Telkom plan to buy back SingTel’s Telkomsel shares: What is the impact on SingTel?

Telekomunikasi Indonesia, Indonesia’s biggest telecom firm plans to buy back the 35% percent stake in Singtel’s subsidiary Telkomsel.

Telkomsel is jointly owned by Telkom (51%) and Singtel (35%)

The main reason given is to boost Telkom’s EBITDA but the main reason could be due to the aftermath of the on-going lawsuits where ST Telemedia, another Singapore government linked corporation, sold its stake in Indosat after Indonesia ruled that Indosat and Telkomsel were fixing prices.

According to CIMB, a likely reason is Telkom’s intention to own 100% of Telkomsel because SingTel is reluctant to sell Telkomsel’s cell towers to Telkom. Telkom had intended to park all the towers of its units under Daya Mitra and eventually list this entity. Taking full control of Telkomsel could pave the way for this transaction. Telkomsel controls the largest number of towers in Indonesia, about 20k or 40% of industry total.

Telkomsel an important contributor to SingTel’s bottomline

The potential impact of the sale is rather large. Telkomsel holds the number 1 market position in Indonesia with a market share of 46%. This tie up with Telkom in the past would have been very strategic with rather strong economic moat.

Bad – Losing a stake in a country market leader with a large population

The lawsuits and protectionist actions from the Indonesia government doesn’t help SingTel. Obviously it looks like another case of state owned enterprise wanting to gobble up a business that have been fine-tuned privately.

However, Indonesia is one of the top 5 most populated country in the world. Holding a stake in Telkomsel long term will always have a cash flow diversification benefit.

Losing this will mean losing the value added potential that comes with 3G data and the cross service and third party service that can be bundled with 3G.

Certain future potential opportunity cost lost is very difficult to calculate. SingTel may not be able get any such good foot hold into the Indonesia market soon.

Bad – Telkomsel was generating high return on assets

Taking a long term stake in Telkomsel in 2001 at 22% for 1 billion dollars look like a very good investment now.

When 3G data comes online, the potential growth here could be big. Current profit contribution is around SGD 650 mil and l wouldn’t be surprise this grows to SGD 800 mil.

If you look at the return on assets of SingTel’s stake in Telkomsel, its about 19%. This is compared to

• 33% on Singapore
• 5.5% on Australia’s OPTUS
• 10% on India’s Bharti
• 13% on Globe
• 72% on Thailand’s AIS
• 7% on other subsidiary telco

The smart manager should focus on potential new markets but also secure market’s where you are able to get a high return on invested capital.

Optus based on return on assets look like a terrible terrible investment if you ask me and losing Telkomsel  which has such a high ROA is quite a smack in the face.

Bad – Losing a key Profit, Dividend Income and Cash Flow generator

Telkomsel makes up 14% of SingTel’s overall post-tax profits. This is compared to:

• 38% on Singapore
• 31% on Austalia’s Optus
• 12% on India’s Bharti
• 3% on Globe
• 4.2% on Thailand’s AIS
• 0.6% on the rest of the other telcos.

Telkomsel’s share of free cash flow is 360 mil of 4 billion or 9% of total free cash flow. This is compared to:

• SGD 1.4 billion on Singapore
• SGD 1.51 billion on Australia’s Optus
• SGD 640 million on other regional telcos

SingTel in total pays out 2.5 billion from this 4 billion in free cash flow for the current 5% normal dividend yield (interim+final).

Shaving 9% off FCF and 14% off net profit, FCF will stand at 3.6 billion and Net Profit 3.7 billion.

SingTel have a policy of paying 55% to 70% of its net profit as dividend and this 5% yield  will bring dividend payout to 70%.

Base on this policy normal dividends will not increase further based on this policy.

Neutral – SingTel will need to effectively redeploy this cash

Should the buy-out goes through, it is likely that SingTel may sit on a sizable amount of cash. What would they do with it?

1. Keep debts at 0? Current debts stands at 7 billion. Getting 10 billion could potentially wipe this off.
2. Distribute it back to share holders? If there are no comparative better investments, the option is to return to share holders
3. Buy back own shares. Same as number 2.
4. Invest in other telcos. Here comes the business risk. Can they find a potentially better investment then Telkomsel?

What is the adequate compensation for losing these opportunity for future profits?

CIMB calculated that based on 16x Calendar Year 2011 Price Earnings, Telkom may offer USD 8.5 billion or SGD 10 billion.

Using a Discount Cash Flow Model,

• Initial Cash Flow = 638 mil (FY11 profit)
• Discount Rate = 3.5%
• Growth Rate = 7% (GDP Growth)

If we project the cash flow for 10 years the intrinsic value of the investment is 7.6 billion. In this case, getting 10 billion sounds great.

But should SingTel value it based on only 10 years of cash flow? If we use 15 years the value is 12 bil and 20 years the value is 18 bil.

In the latter 2 case,  SingTel is not getting a great deal.

Conclusion

At the end of the day, it will depend on a lot of factors for SingTel to negotiate the right compensation. If they become too forceful, political pressure might come in.

As an investor, the job is to evaluate whether this is still a good investment. A lot of these drama will play out but could take some time.

I sense that getting a 10 bil compensation might not be a good deal for SingTel, but hope that the management are able to value their investment in Telkomsel well and sell to Telkom at a premium price.

Disclosure: Writer is vested in SingTel at the time of writing

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