All depends on turning around P1

SPECULATION over the sale of Packet One Networks (M) Sdn Bhd (P1), which has been swirling for some time, finally came to an end last week, with Telekom Malaysia Bhd emerging as the new strategic partner for the WiMAX operator.

Investor reaction was, however, tepid. Shares for Green Packet Bhd closed down 9.6% at 47 sen last Friday.

Recall that its share price surged as high as 64 sen in October on speculation of an imminent sale of its 55% stake in P1. Meanwhile, the share price for Telekom closed down 4.3% at RM5.93.

The lukewarm reaction is understandable. Telekom will inject cash into P1 and recharge its expansion plans, which have slowed significantly over the past year. But that in itself is no guarantee of success in the very competitive telco sector.

No cashing out for Green Packet

Shareholders of Green Packet are likely disappointed that the much talked about sale values P1 at less than when a 25.8% stake was sold to SK Telecom for US$100 million (RM327 million) back in 2010. Telekom is now paying “only” RM350 million for a 57% equity stake in the WiMAX operator.

More importantly, Telekom’s 57% stake comes from the issuance of new shares by P1. This means that Green Packet does not get a share of the RM350 million proceeds but its stake will be diluted to 30% based on the enlarged share capital of P1.

Having said that, Green Packet will get some cash flow — from the issuance of RM210 million worth of redeemable exchangeable bonds to Telekom. The first tranche for RM120 million should be issued later this year with the balance likely in 2015.

Save for some RM30 million that will be used to acquire P1 shares held by minority shareholders, the remaining proceeds can be utilised by Green Packet for settlement of liabilities and working capital. (Telekom can swap the bonds for Green Packet’s shares in P1 in five years’ time, if they are not redeemed.)

But given that Green Packet will also subscribe for 15% of the RM1.65 billion redeemable convertible bonds to be issued by P1 — equivalent to roughly RM248 million — over the next three years, it is unlikely there will be any special payout to shareholders from this whole exercise.

This means that Green Packet shareholders will have to continue to be patient. Instead of cashing out, shareholders will have to wait for P1’s turnaround. In the meantime, the company will likely remain in the red with limited chance for dividends.

We have previously mentioned that Green Packet may well want to retain a stake in P1 (article published Oct 16, 2013). The broadband business is its primary thrust going forward unless the company decides on a major strategic change. Its other businesses, the devices unit is very competitive and marginally loss-making while margins for the communications unit are wafer thin with limited prospects. But it is sorely in need of a game changer if it is to turn the company around. Getting Telekom onboard is potentially that game changer.

Cash infusion to recharge P1’s expansion plans

One of P1’s greatest obstacles was the limits of its balance sheet. Unlike deep-pocketed YTL Communications, which could afford a nationwide rollout, P1 has always been very cautious in expanding, adding sites and capacity only in lock-step with demand. We estimate total capital expenditure (capex) spent to date, since 2007, at just about RM1 billion.

This rollout model works quite well for the home broadband business. Gradually expanding coverage in the later years allowed P1 to launch limited nomadic broadband services but its roughly 55%-60% coverage is too low to offer nationwide mobile broadband services.

To compete fully in the 4G mobile services market, P1 would need nationwide coverage — at least 80% to compete with the likes of Maxis Bhd, Celcom Axiata Bhd and DiGi.Com Bhd. That means substantially more capex, which would be difficult without corresponding improvement in revenue and cash flow. P1 generated RM306 million revenue in 2013 with operating earnings (before depreciation, interest and tax) of just RM38 million and net loss of RM116 million.

With Telekom in the picture, P1 is slated to raise RM2 billion in fresh capital — RM1.65 billion in convertible bonds and RM350 million from new shares issued to Telekom — to fund its LTE network rollout for the next three years. Telekom and SK Telecom will subscribe to 60% and 25% of the bonds while Green Packet will take up the remaining 15%.

Even so, there is no guarantee of P1’s turnaround. The LTE-space is extremely competitive and dominated by Maxis, Celcom and DiGi while smaller players like U Mobile and YTL Communications also jostle for a share of the already saturated market. And then, there is newcomer Altel Communications, which is owned by tycoon Tan Sri Syed Mokhtar Al-Bukhary.

P1 a risky bet for Telekom

As such, the investment could be a risky one for Telekom. The company has been doing well, focusing on the home broadband market segment that is driven by good take up for its UniFi services.

With this proposed acquisition, gearing will rise and earnings in the near to medium term will be hurt by higher interest expenses and consolidation of P1’s losses — probably by between 10%-20% from current earnings estimates.

At the prevailing price, the stock is trading at roughly 22 times our estimated earnings for the current year with net yield of 4.4%. With flattish to slightly negative earnings growth likely for the next year or two, at least, Telekom’s valuations do not appear attractive.

Whether the acquisition turns out to be value accretive depends on P1’s success over the longer term.


Note: This report is brought to you by Asia Analytica Sdn Bhd, a licensed investment adviser. Please exercise your own judgment or seek professional advice for your specific investment needs. We are not responsible for your investment decisions. Our shareholders, directors and employees may have positions in any of the stocks mentioned.

This article first appeared in The Edge Financial Daily, on March 31, 2014.