M1 – CIMB
Highlights from luncheon
Luncheon in Singapore
We hosted a post 3Q luncheon with representatives of M1 on Oct 20th following its 3Q results on Oct 16th. The company was represented by Karen Kooi (CEO), See Leng Sim (Deputy Director of Finance) and Ivan Lim (GM, Finance and IR). There were a total of 8 clients who attended the function. The key talking points centred around the next generation national broadband network (NGNBN), the Qala acquisition, roaming, its single product disadvantage and capital management initiatives. We maintain our earnings forecast, target price of S$2.07 (WACC: 9.5%, LT growth: 1%), and NEUTRAL call. We see a lack of price catalysts but this is offset against the attractive yield of 21% for FY10 which includes our expectations of a special dividend, the most upside to NGNBN and the best exposure to wireless broadband.
In a good position for NGNBN
Qala acquisition to fill in gaps. The Qala purchase provided M1 with access to the corporate fixed broadband market and a customer base to leverage on. Its product suite would also be enhanced as it could provide managed services as well. M1 has commenced the integration process and would realise cost savings from nonduplication systems such as billing and through the rationalisation of staff. Qala is profitable despite a small customer base and has the potential to grow. From this point on, M1 ruled out making other acquisitions as it would only pursue the organic route.
Tight-lipped about strategy. M1 would not divulge specifics over its strategy towards NGNBN. But consistent with its style, M1 would not compete on pricing nor would it bid for premium content. However, we see pricing as an important lever as M1 lacks a unique selling proposition and we gather that some retail service provider (RSP) would be disruptive from the outset. M1 reiterated its longer term goal of obtaining a 20% market share in the corporate and residential fixed broadband market by 2015. Assuming broadband prices remain stable, M1 estimates that the 20% market share could provide a 40% uplift to current revenue.
Roaming to potentially boost earnings
Greater tourist arrivals beneficial in two ways. The opening of the two integrated resorts (IR) in 2010 is expected to draw an additional 2-3m visitors to Singapore, according to the Singapore Tourism Board. The arrival of more visitors would benefit M1 in two ways, namely higher roaming and prepaid revenue. We estimate that FY10’s earnings could be lifted by 5-8% from the additional tourists. We detail our assumptions below. This could also help to spur roaming revenue which has not recovered as roaming traffic was still down some 25-26% on a yoy basis.
• We assume that each tourist would spend the same amount as they did in FY08
• We assume that inbound roaming constitutes 75% of the total roaming revenue
• We assume that EBITDA margins for inbound roaming is 60%
• M1 would capture 30% of the new visitor arrivals
• 5% of the new arrivals would purchase a S$15 prepaid card
Preferred partner to Axiata and Vodafone. M1 is the preferred roaming partner to both Axiata and Vodafone which means that their subscribers automatically lock-on to to M1’s network when they enter Singapore. While the partnership with Axiata was expected given the shareholding linkages, the Vodafone deal is a more stunning coup.
It first secured the deal in 2003 and has recently renewed the arrangement for a further 3 years to 2012. In exchange for a fee, Vodafone supplies business products (such as dongles) at cheaper prices, gets preferential roaming and signalling arrangements. About 70% of Vodafone’s inbound arrivals lock on to M1’s network when they are in Singapore but M1 did not disclose the revenue contribution.
Capital management. M1 would not rule out capital management for FY10 but the final decision rested with the board and any decision would only occur after it had refinanced its S$250m loan due in May 2010. The board has traditionally been conservative and would not support a special dividend unless the environment improves.
We are more optimistic and have built in a special dividend of 23.5 cts/share into our forecast. We expect credit markets to recover and had previously forecasted M1’s net debt/EBITDA to fall to 0.4x in FY10, leaving plenty of room to gear up. M1 last undertook a capital management exercise in 2Q07 when its net gearing was 1.0x net debt/EBITDA, a capital structure M1 has described as ideal.
iPhone value. M1 had received a lot of interest for the iPhone implying pent-up demand despite SingTel’s de-facto exclusivity for more than year. M1 had about 10- 20K iPhone users on its network but we believe that growth will accelerate post the launch of the phone.
We view the iPhone as an excellent acquisition and retention tool and an ARPU stimulator through higher data usage. M1 concurred noting that the main value of the device was the higher ARPUs it generated and the fact that it would have faced an untenable situation without the phone. The iPhone is well-suited for its take 3 programme, where ARPUs are 1.15x higher than that of a normal postpaid user. While pricing has yet to be determined, M1 will not deviate too far from the subsidies provided by SingTel. We estimate that SingTel recovers the iPhone subsidies within a period of 6-14 months and believe that M1 would witness a similar payback period.
Cost cutting measures and competition. M1 attributed the 1.4% pts drop in EBITDA margins in part to seasonality. Over time and in a steady state environment, EBITDA margins would drift back up to the 44-46% of service revenue. The main areas to attack would be in the leased line cost as it completes its backhaul investment by end 09. Besides that, it would focus on cost initiatives by improving staff efficiency, expanding its call centre in Kuala Lumpur to handle 50% of the call traffic and improve its network efficiency.
Meanwhile, M1 has seen heavier competition in wireless broadband which caused its net adds to fall to 12K in 3Q from 15K in 2Q because of price discounting by StarHub. In order to retain its market share, it would have to match those promotional prices.
Valuation and recommendation
The session did not provide major revelation with much of the talking points addressed in the 3Q call and in previous discussion with M1. The only real new area explored was the roaming agreement with Vodafone. As a yield play, we continue to advocate M1 over StarHub as its earnings stream is more visible and secure. Moreover, it has the capacity to gear up and we have factored in a special dividend of 23.5 cts/share into our forecast. We maintain our earnings forecast, target price of S$2.07 (WACC: 9.5%, LT growth: 1%) and NEUTRAL call. Although we see a lack of catalysts, this is balanced out by its yield of 21.4% which is inclusive of the 23.5 cts special dividend, the most upside to NGNBN and the best exposure to wireless broadband.