Telekom Malaysia: Is There Anybody Out There?

The following article on Saturday's Starbiz from Errol Oh highlights the issues within Telekom Malaysia.

The double flip-flop as mentioned by Errol Oh was unreal.

• Crossed lines over TM dividends
  
  THE management of the turning point was when senior executives spoke to analysts in a conference call the following morning. TM’s representatives included group chief executive officer Datuk Zamzamzairani Mohd Isa and group chief financial officer Datuk Bazlan Osman.
  
  That day, the stock plunged 18% from Tuesday’s close of RM3.30 to end trading at RM2.79. The selldown continued on Thursday, pushing the share price to an intraday low of RM2.54 before it came to a rest at RM2.77.
  
  In response, TM issued a statement through Bursa Malaysia on Thursday to say the dividend policy “remains unchanged for 2009 and beyond”. That has helped calmed things down. The shares never fell below RM2.77 last Friday.
  
  The company calls the statement a reiteration of its stand on the policy. There are others who see it as a double flip-flop. At first, the policy was on. Then, it wasn’t. And then, it was on again.
  
  According to analysts who participated in last Wednesday’s teleconference, the attention shifted to the dividend policy when somebody noticed that the dividend policy statement in TM’s presentation contained the phrase “in the current year”.
  
  (It’s interesting to note that last week’s quarterly report contains these lines: “Due to the global economic uncertainties, the board of directors expects TM’s performance for the financial year ending Dec 31, 2008 to remain challenging. However, TM continues to be committed to its current year dividend policy.”)
  
  To the analysts, the reference to the current year was an indication that TM might not stick to the policy after 2008. They asked questions to clarify the matter, but analysts who spoke to BizWeek say the TM management was tentative and vague when pressed about its commitment to the policy.
  
  The main point that the analysts gathered from the management was that the dividends for future years will depend on the excess cash available.
  
  To the analysts, that’s a departure from the dividend policy articulated in December last year, when TM announced the demerger plan that led to the listing of TM International Bhd. For some investment houses, it was a development that merited a downgrade of the stock. Thus, we saw the heavy selling.
  
  The investment case for TM is built largely on its ability to pay generous dividends. A big chunk of its earnings come from mature and stable businesses such as fixed-line voice and data, and these provide a steady cash flow. This makes TM shares a safe haven and this is essentially how TM positions itself with investors.
  
  However, when it appeared that the management did not stand solidly behind the dividend policy during the teleconference, it was seen as a signal that all bets were off. The analysts and investors wondered if TM’s growth plan would be more aggressive than expected, and thus would leave it with less cash to distribute to shareholders.
  
  TM’s announcement on Thursday may have dispelled these doubts, but in the first place, how did things go wrong in a routine conference call?
  
  There are two possibilities. One, it was never TM’s intention to drop the dividend policy but the management somehow failed to get this message across clearly during the teleconference. Two, the TM management indeed wanted to revise the policy but had a change of heart after the stock got a pummelling.
  
  Either way, the management underestimated the importance of what it needs to say about the dividend policy. Sure, the policy is never meant to be a guarantee, but it’s nevertheless central to how analysts and investors evaluate the stock. If TM is adhering to the policy, there shouldn’t be any ambiguity in telling the analysts so.
  
  On the other hand, if TM is convinced that the circumstances have changed since last December, to the point that the dividend policy can’t no longer be upheld, the management should be upfront, lucid and persuasive about it. It would be bad news for the investors, but not as bad as being blindsided by a stealthy switch.

And it's not a shock to me that Credit Suisse has quickly downgraded the stock to UNDERPERFORM with a TP of rm 2.30!

I am lucky enough to get a hold of that copy and here are Credit Suisse reasoning.

• In a surprising conference call with investors, Telekom Malaysia's management stated that its dividend policy (RM700 mn, or 90% of normalised PATMI), which in our view underpins the value of the stock, was now under review for FY09.
  
  Rather than focussing on maximising cash flow generation from existing operations, management's strategy seems to be shifting towards more aggressive investment in non-core areas (e.g. IPTV, content, business process outsourcing) in an attempt to grow.
  
  Following very weak 3Q08 headline results (due to a variety of 'one-off' items), we have cut our FY09 EBITDA and net profit forecasts by 12.6% and 46.2%, respectively. Our FY08 headline earnings forecast has been revised down by 64.1%.
  
  Our DCF-based target price declines by 42.7% from RM4.02 to RM2.30, on assumptions of structurally lower EBITDA margins, and an increase in WACC from 9.9% to 13.0% (earnings and dividend certainty is now under threat). Rating downgraded from Outperform to UNDERPERFORM.
  
  Dividend policy amended (negatively)
  In a surprising conference call with investors, management confessed that a subtle change in wording in its presentation, which stated that the company was committed to a dividend policy of RM700 mn, or 90% normalised PATAMI, whichever higher, in the current year was in fact a statement that the dividend policy (which underpins the valuation of the stock) was effectively under review for subsequent years.
  
  Root of the policy change seems to be a thirst for growth ...
  Telekom Malaysia's balance sheet remains very healthy and in our view it is easily strong enough to meet our previous dividend forecasts. Thus, the problem seems to lie with the willingness of the management team to pay out, rather than with the ability of the balance sheet to meet the payment.
  
  As to why management has changed its view in this way, the issue seems to be with what we have previously highlighted as the key risk facing Telekom Malaysia - the government's high-speed broadband project (HSBB). While we have recognised that value will likely be destroyed by the project, to the tune of RM0.60/share, the wider concern is that management now sees the rollout as a platform for growth into other areas, most notably IPTV. As set out in our recent report (published 17 June 2008) "7.7% dividend yield offsets HSBB risk", we have harboured concerns that Telekom Malaysia's execution on cutting costs as the new network is rolled out, and more specifically harvesting revenue opportunities from the content space (an area outside of Telekom Malaysia's core competency), carries significant risk to the downside.
  
  Unfortunately it seems that, rather than dissuading management from being overly aggressive in this strategy, the opposite has occurred; management is so keen pursue the perceived opportunity that it is prepared to use the cash flows of the existing business to support the plans. The lure of (potential) growth seems to have proven too strong to resist, perhaps because of the difficulties involved in seriously addressing the cost base should revenue falls accelerate.
  
  .. in contrast to Telekom Malaysia's original mandate
  We would highlight that this change in strategy seems to go against both the spirit and the explicit terms set out in the split documentation which shareholders of Telekom Malaysia approved. The concept was that TM International Snd Bhd (TMIT.KL, RM4.40, OUTPERFORM, TP RM7.50) would be the growth vehicle, while Telekom Malaysia would be the stable cash cow.
  
  Earnings cut on very weak 9M09 results ..
  While Telekom Malaysia continues to report "normalised" EBITDA in line with our previous forecasts, the list of "one-off" costs continues to grow quarter on quarter. We had previously been prepared to ignore this given the policy of paying out on the basis of normalised PATAMI. However, it is becoming clear that some elements of what are being termed "one-off" items are structural, and we are now even less optimistic on Telekom Malaysia's ability to control operating costs going forward given the desire to expand into new areas.
  
  We have therefore cut our FY09 EBITDA and net profit forecasts by 12.6% and 46.2%, respectively. Our FY08 headline earnings forecast has been revised down by 64.1%, largely due to various one-off costs, including 3Q08's RM195.7mn loss on foreign exchange.
  
  Most importantly, we have revised down our DPS estimate for FY09 by 46.2%, from 27 sen to 15 sen. While Telekom Malaysia could of course afford to pay out an additional RM1.06/share, if net debt were taken to 1.5x EBITDA, there is now an unwelcome question mark over whether or not management will be willing to actually do so. We downgrade our rating to UNDERPERFORM.