Highlights

Following our report titled “Liberalized as Promised” dated on 19th Nov, we advocated that Telenor may be the first to take advantage of this new development to raise its stake in DiGi which has been standing at the previous threshold of 49%.

It was reported that Telenor has been in talks with the government on its interest since last year. Besides being the key growth driver to the group, raising stake in DiGi would allow Telenor to enjoy higher allocation of consistent dividend distribution from the cash cow.

With accelerated depreciation tapering off significantly to ~RM100m in FY13 (vs. ~RM550m in FY12), FY13 DPS is expected to be elevated by 31.3% (excluding capital repayment in FY12) based on 98% payout ratio. Moreover, if business trust (BT) structure eventually adopted by DiGi, DPS will be further boosted going forward.

To increase DiGi’s shareholding, Telenor may transact via open market as the last closing share price of RM4.58 (a retraction of 17.8% from its historical high of RM5.57) might be considered a good entry point and liquidity is no longer a concern after the share split exercise.

Telenor may even purchase a block from EPF if the latter wish to trim its exposure in the equity and telco sector. Currently, EPF owns 16.2% stake in DiGi, the highest shareholding among its telco portfolios (see Figure #1).

Another possibility would be acquiring TdC who holds 3.5% stake of DiGi. Based on our simple calculation, implied value of TdC’s DiGi stake is at RM1,097.46m or RM4.03 per share after deducting TdC’s fixed assets and cash at book. In turn, this implied an astonishing 11.9% discount to DiGi’s last closing price of RM4.58.

Apart from being a cheaper alternative, we think that TdC’s fixed line asset fit strategically into Telenor group who has strong presences in Asia (Malaysia, Thailand, Bangladesh, India and Pakistan). The asset would be earnings accretive and empowers Telenor to grow the data business efficiently.

For example: immediate savings can be extracted from the existing DiGi-TdC 10-year contract which has an estimated residual value of RM111.2m for the remaining 8 years.

Along with TIME Engineering, Khazanah may view TdC as non-core asset and this is a great opportunity for divestment of its 42.9% interest.

Catalysts

• Cost savings from partnerships.
• Managed services / outsourcing.
• Increased demand for wholesale bandwidth.

Risks

Irrational competition, regulation of tariffs, FOREX.

Forecasts

Unchanged.

Rating

Neutral

• Positives – Low beta, defensive, strong cash-generation and dividends should underpin the share price.
• Negatives – Potential irrational competition, regulatory risks, unable to monetize data, dumb pipes.

Top Picks

Re-iterate BUY call on TdC (TP: RM4.66). Upgrade DiGi to BUY (TP: unchanged at RM5.14) for its decent yield and potential of further capital management (BT) after the recent selldown.

Source: Hong Leong Investment Bank Research - 27 Nov 2012