Yesterday, Telenor and Axiata signed the transaction agreements for the proposed merger. Looking ahead, before Celcom Digi Berhad (CDB) can leverage on its optimized network and dual brands to gain mobile market share, it risks losing market share in the near term from: (i) quality/service issues during integration, and (ii) cannibalization. That said, we foresee CDB continuing to drive growth through its enterprise and FTTH segments. Estimating 5% net savings in FY22, we estimate CDB EBITDA to be RM6b (+10% YoY). FY22E DPS of 15.0 sen yields 3.5%. Full estimates will be updated in due course. Maintain MARKET PERFORM with a TP of RM4.25 @ 10.5x fwd EV/EBITDA. Earliest meaningfully synergy contribution in FY23, caution on continued near-term headwinds.

Potential loss of market share in the near term, especially during the transition period, as CDB may lose subscribers from quality/service issues arising from their integrating of networks and operations. Moreover, without a targeted strategy, any benefits from cross or up- selling products may be outweighed by product cannibalization. (refer overleaf for more)

…but enterprise and FTTH will drive growth. While we foresee continued growth in horizontal SaaS offerings for enterprises, we believe any meaningful enterprise growth should come from offering vertical SaaS offerings (industry-specific 5G use cases), thus the CDB Innovation Centre is the right step forward. (refer overleaf for more)

Net savings of 5% in FY22. We conservatively estimate 5% cost synergies in FY22 as "Day 1" of CDB will likely be some time in 3QCY22, and the initial integration costs may weigh. (refer overleaf for more)

Pro forma, we estimate CDB to have 20m (+5% YoY) subscribers in FY22, boosted by: (i) Celcom's continued acquisition of young subscribers through digital channels and (ii) return of foreign subscribers. Assuming no revenue synergies and change in branding strategy, we estimate CDB to achieve a revenue of RM12.7b (+3% YoY), EBITDA of RM6b (+10% YoY) and PATAMI of RM2b (+16% YoY).

Dividends. We believe that, over time, CDB will be striving towards a payout ratio of close to 100%. For FY22, we assume a DPS of 15.0 sen (85% payout ratio), exceeding the combined Digi and Celcom FY22 DPS of 14.5 sen. DPS of 15.0 sen yields 3.5%.

We maintain MARKET PERFORM on Digi with a fully-diluted TP of RM4.25 (from pre-merger TP RM3.75), as we think CDB is fairly valued at this juncture. We switch our Digi TP to that of CDB and temporarily switch our valuation method from DCF to EV/EBITDA. We have ascribed a forward 10.5x EV/EBITDA multiple on CDB's FY22 EBITDA of RM6b. The 10.5x sits between DIGI’s ascribed 11.6x and merger- implied forward 9.4x for Celcom. The 9% discount from the Digi multiple accounts for: (i) Celcom's lower profitability, and (ii) integration risks. With synergies likely to meaningfully contribute earliest in FY23, we caution on the numerous headwinds that the mobile operators will continue to face in the near future as separate entities, which we have accounted for in our existing estimates.

Potential loss of market share in the near term… While the merger should rationalize competition in the mobile space, we think competition will remain stiff post-merger. We foresee two key areas where Celcom Digi Berhad (CDB) risks losing market share. Firstly, due to potential quality/service issues from the integration of networks and operations, CDB may risk higher-than-average churn. Competitors may likely use this window to lure CDB subs. Secondly from cannibalization. Learning from Axiata's successful dual-brand strategies in Bangladesh (Robi & Airtel) and Indonesia (XL & Axis), CDB will be keeping both Celcom and Digi brands. In Malaysia, while both Celcom and Digi have their distinct geographical and democratic subs base, we think some cannibalization is inevitable, as their mobile products are close substitutes. Without a targeted strategy, any benefits from cross or up-selling products may be outweighed by cannibalization. That said, CDB can leverage on an optimized network and clear targeting of subs base to regain market share post-transition.

…but enterprise and FTTH will drive growth. Combining and continuing Digi/Celcom's existing efforts, we foresee CDB to continue growing its enterprise and FTTH segments. While we foresee continued growth in horizontal SaaS offerings for enterprises, we believe any meaningful enterprise growth should come from offering vertical SaaS offerings (industryspecific 5G use cases). We see CDB's Innovation Centre as a step in the right direction. CDB can also leverage on its parents' know-how of 5G-applications being used in advanced nations. CDB could also leverage on its larger fibre footprint to expand its FTTH offerings.

Net savings of 5% in FY22. In 2019, the guided PV of Digi-Celcom merger was RM7b-RM9b. This time, it's guided to be RM8b, combining cost savings in the initial five years and a terminal value. We take a more conservative view on the guided RM8b, as we think Digi and Celcom would have had some individual cost savings by leveraging on the SPV's 5G network regardless of the merger. Nevertheless, we conservatively estimate 5% cost synergies in FY22 as "Day 1" of CDB will likely be some time in 3QCY22, and the initial integration costs may weigh. Near-term cost savings include: (i) lower network spend from running one network instead of two, (ii) lower procurement capex - less equipment and lower rates from greater bargaining power, and (iii) reducing number of physical stores. Medium/long-term synergies include: (i) lower D&A expense, (ii) lower marketing and IT costs, and (iii) lower labor costs via voluntary separation schemes (VSS). Integration costs include: (i) penalties for early termination of tower contracts - including those between Celcom and edotco, and (ii) VSS compensation. All in, we estimate 5% net savings in FY22.

Risks to our call include: (i) the proposed merger failing to obtain the necessary approvals, (ii) stronger/worse-thanexpected service revenue, (iii) weaker/stronger-than-expected OPEX, and (iv) weaker/stronger-than-expected competition.

Source: Kenanga Research - 22 Jun 2021