Revenue streams to be boosted by OpCo

• Infocomm Development Authority (IDA) of Singapore has selected StarHub Limited as the Operating Company (OpCo) for the Next Generation National Broadband Network (NGNBN). Together with the award of the Network Company to OpenNet in September 2008, the core structure of IDA’s iN2015 vision for an ultra high-speed infrastructure is in place to wire up Singapore as an intelligent island by 2015. OpenNet consortium comprises SingTel (30%), Canadian-based Axia NetMedia (30%), Singapore Press Holdings (25%) and SP Telecommunications (15%).

• StarHub will be setting up a new wholly-owned subsidiary to fulfill the operational separation purpose of the OpCo, called Nucleus Connect, within the next 12 months. OpCo, Nucleus Connect will design, build and operate the active infrastructure of the NGNBN, i.e. lighting up the fibre ducts and wholesaling bandwidth to Retail Service Providers (RSPs). Nucleus Connect will work with OpenNet on a coordinated nationwide rollout of the network. With the NetCo’s sped up deployment from the use of existing ducts and other infrastructure assets transferred from SingTel, Nucleus Connect expects to offer commercial services by April 2010.

• Nucleus Connect expects to spend about S$1bil over its 25-year OpCo licence, while it will receive a S$250mil grant from IDA. In the initial two-to-three years, StarHub expects to invest S$100mil in Nucleus Connect, and projects the latter to be self-financing after. With a ready base of corporate customers (albeit small relative to SingTel’s), StarHub stands all ready to be Nucleus Connect’s first customer as an RSP. As part of the terms of the award, Nucleus Connect has targets to garner 330,000 residential subscribers and 80,000 non-residential subscribers by 2015.

• n For the first six years, IDA has capped pricing at S$15 per residential line and S$50 per non-residential line for Nucleus Connect to pay NetCo for the use of the fiber. At the same time, Nucleus Connect will wholesale basic services starting from S$21 per 100Mbps for residential use and S$75 per 100Mbps for non-residential use. For basic 1 Gbps services, these are S$121 for residential and S$860 for non-residential.

• We view the award as positive for StarHub as Nucleus Connect will open up new revenue streams from an enlarged RSP market. In addition, progress of the NBN project also enables StarHub – as an upcoming RSP – to garner more corporate broadband customers because the Open Access nature of NBN levels the playing field. To-date, StarHub’s coverage is up to 800 commercial buildings, mostly within the CBD area. But as corporates move away from CBD to cheaper premises, there will be increasing demand from outlying areas, which it will be able to serve from April 2010.

• Fair value is raised to S$2.28/share. Our previous fair value of S$2.17/share was based on a 5% discount to DCF approach because of StarHub’s vulnerability to rising content costs and weaker buffer to sustain DPS. Given potential for new revenue streams from OpCo, this offsets such negativity and we believe StarHub should trade up to its fair value. As such we upgrade our rating to BUY with upside of 15%.

What the OpCo win really means for StarHub

IT WAS a case of drinking on the job with champagne flowing freely at StarHub Centre all afternoon as staff celebrated their OpCo (Operating Company) triumph last Friday. Some market analysts also expect investors to add icing to the cake through a near-term rally on the back of the news that StarHub has been anointed by the government to operate Singapore’s upcoming high-speed fibre-optic network.

While any success is undoubtedly positive, the key question to ask when the confetti settles is: just how significant is this victory and what are the implications for StarHub’s lucrative broadband businesses?

From the onset, it would seem StarHub picked the short stick in the long-drawn fight for a stake in Singapore’s new digital superhighway.

To recap, StarHub last week won the bid to operate the Next-Gen NBN (National Broadband Network) and wholesale bandwidth to companies that are keen to provide Internet-related services using the new pipes. To fulfil this obligation, it will establish a new company called Nucleus Connect. Last September, a SingTel-linked group called OpenNet won the government tender to build the fibre-optic network.

New expressway

To put it plainly, OpenNet’s role in the project is akin to a construction company tasked to build a new expressway. Once completed, it leases the highway to StarHub, who then carves out lane markers and puts in place toll booths for charging, say, logistics companies who plan to use the new infrastructure to deliver goods.

While it seems like a win-win case for both, the key difference is that StarHub’s returns hinge on the number of companies that would be willing to use the expressway. While a vibrant broadband market is the desired outcome, it remains to be seen if Singapore’s small market size can support a large service provider crowd.

Furthermore, existing telcos – StarHub, SingTel and M1 – can cross-subsidise their Internet ventures with their sizeable mobile revenue streams, making it difficult for a newcomer to compete from scratch.

Unlike StarHub’s OpCo venture, OpenNet is assured of a stable stream of recurring income from construction and leasing. And SingTel, in particular, stands to land an additional billion-dollar windfall as it will be hiving off the bulk of its existing Internet assets to OpenNet to speed up the construction timeframe.

This masterful stroke allows the operator to pocket nearly $60 million annually and, at the same time, divest infrastructure that is set to lose its strategic value. Owning Internet pipes in future will not be advantageous as the government’s ‘open access’ mandate forces the owner to allow any company to tap the network at a universal price.

As the OpCo, StarHub will be left with the dilemma of deciding the fate of its current Internet assets. The company invested nearly $600 million a decade ago to roll out the cable network it needed for providing pay-TV and broadband access.

It will now have to incur heavier costs from maintaining two separate networks for the next five years at least, since the shelf life of fixed-line assets is usually two decades or more. At the same time, the minting of the NBN in late 2012 threatens to hasten the erosion of StarHub’s broadband margins.

Once the NBN is operational, StarHub can be expected to migrate its higher-end customers to the new ultrafast network, while using its current cable platform to offer cheaper, lower-tier Internet access. While the same is true for SingTel’s broadband portfolio, the red camp would have been compensated in part through the asset divestment.

Road hump

Another road hump stemming from the OpCo contract is that it is exclusive to the StarHub unit only for the first five years, or until it has claimed a 25 per cent broadband market share. After that, other companies can technically be allowed to apply for an OpCo licence.

For StarHub, the priority now is to start nailing down the types of new services that can be powered by the NBN since it will be most well-versed with the mechanics of how it operates. In particular, business offerings – be it hosting services for gaming companies, or high-speed disaster recovery – could be considered since companies are the likely early adopters of breakneck access speeds.

While the NBN presents fresh challenges, it will also allow StarHub to strengthen its corporate push – a segment which SingTel has been aggressively branching into this past year. The difference this time round is that both companies will be competing on a level playing field, so it truly becomes a case of the best man carrying the day.

Wins NBN OpCo Bid

Wins NBN OpCo Bid. StarHub announced Friday that it has been selected by the Infocomm Development Authority of Singapore (IDA) to build and manage the OpCo (Operating Company) for the Next Generation National Broadband Network (NBN). StarHub plans to invest S$100m to set up a wholly-owned subsidiary Nucleus Connect (NC) to design, build and operate the active infrastructure of the NBN. In addition, NC, which is expected to start commercial operations in 1Q10, is also committed to attracting overseas online service providers to host their content in Singapore.

S$1b investment over 25 years. According to StarHub, NC expects to spend about S$1b for the active network over the 25-year period of the license, or around S$40m per year. However, NC is eligible for the government grant of up to S$250m from IDA to defray part of the investment, which we understand will also be dispersed to NC over a period of time. Based on our estimates, we do not believe that StarHub will have any issues funding the S$100m NC investment using its internal funds.

Wholesale pricing ranges from S$21-121 per user. Meanwhile, the IDA has revealed that one of the key factors behind StarHub’s victory was its “attractive” wholesale pricing. Media reports quoted the IDA as saying NC will charge companies (RSPs or Retail Service Providers) S$21 a month for a 100Mbps residential Internet connection and S$121 for a 1Gbps link; a 100Mbps non-residential connection is priced at S$75 a month. The IDA added that NC’s proposed wholesale pricing cannot be raised for the first six years but it can be brought down. Earlier, the NetCo (Network Company) – won by a consortium that includes rival SingTel – said it would offer wholesale prices of S$15 per month per residential fibre connection and S$50 per month per non-residential fibre connection to operating companies.

No near-term impact. In the near-term, we do not see any impact on its earnings – we expect meaningful OpCo contribution to come in from 2011 onwards; we raise our FY10 estimates by less than 0.5%. We also do not expect any change in its capex spending this year although we can expect an increase of S$30m from 2010 onwards; and we can expect a small increase in debt funding somewhere down the road. Nevertheless, based on our DCF valuation model, the win is positive for StarHub and that bumps up our fair value from S$2.78 to S$2.88. Maintain BUY