Sarana Menara Nusantara Better Positioned To Capture Inorganic Growth

We re-initiate coverage on Sarana Menara with a BUY given: Its balance sheet is stronger compared to peers (net debt/EBITDA ratio at 0.9x vs peers’ at 5.1x); Micro cell poles are its growth catalyst. Putting aside the softening organic growth in tower industry, we think that inorganic growth is still on the table. Our DCF-based TP (WACC : 8.5%, TG: 3%) of IDR4,700 (11% upside) implies 10x EV/EBITDA FY17F. We think that the current valuation is already attractive vs Tower Bersama’s and global peers’ of 14.7x and 15.9x EV/EBITDA FY17F respectively.

Factoring XL’s towers
The slowdown in organic growth for towercos has probably compelled Sarana Menara Nusantara (Sarana Menara) to pursue the recent deal to acquire 2,500 towers from XL Axiata (XL) (EXCL IJ, BUY, TP: IDR4,550). The purchase consideration of IDR3.57trn implies USD108,000/tower, a 20% discount to the price Solusi Tunas Pratama (SUPR) (SUPR IJ, NR) paid for 3,500 of XL’s towers in late 2014 while leaseback rates (at IDR10m/month/tower) were similar.

This suggests continuing pressure on new lease rates in the market. Sarana Menara’s lease agreement also has a typical inflation escalation clause built-in, which was not part of SUPR’s transaction. We factor in XL’s towers into our forecast assuming the deal’s completionin 2H16. In our view, the additional towers/tenancies could boost our FY16F revenue by 15% and EBITDA by IDR360bn.

Sarana Menara is in a better position for M&A given its light balance sheet. There are potential for more tower sales as telcos look to hive off non core assets. We believe that there is a good chance of Indosat to dispose more of its towers in the medium term. With Sarana Menara’s net debt/EBITDA of 0.9x (as of end 1Q16) vs Tower Bersama Infrastructure’s (Tower Bersama) 5.1x as of 1Q16 – we believe the former has a better chance to grow inorganically.

Micro cell poles are the growth catalyst for Sarana Menara
In the meantime, we see some potential growth in the new areas from the telco towers operators from the micro cell polesand fibre in FY16. As many of the telco operators are exploring microcell solutions to provide additional capacity in dense locations. As we understand that the 4G roll out is still focused in the big GDP cities like Jakarta, Surabaya – we are likely to see telco operators increase the deployment of microcells to meet capacity requirements in the dense cities.

Reinitiate with BUY call with TP of IDR4,700 (11% upside)
Among the Indonesia tower companies space, we prefer Sarana Menara. We think the market has not priced in the recent inorganic growth from its acquisition of XL towers in early 2016. We factor in the additional income from the acquisition of XL towers and potential growth from micro cell poles. Thus, our forecast is slighlty higher compare to street’s. Valuation-wise of 10x EV/EBITDA is already attractive vs Tower Bersama’s valuation of 14.7x EV/EBITDA, given that Sarana Menara would have a better growth compare to the latter.

1Q16 Performance On Track
Hutchinson and XL supported the growth of Sarana Menara
1Q16 results inline with our/consensus numbers. Sarana Menara reported a 1Q16 EBITDA of IDR1,000.5bn (+12% YoY; -3% QoQ) – representing 23% of our forecast and consensus. Meanwhile, EBITDA margin improved to 85.5% in 1Q16, from 83.3% in 1Q15 – this was due to the lower cost of revenue by 11% YoY on the back of an exclusion of electricity cost from Telkomsel.Revenue in 1Q16 grew by 10% YoY to IDR1.17trn, which is in line with our forecast at IDR1.18trn for 1Q16.

The revenue was supported by a higher contribution from Hutchinson Indonesia (+6.3% YoY) and XL (+2.3% YoY).In 1Q16, Sarana Menara reported a decrease in value of investment properties of IDR213bn (vs IDR460bn gain in 1Q15). As a result, earnings were down by 22% YoY to IDR518bn, from IDR667bn in 1Q15. Tower tenancy ratio slightly declined in 1Q16. As at March, Sarana Menara had 20,951 telco tenants (+3% YoY) and 12,255 telco towers (+5% YoY) with 1.71x tenancy ratio. The tenancy ratio had slightly declined from 4Q15 of 1.72x.

Net debt to EBITDA remained at 0.9x in 1Q16
Sarana Menara’s net debt was at IDR6.48trn as at end-1Q16 – remaining flat from its 4Q15’s net debtof IDR6.7trn. Its net debt to EBITDA (4Q15 annualised EBITDA) remained at 0.9x at the end of 1Q16 (vs 0.9x at 4Q15) – which is still below its net debt covenant of 5x. We expect that this figure to shoot up to 1.6x in 2Q16, as the company is likely to use debt financing for its acquisition of XL towers in 2Q16.

Expect an impact on tower purchase in 2Q16. We estimate FY16 revenue and EBITDA accretion of 15% and 14%, assuming the tower deal is completed in June 2016. We estimate additional IDR360bn from the XL tower acquisition. Our assumption is based on tenancy ratio at 1.5x and 80% EBITDA margin from the new additional towers. The recent tower acquisition deal between Sarana Menara and XL of USD275m was lowered compared to the previous transaction from the same seller to STP of USD450mn. Furthermore, Sarana Menara’s deal is better compared to the previous deal, as the former has been able to negotiate on the inflation adjustment pa.

Sarana Menara’s valuation looks attractive
Attractive valuation. Among Indonesia’s tower companies, we prefer Sarana Menara. We think that the market has not priced in its recent inorganic growth from its acquisition of XL towers that would be completed in June 2016. We think that the valuation of 10x FY17 EV/EBITDA is already attractive vs Tower Bersama’s valuation of 14.7x EV/EBITDA given that the former would have a better growth. In our view, the company’s light balance sheet, and healthy free cash flow (FCF) could give it an advantage to grow inorganically. Furthermore, its healthy FCF could also translate into the possibility of paying a dividend.

Historically, Sarana Menara’s valuation has always been cheaper compared to Tower Bersama, due to its stock liquidity. Based on the historical trend, the discount is at 30%. Given the better outlook in FY16, we think that the company’s valuation is already attractive. Sarana Menara’s valuation has always been at a discount to Tower Bersama due to stock liquidity. However, we think that the valuation is attractive on the back of its growth potential vs Tower Bersama.

Valuation
We assume a risk free rate of 8%, market risk premium of 5%, equity beta of 0.5 and terminal growth of 3%, which result in a WACC of 8.5%. We believe that DCF is most appropriate valuation methodology, as it captures the medium and long term growth prospects of Sarana Menara.