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Morningstar | StarHub’s Fourth Quarter Is a Bloodbath; We Reduce Our Fair Value Estimate to SGD 1.75. See Updated Analyst Note from 15 Feb 2019

Both StarHub’s fourth-quarter 2018 and its guidance for 2019 were below our expectations. Fourth-quarter services revenue decreased by 6.8% with EBITDA down 22.2% and net profit down 70%. The company is forecasting service revenue to decline by 2% in 2019 with EBITDA declining by around 2% to 4%--so a big recovery. As we often see with new management teams, various one-time provisions were raised in the fourth quarter, so we believe such a recovery is possible, at least on a reported accounting basis. We retain our thesis that the company’s profits will remain under pressure for at least the next two years due to increased mobile competition and the secular decline of pay TV negatively impacting on StarHub’s traditional bundling strategy. We lower our long-term forecasts and our fair value estimate to SGD 1.75 per share from SGD 1.80 per share previously and would advise investors to wait for a better entry opportunity. We make no change to our narrow moat rating on StarHub based on cost advantage and efficient scale, with the company continuing to earn returns marginally above its cost of capital despite expectations for ROIC to fall from 21% in 2015 to 9% in 2019 before recovering to 10% in 2023 compared with a 7.9% WACC. The fall in forecast returns, due primarily to the introduction of a new entrant into the mobile market this year and the secular decline of the company’s pay TV service due to over-the-top video services such as Netflix and pirated video content, drive our negative moat trend rating. An aggressive cost reduction strategy to remove SGD 210 million in costs over the next three years has been implemented to try to offset the revenue pressures, but we see these type of measures as par for the course in telecom services around the region as companies fight to retain profitability in the face of declining high margin core network revenue.

The company’s CEO, Peter Kaliaropoulos, made some interesting observations about the industry saying there were too many infrastructure operators addressing a flat to declining consumer opportunity in telecom. He expects consolidation and infrastructure sharing over the next five years. The recent performance of the three listed Singapore telecom operators would not make for great reading for new entrant, TPG, as it readies itself for full commercial launch of its mobile service. SingTel’s domestic business saw revenue increase by 3% but EBITDA decline by 6.9%. M1 reported fourth-quarter services revenue down 2% with EBITDA down 10%. Now that most of the industry’s fixed line and broadband traffic is carried over the National Broadband Network, mobile services are the only remaining (potentially) high margin service to be carried over the operators’ own networks. StarHub’s mobile business saw fourth-quarter services revenue decline by 13.7% (or 7.6% excluding provisions) compared with declines of 6.1% for SingTel and 2.7% for M1 during the same period. We have always questioned the wisdom of TPG’s entry into the Singapore mobile market with industry mobile services revenue having declined for the past three years and the decline seemingly accelerating, all before TPG even fires a shot.

StarHub’s Pay TV also continued its decline with customers falling by 14,000 over the quarter to 409,000, having declined from 545,000 at the peak in the first half of 2015. Netflix was launched at the beginning of 2016, and Singapore has a high rate of fibre broadband connections in Singapore with video piracy also reportedly very high. StarHub’s pay TV revenue declined by 19.1% in the fourth quarter, compared with 2018’s full-year rate of 11.9%. StarHub management admitted at the third-quarter results that the business model “was broken” with content producers going direct to customers over the Internet but still expecting Pay TV providers to sign onto fixed deals for content. Once the Pay TV providers are able to switch their deals to reasonable, variable deals then they could compete against the over-the-top providers.