Asia Telecoms Sector - research-doc.credit-suisse.com

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20 June 2017 Asia Pacific/Hong Kong

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Fraser McLeish

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Eric Cha

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Varun Ahuja, CFA

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Danny Chan

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Viral Shah

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Sohyun Lee

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CONNECTIONS SERIES

Is biggest always best?

Figure 1: Returns versus valuation—FY20 snapshot EV/IC vs ROIC

Source: Company data, Credit Suisse estimates

■ Assessing monetisation and market share differentials. A raft of new

entrants in Asia, which prompted our sector downgrade to UNDERWEIGHT

in August 2016, raises the question of which incumbents and #2 players

have sustainable scale advantages, and which new entrants (if any) have

prospects of generating reasonable returns. We then assess if scale

advantages are overvalued or undervalued by the stock market.

■ Which operators can generate positive returns? Our analysis leads us

to group Asian telecom stocks into four categories: (1) 'undervalued

incumbents', including AIS/Intouch, SingTel, Globe and PT Telkom; (2)

'second players with reasonable prospects of acceptable return,' including

China Telecom, Indosat and SmarTone; (3) 'overvalued challengers,'

including Unicom A share, True Corp and PLDT; and (4) 'overvalued

incumbents in problem markets,' including Bharti.

■ Stock calls. Our top regional picks include three 'second players' in benign

markets, namely Indosat, China Telecom, as well as SmarTone, and Intouch

(as a proxy for AIS) as an 'undervalued incumbent'. Our top

UNDERPERFORM calls include three 'overvalued challengers', in True Corp,

M1 and PLDT, as well as Bharti and Maxis as 'overvalued incumbents'; we

believe that investors in India are underestimating the competitive impact of

Rjio across the coming years, and overestimating the potential positive

impact of consolidation among the smaller players. We downgrade both

DTAC and XL to a NEUTRAL. These 'borderline' challengers look unlikely to

generate adequate returns, and look expensive after sharp YTD rallies.

20 June 2017

Asia Telecoms Sector 2

Focus tables

Figure 2: Scoring Asian cellular markets on competition, regulation and therefore likely monetisation

Indonesia 5 No None 14.7% Tiered 3.0 3.5 3.6

China 3 No Some 56.8% Tiered 3.0 2.0 2.6

Thailand 3 No Some 31.3% Tiered 2.5 2.5 2.6

Philippines 2 No Some 9.0% Tiered 1.5 2.5 2.6

Taiwan 5 Yes Extensive 73.3% Unlimited 3.0 2.0 2.4

Hong Kong 4 No Extensive 93.4% Tiered 2.5 2.5 2.2

Korea 3 No Extensive 90.8% Tiered 1.5 3.5 2.2

Malaysia 5 Yes Some 24.2% Tiered 1.5 2.5 2.2

Australia 3 Yes Extensive 80.2% Tiered 2.5 2.5 2.2

India 6-8 Yes None (yet!) 7.0% Tiered 1.0 1.0 1.8

Singapore 3 Yes Extensive 88.0% Tiered 1.5 1.5 1.4

*5 being most attractive, calculated as ((competition score + regulatory score + growth/2)/2.5). Source: Company data, Credit Suisse estimates

Figure 3: Assessment of strength and sustainability of incumbent scale advantages

Cellular market Incumbent Spectrum

advantage

BTS

advantage

Capex

advantage

Regulatory

advantage

Incumbent

advantage score*

Indonesia Telkomsel 1.0 3.0 3.0 3.0 2.5

China China Mobile 1.0 3.0 2.5 1.0 1.9

Australia Telstra 2.0 2.0 2.0 1.0 1.8

India Bharti 1.5 2.0 1.5 1.0 1.5

Hong Kong HKT Trust 2.0 1.0 1.5 1.0 1.4

Thailand AIS 1.0 1.0 2.0 1.0 1.3

Malaysia Maxis 1.0 1.5 1.5 1.0 1.3

Korea SKT 1.0 1.0 1.0 1.0 1.0

Philippines Globe 1.0 1.0 1.5 1.0 1.1

Singapore SingTel 1.0 1.0 1.0 1.0 1.0

Taiwan CHT 1.0 1.0 1.0 1.0 1.0

* Scoring system: 1.0 for negligible advantage, 2.0 for a small advantage, 3.0 for a material advantage; Source: Company data, Credit Suisse estimates

Figure 4: Top OUTPERFORM and UNDERPERFORM calls

Close Target Potential P/E (x) EV/EBITDA (x) FCF yield (%) Div. yield (%)

price price upside 17E 18E 17E 18E 17E 18E 17E 18E

Top OUTPERFORM calls

Indosat 6,200.0 8,800.0 41.9% 14.9 12.5 3.8 3.4 13.3% 12.5% 3.3% 4.8%

China Telecom 3.8 5.3 40.6% 12.6 10.7 3.5 3.2 1.0% 7.1% 3.3% 4.2%

Intouch 55.8 75.3 35.1% 14.5 13.7 14.4 13.6 6.9% 7.3% 5.5% 5.1%

SmarTone 10.2 13.5 31.8% 15.0 15.4 5.0 5.0 10.0% 8.3% 6.2% 6.1%

Top UNDERPERFORM calls

True Corp 6.2 2.7 -56.3% 1,315.2 273.4 9.9 10.4 -0.6% 4.5% 0.0% 0.0%

M1 2.2 1.5 -33.5% 15.5 20.5 8.1 9.0 5.5% 5.3% 5.2% 3.9%

PLDT 1,900.0 1,500.0 -21.1% 19.9 20.3 8.7 8.5 1.5% 2.6% 3.0% 3.0%

Bharti 364.9 300.0 -17.8% 44.4 35.3 7.3 6.6 4.2% 4.3% 0.2% 0.3%

NJA- Integrated 24.5 16.6 6.5 6.2 6.4% 7.5% 4.3% 4.5%

NJA - Mobile 17.3 15.3 5.7 5.4 4.5% 6.2% 3.4% 3.8%

Note: Pricing as of 16th June 2017 throughout this report.


20 June 2017


Is biggest always best? A raft of new entrants in Asia, which prompted our sector downgrade to UNDERWEIGHT

in August 2016, raises the question of which incumbents and #2 players have sustainable

scale advantages, and which new entrants (if any) have prospects of generating

reasonable returns. We then assess if scale is overvalued or undervalued by the market.

Which markets are monetising data growth?

We have developed a framework to help assess likely degrees of success in monetising

data across cellular markets, by analysing: (1) competitive dynamics; and (2) regulatory

interference. Indonesia, China, and Thailand rank well and are expected to deliver

revenue growth, given stable-to-consolidating market structures. Malaysia, India, Australia,

and Singapore face new entrant threats, which we expect to materially affect data

monetisation. We reflect this in our market revenue growth forecasts across FY16-20.

Market share differentials and drivers

In order to attract subscribers and partake in industry revenue growth, cellular players

must be able to demonstrate broad, seamless coverage to customers. Given that this

overall coverage capex requirement (and associated operating costs) is common to all

cellular operators, we show that relative scale and revenue market share are the primary

determinants of returns on invested capital and profitability within cellular markets.

Assessing spectrum, network resources, balance sheet capacity and regulations leads us

to highlight that Telkomsel, China Mobile and Telstra enjoy meaningful and broadly

sustainable scale advantages.

Which operators can generate positive returns?

As at 2016, of the 31 stocks under our coverage with cellular exposure, only 19 generated

a ROIC of greater that 8% (while 17 generated a double-digit ROIC). Not surprisingly,

given the aforementioned benefits of scale, the majority of 'incumbent' operators fall into

this category. Only Bharti, in hypercompetitive India, and SKT, which has extensive non-

telecoms investments, generate returns below this threshold. By FY20, just two additional

stocks are expected to pass this threshold (China Telecom and Indosat).

Stock picks: What's in the price?

When we overlay valuation we can group Asian telecoms stocks into four categories: (1)

'undervalued incumbents’, including AIS/Intouch, SingTel, Globe and PT Telkom; (2)

'second players with reasonable prospects of acceptable return’, including China Telecom,

Indosat and SmarTone; (3) 'overvalued challengers’, including Unicom A share, True Corp

and PLDT; and (4) 'overvalued incumbents in problem markets,' including Bharti and

Maxis. Our top regional picks include three 'second players' in benign markets, namely

Indosat, China Telecom and SmarTone, as well as Intouch (as a proxy for AIS) as an

'undervalued incumbent'. Our top UNDERPERFORM calls include three 'overvalued

challengers,' in True Corp, M1 and PLDT, as well as Bharti as an 'overvalued incumbent';

we believe that investors in India are underestimating the competitive impact of Rjio

across the coming years, and overestimating the potential positive impact of consolidation

among the smaller players. Our analysis also prompts us to downgrade the ratings of two

'borderline' challengers, DTAC and XL, to NEUTRAL. Improving competitive dynamics in

Thailand and Indonesia have resulted in sharp YTD share price outperformance by DTAC

and XL, yet neither operator is actually expected to generate attractive returns by FY20.

New entrants are causing problems for

sector profitability

We assess data monetisation by

market…

…and the sustainability of scale advantages

19 out of 31 cellular stocks generate

ROIC >8.0%

We like Indosat, China Telecom, SmarTone,

and Intouch

20 June 2017


Sector valuation

Figure 5: Non-Japan Asia telco sector comps

Close Target Mkt cap Normalised P/E (x) EV/EBITDA (x) FCF yield (%) Div yield (%)

Ticker Ccy price Rating price (US$ bn) 17E 18E 17E 18E 17E 18E 17E 18E

Integrated operators

China Telecom 728 HK HK$ 3.77 O 5.30 39.1 12.6 10.7 3.5 3.2 1.0% 7.1% 3.3% 4.2%

China Unicom 762 HK HK$ 11.3 O 14.10 34.7 74.7 26.3 5.1 4.5 15.1% 13.4% 0.3% 1.9%

Chunghwa 2412 TT NT$ 107.5 N 105.00 27.5 21.2 21.2 10.0 9.9 5.1% 5.7% 4.7% 4.7%

HTHK 215 HK HK$ 2.68 N 2.60 1.7 19.7 18.5 7.2 6.9 7.7% 8.0% 3.8% 4.1%

KT 030200 KS W 31600 O 38,000.00 7.3 8.7 7.4 2.6 2.3 12.6% 13.9% 3.5% 4.1%

PCCW 8 HK HK$ 4.35 N 5.20 4.3 19.1 18.4 9.4 8.9 4.5% 6.1% 6.8% 7.0%

HKT Trust 6823 HK HK$ 10.2 O 11.85 9.9 15.3 14.7 11.1 10.9 7.0% 6.9% 6.3% 6.5%

PLDT TEL PM P 1900 U 1,500.00 8.2 19.9 20.3 8.7 8.5 1.5% 2.6% 3.0% 3.0%

SingTel ST SP S$ 3.8 O 4.50 44.9 15.8 15.2 7.1 6.8 2.3% 2.4% 4.7% 4.9%

SPK SPK NZ NZ$ 3.815 U 2.99 5.1 17.7 17.2 8.0 7.9 6.0% 6.2% 6.6% 6.6%

CNU CNU NZ NZ$ 4.72 N 4.24 1.4 14.4 16.6 5.5 5.7 -9.7% -7.7% 4.4% 4.7%

TM T MK RM 6.65 O 7.20 5.8 28.7 26.7 7.7 7.1 0.1% 1.4% 3.1% 3.4%

Telstra TLS AU A$ 4.38 U 4.00 40.7 13.3 12.6 6.3 6.1 6.8% 6.8% 7.1% 5.7%

Jasmine JAS TB Bt 8.45 U 7.25 1.6 23.0 22.6 6.8 5.9 3.7% 6.4% 2.6% 2.6%

True Corp TRUE TB Bt 6.15 U 2.69 7.2 1315.2 273.4 9.9 10.4 -0.6% 4.5% 0.0% 0.0%

HKBN 1310 HK HK$ 8.31 O 10.55 1.1 30.3 23.7 11.4 10.0 6.8% 7.7% 5.3% 5.7%

NJA - integrated 24.5 16.6 6.5 6.2 6.4% 7.5% 4.3% 4.5%

Close Target Mkt cap Normalised PE EV/EBITDA FCF yield Div yield

Ticker Ccy price Rating price (US$ bn) 17E 18E 17E 18E 17E 18E 17E 18E

Mobile operators

AIS ADVANC TB Bt 173.5 O 218.00 15.2 16.6 15.6 8.6 8.2 2.9% 4.9% 4.2% 4.5%

AXIATA AXIATA MK RM 4.99 N 4.80 10.5 29.0 25.9 6.4 6.0 4.7% 6.0% 1.7% 1.9%

Bharti BHARTI IN Rs 364.85 U 300.00 22.6 44.4 35.3 7.3 6.6 4.2% 4.3% 0.2% 0.3%

China Mobile 941 HK HK$ 84.15 O 110.00 221.0 12.8 12.1 3.7 3.3 5.3% 7.2% 3.6% 4.1%

DiGi DIGI MK RM 4.95 N 5.00 9.0 23.0 23.1 13.8 14.1 3.9% 4.0% 4.3% 4.3%

XL EXCL IJ Rp 3160 N 3,600 2.5 60.5 36.1 5.4 4.9 2.7% 6.4% 0.5% 2.2%

FarEasTone 4904 TT NT$ 76.6 O 87.00 8.2 21.9 21.8 9.6 9.4 6.3% 6.4% 5.0% 5.1%

Globe GLO PM P 2,156 O 2,350 5.7 21.3 19.6 7.7 7.6 0.9% 1.8% 4.2% 4.3%

IDEA IDEA IN INR 77.75 U 74.00 4.3 n.m. n.m. 12.0 13.1 2.2% 3.3% 0.0% 0.0%

Indosat ISAT IJ Rp 6200 O 8,800 2.5 14.9 12.5 3.8 3.4 13.3% 12.5% 3.3% 4.8%

LG Uplus 032640 KS W 16,600 O 20,000 6.4 12.9 11.1 4.0 3.7 11.4% 12.0% 2.4% 2.8%

M1 M1 SP S$ 2.18 U 1.45 1.5 15.5 20.5 8.1 9.0 5.5% 5.3% 5.2% 3.9%

PT Telkom TLKM IJ Rp 4370 O 5,100.00 32.4 17.8 16.2 9.3 8.4 3.9% 5.4% 3.9% 4.3%

Reliance RCOM IN INR 19.05 U 30.00 0.7 7.7 5.4 6.2 5.4 45.6% 52.3% 0.7% 0.9%

SKT 017670 KS W 242,000 N 280,000 17.2 7.7 6.9 5.3 5.0 4.0% 3.8% 4.1% 4.1%

SmarTone 315 HK HK$ 10.24 O 13.50 1.4 15.0 15.4 5.0 5.0 10.0% 8.3% 6.2% 6.1%

StarHub STH SP S$ 2.72 U 2.20 3.4 16.9 20.4 8.7 9.5 5.8% 5.3% 5.9% 5.9%

TAC DTAC TB Bt 51.25 N 54.00 3.6 82.2 23.6 5.1 6.0 5.4% 1.2% 0.6% 2.1%

Taiwan Mobile 3045 TT NT$ 113 O 128.00 12.8 20.3 20.0 10.8 10.6 6.1% 6.3% 5.0% 5.0%

NJA - mobile 17.3 15.3 5.7 5.4 4.5% 6.2% 3.4% 3.8%

NJA - telecoms 20.0 15.8 6.0 5.7 5.2% 6.7% 3.8% 4.1%

Note: Priced as of 16 June 2016. O = Outperform, N = Neutral, U = Underperform. Source: Bloomberg, company data, Credit Suisse estimates

20 June 2017


Table of contents

Is biggest always best? 3

Which markets are monetising data growth? ........................................................... 3

Market share differentials and drivers ...................................................................... 3

Which operators can generate positive returns? ...................................................... 3

Stock picks: What's in the price? .............................................................................. 3

Sector valuation 4

Which markets are monetising data growth? 8

Structural drivers explain trends and prospects ....................................................... 9

Market share differentials and drivers 11

Which operators can generate positive returns? 12

Stock picks: What's in the price? 14

Top regional picks ranked by upside to DCF ......................................................... 16

Top regional underperform calls ranked by downside ........................................... 16

China 17

Summary ................................................................................................................ 17

Growth rates recovering as policy effects roll off ................................................... 17

Mid-single-digit growth looks achievable ................................................................ 18

Growth differential to narrow with Unicom 4G roll-out............................................ 20

Does Unicom have a viable business? .................................................................. 23

What is in the price? ............................................................................................... 25

Indonesia 27

Summary ................................................................................................................ 27

High cellular revenue growth, but lopsided ............................................................ 27

Still plenty of room for revenue to grow .................................................................. 28

We expect a more even share of revenue growth ................................................. 29

Do smaller players have a viable business? .......................................................... 32

What's in the price? ................................................................................................ 34

Korea 36

Summary ................................................................................................................ 36

4G-driven cellular revenue growth ......................................................................... 36

Limited upside for cellular revenue......................................................................... 37

We expect LGU to continue to gain market share ................................................. 38

Superior ROIC for LGU .......................................................................................... 42


20 June 2017


India 44

Summary ................................................................................................................ 44

Three dominant players gaining share—before Jio's entry .................................... 44

Market structure changing rapidly since Jio’s entry ............................................... 45

Good growth potential, but ability to monetise is key ............................................. 46

Rapid consolidation of market shares into three operator groups ......................... 49

ROIC has stayed below cost for many years—likely to stay so ............................. 51

See downside to Bharti/Idea .................................................................................. 52

Country sections: Malaysia 54

Summary ................................................................................................................ 54

Data demand up but data pricing down ................................................................. 54

Revenue outlook remains challenging ................................................................... 55

Big 3 to cede more market share to others ............................................................ 56



Country sections: Philippines 62

Summary ................................................................................................................ 62

Cellular revenue growth impacted by higher legacy contribution ........................... 62

Revenue growth to remain under pressure ............................................................ 64

Globe's outperformance to continue ...................................................................... 65



Country sections: Hong Kong 69

Summary ................................................................................................................ 69

Fundamentals improved post consolidation but competition in the low end is

increasing ............................................................................................................... 69

Competitive low end segment to hamper growth ................................................... 70

HTHKH to lose cellular market share ..................................................................... 71



Country sections: Singapore 76

Summary ................................................................................................................ 76

Cellular revenue impacted by ineffective data monetisation .................................. 76

Service revenue outlook continues to be hazy ....................................................... 78

TPG to capture ~2% market share by FY20 .......................................................... 80

ROIC analysis......................................................................................................... 82

What is in the price? ............................................................................................... 83

20 June 2017


Country sections: Taiwan 86

Summary ................................................................................................................ 86

Recent sector growth hampered by increase in competition… .............................. 86

…however, we expect pricing to improve in coming months with focus on

profitability .............................................................................................................. 88

Market share to remain largely stable .................................................................... 88



Country sections: Thailand 93

Summary ................................................................................................................ 93

True Corp gained market share across FY13-FY16 .............................................. 93

Scope for mid-single-digit market growth ............................................................... 94

AIS and DTAC still to lose share, but more slowly ................................................. 95

Do DTAC and True Corp have viable businesses? ............................................... 98

What's in the price? .............................................................................................. 100

Country sections: Australia 103

Summary .............................................................................................................. 103

20 June 2017


Which markets are monetising data growth? The starting point for the analysis of the potential for future revenue growth in cellular

markets in Asia ex-Japan remains smartphone and 4G penetration levels. The snapshot of

penetration by the market as at December 2016, set out below, suggests that there is still

room for growth in the 'emerging' Asian markets of Thailand, Malaysia, China, Indonesia,

the Philippines and India, where 4G penetration ranges from just 7.0% (India) to 56.8%

(China).

Figure 6: Smartphone and 4G penetration Figure 7: 4G penetration vs GDP per capita

Source: Company data, Credit Suisse estimates Source: Company data, Credit Suisse estimates

With data use per 4G subscriber now reaching circa 4.0GB/month in markets such as

Thailand and Indonesia, versus circa 1.0GB/month on 3G smartphones, rising 4G

penetration is driving rapid growth in data volumes; Indonesia witnessed 154.1% growth in

data traffic YoY in 1Q17.

The key question for investors, in our view, is which markets (and which telecom stocks)

are best set to convert this volume growth into revenue, EBITDA, and cash flow. We have

developed a framework to help assess likely monetisation, by analysing (1) competitive

dynamics and (2) regulatory interference.

Competitive intensity is partly driven by the number of players in each market, with a larger

number of players contributing to heightened competition, the potential for unlimited data

plans and handset subsidies, and therefore inferior monetisation prospects. However, in

our experience, an even more important driver of competitive dynamics is a change in the

number of players. In particular, the introduction of a well-capitalised new entrant is, in our

view, the single most damaging structural change that can happen in a cellular market,

given that it triggers: (1) higher spectrum costs, (2) higher capex (as a new entrant is

forced to build nationwide coverage), (3) tariff competition and (4) increased marketing

expenditure. The tariff competition (for example, the introduction of unlimited data plans)

and increased marketing expenditure are the natural result of the new entrant attempting

to fill its empty network and attract revenue over its fixed cost base.

A key pre-requisite to launching services is a licence, and so risks of new entry tend to

spike when the regulator is issuing or auctioning spectrum. Several markets in Asia have

recently undergone such an event, including Malaysia, India, Australia, and Singapore. We

therefore assign a low competition score to these markets—particularly India, where (as

we shall see) the quantum of spectrum purchased by the new entrant, Rjio, together with

the amount of capacity constructed, constitutes a major supply shock to the industry.

The most attractive markets on competition are Indonesia, where we shall show that the

market is consolidating down towards a three-player market, and China, which is already a

stable three-player market. In Taiwan, the new entrants have entered into cooperation

100% 98% 98% 98%

89%86%

69% 68%

60%55%

28%

88%

80%

91% 93%

73%

31%

24%

57%

15%9% 7%

Singapore Australia Korea Hong Kong Taiwan Thailand Malaysia China Indonesia Philippines India

Smartphone penetration 4G penetration

SingaporeHong Kong

Malaysia

Indonesia

Korea

China

Thailand

PhilippinesIndia

Taiwan

Australia

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

- 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000

4G p

enet

ratio

nGDP per capita (US$)

Still room for growth in 'emerging' Asian

cellular

We analyse competitive intensity market-by-

market…

20 June 2017


deals with the incumbents and have constructed only limited infrastructure. Thus, while

new entrants exist, the competitive impact has been minimal.

Figure 8: Scoring Asian cellular markets on competition, regulation, and therefore likely monetisation

Country Number of

players

New

entrants?

Handset

subsidies

FY16 4G

penetration

Data pricing Competition

score

Regulatory

score

Monetisation

score*

Indonesia 5 No None 14.7% Tiered 3.0 3.5 3.6

China 3 No Some 56.8% Tiered 3.0 2.0 2.6

Thailand 3 No Some 31.3% Tiered 2.5 2.5 2.6

Philippines 2 No Some 9.0% Tiered 1.5 2.5 2.6

Taiwan 5 Yes Extensive 73.3% Unlimited 3.0 2.0 2.4

Hong Kong 4 No Extensive 93.4% Tiered 2.5 2.5 2.2

Korea 3 No Extensive 90.8% Tiered 1.5 3.5 2.2

Malaysia 5 Yes Some 24.2% Tiered 1.5 2.5 2.2

Australia 3 Yes Extensive 80.2% Tiered 2.5 2.5 2.2

India 6-8 Yes None (yet!) 7.0% Tiered 1.0 1.0 1.8

Singapore 3 Yes Extensive 88.0% Tiered 1.5 1.5 1.4

* 5 being most attractive, calculated as ((competition score + regulatory score + growth/2)/2.5). Source: Company data, Credit Suisse estimates

It is also necessary to overlay regulatory pressure. As mentioned, probably the greatest

negative influence a regulator can have on a cellular market is the facilitation of a new

entrant, for example through setting aside attractively priced spectrum resources

specifically for new players. This was recently done in Singapore and we score Singapore

1.5 out of 5.0 on this measure. The Indian regulator has also facilitated large numbers of

players in the market (including Rjio), and has kept incumbents spectrum-constrained in

order to maximise spectrum auction receipts. We score the Indian cellular market 1.0 out

of 5.0 on regulator factors.

Among the more aggressive regulatory backdrops regarding tariffs we would highlight

Taiwan, where price increases are not deemed politically acceptable, and formulaic tariff

reductions are in place. We score Taiwan 2.0 out of 5.0 on regulatory factors as a result.

Regulatory attention is also the key actual and perceived risk to monetisation in China.

The government has directly set market structure and technology choices, and in addition

a 'triple dip' in revenue generation was triggered by imposition of VAT (June 2014), data

rollover (October 2015), and abolition of long distance tariffs (July 2016). There have also

been 'higher speed lower price' policies in place since May 2015. We therefore score

China 2.0 out of 5.0 on regulatory attractiveness.

In contrast, Indonesia scores well on regulatory factors, at 3.5 out of 5.0. Since the

aggressive 2007-8 price war, the regulator has been more concerned about network

quality than tariffs. Thus, industry consolidation has been encouraged, interconnect rate

cuts have been minimal, and there has been no downward pressure on tariffs; indeed,

price increases by the 'big 3' operators have been tolerated.

Structural drivers explain trends and prospects

These structural drivers, and in particular the presence or otherwise of new entrants,

largely explain the recent trends in monetisation and revenue growth across Asia. In 1Q17

cellular revenue was under pressure in all of the 'problem markets', namely: India, where

intense competition from new entrant Rjio resulted in a 12.6% YoY decline in revenue;

Singapore, where price competition is pre-empting an imminent new entrant threat;

Malaysia, where there are two new entrants; and the Philippines, which is suffering from

intense competition and cannibalisation of still-high legacy voice SMS revenues by OTT

(Over the Top) services.

…and we factor in regulatory pressure

Indonesia scores well, while Singapore and

India score poorly

20 June 2017


Figure 9: YoY cellular revenue growth trends—Indian growth collapsed in 1Q17


In direct contrast, monetisation continues to be relatively good in markets with stable or

improving competitive dynamics and minimal regulatory interference. Indonesia, with the

most attractive industry and regulatory structure, was the fastest-growing market for the

eighth consecutive quarter in 1Q17, at 7.0% YoY, with market leader Telkomsel again

achieving double-digit growth YoY.

Data monetisation in China was also more evident, with YoY growth recovering to 5.8% in

1Q17, versus 4.9% in 4Q16 and just 0.4% in 3Q16 (when China Mobile had 'voluntarily'

given up domestic roaming revenues in expectation of further regulatory pressure). Growth

was also achieved in Thailand and Korea, given stable three-player market structures.

Figure 10: 1Q17 revenue trends, and FY16-20 revenue CAGRs

Cellular market 1Q17 revenue growth FY16-FY20 revenue CAGR

Indonesia 7.0% 6.9%

Thailand 6.3% 4.5%

China 5.8% 4.5%

Korea 0.5% 1.7%

Hong Kong 0.0% 0.0%

Singapore -1.6% -2.5%

Taiwan -2.3% 1.0%

Malaysia -2.8% 1.5%

Philippines -7.0% -0.2%

India -12.6% 4.0%

Australia -13.8% -1.4%


Looking forward on a longer time horizon (four-year CAGRs across FY16-20), we expect

these structural drivers to remain intact. We project the highest growth to be achieved in

Indonesia (6.9%) followed by Thailand and China (both at 4.5%). While India is expected

to remain under pressure in the near term due to Rjio, the very low penetration rates, and

recently announced round of industry consolidation, lead us to project 4.0% compound

growth though FY20. However, with new entrant TPG having not yet actually launched

services in Singapore or Australia, we are forecasting revenue declines in both markets

across the FY16-FY20 period.

-15.0%

-10.0%

-5.0%

0.0%

5.0%

10.0%

15.0%

20.0%

1Q13 2Q13 3Q13 4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

Malaysia India Singapore Philippines Taiwan

China Indonesia Thailand Korea

The Indonesian cellular market grew fastest in

1Q17

The Thai and Chinese cellular markets are

also expected to grow

20 June 2017


Market share differentials and drivers In order to attract subscribers and partake in industry revenue, cellular players must be

able to demonstrate broad, seamless coverage to customers, using the latest technology

offered by competitors. Given that this overall coverage capex requirement, together with

associated operating costs, is common to all cellular operators, the relative scale or

revenue market share is the primary determinant of returns on invested capital and

profitability within markets.

This is clearly demonstrated in the figures below. We note that widest disparity in returns

is in large geographies such as China, Australia, Indonesia and Thailand, where the very

high 'fixed' cost of rolling out a cellular network leads to starkly differing returns on capital.

Figure 11: Market share and ROIC differentials

Cellular market Number of players Incumbent Incumbent market

share 1Q17

Incumbent FY16

ROIC

Challenger Challenger market

share 1Q17

Challenger FY16

ROIC

Australia 4 Telstra 55.6% 15.4% Vodafone 16.8% NA

China 3 China Mobile 67.2% 17.3% Unicom 16.4% 0.6%

Hong Kong 4 HKT Trust 40.6% 7.9% HTHKH 20.8% 5.5%

India 8 Bharti 29.0% 6.5% Jio 0.0% NA

Indonesia 5 Telkomsel 62.7% 43.9% XL 13.8% 0.1%

Korea 3 SKT 48.0% 5.5% LGU 23.0% 7.0%

Malaysia 5 36.6% 17.7% Digi 27.0% 86.3%

Philippines 2 Globe 52.2% 13.7% PLDT 47.8% 10.0%

Singapore 4 SingTel 53.4% 11.1% M1 18.9% 20.1%

Taiwan 5 CHT 35.5% 11.9% FET 28.5% 13.2%

Thailand 3 AIS 48.6% 26.6% True Corp 25.8% (0.3%)


In addition to geography, the length of time that an incumbent has had to build up its

coverage advantages and brand equity, due to either delays in licensing or limitations in

spectrum allocations to challengers, or constraints in their supply of capital, can have an

impact on market share and therefore ROIC differentials. Conversely, differentials in both

market share and ROIC are far less pronounced in smaller 'city state' markets where

upfront capex burdens are lower and benefits of scale are commensurately lower.

We have explored these issues in detail in the country-by-country sections of this report,

and we summarise the current 'relative strengths' of the incumbent operators by market

below. Again, the largest, and therefore in our view most sustainable competitive

advantages, tend to be in larger geographies.

Figure 12: Assessment of strength and sustainability of incumbent scale advantages

Cellular market Incumbent spectrum advantage BTS advantage capex advantage regulatory advantage Incumbent

advantage score*

Indonesia Telkomsel 1.0 3.0 3.0 3.0 2.5

China China Mobile 1.0 3.0 2.5 1.0 1.9

Australia Telstra 2.0 2.0 2.0 1.0 1.8

India Bharti 1.5 2.0 1.5 1.0 1.5

Hong Kong HKT Trust 2.0 1.0 1.5 1.0 1.4

Thailand AIS 1.0 1.0 2.0 1.0 1.3

Malaysia 1.0 1.5 1.5 1.0 1.3

Korea SKT 1.0 1.0 1.0 1.0 1.0

Philippines Globe 1.0 1.0 1.5 1.0 1.1

Singapore SingTel 1.0 1.0 1.0 1.0 1.0

Taiwan CHT 1.0 1.0 1.0 1.0 1.0

* Scoring system: 1.0 for negligible advantage, 2.0 for a small advantage, 3.0 for a material advantage. Source: Company data, Credit Suisse estimates

Scale drives returns within markets…

…particularly in large geographies

20 June 2017


Which operators can generate positive returns? Competitive intensity, data pricing (tiered or unlimited), handset subsidies, capex and

spectrum requirements, as well as scale advantages/disadvantages, therefore combine to

drive returns on capital.

As at 2016, of the 31 stocks under our coverage with cellular exposure, only 19 generated

an ROIC of greater than 8.0% (while 17 generated a double-digit ROIC). Not surprisingly,

given the aforementioned benefits of scale, the majority of 'incumbent' operators (coloured

blue in the chart below) fall into this category. Only Bharti, in hypercompetitive India and

SKT, which has extensive non-telecoms investments, are incumbents which generated

returns below this threshold.

Figure 13: FY16 ROIC analysis by operator (market share leaders are highlighted in blue)


We also factor in the growth prospects of each market, together with the expected

improvement or deterioration in competitive intensity over the FY17-FY20 period, by

considering the FY20 ROIC. We make the following observations:

■ Market growth, and an increase in market share by smaller players, results in our

forecast that 21 operators in Asia will have surpassed the 8.0% threshold by FY20, up

from 19 in FY16.

■ In most markets, the ROIC gaps between the market leader and challengers are

expected to close somewhat by FY20, as a result of narrower differentials in spectrum

resources and capital expenditure.

■ But ROIC differentials are set to widen in Singapore (where incumbent SingTel has

exposure to more attractive overseas markets while challengers StarHub and M1 do

not), and Malaysia, where the incumbent is expected to suffer lower degradation in

returns than smaller peers.

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

19 cellular stocks generated ROIC > 8.0%

in FY16…

…this rises to 21 stocks by FY20

20 June 2017


■ We do not forecast any circumstances under which the returns of the market leader fall

below the 'challengers'; thus scale advantages are being maintained at least to some

extent.

Figure 14: FY20 ROIC analysis by operator (market share leaders are highlighted in blue)


While the ROIC of China Telecom and Unicom are projected to be 7.2% and 6.4%,

respectively, and therefore falling short of what we consider to be the appropriate cost of

capital (9.7% and 10.1%, respectively), we note that both the operators' returns are

suppressed by cash payments made to the China Tower Company spin-off (in which

China Telecom and Unicom own 27.9% and 28.1% stakes). Adjusting for the impact of the

China Tower Company, we estimate that China Telecom's FY20 ROIC would be 10.1%,

above cost of capital, while Unicom's would reach 9.4%.

XL in Indonesia and DTAC in Thailand are expected to generate ROIC of 6.5% and 6.0%,

respectively, and show improvement versus FY17, but below cost of capital.

Challengers Rjio, True Corp and TPG also look unlikely to generate returns close to cost

of capital. SKT is also expected to generate poor returns by FY20, at 4.4%.

-10%

0%

10%

20%

30%

40%

50%

20 June 2017


Stock picks: What's in the price? We use our understanding of the competitive dynamics and regulatory backdrop to build

our forecasts for overall market revenue growth, the likely trajectory of operating costs

(marketing and handset subsidies) and likely capex intensity.

The relative strengths of the incumbent operators versus challengers then drive our

estimates for the likely shares of incremental revenue by operator, together with stock-by-

stock projections or capital intensity, spectrum payments and likely operating costs. We

then discount the resulting cash flows at the appropriate WACC to set our target prices;

discounted cash flow (DCF) is the only way to fully capture the multi-year nature of cellular

investment and payback (particularly given what we have explained to be heavy upfront

capex to establish nationwide coverage and launch credible cellular services).

While not all-encompassing of multiple years of cash flows, EV/IC versus ROIC is a helpful

snapshot of returns versus valuation—the figure below shows the relevant FY20 figures by

stock and therefore builds in our expectations across the next four years.

Figure 15: Returns versus valuation—FY20 snapshot of EV/IC versus ROIC


We see four broad groupings emerging:

Group 1: Undervalued incumbents

When we overlay valuation we find that in Thailand incumbent AIS's relatively attractive

returns on capital, and resulting cash flows, are not being fully reflected in the current

share price. An even more attractive way to gain exposure to AIS's cash flows is through

an investment in parent company Intouch, which trades at a 17.5% discount to the market

value of its listed holdings.

Singapore incumbent SingTel, with exposure to the relatively attractive markets of

Indonesia and Thailand, also looks to be relatively undervalued by investors, as does its

associate in the Philippines, and market leader, Globe.

PT Telkom in Indonesia also stands out as attractive in a regional context; its high

growth/high return cellular business, and improving fixed line business, look relatively

undervalued.

China Mobile

Unicom

China Telecom

Unicom-A

HKT Trust

SmarTone

HTHKHBharti

IDEA

PT Telkom

IndosatXL

SKT

KT

LGU

Digi

Axiata

Globe

PLDT

SingTelStarHub

M1

CHT

TWM

FET AIS

DTAC

True Corp

Telstra

TPG

0.0x

1.0x

2.0x

3.0x

4.0x

5.0x

6.0x

7.0x

8.0x

9.0x

-5.0% 0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0% 40.0%

FY

20 E

V/IC

FY20 ROIC

Unattractive

Attractive

Competitive dynamics and regulatory

backdrop drive our forecasts

We then discount the resulting cash flows

AIS (Intouch), SingTel, Globe and PT Telkom

are 'undervalued incumbents'

20 June 2017


Group 2: Second players with reasonable prospects of acceptable return

In markets with relatively benign competitive dynamics and reasonable growth prospects,

there are some 'second players' which we expect to achieve sufficient scale by FY20 to

generate acceptable returns on capital. Some of these stocks look undervalued,

suggesting either that investors are not confident of competitive intensity, or the relative

strength of the operators' networks, spectrum resources and marketing budgets.

In this category we include China Telecom, which in 1Q17 became the second-largest

player in the China market. After adjusting for the diversion of cash flows to the China

Tower Company, we estimate that the overall data market in China, together with

consistent market share gains, can result in China Telecom achieving an adjusted ROIC of

10.1% by FY20, above WACC. This prospect does not seem to have been factored into

market valuations.

Indosat overtook XL to become the second-largest cellular operator in Indonesia in 3Q15.

Given Indonesia's benign competitive dynamics, low 4G penetration, rapid data volume

growth and absence of unlimited data plans and handset subsidies, we expect Indosat's

ROIC to improve from 7.6% in FY16 to 16.9% by FY20. Indosat's cautious and efficient 3G

roll-out on the 850MHz band is the other key driver behind its relatively low capital base

(and rising asset turn as revenues expand). Again, this does not seem factored into the

stock price at current levels.

In Hong Kong, the second-largest player, SmarTone, has sufficient scale within the city

state to generate attractive returns. Given our view that competition fears are overplayed

(we believe that MVNO-based competition is less damaging than infrastructure-based new

entrants), SmarTone currently looks undervalued versus the cash flows it generates.

Group 3: Overvalued challengers

There are also some 'challengers' which we do not expect to gain sufficient scale to

generate adequate returns. Yet when we overlay valuation, it appears that the market is

too optimistic about the prospects of these operators.

In this category we include Unicom A-share, which is currently trading at 1.9x FY20

EV/IC, despite our expectation that the company will fail to generate a ROIC greater than

WACC. True Corp in Thailand also falls into this category, trading at 1.5x FY20 EV/IC, in

spite of our forecast ROIC of just 2.6% by FY20 (given over-investment in cellular

spectrum, and a rapidly deteriorating competitive advantage). PLDT also looks

unattractive, trading at 2.0x FY20 EV/IC despite a projected FY20 ROIC of just 9.1%.

Our analysis also prompts us to downgrade the ratings of two 'borderline' challengers.

Improving competitive dynamics in Thailand and Indonesia have resulted in sharp YTD

share price outperformance by DTAC and XL, respectively. However, we expect DTAC's

ROIC to recover to just 6.0% by FY20 (due to spectrum fees), and expect XL's ROIC to

recover to just 6.5%. Given that the stocks now trade at 1.8x and 1.9x FY20 EV/IC,

respectively, we downgrade both DTAC and XL to NEUTRAL.

Group 4: Overvalued incumbents in problem markets

Thanks to the crystallisation of new entrant risks, we continue to have a negative view on

the Indian and Malaysian markets. This is reflected in our forecast of just 4.0% compound

revenue growth in India across FY16-20, and 1.5% compound revenue growth in

Malaysia. We expect the incumbent operators in these markets to suffer from margin and

capex pressure, and this in turn will lead to suppressed returns on capital. Although we

expect the returns of the incumbents to exceed those of the new entrants, when we

overlay valuation we find that the market is over-paying for the incumbent cash flows;

Bharti trades at 1.3x.

China Telecom, Indosat and SmarTone are

second players with reasonable prospects

Unicom A, True Corp and PLDT are

'overvalued challengers'

Bharti is an overvalued incumbent in problem

markets

20 June 2017


Top regional picks ranked by upside to DCF

Our resulting top regional picks include three 'second players' in benign competitive

markets, namely: Indosat in Indonesia, China Telecom in China and SmarTone in Hong

Kong with 41.9% and 40.6% and 31.8% potential upside to our DCF-based target prices,

respectively (our target price for China Telecom continues to include valuation upside from

its holding in the China Tower Company). We also include Intouch (as a cheap proxy for

AIS) as an 'undervalued incumbent'.

Figure 16: Top OUTPERFORM calls

Close Target Upside P/E (x) EV/EBITDA (x) FCF yield (%) Div yield (%)

price price 17E 18E 17E 18E 17E 18E 17E 18E

Indosat 6,200.0 8,800.0 41.9% 14.9 12.5 3.8 3.4 13.3% 12.5% 3.3% 4.8%

China Telecom 3.8 5.3 40.6% 12.6 10.7 3.5 3.2 1.0% 7.1% 3.3% 4.2%

Intouch 55.8 75.3 35.1% 14.5 13.7 14.4 13.6 6.9% 7.3% 5.5% 5.1%

SmarTone 10.2 13.5 31.8% 15.0 15.4 5.0 5.0 10.0% 8.3% 6.2% 6.1%

NJA- Integrated 24.5 16.6 6.5 6.2 6.4% 7.5% 4.3% 4.5%

NJA - Mobile 17.3 15.3 5.7 5.4 4.5% 6.2% 3.4% 3.8%


Top regional underperform calls ranked by downside

Our top UNDERPERFORM calls include three 'overvalued challengers', in True Corp, M1

and PLDT. We also include Bharti as an 'overvalued incumbent'; we believe that investors

in India are under-estimating the competitive impact of Rjio across the coming years, and

over-estimating the potential positive impact of consolidation among the smaller players.

Figure 17: Top UNDERPERFORM calls

Close Target Upside P/E (x) EV/EBITDA (x) FCF yield (%) Div yield (%)

price price 17E 18E 17E 18E 17E 18E 17E 18E

True Corp 6.2 2.7 -56.3% 1315.2 273.4 9.9 10.4 -0.6% 4.5% 0.0% 0.0%

M1 2.2 1.5 -33.5% 15.5 20.5 8.1 9.0 5.5% 5.3% 5.2% 3.9%

PLDT 1900.0 1500.0 -21.1% 19.9 20.3 8.7 8.5 1.5% 2.6% 3.0% 3.0%

Bharti 364.9 300.0 -17.8% 44.4 35.3 7.3 6.6 4.2% 4.3% 0.2% 0.3%

NJA - Integrated 24.5 16.6 6.5 6.2 6.4% 7.5% 4.3% 4.5%

NJA - Mobile 17.3 15.3 5.7 5.4 4.5% 6.2% 3.4% 3.8%


20 June 2017


China

Summary

■ In terms of industry structure, the China market looks relatively attractive, with no new

entrants and no fully unlimited data plans.

■ We expect the China market to grow service revenue at a CAGR of 4.5% across FY16-

FY20.

■ China Mobile is dominant with 67.2% revenue market share as at 1Q17 and an FY16

ROIC of 17.3%. However, this looks to be partly in the price.

■ China Telecom looks to be a #2 player with reasonable prospects of acceptable

returns. Given this, it is currently undervalued and we highlight it as a top pick. Unicom

A share, on the other hand, looks to be an overvalued challenger.

Growth rates recovering as policy effects roll off

The recovery in China's cellular service revenue growth rate continued in 1Q17, with

revenue expanding 5.8% YoY, up from 4.9% in 4Q16 and just 0.4% in 3Q16—when China

Mobile had 'voluntarily' given up domestic roaming and long distance revenues in

anticipation of regulatory requirements to abolish roaming and long distance fees.

In fact, the revenue trajectory of China’s market has experienced a 'triple dip' over the last

three years, entirely due to government policies. Firstly, the YoY growth rates of Chinese

telcos from 2Q14 through 2Q15 were affected by the imposition of VAT on the sector in

June 2014, the government's requirement that VAT should not be passed on to

consumers, and the presentation of revenue net of VAT in the financial statements. After a

recovery in 3Q15—when data growth flowed through to higher revenue unhindered—a

second dip was caused by the introduction of data rollover. This policy, which was again

accounted for very conservatively, effectively resulted in one month of data revenue

'disappearing' from the P&L account in 4Q15, and therefore dragged industry revenue

growth back into negative territory.

As the impact of this policy rolled off reported revenue, growth recovered in 1Q16 and

2Q16, before the third dip caused by the aforementioned abolition of roaming and long

distance fees.

Figure 18: YoY cellular service revenue growth (%)

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

China Mobile -0.3% 1.3% 5.7% -5.3% 1.4% 7.6% -1.3% 1.3% 5.0%

China Unicom -10.0% -9.4% -4.5% -8.0% -1.2% 0.1% 1.5% 6.9% 2.8%

China Telecom -2.0% 3.1% 11.4% 1.9% 10.0% 6.7% 7.3% 18.8% 12.6%

Total -2.4% -0.3% 4.6% -4.7% 2.2% 6.2% 0.4% 4.9% 5.8%

Source: Company data, Credit Suisse

We note that this third dip was less severe than the others, in large part because Unicom

and China Telecom have less exposure to legacy roaming and long distance exposure,

and therefore have suffered less from the abolition of those charges. This also had the

impact of lowering China Mobile's revenue market share to its lowest-ever level of 65.8%

in 4Q16.

Prior to this latest, imbalanced, policy impact, two clear market share trends had been

visible through the 'noise' in the stated revenue numbers. The first phase, between 4Q08

(when China Mobile had boasted 83.6% market share) and 1Q14 (when China Mobile's

market share had declined to 66.9%), was the 3G phase. During this period China Mobile

consistently lost market share as its home-grown TD-SCDMA technology failed to offer

Policy and technology drove down China

Mobile's market share from 4Q08 to 1Q14…

20 June 2017


comparable services versus Unicom's W-CDMA network and China Telecom's EVDO

network. Unicom and China Telecom, therefore, consistently gained market share versus

China Mobile.

This situation changed in 2Q14 after China Mobile launched 4G services using TD-LTE

technology, which, crucially, worked. China Mobile broadly maintained its revenue market

share during this second phase, helped by the fact that Unicom and China Telecom's 4G

licences were granted on a delayed and piecemeal basis, with full nationwide licences only

issued on 27 February 2015. China Telecom and Unicom initially received trial FDD-LTE

licences for 16 cities on 27 June 2014, and then this was subsequently expanded to 40

cities on 28 August 2014, to 41 cities on 17 November, and to 56 cities (comprising in total

some 430 mn in population) on 17 December 2014.

Figure 19: Cellular service revenue market share

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

China Mobile 68.3% 69.3% 68.7% 68.1% 67.8% 70.2% 67.5% 65.8% 67.2%

China Unicom 17.4% 16.4% 16.4% 16.8% 16.8% 15.4% 16.6% 17.2% 16.4%

China Telecom 14.3% 14.3% 14.8% 15.1% 15.4% 14.4% 15.9% 17.1% 16.4%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%

Source: Company data, Credit Suisse research

Technology—allocated on the basis of policy—therefore tilted the playing field against

China Mobile in the 4Q08 to 1Q14 period, before a more level playing field emerged in the

second phase. But the second key trend that emerges is that China Telecom's market

share has continued to grind higher throughout the 4G, VAT and data rollover policy

changes, while Unicom lost market share from 1Q14 (18.9% share) to a low of 15.4% in

2Q16. In fact, China Telecom overtook Unicom to become the second-largest cellular

player by revenue in 1Q17.

The driver in this case is also technology related, though management decisions were also

important. Having built a relatively low-cost EVDO 3G network on 850MHz during the

2008-13 period, China Telecom was prepared financially, and operationally, for rapid

deployment of 4G as soon as the licences were issued province-by-province, and to his

credit Chairman Wang Xiaochu, then Chairman of China Telecom, recognised this

opportunity and executed well. This resulted in a relatively short gap in marketing, and

service speed, versus the re-invigorated and 4G-equipped China Mobile. In contrast,

Unicom, which had invested heavily in an expensive 3G network at 2100MHz, wanted to

continue to sweat the recently constructed assets. Thus, Unicom did not aggressively build

4G coverage until 2H15 (not coincidentally on the arrival of the same Chairman Wang

Xioachu, transferred over from China Telecom to Unicom in August 2015). Prior to 2H15,

Unicom's provincial marketing teams found it very hard to market 3G services in an

increasingly 4G-centric market and ecosystem, and so Unicom lost momentum.

Recovering that momentum has, as we shall see later, been difficult and expensive.

Mid-single-digit growth looks achievable

In large part due to China Mobile's haste to move on from 3G (where it was at a material

technological disadvantage) to 4G, and the resulting impact on both the competitive

environment and the equipment ecosystem, 4G penetration in China is much higher than

in other emerging markets in Asia, having reached 56.8% as at December 2016. This

leaves less potential for future growth than in markets such as Indonesia or the

Philippines.

…and then allowed stabilisation until 3Q16

Management and technology drove gains

for China Telecom, losses for Unicom

4G penetration can still double from current

levels…

20 June 2017




On the other hand, 4G subscriber numbers can still double from current levels.

Furthermore, data volumes per 4G subscriber remain surprisingly low, at circa

1.0GB/month on average among China Mobile and China Telecom 4G subscribers in

2H16, and 1.5GB/month for Unicom 4G subscribers. The relatively low usage could be

related to relatively high home broadband penetration levels in China, with 65.6% of

households already enjoying broadband access. As customer behaviour shifts more

towards mobile, and as 4G penetration rises, we would still expect considerable growth in

total data volumes.

Of course the key question is whether this volume growth will drive through into revenue

growth. Given that there are no truly unlimited data plans in China, rising data volumes

should lead to some growth in data revenue. We would highlight that Unicom's recently

launched "ice-cream" packages, which were branded as 'unlimited' consist of a

Rmb198/month (US$28.7/month) plan, comprising 1500 minutes of voice and 15GB of 4G

data, and a Rmb398/month (US$57.7) plan, comprising 40GB of 4G data and unlimited

voice minutes; the packages have extremely high volumes, extremely high ARPU levels,

and actually have a set limit on usage.

The standard plans across the three operators for lower volumes are set out below, and

there is a clear ARPU uplift versus the 1Q17 average ARPU level.

Figure 22: Published data packages as a multiple of 1Q17 ARPU

Standard user definition Low Low-medium Medium Medium-high High volume

Assumed data per month 250 MB 700 MB 1000 MB 2500 MB 4000 MB

Assumed "outgoing" voice per month 200 200 200 200 200

China Mobile

Implied ARPU post VAT 68.0 88.0 98.0 148.0 178.0

1Q17A blended ARPU post VAT 59.8 59.8 59.8 59.8 59.8

Uplift multiple 13.7% 47.2% 63.9% 147.5% 197.7%

China Unicom



Uplift multiple 19.7% 19.7% 83.8% 242.0% 306.1%

China Telecom



Uplift multiple -2.5% 24.9% 56.5% 203.9% 262.0%


There is ongoing pressure from the 'higher speed lower tariff' policies of the Chinese

government, but so far the impact on standard price points has been minimal. Taking the

SingaporeHong Kong

Malaysia

Indonesia

Korea

China

Thailand

PhilippinesIndia

Taiwan

Australia

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

- 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000

4G p

enet

ratio

n

GDP per capita (US$)

…and usage per customer is still

relatively low

20 June 2017


standard price points and showing them graphically (and in USD) in the figure below, it is

clear that while customers must pay more as they use more, the chart does not slope

upwards at 45 degrees. Thus, customers enjoy volume discounts (lower price per MB as

they consume more data). As customers have moved up the volume curve, the data yield

per MB as reported by the operators has come down at a rate which has satisfied the

Chinese government, and the operators have not been forced to cut price points along the

volume curve.

Figure 23: Monthly fee in USD per month Figure 24: Actual data yield per MB (Rmb)


Given this, the ARPU uplift caused by customers shifting onto 4G has been enough to

drive revenue growth in the industry (now that the 'cosmetic' impact of VAT and data

rollover have rolled off). With 4G penetration continuing to rise, we project mid-single digit

revenue growth in China in FY17 and FY18, with growth tailing off towards FY20.

Figure 25: Cellular revenue growth (Rmb mn) and revenue growth rates (%)

Rmb mn FY14 FY15 FY16 FY17 FY18 FY19 FY20

China Mobile (8,994) (15,533) 31,520 31,263 27,021 11,769 7,414

China Unicom 4,499 (13,012) 2,398 12,408 13,277 12,216 9,125

China Telecom 6,517 4,235 13,108 14,777 15,412 9,091 5,307

Total 2,022 (24,310) 47,026 58,447 55,711 33,077 21,845

Growth (% YoY)

China Mobile -1.5% -2.7% 5.6% 5.2% 4.3% 1.8% 1.1%

China Unicom 3.0% -8.4% 1.7% 8.6% 8.4% 7.2% 5.0%

China Telecom 5.7% 3.5% 10.5% 10.7% 10.1% 5.4% 3.0%

Total 0.2% -2.8% 5.6% 6.6% 5.9% 3.3% 2.1%


Growth differential to narrow with Unicom 4G roll-out

One key difference in FY17 versus the preceding three years is that we anticipate that

Unicom will resume growing faster than China Mobile, as had last been the case in FY14

(before China Mobile's 4G network reached nationwide coverage).

9.9

12.8

14.2

21.4

25.8

8.1 8.1

12.5

23.2

27.5

8.0

10.3

12.9

25.1

29.9

0

5

10

15

20

25

30

35

250 MB 700 MB 1000 MB 2500 MB 4000 MB

China Mobile Apr-17 China Unicom Apr-17 China Telecom Apr-17

0.030 0.028

0.024

0.017

0.013

0.009 0.009

0.006

0.025

0.020

0.016 0.016

0.013

0.009 0.007

0.004

0.043

0.034 0.033

0.029

0.022 0.020

0.013

0.009

-

0.005

0.010

0.015

0.020

0.025

0.030

0.035

0.040

0.045

0.050

1H13 2H13 1H14 2H14 1H15 2H15 1H16 2H16

China Mobile China Unicom China Telecom

20 June 2017


Figure 26: Cellular revenue (Rmb mn) and revenue market share (%)

Rmb mn FY14 FY15 FY16 FY17 FY18 FY19 FY20

China Mobile 581,817 566,284 597,804 629,067 656,088 667,857 675,271

China Unicom 155,632 142,620 145,018 157,426 170,703 182,919 192,044

China Telecom 120,268 124,503 137,611 152,388 167,800 176,891 182,198

Total 857,717 833,407 880,433 938,880 994,591 1,027,668 1,049,513

Market share (%)

China Mobile 67.8% 67.9% 67.9% 67.0% 66.0% 65.0% 64.3%

China Unicom 18.1% 17.1% 16.5% 16.8% 17.2% 17.8% 18.3%

China Telecom 14.0% 14.9% 15.6% 16.2% 16.9% 17.2% 17.4%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


This expectation is based on our analysis of the following key factors:

Spectrum allocations by operator

China is increasingly unusual in a regional and global context, in that the operators are

given allocations by the regulator, the Ministry of Industry and Information Technology

(MIIT), and do not have to bid for it at auction or pay hefty upfront fees. Of course the fact

that the China government is the majority shareholder in all three operators means that to

some extent spectrum fees would be a 'left pocket to right pocket' exercise, except for the

impact on minority shareholders.

On the other hand, there is a different 'price' to pay for spectrum in that the government

allocates specific technology requirements along with the spectrum! As we have seen, the

allocation of TD-SCDMA technology to China Mobile for 3G caused China Mobile to lose

market share from 4Q08 to 1Q14. Furthermore, when this problem was effectively

resolved with the allocation of TD-LTE technology and spectrum to China Mobile in 2013

(4G technology which worked well), the allocated spectrum was in the 2.3GHz and

2.6GHz band, requiring a dense and extremely expensive roll-out.

Figure 27: Spectrum allocations by operator

MHz 800MHz 900MHz 1.8GHz 1.9GHz 2.0GHz 2.1GHz 2.3GHz 2.5GHz 2.6GHz

China Mobile 20*2 25*2 35*1 15*1 50*1 60*1

China Telecom 10*2 15*2 20*2 20*1

China Unicom 6*2 30*2 25*2 20*1 20*1


All three operators are now rolling out 4G technology in China. While, as mentioned, China

Mobile is using TD-LTE technology, and both Unicom and China Telecom are using FDD-

LTE technology, both technologies come from the same 'embryo' and are capable of

offering similar speeds. The spectrum allocations to all three players are relatively

generous in the regional context, with China Mobile having been compensated for the

unpaired nature of TD-LTE technology through receipt of large blocks of spectrum. Other

than required capital intensity, we see spectrum and technology allocations in China for

the current 4G phase as having created a relatively level playing field (for the first time in a

decade).

BTS by operator

China Mobile's extremely rapid 4G roll-out, starting in 2013, resulted in the construction of

1.5 mn 4G BTS, covering 95% of the population, by December 2016. China Telecom

followed quickly, aided by the formation of the imposition of mandatory sharing of towers in

April 2015 and the subsequent creation of the China Tower Company in October 2015. By

December 2016, China Telecom had 890,000 4G BTS in place, also covering 95% of the

population (given roll-out at the 1800MHz band). Coming from behind, Unicom's

accelerated roll-out programme took total 4G BTS to 736,000 by December 2016, taking

population coverage to 80.0%.

20 June 2017


Figure 28: BTS by operator

2G BTS 3G BTS 4G BTS Total BTS Proportion

China Mobile 900,000 500,000 1,510,000 2,910,000 48.4%

China Unicom 424,000 472,000 736,000 1,632,000 27.1%

China Telecom 290,000 290,000 890,000 1,470,000 24.5%

Total BTS 1,614,000 1,262,000 3,136,000 6,012,000 100.0%


Given that 4G penetration reached only 56.8% as at December 2016, we now consider

Unicom's 4G coverage and network quality to be competitive with that of China Mobile and

China Telecom, at least within the areas relevant for 4G subscriber growth at present.

With Unicom having caught up, we see no reason for market share losses to continue (as

long as pricing and promotional efforts remain competitive).

Capital intensity

During the most intense phase of its 4G roll-out, in FY14, China Mobile spent more than

China Telecom and Unicom combined. The gap narrowed in FY15 and FY16, as Unicom

and China Telecom ramped up 4G coverage, and as China Mobile's capital intensity

declined after meeting its population coverage targets.

Figure 29: Capex by operator (Rmb mn) Figure 30: Capex-to-sales ratios (%)


The absolute figures are somewhat skewed, given that China Mobile rolled out 4G

primarily on the 2600MHz band using TD-LTE technology. China Telecom has estimated

that to cover the same geographical area, its 1800MHz FDD-LTE roll-out cost only half of

China Mobile's 2600MHz TD-LTE roll-out, on a like-for-like basis.

Of course, given China Mobile's larger revenue base, it was well placed to cope with this

additional burden, though in FY14 it faced the highest capex-to-sales ratio in the sector, at

36.7%. Unicom's relatively late start on 4G can be seen in the FY15 figures, with

committed capex surging to Rmb133.9 bn, though capex declined sharply into FY16, and

is guided to decline again into 2017 given the completion of core 4G coverage. All three

operators are now experiencing declining capex, as all three have similar coverage levels

and relatively low 4G network utilisation. Therefore, we no longer see capex levels as a

key differentiator in the expected growth trajectory.

Balance sheet strength and capex sustainability

As state-owned enterprises, the three China telcos can borrow easily, and so we do not

view capital constraints as a differentiating factor for future growth rates. China Mobile sits

on a large net cash position, China Telecom's net debt to EBITDA is set to reach 0.9x as

at 2017 and, even after including vendor payables, Unicom's net debt to EBITDA is set to

reach 2.7x in 2017—a little high, but manageable, particularly if the company sells

additional shares as part of its mixed ownership reform programme, therefore bringing the

ratio down further. So we do not view Unicom's gearing, built up during the 3G and 4G

-

50,000

100,000

150,000

200,000

250,000

FY14 FY15 FY16 FY17 FY18 FY19 FY20


0%

10%

20%

30%

40%

50%

60%



20 June 2017


investment phases, as a constraint on the company's remaining 4G roll-out. All three

operators are generating positive free cash flow yields in FY17 (and can therefore finance

the capex requirements from EBITDA generated), and sale of stakes in a jointly owned

associate company could raise further cash for the three players.

Regulation

We have shown that regulation has had a material impact on historic market share trends.

Currently, with all three operators offering LTE-based services, the differentials are

minimal. Though the recent abolition of internal roaming and domestic long distance

charges took a particularly heavy toll on China Mobile, the government's ongoing 'higher

speed lower tariff' policies affect all three players. We suspect that it is only in the case

whereby China Mobile continues to grow market share (and Unicom continues to lose

share) that further regulatory measures, most probably designed to constrain China Mobile

and help Unicom, might be introduced. Examples might include further changes in

interconnect rates in Unicom's favour, number portability or possibly even 'one way'

number portability. Implementation of these policies is not our base case, however, given

our expectation that Unicom's market share is set to gradually rise from current levels

'naturally'.

Does Unicom have a viable business?

Unicom's loss of traction in 2014 and 2015 re-emphasises that in order to attract

subscribers, cellular players must be able to demonstrate broad, seamless coverage with

the latest technology offered by competitors. Given that this overall coverage capex

requirement, together with associated operating costs, is common to all cellular operators,

the relative scale or revenue market share is the primary determinant of returns on

invested capital and profitability. The large disparity in revenue market share in China,

together with the very high 'fixed' cost of rolling out a cellular network across China's huge

geography, leads to starkly differing returns on capital.

Thus, in FY16, only one cellular player—China Mobile—was able to generate a return

greater than cost of capital. China Mobile's FY16 revenue market share of 67.9% was able

to drive a ROIC of 17.3%, given its 42.2% EBITDA margin asset turn of 1.2x. While

comfortably above WACC of 10.2%, the returns generated by China Mobile are actually

very low for an incumbent operator with a scale advantage of this magnitude. This in turn

is due to China Mobile's extremely inefficient 3G and 4G roll-outs, together with its

ongoing, value-destructive, investment in fixed broadband services. China Mobile's huge

capex burden has led ROIC to fall from a peak of 45.4% in FY08 (just prior to the shift to a

three-player market and the launch of 3G). NOPLAT is still at 2007-08 levels (thanks partly

to VAT, data rollover and other policies) but the invested capital base has doubled.

Given the lack of scale in the cellular market (16.4% share as at 1Q17), the second-largest

player, China Telecom, does not currently make a return greater than WACC. However,

China Telecom's efficient cellular roll-out, together with higher broadband tariffs from its

fixed line division, allows China Telecom to generate a consolidated ROIC of 5.7%. This is

closer to China Mobile's 17.3% ROIC than the relevant revenue market shares/scale

advantages would normally suggest.

China Unicom's problem is more pronounced. Given its highly inefficient 3G roll-out, loss

of top-line momentum due to a late 4G roll-out (as well as government policies such as

VAT and data rollover), and high marketing costs in order to re-ignite growth, Unicom's

FY16 EBIT margin was just 1.1% and its asset turn was 0.7x. This resulted in ROIC of just

0.6% in FY16.

Only China Mobile generates a ROIC

greater than WACC…

Unicom's FY16 ROIC is very low at 0.3%

20 June 2017


Figure 31: ROIC analysis

FY16 FY20 4-year CAGR

Rmb mn China Mobile Unicom Telecom China Mobile Unicom Telecom China Mobile Unicom Telecom

Subscribers (000s) 848,898 263,822 215,000 874,898 305,846 255,000

Service revenue 623,422 240,982 317,673 723,434 293,788 371,916 3.8% 5.1% 4.0%

EBITDA 263,394 79,498 95,139 304,305 101,269 114,498 3.7% 6.2% 4.7%

EBITDA margin 42.2% 33.0% 29.9% 42.1% 34.5% 30.8%

Depreciation to sales (%) 23.3% 31.9% 21.4% 22.7% 25.7% 19.7%

EBIT 118,088 2,693 27,201 139,997 25,828 41,089 4.3% 76.0% 10.9%

EBIT margin 18.9% 1.1% 8.6% 19.4% 8.8% 11.0%

Tax rate (%) 24.4% 19.6% 24.8% 24.4% 25.0% 24.7%

NOPLAT 89,268 2,164 20,442 105,830 19,371 30,932 4.3% 73.0% 10.9%

Average invested capital 516,171 367,725 393,954 573,940 304,671 429,623

Asset turn 1.2 0.7 0.8 1.3 1.0 0.9

ROIC 17.3% 0.6% 5.2% 18.4% 6.4% 7.2%

Net profit 108,741 625 18,004 131,545 19,831 30,466 4.9% 137.3% 14.1%

Net margin 17.4% 0.3% 5.7% 18.2% 6.8% 8.2%


On the other hand, the 4G BTS figures, and commensurate nationwide coverage, suggest

that all three China telcos are now set to emerge from the 4G investment 'j-curve'. The

1Q17 results showed that for all three operators' revenue was up YoY, EBITDA was up

YoY, and net profit was up YoY. As mentioned, all three operators have also guided for

capex to decline YoY into FY17, and together with rising EBITDA, this is set to drive higher

cash flow.

Looking forward to FY20, we expect China Mobile's ROIC to increase to 18.4%. In our

view this figure could be much higher if China Mobile controlled capex more aggressively

than we have forecast (and in particular invested less in rolling out fibre to the home for

fixed broadband services which at current price points are deeply value-destructive).

With rising revenue, China Telecom's ROIC is projected to climb to 7.2% by FY20. Again,

this projection is dampened by China Mobile's aggression in the fixed broadband space—

a core business of China Telecom. While we forecast total service revenue to grow at a

CAGR of 4.0%, we forecast that China Telecom's cellular revenue will grow at 7.3%,

achieving improved scale, while fixed line service revenue is only expected to grow at a

CAGR of 1.3% given China Mobile's disruption of the broadband market. Nevertheless,

China Telecom's ROIC is expected to be relatively close to WACC of 9.7% by FY20 and

we would certainly view it as a sustainable business. Indeed, if we adjust for cash flows

diverted to China Telecom's associate, China Tower Corporation, FY20 ROIC would be

10.1%, exceeding WACC.

FY16 can be viewed as a trough for Unicom's ROIC, given its aggressive capex and also

promotional costs, in its attempt to kick-start top-line growth. We forecast that rising

revenue will drive higher margins, and a recovery in ROIC to 6.4%. This still represents an

inferior return versus China Telecom, and a meaningful gap versus WACC of 10.1% is still

expected to exist. Thus, Unicom is expected to remain value destroying. However, it is

forecast to have sufficient scale to be comfortably cash flow positive and therefore

sustainable, albeit with low returns on capital invested.

There is, however, one very important caveat to this analysis, and that is with respect to

5G. The history of the China telcos shows that there is always the risk of aggressive capex

on the 'bleeding edge of technology' as the state-owned China telcos attempt to support

top-down government investment-led GDP targets (and the equipment lobby), without

sufficient regard to the potential for appropriate monetisation of the services. China

Mobile's extremely aggressive 4G investment phase at 2600MHz is one example of this,

and its current value-destructive roll-out of fibre to the home is another. While China

Returns are now beginning to rise…

…and even Unicom is likely to reach

sustainable size…

…though 5G represents a material

longer-term risk

20 June 2017


Mobile's dominant revenue share allows it to shoulder this burden (making lower returns

than would otherwise be the case, but at least overall making returns above WACC),

China Telecom and Unicom do not have this benefit, and this increases their risk profile.

With standardisation of 5G not yet completed, mass-market roll-out could easily be a post-

2020 event, and the frequencies which will be used, network density and therefore capital

intensity are not clear as yet. The earlier a 5G roll-out is required, and the more capital

intensive it is, the worse the news will be for China Telecom and Unicom. Indeed, in our

view, a very early and very intense 5G roll-out requirement could trigger industry

restructuring, even to the point of a merger of the two smaller players. (Arguably, creation

of the tower company, which represents consolidation of three sets of tower infrastructure

into one has been critical in supporting the sustainability of Unicom and China Telecom in

the 4G era.)

What is in the price?

We continue to rely primarily on discounted cash flow (DCF) to set our target prices, since

it is the only way to fully capture the multi-year nature of cellular investment and payback

(particularly given what we have explained to be heavy upfront capex to establish

nationwide coverage and launch credible cellular services).

At present, we believe that the market is only marginally overpaying for quality and scale

advantages, given that we have 30.7% potential upside for China Mobile, but 40.6%

potential upside for China Telecom. However, the upside is partly skewed by the

HK$1.69/share value uplift we ascribe to China Telecom for its 27.9% stake in the China

Tower Corporation, versus a much smaller (in proportional terms) HK$3.23/share for

China Mobile. Reference to the P/E ratios suggests that both stocks look attractive versus

the region, and China Mobile's higher scale and higher ROIC look quite fairly represented

in the relative EV/IC multiples; it trades at more than 2.0x the EV/IC multiple but generates

circa three times the return on capital in FY16, declining to 1.8x by FY20 on our forecasts

as China Telecom builds scale and China Mobile continues its value destructive fixed

broadband roll-out.

Figure 32: Chinese cellular sector—comparative multiples

Close Target Upside Normalised P/E (x) EV/EBITDA (x) EV/IC (x) FCF yield (%) Div yield (%)

price price (%) 17E 18E 17E 18E 17E 18E 17E 18E 17E 18E

China Telecom 3.77 5.3 40.6% 12.6 10.7 3.5 3.2 0.9 0.9 1.0% 7.1% 3.3% 4.2%

China Unicom 11.3 14.1 24.8% 74.7 26.3 5.1 4.5 1.3 1.3 15.1% 13.4% 0.3% 1.9%

China Mobile 84.15 110 30.7% 12.8 12.1 3.7 3.3 2.0 1.9 5.3% 7.2% 3.6% 4.1%

Unicom A* 7.47 4.7 -37.1% 130.7 50.5 7.8 6.9 1.9 1.9 7.5% 6.7% 0.2% 1.0%

NJA- Integrated 24.5 16.6 6.5 6.2 6.4% 7.5% 4.3% 4.5%

NJA - Mobile 17.3 15.3 5.7 5.4 4.5% 6.2% 3.4% 3.8%

* We have used the last quoted price for Unicom A – the stock is currently suspended. Source: Company data, Credit Suisse estimates

`

In direct contrast, the valuation of Unicom A-share makes no sense to us, trading at 1.9x

EV/IC despite Unicom's ROIC of 0.6% in FY16 and 6.4% in FY20. Indeed, given that the

Hong Kong-Shanghai Connect exists, investors who want exposure to Unicom's

operations are far better off buying Unicom H-share (0762.HK), the red chip listed in Hong

Kong; while the shareholding structure is different, the underlying operating assets in

which Unicom (A) owns a stake are identical to those of Unicom (H), and Unicom (A) does

not own any other additional assets or businesses. At present, Unicom (A) trades at a

premium of over 100% versus Unicom (H).

Both China Mobile and China Telecom look

attractive…

…while Unicom A share looks very

unattractive

20 June 2017


Figure 33: Share price performance—Unicom (H) has underperformed as it lost scale, the A-share has not

Source: Company data, Credit Suisse

40

60

80

100

120

140

160

180

200

220

240

260

280

300

320

Jan-14 Jul-14 Jan-15 Jul-15 Jan-16 Jul-16 Jan-17

China Mobile Unicom China Telecom Unicom-A

20 June 2017


Indonesia

Summary

■ In terms of industry structure, the Indonesia market looks the most attractive in Asia,

with the best monetisation of data, no new entrants and no fully unlimited data plans.

■ We expect the Indonesia market to grow service revenue at a CAGR of 6.9% across

FY16-FY20.

■ PT Telkom's cellular unit, Telkomsel, is dominant with 62.7% revenue market share as

at 1Q17 and an FY16 ROIC of 43.9%. However the market looks to be slightly

'overpaying' for PT Telkom's scale and liquidity relative to the Indonesian #2 player.

■ Indosat looks to be a #2 player underappreciated for its increasing returns on capital.

Given this, it is currently undervalued and we highlight it as a top pick. XL now looks

close to fully valued following a sharp share price rally.

High cellular revenue growth, but lopsided

Following an aggressive price war in 2007-08, triggered by a shift from a three-player

market to a ten-player market (and leading to new and re-capitalised competitors

attempted to build scale), the Indonesian cellular market in recent years has enjoyed much

more attractive competitive dynamics. This in turn has been supported by (1) what we

would call de facto consolidation, such as the loss of subscriber traction and termination of

investment in the Bakrie Telecom and Telkomflexi fixed wireless CDMA offerings and (2)

actual consolidation through the acquisition of Axis (Not listed) by XL and the merger of

Mobile 8 with Smart to create SmartFren.

As a result of sensible voice and data pricing moves, together with what is still a relatively

low 4G penetration rate (14.7% as at December 2016), the Indonesian cellular market has

delivered the highest cellular revenue growth rate in Asia for seven consecutive quarters.

Figure 34: Cellular service revenue growth

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

Telkomsel 12.1% 13.8% 18.5% 14.5% 17.8% 14.5% 11.5% 13.0% 10.4%

Indosat 5.4% 12.9% 17.1% 13.8% 15.8% 11.2% 9.2% 5.1% 6.6%

XL 2.5% -5.4% -1.1% 0.8% 0.8% -7.1% -10.4% -11.1% -6.9%

Others 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 15.0% 12.0% 12.0%

Total 8.5% 9.7% 14.3% 11.8% 14.2% 10.1% 7.5% 7.5% 7.0%


However, we observe that growth has been tilted heavily towards market leader

Telkomsel. Thus, at first glance perhaps counterintuitively, the largest player in the market

has been getting larger, reaching 62.7% market share by revenue as at 1Q17.


1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

Telkomsel 58.2% 59.0% 60.3% 60.1% 60.7% 61.9% 62.8% 63.4% 62.7%

Indosat 16.7% 17.2% 17.2% 17.4% 17.1% 17.5% 17.5% 17.0% 17.0%

XL 17.7% 17.2% 16.5% 16.4% 15.8% 14.6% 13.8% 13.6% 13.8%

Others 7.4% 6.6% 6.1% 6.1% 6.4% 6.0% 5.9% 6.0% 6.5%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


Indonesia has delivered the fastest revenue

growth in Asia in recent years…

20 June 2017


Several factors have been behind this lopsided industry growth.

■ Strong execution at Telkomsel: Telkomsel has successfully taken advantage of

stabilising competition (and the aforementioned, XL-Axis consolidation) to gradually

raise voice and SMS price points where possible. This has been pursued on a regional

basis; Telkomsel is now run through 206 pricing 'clusters' in order to maximise

opportunities from regional differentials in competitive intensity. Indeed, Telkomsel has

led tariffs upwards on voice, SMS and recently data (by reducing 4G data bonuses).

■ Poor execution at XL: While Indosat has almost kept up with Telkomsel, and has

broadly maintained its market share, XL has been the key market share 'donor' and in

revenue terms has significantly underperformed both of its larger peers. This has in

large part been caused by XL's February 2015 decision to no longer chase after what

were termed 'value-destroying customers', and a resulting loss in overall subscriber

growth and traction in traditional distribution channels.

■ Balance sheet strength: While both Indosat and XL are ultimately controlled by large,

well-capitalised groups, and while management has insisted that the companies were

not constrained on capex, heavy USD-denominated debt exposure prior to a recent

deleveraging process dragged earnings (in FY15 in particular) and contributed to slow

ex-Java roll-out plans in recent years.

■ Regulation: Indonesia's regulator, the BRTI, proposed an interconnect rates cut from

Rp250/min to Rp185/min effective 1 September 2016, and this might have (marginally)

reduced the value proposition to Telkomsel's 'on-net customer communities'

particularly outside of Java. However, this change, together with other draft legislation

on network sharing which would have been negative to Telkomsel, still has not been

implemented. In Indonesia's case, therefore, regulatory intransigence has favoured the

incumbent.

Still plenty of room for revenue to grow

We continue to see a significant opportunity for data volume growth in Indonesia, given

that smartphone penetration only reached 60.2% of the population as at December 2016,

while 4G penetration had only reached 14.7% of the population. Data volumes per

customer are roughly tripling to circa 1GB per month after customers acquire a

smartphone, then quadrupling again to circa 4GB per month on average as they upgrade

to 4G. Rising penetration therefore drove Telkomsel's total data traffic up by 115.5% YoY

into 1Q17.




growth. Having successfully raised voice prices (as shown below), Telkomsel is now

SingaporeHong Kong

Malaysia

Indonesia

Korea

China

Thailand

PhilippinesIndia

Taiwan

Australia

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

- 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000

4G p

enet

ratio

n


…but the largest player has grown fastest

Low 4G penetration rates…

…and sensible data pricing….

20 June 2017


turning its attention to data pricing. The 115.5% traffic growth in 1Q17 led to 21.3% data

revenue growth (a ratio of 0.2x revenue growth to volume growth) as the price per MB

declined to Rp21/month, and Telkomsel’s management is keen to drive that ratio to 0.3x or

above, so that double digit overall revenue growth can be maintained even if voice

revenue growth slows further.

Figure 38: Voice price per minute (Rp) Figure 39: Data price per MB (Rp)

Source: Company data, Credit Suisse research Source: Company data, Credit Suisse research

Benign competitive dynamics, and Telkomsel's strong track record on voice and 3G

pricing, lead us to believe that this is likely to be achieved. We note that Telkomsel

reduced 4G bonus allocations in December 2016 and has also begun limiting usage of

bonus allocations to certain categories of content (video). On the standard '2GB' plan,

priced at Rp95,000 in Jakarta, the 4G bonus is now 3GB plus 5GB of content, rather than

10GB, and the 3GB bonus has a validity of only 15 days, rather than 30 days.

We therefore forecast that in FY17 Telkomsel will again deliver double-digit revenue

growth, for the seventh consecutive year. We also expect the market as a whole to

achieve double digit revenue growth in FY17.

Figure 40: YoY cellular revenue growth (Rp bn) and revenue growth rates (%)

Rp bn FY14 FY15 FY16 FY17 FY18 FY19 FY20

Telkomsel 6,221 9,803 10,670 9,779 7,673 4,627 4,428

Indosat 106 2,415 2,200 2,143 1,231 1,115 1,103

XL 2,179 (546) (1,644) 1,950 1,452 1,281 1,281

Others (2,701) 303 316 1,012 1,134 1,270 1,422

Total 5,804 11,975 11,542 14,885 11,489 8,293 8,235

Growth (% YoY)

Telkomsel 10.4% 14.8% 14.0% 11.3% 8.0% 4.4% 4.1%

Indosat 0.5% 12.4% 10.0% 8.9% 4.7% 4.1% 3.9%

XL 10.6% -2.4% -7.4% 9.5% 6.4% 5.3% 5.1%

Others -25.7% 3.9% 3.9% 12.0% 12.0% 12.0% 12.0%

Total 5.3% 10.3% 9.0% 10.6% 7.4% 5.0% 4.7%


We expect a more even share of revenue growth

One key difference in FY17 versus the preceding three years is that we anticipate that

industry growth will be far more evenly shared. In particular, we forecast that XL will

resume growing far more closely with the industry.

-

50

100

150

200

250

4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16

Telkomsel Indosat XL

-

20

40

60

80

100

120

4Q13 1Q14 2Q14 3Q14 4Q14 1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16


…lead us to expect double digit revenue

growth

We expect all of the 'big 3' to grow broadly

in line with the market…

20 June 2017


Figure 41: Cellular revenue (Rp bn) and revenue market share (%)

Rp bn FY14 FY15 FY16 FY17 FY18 FY19 FY20

Telkomsel 66,252 76,055 86,725 96,504 104,177 108,804 113,231

Indosat 19,480 21,896 24,095 26,238 27,470 28,585 29,688

XL 22,764 22,218 20,575 22,524 23,976 25,257 26,539

Others 7,817 8,120 8,436 9,449 10,582 11,852 13,275

Total 116,314 128,289 139,831 154,716 166,205 174,498 182,733

Market share (%)

Telkomsel 57.0% 59.3% 62.0% 62.4% 62.7% 62.4% 62.0%

Indosat 16.7% 17.1% 17.2% 17.0% 16.5% 16.4% 16.2%

XL 19.6% 17.3% 14.7% 14.6% 14.4% 14.5% 14.5%

Others 6.7% 6.3% 6.0% 6.1% 6.4% 6.8% 7.3%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%




XL purchased an additional 2x10MHz of 1800MHz spectrum through its (albeit very

expensive) acquisition of Axis for US$865 mn. This has created a relatively level playing

field, at least across the 'big 3' operators (Telkomsel, Indosat, and XL) in the core

900MHz, 2100MHz and 1800MHz bands supporting 2G, 3G and 4G services. All three

operators are also using the same technologies (GSM, W-CDMA, and FDD LTE) and are

therefore being supported by the same handset and equipment ecosystem.


MHz 850 MHz 900MHz 1.8GHz 2.1GHz 2.3GHz

Telkomsel 5*2 7.5*2 22.5*2 15*2

Indosat 2.5*2 10*2 20*2 10*2

XL 7.5*2 22.5*2 15*2

Hutch Indonesia 10*2 10*2

SmartFren 10*2 30*1


This in itself is a reason for all three players to take part in industry growth (other things

being equal). Indeed, given Telkomsel's much larger subscriber base, XL and Indosat are

currently carrying far fewer customers per MHz of spectrum, conferring something of a

capacity advantage, though as we shall see Telkomsel's subscriber base is spread over a

much wider geographical coverage, limiting the impact on customers in key cities in Java.

In contrast, smaller players such as Hutch Indonesia look strategically vulnerable in this

context. Hutch's (limited) 1800MHz spectrum is currently used to support voice services

for existing 2G subscriber base, and this constrains Hutch's ability to aggressively role out

4G at 1800MHz. SmartFren has ample 4G spectrum, with 30MHz of 2300MHz spectrum,

but is the only operator offering TD LTE services, given the unpaired nature of the

spectrum allocation it was awarded.

The proposed auctions for two blocks of 2x5MHz of 2100MHz spectrum, and one block of

15MHz of unpaired 2300MHz spectrum, are unlikely to change this 'balance of power' in

our view. We would expect Telkomsel to win 1x5MHz of 2100MHz spectrum to ease

capacity constraints, and if it is also allowed to bid for 2300MHz spectrum we expect it to

do so. Given that no 1800MHz spectrum is available, we do not expect a 'game-changing'

outcome for either Hutch or SmartFren (and we see little prospect of the auction triggering

value destruction on anywhere near the scale witnessed in Thailand in late 2015).

…after analysing spectrum allocations,

network and capital intensity

20 June 2017


BTS by operator

Telkomsel's 62.7% revenue market share is underpinned by its broad geographical

coverage, in the shape of 50,344 2G base transceiver systems (BTS) and 72,327 3G BTS.

With over 100% SIM card penetration of the population, the growth driver is the upgrade

from 2G to 3G and increasingly from 3G to 4G. In this regard the fact that all of the 'big 3'

commenced 4G at the same time after a nationwide re-farming of 1800MHz spectrum in

November 2015 is supportive of our expectation for a more even share of revenue growth

going forward; at present the 4G coverage across all of the 'big 3' is fairly even. On the

other hand, we would not expect XL and Indosat to grow faster than Telkomsel unless and

until significant inroads are made on Telkomsel's geographical dominance; opening up

2G, 3G, and 4G revenue opportunities to the challengers.



Telkomsel 50,344 72,327 6,362 129,033 39.7%

Indosat 24,042 27,724 4,717 56,483 17.4%

XL 37,549 38,731 8,204 84,484 26.0%

Hutch Indonesia 17,000 17,000 6,000 40,000 12.3%

SmartFren 2,000 12,850 14,850 4.6%

Total BTS 130,935 155,782 38,133 324,850 100.0%


Again, Hutch Indonesia and SmartFren look vulnerable. While SmartFren has received a

very generous allocation of unpaired spectrum at 2.3GHz, it lacks coverage. To catch up

on coverage will take a long time and, as we shall see, requires a level of capex

investment which would preclude a reasonable return on capital. Similarly, even 12 years

after Cyber Access (Not listed) was acquired to form Hutch Indonesia, given the size of the

network resources deployed and the aforementioned limitations on 1800MHz (4G)

spectrum resources, we would estimate that the company remains deeply cash flow

negative—just as Axis was before its acquisition by XL.

Capital intensity

Telkomsel's geographical coverage advantage over Indosat and XL looks unlikely to be

overhauled when we consider both recent and projected capex trends. Telkomsel has

been outspending both Indosat and XL by ratios of more than 2:1, and we expect this to

continue. In fact these figures understate the magnitude of Telkomsel's capex advantage,

given that we have compared the capex of Telkomsel alone with the consolidated (fixed

plus cellular) capex of Indosat. Were we to include an allocation of fibre investment from

PT Telkom's fixed line division in support of Telkomsel, the gap would be even wider. On

the other hand, when we consider Telkomsel's much larger subscriber base, Telkomsel is

of course enjoying the benefits of scale (a lower capex to sales ratio), but in our view is

probably maintaining, rather than actually widening its coverage and quality gap over XL

and Indosat based on the current capex trajectories.

20 June 2017


Figure 44: Capex by operator (Rp bn) Figure 45: Capex-to-sales ratios (%)



We note that both XL and Indosat are now well positioned to maintain the aforementioned

capital intensity; on the basis of our current projections both operators are free cash flow

positive. Furthermore, after an aggressive de-leveraging process, XL's FY16 net debt to

EBITDA was lowered to 1.9x and Indosat's was lowered to 1.7x (PT Telkom's net debt to

EBITDA as at FY16 was just 0.0x). Importantly, XL has also cut its USD-denominated debt

exposure to just US$350 mn (fully hedged) from a peak of over US$1.5 bn, while Indosat

has cut its USD-denominated debt exposure to just US$180 mn, from a peak of US$1.2

bn. Neither operator now looks capital constrained therefore, but, as previously mentioned,

balance sheet pressure during FY14-15 in our view clearly contributed to decisions made

by both management teams to minimise capex commitments outside Java, thereby

perpetuating Telkomsel's very strong geographical coverage advantages.

Regulation

Regulation can be a trigger for a step-change in market share dynamics, but we are not

expecting any material changes in Indonesia. High voice interconnect rates favour the

largest player with the largest 'network' of subscribers, since they tend to enjoy a net inflow

of traffic. Indonesia's very high interconnect rates have also increased the 'value

proposition' of Telkomsel offering cheap 'on-network' calls between its subscribers, and

making it difficult for smaller players to break in to Telkomsel-dominated areas (particularly

outside Java where, on average, smartphone penetration is lower and voice usage

higher). As mentioned, Indonesia's regulator, the BRTI, recently drew back from a cut in

interconnect rates cut from Rp250/min to Rp185/min.

Similarly, more radical plans, aired in mid-2015, to make network sharing mandatory (and

therefore potentially to completely remove network coverage advantages), were not

supported by the government and have been abandoned. The ongoing status quo in

regulation can be viewed as positive for Telkomsel, and, together with spectrum, network

and capex considerations, lead us to expect only an improvement in the relative growth

rates of XL and Indosat, rather than material market share gains from the two challengers.

Do smaller players have a viable business?

We note that cellular operators do not really have the luxury of 'cherry picking' coverage

areas. In order to attract subscribers, cellular players must be able to demonstrate broad,

seamless coverage. Given that this overall coverage capex requirement, together with

associated operating costs, is common to all cellular operators, the relative scale or

revenue market share is the primary determinant of returns on invested capital and

profitability. The large disparity in revenue market share in Indonesia, together with the

very high 'fixed' cost of rolling out a cellular network across its wide geography, leads to

starkly differing returns on capital.

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

16,000

18,000

20,000



0%

5%

10%

15%

20%

25%

30%

35%

40%



Only Telkomsel currently generates a ROIC above WACC…

20 June 2017


Indeed, in FY16, only one cellular player—Telkomsel—was able to generate a return

greater than cost of capital. Its FY16 revenue market share of 62.0% was able to drive a

very attractive ROIC of 43.9%, given high EBITDA margin (57.4%) (thanks to the absence

of handset subsidies) and asset turn of 1.4x.

Neither Indosat nor XL is currently generating adequate returns on capital. With FY16

revenue share of 17.2%, Indosat generated an ROIC of 7.6%, lower than our assumed

WACC of 11.2%. XL's returns are even lower, at just 0.1%, versus a WACC of 11.2%.

The crux of the problem is that, due to the aforementioned coverage capex requirements,

Indosat and XL's invested capital, at Rp36.6 tn and Rp37.8 tn represent 57.7% and

59.6%, respectively, of Telkomsel's invested capital. Yet at Rp29.2 tn and Rp21.4 tn,

respectively, Indosat and XL's service revenues represent only 33.7% and 24.7% of

Telkomsel's FY16 service revenue of Rp86.7 tn. Given network operating costs, Indosat

and XL's consolidated EBITDA margins are also much lower than Telkomsel's, at 44.1%

and 37.6%, respectively. On each measure XL is worst-placed than Indosat, in part due to

a relatively aggressive (and in hindsight inefficient) roll-out of 2100MHz 3G equipment, in

part due to the expense of the Axis acquisition, and in part due to the loss of revenue

share following the 1H15 change in strategy.

While we have not explicitly shown an ROIC analysis for Hutch Indonesia and SmartFren

given a lack of consistent published financial information, our market revenue model

suggests that Hutch Indonesia commands a revenue share of around 6%, while

SmartFren's revenue is still negligible as it transitions its business to 4G cellular from 2G

CDMA. At 6% revenue share Hutch Indonesia's revenue would only be one-tenth of

Telkomsel's and less than half of XL's revenue base. Heavy fixed cost would make

negative returns on capital highly likely.


FY16 FY20 4 -year CAGR

Rp bn Telkomsel Indosat XL Telkomsel Indosat XL Telkomsel Indosat XL

Subscribers (000s) 173,920 85,600 46,433 177,920 92,000 62,537

Service revenue 86,725 29,185 21,412 113,231 35,200 27,346 6.9% 4.8% 6.3%

EBITDA 49,781 12,864 8,056 63,183 15,151 10,575 6.1% 4.2% 7.0%

EBITDA margin 57.4% 44.1% 37.6% 55.8% 43.0% 38.7%


EBIT 36,974 3,891 12 46,488 6,618 2,476 5.9% 14.2% 279.0%

EBIT margin 42.6% 13.3% 0.1% 41.1% 18.8% 9.1%

Tax rate (%) 24.7% 28.9% -102.5% 25.0% 25.0% 25.0%

NOPLAT 27,830 2,765 24 34,866 4,964 1,857 5.8% 15.8% 195.7%


Asset turn 1.4 0.8 0.6 1.5 1.2 0.9

ROIC 43.9% 7.6% 0.1% 46.1% 16.9% 6.4%

Net profit 28,194 1,105 375 35,062 3,526 1,712 5.6% 33.7% 46.1%

Net margin 32.5% 3.8% 1.8% 31.0% 10.0% 6.3%


The most obvious way for the smaller players to drive up their returns is to generate more

revenue (while keeping operating costs under control). We believe that in the case of

Indosat and XL, with 17.2% and 14.7% FY16 service revenue market share respectively,

and with the benefit of competitive spectrum allocations, geographical coverage and

capital intensity, this expectation is reasonable.

Indeed, by 2020 we expect Indosat's ROIC to reach double digits, even growing slightly

slower than the overall cellular industry. The high operational leverage conferred by

Indosat's heavy fixed network, spectrum and staff costs lead us to project 33.7%

compound growth in earnings.

..but Indosat is set to achieve double-digit

ROIC by 2020

20 June 2017


XL's ROIC and earnings growth are expected to follow a similar trajectory, but XL's smaller

scale and commensurately heavier fixed costs result in a lower starting point on earnings

and ROIC, and even higher growth. Thus, ROIC is expected to more than triple by FY20,

and earnings are expected to grow at 46.1% compound. We do expect XL to achieve

double digit ROIC and therefore a 'viable' business, but this is expected to occur two years

later, in 2022.

On the other hand, our analysis suggests that without structural change—such as

consolidation, or a material regulatory change such as the introduction of mandatory

roaming—players which are smaller than XL in revenue terms are not likely to generate

returns anywhere close to cost of capital even in the medium term.

What's in the price?





At present, we believe that the market is overpaying slightly for quality and scale

advantages, given that we have only 16.7% potential upside for PT Telkom, but 41.9% for

Indosat. This might reflect PT Telkom's far superior liquidity (average trading volume

US$24 mn per day over the last six months, versus US$1.8 mn for XL and US$0.2 mn for

Indosat). It might also reflect the higher risk attached to Indosat, given that it does not yet

generate adequate returns. However, we would argue that this risk is potentially being

'double-counted', since our DCF already by definition discounts future cash flows more

heavily by applying a time value of money.

While multiples related to any particular year are less helpful (since they only represent a

'slice' of the overall investment project) standard comps for FY17 and FY18 suggest a

similar conclusion. Indosat currently trades at a meaningful discount to PT Telkom on

EV/EBITDA and EV/IC, more than reflecting the lower return on invested capital that is

currently being generated.

While Indosat looks more attractive than PT Telkom, following a sharp share price rally XL

now looks close to fully valued, in our view, particularly in the context of its poor returns on

capital. We downgrade the stock to NEUTRAL.

Figure 47: Indonesian cellular sector—comparative valuation



XL 3,160 3,600 13.9% 60.5 36.1 5.4 4.9 1.3 1.3 2.7% 6.4% 0.5% 2.2%

Indosat 6,200 8,800 41.9% 14.9 12.5 3.8 3.4 1.6 1.5 13.3% 12.5% 3.3% 4.8%

PT Telkom 4,370 5,100 16.7% 17.8 16.2 9.3 8.4 3.8 3.7 3.9% 5.4% 3.9% 4.3%

NJA - integrated 24.5 16.6 6.5 6.2 6.4% 7.5% 4.3% 4.5%

NJA - Mobile 17.3 15.3 5.7 5.4 4.5% 6.2% 3.4% 3.8%


Indonesia remains, in our view, the most attractive cellular market in Asia, with no new

entrants (in fact, consolidation), no handset subsidies, and limited risk on spectrum fees.

While PT Telkom is (1) a 'consensus buy', (2) is slightly expensive versus regional peers

and (3) has outperformed the regional telco sector over the last 12 months, it remains the

only liquid (large cap) way to invest in the successful monetisation of Indonesia's data

boom.

But for investors who can invest in stocks with lower daily trading volumes, Indosat offers

more potential upside than PT Telkom from current share price levels. This makes intuitive

sense; in a growing market with a benign competitive environment the high operational

gearing of the smaller operators can work in their favour. Crucially, we believe that both

XL has what we might call 'the minimum'

scale to be sustainable

The market is 'overpaying' for PT Telkom's scale and

liquidity

We see more upside in XL and Indosat than in

PT Telkom at present

20 June 2017


companies are already large enough to reach appropriate scale and produce returns on

capital above cost of capital in within the next 3-5 years, primarily due to overall market

growth.

Figure 48: Share price performance (rebased); XL could recover as revenue grows and ROIC improves

Source: the BLOOMBERG PROFESSIONAL™ service

In contrast, our numbers show that players with revenue market share of less than 14.7%

in FY16 have little chance of reaching sufficient scale and are therefore not in a position to

generate adequate returns, even in the medium term. We conclude that these businesses

are not sustainable, unless subject to material structural change.

30

60

90

120

150

180

210

240


PT Telkom XL Axiata Indosat

20 June 2017


Korea

Summary

■ In terms of industry structure, the Korean market looks relatively unattractive, with high

4G penetration and extensive handset subsidies.

■ We expect the Korea market to grow service revenue at a CAGR of 1.7% across FY16-

FY20; in positive territory.

■ SKT is dominant with 48.0% revenue market share as at 1Q17 and an FY16 ROIC of

5.5%. However this looks to be partly in the price.

■ #2 player KT and challenger LGU look to be undervalued relative to their strong cash

flow generating ability, with no major capex needs in the years before 5G.

4G-driven cellular revenue growth

Korea telcos rolled out 4G from 2H11, triggering intense competition among the three

operators based on handset subsidy, in pursuit of high ARPU subscribers. All three

operators saw a sharp rise in marketing expenses which also increased regulatory

pressure from the government. Nevertheless, 4G had a positive impact on the revenue

side. Net adds remained limited due to high cellular penetration but Korea telcos were able

to turn around cellular ARPU which had been on a multi-year declining trajectory due to

limited up-selling effect from 3G and government tariff cut pressures. Consumers reacted

positively to enhanced data speed and were willing to pay a premium and the operators

also devised sensible tariff schemes based on data consumption demand, in our view

Driven by rapid 4G take-up rate (30% by end of 2012, 52% by end of 2013, and 63% by

end of 2014), the Korea telcos enjoyed relatively decent top-line growth during 2012-14 in

a market that already was well into maturity growth stage. With 4G penetration now well

over 70%, 4G take-up driven ARPU growth has largely subsided but rather is being

pressured by (1) 'selective tariff discount programme' in which subscribers opt for c.20%

tariff discount over one-off handset subsidy, and (2) rise in MVNO second device subs.


1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

SKT -1.2% -2.4% -2.8% -3.1% -1.0% -1.0% -1.5% -0.4% -0.7%

KT 5.6% 5.6% 2.3% -0.6% 2.8% 2.2% 1.7% 0.2% -1.5%

LGU 4.5% 6.1% 3.7% 0.0% 3.6% 2.8% 3.5% 3.2% 3.8%

Total 1.9% 1.6% 0.0% -1.7% 1.1% 0.8% 0.5% 0.6% 0.0%


During the 4G era, growth has been skewed to the third operator LGU, which previously

had only competed based on price. LGU’s network strategy heavily depended on 4G (i.e.,

pre-emptive investments, aggressive spectrum acquisition) and it paid off due to

consumers' fast take-up of 4G. As a result, LGU became the biggest mover during the 4G

era on cellular service revenue market share, gaining 7.7 pp share during 2011 and 2016,

while the number one player SKT lost 7.3 pp and number two KT lost 0.4% pp.

Korea enjoyed decent revenue growth during 2012-14 driven by rapid

increase in 4G penetration…

20 June 2017



1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

SKT 50% 49% 49% 49% 49% 48% 48% 48% 48%

KT 29% 29% 29% 29% 30% 30% 30% 29% 29%

LGU 21% 22% 22% 22% 22% 22% 22% 23% 23%

Total 100% 100% 100% 100% 100% 100% 100% 100% 100%


Several factors have been behind this lopsided industry growth.

■ Ambitious focus on 4G and strong execution: LGU had a key focus on 4G, pre-

emptively investing in 4G and focused on complete overhaul on branding, which

previously was mostly known for cheaper tariffs but poor network quality. Despite its

smaller scale, LGU aggressively rolled out 4G acquiring 2.6GHz spectrum with 40MHz

bandwidth in 2013 which further helped solidify it as a leading 4G operator. LGU also

was aggressive on the marketing front, consistently outspending its competitors. This

aggressive capex and opex drove FCF into negative during 2011-14 but the focus

appears to have paid off as superior net adds and high growth of ARPU have put FCF

back in black from 2015.

■ Weak execution from SKT/KT: In comparison, SKT initially was less motivated and

proactive on 4G, in our view, due to its previous heavy investments in 3G. KT's 4G roll-

out was c.6 months late due to legal issues regarding 2G network termination.

Relatively relaxed entrances into 4G from SKT/KT have partially helped LGU re-brand

itself in the 4G era, in our view.

Limited upside for cellular revenue

With smartphone penetration close to 98% and LTE penetration at 91%, we see limited

upside for Korea operators' cellular revenue. Data consumption growth is still strong,

growing by 31% YoY (March 2017 average data consumption per 4G subscriber was

6.1GB); however, we believe this may be mainly driven by data consumption from

subscribers with unlimited data plans. Data consumption from subscribers without

unlimited data plans are rising more steadily as they should be more disciplined to stay

within the data capacity of their tariff bracket.



We believe the key revenue drivers are, unlimited data plan take-up rate and increase in

data consumption for non-unlimited data plan subscribers, which should result in migration

to higher data bucket plans.

On the other hand, Korean telcos are seeing pressure from selective tariff discount plans,

initiated by the government. Consumers have a choice to opt for selective tariff discount

SingaporeHong Kong

Malaysia

Indonesia

Korea

China

Thailand

PhilippinesIndia

Taiwan

Australia

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

- 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000

4G p

enet

ratio

n


…LGU has been the great turnaround story

during 4G era

Limited upside on 4G penetration rates…

Uptake in unlimited data plans and

selective tariff discount plans cancel each

other out…

20 June 2017


plans at the expense of subsidy (i.e., cumulative monthly tariff discount should largely

match the upfront subsidy on a handset).

Heading into the latter part of the 4G era, we do not see much change in trend for the

three Korean operators, although there may be some changes in FY20, triggered by the

roll-out of 5G during late FY19. Even for 5G, our current base-case scenario is that, there

may not be too many implications on the B2C side, as currently 4G offers satisfactory

speed for most consumers, in our view, and all three telcos have heavily invested in 4G.

Unless there is an emergence of a killer service which requires 5G on the consumer side,

we believe 5G impact will be more subtle vs 4G.

Figure 53: YoY cellular revenue growth (W bn) and revenue growth rates (%)

W bn FY14 FY15 FY16 FY17 FY18 FY19 FY20

SKT 70 (265) (105) (19) (39) (53) (37)

KT 374 198 112 32 177 70 1

LGU 465 165 159 193 168 129 107

Total 94 98 166 206 307 146 70

Growth (% YoY)

SKT 0.6% -2.4% -1.0% -0.2% -0.4% -0.5% -0.3%

KT 6.3% 3.1% 1.7% 0.5% 2.7% 1.0% 0.0%

LGU 11.0% 3.5% 3.3% 3.9% 3.2% 2.4% 1.9%

Total 4.3% 0.4% 0.7% 0.9% 1.4% 0.6% 0.3%


We expect LGU to continue to gain market share

With similar network quality from the three operators and slightly more aggressive

marketing expense from LGU and arguably the strongest brand in regards to 4G, we think

LGU will continue to get the upper hand on handset-based MNO net adds which will also

lead to a resilient cellular ARPU trend going forward. Thus, we expect LGU to continue to

outgrow its competitors.

Figure 54: Cellular revenue (W bn) and revenue market share (%)

W bn FY14 FY15 FY16 FY17 FY18 FY19 FY20

SKT 11,180 10,915 10,810 10,791 10,752 10,699 10,662

KT 6,313 6,511 6,623 6,655 6,833 6,903 6,904

LGU 4,678 4,843 5,002 5,195 5,363 5,491 5,598

Total 22,171 22,269 22,435 22,641 22,947 23,093 23,164

Market share (%)

SKT 50.4% 49.0% 48.2% 47.7% 46.9% 46.3% 46.0%

KT 28.5% 29.2% 29.5% 29.4% 29.8% 29.9% 29.8%

LGU 21.1% 21.7% 22.3% 22.9% 23.4% 23.8% 24.2%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


Spectrum allocations and BTS by operator

■ KT is the only operator that discloses the number of base transceiver systems (BTS) in

its 20F filing. However, it is our understanding that the three telcos are largely at par in

terms of number of BTS, based on our discussions with Korea telcos. Moreover, with

the data-centric nature of 4G and beyond, we consider bandwidth capacity more of a

driver for network quality compared to the number of BTS.

■ LGU made a surprise move back in 2013, acquiring 40 MHz bandwidth in 2.6 GHz

frequency, securing ample bandwidth for its 4G-centric network strategy. This move

was quite aggressive as LGU did not have a presence in this frequency previously

which meant that the network build-up has to be ground-up. This led to sharp capex

…unless there is an emergence of a killer service in regards to 5G, revenue growth

trend should not see meaningful derail from

the previous trend

LGU should continue to see superior net adds on MNO which in turn

will result in more resilient ARPU trend

20 June 2017


increase for LGU in 2014 on top of high ramp-up of capex during 2011-12 driven by the

initial roll-out of 4G.

■ Currently, SKT/KT/LGU each has 135/95/100 MHz bandwidth for 4G. If we compare

the 4G bandwidth capacity per million 4G subscribers, LGU has the biggest capacity of

9.1MHz per mn subs, followed by KT with 7.0MHz/mn, and SKT with the smallest

capacity at 6.4MHz/mn.

■ It is largely expected that MSIP (Ministry of Science, ICT and Future Planning) will

provide specific plans for allocating 3.5GHz and (or) 28GHz spectrum for 5G services

during 2H18 and host spectrum auction during 2019 for 2020 commercialisation. We

also note that there has also been news flow (Digital Times, 9 May) that the schedule

may be expedited depending on the readiness of the operators.

Figure 55: Spectrum by operator

(MHz) 800MHz 900MHZ 1.8GHz 2.1GHz 2.6GHz

SKT

15*2 10*2 20*2 20*2

17.5*2 10*2 10*2

20*2

KT

5*2 10*2 10*2 20*2

7.5*2 20*2

10*2

LG Uplus 10*2 10*2 10*2 20*2

10*2

Source: Company data

20 June 2017


Figure 56: Detailed spectrum status per network generation


Figure 57: 4G spectrum capacity per 4G subscribers


Capex intensity

There is not much differentiation with regards to geographical coverage among Korea

telcos as all three are well covered. The three telcos had a 4G-driven capex upcycle

during 2011 and 2014 with initial roll-out, followed by additional increase in data

throughput. As can be seen in 2014, LGU was the most aggressive in further data capacity

ramp-up. It is somewhat surprising that after initially enjoying incremental capex

advantage during 2012 and 2013, SKT does not appear to enjoy superior advantage

despite a much larger cellular user base. We do note that our analysis includes fixed

service revenue and capex which may dilute some advantage for SKT and possibly

smaller 4G bandwidth per user may result in higher maintenance capex on the cellular

side. We think a 5G-driven capex upcycle will take place from 2019. Our base-case

scenario is that the capex intensity will reach a similar level to the initial 4G roll-out phase.

In actuality, 5G nationwide roll-out should entail higher capex than 4G as the spectrum

SKT

(MHz) Total Uplink Downlink

Total (4G) 165 (135) 80 (65) 85 (70)

800 - 4G 20 10 10

800 - 2G 10 5 5

1800 - 4G 35 15 20

2100 - 3G 20 10 10

2100 - 4G 20 10 10

2600 - 4G 60 30 30

KT


Total (4G) 125 (95) 60 (45) 65 (50)

800 - 3G 10 5 5

900 - 4G 20 10 10

1800 - 4G 55 25 30

2100 - 3G 20 10 10

2100 - 4G 20 10 10

LGU


Total (4G) 120 (100) 60 (50) 60 (50)

800 - 4G 20 10 10

1800 - EV-DO Rev.A 20 10 10

2100 - 4G 40 20 20

2600 - 4G 40 20 20

4G subs (mn) 4G bandwidth (MHz) 4G bandwidth per mn 4G subs

SKT 21.3 135 6.4

KT 13.6 95 7.0

LGU 10.9 100 9.1

20 June 2017


used for 5G requires higher number of BTS (e.g., for 28 GHz, we understand the reach is

one-fifth of 1.8 GHz or 2.1 GHz) but we think the pace of roll-out will be slower than that of

4G. Admittedly, this is very much a shot in the dark as the size of incremental capex is not

easily quantifiable at this juncture due to several factors as illustrated below.

■ Nationwide or hotspot concentrated? With rapid penetration of 4G, the operators

quickly ramped up 4G network nationwide. However, it is not clear at the moment

whether there will be meaningful demand for 5G for B2C, thus meaningful upselling

across subscribers may be limited, at least initially. Thus, we are inclined to think the

pace of roll-out may be slower and concentrated on hot-spots but competitive factors or

emergence of meaningful B2C/B2B business opportunity regarding 5G may trigger

faster ramp-up, in our view.

■ 3.5 GHz or 28 GHz? Our understanding is the global standards are leaning towards

28GHz for 5G; however, 3.5GHz is also being considered by MSIP. For cost

considerations, 3.5GHz would be beneficial as we understand there is higher

compatibility with existing network equipment and lower frequency would also entail

less need for small cell which should require less BTS.

Figure 58: Capex by operator Figure 59: Capex-to-sales ratio


Regulations

■ Of late, the presidential candidates had been making various pledges with regards to

telecom tariffs, which is a norm looking at past elections, in our view.

■ But the leading five candidates did not have tariff-related pledges in their key ten

pledges list. The emphasis appears to be largely more on enhancing competitiveness

amid the so-called fourth industrial revolution, including by President Moon.

■ We believe the characteristics of 5G (high data throughput, high capacity of

connections and low latency) have strong reliance on the Fourth Industry Revolution.

We believe the government will not be too aggressive in curbing investment capacity

ahead of 5G investments via interventions regarding tariff cuts.

■ The existing pledges from President Moon appear overly negative to be feasible, and

some contradict each other, in our view.

■ As we see from the past, the actual implementation of the tariff cut initiatives did not

yield as much damage since the industry is constantly evolving, and the regulations

often were made irrelevant.

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E

(W bn)

SKT KT LGU

0%

5%

10%

15%

20%

25%

30%

35%

FY12 FY13 FY14 FY15 FY16 FY17E FY18E FY19E FY20E

SKT KT LGU

20 June 2017



All three Korea telcos are displaying solid balance sheet strength to drive up capital

intensity ahead of 5G investments. All three telcos are showing elevated FCF level with

margin improvement from cost efficiency and a declining (or stabilised) capex trend. SKT

has continued to maintain ~1.0-1.2 x net debt to EBITDA but KT and LGU have recently

have gone through a de-leveraging process lowering net debt to EBITDA level to ~1.1-

1.5x. None of the three Korea telcos appear capital constrained assuming 5G capex

intensity remains similar to 4G level (i.e., higher capex requirements but a slower roll-out

agenda)

Superior ROIC for LGU

We find none of the Korea telcos currently generate adequate returns on capital. The three

telcos’ WACC ranges from 7.3% to 7.5% while SKT/KT/LGU’s ROIC in 2016 was

5.5%/5.6%/7.0% respectively.

However, we think KT and LGU’s ROIC will move above cost of capital in FY20E and

FY17E, respectively. On our estimates, we do not think SKT will make a meaningful

improvement in ROIC and will continue to generate returns below cost of capital. Based on

our ROIC analysis, SKT does enjoy superior margins likely based on dominant cellular

share (albeit declining trend); however, its asset turnover is the lowest compared to its

competitors, likely due to non-parent segment.


ROIC analysis FY16 FY20 4-year CAGR

(W bn) SKT KT LGU SKT KT LGU SKT KT LGU

Subscribers (000s) 29,595 18,457 12,235 31,387 21,369 13,856

Service revenue 14,638 19,528 8,607 15,012 20,822 9,886 0.6% 1.6% 3.5%

EBITDA 4,603 4,785 2,400 4,746 5,159 2,825 0.8% 1.9% 4.2%

EBITDA margin 31.4% 24.5% 27.9% 31.6% 24.8% 28.6%


EBIT 1,536 1,440 747 1,440 1,705 1,059 -1.6% 4.3% 9.1%

EBIT margin 10.5% 7.4% 8.7% 9.6% 8.2% 10.7%

Tax rate (%) 20.8% 29.2% 23.3% 24% 24% 24.0%

NOPLAT 1,216 1,019 572 1,094 1,296 805 -2.6% 6.2% 8.9%


Asset turn 0.6 0.8 1.0 0.5 0.7 0.9

ROIC 5.5% 5.6% 7.0% 4.4% 9.2% 9.5%

Net profit 1,660 798 562 2,384 1,409 740 9.5% 15.3% 7.1%

Net margin 11.3% 4.1% 6.5% 15.9% 6.8% 7.5%



To fully capture the multi-year nature of cellular investments and payback, we have

recently shifted our valuation methodology for KT and LGU to discounted cash flow (DCF).

We have been using DCF to value SKT's parent operations in SOTP valuation.

Based on our DCF valuations, we see the biggest upside for LGU (21% upside), while we

see the least upside (16% upside) for SKT. KT also offers a decent upside of 20%.

On relative valuation, KT appears attractive on most metrics. Especially on EV/EBITDA

multiple, the company appears especially cheap. SKT appears cheap on P/E basis due to

large inflow of equity method gain but on EV/EBITDA metrics, it does not look cheap in

comparison to its competitors. LGU is seemingly more expensive; however, we think its

superior returns justify the premium.

20 June 2017


We continue to remain positive on Korea telcos industry position, as for the next 2.5 years,

the operators are set to enjoy latter monetization stage of 4G. We see limited growth for

cellular however benign competition will result in solid earnings trend in our view. Capex

should also remain calm until 5G driven upcycle possibly kicking in from 2H19. On the

regulatory side, we are seeing more noises than previously as Korea now has a new

president. Nevertheless, we think actual implementations will be softer (vs the pledges)

since key agenda for the new government includes supporting ICT industry amid so called

Fourth Industrial Revolution. We see LGU having the biggest upside as the company has

levelled up substantially during the early part of 4G era, making it large enough to scale up

and produce higher returns over cost of capital.

Figure 61: Korea cellular sector—comparative valuation



SKT 242,000 280,000 15.7% 7.7 6.9 5.3 5.0 1.1 1.0 4.0% 3.8% 4.1% 4.1%

KT 31,600 38,000 20.3% 8.7 7.4 2.6 2.3 0.7 0.6 12.6% 13.9% 3.5% 4.1%

LGU 16,600 20,000 20.5% 12.9 11.1 4.0 3.7 1.3 1.2 11.4% 12.0% 2.4% 2.8%


Figure 62: Share price performance (rebased) LGU could continue to

outperform on superior ROIC

Note: Rebased as of 1 January 2014. Source: Quantiwise

70

80

90

100

110

120

130

140

150

160


SKT KT LGU

20 June 2017


India

Summary

■ In terms of industry structure, the Indian market looks unattractive, with Rjio as an

aggressive new entrant posing heavy competitive pressure on industry returns.

■ We expect the Indian market to grow service revenue at a CAGR of 4.0% across

FY16-FY20.

■ Bharti is dominant with 29.0% revenue market share as at 1Q17 and an FY16 ROIC of

6.5%. However, we expect Bharti to suffer margin and capex pressure and suppressed

returns on capital from competition. We highlight it as a top regional sell.

■ IDEA looks to be a #2 player with expectation of the promised merge synergies more

than priced in. Jio's returns look set to be unattractive.

Three dominant players gaining share—before Jio's

entry

Historically, India has been quite competitive with the No.1 player never crossing 34%+

revenue market share due to the presence of 10-12 players at all times. The earlier

regulatory policy of low entry cost (Rs16.5 bn/US$250 mn for nationwide spectrum)

ensured high competition. Prior to the policy of auctioning spectrum which started since

2010, spectrum was allocated administratively with operators required to pay spectrum

usage charges and licence fees (~12% of adjusted gross revenues).

Figure 63: Revenue market share of Bharti, the market leader, peaked out 33.8%

in 2009


However, over the years, there have been a few regulatory changes that have led to

market shares consolidating with the top three operators: Bharti, Vodafone, and Idea.

■ Movement to auction-based spectrum allocation. Post the irregularities in 2G

spectrum allocation, the government has moved on to the policy of auctioning

spectrum with the key intent being highest revenue for the state exchequer. This has

resulted in bigger players bidding aggressively, in effect crowding out the smaller

players.

0%

20%

40%

60%

80%

100%

Dec-06 Dec-07 Dec-08 Dec-09 Dec-10 Dec-11 Dec-12 Dec-13 Dec-14 Dec-15 Dec-16

Bharti Vodafone Idea RCOM BSNL/MTNL

TTSL Aircel BPL HFCL S Tel

Uninor Videocon Etisalat Sistema Shyam Jio

20 June 2017


■ Forced cancellation of licences in 2012. In 2012, the Supreme Court cancelled all

licences issued by the government from 2008 onwards and directed its re-allocation

through the auction process. This put the business continuity of operators in question.

As a result of these, the top three operators have been gaining market share over the last

8-9 years. However, as seen below, Idea, and to a smaller extent Vodafone, have been

the bigger market share gainers while Bharti has been largely stagnant.

Figure 64: Idea, and to a smaller extent Vodafone, gained market shares;

Bharti’s share has been largely stagnant

Source: TRAI, Company data, Credit Suisse estimates

Market structure changing rapidly since Jio’s entry

Reliance Jio started commercial services in September 2016 with the launch of free

services for three months which was later extended for another four months. During this

period, incumbent operators witnessed a sharp contraction in all financial and operating

parameters with ARPU compressing 19-22%, data and voice pricing compressing by 45-

46% and 25-27%, respectively, from the June 2016 quarter levels. This resulted in

significant loss of revenues for the industry. Indeed, Bharti’s India mobile revenues

declined by 6% YoY in 2H FY17, while in the case of Idea it was 9%.

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

35.0%

40.0%

Sep-06 Sep-08 Sep-10 Sep-12 Sep-14 Sep-16

Bharti Vodafone Idea

20 June 2017


Figure 65: Revenues for the industry declined by 5% in 2H of CY16 vs 1H CY16


Even after Jio has announced the start of paid services from April 2017, the price points

are significantly lower than that of the incumbents putting further pressure on them. This

intense competition has resulted in rapid consolidation in the sector with even the number

two and three operator (Vodafone-Idea) announcing their decision to merge.

Figure 66: Jio’s entry has accentuated consolidation among the operators

Deal Expected time line

Bharti - Telenor deal Expected to be completed over next few quarters. (12M)

Bharti - Tikona deal Expected to be completed over next few quarters. (12M)

Idea-Vodafone merger Management expects the deal to be completed in CY2018. A longer time line would be viewed

negatively for both the entities, given that individually both of them stand on a weaker footing to

compete with Airtel and Jio.

RCOM-Aircel merger Companies have received Competition Commission of India, Securities and Exchange Board of India

and stock exchange approvals. Shareholders of both the companies have approved the merger. We

expect the transaction to take some more time.


Good growth potential, but ability to monetise is key

From a top-down perspective, the Indian cellular market does offer good growth potential

given that smartphone and 4G penetration are the lowest amongst other Asian countries.

Smartphone penetration has reached 28% while 4G penetration is expected to have

reached 7%. Further, as we can see in the figure below, countries with higher per capita

GDP tend to have higher 4G penetration. With India having much headroom to grow its

GDP per capita, prospects for increasing 4G penetration seem encouraging.

200,000

250,000

300,000

350,000

400,000

450,000

500,000

550,000

600,000

Jun-10 Sep-11 Dec-12 Mar-14 Jun-15 Sep-16

Telecom Indutry revenuesRs mn

Launch of free services by Jio

20 June 2017




With Jio’s entry offering free services for seven months, volumes have increased

significantly especially with data volumes for Bharti and Idea increasing 42%/36% from the

June 2016 quarter. However, one of the key questions to answer is whether this volume

growth will drive revenue growth even in the longer term. We have seen operators

struggling to take up data and voice tariffs, even before Jio's entry. In particular, Idea was

seen as using pricing aggression to gain share.

Figure 69: Industry struggled to take up pricing even before Jio’s launch—Idea

was focusing on market share gain keeping pricing in check


Even after Jio started its ‘paid’ services beginning April 2017, its price points are

significantly below the current pricing levels seen from incumbent operators. Over the

course of the last nine months, Jio has managed to bring down the data pricing levels by

45-46% for incumbents. Also, Jio’s bundled plans—offering voice bundled with data—are

increasingly causing incumbents to also offer bundled plans.

SingaporeHong Kong

Malaysia

Indonesia

Korea

China

Thailand

PhilippinesIndia

Taiwan

Australia

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

- 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000

4G p

enet

ratio

n


20.0

25.0

30.0

35.0

40.0

45.0

Jun-10 Mar-11 Dec-11 Sep-12 Jun-13 Mar-14 Dec-14 Sep-15 Jun-16

Idea voice RPM Bharti voice RPM

20 June 2017


Figure 70: Jio has managed to bring down data price tables


Increasingly, there have been reports of Jio coming out with 4G feature phones to cater to

the lower end of the market, which is primarily voice-centric. To give some perspective,

Bharti (India mobile) and Idea receive 73-75% of their revenues from voice. Even on its 4Q

FY17 earnings call, Bharti Airtel’s CEO alluded to potential disruption from 4G feature

phones if Jio were to come up with one at a subsidised cost.

We now build low revenue growth for FY18 and FY19 for the industry (which coupled with

Jio's growth means flat/decline in top line for others). While we build in a strong recovery

period with ~9% revenue growth for the following 2-3 years, we eventually normalise

growth rates to a ~6% CAGR upto FY25. We believe this will be in line with the telecom

spend/GDP trajectory in India and other countries—and reflect the 'undisturbed' growth

rates for the industry 18 months prior to Jio's entry. We believe risks, if any, to these

expectations are to the downside.

Figure 71: YoY cellular revenue growth and revenue growth rates

Rs mn FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25

Bharti 36,127 52,801 41,182 4,693 9,626 28,765 95,115 65,848 73,052 51,683 46,547 44,908

Vodafone + Idea 85,689 79,868 53,178 13,511 (63,567) (6,241) 46,458 62,007 64,162 53,925 48,567 46,857

Jio - - - - 277,628 180,464 101,483 115,214 154,367 51,142 46,061 44,439

Others 31,794 45,843 7,713 16,267 (208,788) (103,808) (59,806) (45,822) (79,618) 8,225 7,408 7,147

Total 153,610 178,513 102,074 34,471 14,899 99,180 183,251 197,247 211,963 164,975 148,583 143,351

Growth (% YoY)

Bharti 8.4% 11.3% 7.9% 0.8% 1.7% 5.0% 15.8% 9.4% 9.6% 6.2% 5.2% 4.8%

Vodafone + Idea 15.9% 12.8% 7.5% 1.8% -8.2% -0.9% 6.6% 8.3% 7.9% 6.2% 5.2% 4.8%

Jio 0.0% 0.0% 0.0% 0.0% nm 65.0% 22.2% 20.6% 22.9% 6.2% 5.2% 4.8%

Others 6.0% 8.2% 1.3% 2.6% -33.1% -24.6% -18.8% -17.7% -37.4% 6.2% 5.2% 4.8%

Total 10.2% 10.8% 5.6% 1.8% 0.8% 5.0% 8.8% 8.7% 8.6% 6.2% 5.2% 4.8%


-

50

100

150

200

250

300

350

Jun-14 Jun-15 Sep-15 Jun-16 Dec-16 Mar-17 Apr-17

Indicative pricing for 1GB by incumbentsRs

Launch of Jio's free services

20 June 2017


Figure 72: Cellular revenue and revenue market share

Rs mn FY14 FY15 FY16 FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25

Bharti 466,835 519,636 560,818 565,511 575,137 603,901 699,017 764,864 837,916 889,599 936,146 981,055

Vodafone + Idea 624,899 704,767 757,946 771,457 707,890 701,650 748,107 810,114 874,276 928,201 976,768 1,023,625

Jio - - - - 277,628 458,092 559,575 674,789 829,156 880,298 926,359 970,798

Others 561,367 607,210 614,923 631,190 422,402 318,594 258,788 212,966 133,348 141,573 148,981 156,128

Total 1,653,101 1,831,614 1,933,687 1,968,158 1,983,057 2,082,237 2,265,487 2,462,734 2,674,697 2,839,672 2,988,254 3,131,606

Market share (%)

Bharti 28.2% 28.4% 29.0% 28.7% 29.0% 29.0% 30.9% 31.1% 31.3% 31.3% 31.3% 31.3%

Vodafone + Idea 37.8% 38.5% 39.2% 39.2% 35.7% 33.7% 33.0% 32.9% 32.7% 32.7% 32.7% 32.7%

Jio 0.0% 0.0% 0.0% 0.0% 14.0% 22.0% 24.7% 27.4% 31.0% 31.0% 31.0% 31.0%

Others 34.0% 33.2% 31.8% 32.1% 21.3% 15.3% 11.4% 8.6% 5.0% 5.0% 5.0% 5.0%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


Rapid consolidation of market shares into three

operator groups

We expect rapid consolidation of current fractured market shares where we expect smaller

operators (outside the top three) to go from 30%+ current revenue market share to ~5% in

the long term.

Spectrum allocation by operators

The Indian telecom market has 22 circles with each circle requiring separate spectrum.

Thus having a pan-India spectrum footprint is essential to be able to retain/gain market

share. As can be seen in the table below, only the top three operator groups (i.e., Bharti,

Idea+Vodafone and Jio) along with state-run BSNL/MTNL have the essential spectrum

holdings to be able to compete on a national scale. While BSNL/MTNL has the fourth-

largest spectrum holding, its ability to utilise the spectrum has not been enthusiastic. To

put things in context, it still lacks 4G offerings at a time when the market is rapidly adopting

4G.


Revenue wtd

avg spectrum

800Mhz 900Mhz 1800Mhz 2100Mhz 2300Mhz 2500Mhz Total (paired

equivalent)

Bharti* 5.3*2 12.4*2 6.1*2 26.0 36.75

Vodafone 4.2*2 7.0*2 5.7*2 9.7 21.76

Idea 3.4*2 9.1*2 3.7*2 1.8 6.8 20.45

Jio 7.4*2 6.2*2 27.8 27.47

RCOM 0.3*2 4.0*2 2.5*2 6.70

Aircel 0.8*2 5.2*2 2.7*2 8.73

Tata 1.0*2 5.0*2 2.3*2 8.27

MTNL/BSNL 2.6*2 6.2*2 3.7*2 5.0*2 9.1 21.96

MTS 1.8*2 1.84

* Note: Includes spectrum from Telenor and Tikona deal Source: DOT, company data, Credit Suisse estimates

BTS by operator

Capacity being a function of spectrum, sites and technology, having higher number of sites

becomes important in a geographically vast country such as India to provide ubiquitous

coverage. As can be seen in the table below, Bharti, Idea and Vodafone lead in terms of

number of BTS. Having said that, Jio’s 100k sites need to be seen from the context of

them being purely 4G sites (technologically efficient) giving them higher capacity per site.

Besides, recently Jio has publicly commented on doubling the count of sites to 200k within

few months.

20 June 2017



BTS by operator 2G Broadband (3G+4G) Total

Bharti 162,046 190,860 352,906

Vodafone 141,000 107,000 248,000

Idea 131,486 110,054 241,540

Jio - 100,000 100,000

RCOM 62,250 12,750 75,000

Aircel 46,878 10,500 57,378

Tata 61,234 10,500 71,734

MTNL/BSNL 116,250 10,000 126,250

MTS 12,497 - 12,497


Balance sheet strength

Indian telcos continue to remain one the most leveraged telcos regionally with net

debt/EBITDA for Idea and Vodafone at 4.9x and 4.3x, respectively. Even at 2.7x, leverage

remains higher for Bharti given its credit rating of BBB- from S&P with the rating agency

sounding caution on its high level of leverage.

Figure 75: Leverage levels at operators


With operators now moving increasingly to bundled service offerings (voice + data),

operators without any data offerings will find it increasingly hard to sustain.

With nearly 90% of revenues converging among the top three operators (Bharti, the soon-

to-be merged Vodafone-Idea, Jio), we assume it to be shared largely evenly by the top

three (31-33% share each). But this means largely flat market share for Bharti, fall in share

for Vodafone-Idea, and others and Jio gaining market share. We expect the bulk of the

market share gain for Jio (and loss for the others) to happen over FY18 and FY19.

4.9

4.3

2.7

-

1.0

2.0

3.0

4.0

5.0

6.0

Idea Vodafone Bharti

Trailing Net debt/EBITDA (x)

20 June 2017


Figure 76: We expect market shares of top three to converge over the longer

term; smaller operators should shrink to ~5%


Final market share structure to depend on Jio's ability and willingness to invest

Jio is promoted by RIL, which has already made an investment of US$29.4 bn in its

telecom venture with commitment to further invest US$9 bn over the next three years. To

gauge Jio’s ability to invest, one would have to look at the FCF that its parent generates.

With US$5.5 bn of annual FCF generation, it is easy to conclude that ‘ability’ to invest is

not the question. The right question to ask would be its ‘willingness’ to invest.

Figure 77: Post the end of capex cycle in its core businesses (ex-telecom) in

FY17, RIL will be generating close to US$5.5 bn of FCF p.a. (ex-telecom) by FY20

Note: This fully excludes working capital impact and the telecom business investments. Source: Company data, Credit Suisse estimates

ROIC has stayed below cost for many years—likely

to stay so

Telecom operators need to continuously invest (at times ahead of possible monetisation

opportunities) to be able to offer seamless connectivity and coverage. However, the

peculiar nature of the Indian market—high spectrum prices, high tax burden (by way of

revenue sharing with the government) and heightened competitive pressures—has

0%

20%

40%

60%

80%

100%

FY17 FY18 FY19 FY20 FY21 FY22 FY23 FY24 FY25

Others

Jio

Vodafone + Idea

Bharti

(8,000)

(6,000)

(4,000)

(2,000)

-

2,000

4,000

6,000

8,000

FY16 FY17 FY18 FY19 FY20

RIL FCF (ex telecom business)

20 June 2017


ensured that returns have been below cost for almost all the operators including for market

leader Bharti.

Figure 78: Returns have stayed below cost


We expect the coming couple of years of low industry revenue growth, high capex and

heighted competitive pressures (in a bid to gain higher market share) will lead to further

ROIC decline for the incumbents.



Rs mn Bharti

(consol)

Idea

(Standalone)

Bharti

(consol)

Idea

(Standalone)

Jio Bharti

(consol)

Idea

(Standalone)

Subscribers (000s) – India

mobile 273,648 189,500 291,740 194,835 250,593

Service revenue 954,683 355,756 1,115,440 352,061 559,575 5.3% -0.3%

EBITDA 354,505 102,763 418,012 76,591 155,413 5.6% -9.3%

EBITDA margin 37.1% 28.9% 37.5% 21.8% 27.8%

Depreciation to sales (%) 20.7% 22.0% 19.3% 29.6% 23.2%

EBIT 156,775 24,490 202,456 (27,570) 25,651 8.9% Nm

EBIT margin 16.4% 6.9% 18.2% -7.8% 4.6%

Tax rate (%) 34.0% 34.0% 34.0% 34.0% 34.0%

NOPLAT 103,471 16,163 133,621 (18,196) 16,930 8.9% Nm

Average invested capital 1,582,628 694,389 1,629,307 691,355 2,084,248

Asset turn 0.6 0.5 0.7 0.5 0.3

ROIC 6.5% 2.3% 8.2% -2.6% 0.8%

Net profit 37,997 (3,996) 74,590 (35,243) (23,072) 25.2% Nm

Net margin 4.0% (1.1%) 6.7% (10.0%) (4.1%)


See downside to Bharti/Idea

We still maintain our cautious stance on telecom operators, as we see an extended period

of high competition and low profitability that is not adequately captured in stock prices.

Our Rs300 target price for Bharti is based on DCF, with 10.6% WACC, flat EBITDA from

FY17 to FY19, followed by a 12% EBITDA CAGR until FY25, and 3% terminal growth.

This implies a 6.2x FY19E EV/EBITDA for its India mobile business and 9.4x FY19E

EBITDA for tower investments (before applying holding company discounts).

For Idea, our value for the standalone business pre-merger comes to Rs9/share, with

implied EV/EBITDA valuations given below.

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%


ROCE %

Bharti Consol Idea

20 June 2017


The bulk of the value for the stock now comes from the promised merger synergies. The

total NPV of synergies works out to ~Rs93 per Idea share. With full synergies, the fair

value for the stock would come to Rs102. Given the complexities involved in the merger of

this scale, we assign a 70% probability—leading to a target price of Rs74 per share.

We retain our UNDERPERFORM rating on these two stocks.

Figure 80: India cellular sector—comparative valuation

Close Target Upside/ Normalised P/E (x) EV/EBITDA (x) EV/IC (x) FCF yield (%) Div yield (%)

price price downside (%) FY18E FY19E FY18E FY19E FY18E FY19E FY18E FY19E FY18E FY19E

Bharti 365 300 -17.8% 44.4 35.3 7.3 6.6 1.47 1.44 4.2% 4.3% 0.2% 0.3%

IDEA 78 74 -4.8% n.m. n.m. 12.0 13.1 1.08 1.13 2.2% 3.7% 0.0% 0.0%


Figure 81: Idea—pre-synergy equity value @ Rs9/share

Implied EV/EBITDA

Fair value (Rs/share) FY18 FY19

SOTP for Idea 9 7.1 (Indus @10.4x) 7.8 (Indus @ 9.5x)


Figure 82: Much of the Idea stock's fair value currently hinges on achieving

synergies from the proposed merger

NPV of synergies guided Rs bn 670

No shares mn 7,201

NPV of synergies Rs / share 93

% achievement factored % 70%

Addition to idea SOTP Rs / share 65

Final TP Rs / share 74


20 June 2017


Country sections: Malaysia

Summary

■ In terms of industry structure, the Malaysia market looks relatively unattractive, with

new entrants and ineffective monetisation.

■ We expect the Malaysia market to grow service revenue at a CAGR of 1.5% across

FY16-FY20.

■ Celcom (Axiata) looks to be a #2 player that is fairly valued for its turnaround potential.

Digi, on the other hand, looks to be an overvalued challenger in a competitive

environment.

Data demand up but data pricing down

Following an aggressive price war in 2015-16, triggered by UMobile/Celcom in the

postpaid segment and Maxis/Digi in the prepaid segment, price points, especially for data,

in the Malaysian cellular market in recent years have suffered. To recap, while data

consumption and 4G penetration are growing substantially, mobile operators have been

unable to convert this ‘opportunity’ into revenue as subscribers have been receiving

significantly higher data allowances at the same/lower price. As a result, the Malaysian

cellular market remains unattractive relative to the other markets within Asia as the

sector’s service revenue has been on a downtrend for at least five quarters since 4Q15.


1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16

Maxis 3.4% 1.3% 4.7% 2.8% -0.7% -2.5% -3.1% -0.9%

Digi 2.2% 1.3% 0.0% -2.5% -1.8% -2.0% -1.9% -2.0%

Celcom (Axiata) -4.4% -8.6% -5.1% -9.3% -12.4% -11.4% -11.1% -7.5%

Others 13.3% 13.3% 13.3% 13.3% 10.0% 10.0% 10.0% 10.0%

Total 1.4% -0.8% 1.2% -1.5% -3.5% -3.9% -4.0% -2.1%


We also observe that other players, especially UMobile, continue to gain revenue market

share. However, it was acquired at a hefty cost to its shareholders - based on latest

publicly available information, UMobile’s net loss almost doubled from RM190 mn in 2014

to RM370mn in 2015.


1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16

Maxis 34.5% 34.5% 35.1% 35.4% 35.5% 34.9% 35.4% 35.8%

Digi 27.1% 27.6% 27.2% 27.4% 27.6% 28.1% 27.8% 27.5%

Celcom (Axiata) 29.6% 29.1% 29.0% 28.4% 26.9% 26.8% 26.8% 26.9%

Others 8.7% 8.8% 8.7% 8.8% 9.9% 10.1% 10.0% 9.9%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


Two key factors have been behind this negative industry growth.

■ Competition. While data usage per subscriber per month has more than doubled YoY

from 1-2GB in 1Q16 to 4-6GB in 1Q17, subscribers have been getting an average of

1.5x-10.0x additional data for the same price, resulting in an average decline in price

per GB by ~60%. The ramifications of these generous data allowances were: (1) down-

trading became an issue as consumers began subscribing to cheaper plan, which

offered significant data allowances; and (2) revenue upside potential was eliminated as

consumers no longer had to purchase add-on bundles for data.

Competition has eroded Malaysia’s

opportunity to monetize data

effectively

Revenue outlook remains muted

20 June 2017


■ Poor execution at Celcom. While both Digi and Maxis managed to keep their revenue

market share, Celcom has been the key market share ‘donor’ and in revenue terms

has significantly underperformed both of its larger peers. This has in large part been

caused by three things: (1) severe cannibalization within its subscriber base due to

down-trading (while its subscriber base is up 6% YoY in FY16, ARPU was -8% down

YoY); (2) loss of VAS revenue in 1Q16 onwards; and (3) severe decline in dealership

confidence (management is still trying to repair this).

Revenue outlook remains challenging

We believe that there is still an opportunity for data volume growth in Malaysia, given that

smartphone penetration has only reached between 64% and 73% among the big 3, as at

end 2016, while 4G penetration among big 3’s subscriber base has only reached between

26-44%. Also, data use per subscriber per month has almost tripled in the last 2 years to

circa 4GB per month, mainly due to the higher traffic on the 4G network.

Figure 85: While smartphone penetration is high,

there is still scope for 4G penetration to increase

Figure 86: Data use per subscriber per month has

almost tripled over the last 2 years



growth. Unfortunately for the Malaysian market, data monetization has been hampered by

the generous data allowances given by operators (data boost ranges from 1.5-10.0x YoY).

To make matters worse, price points (estimate price per 1GB of data per subscriber per

month) have declined by as much as 75%. As such, while data revenue has been growing

by circa 3-8% YoY over the last 4-6 quarters, it is not significant enough to offset the

double-digit decline in voice revenue. As a result, the outlook for revenue growth remains

challenging, in our view.

73%68%

64%

44%41%

26%

0%

10%

20%

30%

40%

50%

60%

70%

80%

Maxis Digi Celcom (Axiata)

Smartphone penetration

4G penetration

-

0.5

1.0

1.5

2.0

2.5

3.0

3.5

4.0

4.5

FY14 FY15 FY16


The opportunity is there...

…but it cannot be monetised as price

points declined

20 June 2017


Figure 87: Data prices has been trending downwards

ARPU (RM) Data allowance (GB) Data boost Estimated price reduction

Apr-16 Apr-17 Apr-16 Apr-17 per GB (%)

Maxis

98 98 5 20 4.0x -75%

128 128 10 30 3.0x -67%

158 158 15 40 2.7x -63%

188 188 20 50 2.5x -60%

Digi

48 50 1 10 10.0x -89%

48 50 3 10 3.3x -68%

80 80 10 20 2.0x -50%

Celcom

45 45 4 4 - 0%

80 80 10 20 2.0x -50%

150 150 18 60 3.3x -70%

UMobile

28 28 3 6 2.0x -50%

50 48 5 10 2.0x -54%

70 70 15 22 1.5x -32%


We note that UMobile has recently introduced a sim-only postpaid plan that offers

unlimited data (up to 5Mbps), free roaming and free mobile hotspot for RM78/month.

Theoretically speaking, the big 3’s existing postpaid plan at RM80/month is literally offering

‘unlimited’ data since the monthly data allowance is already significantly higher than

existing usage patterns. As such, it is disruptive, but not game-changing. We therefore

forecast that in FY17, the other operators will continue to grow their cellular revenue by

between 8-9%, while Maxis and Digi’s cellular revenue will be flattish. On the other hand,

Celcom’s cellular revenue will grow at a low single digit level if management successfully

plays catch up on its network coverage and rebuilds its sales channels. Overall, we expect

the market as a whole to achieve 1.2-1.8% growth p.a. between FY17-20. The caveat here

is that we assume the big 3 will avoid underpricing each other once again by lowering

ARPU or introducing cheaper unlimited data plans.

Figure 88: YoY cellular revenue growth (RM mn) and revenue growth rates (%)

RM mn FY14 FY15 FY16 FY17 FY18 FY19 FY20

Maxis (345) 238 (147) (100) 14 11 9

Digi 202 15 (122) (3) 15 15 28

Celcom (Axiata) (102) (494) (717) 263 124 179 18

Others 183 101 59 163 179 196 216

Total (62) (141) (927) 322 331 401 271

Growth (% YoY)

Maxis -4.2% 3.0% -1.8% -1.3% 0.2% 0.1% 0.1%

Digi 3.3% 0.2% -1.9% -0.1% 0.2% 0.2% 0.4%

Celcom (Axiata) -1.4% -6.8% -10.6% 4.4% 2.0% 2.8% 0.3%

Others 11.7% 5.8% 3.2% 8.6% 8.7% 8.8% 8.9%

Total 0.3% -0.6% -4.0% 1.5% 1.5% 1.8% 1.2%


Big 3 to cede more market share to others

We believe that over the next few years, the big 3 should continue to retain their cellular

service revenue base at where it is today, but expect them to cede 1-2% overall market

share to the other operators, mainly UMobile. Within the big 3, we give Celcom the benefit

of the doubt and assume that it can wrestle 0.7% market share in 2017 once it repair its

internal issues. The caveat here is that we assume the big 3 will avoid rolling out unlimited

data plans at cheaper prices as they can still run a profitable business as long as price

points remain relatively high.

We expect big 3 to lose 1-2% market share to

other operators..

20 June 2017


Figure 89: Cellular revenue (RM mn) and revenue market share (%)

RM mn FY14 FY15 FY16 FY17 FY18 FY19 FY20

Maxis 7,858 8,096 7,949 7,849 7,862 7,874 7,883

Digi 6,333 6,348 6,226 6,223 6,238 6,252 6,280

Celcom (Axiata) 7,237 6,743 6,026 6,289 6,413 6,592 6,610

Others 1,740 1,841 1,899 2,062 2,240 2,437 2,653

Total 23,168 23,027 22,100 22,423 22,754 23,155 23,426

Market share (%)

Maxis 33.9% 35.2% 36.0% 35.0% 34.6% 34.0% 33.6%

Digi 27.3% 27.6% 28.2% 27.8% 27.4% 27.0% 26.8%

Celcom (Axiata) 31.2% 29.3% 27.3% 28.0% 28.2% 28.5% 28.2%

Others 7.5% 8.0% 8.6% 9.2% 9.8% 10.5% 11.3%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%




In the recent spectrum reallocation exercise, UMobile emerged as the biggest beneficiary

as it received 2x5MHz of 900MHz and 2x15MHz of 1800MHz spectrums. Digi, to a certain

extent, also benefitted as it received 2x5MHz of 900MHz spectrum (it had merely 2x2MHz

previously), though it did lose 2x5MHz in the 1800MHz band (so did Maxis and Celcom).

The new allocation for the 900MHz band will certainly help both UMobile and Digi address

the relatively weak indoor coverage from June-2017, creating a relatively level playing

field across all four operators (Maxis, Celcom, Digi and UMobile).


900MHz 1.8GHz 2.1GHz 2.3GHz 2.6GHz

Maxis 10*2 20*2 2*15 / 5 10*2

Celcom (Axiata) 10*2 20*2 2*15 / 5 10*2

Digi 5*2 20*2 2*15 / 5 10*2

UMobile 5*2 15*2 2*15 / 5 10*2

Asiaspace 30 (PM)

P1 30 20

Puncak Semangat 20*2

Redtone 30 (EM) 10*2

YTL 30 20

Source: Company data, MCMC.

The reallocation for the 2100MHz, 2300MHz and 2600MHz will take place sometime this

year, and we believe the exercise will probably not shift the balance of power i.e. big 3 to

retain their leadership, but UMobile will not be left out. More importantly, we see little

prospect of an auction triggering value destruction since the government holds sizeable

stakes in these mobile operators. We would expect all four operators to retain their

ownership in the 2100MHz band. However, we believe the regulator will likely reallocate

the ownership in the 2600MHz band by removing inefficient owners from the list. Given

that the 2300MHz band is gazetted for WiMax and is not a ‘game-changing’ band, big 3

and UMobile will probably not negotiate for an allocation here.

While the 700MHz band is not highlighted in our diagram, it should not be ignored since it

will also be re-allocated very soon (likely in 2018/19). We believe it will be priced at a slight

premium to the upper band in the 900MHz/1800MHz reallocation exercise, since it is a

prized asset. To recap, the four operators had to pay RM218-500 mn for 2x5MHz during

the 900MHz/1800MHz reallocation exercise.

In conclusion, we believe the outcome of the recent reallocation implies that the regulator

intends to promote competition in the industry, but in a relatively healthy manner i.e. there

…after analysing spectrum allocations,

network and capital intensity

20 June 2017


is scope for the market to have up to four major operators. As such, we do not discount

the possibility for M&A to materialise (Celcom and TM to merge or TM to acquire UMobile)

since there is only room for four, not five.

BTS by operator

Maxis’ 36.0% revenue market share in FY16 was underpinned by its widest network

coverage for 4G. We estimate that it has the highest number of 4G BTS at 8,000 vis-à-vis

Digi and Celcom which have 7,500 and 6,900 respectively. With SIM card penetration at

circa 140%, the upgrade from 2G to 3G and from 3G to 4G were meant to boost data

revenue significantly, but as highlighted earlier, the generous data allowances capped this

opportunity. Maxis will likely retain its leading population coverage, although we do expect

Celcom and Digi to narrow the gap in FY17/18.

However, it is worth nothing that there were significant cost advantages in FY16 as more

users migrated to the 4G network. As a result, big 3’s EBITDA margins remain as one of

the highest in the region (FY16 EBITDA/cellular revenue – Maxis: 53.8%, Digi: 47.5%,

Celcom: 38.2%).

Figure 91: Likely BTS by operator among big 3


Maxis 9,500 9,500 8,000 27,000 35.8%

Digi 8,000 8,000 7,500 23,500 31.2%

Celcom (Axiata) 9,000 9,000 6,900 24,900 33.0%

Total BTS (big 3) 26,500 26,500 22,400 75,400 100.0%

Note: this does not represent the total number of towers in Malaysia as each tower will likely carry 2G/3G/4G BTS' and each operator may also consider rented BTS as part of their total BTS so there may be overlaps. Source: Company data, Credit Suisse estimates,

As UMobile is not a public company, we were unable to verify its actual number of BTS

and population coverage on 2G/3G/4G. However, we do know that its 2G/3G coverage is

not too far off from its competitors and management intends to spend at least RM1 bn in

the near term to increase its 4G population coverage, following the recent spectrum

reallocation exercise. We believe the amount is reasonable, but it may be tough for

UMobile to overtake the big 3 since big 3, so it will probably deploy the capital in strategic

areas in key cities such as Kuala Lumpur, Penang and Johor Bahru. Therefore, this will

put more pressure on the big 3, who focus on these cities.

Capital intensity

We expect Maxis’ coverage advantage over Digi and Celcom to narrow when we consider

both recent and projected capex trends. Maxis was outspending both Digi and Celcom by

20-50% in 2014-15; but we expect Maxis’ competitors, including UMobile to play ‘catch

up’. It is worth noting, however, that the network advantage Maxis had over its competitors

was crucial as it has allowed Maxis to retain Malaysia’s premium consumers who value

quality over price.

20 June 2017


Figure 92: Capex by operator (RM mn) Figure 93: Capex- to-sales ratios (%)



We note that both Celcom and Digi can maintain the aforementioned capital intensity,

while Maxis’ capital intensity will decline over time since it has a stretched balance sheet.

Should Maxis decide to ramp up capex again, it might impact free cash flows negatively

(dividends will then be affected), unless they recapitalize. As such, we argue that Maxis

looks capital constrained, although management guided that banks are comfortable to let

them borrow up to 4x net debt to EBITDA (it was at 2x as at end 1Q17). While Axiata’s

balance sheet is more leveraged than Maxis currently, there are various options on the

table to de-leverage (sell towers, sell stake in op-cos etc.) so we are not overly concerned.

More importantly, its Indonesian subsidiary, XL Axiata, has also cut its USD-denominated

debt exposure to just US$350mn (fully hedged) from a peak of over US$1.5bn.

Regulation

Regulation can be a trigger for a step-change in market share dynamics, but we are not

expecting any material changes in Malaysia. Based on the outcome of the recent

spectrum re-allocation exercise, we conclude that the regulator has delivered two key

messages: (1) there is space for a fourth operator in the market, therefore, M&A has to

happen as it is unlikely that both TM and UMobile will co-exist; and (2) the government will

not be extreme when pricing spectrum since it holds sizeable stakes in these listed mobile

operators. As such, we believe UMobile will continue to gain revenue market share, but at

a slower pace, if price points remain where they are today.


In FY16, the big 3 were still able to generate returns greater than the cost of capital. This

is, of course, largely driven by the fact that they have minimal retained earnings since

almost all of their profits are paid out as dividends and the high EBITDA margins as well.

In FY16, Digi had the highest ROIC at 86.3%, followed by Celcom and then Maxis at

21.5% and 17.7% respectively. We do expect these returns to decline over the next few

years due to competition (in Digi’s case, the higher borrowings it will incur is also a factor).

While we have not explicitly shown an ROIC analysis for UMobile given a lack of

consistent published information, we understand that the company is still generating

negative ROICs with 6.8% revenue share. It is a puzzling scenario as the company’s

losses almost doubled in 2015 (PAT for FY16: -RM368 mn vs FY15: -RM192 mn), but yet

the company continues to keep the ‘profit switch’ turned off to build subscriber and

revenue market share.

0

200

400

600

800

1,000

1,200

1,400

1,600

FY14A FY15A FY16A FY17E FY18E FY19E FY20E


0%

5%

10%

15%

20%

25%

FY14A FY15A FY16A FY17E FY18E FY19E FY20E

Maxis Digi Celcom

Big 3 still generates ROIC above WACC

20 June 2017




RM mn Maxis Digi Celcom Maxis Digi Celcom Maxis Digi Celcom

Subscribers (000s) 11,926 12,299 10,556 12,326 12,299 13,800

Service revenue 8,455 6,226 6,026 8,528 6,280 6,610 0.2% 0.2% 2.3%

EBITDA 4,551 2,955 2,527 4,541 3,074 2,655 -0.1% 1.0% 1.2%

EBITDA margin 53.8% 47.5% 38.2% 53.2% 48.9% 40.2%


EBIT 3,152 2,304 1,616 2,966 2,354 1,350 -1.5% 0.5% -4.4%

EBIT margin 37.3% 37.0% 26.8% 34.8% 37.5% 20.4%

Tax rate (%) 25.0% 25.0% 25.0% 25% 25% 25.0%

NOPLAT 2,364 1,728 1,212 2,225 1,765 1,013 -1.5% 0.5% -4.4%


Asset turn 0.6 3.1 1.1 0.6 1.3 1.1

ROIC 17.7% 86.3% 21.5% 15.0% 36.3% 17.5%

Net profit 2,013 1,633 1,229 1,869 1,663 804 -1.8% 0.5% -10.1%

Net margin 23.8% 26.2% 20.4% 21.9% 26.5% 12.2%


The most obvious way for UMobile to drive up its returns is to generate more revenue

while keeping operating costs under control. Therefore, it has to consider reducing its

exorbitant data allowances and other ‘revenue generating’ features such as free roaming

and free mobile hot spot. We do not see this happening in the near term until it secures at

least 10% revenue market share.






At present, it would seem that the market is overpaying for both Maxis and Axiata, given

that there is 1.4% potential downside for Maxis and 3.8% potential downside for Axiata.

We believe the market could be rewarding Maxis for its relatively more resilient operational

highlights, but we would argue that there is downside risk due to competition and spectrum

woes. For Axiata, we have not fully baked in the potential recovery of its business although

we do see scope for an eventual upgrade. In short, the recovery hinges on the delivery of

its promises to the market (note that the milestones for recovery have been postponed

multiple times over the last two years).

From a multiple standpoint, both Maxis and Digi would look relatively more expensive

relative to Axiata from an EV/EBITDA and EV/IC perspective (mainly due to the domestic

liquidity factor and also, investors need not worry about the other markets Axiata is

present at); we do not think this is justifiable since FCF yields are similar among all three

players, though arguably, the market could be applying a discount factor on Axiata since it

cut its dividend payout temporarily from 85% of normalised PATAMI to 50%.

Figure 95: Malaysian cellular sector—comparative valuation

Close Target Upside Normalised PE (x) EV/EBITDA (x) EV/IC (x) FCF yield (%) Div yield (5)

Price Price (%) 17E 18E 17E 18E 17E 18E 17E 18E 17E 18E

Maxis 5.88 5.80 -1.4% 23.8 23.9 12.0 11.8 3.8 3.7 4.9% 5.2% 3.4% 3.4%

Digi 4.95 5.00 1.0% 23.0 23.1 13.8 14.1 11.5 8.7 3.9% 4.0% 4.3% 4.3%

Axiata 4.99 4.80 -3.8% 29.0 25.9 6.4 6.0 1.4 1.4 4.7% 6.0% 1.7% 1.9%


The market is 'overpaying' for Maxis

and Axiata

20 June 2017


In conclusion, Malaysia remains in our view a relatively unattractive market in Asia, unless

operators decide to pull back their generous data allowances to monetise data effectively.

While M&A could potentially materialise, the market is still changing structurally as the

saturated market will now have four key players compared to just three. Also, there is still

risk on spectrum fees in the near term. Last but not the least valuations, especially for

Maxis and Digi, remain stretched when compared to companies form other markets within

this region. For bulls who insist on having exposure in Malaysia, we would recommend

Axiata as its eventual recovery should, in theory, result in a further re-rating. Longer-term

investors could consider investing in the stock if it dips below RM5.00 (a level close

enough to our target price).

Figure 96: Share price performance (rebased); Axiata could recover as there is scope for further upgrades if

Celcom and XL Axiata recover

Source: the BLOOMBERG PROFESSIONAL™ service

50

60

70

80

90

100

110

120

130

140


Maxis Digi Axiata

20 June 2017


Country sections: Philippines

Summary

■ In terms of industry structure, the Philippines market looks relatively unattractive

suffering from cannibalisation of legacy SMS and voice, despite low 4G penetration.

■ We expect service revenue in the Philippines to decline at a CAGR of 0.2% across

FY16-FY20.

■ Globe is dominant with 52.2% revenue market share as at 1Q17 and an FY16 ROIC of

13.7%. At present, we believe the market is not fully appreciating Globe's cellular

market improved returns.

■ PLDT is now a challenger, and we believe that too much hope for recovery is priced in

given that it is trading at 2.0x FY20 EV/IC despite a projected return of just 9.1%. We

highlight it as a top regional sell.

Cellular revenue growth impacted by higher legacy

contribution

Being a developing nation, the Philippines generates expectations of a high growth

market. However, the Philippine cellular sector over the past few years has behaved quite

the contrary. The sector's service revenue has declined at a three-year (2014 to 2016)

CAGR of 1.4%, which is a dismal performance when compared to its developing Asian

peers. The Indian and Indonesian cellular sectors are registering revenue CAGR of 3.7%

and 9.6%, respectively, over the last three years. We note that India’s growth rate has

faltered in recent months due to a heightened competitive environment.

Structural changes (changing revenue mix) and increasing competitive dynamics have

affected the Philippine cellular sector’s revenue performance.


1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

Globe -1.5% 5.5% 1.0% 2.9% -2.8% -1.7% -0.7% 4.9% 0.8%

PLDT -6.4% -0.5% -0.1% -0.5% -2.9% -2.3% -7.3% -2.8% -4.6%

Total -4.3% 2.1% 0.4% 1.1% -2.9% -2.0% -4.2% 0.9% -1.9%


However, we note that despite the cellular sector headwinds, Globe Telecom has been

able to outperform PLDT and capture ~12% cellular revenue market share over the past

five years (till 2016). In fact during 4Q16, PLDT lost market leadership to Globe Telecom

as its market share fell to 49% from 51% in 3Q16. Globe further gained 1.4% revenue

market share in 1Q17 from PLDT.


1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

Globe 44.4% 45.9% 46.2% 47.0% 47.0% 47.2% 48.9% 50.8% 52.2%

PLDT 55.6% 54.1% 53.8% 53.0% 53.0% 52.8% 51.1% 49.2% 47.8%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


Several factors contributed to the dismal industry growth and Globe’s outperformance:

■ Higher contribution of legacy services. Philippines used to be colloquially referred to as

the “SMS capital” of the world with text messaging contributing ~40% of service revenues

in 2012. Besides SMS, international voice termination was also big for the Philippine

cellular sector, given the significant presence of overseas foreign workers. They together

Cellular service revenue declined at a

three-year CAGR of 1.4%

SMS and international voice accounted for

~55% of cellular service revenue in 2012

20 June 2017


accounted for ~55% of cellular service in 2012, making the Philippines market ripe for

disruption with the coming of data services. The launch of data network and increasing

penetration of smart devices resulted in cannibalisation of legacy services by data

revenue. As a result, Philippines cellular sector’s service revenue grew moderately by

2.7% and 0.7%, respectively, in 2014 and 2015, while in 2016 service revenue fell by

4.6% as the smartphone subscriber base gained sizeable mass.

Figure 99: Contribution of legacy services to cellular service revenue


■ Superior execution by Globe. Despite structural headwinds, Globe has been able to

outgrow PLDT mainly due to its superior execution (aided by the presence of SingTel).

The company invested heavily on the data network over 2012-15 to position itself as

the data network of Philippines. Globe’s average capex spent was ~36% of wireless

service revenue from 2012-15 vs ~20% by PLDT during the period. The increased data

investment was complemented with sound marketing promotions, which helped Globe

emerge as the preferred data brand in the Philippines. The company introduced free

Facebook promotion in 2013 and 2014 to get customer hooked on to cellular data. The

increased traction in the data market also helped Globe gain market share in the voice

segment since it started replacing PLDT as the primary SIM.

41% 39%35% 32% 29%

17%15%

13%

10%9%

0%

10%

20%

30%

40%

50%

60%

70%


SMS International voice

54%

47%

43%

38%

58%

Globe has been able to outgrow PLDT mainly

due to its superior execution

20 June 2017


Figure 100: Globe invested early into the data

network…

Figure 101: …helping it to grow faster than PLDT

and gain ~12% market share in the last five years


■ Poor execution by PLDT. While Globe’s execution was world class, PLDT’s execution

during the period was at the other extreme. PLDT’s network was historically designed

as SMS-centric and the company did not make necessary investments until 2015 when

market share loss started exacerbating. PLDT was slow to realise the potential of data

services as the company believed that the decline in SMS revenue will be more

gradual. However, Globe’s proactive data investment caught the company unprepared.

■ Increase in competition. With PLDT losing market share, the competitive dynamics

also increased in 2015 and 2016, resulting in ineffective data monetisation during the

period. One of the heavily promoted plans was the P50 plan, wherein the data

allowance was increased to 1GB data for three days from 350MB previously.

Additionally, PLDT provided prepaid handset subsidies in late 2015 and early 2016 in

order to arrest market share loss. However, the company stopped them in 2H16 as it

impacted its profitability without meaningful change in market share.

Revenue growth to remain under pressure

Though the competitive dynamics have largely been stable over the last six months with

PLDT withdrawing handset subsidies and no major price reduction, we expect cellular

sector’s service revenue growth to remain muted over the next three years as legacy

services (SMS and international voice) still account for ~36% of the total service revenue.

Also, increasing smartphone penetration is likely to create further headwinds for legacy

services. Domestic voice revenue has also been on a declining trajectory over the last 12

months due to cannibalisation from data services.

Additionally, we believe consumer behaviour needs to be changed towards regular

charging so that customers are connected online more frequently. Currently, many

customers still look for free WiFi connections to go online, hampering data monetisation.

10%

15%

20%

25%

30%

35%

40%

45%

50%

2011 2012 2013 2014 2015 2016

Globe's wireless capex as % of service revenue

PLDT's wireless capex as % of service revenue

55

65

75

85

95

105

115

125

2012 2013 2014 2015 2016

PDLT Globe

PLDT 5 year CAGR of c. -3%

Globe 5 year CAGR of c. 8%

(P bn)

Revenue growth to be muted till 2019E as

legacy services still account for ~36% of

revenue

20 June 2017


Figure 102: YoY cellular revenue growth (P mn) and revenue growth rates (%)


Globe 6,821 8,682 633 1,448 2,283 3,702 4,169

PLDT (1,642) (7,361) (9,866) (13,146) (2,056) 442 1,927

Total 5,179 1,321 (9,233) (11,698) 226 4,144 6,096

Growth (% YoY)

Globe 9.0% 10.5% 0.7% 1.6% 2.4% 3.9% 4.2%

PLDT -1.4% -6.4% -9.2% -13.4% -2.4% 0.5% 2.3%

Total 2.7% 0.7% -4.6% -6.2% 0.1% 2.3% 3.3%


Globe's outperformance to continue

We forecast PLDT to continue to lose market share over the next four years as the

contribution of legacy services to cellular revenue is high for PLDT (at ~40%) compared to

Globe (which is at ~33%). However, we expect market share loss to subside beyond 2017

as we believe PLDT’s data investment to yield some benefits in later years.

Figure 103: Cellular revenue (P mn) and revenue market share (%)

(P mn) FY14 FY15 FY16 FY17 FY18 FY19 FY20

Globe 82,561 91,243 91,876 93,324 95,607 99,309 103,477

PLDT 115,037 107,676 97,810 84,664 82,608 83,050 84,977

Total 197,598 198,919 189,686 177,988 178,214 182,359 188,454

Market share (%)

Globe 41.8% 45.9% 48.4% 52.4% 53.6% 54.5% 54.9%

PLDT 58.2% 54.1% 51.6% 47.6% 46.4% 45.5% 45.1%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


Our market share expectation is based on our analysis of the following key factors:

Spectrum allocation by operator

As highlighted in the figure below, PLDT has more spectrum than Globe. However, post

the joint acquisition of SMC’s telecom assets (Vega Telecom), we believe Globe is

comfortably placed with respect to its spectrum holding. Vega Telecom has provided

Globe with 700MHz, 900MHz, 1800MHz, 2300MHz and 2500MHz spectrum bands, easing

company’s capacity constraints. That said, Globe would like increasing migrating

customers to 4G network as its spectrum footing on 4G is more even than on 3G. Globe

has 2x10MHz of 2100MHz spectrum compared to 2x25MHz of 2100MHz spectrum with

PLDT. With such vast spectrum holdings (compared to its regional peers), Philippines

cellular operators do not face any spectrum constraints, in our view. Additionally, there is

no spectrum renewal risk as it is linked to the company’s franchise licence, which

generally gets renewed for 25 years.


700MHz 850MHz 900MHz 1800MHz 2100MHz 2300MHz 2400MHz 2500MHz/26

00MHz

3500MHz 5000MHz

PLDT 2x17.5MHz 2x10MHz 2x12.5MHz 2x45MHz 2x25MHz 60MHz 73MHz 75MHz - 10MHz

Globe 2x17.5MHz - 2x22.5MHz 2x30MHz 2x10MHz 30MHz - 90MHz - 10MHz

Government 2x10MHz 10MHz - 2x10MHz - 15MHz 40MHz -


BTS by operator

While the Philippine cellular operators do not disclose the cell sites data, our

understanding is that PLDT has more cell sites than Globe largely due to legacy reasons.

Philippines cellular operators do not face

any spectrum constraints

20 June 2017


Globe has been looking to close the gap by adding more cell sites over the past few years.

The recent changes in regulatory regime are also helping in faster roll-out of sites as the

number of approvals needed for installing a site have been streamlined. However, we do

not believe cell site count will lead to any significant disadvantage for Globe as the

company has good coverage in all major population areas and the recent SMC deal has

eased the company’s capacity constraints.

Capital intensity

Both Globe and PLDT have been investing heavily on the data network over the past few

years. Going forward, the priorities of the two operators (apart from improving the 4G

network) are a bit different with PLDT primarily focused on the modernisation of its legacy

network, while Globe is more concentrated on expanding its footprint to improve its

coverage and network capacity. Hence, we do not see any significant easing in capital

intensity over the next 2-3 years.

Figure 105: Capex by operator (P mn) Figure 106: Capex-to-sales ratios (%)



The recent Vega Telecom acquisition has increased the leverage of both PLDT and

Globe. PLDT’s net debt to EBITDA rose to 2.5x by Dec-2016 (from 1.8x in Dec-2015)

while that of Globe’s rose to 1.9x (from 1.3x). However, we see both the telcos as well-

positioned to maintain the aforementioned capital intensity. We forecast Globe and PLDT

will continue to generate free cash flow, though the quantum has come down compared to

history, which should aid the capex spending.

PLDT has already cut its dividend payout ratio to 60% in 2016 (from ~90% in 2014) due to

headwinds in the core cellular business and the investment needed on the cellular side.

We do not expect any increase in the payout ratio over the next three years. While for

Globe, we believe the company can manage some increase in its dividends over the next

three years, given the growth in operating profit led by cellular market share gain.

Regulation

The key regulatory issues affecting the sector are: (1) the Philippines Competition

Commission's (PCC) review of joint acquisition of SMC’s telecoms assets by Globe and

PLDT and (2) the introduction of a third cellular operator.

On the first, we see low probability of the SMC deal getting cancelled, given: (1) SMC was

not operating a full-fledged cellular network, (2) the deal enables the use of the precious

spectrum resources, which were lying idle, and (3) the regulator has granted the

-

5,000

10,000

15,000

20,000

25,000

30,000

35,000


Globe PLDT

0%

5%

10%

15%

20%

25%

30%

35%

40%


Globe PLDT

We do not see any significant easing in

capital intensity over the next 2-3 years

We see a low chance of: (1) the SMC deal

getting cancelled and (2) a competitive third

cellular operator

20 June 2017


necessary approvals for the co-use of SMC's spectrum. Additionally, we see a lack of

alternatives in case the deal is cancelled. Furthermore, we believe the more (and longer)

investments telcos make in SMC's spectrum assets, the harder it will get to undo the deal

as consumers will start utilising and realising the benefits of the 700MHz network.

We see a low probability of a competitive third cellular operator in the Philippines over the

next 3-5 years, given the availability of limited spectrum and also the significant investment

needed. We believe SMC’s struggle in being the third cellular operator after having an

attractive spectrum portfolio shows how difficult a market the Philippines is for a new player.


Philippines telecom operators have seen a contrasting trend in their return profile over the

past few years. While Globe’s ROIC has, expectedly, increased from 2010 levels, given

that it has been gaining cellular market share, PLDT’s ROIC has been on a declining

trajectory. As of 2016, PLDT had an ROIC of 10.0%, slightly more than our assumed

WACC of 8.5%, while Globe generated an ROIC of 13.7% (~5% above our WACC

assumptions).

Going forward, we expect Globe’s ROIC to decline to ~11% by 2017 due to the joint

acquisition of SMC’s telecom assets. However, after 2017 we expect gradual improvement

in the company’s ROIC as it leverages newly acquired spectrum (from SMC deal) to gain

market share. That said, decline in legacy service revenues will continue to be a headwind

on ROIC. By 2020, we expect the company’s ROIC to reach ~12%. For PLDT, we forecast

ROIC to continue to decline gradually and reach ~9% by 2020. We believe cellular

headwinds are likely to be somewhat compensated by the strong performance in the fixed

line segment. Our estimates suggest that PLDT will barely manage to earn above its

WACC for the next four years.

Given structural issues, the lack of good quantum of spectrum, and the quantum of initial

investment needed, we see no business case for the smaller players in the Philippines.

PLDT’s recent ROIC figures reflect the challenging environment the Philippine telecom

operators currently face despite it being a duopoly.



Globe PLDT Globe PLDT Globe PLDT

Subscribers (000s) 62,799 62,763 58,553 66,509

Service revenue 119,990 157,210 142,036 169,908 4.3% 2.0%

EBITDA 49,978 61,161 58,507 69,510 4.0% 3.3%

EBITDA margin 41.7% 38.9% 41.2% 40.9%

Depreciation to sales (%) 19.9% 22.5% 17.5% 21.0%

EBIT 26,129 25,777 33,718 33,878 6.6% 7.1%

EBIT margin 21.8% 16.4% 23.7% 19.9%

Tax rate (%) 27.6% 6.9% 30.0% 26.0%

NOPLAT 18,925 23,993 23,603 25,069 5.7% 1.1%

Average invested capital 137,942 239,508 191,928 276,965

Asset turn 0.9 0.7 0.7 0.6

ROIC 13.7% 10.0% 12.3% 9.1%

Net profit 15,888 25,521 20,396 22,335 6.4% -3.3%

Net margin 13.2% 16.2% 14.4% 13.1%

Note: There is a change in definition of pre-paid subs for Globe from 1Q17 and hence there is a substantial decline in FY20 figure from FY16 level; Source: Company data, Credit Suisse estimates

PLDT will barely manage to earn above its WACC for the next

four years, in our view

20 June 2017



We use discounted cash flow methodology to value Philippines telecom stocks. We

believe it fully captures the investment nature of the cellular business and its payback

potential.

At present, we believe the market is not fully appreciating Globe's cellular market share

gain potential. On the other hand, we believe PLDT's stock price is building in a recovery

in the cellular business ahead of our expectations as there is 21.1% downside potential on

our PLDT target price.

Even on a relative valuation basis, PLDT's stock looks more expensive (in terms of 2017E

and 2018E EV/EBITDA) than Globe, which in our view is unjustifiable, given that Globe is

gaining market share and its profitability and dividends are growing. Additionally, Globe is

offering higher dividend yield than PLDT.

Figure 108: Philippines cellular sector—comparative valuation

Close Target Upside Normalised P/E 9x) EV/EBITDA (x) EV/IC (x) FCF yield (%) Div yield (%)


Globe 2,156.00 2,350.00 9.0% 21.3 19.6 7.7 7.6 2.4 2.2 0.9% 1.8% 4.2% 4.4%

PLDT 1,900.00 1,500.00 -21.1% 19.9 20.3 8.7 8.5 2.1 2.1 1.5% 2.6% 3.0% 3.0%


Figure 109: Share price performance (rebased). Globe's outperformance is likely to continue


40

60

80

100

120

140

160

180


Globe PLDT

We believe the market is not fully appreciating Globe's cellular market

share gain potential

20 June 2017


Country sections: Hong Kong

Summary

■ In terms of industry structure, the Hong Kong market looks relatively unattractive with

high 4G penetration and extensive handset subsidies.

■ We expect the Hong Kong market to deliver flat service revenue (a CAGR of 0.0%)

across FY16-FY20.

■ HKT Trust is dominant with 40.6% revenue market share as at 1Q17 and an FY16

ROIC of 7.9%. It appears somewhat undervalued as the market is overly punishing the

stock for the rise in MVNO competition.

■ SmarTone looks to be an undervalued #2 player with sufficient scale to generate

attractive returns and appealing cash flow profile. We highlight it as a top pick. HTHKH,

on the other hand, looks to be fairly valued.

Fundamentals improved post consolidation but

competition in the low end is increasing

Hong Kong (HK) has historically been a very competitive market with five cellular

operators vying for market share till 2013. However, 2014 saw in-market consolidation

wherein HKT, the No. 4 operator then, acquired CSLNW, the No. 1 operator. As a result,

the pricing in the sector improved, leading to the sector’s net service revenue (adjusted for

customer acquisition cost) growing by ~1% in 2014. Revenue growth has faltered since

then due to rising competition.

Figure 110: Cellular service revenue growth (% YoY)

1H15 2H15 1H16 2H16

HKT Trust n.a. -3.0% 0.0% 0.1%

SmarTone 10.2% 3.0% -2.7% -0.7%

HTHKH -10.9% -12.4% -5.7% -2.0%

China Mobile and others 4.9% 4.9% 4.3% 4.3%

Total n.a. -2.8% -1.4% 0.0%

Source: OFCA, Company data, Credit Suisse estimates

In terms of market share, Hutch Tel HK (HTHKH) has lost market share to HKT Trust

(HKT), SmarTone, and others (including China Mobile HK) due to poor execution.

Figure 111: Cellular service revenue market share (%)

1H15 2H15 1H16 2H16

HKT Trust 39.4% 40.5% 40.0% 40.6%

SmarTone 26.0% 25.6% 25.6% 25.4%

HTHKH 22.3% 21.2% 21.4% 20.8%

China Mobile and others 12.3% 12.6% 13.0% 13.2%

Total 100.0% 100.0% 100.0% 100.0%


Below we discuss in detail the reasons for the recent decline of HK’s cellular revenue:

■ Competition: Post the in-market consolidation of May-2014, the fundamentals of the

Hong Kong cellular market improved with the easing in competitive intensity. The

pricing in the sector saw a positive uptick with operators increasing the tariffs both at

the lower and higher end of the plans. For example, the price of SIM-only plans were

increased by 5-20% in Sep-2014, while the pricing of 3G speed capped was increased

from HK$68/month to HK$88/month by July-2015. However, post the initial burst of

20 June 2017


positive price actions, the progress on cellular pricing has been disappointing as prices

in the higher-end segment have remained largely flat over the past 24 months, while

the low segment has evolved with the launch of various speed capped plans, limiting

the sector’s growth potential.

The sector has seen the launch of various 4G lite plans at attractive price points of

HK$108-208/month (vs mainstream 4G plans), which offer 1GB to 5GB monthly data

with a maximum speed of 21-42Mbps. We do not believe these plans can be masked

as speed capped plans, as 21-42Mbps is a very good speed for data usage (unlike the

384Kbps plan, which is truly a speed capped plan). HTHKH, HKT (through Sun Mobile)

and China Mobile HK have been more active in this segment, while SmarTone has

presence mainly in the 3G speed capped segment (HK$88). However, the launch of

HKBN cellular services has addressed some of the gaps for SmarTone in the low-end

segment of the market as it is using HKBN as a platform to target that segment.

■ Cannibalisation by OTT services. Besides competition in the low end segment, HK

cellular sector growth has also been impacted by the popularity of OTT services as

they have cannibalised roaming and IDD revenues. The impact of declining roaming

revenue was more pronounced for HTHKH over the last 12-18 months as the company

ended the wholesale roaming arrangement with one of the Japanese operators. For

HTHKH, the contribution of the roaming revenue (to cellular revenue) declined to ~18%

by 2016 from ~20% in 2015 and 25% in 2014. The roaming revenue contribution for

SmarTone is ~14% and for HKT it is 16-18%. In the pre-paid segment, SmarTone has

been impacted the most as it has the highest exposure to the domestic foreign worker

segment, which has been impacted by the cannibalisation of IDD revenue by OTT

services. The company’s pre-paid revenue declined by ~34% YoY over the last 12

months vs ~21% declined registered by HKT and ~4% registered by HTHKH.

■ Poor execution by HTHKH. Hutch Telecom HK (HTHKH) has been facing challenging

times as the company has been unable to revive cellular service revenue growth over

the last three years. HTHKH’s cellular service revenue declined at a two-year CAGR

(2014-16) of ~8%. The revenue was impacted by the decline in roaming revenues and

the company's conscious decision not to offer the 3G speed capped plans, which led to

contraction in the subscriber base. However, the company restarted offering the 3G

speed capped plan in 2H CY15 when the price of the plan was raised to HK$88/month.

Competitive low end segment to hamper growth

The past 3-4 months have seen competitive dynamics worsening further, on the low-end

segment, with first HKBN launching its new bundled plan offering 3GB cellular data (5GB

for port in customers) at a capped speed of 21Mbps (on China Mobile’s network), access

to TVB’s app, and fixed voice services for a monthly fees of HK$90. The HKBN’s launch

was followed by HKT’s response which launched a new cellular plan offering 3GB data

(5GB for port in customers) at a capped speed of 21Mbps for a monthly fee of HK$78.

HKT is offering the new plan under the Sun Mobile brand and it is applicable to “The Club”

members (i.e., customers availing at least one HKT service). Few weeks later, HKBN

matched HKT’s HK$78 plan by launching the similar plan on SmarTone’s network.

The sector has seen launch of various 4G

lite plans in the low-end segment, increasing

down-trading risk

Growth has been affected by OTT

services cannibalising roaming and IDD

revenues

HKBN's entry as a MVNO has worsened

the competitive dynamics further

20 June 2017


Figure 112: HK cellular sector—SIM-only plans


We view these plans as aggressive as they are likely to promote down-trading risk. We

note that the mainstream 4G plan offers 2.5GB data for a monthly fee of HK$238 while the

new plan offers 3GB data (5GB for port in customers) for just HK$78/month (down from

HK$108 previously). Additionally, we believe the sector has moved one step backwards

with HKT launching the HK$78 plan as the pricing is lower than the current price of 3G

speed capped plan, which offers unlimited data at 384Kbps speed for HK$88/month. We

expect HK cellular sector’s service revenue to remain under pressure in the near term. We

are forecasting service revenue to decline at a two-year CAGR (2016-18E) of ~1%.

However, we expect HK cellular pricing (led by the increase in prices of the low end plans)

to improve in the medium to long term as the current pricing in the low end segment is not

sustainable.

Figure 113: YoY cellular revenue growth (HK$ mn) and revenue growth rates (%)


HKT Trust 201 248 2 (21) (9) 66 95

SmarTone 69 296 (82) (22) 14 39 57

HTHKH (492) (540) (160) (60) (71) (39) (28)

China Mobile and others 19 110 101 (30) (22) 12 29

Total (204) 114 (139) (133) (88) 77 153

Growth (%)

HKT Trust 2.8% 3.4% 0.0% -0.3% -0.1% 0.9% 1.3%

SmarTone 1.5% 6.5% -1.7% -0.5% 0.3% 0.8% 1.2%

HTHKH -9.6% -11.6% -3.9% -1.5% -1.8% -1.0% -0.7%

China Mobile and others 0.8% 4.9% 4.3% -1.2% -0.9% 0.5% 1.2%

Total -1.1% 0.6% -0.7% -0.7% -0.5% 0.4% 0.8%


HTHKH to lose cellular market share

We believe HTHKH is likely to be impacted the most from the increasing competitive

dynamics in the low-end segment as it has a substantial share of low-end customers. HTHKH

has lost ~4% cellular revenue market share over the past two years and we expect the

company to lose further ~1% market share to SmarTone and HKT Trust over the next four

years. The market share of China Mobile HK and other MVNOs is expected to remain stable

at ~13%, in our view. Below are our reasons for the market share expectations.

78 88 90

108 128

148

178

208 198

238

298

438

50

100

150

200

250

300

350

400

450

3GB Unli 3GB 3GB 1GB 2GB 3GB 5GB 1GB 2.5GB 6GB 10GB

21Mb/s 384Kb/s 21Mb/s 21Mb/s 42Mb/s 42Mb/s 42Mb/s 42Mb/s 4G 4G 4G 4G

Low-end speed capped plansMainstream SIM only plans

Low end segment has evolved over the last 15-18 months with the launch of these plans (ex 384Kb/s).

(HK$/mth)

These new plans have been launched by HKT and HKBN in Feb-Mar'17

We believe HTHKH is likely to be impacted

the most from the increasing competitive

dynamics

20 June 2017


Figure 114: Cellular revenue (HK$ mn) and revenue market share (%)


HKT Trust 7,292 7,541 7,543 7,522 7,513 7,579 7,674

SmarTone 4,564 4,860 4,778 4,757 4,771 4,809 4,867

HTHKH 4,646 4,106 3,946 3,886 3,815 3,776 3,747

China Mobile and others 2,240 2,350 2,451 2,421 2,399 2,411 2,440

Total 18,743 18,857 18,718 18,586 18,498 18,575 18,728

Market share (%)

HKT Trust 38.9% 40.0% 40.3% 40.5% 40.6% 40.8% 41.0%

SmarTone 24.4% 25.8% 25.5% 25.6% 25.8% 25.9% 26.0%

HTHKH 24.8% 21.8% 21.1% 20.9% 20.6% 20.3% 20.0%

China Mobile and others 12.0% 12.5% 13.1% 13.0% 13.0% 13.0% 13.0%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


Spectrum

The leading HK operators (HKT, SmarTone, and HTHKH) have a good mix of low band

and high band spectrums to offer quality 4G services in HK. From a total spectrum

quantum perspective, HKT has an advantage over its peers largely due to its substantial

holding of the 1800MHz spectrum band (arising from its CSL acquisition). The large

spectrum bank enables HKT to have more capacity and higher network speed. However,

we do not believe that the spectrum advantage can translate into significant market share

gain for HKT as spectrum holdings of SmarTone and HTHKH are good enough to offer

competitive 4G services. Additionally, technological changes are enhancing network

capacities while using existing network resources. For example, SmarTone plans to move

to quad band carrier aggregation (the latest technology) with the re-farming of 2100MHz

spectrum to LTE in 2017. Also, the company is looking to upgrade to 4x4 MIMO (from 2x2

MIMO) and data modulation to 256QAM on downlink, enabling it to offer higher download

speed and, hence, enhancing network capacity.

Post the acquisition of the 2100MHz spectrum in the 2014 spectrum auction, China Mobile

HK’s competitive position has improved as it can offer 3G service on its own network.

Earlier, the company was offering 3G services in a roaming arrangement with the

incumbents. That said, the company does not have access to low band spectrum in HK,

which can be an impediment on its network quality.


850/900MHz 900MHz 1800MHz 2100MHz 2300MHz 2600MHz

HKT 2 x 7.5MHz 2 x 8.3MHz 2 x 36.4MHz 2 x 14.8MHz 2 x 20MHz

HTHKH 2 x 5MHz 2 x 8.3MHz 2 x 11.6MHz 2 x 14.8MHz 30MHz

CMHK - 2 x 13.2MHz 2 x 9.8MHz 30MHz 2 x 20MHz

SMT 2 x 5MHz 2 x 8.3MHz 2 x 13.2MHz 2 x 19.8MHz 2 x 10MHz

GBL1 - 2 x 20MHz

Note 1: GBL is a joint venture between HKT and HTHKH Source: Company data, Credit Suisse estimates

Capital intensity

Like their peers in Taiwan and Singapore, HK telcos are also past their peak 4G capex cycle

as the 4G roll-out is complete. As a result, we saw cellular capex decline in 2015 and 2016,

and the capex guidance for 2017 is for stable capex. HKT's cellular capex increased in 2015

mainly due to the network integration cost related to the CSL merger. The next big capex

cycle for the telcos is likely to emerge from the roll-out of the 5G network. However, we

believe 5G is unlikely to happen before 2020, given 5G standards are not finalised yet.

Hence, we expect cellular capex for HK telcos to remain largely flat over the next four years.

HK telcos are also past their peak 4G capex

cycle as the 4G roll-out is complete

20 June 2017


Figure 116: Capex by operator (HK$ mn) Figure 117: Capex-to-sales ratios (%)



We believe HK telcos are well capitalised to fund their capital expenditure plans.

SmarTone has very little debt (net debt to EBITDA of 0.4x) as of Dec-2016, while the net

debt to EBITDA of HTHKH and HKT are 1.8x and 2.8x, respectively, which in our view are

manageable. Given our expectations of stable capex and operating profits, HK telcos’

future cash flow generation should remain strong to maintain the capital intensity and

dividend pay-outs. China Mobile HK, on the other hand, has a strong parent company,

which should be able to support the company’s capex layout in HK.

Regulation

Currently, the major outstanding regulatory issue in HK is the renewal of 900MHz and

1800MHz spectrum bands. The 900MHz spectrum assignment will expire in November

2020 while 1800MHz in September 2021. OFCA, the HK telecom regulator, has proposed

the hybrid approach wherein: (1) first right of refusal will be given to incumbents for 2x

10MHz of 1800MHz, and (2) the remaining spectrum will be put on auction.

The fees for the reserved spectrum are likely to be HK$38-67 mn per MHz with the

inclination towards the higher end of the range. The fees will be subject to upward revision

depending on the outcome of the auction with a cap of 30-40% higher than the reserved

price. For the spectrum put up for auction, the reserve price is likely to be HK$19-54 mn

per MHz with the inclination towards the higher end of the range.

HKT is likely to be the most impacted with the spectrum renewal exercise as it can lose

some of the 1800MHz spectrum where it currently has a disproportionate share. The other

major concern regarding the spectrum auction is the potential emergence of a new

operator from the auction. We see a low probability of a new entrant in the sector as the

market is very mature and the returns in the sector are not conducive for a new operator’s

business case (as discussed below). The below table shows our expectations from the

upcoming spectrum auctions.

-

200

400

600

800

1,000

1,200

1,400

1,600


HKT SmarTone HTHKH

0.0%

5.0%

10.0%

15.0%

20.0%

25.0%


SmarTone HKT HTHKH

HK telcos are well capitalised to fund their

capital expenditure plans

HKT is likely to be the most impacted with the

spectrum renewal exercise

20 June 2017


Figure 118: CS expectations of upcoming 900/1800MHz spectrum auction

Spectrum coming up for renewal CS expectations of outcome Price (HK$ mn/MHz) Payment (HK$ mn)

900MHz 1800MHz 900MHz 1800MHz 900MHz 1800MHz 900MHz 1800MHz Total

CMHK 2 x 13.2MHz 2 x 18.2MHz HK$100m HK$55m 2,002 2,002

HKT 2 x 8.3MHz 2 x 36.4MHz 2 x 8.3MHz 2 x 21.4MHz HK$100m HK$55m 1,660 2,354 4,014

Hutch Tel 2 x 8.3MHz 2 x 11.6MHz 2 x 8.3MHz 2 x 16.6MHz HK$100m HK$55m 1,660 1,826 3,486

SmarTone 2 x 8.3MHz 2 x 13.2MHz 2 x 8.3MHz 2 x 18.2MHz HK$100m HK$55m 1,660 2,002 3,662



Being a pure cellular operator, SmarTone has the highest ROIC in the HK telecoms

sector. The company generated an ROIC of 21% in 2016, much higher than our assumed

WACC of 7.0%. However, the two integrated telcos (with cellular and fixed line

businesses) had a ROIC of low single digit in 2016. While HKT with a ROIC of 8% in 2016

was able to generate return above its assumed WACC of 6.0%, HTHKH with a ROIC of

5% failed to earn higher than its WACC of 6.8%.

Going forward, the cellular business' ROIC is likely to remain under pressure due to

increasing competition in the low end segment and rising cost of providing cellular services

(especially related to spectrum). We expect SmarTone's ROIC to decline to 18% by 2020

while that of HKT and HTHKH should remain largely stable due to the fixed line business.

For smaller players, we believe the business case is challenging, given the high

competitive dynamics as reflected by the ROIC profile of the sector.



SmarTone HKT HTHKH SmarTone HKT HTHKH SmarTone HKT HTHKH

Subscribers (000s) 2,000 4,469 3,222 2,169 4,477 3,405

Service revenue 4,779 27,944 7,640 4,867 29,314 7,935 0.5% 1.2% 1.0%

EBITDA 1,943 10,206 2,465 1,877 10,831 2,553 -0.9% 1.5% 0.9%

EBITDA margin 41% 37% 32% 39% 37% 32%

Depreciation to sales (%) 19% 12% 19% 19% 10% 18%

EBIT 1,045 6,876 1,044 943 7,920 1,085 -2.5% 3.6% 1.0%

EBIT margin 22% 25% 14% 19% 27% 14%

Tax rate (%) 19% 14% 17% 20% 18% 19%

NOPLAT 844 5,946 870 753 6,495 876 -2.8% 2.2% 0.2%


Asset turn 121% 37% 48% 117% 37% 51%

ROIC 21% 8% 5% 18% 8% 6%

Net profit 787 4,889 701 710 5,491 743 -2.5% 2.9% 1.5%

Net margin 16% 17% 9% 15% 19% 9%



We use DCF methodology to value HK telecom stocks as we believe it rightly captures the

multi-year nature of the cellular investment and payback while factoring in the competitive

dynamics.

Based on our DCF valuation, SmarTone currently looks undervalued as there is ~32%

upside to our valuation. We believe the market is overly punishing the stock for the rise in

competition in the cellular segment. Similarly, HKT also appears undervalued, given ~16%

upside to our DCF-based valuation while HTHKH looks fairly valued currently.

On a relative valuation, SmarTone's valuation looks attractive with the company's stock

trading at 2018E EV/EBITDA of 5.0x and dividend yield of 6.1%. HKT's valuation is also

SmarTone looks undervalued as there is

~32% upside to our DCF-based valuation

20 June 2017


compelling as the stock is offering one of the highest dividend yield spreads in our telco

coverage universe.

Figure 120: Hong Kong cellular sector—comparative valuation

Close Target Upside Normalised P/E EV/EBITDA EV/IC (x) FCF yield Div yield


SmarTone 10.24 13.50 31.8% 15.0 15.4 5.0 5.0 2.4 2.0 10.0% 8.3% 6.2% 6.1%

HTHKH 2.68 2.60 -3.0% 19.7 18.5 7.2 6.9 0.9 0.9 7.7% 8.0% 3.8% 4.1%

HKT Trust 10.20 11.85 16.2% 15.3 14.7 11.1 10.9 1.5 1.5 7.0% 6.9% 6.3% 6.5%


Figure 121: HK telcos' share price performance (rebased)


60

80

100

120

140

160

180

200


SmarTone HTHK HKT Trust

20 June 2017


Country sections: Singapore

Summary

■ In terms of industry structure, the Singapore market looks most unattractive, with new

entrants, extensive handset subsidies and high 4G penetration.

■ We expect the Singapore market to experience declining service revenue at a CAGR

of 2.5% across FY16-FY20.

■ SingTel is dominant with 53.4% revenue market share as at 1Q17 and an FY16 ROIC

of 11.1%. We believe the stock is being overly penalised for domestic competition

without due regard to its growing enterprise business and international associates.

■ On the other hand, the competitive pressure does not seem to be properly priced in for

#2 player StarHub and challenger M1. We highlight M1 as a top regional

Underperform.

Cellular revenue impacted by ineffective data

monetisation

Following IMDA’s decision (on July 2015) to facilitate a fourth cellular operator, the

Singapore cellular market has seen competitive dynamics worsening with operators

launching aggressive plans (such as data add on) in order to pre-empt the entry of the

new operator. This, in turn, has put pressure on sector revenue as operators have not

been able to monetise the data effectively. Singapore cellular sector revenue has been on

a decline (YoY) over the past five quarters as the decline in legacy services (SMS,

international long distance, roaming, and voice) has not been compensated by growth in

data revenue.

Figure 122: Cellular service revenue growth (YoY)

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

SingTel 1.7% 1.2% 0.8% -0.7% -0.8% -2.9% -2.3% -3.7% -2.3%

StarHub -0.2% 0.2% -0.1% -2.3% -2.4% -1.8% -3.6% -0.4% -0.6%

M1 -1.5% -2.0% -0.8% -0.8% -2.6% -0.9% -4.6% -4.7% -1.1%

Total 0.6% 0.3% 0.2% -1.1% -1.6% -2.2% -3.1% -3.0% -1.6%


The market shares of the three Singaporean telcos (SingTel, StarHub and M1 Ltd) have

remained largely stable (though there may be some quarterly variations) over the last two

years as the operators have witnessed similar service revenue decline during the period.


1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

SingTel 53.4% 53.6% 53.5% 53.4% 53.8% 53.2% 53.9% 53.0% 53.4%

StarHub 27.7% 27.7% 27.8% 27.8% 27.4% 27.8% 27.6% 28.5% 27.7%

M1 19.0% 18.7% 18.8% 18.8% 18.8% 19.0% 18.5% 18.5% 18.9%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


The introduction of 4G services in 2012 saw Singapore telecom companies moving away

from unlimited data plans to tiered data pricing. Hence, the sector witnessed decent

growth from 2012-14, though at a slower pace than the previous years as smartphone

penetration peaked. However, the sector growth has started to falter post 2014 due to

factors as detailed below.

Cellular competition has worsened with

incumbents looking to pre-empt the entry of a

new operator

20 June 2017


■ Cannibalisation from OTT services: The emergence of faster networks (fixed and

cellular) and powerful handsets (smartphones) has catalysed the development of OTT

services, which in turn have cannibalised telcos’ core revenue stream (voice, SMS,

roaming, etc.) over the past 3-4 years. Singapore, being a developed nation with very

good cellular and fixed broadband infrastructure, is one of the most adversely impacted

markets. Additionally, the rising competitive dynamics over the past 18-24 months have

made data monetisation ineffective.

■ Regulator’s keenness to introduce competition: Encouraged with the results

yielded by the introduction of competition in the broadband segment, IDA had been

keen to introduce competition in the Singapore cellular market for some time. The

regulator tried to introduce a fourth cellular operator in the 2013 spectrum auction by

reserving 2x20MHz of 2600MHz for new operators (at S$40 mn). However, no new

operator showed any interest in the Singapore cellular market then.

But the 2016 new operator spectrum auction saw three companies—airYotta Pte Ltd,

My Republic and TPG Telecom—submitting expression of interest in being the fourth

cellular operator in Singapore with TPG Telecom finally winning the auction. We

believe the availability of the low band and high band spectrum at attractive terms

(2x10MHz in 900MHz and 40MHz in 2.3GHz for S$35 mn) was one of the main factors

for the active participation in the 2016 new operator spectrum auction.

■ Launch of new aggressive data plans: With IMDA looking to introduce competition,

the Singapore telcos launched new price plans (such as launch of SIM-only plans, data

add-on plans, etc.) in order to deter the entry of the fourth cellular operator. The key

among them was the launch of data X3 plan by SingTel in September 2016 wherein

the data allowance was increased to three times for an additional fee of S$9.90/month.

M1 and StarHub, uncharacteristic of their past behaviour, did not respond immediately

to SingTel’s new plan. M1 finally responded to SingTel’s data X3 plan in Nov-2016 by

launching its own ‘Upsized data plus’ plans while StarHub introduced ‘Data Jump plan’

in May-2017. We view these plans as disruptive as they can lead to significant down-

trading (click here) and believe this is one of the reasons why M1 and StarHub did not

respond immediately.

The figure below shows the changes in data prices (SIM-only plans) over the past 18

months. As can be seen, prices in Singapore have declined during the period, led by the

recent launch of data X3 plans.

The rising competition has led to ineffective data monetisation in

the last two years

The new data X3 plans are disruptive, in our

view

https://plus.credit-suisse.com/u/a6nAW9

20 June 2017


Figure 124: M1's SIM-only pricing trend

Note: Added caller ID charges of S$5.35/month to the basic plan Source: Company data, Credit Suisse estimates

Service revenue outlook continues to be hazy

Service revenue outlook continues to be hazy as we expect further reduction in data prices

with the potential launch of services by TPG Telecom in 2H18. Though the Singapore

cellular sector has seen some price actions over the past 12-18 months, we believe price

competition is likely to intensity further over the next three years with TPG looking to gain

market share. Also, our recent analyses suggest that there is more downside to Singapore

pricing over the next two to three years. In the first of our analysis ('Four is a (bigger)

crowd' dated 2 March 2017), we had looked at TPG Telecom’s cost structure (operating

and capex) to determine the downside potential in Singapore cellular sector ARPU. Based

on inputs from various industry participants, we forecasted TPG’s steady state operating

expenses to reach S$185 mn by 2022E, representing ~51% of M1’s 2016 operating cost.

We believe our assumptions are reasonable given that M1 has a lot of legacy costs and TPG

can also drive significant cost savings from its Australia business. Our sensitivity analysis

suggests that TPG would turn EBITDA breakeven at a discount of ~17% to the current

service ARPU of S$33 with cellular subs share of 6% and fixed broadband (BB) subs share of

6%. Below, we have reproduced the sensitivity analysis published in that report.

35

50

80

130

31 37

47

68

0

20

40

60

80

100

120

140

5GB/6GB 7GB/8GB 12GB 20GB

Sep-15 Mar-17(S$ per month)

Service revenue outlook continues to be

hazy as we expect further reduction in

data prices

https://plus.credit-suisse.com/u/V639Oq1AN-YCCf


20 June 2017


Figure 125: TPG can be EBITDA breakeven at ~17% discount to current sector

ARPU with 6% cellular and fixed broadband subs share

Source: Credit Suisse estimates

In our second analysis (click here), we did global peer comparison to ascertain downside

in Singapore cellular pricing. Our global cellular price comparison suggests limited

downside potential in Singapore's cellular pricing as it is already in the low to mid end of

the price range of the markets that we studied. That said, Asian peer (HK and Taiwan)

price comparison reflects otherwise, as pricing in Taiwan is the lowest in the region while

HK has a much more competitive low-end segment than Singapore. However, we believe

ROIC is a much better metric to gauge the pricing pressure as it factors in the costs as

well. From an ROIC perspective, pricing in Singapore can decline substantially as the

returns in Singapore remain significantly higher than its global peers even though they

have declined over the past two years (M1’s ROIC has reduced from 28% in 2014 to 20%

in 2016).

We are currently building in Singapore cellular sector service ARPU to decline by 15-20%

(from 2016 level) over the next three years (until 2019E). The ARPU decline will be led by

customers down-trading their plans with the increasing adoption of the aggressive data

add-on plans and the launch of cellular services by TPG Telecom in 2H18. As a result, we

expect cellular service revenue to decline at a three-year CAGR of ~4% till 2019E vs

service revenue decline of c.3% witnessed in 2016.

Figure 126: YoY cellular revenue growth (S$ mn) and revenue growth rates (%)

(S$ mn) FY14 FY15 FY16 FY17 FY18 FY19 FY20

SingTel 44 18 (58) (53) (97) (73) (26)

StarHub 12 (8) (25) (23) (69) (40) (18)

M1 (19) (11) (27) (21) (44) (33) (20)

TPG - - - - 11 34 50

Total 37 (0) (111) (96) (199) (112) (14)

Growth (% YoY)

SingTel 1.9% 0.8% -2.4% -2.2% -4.2% -3.4% -1.2%

StarHub 1.0% -0.6% -2.0% -1.9% -5.8% -3.6% -1.6%

M1 -2.2% -1.3% -3.2% -2.6% -5.5% -4.3% -2.8%

TPG - - - - - 321.9% 111.5%

Total 0.8% 0.0% -2.5% -2.2% -4.7% -2.8% -0.3%


3.0% 4.5% 6.0% 7.5% 9.0% 10.5% 12.0%

-45.0% (115) (86) (57) (29) 0 29 58

-37.5% (107) (74) (42) (9) 24 57 89

-30.0% (99) (63) (26) 11 47 84 121

-22.5% (91) (51) (10) 30 71 112 152

-15.0% (84) (39) 6 50 95 139 184

-7.5% (76) (27) 21 70 118 167 215

0.0% (68) (15) 37 89 142 194 247

% d

isco

un

t to

cu

rre

nt

se

rvic

e A

RP

U (

S$33)

Subscriber m arket share (%)

We forecast cellular ARPU to decline by 15-20% in the next

three years

https://plus.credit-suisse.com/u/NQP1m2AN-Wd1W

20 June 2017


TPG to capture ~2% market share by FY20

We expect TPG to launch cellular service in 2H18 and to capture ~2% revenue market

share by 2020E. We believe pricing is likely to be the main lever to gain market share. The

market share gain is likely to come from all the three telcos with M1 losing little more

market share than StarHub and SingTel as it does not have any strong Pay TV

proposition. Although we believe pay TV will lose its bundling attractiveness in the long

term (five years or more), we believe in the initial years it may help StarHub and SingTel to

retain high-end subscribers. Below are the key factors for our expectations.

Figure 127: Cellular revenue (S$ mn) and revenue market share (%)

(S$ mn) FY14 FY15 FY16 FY17 FY18 FY19 FY20

SingTel 2,374 2,392 2,334 2,281 2,185 2,112 2,086

StarHub 1,248 1,240 1,215 1,192 1,123 1,082 1,065

M1 853 842 815 794 751 718 698

TPG - - - - 11 45 95

Total 4,475 4,474 4,364 4,268 4,069 3,957 3,943

Market share (%)

SingTel 53.1% 53.5% 53.5% 53.5% 53.7% 53.4% 52.9%

StarHub 27.9% 27.7% 27.8% 27.9% 27.6% 27.4% 27.0%

M1 19.1% 18.8% 18.7% 18.6% 18.4% 18.1% 17.7%

TPG 0.0% 0.0% 0.0% 0.0% 0.3% 1.1% 2.4%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


Go-to-market strategy

TPG in Australia is known to be a disruptor as the company provides the lowest price

plans in the broadband market. TPG has consistently had the lowest price points in the

market, offering a basic unlimited broadband service with limited add-on services. TPG

has an extremely efficient operating model and lean cost structure, which has enabled it to

offer the lowest prices, while reporting some of the highest margins of its peers

(broadband EBITDA margins of ~40% for the core TPG brand). We believe the company

is likely to carry a similar approach in Singapore to gain market share.

Singapore cellular operators continue to draw revenue from voice coverage (as there are

no unlimited voice plans) and caller id services. We believe, as part of its go-to-market

strategy, TPG may only charge for data services while offering free voice and other

services. Additionally, unlike Hong Kong, Singapore does not have a vibrant low-end

segment, which TPG can target as well, increasing down-trading potential.

Spectrum

The recently concluded general spectrum auction reflected the first major headwind

emerging from the entry of a new cellular operator in the sector. The final auction clearing

price was at a significant premium to the reserve price (3 to 6 times). While the high final

spectrum price for 900MHz is reflective of the scarcity value (as only one lot of 900MHz

was available for auction), the large premium on 700MHz shows M1’s and STH’s quest for

low band spectrum as they currently do not have the low band spectrum for 4G coverage.

SingTel has secured the highest amount of low band spectrum 2x20MHz of 700MHz and

2x5MHz of 900MHz, while StarHub got 2x15MHz of 700MHz and M1 won 2x10MHz of

700MHz. Clearly, SingTel has the best spectrum portfolio in Singapore followed by

StarHub, M1 and TPG Telecom.

Though from the total spectrum quantum perspective, incumbents are at an advantage,

we believe TPG has a good mix of low band (2x10MHz of 900MHz) and high band

(40MHz of 2300MHz and 10MHz of 2500MHz) spectrum to offer high-quality 4G services

in Singapore. Our analysis suggests that TPG can offer theoretical download speed of up

We expect TPG to launch cellular service in 2H18 and to capture

~2% revenue market share by 2020E

We believe TPG will only charge for data

services while offering free voice and other

services

20 June 2017


to 450Mbps using two carrier aggregation (CA), 64 QAM modulation, and 4x4 MIMO

technology. The above download speed can increase further by deploying higher

technologies such as 8x8 MIMO or 256 QAM modulation, etc. We note that category 9,

which is the standard that most premium handsets are currently deploying, can support a

maximum download speed of 450Mbps while the future categories (11 and 12) can

support maximum download speeds of 600Mbps. Also, having two carriers (2x5MHz each)

of 900MHz provide TPG with a marginal advantage to M1 and StarHub in providing better

macro coverage till M1 and StarHub get access to the 700MHz spectrum band (which is

unlikely till 2019).

Additionally, our analysis suggests that TPG’s current spectrum portfolio should be able to

support market share of ~28% (at theoretical speed of 450Mbps), assuming average data

usage per subs of 7GB, which is almost twice of current data usage (click here).


900MHz 1800MHz 2100MHz 2300MHz 2500MHz 2600MHz

SingTel 2x10MHz 2x30MHz 2x20MHz - 15MHz 2x20MHz

StarHub 2x5MHz 2x25MHz 2x20MHz - 20MHz 2x20MHz

M1 2x5MHz 2x20MHz 2x20MHz - - 2x20MHz

TPG 2x10MHz - - 40MHz 10MHz -


Capital intensity

Being a small city state (with an area of 719 sq km) having mostly a low lying area with a

small range of hills (at the centre), Singapore is not difficult to cover from a macro

coverage perspective. Incumbents, having made cellular investments over the last 10-15

years, have good cellular network with not much difference in the network quality. That

said, SingTel may have a slight edge to M1 and StarHub as it has access to higher

quantum of low band spectrum. We believe cellular capex for incumbents is likely to

decline marginally over the next three years, given telcos are past their peak 4G

investments. For TPG, we expect it to start cellular services in 2H18 with 775 macro sites

and then to gradually ramp-up to ~1,000 sites by 2021E. On in-building coverage, we

expect TPG to have coverage of 575 buildings at the beginning, which is likely to expand

to 930 buildings by 2021E. We expect the total capex to be ~S$500 mn by 2021E (out of

which ~S$300 mn will be spent by 2018E).

Figure 129: Capex by operator (S$ mn) Figure 130: Capex-to-sales ratios (%)


-

100

200

300

400

500

600

700

800

900

1,000


SingTel StarHub M1 TPG

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%


SingTel StarHub M1

We believe cellular capex for incumbents

is likely to decline over the next three years


20 June 2017


Balance sheet strength and sustainability

Singapore telcos are well capitalised to make necessary investments in the telecom

network. Based on our forecasts, they will continue to generate free cash flows over the

next three years. Though the quantum will reduce (especially for M1 and StarHub) due to

competition, impacting their ability to pay dividends. We are building in a declining

dividend profile for M1, while for StarHub, we estimate the company’s leverage to increase

to support annual dividends of S$0.20/share.

Regulation

We believe the sector is currently past most of the regulatory headwinds with the

conclusion of recent spectrum auctions (new operator spectrum auction and general

spectrum auction). We believe regulatory intervention may be needed in case TPG

complains to the regulator of any incumbents’ actions that may impede its network roll-out

in Singapore.

ROIC analysis

We believe Singapore is a perfect market showcasing excess cellular returns. Hence, it

presents an opportunity for the new operator to strive for a business case. The figure

below shows the cellular ROIC comparison of the developed global peers that we studied

(click here). As can be seen, Singapore stands out amongst its peers with M1 having one

of the highest ROICs in 2016, highlighting the pricing power in the Singapore cellular

sector compared to its global peers. Only SmarTone with an ROIC of 22% had more ROIC

than M1 in 2016. However, we would highlight that M1’s ROIC declined by 6% in 2016 due

to increase in competition as incumbents looked to pre-empt the entry of the new entrant.

A comparison of ROIC profile prior to 2016 reveals that M1, with an ROIC range of 26-

28%, had the highest returns amongst the global peers we studied.

Additionally, the fact that M1’s cellular market share is one of the lowest among the

operators (we studied) serves as a reminder of the excess return in the Singapore cellular

market. For example, Far EasTone’s and SmarTone’s three-year average (2014-16) ROIC

is less than that of M1’s despite having higher cellular market share. Far EasTone has

~29% cellular revenue market share in Taiwan, while SmarTone has ~25% market share

compared to ~19% market share of M1. Outside of Asia, the return profile appears to be

much weaker. T Mobile, the number three cellular operator in the US, had an ROIC of 5%

in 2016, while in EU, we expect the average ROIC to be in single digits.

We believe the sector is currently past most of

the regulatory headwinds

Singapore is a perfect market showcasing

excess cellular returns

https://plus.credit-suisse.com/u/NQP1m2AN-Wd1W

20 June 2017


Figure 131: Singapore has one of the highest ROIC

amongst its global peers…

Figure 132: …suggesting more downside potential

in Singapore's cellular pricing and ROIC

Note 1: 2016 ROCE comparison; Note 2: For RoCE calculation, we have taken M1 Ltd. in Singapore, SmarTone in HK, FET in Taiwan, Optus in Australia, T Mobile in US, and EU is CS estimate for the region; Source: Bloomberg, Company data, Credit Suisse estimates


However, the sector is likely to witness a diminishing return profile, given the pricing

headwinds along with the increasing cost (resulting from spectrum auction, handset

subsidies, etc.). We forecast M1’s ROIC to decline to ~10% by 2019E which, in our view,

is still decent when seen in the context of global peers. StarHub will also witness a decline

in its consolidated ROIC due to cellular competition while the impact on SingTel is likely to

be limited. For TPG, our sensitivity analysis suggests that it would turn ROIC breakeven at

a discount of 9% to the current service ARPU with cellular subscriber market share of

7.5% and 6% market share in the broadband segment.



SingTel StarHub M1 SingTel StarHub M1 SingTel StarHub M1

Subscribers (000s) 4,137 2,307 2,019 4,151 2,235 1,982

Service revenue 31,314 2,209 811 36,176 2,065 739 3.7% -1.7% -2.3%

EBITDA 11,201 690 312 12,936 563 247 3.7% -4.9% -5.6%

EBITDA margin 36% 31.2% 38.5% 36% 27.3% 33.5%

Depreciation to sales (%) 18% 12% 15.6% 17% 14% 20.6%

EBIT 5,700 425 185 6,883 272 95 4.8% -10.6% -15.5%

EBIT margin 18% 19% 22.9% 19% 13% 12.8%

Tax rate (%) 28.8% 17% 16.2% 29.6% 17% 18.0%

NOPLAT 4,060 354 155 4,845 226 78 4.5% -10.6% -15.9%

Average invested capital 36,733 2,263 775 42,514 2,688 962

Asset turn 0.9 1.0 1.0 0.9 0.8 0.8

ROIC 11.1% 15.6% 20.1% 11.4% 8.4% 8.1%

Net profit 3,915 341 150 4,660 198 69 4.4% -12.8% -17.5%

Net margin 12.5% 15.5% 18.5% 12.9% 9.6% 9.4%


What is in the price?

We use discounted free cash flow (DCF) valuation methodology to value Singapore

telecom companies. And based on our valuation, there is ~34% and ~19% downside to

M1's and StarHub's stock prices, suggesting that they are not building in increasing

competitive dynamics in the Singapore cellular sector. M1 will be impacted the most by the

entry of TPG Telecom in Singapore as it has the highest exposure to Singapore’s cellular

22%

20%

13%12%

8%7%

6%5%

0%

5%

10%

15%

20%

25%

SMT M1 KDDI FET Optus LGU Avg TMobile

HK SG JP TW AU KR EU US

28%28%

26%

20%

17%

13%

10%

5%

10%

15%

20%

25%

30%

2013 2014 2015 2016 2017E 2018E 2019E

M1's RoCE

The sector is likely to witness a diminishing

return profile, given pricing headwinds

20 June 2017


sector followed by StarHub. SingTel has the least exposure to the Singapore cellular

sector as it accounts for only ~5% to our SoTP based target price for SingTel.

We note that M1 has recently announced that its majority shareholders are currently doing

a strategic review of their respective shareholding and have appointed Morgan Stanley as

their financial advisor. M1's stock price has moved up ~11% since the announcement. Our

DCF-based target price of S$1.45 for M1 is based on our fundamental analysis of the

company's business, which is facing headwinds. We believe the key investment thesis for

any potential investment in M1 will be the eventual merger with StarHub as that is where

the real upside resides (from synergies). However, we believe the investment horizon has

to be longer term (five years and beyond) as IDA is unlikely to approve the same in the

medium term. We believe the current stock price is already baking any potential premium

from the general offer.

On SingTel, we believe the market is over-penalising the stock on the threat of increased

competition in the Singapore and Australia markets. As highlighted above, we believe the

impact of TPG's entry to Singapore’s cellular sector is limited on SingTel. In Australia also,

we do not expect TPG to have a significant impact on Optus's longer-term cellular

earnings as TPG will only realistically address relatively niche low end market segments

(e.g., prepaid handheld and consumer wireless broadband).

On a relative valuation basis as well, SingTel appears inexpensive compared to M1 and

StarHub as it is trading at 2018E EV/EBITDA of ~7x compared to multiple of ~9x for

StarHub and M1. Additionally, SingTel's 2018E dividend yield of 4.9% appears attractive.

SingTel is our preferred pick in the Singapore telecoms sector as we have a positive view

on the company's enterprise business and international associates (except for Bharti

Airtel). Additionally, the expectations of special dividends from the Netlink Trust IPO, over

the next 12 months, should limit the downside potential in the stock, in our view

Figure 134: Singapore cellular sector-comparative valuation



SingTel 3.80 4.50 18.4% 15.8 15.2 7.1 6.8 1.6 1.6 2.3% 2.4% 4.7% 4.9%

StarHub 2.72 2.20 -19.1% 16.9 20.4 8.7 9.5 2.2 2.2 5.8% 5.3% 5.9% 5.9%

M1 2.18 1.45 -33.5% 15.5 20.5 8.1 9.0 3.1 3.0 5.5% 5.3% 5.2% 3.9%


We believe the current M1 stock price is

already baking any potential premium from

the general offer

Market is over penalising SingTel's

stock on threat of increased competition

20 June 2017


Figure 135: Share price performance (rebased); M1's and StarHub's underperformance likely to continue


50

60

70

80

90

100

110

120

130


M1 SingTel Starhub

20 June 2017


Country sections: Taiwan

Summary

■ In terms of industry structure, the Taiwan market looks relatively unattractive with new

entrants, high 4G penetration and extensive handset subsidies.

■ We expect the Taiwan market to grow service revenue at a CAGR of 1.0% across

FY16-FY20.

■ Chunghwa is dominant with 35.5% revenue market share as at 1Q17 and an FY16

ROIC of 11.9%. However this looks to be fairly in the price.

■ TWM and FET are #2 and #3 players are more leveraged to improving cellular

fundamentals.

Recent sector growth hampered by increase in

competition…

Taiwan’s cellular sector has seen spurts of competition with the introduction of new

technologies. For example, 3G licensing saw the emergence of two new players VIBO

Telecom and APT in 2002, while the 4G spectrum auction in 2013 saw the entry of Taiwan

Star (TSTAR) and Ambit. Post the 4G auction, Taiwan Star acquired VIBO Telecom to

mark its presence in Taiwan's cellular sector while Ambit acquired APT and rebranded

itself as APT. However, the market continues to be dominated by the incumbent

operators—Chunghwa Telecom (CHT), Taiwan Mobile (TWM) and Far EasTone (FET)—

given their network reach and spectrum holding. The incumbents have consolidated their

market position further post the launch of 4G services. Together they owned ~94% cellular

service revenue market share in 2016, up from ~87% in 2013. However, the market share

of new 4G entrants has remained largely stable over the last two years. Taiwan cellular

sector registered some growth in 2014 and 2015 post the introduction of 4G services as

operators pushed customers to higher tiered plans under 4G. However, growth faltered in

2016 and is likely to follow a similar trajectory in 2017 due to the factors detailed below.

Figure 136: Cellular service revenue growth (%, YoY)

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

CHT 4.6% 5.7% 4.7% 2.6% 1.0% -2.6% -4.1% -4.5% -4.4%

TWM 0.2% 1.6% 1.3% 1.4% 1.7% 1.2% 1.1% 0.9% -2.0%

FET 3.9% 3.3% 1.4% -0.7% -0.6% -1.3% -1.4% -1.5% -1.7%

Others -9.2% -11.3% -11.1% -8.6% -11.4% -5.6% 1.4% 4.6% 5.3%

Total 2.1% 2.6% 1.7% 0.6% -0.1% -1.3% -1.5% -1.5% -2.3%


Figure 137: Cellular service revenue market share (%)

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

CHT 35.9% 36.3% 36.6% 36.3% 36.2% 35.8% 35.6% 35.2% 35.5%

TWM 29.2% 29.3% 29.3% 29.5% 29.7% 30.0% 30.1% 30.2% 29.8%

FET 28.5% 28.3% 28.3% 28.5% 28.3% 28.3% 28.3% 28.5% 28.5%

Others 6.5% 6.1% 5.8% 5.7% 5.7% 5.9% 6.0% 6.1% 6.2%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


■ Consolidation of multi-SIM. Taiwan is one of the few developed telecom markets that

was late to introduce 4G services. The market saw launch of 4G services in 1H14 after

the completion of 4G auctions in 2013. However, once introduced, 4G services have

gained momentum with 4G penetration reaching ~60% by Dec-2016 (vs ~57% in

Taiwan cellular sector registered some growth

in 2014 and 2015 post the introduction of 4G

Number of cellular subs declined at a two-

year CAGR of 2.6% to 28.91 mn by 2016

20 June 2017


Singapore and ~51% in HK). In the 3G era, voice and data were priced separately

resulting in some of the customers having more than one SIM, depending on the best

offers, for each of these services. Also, trade channels heavily promoted the multi-SIM

phenomenon due to the high commissions they earned. However, the coming of 4G

services saw the emergence of bundled plans wherein both voice and data were priced

together. Hence, the industry saw consolidation of SIMs as separate SIM for voice and

data became redundant. Additionally, the emergence of powerful smartphone devices

have also resulted in customers consolidating various handheld devices (such as

tablets, feature phones, etc.). As a result, the number of cellular subscribers in Taiwan

declined at a two-year CAGR of 2.6% to 28.91 mn by 2016. The cellular penetration

reduced to ~123% in 2016 from ~128% in 2014.

■ Cannibalisation by OTT services. The emergence of faster networks (fixed and

cellular) and powerful handsets (smartphones) have catalysed the development of OTT

services, which in turn have cannibalised telco’s core revenue stream (voice, SMS,

roaming, etc.) over the last three years. As highlighted above, Taiwan had separate

voice plans in the 3G era and the introduction of 4G services saw the launch of

bundled services. Hence, the sector was highly susceptible to the cannibalisation of

domestic voice revenues by OTT services, given voice revenue contribution was high

(voice revenue contribution was ~70% in 2012 for FET). The cannibalisation of voice

revenue is also reflected (to a large extent) in the declining minutes of usage (MoU) for

the sector. FET’s MoU declined from 263 minutes in 2012 to 126 minutes by 2016.

■ Reduction in interconnect cost. Taiwan regulator, NCC, has historically been

mandating reduction in cellular interconnect fees. The last round (four-year cycle) of

rate cut ended on 31-Mar-2017, wherein the interconnect fees were gradually reduced

from NT$2.15/min to NT$1.15/min in four years. The reduction in interconnect fees

impacted service revenue performance during the period. However, the impact on

profitability is minimal as there is also corresponding reduction in interconnect cost.

■ Competition in the low-end segment. Pricing in the sector is mainly determined by

CHT, while TWM and FET follow the market leader. The launch of 4G services saw the

sector transitioning from unlimited data plans to tiered data plans. However, that

transition was shortlived as CHT (immediately followed by TWM and FET) launched an

aggressive NT$999/month unlimited plan in 1Q15 in order to promote 4G adoption.

With 4G penetration reaching ~46% by Mar-2016, the threshold of unlimited plan was

raised to NT$1,399/month from NT$999/month in Apr-2016. However, that increase

failed to lift the sector’s service revenue as competition in the low end segment

intensified. A new NT$699 plan was launched in Aug-2016, which offered unlimited

data for 24 months, impacting the sector’s service revenue performance. Additionally,

the lack of popular high end phone models (especially iPhone) during the last two

years has also resulted in customers downgrading to lower tiered plans. However, the

handset subsidies were lowered in 2016, which aided operators EBITDA.

FET’s MoU declined from 263 mins in 2012

to 126 mins by 2016

20 June 2017


Figure 138: Progress of 4G plans in Taiwan

Dec'16 — SIM only

introduced

Aug'16—NT$699

introduced

May'16—Unlimited

threshold raised

Dec'15—NT$499

introduced

Apr'15—NT$998

introduced

Sept'14—Unlimited

introduced

May'14—Initial 4G

plans

Price Data Price Data Price Data Price Data Price Data Price Data Price Data

399 3GB4 399 3GB4 399 3GB4 499 5GB3

599 6GB1,5 599 6GB1,5 599 6GB1,5 599 3GB1 599 1.5GB1 599 1.5GB1 599 1.5GB

5997 Unlimited - - - - - - - - - - - -

6996 Unlimited 6996 Unlimited - - - - - - - - - -

799 9GB1,5 799 9GB1,5 799 9GB1,5 799 7GB1 799 3GB1 799 3GB1 799 3GB

999 16GB2,5 999 16GB2,5 999 16GB2,5 999 Unlimited 999 Unlimited 999 4.5GB1 999 4.5GB

1,199 26GB2,5 1,199 26GB2,5 1,199 26GB2,5 1,199 Unlimited 1,199 9GB - - - -

- - - - - - - - 1,299 10GB 1,299 10GB 1,299 7.5GB

1,399 Unlimited 1,399 Unlimited 1,399 Unlimited 1,399 Unlimited 1,399 Unlimited 1,399 Unlimited

1,599 Unlimited 1,599 Unlimited 1,599 Unlimited 1,599 Unlimited 1,599 Unlimited 1,599 Unlimited 1,599 13.5GB

1,899 Unlimited 1,899 Unlimited 1,899 Unlimited 1,899 Unlimited 1,899 Unlimited 1,899 Unlimited 1,899 18GB

2,599 Unlimited 2,599 Unlimited 2,599 Unlimited 2,599 Unlimited 2,599 Unlimited 2,599 Unlimited 2,599 30GB

Note 1: Unlimited data for the first 6 months in a 24 months contract; Note 2: Unlimited data for the first 12 months in a 24 months contract; Note 3: Unlimited data for the first 12 months in a 30 months contract; Note 4: Unlimited data for the first 3 months in a 30 months contract; Note 5: In case of TWM, the unlimited period extends by 6 months for NT$599-NT$799 plans and by 3 months for NT$999-NT$1,199 plans in a 30 months contract; Note 6: Introduced as a promotional plan limited to students, senior citizens and mobile number portability customers. The plan bundles only low end phones; Note 7: This is a 12 month SIM only plan and is only available online. Source: Company data, Credit Suisse research

…however, we expect pricing to improve in coming

months with focus on profitability

We note that the competitive dynamics in the low end segment have improved over the

last 2-3 months as operators are focusing on monetising their 4G investments. During the

1Q17 earnings call, all three Taiwanese operators highlighted that they are deemphasising

the focus on low end plans (especially the NT$699 plan) and are targeting high end plans.

Additionally, we believe the launch of iPhone 8 (in 2H17) is likely to help telcos migrate

customers to higher tier plans, given the upfront payment for handset is low. Hence, we

expect Taiwan cellular sector growth to resume from 2018 and grow at a three-year CAGR

of 1.8% after declining by 1.6% in 2017.

Figure 139: YoY cellular revenue growth (NT$ mn) and revenue growth rates (%)


CHT 760 3,397 (2,082) (2,099) 687 1,398 1,309

TWM 1,026 714 776 (951) 1,317 1,759 1,691

FET 1,870 1,194 (750) (685) 975 1,326 979

Others (TSTAR + APT) (2,079) (359) (1,554) 260 128 259 189

Total 1,576 4,946 (3,610) (3,476) 3,107 4,742 4,169

Growth (%)

CHT 1.0% 4.4% -2.6% -2.7% 0.9% 1.8% 1.7%

TWM 1.6% 1.1% 1.2% -1.4% 2.0% 2.6% 2.5%

FET 3.1% 1.9% -1.2% -1.1% 1.6% 2.1% 1.5%

Others (TSTAR + APT) -12.2% -2.4% -10.6% 2.0% 1.0% 1.9% 1.4%

Total 0.7% 2.3% -1.6% -1.6% 1.4% 2.2% 1.9%


Market share to remain largely stable

We expect market share for all operators to remain fairly stable over the next four years.

We do not believe new operators (APT and TSTAR) can make a dent on incumbents

market share given their spectrum bank and network reach. APT and TSTAR together

have ~6% as of 2016 and we expect their market share to remain at that level. Of the two,

we think APT is a more able player due to ownership of Foxconn Technology. However,

Competition in the low end segment has

improved over the last 2-3 months

We expect market share for all operators to remain fairly stable

over the next four years

20 June 2017


the company has been rational towards its approach to the cellular business. APT initially

sold part of its 700MHz spectrum to TWM and entered into a roaming arrangement with

the company for its 4G services. We expect the rational behaviour from APT to continue.

On the other hand, TSTAR has been competing aggressively by offering significant

discounts to incumbents. But the company is facing financial constraints after burning cash

on operating losses and the acquisition of 2.6GHz spectrum. We believe the company will

need fresh capital injection to sustain in the medium term.

Figure 140: Cellular revenue (NT$ mn) and revenue market share (%)

NT$ mn FY14 FY15 FY16 FY17 FY18 FY19 FY20

CHT 77,468 80,865 78,783 76,684 77,371 78,769 80,078

TWM 64,691 65,405 66,181 65,230 66,547 68,306 69,997

FET 62,194 63,388 62,638 61,953 62,928 64,255 65,234

Others (TSTAR + APT) 14,998 14,639 13,085 13,345 13,473 13,732 13,921

Total 219,352 224,297 220,687 217,211 220,319 225,061 229,230

Market share (%)

CHT 35.3% 36.1% 35.7% 35.3% 35.1% 35.0% 34.9%

TWM 29.5% 29.2% 30.0% 30.0% 30.2% 30.3% 30.5%

FET 28.4% 28.3% 28.4% 28.5% 28.6% 28.5% 28.5%

Others (TSTAR + APT) 6.8% 6.5% 5.9% 6.1% 6.1% 6.1% 6.1%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%



In terms of total quantum of spectrum, CHT and FET have more spectrum that TWM, mainly

due to TWM’s decision to withdraw from the 2.6GHz spectrum auction in Dec-2015. However,

TWM’s low quantum of spectrum is compensated by the quality of spectrum. TWM has

2x20MHz of precious 700MHz spectrum, while FET has 2x10MHz of 700MHz and CHT has

2x10MHz of 900MHz, providing TWM an edge in offering quality 4G services economically.

Also, we believe the incumbents are unlikely to face capacity constraints in the medium term,

given their vast spectrum holding and constant improvement in technology (resulting in higher

spectral efficiency). Hence, we believe spectrum in Taiwan does not offer competitive

advantage to any of the incumbents in driving market share gain.

Among the two new players, APT has a much better spectrum portfolio than TSTAR.

However as mentioned earlier, we do not believe APT has made any significant network

investments to compete with incumbents. Rather, the telco has sold a part of its 700MHz

spectrum to TWM and also entered into a 4G roaming agreement with it, effectively

consolidating the market. TSTAR got a little breather on the capacity side after it acquired

2x20MHz of 2.6GHz spectrum in the Dec-2015 auction. However, we do not see Taiwan

Star gaining meaningful market share in the medium term, as its financial situation is likely

to keep a tab on market share ambition.


700MHz 850MHz* 900MHz 1800MHz 2100MHz 2600MHz (FDD) 2600MHz (TDD)

CHT 2x10MHz 2x25MHz 2x15MHz 2x30MHz

TWM 2x20MHz 2x15MHz 2x15MHz

FET 2x10MHz 2x20MHz 2x15MHz 2x20MHz 20MHz

APT 2x15MHz 2x20MHz 2x10MHz 20MHz

TSTAR 2x10MHz 2x10MHz 2x20MHz

* APT uses 850MHz band to provide CDMA2000/EVDO (3G) services. Source: Company data, Credit Suisse estimates

Capital intensity

Taiwan operators' capex intensity increased in 2013-15 with the roll-out of 4G services.

However, the telcos are now past their peak 4G capex cycle as the 4G roll-out is

complete. We have already seen cellular capex declining in 2016 and the 2017 guidance

Incumbents are unlikely to face

capacity constraints in the medium term

20 June 2017


for FET and TWM highlight further decline in cellular capex. The next big capex cycle for

the telcos is likely to emerge from the roll-out of the 5G network. However, we believe 5G

is unlikely to happen before 2020, given that 5G standards are not finalised yet. We are

building in some pick-up in FET’s and TWM’s capex in 2018 and beyond, as we believe

the telcos may need to invest more on augmenting capacity and building IoT capabilities.

The two new operators are far behind the incumbent operators in terms of network

coverage and would need to invest more to be competitive. While APT is investing on the

4G network in order to its regulatory obligation, TSTAR is constrained by its balance sheet

to further expand its network.

Figure 142: Capex by operators (NT$ bn) Figure 143: Capex-to-sales ratio (%)



We note that CHT has a net cash balance sheet while the leverage (net debt to EBITDA)

of FET (0.9x as of Dec-2016) and TWM (1.2x) is low. Hence, the incumbents have well

capitalised balance sheets currently. And given the expected improvement in EBITDA

(coming from potential pricing improvement and lower subsidies) and stable capex, the

FCF profile of the telcos should remain healthy. As highlighted earlier, between the two

new operators, TSTAR has a stretched balance sheet and we believe the company would

need a capital injection to sustain in the medium term. We believe TSTAR can be an

acquisition candidate (due to the spectrum asset) but pricing may be a key hurdle for the

incumbents.

Regulation

We believe the regulatory approach in Taiwan’s telecom sector is heavy handed as the

regulator, National Communications Commission (NCC), has historically mandated retail

voice pricing. There are currently no mandatory retail tariff reductions in the cellular sector.

NCC is currently reviewing the voice interconnect regime and there is a high probability of

another round of voice termination rate cuts in the coming months. Most of the price

regulation pertains to the fixed-line segment. Given the history of voice price regulation,

concerns remain among investors that the regulator can manage data pricing in the future

as well. We see a low risk of regulatory intervention on data pricing, as unlike voice pricing

(during the period of regulatory invention) data prices in Taiwan are competitive versus

other regional peers (click here).

In terms of spectrum auction, the regulator has already auctioned most of the

commercially available cellular spectrum (700MHz, 900MHz, 1800MHz, 2600MHz) over

the past two years. The only spectrum due for renewal is 2100MHz, which expires in 2018.

Also, our discussions with sector participants suggest that the regulator may auction the

-

2

4

6

8

10

12


CHT TWM FET

0.0%

2.0%

4.0%

6.0%

8.0%

10.0%

12.0%

14.0%

16.0%

18.0%


CHT TWM FET

We believe TSTAR can be an acquisition

candidate

We see a low risk of regulatory intervention

on data pricing

https://plus.credit-suisse.com/r/_XAB22AA-WEpQ38

20 June 2017


additional 1800MHz spectrum along with 2100MHz spectrum renewal. We expect

2100MHz spectrum auction to happen in 2H17 and believe that the final auction price will

be rational as all major telcos (including Taiwan Star) have 2100MHz spectrum coming up

for renewal. For the 2100MHz spectrum renewal payment, we currently assume NT$22 bn

in our cash flow for CHT, TWM and FET each.


Though the return profile of the sector has diminished post the 4G investments, the three

incumbent operators continue to generate healthy returns (ROIC) at 12-15% above their

WACC of 6-6.5%. We note that TWM has the highest ROIC of 15% in 2016 followed by

FET at 13% and CHT at 12%. CHT’s ROIC is the lowest due to headwinds from the legacy

fixed line businesses. Given our expectations of no significant change in market share, we

expect the ROIC profile of Taiwanese operators to remain stable over the next four years.

The new operators continue to be loss making even after three years of launching services. In

order to improve ROIC, the key thing for new operators is to gain revenue market share,

which in turn requires investments. With APT’s cautious decision to limit investment in order

to contain losses and TSTAR’s balance sheet constraints, we do believe new operators are

likely to generate returns from their cellular investments in Taiwan.



CHT TWM FET CHT TWM FET CHT TWM FET

Subscribers (000s) 10,785 7,439 7,346 11,111 7,788 7,688

Service revenue 197,972 67,950 71,598 197,964 72,995 73,689 0.0% 1.8% 0.7%

EBITDA 81,087 33,872 27,842 82,260 36,407 30,168 0.4% 1.8% 2.0%

EBITDA margin 41% 50% 39% 42% 50% 41%

Depreciation to sales (%) 16% 20% 18% 17% 19% 19%

EBIT 48,602 20,020 15,024 48,856 22,500 16,120 0.1% 3.0% 1.8%

EBIT margin 25% 29% 21% 25% 31% 22%

Tax rate (%) 17% 17% 17% 17% 17% 17%

NOPLAT 40,578 16,616 12,433 40,404 18,675 13,380 -0.1% 3.0% 1.9%


Asset turn 0.6 0.6 0.8 0.6 0.6 0.7

ROIC 12% 15% 13% 12% 16% 13%

Net profit 40,067 15,320 11,391 40,225 16,883 12,509 0.1% 2.5% 2.4%

Net margin 20% 23% 16% 20% 23% 17%



We have a positive view on the Taiwan cellular sector as we expect cellular pricing to

improve over the next 12-18 months and the sector to gradually transition to tiered pricing

in the medium term (3-5 years). We like TWM and FET as they are more leveraged to

improving cellular fundamentals.

We use discounted cash flow methodology to value Taiwan telecom stocks. At present, we

do not believe that the market is fully factoring in the potential cellular price improvement

for Far EasTone and Taiwan Mobile as there is ~14% and ~13%, respectively, upside to

our DCF-based target prices for the two companies, while ChungHwa Telecom's stock

price appears fairly valued.

On relative valuation as well, FET and TWM are offering higher dividend yield spread than

CHT. FET is trading at 2018E dividend yield of 5.1%, while TWM is offering a 5.0% yield

and the yield of CHT is 4.7%.

We expect ROIC profile of Taiwanese operators

to remain stable over the next four years

We have a positive view on the cellular sector as we expect

pricing to improve

20 June 2017


Figure 145: Taiwan cellular sector—comparative valuation

Close Target Upside Normalised P/E EV/EBITDA EV/IC (x) FCF yield Div yield


TWM 113.00 128.00 13.3% 20.3 20.0 10.8 10.6 3.3 3.1 6.1% 6.3% 5.0% 5.0%

FET 76.50 87.00 13.7% 21.9 21.8 9.6 9.4 3.0 2.8 6.3% 6.4% 5.0% 5.1%

CHT 108.00 105.00 -2.8% 21.2 21.2 10.0 9.9 2.4 2.3 5.1% 5.7% 4.7% 4.7%


Figure 146: Taiwan telcos share price performance (rebased)


80.0

90.0

100.0

110.0

120.0

130.0

140.0


TWM FET CHT

20 June 2017


Country sections: Thailand

Summary

■ In terms of industry structure, the Thailand market looks relatively attractive, with no

new entrants, declining subsidies and some remaining growth potential.

■ Indeed, we expect the Thai market to grow service revenue at a CAGR of 4.5% across

FY16-FY20.

■ AIS is dominant with 48.6% revenue market share as at 1Q17 and an FY16 ROIC of

26.6%. However its relatively attractive returns on capital and resulting cash flows are

not being fairly valued. AIS's parent company Intouch is even more attractive trading at

17.5% discount to the market value of its listed holdings.

■ DTAC looks to be a #2 player with reasonable prospects of acceptable returns.

However, this looks priced in after a sharp share price rally. True Corp, on the other

hand, looks to be an overvalued challenger with forecast ROIC of just 2.6% by FY20,

given over-investment in cellular spectrum and deteriorating competitive advantages.

True Corp gained market share across FY13-FY16

Wireless data demand in Thailand is proving to be very strong, and the cellular revenue

growth rate recovered to 6.9% YoY in 4Q16 and 6.3% in 1Q17—the second highest

revenue growth rates in our coverage universe.

Figure 147: YoY cellular service revenue growth

1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

AIS 4.6% 2.9% 2.0% -0.5% -0.9% -1.5% 1.5% 4.5% 2.6%

DTAC -3.6% -5.3% -1.5% -1.6% -2.0% -2.4% -1.2% -3.7% -1.3%

True Mobile Group 14.5% 18.7% 15.7% 20.2% 23.7% 31.2% 31.5% 27.1% 24.3%

Total 3.7% 3.0% 3.3% 2.9% 3.3% 4.4% 6.6% 6.9% 6.3%


However, growth has been extremely lopsided, with True Corp enjoying 24.3% YoY

growth in 1Q17, versus AIS's 2.6% YoY growth and a DTAC's 1.3% YoY revenue decline.

In fact, True Corp has been consistently gaining market share since 3Q13, with market

share having risen by 10.2 pp from 15.6% as at 2Q13 to 25.8% in 1Q17—True Corp has

just overtaken DTAC to become the second-largest operator by revenue in Thailand's

three-player market.


1Q15 2Q15 3Q15 4Q15 1Q16 2Q16 3Q16 4Q16 1Q17

AIS 52.5% 52.7% 52.0% 50.9% 50.4% 49.8% 49.5% 49.7% 48.6%

DTAC 29.1% 28.4% 28.4% 28.3% 27.6% 26.6% 26.4% 25.5% 25.6%

True Mobile Group 18.4% 18.8% 19.6% 20.8% 22.0% 23.7% 24.2% 24.8% 25.8%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


The origin of this dramatic market share expansion can be explained as resulting from

several inter-related factors:

■ Regulation: Prior to the formation of the National Broadcasting and

Telecommunications Commission (NBTC) Thai cellular operators gained access to

spectrum through Build Transfer Operate (BTO) concessions. These concessions

granted the right to use spectrum for a certain period, in return for the transfer of the

assets and a revenue share. Different concessions ended on different dates; True

Corp's 1800MHz concession ended in September 2013. Due to a regulatory vacuum

20 June 2017


over the next steps for the use of this spectrum, True Corp's revenue share dropped

from 30% of revenue (under concession) overnight to zero (under True Corp's

interpretation of the so-called a 'remedy period' that ensued). Competitors AIS and

DTAC continued to be locked into their expensive and restrictive concession

arrangements. Following a military coup in 2014, a proposed auction in September

2014 was delayed until November 2015, elongating True Corp's 'remedy period' and

window of opportunity.

■ Deal-making: In addition to 'free' use of 1800MHz spectrum from September 2013,

True Corp also had the use of a 2x15MHz block of spectrum following the acquisition

of Hutch Thailand (Not listed) in December 2010. The contracts were amended such

that the spectrum could be used for W-CDMA services, rather than CDMA services.

The contract was based on cost-plus economics, rather than a revenue share,

incentivising high utilisation.

■ Marketing expenses. Armed with concession-free (and revenue-share-free) 1800MHz

and 850MHz spectrum revenue, together with 2100MHz spectrum won transparently at

auction in 2012, True Corp re-invested its revenue share windfall in an aggressive

marketing budget to gain scale, and introduced handset subsidies into the Thai market

in 3Q13. With sufficient spectrum resources, True Corp was able to launch 4G services

more than two years prior to incumbent AIS, which was still locked in concession

arrangements. This made the marketing message simple and the handset subsidy

strategy effective.

■ Capital injections. The shift in cost allocation from revenue share payments to

marketing costs and handset subsidies meant that EBITDA was nowhere near

sufficient to fund True Corp's enlarged capex caused by 3G and 4G roll-out. True Corp

sold its tower assets in 2013, then raised equity in both 2014 (with China Mobile taking

an 18% stake in the form of new shares, in addition to a rights issue) and again in

2016. Shareholders therefore financed True Corp's capex, marketing spend and, as we

shall see, auction payments.

Scope for mid-single-digit market growth

Looking forward, we continue to see scope for mid-single digit revenue growth in the Thai

market into the medium term. Smartphone penetration in Thailand has reached 85.9% as

at December 2016 (in part due to the aggression with which the operators shifted their

customers from 2G concession structures to the 2100MHz 3G spectrum won at auction in

2012), but 4G penetration only reached 31.3% of the population as at December 2016.



With AIS's launch of 4G, the average data use per subscriber rose sharply from 2GB per

month in 4Q15 to 4GB as at 1Q17. At present, the conversion of the resulting volume

SingaporeHong Kong

Malaysia

Indonesia

Korea

China

Thailand

PhilippinesIndia

Taiwan

Australia

0.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

80.0%

90.0%

100.0%

- 10,000 20,000 30,000 40,000 50,000 60,000 70,000 80,000

4G p

enet

ratio

n


20 June 2017


growth into revenue growth is sub-optimal. In part, this is due to the fact that when AIS

finally officially launched 4G services, in January 2016, Jasmine had bid for, and won, an

allocation of 900MHz spectrum, and looked to be entering the market as a fourth player.

This expectation led AIS to sharply lower the price points per MB, as shown in the figure

below; subscribers are able to consume 4GB of data for Bt399/month, rather than

Bt599/month under the previous packages. While this still represents a meaningful ARPU

uplift versus AIS's blended average ARPU of Bt256/month, and while AIS's data revenue

grew by 20.0% YoY into 1Q17, the ARPU uplift, and the resulting revenue trajectory, is far

lower than would have been the case if previous price points had been maintained.

Figure 151: Change in implied ARPU from published data packages

Assumed data per month ~250MB ~700MB ~1GB ~2.5GB ~4GB

AIS 3G (Nov 2015)

Implied ARPU 399 399 399 399 599

AIS 3G/4G (Jan 2016)

Implied ARPU 343 343 343 399 399


The re-introduction of an 'unlimited' package (albeit with some usage constraints and a

high price point of Bt899/month) is also sub-optimal for data monetisation, and is another

reason to expect lower market revenue growth in Thailand than in some other emerging

Asian markets (such as Indonesia).

Figure 152: YoY cellular revenue growth (Bt mn) and revenue growth rates (%)

Bt mn FY14 FY15 FY16 FY17 FY18 FY19 FY20

AIS 5,461 2,511 1,201 3,189 3,227 2,826 966

DTAC (1,830) (2,054) (1,527) 1,522 1,701 1,716 1,335

True Corp 3,195 6,646 12,804 12,392 6,933 5,302 5,755

Total 6,826 7,103 12,478 17,103 11,861 9,843 8,056

Growth (% YoY)

AIS 4.9% 2.1% 1.0% 2.6% 2.6% 2.2% 0.7%

DTAC (2.6%) (3.0%) (2.3%) 2.4% 2.6% 2.5% 1.9%

True Corp 9.1% 17.3% 28.4% 21.4% 9.9% 6.9% 7.0%

Total 3.1% 3.2% 5.4% 7.0% 4.5% 3.6% 2.8%


AIS and DTAC still to lose share, but more slowly

Our forecasts for revenue growth also project a slowdown in market share gains for True

Corp, commencing in FY17; we project that True Corp will gain 3.2 pp of market share in

FY17, down from the 4.3 pp of market share gained in FY16. We then expect True Corp to

gain just 1.4 pp of market share in FY18. We note that our forecasts imply that True Corp

will achieve 28.3% market share by FY18, circa 4.0 pp below the company's stated target

of 32.0% revenue market share by that point.

20 June 2017


Figure 153: Cellular revenue (Bt mn) and revenue market share (%)

Bt mn FY14 FY15 FY16 FY17 FY18 FY19 FY20

AIS 117,989 120,500 121,701 124,890 128,117 130,943 131,910

DTAC 68,275 66,221 64,694 66,216 67,917 69,633 70,967

True Corp 38,406 45,052 57,856 70,248 77,181 82,483 88,237

Total 224,670 231,773 244,251 261,354 273,215 283,058 291,114

*ex IC

Market share (%)

AIS 52.5% 52.0% 49.8% 47.8% 46.9% 46.3% 45.3%

DTAC 30.4% 28.6% 26.5% 25.3% 24.9% 24.6% 24.4%

True Corp 17.1% 19.4% 23.7% 26.9% 28.2% 29.1% 30.3%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


These market share expectations are based on our analysis of the following key factors:

Regulation

True Corp's advantages in the 4Q13 through 2Q16 period were primarily driven by

regulation, and in particular to a chaotic and unprecedented shift from the concession

structure to a licenced structure. Crucially, market leader AIS fully emerged from the

concession structure into a licence and deal-based structure in May 2016 (albeit almost two

years after the initial expectations of a September 2014 auction of 1800MHz spectrum). This

puts AIS on a level regulatory playing field with True Corp and has ended True Corp's

'window of opportunity'. In fact the pace of market share loss from AIS to True Corp slowed

immediately to 0.3 pp QoQ in 3Q16, from 0.6 pp in 2Q16. DTAC is still at something of a

regulatory disadvantage, on the other hand, as it continues to operate under a concession

regime until 2018, at which point an auction should facilitate a shift onto the licenced regime.

This is a key reason behind our expectation that DTAC will continue to lose market share in

FY17 (before softening in FY18, thanks to the end of the concession period and a recently

agreed deal with TOT Corp outside of the concession structure).


Following the November 2015 1800MHz auction and 900MHz re-auction in May 2016, a

relatively level playing field in spectrum resources was established. As shown in the table

below, AIS has 2x55MHz of spectrum, DTAC has 2x50MHz (and recently-announced 1x

60MHz of 2300MHz spectrum) and True Corp has 2x55MHz of spectrum, all in low and

medium bands suitable for 2G, 3G and 4G services.


MHz 850 MHz 900MHz 1.8GHz 2.1GHz 2.3GHz

AIS 10*2 15*2 30*2

DTAC 10*2 25*2 15*2 60*1

True Corp 15*2 10*2 15*2 15*2


There are still some nuances; in particular the fact that DTAC's 850MHz spectrum and

1800MHz spectrum resources are both still under concession structure, conferring a

different fee structure and a higher revenue share, as well as limiting DTAC's confidence

in investing in those frequencies (since assets under the BTO concession structure are

transferred and the right to operate them will cease in 2018). This is why DTAC's recently

announced deal to access TOT Corp's 60MHz of unpaired spectrum in the 2300MHz band

is of such importance; on the assumption that the deal is approved by year-end, DTAC will

be free to invest in 2300MHz equipment with full rights and rewards of ownership.

Furthermore, the very expensive auctions for 1800MHz and 900MHz spectrum, won by

AIS and True Corp, reduce the near-term cost disadvantage faced by DTAC under the

concession structure. Thus, the key disadvantage in our view, and the key reason for the

20 June 2017


expectation of sharp ongoing market share losses in FY17, is the relative 'inefficiency' of

DTAC investing in 850MHz and 1800MHz equipment under concession—a situation that

should improve somewhat in FY18 with DTAC's 2300MHz roll-out and potentially slow

True Corp's growth rate relative to DTAC.

BTS by operator

As mentioned, AIS's improving growth rate, and moderating market share losses in FY17,

have been facilitated by the victory in the November 2015 1800MHz auction, allowing the

construction of a 4G network and launch of 4G services. AIS's 4G roll-out was extremely

quick, with 45,200 4G base transceiver systems (BTS) rolled out within just 12 months to

achieve 98% population coverage by December 2016, and the improving revenue

trajectory coincided with the 4G network quality became competitive, in key cities at least,

in mid-2016.



AIS 13,500 46,800 45,200 105,500 41.4%

DTAC 10,827 28,435 21,820 61,082 24.0%

True Corp 25,000 28,000 35,000 88,000 34.6%

Total 49,327 103,235 102,020 254,582 100.0%


True Corp has the second largest network and had enjoyed the competitive advantage of

4G service launch ahead of incumbent AIS. True Corp also invested heavily in building up

2G coverage in the 900MHz band in 1H16, after winning 900MHz spectrum in the initial

auction in December 2015, and AIS's initial auction loss. With Jasmine reneging on its

successful bid, AIS was able to secure 900MHz spectrum in the re-auction in May, and so

True Corp was not in the monopoly position it expected on 900MHz by mid-year. Some of

the 900MHz network resources may therefore suffer relatively low utilisation.

Given that it remains under the BTO concession structure on 850MHz and 1800MHz,

DTAC's network roll-out has been more constrained than AIS and True Corp's roll-outs.

Capital intensity

The impact of the highly disruptive shift from concession structure to licence structure can

also be clearly seen in the historic capex expenditure, and capex budgets, of the three

operators. We have shown consolidated capex budgets for simplicity (though True Corp

also has a fixed line division, and AIS has recently commenced fixed broadband

investment).

True Corp invested heavily in FY14 and FY15 as it pressed home the advantage conferred

by the relatively early end of its concession (and its deal with CAT Corp). AIS was also

investing at this point, primarily in 3G services on its 2100MHz network after winning

2100MHz spectrum under licence in late 2012, but in relative terms True Corp was

investing more.

AIS further ramped up investment in absolute terms in FY16 following its 4G auction

victory, and we forecast that AIS's capex will remain elevated at the Bt40-50 bn level in

FY17 and FY18, before dropping back in FY19 after the completion of a geographically

broad but dense 4G network. This further supports our expectation of slower revenue

market share losses by AIS.

20 June 2017


Figure 156: Capex by operators (Bt mn) Figure 157: Capex-to-sales ratios (%)


With one eye on the end of its concession DTAC was clearly under-investing in relative

terms in 2013 and 2014. After suffering sharp market share losses in 2014, DTAC

attempted to address this problem in 2015, increasing its capex to Bt20.0 bn. Management

acknowledged that part of this expenditure was extremely inefficient, given that DTAC

would only get use of the assets constructed in the 850MHz and 1800MHz bands until

2018 under concession; much shorter than useful life. We forecast that capex will rise to

Bt25 bn level in FY18 as DTAC builds equipment under the 2300MHz deal with TOT Corp,

and we expect capex to remain elevated in FY19 as DTAC re-invests in new equipment

under a clean licence structure post-auction (and enjoys full legal ownership of the assets

across all of its spectrum holding). DTAC's higher-than-industry capex to sales ratio in

FY18 and FY19 supports our expectation of much slower market share losses.


AIS and DTAC are both generating positive free cash flow in FY17. With both operators

having cut their dividend payout ratios (DTAC: 50%, AIS: 70%), the peak gearing ratio for AIS

is expected to reach 1.96x net debt to EBITDA in 2020, while DTAC is expected to hit 2.9x in

2020 based on our current EBITDA forecasts and the capex forecasts set out above.

In spite of seven capital raisings in the last 13 years (an average of one every two years),

True Corp's gearing looks high, at 2.7x as end-FY16, and likely to peak at 3.4x in FY18

under our current assumptions. Participation in the FY18 auctions—which are not yet

factored into our True Corp model—could therefore trigger yet another capital rising.

However, historical track record leads us to fully expect CP Group (Not listed) and China

Mobile to subscribe to any capital raising, and so we view True Corp's participation in the

Thai cellular industry as 'sustainable' (even though, as we explore further below, common

application of financial theory might question this assertion). As an alternative, True Corp

could look to sell additional assets to the Digital Infra Fund, though this would effectively

involve swapping an upfront cash receipt for ongoing lease fees at the EBITDA line.

Do DTAC and True Corp have viable businesses?

AIS and DTAC enjoyed a significant improvement in ROIC following the receipt of

2100MHz spectrum in 2012. The spectrum was inexpensive (Bt13.5-14.6 bn) and allowed

an initial shift of some customers from the high-revenue-share concession structure to a

5.25% revenue share under licence. AIS's ROIC peaked at 68.4% in FY12. DTAC's ROIC

in FY12 was 27.7%.

The difference was largely due to scale. Thailand's concession structure adds a significant

amount of complexity to the trajectory of margins and returns, but Thailand's relatively

large geography, and the requirement from consumers for nationwide coverage, creates

high fixed costs and means that revenue market share is a key driver of returns. In 2012,

0

5,000

10,000

15,000

20,000

25,000

30,000

35,000

40,000

45,000

50,000


AIS DTAC True Corp

0%

5%

10%

15%

20%

25%

30%

35%

40%

45%


AIS DTAC True Corp

20 June 2017


AIS had enjoyed 53.5% revenue market share, while DTAC had enjoyed 31.2%, and True

Corp had just 15.3%. True Corp's consolidated ROIC in 2012 was just 1.1%.

True Corp's introduction of aggressive handset subsidies in September 2013 triggered

market share loss, higher capex, and less EBITDA margin expansion than would

otherwise have been the enjoyed. This contributed to AIS's ROIC declining to 26.6% in

2016—still healthy, thanks to its scale advantage (FY16: 49.8% revenue share) but down

significantly from the 2012 peak.

With the loss of scale, higher capex, defensive handset subsidies and also very high

deprecation charges in FY16 (thanks to a policy of depreciating over an ever-shortening

concession life), DTAC's ROIC fell to just 5.3% in FY16, below what we estimate to be its

cost of capital (WACC: 9.5%).

Perhaps more surprisingly, despite increasing its cellular market share to 23.7%, True

Corp's ROIC had declined to -0.3% by 2016, due to its heavy capex roll-out and

aggressive handset subsidy and promotion costs. True Corp had not captured enough

scale to support its enlarged cost structure.



Bt mn AIS DTAC True Corp AIS DTAC True Corp AIS DTAC True Corp

Subscribers (000s) 41,031 24,480 24,526 43,031 27,330 33,610

Revenue 146,770 77,919 119,409 168,933 84,192 166,361 3.6% 2.0% 8.6%

EBITDA 60,900 27,336 25,072 85,851 33,588 39,156 9.0% 5.3% 11.8%

EBITDA margin 41.5% 35.1% 21.0% 50.8% 39.9% 23.5%


EBIT 39,233 3,904 (492) 47,741 8,677 6,967 5.0% 22.1% n.m.

EBIT margin 26.7% 5.0% -0.4% 28.3% 10.3% 4.2%

Tax rate (%) 14.4% 20.0% -21.1% 20.0% 20.0% 17.6%

NOPLAT 33,572 3,123 (595) 38,193 6,942 5,741 3.3% 22.1% n.m.


Asset turn 1.2 1.3 0.7 0.7 0.7 0.7

ROIC 26.6% 5.3% -0.3% 16.6% 6.0% 2.6%

Net profit 30,667 2,086 (2,814) 33,305 3,956 3,395 2.1% 17.4% n.m.

Net margin 20.9% 2.7% (2.4%) 19.7% 4.7% 2.0%


Is this divergence in returns likely to change going forward? Not much.

On the basis of current competitive dynamics and data pricing, we expect cellular industry

revenue to grow at a compounded annual rate of 4.5%. We also expect EBITDA margins

to rise, in part due to regulatory savings (particularly for DTAC as it shifts from a 30.0%

concession revenue share to a licence with a 3.75% revenue share), and in part due to

declining handset subsidies now that a level playing field on competition is in place.

However, in what we consider to be a major 'collective mistake' by True Corp, Jasmine

and AIS, the fees paid in the recent auctions are set to cause a material drag on industry

returns on capital. Due to the inclusion of Jasmine in the 1800MHz bid in November 2015

auction, AIS and True Corp paid Bt41.0 bn and Bt39.8 bn, respectively, for 2x15MHz

allocation of 1800MHz spectrum. DTAC stopped bidding at Bt17.5 bn, and so if Jasmine

had not continued to the bid, the clearing price for this spectrum would have been Bt18.0

bn.

Jasmine also took part in the December 2015 auction for 900MHz spectrum, as did True

Corp (surprisingly, since True Corp had low-band spectrum through its 850MHz deal with

CAT Corp). Jasmine and True Corp won 2x10MHz allocations for Bt75.6 bn and Bt76.0

bn, respectively, after AIS stopped bidding. Jasmine then reneged and, in a re-auction in

May 2016, AIS was the sole bidder at the Bt75.6 bn 'reserve price', as the company paid

20 June 2017


more than it thought the spectrum was actually worth in order to protect its legacy 2G

business. The ramifications of this unfortunate series of events are material, namely:

■ As a result of Bt117.0 bn in payments for 1800MHz and 900MHz spectrum, plus our

estimate of a further Bt60.0 bn in upfront spectrum payments in 2018, we expect AIS's

ROIC to decline to 16.6% by FY20—still comfortably above its WACC of 9.3%, but

clearly sub-optimal.

■ For True Corp, the Bt116.1 bn in payments for 1800MHz and 900MHz spectrum

completely offset the benefits of higher scale built over recent years and the

expectation of improving competitive dynamics going forward. We forecast ROIC of

just 2.6% in FY20, well below the cost of capital.

■ DTAC bid rationally in the 1800MHz auction and did not take part in the 900MHz 're-

auction', so it does not face any drag on returns from the 2015/16 auctions. However,

our key concern is the prospect of Thai politicians taking the clearing prices of those

auctions as the 'fair value' of spectrum and pressuring the NBTC to use those price

points as a reference for the reserve prices in the 2018 auction round. We therefore

assume that DTAC will need to pay Bt90.0 bn in total for 2x15MHz of 1800MHz

spectrum and 2x10MHz of 850MHz spectrum in the 2018 auction. This leads us to

expect an ROIC of just 6.0%, though we expect this to grind higher to reach 6.6% in

2023 as the spectrum is more fully utilised.

We conclude that AIS's business is, and will continue to be, value accretive. In DTAC's

case, what was a good business has been badly damaged, and due to our expectation of

high spectrum fees DTAC is set to be 'borderline' in generating adequate returns versus

its 9.5% WACC. Returns are probably just good enough to warrant ongoing support from

shareholders (including Telenor Group).

True Corp does not appear to have a viable business. It has not generated returns close to

cost of capital in the 20 years the stock has been listed. Scale benefits from recent strong

cellular revenue share gains were re-invested into spectrum payments in an attempt to

create an ongoing competitive advantage which has failed. While True Corp is not

sustainable on a stand-alone basis, CP Group and China Mobile may continue to support

it using the excess returns generated from their food business and (dominant) China

cellular business, respectively.


We again rely primarily on discounted cash flow (DCF) to set our target prices, since it is

the only way to fully capture the multi-year nature of cellular investment and payback, as

well as spectrum fees and differing revenue share payments in Thailand's complex

regulatory environment.

We believe that there are very significant valuation anomalies in Thailand, which create

opportunities for investors. AIS still looks attractive in absolute terms, with 25.6% potential

upside to our DCF-based target price; the company generates returns above cost of

capital even factoring in the expensive auction fees. However, investors can gain

exposure to the same set of cash flows through AIS's parent company, Intouch, which

offers 35.1% potential upside. Intouch, therefore, looks far more attractive than AIS on a

risk-reward basis at present.

While DTAC's lack of scale means that it generates inferior returns to AIS, this looks fairly

reflected in the valuation. Our DCF-based target price of Bt54.0 offers just 5.4% potential

upside. Reference to multiples suggests a similar conclusion; AIS is trading at 8.6x FY17

EV/EBITDA, while DTAC is trading at 5.1x. AIS trades at 3.7x EV/IC, DTAC trades at 2.6x,

but AIS generates higher returns, given its scale advantage.

AIS's scale and low risk profile drive a higher

valuation

DTAC looks fairly valued versus its return

profile…

20 June 2017


Indeed, given limited remaining upside to our DCF-based target price following a very

sharp share price rally, we downgrade DTAC from Outperform to NEUTRAL. The discount

at which DTAC trading is trading is in our view warranted by its lower returns on capital.

DTAC also suffers a high P/E ratio, though this is in large part due to DTAC's accounting

policy of depreciating over concession life, which leads to under-depreciation in the early

years of the concession, and very heavy (non-cash) depreciation charges as the end of

the concession approaches in 2018.

Figure 159: Thai telecoms—comparative multiples



AIS 173.5 218 25.6% 16.6 15.6 8.6 8.2 3.7 3.0 2.9% 4.9% 4.2% 4.5%

Intouch 55.75 75.3 35.1% 14.5 13.7 14.4 13.6 6.9% 7.3% 5.5% 5.1%

TAC 51.25 54.0 5.4% 82.2 23.6 5.1 6.0 2.6 2.6 5.4% 1.2% 0.6% 2.1%

True Corp 6.15 2.69 -56.3% 1315.2 273.4 9.9 10.4 1.6 1.4 -0.6% 4.5% 0.0% 0.0%

NJA- Integrated 24.5 16.6 6.5 6.2 6.4% 7.5% 4.3% 4.5%

NJA - Mobile 17.3 15.3 5.7 5.4 4.5% 6.2% 3.4% 3.8%


Given True Corp's ongoing destruction of capital, our DCF valuation, using a WACC of 9.2%,

gives a value of Bt2.69. This implies 56.3% downside from current levels. On comparative

multiples, True Corp looks similarly unattractive, at 9.9x EV/EBITDA (a premium to AIS),

1315x P/E, with a zero dividend and a small negative free cash flow yield.

While the asset base is very large, the market is currently paying 1.6x EV/IC, in spite of

the fact that the assets generated a negative return in FY16. We might conclude that the

market is expecting a dramatic improvement in returns on capital and profitability in the

medium term, driven by rising market share, and therefore improving economies of scale.

However, we have shown that, given the return of a level playing field on spectrum,

regulation, BTS and capital intensity market share gains from here on will likely be more

difficult for True Corp. This is already the case versus AIS, and is likely to become more

evident versus DTAC following 2300MHz roll-out.

Furthermore, the benefits of True Corp's increase in scale so far have been offset by higher

marketing and network costs, and future declines in marketing costs going forward are set to

be largely offset by the payment of extremely high spectrum fees bid in the recent auctions.

Thus our forecasts do not suggest that True Corp will be able to achieve reasonable returns

on capital even in the medium term—in contrast to the market's implied view.

But the market is pricing in returns from

True Corp which we do not expect to

materialise

20 June 2017


Figure 160: Relative share price performance


20

40

60

80

100

120

140

160

180

200

220

240


AIS DTAC TRUE

20 June 2017


Country sections: Australia

Summary

■ In terms of industry structure, the Australia market looks relatively unattractive, with

new a new entrant, extensive handset subsidies, and high 4G penetration.

■ We expect the Australia market to experience a decline in service revenue at a CAGR

of 1.4% across FY16-FY20.

■ Telstra is dominant with 55.6% revenue market share as at 1Q17 and an FY16 ROIC

of 15.4%. However the margin impact of the NBN in fixed line and increasing

competition in mobile are yet to be fully priced in.

■ TPG looks to be a challenger with high level of earnings and funding risk not yet

reflected in its (expensive) valuation.

Mobile revenue declines low single digits in 2016

Total Australian mobile service revenue fell 13.5% in 2016. Revenue was significantly

impacted by the reduction in mobile termination rates (MTR) from 1 January 2016, which

had a large impact on revenue, but minimal impact on industry EBITDA. We estimate that

on an underlying basis, the industry service revenue was down low single digit in 2016.

Figure 161: Australian mobile service revenue growth

YE June; A$ mn 1H14 2H14 1H15 2H15 1H16 2H16 1H17

Telstra 7.3% 5.0% 7.4% 7.0% 0.5% -9.7% -9.8%

Optus 1.3% 4.7% 2.9% 6.1% 2.2% -18.3% -20.6%

Vodafone -10.0% -8.9% -8.7% -1.1% 3.0% -14.1% -14.1%

Total 1.8% 2.2% 3.0% 5.3% 1.4% -13.0% -13.8%


The underlying decline in service revenue reflects a general step-up in the level of

competitive intensity across the industry. Optus and Vodafone have both spent the last

few years re-investing in their networks and have been more aggressive and innovative

with plan structures and pricing.

Vodafone has returned to subscriber growth and has stabilised its subscriber market

share. Optus has been winning subscriber share, though revenue market share is down

due to the impact of device repayment credits and MTR on service revenue. Telstra's

subscriber share has slipped slightly, though revenue share is actually up as the lower

MTR has a bigger relative impact on its competitors.

Figure 162: Australian mobile service revenue market share

YE June; A$ mn 1H14 2H14 1H15 2H15 1H16 2H16 1H17

Telstra 51.4% 52.7% 53.6% 53.6% 53.1% 55.6% 55.6%

Optus 29.8% 29.7% 29.7% 29.9% 30.0% 28.1% 27.6%

Vodafone 18.8% 17.6% 16.6% 16.5% 16.9% 16.3% 16.8%

Total 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%


TPG to enter market as fourth operator

There will be a big shift in mobile market dynamics over the next 3-4 years as TPG enters

as a fourth network operator. TPG is the No.2 broadband service provider with 25%

subscriber share.

20 June 2017


TPG paid A$1.26 bn to acquire 2x10MHz of 700 MHz spectrum. It plans to spend A$600

mn over the next 2-3 years to build a national network to cover 80% of the population.

TPG intends to leverage its existing fibre backhaul network and telco infrastructure as it

rolls out its network. TPG is targeting EBITDA breakeven with 2% subscriber share (c500k

subscribers) and EBIT breakeven with 6-7% share.

We expect TPG's network to be of significantly lower quality than its competitors, given the

limited amount that it intends to spend on capex and opex (see report TPG.AX: TPG

takes the high risk road). We expect that TPG will have a strong offering in the prepaid

and consumer wireless broadband market (c25% of the total market), but that it will find

the core postpaid market much harder to address.

We expect TPG to achieve its 500k EBITDA breakeven subscriber target fairly quickly, but

that the 6-7% EBIT breakeven target will be much harder to achieve. We forecast TPG to

achieve 4.5% subscriber market share by FY25F.

Figure 163: FY17F capex by operator (A$ mn) Figure 164: Macro cell sites by operator


TPG's entry to drag down overall market growth

We do not expect TPG's entry to have a huge impact on the existing operators in terms of

taking market share as we expect its network to be lower quality than competitors.

However, we do expect TPG to drag down pricing, particularly in the prepaid and

consumer wireless broadband segments.

As a result, we forecast total market growth of only 0-1% over the next 3-4 years as TPG

launches service.

Figure 165: YoY mobile service revenue growth (A$ mn) and revenue growth rates (%)

YE June; A$ mn FY14 FY15 FY16 FY17F FY18F FY19F FY20F

Telstra 8,178 8,765 8,362 7,893 7,974 8,055 8,067

Optus 4,669 4,878 4,482 3,764 3,801 3,839 3,839

Vodafone* 2,854 2,709 2,559 n.a n.a n.a n.a

TPG - - - - 1 9 43

Total market 15,701 16,352 15,403 14,200 14,371 14,523 14,543

Growth (% YoY) Telstra 6.1% 7.2% -4.6% -5.6% 1.0% 1.0% 0.1%

Optus -2.8% 4.5% -8.1% -16.0% 1.0% 1.0% 0.0%

Vodafone -9.4% -5.1% -5.5% n.a n.a n.a n.a

TPG - - - - - nm nm

Total market 0.3% 4.1% -5.8% -7.8% 1.2% 1.1% 0.1%

* CS does not cover HTAL. Source: Company data, Credit Suisse estimates

4,700

1,800

900

0

500

1,000

1,500

2,000

2,500

3,000

3,500

4,000

4,500

5,000

Telstra Optus Vodafone

8600

6230

5000

2000-2500

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

Telstra Optus Vodafone TPG

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20 June 2017


Spectrum: 5G spectrum auction likely in 2019/20

The table below shows spectrum holdings following the recent 700MHz auction. ACMA is

undertaking a review into whether it may conduct an auction for the 900MHz spectrum,

which is currently held under an apparatus licence.

All operators will require additional spectrum for 5G, most likely in the 3.4-3.6GHz band

range which is emerging as the global standard to 5G. Optus already has a sizeable

holding in this band due to its acquisition of Unwired a number of years ago. We expect an

auction for 3.5GHz spectrum in the 2019/20 timeframe.



Regulation: Domestic roaming won't be declared

The ACCC has been undertaking a review into domestic mobile roaming and recently

issued a draft decision not to declare domestic roaming. This was in line with our

expectations and positive for Telstra as it will not have to open up its regional network to

its competitors.


Capex has stepped up across the sector in the last 1-2 years, driven by increased

competition.

Telstra has said that its capex will increase to 18% of sales over the next three years as it

invests to maintain its network advantage. Optus spent A$1.7 bn on capex in FY16 and

will spend A$1.8 bn in FY17F. Vodafone expects its capex to be in the 'high teens' as a

percentage of sales. We expect capex to remain high as operators start to spend on 5G.

Telstra, Optus and Vodafone are all well-funded with robust balance sheets (Vodafone's

balance sheet is supported by its offshore parents).

TPG's balance sheet will become increasingly stretched as it rolls out mobile networks

across both Australia and Singapore. We forecast TPG’s net debt to peak at A$2.25 bn in

FY20F, equivalent to 3.0x EBITDA (close to debt covenant limit of 3.25x). We see a high

risk that TPG will need to raise additional equity to invest in 5G spectrum and capex.

20 June 2017


Figure 167: Summary financials table

YE June FY16 FY20F

A$ mn Telstra Optus TPG Telstra Optus TPG

Mobile subscribers (000s) 17,233 9,337 - 19,373 9,876 320

Group revenue 27,050 7,533 2,388 28,325 6,799 3,105

EBITDA 10,711 2,462 775 9,674 2,333 759

EBITDA margin 39.6% 32.7% 32.5% 34.2% 34.3% 24.5%

NPAT 4,009 931 361 2,981 734 171

Capex 4,194 1,668 281 4,681 1,390 750

ROIC 15.4% - 13.5% 11.4% - 5.0%


Investment views and valuations

The Australian telcoms sector is a tough investment proposition at the current time, due to

the margin impact of the NBN in fixed line and increasing competition in mobile.

We have an UNDERPERFORM rating on Telstra with a A$4.00 target price (see TLS.AX:

Dividend cut to 25cps from FY18F).

We have an UNDERPERFORM rating on TPG with a A$5.25 target price to reflect the high

level of earnings and funding risk as it rolls out mobile across Australia and Singapore.

Figure 168: Australia telecoms sector—comparative valuation

Close Target Upside P/E (x) EV/EBITDA (x) EV/IC (x) FCF yield (%) Div yield (%)


Telstra 4.38 4.00 -8.7% 13.3 12.6 6.1 5.9 2.2 2.2 7.0% 7.9% 7.1% 5.7%

TPG 5.59 5.25 -6.1% 12.2 15.4 7.9 7.9 2.0 1.5 -10.4% -3.3% 2.8% 2.4%


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Companies Mentioned (Price as of 19-Jun-2017) Advanced Info Service PCL (ADVANC.BK, Bt175.5) Axiata Group Berhad (AXIA.KL, RM5.07) Bharti Airtel Ltd (BRTI.BO, Rs367.05) China Mobile Limited (0941.HK, HK$84.05) China Telecom (0728.HK, HK$3.78) China Unicom Hong Kong Ltd (0762.HK, HK$11.32) China United Network Communications Ltd (600050.SS, Rmb7.47) Chorus (CNU.NZ, NZ$4.72) Chorus (CNU.AX, A$4.53) ChungHwa Telecom (2412.TW, NT$108.0) DiGi.Com (DSOM.KL, RM5.0) Far EasTone Telecom (4904.TW, NT$77.0) Globe Telecom (GLO.PS, P2144.0) HKBN (1310.HK, HK$8.3) HKT Trust (6823.HK, HK$10.22) Hutchison Telecommunications HK Holdings Ltd. (0215.HK, HK$2.72) Idea Cellular Ltd (IDEA.BO, Rs79.8) Intouch Limited (INTUCH.BK, Bt56.0) Jasmine International (JAS.BK, Bt8.3) KT Corp (030200.KS, W31,700) LG Uplus (032640.KS, W16,500) M1 Limited (MONE.SI, S$2.22) Maxis Berhad (MXSC.KL, RM5.88) Optus (Unlisted) PCCW (0008.HK, HK$4.38) PT Indosat Tbk (ISAT.JK, Rp6,250) PT Telkom (Telekomunikasi Indo.) (TLKM.JK, Rp4,400) Philippine Long Distance Telephone Company (TEL.PS, P1890.0) Reliance Communication Ltd (RLCM.BO, Rs19.05) SK Telecom (017670.KS, W247,500) Singapore Telecom (STEL.SI, S$3.8) SmarTone Telecom (0315.HK, HK$10.18) Spark NZ (SPK.NZ, NZ$3.82) Spark NZ (SPK.AX, A$3.64) StarHub Ltd (STAR.SI, S$2.74) TPG Telecom (TPM.AX, A$5.5) Taiwan Mobile (3045.TW, NT$113.5) Telekom Malaysia (TLMM.KL, RM6.62) Telenor (TEL.OL, Nkr138.1) Telstra Corporation (TLS.AX, A$4.41) Total Access Communication PCL (DTAC.BK, Bt52.0) True Corp PCL (TRUE.BK, Bt6.25) Vodafone Group (VOD.L, 222.8p) XL Axiata Tbk (EXCL.JK, Rp3,230)

Disclosure Appendix

Analyst Certification Colin McCallum, CA, Sunil Tirumalai, Fraser McLeish, Eric Cha, Varun Ahuja, CFA and Danny Chan each certify, with respect to the companies or securities that the individual analyzes, that (1) the views expressed in this report accurately reflect his or her personal views about all of the subject companies and securities and (2) no part of his or her compensation was, is or will be directly or indirectly related to the specific recommendations or views expressed in this report.

3-Year Price and Rating History for KT Corp (030200.KS)

030200.KS Closing Price Target Price

Date (W) (W) Rating

08-Jul-14 30,700 36,000 N

13-Feb-15 29,200 36,000 O

04-May-15 32,250 40,000

07-May-15 31,100 37,000

30-Oct-15 29,550 37,000 *

07-Mar-16 28,500 36,000 *

30-Jun-16 29,650 37,000

01-Aug-16 32,600 38,000

* Asterisk signifies initiation or assumption of coverage.

N EU T RA L

O U T PERFO RM

20 June 2017


3-Year Price and Rating History for LG Uplus (032640.KS)


Date (W) (W) Rating

05-Aug-14 9,850 13,000 O

22-Sep-14 12,250 15,000

26-Jan-15 12,500 16,000

07-May-15 9,850 12,000

28-Oct-15 11,350 13,000 *

07-Mar-16 10,300 12,800 *

01-Aug-16 11,400 13,000

31-Oct-16 11,800 13,800

02-Feb-17 11,550 15,000

30-May-17 15,550 20,000


O UT PERFO RM

3-Year Price and Rating History for SK Telecom (017670.KS)


Date (W) (W) Rating

25-Jun-14 240,500 300,000 O

21-Sep-14 292,500 350,000

29-Oct-14 269,500 330,000

29-Jan-15 284,000 345,000

07-May-15 262,500 325,000

03-Nov-15 230,000 R

22-Aug-16 221,000 NR

29-Sep-16 226,000 260,000 O *

06-Feb-17 222,000 280,000

30-May-17 249,000 280,000 N


O U T PERFO RM

REST RICT ED

N O T RA T ED

N EU T RA L

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As of December 10, 2012 Analysts’ stock rating are defined as follows: Outperform (O) : The stock’s total return is expected to outperform the relevant benchmark* over the next 12 months. Neutral (N) : The stock’s total return is expected to be in line with the relevant benchmark* over the next 12 months. Underperform (U) : The stock’s total return is expected to underperform the relevant benchmark* over the next 12 months. *Relevant benchmark by region: As of 10th December 2012, Japanese ratings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. As of 2nd October 2012, U.S. and Canadian as well as European ra tings are based on a stock’s total return relative to the analyst's coverage universe which consists of all companies covered by the analyst within the relevant sector, with Outperforms representing the most attractive, Neutrals the less attractive, and Underperforms the least attractive investment opportunities. For Latin American and non-Japan Asia stocks, ratings are based on a stock’s total return relative to the average total return of the relevant country or regional benchmark; prior to 2nd October 2012 U.S. and Canadian ratings were based on (1) a stock’s absolute total return potential to its current share price and (2) the relative attractiveness of a stock’s total return potential within an analyst’s coverage universe. For Australian and New Zealand stocks, the expected total return (ETR) calculation includes 12-month rolling dividend yield. An Outperform rating is assigned where an ETR is greater than or equal to 7.5%; Underperform where an ETR less than or equal to 5%. A Neutral may be assigned where the ETR is between -5% and 15%. The overlapping rating range allows analysts to assign a rating that puts ETR in the context of associated risks. Pri or to 18 May 2015, ETR ranges for Outperform and Underperform ratings did not overlap with Neutral thresholds between 15% and 7.5%, which was in operation from 7 July 2011. Restricted (R) : In certain circumstances, Credit Suisse policy and/or applicable law and regulations preclude certain types of communications, including an investment recommendation, during the course of Credit Suisse's engagement in an investment banking transaction and in certain other circumstances. Not Rated (NR) : Credit Suisse Equity Research does not have an investment rating or view on the stock or any other securities related to the company at this time. Not Covered (NC) : Credit Suisse Equity Research does not provide ongoing coverage of the company or offer an investment rating or investment view on the equity security of the company or related products.

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20 June 2017


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See the Companies Mentioned section for full company names Credit Suisse currently has, or had within the past 12 months, the following as investment banking client(s): SPK.NZ, TLMM.KL, 0215.HK, CNU.NZ, TLS.AX, STEL.SI, TEL.PS, 1310.HK, TRUE.BK, 030200.KS, SPK.AX, CNU.AX, BRTI.BO, ISAT.JK, RLCM.BO, 017670.KS, AXIA.KL, TLKM.JK, STAR.SI, GLO.PS, ADVANC.BK, 0315.HK, DSOM.KL, VOD.L, TPM.AX, TEL.OL, EXCL.JK Credit Suisse provided investment banking services to the subject company (STEL.SI, TEL.PS, 1310.HK, 017670.KS, AXIA.KL, TLKM.JK, GLO.PS, ADVANC.BK, DSOM.KL, TEL.OL, EXCL.JK) within the past 12 months. Credit Suisse currently has, or had within the past 12 months, the following issuer(s) as client(s), and the services provided were non-investment-banking, securities-related: 032640.KS, STEL.SI, 0728.HK, TEL.PS, 0762.HK, TRUE.BK, RLCM.BO, 017670.KS, 0941.HK, STAR.SI, MONE.SI, IDEA.BO, 600050.SS, TEL.OL Credit Suisse has managed or co-managed a public offering of securities for the subject company (STEL.SI, TLKM.JK, GLO.PS, ADVANC.BK, DSOM.KL, TEL.OL) within the past 12 months. 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Credit Suisse may have interest in (ISAT.JK, TLKM.JK, EXCL.JK) Credit Suisse may have interest in (TLMM.KL, AXIA.KL, DSOM.KL, MXSC.KL) Please visit https://credit-suisse.com/in/researchdisclosure for additional disclosures mandated vide Securities And Exchange Board of India (Research Analysts) Regulations, 2014 Credit Suisse may have interest in (BRTI.BO, RLCM.BO, IDEA.BO) As of the end of the preceding month, Credit Suisse beneficially own 1% or more of a class of common equity securities of (TRUE.BK, 4904.TW). Credit Suisse beneficially holds >0.5% long position of the total issued share capital of the subject company (032640.KS, TRUE.BK, 030200.KS, 017670.KS).

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For Thai listed companies mentioned in this report, the independent 2016 Corporate Governance Report survey results published by the Thai Institute of Directors Association are being disclosed pursuant to the policy of the Office of the Securities and Exchange Commission: Jasmine International () , True Corp PCL (Very Good) , Advanced Info Service PCL (Very Good) , Intouch Limited (Excellent) , Total Access Communication PCL (Excellent) Taiwanese Disclosures: This research report is for reference only. Recipients should carefully consider their own investment risk and note they may be subject to the applicable rules and regulations in Taiwan, including the requirements under the Taiwan Stock Exchange Operational Regulations Governing Securities Firms Recommending Trades in Securities to Customers ("Taiwan Recommendation Rules") on conflicts of interest. Investment results are the responsibility of the individual investor. 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