TELCOs – CIMB

M1 and StarHub launch iPhone plans

iPhone pricing unveiled

Maintain Underweight on telco sector. Both M1 and StarHub announced they will be launching iPhones on 9 Dec. A quick scan shows that both have priced their phones below SingTel’s pricing. However, the telcos are rather rational by not straying too far from the incumbent’s pricing, thereby averting an all-out subsidy war, which had been our earlier concern. M1’s plans are a little more aggressive. We believe M1’s and StarHub’s margins will be depressed in 4Q09 and 1Q10 by the launch of the iPhones, which coincides with festivities. We remain UNDERWEIGHT on the sector given myriad risks and our house preference for cyclical sectors. Our top pick is still M1, rated a NEUTRAL with an unchanged DCF-based target price (WACC: 9.5%) of S$2.07, as we believe there is capital-management potential in 2010 and M1 has the greatest upside from NGNBN.

Comments

Fairly rational pricing. Both M1 and StarHub announced they will be launching iPhones on 9 Dec, well ahead of the peak sale period for Christmas. A scan of all three plans indicates that both StarHub and M1 have stayed fairly rational, which assuages our earlier concern that an all-out subsidy war could erupt. The handset pricing only varies by S$40 at the most, among the most comparable plans, with M1 being more aggressive, and very little differentiation in monthly subscription fees.

As an example, M1 offers the iPhone 3GS 32 GB for S$0-658 with a monthly commitment fee of S$36-198. StarHub offers the same phone at S$0-668 with a monthly commitment fee of S$38-205. SingTel is already offering the same device for S$0-S$678 with a monthly commitment fee of S$39-205.

M1 is the most aggressive, excluding its iPhone 3G 8 GB plan, offering the cheapest handset pricing and lowest monthly commitment fees. It is also the only operator to offer true unlimited plans providing unlimited voice/video calls, SMS/MMS and data surfing. M1 also offered the most data capacity until StarHub upped the ante 12 hours after StarHub’s initial launch by increasing the initial 1GB bundle to a 12 GB bundle
across three of their four plans.

We are not surprised by M1’s aggression as it has the smallest subscriber share and would want to make a bigger splash to lure more subscribers. During our recent nondeal roadshow with M1, we understand that about 10K of its existing subscribers are interested in migrating to the iPhone plans.

Limiting churns but hurting margins. While we see the iPhones as more of a defensive move by the two smaller rivals to cling on to subscribers, the iPhones should also help them acquire new customers and stimulate ARPU. However, the downside is that subscriber acquisition and retention costs (SARC) are set to rise and dent margins as marketing expenses rise in tandem.

We note that SingTel’s EBITDA margin fell 2.6% pts in 2QFY09 when it launched the original Phone 3G in Aug 08 and slipped 3.2% pts in Jul 09 when it introduced the iPhone 3GS. SARC rose to S$306 in 2QFY09 from S$256 in 1QFY09 following the launch of the iPhone 3G and to S$327 in 2QFY10 from S$304 in 1QFY10 when it launched its iPhone 3GS in Jul 09.

How will SingTel react? The thing to watch is counter-measures unveiled by SingTel. During its 2QFY10 conference call, SingTel said it would make both price and non-price responses such as offering more applications and improving its customer service quality to maintain its lead. Given still-fairly rational pricing, we do not expect SingTel to react aggressively when it launches a new iPhone plan this weekend.

Valuation and recommendation

Maintain UNDERWEIGHT with M1 as our top pick. While a subsidy war does not appear to be brewing, we retain our UNDERWEIGHT position on the sector in view of myriad other risks relating to competition and also our house preference for cyclical sectors. Among these risks are further ARPU erosion in broadband for SingTel and StarHub, higher content costs at SingTel, and risks of losing more compelling content at StarHub.

We maintain M1 as our top pick in the sector for its capital-management potential and upside from NGNBN. We rate it a NEUTRAL with an unchanged DCF-based (WACC: 9.5%) target price of S$2.07.

StarHub is our next preference, rated a NEUTRAL with an unchanged DCF-based target price of S$2.15 (WACC: 9.7%) as we like it for its attractive yields and strong free cash flow yields of 10-11%, offset by a lack of re-rating catalysts and a likely erosion in its residential broadband business.

Finally, SingTel is our least preferred stock due to expected weaker margins in Singapore and concerns over competition in India and Australia. We rate it an UNDERPERFORM with an unchanged sum-of-the-parts target price of S$3.30.

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