Telkom: Shifting Toward A Digital Telco

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Summary

  • Telkom reported rather soft results in the 4Q21 thanks to rising expenses but an unrealized gain from its investment in GoTo, a non-operating income, came to rescue.
  • While the management believes that the company is heading toward a healthier competitive landscape, we believe that the industry is dynamic, possibly intensified by the newly-merged Indosat Ooredoo Hutchison.
  • However, Telkom has launched a few initiatives, such as data center business and fixed-mobile convergence service, to open up new sources of revenue growth.
  • We arrive at a 12-month target price of US$33.6 per share via DCF (11% WACC and 3% of long-term growth).
  • Intensifying competition in the mobile service industry and a delay in 5G monetization are risks to consider.

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Recap

In our last article titled “Why We Still Positively View Telkom Despite MNOs Consolidation,” we wrote about how Telkom (NYSE:TLK) can maintain its dominance despite possible intense competition from Indosat Ooredoo Hutchison. The first reason is that Telkom’s balance sheet is healthy, which gives it more flexibility to spend Capex, in our view. Second, the government required the merged company to return the 2x5 MHz spectrum. Lastly, Telkom’s plan to optimize the value of its subsidiaries through an initial public offering or private investments will usher in a transformation to become a digital telco.

Since our last publication, the share price has gone up 17%. This article will update you about the 4Q21 results and discuss what to expect from Telkom in the future.

PK Telkom price
Data by YCharts

4Q21 Results: Slow Day At Work

In 4Q21, Telkom’s revenue grew 1.8% (Y/Y) to Rp37 trillion, driven by its data & digital businesses and IndiHome, a fiber-optic internet broadband service (see Figure 2). In 2021, Telkom raked a total revenue of Rp143 trillion, up from Rp136 trillion (+4.9% Y/Y) a year before.

PK Telkom Revenue growth contribution

Revenue growth contribution (Vektor Research)

Figure 3 shows that Telkomsel’s data payload growth slowed down, but so did the decline in mobile data yield. In addition, Telkomsel also managed to acquire two million net new prepaid subscribers in the quarter, exceeding Indosat (excluding Hutchison 3) and XL Axiata.

PK Telkom Data payload and data yield year-on-year change

Data payload and data yield year-on-year change (Vektor Research)

Moreover, Telkomsel also deployed more than five thousand units of 4G BTS and 113 5G BTS during the quarter. The total number of BTS grew almost nine percent from what was a year ago.

PK Telkom Total BTS

Total BTS (Company, Vektor Research)

IndiHome delivered 10% (Y/Y) of 4Q21 revenue growth, but lower than the previous quarters (23% Y/Y in 2Q21 and 18% Y/Y in 3Q21). Through Triple Play and add-ons, IndiHome increased ARPU to Rp270k, up from Rp262k in the 4Q20 but lower than Rp274k in 3Q21. Also, it added 136 thousand new subscribers.

IndiHome’s revenue grew 18.5% (Y/Y) on a full-year basis, reaching a three-year 23% CAGR. During the 4Q21 earnings call, the management highlighted how it is essential to “increase the quality of the experience,” while, at the same time, adding more customers and maintaining ARPU. However, the management went on to say that it is willing to tolerate a slight ARPU decline in exchange for more customers, noting that generating more revenue is the essential part of the business.

IndiHome's operational metrics

IndiHome's operational metrics (Company, Vektor Research)

Additionally, Telkom’s 4Q21 EBITDA growth slowed down, and margins took a hit due to surging operation & maintenance expenses (+17.5% Y/Y) and personnel expenses (+13.1% Y/Y). As noted in the info memo, increasing Capex to “strengthen digital infrastructure, increase cost of content, and grow managed solution” has resulted in rising expenses. Moreover, the company mentioned that Capex went to the development of fixed-line businesses, towers, and data center. Telkom spent almost Rp12 trillion of Capex (32% of revenue) in the previous quarter alone. But, in total, the company’s capital intensity stood at 21% of revenue in 2021.

Telkom's EBITDA growth and margin

Telkom's EBITDA growth and margin (Company, Vektor Research)

Lastly, Telkom registered a net profit of Rp5.9 trillion, up by 43% (Y/Y) from Rp4.1 trillion in 4Q20. Net profit reached Rp24.8 trillion on a full-year basis, up from Rp20.8 trillion (+19% Y/Y). However, in reality, the company recorded a non-operating income of Rp3.4 trillion thanks to an unrealized gain in Telkomsel’s investment in GoTo (PT GoTo Gojek Tokopedia Tbk), totaling almost Rp2.5 billion.

Expect A Better Competitive Landscape

Regarding the mobile service, the management described competition and data pricing as “the main issues Telkomsel had to address,” as players were “still very aggressive on acquisitions and renewal packages” to acquire low-end market share. For example, Telkomsel launched lower denomination packages such as Ketengan, OMG Internet, and Paket Belajar.

Yet, the management believes it is moving toward a healthier competitive landscape. Telkomsel has started to apply a fair usage policy and focused on personalized packages to avoid another price war. Still, the management expects some competition in the industry.

We think that the mobile service industry is dynamic, and an aggressive pricing strategy from one player could stir up another price war. First, as the second-biggest operator in the country, Indosat will seek to compete with Telkomsel. Nevertheless, we believe that Telkomsel will still retain its incumbency, at least for the foreseeable future. Second, as we are on the brink of 5G monetization, pricing and Capex wars might reemerge.

PK Telkom Data payload year-on-year change

Data payload year-on-year change (Vektor Research)

PK Telkom Data yield year-on-year change

Data yield year-on-year change (Vektor Research)

When asked about 5G, the management said that the company would be looking forward to the upcoming 700 MHz spectrum auction for 5G deployment. On the other hand, Indosat has not yet decided whether to join the auction or not. However, the company will still allocate most of this year’s Capex (~25% Capex to revenue) to 4G deployment. While at the same time, it expects to start spending in 5G in 2023, as cited in the 2Q21 earnings call transcript.

Shifting Toward A Digital Telco

Fortunately, Telkom is looking beyond a traditional telco operator model amid a dynamic competitive landscape in the industry. To solidify its competitive advantages, Telkom unveiled five initiatives: 1. Mitratel IPO, 2. Accelerating DigiCo business, 3. Unlocking Data Center Business, 4. Strengthen B2B IT service, and 5. Fixed-Mobile Convergence Initiative.

Telkom's five initiatives

Telkom's five initiatives (Company)

First, Telkom is integrating its data center business into Sigma Tata Sadaya, Telkom’s subsidiary, to form a data center business known as Telkom DC Co. In addition, a Hyperscale data center with a 75 MW capacity is heading toward the completion of the first stage (22.5 MW) by the first half of this year. The data center business’ growth trajectory is something we should consider. For instance, the company reported Rp1.7 trillion of revenue (+19% Y/Y) from its data center business in 2021. But the management believes that the figure will reach around Rp14 trillion in 2025. This equals 70% of year-on-year growth.

Second, Telkom aims to offer fixed-mobile convergence services. As we move forward, Telkom will focus on the B2B segment, while Telkomsel will cater to the B2C needs. When asked about the FMC product launching, however, the management could not disclose the timeline unless it had figured out the business model and worked out with regulators.

And Telkom has made another step. Last month, the company signed a memorandum of understanding with Singtel Group to develop the regional data center business and integrate fixed-mobile convergence service, strategies expected to bear fruit within two years. How will such a partnership benefit Telkom?

First, the idea is to build regional data centers by creating a new joint venture company, including other strategic partners. The company hopes that the partnership will provide “many synergies” to put the business into a competitive position. In addition, the management mentioned that Telkom will still have the majority ownership of the Hyperscale data center in Indonesia.

Second, Telkomsel and Singtel will collaborate to produce strategies for its fixed-mobile convergence service by building a go-to-market strategy, creating a product, and formulating a business model.

We think that Telkom’s strategy to shift from a traditional telco to a digital telco will be beneficial in the long run, reducing its dependency on its mobile business amid a dynamic and competitive landscape. Moreover, its digital business will open up new sources of revenue growth, and the completion of the first phase of the Hyperscale data center will mark one of the many steps toward its long-term goal.

5G And Data Center Business Will Be Growth Drivers

This year, the management set a 5-6% revenue growth target, exceeding the three-year CAGR of 3%. We expect the data business to continue its solid contribution, as a healthier pricing strategy will alleviate the self-inflicted pains, although competition will remain. Legacy business should decline by about 20% a year, while we believe IndiHome can still post a double-digit growth despite the recent soft results.

We estimate Telkom to record 9% of revenue growth per year in the next six years, driven by 5G monetization and data center business. First, in an article titled “Unlocking the value of 5G in the B2C marketplace,” McKinsey believes that a traditional business portfolio with 5G speed can increase ARPU by 3-6%. Adding to the current data revenue growth of 7% a year, we think a revenue growth of somewhere between 10% and 13% remains reasonable. Additionally, we baked in the data business’ potential of Rp14 trillion revenue by 2025.

Telkom's revenue estimates

Telkom's revenue estimates (Company, Vektor Research)

In addition, we estimate Telkom’s EBITDA margin to improve to about 54%, up from 53% last year, as a healthier pricing environment should result in margin improvement.

Telkom's EBITDA margin estimate

Telkom's EBITDA margin estimate (Company, Vektor Research)

Valuation

We arrive at a 12-month target price of US$33.6 per share, implying a forward EV/EBITDA of 5.9x. Our target price is based on DCF, with an 11% WACC (13% cost of equity, 5% after-tax cost of debt, and a 3% long-term growth).

Telkom's DCF valuation

Telkom's DCF valuation (Vektor Research)

Sensitivity analysis

Sensitivity analysis (Vektor Research)

Investment Risks

Competition from other players

With the emergence of Indosat Ooredoo Hutchison, we think the competition in the mobile service industry will intensify, particularly in pricing. As 5G monetization is on the horizon, we believe that price and Capex wars will reemerge.

Delay in 5G monetization

We assume that 5G monetization will allow operators to increase their ARPUs. Two possible schemes could jeopardize our thesis. First, a delay in the 700 MHz band spectrum auction could delay the 5G monetization. Second, demand for 5G is not as robust as expected.

Final Thoughts

We believe that the mobile service industry still has room to offer. For example, 5G monetization will help operators increase their ARPUs, which, in turn, help them drive their revenue growth. But we think another intense competition could be on the cards. Nevertheless, we believe that Telkomsel is likely to retain its incumbency, given its extensive network coverage and capability to spend a massive amount of Capex, thanks to its healthy balance sheet.

As it stands, Telkom is looking beyond a traditional telco model by developing its digital businesses, which we positively think is a sound initiative that will help Telkom drive its revenue growth in the future. Based on DCF, the estimated fair value is slightly above the current share price, which implies an upside potential of ~6%. With a dividend yield of 2.7%, we are looking at a potential return of roughly ~9%.

However, we do acknowledge limitations in our model. First, we assume that Telkomsel will only monetize a traditional data portfolio with a 5G speed. For example, McKinsey estimates telcos to increase ARPU by a total of 16-20% if they can, for example, offer differentiated tariffs and utilize network slicing. While this vision is still a long way to go, we think investors should consider the upside potential of the 5G network. Second, we also believe that Telkom’s data center business has the potential to exceed Rp14 trillion of revenue, as demand for data centers is surging.

In conclusion, we think Telkom’s vision to become a digital telco is an exciting idea to look upon, a vision that offers different sources of growth and puts itself in a competitive advantage position. Although our estimate suggests that the potential return is "only" 9%, we positively view Telkom because of its leadership in the mobile service industry and its digital business that will become new sources of revenue growth as we move forward. If you have any thoughts, please do not hesitate to comment below.

This article was written by

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Founded in 2021, Vektor Research aims to provide independent opinions accessible to investors. Furthermore, we also regularly post research about Indonesian stocks on our website.

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such 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.

Additional disclosure: Research reports are written based on analyst(s) analysis and expectations, and the analyst(s) must include sources for external data included in the analysis. The research analyst is not responsible for any inaccuracy caused by human errors. Still, Vektor Research will make sure, with reasonable efforts, to reduce such mistakes as minimal as possible. Please note that the forecasts do not guarantee any future performance. Vektor Research, along with the analyst(s), is not responsible for any loss, expenses, and the reader's decision-making, as we do not force readers to act towards any securities.

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