Telecommunications Infrastructure Test Of The Fittest

We reinitiate coverage on the Indonesia Towerco sector with a NEUTRAL call premised on: i) the structural and operational headwinds impacting the sector in the longer term, ii) the still relatively attractive/superior EBITDA margin of the ITCs, iii) potential for opportunistic M&As, iv) and the valuation discount that the ITCs trade at when stacked against their global peers following the share price de-rating over the past 12-18 months. Our preferred pick is Sarana Menara (TOWR IJ, BUY, TP: IDR4,700) owing to its stronger balance sheet and hence scope for more inorganic growth.

Pricing pressure is getting intense
The latest transaction deal between XL and Sarana Menara in early 2016 indicated that the telco players are actually pressures the tower companies to lower the lease rates. We think that the latest transaction of towers sale has become the benchmark for the future rental contracts, as from the latest transaction deal, the lease rate per month per tower has maintained at IDR10mn/month/tower which is lowered compared to their average lease rate of IDR15mn/month/tower. In our view, the competition in the telco tower operators has given the telco operators many options to sell their towers and to get a better deal on lease rates.

Potential pressures on EBITDA margin in the long run
In our view, the EBITDA margin has not shown a decline in a lease rates for tower companies given it was still overshadowed by the existing lease rates (at a higher rate) which are contracted under 10-15 year master lease agreements. However, we believe that the new lease rentals on build to suit tower site will be lowered than the existing sites.

In the long run, we foresee that the average lease rates on existing towers will only have a marginal decline, because (1) the contract will expire at different time periods, (2) for the existing towers, it will not be easy for the telco operators to lower the lease rates as there are some legacy contracts that prohibit such changes.

Sarana Menara has a better position given their light balance sheet compare to peers. There are still a few potential towers sale, c. Indosat has 9,000 towers, Mitratel has 5,500 towers for sale in the future, from the big telco players or even from small carriers. Among these two players, we believe there is a better chance of Indosat to unload its tower assets in the medium term. With the net debt/EBITDA stood at 2x as of end Dec15 vs. Tower Bersama at 5.3x as of Dec15 – we believe Sarana Menara has a better chance to grow inorganically.

Micro cell pools is 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 pools (MCP) and fibre in FY16. As many of the telco operators are exploring microcells solutions to provide additional capacity in dense locations that limit the transmission radius of micro cells. As we understand that the 4G roll out are still focussing in the big GDP cities like Jakarta, Surabaya – we would see telco operators increasingly deploying microcells to meet capacity requirements in the dense cities.

Reinitiate the sector with a NEUTRAL call and Sarana Menara is our top pick
In the Indonesia tower companies, we prefer Sarana Menara (TOWR IJ, BUY, TP: IDR4,700). In our view, we think that the market has not priced in the recent inorganic growth from the acquisition of XL towers in early 2016. We think that the valuation of 11x EV/EBITDA is already attractive vs. Tower Bersama’s valuation of 16x EV/EBITDA given that Sarana Menara would have a better growth organically or inorganically compare to Tower Bersama.

Reinitiate Coverage With A Neutral Call
We reinitiate coverage on Indonesia’s telco tower industry with a NEUTRAL call and reinitiated coverage on companies in this sector with a BUY call on Sarana Menara Nusantara (SMN) and NEUTRAL call on Tower Bersama Infrastructure (TBIG). We reinitiate with a NEUTRAL call on the back of:
1. Consolidation in Telco industry that could lead to a slower network expansion and co-location requirement
2. Additional number of spectrum which lead the telco companies to expand without new tower
3. Intensifying competition from other tower companies – could lead to a soften return and growth (supply side problem)
4. Pressure on lease rentals

In our view, the strong earnings growth on average of 40% between 2010-2015 will not be sustainable – the high earnings in the previous years was due to the rapid rollout of 3G service since 2012-2013. In FY16, we foresee a potential near term to medium term slowdown in capex spending from telco operators as they re-farm 1800MHz spectrum last year. Furthermore, we also see that the network active and passive sharing in Telco industry will resulted into lower capex spending on BTS. We expect the earnings from the organic growth will not as high as before in FY16.
Why do we have a BUY call on Sarana Menara?

Decent track record on acquisition
Based on historical trend, Sarana Menara has proved to be succesfull in acquiring the towers from the telco operators, c. Hutchinson deal of 3,600 towers in 2008 and 2010, and the latest on XL towers deal in 2016. Sarana Menara is one of the least leverage tower companies globally – its net debt to EBITDA of 2.0x, which is much lower compared to an average global peers of 6.04x and from local peers, Tower Bersama of 5.3x. We think that Sarana Menara has more leeway in terms of balance sheet to do more acquisition of towers in the future. Some of the telco operators like Indosat is more likely to divest their towers and Sarana Menara will have the ability to grow inorganically.

Better growth outlook
We expect revenue and EBITDA CAGRs of 11.8%/12% over FY15-FY18F respectively for Sarana Menara – these metrics are better than their local peers c. Tower Bersama of 9%/10% over FY15-FY18F. These metrics reflect our additional new tower of 2,500 and tenancies of 3,750 from XL acquisition.

Sarana Menara (TOWR IJ, BUY, TP: IDR4,700) is our top pick in the tower industry due to its strong cash flow and healthy balance sheet to do more tower acquisitions (inorganic growth) – we believe that Sarana Menara has better financial capacity (net debt/EBITDA of 2x vs. Tower Bersama of 5.3x in FY15). We factor in the recent purchased of tower from XL Axiata and expect the revenue to grow by 15% in FY16. After the purchased of XL’s towers, Sarana Menara will become the biggest ITC in terms of towers by 14,737 in FY16.

Tenancy outlook somewhat looks uncertain
Given that the current condition of Indonesia tower sectors – there are still uncertainty on tenancy outlook given revenue contribution from the big 3 telco operators. As we understand from the telco companies perspectives like Indosat and XL that would probably scale back their expansion on new BTS in FY16 after the finalisation of refarming for Indosat and restructuring to lowered their leverage for XL and Indosat. We would see the new net adds to declined for Tower Bersama.

We have seen the slowdown in new tenancies in FY15, as the revenue contribution from XL and Indosat have been reduced and resulted into only 1,715 net adds of tenancies in FY15. We forecast that in FY16, the new net adds of 1,400 or lowered compared to a historical average of 4,179 between FY12-FY14.

Inability to grow inorganically due to their tight balance sheet
We notice Tower Bersama’s net debt/EBITDA has reached 5.3x in FY15 (almost reach their covenant of 6.5x). This implies that Tower Bersama has a limited room to further leverage its balance sheet to either build more towers ahead or grow inorganically. In FY16, where we expect the organic growth to remain muted. But, we think that the inorganic growth from the tower sale from the telcos players are still on the table.

The next tower tender would probably come from Indosat. In our view, inorganic growth is a way to improve their revenue and EBITDA simultaneously, and in turn it could drive the share price in the event of muted organic growth. However, given their stretched balance sheet – it is unlikely for the company to grow inorganically.

We are NEUTRAL on Tower Bersama (TBIG IJ, NEUTRAL, TP: IDR6,450) as we expect a slower additional tower tenancies of 1,400 towers/year and the tenancy ratio of 1.67 in FY16 – we think that the organic growth will be muted this year due to the slowdown of capex from telco operators. In our view, it would be hard for the Tower Bersama to grow inorganically given their high gearing level.

Competition in the tower industry is getting more intense
Indonesia tower companies’ EBITDA and tenancy ratios have long been admired which attracted some of the new entrants in the market – in our opinion, the new entrants has created a pricing pressure to the big Independent Tower Companies (ITC) like Sarana Menara and Tower Bersama. The cancellation of the Mitratel deal with Tower Bersama in FY15, as the owners of Telkom terminated the deal at the behest of the commisioners.

The future of Mitratel and their 5,500 towers remains uncertain. As a results, Sarana Menara is still the market leader with 12,156 towers in FY15. Tower Bersama is the second largest with 11,389 towers in FY15, and Solusi Tunas Pratama (STP) (SUPR IJ, NR) owned 6,790 towers. PT Inti Bangun Sejahtera (IBS) owns 2,185 towers, and PT Komet Infra Nusantara (KIN) that owns 450 towers is still flush with capital injection from telecom and towerco throughbred PE-firm Providence equity and fuelled by a strategy to roll up selected small local towercos, of which Indonesia have dozens.

Lower bargaining power of ITC on the back of competition and consolidation among telco operators. Currently, the lease rate of tower is at IDR15mn/month for ITCs. Meanwhile, the new entrants are surprisingly offering lower lease rate at a discount compare to ITCs, such as Sarana Menara and Tower Bersama. Based on the transaction deal between XL and Solusi Tunas Pratama (SUPR IJ, NR) in 2014, whereby XL sold 3,500 towers and lease it back from Solusi Tunas for IDR10mn/month/tower without inflation escalator yearly.

Furthermore, this value transaction has continued in the latest transaction deal between XL and Sarana Menara – it has indicated that the telco players are actually pressures the tower companies to lower the lease rates. We think that the latest transaction of towers sale has become the benchmark for the future rental contracts, as from the latest transaction deal, the lease rate per month per tower has maintained at IDR10mn/month/tower which is lowered compared to their average lease rate of IDR15mn/month/tower.

In our view, the competition in the telco tower operators have given the telco operators many options to sell their towers and to get a better deal on lease rates. These smaller players are also willing to compromise on the terms and conditions of the lease contracts, making it even more attractive to the telco operators. The discount rate given from the smaller players have created a downwards pressure on Sarana Menara and Tower Bersama’s new tower lease rates.

Potential pressure on EBITDA margins in the long run
In our view, the EBITDA margin has not shown a decline in a lease rates for tower companies given it was still overshadowed by the existing lease rates (at a higher rate) which are contracted under 10-15 year master lease agreements. However, we believe that the new lease rentals on build to suit tower site will be lowered than the existing sites. In the long run, we foresee that the average lease rates on existing towers will only have a marginal decline, because (1) the contract will expire at different time periods, (2) for the existing towers, it will not be easy for the telco operators to lower the lease rates as there are some legacy contracts that prohibit such changes.

We foresee the potential decline in EBITDA margin from (1) intensying competition in the tower industry, which has attracted several new entrants and (2) the new towers that they built will have a lower lease rates. Based on the telco operators, the lease rate has been declined since last year, and the telco operators have looked into the tower operators that could give the most favorable lease rate.

To get a better understanding on the long run dilution of a decline in lease rate on new tower, we conducted an analysis to show its impact on total return on investment per tower sites. In our view, every 5% change in lease rates, the IRR will drop by 1.5% for TOWR and TBIG. Note that our scenario in figure 13 and 14, assuming each new tower starts off with 1.7x tenancy ratio from year one. Realistically, the cash flow per site for the first few years is lower than what we have built into our scenario.

No more high capex on tower from telco operators
The revenue growth of the tower companies in Indonesia’s during rapid rollout of 3G service in 2012-2013 have so significant; where Tower Bersama booked an average 61% revenue growth between 2012-2013 and Sarana Menara booked an average 40% revenue growth between 2012-2013. We disagree the concept of new rollout from new technology could translate into an equivalent growth in the tower companies, because not every 4G BTS activated by the telcos will require a new tenancy spot on a tower. As the Government plan to roll out 4G services on the 900MHz spectrum, with service later expanding to the 1,800MHz band.

More than 50% of the telcos’ companies 3G BTS are running on single “Radio Access Network” (RAN), which means it is equipped with the technology to serve 4G LTE devices; only a few adjustments to the BTS are required to switch it from 2G/3G to 4G. In our opinion, the telcos’ companies will invest more into fibre rather than additional number of towers in order to ensure a high quality 4G LTE service. Thus, we believe the capex proportion for BTS will be limited in FY16 and the telcos’ companies will focus on rolling out fibre optic cables.

Land lease rate will be more expensive. In the cost side, land lease expenses are subject to negotiation as well with the landlords each renewal cycle (probably around 10 years). In the long run, we think that the landlords demand a higher lease rates which could result into a higher than inflation adjustments on an annualised basis. As we believe, the landlord are now more knowledgeables and it will be difficult for the tower companies to renegotiate the lease with the landlords.

With regards to new sites location rates, in our view, it would be even more escalated than the existing ones. In addition to the smarter landlords, the community consent agreement will become harder and more expensive to obtain. As we understand now the land is getting scarcer, we think that the local community would demand a higher compensation from the tower companies.

Remain Positive In The Long Run
Positive outlook for telco towers operators in the long run. In our view, we could see a potential slowdown in near terms – as telco operators are slowing down their capex spending on BTS after some of they re-farm 1,800Mhz spectrum. However, we remain positive on the tower sector in Indonesia as we think that data consumption would lead the growth in Indonesia tower sector in the long run. There are several reasons why we foresee the telco towers operators still have a positive outlook going forward:

Inorganic growth are still in the table
New oppportunities arising from the Micro Cell Pools (MCP) and fibre
Development in the Eastern part of Indonesia that requires new BTS
Data traffic is expected to grow significantly in the coming years, fostering nationwide 4G deployment
Highest return compare to the Global peers
Low valuation compare to peers

Inorganic growth are still on the table for telco towers operators
In the past, we saw some improvement in earnings for telco towers operators in the event of tower divestment from telco operators. Furthermore, the share price of the telco towers operators also increase significantly post acquisitions.

The recent transaction deal between XL and Sarana Menara is a good catalyst for both parties, whereby XL announced the sale of 2,500 towers which will be completed by mid 2016 at IDR3.57trn – the sale is schedulled for completion by June 30, paid by mixed of debt of IDR3trn and cash of IDR568bn. XL will lease 2,432 towers for 10 years, with anchor tenant rents of IDR10mn/month/tower, which IDR2mn/month is escalated at inflation. For Sarana Menara, this transaction could escalated their interest expense as the company need to borrow IDR3trn from the banks.

We expect the interest expense would increased to IDR730bn in FY16 from IDR550bn in FY15. However, we think that the transaction would improved their number of sites at 14,643 (up from 12,211) – making the company a clear leader in the tower industry. In addition, the company also managed to closed the deal at a valuation of USD108k/tower which is lower than the previous transaction (USD131k/tower). In our view, the transactions could give a positive impact to the company, as the company could add an additonal 3,750 new towers which could implicated into a better revenue, EBITDA (around IDR300bn) from more towers.

There are still a few potential towers (Indosat has 9,000 towers, Mitratel has 5,500 towers for sale in the future, from the big telco players or even from small carriers. The cancellation of divestment of Mitratel in FY15 due to some reasons – in our view, the divestment of Mitratel might not be happened at all. Among these two players, we believe there is a better chance of Indosat to unload its tower assets in the medium term.

Sarana Menara has a better financial capability to capture the inorganic growth
Sarana Menara and Tower Bersama’s net debt/EBITDA stood at 2.0x and 5.3x as of end of Dec15. Although, their balance sheet looks stretched, we think there is some room for both companies to acquire more towers with debt financing given 1) relatively lenient loan covenants on both companies.

For Sarana Menara debt covenant, the requirement is to keep the net debt to annualised EBITDA below 5x. Meanwhile, for Tower Bersama, the requirement is to keep the net debt to EBITDA below 6.5x. Based on our calculation, we see that Sarana Menara has a better position to raise more debt in order to finance the inorganic growth – the company could raise another IDR10trn of debts in FY16. Meanwhile, we think that Tower Bersama has a tight balance sheet to grow inorganically – based on our calculation, the company could only raise another IDR3trn of debts in FY16.

Based on the last transacted value of tower sale in Indonesia of USD108k/tower – we estimate that Sarana Menara could acquire additional 7,000 towers and 2,000 additional towers for Tower Bersama. Based on our number, it shows that Sarana Menara is better prepared for inorganic growth in the near future, in our view.

New opportunities arising from the Micro Cell Pools (MCP) and fibre
In the meantime, we see some potential growth in the new areas from the telco towers operators from the micro cell pools (MCP) and fibre in FY16. As many of the telco operators are exploring microcells solutions to provide additional capacity in dense locations that limit the transmission radius of micro cells.

The advantages of the micro cells for telco operators, are it can be deployed in many types of locations, such as small shop houses, enterprise buildings, street cabinets, etc – facilitating their deployment in dense urban locations such as Greater Jakarta. In Indonesa, there are three companies that have the licensed to deploy micro cells in Jakarta, c. BIT (an STP subsidiary), PT iForte Solusi Infotek (iForte), and PT Citra Sari.

In May 2015, Sarana Menara signed an agreement to acquire 100% of iForte shares from Saratoga group. The acquisition of iForte by Sarana Menara is to be added to business portfolio of Sarana Menara, which currently has 11,675 towers with 20,325 tenants as of December 2015. iForte manages over 500 micro cells towers and 7 based transmission services (BTS) hotels in operation. Furthermore, it also owns and operates over 750km of fibre optic network with over 180 points of presence in Metropolitan Jakarta and Surabaya.

In our view, this transaction could benefit Sarana Menara in FY16 – as the company could grow their micro cells business. As we understand that the 4G roll out are still focussing in the big GDP cities like Jakarta, Surabaya – we would see telco operators increasingly deploying microcells to meet capacity requirements in the dense cities.

Furthermore, micro cell poles provides more favorable economics value that the traditional macro towers (higher revenue, lower capex) and greater scalability for telco operators, as they allow faster development and lower capex per cell (less land space is required, so they are less capital intensive and require less time to construct).

Cherry picking in the industry
In figure 18, we saw that Indonesia tower companies have a lower P/E and better ROE compare to global peers. Valuation wise currently, the negative news on the slowdown of capex spending from telco operators, competition from smaller players, and lower lease rates have already priced in from the share price. The sector valuation at 11x-16x EV/EBITDA vs global peers at 17x-18x EV/EBITDA is already attractive given the potential for re-rating in Indonesia tower sector in the long run.

In the Indonesia tower companies, we prefer Sarana Menara (TOWR IJ, BUY, TP: IDR4,700)
In our view, we think that the market has not priced in the recent inorganic growth from the acquisition of XL towers in early 2016. We think that the valuation of 11x EV/EBITDA is already attractive vs. Tower Bersama’s valuation of 16x EV/EBITDA given that Sarana Menara would have a better growth compare to Tower Bersama. The company do not only depend to grow organically – the company light balance sheet and healthy financial cash flow would drive the growth inorganically. Furthermore, their healthy FCF could also translate into possibility of paying a dividend.

Sarana Menara share price looks more stable
The share price of both tower companies were jumped significantly in FY12-FY13 on the back of rapid rollout of 3G service in Indonesia. Most of the telco players disbursed a huge amount of capex to expand and add a new BTS. We saw that the share price re-rate at that time. Moreover, it was supported by the inorganic growth as well – Tower Bersama succesfully acquired Indosat towers in FY12. While, Sarana Menara acquired Hutchinson towers in FY12.

Meanwhile, in FY15 we started to see a slowdown in the new BTS from the telco operators – as some of the telco operators were concerned to reduce the leverage and also refarming the 1,800Mhz. Besides, some of the smaller telco players like Bakrie Telecom was at the downside.

Despite the slowdown in the tower industry in FY15, Sarana Menara has been able to grew better than Tower Bersama in terms of revenue and EBITDA. Sarana Menara’s revenue and EBITDA grew at 9%/11% respectively. While, Tower Bersama’s revenue and EBITDA grew at 4%/8% respectively. The primary driver of Sarana Menara’s better performance was due to their acquisition of Micro Cell Pools (MCP) companies, PT iForte in May 2015.

These inorganic growth has helped to support the slowdown in the organic growth. We foresee that Sarana Menara’s better financial cash flow and balance sheet would supported the growth for the company in FY16. Thus, we prefer Sarana Menara over Tower Bersama in Indonesia Tower industry.