M1 – DB

1Q10 not as good as earlier thought and 2Q10 preview

1Q10 performance not as good as previously thought; stay cautious

M1 is the best performing Singapore telco YTD with its 3M share price supported to some extent by the view that the 1Q10 results were “not as bad as earlier feared”. But M1’s 1Q10 was in fact flattered by a new accounting treatment, which we believe masked 7-yr EBITDA and NPAT lows. Although margins are expected to improve in 2Q10e and continue to recover over 2010e, the new accounting treatment clearly raises some uncertainty around M1’s relative performance. We remain fundamentally cautious but maintain Hold for the yield.

New accounting treatment flattered 1Q10 financials

M1’s 1Q10 results were flattered to an extent by a new iPhone accounting treatment (currently only adopted in the sector by M1), under which a subscriber’s lifetime revenues are front-end loaded. M1 has not disclosed specific details on the methodology, but our analysis suggests 1Q10 revenues may have been boosted by approx S$10-20m. Without the accounting adjustment, we estimate the 1Q10 EBITDA margin would have compressed to approx 25-27% (vs reported 31%) and driven EBITDA to a 7-yr low while NPAT would have fallen by up to 45% YoY (vs reported -6% YoY). M1 is expected to provide more clarity on the new accounting methodology with the 2Q10e results, but its adoption does raise uncertainties around M1’s performance vs the S’pore telcos and historical trends.

Recovering margin the key theme for 2Q10e

We expect QoQ margin recovery to be the key theme when M1 announces 2Q10e results on 15 Jul. Handset revenues will remain the key driver of M1’s 2Q10e performance (despite slowing iPhone sales) and we expect total reported revenues of S$230m (+20% YoY). But otherwise, mobile service revenue growth is likely to be modest. Positively, handset costs should moderate with lower volumes sold (although acquisition cost per sub expected to stay high) and drive QoQ margin recovery to 34.5%. Overall, we expect 2Q10e EBITDA to inch up to S$79m and NPAT to reach S$40m (+7% YoY), taking 1H10 NPAT to S$79m.

DCF-derived S$2 TP; key risks include competition and fixed-line execution

Our M1 TP is derived from DCF analysis using 7.2% WACC and 0% g to reflect the long-term ex-growth nature of Singapore’s telco market. Key risks include competition, fixed-line execution and capex.

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