Dialog Axiata PLC (DIAL.N0000)

Transcription

1 Sri Lanka Telecommunication EQUITY RESEARCH Initiation of coverage 28 November 2013 Dialog Axiata PLC (DIAL.N0000) Connecting your future Dialog Axiata PLC (DIAL), Sri Lanka s largest mobile telecommunications operator (with a market capitalization of LKR73.3bn as at 27 November 2013), has operations focused on mobile, fixed business (FB) and pay-tv services. We believe DIAL s future revenue growth will stem from its mobile operations (voice and data) segment (which when compared with those of regional countries, indicates headroom for further penetration). We also expect the nonmobile segments to contribute to revenue growth and be the primary catalyst for group EBITDA margin expansion, amid intense domestic competition in the mobile operations segment. Competition among local peers has caused DIAL to report lower EBITDA margins compared with those of its regional peers. We further believe that the DIAL s current capex cycle will exert pressure on its FCF starting from 2013E until 2014E, and that this could lower its dividend payout going forward. Our DCF valuation (which includes a scenario analysis) and our relative valuation analyses suggest a share price range of LKR , compared with the share price of LKR9.0 as of 27 November We forecast DIAL s revenue to grow at a 10.0% CAGR through 2015E. We expect DIAL s revenue growth to come from increasing penetration levels in both mobile voice (despite near-100% penetration at present) and data operations, supported by growing income levels, DIAL s large, and growing, customer base (38% of mobile subscriber market share) and increasing smartphone adoption. We believe this should be supported by the FB and pay-tv segments, although growth would come off a lower subscriber base, as these segments are still at lower levels of penetration. We forecast modest EBITDA margin expansion of 54bps to record a margin of 33.1% by 2015E. We expect the mobile operations segment (which represents roughly 87% of the EBITDA mix) to post a flat EBITDA margin expansion over 2013E-2015E, mainly due to intense competition seen among domestic peers. This has also resulted in DIAL reporting EBITDA margins lower than its regional peers. However, we believe that any margin upside will come from the smaller FB (which has relatively higher margins) and pay-tv segments. Cost inflation, industry rivalry, lower-than-expected returns from capital investments and delayed pay-back could result in downward pressure to our EBITDA margin forecasts. Higher capex could pressure FCF generation. When compared with regional peers, DIAL has a higher capex-to-revenue ratio. We believe this is likely due to DIAL investing in its strategic objective of maintaining a first-mover advantage, as its product mix continues to shift into non-mobile operations. As DIAL is currently into a new capex cycle, we expect (based on past trends) high levels of capex, estimated at approximately LKR68.0bn over 2013E-2015E (including the 4G-LTE [fourth generation long-term evolution] rollout and spectrum acquisitions), to result in negative FCF over 2013E-2014E, with FCF returning to positive levels only in 2015E. Furthermore, we believe that this FCF pressure could stem the dividend payout over 2013E-2015E. In addition, we believe these investments have led DIAL to raise capital via debt and we estimate its gearing levels to increase further over the capex cycle (with gearing at 41% in 3Q13). We establish a valuation range of LKR Our DCF valuation includes a bulland bear-case scenario analysis that factors in potential upside and downside risks to our base-case assumptions, to yield a range of LKR Our EV/EBITDA analysis estimates that DIAL currently trades at a 2014E multiple of 4.1x a 35.5% discount to its regional peer average. Applying a 5% premium and discount (warranted by several positive and negative factors that could affect our valuation estimates) to DIAL s twoyear historical EV/EBITDA average of 4.2x, determines a range of LKR Key statistics CSE/Bloomberg tickers Share price (27 Nov 2013) No. of issued shares (m) Market cap (USDm) Enterprise value (USDm) Free float (%) 52-week range (H/L) Avg. daily vol. (shares,1yr) Avg. daily turnover (USD 000) DIAL.N0000/DIAL SL LKR9.0 8, % LKR9.9/7.9 1,502, Source: CSE, Bloomberg Note: USD/LKR=128.9 (average for the one year ended 27 November 2013) Share price movement 130% 110% 90% Nov-12 Feb-13 Apr-13 Jul-13 Sep-13 Nov-13 DIAL ASPI S&P SL 20 Source: CSE, Bloomberg Share price performance 3m 6m 12m DIAL 11.1% -4.3% 12.5% S&P SL % -12.8% 7.8% All Share Price Index -0.1% -10.7% 7.7% Source: CSE, Bloomberg Summary financials LKRm (year end 31 December) E 2014E Revenue 56,345 63,928 69,584 EBITDA 18,357 20,737 22,929 EBIT 6,801 7,721 8,065 Net profit 6,030 6,631 6,967 Recurrent EPS ROE (%) EV/EBITDA (x) Source: DIAL, Amba estimates 1

2 Table of Contents DIAL s revenue to grow at a 10.0% CAGR over 2013E-2015E... 3 Mobile voice and data revenues to fuel DIAL s revenue growth... 3 FB segment to contribute to revenue supported by favorable industry dynamics... 5 Pay-TV operations to contribute to revenue growth, but continue to face competition from local free-to-air entertainment... 6 Foray into e- and m-commerce initiatives... 7 Factors that warrant a potential upside to top-line growth... 7 Downside risks to top-line growth... 8 We forecast modest EBITDA margin expansion of 54bps by 2015E due to competition in mobile operations... 9 Mobile segment EBITDA margin to remain flat through 2015E FB operations to be the main margin driver for the group Pay-TV operations EBITDA margin to also support group margin Higher capex results in short-term pressure on FCF, higher gearing and lower dividend pay-out DIAL to invest roughly LKR68.0bn in capex over 2013E-2015E New capex cycle leads to negative FCF through 2014E We anticipate higher gearing on account of pressured FCF We forecast a lower dividend payout over 2013E-2015E We establish a valuation range for DIAL s shares of LKR DCF analysis yields a valuation range of LKR per share EV/EBITDA used as the primary relative valuation technique to support our DCF analysis P/E analysis yields a range of LKR per share Share price performance Earnings release focus areas Appendix 1: The Sri Lankan mobile telecommunications industry Industry overview Competitive landscape in the mobile telecommunications industry Broadband industry in Sri Lanka Pay-TV industry in Sri Lanka Industry regulation Appendix 2: Company overview DIAL s business segments Management strategy, transparency and governance Shareholding structure Board of directors Corporate holding structure Appendix 3: Key financial data Summary group financials (LKRm) Segmental summary Appendix 4: SWOT analysis Fact Sheet

3 DIAL s revenue to grow at a 10.0% CAGR over 2013E-2015E We expect DIAL s revenue growth to stem primarily from its core business of mobile operations (including both voice and data revenues) and to be supported by its smaller segments of FB and pay-tv operations. Further, we believe DIAL is continuing to invest in the required infrastructure and technology to prepare itself for future growth opportunities, particularly in relation to its broadband operations; we expect these investments to support a revenue CAGR of 10.0% over 2013E-2015E. Figure 1: DIAL s revenue to grow at a 10.0% CAGR over 2013E-2015E LKRm 80,000 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 YoY growth 30% 25% 20% 15% 10% 5% 0% E 2014E 2015E DIAL group revenue (LHS) YoY growth (RHS) Source: DIAL, Amba estimates Mobile voice and data revenues to fuel DIAL s revenue growth We expect DIAL s mobile operations (87% of 2012 revenue) to generate a 9.1% revenue growth CAGR over 2013E-2015E (from a relatively higher base) despite near-100% penetration rates. This growth would be driven by increasing penetration rates, particularly in the fast-growing mobile data segment. We believe DIAL s strong brand name will allow it to maintain its market leadership in the mobile operations market (38% of subscriber market share), while enabling the company to also further grow its market share. We forecast higher ARPU and net subscriber additions, with blended ARPU levels (for both pre- and post-paid customers) estimated to grow at a 3.4% CAGR over 2013E-2015E and subscriber numbers forecast to grow at a 5.5% CAGR over the same period (below its historical growth level of 8.8% over ), as the Sri Lankan mobile telecommunications market approaches maturity. DIAL s brand positioning to drive new subscriber additions, and thereby higher revenues in the mobile operations segment Figure 2: Mobile operations to post a revenue CAGR of 9.1% over 2013E-2015E LKRm 70,000 60,000 50,000 40,000 30,000 20,000 10,000 0 YoY growth 30% 25% 20% 15% 10% 5% 0% E 2014E 2015E Mobile operations revenue (LHS) Mobile operations revenue YoY growth (RHS) Source: DIAL, Amba estimates 3

4 Voice revenue driven by higher penetration rates and MoUs We believe ARPU levels should increase on account of the growing spending power among the mobile subscriber base, supported by GDP per capita growth. In the voice segment, ARPU should mainly be driven by increasing minutes of use (MoUs) and incremental revenue per minute (RPM), through the introduction of more value added services (VAS), such as voice mail and call conferencing, for example. We believe VAS will become increasingly important for DIAL going forward to both attract new users and get existing subscribers to use more of its services, thereby increasing customer stickiness. Due to the intensity of competition in the industry, it is unlikely that DIAL will be able to grow ARPU solely through tariff increases. Furthermore, we believe the relative inelastic demand for telecommunications services, which has now become an essential service in Sri Lanka, and the growing need among mobile users to stay connected, should contribute to higher ARPU levels. Rising GDP levels and increasing MoUs lead to higher mobile ARPU Figure 3: Mobile ARPU growth supported by anticipated boost in GDP per capita LKR 7,000 6,600 6,200 5,800 5,400 YoY growth 9% 8% 7% 6% 5% 5, E 2014E 2015E Blended ARPU (LHS) GDP per capita growth rate (RHS) 4% Source: DIAL, World Bank, Amba estimates Although the level of mobile voice penetration is expected to pass the 100% mark this year, we believe the cellular market in Sri Lanka can be penetrated further. In comparison with regional peer countries, statistics show that there is room for further penetration within the Sri Lankan market (see Figure 26), as countries such as Singapore and Malaysia, for example, had penetration levels of 150% and 127%, respectively, in We believe there is headroom for further subscriber growth, mainly due to DIAL s established brand name, customer service quality, nationwide coverage and its widespread service center network, together with increasing affordability of hardware devices. The Sri Lankan telecommunications market has headroom for further penetration Figure 4: Mobile penetration rates in Sri Lanka to surpass the 100% mark in 2013 '000s 21,000 19,000 17,000 15,000 Penetration 110% 105% 100% 95% 90% 85% 80% 75% E 2014E 2015E Population (LHS) Mobile subscribers (LHS) Penetration rates (RHS) Source: Central Bank of Sri Lanka, Amba estimates 4

5 Growing middle-class spending and DIAL s tech investments to fuel mobile data growth We believe the increasing adoption of smartphones (and hence greater usage) will contribute positively to higher mobile data subscriber numbers. We believe this will be supported by the low broadband penetration rates in Sri Lanka approximately 7% in 2012, as reported by DIAL and the Telecommunications Regulatory Commission of Sri Lanka (TRCSL). Although Sri Lanka is regionally a much smaller market (in terms of volume), the emerging market trend of rapid growth in smartphone usage (see Appendix 1) can be identified, with smartphones accounting for approximately 13% of mobile handset shipments to Sri Lanka in 2Q13, compared with just 9% in 2012 (according to CyberMedia Research, a South Asian market research, consultancy and advisory firm). In addition, to ramp up the pace of adoption, DIAL started selling hardware devices in early-2013, with units as affordable as USD60, according to management; this, together with enhanced 3G and 4G connectivity across the island that is supported by DIAL s investments in network coverage and infrastructure, should only serve to fuel growth. DIAL has stated that it was the first mobile operator in Sri Lanka to launch mobile 4G-LTE services in April Although coverage is only available within Colombo city limits at present, we believe that DIAL will roll out this new technology across the island over the next few years. We believe mobile ARPU will be driven up by the growing adoption of small-screen data usage, which will increase MoUs and the willingness of subscribers to pay slightly higher tariffs (compared with those of voice operations) for faster speeds and better quality of service. Furthermore, Sri Lanka s broadband tariffs which are among the lowest in the world should encourage higher usage (MoUs) among subscribers, thereby supporting revenue growth. FB segment to contribute to revenue supported by favorable industry dynamics We expect revenue from the FB segment (which accounted for 7.5% of 2012 revenues) to grow at a 15.7% CAGR over 2013E-2015E, driven largely by the favorable industry dynamics discussed below. DIAL was able to increase its FB customer base by 169% through its acquisition of Suntel Limited (one of Sri Lanka s leading fixed line and broadband telecommunications operators) in May We used statistics released by the Central Bank of Sri Lanka (CBSL) to calculate FB penetration in Sri Lanka at approximately 17% in 2012 relatively lower than in other countries in the region and hence showing significant potential for growth. We expect both enterprise and household FB subscribers to increase at a 14.5% CAGR over 2013E-2015E, supported by FB penetration levels of 22% by 2015E, as well as stable pricing. Increasing adoption of smartphones and low broadband penetration rates to support mobile data growth Suntel acquisition in May 2012 allowed DIAL to grow its FB subscriber base significantly Figure 5: FB penetration rates to increase by 532bps through 2015E '000s 1, Penetration 22% 18% 14% E 2014E 2015E 10% DIAL's FB subscribers (LHS) FB penetration rates (RHS) Source: DIAL, Central Bank of Sri Lanka, Amba estimates 5

6 We believe growth in DIAL s enterprise subscriber base will be driven by the Sri Lankan government s plans to make the country a knowledge hub, the increasing importance of the growing BPO/KPO industry in Sri Lanka and ongoing economic/commercial developments within the country. These would all require larger volumes of data transfer, and could consequently provide an upside to our FB ARPU forecasts. Furthermore, we believe increased data-sharing, social networking and a growing middle class (who will be able to pay higher rates for faster speeds and uninterrupted services) could fuel growth in household subscriber numbers. 4G-LTE rollout, supported by increased investments in broadband infrastructure, to fuel revenue growth DIAL stated that it had gained a first-mover advantage with its commercial launch of 4G-LTE fixed broadband in December Although its 4G services are only available in Colombo, we expect a gradual rollout across Sri Lanka over our forecast period. DIAL is also increasing its investments in broadband infrastructure, spectrum acquisitions and bandwidth. In March 2013, DIAL won the 4G spectrum auction held by the TRCSL, securing access to 10MHz of the 1,800MHz spectrum band to support its 4G-LTE rollout. The company also gained a share in the 2.3GHz spectrum band through its acquisition of Sky Television in May DIAL has also entered into an agreement with the Bay of Bengal (BB) consortium (see Appendix 2), gaining a share of the new submarine cable that is expected to be commissioned in the fourth quarter of This agreement should boost international connectivity through greater availability of international bandwidth to Sri Lankan consumers. Pay-TV operations to contribute to revenue growth, but continue to face competition from local free-to-air entertainment Since launching its digital satellite TV services in 2006, DIAL s pay-tv operations segment (5% of 2012 revenue) has established itself as the clear leader in the domestic pay-tv market, with an estimated market share of 78% (as reported in the DIAL annual report). We expect revenue from this segment to increase at a CAGR of 16.0% over 2013E-2015E, driven by improving penetration rates, from the low level that is currently prevalent in the industry. We believe that a growing middle-class population, supported by rising GDP per capita and higher levels of disposable income, will fuel this revenue growth. We estimate a 56% increase in DIAL s subscriber numbers to reach 413,000 by 2015E, with penetration levels increasing to 10% (based on our estimates) and with an ARPU CAGR of 1.0% over 2013E-2015E. Penetration levels in the pay-tv industry to increase to 10% by 2015E, according to our estimates, from roughly 8% in 2012 Figure 6: Pay-TV revenue to grow at a 16.0% CAGR over 2013E-2015E LKRm 5,000 LKR 9,700 4,000 9,500 3,000 9,300 2,000 9,100 8,900 1,000 8, , E 2014E 2015E Pay-TV revenue (LHS) ARPU (RHS) Source: DIAL, Amba estimates Figure 7: DIAL controls over 75% market share in the domestic pay-tv industry Subscribers (000s) E 2014E 2015E Estimated pay-tv market size DIAL's subscriber base Source: DIAL, Amba estimates 6

7 It should be noted, however, that while low penetration indicates that the industry is still in its infancy with material revenue growth potential, the Sri Lankan TV entertainment industry is dominated by almost 20 domestic private and state-owned analog free-to-air television channels, which are still favored by the majority of the population. These channels primarily cater to daily primetime local-language entertainment requirements. DIAL also faces stiff competition from its closest rival Sri Lanka Telecom PLC (SLT), which has its PEO TV offering. In addition, there could be further downside risks to pay-tv revenue stemming from the large number of illegal pay-tv connections (particularly in the north of Sri Lanka, according to DIAL s management), with subscribers receiving signals from neighboring India. Although the TRCSL has recently issued legislation making such connections illegal, these regulations are not strictly enforced, resulting in several such connections in Sri Lanka, and thereby the loss of potential subscribers for DIAL. Foray into e- and m-commerce initiatives As part of its strategy to be the first-to-market with innovation, DIAL made its foray into Sri Lanka s digital e-commerce space by acquiring 26% of Digital Commerce Lanka Pvt Ltd in December The company aims to use this investment to widen its footprint in the digital commerce industry. Also in 2012, DIAL became the first mobile operator in Sri Lanka to receive a Payment Systems Provider (PSP) license from the CBSL, allowing the company to gain another first-mover advantage through its new mobile money transfer service ez Cash (refer to Appendix 2). We have not factored these services into our forecasts, as although these are promising investments, their benefits would be reaped only in the long term. However, there is the risk that competition from other telecommunications operators in Sri Lanka could erode DIAL s first-mover advantage benefits through the introduction of similar services (e.g., SLT s mcash, a domestic mobile money service). This could result in pricing pressure, which could impede revenue growth from these streams and have knock-on effects on DIAL s bottom line. Competition from domestic free-to-air content and illegal pay-tv connections could hamper revenue growth Factors that warrant a potential upside to top-line growth Possible industry consolidation in the mobile operations segment With five operators in the mobile telecommunications industry battling to gain market share, industry consolidation appears to be the only way to go forward. Although there have been some acquisitions in the recent past, we believe there is still room for a few more mergers, which would leave only two or three large established operators in the industry. This would put these remaining operators in a more favorable position to compete and grow market share as well as revenue. However, the smaller competitors appear reluctant to dispose of their holdings, as recently indicated by Bharti Airtel officials, who denied rumors of a possible sell-off of Airtel s Sri Lankan operations. First-mover advantage DIAL s parent company Axiata Group Berhad (AGB) views DIAL as strategic to its group portfolio, even though it accounts for only approximately 8% (based on 2012 data) of group revenue. According to DIAL s management, AGB sees Sri Lanka as a testing ground for new product ideas and launches (e.g., pay-tv and the 4G-LTE rollout). Therefore, this would result in DIAL being the first-to-market (with new products or services) and give it a first-mover advantage in the Sri Lankan market. It would also mean a variety of new product and service innovations as well as better value additions to customers, which we believe could lead to lower churn rates and greater customer and brand loyalty. Better-than-anticipated penetration rates in FB services Current FB penetration rates in Sri Lanka are estimated at approximately 17% (based on our calculations). DIAL may see significant upside to its revenue growth if its recent investments in broadband infrastructure and technology are supported by higher-than-expected subscriber penetration rates. Industry consolidation, DIAL s competitive advantage and better-than-anticipated broadband penetration rates in FB operations could lead to incremental top-line growth 7

8 Downside risks to top-line growth Increase in telecommunication levy to 25% The 2014 budget proposal saw a 5% increase in taxes on telecommunication services (including voice calls), which could increase charges and consequently cause a slowdown in customer usage (MoU). This could lower our ARPU forecasts. Lower-than-expected economic growth DIAL s business model is driven by higher consumer spending and a growing middle-class in Sri Lanka (GDP per capita projected by the CBSL to reach USD4,000 in 2016 a 37% increase from 2012 levels) and the subsequent increase in disposable income levels would benefit DIAL. However, the downside risk to DIAL, in the event of low lower-than-forecasted periods of economic growth in Sri Lanka, could be consumers reluctance to pay for non-essential product offerings, such as pay-tv and broadband, which, in turn, could impact revenue growth. Implementation of the number portability rule (NPR) The NPR will allow subscribers of a particular operator to switch over to any other telecom provider while still maintaining the same number. Most subscribers are currently reluctant to switch over to other providers due to the hassle involved in informing their contacts of the number change. Instead, they opt to maintain multiple SIMs from different operators, but in most cases will use the additional connections sparingly. The TRCSL has been contemplating the implementation of this rule since However, if this rule comes into play, we believe DIAL could stand to lose out, as smaller network operators could use this as an opportunity to entice subscribers from DIAL through more competitively priced offers. Damage to the cable lines used to provide broadband services The optical fiber submarine communication cables (e.g., SEA-ME-WE 4) connecting Sri Lanka to Southeast Asia, the Middle East and Western Europe have been damaged on various occasions in the past, resulting in network outages and limited usage and connectivity during periods of repair. The most recent incident on 27 March 2013 reported a cut in the cable that ran from Pakistan through to Alexandria, Egypt, and this disrupted Internet connectivity for over a month. A similar incident that affects Sri Lanka could impact DIAL s revenues. Inability to grow customer base in the pay-tv segment This is one of the key growth areas that DIAL has diversified into to support future revenue streams. However, the tendency of Sri Lankan subscribers to prefer local free-to-air channels that offer a wide variety of local-language content is a threat to DIAL. Negative macroeconomic factors, NPR and possible damage to cable lines could hamper revenue growth in future 8

9 We forecast modest EBITDA margin expansion of 54bps by 2015E due to competition in mobile operations We estimate a 54bps increase in DIAL s EBITDA margin over 2013E-2015E to 33.1% in 2015E. We expect the mobile operations segment (which represents roughly 87% of the EBITDA mix) to post relatively flat EBITDA margin expansion over 2013E-2015E, and we believe that any margin upside will come from the smaller FB (which has relatively higher margins) and pay-tv segments. Figure 8: DIAL s EBITDA margin expansion from FB and pay-tv operations to be offset by modest mobile operations margins 50% 45% 40% 35% 30% 25% 20% 15% 10% E 2014E 2015E DIAL EBITDA margin Mobile EBITDA margin FB EBITDA margin Pay-TV EBITDA margin Source: DIAL, Amba estimates Our guarded view on margin expansion is backed by the fact that Sri Lankan telecommunication operators face intense price competition amid some of the lowest tariff rates in the world. Moreover, our analysis shown in Figure 9 indicates that, historically, DIAL s EBITDA margin has been lower than those of its regional peers and we expect this trend to continue. Figure 9: DIAL s EBITDA margin lower than its regional peers, a trend we expect to continue 50% 45% 40% 35% 30% 25% 20% E 2014E 2015E Peer average EBITDA margin DIAL's EBITDA margin Source: DIAL, Bloomberg, Amba estimates Note: Our regional peer sample includes a domestic peer (Sri Lanka Telecom PLC), India-based peers (Reliance Communications, Bharti Airtel, Idea Cellular), Indonesia-based peers (Indosat Tbk PT, PT XL Axiata Tbk), a Singapore-based peer (Singapore Telecom) and a Philippines-based peer (Globe Telecom Inc.) 9

10 Mobile segment EBITDA margin to remain flat through 2015E We expect the mobile operations segment to yield slight EBITDA margin growth of 36bps to 32.8% in 2015E, on the back of intense price competition prevalent in the industry as well as the shift toward increasing data usage from voice. In the voice sub-segment, DIAL s mobile customer base is split approximately 88:12 between preand post-paid subscribers, with a noticeable trend (albeit at a slow pace) of more customers switching over to post-paid connections. This may lead to minor increases in EBITDA margins, as post-paid customers reportedly are also the higher-margin contributors to this segment. Figure 10: The number of higher-margin post-paid subscribers is on the increase 100% 10.4% 12.1% 11.6% 12.0% 12.2% 12.5% 80% 60% 89.6% 87.9% 88.4% 88.0% 87.8% 87.5% 40% 20% E 2014E 2015E Pre-paid subscribers Post-paid subscribers Source: DIAL, Amba estimates Therefore, we believe DIAL should focus on retaining and increasing subscribers in this sub-segment to ensure that it at least maintains its contribution to the group s EBITDA margin in the future. Furthermore, marginal EBITDA margin improvements can be expected through operational cost-control efforts and economies of scale enjoyed by DIAL (with over 8.5m subscribers). However, we believe there is also a shift toward greater data usage from voice, with current trends indicating higher mobile data usage by subscribers. This could exert additional pressure on margin growth as mobile data services yield lower margins than voice services (likely due to the lower penetration levels in mobile broadband in Sri Lanka), and also incur relatively higher costs in rolling out the required infrastructure. We believe the segment s margin could be further impacted by the following factors: The previously mentioned intense competition from DIAL s closest domestic rivals While DIAL is the undisputed market leader in the mobile market in Sri Lanka, it still faces intense price competition from other operators such as Mobitel (SLT s mobile operations arm and wholly owned subsidiary), Etisalat, Airtel and Hutch. Furthermore, DIAL is still behind SLT in the fixed broadband market, and could therefore face higher marketing and operational costs if SLT aims to become the market leader. Cost inflation Unlike most other consumer spending-driven industries, where cost escalations can partially or wholly be passed on to customers, DIAL operates in a highly competitive industry where cost escalations must be borne by the industry operators. Any high cost escalations would exert pressure on EBITDA margins in the future. Mobile segment EBITDA margin to remain flat on the back of intense price competition and the mix shift from voice to data; segmental margin growth to be driven by cost-control efforts and economies of scale 10

11 FB operations to be the main margin driver for the group We expect the FB segment s EBITDA margin to widen by 162bps, with EBITDA reaching LKR2.9bn in 2015E (a margin of 43.5%), and the segment to contribute 11.5% to group EBITDA (versus 9.7% in 2012). As we expect DIAL to roll out its 4G-LTE services on a nationwide scale over our forecast period, EBITDA margin should expand, driven by higher revenues (supported by higher penetration levels, and consequently an increase in net subscriber additions). We also believe that customers are willing to pay a slight premium for better quality and faster broadband services, afforded by switching to 3G/4G services. Furthermore, margin expansion may be supported by the recently concluded acquisition and amalgamation of Suntel Limited, which should assist in rationalizing operations and yield economies of scale. DIAL s acquisition of an international data cable (BB gateway investment) should also contribute to higher margins, once this cable is commissioned in 2014, as DIAL will be able to lease bandwith from international telecommunications operators (in Singapore and the Middle East, for example) at a relatively low cost (and thus avoid paying the current high lease-line rates to SLT). We note, however, that margin expansion could be hampered if ROI from new infrastructure rollouts take longer than expected to materialize and if they do not meet the required targets. FB operations EBITDA margin expansion to be supported by higher penetration rates resulting from recent infrastructure investments Pay-TV operations EBITDA margin to also support group margin This segment, much like the others, is largely supported by a fixed-cost structure, which means that once breakeven levels are reached, every additional subscriber will contribute to a higher EBITDA margin. As such, we believe that the projected 56% growth in subscribers over 2013E-2015E, supported by higher penetration levels in this market, should boost segmental EBITDA margin by 109bps to reach 22.8% in 2015E. 11

12 Higher capex results in short-term pressure on FCF, higher gearing and lower dividend pay-out DIAL to invest roughly LKR68.0bn in capex over 2013E-2015E In the dynamic telecommunication industry, service providers need to invest in new technology and supporting infrastructure to maintain and expand their subscriber base and product and service offerings. These companies, including DIAL, go through capex cycles, where essential investments are made to remain up-to-date with the latest technologies, keep pace with competition and possibly to reap the resulting benefits in the years to follow. DIAL s previous capex cycle was during , where DIAL invested approximately LKR48.5bn (LKR25.5bn in 2007 and LKR23.0bn in 2008), with investments linked to network modernization and expansion of its existing services. We expect the latest capex cycle to continue over our explicit forecast period, with our estimates of capex at roughly 40% of revenue in 2013 (capex of LKR25.2bn), 30-35% in 2014 (LKR23.8bn), and approximately 25% in 2015 (LKR18.7bn), leading to capex of approximately LKR68.0bn in total over 2013E-2015E. We believe these investments will be linked to infrastructure development, such as the company s fiber optic cable network and spectrum acquisitions. New capex cycle leads to negative FCF through 2014E The above mentioned capex cycles generally result in very low/negative FCF figures during the period incurring capital investments, followed by an upturn in FCF in the following years (as the capital investments yield benefits to these companies). After DIAL s initial capex cycle over (during which capex came in at roughly LKR48.5bn, resulting in negative FCF), the company generated positive cumulative FCF of LKR20.6bn over Therefore, we believe that the new round of capex plans could pressure DIAL s FCF in the short to medium term, and we expect 2013E and 2014E to see negative FCF. On a more positive note, we expect FCF to improve in FY15E, with our estimate at LKR6.0bn, as the company s capex program phases out and investment benefits begin to materialize. LKR68.0bn in capex investments linked to network infrastructure development and spectrum acquisitions We expect FCF to turn positive again in 2015E Figure 11: High capex to pressure DIAL s FCF through our explicit forecast period LKRm 26,000 20,000 14,000 8,000 2,000 (4,000) (10,000) (16,000) E 2014E 2015E Total capex FCF Source: DIAL, Amba estimates 12

13 Further analysis indicates that in a regional context, on average, DIAL has much higher capex requirements than its domestic and regional peers, with its capex-to-revenue ratio coming in at a 40% average over , compared with a peer average of 34%. We believe this is likely due to DIAL s strategic objective of being the market leader in technology and innovation, (supported by DIAL s extensive foreign direct investments [FDI] accumulating to approximately USD1.5bn, which has resulted in DIAL becoming Sri Lanka s largest FDI contributor). Figure 12: DIAL s capex spend (as a proportion of revenue) is the highest among its regional peer group 80% 70% 60% 50% 40% 30% 20% 10% 0% E 2014E 2015E South Asia average capex/revenue DIAL's capex/revenue Southeast Asia average capex/revenue Source: DIAL, Bloomberg, Amba estimates Note: Our regional peer sample includes a domestic peer (Sri Lanka Telecom PLC), India-based peers (Reliance Communications, Bharti Airtel, Idea Cellular), Indonesia-based peers (Indosat Tbk PT, PT XL Axiata Tbk), a Singapore-based peer (Singapore Telecom) and a Philippines-based peer (Globe Telecom Inc.) As shown below in Figure 13, we note that historically, during periods of high capex, DIAL s FCF margin is largely negative and once capex is relaxed, the company s FCF margin is distinctly higher. This trend further supports our cautious view on the company generating negative FCF margins with DIAL going into a new round of capex investments over 2013E-2014E. Figure 13: Post DIAL s capex cycle in 2007/2008, its FCF margins were higher than peers 30% 20% 10% 0% -10% -20% -30% -40% -50% E 2014E 2015E DIAL's FCF/revenue South Asia average FCF/revenue Southeast Asia average FCF/revenue Source: DIAL, Bloomberg Note: Our regional peer sample includes a domestic peer (Sri Lanka Telecom PLC), India-based peers (Reliance Communications, Bharti Airtel, Idea Cellular), Indonesia-based peers (Indosat Tbk PT, PT XL Axiata Tbk), a Singapore-based peer (Singapore Telecom) and a Philippines-based peer (Globe Telecom Inc.) 13

14 We anticipate higher gearing on account of pressured FCF We expect DIAL s pressured FCF, resulting from higher capex investments, to lead to higher financial leverage, as we believe the company would increasingly utilize debt funding to meet its investment expenditure. We believe that the new USD200m term loan (a five year tenure syndicated loan, taken on in tranches starting in July 2013) will push gearing up to above 45% in 2014E and exert pressure on DIAL s balance sheet due to loan repayments and a higher interest burden. DIAL s gearing levels have increased over the year to reach 41% in 3Q13 higher than its closest domestic peer (its only locally listed competitor, SLT, had a gearing level of 25.5% at the end of the same quarter) and in line with its regional peer average. Figure 14: Currently in line with its regional peer average, we expect DIAL s gearing to increase further in 2014E Gearing 60% 50% 40% 30% 20% 10% 0% Bharti Airtel Singapore Telecom Sri Lanka Telecom DIAL PT XL Axiata Tbk Idea Cellular Reliance Communications Gearing Regional peer average Source: DIAL, Bloomberg Since 2010, DIAL has maintained healthy levels of interest cover, with an average interest cover (EBIT/interest expense) ratio of 11.1x. However, we expect this ratio to reduce to 3.9x in 2013E on the back of the higher interest burden, due to greater leverage. It is noteworthy mentioning that DIAL s credit risk profile is somewhat mitigated due to reliable support from its parent AGB, which in the past has provided corporate guarantees on debt when required. We believe this parental backing has helped DIAL to maintain its AAA credit rating (by Fitch Ratings) and a stable outlook. Anticipated higher financial leverage to lower interest cover Figure 15: Higher financial leverage to lower interest cover Gearing Interest cover 48% % % % % % E 2014E 2015E - Gearing Interest cover Source: DIAL, Amba estimates 14

15 We forecast a lower dividend payout over 2013E-2015E We highlight that although DIAL has maintained a stable dividend payout ratio over the past few years ( ) of roughly 40%, the company did not pay dividends in 2008 and 2009 during which the company incurred significant capex. Therefore, on the back of our forecast of DIAL generating negative FCF during 2013E and 2014E, we have lowered our dividend payout ratio to 25% over our explicit forecast period (from a 45% payout in 2012). Dividend payout to come under pressure due to negative FCF Figure 16: Dividend payout to shareholders may face pressure due to capex commitments 50% 40% 30% 20% 10% 0% E 2014E 2015E LKR Dividend pay-out (LHS) DPS (RHS) Source: DIAL, Amba estimates 15

16 We establish a valuation range for DIAL s shares of LKR Based on our current earnings outlook for DIAL shares, our 12-month valuation range is LKR per share, compared with the current share price of LKR9.0 as of 27 November We arrived at our valuation range after conducting a scenario analysis to a DCF valuation, and using EV/EBITDA and P/E-based relative valuation approaches. For factors that will provide an upside/downside to these suggested valuation ranges, please refer to pages 7 and 8 of the report. Figure 17: Valuation range analysis provides a range of LKR per share (current share price of LKR9.0) DCF analysis EV/EBITDA analysis P/E analysis (scenario analysis) week range Source: DIAL, Bloomberg, Amba estimates DCF analysis yields a valuation range of LKR per share For DIAL, our base-case assumptions of a risk-free rate of 9.8% and a market risk premium of 5.0% yield a value per share of LKR9.2. Adjusting these assumptions (to allow for bull- and bear-case scenarios) implies a valuation range of LKR Other elements of our valuation approach include the following: DIAL s current capital structure comprises 28% debt and 72% equity. We have assumed a 40% debt and 60% equity target capital structure. Our base-case valuation assumes a terminal growth of 1.0%. Figure 18 reflects our DCF assumptions for DIAL. We have estimated the following: EBIT and FCF figures throughout the explicit and fade periods. We have assumed a nominal effective tax rate of approximately 17.0% from 2014E onwards, following the expiration of DIAL s 15-year tax holiday period. Terminal value at 2022E, calculated by applying a terminal growth rate to unleveraged FCF as of 2022E. Finally, we arrived at our enterprise value (EV) by discounting the unleveraged FCF values over the explicit and fade periods at the group WACC. Our base-case assumptions include a risk-free rate of 9.8% and a market risk premium of 5.0% 16

17 Figure 18: Amba DCF assumptions schedule (base case) WACC assumptions 2014E Target capital structure 40/60 Cost of equity 15.1% EBIT total (1-t) 6,722 Cost of debt 12.5% FCF (1,280) Growth rate 1.0% Terminal value (undiscounted) 167,781 WACC 13.2% EV 74,767 Source: Amba estimates Note: All figures are in LKRm unless otherwise stated Taking into consideration the upside and downside risks discussed on pages 7 and 8, we arrive at bull- and bear-case scenarios (shown in Figure 19) to establish our valuation range of LKR These assumptions yield the following scenarios: Bull-case scenario: Here, we assume that DIAL performs better than our estimates and achieves a 5.0% increase in net subscriber additions each year, over and above our base-case assumptions, across all three segments. This scenario also assumes ARPU to be 2.0% higher than base-case YoY growth rates across all segments. This leads to revenue growth of 14.1% YoY in 2013E (compared to the base-case YoY growth rate of 13.5% in 2013E), and translates to a 10.9% CAGR over 2013E-2015E (compared to our base-case estimate of 10.0%). This scenario also assumes a 0.5% expansion (above our base-case estimates) in the EBITDA margin across all segments, leading to a 102bps increase through 2015E (compared to our base-case estimate of 54bps over the same period). Scenario analysis driven by changes to subscriber additions, ARPU levels and EBITDA margin estimates Bear-case scenario: The potential downside assumes a 5.0% decline in subscriber net additions and a 2.0% decline in ARPU across all segments over our explicit forecast period, compared to our base-case estimates. This results in a YoY revenue growth rate of 12.8% in 2013E (compared to the base-case YoY growth rate of 13.5%) and a 9.0% CAGR over 2013E- 2015E (compared to our base-case estimate of 10.0%). Here, we also assume a 0.5% contraction in the EBITDA margin (below our base-case estimates) across all segments, resulting in a 3bps increase through 2015E (compared to our base-case estimate of 54bps over the same period). 17

18 Figure 19: DIAL scenario analysis assumptions Base Case Bull case Bear case E 2014E 2015E 2013E 2014E 2015E 2013E 2014E 2015E Mobile operations Revenue 49,123 55,360 59,618 63,707 55,666 60,921 65,241 55,055 58,320 62,183 YoY growth 19.0% 12.7% 7.7% 6.9% 13.3% 9.4% 7.1% 12.1% 5.9% 6.6% Blended ARPU 6,357 6,463 6,779 7,027 6,497 6,916 7,174 6,430 6,643 6,880 YoY growth 10.7% 1.7% 4.9% 3.6% 2.2% 6.5% 3.7% 1.1% 3.3% 3.6% Subscribers 7,727 8,566 8,794 9,067 8,568 8,808 9,094 8,563 8,780 9,039 Net adds EBITDA margin 32.4% 32.6% 32.7% 32.8% 32.7% 33.2% 33.3% 32.4% 32.2% 32.3% FB operations Revenue 4,246 5,036 5,887 6,576 5,066 6,046 6,797 5,007 5,730 6,358 YoY growth 137.9% 18.6% 16.9% 11.7% 19.3% 19.3% 12.4% 17.9% 14.4% 11.0% ARPU 8,057 8,330 8,322 8,322 8,361 8,483 8,488 8,299 8,483 8,155 YoY growth -10.2% 3.4% -0.1% 0.0% 3.8% 1.5% 0.1% 3.0% 2.2% -3.9% Subscribers Net adds EBITDA margin 41.9% 40.0% 43.3% 43.5% 40.2% 43.6% 43.7% 39.8% 42.8% 43.0% Pay-TV operations Subscription revenue 2,500 2,983 3,503 4,034 3,000 3,596 4,171 2,965 3,412 3,900 YoY growth 28.4% 19.3% 17.4% 15.2% 20.0% 19.8% 16.0% 18.6% 15.0% 14.3% ARPU 9,468 9,499 9,624 9,768 9,535 9,793 9,964 9,464 9,454 9,573 YoY growth 5.1% 0.3% 1.3% 1.5% 0.7% 2.7% 1.7% 0.0% -0.1% 1.3% Subscribers Net adds EBITDA margin 21.7% 19.7% 22.4% 22.8% 19.9% 22.9% 23.3% 19.5% 21.9% 22.3% DIAL group DIAL revenue 56,345 63,928 69,584 74,922 64,284 71,150 76,826 63,574 68,026 73,034 YoY growth 24.1% 13.5% 8.8% 7.7% 14.1% 10.7% 8.0% 12.8% 7.0% 7.4% DIAL EBITDA margin 32.6% 32.4% 33.0% 33.1% 32.6% 33.4% 33.6% 32.3% 32.4% 32.6% Source: DIAL, Amba estimates 18

19 EV/EBITDA used as the primary relative valuation technique to support our DCF analysis DIAL s 12-month forward EV/EBITDA has ranged from 3.0x to 8.4x since We have used DIAL s two-year, average historical forward EV/EBITDA multiple (which stands at 4.2x) and have applied a 5% premium and a 5% discount to this historical average to arrive at a range of LKR Figure 20: DIAL has traded at an EV/EBITDA range of 3.0x-8.4x since 2010 LKRm 190, , , ,000 70,000 40,000 Jan-10 May-10 Sep-10 Jan-11 May-11 Sep-11 Jan-12 May-12 Sep-12 Jan-13 May-13 Sep x 4.3x 5.7x 7.0x 8.4x EV Source: DIAL, Bloomberg DIAL currently trades at a 2014E multiple of 4.1x a 1.9% discount to its two-year average. In determining an EV/EBITDA valuation range, we apply two scenarios: Optimistic scenario: Under this scenario, we applied a potential upside to subscriber net additions resulting from DIAL s strong brand name and established market presence, which promote customer loyalty and therefore referral customers, as well as a demand-driven increase in ARPU. We also assume that the company s capex investments (particularly on broadband and 4G-LTE technology) will reap better-than-expected results over our forecast period. We applied a 5% premium to the two-year EV/EBITDA average and arrived at a forward multiple of 4.4x. Applied to our forecast EBITDA of LKR22,929 in 2014E, this leads to a share price of LKR9.8 per share. Pessimistic scenario: Here we assume a 5% discount to the two-year average, implying that DIAL will trade at a forward multiple of 4.0x. This could be justified mainly by lower-than-estimated net subscriber adds, as well as by a fall in ARPU levels (primarily in the broadband and pay-tv segments). Here, we also assume that cost escalations could erode margins further. Applying this multiple to our 2014E EBITDA estimate, we arrive at a share price of LKR8.6 per share. Further comparison with regional peers indicates that DIAL trades at a 35.5% discount to its peer average. We believe this is likely due to the competitive pressures facing DIAL within the domestic telecommunications industry, largely due to the intense price competition prevalent in the market, which has led to the company reporting lower EBITDA margins compared to its regional peers. 19

20 Figure 21: DIAL trades at an EV/EBITDA of 4.1x 2014E a 22.9% premium to its domestic peer SLT EV/EBITDA EBITDA CAGR Company name E 2014E 2013E-2015E Dialog Axiata PLC 9.5x 5.1x 4.6x 4.6x 4.1x 10.6% Domestic peers Sri Lanka Telecom 5.0x 5.1x 4.8x 3.7x 3.4x 9.7% International peers Reliance Communications 5.9x 7.9x 8.9x 8.5x 8.1x 14.5% Indosat Tbk PT 5.4x 5.6x 5.1x 3.8x 3.6x 5.4% China Mobile 4.4x 3.6x 4.2x 3.5x 3.5x 0.9% Bharti Airtel 9.9x 8.2x 7.2x 7.1x 6.2x 12.1% Idea Cellular 8.8x 9.1x 8.5x 8.0x 6.9x 23.2% Singapore Telecom 10.4x 11.1x 12.4x 13.5x 13.3x -0.1% PT XL Axiata Tbk - Indonesia 5.9x 5.3x 6.4x 6.6x 5.9x 4.2% Globe Telecom Inc - Phillipines 4.2x 5.6x 5.5x 7.5x 6.9x 5.4% Mean 6.6x 6.8x 7.0x 6.9x 6.4x 8.4% Median 5.9x 5.6x 6.4x 7.1x 6.2x 5.4% High 10.4x 11.1x 12.4x 13.5x 13.3x 23.2% Low 4.2x 3.6x 4.2x 3.5x 3.4x -0.1% Source: DIAL, Bloomberg, Amba estimates Note: All of the selected peers have the majority of their business focused on mobile operations 20

21 P/E analysis yields a range of LKR per share DIAL s 12-month forward P/E has ranged from 6.8x to 14.8x since January The share s oneyear historical forward average P/E stands at 10.2x. The stock currently trades at 10.5x its oneyear 2014E forward EPS (based on our forecasts) a 3.3% premium to its one-year historical average. Figure 22 presents DIAL s valuation metrics relative to its peers. DIAL trades at a 41.5% discount to the average peer P/E and at a 24.9% discount in relation to SLT. Applying a 5% upside and 5% downside (warranted by the upside and downside risks as discussed on pages 7 and 8) to the 12-month historical average, we arrive at a range of LKR Figure 22: DIAL trades at a 2014E P/E multiple of 10.5x P/E EPS CAGR FCF yield Company name E 2014E 2013E-2015E Dialog Axiata PLC 24.5x 14.0x 11.2x 11.1x 10.5x 8.2% 14.5% 6.1% Domestic peers Sri Lanka Telecom 22.5x 19.2x 19.9x 15.1x 14.0x 11.8% 2.8% -1.6% International peers Reliance Communications 16.5x 18.7x 17.0x 23.4x 19.4x 46.7% -4.5% -6.5% Indosat Tbk PT 45.3x 36.8x 93.4x 110.2x 23.9x 43.5% 4.2% 3.5% China Mobile 11.0x 9.8x 11.3x 10.3x 10.8x -3.2% 8.9% 7.9% Bharti Airtel 22.4x 30.1x 48.6x 33.3x 19.9x 63.9% 3.8% 5.6% Idea Cellular 24.8x 45.2x 37.3x 29.5x 21.3x 63.9% -6.2% 5.0% Singapore Telecom 12.6x 12.6x 16.3x 16.1x 14.8x 4.7% 6.2% 6.1% PT XL Axiata Tbk - Indonesia 15.6x 13.6x 17.6x 22.9x 20.7x -13.8% 5.0% -2.5% Globe Telecom Inc - Phillipines 10.9x 15.3x 21.2x 19.7x 17.1x 10.2% 6.5% 1.4% Mean 20.2x 22.4x 23.6x 21.3x 18.0x 25.3% 2.9% 2.1% Median 16.5x 18.7x 18.7x 21.3x 19.4x 11.8% 4.2% 3.5% High 45.3x 45.2x 48.6x 33.3x 23.9x 63.9% 8.9% 7.9% Low 10.9x 9.8x 11.3x 10.3x 10.8x -13.8% -6.2% -6.5% Source: DIAL, Bloomberg, Amba estimates Note: Any multiple above 50 has been considered an outlier and has been excluded from calculations 21

22 Share price performance DIAL shares closed at LKR9.0 on 27 November 2013 LKR1.0 higher than 12 months earlier and up 12.5% YoY compared to a 7.8% increase in the S&P SL 20, a 7.7% increase in the All Share Price Index (ASPI) and a 10.2% decline in SLT over the period. Figure 23: DIAL has outperformed SLT and the local indices during the last 12-month period 140% 120% 100% 80% 60% 40% Nov-10 Mar-11 Jul-11 Nov-11 Mar-12 Jul-12 Nov-12 Mar-13 Jul-13 Nov-13 DIAL SLT ASPI S&P SL20 Source: CSE, Bloomberg As shown in Figure 24, over the past two years, DIAL has outperformed the ASPI and the S&P SL 20 indices as well as its closest domestic rival SLT. Figure 24: DIAL versus key indices 3m 6m 1 year 2 years 3 years DIAL 11.1% -4.3% 12.5% 15.4% -24.4% SLT -5.3% -12.1% -10.2% -21.1% -16.9% S&P SL % -12.8% 7.8% 2.0% -14.2% ASPI -0.1% -10.7% 7.7% -4.6% -10.0% Source: CSE, Bloomberg 22

23 Earnings release focus areas Here is a checklist of items that investors should track in the next and subsequent quarterly earnings release. We will closely track the performance of DIAL across these key areas, and will revise our forecasts and update our valuation range in upcoming earnings notes. For the firm as a whole 1. Has the group taken on any new debt, which has resulted in a change to the credit rating or credit outlook for DIAL? 2. Have there been any new telecommunication regulations imposed by the government of Sri Lanka or the TRCSL? Mobile operations segment 1. How have penetration rates changed? 2. Any updates on industry consolidation in this segment? 3. Has the TRCSL made further revisions to the minimum floor tariff rule? 4. Has the number portability rule come into effect? Fixed business operations segment 1. Has DIAL made any additional spectrum acquisitions? 2. Is there an increase in broadband penetration rates in Sri Lanka? 3. Is the BB project on track, to be commissioned in the fourth quarter of 2014? Pay-TV operations segment 1. Are there any new entrants (domestic or foreign) into this segment? 23

24 Appendix 1: The Sri Lankan mobile telecommunications industry Industry overview The Sri Lankan mobile telecommunications industry comprises five main licensed players (as highlighted below in Figure 25). Dialog Axiata PLC (CSE ticker: DIAL) and Sri Lanka Telecom PLC (CSE ticker: SLT) are the only two listed operators, dominating the industry with an estimated combined revenue market share of approximately 80%. Of the two, DIAL has the higher market share in the mobile operations segment and a larger mobile subscriber base of over 8.5m (compared to SLT s 4.5m). SLT, like DIAL, is a quad-play (mobile, fixed, data and TV) services provider. It is currently the market leader in fixed voice and broadband. Etisalat, in Sri Lanka is a fully owned subsidiary of Emirates Telecommunications Corporation of the United Arab Emirates. It began operations in Sri Lanka in February 2010, after acquiring a 100% stake in Tigo (a subsidiary of Millicom International Cellular [MIC]). Tigo was Sri Lanka s first mobile network provider when it launched operations in 1989 under the brand name Celltel, which was later rebranded as Tigo in 2007 (following its acquisition by MIC). Airtel Lanka Ltd (ALL), a subsidiary of Bharti Airtel Limited (India), commenced its Sri Lankan operations in January Entering the industry as the fifth player, ALL became the fastest operator to reach 1m customers in Sri Lanka and has now achieved island-wide coverage. Hutchison Telecommunications Lanka (Pvt) Ltd (Hutch) launched operations in Sri Lanka in 2004, initially under the brand name Call Link. It is a member of Hutchison Asia Telecom, a subsidiary of the Hutchison Whampoa Group. The Sri Lankan telecommunications sector s value (LKR147bn in 2012) is set to increase to LKR167bn by 2015, according to SLT s annual report and Telecommunications Regulatory Commission of Sri Lanka (TRCSL) estimates. The market also includes mobile phone operators that provide triple- and quad-play services. Figure 25: Licensed telecommunication operators Category of service Fixed-access telephone service 3 Cellular mobile phones (DIAL, SLT, Etisalat, ALL, Hutch) 5 Data communications (facility-based) 6 Data communications (non-facility based) and ISPs 9 Trunk mobile radio 1 Leased circuit providers 1 Licensed payphone service providers 1 External gateway operators 10 Direct-to-home satellite broadcasting service 3 Cable TV distribution network 4 Source: TRCSL Note: Data as of June 2013 Number of operators Competitive landscape in the mobile telecommunications industry The domestic mobile telecommunications industry is highly saturated, with penetration levels of over 98% in 2012 (versus 55% in 2008), according to statistics issued by the Central Bank of Sri Lanka (CBSL). However, despite this, we believe the domestic mobile market has further headroom for penetration, similar to other regional markets, as indicated in Figure

25 Figure 26: Sri Lanka has more headroom for mobile penetration similar to other regional markets Penetration 250% 215% 200% 150% 100% 72% 73% 87% 99% 103% 127% 150% 50% 0% India China Sri Lanka Philippines Indonesia Malaysia Singapore Hong Kong Source: The Global Information Technology Report 2013 (GITR 2013) Note: Data as of 2011 (most recent data available from this source). As per statistics released by the CBSL, mobile penetration in Sri Lanka stood at 98% in As mobile penetration in the country nears 100%, growth in the industry would slow, thereby increasing competition, as the five incumbent operators battle for a larger share of the approximately 21m potential subscribers through tariff reductions (although not below floor rates) and value additions. Incumbents have different subscriber bases, mostly operating on similar technology platforms (offering triple- and quad-play services) and have sufficient parent company backing to invest further, if required. Sri Lankan operators have seen robust growth since the war ended in 2009, and we believe further growth would be limited, unless it comes through diversified offerings such as quad-play, the adoption of new technology (such as fourth-generation long-term evolution [4G-LTE] mobile and fixed broadband services, which have recently been introduced in Sri Lanka), or industry consolidation to eliminate competition and increase market share (such as DIAL s acquisition of Suntel Limited (one of Sri Lanka s leading fixed line and broadband telecommunications operators) in May 2012). We believe over 80% of the current national subscriber base uses prepaid connections; while prepaid ARPU is lower than postpaid ARPU, we believe that most new subscriber additions would fall into this segment. Furthermore, price increases (currently above the minimum stipulated floor rate, as set by the TRCSL) may not be practical, given the intense competition within the industry and the fact that Sri Lanka already has one of the lowest mobile tariff rates in the region. Figure 27: Mobile cellular tariffs (average per-minute cost) in Sri Lanka is among the lowest in the region USD Hong Kong Sri Lanka India China Indonesia Singapore Malaysia Philippines Source: GITR

26 Investments in technological infrastructure are also a key component of growth, as firms need to set up the foundation to prepare for the adoption of new technology. DIAL and SLT have already identified this need, as evidenced by their capex averaging 30% of total revenues. Figure 28: Capex/revenue averaged roughly 30% for DIAL and SLT in 2012 Capex/revenue 70% 60% 50% 40% 30% 20% 10% 0% DIAL SLT Source: DIAL, Sri Lanka Telecom PLC A key success factor in this industry is network coverage, which is supported by increasing infrastructure spending and leads to economies of scale through a higher resulting subscriber base. The recent rollout of 4G LTE services has brought on higher capex for the largest companies in the industry; however, this is a much needed investment. Global smartphone trends highlight the dominance of emerging markets Over the past few years, global smartphone penetration has increased substantially due to changing consumer dynamics (moving from the need for simple voice telephony to data consumption and creation) and greater affordability. According to Gartner Inc. (a global information technology research and advisory company), smartphone sales accounted for approximately 52% of total mobile phone sales in 2Q13, exceeding sales of feature phones for the first time. International Data Corporation (IDC), (a global provider of market intelligence and advisory services for the information communications technology [ICT] sector), forecasts global smartphone shipments to grow 40% YoY to reach over 1.0bn units in 2013 and 1.7bn units in In addition, global average selling prices (ASPs) are estimated to decline to USD372 in 2013, according to IDC statistics, from USD407 in 2012 and USD443 in IDC expects emerging markets to spur demand and growth in smartphone adoption, with smartphone shipments expected to grow at a 15.7% CAGR over in emerging markets compared with an 8.3% CAGR in developed markets. In addition, IDC expects emerging markets to dominate the global smartphone market, accounting for approximately 71% of all smartphone shipments in The ASPs in emerging markets should decline at a 4.2% CAGR over down to USD259 in 2017 from an expected USD307 in Vendors in these markets are compelled to lower their price points, as emerging markets generally have lower average per capita income levels than developed nations. Furthermore, smartphones have now become the preferred choice for affordable access to computing in these markets, further driving demand for low-cost devices. Broadband industry in Sri Lanka Sri Lanka s fixed and mobile broadband subscriber base grew at an 88.5% CAGR over , off a small subscriber base. As shown in Figure 29, at the end of 2011, Sri Lanka s broadband subscriber base was 4.0% of the total population, well below its regional peer average of approximately 11.1%. This lag indicates that Sri Lanka s broadband and data usage market is still at its infancy and has immense potential for growth. The growing use of smartphones is likely to drive additional broadband growth, as these devices enable much larger volumes of data transfer, requiring higher usage speeds and larger data packages. Sri Lanka also has the lowest broadband 26

27 India Sri Lanka Philippines Malaysia China Indonesia Singapore Hong Kong Sri Lanka India China Indonesia Hong Kong Malaysia Singapore Philippines Dialog Axiata PLC tariff rates in the region (and one of the lowest in the world), which could encourage faster and higher penetration. Figure 29: Sri Lanka s broadband penetration rates come in at 4.0%, lower than its regional peer average of 11.1% Figure 30: Fixed broadband internet tariffs in Sri Lanka are the lowest in the region Penetration 30% 25% 20% 15% 10% 5% 0% USD/month Fixed broadband Mobile broadband Source: GITR 2013 Note: The regional average excludes Hong Kong, an outlier with 55.2% mobile penetration. DIAL states that 7% of the country s population and 29% of total households have broadband access as of September 2013 Source: GITR 2013 Note: The regional average excludes Hong Kong, an outlier with 55.2% mobile penetration. DIAL states that 7% of the country s population and 29% of total households have broadband access as of September 2013 Pay-TV industry in Sri Lanka As of June 2013, there were three direct-to-home (DTH) satellite broadcasting service providers and four cable TV distributors in Sri Lanka s pay-tv market. DIAL s key competitors in the pay-tv arena include Peo TV (from SLT) and Lanka Broadband Networks (LBN). DIAL dominates the market with 78% market share (based on subscriber numbers) in Figure 31: Pay-TV operators in Sri Lanka Name Technology Established Dialog TV Digital satellite 2005 Digital Pay TV (TV Lanka) Digital signals 2012 PEO TV (SLT Visioncom) IPTV (ADSL and WiMAX) 2008 Lanka Broadband Networks (LBN) Analog/digital cable 2000 Source: Online journal articles Pay-TV is an avenue of growth for Sri Lankan telecommunication operators, particularly as the mobile market has near-100% penetration. However, the TV entertainment industry in the country is dominated by free-to-air (terrestrial) television broadcasting, which does not use satellites or transmission cables. In Sri Lanka, the terrestrial broadcasting network comprises approximately 20 private and state-owned operators, providing a variety of free entertainment programs, thereby limiting demand for pay-tv in Sri Lanka. This is one of the main reasons for the low penetration (8.2% in 2012) of pay-tv operators in the country. Industry regulation Entry into Sri Lanka s mobile industry is regulated by the TRCSL through additional licenses. Although the industry is highly competitive, the TRCSL has the authority to issue a license, if necessary, at its discretion. The actions of this regulatory body could either ease or increase competition among operators. For example, the TRCSL imposed a minimum tariff of LKR1.50 per outgoing minute to ease price competition among operators. Despite this floor tariff, operators try to charge above this rate to meet their rising fixed and maintenance costs. 27

28 Another potential regulatory impact on the country s telecom operators could be the approval of number portability this would allow a subscriber to switch operators without changing their phone number, thus minimizing switching costs, and possibly encouraging higher churn rates. 28

29 Appendix 2: Company overview Dialog Axiata PLC (DIAL), an 83.3%-owned subsidiary of Malaysia s Axiata Group Berhad (through its wholly owned subsidiary Axiata Investments [Labuan] Limited), was the fourth entrant to the Sri Lankan cellular industry in As of today, it is the largest mobile operator in the country in terms of subscriber numbers and revenue share. As of 30 September 2013, DIAL had over 8.5m mobile customers (around 38% market share), making it the market leader in the domestic mobile operations industry. It is also among the largest listed companies on the Colombo Stock Exchange (CSE) by market capitalization, with a market cap of LKR73.3bn as of 27 November 2013, and one of only two listed telecom operators in the country. Figure 32: Mobile operations bring in just over 87% of group revenue Figure 33: EBITDA Mobile operations generate around 85% of group LKRm 60,000 50,000 40,000 30,000 20,000 10, Mobile operations Fixed business operations Television operations Source: DIAL LKRm 60,000 50,000 40,000 30,000 20,000 10, Mobile operations Fixed business operations Television operations Source: DIAL DIAL recorded LKR56.3bn in revenue in 2012, at a 10.5% CAGR over EBITDA came in at LKR18.4bn (based on our calculations), representing a 5.1% CAGR over Figure 34: DIAL s revenue grew at a 10.5% CAGR over Figure 35: DIAL s EBITDA grew at a 5.1% CAGR over LKRm 60,000 50,000 40,000 30,000 20,000 10,000 0 Source: DIAL YoY growth 20% 16% 12% 8% 4% 0% Revenues (LHS) YoY growth (RHS) LKRm YoY growth 20, % 80% 15,000 60% 40% 10,000 20% 0% 5,000-20% -40% 0-60% EBIT (LHS) YoY growth (RHS) Source: DIAL 29

30 DIAL s business segments Mobile operations DIAL is involved in domestic mobile (through Dialog Mobile), international (Dialog Global) and teleinfrastructure (Dialog Tele-Infrastructure [DTI]) operations, and these continue to remain the cornerstone of the company s business. The mobile operations segment is DIAL s largest revenue source, as well as its most profitable (it accounted for approximately 87% of revenue and EBITDA in 2012). Dialog Mobile (DM) offers 2.5G, 3G and 3.5G mobile services, and was the first telecom service provider in South Asia to launch mobile 4G-LTE broadband services in April As mentioned previously, its customer base of over 8.5m makes it the market leader in Sri Lanka s mobile communications industry, and this is achieved through its wide mobile coverage encompassing 2,600 base stations. During 2012, DM became the first mobile operator in Sri Lanka to receive a Payment Systems Provider (PSP) license by the Central Bank of Sri Lanka, allowing DM to gain a first-mover advantage through its new mobile money transfer service, ez Cash. A PSP can connect to multiple acquiring banks, cards and payment networks to offer online services for accepting electronic payments from a customer through credit cards, bank transfers, debit cards and other bank-based payments. Dialog Global (DG), the international arm of DIAL, commenced operations in It provides state-of-the-art gateway facilities (with access to satellite earth stations and submarine cable systems) offering retail and wholesale data, and voice services in partnership with 583 operators in over 200 global destinations. Recently, DG invested in a new high-speed submarine cable at a cable landing station to be located in south Colombo, through the Bay of Bengal. Anticipated to be commissioned in 4Q14, this investment is expected to boost international connectivity by creating the single-largest infusion of international bandwidth in Sri Lanka to date. DIAL s Tele-Infrastructure (DTI) arm provides infrastructure (tower and ground space) facilities, as well as data communication services (through its optical fiber network) across major cities in Sri Lanka. At the end of 2012, DIAL had 1,345 shareable tower sites (an increase of 35% YoY), with an external tenancy ratio of 1.05x (compared with 1.19x in 2011). Income from this sub-segment is generated primarily through tower sharing with other mobile and radio operators. Fixed business (FB) operations This segment operates under DIAL s fully owned subsidiary, Dialog Broadband Networks Pvt Limited (DBN), and is the second-largest fixed telecommunications provider in Sri Lanka (after Sri Lanka Telecom PLC). In 2012, the segment accounted for approximately 8% of revenue and approximately 10% of group EBITDA. It provides a range of services to both households and businesses, including fixed telephony, broadband Internet, and converged information and communications technology solutions (such as IPVPN, VoIP and hosted PABX). DBN also provides radio and optical fiber-based transmission infrastructure facilities, and has successfully established Sri Lanka s largest Wi-Fi network, comprising 2,000 hot spots. According to DIAL, DBN was the first in Sri Lanka to launch 4G-LTE high-speed broadband services in December The company also consolidated its market position in 2012, with its acquisition of Suntel Limited (one of Sri Lanka s leading fixed line and broadband telecommunications operators) in March 2012, leading to an approximately 170% increase in the subscriber base to 537,000 subscribers. Further, in May 2013, DBN acquired a 2.3GHz spectrum band through its 100% acquisition of Sky Television and Radio Network Pvt Ltd, which it plans to use to expand its 4G-LTE services. Television operations DIAL operates a pay-tv business under its Dialog TV (DTV) subsidiary, where it has an estimated 78% market share (according to DIAL s 2012 annual report) in an emerging industry, serving over 264,000 Sri Lankan households. In 2012, this segment brought in approximately 5% of revenue and 4% of group EBITDA. 30

31 DTV is the largest satellite-based, direct-to-home (DTH) digital television provider in Sri Lanka and the only pay-tv operator to have island-wide coverage. This service allows subscribers to receive television signals through a satellite dish connected to their homes. DTV s product offerings include approximately 10 local channels and over 70 international channels (such as CNN, BBC, Star, HBO, AXN, ESPN, Ten Sports, Discovery and MTV), offering content in both standard and high-definition formats. During 2012, DTV commenced upgrades of its digital satellite broadcasting network (from MPEG2 to MPEG4 and HD technologies). Management strategy, transparency and governance As Sri Lanka s market leader in mobile communications, DIAL continues to focus on pioneering information communications technology (ICT) services in Sri Lanka. The company s management strategy incorporates an aggressive, but planned capital expansion program, while maintaining prudent resource management policies. In addition, DIAL believes that further shareholder value can be added through cost optimization and judicious cash flow management. DIAL s disclosure is reasonably adequate in a Sri Lankan context, with sufficient information presented through the annual and quarterly reports, and investor presentations. In addition, it is noteworthy to mention that DIAL maintains a proactive and responsive investor relations department, capable of handling inquiries from investors and analysts and are forthcoming with requested information. Shareholding structure DIAL s largest shareholder is its parent company, Axiata Investments (Labuan) Limited (a private subsidiary of Axiata Group Berhad), with an 83.3% stake. Domestic retail investors own 6.8% of the shares, while the Dialog Employee Share Option Scheme (ESOS) holds a minority stake of approximately 2.0%. Figure 36: DIAL s largest shareholder is its parent company Axiata Investments (Labuan) Limited Foreign investors - public 7.9% Local investors - public 6.8% Axiata Group 83.3% Source: DIAL Note: Data as of June The grey section represents the ESOS minority shareholder base. The top five shareholders as of September 2013 are presented below. Name of shareholder Description Stake Axiata Investments (Labuan) Limited Parent company 83.3% HSBC-BBH-Genesis Smaller Companies An emerging markets investment fund 2.4% Employees Provident Fund A state-controlled pension fund in Sri Lanka 2.2% Dialog Axiata Employees ESOS Trust Trust set up to administer the Employee Share Option Scheme 2.0% HSBC International nominees Limited Morgan Stanley and INTL PLC A US-based banking and financial services MNC 1.1% Source: DIAL 31

32 Board of directors As of December 2012, DIAL s board comprised eight directors. Their details are provided below. Name of Director Description Datuk Azzat Kamaludin Chairman of DIAL, and non-independent and non-executive director. A member of the board since July An attorney-at-law by profession. Dr. Hans Wijayasuriya Group CEO and non-independent, executive director. A member of the board since 2001, and has been with DIAL for over 19 years. Mr. Moksevi Prelis Independent non-executive director. A member of the board for nine years. A banker and engineer by profession. Mr. Mohamed Muhsin Independent non-executive director. A member of the board since June An accountant by profession. Mr. Jayantha Dhanapala Independent non-executive director. Appointed to the DIAL board in August Dato Sri Jamaludin Ibrahim Non-independent non-executive director since March Currently also the president and group CEO of Axiata. A veteran in the ICT industry (since 1981). Non-independent non-executive director. Appointed to the DIAL board in May Currently the Mr. James Maclaurin group CFO of Axiata. Has over 16 years of experience in the telecommunications industry and has held a number of senior finance positions throughout his career. Mr. Mohd Khairil Abdullah Non-independent non-executive director. Appointed to the DIAL board in November Currently serves as the group chief marketing and operations officer of Axiata. An engineer by profession. Source: DIAL Corporate holding structure Figure 37: DIAL Corporate holding structure Dialog Mobile (DM) Mobile operations Dialog Global (DG) Dialog Tele-infrastructure (DTI) Dialog Axiata PLC Fixed business operations Dialog TV Pay-TV services Source: DIAL 32

33 Appendix 3: Key financial data Summary group financials (LKRm) INCOME STATEMENT E 2014E 2015E (For the year ended 31 December) Revenue 41,423 45,412 56,345 63,928 69,584 74,922 EBITDA 15,218 16,512 18,357 20,737 22,929 24,814 EBIT 5,413 6,207 6,801 7,721 8,065 9,030 Interest expense (655) (480) (558) (1,981) (1,174) (1,416) Net profit 5,047 4,870 6,030 6,631 6,967 7,201 BALANCE SHEET E 2014E 2015E (As at 31 December) Current assets Cash and cash equivalents 5,434 10,452 8,647 7,458 8,000 8,499 Accounts receivable 9,635 10,281 12,022 13,695 14,615 15,241 Inventories Total current assets 15,340 21,143 20,953 21,596 23,049 24,209 Non-current assets Property, plant and equipment 53,014 51,128 59,064 64,831 76,556 81,366 Goodwill 1,894 1,894 8,248 8,248 8,248 8,248 Intangible assets 1,863 1,975 2,138 8,560 5,821 3,958 Total non-current assets 56,820 55,084 69,727 81,615 96, ,661 Total assets 72,160 76,227 90, , , ,870 Current liabilities Short-term debt 4,864 6,055 12,833 21,147 19,682 14,216 Accounts payable 13,841 15,837 26,164 31,024 32,920 34,225 Total current liabilities 18,718 21,955 39,020 52,756 53,185 49,024 Non-current liabilities Long-term debt 20,672 17,018 12,094 7,959 18,323 28,687 Post-retirement benefit obligation Total non-current liabilities 23,539 21,078 14,478 10,939 21,332 31,704 Equity Common share capital 28,104 28,104 28,104 28,104 28,104 28,104 Retained profit 3,529 6,789 10,737 13,019 18,244 23,645 Total equity 29,902 33,194 37,182 39,516 44,741 50,142 Total liabilities and equity 72,160 76,227 90, , , ,870 33

34 CASH FLOW STATEMENT E 2014E 2015E (For the year ended 31 December) Operating activities Net cash flow from operating activities 14,861 18,611 21,522 23,211 23,751 24,768 Investing activities Purchase of PPE and intangible assets (6,790) (8,719) (17,409) (25,206) (23,849) (18,730) Net cash flow from investing activities (6,662) (8,268) (20,517) (24,788) (29,191) (25,951) Financing activities Debt issuance/(repayment) (4,406) (2,065) 968 4,180 8,898 4,898 Dividends paid to common shareholders - (1,629) (2,036) (2,106) (1,742) (1,800) Net cash flow from financing activities (6,690) (5,450) (2,695) (1,101) 5,982 1,682 Net increase/(decrease) in cash and cash equivalents 1,510 4,893 (1,691) (2,678) KEY RATIOS E 2014E 2015E Growth Revenue growth (%) EBITDA growth (%) EBIT growth (%) Net profit growth (%) (3.5) Recurrent diluted EPS growth (%) (1.3) Margins EBITDA margin (%) EBIT margin (%) Net profit margin (%) ROCE (%) ROE (%) Liquidity and Efficiency Current Ratio (x) Total asset turnover (x) Gearing and Cash Flow Debt/capital (%) Interest cover (x) Free cash flow (FCF) yield (%) (2.7) (0.1) 8.2 Net debt/fcf (x) (10.9) NM 5.7 Valuation P/E (x) P/BV (x) EV/Sales (x) EV/EBITDA (x) EV/FCF (x) (47.6) NM 15.7 PER SHARE DATA E 2014E 2015E Recurrent diluted EPS Common dividend per share (LKR) Book value per share (BVPS) Net operating cash flow per share Net cash flow per share (0.21) (0.33) Source: DIAL, Amba estimates 34

35 Segmental summary (For the year ended 31 December) Mobile operations E 2014E 2015E Revenue 37,420 41,282 49,123 55,360 59,618 63,707 EBITDA 14,577 15,260 15,934 18,026 19,466 20,896 YoY growth Revenue NM 10.3% 19.0% 12.7% 7.7% 6.9% EBITDA 4.7% 4.4% 13.1% 8.0% 7.3% Margin EBITDA 39.0% 37.0% 32.4% 32.6% 32.7% 32.8% Fixed business operations E 2014E 2015E Revenue 2,001 1,785 4,246 5,036 5,887 6,576 EBITDA ,778 2,015 2,551 2,861 YoY growth Revenue NM -10.8% 137.9% 18.6% 16.9% 11.7% EBITDA NA 123.5% 166.1% 13.3% 26.6% 12.1% Margin EBITDA 14.9% 37.4% 41.9% 40.0% 43.3% 43.5% Television operations E 2014E 2015E Revenue 2,002 2,345 2,976 3,532 4,079 4,639 EBITDA ,058 YoY growth Revenue NM 17.1% 26.9% 18.7% 15.5% 13.7% EBITDA 68.0% 12.5% 7.6% 31.3% 15.9% Margin EBITDA 17.1% 24.5% 21.7% 19.7% 22.4% 22.8% Source: DIAL, Amba estimates FX rates (USD/LKR): Y/E 31 December 2012 = Y/E 31 December 2011 = Y/E 31 December 2010 =

36 Appendix 4: SWOT analysis Strengths Strong brand recognition Experienced management team backed by the parent company Axiata Group Berhad Perceived as the leading mobile telecom operator in Sri Lanka Diversified portfolio supported by planned capital investments AAA stable Fitch credit rating Weaknesses Pressured FCF due to capex High levels of debt financing High interest burden Opportunities Industry consolidation in the mobile operations segment Rising GDP per capita and disposable income Increasing smartphone adoption and usage Threats Increasing competition from its domestic rivals SLT, Etisalat, Airtel and Hutch Penetration rates in the pay-tv industry growing less than expected due to macroeconomic pressures, such as a slowdown in economic growth and disposable income levels Number portability legislation coming into effect High rate of technological obsolescence Damage to submarine cable lines causing disruptions to operations 36

37 E 2014E E 2014E 2015E E 2014E 2015E 2016E E Dialog Axiata PLC Fact Sheet Sri Lanka investment environment overview Sri Lanka s economy has been on an upward trajectory since the end of the three-decade civil war in May Sri Lanka currently boasts South Asia s highest GDP growth, conducive fiscal and monetary policy, and favorable socio-economic conditions, which together create an attractive investment destination. Figure 38: Sri Lanka's GDP projected to increase at a 7% CAGR E Figure 39: GDP per capita to increase 33% by 2016E % USD 5,000 4,000 3,000 2, , Source: Central Bank of Sri Lanka, Department of Census and Statistics Figure 40: Annual core inflation post-war has averaged 6.7%, government targeting mid-single digit levels in the medium term % Source: Department of Census and Statistics, Central Bank of Sri Lanka Source: Central Bank of Economic and Social Statistics of Sri Lanka 2012, Road Map Central Bank of Sri Lanka Figure 41: CBSL expects the rupee to stabilize in the medium term despite recent volatility Jan-07 May-08 Oct-09 Feb-11 Jul-12 Nov-13 Source: Bloomberg LKR/USD LKR/EUR LKR/GBP Figure 42: Fiscal deficit target of 5.2% of GDP for 2014E Figure 43: Debt-to-GDP to fall to 71% by 2015E LKRbn % 8% 4% 0% % Fiscal deficit LKRbn As a % of GDP Source: Central Bank of Sri Lanka Source: Central Bank of Sri Lanka 37

38 Banks, Finance & Insurance Beverage, Food & Tobacco Chemicals & Pharmaceuticals Construction & Engineering Diversified Hotels & travels Investment Trusts Land & Property Manufacturing Plantations Power & Energy Services Telecommunication Trading Banks, Finance & Insurance Beverage, Food & Tobacco Chemicals & Pharmaceuticals Construction & Engineering Diversified Hotels & travels Investment Trusts Land & Property Manufacturing Plantations Power & Energy Services Telecommunication Trading Dialog Axiata PLC The Sri Lankan equity market offers a rare and attractive alternative to investors in an investment era impacted by economic growth worries. Backed by the country s robust economic growth, the Sri Lankan capital market is well set to offer attractive returns to investors who are keen to be a part of this emerging market success story. There are several strong incentives for entering the Sri Lankan capital market. Figure 44: Post war, the ASPI has significantly outperformed global and developed market indices Jul-09 May-10 Apr-11 Feb-12 Jan-13 Nov-13 ASPI Dow Jones FTSE 100 MSCI World Source: Bloomberg *Note: All figures re-based to 1 July 2009 DAX Figure 45: Post war, the ASPI has also outperformed some of the best-performing regional indices Jul-09 May-10 Apr-11 Feb-12 Jan-13 Nov-13 ASPI Bombay (BSE 500) Jakarta (JCI) Philippines (PASHR) Thailand (SET) Hanoi (VNINDEX) MSCI Emerging Market Index Source: Bloomberg *Note: All figures re-based to 1 July 2009 Figure 46: 2009 The CSE s market capitalization has doubled since Figure 47: The government anticipates FDI inflows to reach USD2bn in 2013, a 19% CAGR E LKRbn 3,000 2,000 1, ,092 2,211 2,214 2,168 2, (November) USDm 2,500 2,000 2,000 1,500 1,066 1,338 1, E Source: Bloomberg, Central Bank of Sri Lanka Source: Ministry of Finance and Planning, Board of Investment of Sri Lanka Figure 48: Most sector P/Es are below market average and historical valuations Figure 49: Trend is similar on a P/BV value Average market P/E Average market P/BV Source: Colombo Stock Exchange Source: Colombo Stock Exchange 38