Why TM’s minimum RM700m dividend promise has run its course

This article first appeared in The Edge Malaysia Weekly, on July 2, 2018 - July 08, 2018.
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IF Telekom Malaysia Bhd can keep its minimum RM700 million dividend promise, the stock will be oversold and the company undervalued. Yet the odds are stacked against the company rebounding in the near term due to uncertainties on multiple fronts. These uncertainties need to clear up before investors find TM appealing again, experts say.

More on the challenges later. First, the 38% plunge in the telecommunications company’s share price and RM7.1 billion market capitalisation lost in the seven weeks post the May 9 general election.

Closing at RM3.11 last Friday, the stock is at its lowest level since September 2011. The implied yield is 6% if TM can be counted on to pay at least 18.6 sen dividend per share, which would be roughly what every share gets if the total dividend payout stays at the minimum RM700 million.

According to Bloomberg data, at least three analysts think TM will soon choose to revise its dividend policy — as reflected by their dividend forecast of below 19 sen a share for 2018. If you believe the lowest dividend forecast of 12 sen, a 4% yield assumption would imply a RM3 share price — the level to which TM fell intraday last week before recouping some losses. A 3.5% yield assumption would imply a RM3.40 share price while a 3% yield would imply RM4, back-of-the-envelope calculations show.

At least seven analysts still see dividend at 19 sen, which reflects the promised minimum, while only one expects the 22 sen dividend paid in 2017 to be maintained this year.

At its current share price, the broadband giant has little to lose and much to gain in terms of balance sheet flexibility if it were to vary the wording of its dividend policy from its decade-old promise of up to 90% of net profit or at least RM700 million, whichever is higher.

Old-timers would remember that the dividend promise was made to provide investors with some comfort as TM embarked on a multibillion-ringgit high-speed broadband (HSBB) infrastructure investment, the backbone that today enables its UniFi broadband service as well as third-party broadband offerings. This was in 2008 when the sexier local and mobile business was spun off from TM and housed under Axiata Group Bhd. TM shares enjoyed something of a safe haven status because of the minimum dividend promise as investors chased dividend-paying stocks higher during the era of cheap debt. That era is coming to an end as interest rates normalise. TM’s share price plunge was probably exacerbated by fund repatriation from regional markets. The looming industry challenges mean that TM has to weather a storm.

 

In the eye of the storm

The storm stems from the Pakatan Harapan government’s promise to halve the price of broadband while doubling its speed within five years to make internet affordable and accessible to people in “all towns and villages across the country”. This is so that the power of the internet can be leveraged to create entrepreneurial opportunities and reduce the burden of the high cost of living.

The government is right to see high-speed broadband as a basic necessity, just like water and electricity, as its ubiquitous availability at affordable prices would boost Malaysia’s economic competitiveness. Multimedia and Communications Minister Gobind Singh Deo has indicated that broadband prices will drop at least 25% in the next six months and TM has said the new prices will be revealed in the third quarter.

For TM investors, however, broadband price cuts spell profit squeeze, which would directly affect the telco’s ability to invest and pay dividends.

“A 10Mbps broadband package costs about RM130 per month. If you cut that by, say, RM50 a month, that’s a RM1.4 billion potential revenue loss in one year if you multiply that by 2.3 million customers over 12 months … it’s not rocket science,” a seasoned telecoms analyst says, quantifying the size of the potential top-line loss.

This also implies a potential earnings loss of some RM300 million if one were to assume 20% to 25% margins. TM had 1.18 million UniFi subscribers and 1.13 million broadband subscribers as at end-March 2018. Some 98% of UniFi subscribers are on 10Mbps speeds or higher.

Last year, TM paid out RM808 million to shareholders. Operating revenue was RM12.09 billion and pre-tax profit was RM1.05 billion while profits attributable to equity holders stood at RM929.7 million.

To maintain decent margins, TM will need to rework its cost structure, which means time, good leadership and strong execution, the analyst says, adding that while this is not the first time policymakers are pushing for lower broadband prices, the new government is seen as more serious about attaining its target.

Eleven of the 15 analysts who updated their earnings estimate for TM after May 9 expect the telco to make less than RM700 million net profit for 2018 and six of them expect 2019 earnings to be below this year’s, Bloomberg data showed at the time of writing.

TM paid its shareholders more than RM930 million in dividends in FY2014 and kept the amount at more than RM800 million a year between FY2015 and FY2017 — a threshold that appears challenging in the near term.

Adding to the 50% price-cut scare are the uncertainties about what looks like a directive to TM to let rivals ride its infrastructure at cheaper prices. As the wholesale prices at which TM sells broadband capacity to rivals are not known, it is hard for outsiders to gauge the potential impact of the policy, experts say.

What is certain, however, is that all industry players, not just TM, would need to look again at their cost structure and work out a formula that would help them build a profitable and sustainable business while selling broadband to consumers at prices the new government wants.

“A good grasp of the cost of providing the broadband service and the ongoing investments necessary to maintain a top-notch backbone for the country’s economy would help policymakers determine what needs to change and at what prices broadband can and should be sold to consumers,” an observer says.

Could M&A be on the cards, given the changes that industry players are faced with?

“Who is going to drive change? Is it safe to bet on top-down direction in the near to medium term, be it a restructuring, a merger or just cost-cutting?” another veteran industry observer says when asked about the possible remerger of TM and Axiata or at least the merging of all local or mobile units under one entity.

“Realistically, it has only been about 50 days [since GE14]; we’re talking about the overhauling of the government, key institutions and the entire economy. Change will take time, the policymakers will need time,” he adds.

He, for one, does not expect any major corporate exercise before the dust settles.

Khazanah Nasional Bhd owned 26.2% of TM as well as 37.3% of Axiata as at end-March 2018 and counts both companies among its key strategic investments. The Employees Provident Fund owned 17.88% of TM and 16.72% of Axiata as at end-March while Permodalan Nasional Bhd had 21% of Telekom and 18% of Axiata as at end-December 2017. Together, the trio owns about 65% of Telekom and 72% of Axiata.

 

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