Telecom Sector. Singapore Industry Focus. Few years of pain to turn TPG unviable. DBS Group Research. Equity 26 Jun 2018 STI : 3,260.

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1 Singapore Industry Focus Telecom Sector Refer to important disclosures at the end of this report DBS Group Research. Equity 26 Jun 2018 Few years of pain to turn TPG unviable TPG s business case rendered unviable by aggressive mobile virtual network operators (MVNOs) After 44% correction YTD, StarHub is still not attractive at 12-month forward EV/EBITDA of 6.8x versus M1 s 6.4x and Singtel s core 5.4x. Too early to buy StarHub for potential sector consolidation a few years later Prefer Singtel > M1 > StarHub. Singtel continues to be our preferred stock for its stable core EBITDA prospects vs potential decline at M1 & StarHub. Singtel is expected to resume earnings growth in FY20F, led by Bharti Few years of pain ahead as telcos intend to minimize revenue share gains for TPG. MVNOs such as Circles.Life and MyRepublic with their low-cost model and superior customer service (100% app based), may garner a big portion of customers shifting to cheaper SIM-only plans (~10% gross revenue share in 2022). As the majority of MVNOs revenue will flow back to their telco partners, telcos are better off losing revenue share to MVNOs than TPG by offering flexible wholesale pricing to their MVNOs. TPG is likely to compete on cheaper pricing but will be challenged by MVNOs that offer superior network quality and differentiated services. We forecast 4% mobile industry revenue contraction over vs 1% contraction earlier due to higher take-up of cheaper SIM-only plans. We project TPG to show EBITDA losses versus positive EBITDA in 2022 earlier with just 4% revenue share in 2022 (vs 5.5% earlier) forcing it to seek exit opportunities. Singtel s core business is trading at 12-month forward EV/EBITDA of 5.4x versus 6.4x for M1 and 6.8x StarHub. We argue that Singtel s core business should trade at the regional average of 7x EV/EBITDA given its ability to stabilise core- EBITDA via cost savings and revenue share gains in Australia. We peg M1 & StarHub to trade at 6x & 5.6x 12-month forward EV/EBITDA respectively at 15% & 20% discounts to the regional average due to their declining EBITDA prospects. M1 is better placed than StarHub in our view, due to its nonreliance on Pay TV-mobile bundling (Pay TV expected to decline), and its proven MVNO partner Circles.Life. After recent correction, we upgrade StarHub to HOLD for potential returns of -3% including ~10% yield. STI : 3, Analyst Sachin MITTAL sachinmittal@dbs.com STOCKS Singtel s valuation discount to M1 & StarHub has narrowed and is likely to disappear in the future Source: DBS Bank 12-mth Price Mkt Cap Target Price Performance (%) S$ US$m S$ 3 mth 12 mth Rating Singtel , (7.4) (17.9) BUY StarHub , (30.6) (40.1) HOLD (upgrade from FV) M , (11.3) (27.7) HOLD Source: DBS Bank, Bloomberg Finance L.P. Closing price as of 25 Jun 2018 ed: CK / sa: YM, PY, CS

2 Industry Focus Telecom Sector Telcos pro-actively closing the gaps in the SIM-only plans via MVNOs. TPG, the fourth Mobile Network Operator (MNO) set to enter Singapore in 2H18, faces an uphill battle, amid the myriad of Mobile Virtual Network Operators (MVNO) the incumbents have partnered with. Each incumbent has partnered with at least one MVNO, with the market leader Singtel joining hands with two, taking the total number of mobile service providers in the country to seven from just three players at the end of By partnering with MVNOs the incumbents are 1) making it difficult for TPG to succeed by stirring up competition in the SIM-only segments, which TPG is likely to target first, and 2) generating wholesale mobile revenues, offsetting any potential revenue impact in the low-end segments that is likely to be caused by TPG. TPG has already announced plans to offer unlimited voice and 3GB of data free of charge for 24 months to senior citizens in Singapore. The telco is also offering free unlimited data for six months (A$9.99 thereafter) in Australia, where TPG entered as a MNO. We believe that TPG will likely adopt a similar strategy of offering free services at the initial stages of its entry in Singapore as well, possibly leading to price wars between operators. MVNOs in Singapore Circles.Life Zero Mobile Zero1 MyRepublic Plans Base Flexi Zero X Zero XO Zero1 Uno Ultimate -Price S$28 S$0 S$69.95 S$39.95 S$29.99 S$8 S$80 -Data 6GB 1GB Unlimited 6GB 3GB* 1GB* 80GB* -Voice (mins) Unlimited Unlimited MNO Partner M1 Singtel Singtel StarHub Launch Date H18 *Unlimited data at reduced speeds once the data quota is over Source: Companies, DBS Bank We project annual industry contraction of 4% over in the base case scenario. We have revised our assumptions of annual decline in the mobile industry through 2017A-2022F to 4% from 1% earlier on the back of 1) rising adoption of SIM-only plans, and 2) escalation of price wars in the industry as TPG battles it out with MVNOs. SIM-only plans (8-9% of postpaid plans currently) are seeing rising adoption amid lengthening smartphone replacement cycles and aggressive promotions by MVNOs. Judging from Australia s experience, where SIM-only constitutes ~25% of the total postpaid, Singapore is likely to see a big rise in these plans. Customer spend on SIM-only plans vis-à-vis handset plans tends to be substantially lower and growing uptake would negatively impact mobile service revenues and dilute industry ARPU going forward. We also believe TPG would need to adopt very aggressive pricing strategies during the first few years of entry to snatch revenue share in an overcrowded mobile space with seven service providers. This would likely lead to steep contraction of voice and data yields, further weighing down the industry topline. Factoring these, we project an 18% contraction in industry revenues by 2022 from present levels vs our previous assumption of just 4% contraction of the industry topline over the same period. Annual industry contraction of 6% over if TPG is more successful than our projections under the bear-case scenario. We project that almost a quarter of the industry topline could be wiped out by 2022, if TPG, backed with a strong balance sheet, adopts heavily disruptive pricing policies, much like Reliance Jio in India, driving MVNOs out of the market and instigating severe downward adjustments to industry yields. Under this scenario, we expect the mobile industry to contract at an annual rate of 6% over Annual industry contraction of 2-3% over if TPG is acquired in under our bull-case scenario. Under our bull case, we assume that TPG will exit the Singapore mobile market by 2021, after intense competition from MVNOs and the incumbents, via a sale of its operations to an incumbent operator. Under this scenario, we expect the mobile industry to return to a growth trajectory by 2022 and the annual contraction of the mobile industry to be limited to 2% vs our base-case projection of 4%. Page 2 Page 2

3 Industry Focus Telecom Sector 3.5% and 4% revenue share grab by MVNOs and TPG, respectively, by 2022 under our base-case scenario *We have assumed that 65% of MVNO revenue will flow back to their telco partners as MVNOs could occupy 10% gross revenue share Source: DBS Bank With the revision of our base-case scenario for the Singapore mobile industry, we have revised down the potential revenue share grab of TPG by 2022 to just 4.0% from 5.5% before, after factoring in the MVNOs. Under our new base-case scenario, TPG could remain cash-flow negative till 2022, four years after its entry. Negative cash flow generation in Singapore, coupled with TPG s on-going investments in deploying a mobile network in Australia, could heavily weigh on the telco s balance sheet, making TPG a potential target for acquisition. TPG may not reach EBITDA breakeven revenue of ~S$150m by FY22F (previous estimate of FY21F revenue of S$156m) TPG- Base Case Revenue market share 0.0% 0.4% 1.3% 2.2% 3.1% 4.0% TPG revenue EBITDA margin -150% -50% -40% -30% -20% Cash flow (Assumptions) EBITDA (breakeven at S$150m revenue) Capex (10-20% of revenue) Spectrum price -129 Free Cash Flow Source: DBS Bank Page 3 Page 3

4 Industry Focus Telecom Sector Emerging Industry trends Mobile SIM-only plans gaining popularity. SIM-only subscribers already account for ~12% of M1 s postpaid subscriber base (~83k subs) and a mid-single digit portion of Singtel s subscriber base. SIM-only sales also contributed to ~18% of total plan sales of Singtel in 4Q18, up from 15% in the previous quarter. We believe SIM-only plans will rise in popularity over the medium term, with lengthening smartphone replacement cycles and the emergence of handset leasing plans, which could further incentivise subscribers to move away from bundled plans. Growing adoption of SIM-only plans presents a challenge to operators, with potential declines in mobile service revenues, dilution of ARPU and profitability, despite the elimination of handset subsidies. Customer spend over the life of SIM-only contracts tends to be substantially lower than handset plans, and SIMonly plans remain less profitable vis-à-vis handset plans, even after taking handset subsidies into consideration. SIM-Only plans on offer by three incumbents Singtel SIM-only plans with contracts Price S$20 S$36.05 S$46.75 S$73.5 Data 5GB 10GB 30GB 55GB All SIM-Only plans come with 150 mins of Voice and 500 SMS StarHub SIM-only plans with contracts Price S$24 S$34 S$44 S$54 S$119 Data* 6GB 8GB 10GB 16GB 30GB Voice Unlimited All plans are entitled to unlimited data over weekends M1 SIM-only plans with contracts Price S$20 S$40 S$50 S$98* Data 5GB 15GB 30GB Unlimited All SIM-Only plans come with 100 mins of Voice and SMS * - Unlimited data, SMS and Voice services Sources Companies, DBS Bank SIM-only plans translate to lower net revenue for operators (for iphone 8 plus devices) SIM-Only plan with 5GB Singtel StarHub M1 Combo -3 Handset XS SIM-Only 4Gb "S" mysim(3) plan with 5GB plan plan 15GB mysim(e) 15GB Monthly Contract Price Upfront fee on handsets Total customer spend over 24- months , , ,245.0 Handset cost* (1,177.2) (1,177.2) (1,177.2) Net revenue over 24-months , ,067.8 * - Assumed to be at a 10% discount to the listed price of an iphone 8 Plus in Singapore Sources Companies, Apple Singapore, DBS Bank Page 4 Page 4

5 Industry Focus Telecom Sector Singtel introduces handset leasing plans. Singtel has recently introduced handset leasing for SIM-only plans over a selected range of high-end iphone and Samsung devices. The leasing plans carry a 24-month contract term during which subscribers make monthly payments to Singtel. At the end of the 24-month period, users are expected to return the device to Singtel in good working condition. We believe handset leasing plans would stimulate the adoption of SIM-only plans as the ability to lease handsets could lure subscribers on handset plans to SIM-only plans, given the zero upfront payment and lower payments over the lifetime of the contract. Whilst we believe moving towards handset leasing could potentially lower mobile revenues, our estimates indicate the impact on earnings from the adoption of handset leasing plans would be marginal. Handset leasing plans have 10-20% adverse impact on net revenue, depending on the salvage value of the phone iphone 8 Plus (64GB) Singtel 5GB SIM-only plan Combo-3 plan with 5GB Monthly contract value SIM-Only plan Leasing plan 42.0 Upfront Fee Total customer spend over the 24-month contract 1, ,225.6 Salvage Value after 2 years* Total Revenue 2, ,225.6 Handset cost (1,177.2) (1,177.2) Net Earnings ,048.4 * - Based on a salvage value of 50% of the listed price after two years. Used versions of the iphone 7 Plus (32GB) model released in 2016 presently trades at a ~50% discount to the original listed price in 2016 Sources: Company, Apple Singapore, Carousell, Red While Mobile, DBS Bank Circle.Life shakes up the marketplace with free mobile plans. Circles.Life shook the Singapore mobile space with Flexi, a free mobile offering loaded with 1GB of data, 30 mins talk time and 10 SMS. The SIM-only service offered with no contracts, also allows subscribers to top up data capacity with S$8 for 1GB and S$12 for 2GB. With Flexi plans Circles.Life is expanding its targeted segments in the low-arpu space. The Flexi plans are targeted at low-data users, without a possible cannibalisation of its existing subscriber base on the 6GB-S$28 base plan. Whilst, the Flexi plan is unlikely to generate counter-offers from the major mobile operators, the MVNO is making life difficult for TPG in the battle for low- ARPU subscribers, which TPG is likely to target when it enters Singapore in the later part of Stock Profiles Singtel to better weather the storm. StarHub likely to be most affected over the medium term. We believe Singtel would be the least affected by the projected contraction of the industry, Singapore mobile accounts for only 13% of the telco s service revenues vs. 84% for M1 and 54% for StarHub. Rising contributions from Optus, with a growing mobile business in Australia, and the S$500m expected cost savings & avoidance in FY19F through digitalisation and other initiatives should help Singtel defend its core EBITDA vs. likely declines at M1 and StarHub. Mobile revenue support from Circles.Life, M1 s MVNO partner, and a growing fixed and IoT business should help M1 partially offset declines in EBITDA in M1 s mobile segment. Page 5 Page 5

6 Industry Focus Telecom Sector StarHub, however, could likely record bigger contractions in EBITDA owing to a contracting Pay-TV business, heavy competition from M1 in the broadband segment and the lack of support for mobile revenues from an MVNO. Whilst StarHub has struck a MVNO partnership with MyRepublic, we believe it could take at least 1-2 years before StarHub records any meaningful contributions from MyRepublic. It took M1 ~2 years to generate meaningful revenue contributions from Circles.Life. We argue for 6x 12-month forward EV/EBITDA for and M1, 5.6x for StarHub and 7x for Singtel s core EBITDA. We argue that Singtel s core business should trade at the regional average 12-month EV/EBITDA of 7x vs. 5.5x currently, given the telco s limited exposure to the declining mobile industry of Singapore and its ability to stabilise core-ebitda through cost savings and support from Optus. We believe that M1 and StarHub should trade at 6x and 5.6x forward EV/EBITDA respectively, at ~15% and ~20% discounts to the regional average, given the weak EBITDA outlook of these players. Page 6 Page 6

7 SingaporeCompany Guide Singtel Version 4 Bloomberg: ST SP Reuters: STEL.SI Refer to important disclosures at the end of this report DBS Group Research. Equity 18 Jun 2018 BUY Last Traded Price (14 Jun 2018): S$3.19 (STI : 3,356.73) Price Target 12-mth:S$3.70 (16% upside) (Prev S$3.85) Analyst Sachin MITTAL sachinmittal@dbs.com What s New Earnings rebound likely in FY20F with the potential recovery of Bharti; Singtel opens to partial exit opportunities from digital businesses in 2-3 years Potential risk of -7% under our bear-case scenario versus +21% reward under our base-case scenario BUY with a lower TP of S$3.70 as we adjust our core EBITDA and market cap of associates Price Relative Forecasts and Valuation FY Mar (S$m) 2017A 2018A 2019F 2020F Revenue 16,711 17,532 18,113 18,682 EBITDA 7,961 7,572 7,438 7,874 Pre-tax Profit 5,353 6,772 4,534 4,832 Net Profit 3,853 5,451 3,331 3,500 Net Pft (Pre Ex.) 3,885 3,538 3,331 3,500 Net Pft Gth (Pre-ex) (%) 1.9 (8.9) (5.9) 5.1 EPS (S cts) EPS Pre Ex. (S cts) EPS Gth Pre Ex (%) (1) (9) (6) 5 Diluted EPS (S cts) Net DPS (S cts) BV Per Share (S cts) PE (X) PE Pre Ex. (X) P/Cash Flow (X) EV/EBITDA (X) Net Div Yield (%) P/Book Value (X) Net Debt/Equity (X) ROAE (%) Earnings Rev (%): (5) (8) Consensus EPS (S cts): Other Broker Recs: B: 15 S: 0 H: 7 Source of all data on this page: Company, DBS Bank, Bloomberg Finance L.P Favorable risk-reward, -7% risk vs. + 21% reward Temporary earnings decline presents an opportunity to accumulate. We expect Singtel s earnings to rebound by FY20F, driven by the potential earnings recovery of Bharti (earnings recovery may delay to FY21F under our bear case scenario for Bharti). Excluding market cap of its associates, Singtel s core business is trading at only 5.5x FY19F EV/EBITDA, at ~15-20% discount to its local peers. With 5.4% yield, we see potential risk of -7% vs potential reward of +21% Where we differ: Digital businesses monetisation may lead to value accretion of S$0.16 per share. We argue that Digital Life! and cyber security businesses are worth S$0.13 per share based on ~1x revenue multiple versus market ascribing them a value of -S$0.03 per share. Singtel is open to partial exit opportunities from its cyber-security and Digital Life! businesses over the next 2 years via a sale to a strategic investor or public listing. Potential Catalyst: Final DPS of S$10.7 Scts going ex in late July, price hike by Telkomsel in 2H18F and Singtel raising stake in regional associates. Final DPS of S$10.7 Scts will go ex on 26 July. Telkomsel, who is the biggest earnings contributor to Singtel, may raise data pricing by 5-10% in 2H18F. Singtel may also look to raise its stake in AIS or Bharti, enhancing its FY19F/20F earnings. Valuation: BUY with a revised TP of S$3.70. We lower our sum-of-theparts (SOTP) valuation to S$3.70, mainly from (i) FY19F core EBITDA growth of +1% vs +4% earlier, and (ii) recent drop in the market capitalization of Bharti and AIS. Key Risks to Our View: Bear-case valuation of S$2.79 suggests -7% risk. This assumes (i) 23% drop in valuation of the core business due to EBITDA decline versus stable EBITDA expectations; (ii) 20% drop in Bharti s & Telkomsel s valuation and 10% drop in market cap of other associates; (iii) 15% holding company discount vs. 5% base case At A Glance Issued Capital (m shrs) 16,329 Mkt. Cap (S$m/US$m) 52,090 / 38,548 Major Shareholders (%) Temasek Holdings 52.3 Free Float (%) m Avg. Daily Val (US$m) 58.6 ICB Industry :Telecommunications / Fixed Line Telecommunications ed: CK / sa:ym, PY, CS Page 7

8 Singtel WHAT S NEW Short-term pain before long-term gain When will Singtel s earnings return to a growth trajectory? We project Singtel s earnings would rebound in FY20F, after contracting in FY19F. Rebound in FY20F would be primarily driven by the recovery of Bharti Airtel for two key reasons. 1) Airtel is set to gain revenue market share from the ongoing Vodafone-Idea merger, which is fraught with complications caused by vendor and staff issues. Vodafone is also highly levered with a net debt-to- EBITDA of 6.5x, limiting its potential to counter aggressive pricing measures of Reliance Jio or expand capacity, which the telco is seemingly having issues with. Vodafone is also losing subscribers as it has not adopted cheaper bundled plans due to the lack of capacity. Armed with a stronger network coverage and capacity, we project that Bharti Airtel will have the opportunity to increase its revenue share over the next months on the back of Vodafone s weakness. 2) The integration of Tata telecom s spectrum and subscribers, expected to take place over FY19F, should also help Bharti Airtel s efforts to uplift its revenue share gains and earnings. Hence, we expect to see a substantial improvement in contributions from Bharti Airtel by FY20F, putting Singtel s earnings back in positive territory. What could potentially delay a rebound in Singtel s earnings by FY20F? We see the recovery of Bharti Airtel as the key catalyst for a rebound in earnings by FY20F. However, if competitive pressures in the Indian telecom market persist, with an aggressive Jio continuously driving tariffs lower in a bid to gain revenue share, a potential recovery of Bharti Airtel and consequently a rebound in Singtel s earnings could be further delayed to FY21F. Jio continues to be aggressive in the market, maintaining ~20% lower tariffs vs. incumbents as it continues to battle towards gaining further revenue market share by 2021 vs 25% presently. However, much of these market share gains will be at the expense of smaller operators and Vodafone-Idea with minimal losses expected from Airtel. In our base case, we have assumed that Jio will adopt a more moderate competitive stance and move away from price competition by 2020, once the consolidation of the industry is completed, with the hope of monetising Jio s subscriber base. However, if Jio continues to maintain competitive pressures at the present hyper-intensive levels, even after industry consolidation, Airtel may fail to stage a recovery in earnings, prolonging a rebound in Singtel s bottomline. We trim our FY19F earnings forecast by 5%. We forecast a 6% y-o-y decline in underlying earnings for FY19F on the back of (i) projected decline in contributions from associates driven by Bharti Airtel and Telkomsel, and (ii) intensifying competition in the mobile and enterprise services market in Singapore, that could weigh on core EBITDA. Competitive pressures and the curtailment of inter-connection charges by the regulator in India will continue to weigh on contributions from Bharti Airtel for FY19F. Meanwhile, the prepaid SIM registration exercise in Indonesia, which concluded in May 2018, has also taken a toll on Indonesian mobile operators and could likely weigh down contributions from Telkomsel further in FY19F. However, Telkomsel who has been the aggressor so far, plans to raise data pricing by 5-10% post Lebaran holidays and hopes to sustain higher pricing if other players follow suit. Associate Pre-tax contribution base-case projections Associate pre-tax contribution S$m FY18A FY19F FY20F Telkomsel 1,372 1,262 1,260 Bharti Airtel AIS Globe NetLink Others Overall 2,454 2,278 2,669 Y-o-y Growth FY18A FY19F FY20F Telkomsel -4% -8% 0% Bharti Airtel -63% -28% 200% AIS 7% 19% 7% Globe -8% -4% 13% NetLink -48% -81% 31% Others -6% -17% 13% Overall -17% -7% 17% Source: DBS Bank We expect core EBITDA from Singapore and Australia to show 1% decline in FY19F and FY20F each due to tightening competitive pressures in the Singaporean mobile market and declining margins in the enterprise market with higher Infocomm Technology (ICT) contribution. Core business trading at 15-20% valuation discount vs local peers is hard to justify. The market is attaching a significant valuation discount to the core plus digital business of Singtel, possibly over concerns on the magnitude of losses in the digital segment in the past. This has resulted in Singtel s core plus digital businesses trading at only 5.5x FY19F EV/EBITDA vs 6.8x for M1 and 7.5x for StarHub, despite having a much more resilient business model. Page 8

9 Singtel Base-case valuation for Singtel Singtel's Valuation Breakdown Value Per Valuation Basis (S$ m) share(s$) Singapore core business 12,942 7x FY 19F EV/EBITDA based on regional average Australia core business 16,910 7x FY 19F EV/EBITDA based on regional average Digital Business 2,209 ~1x EV/Revenue multiple: Cyber-security S$648m and Digital Life! - S$1.3bn Debt -10,278 Equity value of the core business 27, (Previously 1.69) Regional investments 34,657 Target Price 61,784 Source: DBS Bank, Reuters, Company 2.07 (Previously 2.12) 3.70 (Previously 3.85) Based on closing share prices and 15x PE for Telkomsel. Drop is due to lower market cap for Bharti Airtel and AIS. We have valued Singtel s Singapore and Australia operations at FY19F EV/EBITDA valuations of 7x each. Digital Life! And Cybersecurity businesses (Digital businesses) were valued at an EV/Revenue multiple of ~1x. The valuations of regional associates are based on current share prices, while the valuation of Telkomsel is based on a FY19F PE (March YE) of 15x as we assume a 10% y-o-y drop in Telkomsel s earnings Associates' valuation contribution based on current market capitalisation except for Telkomsel Associates Total shares Share price (local Currency?) Exchange rate Stake Value (S$ m) Per Share (S$) Bharti Airtel 3, % (Prev 0.73) AIS 2, % (Prev 0.45) Globe* 132 1, % SingPost % FY19F Profit (Rpm) FY19F PE Exchange rate Stake Value (S$ m) Telkomsel 27,963, , % 1, (8% earnings decline in FY19F) Total 3,6481 Holdco discount (5%) Net investment holdings 3, *Ownership stake of ordinary shares Source: DBS Bank, Reuters, Company Page 9

10 Singtel Bear-case assumptions for the core business. We have assumed FY19F core EBITDA to be 4% lower than the base-case scenario with an EV to EBITDA multiple of 6x vs 7x in the base-case scenario. Bear-case assumptions for associates. We have assumed 20% drop in Bharti s stock price due to higher-than-expected competition, 20% drop in valuation for Telkomsel due to 15% earnings decline vs 8% decline under the base case, a 10% decline in the stock price for other associates and a wider holding company discount of 15% vs 5% under the base case. Bear-case scenario valuation Singtel's Valuation Breakdown Valuation Basis Value (S$ m) Per share(s$) 12,942 4% lower EBITDA than base case and 6x FY 19F EV/EBITDA Singapore core business versus 7x in the base case 16,910 3% lower EBITDA than the base case and 6x FY19F Australia core business EV/EBITDA versus 7x in the base case Digital Business 2,209 ~1x EV/Revenue multiple: Cyber-security S$648m and Digital Life! - S$1.3bn Debt -10,278 Equity value of the core business 27, Regional investments % share price drop for Bharti, 20% drop in valuation for Telkomsel, 10% drop for AIS, Globe, others and 15% holdco discount vs 5% in the base case Bear-case Target Price 2.79 Source: DBS Bank, Reuters, Company Page 10

11 Singtel Bear case scenario associates' valuation contribution Associates Total shares Share price Exchange rate Stake Value (S$ m) Per Share (S$) Airtel 3, % AIS 2, % 6, Globe* 132 1, % 2, SingPost 2, % FY19F Profit (Rpm) FY19F PE Exchange rate Stake Value (S$ m) Telkomsel 25,835,750 (Assuming 15% 0.67 earnings decline 13 10,505 35% 11,190 Total Holdco discount (15%) Net investment holdings *Ownership stake of ordinary shares Source: DBS Bank, Reuters, Company Singtel s core business is trading at a significant discount to regional peers Source: Reuters, DBS Bank Page 11

12 Singtel SINGTEL INVESTOR DAY 2018 Q&A Singtel Singapore Consumer Q&A How does Singtel differentiate its MVNO strategy? Smaller operators are shoring up customers before the entry of TPG, primarily in the SIM only space. A few more MVNOs have expressed interest in partnering with Singtel and the addition of more MVNO players will dilute the revenue pie up for grab for TPG, as MVNOs would have much better network quality. Singtel Enterprise Business Q&A What s Singtel s strategy for the Singapore enterprise business going forward? ~75% of EBITDA still comes from its traditional core businesses which account for ~54% of revenue. Moving forward, Singtel will focus on growing ICT revenues and undertake significant cost transformation programmes to improve EBITDA generation in the enterprise segment. A large chunk of the projected S$500m cost savings planned for FY19 will be derived through the enterprise segment. What is Singtel s strategy in the SIM Only space? Singtel sees a rising trend for SIM only plans in Singapore, which accounts for a single-digit proportion of the subscriber base in Singapore vs. 25% in Australia. Allowing subscribers to lease handsets over 12 months is the key differentiator of Singtel s SIM only plans as opposed to offering cheaper data, which the other players have resorted to. Any regulatory support for TPG s ramp-up? Nothing much except Singtel sharing some MRT tunnel infrastructure for the first 72 months of operation as access often takes a lot of time. What s Singtel s view on topline growth in Singapore? Mobile revenues are likely to decline over the course of FY19, with the entry of TPG. Over the medium term, Singtel believes that 4- players cannot survive independently and there will be room for consolidation in the market. Singtel s IoT strategy is primarily focused on the enterprise segment, which is expected to account for ~75-80% IoT revenues of Singtel. What s Singtel s monetisation strategy for Trustwave? The US$ 85b cybersecurity market is growing at 8% and is a very fragmented marketplace with the top players controlling only 5-6% market share. Trustwave has been consistently ranked among the top 5 players by Gartner. The cybersecurity arm now has 10 security operation centres around the world to monitor cyber-attacks. Trustwave is now a US$500m business vs. US$200m in 2015 as Singtel has integrated a number of businesses under Trustwave. As the business is valued on a revenue multiple basis, exit opportunities through a public listing or through a sale to a strategic investor would be possible when the scale is big enough. Page 12

13 Singtel Singtel Digital Life! Q&A Future plans of the Digital advertising business? Amobee and Turn are in a strong position, capitalising on the access to data provided by telecom operators, easy access to customers through the telcos and a strong network of advertising agencies. Amobee is expected to be EBIT positive over the next 5-6 quarters. Its strategy is to capture market share from smaller operators and focus on growing video advertising, which expanded 40% y-o-y in FY18. Singtel may look to exit Amobee over the next 2-3 years if Amobee can move towards a selfmanaged revenue strategy and demonstrate its leadership as a leading independent ad-tech player. How is the OTT video service, HOOQ, progressing? HOOQ is likely to break even at US$100m revenue. Content spending last year largely revolved around Hollywood content but this year ~50% of content expenses will be directed towards local content. Some of the major Indonesian channels have signed up with HOOQ to add it as a Linear TV channel (a channel that broadcasts scheduled programmes in real time). What s going on with the data analytics business? DataSpark is primarily involved in ingesting data to identify potential use cases and deploying these applications. Advertising, financial services, transportation and telecom are some of the key verticals the company is looking into. Optus Australia Consumer Q&A Is there a risk of TPG adopting a similar strategy to Jio? TPG has announced a free mobile plan with unlimited data for the first six months, with a monthly charge of A$10 thereafter in Australia. TPG is unlikely to have good network coverage as its planned capex spend of A$600m in Australia is just half of the annual capex spend of Optus (~A$1.5bn). Jio in India on the other hand spent nearly US$10bn and had a network similar to those of the leading players which allowed it to disrupt the market. TPG also has very few (less than 200) macro cells, which cover a radius of 5KM along with a number of small cells, which provide coverage to much smaller areas. The entry of TPG is likely to have an impact on the pricesensitive 25% of the market, which is not targeted by Optus. Optus does see some adverse revenue impact on wholesale (MVNO) and low ARPU segments. However, Optus s strategy of acquiring high value subscribers in the SME and regional spaces will continue to drive market share gains and Optus s topline, offsetting any potential declines from the entry of TPG. Optus has also differentiated itself with content, with exclusive rights to broadcast National Geography and the English Premier League. Possibility of a reduction of capex spend in Australia? Densifying metro areas and regional area network expansions will continue with Fixed Wireless Access (FWA). Optus has already recorded a reduction in capex from A$1.6 to A$1.4 in FY18. Strategy for the upcoming 3.6GHz spectrum auction? Optus does not intend to take part for spectrum covering metropolitan areas but may take part for coverage in regional areas. The auction is likely to see more interest from Telstra and TPG. What is Optus 5G rollout strategy? Optus has acquired significant GHz bandwidth in Australia and hence is deploying FWA as a replacement for fixed bandwidth. FWA offers speeds of up to 100Mbps vs only 20Mbps in certain areas via NBN. Regional Associates Bharti Airtel Q&A How has Bharti Airtel s revenue share changed following the recent mergers? The Indian telco industry is effectively a threeplayer market following the Bharti Airtel-Telenor India integration and Bharti Airtel-Tata India telecoms and Vodafone- Idea mergers. Following the mergers, market share based on revenue, places Vodafone-Idea at 38%, Bharti Airtel at 32% and Reliance Jio at 20%. Is the Indian telco sector facing revenue share stabilisation? The Vodafone-Idea merger is expected to be fraught with complications due to contracts with multiple vendors and staff issues. Vodafone is currently facing net debt to EBITDA of 6.5x while also losing customers since the telco has not adopted cheaper bundled plans due to the lack of capacity. Vodafone is also losing subscribers although it has not been evident in the revenue share as they have not lowered their pricing to the same level as Bharti s bundled plans. The Rs49 VoLTE feature phone plan is driving Reliance Jio further towards a lower quality customer base. Taking all these into consideration, we foresee that Bharti Airtel will have the opportunity to increase its revenue share over the next months. Has ARPU bottomed out in India? During the last six months prices have been relatively stable. ARPU is unlikely to drop over the next months after bottoming out at INR135 with subscribers moving from feature phones to smart phones. Bharti Airtel is opting to place products such as device insurance and free Netflix access in the post paid category rather than lowering prices to defend the telco s revenue. Bharti Airtel is the clear leader in the over INR20,000 per device segment while it is neck-to-neck with the competition in the INR7,000-15,000 segment. What s Bharti Airtel s forecasted capex spend? Bharti Airtel plans to invest US$4bn as capex to drive down customer complaints. Any proposed new business ventures? Plans are underway to launch music and TV business separately under Wink. Also, the launch of micro enterprises with fibre is expected to be a big step-up in the home fibre broadband market. Strategy for operations in Africa? Bharti Airtel s African operations are likely to see a 30-40% revenue growth in FY19, and a planned public listing commanding 8-12x EV/EBITDA in early 2019 is underway. Page 13

14 Singtel Telkomsel Q&A Price hike potential in the post-prepaid SIM registration era? After Lebaran, Telkomsel plans to increase pricing by 5-10% to prevent further declines in data tariffs. Already there are one or two instances of competitors reducing data allowances in existing packages. More incentives are being handed out via renewal packages now as the SIM starter pack sales have slowed down due to the slow process of validation. Subscribers are only allowed to hold a maximum of three SIM cards per operator. AIS Q&A Is the current spectrum and network capacity sufficient? AIS finds the existing spectrum sufficient to operate efficiently over the next two years using newer technologies with higher efficiency. Efficiency of contiguous vs. non-contiguous spectrum? The telecom regulator has stated that the winner of the1,800mhz spectrum auction will be able to freely reshuffle the spectrum with other operators 1,800MHz slots. Reshuffling will be carried out if AIS feels that this will lead to gain more efficiency in frequency management. Globe s favour. Even employees prefer to work at Globe compared to PLDT. Key regulatory concerns? The government is trying to bring in a 3rd player but things are not clear at this point as any new player, if any, may not be allowed to sell its spectrum and resources to the existing players. Several bills related to the telecom industry are also in the works. A). Bill to declassify the telecom industry as a utility Amendments to the Public Service Act or Commonwealth Act have been proposed to remove telecommunication services from the definition of public utility B). Ownership Bill The government is contemplating a readjustment of the 40% cap on foreign ownership in the telecom sector. According to reports, the cap could be increased up to 70%. C). Removal of the franchise tax exemption The government is also contemplating the re-imposition of a 3-8% franchise tax, that the telecom industry is currently exempted from. Is there evidence of rising marketing cost after the auctions? During the last two years, competition was intense since True was competing to grab the #2 spot. However, at the moment the level of competition is back to normal and benign compared to last year. What s AIS s plan to counteract True s market share gains? AIS does not intend to lose out on revenue share. The telco plans to cut back on unlimited data plans. Projections for the fixed broadband segment? Fixed broadband ARPU has been stable at Bt600 for several years and is unlikely to change during this year. The telco is targeting a 20% share in the fixed broadband segment. Future capex spend? AIS has already passed the time period of peak capex spend. Capex on 5G technology is expected only around FY22. Globe Telecom Q&A Current state of the telecom market in the Philippines? Capex is likely to remain high going forward. Population coverage at the moment hovers around 97%. Competition is rather intense in the mobile segment with PLDT leading the pricing revisions while it is more sustainable on the fixed broadband segment. What is the key differentiator of Globe vs. PLDT? Globe s branding strategy appeals to the millennial population, which forms a substantial segment of the market, and has been a key strength for Globe. Globe has seen many parties interested in forming partnerships because of the positioning of the Globe brand. While PLDT has closed much of its network coverage gap with Globe, the perception in the market is that Globe still possesses superior network quality, which is working well in Page 14

15 Singtel CRITICAL DATA POINTS TO WATCH Associate pre-tax contribution to decline 7% in FY19F before rising 17% in FY20F. Going forward, we expect AIS and SingPost to drive growth in FY19F, partially offsetting weakness from Telkomsel and Bharti. AIS benefits from benign competition in Thailand while SingPost is likely to benefit from rising volume of e-commerce international mail and parcels. Meanwhile, Telkomsel and Bharti are facing earnings headwinds due to competitive pressures and voice/sms cannibalisation. Bharti is likely to see some decline in FY19F earnings due to an aggressive Jio in India before recovering on the back of revenue share gains from Vodafone and Idea in FY20F. The prepaid SIM registration exercise and accelerating declines in voice and SMS services should weigh on contributions from Telkomsel for FY19F before stabilising in FY20F. Singapore Revenue (S$m) Singapore EBITDA Margin (%) Associate contributions to return to growth in FY20F Associate Pre-tax contributions (S$m) FY17A FY18A FY19F FY20F Telkomsel 1,422 1,372 1,262 1,260 Bharti Airtel AIS Globe NetLink Others including SingPost Total 2,941 2,454 2,278 2,669 Optus Revenue (A$m) YoY Growth FY18A FY19F FY20F Telkomsel -4% -8% 0% Bharti Airtel -63% -28% 200% AIS 7% 19% 7% Globe -8% -4% 13% NetLink -48% -81% 31% Others including SingPost -6% -17% 13% Overall -17% -7% 17% Source: DBS Bank Optus EBITDA Margin (%) Low single-digit EBITDA growth due to growth in Australia and lower losses in Digital Life. We expect the core business of Singtel (Singapore + Optus) to see low single-digit EBITDA growth in FY19F, similar to what we have seen in FY18. We expect growing contributions from Optus and narrowing losses in the digital segment to offset any potential declines in Singapore consumer and enterprise segments. Singtel could also benefit from the resumption of quarterly NBN migration fees of ~A$60-70m from 2Q19F in Australia which were halted by the regulator in November 2017 due to technical issues. Narrowing losses on the digital life segment, supported by growth of Amobee, should further support EBITDA of the core business in FY19F. Associate pre-tax earnings (S$m) Source: Company, DBS Bank Page 15

16 Singtel Appendix 1: A look at Company's listed history what drives its share price? EBITDA is the most critical factor followed by the Associate profits. In the critical factor analysis, we conducted over the past ~10 years, Singtel s share price seems to follow associate profits and EBITDA. Singtel s share price movements had a positive correlation of 0.7 with the associate profit and a positive correlation of 0.6 with EBITDA. The two factors are directly indicative of the profitability and cash flow generation of Singtel and are very importance factors in understanding the overall health of the firm. Share price vs. associate profits S$ ,500 3,000 2,500 2,000 1,500 1, S$ Mn Share price (LHS) Associate profits (RHS) Share price vs EBITDA S$ ,000 8,000 7,000 6,000 5,000 4,000 3,000 2,000 1,000 0 S$ Mn Share price (LHS) EBITDA (RHS) Sources: Reuters, Companies, DBS Bank Page 16

17 Singtel Peers Valuation 12-mth CA GR Company Target Price % PE (x) Div idend Yield (%) P/BV EV /EBITDA LCL Upside Rcmd (%) 17A 18F 19F 17A 18F 17A 18F 17A 18F 19F China / Hong Kong China Mobile % BUY % 4.7% 1.2x 1.1x 2.5x 2.2x 1.8x China Telecom % BUY % 3.6% 0.7x 0.7x 3.2x 2.8x 2.4x China Unicom % BUY % 1.2% 0.9x 0.8x 3.6x 2.8x 2.2x Smartone Telecom % HOLD % 4.7% 2.0x 2.0x 4.7x 4.6x 4.7x Hutchison Telecom % HOLD % 2.0% 0.9x 0.9x 0.6x 3.0x 2.9x HKT Trust % BUY % 6.6% 2.0x 1.9x 8.7x 8.3x 8.3x Malay sia Digi.Com % FV % 4.3% 67.2x 67.2x 12.8x 12.6x 12.4x Maxis Bhd % HOLD % 3.5% 6.4x 6.0x 11.4x 11.4x 11.4x Telekom % HOLD % 4.8% 1.8x 1.9x 5.9x 5.9x 5.6x Axiata Group % HOLD % 1.9% 1.7x 1.7x 6.8x 6.7x 6.1x Singapore M % HOLD % 6.7% 3.5x 3.4x 6.4x 6.3x 6.7x NetLink NBN Trust % BUY % 4.3% 1.0x 0.9x 15.4x 20.2x 13.8x SingTel % BUY % 5.5% 1.8x 1.7x 8.2x 8.3x 7.8x Starhub % FV % 8.8% 22.4x 33.9x 6.5x 6.8x 7.5x T hailand Advanced Info Service % BUY na na 3.7% 4.2% 11.3x 9.2x 9.3x 8.6x 7.7x Total Access Comm % BUY % 1.3% 3.7x 3.5x 4.4x 4.9x 5.9x Indonesia Indosat 5,200 59% HOLD % 0.0% 1.3x 1.1x 3.1x 2.8x 2.6x PT Link Net Tbk 6,200 36% BUY % 4.2% 3.0x 2.6x 6.4x 5.6x 4.8x PT Telekom 3,600 0% HOLD % 4.0% 3.9x 3.9x 6.0x 6.4x 6.4x XL Axiata 3,500 33% BUY nm nm % 2.1% 1.3x 1.2x 5.5x 5.0x 4.5x PT Sarana Menara 4,500 50% BUY % 5.0% 4.3x 3.8x 8.1x 7.7x 6.6x Tower Bersama 6,900 41% BUY % 3.4% 7.2x 6.8x 12.1x 11.2x 10.3x A v erage Singapore Telecom 19 & 20 forecast respectively Source: DBS Bank; DBS Vickers; AllianceDBS Page 17

18 Singtel Leverage & Asset Turnover (x) Balance Sheet: Strong balance sheet. This is reflected in FY18 net debt-to- EBITDA (after pre-tax profit contributions of associates) of only ~1.3x giving ample room to Singtel to invest in new business opportunities and/or raise its earnings payout ratio from 70-75% now. If Singtel were to leverage to 2x net debt-to-ebitda, it implies the company could borrow another S$5bn if it wants to. In our view, Singtel should be able to sustain its dividends at the current level even if earnings were to decline due to any reason. Share Price Drivers: Long-term earnings growth at a bargain. The market is seemingly worried over staggering growth in Singtel s earnings caused by the weakness of its regional associates, particularly Bharti Airtel and Telkomsel. As a result, the stock is trading cheap at 5.8x EV/EBITDA, at 15-20% discount to Singtel s local peers. We believe this offers an attractive opportunity for investors to accumulate Singtel and gain exposure to its long term potential for growth. We expect the telco s earnings to return to a growth trajectory in FY20F, supported by the recovery of Bharti Airtel, which should uplift the telco s valuations. The counter also offers a decent yield of 5%. Key Risks: Bear-case valuation of S$2.79 if core, Bharti and Telkomsel disappoint. We have assumed FY19F core EBITDA to be 4% lower than the base-case scenario with an EV to EBITDA multiple of 6x vs 7x in the base-case scenario. We have assumed 20% drop in Bharti s stock price due to higher-thanexpected competition, 20% drop in valuation for Telkomsel due to 15% earnings decline vs 8% decline under the base case, a 10% decline in the stock price for other associates and a wider holding company discount of 15% vs 5% under the base case. Capital Expenditure ROE (%) Forward PE Band (x) Company Background Singtel is the largest telecom operator in Singapore and its Australian subsidiary Optus is the second largest operator in Australia. Singtel also has substantial stakes in telcos in the region Telkomsel in Indonesia, Bharti Airtel in India, AIS in Thailand and Globe in the Philippines. PB Band (x) Source: Company, DBS Bank Page 18

19 Singtel Key Assumptions FY Mar 2016A 2017A 2018A 2019F 2020F Singapore Revenue (S$m) 7,663 7,927 8,396 8,704 9,084 Singapore EBITDA Margin Optus Revenue (A$m) 9,106 8,425 8,710 8,971 9,151 Optus EBITDA Margin (%) Associate pre-tax earnings 2,788 2,886 2,454 2,278 2,669 Income Statement (S$m) FY Mar 2016A 2017A 2018A 2019F 2020F Revenue 16,961 16,711 17,532 18,113 18,682 Cost of Goods Sold (12,097) (11,929) (12,702) (13,213) (13,736) Gross Profit 4,864 4,782 4,830 4,901 4,946 Other Opng (Exp)/Inc (2,001) (2,024) (2,081) (2,287) (2,407) Operating Profit 2,864 2,759 2,749 2,614 2,539 Other Non Opg (Exp)/Inc Associates & JV Inc 2,788 2,886 2,454 2,278 2,669 Net Interest (Exp)/Inc (309) (337) (374) (358) (376) Exceptional Gain/(Loss) 56.9 (31.9) 1, Pre-tax Profit 5,444 5,353 6,772 4,534 4,832 Tax (1,586) (1,522) (1,341) (1,224) (1,353) Minority Interest Preference Dividend Net Profit 3,871 3,853 5,451 3,331 3,500 Net Profit before Except. 3,814 3,885 3,538 3,331 3,500 EBITDA 7,845 7,961 7,572 7,438 7,874 Growth Revenue Gth (%) (1.5) (1.5) EBITDA Gth (%) (4.9) (1.8) 5.9 Opg Profit Gth (%) (2.2) (3.7) (0.4) (4.9) (2.9) Net Profit Gth (Pre-ex) (%) (0.6) 1.9 (8.9) (5.9) 5.1 Margins & Ratio Gross Margins (%) Opg Profit Margin (%) Net Profit Margin (%) ROAE (%) ROA (%) ROCE (%) Div Payout Ratio (%) Net Interest Cover (x) Associate contributions to dip in FY19F before bouncing back Source: Company, DBS Bank Page 19

20 Singtel Quarterly / Interim Income Statement (S$m) FY Mar 4Q2017 1Q2018 2Q2018 3Q2018 4Q2018 Revenue 4,308 4,232 4,370 4,603 4,326 Cost of Goods Sold (3,061) (3,036) (3,125) (3,391) (3,150) Gross Profit 1,247 1,197 1,245 1,212 1,176 Other Oper. (Exp)/Inc (524) (499) (552) (505) (526) Operating Profit Other Non Opg (Exp)/Inc Associates & JV Inc Net Interest (Exp)/Inc (82.0) (87.8) (91.0) (81.0) (85.0) Exceptional Gain/(Loss) (25.0) (28.5) 1,960 (8.0) (26.0) Pre-tax Profit 1,336 1,315 3,221 1,171 1,058 Tax (381) (429) (338) (290) (280) Minority Interest Net Profit , Net profit bef Except EBITDA 1,443 1,431 1,352 1,260 1,169 Growth Revenue Gth (%) (2.3) (1.8) (6.0) EBITDA Gth (%) 6.7 (0.8) (5.5) (6.8) (7.2) Opg Profit Gth (%) 9.7 (3.5) (0.7) 2.0 (8.1) Net Profit Gth (Pre-ex) (%) 1.2 (6.9) 1.0 (3.3) (10.1) Margins Gross Margins (%) Opg Profit Margins (%) Net Profit Margins (%) Balance Sheet (S$m) FY Mar 2016A 2017A 2018A 2019F 2020F Net Fixed Assets 11,154 11,893 11,801 12,079 12,301 Invts in Associates & JVs 11,086 14,235 14,788 15,536 16,413 Other LT Assets 16,160 16,249 15,684 15,281 14,885 Cash & ST Invts ,731 2,776 Inventory Debtors 4,366 4,924 5,035 5,202 5,366 Other Current Assets Total Assets 43,566 48,294 48,254 50,264 52,186 ST Debt 686 3,134 1,824 1,824 1,824 Creditor 4,597 4,922 5,234 5,408 5,577 Other Current Liab 1,257 1,216 1,236 2,108 2,237 LT Debt 9,255 8,052 8,607 9,607 10,607 Other LT Liabilities 2,768 2,756 1,701 1,701 1,701 Shareholder s Equity 24,967 28,191 29,657 29,641 30,285 Minority Interests (3.2) (24.3) (45.4) Total Cap. & Liab. 43,566 48,294 48,254 50,264 52,184 Non-Cash Wkg. Capital (1,151) (755) (1,013) (1,880) (2,002) Net Cash/(Debt) (9,479) (10,652) (9,905) (9,700) (9,655) Debtors Turn (avg days) Creditors Turn (avg days) Inventory Turn (avg days) Asset Turnover (x) Current Ratio (x) Quick Ratio (x) Net Debt/Equity (X) Net Debt/Equity ex MI (X) Capex to Debt (%) Z-Score (X) Ample room to raise debt to fund acquisitions/dividends Source: Company, DBS Bank Page 20