Malaysia-listed telecommunications services provider Telekom Malaysia Berhad (OTC:MYTEF) [T:MK] has provided clarity on its mobile plans recently, suggesting that it intends to become the national 5G infrastructure provider, providing mobile operators with wholesale wired and wireless services, rather than competing with existing mobile operators by building a new mobile network.
Telekom Malaysia trades at 6.0 times consensus forward next twelve months EV/EBITDA, which is at a discount to its historical five-year average forward EV/EBITDA of approximately 7 times. The stock also offers a consensus forward FY2020 dividend yield of 3.1%.
This is an update of my initiation article published on Telekom Malaysia on October 1, 2019. Telekom Malaysia's share price has increased +8% from RM3.60 as of September 30, 2019 to RM3.91 as of December 5, 2019. I maintain my "Neutral" rating on the Telekom Malaysia; increased capital expenditures and a dilution in broadband ARPU (Average Revenue Per User) are negative for the stock, although there is future upside if Telekom Malaysia is successful in obtaining the mandate from regulators to be the country's 5G infrastructure provider. Furthermore, there is downside risk to Telekom Malaysia's consensus forward FY2020 dividend yield of 3.1%, if capital expenditures are above expectations.
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In my initiation article on Telekom Malaysia published in October 2019, I had highlighted that the company's mobile ambitions were a key risk factor for the stock. More specifically, the market was concerned that Telekom Malaysia had plans to invest aggressively to grow its mobile business by securing spectrum and building a new mobile network. This could have implied significantly higher capital expenditures and lower dividends for Telekom Malaysia in the future.
At the company's 3Q2019 earnings call on November 26, 2019, Telekom Malaysia clarified that it had no plans to construct a new mobile network and compete with the incumbents in the Malaysian mobile market. Instead, Telekom Malaysia intends to be the national 5G infrastructure provider, servicing mobile operators with the provision of wholesale wired and wireless services.
There were several key developments for Telekom Malaysia in recent months, as the company tried to signal its commitment to 5G development in Malaysia, so as to be better positioned to obtain regulatory approval for its targeted role of 5G infrastructure provider. Telekom Malaysia recently participated in the 5G Demonstration Project undertaken by the Malaysian Communications and Multimedia Commission in October 2019. Telekom showcased its 5G use cases in Selangor and Langkawi, Kedah, in collaboration with local municipal councils and other partners. These included smart agriculture use cases under the agriculture vertical and other use cases under the tourism vertical among others. In November 2019, Telekom Malaysia signed a Memorandum of Understanding or MOU with China's Huawei Technologies to work together on a range of 5G use cases such as Smart Cities and vehicle-to-vehicle/vehicle-to-infrastructure solutions. Telekom Malaysia conducted a live 5G transmission in Langkawi this week, which was the first deployment of 5G Standalone network in Malaysia.
Telekom Malaysia's plans to become the national 5G infrastructure provider is contingent on its ability to secure the 700MHz and 3.5GHz spectrum, after Malaysian Communications and Multimedia Commission starts the auctions for these spectrum. Specifically, the 700MHz spectrum is especially critical for Telekom Malaysia to allow the company to offer superior coverage for rural and remote areas in the country.
More importantly, there is no guarantee that the regulators have plans for a national 5G infrastructure provider, and are willing to grant the mandate to Telekom Malaysia. Telekom Malaysia currently offers mobile roaming services relying on mobile operator Celcom's network, so it is unlikely that a single company is allowed to provide both infrastructure and services for the 5G mobile network.
Furthermore, existing mobile operators could have plans of their own and they might not agree with Telekom Malaysia being appointed as the national 5G infrastructure provider. For example, mobile operators Maxis (OTC:MAXSF) [MAXIS:MK] and Celcom recently signed a MOU in end-November 2019 to partner on the deployment of Malaysia's 5G infrastructure, which is expected to involve the joint deployment of 5G infrastructure in specific areas of Malaysia and other plans.
In addition, it is uncertain what Telekom Malaysia's future strategy for its mobile business will be, if regulators reject the company's plans to become the national 5G infrastructure provider. A possibility of Telekom Malaysia reverting to building its own mobile network can't be ruled out completely.
Returning to company fundamentals, Telekom Malaysia performed well in 3Q2019, as its EBITDA grew +2.6% QoQ and +5.9% YoY to RM996.5 million in the quarter. The company's EBITDA was up +18.8% YoY at RM3.0 billion for 9M2019. Telekom Malaysia's cost optimization initiatives were the key contributor to the company's improved EBITDA in the recent quarter.
Telekom Malaysia's total cost-to-revenue ratio decreased from 90.9% in 2Q2019 to 86.5% in 3Q2019, while the total cost-to-revenue ratio declined from 103.3% in 9M2018 to 86.7% in 9M2019.
Drilling down to specific cost categories, direct costs declined by -15% YoY to RM2,243 million for 9M2019, due to reduced domestic roaming charges (lower revised rates) and lower content costs (content rationalization and successful negotiations for lower rates for certain contracts upon renewal). Other operating expenses fell by -44% YoY to RM1,187 million in 9M2019, as Telekom Malaysia terminated certain sports sponsorship deals to cut back on advertising & promotion expenses, reduced maintenance charges and a lower impairment charge for trade receivables.
Cost optimization initiatives should continue to be a boost to 4Q2019 and FY2020 earnings, as Telekom Malaysia guided for a higher EBIT in FY2019 vis-a-vis FY2018, despite expecting a low-to-mid single digit revenue decline for full-year FY2019. Further cost savings are expected to be derived in the area of content costs, staff costs and other direct costs.
With regards to capital expenditures, Telekom Malaysia has been under-spending year-to-date with capital expenditures-to-revenue ratio of 8.8% in 9M2019. With the company guiding for a full-year FY2019 capital expenditures-to-revenue ratio of slightly under 18% at its 3Q2019 results briefing on November 26, 2019, capital expenditures are expected to spike in 4Q2019. This implies that capital expenditures could potentially more than double from RM286 million in 3Q2019 to over RM700 million in 4Q2019.
Moving beyond FY2019, Telekom Malaysia's capital expenditures should trend higher as the company bids for the 700MHz and 3.5GHz spectrum. While the 3.5GHz spectrum has yet to be priced, securing the bulk of the 700MHz spectrum, let's say eight blocks of 2 x 5MHz, could cost Telekom Malaysia RM1.7 billion (or 14% of its FY2018 revenue) based on a RM215 million price tag for a single block of 2 x 5MHz for the 700MHz spectrum.
With a net debt-to-EBITDA ratio of 1.60 times and a net debt-to-equity ratio of 0.85 times as of end-September 2019, Telekom Malaysia's balance sheet could be further stressed with the spike in capital expenditures.
Telekom Malaysia's broadband business continued to under-perform in 3Q2019, with revenue down -1.7% QoQ and -10.5% YoY at RM1,180 million for the recent quarter. The number of broadband subscribers declined -5.6% YoY to 2,159,000 in 3Q2019, as the +8.9% YoY increase in unifi fiber broadband subscribers (subscribers on the faster fiber broadband network, most of which have upgraded from Streamyx) to 1,373,000 could not completely offset the -23.3% YoY decrease in Streamyx subscribers (legacy broadband subscribers on the slower copper network) to 786,000 for the quarter.
The broadband business' ARPU also continued to fall, with unifi ARPU decreasing from RM186 in 3Q2018 to RM167 in 3Q2019, while Streamyx ARPU declined marginally from RM113 to RM111 over the same period.
Going forward, a further dilution of Telekom Malaysia's broadband ARPU in the short to medium term is expected.
Telekom Malaysia launched its "Pay Nothing" marketing campaign for existing and new unifi broadband subscribers at the start of October 2019. Under the "Pay Nothing" marketing campaign, existing and new unifi broadband subscribers enjoy free broadband internet subscription till end-2019 when they either sign up for new broadband internet plans or renew their existing subscriptions for 24 months. This is likely to have been an aggressive move by Telekom Malaysia to retain existing subscribers and win new ones, in view of the significant subscriber churn in 2019. A maximum three-month waiver of subscription fees for a 24-month period is equivalent to a hefty 12.5% discount. Telekom Malaysia faces stiff competition in the Malaysian broadband space from rival Maxis, and new entrants like Celcom, Digi.Com Berhad (OTC:DIGBF) [DIGI:MK] and Astro Malaysia [ASTRO:MK].
Furthermore, there is pressure from the regulators to keep broadband prices affordable in Malaysia to boost internet penetration in the country. The Draft National Fiberisation and Connectivity Plan or NFCP drawn up in October 2018 targets to reduce broadband cost to 1% of Gross National Income by 2020. This could involve the government mandating broadband companies such as Telekom Malaysia to introduce mandatory entry-level broadband plans at prices at an estimated 50% discount to current market levels.
Telekom Malaysia trades at 5.1 times trailing twelve months EV/EBITDA and 6.0 times consensus forward next twelve months EV/EBITDA based on its share price of RM3.91 as of December 5, 2019. Telekom Malaysia's forward next twelve months EV/EBITDA is at a discount to its historical five-year average forward EV/EBITDA of approximately 7 times.
Telekom Malaysia offers consensus forward FY2019 and FY2020 dividend yields of 3.3% and 3.1% respectively.
The key risk factors for Telekom Malaysia are a failure to obtain regulatory approval and acquire the necessary spectrum for the company to become a national 5G infrastructure provider, higher-than-expected capital expenditures, lower-than-expected savings from cost optimization initiatives, a greater-than-expected decline in broadband ARPU and a lower-than-expected dividend payout.
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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.