M1 – Kim Eng

Subsidy Hiccup

Downgrade to HOLD. M1’s full year earnings outlook is now more uncertain on a 2Q12 miss, and the company has withdrawn its earnings guidance. The current re-rating of the stock is likely to be cut short for now. We have cut our FY12 forecast by 5%, which could fall further if demand for iPhone 5 is stronger than expected. We are not totally negative on M1 as there is a chance Android will hold its ground. Although we usually steer clear of neutral calls, we reckon this uncertainty should clear up within a couple of quarters. Its longer term catalysts such as data monetisation, 4G and NGNBN are still valid. Fair value is pegged at peer average PE of 14x or SGD2.45 for now.

2Q12 below expectations despite lower iPhone sales. M1 reported lower-than-expected net profit of SGD35.3m, down 18% YoY and 12% QoQ. Although subsidies fell on greater demand for Android handsets in 2Q12, margins were hit by its accounting treatment for Android handset subsidies (which differ from iPhones) as M1 did not recognize any service revenue upfront to offset the handset cost as it does with iPhones. 70% of handsets sold during the quarter was Android, mainly the high-end Samsung S3, pushing SAC down 12% QoQ to SGD320.

Full year earnings guidance withdrawn. Earnings outlook will be uncertain for the next two quarters as we are not sure how strong Android handset sales will be in the face of a new iPhone. Higher Android adoption should be long term positive for margins and future revenue but M1’s accounting policy is muddling the short term picture. The best case is for flat margins in 3Q12 if users hold off and wait for the iPhone 5, and the worst case is if iPhone 5 demand surges in 4Q12. Neither case is very positive for M1 in the short term.

Longer term catalysts still valid, but overshadowed for now. We believe catalysts such as revenue and margin upside from data monetisation, its early mover position in 4G and the lifting of service activation bottleneck in NGNBN will still be valid for M1. However, those are longer term catalysts and for now, will be overshadowed by the confusion caused by its different accounting treatments for iPhone and Android handset subsidies, as well the earnings uncertainty arising from Apple’s upcoming iPhone 5.

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