Sector Focus Telecommunications

Malaysia Equity Research PP 12942/03/2012(029402) 7 June 2011

Telcos smartening up
YTLs YES is gaining pace in the smartphone segment, while Celcom has the most attractive iPhone plans High-margin, less penetrated, smartphone segment is key growth driver; Celcom and Maxis will benefit more than Digi Top pick is Axiata with a BUY call and RM5.60 TP Telcos are more inclined to grow smartphone subscribers, despite having to subsidise phone costs. These subscribers are more profitable with RM100-170 ARPU (30-60% higher than average postpaid ARPU) and margins are protected by limited data packages. Celcom and Maxis will benefit more from rising smartphone demand than Digi, because of their wider 3G coverage (80% vs Digis 50%) and larger share of total revenue. Mobile internet revenue (mostly generated from smartphone bundles) is estimated to be larger than mobile broadband. Maxis and Celcoms combined mobile internet and broadband revenues account for c.25% of their respective total revenues, larger than Digis c.10%. These are expected to drive data revenue (estimated to grow by 1525% yoy in FY11-12F) which in turn will support the sectors mobile revenue growth of 6% p.a. in FY11F-12F. YTLs YES is gaining pace in smartphones, but Celcom has best iPhone 4 plans as the latest entrant in the market. At the lowest cost of RM3,800, a Celcom subscriber gets double the internet usage limit (vs Digi and Maxis) and 6,000 mins of free voice calls within Celcoms network (plus free minutes for calls to other networks). Celcom currently has 18% share of the iPhone market in Malaysia. Meanwhile, YES recently launched YES Life for iOS devices, making their services available on iPhones, iPod Touch and iPads. But like other messengers, subscribers need a separate internet connection to run YES Life. And that means network quality and availability will be key concerns for frequent users. Until more WiMAX-enabled mobile phones are available, YES will be seen more as a broadband player. Axiata (Buy; SOP-TP RM5.60) remains our top pick. iPhone subsidies could hurt Celcoms margins, but the impact will be minimal. Axiata is the fastest growing Malaysian telco and still the cheapest in our coverage. Although Digi (Hold; TP RM30.40) and Maxis (Hold; TP RM5.10) should benefit from growing demand for mobile data, these have been priced in. TM (Hold; TP RM3.90) should also benefit from growing demand for fixed broadband services. But this year will be challenging for Maxis and TM as both expand their fixed services (i.e. Maxis fixed Home service and TMs Unifi).

KLCI : 1,552.14
Analyst Juliana Ramli +603 2711 2222 Juliana@hwangdbsvickers.com.my

TOP PICKS
Price RM Mkt Cap US$m Target Price RM Rating

Axiata Group

4.92

13,840

5.60

BUY

Source: DBS Vickers

Axiata Group : Regional cellular telecommunications company DiGi.Com : A Malaysia-focused GSM cellular operator. Maxis Bhd : A Malaysia-focused GSM cellular operator. Telekom Malaysia : Malaysian fixed line operator Green Packet: R&D and marketing of wireless and telecommunication networking solutions, and WiMAX-based telco

Refer to important disclosures at the end of this report

HWANGDBS

Sector Focus Telecommunications

YES is slowly gaining pace in smartphone segment Now riding on iOS, Android and BlackBerry versions soon. YES recently launched its new feature YES Life application for iOS (Apples mobile operating system) to make its voice and SMS services available on Apple iOS devices including iPhone, iPod Touch and iPad. This allows Apple iOS users to make and receive calls as well as text with 018 mobile numbers on top of their existing mobile number, which means the subscribers can have two numbers in one phone. Currently, the RM50 activation fee is waived and there is a free 4-day trial period with RM5 free credit to gain customer confidence and attract new subscribers. But YES still has limitations. The major limitation is that a subscriber would require a separate internet connection, whether provided by YES or other telcos, in order to run YES Life (like other messengers such as Yahoo! Messenger (YM) and Skype). For instance, an iPhone user needs a data plan before he can use YES Life. The usability of the service is also dependent on the quality and availability of networks, which are currently provided mainly by the incumbent telcos Maxis, Celcom and Digi (given YES limited network coverage). For frequent phone users, this could be a key concern. Until we see more WiMAX-enabled mobile phones in the market, YES will be more of a broadband player rather than voice. YES Life is not very different from the existing messengers that are available on smartphones. And users who are used to the popular messengers such as YM and Skype are unlikely to change to YES Life unless it offers different and more appealing features. YES launched its WiMAX-enabled mobile phone (Buzz 4G Cloud Phone by Samsung) in 1Q11, but we understand response has not been good because of the lack of applications. WiMAX-enabled mobile phones would have to offer at least the same, if not more attractive features than those currently available on 3G smartphones, in order for YES to win subscribers. It is also crucial that YTL consider embedding its services in a wide range of phones to cater to different market segments and/ or users preferences. But given the current relatively slow pace, it could take a while before the telco would be able to offer a wider range of WiMAX-enabled mobile phones to capture a meaningful share of the mobile voice market.

Main features of applications available on iOS devices

Features YES Yahoo! Skype Windows Msgr

Voice call to a: 1) phone 2) another app user SMS Voicemail Video call to a: 1) phone 2) another app user Chat between app users

Yes* Yes* Yes* Yes* No No No

Yes* Yes Yes No No Yes Yes

Yes* Yes Yes* Yes* No Yes Yes

No No No No No No Yes

*charges apply Source: DBS Vickers Research

YES value packs are more appealing for data users, but network coverage is limited. The majority of YES current c.200k subscribers likely use more data than voice or text as they take advantage of the high speed WiMAX network. YES offers RM68 and RM150 monthly plans, which seem attractive with data rates as low as 1.9sen and 1.5sen/MB, respectively. And it should attract more subscribers as network coverage picks up. Although YES current network coverage is just over 65% of Malaysias population (wider than Green Packets 47%), we understand it is not as deep as for other telcos because YES has a smaller number of base stations. It has 1,900 sites against Green Packets target 2,500 sites for 65% coverage and 3G players usual 2,000-3,000 sites for 65-70% coverage. For instance, we understand YES subscribers often get poor network reception when indoor.

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Sector Focus Telecommunications

Jumping onto the iPhone bandwagon not too late for Celcom Sold 10k units so far. Celcom recently launched its new iPhone 4 plans, still not too late in our view. Even without first mover advantage, Celcom should still gain market share in the iPhone market, given its relatively attractive plans and strong demand. We understand that to date, Celcom had sold c.10k units of iPhone 4, which accounts for c.18% share of the iPhone market in Malaysia. Demand for iPhone still growing, based on Gartners latest statistics on worldwide smartphone sales volume. According to the data, in the smartphone operating system (OS) market, Apples iOS (which runs on the iPhone) sales almost doubled yoy to 46.6mil units last year. It was the 4th largest in terms of sales volume last year with 15.7% market share. This was mainly due to the wider availability of iPhone 4. This year, Gartner predicts sales of iOS will double again to 90.6mil units, bringing iOS to the second position with 19% market share (after Googles Android, on par with Nokias Symbian). In 1Q11 alone, sales of iOS reportedly doubled yoy to 16.9mil units. Celcoms new iPhone plans are better deals in terms of internet usage limits, free voice calls and texting. At a lowest total cost of RM3,800 for Celcom Exec i98 iPhone 4 (32GB) 24-month plan (5% lower than Maxis iValue 1 and Digis iDigi 88 plans), a Celcom subscriber would get the same number of free text messages as Digi and Maxis (200 text messages), but also higher internet usage limit of 2GB (vis-vis Digis and Maxis 1GB). However, Celcom is inferior in

terms on free voice calls to other networks it offers only 100 free minutes (vis--vis Maxis 333 mins and Digis 200 mins). But the offer of additional 6,000 mins of free voice calls within Celcoms network is an appealing value proposition for its subscribers, which makes up c.32% share of the countrys mobile subscriber base. Maxis has slashed iPhone 4 prices further after launching it in Sep10. The RM100-200 reduction is mainly for 24-month iValue plans. Maxis 24-month plans compete directly with Digis, as the latter only offers 24-month plans. The reduced prices puts Maxis iValue 1 plan in a slightly better position than the iDigi 88 plan. At a total cost of RM3,990 (vs Digis RM4,002), a Maxis subscriber not only gets 200 free text messages and 1GB of data (same as Digis), but also additional free 333 mins of voice calls (vs Digis 200 mins). But as we move up the value chain, Digi offers better deals for data centric users with additional 1-2GB internet usage limits at 46% lower cost than Maxis. However, Maxis offers c.50% more free minutes for voice. Although Digis offers are better for data centric users, it is important to note that Maxis offers more flexible contract periods i.e. 12 and 24 months, compared to Digis 24 months. Moreover, Maxis 3G coverage is also wider at c.80% compared to Digis c.50%. Celcom could win more subscribers. All in, although, we believe Celcom can win more subscribers, followed by Digi, then Maxis, given that iPhone users are generally heavy data users and will benefit from Celcoms cheaper data rates.

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Sector Focus Telecommunications

iPhone 4 postpaid plans (32GB) on 24-month contract Digi vs. Maxis vs. Celcom
Celcom Digi Maxis

Plans

Exec i98 Exec i148 Exec i248

iDigi 88

iDigi 138

iDigi 238

iValue Lite

iValue 1

iValue 2

iValue 3

iValue 4

(Initial) phone cost (RM) Monthly fees (RM) Total cost (RM)* Free Voice (minutes) SMS MMS Internet

1,448 98 3,800

1,148 148 4,700

538 248 6,490

2,490 63 4,002

2,490 93 4,722

2,490 163 6,402

2,290 70 3,970

1,590 100 3,990

1,290 155 5,010

690 250 6,690

Free 375 9,000

100 200 20 2GB

250 400 40 4GB

500 600 80 6GB

200 200 20 1GB

450 400 40 3GB

1,000 600 60 5GB

150 80 10 0.5GB

333 200 20 1GB

667 400 40 2GB

1,500 600 60 3GB

2,500 800 80 4GB

6000 (within network)

Additional charges beyond entitlement Voice (per minute) SMS (sen) Internet 15 10 12 10 10 10 15 10 12 10 10 10 18 10 15 10 12 10 10 10 10 10

Free (within Malaysia) speed will be throttled to 128kbps

Free (within Malaysia) speed will be throttled to 128kbps

RM0.05/10kB with maximum charge of up to RM250 (within Malaysia)

*Total cost for iPhone 4 and monthly fees over 24 months Source: Company websites, and DBS Vickers Research

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Sector Focus Telecommunications

Growth of mobile internet usage will remain robust Incurring subsidies in the near-term to grow quality subscriber base. To attract subscribers, telcos normally have to subsidise devices (by bundling smartphone plans with devices), which could pressure EBITDA margins. However, the impact is temporary. Digi and Celcom expense off all its subsidies immediately, while Maxis capitalizes and amortise the amount over the contract period (12-24 months). However, it is more important to note that the subsidies would allow telcos to grow their quality subscriber bases that generate better ARPUs and margins. Smartphone segment is more profitable because of significantly higher ARPUs than mobile broadband (large screen). We understand that for a telco, smartphone ARPUs can range between RM100 and 170. Below is a summary of the current available smartphone plans. Current available smartphone plans (monthly packages)
iPhone Android Blackberry Others

Estimated mobile internet and broadband revenue share by major telcos Maxis is still the largest
C e lcom 39% Ma xis 48%

D igi 13%

Source: Companies, DBS Vickers Research

Share of smartphone subscribers by major telcos Maxis is still leading

C elc om, 1.8mil, 34% Maxis , 2.2mil, 42%

Maxis Digi Celcom

RM70RM375 RM63RM163 RM98RM248

RM108RM588

RM70RM620

RM108RM588

RM33-68 (for data only, calls/SMS are based on pay-per-use) RM78RM250 RM88RM168 RM78RM250

D igi, 1.3mil, 24%

Source: Companies, DBS Vickers Research

Source: Company websites, and DBS Vickers Research

Margins are protected. This is because of the limited data plans available, unlike for mobile broadband (where many offer unlimited data usage). We also understand that small screen users do not generally exceed their monthly quota both for voice and data, unlike large screen users. A key revenue driver, and still ample room for growth. Since the last few quarters, data has been and will be the key revenue driver for telcos (specifically non-SMS revenue, which comprises mainly mobile internet and mobile broadband revenues). Our analysis suggests that mobile internet revenue (mainly generated on smartphone bundles) is larger than that for mobile broadband (but telcos do not normally give breakdown for these two segments), and this segment is expected to be the main driver of data revenue, spurred by the proliferation of smartphones. We believe there is ample room for small screen business to grow as the number of smartphone users are still small at 15-20% of total Malaysias mobile subscriber base.

Celcom and Maxis likely to benefit more from rising demand for smartphones compared to Digi, given their wider 3G coverage (80% vis--vis Digis 50%) and larger share of total revenue. Combined mobile internet and mobile broadband

revenue forms a large part of data revenue (36% for Digi, 58% for Maxis, and 65% for Celcom). 1Q11, data revenues accounted for 25%, 36% and 40% of Digis, Celcoms and Maxis total revenue respectively. For Maxis and Celcom, mobile internet and broadband revenues accounted for c.25% of their total revenues, larger than Digis 10%. These are expected to drive data revenue (estimated to grow by 15-25% yoy in FY1112F) which in turn will support sectors mobile revenue growth of 6% p.a. in FY11F-12F.

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Sector Focus Telecommunications

Maxis share of data revenue is estimated to increase to 40-45% I FY11F12F from 36% in FY10
1000 900 800 700 600 500 400 300 200 100 0 1Q10 2Q10 3Q10 4Q10 1Q11 D ata revenue (L HS ) D ata as % of revenue (R HS ) 42% 40% 38% 36% 34% 32% 30%

Digis share of data revenue is estimated to increase to 24-26% I FY11F12F from 22% in FY10
400 350 300 250 200 150 100 50 0 1Q10 2Q10 3Q10 4Q10 1Q11 D ata revenue (L HS ) D ata as % of revenue (R HS ) 26% 25% 24% 23% 22% 21% 20%

Source: Companies, DBS Vickers Research

Source: Companies, DBS Vickers Research

Celcoms share of data revenue is estimated to increase to 38-43% I FY11F-12F from 33% in FY10
700 600 500 400 300 200 100 0 1Q10 2Q10 D ata revenue (L HS ) 3Q10 4Q10 1Q11 D ata as % of revenue (R HS ) 37% 36% 35% 34% 33% 32% 31% 30% 29% 28% 27%

Source: Companies, DBS Vickers Research

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Sector Focus Telecommunications

Valuation Top pick is Axiata, iPhone subsidies might hurt Celcoms margin but impact will be minimal. We understand iPhone subsidies could reduce Celcoms EBITDA margins by 2-3ppts in the coming quarters, but given that Celcom had only sold 10k iPhones so far (18% share of the market), the net impact on Axiatas earnings is expected to be minimal at RM10-15m or 0.3-0.5% of FY11F earnings. We have a Buy call and SOPderived RM5.60 TP for Axiata. We continue to like Axiata as it is the fastest growing Malaysian telco and still the cheapest in our coverage (in terms of PE and EV/EBITDA). 1Q11 core earnings growth of 19% has surpassed our full-year forecast of 16%. There could be more upside to our forecast if the Groups cost control measures continue to bear fruit and lift EBITDA margins. Growth of mobile data revenue may be offset by weaker margins as Maxis (Hold; DCF TP RM5.10) expands its fixed services. We expect Maxis to incur additional costs (including subscriber acquisition costs) for its new fixed Home services (partly via TMs HSBB network) that were launched recently. Given that these services are new and therefore, lacks scale, it

could drag down margins over the next 2-3 years. TM (Hold; DCF TP RM3.90) should also benefit from growing demand for fixed broadband services. However, TMs EBITDA margins could be squeezed down the road with more installation and customer acquisition costs incurred for UniFi as TM ramps up the number of premises passed and aggressively acquire subscribers. To date, UniFi subscriber net adds have grown to 13k/month from 10k/month in 1Q11. Its subscriber base has also grown to 86k, up 22k since end-1Q11. Strong data revenue growth has been priced in for Digi (Hold; DCF-TP RM30.40). This year will be challenging for the Group as Digi embarks on a network modernisation exercise. This will result in accelerated depreciation of its existing equipment and consequently, a 14% drop in FY11F earnings. But despite expectedly weaker earnings, the Group plans to maintain nominal DPS this year. We believe this is possible but retained earnings could drop significantly (probably by 15% yoy to RM1.47 BVPS). We understand that management is working on capital management initiatives to improve the current payout ratio. Our forecast assumes RM1.63 net DPS (unchanged yoy), translating into 125% payout ratio and 6% yield.

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Peer comparison - Valuations

S toc k Indones ia (IDR ) XL Axiata Indos at T elekomunikas i Indones ia P ric e T arget R atings E V/E B IT DA CY10 CY11 CY12 6.5 5.3 4.6 5.6 5.0 4.4 4.9 4.4 4.2 Net Div idend Yield CY10 CY11 CY12 1.2 1.1 4.2 3.8 2.2 4.6 4.3 3.1 4.8 CY10 16.5 26.7 13.1 P E (x ) CY11 13.2 23.1 12.1 CY12 11.5 16.2 11.4

5,950 5,200 7,600

7,100 6,200 7,700

B uy B uy Hold

Malays ia (MYR ) Digi.Com Green P acket Axiata Maxis T elekom Malays ia S ingapore (S GD) MobileOne S ingapore T elecom S tarhub S imple av erage

28.90 0.73 4.92 5.45 3.87

30.40 0.65 5.60 5.10 3.90

Hold Hold B uy Hold Hold

9.5 n.m. 6.2 10.3 5.5

8.6 115.2 5.4 9.8 6.1

7.9 24.7 4.8 9.5 6.0

5.6 0.0 2.0 7.3 7.8

5.6 0.0 2.5 5.9 5.1

5.6 0.0 2.9 6.3 5.1

19.2 n.m. 16.2 17.8 24.6

22.3 n.m. 13.9 16.8 24.6

21.4 n.m. 12.2 15.9 22.9

2.48 3.17 2.77

2.60 3.20 2.90

B uy Hold Hold

8.2 7.7 8.9 7.3

8.0 7.7 8.0 16.7

7.8 7.3 7.8 8.1

7.0 4.5 7.2

7.6 5.3 7.2

7.7 5.9 7.4

14.2 12.9 18.0 17.9

13.2 13.2 15.3 16.8

13.0 12.7 15.1 15.2

Source: Bloomberg, companies, DBS Vickers Research

Peer comparison - Gearing

S toc k P ric e E B IT DA margin CY10 CY11 CY12 53.2% 48.5% 54.2% 53.1% 48.1% 53.1% 52.8% 49.7% 53.2% Net gearing (x ) CY10 CY11 CY12 0.8 1.2 0.1 0.5 1.2 CAS H 0.3 1.0 CAS H Net Debt/E B IT DA (x ) CY10 CY11 CY12 1.1 2.3 0.1 0.7 2.2 n.m. 0.4 1.9 n.m.

Indones ia (IDR ) XL Axiata 5,950 Indos at 5,200 T elekomunikas i Indones ia 7,600

Malays ia (MYR ) Digi.Com Green P acket Axiata Maxis T elekom Malays ia

28.90 0.73 4.92 5.45 3.87

44.2% n.m. 48.9% 49.5% 33.3%

45.8% 1.7% 49.1% 49.9% 32.5%

45.9% 7.4% 49.6% 49.2% 32.8%

0.1 0.1 0.2 0.5 0.3

0.4 0.8 0.1 0.5 0.6

CAS H 1.7 CAS H 0.5 0.6

0.1 n.m. 0.6 0.7 0.7

0.2 38.8 0.3 0.5 1.3

n.m. 11.8 n.m. 0.9 1.4

S ingapore (S GD) MobileOne 2.48 31.5% 32.1% S ingapore Telecom 3.17 43.1% 40.2% S tarhub 2.77 26.8% 28.8% Source: Bloomberg, companies, DBS Vickers Research

32.1% 40.6% 29.0%

1.0 0.2 10.8

0.9 0.2 24.3

0.9 0.2 221.9

0.9 0.8 1.0

0.9 0.7 0.9

0.9 0.7 0.8

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Sector Focus Telecommunications

This document is published by HWANGDBS Vickers Research Sdn Bhd (HDBSVR), a subsidiary of HWANGDBS Investment Bank Berhad (HDBS) and an associate of DBS Vickers Securities Holdings Pte Ltd (DBSVH). The research is based on information obtained from sources believed to be reliable, but we do not make any representation or warranty as to its accuracy, completeness or correctness. Opinions expressed are subject to change without notice. This document is prepared for general circulation. Any recommendation contained in this document does not have regard to the specific investment objectives, financial situation and the particular needs of any specific addressee. This document is for the information of addressees only and is not to be taken in substitution for the exercise of judgement by addressees, who should obtain separate legal or financial advice. HDBSVR accepts no liability whatsoever for any direct or consequential loss arising from any use of this document or further communication given in relation to this document. This document is not to be construed as an offer or a solicitation of an offer to buy or sell any securities. DBS Vickers Securities Holdings Pte Ltd is a wholly-owned subsidiary of DBS Bank Ltd. DBS Bank Ltd along with its affiliates and/or persons associated with any of them may from time to time have interests in the securities mentioned in this document. HDBSVR, HDBS, DBSVH, DBS Bank Ltd, and their associates, their directors, and/or employees may have positions in, and may effect transactions in securities mentioned herein and may also perform or seek to perform broking, investment banking/corporate advisory and other banking services for these companies. HDBSVR, HDBS, DBSVH, DBS Bank Ltd and/or other affiliates of DBS Vickers Securities (USA) Inc (DBSVUSA), a U.S.-registered broker-dealer, may beneficially own a total of 1% or more of any class of common equity securities of the subject company mentioned in this document. HDBSVR, HDBS, DBSVH, DBS Bank Ltd and/or other affiliates of DBSVUSA may, within the past 12 months, have received compensation and/or within the next 3 months seek to obtain compensation for investment banking services from the subject company. DBSVUSA does not have its own investment banking or research department, nor has it participated in any investment banking transaction as a manager or co-manager in the past twelve months. Any US persons wishing to obtain further information, including any clarification on disclosures in this disclaimer, or to effect a transaction in any security discussed in this document should contact DBSVUSA exclusively. DBS Vickers Securities (UK) Ltd is an authorised person in the meaning of the Financial Services and Markets Act and is regulated by The Financial Services Authority. Research distributed in the UK is intended only for institutional clients.

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