We maintained our NEUTRAL view on the telecommunication sector. StarBiz reported that a merger between Telekom Malaysia Bhd (“TM”) and Axiata Group Bhd could be potentially on the cards given that both companies have already hired advisors to study the deal, according to sources. While finding synergies would not be too complicated, we believe the deal (if any) could raise more doubts than confidence over the short-term and would require more concrete rationales to convince both companies’ shareholders. All in all, while we retained all our Telcos’ FY17/18E earnings estimate, we have decided to alter the valuation method to DCF as the previous EV/Forward EBITDA technique appeared to be less compelling. We continue to favour fixed-line player (TM, OP, TP: RM7.03) over the mobile names under the current challenging time given that the latter’s earnings are set to be continued being affected by the prolonged heightened competition while the upcoming spectrum refarming exercise is also expected to change the mobile landscaping in the long-term. Barring any unforeseen circumstances, we believe the sector is likely to trade side-ways range-bound while waiting for new catalysts to emerge. Digi (MP, TP: RM4.98) is the better choice for consistency play (supported by its agile execution capability and high dividend yield of >4%) while Axiata (UP, TP: RM4.64) remains a better candidate for trading theme.

Falling in love again? StarBiz reported that TM and Axiata could potentially merge as both companies have already hired advisors, with CIMB Investment Band advising TM while Goldman Sachs is working for Axiata on the deal. Khazanah National Bhd is the largest shareholder of both companies, which owns 26.2% of TM and 37.6% of Axiata.

Raising more doubts than confidence. While finding synergies would not be too complicated (in view of both companies used to operate under the same roof prior to the demerger and controlled by the same major shareholder), we are doubtful that the synergies (besides the usual merger-associated benefits, such as staff, network, marketing rationalisation and etc.) could be material enough to create further value to shareholders. Indeed, it could raise more doubts than confidence for now, in our view, such as: (i) why the original demerger happened, (ii) both companies are not in the distress financial situation currently, thus, why initiate a major ownership/operational change, and (iii) why grant an approval for TM to purchase wireless mobile operator P1 from Green Packet Bhd and subsequently allocate >RM1b capex plan?

Merger or spin-off? We are unsure the above speculation will involve the Axiata Group or merely the merger of Axiata’s Celcom with TM. Should the latter scenario materialise, the business direction of both companies could be somehow uncertain, in our view. Note that, Celcom recorded RM2.3b/RM966m EBITDA/PATAMI on the back of RM6.6b revenue in FY16 vis a vis TM’s Revenue/EBITDA/PATAMI of RM12.1b/RM3.8b/RM776m, respectively, during the same period. In view of the sizeable Celcom contribution, the enlarged entity could potentially lead TM to reposition its direction away from a ‘convergence champion’ where the primary focus is on its broadband while the mobile segment is merely playing a supplement role under the convergence path. From Axiata’s perspective, without Celcom’s contribution, Axiata could potentially be facing severe challenging time ahead judging from the sizable contribution (where Celcom accounted for c.30%/29% of Axiata’s turnover/EBITDA and >100% at the PATAMI level in FY16).

Potential valuation for Celcom. According to Bloomberg, the median target companies’ EBITDA multiplies of Cellular companies in the Asia Pacific Emerging market over the past five-year is 10.4x, suggesting that Celcom’s enterprise value could potentially be valued at RM24b. The estimation, however, is below Maxis and Digi’s EV/EBITDA (at 12.7x/14.2x, respectively), and suggests rooms for valuation expansion. In view of the potential hefty valuation ahead, we believe the merger (if any) is likely to involve share swap mechanism rather than cash outlay. Having said that, the deal could be dilutive to TM’s shareholders considering its market capitalisation is merely half of Axiata (RM22.3b vs. RM42.3b).

Changing the valuation methodology. While we made no changes to all our Telco’s FY17/FY18E earnings estimate, we have decided to alter our valuation method to Discounted-Cash-Flow methodology as our previous EV/Forward EBITDA technique appears less compelling given that telecoms have the tendency to raising funds via debt instruments. With that, we have revised all our big-cap telecom target prices where we continue to peg an OUTPERFORM call to TM but with a higher target price of RM7.03 (WACC: 6.8%, TG: 1.0%, previous TP: RM6.80). For Digi and Maxis, likewise, ratings are maintained at MARKET PERFORM but with a higher target price of RM4.98 (WACC: 6.2%, TG: 1.5%, previous TP: RM4.74) and RM6.20 (WACC: 6.7%, TG: 1.5%, previous TP: RM5.90), respectively. Axiata’s target price, meanwhile, has moved up to RM4.64 (from RM4.30 previously) based on Sum-of-Parts methodology with unchanged UNDERPERFORM call.

Source: Kenanga Research - 20 Mar 2017