(DEC 12): Axiata Group Bhd’s (KL:AXIATA) earnings quality will weaken if a merger in Indonesia goes through as the state-owned telecommunication company will be more reliant on higher-risk markets.

The merger between its 66.5%-owned PT XL Axiata and Smartfren Telecom would result in Axiata’s stake in the combined entity falling to under 35%, leading to more earnings volatility with dividends being discretionary that will fluctuate with cash flow needs, the ratings agency flagged in a note.

With the loss of direct control over XL Axiata, a higher proportion of Axiata’s consolidated cash flow will be from higher-risk markets that worsen earnings volatility, S&P said.

While frontier markets like Bangladesh, Sri Lanka and Cambodia offer better growth potential than developing economies of Malaysia or Indonesia, they are subject to more regulatory and volatility risk, it noted.

The comment follows the signing of definitive agreement with Sinar Mas to proceed with the merger of XL Axiata with two other companies in Indonesia. XL Axiata plans to issue 5.1 billion new shares at 65 sen per share to acquire Smartfren and its subsidiary PT Smart Telcom for RM3.3 billion.

Sinar Mas would also own 34.8% and jointly control the enlarged entity with Axiata. The transaction is expected to be finalised by June 2025, subject to regulatory and shareholder approvals.

Government support key plank for Axiata

S&P nevertheless maintained its long-term credit rating on Axiata of 'BBB' with a 'stable' outlook, citing Malaysian government’s support — given sovereign wealth fund Khazanah Nasional Bhd’s direct 36.7% stake.

Further, the ratings agency also expects Axiata to use most of the merger’s proceeds to cut debt as a proportion of operating profit to 3.1 times in 2024, 2.7 times in 2025 and 2.9 times in 2026.

“Supporting the improvement is moderate earnings growth, slower debt-funded expansion of the company’s tower arm, and our expectations of gradual strengthening in [the] ringgit against US dollar,” S&P said.

Axiata’s current BBB rating can accommodate the likely risk of a one-notch decline to its stand-alone credit profile that excludes support from its parent or government, though a reassessment will come only after the proposed merger clears regulatory hurdles, S&P said.

Malaysia’s government can influence Axiata’s strategic and operating decisions through its holdings, S&P said. A downgrade however would require a two-notch cut to Axiata’s stand-alone credit profile from BBB, “which we see as unlikely,” the credit rating agency added.