Higher dividends amid rising competition?

At a Glance

• Excluding S$3m forex gains, net profit of S$82m inline with consensus and our expectations.
• Raised dividend guidance, surprisingly, to 5 cents each quarter (4.5 cents earlier). The dividends may not be sustainable in the long term, in our view, and leave limited flexibility for the new CEO, joining in Jan 2010.
• Management mentioned that EPL loss should not be EBITDA and FCF negative, bit too optimistic in our view.
• Maintain FULLY VALUED in view of regulatory changes due to National Broadband Network and rising competition in the pay TV business, potentially spilling over to mobile business.

Comment on Results

3Q09 revenue of S$537m (+2%yoy, +1% qoq) and underlying profit of S$82m (unch. yoy, +5% qoq) after excluding forex gains were in line with our expectations. StarHub has achieved 77% of our FY09F forecast. 4Q is typically weak due to festive promotions.

Service EBITDA margins improved to 33.4% versus 31.5% in 2Q09. Mobile margins improved to 37.8% versus 36.8% in 2Q09, as StarHub was not overly aggressive in customer acquisition, as mobile market share declined slightly to 28.1% versus 28.4% in 2Q09. Pay TV margins improved to 21.4% versus 19% in 2Q09, which was impacted by one-off content costs in 2Q09. Fixed lines margins improved to 41.9% versus 38.3% in 2Q09 as StarHub benefited from higher contribution from corporate data business.

Recommendation

Annual DPS of 20 Scts implies annual dividends of S$343m, translating to earnings payout ratio of 118% on our FY10F estimates as we expect an 8% yoy decline in FY10F earnings. StarHub can still support the dividend payout in 2010, due to lower cash tax in 2010 but we are doubtful beyond that. Maintain FULLY VALUED. The stock trades at 6.1x FY09F and 6.3x FY10F EV/EBITDA compared to M1’s 5.9x and 5.7x EV/EBITDA respectively.

3Q09 results above expectations

3Q09 results above expectations. StarHub Ltd reported a better-thanexpected set of 3Q09 results; revenue came in at S$537.1m (+2.4% YoY and 0.9% QoQ) vs. our forecast of S$534.0m; net profit came in at S$85.2m (+7.3% YoY and 9.4% QoQ) vs. our S$78.1m estimate. The main reason for the outperformance was improved service EBITDA (up 4.6% YoY and 6.9% QoQ, aided by higher fixed network margins). For 9M09, revenue inched up 0.6% to S$1600.1m, meeting nearly 74.5% of our FY09 forecast, while net profit climbed 9.6% to S$245.4m, or around 77.8% of our fullyear estimate. StarHub has increased its quarterly dividend from S$0.045 to S$0.05 per share – this is expected to continue into FY10.

Mobile segment remains strong. Its mobile segment continues to improve, growing 4.7% YoY and 1.8% QoQ; this as it added another 35k subscribers (22k in pre-paid). It was also able to sustain its post-paid monthly ARPU at S$69 and pre-paid at S$23, as well as reduce its acquisition cost to S$74 (vs. S$104 in 3Q08 and S$79 in 2Q09). Again, its broadband business was its worst performer, down 6.1% YoY and 2.4% QoQ, as monthly ARPU continues to fall, although churn has eased from 1.4% in 2Q09 to 1.2%. Lastly, fixed network services grew 6.3% YoY but down 0.2% QoQ; StarHub expects sequential growth to be flat due to an expected increase in competition ahead of the NBN launch in 1Q10.

Maintains outlook for 4Q09. Going forward, management has kept its guidance for 4Q09 but we are more concerned about the loss of its EPL and ESPN and STAR Sports content from mid-2010 onwards. While management believes that the loss is “EBITDA neutral”, where it expects to lose just 10% of its pay TV subscribers, we are less sanguine. Instead, we believe the loss is probably closer to 15-18% and it will also suffer a double whammy in terms of ARPU. Last but not least, it may also lose some of the stickiness needed to keep its “hubbing strategy” going. As such, we have adjusted our FY10 estimates accordingly to reflect our concerns (revenue down 12.8%, earnings down 11.4%).

Reducing fair value to S$2.29. While we have adjusted our FY09 earnings forecast by 2.2% to reflect the higher 9M09 showing, our DCF-based fair value eases from S$2.88 to S$2.29. But given the combined upside potential of 23.8%, we maintain our BUY rating.

A more starry hub

• In line, upgrade to NEUTRAL from Underperform. 3Q09 net profit was in line as 9M09 net profit forms 76% of our FY09 forecast and 77% of consensus. StarHub declared a 5cts DPS as it raised its payout policy, higher than the expected 4.5cts. We raise our FY09-11 earnings forecasts by 0-10% after: 1) removing all BPL costs from our assumptions but factoring in 5-10% churns for pay TV for FY10-11; and 2) updating our numbers to keep them in line with trends. Consequently, our DCFbased target price rises to S$2.15 from S$1.76, partially offset by a higher WACC of 9.7% from 9.4%, to reflect risks of losing more content or higher-than-expected churns. We upgrade StarHub to NEUTRAL following a less negative outcome from the loss of BPL, attractive yields of 10% and strong free cash flow yields of 10.6%. Meanwhile, M1 remains our preferred pick given its higher potential for capital management in 2010 and benefits from NGNBN.

• Revenue ticked up slightly. Topline was up 0.9% qoq, led by the mobile division’s (+1.8% qoq) subscriber growth, data and prepaid usage and equipment sales (+8.1% qoq). Pay-TV revenue and revenue from fixed network services were stable but broadband was weak (-2.5% qoq) owing to pricing pressure ahead of NGNBN and down-trading.

• Margins were surprisingly strong, advancing 1.8% pts qoq, from lower operating lease costs as the overlap of office rental expired in 1H09, lower marketing costs and lower cost of services. Notably, there were margin improvements in all divisions.

• Guidance kept but higher dividends. StarHub stuck to its guidance of stable service revenue, service EBITDA margins of 32% and cash capex of not more than 11% of revenue. Surprisingly, StarHub raised its FY09 DPS to 19cts from 18cts and promised a minimum of 5cts/quarter for the foreseeable future starting 3Q. We have raised our DPS forecasts to 19cts for 2009 and 20cts for 2010 to reflect this.

Better than expected 3Q09; dividends raised

• StarHub Ltd’s 3Q09 earnings came in better than expected with net profit at +7% YoY to S$85.2mil. We have raised FY09 EPS up by 2% to 19.1 cents Singapore.

• On the upside, mobile revenues grew 5% YoY to S$277mil, accounting for 54% of total service revenue. This was helped by 8% YoY growth in subscribers to 1.88 million while prepaid and postpaid ARPUs maintained at 2Q09 levels, at S$23 and S$69 respectively.

• Cable TV, its second largest revenue stream making up 19%, saw a pick up in net adds by 5,000 for the quarter to 535,000, with a similar ARPU trend at S$56.

• Fixed network revenues, which account for 16%, grew moderately at 6% YoY to S$80mil with growth in corporate data offsetting a fall in voice.

• But we are cutting our FY10 and FY11 forecasts by 3% each year to EPS of 18.0 cents and 18.7 cents respectively.

• On the downside, StarHub’s broadband revenue fell 6% YoY to S$59mil. While net adds slowed to 3,000 for the quarter, ARPU came in at S$50 versus S$51 in 2Q09 and S$57 a year ago. Management expects continued downward pressure on broadband ARPU due to the upcoming launch of Singapore’s new all-fibre Next Generation National Broadband Network (NGNBN) and guides that ARPU will likely trend towards S$45.

• Cost-wise, handset subsidies were higher than expected due to retention efforts as mobile churn rose to 1.2% from 1.1% in 2Q09. StarHub has also just obtained the distribution contract for iPhones, putting it on even keel with M1 and SingTel. Flipside is that we factor in higher handset subsidies going forward.

• On outlook, despite a 6% fall in earnings in FY10F from impact of the loss of Barclays Premier League and ESPN Sports content, StarHub’s cash flows remain strong. Full year savings in content costs will be felt in FY11, leading to EPS growth of 4%.

• Management is raising its quarterly DPS to 5 cents from 3Q09 (previously 4.5 cents). This amounts to 19 cents for FY09 and 20 cents for forecast years.

• We rate StarHub a HOLD with fair value at S$1.93. Dividend yield of 10% is highest among the three telcos. An improvement in newsflow for StarHub’s OpCo operation in the NGNBN from end 2009 into 1Q10 buoys prospects for StarHub in the mid-term. Market has not factored in the potential upside from this new revenue stream due to a lack of disclosure so far.

StarHub sees less than 10% defecting

Loss of some sports programming won’t hurt pay-TV business too much

STARHUB says the loss of some of its popular sports programming to Singapore Telecom will not make much of a dent in its pay-TV business.

‘Less than 10 per cent of our cable TV base is at risk,’ said CEO Terry Clontz. ‘Most subscribers are going to struggle with two (set top) boxes.’

The 10 per cent figure was derived after customer surveys and a ‘rigorous analysis’ of StarHub’s pay-TV mix, he said.

This showed that instead of defecting, most StarHub customers will subscribe to two separate pay-TV packages – for entertainment and sports content.

To save consumers from having to deal with the inconvenience of two pay-TV set-tops, Mr Clontz said StarHub will make a formal proposal to SingTel to carry each other’s pay-TV content ‘pretty soon’.

If a deal is struck, SingTel’s pay TV offerings will be available as new channels on StarHub’s cable TV platform. Similarly, the green camp’s programmes can be delivered via the red camp’s mio TV service, but customers will still pay the respective companies for their subscriptions.

‘Technology has moved on where it is now possible to offer a carriage of someone else’s channels over our network and vice-versa,’ Mr Clontz said.

Last month, SingTel outbid StarHub to score the broadcast rights for the next three seasons of the coveted English Premier League (ESPN). It also lured ESPN Star Sports to jump to its mio TV platform.

After considering the various scenarios and the cost of EPL and ESPN Star Sports content, StarHub said the loss will have no impact on its ebitda (earnings before interest, taxes, depreciation and amortisation) or free cash flow.

As a sign of its confidence, the company has proposed to raise its quarterly dividend payouts to five cents a share starting from the third quarter of this year, up from 4.5 cents previously.

‘Once we announce a dividend, it’s our intention to maintain it,’ Mr Clontz said.

The increased payout comes on the heels of a 7.1 per cent year-on-year increase in StarHub’s Q3 net profit to $85.2 million on a better performance across its three key business lines.

Earnings per share for the three months ended Sept 30 rose to 4.97 cents, from 4.65 cents in Q3 2008, while operating revenue edged up 2.4 per cent to $537.1 million.

StarHub’s Q3 performance put its nine-month net income at $245.4 million, up 9.6 per cent from last year.

With its new dividend policy, shareholders will be assured of a minimum payout of 19 cents per share in 2009. If the operator keeps to its word, the figure will be 20 cents or more from next year on.

StarHub generated higher sales in three out of its four businesses in Q3.

Its mobile sales, which accounts for half of its revenue, grew 4.7 per cent to $276.8 million. It gained 35,000 new mobile subscribers to take its customer tally to 1.88 million.

Pay-TV sales were up 1.9 per cent to $100.3 million, while fixed network services revenue rose 6.2 per cent to $79.8 million. StarHub gained 5,000 new cable TV customers during the period to take its residential pay-TV base to 535,000.

But broadband revenue fell 6.1 per cent to $58.8 million as more customers opted for discounts and lower-priced Internet packages.

As a result, StarHub’s average revenue per user (ARPU) for broadband was $50 in Q3, down $7 year-on-year.

For the full year, StarHub’s service revenue is expected to be the same as in 2008. Ebitda margin on service revenue will be maintained around 32 per cent, Mr Clontz said.

This will be the last results conference chaired by the StarHub CEO of 10 years. Mr Clontz will retire at the end of the year and hand the reins to former M1 chief Neil Montefiore.

StarHub shares closed two cents lower yesterday at $1.93 before its Q3 results were released.