Investment Highlights

• We maintain HOLD on Axiata Group (Axiata) with a lower SOP- based fair value (FV) of RM2.90/share (vs. RM2.95/share previously). This reflects a 9% reduction in Axiata’s stake in Dialog Axiata (Dialog) due to post-merger share dilution and implies FY24F EV/EBITDA of 6.3x, which is the 5-year median. We have a neutral 3-star ESG rating for Axiata.

• Following the analyst briefing on Friday, we maintain our earnings forecast due to negligible impact from the merger of Dialog and Airtel in Sri Lanka. We believe Airtel’s losses will be mitigated by Dialog’s continuous cost rescaling initiatives coupled with potential profit increase contributed by other emerging frontier market like Indonesia and Philippines.

• Upon completion of Dialog-Airtel merger, Axiata’s effective stake in Dialog will be diluted to 74% from 83% with Bharti Airtel emerging as the new shareholder, holding a 10.4% stake. Management guided that the transaction is expected to be completed earliest in 3Q24.

• Before the merger, Dialog faced challenging operating conditions due to i) reduced consumer affordability, ii) escalating operating costs, and iii) diminishing investment returns.

• Market consolidation is crucial to address the largely fragmented telecommunication industry in Sri Lanka, where many operators serve a small fraction of population. Every Sri Lankan operator served 6mil subscribers on average out of the total population of 22mil. In comparison, major countries in Asia have a higher population served per operator like Pakistan (58mil subs per operator), Bangladesh (56mil subs per operator) and Malaysia (11mil per operator) .

• In addition, the fragmented industry structure resulted in inadequate spectrum. A lower spectrum per customer limits Dialog’s capability to offer better user experience and wider coverage especially in rural areas.

• Rationale of merger: - i) efficient spectrum utilisation, ii) tower infrastructure rationalisation, iii) operational synergies, and iv) market consolidation.

• Management guided that Dialog will receive an additional 3mil subscribers from Airtel, making raising its consolidated market share to 64% on voice and 66% on data from 57% previously.

• Dialog plans to minimise network duplication by cutting Airtel’s 2,400 sites nationwide, retaining less than 1,000 sites. These sites will be redeployed to provide additional capacity for both Dialog and Airtel traffic while improving coverage in marginal areas. To note, network integration has already started in 1QFY24.

• Recall that in our report dated 19 March 2024, we viewed that the acquisition of the loss-making Airtel will affect Dialog’s earnings, dragging its bottom line by 70-75% in FY25F before breaking even. Management is guiding that Dialog’s EBITDA will break even within 6 to 12 months via cost savings from lower administrative and integrated network costs. Hence, we expect the earnings drag from the merger to be short-lived. In FY23, the share of Dialog’s profit was 20% of Axiata’s normalised PAT of RM542mil.

• We believe that Dialog will be able to deliver better user experience premised on higher spectrum availability post- merger. Sri Lanka has undergone spectrum rearrangement, settling from fragmentation to contiguous blocks of spectrum. Post-rearrangement, Dialog will own new and enlarged of spectrum 850Mhz, 1.8GMhz, 2.1GMhz and 2.6GMhz . The new spectrum pool contributes to a higher capacity of 26Hz per customer from 24Hz per customer.

• Additionally, Dialog-Airtel is well-positioned to embark on 5G journey. The merged company will have a stronger infrastructural foundation for 5G deployment. Dialog owns 2,500 sites of 2.6Ghz, while Airtel has another 1,500 sites of 2.6Ghz that are 5G-ready. This extensive network will potentially provide broad 5G coverage and high-speed connectivity to a significant portion of the population.

• In our earlier forecast, we estimate that Axiata’s FY25F consolidated net debt to EBITDA will rise from 3.5x to 3.6x due to the significant debt holdings of LKR68.1b (RM1.06bil), which mainly consists of long-term debt. However, management guided that Airtel Lanka will bring in a proportionate 10% of net debt into the amalgamated entity, which translates to RM110mil. According to our calculation, this will have a negligible impact, and the FY25F net debt to EBITDA ratio will remain at 3.5x.

• Looking forward, we are cautious on Axiata’s prospects. The group may be affected by digital banking losses and higher interest expense arising from additional debt financing for Link Net’s fibre rollouts.

• We believe that Axiata is fairly valued due to near-term earnings risks, currently trading at 6.1x EV/EBITDA, at parity to its 5-year historical mean.

Source: AmInvest Research - 22 Apr 2024