SELL

• The stock has fallen below the long term trendline established since mid 2004.

• Support at $2.58 is likely to be tested in near term.

• 2Q08 net profit of $64m (-20.5% yoy ) is well below consensus of $83m. The disappointing results is due to margin squeeze as equipment subsidies, higher marketing costs and loss of Euro 2008 rights arising from intense competition ate into EBITDA margins.

• Although competition in 2H08 is expected to ease, management guided lower FY08 revenue growth of 7% and margin of 31% while maintaining DPS at 18¢.

• At $3.80, the stock currently offers a dividend yield of 6.4% vs MobileOne’s 7.5%

• Recommend sell.

Management lowers guidance

Story: Net profit fell 21% y-o-y to S$64.2m, lower than our below-consensus estimate of S$75m (consensus S$83m). This was due to 650 bps y-o-y decline in EBITDA margin to 28.9%.

Point: Lower margins were due to (i) decline in pre-paid mobile ARPU (-23% y-o-y, -10% q-o-q) and broadband ARPU (-5% y-o-y, -3% q-o-q) as a result of intense price competition (ii) Huge increase (41% y-o-y, 32% q-o-q) in marketing and promotional (M&P) costs ahead of MNP and (iii) a one-time increase of S$4-5m in content cost due to Euro cup rights. Going forward, we expect M&P and content cost to fall from 2Q08 levels. However, pre-paid mobile and broadband might continue to see competitive pressures. The launch of iPhone by SingTel, most likely in late Aug, could put fresh pressure on StarHub’s post-paid mobile business in 2H08.

Relevance: We have changed our valuation methodology to PER basis, given lower long-term earnings visibility. Based on its historical PER band (13.3x-19.4x), we peg our target price to 14x average FY08-09F EPS, comparable to SingTel’s 14.5x PER on FY09F EPS and M1’s 11.0x PER on FY08-09F EPS. Downgrade to FULLY VALUED with a lower TP of S$2.60. Management clarified that potential for capital reduction would depend on its decision to participate in the OpCo bidding. From StarHub’s track record, we see more likelihood of capital reduction than special dividends, resulting in additional cash yield of 3% assuming net debt to EBITDA (FY08) target of 1.5x.

Management finally lowers 2008 guidance. We had highlighted the risk to FY08 management guidance last quarter. Management has lowered its FY08 guidance for revenue growth to 7% y-o-y (from 10%) and EBITDA margin to 31% (from 33%), which are conservative. We have imputed 32% EBITDA margin in our FY08 estimates, assuming SingTel will cool off competition to fulfill its own margin guidance. We lowered our FY08F and FY09F earnings by 7.5% and 6.3%, respectively.

Disappointing 2Q08 results

Disappointing 2Q08 results. StarHub Ltd posted a disappointing set of 2Q08 results. Although revenue rose 8.6% YoY to S$531.4m, it was down 0.7% QoQ, missing both our S$540.2m estimate and the street’s S$552.5m figure. Meanwhile, net profit tumbled 20.5% YoY and 19.9% QoQ to S$64.2m, way shy of our S$76.2m estimate and the street’s S$83.6m number. Management attributed the sharp earnings decline to three reasons – 1) a 4% fall in mobile pre-paid revenue; 2) increased acquisition & retention costs; and 3) higher Pay TV content costs. Together, these resulted in a compression of EBITDA margin from 33.5% in 2Q07 (31.4% in 1Q08) to 27.6% in 2Q08. On an interim basis, revenue rose 10.9% to S$1066.3m, meeting 48.2% of our FY08 estimate, while net profit fell 4.3% to S$144.3m, or 43.1% of our FY figure.

Intense competition in mobile segment. Mobile business sales rose 6.5% YoY (down 1.4% QoQ) to S$269.3m, or about 50.7% of total revenue. Although StarHub recorded its highest quarter net adds (36k) for its postpaid segment in over five years, its pre-paid segment saw a 40k net drop after it failed to respond promptly to a competitor’s aggressive strategy. And as expected, average acquisition cost jumped by another 19.4% QoQ (+27.8% QoQ in 1Q08) ahead of the implementation of true mobile number portability (MNP) in June 2008. But on the flip side, StarHub has managed to reduce its churn rate to 0.9%, the lowest level since 4Q05.

Slower growth and lower margin expected. Going forward, management has moved to slash its revenue guidance from 10% previously to 7%, citing flat pre-paid revenue growth projection. In addition, StarHub has cut its EBITDA margin guidance from 33% previously to 31%, even though it expects the aggressive handset subsidies to ease towards the end of the year. However, it kept the total dividend payout of S$0.18/share for the year; it has also made S$0.045/share for 2Q08. In light of the latest developments, we have cut our FY08 forecast for sales by 3.3% and earnings by 9.9%.

Fair value eases to S$3.19. Our DCF-based fair value also eases from S$3.51 to S$3.19. Given the disappointing 2Q08 results and more muted outlook, we do expect the stock to suffer some near-term weakness, which we view as a good entry point. We still like StarHub as a defensive play with its still attractive 6.5% dividend yield for this year, and hence we retain our BUY rating on the stock.

StarHub Q2 profit falls 20.5% to $64.2m

Telco lowers revenue growth, ebitda margin guidance for 2008

STARHUB’s second-quarter net profit fell a sharp 20.5 per cent to $64.2 million due to aggressive marketing to retain mobile phone customers.

Earnings per share fell to 3.76 cents from 4.48 cents for the three months to June 30.

It also lowered guidance for revenue growth and ebitda (earnings before interest, tax, depreciation and amortisation) margin for the full year.

StarHub said that operating revenue growth is now expected to be around 7 per cent from earlier guidance of 10 per cent while blended Ebitda margin is lowered to 31 per cent from 33 per cent.

But it said that capital expenditure will not exceed 12 per cent of operating revenue and maintained its commitment to pay a minimum annual dividend of 18 cents per ordinary share.

Yesterday, StarHub declared a quarterly dividend of 4.5 cents, same as in the first quarter. For last year, StarHub had paid ordinary dividends of 16 cents in total.

Terry Clontz, StarHub chief executive, said competition remains intense and the telco had seen higher acquisition and retention costs ahead of the launch of mobile number portability (MNP).

MobileOne, its smaller rival which reported results last month, managed a slim 1.2 per cent increase in second-quarter net profit to $41.1 million.

Singapore Telecommunications will report its results on Aug 12.

For the quarter under review, StarHub said that group operating revenue increased 8.6 per cent to $531.4 million from a year ago. Group ebitda fell 10.4 per cent to $146.7 million, primarily due to substantially higher acquisition and retention costs ahead of the June 13 MNP.

The intensified competition and various marketing promotions carried out in the mobile segment saw acquisition cost per gross connection jump 63 per cent to $148.

The quarter saw daily advertisements of new mobile service promotions, including zero cost handsets and aggressive discounts off monthly subscriptions.

‘It’s not a trend we like to see, we like to see that number move back to the $100 mark,’ said Mr Clontz. ‘But the good news was the number of customers who stayed.’

Average monthly churn rate fell to an ‘all time low’ of 0.9 per cent.

Although StarHub managed to grow its mobile customers by 9.9 per cent to 1.8 million, its market share fell to 29.6 per cent from 32.7 per cent a year ago.

Mobile revenue grew 7 per cent to $269 million.

Pay TV revenue rose 25 per cent to $102 million, driven by the increase in fees for its sports channels. Customer base was up 3 per cent to 511,000. Broadband revenue was flat at $62 million. Fixed network revenue grew 12 per cent to $75 million.

Free cash flow at $140 million was 14 per cent lower compared with last year’s $162 million.

Giving an optimistic take on its results, Mr Clontz said that the telco added a record number of post-paid mobile customers who will increase their use of its services.

‘We added a record number of post-paid mobile customers in the second quarter and first half of 2008. The short-term financial consequence of this success is a dilution to earnings. However, this positive trend in customer preference for StarHub services should deliver good momentum in future periods,’ he said.

StarHub ended trade yesterday at $2.80, up seven cents.