Sri Lanka Equities Corporate Update Dialog Telekom PLC (DIAL) Rs. 6.25 78.00 BUY Rs. 28.00 26.00 Volume Adjusted Price Adjusted DIAL Price Volume Graph 250,000,000 Financial Year NPAT (Rs.m) NPAT after Pref. Dividend (Rs.m) EPS* (Rs.) EPS attributable to equity EPS Growth (%) PER (x) EV / EBIDT (x) Dividend Yield % DPS (Rs.) 24.00 22.00 20.00 18.00 16.00 14.00 12.00 10.00 8.00 6.00 28-Jul-05 07-Sep-05 12-Oct-05 23-Nov-05 30-Dec-05 09-Feb-06 20-Mar-06 28-Apr-06 08-Jun-06 14-Jul-06 08-Sep-06 18-Oct-06 23-Nov-06 04-Jan-07 13-Feb-07 22-Mar-07 11-May-07 19-Jun-07 24-Jul-07 30-Aug-07 09-Oct-07 15-Nov-07 20-Dec-07 31-Jan-08 11-Mar-08 23-Apr-08 2-Jun-08 8-Jul-08 13-Aug-08 17-Sep-08 24-Oct-08 200,000,000 150,000,000 100,000,000 50,000,000 0 2004 4,801 4,801 0.59 0.59 67.92 10.60 9.17 119.04 7.44 2005 7,010 7,010 0.86 0.86 46.02 7.26 6.40 6.40 0.40 2006 10,118 10,118 1.24 1.24 44.33 5.03 4.37 8.80 0.55 2007 8,969 8,908 1.10 1.09 (11.35) 5.67 4.26 8.80 0.55 2008E 1,251 643 0.15 0.08 (86.05) 40.69 7.55 1.20 0.08 2009E 458 (160) 0.06 (0.02) (63.36) 111.06 6.45 0.44 0.03 * Adjusted for Rights Issue * Financial Year End - December Dialog Telekom PLC (DIAL), a subsidiary of Telekom Malaysia, is currently one of the largest listed entities in Sri Lanka with a market capitalization of Rs. 54.97 billion accounting for 9.8% of the total market capitalization as at 21st November 2008. Since its incorporation in 1995, the company has spearheaded the mobile industry in Sri Lanka, capturing approximately 51% of the fixed and mobile segments by 2Q2008. DIAL Reuters Code Bloomberg Code Share Price LKR Issued Share Capital (Shares) Voting 12 mth High/Low (Rs.) Average Daily Volume (Shares) Market Capitalisation Rs. mn Price Performance (%) 1 mth 6 mth 12 mth ASPI (12.14) (35.75) (35.69) DIAL (18.75) (56.67) (70.11) * Adjusted for Rights Issue Jeewanthi Malagala jeewanthi@jkstock.keells.com John Keells Stock Brokers (Pvt) Ltd. Company No. PV 89 130, Glennie Street, Colombo 2, Sri Lanka. Tel: 94 11 242 1101-9 (Gen.) 94 11 234 2066/7 94 11 243 9047/8 Fax: 94 11 234 2068 94 11 232 6863 December 2008 DIAL.CM DIAL.SL 6.25 8,143,778,405 21.75 / 6.50 915,205 50,899 The operations of DIAL span a future oriented quadruple play service offering fixed line, mobile, broadband and media through its fully owned subsidiaries, namely, Dialog Broadband Networks (Pvt) Ltd. (DBN) and Dialog Television (Pvt) Ltd. (DTV). Industry 2002 2003 2004 2005 2006 2007 2Q2008 Fixed Line Subs 883,108 939,013 991,239 1,243,994 1,884,076 2,742,059 3,861,742 Growth in Fixed Line 6% 6% 25% 51% 46% 41% SLT Market share 87% 88% 87% 77% 63% 53% 40% Mobile Subs 931,403 1,393,403 2,211,158 3,361,775 5,412,496 7,983,489 9,473,931 Growth in Mobile 50% 59% 52% 61% 48% 19% Dialog Market share 52% 60% 61% 63% 57% 53% 51% Mobitel Market share 12% 10% 13% 12% 16% 18% 20% Total Line Population 1,814,511 2,332,416 3,202,397 4,605,769 7,296,572 10,725,548 13,335,673 Growth in Line 29% 37% 44% 58% 47% 24% SLT Market share 49% 41% 36% 30% 28% 27% 25% Fixed Line Penetration 5% 5% 5% 6% 9% 14% 19% Mobile Penetration 5% 7% 11% 17% 27% 40% 47% Line Penetration 10% 12% 16% 23% 37% 53% 66% Penetration Levels are calculated on an estimated population of 20.265 million for 2Q2008 Source : Central Bank Data & Company Quarterly Results Total mobile subscribers increased to 9.5 million by the end of the 2Q2008 with a mobile penetration of 47%. Incremental connections for 2008 amounted to approximately 248,000 per month compared to 214,000 connections in 2007 and we expect this figure to increase during FY2008 with Bharti Airtel due to begin operations this month. This is also expected to increase the churn rates of existing operators as subscribers are likely to shift to Airtel if cheaper packages are offered. Currently, DIAL faces an annualised churn rate of 7.68%. However, in 3Q2008, Hutch restated its subscriber base at 958,000 from 1.29 million subscribers which will dampen penetration and incremental connection numbers. Further, fierce price competition across the industry combined with falling handset prices has enhanced affordability with a positive impact on penetration levels. Page 1 of 5
Operational Developments Mobile DIAL experienced a 54% CAGR in mobile subscribers within a period of 5 years and is currently regarded as the market leader with over 4.8 million subscribers or 51% of the total mobile subscribers as of 30 th June 2008. Total subscribers as of 3Q2008 was recorded at 4.98 million. Pre paid segment which amounts to over 88% of mobile subscribers and over 93% of incremental connections, is the dominant contributor to the company s revenue, despite a fall in its contribution to 49% in 3Q2008. However, the increase in incremental pre paid connections coupled with falling tariffs has adversely affected ARPUs, leading to a 19% and 17% decline in blended ARPU and pre paid ARPU respectively since FY2007. Since the announcement of entry of Bharti Airtel, all operators announced a series of price reductions to attract more subscribers to their networks while retaining its existing ones. In July 2008, DIAL reduced its call charges by 50% from the 3rd minute onwards with a view of increasing Minutes of Use (MoU). More recently, DIAL shifted to a per second billing system which will be applicable from 4Q2008. Although usage volumes were deemed to be highly responsive to tariff revisions, former price revision proved otherwise as prepaid and post paid usage increased by only 10% and 9% respectively, from 2Q2008, while average revenue per minute fell 14% and 12% for prepaid and post paid segments over 2Q2008. DIAL continued its aggressive investments in expanding and upgrading its network to support the growth of its subscriber base. The company currently operates on a 3G network with 540 3G base stations and 1,255 2.5G base stations across the island. Even though the market witnessed declining 3G handset prices, it is unlikely that the heavy investments would bear fruit in the short to medium term due to lack of interest and spending power faced by subscribers. However, the 3G network is capable of handling more capacity and operates at higher efficiency levels than the 2.5G network. In the short to medium term, the company will focus on the provision of Value Added Services (VAS) until a steady growth in the use of 3G services is seen. During 1-3Q2008, VAS accounted for nearly 10% of total turnover while SMS revenue continued to be the largest component of non-voice revenue accounting for 5% of total revenue. Incremental mobile connections for Dialog amounted to approximately 96,000 per month in 2007, which has declined to 80,000 during 1-3Q2008. We expect this figure to range between 75,000 and 80,000 a month in 2008 as other operators offering lower prices tend to grab an increasing share of the incremental connections. DIAL s market share in incremental connections dipped to 37% during 1H2008 from 45% in 2007. CDMA and Broadband Despite a delay in obtaining license, DBN had acquired over 125,000 subscribers by 3Q2008, majority being pre paid users. This segment too has been affected by a slow growth in usage volumes despite lower tariffs Page 2 of 5
compared to other operators. During 2H2008, new CDMA connections stood at approximately 13,400 subscribers a month but had slipped down to 4,090 per month in 3Q2008 as a result of higher penetration levels. In 3Q2008, CDMA accounted to 56% of DBN revenue, while transmission and infrastructure business accounted for 23%. DIAL currently operates on a 450MHz spectrum which enables greater coverage requiring fewer base stations than competitors. Group s broadband internet service based on WiMAX access technology launched in July 2007, witnessed growth during the current year. We believe that given the sluggish growth in subscriber number for both CDMA and WiMAX technologies, this unit may take longer to turnaround as costs mount higher amidst slow growth in revenue. Pay TV Dialog s Pay TV business witnessed growth with over 117,512 subscribers as of 3Q2008. Slower growth is expected to continue as a result of an erosion of consumer spending in the light of macro-inflation. The company claims that break even numbers for DTV is a moving average but we expect this figure to remain high as a greater proportion of incremental connections tend to be from the low priced- packages thereby dragging down ARPU levels. Further, additions during 3Q2008 fell to 15,219 from 24,787 in 2Q2008, indicating that the unit may require at least 2 years to turnaround. Earnings Outlook In its latest results released for 3Q2008, Dialog experienced a 86% decline in its 1-3Q2008 earnings reaching Rs. 1.03 billion, caused by staggering inflation, higher energy costs and expansion of its network infrastructure resulting in higher depreciation. Further, earnings for the 3Q2008 moved into negative territory for the first time since its listing in 2005, recording a loss of Rs. 192 million. The company s broadband unit and Pay TV unit too recorded losses of Rs. 922 million and Rs. 542 million respectively, for the cumulative period. A majority of the company s base stations are being run on fuel based electricity and has expanded the company s costs due to rising fuel prices. The increase in frequency charges also took the toll on DIAL s earnings as charges increased by over 306% YoY for 1-3Q2008. Further, telco depreciation grew by 64% on the back of aggressive investments causing EBITDA margins to drop drastically to 27% from 43% in 1-3Q2007. We expect the group s profitability to be driven by its mobile arm but the segment will face lower growth in revenue due to lack of responsiveness in usage volumes to tariff revisions. However, the company s of the view that its latest price revision in October 2008 which is also aimed at increasing the average call duration, may prove to be beneficial in medium to long term as inflationary pressures subdue. In the short term, with low levels of elasticity, we believe that the growth in turnover is likely to weaken while costs continue to mount higher. Page 3 of 5
The latest entrant to the local mobile market, Bharti Airtel, is expected to begin its operations before the end of the year and its pricing strategy is unknown. However, the company claimed that call charges in Sri Lanka are still higher than those in India. Therefore, we could expect lower prices being offered both locally and between Sri Lanka and India which may in the medium term lead to further price reductions by the existing operators. The company is currently undertaking strict cost cutting strategies by attempting to move its base stations on to the National grid, although this is expected to take a longer time. Until such time the base stations will continue to run on fuel based electricity. The recent reduction in fuel prices may therefore, reduce its direct costs. Further, the company has undertaken consolidation of office space by moving its offices to the outskirts of Colombo. The company expects to reduce capex in the coming years. The counter currently trades at approximately 39x FY2008E earnings, a significantly high premium to the market and the sector. We expect DIAL to post earnings of Rs. 1,251 million prior to the adjustment for Preference Dividend which is expected to cost at least Rs. 700 million for the current year. FY2008E earnings represent a drop of 86% over 2007 on the back drop of heavy cost pressures and sluggish revenue growth. The mobile arm of the group currently enjoys a tax holiday till 2012. Earnings for 2009 are expected to worsen with the per second billing system in place and with a possibility of further tariff revisions with the commencement of Bharti Airtel s operations. However, given that no further tariff reductions take place, we expect DIAL to post Rs. 458 million as PAT for FY2009E, as the benefit of cost savings from possible lower fuel prices and other costs being outweighed by the declining revenues from tariff reductions. Page 4 of 5
Profit & Loss Statement (Rs.m) 2003 2004 2005 2006 2007 2008E 2009E Year Ended 31 December Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Assumptions Average Subscribers 658,718 1,094,673 1,741,227 2,615,217 3,683,592 4,696,167 5,525,367 Prepaid 461,619 816,032 1,355,958 2,152,024 3,164,339 4,111,324 4,883,039 Post Paid 197,064 278,641 385,269 463,193 519,253 584,843 642,328 Usage Per Subscriber (mts) Prepaid 1,129 1,224 1,231 1,478 1,556 1,518 1,533 Post Paid 4,163 4,409 4,785 5,909 7,775 7,720 7,848 Revenue Post paid 3,562 4,931 7,282 9,306 10,439 10,331 10,739 Pre-paid 2,263 4,010 6,593 10,816 14,811 15,393 18,606 International Termination Revenue 120 544 1,364 2,221 3,270 4,176 4,597 Other Revenue 209 925 1,178 1,788 3,063 3,729 4,529 International Roaming Revenue 1,323 1,703 1,616 1,548 933 1,064 1,224 Total Revenue 7,476 12,113 18,033 25,679 32,516 34,693 39,694 Direct Costs 2,973 3,932 6,214 8,821 13,402 19,521 22,145 Gross Profit 4,503 8,182 11,819 16,858 19,114 15,172 17,548 Other income 17 30 53 123 380 395 416 Administration costs 991 1,597 2,222 3,064 6,076 8,948 11,164 Selling and distribution costs 863 1,562 2,335 3,067 3,774 4,321 4,645 Finance Costs 253 212 263 657 629 1,035 1,692 PBT 2,414 4,840 7,052 10,193 9,015 1,264 463 Tax 445 (39) (42) (75) (45) (13) (5) PAT 2,859 4,801 7,010 10,118 8,969 1,251 458 Balance Sheet (Rs.m) 2003 2004 2005 2006 2007 2008E 2009E As at 31 December Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Fixed Assets 10,985 13,469 22,430 33,633 54,337 68,240 78,267 Current Assets Inventories 173 229 350 580 954 1,018 1,165 Recievables 1,546 2,268 3,726 6,910 10,090 10,765 12,317 Cash and equivalents 611 3,188 6,690 2,302 6,344 133 444 2,330 5,685 10,766 9,793 17,387 11,917 13,926 Total Assets 13,315 19,154 33,197 43,426 71,724 80,157 92,193 Ordinary share capital 370 370 7,403 7,403 8,144 8,144 8,144 ESOS Trust Shares (2,385) (1,925) (2,000) (2,000) (2,000) Preference Shares 1,269 1,269 - - 5,000 4,500 3,750 Share Premium 5,277 5,277 20,084 20,084 20,084 Retained earnings 3,834 7,068 6,901 14,206 19,096 19,796 20,053 Revaluation reserve 5 5 5 21 20 21 21 Shareholders Funds 5,478 8,712 17,201 24,982 50,343 50,544 50,051 Non Current Liabilities Subscription in advance 3,414 3,414-1 0 1 - Borrowings 2,347 3,137 9,049 8,185 5,313 11,841 20,966 Retirement benefit obligations & Others 29 49 82 112 355 390 558 5,790 6,600 9,131 8,298 5,668 12,232 21,524 Current Liabilities Payables 1,515 3,483 5,214 8,866 14,811 15,803 18,080 Current tax liability - 33 36 63 24 78 80 Borrowings 532 325 1,615 1,216 877 1,500 2,457 2,047 3,841 6,865 10,145 15,713 17,381 20,617 Total liabilities 13,315 19,153 33,197 43,426 71,724 80,157 92,193 Cashflow Statement (Rs.) 2003 2004 2005 2006 2007 2008E 2009E Year Ended 31 December Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn Rs 'mn PBIT 2,414 4,140 7,054 10,193 9,015 1,264 463 Depreciation 1,000 1,452 1,954 2,736 4,547 6,335 8,052 Other non cash items 94 239 156 (959) 220 (581) 519 Net change in working capital (32) 1,139 (152) 238 2,392 252 579 Net cash generated from operations 3,476 6,970 9,011 12,207 16,173 7,269 9,613 Investing activities Plant property and equipment (3,847) (3,931) (8,205) (11,878) (24,815) (19,350) (18,360) Intangibles (91) (136) (463) (503) (187) (60) - Acquistition of subsidiary, net of cash reqd. (1,441) (849) (40) - - Others 1 6 36 19 20 19 40 Net cash used in investing activities (3,937) (4,061) (10,073) (13,212) (25,022) (19,391) (18,320) Financing Activities Share premium on issue of shares 491 14,807 - - Proceeds from ESOS 460 129 Option Scheme ESOS Shares 1 Preference Share Issue 5,000 (500) (750) Proceeds from issue of shares 5,402 740 - - IPO cost set off (113) Repayment of subscription in advance (2,460) Payment to ESOST (2,399) (205) Finance lease repayment (22) (18) (22) (23) (44) (26) (26) Loan repayment (430) (424) (521) (1,151) (12,198) (1,500) (1,500) Borrowings 904 1,054 7,061 143 8,793 8,500 11,500 Dividends (760) (866) (2,859) (2,813) (4,132) (563) (206) Net cash used in financing (308) (254) 4,581 (3,383) 12,891 5,912 9,018 Inc./dec. in cash and equivalents (769) 2,655 3,519 (4,388) 4,042 (6,210) 311 Cash at beginning 1,285 516 3,170 6,690 2,303 6,345 134 Cash and equivalents at end 516 3,170 6,690 2,303 6,345 134 445 Page 5 of 5 This document is published by John Keells Stockbrokers (Pvt.) Limited for the exclusive use of their clients. All information has been compiled from available documentation and JKSB s own research material. Whilst all reasonable care has been taken to ensure the accuracy of the contents of this issue, neither JKSB nor its employees can accept responsibility for any decisions made by investors based on information contained herein.