Focus On Dividends Still

Underweight. We are underweight on the telco sector mainly because of our Sell call on SingTel, which is being challenged on many fronts, both domestic and overseas. It is into its fourth year of declining earnings and if this continues, radical action may be called for at the management level. This year, all the telcos will be focusing on how to monetise data use, but we expect the benefit flow to be gradual. Subscriber churn in Pay TV is also likely to rise, mainly from StarHub, as SingTel beefs up content but we think this will be temporary. Earnings growth for the sector will be plodding at best. As such, we see the telco sector as still a sector to tap for dividends, and StarHub offers the best bet for sustainable dividends, especially if raises its 2013 annual DPS on record low net debt/EBITDA.

LTE/4G to see faster adoption than 3G. It took three years for 3G mobile subscriptions to exceed 2G as (1) 3G handsets were very limited in the early days, (2) were significantly more expensive than 2G handsets and (3) there was also very limited content positioned specifically for mobile screens, which are not suitable for desk top oriented content. There are now more 4G handsets available and it is very likely that users upgrading to new handsets will want them to be 4G capable. In addition, content customised for mobile handsets’ smaller screens is much more common now. As such, we would expect to see LTE adoption to be faster than 3G.

However, challenge is still in monetisation. Data monetisation will be the top priority in 2013. Despite surging data usage in the last few years on the back of the popularity of the iPhone and as more online content was made modified for small screens, past attempts to monetise this trend had been foiled by the universal availability of unlimited data plans. Now that the telcos have imposed much lower caps (from 12GB to 2GB) since 2H last year, the telcos now have a fighting chance to boost contributions from data. This will be aided by a greater diversity of LTE handsets, network coverage and price plans. However, given that less than 15% of mobile users exceeded 2GB monthly to begin with, the boost is likely to be gradual in 2013.

SingTel to be more aggressive in Pay TV. Last year, SingTel added 40 Fox International channels including popular channels such as National Geographic, StarWorld and Fox Movies. It also renewed the next three seasons of the Barclay’s Premier League ahead of StarHub on a non-exclusive basis. This year, we expect SingTel to be aggressive again in adding content as it continues to build up its channel line-up to match StarHub. StarHub still holds an edge in the depth of its content offerings especially in niche demographics but SingTel has a superior sports lineup.

Spectrum auction sooner rather than later. IDA, Singapore’s telco regulator, is expected to hold an auction in 2013 to refarm existing 1800 MHz, 2.3GHz and 2.5GHz spectrum bands from their current 3G use to 4G. The auction is designed to ensure service continuity beyond 2015 and 2017 when existing rights expire. As IDA is typically prudent in its long-range planning, we would not be surprised if the auction is held before mid-2013. The outcome is likely to be benign as sufficient spectrum is available and rationality should prevail amongst the telcos. While no reserve price has been set yet, we do not expect it to be significantly higher than the last round in 2010.

Underweight. We are underweight on the telco sector mainly because of our Sell call on SingTel, which is being challenged on many fronts, both domestic and overseas. In Singapore, margin downside is the biggest challenge as SingTel continues to compete on content even as it restructures away from a pure telco toward a multimedia strategy. In Australia, competitive pressures could start to simmer again given recent new capital received by smallest telco VHA, while India continues to be a nightmare of regulatory risks. SingTel is into its fourth year of declining earnings and if this continues, radical action may be called for at the management level.

Three keys:4G, NBN & Spectrum

• No premium pricing for 4G, but lower data caps will drive moderate growth; Extra 1GB costs S$5-6 now (free before) Expect market shares to change in corporate data market as StarHub spends capex on top of Broadband Network (NBN) to extend its reach
  
• Spectrum sale could be a burden especially for smaller telcos with higher gearing
  
• Top pick: StarHub for higher dividend yield, superior growth and lower gearing than peers
  

Lower data caps to drive growth M1’s attempt to charge an extra S$10 for 4G service did not succeed as SingTel did not respond in kind. How can a Telco charge a premium when real 4G speeds are limited to few spots? We understand 4G speeds drop sharply as a user moves away from 4G base stations. However, Telcos are using 4G as an excuse to lower data-caps, which should benefit ARPU moderately. Currently, heavy data users (~10% of the total) have to pay S$5-6 to enjoy an extra 1GB or S$20 for additional 2GB bundled with more voice minutes and SMS.

StarHub may gain market share in corporate data space. SingTel leads in the corporate data market with ~ 80% share of a market that is worth over S$1.5bn. StarHub has less than 20% share as it did not have cables that reach commercial buildings. Progress has been slow on this front as NBN provides access to the buildings but not the individual floors due to operational issues. However, it is ready to spend some capex to wire up the buildings now. Recently, StarHub also started to offer data-mining services to small & medium size enterprises to strengthen its business relationships.

Telcos may have to spend S$80m-S$100m in spectrum auction in 2013. The regulator is expected to re-farm and auction the 1800MHz, 2.3GHz and 2.5GHz spectrum bands in 1H13. The cost is significant for smaller players with higher gearing.

BUY StarHub for 5.8% yield. StarHub’s net debt to EBITDA stands at 0.5x compared to 1.0x for peers. This implies it can afford to pay additional S$350m dividends (21 Scts DPS or 5.5% yield) to reach 1.0x net debt to EBITDA. With spectrum sale due in 1H13, it is even more important to have lower gearing.

Results Season Takeaways

Sector Overview

The Telecommunications Sector under our coverage consists of SingTel, Starhub & M1. Starhub (STH) and M1 are pure plays to the Singapore market, while SingTel (ST) has exposure to the Asia-Pacific region through its regional mobile associates.

• Revenue remains stable q-q
  
• Telcos remain attractive due to high dividend yield
  
• Neutral on Starhub, SingTel, and M1. We prefer Starhub over SingTel and M1
  

Mobile

• Q-Q post-paid net adds similar across three Telcos
  
• Post-paid ARPU mostly flat q-q, Starhub marginally lower
  
• Data monetization key revenue growth driver
  

Pay TV

• SingTel continues to gain market share
  
• Revenue to remain stable and strong
  
• Cost of non-exclusive contents, previously signed on exclusive basis, unlikely to decrease significantly
  

Broadband

• Fibre broadband continues to grow rapidly
  
• SingTel continues to dominate, with market share higher than those in the post-paid mobile segment
  

Others

• Sep – Dec 2012 may see an increase in equipment revenue and cost, due to the launch of popular iPhone 5
  
• 320 MHz of spectrum may be up for auction in 2013
  

Recommendation

We are neutral on the sector, while maintaining that they remain attractive due to their high dividend yield and stable earnings. We prefer Starhub and SingTel over M1 due to their bundled packages, which include Pay TV, being better able to retain customer loyalty. With both having higher operating revenue than M1, while Capital expenditure as a ratio of Total Operating Revenue is similar across all three Telcos, Starhub and SingTel have a higher budget to spend on future enhancements.

We prefer Starhub to SingTel due to its single geographical exposure, compared to the multiple countries that SingTel has a stake in. Starhub is therefore less volatile. Starhub also creates shareholder value, while paying out a higher dividend yield based on current price. Based on current share price, we are Neutral on Starhub, SingTel and M1.

3Q12 results round-up

Telcos’ 3Q12 results were a mixed bag. StarHub surprised on the upside due to lower traffic costs while SingTel disappointed. The main notables were 1) the deceleration of mobile revenues, 2) acceleration of fibre broadband net adds, and 3) rise in pay TV competition.

We remain Neutral on the sector as we see no major rerating catalysts. StarHub (Outperform) is still our top sector pick as it offers the highest dividend yield among Singapore telcos and upside potential to its dividends due to its strong FCFE and robust balance sheet.

Mixed results

SingTel’s 3Q12 results missed expectations because of the drag from Bharti which overshadowed the anticipated strong showing in Singapore. Overall, SingTel continued to gain market share in all segments: mobile, fixed broadband, and pay TV. StarHub’s 3Q trumped expectations with the help of lower traffic costs but M1’s results undershot due to unexpectedly high subscriber acquisition costs (SAC).

Mobile revenues dipped

Industry mobile revenue growth slowed to 1.1% yoy from 1.5% in 2Q12 and 4.2% in 1Q12. The slowdown came from lower roaming revenue due to less inbound and outbound roaming. M1’s and SingTel’s mobile revenues rose qoq (seasonality) but StarHub (-1.4% qoq) disappointed as it had lowered roaming rates with the Vodafone group. SingTel is still gaining market share, thanks to its aggressive bundling of mobile broadband with fixed broadband. Its revenue share rose 0.5% pts to 51.7% at the expense of StarHub whose share fell 0.5% pts to 32.2%.

Fibre accelerated

3Q fixed broadband revenue accelerated to 8% yoy because of an 11% jump in SingTel’s 3Q revenue. SingTel captured 59% of new subscribers in 3Q, similar to 60% in 2Q. The telco now has 58% fibre broadband market share.

Pay TV race heats up

SingTel’s mioTV notched up 4.7% qoq growth in revenue and raised its market share by 2% pts to 24%, driven by a combination of higher ARPU and subscribers. With a new line-up of >130 channels, SingTel has substantially narrowed the gap with StarHub’s 157 channels, eroding the latter’s differentiation and dominance.

3QCY12 REVIEW – STILL OVERWEIGHT

• 1 hit, 2 near-misses
  
• Defensive story intact
  
• Yield compression also likely
  

StarHub again above forecast

Out of the three telcos, StarHub again posted 3Q12 results that were above our forecast, aided by a stronger-than-expected margin recovery (mainly coming from lower traffic expenses). M1 and SingTel both posted results that were slightly below our estimates, with the former citing continued upfront smartphone subsidy expensing for the shortfall, and the latter hit by weaker Optus performance and also a slide in regional currencies against the SGD.

Review of Singapore mobile operations

On the core post-paid mobile market, SingTel continues to dominate with ~48% share, then StarHub with ~28% and M1 ~26%. But we note that post-paid subscriber base grew 55k QoQ to 4180k, even though the market already has a penetration rate of nearly 150%, with some 70% of post-paid subscribers using smartphones. Monthly ARPUs are relatively stable; but could see increases once LTE (or 4G) takes off from 1Q13, aided by the introduction of more LTE-enabled phones and also tiered pricing plans with less generous data bundles.

Biggest surprise from SingTel

Both M1 and StarHub are still guiding for relatively stable outlook for 2012, albeit with potential erosion in service EBITDA margins. However, SingTel surprised by guiding for consolidated group revenue to see a low single-digit (versus single-digit growth previously), mainly dragged down by continued weakness in Australia. However, we think that all the three telcos should continue to generate very positive operating cashflows and this should keep their healthy dividend payouts intact.

Maintain OVERWEIGHT

While the three telcos have performed reasonably well this year, led by StarHub, we continue to like their defensive business against the still-uncertain economic backdrop. Further yield compression could also be another price catalyst over the next 12 months. Hence we maintain our OVERWEIGHT rating and keep M1 as our top pick.