AXIATA has entered into a non-binding MOU with Sinar Mas group to explore the merger of XL Axiata and Smartfren. The merged entity may potentially benefit from improved economies of scale, operational synergies, reduced competition, and capex savings from an enlarged spectrum. Nevertheless, we are neutral at this juncture pending more details. We maintain our forecasts, TP of RM3.00 and OUTPERFORM call.

MergeCo will be jointly controlled. The proposed merger is at early stage of evaluation where both AXIATA and Sinar Mas group intend to remain as joint controlling shareholders of the merged entity (MergeCo). Key activities during this exploratory phase include: (i) validation of merger rationale and value creation, (ii) due diligence, (iii) preparation of a joint business plan, and (iv) agreement on key terms.

Additionally, further progress will be subject to signing of definitive agreements, and obtaining required approvals. There is no certainty that ongoing discussions will result in completion of the merger.

Partnership with leading conglomerate. In a nutshell, AXIATA believes that MergeCo will gain from larger economies of scale and other operational synergies. In addition, it will also benefit from Sinar Mas’ local market knowledge. The latter is one of the largest conglomerates in Indonesia with sprawling key businesses (i.e. pulp & paper, agri-business &food, financial services, real estate, communications & technology, energy & infrastructure, and healthcare).

Closing in on 2nd largest player. Currently, XL and Smartfren are ranked 3rd and 4th in terms of mobile market share in Indonesia with 58m and 37m subscribers, respectively. Post-merger, MergerCo will be ranked 3rd with 94m subs after Telkomsel (153m) and Indosat (100m).

Smartfren’s primary target market comprises millennials, Gen-Z and young professionals. This is evident from its larger share of prepaid subs (99%) vis-à-vis XL (97%), coupled with lower FY23 blended ARPU of IDR26k (XL: IDR43k).

Post-merger Smartfren may turn around. We estimate that Smartfren delivered core net loss of IDR892.1b (RM262.7m) in FY23, while XL reported normalized PATAMI of RM172m. Although Smartfren was loss-making in FY23, we do not discount the possibility of a turnaround after post-merger accounting adjustments and cost synergies. It currently trades at trailing FY23 EV/EBITDA of 8.9x on the Indonesian Stock Exchange.

Enlarged spectrum may finally match peers. Smartfren transmits 4G LTE via 46k sites (XL: 105k) on the 850MHz and 2.3GHz spectrum blocks. We understand that Smartfren and XL each own 40MHz of 5G spectrum across the 800/900 MHz, 1.8GHz, 2.1GHz and 2.3GHz frequencies. In comparison, Telkomsel and Indosat own much larger capacities totalling 87.5MHz and 70MHz, respectively. Therefore, we believe that the enlarged spectrum holdings for MergeCo will enable it to compete more effectively against peers. Nevertheless, there is a possibility that MergeCo may need to partially surrender its spectrum holdings back to the Indonesian regulator.

Imminent industry consolidation. We were not surprised by the announcement as we believe that local regulatory forces advocate industry consolidation. This is underpinned by benefits such as long-term business sustainability, efficient deployment of spectrum, enhanced quality of service etc. According to Reuters, Indonesia’s Minister of Communication and Informatics, Budi Arie Setiadi remarked that it would be “more manageable” to just have three telcos in Indonesia.

Neutral pending granularity. On top of all the benefits mentioned above, we believe that MergeCo will also gain from: (i) easing competitive pressure, and (ii) 5G capex savings from enlarged spectrum holdings. Nevertheless, we are neutral at this juncture, as we await more clarity, including details on mode of settlement (e.g. shares, cash), effective spectrum holdings, financial impact etc.

Forecasts. Maintained pending finalization of merger.

Valuations. We also maintain our Sum-of-Parts TP of RM3.00 per share (refer below).There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 5).

Investment case. We continue to like AXIATA for: (i) its plans to deleverage and strengthen its balance sheet, (ii) growth prospects for digital telcos and tower assets at emerging markets, and (iii) strong asset monetization prospects for Edotco and its digital businesses.

Maintain OUTPERFORM.

Risks to our call include: (i) a strong USD weighing on the performance of its digital telcos at frontier markets (e.g. Robi Bangladesh, Dialog Sri Lanka, Smart Cambodia), (ii) gestational earnings and cash flows drag from Link Net’s aggressive expansion, and (i ii) capex up-cycle from looming implementation of 5G in Indonesia.

Source: Kenanga Research - 16 May 2024