SingTel – CIMB

Telkom to buy SingTel’s stake in Telkomsel Government wants Telkomsel back

Maintain Underweight on sector. We maintain our UNDERPERFORM rating for SingTel and urge investors to sell into expected strength in its share price on news that Telkom Indonesia plans to buy SingTel’s 35% stake in Telkomsel. Should the acquisition take place, we believe SingTel will return the proceeds to shareholders. However, any acquisition will take time and SingTel’s share price could be de-rated after the initial euphoria. Telkom remains an UNDERPERFORM with an unchanged DCF-based target price of Rp7,400 (WACC 12.2%) as the acquisition would deplete its cash, ratchet up its gearing, and possibly affect its plans for a share buyback. Axiata remains our top regional telco pick.

The news

Indonesia’s State-Owned Enterprise (SOE) Ministry has asked Telkom Indonesia to buy SingTel’s 35% stake in Telkomsel. The Minister Mr Mustafa Abubakar said the acquisition will “strengthen the position of Telkom.” Eddy Kurnia, Telkom’s Head of Corporate Communication said, “We support the statement by the SOE Minister because it was expected by Telkom or the shareholders.” But he added that it would take a while to buy back the shares and did not provide a timeframe.

Comments

A surprise. The news surprised us although rumours had been circulating. It is indeed puzzling why the government is now eyeing Telkomsel. This comes after ST Telemedia, another Singapore government-linked corporation, sold its stake in Indosat after Indonesia ruled that Indosat and Telkomsel were fixing prices. We suspect Telkom’s intention to own 100% of Telkomsel is related to SingTel’s reluctance for Telkomsel to sell its towers to Telkom. Telkom had intended to park all the towers of its units under Daya Mitra and eventually list this entity. Taking full control of Telkomsel could pave the way for this transaction. Telkomsel controls the largest number of towers in Indonesia, about 20k or 40% of the industry total.

Negative for Telkom. This news is negative for Telkom because SingTel will not relinquish its stake cheaply, in our view. Having said that, the government may find means to compel SingTel or the Singapore government to do so. The purchase could deplete Telkomsel’s cash pile of Rp10tr (US$1.25bn), weaken its balance sheet of 0.2x net debt/EBITDA and possibly affect its plans for a share buyback.

Assuming Telkom buys Telkomsel at 16x CY11 P/E or Rp72tr (US$8.5bn) and funds 70% of this with debt, Telkom’s gearing and net debt/EBITDA will rise from 0.2x and 0.3x to 1.1x and 1.4x respectively. While Telkomsel is the growth driver for Telkom, we believe Telkom should return excess cash to shareholders instead of sinking more money into Telkomsel given the lacklustre performance of Telkomsel and a maturing mobile industry. We also believe SingTel has been injecting talent and its regional experience into Telkomsel, and has been instrumental in driving Telkomsel’s operations.

Positive for SingTel’s shareholders, as proceeds from the sale are likely to be returned to them. Assuming an acquisition price of US$8.5bn or S$10.1bn, the sale would raise S$10.1bn (US$8.4bn) or a hefty S$0.70/SingTel share. Telkomsel has not been the growth driver it used to be as the Indonesian telco market matures, having lost market share. However, this may be a protracted transaction as price will be a key contention, in our view.

Valuation and recommendation

Sell SingTel into strength. We reiterate our UNDERPERFORM on SingTel and urge investors to sell into expected strength in its share price on news that Telkom Indonesia plans to buy its 35% stake in Telkomsel. Should the acquisition take place, we believe SingTel will return the proceeds to shareholders. However, any acquisition may take time and SingTel’s share price could be de-rated after the initial euphoria. Lastly, even if Telkom acquires Telkomsel at a 30% premium (i.e. 16x CY11 earnings) to our valuation of Telkom (based on 12.5), our SOP valuation for SingTel would only rise by S$0.15/share or 5%. SingTel continues to face competitive headwinds in Australia, margin pressure in Singapore and earnings drags in India, in our view.

Telkom remains an UNDERPERFORM with an unchanged DCF-based target price of Rp7,400 as the acquisition would deplete its cash, ratchet up its gearing, and possibly affect its plans for a share buyback. We believe Telkom’s outlook remains poor with declining fixed-line revenue and a lacklustre mobile performance due to a maturing industry and Telkomsel’s loss of market share. Axiata remains our top regional telco pick.

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