Acquiring Qala

M1 announced last Friday that it will be acquiring a local Internet service provider (ISP) Qala Singapore from its existing shareholders for S$14.9m cash. If certain financial targets (revenue and net profit growth) are met as at end-FY6/11, M1 may have to fork out an additional S$3m to the existing shareholders of Qala. The transaction is expected to be completed within one month and the entire acquisition will be funded by internal resources.

More on Qala. Qala is a 9-year-old ISP with a service-based operator licence. It offers a full suite of data and communications products and services to corporate, enterprise and public-sector customers in Singapore. It is one of three providers of the free nationwide Wi-Fi service, wireless@SG, and the only commercial WiMAX provider in Singapore. Qala’s net book value as at end-June was S$2.8m.

Comments

M1 not likely to have overpaid. There is very little clarity on Qala’s financials as it is a private entity and M1 is unable to divulge much on its financial conditions. We understand that revenue and profit are not significant but we believe that M1 did not overpay in keeping with its typically conservative management. The P/BV tag of 5.3x-6.4x is slightly misleading as Qala is a pure reseller and does not have significant fixed assets on its books.

Rationale? We see the rationale for the acquisition as:

• Providing M1 with a foothold in the corporate fixed broadband market ahead of NGNBN. This would enable M1 to address some of its shortcomings in broadband when it comes to tackling this market on top of providing M1 with a ready client base. We understand that M1 will retain Qala’s management team, which is positive given that the team has nine years of experience in this segment.

• Enabling M1 to develop its business as it derives synergies from the acquisition. As it migrates to an open access network, Qala would face lower leasing charges, enabling margins to improve. On top of that, the ability to cross-sell M1’s services such as wireless broadband to Qala’s customers should lift its revenue growth prospects.

• Over the longer term, the acquisition may help M1 achieve its longer-term target of a 20-25% market share in broadband by 2015. This applies to all segments of the broadband market: corporate, SME and residential.

• Providing M1 with a headstart over other new entrants. The SME market, we believe, is a higher-yielding market where customers tend to be more sticky than the residential segment. Moreover, M1 could potentially undercut SingTel in pricing given the relatively high charges being paid by these customers. This would enable M1 to gain market share. The corporate segment will be tougher to break into as SingTel is bound to have retained most of its customers through long-term contracts.

Could other acquisitions follow suit? We gather that M1 has ruled out making acquisitions in residential broadband as it feels confident of managing that market. Furthermore, it has been gaining experience re-selling StarHub’s access. However, we would not rule out other acquisitions in the corporate/SME market as these would enable M1 to leapfrog other ISPs and help it gain more scale here.

Valuation and recommendation

Making the right start. We believe this is a good start for M1 as it seeks to make inroads into the broadband arena. Although margins may be tight and net profit contributions negligible, we believe that M1 will be able to develop its business here.

Management has traditionally been conservative and we see no departure with this acquisition. With a fairly low cash outlay of S$15m-18m, we see this as a fairly low risk venture, more so as funding will come from internal resources (cash balance of S$40.7m as at end-2Q09).

Once again, we reiterate our view that M1 has the most upside from NGNBN, of the three incumbents, as it has no existing broadband business to cannibalise and would be able to compete on an equal footing via open access and address its singleproduct disadvantage.

No change to earnings, target price and NEUTRAL rating. We make no adjustments to our earnings forecasts given the scant details and the fact that contributions are bound to be rather small. We retain our DCF-based target price of S$1.71, based on a WACC of 10.5%. M1 remains a NEUTRAL and our top pick in the sector. The above acquisition is not likely to have a significant impact in the short term but could prove strategic over the long run. Apart from that, we see few catalysts although this is offset by attractive yields of 8% and M1’s best exposure to the fastgrowing wireless broadband segment.

Hitting the right buttons for NBN

• M1’s acquisition of Qala demonstrates a clear strategy of leveraging on corporate broadband opportunities through National Broadband Network (NBN).
• TP revised to S$2.05, still pegged to 12x PER, as we roll over to average FY09F-10F earnings. M1 remains our top sector pick.
• 15% potential upside and 8% regular yield plus likelihood of an additional 10% yield in FY10F, through capital management.

A concrete step in the corporate data segment. M1 has acquired Singapore-based Internet Service Provider “Qala Singapore” for about S$17.9m in cash. Out of S$17.9m, S$3m would be paid only if Qala meets its annual targets in June 09. Qala has 9-year experience in providing data centre and broadband solutions to Singapore corporates.

Corporate data segment is worth over S$1 bn annually. Corporate data market is estimated to be worth over S$1 bn annually in Singapore, where SingTel is the dominant player. Despite NBN providing level playing opportunity in 2010, our earlier impression was that M1 could hardly make an impact in the corporate segment due to the lack of expertise and track record. However, by acquiring corporate data capability through Qala, M1 should be able to secure decent market share among SMEs and corporate customers. M1 can take care of consumer broadband segment on its own through its extensive island wide distribution network.

How much can M1 benefit from broadband? The household fixed broadband penetration is around 74% in Singapore, implying the market is not completely saturated yet. M1 is keen to gain 20% market share in the broadband market in the next five years. Overall, we estimate, M1’s top line could grow by about 20-25% in the
next five years from consumer and corporate broadband. While broadband margins are difficult to estimate, M1’s bottomline should grow by at least 10% in a similar time frame. We would model NBN benefits into our model, once we have more clarity on broadband margins.

M1 turns subscriber tide in Q2

SINGAPORE’S smallest telco registered the biggest subscriber gain among the three local operators in the second quarter of this year.

MobileOne added 50,000 local mobile customers, while StarHub came in second with a net addition of 34,000 users.

The usual frontrunner – Singapore Telecom – trailed the pack with the addition of only 15,000 new local subscribers.

According to a SingTel statement yesterday, the company’s customer tally was affected by the deactivation of improperly registered pre-paid subscribers during the quarter.

Despite adding 22,000 post-paid users here, the cancellation of 7,000 pre- paid accounts resulted in the net addition of 15,000.

Still, SingTel remains the dominant local player, with a mobile market share of 45.9 per cent.

On the regional front, SingTel – which reports its earnings today – grew its mobile user base sequentially by 12.8 million to end Q2 with 262 million subscribers across the eight markets it operates in.

India’s Bharti continues to be the best performer among SingTel’s six regional associates. Bharti added 8.4 million customers during Q2 to lift its subscriber base past the 100 million mark.

Indonesia’s Telkomsel grew its user base by 3.9 million sequentially, while Globe in the Philippines witnessed a decline of 713,000. Thailand’s AIS gained 320,000 customers in the three months ended June 30.

In Pakistan, Warid added 511,000 subscribers, while Bangladesh’s PBTL registered a sequential increase of 91,000.

SingTel’s Australian unit Optus attracted 213,000 customers in Q2 as a result of the strong demand for Apple’s iPhone and attractive subscription plans, the operator said.

Industry observers say SingTel’s subscriber base in Singapore and Australia could swell further in the current quarter with the launch of the beefed-up iPhone 3GS last month.

Due to supply constraints, BT understands the initial shipment of the new touchscreen handset has almost sold out in Singapore and a similar shortage appears to have surfaced in Australia.

The iPhone 3GS has turned out to be a bigger hit than its predecessors since it debuted on June 19 in eight countries. More than a million units flew off the shelves during the launch weekend alone.

Yield plus opportunities ahead

• Recovery in mobile business coupled with key cost saving initiatives, should drive single-digit growth.
• While M1 has surged 13% since our upgrade on 22 June, there is more upside potential given its aggressive
broadband plans as revealed by management.
• Our target price is raised to S$1.95, still pegged at a 10% discount to StarHub’s target PER of 13x. BUY for 8% yield, potential upside of 15% and 10%-20% capital management yield in FY10F.

Recovery in mobile ARPU coupled with cost saving initiatives. With pick up in the Singapore economy, we expect mobile ARPU and subscriber growth to recover before the broadband and pay TV segments. This was evident in 2Q09 results of both M1 and StarHub. We understand that negotiation of lower network maintenance fee and continued offshoring of call centre operations should lead to cost savings of about S$10m each year. Another S$10-15m cost savings should accrue as more traffic shifts from leased-lines to M1’s
own backhaul network in FY10F. As such, our forecast of 6% yoy growth in FY10F earnings may prove conservative.

M1 keen to defend mobile market share before attacking broadband market. M1 management disclosed its aim to achieve over 20% broadband market share by 2015, through the National Broadband Network (NBN) opportunity, translating into top line growth of about15-20%. However, we would wait to include any numbers from broadband until we see the execution plan. Meanwhile, M1 is committed to defend its mobile market share (25.4% currently) with initiatives such as “Take 3” plan targeting high-end customers.

Buy with revised TP of S$1.95. Our target price is pegged at 12x FY09F PER (11x earlier) still pegged at a 10% discount to StarHub’s target PER of 13x. Unlike its peers, M1 is not affected by falling broadband price and rising content costs.