Axiata Group: Regulatory Risks In The Spotlight

Dec. 11, 2019 11:50 AM ETAxiata Group Berhad (AXXTF)1 Like

Summary

  • Axiata Group's overseas subsidiaries, Bangladesh's Robi and Nepal's Ncell, are facing regulatory issues in their respective markets.
  • The unlocking of the value of Axiata Group's 62.4% stake in independent tower company edotco was highlighted as a positive re-rating catalyst earlier, but a potential IPO could be delayed.
  • Network infrastructure sharing plans could help to ease concerns regarding higher-than-expected 5G-related capital expenditures going forward.
  • Axiata Group expects to meet three-quarters of its five-year RM5 billion cost savings target by end-FY2019, which is ahead of schedule.
  • Axiata Group trades at 5.3 times consensus forward FY2020 EV/EBITDA and offers a consensus forward FY2020 dividend yield of 2.7%.
  • Looking for more stock ideas like this one? Get them exclusively at Asia Value & Moat Stocks. Get started today »

Elevator Pitch

Malaysia-listed Axiata Group Berhad (OTCPK:AXXTF) [AXIATA:MK] is a regional telecommunications company which owns controlling stakes in market-leading mobile and fixed operators across Asia. Readers can refer to my recent article on PT XL Axiata Tbk (OTCPK:PTXKY) (OTC:PTXAF) [EXCL:IJ], Axiata Group's 66.4%-owned Indonesia subsidiary, published on November 8, 2019 for more details about the company's Indonesian operations.

Axiata Group trades at 5.3 times consensus forward FY2020 EV/EBITDA which represents a discount to its historical five-year forward EV/EBITDA of approximately 7 times. The stock also offers a consensus forward FY2020 dividend yield of 2.7%.

This is an update of my initiation article published on Axiata Group on September 23, 2019. Axiata Group's share price has slightly declined by -2% from RM4.28 as of September 20, 2019 to RM4.19 as of December 9, 2019.

I maintain my "Neutral" rating on Axiata Group. I am positive on the company's cost savings initiatives and 5G network infrastructure sharing plans. But the company faces regulatory issues in Nepal and Bangladesh, while the potential listing of its independent tower subsidiary edotco could be delayed.

Readers are advised to trade in Axiata Group shares listed on Bursa Malaysia (the stock exchange of Malaysia) with the ticker AXIATA:MK where average daily trading value for the past three months exceeds $3 million and market capitalization is above $9 billion. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage such as Interactive Brokers, Fidelity, Charles Schwab, or local brokers operating in their respective domestic markets.

Regulatory Risks In The Spotlight

Regulatory risks are an issue for a lot of companies, but especially so for regulated industries like telecommunications. As a regional telecommunications headquartered and listed in its home market Malaysia, Axiata Group has encountered its fair share of regulatory issues with its overseas subsidiaries, namely Bangladesh's Robi (68.7% stake) and Nepal's Ncell (80% stake).

In Nepal, Axiata Group is involved in a dispute with Nepal's tax authorities regarding capital gains tax in relation to the company's acquisition of a 80% stake in Ncell from seller TeliaSonera Norway in December 2015. While capital gains tax should be rightfully paid by the seller TeliaSonera Norway rather than the acquirer, Nepal's tax authorities have determined that Axiata Group and Ncell are liable for capital gains tax in relation to the past acquisition.

In end-November 2019, The Supreme Court of Nepal ruled that Axiata Group and Ncell have to pay the outstanding capital gains tax (Axiata Group had already paid a total of NPR23.6 billion to Nepal's tax authorities previously), notwithstanding the fact that the outstanding capital gains tax was reduced from NPR39.06 billion (Nepalese rupees) earlier to NPR21.1 billion, or approximately RM770 million.

Axiata Group has already started arbitration proceedings with the International Centre for the Settlement of Investment Disputes since April 2019 to dispute the outstanding capital gains tax, on the basis that Axiata Group's acquisition of Ncell involved "the transfer of shares outside of Nepal in a non-Nepalese company (Ncell's immediate holding company Reynolds Holdings was acquired by Axiata Group as part of the 2015 acquisition) and is not subject to CGT (Capital Gains Tax)." and "neither made any capital gains in consequence of the transaction."

With market consensus expecting a net profit of slightly above RM1 billion for Axiata Group in full-year FY2019, the company's earnings would be badly hit if it had to either make additional provisions in relation to the RM770 million tax liability or it eventually choose to pay the outstanding capital gains tax. At the company's 3Q2019 earnings call on November 28, 2019, Axiata Group highlighted that the "overall provisions we have on various tax matters should be sufficient." The company believes that its position on the Nepal capital gains tax case is strong, and does not think that there will be additional provisions until there is a result from the current arbitration proceedings.

Besides Nepal, Axiata Group is also facing tax issues in Bangladesh with respect to its 68.7%-owned subsidiary in Bangladesh, Robi.

Firstly, the minimum turnover tax rate imposed on mobile phone operators' annual sales was increased from 0.75% to 2% starting in 2Q2019. Secondly, the Bangladesh Telecommunication Regulatory Commission had earlier made a claim (outstanding tax and late payment of fees etc) of BDT8.7 billion (Bangladeshi taka), or RM426 million, against Robi in mid-2018 as part of an information system audit, and requested Robi to pay for the claims in June 2019. Robi subsequently filed a suit in August 2019 seeking an injunction against the Bangladesh Telecommunication Regulatory Commission's claims, which was rejected by the Joint District Judge in September 2019. Robi then made an appeal before the High Court Division which was heard in end-November 2019, with the High Court decision pending.

Axiata Group derived approximately 14% and 10% of its 9M2019 EBITDA from Bangladesh and Nepal respectively. Apart from financial penalties in terms of taxes and other claims, there could be serious repercussions, if Axiata Group's overseas subsidiaries have their telecommunication services suspended by the regulators in the worst case scenario.

Tower Listing Catalyst Could Be Delayed

In my initiation article on Axiata Group published on September 23, 2019 and referred to in the "Elevator Pitch" section of this article, I had highlighted the unlocking of the value of Axiata Group's 62.4% stake in independent tower company edotco as a positive re-rating catalyst.

However, it seems that the potential list of edotco could be delayed. In an interview with local media publication, The Edge, published on September 30, 2019, Axiata Group's president and group CEO Tan Sri Jamaludin Ibrahim mentioned that the company will revisit the possibility of an IPO for edotco more seriously in 2020 if edotco needed to fund a major acquisition. But the CEO also stressed that edotco has other funding sources, and it is not reliant on a listing to raise funds.

A Bloomberg article titled "Axiata revives IPO of $2.5 billion tower arm Edotco" published in February 2019 suggested that Axiata Group had earlier planned to list edotco at a valuation of $2.5 billion, which implied that Axiata Group's 62.4% stake in edotco could be potentially worth RM6.5 billion, or close to 17% of Axiata Group's current market capitalization.

On the positive side of things, the growth momentum of edotco is still expected to be strong in FY2020. Axiata Group expects a double-digit organic revenue growth for edotco next year, driven by higher growth from new and emerging markets like Pakistan, Myanmar and Bangladesh, which will be partially offset by weakness from Malaysia where growth has slowed due to a gestation period pending 5G deployment.

5G Collaboration To Partially Ease Concerns On Capital Expenditure

In Malaysia, higher-than-expected 5G-related capital expenditures are the biggest concern for mobile operators going forward.

Digi.Com Berhad (OTC:OTC:DIGBF) [DIGI:MK], Maxis Bhd (OTC:OTC:MAXSF) [MAXIS:MK] and Celcom Axiata (Axiata Group's Malaysian mobile operator subsidiary), are the three major mobile operators in Malaysia. Celcom Axiata signed a Memorandum Of Understanding or MOU with Maxis in end-November 2019 to explore 5G network infrastructure sharing. Celcom aims to focus on 5G collaboration with Maxis in the city center and urban areas in Malaysia, with plans for 5G collaboration (possibly with other operators such as Digi) in other areas yet to be determined. Celcom and Maxis are currently in the very early stages of planning for potential 5G collaboration.

The two companies have studied network infrastructure sharing arrangements by other telecommunications companies outside of Malaysia, and Axiata Group noted at the recent 3Q2019 results briefing that "both of our networks are quite comparable" which makes 5G network infrastructure sharing plausible. Axiata Group plans to share more details of the actual 5G network infrastructure sharing in half a year or so. While Axiata Group understands the need for Malaysia to roll out 5G and maintain technology leadership in the region, the company highlights that there are limited 5G commercial use cases at the moment to generate incremental revenue to justify the costs associated with 5G deployment. In terms of timeline, the regulators could potentially allocate 5G spectrum in 2Q2020.

Cost Savings Critical In Improving Future Profitability

Axiata Group's EBITDA margin expanded by 230 basis points YoY to 37.8% for 3Q2019, and the company is targeting a further +300 basis points improvement in EBITDA margin by FY2022 (approximately 40.8%) with a near-term target of 40% EBITDA margin for FY2020.

The achievement of the company's short-term and medium-term EBITDA margin targets is dependent on the execution of its cost savings initiatives. Axiata Group had earlier set a cost savings target of RM5 billion for the FY2017-FY2021 five-year period. In 9M2019, the company achieved over RM800 million in cost savings mainly generated from the reduction in network, IT cost and sales and marketing costs, and it is on track to deliver RM1 billion in cost savings for full-year FY2019. Taking into account cost savings of RM1,250 million and RM1,497 million in FY2017 and FY2018 respectively, Axiata Group expects to meet three-quarters of its RM5 billion cost savings target by end-FY2019, which is ahead of schedule.

If cost savings are evaluated on a per-GB basis, Axiata Group's network cost per GB (gigabyte) has declined from RM1.89 per GB in 3Q2016 to RM0.31 per GB in 3Q2019 in the past three years, as revenue per GB declined at a slower pace from RM1.55 per GB to RM0.46 per GB over the same period. In other words, Axiata Group's data margin was 33% in 3Q2019, versus 3Q2016 when network costs exceeded data revenues. Network costs on a per GB basis has declined by a CAGR of approximately -40% in the last three years.

Axiata Group has managed to achieve such significant cost savings in the past few years by emphasizing a consistent network experience for its customers, rather than blindly targeting to achieve the fastest network. This involved the use of analytics to prioritize capital expenditure spending with high return and fast payback. Also, the company increased customer engagement efforts via cheaper digital channels, rather than more costly physical face-to-face engagement or phone calls. Axiata Group also relied on the company's scale (over RM20 billion in annual revenues) to do bulk purchases where possible.

However, it must be noted that the later stages of multi-year cost savings plans tend to be more difficult than the initial stages, because companies usually start by cutting the expenses that are easiest to get rid of, and structural cost reductions at the end could potentially be more challenging.

Valuation

Axiata Group trades at 5.5 times consensus forward FY2019 EV/EBITDA and 5.3 times consensus forward FY2020 EV/EBITDA based on its share price of RM4.19 as of December 9, 2019. The stock's forward FY2020 EV/EBITDA represents a discount to its historical five-year forward EV/EBITDA of approximately 7 times.

Axiata Group offers consensus forward FY2019 and FY2020 dividend yields of 2.3% and 2.7% respectively.

Variant View

The key risk factors for Axiata Group are an escalation of regulatory issues particularly in overseas markets, a longer-than-expected time to monetize its stake in independent tower company edotco, cost savings below expectations and higher-than-expected capital expenditures in the future, especially pertaining to 5G.

Asia Value & Moat Stocks is a research service for value investors seeking value stocks with a huge gap between price and intrinsic value, leaning towards deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like "Magic Formula" stocks, high-quality businesses, hidden champions and wide moat compounders). Sign up here to get started today!

This article was written by

The Value Pendulum profile picture
7.88K Followers
Uncover cheap stocks, great businesses listed in Asia focusing on HongKong
Asia Value & Moat Stocks is a research service for value investors searching for attractive Asia-listed investment opportunities  with a huge gap between price and intrinsic value, leaning towards both deep value balance sheet bargains (i.e. buying assets at a discount e.g. net cash stocks, net-nets, low P/B stocks, sum-of-the-parts discounts) and wide moat stocks (i.e. buying earnings power at a discount in great companies like "Magic Formula" stocks, high quality businesses, hidden champions and wide moat compounders).


Those who believe that the pendulum will move in one direction forever or reside at an extreme forever eventually will lose huge sums. Those who understand the pendulum's behavior can benefit enormously. ~ Howard Marks

Follow

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.

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.