M1 – CIMB
M1 announced last Friday that it will be acquiring a local Internet service provider (ISP) Qala Singapore from its existing shareholders for S$14.9m cash. If certain financial targets (revenue and net profit growth) are met as at end-FY6/11, M1 may have to fork out an additional S$3m to the existing shareholders of Qala. The transaction is expected to be completed within one month and the entire acquisition will be funded by internal resources.
More on Qala. Qala is a 9-year-old ISP with a service-based operator licence. It offers a full suite of data and communications products and services to corporate, enterprise and public-sector customers in Singapore. It is one of three providers of the free nationwide Wi-Fi service, wireless@SG, and the only commercial WiMAX provider in Singapore. Qala’s net book value as at end-June was S$2.8m.
M1 not likely to have overpaid. There is very little clarity on Qala’s financials as it is a private entity and M1 is unable to divulge much on its financial conditions. We understand that revenue and profit are not significant but we believe that M1 did not overpay in keeping with its typically conservative management. The P/BV tag of 5.3x-6.4x is slightly misleading as Qala is a pure reseller and does not have significant fixed assets on its books.
Rationale? We see the rationale for the acquisition as:
• Providing M1 with a foothold in the corporate fixed broadband market ahead of NGNBN. This would enable M1 to address some of its shortcomings in broadband when it comes to tackling this market on top of providing M1 with a ready client base. We understand that M1 will retain Qala’s management team, which is positive given that the team has nine years of experience in this segment.
• Enabling M1 to develop its business as it derives synergies from the acquisition. As it migrates to an open access network, Qala would face lower leasing charges, enabling margins to improve. On top of that, the ability to cross-sell M1’s services such as wireless broadband to Qala’s customers should lift its revenue growth prospects.
• Over the longer term, the acquisition may help M1 achieve its longer-term target of a 20-25% market share in broadband by 2015. This applies to all segments of the broadband market: corporate, SME and residential.
• Providing M1 with a headstart over other new entrants. The SME market, we believe, is a higher-yielding market where customers tend to be more sticky than the residential segment. Moreover, M1 could potentially undercut SingTel in pricing given the relatively high charges being paid by these customers. This would enable M1 to gain market share. The corporate segment will be tougher to break into as SingTel is bound to have retained most of its customers through long-term contracts.
Could other acquisitions follow suit? We gather that M1 has ruled out making acquisitions in residential broadband as it feels confident of managing that market. Furthermore, it has been gaining experience re-selling StarHub’s access. However, we would not rule out other acquisitions in the corporate/SME market as these would enable M1 to leapfrog other ISPs and help it gain more scale here.
Valuation and recommendation
Making the right start. We believe this is a good start for M1 as it seeks to make inroads into the broadband arena. Although margins may be tight and net profit contributions negligible, we believe that M1 will be able to develop its business here.
Management has traditionally been conservative and we see no departure with this acquisition. With a fairly low cash outlay of S$15m-18m, we see this as a fairly low risk venture, more so as funding will come from internal resources (cash balance of S$40.7m as at end-2Q09).
Once again, we reiterate our view that M1 has the most upside from NGNBN, of the three incumbents, as it has no existing broadband business to cannibalise and would be able to compete on an equal footing via open access and address its singleproduct disadvantage.
No change to earnings, target price and NEUTRAL rating. We make no adjustments to our earnings forecasts given the scant details and the fact that contributions are bound to be rather small. We retain our DCF-based target price of S$1.71, based on a WACC of 10.5%. M1 remains a NEUTRAL and our top pick in the sector. The above acquisition is not likely to have a significant impact in the short term but could prove strategic over the long run. Apart from that, we see few catalysts although this is offset by attractive yields of 8% and M1’s best exposure to the fastgrowing wireless broadband segment.