Keppel and SPH have thrown lifeline to M1’s minorities as dividends decline

A pre-condition to the offer is that Konnectivity receives the relevant approvals from the Info-Communications Media Development Authority (IMDA). Konnectivity’s intention is to gain majority control of M1. In the event the free float requirement is not satisfied, Konnectivity does not intend to preserve the listing status of the company and has no intention of undertaking or supporting any action to satisfy the free float requirement.

The largest single shareholder of M1 is Bursa Malaysia-listed Axiata Group, with 28.7%. Axiata, whose largest shareholders are Khazanah Nasional with 36% and the Employees Provident Fund with 15%, has yet to make an announcement on what it plans to do with its M1 stake.

Axiata said on Sept 24 it would “consider all appropriate and viable actions” to raise shareholders’ value.

Eventually, a third party could emerge to acquire Keppel Corp’s and SPH’s stakes, suggests UOB Kay Hian analyst Jonathan Koh in a Sept 25 report. “The potential investor could be attracted by the possible consolidation of the mobile industry from four to three players over the longer term,” he says.

On Sept 3, Keppel Land, a wholly-owned subsidiary of Keppel Corp, completed the sale of 4.08%, or 55 million units, in Keppel DC Real Estate Investment Trust. Without ownership of Keppel DC REIT, Keppel Corp can privatise Keppel T&T without having to make a chain offer for the REIT.

Some market watchers had already seen the decline in M1’s share price as an opportune time for its shareholders to privatise it. The stock touched a low of $1.52 on Sept 10, down 14.6%, or 26 cents, since Jan 2. In March 2017, M1’s shareholders commissioned Morgan Stanley to do a strategic review of M1, but no action was taken following that. M1’s major shareholders released a statement in July last year saying they had “taken into consideration the proposals from interested parties, which despite a favourable level of interest, have not met the minimum criteria and parameters as determined” by them. M1’s share price was trading above $2 then.

When it announced its 1HFY2018 results in July this year, M1 said its 2H net profit would be lower than the $68.8 million recorded in the previous corresponding period. 1HFY2018 net profit was marginally higher at $71 million. However, net profit has been on a declining trend for the past three years and dividend per share has been falling for the past four (see Charts 1 and 2). Without a corporate transaction, M1’s shareholders could see their dividends cut next year if net profit continues to fall.

Opportunity for shareholders

M1 chief financial officer Lee Kok Chew said in an earnings call in July that M1 plans to maintain its 80% payout ratio for the year. For 1HFY2018, it paid dividends of $57.4 million, or 5.2 cents a share. That translates into a payout ratio of 80.8%. Costs are likely to rise. Lee also confirmed that there would be a lot more marketing activity, seasonal promotions and impending competition from the fourth telco during the second half of the year. Meanwhile, M1 is planning to lease bandwidth to new players such as MyRepublic.

Despite these initiatives, a small player like M1 is at a disadvantage. In a Sept 24 note, Maybank-Kim Eng recalls: “Back in 2017, newswires claimed that China Mobile and global private-equity funds were among those keen. A new shareholder could alter M1’s business strategy and balance sheet.”

The rationale for the offer is not new and addresses shareholder concerns. According to Keppel Corp, M1 is facing intensifying competition and industry disruption from the impending launch of a fourth Mobile Network Operator (MNO), as well as the launch of new Mobile Virtual Network Operators (MVNO) in Singapore. “Continuing the status quo risks stagnation and further decline in shareholder value,” Keppel Corp’s announcement says.

Several MVNOs have recently commenced operations in Singapore. On July 8, 2015, M1 announced that it had reached an MVNO agreement with Liberty Wireless, operating under the brand of Circles Asia, while on May 3, 2018, MyRepublic and StarHub announced that they had formed an MVNO partnership.

“The emergence of new entrants will intensify the competition in the Singapore telecommunications market, potentially leading to shifts in market share between competitors, as well as potential downward pressure on revenue generation and margins for MNOs at a time when sustained investments are required to ensure long-term competivity,” Keppel Corp says.

The decline in M1’s share price over the past two years reflects the challenging local landscape. Competing with the new entrants could continue to destroy shareholder value.

“The anticipated business transformation is complex and expected to take a number of years,” Keppel Corp states. During this period, dividends are likely to be cut, it adds, “as [more] resources [are] required for these transformation efforts”.

Market watchers expect Axiata Group to be ready to divest itself of its M1 stake, given that it had an impairment for RM3.3 billion in 1HFY2018. M1’s minority shareholders, too, now have the opportunity to divest themselves of M1 at an attractive price.

Keppel to take KT&T private

Keppel Corp has proposed to take KT&T private by a scheme of arrangement. This requires the approval of more than 50% of the number of shareholders representing 75% of the value of KT&T shares held by shareholders present in an EGM. Keppel Corp will abstain from voting. After the EGM vote, High Court approval is required.

Eventually, with Keppel T&T in its belly, Keppel Corp would benefit as well, UOB Kay Hian reasons. It would reap advantages from the data centre business, and a possible spin-off of Keppel T&T’s logistics business.

While UOB Kay Hian maintains a “hold” on Keppel — once the world’s largest jack-up rig builder — it too could start to look more than the sum of its parts. There is market talk that Keppel could eventually spin off Keppel Capital as a property funds management business. Keppel Capital holds the manager of Keppel REIT and Keppel DC REIT, and has a 50% stake in the manager of Keppel-KBS US REIT. In addition, Keppel Capital will have a 30% stake in the manager of the yet-to-be-listed Prime US REIT, an office REIT.

Deteriorating payouts

According to SGX’s My Gateway report dated Sept 24, as at Sept 21, StarHub had a total return including dividends of -16.75% this year, while M1’s was -2.1% and Singtel’s -8.8%. A significant portion of their returns are from dividends. StarHub and M1 rank among the top dividend-yield stocks on the SGX.

Relative to M1, StarHub is seen to have a greater challenge maintaining its quarterly dividend payout of four cents. Its dividend payout ratio for 1HFY2018 was 111%, compared with M1’s 80% (see Charts 1 and 3). Its historic yield is 9.52%, and its annualised yield based on its dividend of 16 cents a year — the company has paid eight cents so far — remains at 9.3%. The company has a December year-end.

StarHub’s headline yields are likely to be under pressure as competition in the sector increases. TPG Telecom successfully bid to become Singapore’s fourth mobile operator in December 2016, and is scheduled to launch this year. It is currently building its mobile infrastructure.

Even before TPG starts operations, there are already doubts over whether StarHub can maintain its dividend payout. As at June 30, its dividend payout was $138.4 million compared with net profit after minority interest of $124.7 million. The payout ratio for 1HFY2018 remains stable compared with 1HFY2017, which was also 111%, but is higher than FY2016’s 101% (see Chart 3).

In fact, StarHub’s dividend payout ratio has been rising as dividends and earnings fell. Its balance sheet paints a stressful picture. Last year, the company issued $199.9 million of perpetual securities, which account for some 34% of shareholders’ funds (of $581.9 million as at June 30).

Another red flag in StarHub’s balance sheet is its $244.5 million cash balance compared with some $550.3 million of payables. That means, in the short term, the company owes its business partners more than it can pay.

Equity could get wiped out

Companies have to weigh their investments for future growth against the demands of their shareholders. This means putting monies into reserves. StarHub’s reserves are modest, at $82 million compared with a negative $159.1 million as at Dec 30, 2017. The largest portion of its shareholder equity is ordinary equity, but this could get depleted if the company does not build up its reserves.

The company’s dividends have fallen over a five-year period, even as dividend payout ratios have been rising. StarHub has committed to pay $227 million in dividends this year, but a 100% dividend payout ratio is not sustainable for its business, and investors should expect a cut in dividend payouts. “We believe StarHub’s equity value will be wiped out by 2020 if it maintains similar dividend payments. As such, we project StarHub to bring its dividends to match its net profit level,” says DBS Group Research in a report.

DBS is expecting the company’s earnings before interest, taxes, depreciation and amortisation to fall 4.4% from now until 2020, compared with just a decline of 2.2% in Ebitda by M1 for the same period. StarHub’s pay-TV business is contracting and it is experiencing heavy competition from M1 for its mobile business, DBS says.

Although corporate moves around M1 have ignited interest in StarHub, UOB Kay Hian does not see any further consolidation in the near term. “We do not think that the [M1] transaction would lead to an early consolidation of the telco sector from four to three players. StarHub and TPG Telecom have not made any announcements (we would rule out SingTel being an acquirer).”

What should investors do? They have been thrown a lifeline by Keppel’s and SPH’s announcements on Sept 27. UOB Kay Hian is recommending a “buy” for StarHub, but some investors who have seen their portfolios decimated by StarHub’s decline may take the opportunity to sell into strength.