Would record Holding Company discount narrow?
- The expansion in HoldCo discount to a record 47% level seems to be a timing issue; a delay in its core operating profit growth to 3QFY24F could be the key reason
- Potential consolidation in Singapore could aid further recovery in Singtel’s core operating profit in the medium term.
- Raise FY24F/25F earnings by 3%/4%, to reflect the sale of Trustwave. Maintain BUY with a higher TP of S$3.39, led by Singapore and Bharti
Two key drivers for Singtel’s core operating growth in 3QFY24F. 1QFY24 Singtel’s core operating profit of S$300m (- 9% y-o-y) was hurt by weak Optus. Optus’ EBIT declined 35% y-o-y to S$56m mainly due to a big rise in its operating costs from a spike in energy costs following expiry of a fixed price contract. However, we see two key drivers for Singtel’s core operating profit in 3QFY24F.
- Optus to benefit from tariff hikes effective from Aug and Nov 2023 onwards. Optus has raised pricing for its legacy postpaid plans by 60% from A$30 to A$49 effective from Aug 2023, which will affect only few customers who were on its legacy plans. On the non-mobile side, Optus has raised pricing for NBN 25 and NBN 50 by A$1 and A$6 per month respectively for new customers, effective from Nov 2023. According to the Australian Competition and Consumer Commission (ACCC), NBN 50 plans are the most popular internet option in Australia, accounting for 52% of the total. More importantly, its key competitor – Telstra has raised the pricing of its mainstream post-paid plans by A$4-6 per month from July 2023 onwards. Optus is also expected to raise pricing on its mainstream postpaid plans in response over the next few months. Optus is taking more time to raise pricing as it is waiting for virtual operators (c.25% subscriber share) to raise pricing to defend its market share. Both Telstra and Optus are in the process of raising their wholesale pricing to these virtual operators as and when their wholesale contract comes for renewal.
- S$30m rise in operating profit each quarter from 3QFY24F onwards following the sale of Trustwave. Trustwave divestment is expected to bring in annual savings of S$120m-130m. By the end of 2Q24F (30th Sep 2023), it will be classified for sale, hence beginning of 3Q24F, an estimated S$30m will be realized as a benefit to Singtel’s core operating profit.
Potential consolidation in Singapore could aid further recovery in Singtel’s core operating profit
StarHub announced a S$50m share buyback programme in June 2023. StarHub has unveiled a new initiative, setting aside approximately S$50m for a share buyback programme aimed at repurchasing up to 3% of the company’s issued share capital, equivalent to 51.9m shares. The company has also disclosed that the acquired shares will be held as treasury shares and can also be used for any potential merger and acquisition (M&A) opportunity in Singapore. Additionally, as of 1H23, StarHub maintains a low net debt-to-EBITDA ratio of 1.57x, providing ample capacity for investments.
What is the rationale for SIMBA to be acquired? We see three key reasons as to why SIMBA might be a potential candidate for acquisition.
- Slow growth in subscriber share. SIMBA has been experiencing a slower growth in subscriber market share. For instance, SIMBA’s subscriber market share gain has slowed from 3% in 2021 to 1% in 2022 (calendar year). We expect SIMBA’s subscriber market share to hover between 10%-12% in the long-term, due to stiff competition from mobile virtual network operators (MVNOs).
- Negative free cash flow despite positive EBITDA. SIMBA has been able to narrow its EBITDA losses from (S$0.5m) in FY21 (July YE) to a positive EBITDA of S$31m in FY23. However, despite achieving EBITDA breakeven and recording growth in EBITDA, the free cash flow (EBITDA less capex) is still negative. As of FY23, SIMBA’s negative free cash flow stood at (S$14.1m) and is expected to remain even higher over the next 2-3 years due to the 5G capex commitment since the consensus expects EBITDA CAGR of 20% over FY23-FY26. SIMBA’s capex in FY23 was S$45m and management has guided for a capex of S$45-50m in FY24F.
- SIMBA’s outdoor coverage is decent but will require more capex for its indoor coverage expansion. SIMBA expects to surpass 60% outdoor coverage by the end of 2023 (calendar year), compared to Singtel reaching 95% of outdoor coverage by 1H22 (calendar year) three years ahead of the target, while StarHub and M1 reached 95% and 90% by 2H22 (calendar year) respectively. SIMBA received the 2.1GHz frequency spectrum in Nov 2021 and is expected to reach at least 50% coverage before 2023 (on track) and nationwide coverage before 2026. However, providing reliable and strong indoor coverage is pivotal for SIMBA but the capex requirement for indoor coverage will be high which require more differentiated and extensive network capabilities in more dimensions.
- Potential to sell the business above 2.5x the book value. SIMBA’s FY23 book value stood at A$444m (S$390m) and its net cash was A$41m (S$36m), translating to a book value minus net cash of A$403m (S$354m). Based on its current market cap of A$990m (S$875m), the current market cap to enterprise value is at 2.5x. It might make sense to cash out due to the rising 5G capex commitments.
Why should StarHub be the acquirer of SIMBA? All mobile network operators (MNO) have been awarded the spectrum to operate a 5G standalone (SA) network on 2.1GHz (Singtel, StarHub+M1 and SIMBA). SIMBA has 2 paired lots (10MHz) of the 2.1GHz band which can be a rationale on acquiring SIMBA by StarHub. Additionally, as of 1H23, StarHub maintains a low Net Debt to EBITDA ratio of 1.57 times, providing ample capacity for future investments aimed at driving growth. This financial strength ensures sufficient flexibility for seizing potential opportunities that may arise. If StarHub acquires SIMBA for S$875m-S$1.0bn, its net debt to EBITDA could rise from 1.25x in FY24F to 2.8x-3.0x.
Consolidation is required in Singapore for average revenue per user (ARPU) to improve and the players investing more to improve customer experience. Consolidation in this sector offers advantages due to economies of scale, resulting in cost savings on both capital investments and operational expenditures. Southeast Asian telecom industry is witnessing consolidation to improve operational efficiency, improve net debt to EBITDA position and channel resources into new investments such as cloud, IoT and data centres. For instance, the merger between Indonesia’s Indosat Ooredoo and Hutchison Indonesia saw the elimination of aggressive pricing, and now the industry is witnessing improving average revenue per user (ARPU) levels and EBITDA margin. Hence, it is about time that the Singapore market goes through consolidation to further enhance 5G investment and experience.
It may be fair to acquire SIMBA at over 20x forward EV/EBITDA, due to the value of the spectrum and future market repair. SIMBA got its initial spectrum of 900MHz and 2300 MHz spectrum quite cheap at S$105m. Based on the price paid by other telcos, we estimate that these two spectrums are worth S$314m. So the market value of total spectrum held by SIMBA is at least S$370m vs S$160m paid by SIMBA. Total Singapore mobile revenue in 2022 including equipment sales stood at S$3.7bn, which we estimate can recover by 15-20% gradually over 3-4 years in case of any consolidation.
We raise our Singtel’s FY24F/25F underlying net profit by 3%/4% on lower net finance expenses and absence of Trustwave losses. Singtel recorded net finance expenses of S$52m (down 54% y-o-y) in 1Q24 on proceeds from capital recycling initiatives. We have factored in S$1.1bn in FY24F as cash proceeds from selling a 20% stake in its regional data centre (RDC) business to Kohlberg Kravis Roberts & Co. L.P. (KKR) and S$800m as net proceeds from the comcentre development in FY25F. Singtel expects to recycle its capital and gain an estimated S$6.0bn, and following the above two initiatives, Singtel is left with S$4.0bn, which is expected to be received over the next two to three years. Furthermore, the divestment of Trustwave will remove ~S$120-130m in losses each year, or 4%-5% of group earnings, which will be realised in the next financial year (FY25F as of March year-end).
Maintain BUY with a higher TP of S$3.39 (prev: S$3.18). Our fair value for the company’s core business is S$0.89 (prev: S$0.84) per share due to higher Singapore operating profit coupled with a higher valuation of the data centre business. We value regional associates at S$2.50 per share (prev: S$2.34) using a 15% HoldCo discount, with most of the increase coming from the high market value of Bharti Airtel