We expect TM’s mobile converged service to be EPS dilutive over the next two years on the back of rising opex (marketing, subscriber acquisition and staff costs) and depreciation. Nonetheless, the HSBB2/SUBB projects and its venture into the mobility space should drive long-term growth for the group in addition to providing customer stickiness. Maintain NEUTRAL with a revised DCF-based MYR6.40 TP (from MYR6.80, 3% downside).

Cost of convergence. P1 continued to be a drag on Telekom Malaysia (TM) with an FY15 EBIT loss of MYR290m (18%) and net loss of MYR135m (13%). We believe earnings prospects would remain challenging in the near term on higher marketing and depreciation charges as TM deploys its LTE network. That said, we are sanguine on the prospects of its convergence product that, if successfully executed, should ensure customer stickiness and ARPU uplifts from bundled offerings. The fibre expansion. We believe the High Speed Broadband Phase 2 (HSBB2) and Sub-Urban Broadband (SUBB) projects would be key growth drivers for TM’s internet segment. Under HSBB2, the group would be able to provide access to an additional 390,000 ports by 2017 while SUBB should provide further avenues for upselling. Forecast. After updating our cost and capex assumptions, we adjust our FY16-17 earnings by -3%/-8% respectively. Risk to our recommendations include heightened competition in the mobile space, which could crimp ARPU.

Maintain NEUTRAL. While we are excited about TM’s long-term growth prospects, we remain cautious due to the short to medium term earnings risks from the LTE roll-out. Maintain NEUTRAL with a revised DCF-based MYR6.40 TP (3% downside, 8% WACC, 2% TG), reflecting an implied 7.8x FY16F EV/EBITDA, which is above the historical 1.5SD trading band of 7.2x.

Key takeaways from the result call

P1 update. P1, TM’s 73%-owned converged mobile outfit, has completed fresh user trials for broadband and voice/SMS services, and is likely on track for commercial launch by mid-2016. We gather from channel checks that P1’s rollout has been pushed back slightly due to site access issues and the late delivery of sites. In addition to de-commissioning some of the 2,500 WiMAX sites under P1, TM is converting most into LTE sites and adding new greenfield sites. We expect the group to roll out mobile LTE in urban areas on P1’s 2300MHz spectrum (previously WiMAX) while the 850MHz (currently used for its TMgo dongle service) is to serve rural areas. The agreement inked with Celcom on domestic roaming (in exchange for TM’s fibre backhaul) would help address coverage and connectivity issues in the interim as it rolls out its own network. While TM has not shared the cost structure of the tie-up, we expect this to be defrayed from its LTE network investments. Our forecast has modelled in extended EBIT losses at P1 for FY16-17. Over-the-top (OTT) boost to TM’s content proposition. We view positively the recent tie-ups with iflix and Viu – leading over-the-top (OTT) on-line video streaming services – to strengthen TM’s content proposition. The OTT operators benefit from access to a strong base of fixed broadband customers via a revenue share model with TM. Management indicated that the video OTT applications may be pre-loaded into its HyppTV set-top box in the near future. This would give it direct access to viewers for upselling purposes. 2016 capex. Management has guided that capex would be between 25-30% of revenue for 2016. As such we forecast a capex of MYR3bn-3.5bn for the year ahead. Dividends. TM has declared a second interim dividend of 12 sen, bringing overall FY15 dividend to 22 sen per share. This translates into a core payout of 90% and a 3.3% yield, which is roughly around the same yield levels as Maxis (MAXIS MK, SELL, TP: MYR4.70) and Axiata (AXIATA MK, NEUTRAL, TP: MYR6.32).

SWOT Analysis

Source: RHB Research - 25 Feb 2016