This article first appeared in The Edge Financial Daily, on April 1, 2016.

Telco sector
Maintain neutral: On Feb 1, the  Malaysian Communications and Multimedia Commission (MCMC) announced the redistribution of the 900/1800MHz spectrum to Maxis Bhd, Celcom Axiata Bhd, DiGi.Com Bhd and U Mobile Sdn Bhd. 

The biggest beneficiary was U Mobile, which get access to the lower-frequency spectrum, while DiGi benefits from an extra 900MHz spectrum.  Given the likely new spectrum slot arrangements, Celcom will have more options to select partners for potential future spectrum pooling. 

The MCMC has allocated 5MHz in the 900MHz band for the Malaysia-Singapore High Speed Rail’s communication system. It could announce spectrum fees by mid-year.

Telcos may need to pay RM1.34 billion to RM1.65 billion for the 900/1800MHz spectrum. They may also have to pay RM1.59 billion for the 700/2100/2600MHz spectrum when it is reallocated in 2017. 

Pending the MCMC’s final decision, there are uncertainties about the reallocation of these spectrums.    

Assuming equal five-year instalments, the net debt/earnings before interest, taxes, depreciation and amortisation of Malaysian telcos should only increase by 0.1 times to 0.2 times in financial year 2016 (FY16) to FY18 (0.3 times to 0.4 times including 700/2100/2600MHz spectrum payments). 

However, there is risk that spectrum fees may be front-loaded to more substantially plug the Malaysian government’s budget deficit. If so, our scenario analysis suggests that the balance sheets of Maxis and Axiata Group Bhd may become stretched.    

Factoring in only the 900/1800MHz spectrum fees, the potential negative impact on our FY17 to FY19 core earnings per share is manageable at 3.9% to 5.8%.  If we include the 700/2100/2600MHz spectrum, the potential impact could be a larger 4.1% to 11.9%. 

The biggest impact will be on DiGi (smaller profit base), with the smallest impact on Axiata (diversified regional operations). 

Our FY17 to FY19 dividend yield forecasts may be reduced by up to 40 to 60 basis points.  

Our discounted-cash-flow-based target prices (TPs) for Maxis, Axiata and DiGi may be cut by 1.7%, 1.6% and 2.1% respectively, if we factor in the 900/1800MHz spectrum fees. If we include the spectrum fees for 700/2100/2600MHz, the potential hit is 3.3%, 3.2% and 3.5% respectively. While telcos are in discussion with the MCMC to lower the 6% universal service provision fee to neutralise the spectrum fee impact, we gather from our industry sources that the chances are slim.  

We maintain our “neutral” sector rating and keep our TPs for Malaysian telcos, pending the MCMC’s final decision on spectrum fees. 

We think that DiGi’s share price does not fully reflect the potential cash outflow for spectrum fees and there is an up to 8.4% downside risk if our assumptions materialise. 

Meanwhile, Axiata’s and Maxis’ share prices appear to have largely priced in the risks. Axiata remains our top Malaysian telco pick. — CIMB Research, March 30