iPhone 5 To Dampen Margins in 2H12

Slower 2H ahead. We are maintaining our SELL calls on SingTel and StarHub as we expect them to be hardest hit by the higher subsidies and longer clawback periods of the iPhone 5 in 2H12. However, M1 is likely to see a more muted impact due to its accounting treatment which brings forward part of future revenue to offset the cost of the subsidy. As such, M1 remains a HOLD, and is our top telco pick in Singapore.

iPhone 5 trumps iPhone 4S. Apple’s iPhone 5 started selling around the world last Friday, including Singapore, and demand is much stronger than the 4S model. Apple has reported that pre-orders for iPhone 5 topped 2m units in 24 hours, more than double the amount of pre-orders it took for the iPhone 4S, reflecting strong pent-up demand for this new model. In Singapore, all the telcos sold out online 90 minutes after opening for booking.

Subsidies rise sharply. Based on the telcos’ iPhone 5 plans, they are stretching their subsidies out over a longer period for iPhone 5 compared to the iPhone 4S. At the sweet spot of the two cheapest plans, which have a minimum contract period of 24 months, the telcos will need almost 1.5 months more to recoup their subsidy cost for the iPhone 5 than the iPhone 4S.

Margin impact likely to be worse than iPhone 4S. EBITDA margins are likely to be affected in 3Q12. Based on past trends, we expect a larger impact (3-4ppt) for SingTel and StarHub, but a more muted impact on M1 (1-2ppt) due to its accounting treatment for iPhones where future revenue is brought forward to cover the cost of subsidies. Based on current reported iPhone sales however, we think our existing forecasts are still in the money.

Hopefully, higher data usage can offset higher subsidy. iPhone 5 is an LTE handset, and the faster LTE speeds should drive up data usage as it would be much easier to consume data, particularly when viewing video and using FaceTime for video chats. We are not assuming a significant rampup in data revenue yet because we think there will be a period of adjustment, where telcos need to improve their app and content offerings, and users need to adjust their consumption patterns.

IPHONE 5 TO HELP DRIVE LTE

• iPhone 5 to help LTE adoption
  
• LTE still likely 2013 story at best
  
• Defensive earnings, attractive yields
  

Launch of new iPhone 5

Apple has unveiled the latest reiteration of the hotly popular iPhone, which will be available in Singapore from 21 Sep. Besides sporting a slightly larger screen and better resolution, faster processor, improved battery life, the iPhone 5 is 4G LTE-enabled and will work on the 4G (1800MHz) networks being implemented here.

Demand likely strong

As with the previous versions of the iPhone, we expect the demand for the new iPhone 5 to be pretty strong, especially from people still holding the iPhone 4, which is becoming pretty long in the tooth. We also believe that most iPhone 4 subscribers are eligible for a subsidized upgrade, as the 2-year lock-up period should be over by now.

Should help drive LTE adoption

While the strong demand could see near-term pressure on the telcos’ EBITDA margins due to the higher subsidies for the new iPhone (as compared to Android phones), we also expect the smartphone’s popularity to help drive LTE adoption over the medium to longer term. We had earlier identified the lack of LTE-enabled handsets to be a stumbling block to the adoption of LTE.

Gradual recovery in margins

However, with both M1 and StarHub recently announcing their new mobile plans with tiered data pricing, new and re-contracting subscribers will get greatly reduced free data bundles (starting from 2gig compared to 12gig previously). Because of this, we could see subscribers initially reining in their data usage, thus resulting in minimal – if any – ARPU uplift for the telcos. However, we think that this is just a temporary setback, and should see data usage continuing to increase, thus resulting in a gradual recovery in margins.

LTE is still 2013 story at best

While we expect the iPhone 5 to help subscribers make the jump from 3G to 4G LTE, we still opine that LTE is still a 2013 story at best. Nevertheless, we continue to like the overall telco sector for its defensive earnings and attractive dividend yields (backed by strong operating cashflows). Maintain OVERWEIGHT.

4G pricing is an ultimate cure

• M1 & StarHub to price 4G services significantly higher than 3G. Players with bigger exposure to the mobile sector will benefit more
  
• Even if we ignore the impact of lower data-caps StarHub’s FY13F/14F earnings could benefit 4%/8%, marginal impact for SingTel.
  
• Raise StarHub’s TP to S$3.67 assuming DPS of 22 Scts in FY13F, implying 6% yield. HOLD SingTel for 5% yield, intense competition in India, Australia and startup cost for mobile advertising as key concerns
  

4G pricing to correct 3G’s too generous data pricing in Singapore. In June, SingTel lowered the data-caps to 2GB from 12GB. During the 3G era, c.22% of M1’s users exceeded the 2GB limit without paying an extra cent. With higher 4G speeds (five times higher than 3G), more users are likely to exceed the 2GB data-cap to end up paying S$5.35 per extra GB. In addition, SingTel will charge S$10.70 per GB for exceeding the data-cap from Jan 2013 onwards. M1 took it one step further in September and announced that it will charge an additional S$10.70 in subscription fees for 4G versus its 3G ARPU of S$53. StarHub has also put in place higher 4G pricing of an additional S$10.70 for 4G plans from March 31, 2013 onwards when its 4G coverage will be significantly higher. StarHub will charge slightly higher S$6.42 per GB for exceeding the datacap. An additional S$10 per month works out to be 19% of M1’s, 14% of StarHub’s and 12% of SingTel’s reported postpaid ARPUs.

4G penetration of 8% in 2013F, 20% in 2014F. These projections are based on experience in countries like the US where 4G penetration reached around 9% after 18 months of launch, while in Korea, penetration hit 17% after 13 months of launch. 4G network coverage and handset availability are the two most important factors. However, 4G is not priced at a premium in the above countries, hence 4G adoption could be slightly slower in Singapore despite the widespread 4G network.

Robust longer-term outlook for the sector. We raise StarHub FY13F DPS to 22 Scts versus our expectations of 21 Scts earlier on better longer-term outlook and a very low FY12F net debt to EBITDA ratio of only 0.5x. In our DDM model, we assume 8% cost of equity, 2% long-term growth rate and 22 Scts DPS. However, upside for StarHub is limited as 22 Scts DPS is already reflected in the share price.

2QCY12 REVIEW – OVERWEIGHT

• Mostly stable 2012 outlook
  
• But margins pressure exist
  
• Defensive earnings and still-attractive yields

Only StarHub was above

All three telcos recently reported 2QCY12 results, but the only bright spark came from StarHub (even beat our earnings forecast) while both M1 and SingTel turned in quarterly results that were somewhat disappointing. For M1, it attributed the softer showing to accounting treatment for a popular Android phone (where subsidies are expensed upfront), while SingTel cited weaker forex rates (affecting Optus and regional associates) as reason behind for its muted showing.

Review of Singapore mobile operations

For the post-paid mobile market, there was no change to status quo – SingTel continues to dominate with a ~48% share, followed by StarHub with ~28% and M1 ~26%. Overall, the post-paid subscriber base here grew by 58k to 4125k, led by SingTel (+45k). We note that some 70% of new signups now take up smartphones, and data as a percentage of ARPU – currently around 37-42% – could increase further.

Mostly stable 2012 outlook

SingTel and StarHub have guided for a stable outlook ahead, although their EBITDA margin outlook continues to be fairly muted; this probably due to rising content cost for their Pay TV businesses. On the other hand, M1 has not reiterated its “stable performance at both top and bottom-line guidance”, given the continued strong interest in Android phones (also possibly expecting higher subsidies for another new iPhone, which should also affect both SingTel and StarHub). Nation-wide LTE roll-out is also on the cards for all three but it remains at best a 2013 story (largely dependent on availability of LTE handsets).

Maintain OVERWEIGHT

Again, StarHub has continued to do well (+23% YTD), while SingTel (+7%) and M1 (+3%) have continued to lag the STI’s 14% gain. But with markets likely to remain volatile, we believe that the telcos’ defensive earnings and still-attractive yields offer a safe harbour for risk-adverse investors. Maintain OVERWEIGHT on the sector, with M1 still our preferred pick.