INVESTMENT MERIT

Redtone, a provider of telco services and managed telco network services, is poised to benefit from: (i) potential wins from the RM4.6b JENDELA tender, (ii) engineering and maintenance jobs from the 5G rollout, and (iii) 5G-enabled connectivity and digital services. Having previously won 25%- 70% of large-scale government contracts, Redtone is well positioned to win some of the RM4.6b JENDELA tender, in our view. We call for a “Trading Buy” with a fair value of RM0.61. Its current forward PER of 13x makes it a cheaper play on JENDELA and Malaysia’s 5G rollout, compared to the 20~35x PER of the traditional telcos. Our FY22E DPS of 1.8 sen also implies a decent yield of 3.7%.

Potential beneficiary of JENDELA Phase 1 tender. Redtone has tendered for all RM4.6b worth of contracts in the JENDELA Phase 1 tender, (winners to be announced in next 4 weeks). Historically, Redtone has won 25%-70% of large-scale government contracts, with MCMC’s 2017 Time-3 being the latest one. Although historically, the Group’s gross margin has been around 40%, any large-scale project will likely bring lower gross margins, potentially around 20%. However, the sheer size of the large-scale projects should still bring material EPS enhancement. Our modelling shows that in the scenarios where Redtone wins 10/25/50/70% of the contracts worth RM4.6b, they will have EPS enhancements of 22/56/112/157% from FY21 CNP, assuming any incremental revenue is spread across five years.

5G a near- and long-term catalyst. Redtone’s MTNS will benefit from Malaysia’s 5G rollout and continue driving growth regardless of whether it wins any JENDELA tenders. As 5G networks require a greater number of sites, Redtone should benefit from more engineering and maintenance jobs from Malaysia’s 5G rollout, which Digital Nasional Berhad (DNB) has tasked Ericsson to do. We gathered that Redtone is currently in discussions with Ericsson, with whom Redtone has previously worked with to roll out 4G networks. Thus, we wouldn’t be surprised if Redtone wins jobs from Ericsson for the 5G network rollout. Management has also indicated that they have sufficient in-house resources to fulfil both JENDELA and 5G related jobs. When the 5G network is available, Redtone’s telco services as well as its Industry Digital Services (IDS) will benefit as they can offer 5Genabled services. The former will be able to tap on the network to offer enterprise customers 5G connectivity services, such as 5G FWA. The latter, which currently offers data centre and cloud, virtual reality, e-Health, and smart farming services, could also leverage on 5G’s low-latency capabilities to offer new or enhanced services.

“Trading Buy” with a FV of RM0.61 on 16x PER to its FY22E EPS of 3.80 sen. Note that our earnings estimate doesn’t include earnings contributions from the JENDELA Phase 1 tender, and thus any wins from the tender presents room for upside surprise. The 16x PER is at +2SD of its 3-years historical average of 11.3x and comparable to the 17x PER we have ascribed its closest peer OCK. We believe that Redtone deserves the valuation premium given the numerous catalysts behind its business segments and its earnings growth of 20%/13% in FY22/FY23. Its current forward PER of 13x makes it a cheaper play to gain exposure to JENDELA and 5G relative to the traditional telcos, with PER ranging from 20x to 35x. While telco infrastructure players’ stocks have risen in recent days in anticipation of the announcement of the JENDELA tender winners in the coming four weeks, we are calling a “Trading Buy” and advocate investors/traders to accumulate on weakness, as Redtone’s potential JENDELA tender wins could continue fuelling excitement in the stock.

Business Segments & Outlook

Telecommunications Services

In this segment, Redtone services the government, enterprises and SMEs, by providing broadband and voice connectivity services. The revenues from this segment are relatively recurring and stable, given the essential nature of connectivity. That said, the segment was adversely affected by the Covid-19 induced lockdowns, as the work-from-home trend meant that many enterprises no longer needed voice/broadband connectivity in offices, especially the customers in the hospitality and leisure industries. It’s worth noting that there are no cash collection concerns, as (i) Redtone serves thousands of customers in this segment, spreading out any collection risks, and (ii) the services are provided on a subscription-based model, therefore any non-payment will result in a termination of the service provided. While this segment ranks second (behind MTNS) in terms of revenue contribution, it is the most profitable with operating margins ranging from 36% to 41% over the last three financial years, and thus makes up a sizeable chunk of its operating profit (62%~86% over the last 3 financial years). Moving forward, we expect this trend to continue as the margin for this segment should remain stable. The key catalysts driving this segment include: (i) 5G-enabled services and (ii) recovery in Covid-hit sectors such as hospitality and leisure.

Managed Telco Network Services (MTNS)

In this segment, Redtone provides engineering of telco infrastructure, and maintenance and support services. This segment stands to benefit from both JENDELA and Malaysia’s 5G rollout. The higher number of sites for the 5G network bodes well for Redtone as it benefits from more engineering works (in the installation of infrastructure for the 5G network), as well as more recurring revenues from the maintenance and support services. We gathered that Redtone is currently in discussions with Ericsson regarding the 5G rollout. Having worked with Ericsson to roll out 4G, we believe that Redtone should be able to secure 5G rollout jobs from Ericsson. Importantly, management has indicated that they have sufficient in-house resources to fulfil the JENDELA and 5G jobs. In the unlikely event that Redtone does not get any additional jobs for JENDELA and 5G, its current order-book of RM130m should be able to support its MTNS revenues for over the next two years. In terms of profitability, this segment has an operating margin ranging from the mid to high teens, ranking this segment second in terms of profit contribution within the group. Key catalysts driving this segment include: (i) JENDELA tender wins, (ii) 5G rollout jobs, (iii) 5G site maintenance jobs.

Industry Digital Services (IDS)

We gathered from management that this is a complementary segment to its core business of telco services, as these are value-added services that customers can use in addition to Redtone’s connectivity services. For example, Redtone provides Cloud, Data Centre, VR, IoT (namely smart farming), and e-Healthcare services. Currently, this segment contributes only 2% to Redtone’s total revenue. Due to the complementary nature of this segment, we believe that this segment will likely grow in tandem with its telco services. Unlike the previous two segments, IDS has always been loss-making (on the operating level), as its staff and marketing costs have been weighing on its profitability. Even though its operating losses have been shrinking over the years (RM4.9m loss in FY18 vs. RM2.6m loss in FY21), we believe that this segment will likely continue to be loss making in the near-future, until the segment has reached a required level of scale to be profitable. Key catalysts driving this segment include: adoption of Cloud and data centre services.

JENDELA Phase 1 Tender

The Jalinan Digital Negara (JENDELA) plan is a government initiative aiming to enhance national digital connectivity and to prepare Malaysia for the 5G world. Phase 1 began in 2020 and will end in 2022, with its main goals being: (i) increase 4G coverage from 91.8% to 96.9%, (ii) increase mobile broadband speed from 25 Mbps to 35 Mbps, (iii) 83% premises nationwide to have access to gigabit speed of fixed broadband, and (iv) 3G sunset, upgrade of 4G and fiberisation. Phase 2 will likely begin in 2023 and targeted to end in 2025, with its main goals being: (i) 100% 4G coverage, (ii) 100 Mbps mobile speed, and (iii) full 5G deployment. The first phase of the JENDELA tender will cover the construction and setting up of 1,661 sites, which is more than 3x from the 500 sites planned for NFCP 2. The greater number of sites was driven by the need to expedite the resolution of Malaysia’s digital divide and to ensure a prompt 5G network rollout.

JENDELA Phase 1 is split into two parts, where the RM4.6b funding will be divided into 30% and 70% into Parts 1 and 2, respectively. Part 1 involves site acquisition and the installation of towers, and any interested licensee for Part 1 is required to hold a valid Network Facilities Provider (NFP) license. Part 2 involves the installation of network equipment, and requires the infrastructure provider to ensure interoperability with telcos’ networks to provide capacity for 2G and 4G services. Any interested licensee for Part 2 is required to hold both valid NFP and Network Services Provider (NSP) licenses. The nature of the licensing requirements makes Part 1 a more crowded and competitive space than Part 2. Redtone has both NFP and NSP licenses and is therefore eligible for both parts of the tender. While the winners of the tender were initially meant to be announced sometime in July/August, there has been a delay. That said, the Minister of Communications and Multimedia recently signalled that the winners will be announced over the next four weeks.

Cash-rich and cash generative business

Redtone has always had a healthy balance sheet, as it has been in a net cash position over the last five years, with its latest net cash position of RM83.6m continuing this healthy trend. Its latest cash balance of RM92.5m (or cash per share of RM0.12) also makes up a noteworthy 24% of its market cap. As a business with minimal capex requirements, shown by its annual capex intensity of <1%, along with annual capex of

Source: Kenanga Research - 24 Sept 2021