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Telecoms & Media
We have shifted towards a more positive view on telecom services
in developed markets based on wireless data/dividend catalysts.
We remain positive on the China-Korea internet space, and are
more cautious on the near-term profitability for China vendors
Key themes for 2011 will be the ability to monetise wireless data,
a greater emphasis on returning excess cash to shareholders, and
renewed interest in the internet services space
Top picks include Telstra, China Telecom and Korea Telecom
2011 outlook
Telecom services
We are cautiously optimistic on the Asian telecom
services space, based on an improved outlook for
core business earnings growth and a shift towards
higher dividend payouts. The key driver for
telecom services is the shift towards a datacentric, wireless broadband business model.
Smartphone customers consume 10x as much data
capacity as feature phone customers. This
capacity crunch creates challenges for operators
that have underinvested in network capex but
opportunities for operators that have overinvested
to grab high-end, data-centric customers. We see
initial signs that some operators are regaining
pricing power, allowing for significant increases
in average revenue per customer (ARPU) on twoyear contracts. This growth in organic
demand/core business earnings is also allowing
some operators to increase dividend payouts to
shareholders, rather than chasing “risky” out-ofsector/market growth.
At this juncture, this is a developed market story
and our Overweights are concentrated in Korea,
Hong Kong, Japan, and Singapore. In more
developed markets we like Korea Telecom,
Smartone, PCCW, DoCoMo, eAccess, and Telstra.
In contrast, we have just one Overweight rating in
each of the traditional growth markets of China,
India and Indonesia. In developing markets we like
China Telecom, Axiata-Excelcomindo, and Tulip.
We see increased investor interest in India on the
back of the resignation of telecoms minister
Andimuthu Raja but believe it’s too early to invest.
Internet services
We remain structural bulls on both the China and
Korea internet services space and believe that
content creation-distribution companies are the
most attractive subsegment in our coverage
universe. China is still in the early stages of the
broadband revolution, with 30% internet
penetration and dramatic increases in broadband
access funded by a wave of Chinese telecom
operator capex. In contrast to the telecoms
services space, China internet services enjoy no
government players, no tariff/rate of return
restrictions, and a focus on shareholder value
creation. We are OW(V) on both Tencent and
Netease and are bullish on the China online
gaming, online advertising, and e-commerce
markets and believe these emerging companies
are much better structural proxies for the China
domestic consumption story. In Korea we like
Daum Communications, which is highly geared to
the uptake in mobile ad spending that we expect
to see as the smartphone penetration rate surges,
and NCsoft, a leading global game developer that
is geared to the China story.
Telecoms equipment vendors
We remain longer-term structural bulls on the
Chinese telecom equipment vendors, but are
cautious on the near-term outlook for domestic
capex earnings. China has moved to the old
Korean-style management of the telco sector, with
a focus on supporting domestic telecom
equipment vendors at the expense of the domestic
telecom services providers. China’s decision to
build three huge, overlapping 3G networks based
on three different technology standards is ample
evidence of this bias. In particular, the decision to
task dominant wireless operator China Mobile
with the national service obligation to fund the
development of the native TD-SCDMA standard
is a harbinger. Domestic Chinese vendors
Huawei, ZTE and Comba have emerged as
powerful global competitors, fuelled in part by a
combination of direct/indirect subsidies/tax
breaks. We expect these trends to continue and
see another wave of domestic China capex
coming with the deployment of 4G LTE and
modernisation of the Chinese cable TV (CATV)
industry in 2012. Our Neutral (V) rating on ZTE
reflects a cautious view on near-term earnings, as
an aggressive focus on handsets/GEM expansion
drags down OP margins (1% in 3Q10). Our OW
rating on Comba reflects a more bullish view on
the antenna space.
Top pick for 2011
Telstra (TLS AU, OW, AUD2.81,
TP AUD3.3)
We believe Telstra is a high risk/high return play
given the uncertainty over the regulatory framework
for network separation – the National Broadband
Network (NBN). Telstra has moved up over the past
few weeks on positive management comments on
the stable dividend for the next two years and the
possibility of a special dividend in the event of a
rapid NBN resolution. We argue the proposed NBN
deal, which would generate an NPV for Telstra
shareholders of AUD11bn, is a fair-equitable
solution that could be finalised before the end of the
year. Management lost focus on the core business
earlier in the year and the commitment to invest
AUD1bn in operating costs in FY June 2011 to
recapture market share is positive. Telstra has the
best wireless network in Australia and is well
positioned to regain share in the high-end, datacentric smartphone segment.
Valuation: We value Telstra using a dividend
discount model – our target price is AUD3.3 per
share. Telstra is our top dividend play.
Risks: The key risks for Telstra relate to
uncertainty over the dividend payment/NBN. The
current political coalition ruling Australia is
fragile and the opposition party has suggested a
wholesale review of NBN is likely if they return
to power, creating uncertainty over the dividend.
Themes for 2011
Techtonic shifts
The emergence of smartphone-based wireless
broadband services provides the biggest structural
catalyst for the developed market telecom
business model in the past decade. The release of
Apple’s iPhone followed by a much wider range
of Google Android-based devices has created a
powerful, easy-to-use interface to high speed
networks and rich content. The development of
the Apple and Google applications stores has
allowed telecoms operators to outsource content
development/management to skilled media
companies. Explosive customer demand for these
services is creating wireless capacity crunch
pressures, which in turn are allowing selected
telco operators to push through de facto price
increases. China is driving down retail prices of
low-end smartphones into the USD150-200 range,
creating the potential for global adoption of the
smartphone-driven wireless broadband operatingbusiness model. ZTE’s recent release of a lowcost Indian smartphone in the run-up to 3G launch
highlights the potential of this technology to
stimulate a global shift in wireless data growth.
China Telecom (728 HK, OW,
HKD3.91, TP HKD5.1)
China Telecom is our only OW in the China space
and is one of our top regional telco services picks.
It has executed a remarkable turnaround in the
CDMA business and should surpass Verizon as
the largest CDMA operator in the world in 1Q11
with over 100m subscribers. It has expanded
handset inventory and aggressively bundled
services, but careful cost management and a
preferential off-balance sheet lease structure for
the CDMA network should allow a doubling of
net profit margin (NPM) to 8.5% in 2010.
Valuation: Our target price of HKD5.1 is based
on 13x 2011e EPS.
Risks: Investor scepticism on CDMA runs deep,
raising questions about the stock’s ability to re-rate
despite strong sub growth. China Telecom’s 3G net
ads are focused on the lower ARPU youth-student
segment, in a market where most investors continue
to focus on top-line versus bottom-line growth. The
core fixed-line business continues to compress as
PHS migrate off, which could overshadow the
dramatic turnaround in the wireless segment.
Cash-rich companies
One of the key themes for our telecom services
companies is the re-rating catalyst created by
higher dividend payouts. The smartphone-driven
wireless model creates the potential for a structural
shift in core business revenue/profit growth. We
are encouraged by the recent trend towards Asian
operators returning cash to shareholders rather
than chasing higher-risk acquisitions outside their
core markets/countries. Given our cautious stance
on wireless penetration and M&A driven growth
strategies, the development of a yield-centric
domestic investor base is encouraging.
KT Corp (030200 KS, OW,
KRW46,500, TP KRW67,000)
KT provides a rare combination of growth and yield
at compelling valuations. KT has undergone a
dramatic transformation over the last two years via
the full integration of former wireless unit, KTF, the
shift towards a bundled services model designed to
lower sales and marketing costs, and a new CEO
with the political power to push through a 16% cut
in the workforce. The key challenges are the
technical issue of the foreign ownership cap being
filled, smartphone-related marketing expenditure
remains high, and local investors remain focused on
top-line growth. We are 20% and 38% above
consensus operating profit estimates for FY11-12.
Valuation: Our target price of KRW67,000 is
based on 8x 2011e EPS.
Risks: Korea is our favourite market in Asian
telco services on a growth/valuation basis and the
key risks relate to industry level shifts in
competitive intensity, regulatory approach and
capital management. If all operators don’t
continue to benefit from the smartphone shift, we
could see a return to value-destructive
pricing/marketing spend wars. We are optimistic
on the near-term KT dividend yield but
acknowledge long-term systemic risks associated
with the industry focus on IT services.
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