Goodies priced in

• Downgrade to UNDERPERFORM. FY09 results were broadly in line, at 98% and 99% of our forecast and consensus respectively. StarHub declared a final DPS of 5 cts, taking full-year DPS to 19 cts, in line with our forecast. Key takeaways were: 1) weaker margins; 2) continued pressure in fixed broadband and fixed network services; and 3) a subdued FY10 outlook. We trim our FY10-11 EPS estimates by 2% and our DCF-based target price from S$2.15 to $2.14 (WACC 9.7%) following higher capex guidance and housekeeping adjustments. We downgrade the stock from Neutral to UNDERPERFORM following its recent strong share-price performance coupled with investors’ preference for cyclical stocks. We believe the stock has largely priced in its higher dividend payout and StarHub would face pricing and margin pressure from NGNBN. We recommend a switch to M1 (Outperform, TP: S$2.07), for its capital-management potential and benefits from NGNBN. We have introduced FY12 forecasts in this report.

• Slight seasonal bounce but margin weakness. Stripping away a 35% growth in handset sales, StarHub’s service revenue only climbed 1% qoq despite growth in all divisions except fixed network services. Like M1 (+1.6% qoq), StarHub’s mobile revenue rose 1.4% qoq, aided by increased usage, its iPhone launch and strong take-up of data services. Broadband revenue was flat qoq as a 2% subscriber increase was offset by a similar reduction in ARPU. EBITDA margin was down 4.4% pts qoq owing to higher acquisition costs from the expensing of iPhones and heavier promotions/marketing.

• Subdued 2010 guidance. StarHub guided for rather muted low-single-digit growth in FY10 topline. The growth would be aided by the economic recovery, the opening of two integrated resorts along with growth in mobile voice, mobile data, wireless broadband and fixed data, though offset by lower fixed broadband and pay-TV revenue due to competition ahead of the launch of NGNBN. It also expects a lower FY10 service EBITDA margin of 30% (31.7% in FY09) due to start-up costs for OpCo and its own RSP, broadband discounts, high content costs and iPhone subsidies. StarHub raised its cash capex to a maximum of 14% of sales from 13%. Finally, it kept its dividend policy of a minimum DPS of 5 cts/quarter for 2010.

A year of reckoning

DPS of 20cps seems unsustainable; Maintain Underperform

We maintain Underperform rating post 4QFY09 results, which missed ours and consensus estimates. We believe that StarHub’s business model is facing unprecedented pressure on multiple fronts – intensified bundling discounts to defend pay TV base post EPL loss, spike in fixed broadband competition in runup to NBN rollout, mobile hitting low single-digit growth era with penetration >136%. This is likely to result in a structural FCF declines. We estimate StarHub’s FCF to average ~S$320mn p.a. for 2010-12 vs S$415mn p.a. in 2006-9. Hence,

we question the sustainability of the committed S$343mn p.a. or 20cps dividend.

Guidance suggests tough times ahead, declining FCF

Mgt’s FY10 guidance include low single-digit revenue growth, service EBITDA margin of ~30% (-1.8ppts YoY) and higher capex/sales of 14% vs 11% in 2009. We also understand that cash tax will start kicking in from 4Q10.

4QFY09 disappoints on margin pressure

4QFY09 EBITDA of S$152mn (-12% QoQ, -8% YoY) was below ours and consensus estimates. This was due to sharper than expected margin erosion from iPhone launch and pricing pressure at fixed broadband & fixed network services.

PO & f’casts raised; More +ve on ability to retain subs

We raise our PO by ~10% to S$2.00 and FY11-12E EBITDA by ~6% to reflect a more optimistic view of the EPL content loss impact on StarHub. We now only assume 10% of StarHub’s pay TV franchise will leave vs our previous view of 15% pay TV subscribers leaving and 50% of them walking with a mobile and fixed broadband plan. We think StarHub’s strategy of driving pay TV adoption by dropping prices, expanding content range and bundled discounts are likely to drive subscriber stickiness going into 2H10 when EPL moves to SingTel (SNGNF, S$2.98, B-1-8).

2010 outlook still quite positive

4Q09 results were in line. StarHub Ltd reported its 4Q09 results last evening, which were mostly in line with our estimates. Revenue was up 2.5% YoY and 2.4% QoQ at S$550.0m (versus our S$546.6m estimate), driven mainly by higher equipment sales. But net profit fell 15.1% YoY and 12.8% QoQ to S$74.3m (versus our S$77.1m estimate); sharper-than-expected decline in service EBITDA margin from 32.1% in 4Q08 and 33.4% in 3Q09 to just 29.2% was the culprit – this was mainly due to the more intense festival promotions as well as the Apple iPhone 3GS launch. For the full year, revenue rose 1.1% to S$2150.0m (versus our S$2146.7m estimate), while net profit rose 2.7% to S$319.7m (versus our S$322.8m forecast). StarHub declared a quarterly dividend of S$0.05 per share as guided.

Modest iPhone boost. On a segmental basis, its mobile segment improved 3.1% YoY and 1.4% QoQ, driven by the 4% YoY and 2.3% QoQ increases in post-paid revenue; this as iPhone users typically take up higher value plans – monthly ARPU has recovered by S$1 QoQ to S$70. However, due to intense promotions for the iPhone by all three telcos, StarHub’s monthly churn rose further from 1.2% in 3Q09 to 1.3%, while acquisition cost jumped 43.2% QoQ to S$106 per subscriber. Nevertheless, management believes that things should normalize soon. While its broadband revenue fell 7.9% YoY, it was up 0.5% QoQ; this as monthly ARPU has stabilized around S$49, down just S$1 QoQ, and is also holding at the top end of StarHub’s S$45 to S$49 guidance.

2010 outlook is actually quite positive. For 2010, StarHub expects revenue to grow in the low single digit range and is guiding for service EBITDA margin to be lower around 30%. But in view of the loss of its key EPL sports and ESPN STAR Sports content from mid-2010, we note that these numbers suggest that management is actually quite confident that its other business segments will be able to make up for revenue decline in its Pay TV segment. StarHub has also maintained its S$0.05 per share quarterly dividend guidance for 2010 as expected; this despite raising its cash capex to a maximum of 14% of operating revenue (versus 12% in 2009) to cater for the NBN rollout from mid-2010.

Maintain BUY with S$2.29 fair value. Total dividend of S$0.20 translates to an attractive 9.2% yield, bringing the total return to 14.7%; as such, we maintain our BUY rating on StarHub and S$2.29 fair value.

Lower guidance, vindicates our fears

At a Glance

• 4Q09 net profit of S$74m in line with our S$75m estimate, but below consensus forecast of S$82m. DPS of 5 Scts declared, as expected.

• 2010 guidance disappointing – street likely to cut FY10F/11F by 8-10%, closer to our forecasts.

• Capex guidance raised to 14% of sales (< 11% in 2009), implying 35% yoy decline in free cash flow, in our view.

• Maintain FV with TP of S$2.06 based on 12x FY10 PER. We doubt sustainability of 20 Scts DPS from FCF, amid earnings decline.

4Q09 results below expectations. 4Q09 net profit of S$74m (-15% yoy, -13% qoq) was below expectations of S$82m due to iPhone subsidy; also evident in lower mobile EBITDA margins. Mobile market share declined slightly by 30 basis points to 27.8%.

Weak 2010 guidance; FY10F could fall 8-10% yoy. (i) Low-single digit revenue growth; (ii) 30% EBITDA margins (31.8% in 2009); (iii) Much higher depreciation to sales ratio of 13% (11.3% in 2009); (iv) Capex to sales ratio of up to 14% (10.6% in 2009). Based on the guidance, FY10F could decline 8-10% yoy. We forecast a further 4% yoy decline in 2011F due to churn in its pay TV customers spilling over to other segments.

Lower EBITDA margins reflect pricing pressure in the broadband business; iPhone subsidies and the cost of new content in order to retain pay TV customers. Higher capex stems from OpCo capex, although OpCo revenue would be negligible in 2010. Management expects to spend less than S$100m OpCo capex in three years.

Doubts over sustainability of DPS of 20cts. We forecast S$300m, down 35% yoy, of free cash flow in 2010 (despite low cash tax) and S$290m in 2011 (cash tax kick s in) compared to S$343m dividend (20 Scts) commitment. Amid declining earnings, dividends could be sustained only by raising more debt, implying weaker share price once dividends are paid out.

iPhone launch hits short-term EBITDA margin

• 4Q09 revenues up 2.5% y/y: StarHub’s reported 4Q09 revenues of S$550MM (2.5% y/y) managed to beat our estimates by 1.9%. Higher subsidy expense on IPhone sales led to a 4.2 percentage point decline in EBITDA margin to 29.2%. Thus, EBITDA at S$152 MM (-7.9% y/y) missed our forecasts by 8.5%. Net profit at S$74MM fell 10.6% short of our estimates. StarHub added 25k wireless subs in 4Q09 versus 2k disconnections in 3Q09. Mobile and pay TV ARPU at S$50/S$56 remained stable sequentially, while broadband ARPU declined by 2% to S$49. StarHub declared a final dividend of 5 cents per share, implying a total payout ratio of 109% in 2009. StarHub remains one of our top dividend picks in the region.

• Minor earnings revisions and S$2.30 price target unchanged. We have revised 2010E revenues by 1.6%, driven primarily by a 2.3% revision to our wireless revenue forecast. Short-term pressure on margins has resulted in a 1.4% and 2.3% cut in EBITDA and net profit. Capex has been revised by +1.3% due to higher sales. The combined effect is a small 1.1% decrease in our DCF value to S$2.28. Our December 2010 DCF–based price target is unchanged at S$2.30.

• 5.0 cents per share quarterly dividend guidance intact: With higher cash flows and low net debt/EBITDA at 1.0x, StarHub remains confident of paying out at least 5 cents per share quarterly. Management guidance is for low single digit revenue growth in 2010 while EBITDA is expected to be around 30% of service revenues. Cash capex is expected to remain below 14% of revenues.

• Key risks: Further decline in EBITDA margins, a cut in dividend payout, and greater-than-expected competition post NBN are the key risks to our price target.