Link Net, Poised To Greatly Benefit From The Internet Boom

We initiate coverage on Link Net, a leading cable broadband and pay TV services provider with networks in affluent areas, with a BUY and DCF-based IDR6,250 TP (20% upside), implying 30x/23.2x FY15F/FY16F P/Es. It is in a significantly advantageous position to benefit from the internet boom in Indonesia as it could bank on rising wealth, e-commerce activities, internet penetration and growing urbanisation.

A major player to benefit from Indonesia’s internet boom
Link Net is a player in a market where broadband and cable TV penetration is only at 7% and 11% respectively. We also believe there is significant growth potential for the broadband industry, as it ought to be able to ride on Indonesia’s growing wealth, rising internet penetration and the e-commerce boom. We estimate for Link Net to record revenue CAGR of 21% CAGR for FY14-17F. We like its focus on big cities (which are less sensitive to economic downturns) vs having a business that is spread across the country.

Broadband subscribers (subs) a major driver
Link Net’s FY14 revenue stemmed from: i) broadband (57%) – household and enterprise, ii) pay TV (34%), and iii) others (9%). We expect it to book earnings CAGR of 24% in FY14-17F, largely driven by an increase in new subs. We also forecast for the number of new subs to expand at a CAGR of 21% during the same period to reach 1.35m in FY17, but expect ARPU to remain muted due to competition.

Indosat (ISAT IJ, BUY, TP: IDR4,900), XL Axiata (XL) (EXCL IJ, BUY, TP: IDR5,100) and Media Nusantara Citra (Media Nusantara) (MNCN IJ, NEUTRAL, TP: IDR2,100) are eyeing Link’s stake sale. According to Bloomberg, Indosat, XL and Media Nusantara are looking into the possibility of acquiring Link Net, which is allegedly being put up for sale by major shareholder the Lippo Group.

Initiate coverage on Link Net with a BUY and IDR6,250 TP
Our DCF-based TP assumes a WACC of 11.6% and a TG of 3%. It also implies 30x/23.2x FY15F/FY16F P/Es. Key risks are: i) a macroeconomic downturn that would affect purchasing power, ii) higher competition may crimp ARPU in the future, and iii) the IDR weakening against the USD, given that 40% of Link Net’s opex is greenback-denominated.

Investment Summary
To benefit from Indonesia’s internet boom
As at end-2014, Link Net owns and operates an upgraded cable network that covers 1.4m homes, mainly in Jakarta, Surabaya and Bali. The company is operating in a low penetration environment, ie 7% for broadband and 11% for cable TV. We believe there is significant growth potential for the broadband industry, premised on Indonesian’s rising wealth, growing internet penetration and the country’s e-commerce boom. We forecast for Link Net’s revenue CAGR at 21% for FY14-17F. We like the company’s focus on big cities, which are less sensitive to macroeconomic downturns, rather than being spread out across the country.

Broadband subs numbers the driver for growth
Given the current domestic economic condition and the depreciation of the IDR, which has led to weak consumer purchasing power, fierce competition has arisen from the likes of Telekomunikasi Indonesia’s (Telkom) (TLKM IJ, BUY, TP: IDR3,600) IndiHome Fiber, MNC Play Media Go and Biznet. We believe these would lead to a downside risk, ie ARPU growth being potentially muted in the next few years. However, in our opinion, Link Net could maintain its performance due to the additional number of subs, since it has the largest market share in the broadband industry.

FY14 revenue came largely from broadband – household and enterprise (57.0%), pay TV (34.0%), and others (9.0%). We forecast that the company’s earnings could expand at a CAGR of 24.0% between FY14 and FY17F, largely driven by higher broadband subs growth. We also forecast for Link Net’s new subs to increase at a CAGR of 21.0% in the same period, hitting 1.35m in FY17. However, ARPU growth for broadband and pay TV could stay muted due to the fierce competition in the market.

New players would pressure ARPU growth
Competition in the fixed broadband market may intensify in the future, as new entrants such as IndiHome, MNC Play Media Go and Biznet could go up against Link Net to grow their subs bases. This has been imputed into our model, and we estimate for its ARPU for broadband to decline in FY15F, growing 4.0% YoY to IDR225,000 vs a 6.5% YoY growth in FY14. We also cut our pay TV ARPU growth assumption for FY15 to 2.2% YoY to IDR190,000 vs 23.0% YoY growth in FY14.

We see more tense competition in FY16 and FY17, as most of the new players would be more able to compete with Link Net. Hence, we are assuming a lower ARPU growth of 2.5% (broadband) and 2.3% (pay TV) ARPU in FY17. We believe that Link Net’s revenue growth would depend on the volume of its additional subscribers.

Indosat, XL and Media Nusantara are looking into the possibility of acquiring Link Net. According to Bloomberg reports dated 15 June, Indosat, XL and Media Nusantara are apparently looking into the possibility of acquiring Link Net, as the company is reportedly about to be put up for sale by major shareholder the Lippo Group.

According to the report, Media Nusantara is trying to acquire Link Net in order to boost synergy with its broadband business, meanwhile we observe Indosat and XL are also trying to establish their footprint in this segment in order to compete with Telkom.

Initiate coverage with BUY and a IDR6,250 TP (20.0% upside from the current share price). Our rating is based on the following:
i. Link Net has the biggest market share in the broadband industry, and we believe it could significantly benefit from the internet boom in Indonesia and the growing popularity of e-commerce.
ii. The under-penetration of broadband in the country – it was only at 7.0% in FY14, and we believe there is room for growth
iii. The stock offers the highest ROEs of 19.0%/20.1% in FY15F/FY16F respectively (based on our analysis) when compared to its regional peers.

We do not take into account Astro Malaysia’s (Astro) (ASTRO MK, NEUTRAL, TP: MYR3.28) numbers, given that Astro operates in a different business environment vis-à-vis its Indonesian peers. This is because Astro has a dominant presence in the pay TV market in Malaysia.

Our TP of IDR6,250 is based on DCF valuation, which we believe is the most appropriate methodology to reflect Link Net’s medium- and long-term growth prospects. We assume a risk-free rate of 8.0%, market risk premium of 5.0%, equity beta of 0.8 and TG rate of 3.0%, which results in a WACC of 11.6%.

Valuation
We assume a risk-free rate of 8.0%, market risk premium of 5.0%, equity beta of 0.80, cost of debt of 7.5% (after tax) and a TG rate of 3.0%, which results in a WACC of 11.6%. We believe that DCF is the most appropriate valuation methodology for this stock as it captures the company’s medium- and long-term growth prospects. Our TP also implies 30x/23.2x FY15F/FY16F P/Es respectively.

In our model, we take into account the competition in the industry, the economic slowdown in Indonesia and the depreciation of the IDR. We also assume an additional 158,000 broadband and cable TV subs for the company, or an increase of 34.0% YoY, in FY15. We expect Link Net’s ARPU growth to be muted in FY15F-17F, due to competition, and estimate broadband ARPU at IDR225,000 (FY15) and IDR232,695 (FY16). Meanwhile, we also estimate for its pay TV ARPU to be at IDR190,000 (FY15) and IDR195,957 (FY16).

Risks
Macroeconomic downturn. Further deceleration in the economy could continue to hurt customers’ purchasing power, which would in turn lead to slower subs growth.

Weaker IDR
Link Net has some exposure to USD/IDR fluctuations through their content purchases (for pay TV) and set top box costs. A further weakening of the IDR could pressure margins.

Increasing competition
More intense competition in the fixed broadband space may intensify, as new entrants such as IndiHome, MNC Play Media Go and Biznet could go up against Link Net in the battle for market share.

ARPU pressure
Competition between incumbents and new entrants could lead to a price war, which could lead to lower ARPU.

Rising Internet Penetration
Rising internet industry in Indonesia. We are positive on the broadband sector due to several reasons, namely: i) rising wealth, ii) internet penetration, iii) e-commerce, and iv) growing urbanisation in Indonesia. According to Media Partner Asia, Indonesia’s wireless broadband internet penetration is set to grow to 108.0% in 2023 from 14.0% in 2013, on the back of a growing middle class. Furthermore, based on the data from EMC Research, we find that there is a growing population of Indonesians who believe that the internet is a necessity.

Riding on a wealthier generation and urbanisation trend
Indonesia’s population is young, growing and rapidly urbanising – making it one of the fastest-growing consumer markets in the world. We believe this could further drive the future take-up of broadband and pay TV in the country. Based on CEIC data, 60% of the population is below the age of 30 and still lives under one roof with the older generation.

We believe that, in the coming years, when this younger population gets older and moves out of the family home, this shift in the household dynamic can drive demand for broadband and pay TV. Furthermore, the population is swiftly urbanising. According to data from the World Bank, 54% of Indonesians shifted to the country’s urban centres from the rural areas in 2010.

The World Bank expects this number to rise to 67% in 2050. This trend should benefit Link Net, as demand for its services could grow, as well as the fact that its business is focused in Indonesia’s three largest cities. The urbanisation trend could also help to boost the penetration rate within the company’s coverage area, which stood at 27.5% in 2014.

Focus on high GDP cities
Link Net has a different customer focus when compared to its competitors. The company’s business is concentrated in the three largest cities in Indonesia – Jakarta, Surabaya and Bandung – and targets the affluent upper and middle income households. This is what Nielsen terms as “AB” and “C1” socio-economic types, where household income is greater than IDR2m per month.

According to 2013 data from Nielsen, there are approximately 4.1m households in Jakarta, Bandung, and Surabaya. In the future, Link Net plans to establish a presence in other cities in Indonesia that have dense population (ie a high number of people per sq km) and high GDP growth, eg Medan, Semarang and Jogjakarta.

Broadband Is a Cash Generator
Trio of business pillars. Link Net has a dominant market share in the broadband segment – excluding asymmetric digital subs lines (ADSL) – in Indonesia, at 98.0% based on its FY14 data. We believe that the company is in a prime position to capitalise on the Internet boom in Indonesia due to its dominant market share and the fact that there is no competition at the moment. As per FY14, around 56% of Link Net’s total revenue came from its broadband (household and corporate) unit while pay TV contributed 37%. The rest stemmed from installation charges and the sale of cable modems.

Broadband is the driver
We forecast for Link Net’s new subs could grow at a CAGR of 21.0% in FY14-17F and hit 1.35m in FY17 (FY14 subs: 755,000, 1H15: 813,357). However, the company’s broadband and pay TV ARPU growth may remain muted due to fierce competition from emerging new players. Despite the fierce competition that could pressure ARPU, we believe that Link Net is likely to be among the biggest beneficiaries of the Indonesian broadband industry, riding on the back of the country’s growing middle class, urbanisation trends and the growth of the e-commerce sector.

We also believe that broadband companies – having built the infrastructure long ago – may have a better and more mature infrastructure than telco players in terms of internet access.

Bundling Packages Makes All The Difference In Pay TV
Negative on pay TV industry alone
We are negative on the pay TV industry going forward as we believe that there are no premium differences between free-to-air (FTA) and pay TV channels. We believe pay TV packages are not attractive enough to draw the mass market. Furthermore, higher competition in the pay TV industry has put pressure on ARPU.

Pay TV more attractive when bundled with broadband
We believe Link Net’s pay TV business can complement its core business unit in broadband – which is the reason why we are positive on the company. As at FY14, 93% of customers subscribe to both next generation broadband (NGBB) and cable TV services from 91% in FY13. We also believe that the pay TV business could be a sweetener for Link Net’s broadband products and also help maintain high ARPU in the medium term.

Rising Competition Pressures ARPU Growth
New players may pressure ARPU growth. Competition in the fixed broadband market may intensify in the future, as new entrants such as IndiHome, MNC Play Media Go and Biznet would compete with Link Net over the number of subs. As more companies enter the broadband industry, and as they would offer relatively similar products or services, we believe pricing is likely to decline.

Such a scenario could have a negative impact on Link Net’s performance
The downside risk lies in ARPU growth being potentially muted, given tougher-than-expected competition, as well as the weaker purchasing power, as consumers feel the effects of an economic slowdown. We have imputed this into our model. We expect its ARPU for FY15 to grow 4.0% YoY to IDR225,000 from IDR216,000 in FY14.

We also see more tense competition in FY16 and FY17, as most of the new players would be ready to compete against Link Net. Therefore, we assume a lower ARPU growth of 2.5%/2.3% for broadband and pay TV ARPU respectively in FY17. We believe that the revenue growth would also depend on the volume, ie the number of additional subs.

Financial Highlights
Revenue and gross margins
Historically, Link Net posted average revenue of 28% in FY13-14. Topline growth was driven by the number of additional subs and higher ARPU. However, due to an expected rise in competition in the coming years, we believe that the company would book lower growth as we think ARPU is likely to be under pressure. We estimate for FY15/FY16/FY17 revenue of IDR2.43trn/IDR3.02trn/IDR4.19trn in respectively, implying a CAGR of 24% in FY14-17F.

Meanwhile, we forecast for FY15/FY16/FY17 GPM of 77.3%/76.8%/76.3% respectively on the back of softening ARPU growth and a weakening IDR, given that cable television costs are USD-linked.

High barriers to entry
For a new player to enter into the broadband market, the companies need to obtain multilevel permissions from Indonesia’s government. Besides the permission from Government, we think building broadband infrastructure could be the biggest barrier to entry – since it requires big chunk of capex.

Balance sheet
As of FY14, Link Net was still in a net cash position of IDR358.7bn, with gearing (debt/equity) of 3%. We estimate that the company may spend IDR995.1bn in capex in FY15 for expansion into new city and also to change the coaxial cable with fiber optic. Link Net is planning to launch their new project in Medan, if they see any improvement in Indonesia’s economy, as the infrastructure in Medan is ready.

Company background
Link Net is one of the leading providers of broadband (c.98% market share for cable technology ex-ADSL) and pay TV services in Indonesia. For pay TV, the company offers 120 standard definition (SD) and 60 high-definition (HD) channels. It caters to residential (ie household) customers, as well as corporate users – such as Bank Central Asia (BBCA IJ, BUY, TP: IDR14,400), Unilever Indonesia (UNVR IJ, NR), the Indonesia Stock Exchange (IDX) and more – with customised product packages.

Link Net also owns and operates an upgraded high-fibre coaxial (HFC) cable network passing 1.4m homes (as per FY14), which management targets to grow by 200,000 homes pa. The company’s services are available predominantly in Jakarta, Surabaya and Bali. Furthermore, Link Net also plans to expand its network to Medan, Semarang and Jogjakarta in the future and lift its homes passed number to 1.8m in FY16. This is as the company capitalises on the growing demand for broadband and bundles of digital video with high-speed internet.