Asia Telecoms Sector
SECTOR REVIEW
Modelling by minutes II – go for growth
■ Our top five defensive picks for 2008, namely Chungwha, Telekom
Malaysia, AIS, M1 and SingTel, have outperformed both their local
markets and the MSCI Asia ex. Japan YTD in 2008. The sheer
magnitude of the outperformance suggests this is unlikely to continue
into 2009. Instead, a return of risk appetite may cause a rerating of
cellular growth plays. We identify TMI, Idea, Bharti, PLDT and China
Mobile as the best growth telcos to own into 2009.
■ Go for growth – underweight fixed line. Year to date, the Credit Suisse
fixed-line sector has outperformed the MSCI Asia ex. Japan Index by
65.1%, versus 42.7% outperformance by the cellular sector. Even on
P/E, the cellular sector now trades at 10.8x FY0E, versus 12.2x for fixed
line, despite cellular’s much stronger growth prospects. We would look
to trade out of the low-growth/high cash flow-yielding fixed operators
and position for growth.
■ Modelling by minutes helps identify growth markets. The Indian market
generates only 16.0% of the voice traffic per population that the US
enjoys, Indonesia generates 27.5%, China 26.1%, Thailand 65.4% and
the Philippines 2.2%. We expect the highest compounded FY08-14
revenue growth (13.2%) in India, followed by China, then Indonesia,
Thailand and the Philippines. We believe that aggregate cellular
industry EBITDA margins are set to fall in China and India, but can
actually rise in Indonesia and Thailand.
■ While DCF forms the basis of our target prices, for the purposes of this
report we rank the emerging Asian cellular stocks on EV/OPCF in 2014
to identify the best cash flow growth prospects (at the most attractive
current share prices). Our top-five large-cap (with market capitalisation
over US$2.5 bn) picks, in order of preference, are: TMI, Idea, Bharti,
PLDT and China Mobile.

Model by minutes II – go for growth
Our top-five defensive picks for 2008, namely Chunghwa, Telekom Malaysia, AIS, M1 and
SingTel, have outperformed both their local markets and the MSCI Asia ex. Japan YTD in
2008. The sheer magnitude of fixed-line players’ outperformance suggests that this is
unlikely to continue into 2009. While we do not expect a raft of earnings upgrades or
downgrades (in fact, we believe that secular/competition factors rather than macro issues
are the primary earnings drivers for telcos), a return of risk appetite could result in a
rerating of operators which are investing to capture attractive longer term growth prospects.
This report identifies TMI, Idea, Bharti, PLDT and China Mobile as the best growth telcos
to own into 2009.
Go for growth – underweight fixed line
In 2008 YTD, the telecoms sector has outperformed the MSCI Asia ex. Japan index by
47.9%. This has not surprised us, as telecom stocks offer highly visible cash flows that are
driven by domestic consumption. The low growth/high cash flow-yielding fixed-line telcos
have held up best, with the Credit Suisse fixed-line operator sector declining by only
32.1%, and outperforming the MSCI Asia ex. Japan index by 65.1%. However, we believe
this is unlikely to continue into FY09E; even on P/E, the cellular sector now trades at 10.8x
FY09E, versus 12.2x for fixed line, despite cellular’s much stronger growth prospects.
Modelling by minutes helps identify growth markets
Traditional measures of growth potential, reflected as a penetration number (reported
subscribers divided by population), are becoming less useful with the predominance of
pre-paid cards and the advent of individuals holding more than one SIM card (and in some
cases several). We believe that voice traffic per population is a more accurate indicator of
growth prospects. The Indian market generates only 16.0% of the voice traffic per
population that the US enjoys, Indonesia generates 27.5%, China 26.1%, Thailand 65.4%
and the Philippines 2.2%. We expect the highest compound FY08-14E revenue growth
(13.2%) in India, followed by China, then Indonesia, Thailand and the Philippines. We
believe that aggregate industry EBITDA margins are set to fall in China on the shift to a
three-player market and India on new operator launches, but that aggregate EBITDA
margins in Indonesia and Thailand could rise. MOU growth should, of course, drive capex.
If anything, we believe that there may be downside risk to our capex forecasts for China,
but upside risks to our Indian forecasts.
TMI, Idea, Bharti, PLDT, China Mobile attractive
While DCF, in our view, offers the purest measure of telco value, and forms the basis of
our target prices, for the purposes of this report we rank the emerging Asian cellular stocks
on EV/OPCF in 2014 to identify the best cash flow growth prospects (at the most attractive
current share prices). Our top-five large-cap (market capitalisation over US$2.5 bn) picks
in order of preference are: TMI, Idea, Bharti, PLDT and China Mobile. For more valueorientated
investors, using EV/discounted cash flow from FY09-14E would mean that
China Mobile, Idea and Bharti would drop out of our top five, to be replaced by AIS,
SingTel and PT Telkom. However, we note that all of these relative “safe haven” stocks
have outperformed this year, and looking into FY09, we prefer to shift our portfolio towards
cellular operators with direct exposure to the higher-growth Indian market. The key caveat
to our “go for growth” thesis for 2009 is that, of course, operators which cannot finance the
capex required for growth should continue to be avoided. Potential problem areas include
TT&T, Bakrie Telecom and Mobile 8, though of the three, Bakrie Telecom is in by far the
soundest position, having been fortunate enough to raise US$320 mn through a rights
issue in 1Q08. Among the small-cap telcos which should, in our view, continue to be able
to invest, and which deserve dramatic reratings, we would highlight Globe, Excelcom and
True Corp.

Go for growth – underweight fixed line
Defensive telcos look set to UNDERPERFORM
In 2008 YTD, the telecoms sector has outperformed the MSCI Asia ex. Japan index by
47.9%. This has not surprised us, as telecom stocks offer highly visible cash flows that are
driven by domestic consumption. This has become ever more appealing throughout the
year, as a slowing US (and subsequently global) economy has hurt financials, cyclicals,
commodity plays and exporters. Our view is that secular factors (new entrants/price
competition) have been shown to be stronger drivers of telco earnings than the general
economic backdrop. Furthermore, cost inputs into the telecoms business largely continue
to decline, affected by scale and technological progress rather than global oil or material
prices, and helping to provide good visibility of margins.
Not surprisingly in a falling market the low growth/high cash flow-yielding fixed-line telcos
have held up best, with the Credit Suisse fixed-line operator sector declining by only
32.1%, and outperforming the MSCI Asia ex. Japan index by 65.1%. The more growthorientated
(and cash-hungry) cellular sector has declined by 41.4%, outperforming the
MSCI Asia ex. Japan index by only 42.7%.
Thus, our defensive portfolio, reiterated on 4 August 2008, has performed well, with fixedline
heavyweights Chunghwa Telecom and (the recently downgraded) Telekom Malaysia
having outperforming the MSCI Asia ex. Japan index by 138.2% and 145.6% YTD,
respectively. High cash flow- and dividend-yielding AIS has also performed well. While we
are surprised by the severity of the sell-off in M1, following disappointing 3Q08 results, it
has remained a strong relative YTD performer. Similarly SingTel, which we included as a
larger-cap defensive proxy, despite its exposure to the emerging market currencies, has
performed reasonably well in relative terms.

The sheer magnitude of fixed-line players’ outperformance YTD in 2008 suggests this is
unlikely to continue into 2009. We therefore introduce an UNDERWEIGHT call on the
fixed-line telecoms sector, expecting financials and cyclicals to bounce back strongly from
historical lows.
Within the sector we would now “go for growth” …
Clearly, just as downward revisions to telecoms earnings have been more muted than for
other sectors during 2008, we would not expect to see a raft of earnings upgrades in the
telecoms sector even if global economic growth begins to recover.
A return of risk appetite may, however, result in a rerating of stocks that have attractive
longer-term growth prospects. This would imply a preference for cellular stocks over lowgrowth
cash flow yielders, and within the cellular sector, we fully expect to see investors shift
“further back down the penetration curve”, as markets rally. Although we acknowledge that
financials and cyclicals are likely to rally even more strongly than the cellular sector, Credit
Suisse’s strategist Sakthi Siva has nevertheless upgraded the cellular sub-sector to
OVERWEIGHT, in particular relative to the consumer staples sector. Investors looking to
retain some exposure to Asian domestic consumption plays may prefer those with a
demonstrable growth angle.

Modelling by minutes helps identify
growth markets
Asian traffic penetration remains low
The key premise of our original Modelling by Minutes report, published on 4 April 2008,
was that traditional measures of growth potential, reflected as a penetration number
(reported subscribers divided by population), are becoming less useful with the
predominance of pre-paid cards and the advent of individuals holding more than one SIM
card (and in some cases several). This is even more the case now as “reported”
subscriber numbers in Asia have ticked up aggressively throughout 2008, particularly in
competitive markets where operators are keen to appear to be growing their businesses.

Thus, we find that as at December 2008, Thailand is reporting a headline penetration rate
of 87.8%, while we observe that the number of minutes of paid outgoing traffic per capita
is still only 65.4% of US levels (57.0% if SMS is added to minutes of usage [MOU]). This
broadly supports operators’ assertions that “double SIMs” inflate the headline penetration
rate by over 20 p.p. Similarly, Indonesia now reports 64.7% headline penetration, but
traffic was only at 27.5% of US levels during 4Q08 (34.9% if SMS is added to MOU).

The Philippines remains an extremely unusual case, given the predominance of SMS
rather than voice for telecoms traffic. As at FY08, the country’s average voice MOU was
only 12 minutes/month, yet there were 599 SMS sent per subscriber per month (20 per
subscriber per day). Thus, SMS has evolved as the primary means of cellular
communication. This is largely due to pricing differentials, in our view, as a local voice call
costs around P6.5 per minute (US$0.16), while average SMS pricing is now as low as
P0.2 (US$0.005), or 1/30th of the price, following the recent introduction of SMS bucket

plans. The difference is even wider when the blended average RPM (including longdistance
calls) is considered (see table below). Some commentators also believe that
cultural factors are a driver, given that texting is fairly straightforward in Tagalog, and given
a perception that Filipinos prefer “indirect communication”. However, these factors may
well have emerged following the development of market price points.

The unusual traffic pattern gives a very skewed result. On the one hand, if voice alone is
considered, the Philippines has by far the lowest penetration of voice minutes per
population, at eight minutes/month, or only 2.2% of US levels. If SMS is included, there
are 388 communications per head of population per month, the highest level in Asia and
92.5% of US levels. Since this implies that people are having SMS “conversations”, it is in
our view, probable that if the voice/text differential narrows, voice traffic could pick up and
SMS traffic could fall. PLDT’s recently launched “Red” service, offering 3G voice, is
expected to achieve over 50 outgoing minutes of voice, versus the current average of 12.
Minutes’ growth creates a revenue opportunity
There are two ways in which emerging Asia’s MOU are likely to increase. Firstly, even if
price points remain the same, rising GDP should result in more individuals in emerging
markets consuming greater amounts of telephony. Furthermore, handset prices continue
to fall due to rising global volumes, further improving affordability for new users even if
GDP growth is slow. The strategy of keeping prices steady and awaiting GDP increases is
ideal from the operators’ perspective, since it ensures that maximum revenue is generated
from each additional minute of voice traffic or SMS sent. However, it is only likely to
succeed in markets with few players, where operators are willing and able to maintain
cartel-like pricing.
In more competitive markets, particularly those facing entry by new players with half-empty
networks (given the requirement to build basic coverage before launching a service), price
points are expected to decline. This should further increase affordability, allowing
individuals who have not yet started using cellular telephony to become subscribers. It is
also expected to encourage higher usage from existing subscribers.

Clearly, a combination of high GDP growth and rapid price declines is set to drive the
fastest growth in market MOU. From FY05-08E, Asia’s fastest growth in total market
minutes was in Indonesia, where strong GDP growth in FY05-07, together with a collapse
in tariffs following the introduction of competition, resulted in market MOU increasing tenfold.
India, a competitive market with at least five to six players per circle, produced the
second-highest MOU growth and, as price declines were more gradual than the sudden
FY07-08 collapse in Indonesia, India was able to enjoy the highest service revenue growth.
Looking forward, we expect the fastest market MOU growth to FY14E to occur in the
Philippines, as PLDT’s recently launched “Red” brand stimulates the voice market from an
extremely low base. The next highest MOU growth is expected to be in India, closely
followed by Indonesia and then, somewhat slower, China. The crucial driver is that new
entrants exist in each of these markets, to push prices downwards. Again, however, we
believe that India will produce the highest service revenue growth, with RPM declines
remaining gradual. We believe that on the introduction of a three-player market, RPM will
fall fairly quickly in China, but not collapse, allowing China to produce the second-highest
revenue growth.

Competition and MOU growth also drive EBITDA
margins …
The key determinant of telecoms margins market by market is whether or not handset
subsidies are a feature of the competitive landscape. Clearly, margins are dramatically
lower in markets where handset subsidies are a key competitive tool, but in Asia, this
tends to be confined to the developed markets (specifically Korea, Hong Kong and
Singapore) where post-paid subscriptions still predominate. In the five developing markets

which are the subject of this report, prepaid is the key growth driver and any subsidies
given to the very small post-paid subscriber bases has a more muted margin impact.
Within markets, the key determinant of margins is the scale of the operator. Given that all
operators carry some element of fixed costs (e.g. staff), the higher the revenue share, the
higher the EBITDA margin generated. Conversely, new entrants and sub-scale operators
should drag industry margins and profitability, as they will initially generate negative EBITDA.
Ceteris paribus, more competitive intensity tends to result in higher marketing and
promotion costs and lower margins. Higher MOU would also drive up operating and
maintenance costs – an increased number of base transceiver stations (BTS) would
increase cell site rental charges, power consumption, maintenance costs and, in the case
of Indonesia, for example, licence costs. Thus, the introduction of new competitors and the
subsequent explosion in MOU in Indonesia has resulted in industry EBITDA margins
falling from 65.4% in FY04 to 53.1% in FY08E.

Looking forward, we expect margins in China to decline, as competition intensifies and the
newly restructured competitors ramp up services aggressively. Thus, we only project 3.4%
compound EBITDA growth to FY14 for China, despite 8.1% compound revenue growth.
We also now expect aggregate margins in India to decline, as new entrant losses
(including launch costs from Reliance’s GSM business) more than offset rising EBITDA
margins from incumbent operators with increasing scale. Nevertheless, even with the
decline in aggregate margin, we estimate that the Indian mobile market will be able to
produce 11.0% compound EBITDA growth to FY14E, still the highest in emerging Asia.
On the other hand, we believe that margins in Indonesia are likely to increase, as the scale
of incumbents increases and new entrants either reach EBITDA breakeven or are
consolidated out of the industry. We expect a 7.4% compound growth rate in Indonesia, as
a de facto three-player market arises.
EBITDA margins are also expected to rise in Thailand, where the advent of 3G licences
should, in our view, herald structurally lower regulatory fees.
… and capex requirements
Over the past three years, we have seen a surprisingly wide divergence in capex per
minute in Asia. As highlighted in our initial Modelling by Minutes report, published 4 April
2008, Indonesia was a clear outlier from FY04-07, with blended average capex per
incremental minute in FY07 still at US$0.16, far higher than the averages found around the
rest of Asia. We also highlighted that Indonesia therefore represented the market with the
greatest risk of nasty upside capex surprises relative to our forecasts at the time. Sure
enough, with the explosion of MOU (brought on by faster-than-expected declines in RPM)
capex has indeed been higher than forecast. Our total market capex forecast for FY08E
has increased by 14.8% to Rp50.8 tn (US$5.4 bn). On the other hand, on a per-minute
basis, FY08E capex-per-minute declined rapidly to US$0.030/minute, or one fifth of the
level in FY07. We believe that this is in large part due to the shift from coverage
expenditure to a focus on capacity expenditure. In addition, most operators have been
prepared to sacrifice call quality by making use of technologies, such as dynamic Half
Rate and WMR to solve congestion issues and lower capex budgets during this year.

In total, we estimate that US$202 bn has been invested in the cellular networks across the
five emerging Asian markets (that we cover) to date. We expect a further US$216 bn to be
invested by 2014, with almost three-quarters of this coming from China. China has
suffered consistently high capex even as a one to two player market (China Mobile’s
capex-to-sales ratio was still 26.1% in FY07, despite dominant market share and 39.8%
penetration as at December 2007). With a three-player market now developing, and the
advent of 3G (at least partially involving home-grown technologies), we have
conservatively assumed that capex/minute remains high at US$0.08/minute. If anything,
there is probably downside risk to this forecast.
The greatest upside risk looks to be to our Indian forecasts. India has been at the forefront
of driving down capex costs; given its low GDP and low price per minute, the operators
have needed to establish very aggressive vendor terms and shared passive infrastructure.
Subscribers have also been prepared to accept poor network quality in return for
becoming connected at low tariffs. We are forecasting that these trends will continue,
though we note that the risk to our forecast of US$0.01/minute incremental capex costs is
probably on the upside, particularly if the operators start to focus less on price competition,
and more on network quality. Interesting Bharti management is now looking at increasing
pressure on financially constrained new competitors by launching in-building coverage and
pico cells. This could be the start of a trend towards quality rather than simply price.