M1 released Q3 2017 results on the 16th of October and I am now ready to close a long-standing negative position on the sector. Singtel remains the top long-term pick.
M1 Results Takeaways
This is not to say that the results were excellent, but at this stage the negatives are largely recognized and increasingly priced in, while signs of stabilization or dare I say improvement are becoming visible. Let’s briefly review the results (all growth numbers expressed as change vs previous year’s 3rd quarter):
number of mobile subscribers broadly stable (+0.7%) with postpaid rising 3.2% and prepaid falling 3.4%
voice minutes down -10% (postpaid) and -26% (prepaid)
acquisition cost per customer S$378 vs S$357 (although in-line with previous years)
ARPUs generally negative
Data usage up massively to 4.2GB/month from 3.4GB a year ago
As a result, mobile data contributed 55.9% of revenues, up 1.7% points
Mobile Telecommunications revenue +3.4% to S$160.5m
Fibre customers up 30k to 182k, while ARPU declines modestly
EBITDA broadly stable (+1.3%)
Operating cashflow is broadly stable ex-working capital changes
Free Cashflow generation was stable ex-working capital changes and ex-spectrum rights payments
Net Debt/EBITDA remained stable at at 1.3x (up 0.1x)
As noted earlier, dividends have been cut to 11.1 cents in 2017 (from 15.3 in 2016 and 21.2 in 2014) and further steep cuts should not be required.
Clearly, data usage is exploding and further substituting traditional voice calls – a trend likely to continue. 33% of data plans were exceeded – ie customers went over limit and had to pay extra. There will surely be further pressure on the market in the coming years as TPG enters the game, however for now 1) data usage is growing and will help the whole sector 2) dividends and expectations have been reduced sufficiently and 3) current results are stable to positive. A dividend yield of 5% or more (6.1% on trailing 12-month dividends paid) is likely to be maintained from the current entry price (S$1.80). I am thus closing the long-held short position on M1 and Starhub.
Singtel remains top long-term pick
Singtel remains the top-pick as it is best placed to defend its turf in Singapore via triple and quadruple plays – and important advantage in an environment of growing data volumes – as well as high market share at 52.2%. The positive view on Singtel is, however, not driven by a view on the domestic market, which represents less than 10% of its value, but rather its associate companies. Bharti Airtel (about 25% of Singtel’s value) is the clear winner from India’s mobile sector consolidation. It has recently announced the acquisition of Tata’s consumer mobile service in a favorable transaction. The share price of Bharti has responded appropriately, rising over 30%. Globe Telecom is performing well, gaining market share in the Philippines, while Telkomsel has reported strongest YoY growth numbers among operators in Indonesia. Data volumes at AIS in Thailand have been exploding. Even Optus in Australia is experiencing a period of recovery after network upgrades have been completed.
Singtel has a 4.7% dividend yield, which is safe, an excellent diversified portfolio and great management. It makes it the top long-term pick in the sector – risk-on!
This is a short update of share price performance, following my piece from January calling for continued weakness in M1 and Starhub due to the entry of a fourth mobile operator (TPG).
As can be seen on the screenshot, total return performance (including paid out dividends) on both M1 and Starhub has been weak (at -9% and -5.5%), clearly underperforming Singtel (~flat) and the broader market (+11%).
Both telcos have largely recognized the weakening operational environment by cutting dividends. M1 has paid out 11.1 cents in 2017 (vs 15.3 in 2016 and 21.2 in 2014), while Starhub has lowered the quarterly pay out by 20% (from 5 cents to 4 cents). These dividend reductions leave yields at 6% and 6.2% respectively.
These operators face continued pricing pressure, while TPG hasn’t started marketing yet. In the meanwhile, unlimited data plans have are making inroads into the Singapore mobile market, with great benefit to the consumers and the broader Smart Nation objectives, while at the expense of shareholders.
The Singapore telecom regulator has opened the market to a fourth operator (TPG), thereby increasing pressure on revenues and profits of the three incumbents. We have explained how this may force M1 and Starhub to cut dividends in a post in January. In this piece we would like to present the main takeaways from a research piece published by Credit Suisse on the second of March. Thanks to Chee Tiong Lim for kindly sharing the piece. The main takeaways are presented below.
Mobile pricing to fall by 15-25% over the next 3 years
Pricing for mobile data and calls will drop significantly as TPG rolls out its service. This is great news for consumers who will pay lower bills, but it will be painful for the incumbents – in particular M1 and Starhub who have significant exposure to the Singapore mobile market. According to the forecast, overall revenues from mobile in Singapore will trend lower for the next 6 years (-7%), in addition, these revenues will now be divided among 4 operators resulting in mobile (revenues at M1 and Starhub falling by 16% and 13% respectively.
Key TPG Forecasts
The company will spend S$ 500m in CAPEX by 2021.
It will start the mobile operation in 2H 2018 with 775 sites (base stations) and reach 1’000 sites by 2021
The company has a good mix of low-band and high-band spectrum (2x10Mhz in 900Mhz and 2x40Mhz in 2300Mhz). This spectrum could support a market share up to 28%.
TPG is expected to have 150 employees by 2021 (vs 1’500 at M1 today) – a lean operation indeed
TPG will enter the broadband market (possibly before launching the mobile service) in order to compete more effectively in mobile.
Credit Suisse doesn’t expect TPG to become massively profitable over the forecast 2017-2022 period (although the break-even crucially depends on how much market share the company manages to take and how far ARPU will fall). Indeed, the profitability of the whole sector will fall due to new competition brought about by the entrance of TPG. Surely the incumbents (Singtel, Starhub and M1) will be cutting costs as revenues decline. The real winners will be the consumers who will get more data for less – the ultimate goal of the regulator.
Conclusion: Remain underperform on M1 and StarHub
The inevitable conclusion is to remain underweight the sector and in particular M1 and Starhub. Singtel is in a different situation as Singapore revenues represent a small portion of the company’s enterprise value – the bulk consists of its interests in Telekomsel (Indonesia), Bharti (India), AIS (Thailand), Intouch (Thailand), Globe (Philippines) as well as Optus (Australia). Shareprices of M1 and Starhub are down substantially over the past 2 years, however as per out analysis dividends are not sustainable – especially in this deteriorating environment.
As can be seen in the table below, valuation of M1 and Starhub (8x-9x EV/EBITDA) still appears to be on the high side within the sector. Given that earnings will be under pressure in the coming years, there will be further pressure on the share prices of these companies. As an aside, the company this analyst likes most from this list is SmarTone (315 HK) – but that’s an idea for another post!
On December 14th The Infocomm Media Development Authority (IMDA) announced that TPG Telecom won the “New Entrant Spectrum Auction” with a bid of S$105 million and will become the fourth mobile operator in Singapore. TPG has acquired spectrum in both the 900MHz and 2.3GHz band and the company will have 18 months from the start of the spectrum rights to provide street level coverage and an additional year to provide network is coverage in buildings. For close to 20 years mobile voice-and-data was a three-player market in Singapore, however the sector will soon be dividing the pie between four players – the three incumbents and the new entrant. Although the speed at which the new entrant takes market shares is a subject of debate, there is no doubt that it will put pressure on pricing and revenues in the sector – a trend that was already visible in recent quarters.
IDMA is in charge of spectrum licenses in the city-state (before 2016 the predecessor organization – IDA – held this responsibility). It’s mission is not strictly regulatory, indeed it is to foster the development of the information & communication sectors, considering interests of end-users and nurturing a healthy environment for innovation. The organization has first announced that a new player would enter the market in July 2015. It underscored that previous episodes of more competition in the mobile communication sector (in France & Spain) have shown more competitive price plans and infrastructure upgrades by incumbents. It also pointed out that mobile traffic is expected to grow significantly in the coming years providing enough growth for the sector even with a new competitor. This last statement is true in data terms (gigabytes of data transferred), but as we will see is less certain in terms of dollar value o revenues. In any case, IDMA would like to see lower prices. Cheap access to the internet is one of the requirements to succeed in some of the top-level objectives of the authorities such as the Smart Nation national project – better living and advancement through technology, info-comm technologies and big data.
TPG Telecom paid S$105 million – three times the auction reserve price – for the right to become Singapore’s fourth mobile operator. In a press release TPG said it expects to invest a further S$200-300 million to build the network. Earlier estimates for the roll out of the fourth mobile network were higher and it is likely that the total bill will be higher. However TPG should be able to reduce the number of towers by optimizing its locations using inputs such as current data traffic at various hotspot locations, data quality and building floor plans across the island-nation.
TPG Telecom is 34%-owned by David Teoh. Originally from Malaysia, he founded TPG’s predecessor – a desktop computer distributor – and transformed it into Australia’s second-largest broadband provider. With this achievement the entrepreneur and investor has gained tremendous respect in the industry and also made it into the billionaires’ club. TPG Telecom has a market capitalization of $5.8 billion AUD, with another $1.4bn of debt and generated an underlying EBITDA (earnings before interest depreciation and tax) of $775m online AUD in the year ending July-2016. In this context it is clear, that the commitment to invest S$400m+ in the network roll out in Singapore will not be a stretch for the company. TPG commands a 27% market share in broadband access in Australia with 1.87m subscribers and has 475k mobile subscribers in a MVNO (mobile virtual network operator) network operated through Vodafone infrastructure. Thus, the new network in Singapore, will be the company’s first mobile network in which it owns and controls the infrastructure. According to the press release, operations will become profitable once a market share of 5-6% is reached.
Analysts at broker CLSA have made a simple model for TPG’s new operation for the first 10 years. They assume an annual rate of growth of 2% in the total number of subscribers from the current 8.6m (penetration is already at almost 150%) to 10.5m in 2028. TPG’s share would reach 10% by 2028 on these assumptions and revenues would amount to over S$350m. The model uses a constant ARPU (average revenue per user) of S$30 (per user per month) – ie a mobile bill of S$30 for the average user. The EBITDA margin is expected to start at 35% in 2018 and rise to 45% over the next two years and remain there. This analyst would disagree with these rosy assumptions in the early years and would expect higher customer acquisition costs. For example the third mobile operator in Singapore – M1 – calculates the cost of acquiring a postpaid customer at S$363. At this rate acquiring 300k subscribers would cost over 100m SGD – a huge amount even compared to the initial CAPEX spend on network roll out. It is not clear that the offered packages will be so much more competitive than the incumbents’ at the time, allowing to attract tens of thousands of subscribers easily. The market will be adjusting the pricing of packages in the in expectation of the launch of TPG’s offer over the next 18 months and that is precisely why the existing players in the Singapore mobile market will remain under pressure.
Singapore Mobile Telecom market
Almost since the outset in the late 90’s the telecom market has had three players: Singtel, Starhub and M1 with current market shares of 50%, 27% and 23% respectively. The penetration rate is high at 148.8%, which means that there is more than one connected device per person. The market is fully deregulated since 2001 and is dominated by postpaid subscribers. Over two-thirds of contracts have a defined duration of 1-2 years and come bundled with a handset. This allows operators to lock subscribers in and prevents them from switching during the duration of the contract. What makes these deals appealing to consumers is the discount (or effectively subsidy) that the operators give on handsets in these packages. Instead of paying S$1000 for an iPhone 6, the consumer will pay S$200 and a share of his bill over the subsequent 24 months (S$25-30) will effectively go towards paying down the handset. This is still the most common way of subscribing to a mobile service, it is however under pressure since the appearance of SIM-only (or Line-only) contracts first introduced by M1 in July 2015 and quickly taken up by others. SIM-only offered for the first time a cost-effective alternative for users who did not wish to purchase a handset.
In addition to pressure on operator revenues from SIM-only packages, share of traditional services such as voice, SMS and roaming have been on the decline as users prefer to use messaging platforms such as Line and Whatsapp, which use the data connection. These “legacy” revenues have been declining for some time and were offset by subscriber growth and other business lines, but in essence the operators have been running only to stand still.
Company valuations and Stock Implications
As can be seen below, the shares prices of M1 and Starhub have had rather lousy two years (total returns in SGD assuming reinvested dividends are shown). Singtel stock has not suffered, but then the vast majority of Singtel’s revenues comes from abroad – Optus (Australia), Bharti Airtel (India), AIS (Thailand). Indeed only 12% of its revenues come from the Singaporean consumer business – pure mobile revenues (ex-Pay TV and ex-broadband) represent and even lower percentage. However M1 and Starhub – companies whose businesses are entirely reliant on Singapore are down 23% and 39% since the beginning of 2015.
The apparent reason for the poor performance is the expectation of more competition from the new entrant. However the underlying business has been showing signs of weakness at both Starhub and M1 before the IDMA announced the new licence would be issued. Over the period 2013-2015 EBITDA was flat (M1) to down (Starhub) while revenues were trending lower – weakness more clearly visible in recent quarters. The drop in legacy revenues (SMS, voice and international calls) and increase in the share of SIM-only plans and declinging ARPUs are all putting downward pressure on revenues.
However the most important and overlooked reason behind the sell-off is the realisation that dividends will need to be cut. This is important because many investors bought Singapore telco shares for the dividend in a yield-starved environment. The proposition of a high dividend yield combined with a household name appeared very attractive. Yet during 2013-2015 both companies did not cover their dividends with cashflows. During this period M1 generated S$125m FCF (free cashflow or operating cashflow after capital expenditure), while it paid out $S190m in dividends per year (using 3-year averages in both cases), thus creating a total cash shortfall of close to S$200m. Indeed M1’s net debt increased S$150m during this period, suggesting that about a third of the dividend was debt-financed. Similarly Starhub generated on average S$280m SGD of FCF in 2013-15, while it paid out S$345 in dividends thereby financing about 20% of the dividends paid through new debt. The company’s net debt has increased by just under S$100m thus confirming the above observation. Both companies would have needed (and maybe initially planned for) a strong growth environment in order to eventually cover dividends from internal funds, but have been in a flat-growth environment at best while pressure on revenues and margins is now intensifying.
What is priced in?
Using last 12 months’ trailing dividends M1 and Starhub yield 7.7% and 7.0%, which is on the face of it a juicy yield, but these dividends will not be maintained. The timing of the dividend cut, was not easy to predict as leverage at both companies is under control (ND/EBITDA at 1.0x (M1) and 0.7x (Starhub) as of dec-2015) and the shenanigans could go on for a while longer. However the sell-off makes it clear that the market recognizes the insufficient cashflow generation and the managements will have an incentive to put a floor in and reset the dividend at a lower level.
How much lower do payouts need to go? At the very least payouts can not exceed free cashflow, but in reality given a deteriorating environment, I would expect them to fall comfortably (ie 25%) below recent FCF figures in order to ensure reasonable coverage and leave some leeway. That would take dividends at M1 and Starhub 50% and 40% lower respectively and using current share prices (of S$2.0 and S$2.85) would imply dividend yields of 3.8% and 4.2%. Given that Singtel with its excellent assets and geographic diversification currently yields 4.7 (and is not at risk of reducing their payout), I would view M1 and Starhub as relatively expensive. For dividend yields to become comparable or slightly superior to Singtel (say 5%) share prices would have to fall by a further 20-25% for M1 and 15-20% for Starhub. Dividend yields are not necessarily the holy grail of valuation, but the objective here is simply to demonstrate that the current price still doesn’t discount the new normal in terms of profitability and cashflow generation, and the dividend cut announcement effect is still ahead of us. At those levels (20% lower for M1 at $S1.6 and 15% lower for Starhub at S$2.40) the share prices wouldn’t be discounting the worst case scenario with a terminal decline in revenues but would be pricing in the upcoming dividend cut and some further revenue/margin weakness in the coming 3-4 years.
TPG Telecom appears to be an aggressive and well-financed new entrant in a sector which has already been experiencing revenue pressures and in terms of dividend payout was “living above its means”. We are consuming ever more data and in its 2015 new mobile entrant announcement the IDA acknowledged as much, expecting 40%-60% traffic growth in the coming years. The incumbents will in all likelihood see traffic growth, but that will not translate to rising revenues with falling prices for each gigabyte of data transferred. The operators (in particular M1 and Starhub) will have to adjust to declining revenues by containing costs, but dividend reductions are unlikely to be avoided.