This article first appeared in The Edge Financial Daily on May 8, 2019

Telecommunications sector
Maintain neutral: Axiata Group Bhd and Telenor Group are in discussions to establish a new merged global entity by combining their Asean and South Asia footprints. It is uncertain whether this will result in any binding agreement of obligations for the parties to make any acquisition, merger or divestment.

The intention is to list the new merged entity (MergedCo) on Bursa Malaysia and another major international exchange within the next few years. MergedCo will include a Malaysian champion, a global tower business and the largest innovation in the region, all headquartered in Malaysia. MergedCo’s pro forma: RM50 billion revenue, RM20 billion earnings before interest, taxes, depreciation and amortisation and 300 million subscribers.

The rationales are to strengthen the balance sheet to support aggressive growth, a RM15 billion to RM20 billion incremental value in synergies, a strong cash flow generation and an accelerating vision of digital champion. Telenor will own 56.5% of MergedCo and Axiata the remaining 43.5%, subject to adjustments and due diligence. The target is to achieve a binding agreement by the end of the third quarter of 2019.

Despite a scarcity of information, we are pleasantly surprised by this development. Market consolidation usually leads to a healthier market rivalry, an improved operational leverage, an effective capital expenditure spending without duplication, more procurement bargaining power, and the hostility in spectrum auctions will be greatly reduced.

Malaysia is the only overlapping market in this proposed deal. Combining Celcom with DiGi will lead to a largest telco with revenue and subscriber market shares of 35% and 47% respectively, potentially attracting scrutiny from an anti-competition perspective. Together, they will also hold 43% of the operating time division duplex airwave in the market. It is uncertain how the Malaysian Communications and Multimedia Commission will handle spectrum distribution upon a merger and acquisition.

Axiata may end up with conflicting stakes in Grameenphone via MergedCo, and Robi — the Nos 1 and 2 competitors in Bangladesh. Other Robi shareholders — Bharti with a 25% stake and NTT Docomo a 6.3% stake, may not favour this scenario. We think Axiata is better positioned and this proposed corporate exercise allows it to crystalise its assets’ true value. Besides, those operating companies will be better managed going forward under a combined experience and with the parent companies’ knowledge.

For DiGi, consolidating with Celcom may lead to a short-term indigestion due to huge duplications in assets — towers and infrastructure, among others — and human capital. We do not discount that the merger may lead to asset impairments and one-off restructuring costs. However, we are still positive on the amalgamated DiGi-Celcom over the long term.

Our forecasts are unchanged for now pending further guidance from companies. We maintained our “neutral” rating. The telecommunications sector remains stable supported by a resilient domestic demand. Its dependable dividend yield will be a plus point in a volatile market. Our top pick is Time dotCom Bhd with a “buy” call and a target price (TP) of RM10.21. Although our call and TP are unchanged, we have removed DiGi.Com Bhd (“buy”; TP: RM5) as our top pick for now due to the aforementioned concerns. — Hong Leong Investment Bank Research, May 7