Telecom sector

The risk of a delay in 3G licensing further strengthens our contrarian negative outlook on the sector. In addition to the mismatch between 3G-related costs and benefits, our channel checks also indicate that heated competition would curtail margins in the short-term. Our sector rating falls to Underweight from Neutral following our downgrade of DTAC to Underperform. We believe public pressure for mobile tariff and interconnection rate cuts would also be detrimental to the margin outlook. We would avoid 3G-related stocks (AIS, DTAC and True) but stay invested in Jasmine and Thaicom. 
Our sector rating falls to Underweight from Neutral following our downgrade of DTAC to Underperform.
We believe public pressure for mobile tariff and interconnection rate cuts would also be detrimental to the margin outlook. We would avoid 3G-related stocks (AIS, DTAC and True) but stay invested in Jasmine and Thaicom.

3G licensing in 90 days?
We believe the National Broadcasting and Telecoms Commission (NBTC) will be able to issue 3G/2.1GHz spectrum and business licences to three winning bidders (AIS, DTAC and True) by 16 Jan 13 (90 days after the NBTC’s telecoms panel has endorsed the auction result on 18 Oct
12). The NBTC’s secretary general said that the licence issuance should be carried out on schedule if the NBTC’s reviewing committee certifies the legality and transparency of the
auction in 15 days and if there is no Administrative Court injunction to stop the licensing process. However, the risk of a licensing delay is rising as several authorities have threatened to file lawsuits against the NBTC on the auction’s design failure as the uncompetitive bidding results drew criticism from several public groups, including academics, NGOs, senators, government officials and even several commissioners.
Competition heats up
Our regular checks on mobile price plans indicate heated price competition, led by DTAC. True, still focused on brand building and subscriber acquisition, has price plans with the most generous
download quota. AIS turned more aggressive with its mid-tier price plans but lowered its download quota for low-end plans.

Negative earnings outlook
We expect earnings in the first 2-3 quarters after 3G licensing to head south as telcos would have to ramp up spending on capex and opex while the regulatory cost savings will only
gradually emerge in the second or third quarters after the licences are granted. The NBTC’s plan to enforce a 15-20% tariff reduction measurement and proposals by academics for the
lowering of the mobile termination rate to THB0.25/min from THB1 currently would be even more
negative to revenue growth outlook.

Left hanging on the line
1. BACKGROUND
1.1 Will the low competitive intensity be sustainable?
The Thai mobile industry has been buoyant over the past seven quarters due to low competitive intensity. Unlike other ASEAN mobile sectors, the Thai mobile sector has produced decent voice revenue growth (despite the 121% SIM penetration rate) and spectacular data revenue growth on the back of pent-up broadband demand.

Factors driving voice revenue growth include: 1) rapid upcountry urbanisation,2) shorter concession periods, and 3) inefficient mobile interconnection rates.Although upcountry urbanisation would structurally drive local mobile demand for years, the other two factors, which have helped to stabilise voice prices, areunlikely to stay like this for long.

2. OUTLOOK
2.1 3G/2.1GHz licence issuance likely in 90 days
Although we still believe that the 3G/2.1GHz spectrum and business licence issuance should be carried out by 16 Jan 13 (90 days after the NBTC’s telecoms panel endorsed the auction result as stipulated in the information memorandum), we have to admit that the risk of licensing delay exists. And 3G related stocks might be heavily sold off if any state authority files a lawsuitagainst the NBTC or the auction procedure before the commission can issue the licences.On the one hand, the NBTC’s telecoms panel is explicitly rushing to issue the licences immediately the 3G reviewing committee appointed by the panel has certified the auction procedure. As a result, the earliest the licences can be granted is this Nov. On the other hand, several authorities including the National Anti-Corruption Commission (NACC), the Department of Special Investigation (DSI), the Office
of the Ombudsman and the Office of the Auditor General (OAG) are conducting urgent investigations on the NBTC and the auction procedure after many groups including TOT’s labour union, some senators, political activists, telecoms scholars and even several NBTC commissioners publicly questioned the auction result citing that the procedures were uncompetitive.

2.2 Tariff tracking indicates heated competition
Our regular checks across mobile price plans indicate a certain degree of heated competition in postpaid smartphone and prepaid voice segments, primarily led by DTAC. This is pretty much in line with our anticipation but probably go against the market’s expectation. We are not surprised to see DTAC’s aggressive reaction as its voice revenue has lost momentum since 1Q12 after the company faced service blackouts five times this year. As long as there is no significant
response from AIS and True, DTAC is likely to regain its net addition and revenue market shares in 4Q12, in our opinion.
True is still focused on brand building and customer acquisition mainly on postpaid but management admits that the net add target of 4m by year-end is unlikely to be achieve for two key reasons. Firstly, True missed the rollout plan by half (7k vs. 13k cell sites) and lacked available mobile phone numbers for sale as its relationship with CAT turned sour after CAT’s new CEO was appointed. Secondly, True failed to swiftly transfer millions of high-value voice customers
from True Move’s 2G/1800MHz system to True Move H’s 3G/850MHz system as the domestic roaming scheme would incur hefty interconnection (IC) expenses. Note that True Move has tried but failed to convince the NBTC to amend the IC rate from THB1 per minute to THB0.5 as adopted by True Move H.
Meanwhile, AIS’s price plan development has surprised us the most as its plans are more reflated than deflated. We are sceptical on AIS’s network capacity limitation rather than the resumption of pricing power to raise the tariff at this stage.

2.3 Voice revenue outlook in jeopardy
We are negative toward the 15-20% tariff reduction promised by the NBTC’s telecoms panel and THB0.25 per minute mobile interconnection rate proposed by the president of Thailand Development Research Institute (TDRI) as both might intensify the competitive landscape, in our opinion. Although the panel’s tariff reduction target is vague, lacks of details and is in
fact difficult to implement, the NBTC would be under greater public pressure to lower retail prices and stimulate competition in the market. This could be a negative overhang for revenue growth outlook. In fact, we are more concerned about the IC rate reduction proposal as it might
reset the voice price equilibrium (on-net vs. off-net and postpaid vs. prepaid) and also resume voice price competition. Not only TDRI but True has also tried very hard to convince the NBTC to amend the industry wide IC rate of THB0.5 per minute from THB 1 currently. However, both AIS and DTAC still advocate the current IC rate, which benefits large operators and prolongs the benign competitive environment. In theory, the IC rate reduction is likely to benefit smaller operators than larger ones. In a market situation with 121% SIM penetration and fairly exhausted
price elasticity of demand, the hefty IC rate reduction would jeopardise voice revenue as a whole.

3. RISKS
3.1 What if 3G licensing gets derailed?
Despite less than 1% probability in our assumption, the court’s injunction to delay 3G licence issuance would be a real catastrophe. That’s why the market should begin to panic if any authority files a suit to stop or delay 3G licence issuance. We assign below a 1% probability on this unpleasant scenario as 1) the window for court filing is quite short, 2) the government through the minister of information and communication technology (ICT) has placed its full support for
this auction, 3) it does not make any sense for three qualified bidders to collude in bidding for 2x45MHz bandwidth with 2x15MHz maximum bid allowance, and 4) there is no regulation requiring the NBTC to take responsibility for an uncompetitive auction.

4. FINANCIALS
4.1 Upbeat revenue forecast
We forecast overall mobile service revenue to grow 4-7% in FY13-15 on the back of 25%-35% non-voice revenue growth and 1-3% voice revenue growth. We expect the country’s mobile penetration rate to reach 132% in FY15 from 127% in FY13 thanks to second-to-third SIM demand for tablet or dongle and the new registration in upcountry areas. We assume the smart device penetration rate to surge from 24% in FY12 to 43% in FY15 due to more model variety, cheaper
device prices and more popular social media applications. Meanwhile, we estimate voice revenue growth to slow down due to the high base and market saturation effects. Note that our revenue assumption is based on an unchanged mobile interconnection rate and no implementation of the 15-20% tariff reduction proposal by the NBTC’s telecoms panel.

4.2 Cost overrun in near term
We expect the effective regulatory cost to service revenue to slip from 26% in FY12 to 22% in FY15 through revenue migration from the expensive regulatory cost based concession network (25-30% of service revenue) to much cheaper regulatory cost based licence network (10%). However, other 3G related costs and expenses, i.e. network opex, facility rental fee, domestic roaming fee,
cost saving benefit in the early stages and hurt near-term profitability as a result.We assume FY13-15 capex (including spectrum upfront) of THB67bn for AIS and THB48bn for DTAC, which would add 15k 3G/2.1GHz cell sites and 18m 3G subscriber capacity for AIS and 10k cell sites and 12m capacity for DTAC. Applying the incremental network opex in FY12 as a benchmark, the network
opex per new cell sites should be about THB0.4m-0.6m per year. Apart from higher network opex, which are largely about electricity, vendor service and outsourced maintenance expenses, the network facility rental fee should be incorporated in the model too. Note that True is excluded from this comparison due to lack of capex breakdown, complicated business models for 2G/1800MHz,
3G/850MHz and 3G/2.1GHz and unclear capital increase requirement. Using the smart device penetration rate as a benchmark, we forecast the average concession-to-licence revenue migration rate of 11% in FY13, 33% in FY14 and 36% in FY15, which is likely to minimise the domestic roaming fee given the balance between 3G customers and 3G network coverage and capacity. Our assumption also jacks up the marketing and general administration spending
for sake of new service introduction to the mass market.

4.3 Forecast discrepancies
We reiterate our view that the 3G cost-and-benefit mismatch would be a drag on operators’ profitability in FY13, which would go against the consensus expectation of 5-7% yoy EBITDA growth. In comparison, the key difference would be capex and cost assumptions as our revenue forecast is broadly in line with consensus estimates.

5. VALUATION AND RECOMMENDATION
5.1 Downgrade to Underweight from Neutral
After recently cutting the rating on DTAC to Underperform from Neutral, we downgrade the sector weighting to Underweight from Neutral owing to 1) negative industry earnings growth in FY13 (-5% vs. +18% SET), 2) possible downside surprise on the consensus EBITDA estimate in FY13 (+6%
consensus’s forecast vs. –1% our estimate), 3) demanding valuations vs. their regional peers, and 4) higher risks of 3G licensing delay and sloppy voice revenue growth outlook. Again, 3G/2.1GHz licensing is no longer a rerating catalyst as the market’s interest is shifting towards company guidance on business strategy and financial performance, which will be available right after the operators are awarded 3G licences expected in early Jan. Our top picks in the sector are Jasmine (Outperform; target price: THB5.07) and Thaicom (Outperform; target price: THB22.7) on the back of 1) +60% and +92% FY13 earnings growth for Jasmine and Thaicom respectively, 2) +70% and +105% FY13 DPS growth, 3) both under-owned by foreign investors (23% foreign holding in case of Jasmine and 11% for Thaicom), and 4) undemanding valuations (6x FY13 EV/EBITDA for Jasmine and 7x for Thaicom vs. 8.6x for regional peers).

5.2 When is the right time to rebuild positions?
We would revisit our financial assumptions once operators provide guidance and reconsider our investment recommendations when earnings have bottomed,which should be either in 1Q13 or 2Q13. So, this is not the right time to collect 3G-related stocks. Note that if the 15-20% tariff and mobile interconnection rate reduction policies are implemented sooner rather than later, the near-term earnings outlook would get worse for one to two more quarters before the price competition shifts to the new equilibrium.

5.3 Where can we go wrong?
Our non-consensus bearish view on 3G-related stocks (AIS, DTAC and True) relies heavily on our expectation of the consensus downgrades on operators’ earnings and target prices, which would be more valid if the operators’ new guidance swing in our favour. Our sensitivity analysis suggests that every 1% of capex reduction, higher revenue migration and lower costs related to 3G would
increase AIS’s FY13 core net profit by 0.01-0.59% and its DCF-based target price by 0.57-1.29%. The comparable impact on DTAC’s core net profit would be 0.02-0.88% and its DCF-based target price would be 0.22-1.91%.
However, it is a paradox strategic decision for operators to control either capex or cost. If operators squeeze their 3G capex, which would lower network opex, depreciation expense and financial costs, the regulatory cost saving benefits would take off more slowly, and other costs such as domestic roaming and subscriber acquisition costs would escalate.