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JKSB Corporate Update_Dialog Axiata PLC (DIAL)_August 2016

Data and Pay TV businesses to drive DIAL’s next growth phase

We expect DIAL’s data and Pay TV businesses to drive top line growth over the next 3 years, given 1) near saturation of core voice revenues; and 2) growing erosion of SMS and international revenues by OTT applications such as Skype, Whatsapp, and Viber (in-line with a rapid increase in smart phone penetration in SL). Reduced box prices (stemming from increased price competition following the entry of Dish TV) should drive Pay TV subscriber demand, while the availability of cheap 3G handsets continues to drive robust growth in new data subscribers. DIAL, as market leader in both Pay TV (75% market share) and small screen data, should be the prime beneficiary. With smart phone penetration (at 38% on DIAL’s subscriber base as at end June 2016) increasing by 1% MoM, we project data to contribute >20% of Group revenues by end 2017E (vs. 16% currently). While we maintain our view that an industry wide upward revision of data pricing is required (prices currently range upwards from 20 cents per MB), data profitability is steadily improving on the back of volume growth, with EBITDA margin currently at ~30% (vs. a -14% EBITDA margin in 1HCY14). DIAL’s new BBG cable - which came on-stream in April 2016 - should generate a further 1.0ppt expansion in EBITDA margin stemming from expected cost savings of Rs. 80mn a month.

Spectrum requirements could support longer term industry consolidation

The SL telco space is, in our view, overcrowded and is ideally a 2-3 player market. Hutch and Airtel are operating at sub optimal levels (as per our channel checks) and have failed to grow market share, while Etisalat has steadily lost market share to its competitors over the last three years, with DIAL being the biggest beneficiary (reflected in a ~3ppt increase in its market share vs. 2012). Consolidation opportunities currently exist in the sector, with both Airtel and Hutch being reportedly available for sale at a price range of US$130mn – US$150mn. However, given the market share dominance of DIAL and SLT within the current regulatory framework, M&A activity is, in our view, unlikely to take place at a premium to fair value, as eliminating competitors is not pivotal to volume/profitability growth. DIAL’s management has stated that it is open to acquisitions at the right price, while SLT was previously in negotiations to purchase Hutch. Both operators have structurally strong, relatively unleveraged balance sheets with which to fund M&A activity. Acquisition of either Airtel or Hutch would provide the acquirer with further spectrum bandwidth in the 800/900 MHz, 1,800 MHz (used for 4G mobile), and 2,100 MHz (used for 3G mobile) bands.

Currently trades at 3.9x CY16E EV/EBITDA

We project full year earnings of Rs. 7.2bn for CY16, +38% YoY, on the back of 12% YoY revenue growth, and a 1ppt YoY expansion in EBITDA margin (stemming from eight months of cost savings from the company’s BBG cable and roughly two months of input VAT credits). Given that 70% of DIAL’s debt was dollar denominated as at end June 2016, we have also factored in non-cash forex translational losses stemming from our expectations of likely LKR depreciation during the year. Given that VAT and NBT charges on telco were suspended w.e.f 11th July, our subscriber growth forecasts and input VAT credit projections for CY16 are based on only two months impact. This would, however, be revised if required if these charges are resumed. At its current price of Rs. 11.00, DIAL trades at a CY16E P/E of 12.5x, at a ~16% premium to our coverage universe. However, given the capital intensive nature of the business - and the consequent impact of non-cash depreciation charges on earnings - we prefer to value the stock on an EV/EBITDA basis, which yields an attractive CY16E multiple of 3.9x. Key downside risks: a resumption of VAT and NBT charges and higher than expected rupee depreciation.