Writing is on the wall – NBN

Story: The award of NetCo contract to OpenNet (SingTel consortium) is as per market expectations. Three new key points to note are:

(i) OpenNet has offered whole price of S$15 and S$50 for residential and non-residential users, compared to cap of S$25 and S$75 imposed by IDA.

(ii) SingTel would transfer its existing network to a new company called AssetCo, which would lease the network to OpenNet consortium. SingTel has committed to reduce its stake in AssetCo in another five years.

(iii) OpenNet would spend about S$2bn over the next 25 years, including up to S$750m in subsidy.

Point: We highlight three key implications for the sector:

(a) NBN to benefit consumers and business at the cost of service providers. NBN would bring a shift to regulated wholesale price and multiple retail service providers (RSP) from unregulated price and effective duopoly today. This should result in more competitive pricing and differentiated offerings. We estimate retail price could be S$25-30 per month for 100 Mbps in 2010, compared to S$45-50 for 8- 12 Mbps today. This is also supported by the fact that broadband tariff in Hong Kong is less than S$20 for 10 Mbps today.

(b) Less impact on SingTel than StarHub due to its diversified earnings base. StarHub’s existing network may not be able to compete with the high speed and competitive rates offered by NBN. Broadband business constitutes an estimated 20% of StarHub’s earnings, and less than 10% of SingTel’s earnings. These companies may have to contend with lower margin – RSP business in the future.

(c) M1 is the only beneficiary. Unlike SingTel and StarHub, M1 stands to gain from NBN by entering as retail service provider (RSP). Although, RSP opportunities may not be big due to high broadband penetration in Singapore, it would still help M1 to grow its bottom-line.

Relevance: We prefer M1 for its attractive valuations and regular dividend yield of c. 8%. We see more downside for StarHub, and believe that the large valuation gap between it and M1 should narrow going forward. We rule out capital management with FY08 results from StarHub and M1 due to higher borrowing costs. StarHub has indicated that it might wait for six months or more to refinance its debt, which will mature soon.

Still key defensive stocks

MNP concerns likely overdone. The initial worries over true mobile number portability (MNP) on 13 June in Singapore are likely to be overdone. For one, the initial fanfare over the MNP implementation appears to have since been scaled back, as seen by the drop in full-page equivalent advertisements in the month of August. While handset discounts remain attractive, these appear to have stabilized and we should see a reduction in acquisition costs over the next few quarters. Secondly, we have not seen any sign of a significant spike in monthly churns. More importantly, none of the telcos has actually made any price adjustments to their subscription plans, thus reducing the risk of a debilitating price war. As such, we believe that there would not be any prolonged impact from the event.

Focus on NGNBN next. With MNP likely behind us, the next focus would be on the Next Generation National Broadband Network (NGNBN). The IDA (Infocomm Development Authority of Singapore) is set to announce the winner of the tender for the NetCo (Network Company – builder and owner of the fiber optic network) this month. With the recent replacement of StarHub as the consortium lead following the withdrawal of City Telecom Limited from Infinity Consortium, we believe this further shifts the odds towards OpenNet (led by Axia NetMedia) winning this two-horse race. As a recap, OpenNet proposes to leverage on SingTel’s existing extensive but dated ducting network and turn it into an ultra-fast broadband network. OpenNet also believes it can deliver a resilient tamper-proof fibre-to-thehome network at least 2.5 years ahead of the iN2015 vision schedule. IDA has also extended the closing for the RFP (request for proposal) for the OpCo (Operating Company) from 20 August to 29 September 2008.

Defensive bet in these uncertain times. Going forward, we continue to expect flat to steady topline growth for the three telcos, even if there is a slowdown in the economy, as the usage of mobile phones has become an integral part of our daily lives. This can be seen in the high penetration rate that Singapore has achieved over the past few years, where it has been hovering above 100% since Sep 2006. And with their strong cashflow generating abilities, we believe their good dividend yields, at least for both M1 and StarHub, would be a good defensive bet in these still very uncertain times. We maintain our Overweight rating on the sector.

City Telecom pulls out of NGNBN NetCo Bid

A blow to Infinity

City Telecom (CTI) has ceased to be a member of the Infinity NGNBN Netco consortium, whom StarHub and MobileOne are also members. With CTI’s withdrawal, StarHub will be taking over the role of consortium leader. M1 will continue to play an active role and Qatar Investment Authority (QIA) has been tapped to replace City Telecom in the consortium. No reason was provided as to why CTI dropped out although we believe the direction and strategy of the bid could have prompted such a move. This comes soon before the winner of the bid is announced.

Who is City Telecom? Established in 1992, City Telecom (HK) is a provider of residential and corporate fixed network and international telecommunication services. It started off as an alternative IDD service provider in 1992, before obtaining a fixed line licence in 2000. In that same year, it set up its wholly own subsidiary, Hong Kong Broadband Networks (HKBN) which is a major fixed network service operator, providing the world’s fastest residential access, with speeds hitting up to 1Gbps.

Who is QIA? QIA was established on June 23, 2005 as the investment arm of the state of Qatar. The principal aim is the investment of surplus financial resources in regional and international markets, blue chip companies and projects.

Reduces Infinity’s chances

Key loss. CTI’s pullout caught us by surprise. With CTI’s pullout, we see less odds of Infinity winning the bid for NetCo as we find approximately 30% of the criteria of the NetCo RFP (25% from quality of network infrastructure and 5% of bidder’s track record and management expertise. See Figure 1 below.) being at risk with the loss of such a key partner as CTI. QIA, is in our view, more of a financial investor given limited experience in the telco space.

Prior to this announcement, we had already regarded the SingTel led OpenNet consortium as having the better odds of winning for three key reasons:

• proposition of rolling out 2 years before iN2015 vision would be welcomed,
• significantly lower cost of rollout from having a more extensive fibre network,
• likelihood of lower civil works disruption.

Extensive experience in rolling out broadband. CTI has extensive experience in rolling out broadband as it built up its network up from scratch to compete against the bigger boys of PCCW. Today, it standard product, offers much greater speed of 100 Mbps uplink and downlink versus the incumbent’s offering of 8 Mbps downlink and 1 Mbps uplink. More crucially, CTI’s experience in building the NBN in densely populated areas by using existing infrastructure such as bridges and drains while causing minimum disruption would have proven handy and would have been a key attraction of the Infinity-led consortium.

NetCo is mildly positive to SingTel. The much improved odds of securing the NetCo bid would be slightly positive for SingTel, in our view. This would negate them building an alternative network to rival the winning competitors on top of securing them the $750m grant to upgrade their existing network. Returns from the network should offset potential loss of revenue from lower revenue of leasing backhaul capacity to StarHub and M1.

Win or lose, NetCo is mildly positive for StarHub and M1. Win or lose, we believe StarHub stands to gain. If it wins, it gains three advantages, a) part ownership of the network, saving on rental costs for backhaul, b) grant of $750m, covers approximately 50% of entire capex and c) layering of income if multiple OpCos enter the frame. If Infinity loses, both M1 and StarHub would still benefit from lower leasing costs, access to commercial and residential homes and lower interconnect charges.

Valuation and recommendation

Maintain Neutral on the sector, and Neutral for all the telcos. The dogged determination of SingTel in pursuing market share gains overshadows the consumption growth and dividend stories and trains the spotlight on margin compression. SingTel’s diversified earnings base offers better downside protection with Singapore contributing about 30% of SingTel’s earnings vs. 100% of StarHub and M1. Between StarHub and M1, we prefer StarHub for its more diversified earnings base.