Studio Press

IT lost out in the recent third-generation (3G) spectrum licence battle and has seen its share price succumb to weak sentiment on concerns over heightening competition in the domestic telecommunication industry.

Small wonder then that DiGi.com Bhd last week saw fit to reinforce the case for the investment community to hold on to its shares.

It did this with a surprise announcement of a second capital repayment of 60 sen per share, even before its first capital repayment of 75 sen per share is completed. The first exercise was proposed last October.

The news produced the desired effect as evidenced by DiGi's share price performance the following day, and the slew of analysts' reports that followed, many of them containing earnings and rating upgrades.

Several analysts have noted that the mobile operator is increasingly turning into a yield play, a point that has gathered strength following the management's assurance last week that the company's dividend policy involving a payout of more than 50% of net profit remains intact despite making over RM1bil in capital repayments.

As pointed out by Hwang-DBS Vickers Research, the telecommunication company (telco) is still in a mild net cash position.

In addition to the RM700mil unused commercial papers and medium-term notes facility it has on standby to finance its capital exercises, DiGi is expected to generate in the region of RM1.5bil in operating cashflow.

This would bring its sources of funds to about RM2.2bil.

“DiGi is expected to make an interim dividend in the second half of the year. We expect a gross dividend of 52.1 sen for FY06,” Hwang-DBS Vickers says.

The analyst says it is rare for a company in a capital-intensive business to be in a net cash position. “As such, we feel DiGi still has the capacity to issue bigger dividends”.

A foregin brokerage reckons that after 2006, DiGi will be very similar to Singapore's MobileOne Ltd, which is experiencing slow growth but has lots of cash for dividends.

This is because, unlike its rivals, it has the benefit of leaving investments in other regional markets to its parent Telenor ASA.

A Stronger 2006

Upon completion of the two capital repayment exercises, DiGi’s paid-up capital will be reduced from RM750mil to RM75mil.

Its shareholders’ fund would be lowered from RM2.25bil to RM1.24bil, and its net tangible asset per share reduced from RM3.00 per share (RM1.00 par) to RM1.65 per share (10 sen par).

The reduction in its shareholders’ funds will raise DiGi’s gross gearing (based on borrowings of RM300mil) to 0.24 times from 0.13 times after the capital repayments.

But the exercises will have a positive effect on the company’s return on equity, which will be boosted to about 38% from 21% in FY05.

It helps that the management has guided that net profit in the current financial year ending December 2006 is likely to be firmer and its capital expenditure lower now that the mobile operator does not have to proceed with a 3G rollout.

In a conference call with analysts, the management said it expected revenue to experience mid-teen growth, compared with its earlier guidance of 10%-15% growth.

This is expected to translate into a net profit growth of at least 20%, against earlier expectations of increases in the mid-teens.

Still, DiGi's EBITDA (earnings before interest, tax, depreciation and amortisation) margin for the full-year is expected to be softer.

A few have taken this is an indication that DiGi's operating environment is set to get tougher still. But others, clearly more sanguine, say the mobile operator still has at least a year to go before it has to worry about real competition arising from the country's four 3G players.

DiGi lost out to MiTV Corp Sdn Bhd and TT dotCom Sdn Bhd, a unit of Time dotCom Bhd, in the latest 3G beauty contest. The two will join incumbents Telekom Malaysia Bhd (TM) and Maxis Communications Bhd in the domestic 3G arena.

Alternatives to 3G

Right now, lack of content and expensive handheld devices are putting the lid on demand. DiGi nevertheless is already on the look out for alternative technologies to 3G.

Says AmResearch, “Where we had raised the discount applied from 20% to 30% to reflect the negative outcome of the 3G bid, the sharp discount is no longer necessary as we believe DiGi would be able to deploy alternative technologies that would enable it to remain competitive in the provision of mobile broadband service,” it says.

According to Hwang-DBS Vickers, one of the options open to DiGi is the second-generation Enhanced Data GSM Environment (EDGE) technology that can potentially offer twice the bandwidth of its current EDGE technology.

“As the existing EDGE technology is comparable to 3G in terms of actual speed experienced by users, we are hopeful that the EDGE2 technology will help DiGi retain its competitiveness,” the research house says.

Also, the existing 3G technology can be deployed on 1800MHz, which is the spectrum that the telco is currently using to offer its GSM services.

The question is whether the Government would allow DiGi to offer 3G services using its 1800MHz spectrum.

At any rate, AmResearch says the latest news of another capital repayment would see positive reactions from investors.

It notes that the revisions in DiGi's profit and capex have increased its discounted cash flow valuation from RM11.37 per share to RM12.06.

By applying a smaller discount of 10% to its discounted cashflow valuation, the house has a revised target price of RM10.86 on the stock, and has upgraded its call to buy.

Even from a valuation standpoint, some seem to think that the investment case for DiGi remains compelling given that it is the cheapest telco in the country currently.

Its shares trade at about 12 times (x) and 11x FY06 and FY07 earnings, respectively.

Hwang-DBS Vickers also makes a note of the point that in addition to DiGi's 15.3% net yield from the RM1.35 capital repayment (in total), its 6% regular gross yield is comparable to Maxis' 6.4% and higher than TM’s 4.4%. -the Star