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What happened to telco stocks last week?

/ 05:08 AM November 12, 2018

Telco stocks were among the most actively traded issues last week as the winning bidder for the third telco license was finally chosen. The consortium composed of businessman Dennis Uy’s Udenna Corp. (ISM) and Chelsea Logistics Holdings Corp. (CLC), state-run China Telecom and Mindanao Islamic Telephone Co. Inc. (Mislatel) was named the provisional third telco.

As expected, stocks of other potential third telco candidates that did not win were sold down. These included Transpacific Broadband Group, MRC Allied Inc., NOW Corp., EasyCall Communications and Vulcan Industrial Mining. In fact, none of these companies submitted a bid for the third telco license.

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What was surprising though was the significant drop in the shares of PLDT (TEL) and Globe (GLO). Although the public already knew that the bidding for the third telco license was on Nov. 7, TEL and GLO were only sold down when the names of the actual bidders were announced. In fact, shares of TEL and GLO fell even more significantly after the Uy-China Telecom-Mislatel consortium was named the provisional third telco.

Admittedly, we underestimated the threat of the third telco player. Prior to the actual bidding, we thought that there would be very little, if any, interest in the third telco license. This is because of the government’s very strict requirements for the potential third telco which include a high level of capex, fast minimum speed and wide coverage requirements in a short span of time with stiff penalties for noncompliance. In fact, the consortium of Converge ICT and Korea Telecom raised this as one of the main reasons why it decided not to participate in the bidding for the third telco license.

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Aside from the high level of service quality required of the third telco, the government has yet to come out with a common tower policy. This raises the amount of capex required by the new player to succeed. The winning bidder is also prohibited from selling out to either of the two incumbents in case it fails. Coupled with the high penetration rate of telco services, the strength of the two telco giants and the low prices of data, it would be very difficult for the new entrant to operate profitably in the local telco industry.

While the challenges facing the third telco are still the same, what surprised us was the aggressiveness of the Uy-China Telecom—Mislatel consortium’s bid.

Note that the consortium committed to spend P150 billion in capital and operating expenditures in its first year of operation and spend a total of P258 billion in five years. In contrast, the government’s minimum capex requirement is only P40 billion in year one and P25 billion annually for the next four years. PLDT and Globe each currently spend only around P50 billion to P60 billion annually on capital expenditures.

The winning consortium also promised to deliver a minimum average internet speed of 27 Mbps and cover 37 percent of the population on its first year, increasing to 55 Mbps and cover 84 percent of the population in five years. In contrast, the government is only requiring a minimum average internet speed of 5 Mbps and a coverage of 10 percent of the population in year one. Furthermore, the Philippines’ mobile speed is only 6.03 Mbps as measured by OpenSignal in September.

If the consortium succeeds in delivering its commitments, then the third telco would really be a major threat to PLDT and Globe. Aside from the quality of service committed by the consortium, compared to the other potential third telco players, the Uy-China Telecom-Mislatel consortium has more resources and much deeper pockets to deliver on its commitment.

Note that China Telecom earned P146 billion in 2017. Moreover, being a Chinese state-owned enterprise, it is not expected to be as concerned with profitability as any normal privately owned company.

Meanwhile, Uy is a very aggressive businessman who recently entered several new businesses, including food (Enderun, Conti’s), retail (FamilyMart), casino and airports (Uy’s CLC recently secured the original proponent status for its unsolicited proposal to operate, maintain and expand the Davao International Airport).

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Whether or not the consortium will succeed remains uncertain. As such, we also don’t think the strong performance of ISM and CLC is sustainable in the short term. However, given what is known about the winning consortium and its plans, PLDT and Globe cannot afford to be complacent. As a defensive strategy, the two companies will need to improve their service quality faster to discourage their clients from switching to the third telco. This requires a higher capex budget and higher expenses. Moreover, once it is ready, the third telco would most likely engage in a price war with PLDT and Globe to grab market share. This, in turn, will hurt the revenues and profitability of the two incumbents, which are only now seeing profits grow sustainably. The shares of TEL and GLO were sold down most likely because of these risks.

I remain positive on both TEL and GLO over the long-term as demand for data continues to grow rapidly, benefiting the two companies. However, until the actual numbers prove that TEL and GLO can peacefully coexist with the third telco and that profits can continue to grow, sentiment for both stocks will most likely stay poor. Until then, investors of TEL and GLO will need to wait patiently.

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