Samart Corporation

Solid growth prospects at all business units

Samart Corporation Plc (SAMART)

Action and recommendation

Initiate with Bt14 fair price. We initiate coverage of SAMART with an Outperform rating and a 2013 DDM-based fair price of Bt14/share (12.5x PER and 1.8x PBV). The APPS project expected to be signed in 2013 and the recovery of revenue and margin at SIM as well as the better outlook for non-listed businesses should enable SAMART to deliver earnings growth of 20% CAGR in 2011-14. There is a potential upside to our fair price to Bt15.7/share if the company wins the 3G TOT Phase II bidding.

Key investment points

CAGR earnings growth of 20% in 2011-14. We expect SAMART to report 2011-14 net profit growth of 20% CAGR on improving sales at existing businesses, driven by acquisitions and successful bids for several large new projects in 2013-14. Gross margin is also expected to improve on higher services revenue at SAMTEL, SIM's turnaround and an expanded high-margin call center business, One-to-One. SGA to sales is expected to be flat but effective tax rate should fall. We thus believe SAMART's net profit margin will jump to 6.9% in 2014 from 4.2% in 2011.

Recurring income projects to drive long-term prospects. We expect the recurring revenue portion from SAMTEL (70% held by SAMART) will increase to 48% in 2014 from 19% in 2011 following the acquisition of Portal Net in 3Q12 and on revenue from the APPS project, which is expected to be signed in 1Q13 (revenue contribution is expected to start from 2H13). Moreover, we expect 3G maintenance service work for TOT Phase I (Bt5.2bn, 10 years) as well as the Free WiFi project (Bt15.0bn over 10 years) that is due to begin operations in 2014, will help reduce SAMART's revenue volatility while also enhancing its margin.

Recovery in mobile handset sales and MVNO. After declining during 2009-2011, we see mobile multimedia revenue (operated under SIM) approaching a turnaround point. Handset revenue and gross margin should rise gradually on SIM's new strategy to add more smart-phones that have higher selling prices and better gross margins to its handset portfolio. Also, the prospects for the MVNO business are bright. The delay in the awarding of 3G 2.1 GHz license to the 3 major operators will create extra opportunities for SAMART in its role as an MVNO wholesaler/reseller for TOT, which controls the 2.1/2.4GHZ frequency.

Hidden treasures in non-listed businesses. Non-listed companies held by SAMART contributed only 16% to total revenue in 2011 but provided as much as 28% of net profit. Clearly they are high profit margin businesses. Air traffic management in ASEAN countries, call centers, Vision, and a new power substation business will be key projects generating growth opportunities in the future.

TOT 3G Phase II will be upside. While the TOT 3G (Phase I) network installation project boosted SAMTEL's revenue to a new high in 2011, we believe that Phase II of the project will provide a lot more excitement given its bigger size (Bt31.5bn vs. Bt16.0bn for Phase I). However, as we have not yet included this in our projections, it provides upside to our forecast. SAMART's revenue could grow as much as 33% and 27% in 2013 and 2014 from our current estimates of 5.7% and 7.3%. Net profit CAGR in 2011-14 could also increase to 45percent from 20%.

Price catalysts

3G TOT Phase II bidding will provide upside to our earnings forecast and target price.

Risk

Capital increase may be required for SAMTEL if it wins the 3G Phase II project.

Big projects lined up for Samart Telcom (SAMTEL)

A new investment era for telecom businesses

TOT 3G Phase I" lifts SAMTEL's earnings to record high. TOT, which controls 3G/4G frequencies, wants to utilize the assets it has to generate revenue by investing in a network rollout across the country. This will also help TOT to generate its own income after its revenue-sharing concession deal with ADVANC expires in 2015. SAMTEL as a systems integration and equipment provider has benefited from the move. In 2011, SAMTEL won an auction for TOT's 3G mega turnkey project (installation of 4,772 cellular base stations nationwide worth Bt16bn; SAMTEL won 65% of the project while the remainder went to LOXLEY), which boosted its 2011 profit to a record high. The project will remain the key revenue contributor through 2012-13, given the 3-year construction period.

The bigger TOT 3G/4G Phase II is coming. TOT plans to open bidding for Phase II of the project, to install 9,500 base stations with a total value of Bt31.5bn (double that of the first phase). The bidding process for this 3-year project is expected to begin in 2013 and SAMTEL has a good chance of winning it, in our view. This is because using the same supplier as in Phase I would make it easier for network rollout (SAMTEL has an agreement with the equipment supplier to go with them in the Phase II bidding). We haven't included this project in our projections, but should SAMTEL win the bid, we expect its revenue would rise to a new high of Bt13bn in 2013 and Bt19bn in 2014, while boosting SAMART's revenue to Bt24bn and Bt30bn over the same period.

Portal Net deal completed since 3Q12. At the end of 3Q12, SAMTEL finished its acquisition of Portal Net Company. Portal Net leases a computer software system to the Provincial Electricity Authority (PEA) under a 5-year contract (2012-16). SAMTEL started to recognize revenue from Portal Net in 3Q12 with guaranteed revenue of Bt160mn/quarter, or Bt638mn a year. SAMTEL believes it has a good chance of extending the contract for a further 3 years to from 2017-19.

Expect recurring income to account for 48% of SAMTEL's revenue by 2014. In 2011, recurring revenue (including long-term services projects and long-term turnkey projects) accounted for 19% of SAMTEL's total revenue. We expect this portion will increase to 48% in 2014, mainly driven by the Portal Net and APPS projects. Moreover, we expect the company to be awarded a maintenance service for the TOT 3G Phase I project as well as assuming it will win the Free WiFi project, which will begin service in 2014. We expect the value of the 3G maintenance contract to be about Bt520mn/year (5% of total value of the Phase I project) while the Free WiFi project will be worth Bt1.5bn a year over 10 years (assume 50% of the total Bt30bn project value). This will help make SAMTEL's revenue less volatile in the future as well as improve its margin given the historical average GPM of recurring income is 25% while that of its turnkey business is 15%.

New potential projects to support backlog. We expect SAMTEL to sign the APPS project totaling Bt6.0bn in the beginning of 2013 following the Department of Civil Aviation (DCA) approval of the Bt50/passenger/flight total fee on 20-Nov and that it will finalize procedural negotiations with stakeholders within about 1 month of the bid winner being announced. Bt12/passenger/flight for SAMTEL is in line with the company's target and our assumption (breakdown of the Bt50 is Bt32 for the system providers - SITA and SAMTEL, Bt5 for the Immigration Bureau, Bt4 for AOT, Bt2 for the Treasury Department, Bt1 for the airline and the remainder for tax and others). Including other projects totaling Bt5.0bn that we assume will be signed in 2013, SAMTEL's backlog at the end of 2013 will rise to Bt14bn.

Turnaround of Mobile multimedia: Samart I-Mobile (SIM)

Rising mobile handset sales

Recovery signs seen. Mobile handset revenue, the largest revenue portion of SIM (84%), has been declining since 2008. This is due to declines in mobile phone sales volume and the average selling price. However, we see good signs for a pickup in average selling price in 3Q12 of Bt1,574/unit (up from Bt1,310/unit in 1H12), in Fig 8. This is due to a change in product mix, with a rising portion of higher-priced smart phones compared with feature phones/normal phones. This has not only increased the average selling price but also boosted handset gross margin (Fig 9), due to the higher gross margins for smart phones (about 25%) compared to feature phones (about 15%).

To grow with smart phone trend. Smart phone sales volume in Thailand rose a significant 70% YoY in 1Q12, underlining the popularity of the phones among Thai consumers. However, the average price of a smart phone, which is quite high at Bt9,000-10,000/unit, may make it unaffordable for many people. To solve this problem and capture the demand, SIM introduced an economy-priced smart phone beginning at Bt3,990 that uses the Android operating system. We see this as a sound strategy and the company's ability to serve the needs of this large market group supporting a new growth cycle for SIM.

More profit after capturing the right trend. We see earnings from the mobile handset sales business rising gradually. The increase in smart phone handset sales volume will not only boost the average selling price but also improve margin. We expect the average selling price in 2013 to rise to Bt2,600/unit along with higher smart phone sales volume to 1,500,000 units (from 587,000 units in 2012) compared with feature phone sales of 1,020,000 units (from 3,322,000 units in 2012) in 2013. This will boost handset revenue by 7% in 2013 after decreasing every year since 2009. Moreover, handset gross margin is expected to improve to 21% in 2013 from 15% in 9M12.

Growth in MVNO business will add more excitement to SIM

Higher subscriber numbers will boost profit. In the past, the Mobile Virtual Network Operator (MVNO) business generated only 2% of SIM's revenue, or a very small portion of only Bt118mn in 2011, resulting in a loss being contributed to the bottom line (as the number of subscribers was too low to offset fixed costs). However, based on the advantages of the business operated under SIM, which requires a low level of capex since the company doesn't have to invest in a network (it uses TOT's network), we see a high growth potential with low additional risk when SIM is ready to market the product. The major cost of the business is just selling and marketing expenses. The higher number of effective subscribers will boost profit growth directly as it will benefit from economies of scale. We

see the number of accumulated effective subscribers growing to 300,000 in 2013 and 400,000 in 2014 (this is more conservative than management's target of 500,000 effective subscribers in 2013) from the current number of about 150,000. Along with expected higher ARPU in the early cycle for growth of mobile data usage, MVNO revenue should rise dramatically by 150% in 2013 and 62% in 2014 to provide 6% and 9% of SIM's total revenue in 2013-14. Although it will account for only 2% and 4% of SAMART's revenue in 2013-14, there will be more upside to our projections if the company can gain a larger subscriber base than our estimate.

Target is to be consumers' 2nd SIM card for data usage. As the mobile penetration rate in Thailand has been above 100% (number of SIM cards is higher than the country's population) since 2010, it is hard to steal customers from other existing big operators. SIM positions its brand, "i-mobile 3Gx", as the 2nd SIM card for mobile Internet usage. The network frequency that TOT provides for resale, "3G 2.1GHZ", helps support this strategy because it is one of the best suited for data usage. TOT also has the 2.3 GHz frequency in hand and plans to develop it for 4G LTE. If the plan is implemented, SIM will also benefit from reselling the frequency to its customers because as a strategic partner it has rights to at least 40% of TOT's total network's capacity.

Riding the growth stage of mobile Internet. As shown in Fig 10, non-voice revenue (mainly from Internet services) of the three main operators -- AIS, DTAC and TRUE -- has grown strongly to account for 33% of telecom operator revenue from just 23% in the past. Since data revenue is becoming a key growth driver for telecom businesses on changing customer behaviors, there is still more room to grow as data subscribers account for only about 20% of total mobile users. As mentioned earlier, SIM's strategy is not only to match the frequency they use, but to ride the boom in mobile data.

Delay in issuing 3G 2.1 GHZ license will benefit SIM. As the three winning bidders of the 3G 2.1 GHZ licenses awarded by the NBTC are also the three main operators (ADVANC, DTAC, TRUE) with a total market share of over 100% of the total Thailand subscriber base, the delay of license awarding will lag 3G demand. This will be an opportunity for SIM as an MVNO (a wholesaler/reseller) for TOT, which controls the 2.1GHZ frequency. TOT's plan to roll out 14,000 base stations during 2014 -15 (compared with the current 16,000 of ADVANC, 12,000 of DTAC and 10,000 of TRUE) will benefit SIM as in its role as an MVNO operator it will have access to TOT's nationwide network coverage. This will help boost SIM's service ability to make it comparable with those of the other large operators.

Stable growth of content business

SIM's sales have grown steadily by 10% per annum over the past 3 years to now account for 14% of the company's revenue in 2011, up from just 6% in 2008. We believe SIM's strong platform content, such as BUG and the EDT guide website, will drive revenue growth for the business of 8%, 10% and 9% in 2012-14. We expect the content business to account for 6% of SAMART revenue in 2014 from 5% in 2011.

Hidden value in non-listed businesses

Non-listed companies - high-gross margin contributors. Remarkably, non-listed companies (more details of the companies are shown in the company profile section in the last part of this report) held by SAMART contributed only 16% of total revenue in 2011 but as much as 28% of net profit. This is because they can generate higher gross profit margins compared to other segments (See Fig 12). For instance, Cambodia Air Traffic Services (CATS) is a monopoly concession that manages nationwide air traffic under a revenue sharing scheme (sharing 30% of overflight fees and 50% of landing fees) while Kampot Power Plant provides USD6mn per year of guaranteed revenue. These two units had a combined high gross margin of 46% in 2011, boosting the average gross margin for all non-listed businesses.

Opportunity in air traffic management business on the startup of the AEC. We expect all business activity within the region will increase significantly after the commencement of the AEC. The air traffic management business will thus benefit from increasing air traffic volume. According to KResearch (Fig 14), the number of tourist arrivals to ASEAN will grow at an average rate of 8% p.a. in 2012-15, which we believe will boost SAMART's revenue share from the air traffic business. Cambodia Air Traffic Services, or CATS, (details shown in the company profile section), may serve as a prototype that SAMART can use to expand this business throughout ASEAN. The company revealed it has the possibility to administer similar projects in Myanmar and Laos in the near future.

A new star business: One-to-One call center. One-to-One Call Center, a turnkey and fully outsourced call center business, was the largest revenue contributor to SAMART from among non-listed businesses in 2011, providing 5% of SAMART's total revenue. We saw uninterrupted growth in the company from 2008-2011. A greater focus on call center outsourcing rather than turnkey projects has benefited the company by generating more stable revenue and higher margins. 3Q12 profit from One-to-One jumped to Bt49mn from only Bt4mn in 2Q12, up 1,138% QoQ compared to only 7% revenue growth QoQ. We see its revenue growing by a further 10% and 9% in 2013-14 with a higher percentage of recurring income, which will help improve its margin (Fig 15). Main clients of the company are Thai Air Asia, SSO, TOT, PEA, SRT and the Royal Thai police with more potential clients such as THAI, MOC, and TBANK.

Recovery of Vision and Security System expected next year. Vision and Security System (VISION), which provides security design for integrated solutions, may be another revenue and earnings growth driver next year. In 2011, Vision contributed roughly Bt430mn to SAMART in income, up from only Bt73mn in 2008. However, we expect VISION's revenue to drop in 2012 as a result of the delays in many government/state enterprise-related bidding projects in 1H12 due to the flooding. However, we expect it will recover in 2013. Potential customers of Vision are the Bangkok Metropolitan Authority, Ministry of Defense, AOT, TOT and the Government Center.

A new acquisition - "Teda". SAMART announced the acquisition of Teda Company in 4Q12. The business is involved in the design and construct of high-voltage substations, transmission and distribution lines as well as mechanical and electrical installation services (ME). Customers include EGATT and MEA. SAMART says that Teda has a backlog of Bt1,500mn in orders.

Financial Forecast

2012 profit to grow 28% YoY. We expect SAMART to report 2012 net profit of Bt1,071mn, up 28% YoY. Even though full-year revenue should drop 9% YoY due to the lower revenue recognition of TOT 3G Phase I, we believe a larger share of high margin revenue should support its bottom line. We expect 2012 gross margin to rise to 22.5% (from 19.9% in 2011) mainly due to the reversion of COGS from better-than-expected cost control. SGA to sales is expected to decrease slightly from 10.7% in 2011 to 10.3% in 2012. The decline in effective tax rate to 23% in 2012 from 30% in 2011 is another key factor that will boost net profit margin to 5.9% in 2012 from to 4.2% in 2011. Note that 9M12 net profit accounts for 73% of our full-year estimate.

2013 profit will remain high regardless of TOT 3G Phase II. We expect SAMART will be able to maintain net profit at a high level in 2013 (up 3.7% to Bt1,111mn) despite assuming no contribution from the TOT 3G Phase II project and a gradual deterioration in revenue contribution from 3G Phase I, which will cut system integration revenue (SAMTEL) by 13% YoY. The better performance will be driven by a moderate improvement in overall GPM by 0.8 ppts to 23.3%, and strong gains in revenue at both SIM (+11% YoY) and non-listed businesses (+46%), supported by full-year contributions from "Portal Net" plus revenue from APPS in 2H13, which should increase SAMART's 2013 total revenue by 5.7%. SGA to sales is expected to rise by 1 ppt. to 11.3% due to an aggressive marketing campaign for SIM, especially for its MVNO and the handset businesses. Net profit margin in 2013 is thus expected to be maintained at the same healthy level of 5.8% as in 2012.

Healthy net profit growth of 29% expected in 2014; indicating 20% CAGR growth in 2011-14. SAMART should show strong net profit growth of 29% in 2014 on the back of improving sales at existing businesses (handsets and MVNO) as well as the 3G maintenance and Free WiFi projects expected to start in 2014. We also expect gross margin to improve further on more services revenue from SAMTEL, the turnaround at SIM and a better margin at One-to-One call centers. SGA to sales is expected to be flat with a lower effective tax rate. We expect 2014 net profit margin to improve to 6.9percent from 4.2% in 2011. Along with the acquisition of Portal Net in 2Q12, Teda Company in 4Q12 and the expected startup of the APPS project in the beginning of 2013, we believe these factors will support outstanding net profit growth during 2011-2014 at a CAGR of 20%.

Large upside from TOT 3G phase II. We do not include "TOT 3G Phase II" in our projections. The project will provide upside to SAMART revenue of up to Bt24,221mn in 2013 and Bt30,628mn in 2014 (we assume SAMART will get Bt20bn of the Bt31.5bn project value and recognize revenue of Bt5bn in 2013 and Bt10bn in 2014). Including this project, forecast net profit in 2013 will rise to Bt1,651mn (+54.2% YoY) and to Bt2,540mn (+53.8% YoY) in 2014, or 45% CAGR in 2011-2014.

3Q12 result. SAMART reported net profit of Bt291mn (+22% QoQ, +9% YoY) as a higher gross margin more than offset a 34% YoY decline in revenue, due to an abnormally high 3G revenue proportion in 3Q11 and higher SGA to sales in the quarter. A lower effective tax rate also helped the bottom line.

Debt level moving in a downward direction, strengthening its balance sheet. Net interest-bearing D/E ratio at the end 3Q12 was 1.15x, down sharply from 1.43x at end-2011. With more profit contributed to equity; we expect interest bearing debt to equity will decline to 0.94x in 2014 (excluding TOT 3G Phase II).

Risk

Risk of capital increase of SAMTEL if it wins "TOT 3G Phase II". In our assumptions, we do not include SAMTEL winning the 3G TOT Phase II project. However, if SAMTEL really does secure this big contract next year together with our assumption that the company will win the APPS project in 2013, SAMTEL will face a high financial leverage (interest-bearing debt to equity may rise to 3x). In order to cover this tight balance sheet, we think SAMTEL may have to increase capital. SAMART, as the major shareholder of SAMTEL (it holds 70%), would be required to participate in the transaction. Based on our assumption that SAMTEL will require up to Bt2.0bn of new capital, we see SAMART having to provide this additional capital to maintain its stake in SAMTEL without a capital increase.

Valuation Recommendation

Fair value of Bt14.0/share. Using a dividend discount model (DDM), we derive SAMART's 2013 fair value at Bt14.0/share. This fair value reflects a 2013E PER of 12.5x and a PBV of 1.8x. Our key assumptions are:

11.45% cost of equity (risk-free rate of 3.75%, equity-risk premium of 7% and 1.10 beta) with 60% dividend payout ratio in 2013-14 and 70% payout ratio in 2015 onward (average 63% in 2008-2011).

3G Phase II will boost fair value to Bt15.7. If SAMTEL wins the TOT 3G Phase II project as we expect - i.e., 65% of the Bt31.5bn total project value, or Bt20bn -- the project will provide upside to our valuation of Bt1.7/share. SAMART's new DDM-based fair value would rise to Bt15.7/share. This fair value would reflect a 2013E PER of only 9.4x.

Attractive valuation

Below historical average PER and PBV. At the current market price, SAMART is trading at a 2013 PER of 10.4x and 2013 PBV of 1.5x, which is still below its historical 3-year average of 12.2x for PER and 1.7x for PBV (Fig 18-19). This means SAMART's current share price is not expensive compared to its historical average.

Lower EV/EBITDA compared to regional ICT companies. We think EV/EBITDA is another suitable method to compare the valuation of ICT stocks due to the high depreciation rates inherent in the telecom business. SAMART has a 2013 EV/EBITDA of 5.3x and 2014 EV/EBITDA of 4.3x, which is cheaper than the average of its regional ICT peers of 5.4x in 2013E and 5.1x in 2014E (Fig 20), adding more attractiveness of the stock in terms of valuation.

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Article source: http://www.thethailandlinks.com/2012/12/03/samart-corporation/