Telekom Malaysia (TM) announced the  investment agreement signed on 27 March  2014  with  Green  Packet  (GP)  and  SK  Telecom  (SKT)  has  become unconditional  on  25  September  2014.  The  purpose  of  the  investment agreement  is  for  the  three  parties  to  develop  a  next-generation  LTE infrastructure to offer converged communications services and will also result in  TM  taking  a  57%-stake  in  Packet  One  Networks  (P1).  The  news  was expected as TM management had previously guided that the deal would be completed by end-3Q14. While we like TM‟s  push  into the wireless space to complement its fixed-line business over the long-run, we have our concerns on the costs and implementation of its wireless ambitions  over the few years, in particular on turning around the loss -making P1. We believe the run-up in TM‟s share price in the past week is related  to the completion of the deal and view  its  recent  share  price  increase  has  overvalued  its  wireless  ambitions. Thus, we maintain our Underperform call on TM.

Details on investment and associated subscription agreements. TM will initially invest RM350m into P1 through subscription of new ordinary shares to make it the major shareholder with an estimated 57% stake, while  GP  and  SKT  will  hold  around  30%  and  13%  respectively.  The RM350m  proceeds  will  be  used  by  P1  to  settle  certain  debts  &  trade payables and for working capital purposes. Pursuant the above, TM will also  enter  into  the  following  agreements:  (i)  to  subscribe  to  an  8-year exchangeable bond  programme issued by GP to raise up to RM210m (intial tranche of RM120m and subsequent tranches up to RM90m); and (ii) to subscribe to 60% of an 8-year convertible  bond  programme by P1 to raise RM1.65bn. The remaining 25% and 15% will be taken by SKT and GP respectively.

TM’s  rationale  and  our  opinion  on  the  deal.  TM‟s  rationale  for  the deal  is  to  use  P1  as  the  platform  to  launch  its  wireless  services  to provide a full-suite  of communication services. P1 acquisition can jumpstart TM‟s wireless business with P1‟s spectrum (30MHz in 2.3Ghz  and 20MHz  in  2.6GHz  band),  ~2,000  WiMAX  sites  and  ready  customer base.  TM‟s  initial  outlay  in  the  first  year  will  be  around  RM866m (RM350m  to inject into P1, RM120m for EB and RM396m for CB), and total outlay will be up to RM1.55bn over 3-5 years.  While we like TM‟s strategy to penetrate wireless segment to ride on strong data demand over  the  long-run,  we  have  our  reservations  on  turning  around  lossmaking P1 (net loss after tax of RM62.4m mainly due to finance costs of RM52.6m  in 2Q14)  and technological challenges of rolling out wireless broadband nationwide for a predominantly fixed-line player such as TM.

Maintain Underperform. We reiterate our Underperform call on TM with an unchanged DCF-derived TP of RM5.78. Our call is premised on: (i) at the current share price, TM is trading at forward (FY15) P/E of 25.3x and EV/EBITDA of 7.1x  which is at the top end of its historical trading range; and  (ii)  we  believe  TM‟s  recent  share  price  increase  has  overrated  its push into wireless businesss through P1 acquisition. KEY FORECAST TABLE

Source: PublicInvest Research - 26 Sep 2014