Weak 3Q expected; shadow cast by BPL

3Q09 results preview

Maintain Underperform. StarHub will be releasing its 3Q09 results on 10 Nov. We are expecting a core net profit of S$75m-78m, flat to down 3.6% qoq on the back of a 0% to 2% decline in revenue. We expect margins to be flat qoq and a DPS of another 4.5cts, in line with guidance. We retain our earnings forecasts but raise our DCFbased target price to S$1.76 from S$1.58 (WACC 9.4%, LT growth 1%) following our rollover to CY10. Maintain UNDERPERFORM on potential de-rating catalysts from: 1) an expected spike in churns at its pay-TV division; 2) some unravelling of its hubbing model; and 3) prospects of losing more content to SingTel.

Revenue to be uninspiring. We are expecting revenue weakness at its mobile and fixed broadband divisions but stable pay-TV and fixed-network revenue on a qoq basis. As with M1, we believe StarHub’s mobile business (51.1% of revenue) came under pressure in the quarter from more competitive tariff plans, bundling discounts and lower roaming and IDD revenue. However, this could have been cushioned by wireless broadband growth as StarHub gained customers at the expense of M1. In fixed broadband (11.3% of revenue), downtrading had not fully played out during the quarter, which could continue to dampen ARPU and revenue. Pay-TV revenue (18.9% of revenue) is expected to be fairly stable as pay TV is one of the cheapest forms of entertainment in Singapore. Finally, in fixed network services (15% of revenue), we expect both the voice and data components to be stable.

Margins should be flattish. We expect flat margins in 3Q09 on the back of rising content costs due to step-up clauses in its content offerings and the addition of content. Cost of services, the bulk from content costs, made up about 15.9% of revenue in 2Q09. Moreover, with the growth in wireless broadband, we believe there would be more pressure on operating lease costs, which constitute about 7.7% of revenue, to cater for backhaul requirements.

SingTel unlikely to accept StarHub’s offer? StarHub has extended an olive branch to SingTel. It has offered to carry BPL matches over its cable platform for free. We regard this as an astute move to stanch potential customer defections come Aug 2010. However, we believe SingTel is unlikely to take up the offer because it:

• Could lose some control over the quality of its offering as programming is carried over StarHub’s network and through StarHub’s set-top boxes. This is probably why such a model has not been used anywhere else in the world.

• May introduce a more updated set-top box which offers greater functionality over StarHub’s to increase user appeal.

• Probably wants churners from StarHub to sever all relationships with StarHub. The continued use of StarHub’s set-top boxes would not achieve this.

Valuation and recommendation

Maintaining earnings forecasts and UNDERPERFORM rating but with a higher target price. We make no adjustments to our earnings forecasts but raise our DCFbased target price (WACC 9.4%, LT growth 1%) to S$1.76 from S$1.58 as we roll over to CY10. Maintain UNDERPERFORM on potential de-rating catalysts from: 1) a spike in churns at its pay-TV division; 2) an unravelling of its hubbing model; and 3) prospects of losing more content to SingTel. The rights to the football World Cup 2010 would be open for bidding at end-2009 and we believe SingTel will be aggressive.

Just move on, StarHub

DESPERATE times call for desperate measures, so the saying goes. And when one has to turn to one’s rival for balm, that must surely signal that the situation is as dire as it gets.

StarHub may have done just that when it extended an olive branch to Singapore Telecommunications to carry the latter’s pay-television content on its cable platform for free.

On the surface, the suggestion – unheard of in the pay TV industry – appears to be a rare case of business altruism. StarHub’s 500,000 cable television customers can be spared the hassle of having two set top boxes when the new BPL (Barclays Premier League) kicks off next August.

Rival SingTel also stands to gain as it could save millions by tapping StarHub’s infrastructure to reach consumers and businesses instead of investing in its own wiring.

To make the deal even sweeter, customers will pay SingTel for their BPL subscriptions, even though the channel is delivered via StarHub’s cable television set-up. After all, the argument is that StarHub has already been doing the same for free-to-air channels such as MediaCorp 5 and 8.

It would seem that the complaints of long-suffering football fans have finally been heard and, short of any government intervention, an interim win-win work-around has now been found. However, if you peel the bark off the StarHub olive branch, it is quite clear that damage-control is the true self-serving intent.

The BPL has always been the crown jewel of StarHub’s sports line-up and its latest offer to SingTel seems like a veiled attempt to cling on to this prized trophy.

StarHub’s mooted approach will indeed save consumers the inconvenience of owning two pay TV boxes.

What is left unsaid is that it will also help stem the exodus among its current cable television base. This is because StarHub customers who want to watch the BPL will be more inclined to hang on to their pay-TV subscriptions.

Another fact is that StarHub is mandated to carry terrestrial channels such as MediaCorp 5 and 8 by the Media Development Authority of Singapore (MDA). In the latest plot twist, StarHub extended the offer to carry SingTel’s content out of its own free will.

The MDA has already said that it would not interfere in the commercial arrangements of pay-TV operators despite some recent customer rumblings. This is consistent with its decision in 2006 when SingTel appealed successfully to the MDA to ban exclusive content such as the BPL on the grounds that it discourages competition.

This means that any tweaks to the regulator’s policy should only be made in the next round of bidding three years later when the scores between the two quibbling foes are even.

While StarHub could be using the media to influence public opinion to get SingTel to concede the middle ground, it may have done the exact opposite of stirring the hornet’s nest.

At the red camp, this suggestion will undoubtedly be seen as yet another gibe at its ability to wire-up the nation over the next 10 months for BPL broadcast.

StarHub’s outgoing helmsman, Terry Clontz, had already questioned this once and the comment was met with a stern rebuttal from SingTel Singapore CEO Allen Lew.

‘We have never said something and not delivered,’ Mr Lew told BT then.

If SingTel takes up the StarHub offer now, it will be seen as backtracking on a public commitment. Pride aside, a compromise also cast doubts over the viability of its own mio TV platform.

If SingTel can resort to door-to-door selling in housing estates to push its mio TV service two years ago, you can be sure it will spare no expense to drive the take-up for its new sports portfolio.

Furthermore, the marketing machinery at SingTel has already been fired up. Its telemarketers have already started calling customers to up-sell its new sports line-up. Such a content-sharing arrangement would only complicate the sign-up process.

Rather than moping over the BPL loss, StarHub should move quickly to resolve lingering consumer doubts. Concede that the sports battle is lost and move on quickly to reposition itself with its other exclusive pay-TV content. Make the necessary price adjustments and offer perks to lock in consumers with shorter-term one-year contracts to stem immediate customer outflow.

StarHub has said that it would bounce back after being one goal down. Now it’s time to put the money where its mouth is. Offering to take in your rival’s star striker can hardly be considered a viable solution.

Hubbing strategy at risk

Loss of the BPL will affect medium-term earnings

Forecasts and fair value lowered on loss of BPL and ESPN Star Sports

• We have lowered our fair value to S$1.94 – based on a DCF approach – revising our terminal growth assumption from – 5% to -6% on the back of reduced opportunities and increased competition in the Pay TV market. StarHub Ltd (StarHub) is currently trading close to our fair value. We recommend a HOLD rating.

• Recent price fall reflects much negative impact from the loss of key sports content in the Barclays Premier League (BPL) and ESPN Star Sports. With the outcome of its biggest risk known, we believe downside is now limited. We quantify the impact as muted on overall bottomline as Pay TV accounts for a fifth of total revenue.

• We have cut our EPS forecasts by 5% in FY10 and FY11, based on a worst case scenario of StarHub losing all sports pack revenues and a 10% cable TV subscriber migration. Management guides that less than half of subscribers take up sports pack among other add-ons with a lesser 10% solely adding-on sports. Latter 10% segment represents risk of migration.

• Elimiation of BPL as a loss leader will be positive after initial negative sentiment over a shake-up in the cable TV segment. We estimate that three-year rights to BPL and ESS amounts to S$240mil. Our low-end estimate for this cost item renders our revised bottomline forecasts as conservative. Strpping off S$80mil in expenses on a full year basis from 2H 2010 revises our EBITDA forecast margin for FY11 from 31.3% previously to 31.7%.

• All is not lost in the Pay TV market. Genre of football and sports is SingTel’s only big value proposition, but StarHub still holds sway with a wider range of other content. We believe there is room for both operators, each serving different interest groups with their differentiated packaging and pricing.

• An improvement in newsflow for StarHub’s OpCo operation  in the Next Generation National Broadband Network from end 2009 into 1Q10 buoys prospects for StarHub in the mid-term. Market has, hitherto, not factored in a potential upside from this new revenue stream due to a lack disclosure so far.

• We expect more revelations, as NetCo, the infrastructure provider in NGNBN, approaches its critical 60% rollout target at end 2009. StarHub’s wholly-owned OpCo is scheduled to launch commercial operations at end 1Q10.