We view positively Axiata’s proposed acquisition of Ncell, Nepal’s largest mobile operator. Upgrade to BUY with a revised MYR7.00 TP(from MYR6.40, 17% upside). The USD1.37bn consideration translates into a compelling 5x EV/EBITDA for an earnings-accretive asset from the outset. The deal is expected to lift the firm’s earnings by 7-14% for FY16-17, net of funding cost. It remains our Malaysian telco Top Pick.

Calling the Himalayas. Axiata is looking to buy 80% of Ncell Pvt Ltdfrom Sweden’s TeliaSenora for a total consideration of USD1.37bn (c. MYR5.91bn). This translates into an attractive 5x EV/EBITDA (4x on an ex-cash basis) and 9.3x FY15F P/E for a controlling stake in a highgrowing asset. The valuation compares with Axiata’s 8.3x EV/EBITDA and South Asia/ASEAN peers’ 5.7-8.4x. Axiata has concurrently entered into a shareholder agreement with a minority shareholder to regulateNcell’s operations and management. The acquisition is to be largely funded via debt (USD1.4bn), with Axiata looking to tap into its USD1.5bn sukuk facility. Pending various regulatory approvals and its shareholdersEGM, the deal is expected to be completed by 2Q16.

Attractive market and asset. Ncell reported revenue/EBITDA/PATAMI of NPR55.7bn/NPR34.7bn/NLR18.3bn respectively for FY15. It has a leading 58% and 49% share of industry mobile revenue and subscribersrespectively. The remainder is held by state-owned Nepal Telecom.Ncell’s FY13-15 revenue/EBITDA CAGR growth rate of 20%/27%respectively were driven by commendable revenue share gains, with voice making up c.80% of service revenue. International long distance (ILD) revenue accounted for 35-40%.of revenue, which partly explainsNcell’s superior EBITDA margins of >60%. The industry prospects are promising, given Nepal’s young population (68% are below 35) and the relatively under-tapped mobile data market, with mobile internet penetration of only 22% and smartphone penetration of <20%.

Deal is earnings-accretive from the outset. We raise our FY16/FY17 core earnings forecasts by 7-14% to factor in Ncell’s contributions. Our SOP-based TP is bumped up to MYR7.00 (from MYR6.40) after imputing Ncell’s valuation. We upgrade Axiata to BUY (from Neutral), as the stock trades at a discount, ie 8.1x FY16F EV/EBITDA vs peers’ average of 10.7x. With the recovery in units Celcom’s and XL Axiata’s (EXCL IJ, BUY, TP: IDR5,100) earnings as share price catalysts, Axiata is our Top Pick for exposure to the Malaysian telco sector.

Key takeaways from the conference call Axiata held a conference call on the acquisition of Ncell, which was chaired by Group CEO Dato' Sri Jamaludin Ibrahim and Group CFO Mr Chari TVT. Queries were centred on: i) the prospects of the Nepalese market, ii) funding and capex plans, and iii) key risks (with respect to competition, ILD rates and spectrum.

Ticks all the boxes. Axiata said the purchase met its strict M&A criteria, which included: i) immediate earnings accretion, ii) majority control, iii) brownfield asset s, iv)target markets in South Asia/ASEAN, and v) attractive valuations. The deal marks a departure from Axiata’s preference for in-country consolidation to strengthen its regional footprint. According to media reports, TeliaSenora had signalled its intention to exit Nepal back in September. This was part of a broader plan to hive off seven mobile assets in Central Asia to refocus on the Nordic and Baltic markets. We view the deal positively, which is priced at a relatively undemanding 5x EV/EBITDA (4.1x ex-cash) and the immediate earnings accretion of 11-14% based on pro-formanumbers. Ncell is in a net cash position, which should also bolster Axiata’s future dividend prospects.

Gearing remains manageable. Management acknowledged that, with the deal to be funded largely through debt, Axiata’s FY16 gross debt/EBITDA ratio could likely breach 2.3-2.4x (our estimation: 2.44x). That said, management believes that over the longer term, there were still avenues to pare down its gearing ratio, such as through the sale of towers at XL Axiata, better performances from its operating companies and/or the listing of its subsidiaries. Management aims to keep its gross debt/EBITDA at below the 2.3x level over the medium term. Capex intensity for Ncell is expected to remain at about 23-25% going forward, due to the expansion of its 3G coverage (currently 20% of the population).

ILD business a key risk going forward. Although Ncell’s revenue has been growing at a CAGR of 20% between FY13-15 (Jul) and it has booked EBITDA margins of more than 60%, this has been largely driven by the growth in voice revenue –specifically from the growth in the ILD market, which makes up 30-40% of voice revenue. We note that the Nepalese overseas foreign workers (OFW) market is substantial, with about 3m of the country’s citizens working outside of Nepal. Given that the majority of the ILD revenue is denominated in USD, and the substitution effect from over the top (OTT) services as data picks up, we believe this segment’s growth could be susceptible to changes in the microenvironment. As such, Ncell’ssuperior EBITDA of above 60% could see some erosion once there is a pickup in the data segment. Management expects EBITDA margins to eventually settle in the low50% levels, which is still above Axiata’s current EBITDA of 36.6% (as at 9M15).

Competition still manageable. Although we believe that the m arket is now wary on the bidding prices for spectrums after the recent conclusion of the 900Mhz and 1800Mhz spectrum auctions in Thailand, Axiata believes that there are no short-term risks relating to Ncell’s spectrum. This is given that the spectra are only due to expire in 2019. On the possibility of a disruptive player in the market, management believes that it would be most difficult for a new player to take away market share from Ncell and Nepal Telecom, as these two dominant players currently make up about 95% of total subscribers.

Earnings bumped up. We raise our earnings forecasts by 7-14% for FY16/17 after factoring in high single-digit to low-teens revenue and EBITDA growth for Ncell and taking into account the higher interest expense from the drawdown of its sukuk facility and other debt facilities to fund the acquisition.

Valuation and recommendation Upgrade to BUY, Top Pick for Malaysia telcos. Our SOP-based TP is raised to MYR7.00 (from MYR6.40) after imputing Ncell’s valuations. We upgrade Axiata to BUY (from Neutral) as the stock trades at a discount, ie 8.1x FY16F EV/EBITDA vs its peers’ average of 10.7x. The stock remains our Top Pick for exposure to the Malaysian telco sector, with the recovery in units Celcom’s and XL Axiata’s earnings as share price catalysts. Note that Axiata has the capacity to pay more dividends visà-vis its peers, which are distributing close to their maximum payouts.

Source: RHB Research - 22 Dec 2015