Axiata was served with an RM2.2b tax bill in the Ncell buyout which caught us by surprise. This may lead to negative kneejerk reactions over the short-term. Besides, the group may also potentially provide for some non-core impairments related to its legacy equipment. We made no changes to our FY18-19E earnings forecasts. Reiterate OUTPERFORM call but with a lower SoP-derived TP of RM4.50 (implied -0.5x below its 5-year EV/EBITDA mean).

Additional capital gains tax woes. The Supreme Court of Nepal (“SCN”) had ordered Ncell and its major shareholder Axiata Group (which owned 80% of the former) to pay the due capital gains tax (amounting to Rs61b (or c.RM2.16b) excluding late fees and fines) on the Ncell buyout deal, according to a 6 Febuary report by The Himalayan Times (Nepal’s largest English daily newspaper). Although Axiata had already paid a total tax of Rs23.6b in mid-2017, the Nepal’s authority may require both Ncell and Axiata to deposit the entire Rs66b (including the late fees and fines) and deduct the paid amount after both companies file a formal application demanding reduction in the tax bill, according to the local authority.

How did the tax woe happen? In a record deal struck in April 2016, Axiata bought Reynolds Holding (majority owned by TeliaSonera) for USD1.365b. The issue of tax debate came to the fore after the tax authority failed to notify Axiata about the tax liability (despite Axiata seeking to find out whether the deal would attract tax in Nepal) as the taxman only initiated the process to tax the transaction after TeliaSonera exited Nepal. As per existing laws, the Nepalese authority should get 25% of the profit made from the TeliaSonera-Axiata deal. Of that amount, 15% of the applicable tax should be left at the company that was sold while the remaining 10% of the amount should be paid by the seller. The latest SCN’s decision has ended a long-drawn debate over whether the buyer should pay the tax in cases when the seller does not settle its tax liabilities.

A negative surprise. The latest tax woes caught us by surprise as Axiata had earlier highlighted in June-2017 that the tax dispute was settled after paying an advance deposit of Rs13.6b (following the first deposit of Rs9.97b in May 2015) to the Nepalese taxman to resolve a capital gain tax dispute. Should Axiata comply with the SCN’s order and deposit the entire Rs66b (or RM2.35b), it will raise our estimated FY19 Gross Debt/EBITDA and Net Debt/EBITDA ratios to 2.4x/1.7x (vs. 2.1x/1.5x previously).

Expect some disappointments from non-core impairments. We believe our reported PATAMI for FY18 may be overstated given Axiata is expected to provide for impairments in the upcoming 4Q18 result (which is set to be released on 22 February). The impairment is believed to be related to the modernisation and technology change in certain markets and thus leading to some legacy equipment made redundant. Having said that, we believe our full-year core PATAMI estimate of RM912m (9M18: RM668m) remains intact.

Maintain OUTPERFORM call. While we made no changes to our FY18- 19E earnings forecast (pending the upcoming 4Q18 results release), we have lowered our Axiata’s SoP-derived TP to RM4.50 (vs. RM4.60 previously) after lowering our Ncell’s targeted earnings multiplier to 5.0x (vs. 6.0x previously) to account for the higher regulation risks ahead in Nepal. All in, we are keeping our OUTPERFORM call for now in view of its relatively decent valuation (Forward EV/EBITDA of 7.2x vs. peers of 12- 13x) coupled with a stronger Celcom and earnings recovery at XL. Bargain-hunting opportunity could potentially arise on any share price weakness due to the recent hiccup. We advocate investors to start accumulating the share at c.RM3.70 level.

Key downside risks include: (i) keener competition, (ii) tax and regulatory challenges, and (iii) currency volatility; Upside risks are: (i) stronger-thanexpected recovery at Celcom and XL, and (ii) edotco’s organic and inorganic growth.

Source: Kenanga Research - 8 Feb 2019