Key takeaways from Bharti’s conference call on Zain

• Bharti highlighted warm responses from African governments and regulators. This may signal potential for interconnection rate cut in Africa.

• SingTel’s FY11F/12F/13F earnings would be raised by 1%/2%/3% if Bharti can improve Zain’s margins.

• SingTel is our top sector pick, for strong Optus & renewed Bharti, not reflected in its 12.3x PER (Hist avg. 13.4x) compared to STI FY10F PER of 13.9x.

Takeaways on regulations and strategy in Africa. Bharti acknowledged that interconnection rates were too high in Africa and could be lowered substantially based on interconnection costs incurred by most efficient operators. Bharti believes that new licenses are unlikely to be issued due to lack of cellular spectrum in Africa. Management plans to kick-start infrastructure sharing to lower the capex while expanding coverage in rural areas. Bharti sees huge opportunity in lower minutes of usage of 60 min/subscriber (Indian average is 450 minutes). Management also clarified that annual interest cost on Zain’s related debt is around US$200m, which can be serviced from Zain’s free cash flow. Bharti guided for annual capex of about US$800m, slightly lower than our US$1bn expectations.

Key challenge is to improve EBITDA margins in our view. Bharti intends to grow Zain’s subscriber base to 100m, revenue to US$5bn and EBITDA to US$2bn by FY13F. This translates to subscriber CAGR of 33%, revenue CAGR of 11% and EBITDA CAGR of 18% over FY10-FY13F. We believe 11% revenue CAGR is comfortably achievable. However, the key challenge would be to improve EBITDA margins, especially with declining ARPU as Bharti penetrates into the rural regions. We have assumed EBITDA CAGR of 11% for Zain in our model. If Zain can achieve 18% EBITDA CAGR, it would raise SingTel’s FY11F/12F/13F earnings by 1%/2%/3%, adding 10 Scents to our TP for SingTel.

Optus Investor Day: Key Takeaways

Quick Comment – Conclusion: We remain EW following the Optus Investor day. While the Australian business appears to be performing well in a wireless market that continues to deliver stronger growth than global peers, we see risks to the core Singapore business from NBN as well as “fairish” valuations at F’11e PE of 12.3x.

What’s new: Optus presented a bullish outlook for the Australian business at its investor day yesterday, driven principally by Optus’ continued strong growth in an increasingly attractive Australian wireless market. Opportunities may also emerge in fixed line, as the open-access National Broadband Network gradually replaces Telstra’s copper network, but these are a lot less clear. The question of a local IPO for Optus continues to be asked by the Australian financial community, but continues to be answered by SingTel management in the same way: there are no current plans to reduce SingTel’s stake in Optus, and any transaction must be value accretive.

Three Key Takeaways: 1) Australian mobile revenue growth at 8.8% in CY09 continues to comprehensively outpace other developed markets, which are flat or falling; 2) 60% of the mobile market growth is due to wireless broadband, which Australians are clearly embracing, refocusing the market away from calling to data services; 3) Optus is currently out-growing its rivals, at the expense of higher acquisition costs and consequently lower margins. Our view remains that this above-market growth is unlikely to be sustained. Telstra has already launched its competitive response to market share losses with the introduction of new ‘any-net’ cap plans. Notably, these plans extend down to the A$49 price point, Optus territory, but not to A$29, traditionally a Vodafone-3 stronghold.

Fixed Line Opportunity May Emerge post-NBN, But Competition is Likely to Erode Margins

Optus has been hampered in the fixed line market, in its view, by an uneven competitive environment dominated by Telstra. The National Broadband Network (NBN), a government-owned fibre replacement for the current copper last mile network, promises to improve Optus’ access to fixed line infrastructure. Unfortunately for Optus, the NBN will also improve infrastructure access for everyone else also. Optus management commented that they expect aggressive competition at the outset, but that new entrants may underestimate the skills required for success in fixed line, and subsequently exit, or be consolidated in the longer term. For Telstra, we assume that fixed line EBITDA margins will fall to ~20% post-NBN, and we attribute very little value to Telstra’s fixed line business post-NBN. At this stage we see a broadly similar outlook for Optus in fixed line.

Customer Transition to NBN Key to Retaining Value in Existing Fixed Line Business

We see some risk to the market share of incumbent fixed line service providers in the transition to NBN fibre-based services. If the government and/or competition regulator prompts customers to re-evaluate their choice of service provider as the NBN is connected to the customer’s premises (or customers do so of their own volition), incumbent market shares could be threatened by new entrants. Optus currently enjoys a 16.4% fixed revenue market share, which is well behind Telstra’s share, but still threatened in our view.

Multiple headwinds

• Facing headwinds. We maintain our UNDERPERFORM on SingTel following our recent visit as the telco faces de-rating catalysts in the medium term except that dividend payouts should remain high, in our view. Concerns over Bharti’s gearing and earnings dilution, margin pressure in Singapore and Telkomsel’s poor performance will likely weigh down on SingTel. In the longer term, we continue to see SingTel benefiting from NGNBN. We also believe Bharti’s acquisition of Zain Africa will effectively shut SingTel out of a direct foothold in Africa. We maintain our earnings forecasts and sum-of-the-parts target price of S$3.00.

• Prefers to raise its stakes. SingTel still prefers to raise its stakes in its associates. However, we gather that consolidation could happen in Pakistan which suffers from stiff competition and political uncertainties.

• Dividend payouts likely to remain high. We believe SingTel will continue to pay dividends at the upper bound of its policy of 45-60% given a lack of imminent sizeable acquisition targets. Bharti’s acquisition of Zain Africa should effectively preclude SingTel from trying to acquire a direct stake in an African telco group, if it wants to avoid straining its relationship with Bharti

• Beneficiary of NGNBN. We continue to believe that SingTel will be a net beneficiary of NGNBN, namely from monetising its passive assets in 2014. In the medium term, SingTel will benefit from fixed and revenue share payments from OpenNet.

STel’s Sing/Australia fwd PE looking stretched again

STel fell 2.9% today but is still up 18c (6.3%) over the last month despite the per share value of STel’s listed Associates staying effectively unchanged over the same period. The result of this relative STel out-performance versus its listed Associates has been a re-rating of the Sing/Australia businesses. In fact, the current implied Sing/Au fwd PE at 15.5x, although down on yesterday’s 16.3x, is still close to 2yr highs.

A high Sing/Au PE signals near-term STel price weakness

As previously highlighted, the implied Sing/Au fwd PE is inversely correlated with STel’s subsequent near-term price performance. On the 200 specific days over the last 5yrs when the estimated Sing/Au fwd PE exceeded 15.5x, STel’s price fell over the next three months on 89% of such times with an average 11% decline. And since it is difficult to imagine the Associates being significantly re-rated over the near-term (which would de-rate Sing/Au), we expect STel’s share price to be near-term pressured.

STel has been range-bound around S$2.90-3.20 for more than a year. On 26 June 09, it closed at S$3.01 with the Associates valued at S$1.53/share. Today STel is at S$3.04 but the estimated value of the Associates is now S$1.26. This divergence seems a bit odd. In fact, on current FX and prices, the listed Associates are worth S$0.89/share and the Telkomsel stake is estimated at S$0.37/share. And if we apply the average historic PE multiple to our Sing/Au estimate, then the implied value of those business would be S$1.54/share – giving a total theoretical price of S$2.80.

In summary, we expect STel to stay range-bound. But given the current Sing/Au fwd PE, near-term risks are skewed to the downside and it is possible the lower end of the range could be reset at or below S$2.80 over the near-term.