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This article first appeared in Corporate, The Edge Malaysia Weekly, on September 5 - 11, 2016.

 

WHEN the government first announced a spectrum reallocation earlier this year, it triggered a knee-jerk selldown of telecommunications stocks. Investors worried that the government’s need to keep the budget deficit in check would come at a heavy cost to telcos’ bottom lines.

Last week, the telcos’ fees were finally announced —RM2.7 billion. Including a total annual maintenance fee of RM235 million, the government will collect RM6.265 billion in fees from the telcos over the 15-year spectrum licence.

For the telcos, this represents an immediate  albeit expected hit to their bottom lines. DBS Group Research estimates a 2% to 3% hit to telcos’ earnings — manageable, but not ideal against the highly competitive telco landscape.

“Given the level of competition for subscribers at the moment, it will be very tough for telcos to pass these costs on to consumers. That said, the fees are not unreasonably high, especially when you compare regionally,” one industry executive tells The Edge. “Other than the government’s need for revenue, MCMC (the Malaysian Communications and Multimedia Commission) needed to ensure that the fees were not so high that investment in the industry is stifled. They had to take into consideration the high level of competition at the moment as well. All things considered, I think they struck a fine balance,” he adds.

That said, each telco will feel the sting differently. The spectrum reallocation will serve to level the playing field between the top three incumbents and the new entrants like U Mobile Sdn Bhd; in turn, fuelling competition.

Recall that the 900MHz spectrum and the 1,800MHz spectrum were exclusively held by Maxis Bhd and Axiata Group Bhd’s Celcom. The reallocation will see U Mobile and DiGi.Com Bhd get a slice of these bandwidths. The additional spectrum will allow both DiGi.Com and U Mobile to invest more efficiently, delivering a better user experience at lower cost. DiGi.Com and U Mobile were each allocated 10MHz bands of the 900MHz spectrum, as well as a 40Mhz band and 30MHz band in the 1,800MHz spectrum respectively (see table).

Note that the MCMC opted to allocate the spectrum on a flat-fee structure as opposed to an auction so all telcos will pay the same per-unit cost.Hence, DiGi.Com will pay RM598.55 million in upfront fees and RM51.48 million annually. U Mobile will pay RM503.46 million upfront and RM43.3 million annually. Maxis and Axiata’s Celcom, will have to pay the same RM816.75 million upfront and RM70.25 million annually. Both received the same allocation — 20MHz of the 900MHz spectrum and 40MHz of the 1,800MHz spectrum.

Note that payment of the upfront spectrum fees is expected by the end of the year. Telcos can opt to stagger the payments but the fees will be higher.

Nonetheless, it will weigh on their ability to pay dividends, particularly Maxis and Axiata.

“Maxis is currently the most leveraged Malaysian telco at 1.7 times net debt-to-Ebitda (earnings before interest, taxes, depreciation and amortisation),” writes DBS Group. 

“Unless the dividend is cut, we estimate the upfront payment could raise Maxis’ gearing level to 2.1 times net debt-to-Ebitda by end-2016,” adds the report. Note that Maxis has a self-imposed internal gearing limit of two times net debt-to-Ebitda.

DBS Group has a “fully valued” call on Maxis with a target price of RM5.10, implying a 19% downside. That said, Maxis may opt for the staggered payment of the spectrum fees, even if it costs more, in order to maintain its dividend. Other analysts estimate that a lump-sum payment of the fees would compress Maxis’ free cash flow yield to 2.3%, less than its current dividend yield expectation of 3.2%.

Recall that Maxis halved the dividend in 2015 to 20 sen per share, as the previous payout was unsustainable. However, the company is under pressure not to cut the dividend further as its 65% controlling shareholder, BGSM Management Sdn Bhd, needs it to service RM5.4 billion in bonds that are secured to the latter’s Maxis shares. Some RM324.5 million in interest and RM1.07 billion in principal payments are due this year.

Axiata’s balance sheet may be slightly healthier, but heavy investment in foreign telco operations has increased net debt-to-Ebitda to 1.6 times. Recall that Axiata concluded the RM5.9 billion acquisition of an 80% stake in Nepal’s Ncell in April.

A lump-sum payment for the spectrum fee would bump Axiata’s net debt-to-Ebitda up to 1.7 times by end-2016, estimates DBS Group. Unlike Maxis, however, Axiata has more room to manoeuvre when it comes to its balance sheet.

“Axiata has plans to eventually monetise and list its tower arm, edotco. To boost its IPO profile, edotco has been focusing on reducing capex, improving operating efficiencies and raising the tenancy ratio of its tower assets over the last 12 months,” writes the DBS report, which has a “hold” call on Axiata with a target price of RM4.95.

Just like Maxis, Axiata’s free cash flow yield is expected to fall below the dividend yield — 0.9% versus 2.2% — if the spectrum fees are paid in a lump sum.

At the other end of the spectrum is DiGi.Com. The company is the least leveraged telco with only 0.4 times net debt-to-Ebitda. A lump-sum payment would lift the ratio to 0.5 times.

Against this backdrop, it appears that DiGi.Com is the best positioned to maintain its dividend payout. Currently, it boasts a yield of 4.1%. The dividend yield is unlikely to rise much, however, since the payout is already at 100% of earnings, the company’s self-imposed cap.

Unlike Maxis and Celcom, however, DiGi.Com will be gaining access to new spectrum. Previously, DiGi.Com only had the 2,100MHz and 2,600MHz bandwidths. Compared with U Mobile, DiGi.Com will also have more muscle to invest and make the most of its new spectrum.

Note that despite strong growth in subscribers, U Mobile is still loss-making. For the financial year ended Dec 31, 2015, the group posted an after tax loss of RM367.7 million against revenue of RM1.43 billion.

Interestingly, the new maintenance fee structure is slightly disadvantageous to smaller telcos like U Mobile. Previously, the annual fee was calculated based on the number of towers a telco had. The new fixed annual fee, however, will put pressure on U Mobile to plant more towers to make full use of the spectrum. The twist is that U Mobile will then be less reliant on Maxis’ network, which it is currently using for domestic roaming. It is understood that U Mobile paid Maxis over RM200 million last year. That figure is likely to decline once the new spectrum allocation comes into play in mid-2017.

Looking ahead, this won’t be the last time the industry has to grapple with spectrum reallocation. The 2,100MHz and 2,600MHz spectrums expire in December 2017 and April 2018, and rest assured the government will monetise these as well.  

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