• Keep BUY and MYR3.40 TP (SOP), 20% upside, c.4% yield. Axiata Group is in non-binding talks with Sinar Mas Group for the potential merger of the Indonesian mobile businesses. A consolidation should give rise to a healthier market conduct, although clear articulation of the rationale and synergies are required to drive value accretion, given Smartfren’s weaker franchise, in our view. We like Axiata for its earnings recovery and balance sheet deleveraging thesis. Key risks: Weaker-than-expected earnings, regulatory setbacks, and merger discussions falling through. Our TP includes a 2% ESG premium.

• Courtship begins. Axiata entered into a non-binding MOU with Indonesia’s Sinar Mas Group to explore a proposed merger between its 66.3%-owned XL Axiata (EXCL IJ, BUY, TP: IDR3,170) and Smartfren – Indonesia’s smallest mobile operator. This confirms earlier market talks, with recent media reports citing approvals being sought from the Government for the merger. The transaction is at the exploratory stage with no certainty that a binding agreement will be reached. Further progress on the transaction will be subject to a due diligence, preparation of a joint business plan, agreement of terms, signing of a definitive agreement, and obtaining all required approvals.

• Needs to articulate transaction rationale and synergies, given Smartfren’s sub-scale and lower quality subs. Axiata is no stranger to in-country consolidation, having executed mergers in Sri Lanka (ongoing), Bangladesh, Cambodia, and Malaysia. If the Smartfren deal materialises, it would be EXCL’s second mobile merger following the acquisition of Axis Indonesia a decade ago. While we acknowledge the deal’s strategic intent, we believe the key focus should be establishing a strong transaction rationale. Investor concerns are likely to be on the potential merger synergies, as Smartfren lacks scale and commands among the market’s lowest ARPUs. Based on pro- forma numbers, the merger will be earnings dilutive in the medium-term (Smartfen is loss-making) in the absence of synergies. It would also narrow EXCL’s revenue and subscriber market share gap from a distant third place to c.27% and c.24% (>94m subs), behind second-largest operator Indosat’s (ISAT IJ, BUY, TP: IDR10575) c.28% revenue and subs share (99m subs).

• Access to more/valuable spectrum. EXCL currently owns 90MHz of paired spectrum in the 900/1800/2100MHz frequencies while Smartfren has 62MHz (800MHz/2300Mhz). We gather from industry sources that the government/regulator may allow for spectrum retention in exchange for an undertaking by the merged entity to expand coverage in rural areas/outside Java. If EXCL gets to keep Smartfen’s spectrum, it would own a combined 34% of the overall spectrum, narrowing the gap with Telkomsel and Indosat, which collectively hold 66% of assigned spectrum rights.

Source: RHB Research - 16 May 2024