Competition takes its toll

Story: Net profit fell 21% y-o-y to S$34.4m, significantly lower than our estimate of S$40m. Service revenue fell for the first time (-1.8% y-o-y, -5.2% q-o-q) this year, as M1 struggled to keep churn rate under control. Management has lowered its guidance from “stable operations” to “single digit decline in core earnings” for FY08.

Point: We want to highlight two key points.

1. Post-paid mobile competition stronger than expected.
Handset subsidies are coming down, evident in lower handset sales. But free 3-6 months subscription plans offered by competitors have led to higher churn rate and weaker ARPU. M1’s monthly churn rate reached 1.8% from 1.5% in the previous quarter. SingTel and StarHub seem to be benefiting from high churn at M1.

2. Pre-paid mobile subscriber growth slowing sharply.
Although M1 managed to increase its pre-paid market share slightly, the sector pre-paid subscriber base has contracted 2.3% q-o-q. The slowing Singapore economy could have resulted in a net outflow of workers and tourists, who are typical pre-paid subscribers. We would like to highlight that with aggressive pricing of international direct dialing (IDD) service, traffic has increased significantly but IDD revenue has fallen by 15% q-o-q.

Relevance: We lowered FY08F and FY09F earnings by 8.6% and 12%, respectively, after imputing lower revenue assumptions. Based on M1’s historical trading range (8x-13x), we applied 10x average FY08-FY09F EPS (instead of 12x) to derive a revised target price of S$1.65. The stock has performed well compared to the broader market, and could see a de-rating after this set of dismal results. We downgrade M1 to FULLY VALUED.

Eyes lower FY08 earnings after poor 3Q08

Disappointing 3Q08 results. MobileOne (M1) reported a slightly disappointing set of 3Q08 results on Friday, with operating revenue down 1.7% YoY and also 4.2% QoQ to S$196.7m, which was much steeper than the 1.5% QoQ decline that we had expected, hit by lower service revenue. On the other hand, net profit tumbled 20.9% YoY and 16.1% QoQ to S$34.5m, below our S$40.6m estimate. The telco blamed it on higher acquisition and retention costs, although in absolute numbers, acquisition cost eased from S$218 to S$162, while retention cost fell from S$167 to S$155. For 9M08, operating revenue came up to S$605.9m, up 1.6% YoY, meeting 75.6% of our FY08 forecast, while net profit fell 15.2% to S$113.6m, or 70.0% of our FY08 estimate.

Lowest net add since 2Q06. M1 also posted the lowest net add of just 10k subscribers in 3Q08 – the lowest since 2Q06. Management explained that it was still feeling the impact of full MNP (mobile number portability), despite saying during its 2Q08 announcement that it had minimal impact and competition was easing. As a result, its monthly churn rate rose further to 1.8% – again the highest since 2Q06. M1’s inability to offer “bundling” of services was another reason for the higher churn. Also worrying, the easing of its post-paid ARPU (average revenue per user) from S$61.9 in 2Q08 to S$59.2 in 3Q08 – management cited its MNP promotion which offered free six-month mobile subscription upfront as compared to those offered by its competitors which gave them towards the end of the two-year contract period.

Defensive but earnings likely lower. Although we continue to believe that M1’s business is fairly defensive in an economic downturn, we believe M1’s earnings are likely to be lower, especially if the recent ARPU and margin trends continue. M1 has also guided for a single-digit decline in net profit in 2008, versus one of a stable operation earlier. For our estimates, we have eased FY08 operating revenue by 0.7% and earnings by 9.3%; FY09 operating revenue by 3.6% and earnings by 13.3%. This in turn pares our fair value from S$2.33 to S$2.12. With M1 still committed to paying out at least 80% of its underlying net profit this year and likely next year as well, we maintain our BUY rating.

M1’s Q3 net dives 21% to $34m

Higher customer acquisition and retention costs dent profitability

The curtain raiser for the quarterly results of local telcos got off to a gloomy start yesterday, with MobileOne reporting a 21.1 per cent drop in third-quarter net profit and warning of a drop in full-year earnings.

Net income for the three months ended Sept 30 slid to $34.4 million from $43.6 million last year, as higher customer acquisition and retention costs dented profitability, M1 said.

Earnings per share dropped 22.4 per cent to 3.8 cents, while revenue eased 1.7 per cent to $196.7 million. M1’s gearing – debt-to-equity – ratio for the quarter was 128.2 per cent, down from 132.8 per cent last year.

‘Increased competitive activity prior to the launch of full mobile number portability on June 13, 2008 continued into Q3,’ said chief executive Neil Montefiore. ‘The combination of an increased take-up of new competitive tariff plans and continuing high acquisition and retention costs caused a decline in profitability in the quarter.’

Local telcos have seen profits suffer as a result of a full-blown marketing war to attract new customers and lock in existing subscribers in the wake of number portability.

M1’s customer retention cost soared 30.3 per cent in the third quarter to $155, while acquisition cost declined 6.9 per cent to $164, with the advertising and promotional blitz starting to show signs of cooling down.

Singapore’s smallest telco added 10,000 customers in Q3 to lift its total customer base to 1.621 million. Despite the increase, its overall market share had slipped to 26.1 per cent at end-July from 28.3 per cent a year earlier, as competitors chalked up bigger customer gains.

During Q3, M1 finally branched into the market for fixed-line broadband services by launching four new high-speed Internet access packages, thanks to an infrastructure leasing deal with rival StarHub.

The two companies also joined hands to bid for a government tender to build Singapore’s upcoming ultra-fast fibre-optic broadband highway, but the authorities awarded the contract last month to a rival consortium involving Singapore Telecom.

For the first nine months of this year, M1’s net profit dropped 15.2 per cent to $113.5 million, though sales edged up 1.6 per cent to $605.9 million.

With the worsening economic climate, the company is predicting a ‘single-digit’ decline in full-year earnings. However, it still expects its total cash distribution for 2008 to be at least 80 per cent of net profit. M1 shares closed six cents lower yesterday at $1.70.

Rivals StarHub and SingTel are expected to report their quarterly results in the coming weeks.

However, SingTel has already hinted of a possible slowdown for some parts of its Singapore business and has responded with cost-cutting measures such as a hiring freeze and advertising cutbacks.

Rising to the top

• Upgrade to OUTPERFORM from Neutral. We are upgrading M1 to OUTPERFORM from Neutral as we believe the worst from mobile number portability is over. The stock offers fairly strong dividends and an upgrade in its backhaul could conservatively save it S$20m p.a. starting end-FY09. M1 is the top pick in our sector for the above reasons and the fact that surplus cash could be released.

• Could return excess cash. The possibility of this is contingent on whether it bids for OpCo but assuming it loses/does not bid, we estimate that M1 could return up to an additional 17.8cts/share for a 9.3% yield by end-2009, if it pursues a net debt/EBITDA of 1.0x, the lower end of its 1.0-1.5x target. This is in addition to a recurring dividend yield of 8%.

• Earnings adjustments. We downgrade our FY08 earnings estimate by 2.7% after reducing revenue expectations for its mobile and handset divisions, partially offset by higher IDD expectations. For FY09-10, we raise our estimates by 0.9-14.1% on account of lower capex and depreciation as well as a conservative S$20m p.a. M1 could save on its network.

• Raising target price. Our target price rises to S$2.31 from S$2.15 following our earnings adjustments, still based on DCF valuation (unchanged WACC of 7.9%). Rerating catalysts could include capital-management initiatives and stronger-thanexpected earnings.

Likely stable 3Q08 showing

Infinity consortium loses NetCo bid. Recently, MobileOne (M1) and its partners (StarHub, Qatar Investment Authority) from the Infinity consortium lost out on the NetCo (Network Company) tender to OpenNet (Axia, SingTel, SPH, SP Telecoms) consortium. Given that OpenNet can leverage on SingTel’s existing extensive ducting network and deliver the NGNBN at least 2.5 years ahead of the iN2015 vision schedule, the smart money was always on OpenNet winning the two-horse race, even before the surprise pullout of City Telecoms from the Infinity consortium in late August. Nevertheless, the decision will pave the way for M1 to concentrate on the Operating Company (OpCo) tender, whose deadline has been again delayed to 14 November. And we believe that M1 stands to benefit the most from this as it can broaden its service offering into the broadband space. We note that M1 has already started to make some headway in this area with its mobile and cable broadband services.

Slowing economy but earnings relatively resilient. But the greatest challenge facing the company is an economic slowdown, which the government expects to last for several quarters. While M1 is still expecting stable operations for this year, we believe that the pace of new additions in both the pre-paid and post-paid segments could slow in 2009. In addition, we can also expect some deterioration in ARPUs (Average Revenue per User) in both segments. However, we are not expecting a serious drop given that mobile communication has become well entrenched as a part of our daily lives. Hence earnings would remain relatively resilient even in an economic downturn. Furthermore, margins are likely to remain intact as we expect retention and acquisition costs to normalise as the MNP (true mobile number portability) has largely been a non-event for most subscribers.

3Q08 results likely stable. M1 will be announcing its 3Q08 results on 17 Oct after market closes. We are expecting revenue to be down 1.5% QoQ at S$202.2m, as subscribers wait for the usual year-end promotions, especially for the Apple iPhone 3G, before committing to a new contract. Net profit is likely to ease by a smaller 1.2% to S$40.6m as margins recover slightly. No dividend is likely to be declared in 3Q, but we continue to expect a final dividend of S$0.074 in 4Q, bringing the total payout to S$0.136/share (yield: 7%). We maintain our BUY rating and S$2.33 fair value.