Two weeks ago, i Capital analysed Telekom Malaysia Bhd (TM) by focusing on its fixed line business. This week, i Capital will focus on TM International Sdn Bhd (TMI).
CELCOM (M) Bhd is the core profit generator for the de-merged TMI. Taking into consideration the current mobile penetration rate of 79% and Celcom’s growth potential, the telco’s earnings power equates to an average of RM900mil over the next few years.
Both PT Excelcomindo Pratama TBK (Excel) and Dialog Telekom Ltd have performed credibly. Despite operating in a young market (see table), both have started to report strong profits.
Dialog’s substantial lead in terms of the number of subscribers over the other three mobile telecommunications players, and the fact that all call tariffs have to be first approved by the Government, places Dialog in a very comfortable position. The sole concern with regard to Dialog is the ethnic conflict in the region. We do not foresee the conflict putting Dialog out of business.
However, political unrest will have some effect on Dialog’s costs, as witnessed by a slight dent in Dialog’s profitability in 2Q07. In that quarter, due to the escalation in the conflict, Dialog’s operating margin, i.e. earnings before interest, tax, depreciation, and amortisation, fell to 49% from 54% in the previous corresponding period.
In Indonesia, the mobile telecommunications market is basically dominated by Excel (15% market share), Indosat (24%) and Telkomsel (52%). Excel has proven its ability to operate profitably. The key challenge for Excel would be to select profitable areas to roll out its mobile coverage.
The implementation of the interconnection regime will further place Excel, Indosat, and Telkomsel on equal footing. TMI has announced its intention to acquire a further 16.81% interest in Excel from Khazanah Nasional Bhd for RM1.425bil, payable via issuance of 158.7 million new TMI shares.
As for TM International (Bangladesh) Ltd (TMIB), the plunge in profit in its first half was due to the downward revision of interconnection charges, as required by the army-backed interim government that took control over the country earlier this year. Going forward, the uncertain policy and regulatory decision making environment under the interim government will be a significant barrier that TMIB has to overcome.
As for Telekom Malaysia International (Cambodia) Co Ltd (TMIC), we do not expect any major contribution for the next two to three years.
Jointly controlled entities (JCEs)
TMI’s JCEs are MobileOne Ltd (M1, 15.15% interest) and Spice Communications Ltd (46.89%). M1 is listed on the Singapore stock exchange and is the smallest mobile telecommunications player in Singapore with 1.41 million subscribers (29% market share).
Spice provides mobile telecommunications services in the states of Punjab and Karnataka. Spice is the second largest operator in Punjab, with 2.1 million subscribers, and the fifth largest operator in Karnataka, with 1.1 million subscribers.
TMI’s interest in M1 is held via SunShare Investments Ltd, a company in which TMI holds 51%, and Khazanah the balance. TMI recently proposed to acquire the remaining 49% of SunShare from Khazanah for RM155mil, payable via issuance of 17.3 million new TMI shares. The acquisition of the remaining interest in SunShare would increase TMI’s interest in M1 to 29.7%.
What is the value of TMI?
Based on Celcom’s earnings, capital structure, and capital expenditure requirements, Celcom would be able to comfortably generate free cash flow of RM700mil to RM800mil per annum. As for the remaining core overseas subsidiaries and the JCEs, profit contribution of RM550mil can be expected over the next one to two years, which will put a value of RM5bil on these entities. In short, TMI is valued at between RM25bil and RM28bil.
At RM11.40, TM is valued at RM34.6bil. Two weeks ago, i Capital valued the fixed line division at between RM15bil and RM17bil, and this division is now expected to pay an annual dividend of RM700mil.
The combined value of the fixed line division and TMI is between RM40bil and RM45bil, a premium to the current market capitalisation. For this, what do investors get in return?
The investment community has downplayed the potential of the fixed line division. Most do not know that British Telecommunications plc undertook the same de-merger route in 2001 that saw the creation of BT Group plc (fixed line unit) and mm02 plc (the mobile unit).
The chart shows that BT did not disappear with the loss of its mobile units. Instead, broadband demand continued to drive its revenue growth.
Similar trends can be witnessed in South Korea’s Hanarotelecom Inc (Hanaro). Formed in 1997, Hanaro is mainly involved in the provision of fixed line telecommunications and broadband services.
The earlier years of its formation showed a strong increase in revenue, driven by broadband demand. KT Corp, the dominant fixed line player in South Korea, also saw its fixed line revenue improving with the growth in broadband demand.
The de-merger is a positive move, as it will unlock the value of the fixed line division. The division would be a cash cow post de-merger.
The position of Streamyx and the high-speed broadband (HSB) project that the fixed line division will undertake will provide ample growth for the division.
The HSB project involves connecting fibre optic cables to 2.2 million premises in the urban areas. Currently, TM is still negotiating the terms with the Government.
The cost of the project is estimated at RM15.2bil over 10 years, and the Government will award TM a RM4.8bil grant to undertake the project.
Some RM10bil will be spent in the first four years, i.e. TM’s capital investment in the first four years will amount to RM5.2bil. The project will be funded via external financing. Revenue is expected to fully flow in by the fourth year on commencement of the project.
i Capital sees the de-merger as a chance for investors to get hold of TM’s fixed line division at an attractive valuation, based on its current share price. With this, i Capital rates TM a “buy” for the longer term.