Acquisition of 30% stake in Warid

SingTel has successfully beaten rivals MTN of South Africa and Britain?s Vodafone for the 30% Warid stake. Warid is Pakistan?s 3rd largest mobile phone operator with 16.6% market share. Key highlights of the deal:

? US$758m cash deal, of which 50% is for subscription of new shares and 50% vendor sale by owner, Abu Dhabi Group.

? Deal values Warid at EV/Sub at US$299.

? Warid is EBITDA positive at US$15m for 9M07 (ended Mar 07) on revenue base of US$232m or EBITDA margin of 6.5%.

Comments

Expensive. The key take-away from our conference call with management is that SingTel has overpaid for Warid and we believe SingTel would find it challenging to deliver an acceptable shareholder return for this investment. While the deal looks reasonable at EV/sub of US$299 when regional peers range from US$229 to US$930, a closer look on an EV/revenue basis suggests that the deal is rich relative to regional peers. In our opinion, the EV/sub comparison fails to take into account the differences in profitability derived from each subscriber among different telcos. While we think EV/EBITDA would be a better valuation comparison for emerging telcos, we have used EV/revenue as Warid has just achieved profitability at the EBITDA line.

SingTel?s acquisition values Warid at around 9.4x CY07 EV/revenue while the 3 listed Indian mobile operators are valued at 5-7x CY07 EV/revenue, as shown on Figure 1 below. The deal also looks pricey relative to peers in the Indonesian market which has similar penetration and growth rates but are only valued at close to 3.0x CY07 EV/revenue. The 30% stake in Warid also looks expensive compared to Vodafone?s recent acquisition of Hutch Essar, which was valued at 7.5x EV/revenue for a controlling 67% stake.

Warid?s low EV/sub of US$299 masks the fact that Pakistan is a very competitive market, arguably more competitive than India and Indonesia. Mobile number portability was introduced in Pakistan earlier this year whereas Bangladesh, India, and Indonesia have not introduced MNP. ARPU of Mobilink, Pakistan?s largest mobile operator with 44% market share has fallen at a 3 year CAGR of 35% to US$4.90 as at end-2006. A comparison of ARPU across regional markets in Figure 2 shows that Pakistan mobile operators have the lowest ARPU, supporting our view that competition is particularly high in Pakistan. We are not surprised that profitability for mobile operators in Pakistan is notably lower than regional peers (Figure 3) as a result.

Mildly earnings dilutive. Another take-away from the conference call is that Warid is not expected to be profitable over the next few years. While Warid?s net profit/loss figures were not disclosed, we believe the company is currently loss making, at about US$60m. We expect losses to remain at similar levels at best in the near term given limited scope to lift ARPU due to intense competition and as Warid rolls out its services to rural markets which offer lower incremental ARPU. In addition, depreciation expense for Warid is expected to rise as it incurs US$1bn in capex over the next 3 years to expand coverage to 80% from 60%. We tweak SingTel?s earnings downwards by 0.5 to 0.8% for FY08-10 to reflect our expectations for losses at Warid over the next 3 years.

Valuation and recommendation

Maintained Neutral, target price trimmed downwards to S$3.74 from S$3.75.

Our sum-of-parts valuation (Figure 4) for SingTel is trimmed to S$3.74 as we apply a 25% discount to Warid?s acquisition value. This brings Warid?s EV/revenue valuation in-line with price Vodafone paid for Hutch Essar. We see limited scope for SingTel to outperform the STI on a 12-month horizon given the absence of a significant catalyst and maintain our Neutral call.