Bigger is deemed better

  • Business Premium
  • Saturday, 11 May 2019

FOR a company that was carved out of Telekom Malaysia Bhd (TM), much was expected from Axiata Group Bhd.

Its operating companies (opcos) offered growth to its investors and a regional footprint most companies would crave for. But that did not turn out the way it was envisaged. The reality is that the cellular communications business has taken a U-turn from its initial optimism.

Axiata has had a very patchy financial performance of late, thanks also to the fast saturating and competitive pressures that have cut into it.

For Norwegian-Telenor ASA, its business model was built on Asia. It has focused on Asia, unlike most European cellular companies, for two decades now with half of its revenue coming from Asia.

When the opportunity came to add a business that would turn the combined Axiata-Telenor Asia operations into a regional powerhouse, it was hard to pass, given the changing dynamics within the cellular business.

On its home ground, Telenor is also facing a campaign by Constructive Capital, a little-known activist investor from Norway. The state-owned telecoms operator has hinted it may bow to some of the activist’s demands, such as increasing its debt levels and looking at options for its mobile infrastructure assets, reports the Financial Times.

But is it a done deal?

“Not so,’’ says Axiata president and CEO Tan Sri Jamaludin Ibrahim.

He is determined to make sure that Axiata does not get the short end of the stick.

To realise the value and benefits of the merger, he cites three major components that will be ironed out before the deal is signed – the commercial aspect, including valuations, share ratios and financials; the people aspect; and details of the implementation of the merger.

“There are many things that I as CEO must take care of before we sign. My assurance to everyone is that, if they don’t agree with what we want, we don’t sign.

“At the point of signing, we will announce the line-up of the board and management of the units and merged company, and not at the point of completion of the merger,’’ Jamaludin says in an interview.

Both parties have given themselves till the third quarter of the year to hammer out a definitive agreement. A due diligence will be done to determine the final valuations. After the signing, the entire completion will be one year later, ie, the third quarter of 2020.

On Monday, Jamaludin and Telenor’s president and CEO Sigve Brekke surprised the market with an announcement to merge their Asian assets in nine countries. It is their dream to create a “global champion.’’ It will be one of the biggest telecoms mergers in Asia.

The merger will result in a wider footprint for both Telenor’s Asian operations and Axiata. Axiata is in six countries, excluding a minor investment in India via Idea Cellular, while Telenor is in five. Axiata’s investment in India, Bangladesh (Robi) and its digital business held via Axiata Digital Services (ADS) is not part of the deal. ADS is valued at about US$700mil. The plan is also to merge their tower assets to create the fourth-fifth largest global tower company. Each party is also committed to investing RM100mil yearly to create an innovation center and global talent factory in Malaysia.

Telenor gains presence in Cambodia and Sri Lanka with the merger, but experts believe the prized jewel is mobile service provider XL in Indonesia, a huge market that is set for major growth.

The plan is to create a new company (MergedCo), in which Telenor will own 56.5% and Axiata, 43.5%. This mergedco will be listed on Bursa Malaysia and an international exchange at some point.

“Our focus is on the integration. The listing of MergedCo could be anytime between two to five years,’’ Jamaludin says.

The only overlapping operations will be in Malaysia, where Axiata holds a 100% stake in Celcom Axiata Bhd and Telenor, 49% in Bhd. Both are the second and third-largest mobile players behind Maxis Bhd. The plan is to merge both the units, making them the biggest local cellular company with over a 50% market share. Digi-Celcom will have over 21 million subscribers, revenues of RM14bil and an earnings before interest, taxes, depreciation and amortisation (EBITDA) of RM5bil. For now, Digi-Celcom or DigiCel will remain listed on Bursa Malaysia, but will there be a general offer?

“We don’t know yet. In fact, it would be too presumptuous to answer that question. But yes, if at all (there is a general offer), it would be at the Digi level,’’ Jamaludin says when asked if there would be a general offer at the Axiata or Digi level.

The board of Digi-Celcom will comprise majority Malaysians. Both parties at some point will decide on the branding of the group, especially Digi-Celcom.

Even though the merger is still at the proposal stage, there are enough alarm bells going off about anti-competitiveness, as it will reduce the number of large players from three to two.

“It (potentially) will reduce the level of competition at the expense of consumer’s choice and pricing alternatives,’’ says AmInvestment Bank Research.

However, Malaysian Communications and Multimedia Commission (MCMC) chairman, Al-Ishsal Ishak, says there are nine spectrum holders in Malaysia, of which seven are provisioning services.

“So, it is not three to two really. Our role is to ensure fair protection of subscribers who can be individuals or companies. The government remains focused on its National Fiberisation and Connectivity Plan, which upholds the need to ensure networks in the country are pervasive, robust, high-quality and affordable,’’ Al-Ishsal says.

Both Maxis and TM will be affected by the merger. An enlarged Digi-Celcom is negative for Maxis and TM in the longer term, writes UOBKayHian Research.

Khazanah Nasional Bhd has about a 36% stake in Axiata. Jamaludin says “we have the blessings of our majority shareholder, Khazanah”.

Why the need to merge?

“It is an issue of need versus doing nothing and slugging it out. Both need to realign their businesses in Asia. It is just too competitive and challenging to fight the odds with thinning margins and rising capital expenditures (capex). Competition is no longer from peer groups alone, it is also from over-the-top. By combining, they can be a force that can achieve more and get into new areas of business,’’ says an industry expert.

The merger gives both players access to nine markets where a billion people reside. The mergedco to be set up will have 300 million customers, and about RM50bil annual revenues are expected, RM20bil in Ebitda and RM4bil in profits.

Brekke says the merger allows it to “combine scale and competence, thereby unlocking considerable synergies. We are confident this will create significant value for shareholders and will be beneficial to our customers”.

The cost savings will be in the RM20bil range with consolidation of assets and economies of scale.

Yearly, Axiata spends about RM6bil in capex for all its six markets, while Telenor‘s capex for last year was 16.8 billion Norwegian krone (RM7.95bil). For Axiata, Celcom and Dialog are major contributors to its earnings, while the Asian operations account for half of Telenor’s revenues.

Jamaludin says it needs to invest more money in XL in Indonesia, and even in Malaysia for its broadband, home and enterprise segments.

But it has been a rough ride for Axiata in its regional expansion drive. It has been lumbered with so many issues that most of its opcos are in need of funding, stretching the group’s balance sheet. Its investment in Ncell in Nepal has been a sore point and now there are questions if it can ever recover. This is because it is now saddled with a RM1.45bil tax bill that it has to settle at some point even though it is appealing its case in court. It had to make RM3.6bil in provision for Idea and RM600mil for XL last year.

“It is not that a merger will solve all its issues. But it is a big name in the telecoms industry and Telenor comes with years of expertise and experience,’’ says a source.

Axiata reported a net loss of RM5.03bil in the financial year ended Dec 31, 2018 (FY18). This was due to a RM3.7bil loss from the dilution and de-recognition of its investment in India, as well as a one-off asset write-off or accelerated depreciation of RM1.82bil. In comparison, for FY17, the group posted a net profit of RM909.48mil. Revenue also declined for FY18 to RM23.89bil from RM24.4bil a year earlier. Telenor, on the other hand, reported 14.6 billion krone in net profit for FY18, an increase of 2.6 billion krones a year earlier.

“A merger is needed and this is a very good proposition. My concept is of equals and triangular – it must benefit Axiata, Malaysia and Telenor,’’ Jamaludin says.

He adds that “our competitors are not just Vodafone and Singapore Telecommunications Ltd (SingTel). The nature of the business is no longer very local to me. With social media, new avenues have been opened. So, we are competing with the likes of Apple, Google, Whatsapp... to fight a giant, we need to be a giant too. We think that’s very important.’’

Goldman Sachs in a report says that the “potential merger of Telenor’s Asian assets with Axiata looks credibly value-accretive from a material synergy opportunity.’’ It adds that the deal would increase Telenor’s geographical reach, while also helping simplify its asset portfolio and valuation.

The merger will make them the biggest pan-Asian telecoms player ex-China and Japan, ahead of SingTel by revenue but not profit.

“We will be much bigger than SingTel by revenue but not profit for now. That does not mean the future will be lower, right? Potentially, we can be higher,’’ Jamaludin says.

The merger allows both parties to venture into the home, enterprise and Internet of Things (IoT) areas more aggressively.

Fitch Ratings believes the “proposed merger of Axiata and Telenor’s telecoms and infrastructure assets in Asia underscores the significance of scale”. It adds that continuous investment is needed to maintain modest EBITDA growth in the highly competitive Asian telecoms market.

A day after the announcement, the share prices of Axiata, Digi and Telenor rose. However, they have succumbed to selling pressure since. The market capitalisation of Axiata has risen to RM39.85bil while that of Digi is RM36.46bil.

While Telenor and Axiata want the merger to proceed, pending the due diligence with some analysts already talking about a re-rating for Axiata, the naysayers believe that Axiata should remain very much a Malaysian company. Some even say the merger will allow Telenor to exit the Malaysian marketplace despite Brekke stressing that “we have been in the region for 20 years”.

“We think Axiata is better positioned and this proposed corporate exercise will allow it to crystallise its assets’ true value. Besides, these operating companies will be better managed going forward under a combined experience and with the parent companies’ knowledge,’’ says Hong Leong Investment Bank Research.

What could derail the merger?

“Valuations and disagreements over who manages what. That understanding is critical and they have to throw their egos away to make this work. It is the first of its kind where a Malaysian telecoms company can go on a global scale,’’ says an industry expert.

The other is regulatory approvals, which most analysts think would be challenging.

Even Moody’s Investment Service cautions on that, saying that “we expect that regulatory approvals in Malaysia will be the most difficult of the steps that the company needs to climb to complete the transaction”.

But Al-Ishsal says “we are always open to initiatives by the industry. The due process to evaluate all angles of the proposal will be carried out at the right time”.

The other sore point as seen by many is Telenor having a higher stake (56.5% versus Axiata’s 43.5%) in the mergedco.

Jamaludin says the valuations were arrived at after taking into consideration the “current and future valuations of the assets. This was based on consensus by analysts on the value of all the listed and non-listed telcos, the overall market value...we used the discounted cash flow (DCF) model to be more accurate and the current and future share price”.

Axiata’s enterprise value (current market cap and net debt) is US$14bil, but that does not necessarily represent the value of the proposed merger.

If Robi, Idea Cellular and ADS are included, the percentage would be different. Robi was not included because of regulatory issues and Idea is no longer a strategic investment.

“We can still value them and have more shareholding..... but not yet. We are open to that at some point. As for the digital business, we want to put it into the deal but we cannot agree on the valuations. Telenor also has such a venture, so before signing we will decide on that,’’ Jamaludin says.

The chairman of the mergedCo will be a Malaysian and the CEO will be named jointly. If there are nine or ten seats, the ratio would be 5:4 or 6:4, with Telenor having one more seat than Axiata. As for the business plan, both parties will craft it together. The headquarters of the mergedco will be in Malaysia.

People management

At all the Town Hall sessions by both companies before and after the announcement, the one question that kept cropping up was “is my job safe?”.

Axiata has 12,000 people, including Robi and ADS, and after minusing that, only 9,000 employees will be affected by the merger. Of this, 3,000 are at Celcom. As for Telenor Asia, it has 13,000 employees, of which 1,700 are in Digi.

The industry is facing tough times. The growth has been flat in Malaysia for the past few years and globally, it is also down or flat. Last year, over 100,000 people lost their jobs globally in the sector and of the 33 sectors, it is one of the worst-performing globally. High spectrum costs and the rising cost of providing services are factors, compounded by intense competition in most markets. Prices of data and broadband has also halved in the country.

“Given that scenario, regardless of a merger or not, there will be a serious need for reduction for productivity gains. We are not saying we will cut jobs or that anybody will. What we are saying is that players will be hard-pressed if they do not do anything,’’ Jamaludin says.

He adds that “I told Sigve that we should not have retrenchments. It’s very important, and he agreed immediately”.

In the case of the merger, he foresees only a 0.5% job cuts at senior management level when the units are merged. Of the entire workforce, senior management makes up only 1%.

He has told his board that the “merger is needed and is good. Even without the people reduction.

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