Singapore Telecommunications Sector - UOB Kay Hian 2015-09-18: Almost Out Of The Woods

• Spectrum auction facilitates entry of a fourth mobile operator. 

  • The Infocomm Development Authority (IDA) has proposed to conduct an auction to allocate 225MHz of spectrum, of which 60MHz (2x10MHz for 700MHz, 2x10MHz for 900MHz and 20MHz for 2300MHz) would be set aside for one new entrant. 
  • Potential new entrants, aspiring to be the fourth mobile operator, have to bid for the entire 60MHz block of spectrum with reserve price set at only S$40m. IDA targets to finalise the auction framework by end-15 and the auction should be conducted in early-16. 

• Scenario analysis brings clarity. 

  • The outlook for the telco sector is fuzzy and perplexing with the confusion centring on whether Singapore will have a fourth mobile operator commencing commercial operations as early as Apr 17. 
  • To put the issue into perspective, we have conducted a scenario analysis based on two possible outcomes: a) Scenario A - No new entrant, and b) Scenario B - Fourth mobile operator disrupts the status quo. 

• Impact from entry of a fourth mobile operator. 

  • We estimated that M1’s and StarHub’s net profit would decline by 32% and 25.8% respectively, two years after the entry of a fourth mobile operator in 2019. M1 and StarHub are more reliant on the mobile business, which accounted for 78.3% and 56.1% of service revenue in 2Q15. We estimated that Singtel’s FY19 net profit would decline by 2.2% as overseas operations accounted for 68.6% of group EBITDA while mobile accounted for only 29.8% of operating revenue in Singapore. 

• Using probability to determine weighted target prices. 

  • We apply the DCF methodology to derive our target prices for M1, StarHub and Singtel for both Scenario A and Scenario B. We attribute a probability of 75% for Scenario A and 25% for Scenario B. We believe potential new entrants face difficulties in canvassing for funds as investors are deterred by the huge capex and practical difficulties involved in penetrating a - mobile market. Thus, our target prices are S$3.26 for M1, S$3.50 for StarHub and S$4.56 for Singtel. 
  • In the event that we do not have a fourth operator (Scenario A), our target prices would be S$3.58 for M1 (upside: 22.6%), S$3.83 for StarHub (upside: 7.6%) and S$4.65 for Singtel (upside: 26.4%). 
  • In the event that a fourth operator enters the mobile market (Scenario B), our target prices would be S$2.31 for M1 (downside: 20.9%), S$2.46 for StarHub (downside: 30.9%) and S$4.30 for Singtel (upside: 16.8%). 

• Upgrade to OVERWEIGHT. 

  • We started the year with many investors complacent about the impact from the potential entry of a fourth mobile operator. The recent correction has skimmed the froth from telcos’ share prices. Singtel remains our top pick. We have upgraded M1 from HOLD to BUY. We maintain our HOLD recommendation for StarHub. 

• M1 (BUY/S$2.92/Target: S$3.26). 

  • M1 has suffered the brunt of the recent market correction and would rebound most strongly in the event that we do not have a fourth mobile operator. The stock provides the most attractive free cash flow yield of 6.3%. 

• StarHub (HOLD/S$3.56/Target: S$3.50). 

  • Free cash flow yield is less attractive at 5.4% given that the recent share price correction is relatively mild. Management is committed to paying a dividend of 20 cents/year, which provides an attractive dividend yield of 5.6%. 

• Singtel (BUY/S$3.68/Target: S$4.56). 

  • Singtel benefits from explosive growth in data usage at its regional mobile associates, where data revenue has expanded by 45% yoy for Telkomsel and 67% yoy for Bharti Airtel. Singtel offers the most favourable riskreward trade-offs based on historical trading range for PE and EV/EBITDA.