Philippine Stock Market Research

The Telecom Sector’s Limbo Rock.  How Low Can You Go?

March 31, 2010

It was Tuesday afternoon en route to our presentation on the PSEi that we learned about TEL’s PHP74.1 bn acquisition of DGTL.  So aside from our presentation, we had to give advise on the biggest telecom deal in the Philippines in the past decade.

In one swoop, TEL captured 16 million mobile, 400,000 broadband and 500,000 land-line subscribers.  That’s what it’s all about in the Philippine telecom industry.  Capture subscribers at all costs!  And that cost is just too high.  The industry players have lost their pricing power, one of the most important elements of a successful business.

In 2005, Sun Cellular introduced its 24/7 plan to the mobile market segment of the telecom industry to expand its subscriber base.  This ushered the era of low-priced Bucket Plans that benefited us subscribers but not TEL, GLO and DGTL.  Even before that, TEL and GLO couldn’t raise prices since 1998.  What happened five years after 2005 was a slow erosion of Average Revenue Per User (ARPU) and margins, and it has already floored the profitability of the Big Three.  TEL had to issue a disclosure that 2011 and 2012’s profitability are strained by high interest and depreciation expenses.  GLO’s 2010 net income fell by 22%.  This is the second time in five years that its net income fell.  It is quite shocking that despite their weak financials, TEL and GLO still pay hefty cash dividends to its shareholders every year.  This makes them borrow more debt to finance their huge capex requirements.  DGTL, well DGTL is worse.  The promoter of bucket plans has been carrying deficits eating away its stockholders’ equity.

TEL’s DGTL acquisition is very expensive.  It’s another high cost to pay or bitter pill it has to take to “win” the telecom war.  Once DGTL is consolidated to TEL, it will weaken TEL’s financials due to high debt, the deficits we mentioned and weak profitability.  TEL, however, is banking that the increase in its subscriber base will finally take them to the promised land.  That promised land is the broadband market.  Only 4% penetrated, it is the telecom sector’s only growth driver.  This means that 4 million out of 94 million Filipinos have fixed-line and wireless broadband internet.  This is a young and booming market compared to the 94% penetrated mobile market.  This means that 88 million out of 94 million Filipinos have mobile communications.  Is the broadband market worth it?  TEL is spending PHP67 bn in two years for capex for it.  We think it will go the way of what happened in the mobile market segment of the telecom sector.  Bucket Plans again.

Note:  Sun already absorbed in the pies

The winner here is clearly JGS.  It has let go of its under-performer ala the AEV-ATS-Nenaco deal and got TEL shares it can dispose later on for funding of better businesses.  Th AEV-ATS-Nenaco deal to us though is sweeter for all parties.  This telecom deal has one clear winner, a cornered GLO, a soon to be delisted DGTL with a low PHP1.60 per share tender offer, a bloated TEL that has to shape up soon and a probably snickering SMC.  Ah yes, Vega Telecom.  This might probably be the hidden reason in this telecom deal.  Vega, if it does break into the already saturated mobile market, will eat into the Big Three’s (Now Two’s) subscriber bases, the subscriber bases that they have fought for five years to build.  Imagine a bathtub already full of an elephant and two hippos and here comes another hippo coming in.  That bathtub is just going to tumble down with the rest of its occupants.  Beefing up its subscriber base with DGTL shields TEL against this threat.  If Vega breaks into broadband, it is better for us subscribers again, and it has sizable room for it, TEL and GLO to compete in unlike the bathtub example we used for the mobile market segment.

While this deal broke into the news, there was another news that an HK telco has finally generated profits after seven years.   Wow.

This is a big deal in a challenging, expensive and intense industry.  Our title reflects our enthusiasm.


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