. TM (MP, TP: RM6.92) remains our favourite pick for the sector while we continue to like Digi among the Celcos. We have lowered the sector’s FY15E service revenue annual growth rate to 3.8% YoY (from 5.1% YoY previously) after reducing our voice and SMS growth assumptions in both Digi and Maxis. The slight earnings revision has led us to lower our target prices for both Digi (to RM5.98 from RM6.03 previously) and Maxis (to RM7.16 from RM7.20 previously). We continue to have MARKET PERFORM ratings on both Axiata (TP: RM6.88) and Redtone (TP: RM0.77).

Mobile Incumbents’ service revenue appeared to be under pressure in view of the heightened competition from tier-2/MVNOs mobile players and OTT (Over-The-Top) applications where the country’s top three mobile incumbents’ service revenue slipped by 1.1% to RM16.3b in 9MCY14 (1H14: -0.6% YoY; 3M14: -0.5% YoY). Moving into CY15, while all the telcos have yet to unveil their respective KPI targets, we believe the targets are likely to trend downwards in general. We opine that the sector’s service revenue annual growth rate is likely to grind to a low-to-mid single digit in CY15 (rather than a mid-single digit that recorded previously) in view of the intensifying competition from both local as well as overseas (i.e. OTT) players.

Partnership with the OTT players may pose some threats to the local telecom players over the mid-to-long term, should the applications are powered with more advanced video/voice functions, bringing mobile VoIP to the mainstream. These applications could provide a greater challenge to the local incumbents when the country’s network infrastructure becomes more mature, allowing the applications to operate under a much wider WiFi coverage and bigger data backhaul/capacity. To mitigate the potential impact, we do not discount the possibility of local incumbents imposing fee charges on using OTT applications (such as WhatsApp, Viber, WeChat, Skype and etc.) in the future.

Smartphone trends in 2015. The smartphone wave of 2015 is expected to come with more refined design, faster performance, bigger display, better camera capabilities, and longer-lasting batteries. It will also mark the beginning of the transition to 64-bit for Android, and Qualcomm (the largest chip maker on Android) has started to take the challenge with a vast lineup to produce 64-bit chips from high to the low-end range. With more advanced network infrastructure scheduled to be built coupled with more advanced handset offerings, data demand is expected to be accelerated in CY15. These will ultimately benefit the back haul providers’ (i.e. TM) which have an excess capacity to lease to Celcos for data offloading.

GST implementation. The 6% GST implementation form 1 April 2015 onwards will allow operators to remove tax subsidy for the prepaid subscribers. This could potentially benefit all the Cellcos should the segment subscribers’ usage behaviour remains unchanged. Based on our estimates, Digi will benefit the most which could improve its FY15E net profit by 3.7%, followed by Maxis (+2.7%) and Axiata (+0.9%).

TM - a new integrated communications service's provider. The partnership and collaboration between TM, Green Packet and SK Telecom are expected to enable TM to offer a full-suite integrated communications service in 1H15. While the details of P1’s business plan is only expected to be unveiled in 1Q15, we believe TM is likely to leverage its strength in the fixed-line services (with mobile elements) and targets certain sectors as well as geographical areas. Head-to-head competition with other cellcos is unlikely, in our view.

3QCY14 result's snapshot. Telco players reported mixed set of results in 3QCY14 of which two companies, namely Digi and Maxis, came in within estimates, while the other two (Axiata and TM) failed to meet our, as well as the consensus expectations. The key culprits in Axiata were mainly due to weaker-than-expected Celcom (as a result of the IT transformation) and XL’s performance (due mainly to Axis integration costs) while TM was generally hit by higher-than-expected operating expenditure. Notably, Maxis appeared to be showing some early signs of recovery in 3QCY14 where its service revenue recorded flattish growth instead of persistently declining trend on a QoQ basis. Digi’s performance, meanwhile, continues to outpace its peers and recorded a positive QoQ growth in the service revenue, albeit its annual growth rate target may likely be at the lower-end of its guidance (4%-6% YoY).

Top three mobile incumbents’ service revenues are under pressure. The intensifying competition from tier-2 or MVNOs mobile players (i.e. U-Mobile and etc.) coupled with the increasing popularity of OTT applications have continued to yield pressure to the top three mobile incumbents’ Voice and SMS revenues and led the three mobile incumbents’ aggregate service revenues slipping by 1.1% YoY to RM16.3b in 9MCY14 vis-à-vis -0.6% YoY (to RM10.8b) in 1HCY14 and -0.5% YoY (to RM5.4b) in 3MCY14. Data revenue, meanwhile, is the only segment that recorded positive growth but has yet to provide an adequate cushion to offset the declining trend from both the Voice and SMS segments.

On a corporate front, both Maxis and Celcom’s service revenue trend continued to remain weak. The former was mainly hit by its on-going transformation programme while the latter suffered an IT system glitch. Digi, meanwhile, is the only mobile incumbent that recorded a positive service revenue growth, thanks to its strong data revenue growth on the back of its wider coverage and better network quality.

Moving into CY15 and though all the telcos incumbents have yet to unveil their respective FY15 KPIs targets, we believe the sector’s service revenue annual growth rate is likely to grow at low-to-mid single digit range instead of a mid-single digit enjoyed over the past few years in view of the intensifying competition from both local as well as overseas (i.e. OTT) players. We have lowered our expectation on the industry’s service revenue growth target to 3.8% YoY (vs. 5.1% YoY previously) after lowering voice and SMS revenue assumptions for both Maxis and Digi.

Source: Kenanga