We reiterate our NEUTRAL call on the telecommunication sector. The Government’s decision to optimise revenue from telco spectrum via a redistribution and bidding process may pose a great challenge to the sector’s incumbents. While the details of the plan have yet to be unveiled, the latest decision of the authority suggested that operators may need to allocate more funds to retain spectrums. Thus, in view of the hefty funds required ahead, we scaled down our fairly neutral view on the sector operators’ prospect. Although we make no changes to all our telco companies’ FY15- FY16 earnings estimate, we have trimmed all our celcos’ target prices as well as their standard deviation level by 1.0x to reflect the latest change in government policy. Telekom Malaysia’s (TM) targeted standard deviation, meanwhile, has been lowered by a lower 0.5x as we believe the spectrum re-farming exercise may have a lesser impact to the group. TM (OP, TP: RM7.00 (lowered from RM7.33 previously)) remains our favourite pick for the sector given: (i) the lesser competition in its fixed-line broadband business, and (ii) potential better-than-expected synergies from P1. We continue to favour Axiata (OP, TP: RM6.30 (from RM6.92 previously)) post the proposed acquisition of Ncell which could provide immediate earnings accretion to the group. Meanwhile, we are keeping our MARKET PERFORM ratings on Digi (TP: RM5.15 (from RM5.60 previously)) and Maxis (TP: RM6.31 (from RM6.48 previously)).

The end of “beauty contest”. The government will optimise revenue from the telecommunication spectrum through a redistribution and bidding process which will be implemented soon, according to the Prime Minister Datuk Seri Najib Razak. Meanwhile, the authority also shared its intention during yesterday’s 2016 Budget Recalibration to develop several strategic areas owned by the Government through a bidding process to invigorate economic activity. The introduction of tender process on spectrum suggested that the authority may terminate its usual practice of allocating spectrums through the beauty contests method. Note that, beauty contests are an extension of a tender process. In a beauty contest, applicants for an assignment are assessed only based on their experience and technical and commercial proposal.

Statement falling short. The short statement above, however, did not elaborate further on the details of the plan, which include: (i) spectrums involved (i.e. fixed/mobile spectrums and its frequencies), (ii) bidding process, (iii) timeframe, and (iv) bidder’s qualifications. The statement has surprised the market negatively which led to the local celcos’ share prices plunging by 4% – 8%. TM’s share price, meanwhile, was relatively stable but still lower by nearly 2% yesterday. Potential winner and loser. All the telco operators will be on the losing end should the authority impose a tender scheme under the upcoming spectrum re-farming exercise. Operators are expected to allocate additional capex if they intend to participate in the spectrum auction and thus, may leave operators no choice but to revise subscription plans in the future. On the fund raising capability front, unlike TM and Digi, both Maxis and Axiata’s latest gearing are close to their respective optimal capital structure, suggesting limited room to gear ahead. As a result, we do not discount that operators may consider raising fund through assets’ rationalisation or lowering their respective dividend payout to preserve cash moving forward. Sector de-rating may be underway. Although the government has yet to unveil the details, we believe the message could deliver a de-rating element to the sector in view of the hefty funds required ahead. While we are maintaining all our telco companies’ earnings forecast for now, pending their upcoming 4QCY15 result review, we have scaled down our fairly neutral view on the sector players’ prospect.

Leveraging each other strengths. On a separate announcement, TM’s subsidiary - Packet One, has entered into a domestic roaming services and facilities agreement with Celcom Axiata to effect the roaming arrangement. The collaboration agreements will enables P1 to provide Domestic Roaming services. At the same time, the Infrastructure Collaboration agreements with Celcom, Celcom Mobile and Celcom Networks will allow TM to provide wholesale arrangement on fiber backhaul connectivity through its Next Generation Backhaul (NGBH) Services and High Speed Broadband (Access) (HSBA) for Celcom’s mobile access sites and fixed broadband coverage. The proposed domestic roaming agreement is for a minimum five years with an automatic renewal for a further period of five years while the infrastructure collaboration period ranges from one year to ten years based on the services provided. All in all, we are POSITIVE to this latest infrastructure collaboration, which will allow both entities to leverage on each other strengths. Immediate earnings enhancement is unlikely in our view, but we expect the collaboration to contribute positively to both parties over the medium-to-long term.

What’s spectrum? According to the Digital News Asia, Spectrum is a term used to describe the range of frequencies by which the electromagnetic wave is transmitted from one point to another. The information embedded in the spectrum commonly includes radio, TV, cellular voice, and broadband wireless data.

Spectrum re-farming or bidding approaches? We are uncertain about the latest government’s decision as the statement could be referring to the existing spectrum bands and/or the new frequencies. Should the re-farming exercise take place for the existing bands, we reckon it will likely involve the 900MHz & 1800MHz band to align with the Malaysian Communications and Multimedia Commission’s (MCMC) direction. The move could potentially pose a challenge to the big three mobile operators (especially to Celcom and Maxis due to their massive holdings in these spectrums) should the authority include the tier-two players or fixed lines operators into the exercise. The process could turn into a more massive manner under the tendering process, where we do not discount that TM/P1/U Mobile may be interested to grab some allocations in the 900MHz band to strengthen its mobile voice segment. On the other hand, should the bidding process merely involve the new frequencies, we reckon it will likely involve the 700MHz band (currently used for analogue TV transmission) as both Telco and Media players are keeping no secret on targeting this useful lower band spectrum following the completion of the analogue switch off in early 2017. The current spectrum allocations for the 900MHz and 1800MHz frequencies are based on an Apparatus Assignment basis which is renewed on an annual basis (Figure 2). We understand that MCMC has the power to reassign the spectrum upon expiry. Having said that, the award of these frequencies is also tied loosely to the validity of the operators’ NFP (network facilities provider)/NSP (network service provider) licenses. Maxis’ NFP and NSP licenses will remain valid until 30th September 2019 whereas Celcom’s licences will expire on 29th August 2025. Digi’s licenses, meanwhile, will be due for renewal on 17th January 2025.

Spectrum re-farming exercise – A threat to the big cap telcos? MCMC has earlier highlighted that the purpose for refarming the spectrums are to address the network congestion issue faced by the telecom as well as to narrow the gap between the big boys and smaller players. While the authority’s intention appears negative to the big cap telecom players (especially to Maxis and Celcom) at the first glance, the actual operational impact may not be severe in our view. The reasons being are: (i) Cellcos are transmitting their legacy network to SingleRAN, which allow operators to provide seamless mobile services under decent spectrums with single network, (ii) the authority is expected to ensure operators minimize network disruption during the re-farming period, thus suggesting that sudden surge in churn rate is unlikely, and (iii) new network technology may emerge to provide better spectrum management. All in, we believe that the big cap telecom players could potentially surrender some spectrums to the authority, but the impact on earnings will very much depend on the auction results should they decide to participate. Potential beneficiaries for these spectrums re-farming exercise will be Digi, U Mobile and some other smaller players given their relatively lesser spectrum in these frequencies. 

Source: Kenanga Research - 29 Jan 2016