Our NEUTRAL view on the telecommunication sector remains unchanged as the heightened competition coupled with the uncertainty of spectrum fees are expected to continue capping the incumbents’ near-term performance. The current price & data quotacentric competition is expected to prolong with the new entrance of Webe in 2H16. Our recent spectrum study suggested that Cellcos’ FY16E core PATAMI could potentially be lowered by 0.7% to 13.0% (on a full-year basis) if we value the combined 900MHz and 1800MHz bands at approximately RM1.6b-RM1.7b. A short-term re-rating catalyst could emerge should the spectrum fee structure renewal results in less financial impact to the incumbents. Valuation-wise, we make no changes to all our telco companies’ FY16-FY17 earnings estimates. We reiterate our OUTPERFORM call on Telekom Malaysia (TM, TP: RM7.20) while keeping MARKET PERFORM rating on Axiata (TP: RM5.81), Maxis (TP: RM5.90) and Digi (TP: RM4.84). TM remains our favourite pick for the sector given: (i) less competition in its fixed-line broadband business, and (ii) potentially better-than-expected synergy from Webe. OCK, on the other hand, is maintained at OUTPERFORM with an unchanged target price at RM0.95.

All eyes on the spectrum fees. YTD, the uncertainty of the 900/1800MHz spectrum fees has been a major overhang to the local telco sector performance. While the decision is set to be announced by the authority any time now, we believe the fees may mirror the reserve prices recommended in Thailand and Singapore’s spectrum auctions, thus suggesting that the value of Malaysia’s 2x10MHz for the 900MHz band may be worth RM605m while the 2x20MHz 1800Mhz frequency may fetch a price tag of RM1.07b. Meanwhile, should we measure the valuation based on the International Telecommunication Union recommendation (where the auction reserve price for each spectrum is recommended to be equivalent to 70% of the spectrum’s ‘full value’), the full value price tags for the 2x10MHz 900MHz and 2x20Mhz 1800MHz bands could be up to RM865m and RM1.53b, respectively.

Impact on the potential new spectrum fee will rely on the payment schedule. All the big three mobile incumbents are currently paying a combination of RM70m-RM80m annual spectrum fee for their respective 900MHz and 1800MHz bands (under the current Apparatus Assignment structure). Based on our earlier sensitivity analysis, if the projected spectrums' fees stagger into 5-15 years, we estimate that it would lower Cellcos’ FY16 core PATAMI by 0.7% to 13.1% on a full-year basis or by 3.0% to 20.5% if we were to use the ‘full value’ of spectrum price. Meanwhile, Digi will suffer the least earnings impact due to its relatively smaller spectrum allocation (please refer to the sector report – Still in War Mode - dated on15- June 2016 for more details).

A crowded battleground in the mobile space. The current tussle in the mobile space has yet to see any signs of abating with the incumbents continuing to offer enriched plans (by giving more Internet quotas and bundled services) at low or similar subscription prices. The recent launch of new UMobile’s Hero P98 (which offers a massive 30GB of data with unlimited calls and video streaming for only RM98/month), YES’ 4G plans, as well as Webe’s services (RM199/month for unlimited calls, SMS and data or RM79/month if you are an existing TM/Webe customers and use Webe certified phone) could complicate the battlefield further if the big three Cellcos decide to response. Having said that, while product contents and pricing remain as vital factors, users’ experience and satisfaction are equally essential, in our view. These could provide the big three Cellcos a relatively better position in the battleground due to their vast network.

Landscaping keeps changing but…. The local major Cellcos are expected to remain busy in the remaining quarters to remodernise/ re-configure their new 900MHz and 1800MHz networks (where the frequency assignments are expected to be issued in August 2016 for full implementation by 1 July 2017). The new landscaping, however, is not expected to be decided from here given the authority’s intention to optimise usage of other relevant spectrum bands such as the 700MHz, 2300MHz, 2600MHz bands and etc., by the 4Q16. All the Cellcos have shown their interest in the remaining spectrum bands, especially the 700MHz due to its wider coverage (which implied lower capex) and better indoor strength signal.

…….may stabilised a little post the announcement of the 900/1800 spectrum fee structure. The announcement of the upcoming 900/1800MHz spectrum fee structure could provide the much-needed clarity for future spectrums fee and allocation to investors. Should the structure come in at a less extensive manner, it could provide a short-term re-rating catalyst to the incumbents, in our view.

Source: Kenanga Research - 8 Jul 2016