Non-deal roadshow feedback – more ready for NGN than the market expects

● CEO Karen Kooi explained to investors in the UK and the US that M1 intended to maintain revenue market share, using product innovation (e.g. Take 3) and, post-NGN, bundling with broadband.

● However, profitability will also be monitored carefully, and cost control remains a key area of focus. Off-shoring of call-centre operations and backhaul rollout are progressing on schedule.

● M1 is extremely bullish on its prospects under the NGN; fully open access at low wholesale prices points is the “best case scenario” for the company. M1 aims to achieve a 20% share in the residential and corporate sectors by 2015, uplifting revenue by up to 40%. Given M1’s existing strengths (distribution, wireless broadband share) we believe a 21.9% market share is achievable.

● The NGN therefore puts M1 in a position to enjoy structural growth which is not, we believe, priced in by the market given current multiples (9.3x FY10E P/E , 11.5% FY10E cash flow yield). M1 will also finally be able to bundle broadband with cellular, further stabilising cellular market share. Maintain OUTPERFORM rating.

Yield The Only Attraction

Cost controls in place but little else

• In line. M1’s 1H09 annualised results are in line with market and our expectations, with deviations of 0.3% and 0.7% respectively. As expected, a tax-exempt interim DPS of 6.2cts (2Q08: 6.2cts) for a 70% net payout was declared.

• Topline belatedly rose. M1 reversed four successive quarters of revenue decline with revenue growth of 2.2% this quarter, thanks to higher postpaid revenue, more emphasis on customer acquisition/retention, higher handset sales, stabilising roaming and robust growth of wireless broadband. Postpaid revenue (65% of 1H09 revenue) rose 1.1% qoq, aided by a 0.8% qoq increase in postpaid subscribers and a 1.1% increase in ARPUs largely due to the success of its Take 3 programme. Take 3 has also attracted more mid-to-high-end users.

• Cost controls hemmed in higher SARC. Despite chasing market share and ramping up subscriber acquisition and retention costs (SARC), EBITDA margins were fairly stable qoq (+0.1% pt qoq), thanks to fairly active cost control. The main savings came from lower staff costs from a freezing of headcount, and lower bonuses and bad debts.

• Guidance in place. M1 elucidated its 1Q guidance of “stable operations”. It now expects FY09 PAT to be comparable to FY08’s, in line with our forecast of 1.8% yoy growth, despite challenging operating conditions. It will continue to focus on cost management, efficiency, the introduction of new initiatives to address growth segments and investing in future growth. M1 also reiterated its dividend policy of an 80% net payout for FY09.

• Maintain forecasts, target price and rating. We leave our forecasts and DCFbased target price of S$1.54 (WACC: 11.5%, LT growth: 1%) intact as the financial performance was in line. M1 remains a NEUTRAL as we see few positive catalysts for the stock. While revenue has rebounded qoq, growth remains unexciting. But downside should be limited by its attractive yields of about 9%. Our top pick remains SingTel (OUTPERFORM, target of S$3.20 under review). For exposure to yields, we advocate a switch out of StarHub (Underperform, target S$1.58) to M1.

2Q FY2009 results

2Q FY2009 results. For 2Q FY2009, M1 reported operating revenue of S$190.5m (-7.2% yoy), profit before tax of S$45.0m (-11.4% yoy) and net profit of S$37.1m (-9.7% yoy).

There are four main revenue segments: telecommunication services, international call services, fixed network services and handset sales. Telecommunication services registered 7.7% decrease in revenue to S$141.6m. Postpaid revenue fell by 8.5% to S$124.0m while prepaid revenue decreased by 2.2% to S$17.5m. Moreover, international call services posted 13.7% drop to S$32.8m while handset sales rose by 12.2% to S$15.6m. Fixed network services was a new segment that contributed revenue of S$0.5m.

Operating expenses also decreased to S$144.1m (-5.6% yoy) due to lower staff costs, facilities expenses amd provisions for doubtful debts. M1 benefitted from the Jobs Credit Scheme, paid lower bonus and hired fewer staff.

Therefore, net profit decreased due mainly to lower revenue despite lower operating expenses.

Profit margin. Net profit margin decreased from 22.5% in 1Q FY2009 to 19.5% in 2Q FY2009 due mainly to higher operating expenses. Based on a year-on-year comparison, it fell from 20.0% in 2Q FY2008 due to lower revenue.

Increase in number of customers. M1 saw an increase in the number of prepaid and postpaid customers from 740,000 and 879,000 in 1Q FY2009 to 783,000 and 886,000 in 2Q FY2009 respectively. Its market share for the prepaid and postpaid segments has changed from 23.9% and 26.8% in 1Q FY2009 to 24.5% and 26.5% in 2Q FY2009 respectively. We are concerned as M1 continues to lose market share for the postpaid segment. This is because M1 does not have Pay TV and is unable to offer bundled services to customers.

Outlook for FY2009. M1 expects 2009 to be a challenging year due to the global financial crisis. However, it expects the net profit for 2009 to be comparable to 2008. Moreover, its dividend policy for 2009 is to pay 80% of net profit after tax as dividend. Maintain Hold with fair value at S$1.67. We keep our hold recommendation on the stock because M1 has a limited focus on the domestic market and does not have Pay TV services. As M1’s net profit of S$37.1m only came in 3.6% below our expectation of S$38.5m, we maintain the target price at S$1.67 based on our valuation using the free cash flow to firm model.

Improved execution

• Net profit exceeded our expectations as M1 arrested market share decline, without hurting the margins.
• Added 50K new subscribers in the quarter, compared to a loss of 12K in 1Q09
• Announced interim dividend of 6.2 cents per share. Reiterate BUY for 12% potential share price upside, 9% regular yield and an additional 10-20% yield through potential capital management in FY10F.

In 1H09, M1 has achieved 51% of our FY09F forecast. Core net profit of S$37m (+5% y-o-y excluding S$6m one-off gain last year, +3% q-o-q) exceeded our S$33m forecast, due to lower staff costs, network related expenses and lower than expected increase in marketing expenses. We like to highlight that M1 has negotiated lower network expenses for FY09F, which alone should result into annual cost savings of about S$10m. Management declared interim dividend of 6.2 cents, flat yoy, in line with our expectations.

Operating metrics look better. Most importantly, mobile market share decline was arrested. It stood at 25.5% compared to 25.4% in 1Q09. ARPU was stable as minutes of usage showed some improvement sequentially. Churn rate of 1.5% was slightly lower than 1.5% in 1Q09.

M1 may not remain undervalued with signs of improved execution. Next year, M1 would benefit from about S$10-15m cost savings from the shifting of traffic to M1’s own backhaul network, implying room for earnings growth. Management is also enthusiastic about benefits from National Broadband Network in 2010. Maintain Buy with target price of S$1.80, pegged at 11x PER, a 10% discount to our StarHub’s target PER of 12x.