Indosat: Signs Of Improvement But Certain Risks Remain

Summary

• Indosat's 4Q2019 revenue growth of +14.0% was better than expected, as the company discontinued the sale of unlimited data plans to new subscribers while raising the prices for existing plans.
• Indosat's investments in improving network quality have paid off, with its network experience improving, especially in terms of mobile video experience and download speeds.
• Key concerns for Indosat and the Indonesian telecommunications industry relate to price competition and an earlier-than-expected 5G spectrum auction.
• Indosat, currently, trades at 3.7 times consensus forward next twelve months EV/EBITDA, which represents a discount to its historical five-year average forward EV/EBITDA multiples of 4.3 times.
• Looking for more stock ideas like this one? Get them exclusively at Asia Value & Moat Stocks. Get started today »

Elevator Pitch

I maintain a "Neutral" rating on Indonesia-listed telecommunications services company PT Indosat Tbk (OTCPK:PTITF) [ISAT:IJ]. I see signs of improvement for Indosat in the recent 4Q2019, with ARPU and subscriber growth, better network experience for subscribers and a reduction in financial leverage. On the flip side, the risk of a full-blown price war in the Indonesian mobile market remains a real threat in the near term, while an earlier-than-expected 5G spectrum auction could be disruptive for Indosat's capital expenditure plans in the medium term. With Indosat's severe share price correction in the past three months, part of the negatives and risk factors have been factored into Indosat's valuations, which suggests that a "Neutral" rating is warranted.

This is an update of my prior article on Indosat published on November 26, 2019. Indosat's share price has declined by -28% from IDR3,120 as of November 25, 2019, to IDR2,240 as of March 5, 2020. Indosat, currently, trades at 3.7 times consensus forward next twelve months EV/EBITDA, which represents a discount to its historical five-year and 10-year average forward EV/EBITDA multiples of 4.3 times and 4.4 times respectively. Indosat is also valued at a discount to its Indonesian telecommunications peers on a forward EV/EBITDA basis.

Readers are advised to trade in Indosat shares listed on the Indonesia Stock Exchange with the ticker ISAT:IJ, where average daily trading value for the past three months exceeds $800,000 and market capitalization is above $800 million. Investors can invest in key Asian stock markets either using U.S. brokers with international coverage, such as Interactive Brokers, Fidelity, and Charles Schwab, or local brokers operating in their respective domestic markets.

4Q2019 Results Above Expectations As Company Maintained Price Discipline

Indosat's 4Q2019 financial results were above expectations, as the company's revenue and EBITDA grew +14.0% YoY and +93.2% YoY to IDR7,264 billion and IDR2,619 billion respectively.

The company's stronger-than-expected revenue growth for 4Q2019 was mainly attributable to the fact that Indosat managed to maintain price discipline. In 4Q2019, Indosat discontinued the sale of unlimited data plans to new subscribers while raising the prices for existing plans. For Indosat's existing subscribers who are still on unlimited data plans, the company has encouraged them to switch to its new higher-yielding "Freedom Internet" plan which boasts a better streaming experience.

Indosat disclosed at the company's 4Q2019 earnings call on February 24, 2020, that the "Freedom Internet" is the mobile plan with the most number of subscribers for the company five months after its launch, exceeding the number of Indosat subscribers on unlimited data plans. This suggests that Indosat's strategy of "upgrading" its existing subscribers on unlimited data plans to the new higher-yielding "Freedom Internet" plan with superior streaming experience has worked well.

With the changes to its mobile plans as highlighted above, Indosat increased its ARPU (Average Revenue Per User) by +2.5% QoQ from IDR27,600 per month in 3Q2019 to IDR28,300 per month in 4Q2019. Despite maintaining price discipline instead of being aggressive on pricing to grab subscribers, Indosat did not suffer from a loss of subscribers and still managed to achieve a marginal +0.5% QoQ increase in subscribers to 59.3 million for 4Q2019. Notably, this is the third consecutive quarter of positive net subscriber additions for Indosat since 2Q2019.

More importantly, Indosat emphasized that it will steer clear of price competition by stating that "we don't want to react to any pricing thing, which we believe is not sustainable in the market", as per the company's comments at the recent 4Q2019 results briefing on February 24, 2020. The company added that it will focus on "value for money" and "customer experience" in retaining existing subscribers and adding new subscribers.

In addition, moving away from unlimited data plans implies less pressure on Indosat's network utilization. Indosat has made great progress in improving the company's network quality, as detailed in the next section.

Improvement In Network Quality Pays Off

In late-2018, Indosat announced that the company planned to allocate $2 billion to capital expenditures aimed at improving its network quality in the next three years, and that has clearly paid off. The most recent OpenSignal Mobile Network Experience Report published in December 2019 shows the degree of improvement in Indosat's network quality.

According to OpenSignal's findings, Indosat's average download speed has improved by +37% from 4.8Mbps in July 2019 to 6.6Mbps in December 2019. Over the same period, the company's average upload speed also increased by more than +40% from 2.5Mbps to 3.6Mbps. Notably, Indosat's Mobile Video Experience score improved from 34.7 points in July 2019 to 41.7 points in December 2019. Full marks for mobile video experience are 100 points as calculated by OpenSignal; the best performer had 58.8 points, while the worst performer had 34.7 points.

Mobile video experience and download speeds are definitely key considerations for mobile subscribers when it comes to selecting their preferred mobile operator, and it is reassuring to see that Indosat is showing signs of improvement and catching up with certain of its peers. The improvement in Indosat's network quality is a key factor in allowing the company to maintain its price discipline while still adding new subscribers.

Looking ahead, Indosat is guiding for capital expenditures in the IDR8.5-9.5 trillion range for FY2020. In comparison, the company spent IDR10.1 trillion on capital expenditures in FY2019, which is equivalent to a high capital expenditures-to-revenue ratio of 38.8%.

The company entered into sale-and-leaseback transactions for 3,100 of its telecommunications towers in 4Q2019, and the sales proceeds of IDR6.39 trillion will help to partly finance Indosat's future capital expenditures. Indosat's financial position also improved with the tower sales. The company's net debt-to-EBITDA ratio declined from 3.14 times as of end-FY2018 to 1.60 times as of end-FY2019, while its interest coverage ratio, calculated as the ratio of EBITDA to interest expenses, increased from 3.87 times to 4.83 times over the same period.

Key Concerns Relate To Industry Competition And 5G Spectrum Auction

The key concerns for Indosat and the Indonesian telecommunications industry relate to adverse price competition and 5G capital expenditures.

As mentioned earlier, Indosat has made a commitment to maintaining price discipline. While this is a positive sign, this doesn't stop other competitors from being aggressive on pricing and engaging in a price war. In the company's FY2019 earnings call on February 24, 2020, Indosat singled out fellow mobile operators Smartfren and Telkomsel. The company noted that Smartfren continues to "be going very aggressive on unlimited (data plans)", while market leader Telkomsel has lowered the price of some of its cheaper entry-level mobile plans.

Separately, there is limited visibility on the timeline for 5G development in Indonesia. While most other Southeast Asian and East Asian countries have either already conducted 5G spectrum auctions or set a timeline for such auctions, it seems that Indonesia will be lagging the other countries in terms of 5G development.

In an interview with the media in November 2019, Indonesia's Minister of Communication and Information Technology Johnny Gerard Plate highlighted that "the government has to make sure the (mobile) operators can do proper business to recover the (4G) investments they made in the past."

Nevertheless, 5G is a case of "when" rather than "if". Spectrum costs and capital expenditures relating to the eventual roll-out of 5G in Indonesia are merely deferred for the time being. An earlier-than-expected 5G spectrum auction could disrupt Indonesian mobile operators' current capital expenditure plans. This is especially true for Indosat, which has a relatively higher capital expenditure burden than its peers, as the company works at improving its network quality.

Valuation

Indosat trades at 4.7 times trailing twelve months EV/EBITDA and 3.7 times consensus forward next twelve months EV/EBITDA based on its share price of IDR2,240 as of March 5, 2020. In comparison, the stock's historical five-year and 10-year average forward EV/EBITDA multiples were 4.3 times and 4.4 times respectively.

Indosat's Indonesian telecommunications peers include Telekomunikasi Indonesia's (TLK) (OTCPK:TLKMF) [TLKM:IJ] and PT XL Axiata Tbk (OTCPK:PTXKY) (OTC:PTXAF) [EXCL:IJ], which are valued at consensus forward next twelve months EV/EBITDA multiples of 6.1 times and 4.6 times respectively.

Indosat does not pay a dividend.

Risk Factors

The key risk factors for Indosat are a full-blown price war in the Indonesian mobile market, higher-than-expected capital expenditures, a failure to be competitive with its peers in terms of network quality, and a larger-than-expected increase in gearing.

Analyst’s 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.