We downgrade our telecommunication sector rating to UNDERWEIGHT (from NEUTRAL previously) as the on-going spectrum re-allocation exercises coupled with the higher-than-expected spectrum fees on the 900Mhz and 1800Mhz bands are expected to cap incumbents’ near-term performance. While Cellcos have yet to decide on the payment scheme, we foresee potential 5-10% earnings downside risk based on our base case assumption of 5-year staggered payment. We made no changes to our FY16/FY17E earnings estimates for now, pending the unveiling of detailed spectrum payment scheme. Nevertheless, we have trimmed all our Cellcos’ targeted FY17E EV/forward EBITDA by 0.5x to reflect the earnings risk ahead. Both Axiata and Digi are downgraded to UNDERPERFORM (from MARKET PERFORM previously) with lower target prices of RM5.19 and RM4.57 (vs. RM5.70 and RM4.84 previously), respectively. Maxis, meanwhile, remains at UNDERPERFORM but with a lower target price of RM5.75 (vs. RM5.85 previously). We reiterate our OUTPERFORM call on TM (TP: RM7.20) given: (i) less competition in its fixed-line broadband business, and (ii) its inroad to become a convergence champion. OCK, on the other hand, is maintained at OUTPERFORM with an unchanged target price at RM0.93.

Received letter of offer. Maxis, Axiata and Digi have finally received the long overdue letter of offer from the Malaysian Communications and Multimedia Commission (MCMC) on 30th August 2016 in respect of the spectrum reallocation of the 900Mhz and 1800MHz bands. The assignments upon issuance will be effective from 1 July 2017 for 15 years. All companies have until 12 noon, 1st November 2016 to accept the offers and effect the required payments.

Spectrum’s fee structure. The payment for spectrum consists of: (i) a price component of RM816.75m (for both Maxis and Axiata) and RM598.545m for Digi, where companies have the option to pay full settlement or higher amounts under staggered payment options, and (ii) fixed annual spectrum maintenance fee where both Maxis and Axiata have to pay RM70.25m each while Digi needs to fork out RM51.484m for upholding the spectrums. All in, both Maxis and Axiata have to pay a total RM1.87b (for 2x10MHz in 900MHz band and 2x20 in 1800MHz) while Digi has to spend RM1.37b (for 2x5MHz in 900MHz band and 2x20 in 1800MHz frequency) to use these two blocks of bandwidth for 15 years. The new pricing structure implied that the annual maintenance fee will account for c.56% (of the total spectrum price) while the balance comes from the one-off fees. The latest bandwidth offer prices appeared 11% higher as compared to our earlier estimation (please refer to our sector report –“Still In War Mode” dated 15 June 2016 for details), although the price tags are not too outrageous compared to the region countries.

Authority’s formulation. MCMC highlighted that a study shown the total cost of a 2x5MHz block in the 900MHz band will cost RM499.725m whilst the total cost of a 2x5MHz block in the 1800MHz band will be priced at RM217.77m. The total fee payable by each player will depend on the amount of spectrums that has been allocated to them in these bands. On top of that, to ensure costs are not passed down to subscribers, the authority has set a condition of the allocation that players shall offer packages that are cheaper than current prices to their subscribers. MCMC also added that the same approach in spectrum optimisation would be used for all other relevant spectrum bands such as the 700MHz, 2300MHz and 2600MHz bands, where the authority has set to optimise the above-said spectrum bands by the 4Q16.

Potential financial impact on the new spectrum structure. While Cellcos have yet to decide on the payment scheme, the new regime is set to impact the incumbents negatively given players are merely paying a combination of RM70m-RM80m annual spectrum fee (under the Apparatus Assignment structure where payment is based on the number of base stations rollout) each for their respective 900Mhz and 1800MHz bands. Based on our sensitivity analysis, should the incumbents decide to pay the spectrums’ fee in lump sum, it would lower Cellcos’ FY16E core PATAMI by 33%-49%. Alternatively, should the spectrum fees stagger into 5-15 years, we estimated that it would lower Cellcos’ FY16E and FY17E core PATAMI by 0.7%-10% and 0.7%-8.3%, respectively, on a full-year basis. (Please refer to figure 1 for details).

Lower our expectations on Cellcos. We believe Cellocs would likely to opt for the staggered payment scheme rather than paying in lump-sum to avoid the enormous negative impact. Meanwhile, in view of the authority’s view to monetarise the spectrums, a 5-year staggered payment scheme is likely to be the base case, in our view, and thus, suggesting 5-10% downside risk to our FY16E/FY17E earnings. All in, we are keeping all our Cellcos’ earnings forecasts unchanged for now (pending detailed spectrum payment schemes). However, we have lowered all our Cellcos’ targeted FY17E EV/forward EBITDA by 0.5x to reflect the earnings risk ahead.

Source: Kenanga Research - 1 Sep 2016