KEY INVESTMENT HIGHLIGHTS

• Maintain NEUTRAL with an unchanged target price of RM2.44 post announcement of XL Axiata with Smartfren
• The exercise will solidify the No.3 position in the country in terms of subscriber market share and fortify the spectrum portfolio
• Axiata will receive cash injection of USD475m from the equalisation exercise, primarily to pare down debts
• Competitive landscape of the telecom sector in Indonesia may cap the future revenue growth potential

Increasing its footprint in Indonesia. We maintain our NEUTRAL recommendation on Axiata with an unchanged target price of RM2.44 post the announcement on the merger exercise between XL Axiata and Smartfren. We view that Axiata Group is the main beneficiary of this exercise, premised on the cash injection of USD475m from Smartfren to equalise the shareholding which will be largely utilised to reduce the debt holding. This implied a premium EV/EBITDA of 5.3x as compared to the two larger listed peers of less than 5x and Axiata's current EV/EBITDA of 4.7x. Nonetheless, we remain concern on the outlook of the merged entity, i.e. XLSmart, given competitive landscape of the telecom sector in Indonesia. In addition, Smartfren's financial loss continued to widen as seen in its 3QFY24 financial result. All things considered, we are keeping our earnings estimates, target price and recommendation unchanged at this juncture as we await completion of the exercise as well as seeking further details on the action plan of XLSmart.

Merger of XL Axiata and Smartfren. Axiata announced that it is signing a definitive agreement with Sinar Mas to progress the proposed merger of PT XL Axiata Tbk, PT Smartfren Telecom Tbk and PT Smart Telecom in Indonesia. This will lead to the creation of PT XLSmart Telecom Sejahtera Tbk. The merger continues to signal the consolidation of the telco industry in Indonesia amidst the competitive telecom landscape in the archipelago. The exercise is expected to be completed by 1HCY25.

Equal ownership between Axiata and Sinar Mas. Under the merger exercise, XL Axiata will the surviving entity and remain listed in IDX while issuing new shares to Smartfren shareholders based on merger ratio of 72:28 equity value split between XL Axiata and Smartfren respectively. In the early part of the process, Sinar Mas will receive 21.7% stake in XLSmart while Axiata stake will be at 47.9%. Subsequently, Sinar Mas would acquire additional 13.1% stake in XLSmart from Axiata at a cash consideration of USD475m. At the end of the exercise, both Axiata and Sinar Mas would each have 34.8% stake in XL Smart.

The equalization consideration translates into an implied EV/EBITDA multiple of 5.3x which is a premium above the two largest peers i.e. Indosat Ooredoo Hutchison (IOH) and Telkomsel of 4.9x and 4.3x respectively. This is also above Axiata Group's EV/EBITDA of 4.7x.

Note that the cash injection of USD475m and deconsolidation of XL will reduce the net gearing to 0.77x from 1.21x as at 3QFY24. This will lead to improvement in Net Debt/EBITDA to 2.48x from 2.59x.

Larger market share and spectrum holdings. Based on the merger, the subscriber base of XLSmart will stand at approximately 94.5m (XL Axiata: 58.6; Smartfren: 35.9m). This will solidify the "No. 3" position in the Indonesia Telecom sector after Telkomsel and IOH which has approximately 150m and 100m subscriber respectively. Meanwhile, the spectrum portfolio will grow from 90Mhz to 152Mhz marking it the second largest portfolio owner of spectrum, especially in low band i.e. 850Mhz and 900Mhz. The larger scale in spectrum will enable XLSmart to compete more effectively against the two nearest peers. Also, there is greater capacity to improve network experience for the enlarged customer base.

Anticipating better synergies. XLSmart is expected to realize an annual run rate pre-tax synergies of USD300-400m via strategic network integration and resource optimisation. There will be savings from opex, capex and lease spread across: i) network and IT, ii) procurement, and iii) commercial. The bulk of the savings will primarily come from network and IT.

Growing bottomline remains a concern. Based on the pro-froma 3QFY24 financial performance of XL Axiata and Smartfren, the enlarged entity will experience a +34.3% and +28.7% improvement in revenue and EBITDA respectively. Nonetheless, we understand that Smartfren currently is loss-making. As at 3QFY24, the cumulative net loss for the three quarters widened to IDR1,007.7b or USD280m, a decline of -68.1%yoy. Comparatively, management guided that on a proforma basis, the merger would lift Axiata’s 9MFY24 PATAMI by +3.8% to RM1,217m from RM1,172m which we view is rather marginal.

On the revenue side, we understand that there could be opportunities from the potential uplift in subscriber ARPU as well as higher contribution from home fibre and ICT services. However, our main concern lies with the competitive landscape of the telecom sector in Indonesia. This may cap the revenue growth potential. Thus, we opine it is more realistic to expect the pace of future earnings growth will primarily be driven by how fast the pre-tax synergies of USD300m-400m can be realised.

Awaiting completion of the exercise. To be on the conservative end, we are keeping our earnings estimates, target price and recommendation unchanged at this juncture as we seek further guidance from the management on the action plan of XLSmart and await the completion of the exercise.

Source: MIDF Research - 12 Dec 2024