Investment Highlights

• We maintain HOLD on Axiata Group (Axiata) with unchanged SOP-based fair value (FV) of RM2.90/share, whi implies a FY24F EV/EBITDA of 6.3x - at parity to the 5-ye median. We have a neutral 3-star ESG rating for Axiata.

• On 15 May 2024, Axiata’s 66%-owned XL Axiata entered into non-binding Memorandum of Understanding (MOU) w Sinar Mas for a merger with its telecom unit, Smartfr Telecom. The proposed transaction is still at an early stage evaluation, with Axiata and SinarMas intending to remain joint-controlling shareholders of MergeCo.

• PT Sinar Mas Group is Smartfren’s major shareholder throu the holdings of its subsidiaries i.e. PT Global Nusa Da (23.8%), PT Wahana Int Nusantara (14.5%), PT Bali Med Telekomunikasi (9.8%) and PT Dian Swastatika Sento (6.7%).

• The deal could involve a mix of cash and shares. In 1QFY2 XL Axiata posted higher free cash flow (FCF) of IDR2.3 (RM670mil), an increase of 10% YoY. For FY23, Smartfr registered a positive EBITDA of IDR5.1tril (RM1.5b (+2.4%YoY) but high interest expenses led to a net loss IDR109bil (RM239mil).

• We view the merger as an opportunity for XL Axiata to bet compete with the country’s 2 leading mobile operators Telkomsel and Indosat.

• The merger will enlarge XL Axiata’s subscribers from 57m subscribers to 94mil subscribers by onboarding Smartfren 37mil users. The actual number might be lower due to t elimination of existing users with dual SIM cards from bo telcos. Nevertheless, the larger subscriber base would allo XL Axiata to edge closer to Indosat, which has 100m ) subscribers after the merger with Hutchinson in 2022.

• The merged entity’s market share will expand to 26%, whi is close to Indosat’s 28%. Telkomsel remains the nation leading mobile leader with a 45% market share.

• We positively view the merger which would allow XL Axiata achieve economies of scale from streamlined processes a optimised capex/operations. The merger would also help Axiata reduce operating costs by eliminating duplicated sit and sharing marketing/administration resources.

• Additionally, XL Axiata can leverage on Smartfren’s low band spectrum to improve indoor network coverage quali Smartfren owns 850Mhz, which is important for buildi penetration. The low frequency spectrum is valuable indoor network coverage as it can penetrate walls mo efficiently than the higher frequency bands.

• Through the merger, XL Axiata will be adding Smartfren’s 850Mhz and 2300 Mhz to its existing spectrum portfolio of 900Mhz, 1800 Mhz and 2,100 Mhz. Consequently, XL Axiata-Smartfren will have a spectrum market share of 34%, comparable to the nation’s largest telco carrier, Telkomsel’s 37%. Even so, we do not discount the possibility of the merged XL-Smartfren entity being required by the regulator to surrender some spectrum similar to XL’s acquisition of Axis in 2014.

• The merged entity may be valued at IDR58tril (US$3.6bil) based on XL Axiata’s market cap of IDR34tril (US$2.1bil) and Smartfren’s market cap of IDR24tril (US$1.5bil).

• There is a risk that XL Axiata’s gearing may increase post-merger. Smartfren’s FY23 net-debt-to-EBITDA was relatively high at 4.9x vs XL Axiata’s 2.5x. In FY23, Smartfren’s net debt was IDR12.3tril (RM3.4bil).

• In the near term, we are cautious on Axiata’s prospects due to i) network integration risk, ii) regulatory risk, and iii) foreign exchange risk. We made no changes to our forecast as there is no entry to any binding agreement yet.

• We believe that Axiata is fairly valued as it is currently trading at a 6.1x EV/EBITDA, at parity to its 5-year historical mean.

Source: AmInvest Research - 16 May 2024