STRATEGIC FINANCIAL REVIEW OF DIGI.COM BHD

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STRATEGIC FINANCIAL REVIEW OF DIGI.COM BHD

  1. 1. Nottingham University Business School MBA Programmes ACCOUNTING AND FINANCE (N14M01) STRATEGIC FINANCIAL REVIEW OF DIGI.COM BHD GROUP MEMBERS: SHANMUGA PILLAIYAN (010194) KEVIN CHOO (010226) GURMEET SINGH (002967) ORIGINAL
  2. 2. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad TABLE OF CONTENTS 1.0 EXECUTIVE SUMMARY ..................................................................................................................... 3 2.0 KEY ISSUES............................................................................................................................................ 5 2.1 LONG TERM SUSTAINABLE GROWTH DOES NOT LOOK PROMISING .......................................................... 5 2.2 NET PROFIT MARGINS ARE NOT GROWING IN TANDEM WITH REVENUE GROWTH ................................. 11 2.3 GEARING IS INCREASING ...................................................................................................................... 18 2.4 SHORT TERM LIQUIDITY IS OF CONCERN............................................................................................... 22 2.5 SPECIAL NOTE: ROE IS DISTORTED BY CAPITAL STRUCTURE ............................................................... 23 3.0 CONCLUSION ...................................................................................................................................... 26 3.1 APPROACHING MILESTONES ................................................................................................................ 26 3.2 SUMMARY OF RECOMMENDATIONS ..................................................................................................... 28 4.0 APPENDIX ............................................................................................................................................ 29 4.1 FINANCIAL FIGURES – DIGI BHD ......................................................................................................... 29 4.2 FINANCIAL FIGURES – XL AXIATA ...................................................................................................... 31 4.3 FINANCIAL FIGURES – M1 ................................................................................................................... 33 4.4 REFERENCES ........................................................................................................................................ 35 Word Count: 4171 Page |2
  3. 3. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 1.0 EXECUTIVE SUMMARY DiGi has performed admirably over the last five years, in terms of operational efficiency, growth and share holder value, culminating in the highest gross revenue level in its corporate history at approximately RM 5.5 billion in 2010 (refer to Appendix 1). However, a closer look at our financials have revealed several trends that may have long term repercussions on our ability to successfully surmount the challenges that lay ahead over the next few years. Long term sustainable growth does not look promising Net profit margin is not growing in tandem with revenue growth Gearing is increasing Short-term liquidity position is precarious In order to derive further insights into our performance, we have also benchmarked our performance with 2 other players based in different markets, namely XL Axiata in Indonesia and M1 in Singapore. These companies were selected on the following basis: DiGi1, XL2 Axiata and M13 are currently the third ranked telcos in their respective markets. All 3 telcos deploy similar telecommunication technologies (GSM, GPRS, UMTS, HSPA) and have similar product offerings4 Hendrik Clausen (2011), Analyst Briefing, 22 September 2011, DiGi Bhd.. Axiata Group Berhad (2010), 3 rd Quarter 2010 Analyst and Investor Briefing, 24 th November 2010, Axiata Group Berhad 3 M1, (2011) Investor Presentation Jan 2011, available at: http://m1.com.sg/M1/CMA/About_Us/Corporate_Information/IR/PDF/Investor%20Presentatio n%2019%20Jan%202011.pdf (accessed on 7th November 2011) 4 1. DiGi Berhad, www.digi.com.my (accessed on 5th November 2011). 2. XL Axiata, www.xl.co.id (accessed on 6th November 2011). 3. M1, www.m1.com.sg (accessed on 5th November 2011) 1 2 Page |3
  4. 4. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad To have a comparison with markets that have different mobile penetration rates. XL Axiata is from Indonesia a growth market (around 85% mobile penetration) and M1 is in Singapore which is a mature market (around 155% mobile penetration). Malaysia is between these two markets as a maturing market5 (around 120% mobile penetration) Over the long term, we need to be financially prepared for the milestones such as the Telco Spectrum Auction6, DiGi’s 3G license expiry in 20187 and the Long Term Evolution (LTE) roll-out to enhance mobile data services8 The following are our key recommendations to address both the highlighted issues and the financial challenges presented by these milestones. Dividend payout policy to be set at a maximum of below 100% of net profit To focus on improving net profit margins by increasing monthly Average Revenue Per User (ARPU), and reducing 3rd party mobile traffic charges. Use more internally generated funds to fuel future growth. Short term debt facility should be arranged to mitigate short-term liquidity risks. Central Intelligence Agency, World Factbook, available at: https://www.cia.gov/library/publications/the-world-factbook/index.html (accessed on 9th November 2011) 6 Kelvin Goh (2011), “Telecommunication, Muffled by regulation and competition”, CIMB Research Reports (17 Feb 2011). CIMB Bhd. 7 Kelvin Goh (2011), “Telecommunication, Muffled by regulation and competition”, CIMB Research Reports (17 Feb 2011). CIMB Bhd. 8 Hendrik Clausen (2011) , Analyst Briefing, 22 September 2011, DiGi Bhd 5 Page |4
  5. 5. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 2.0 KEY ISSUES Despite DiGi’s many successes over the years, we have noticed several trends arising from our analysis of several financial indicators that do not appear to be benign. These issues will be detailed in the following sections. 2.1 2.1.1 Long term sustainable growth does not look promising Indicators Although DiGi’s financial performance is looking very healthy in the light of its balance sheet and income statement reflecting asset growth and year-on-year growth of topline revenue (refer to Appendix 1), we are concerned about its prospects for future growth. The following is a table showing some of the major financial indicators that have raised our concerns over DiGi’s long term growth. Indicators for DiGi Revenue growth rate 2006 2007 2008 2009 2010 28.35% 19.04% 10.08% 1.68% 10.69% Sustainable Growth Ratio 0.29 -0.11 -0.19 -0.25 -0.13 Equity Reserves (RM’000) 1,677,401 1,502,645 1,819,422 1,443,718 1,268,872 Altman Z-score 1.15 1.53 1.32 1.17 1.19 Dividend Cover 278.82 85.89 76.94 72.71 87.07 Diagram 2.1.1: Key financial indicators of DiGi related to long term growth Page |5
  6. 6. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad All of the Z-scores between 2006 and 2010 are below the 1.8 watermark, which theoretically signals that the company is in distress9. While the z-scores do not indicate that DiGi is in immediate danger of bankruptcy (especially when all these indicators are taken in conjunction with DiGi’s strong cash flow and balance sheet), it does however indicate that DiGi is in a grey zone that is fairly worrying in terms of long term business sustainability should this trend continue on. As presented in the table above, it can clearly be seen that equity reserves have also been declining steadily since 2008, even though overall revenue growth and market share has been on the rise during the same period. Such divergent trends warrant a closer look. Also, one can see that DiGi’s dividend cover is substantially lower from 2007 onwards, and it appears to be trending downwards. Some improvement is seen in 2010 which can be attributed to DiGi achieving its highest gross revenue levels ever. 2.1.2 Root Cause It appears that the biggest culprit causing the negative trend in the sustainable growth ratio is the fact that DiGi has been aggressively and excessively delivering more dividends back to the shareholders every year since 2007. Looking at the dividend payout ratios listed in the table below, DiGi has been paying out between 15% - 40% more than its net earnings as dividends every year since 2007. This has had a detrimental effect on DiGi’s equity reserves and has severely diminished retained earnings. 9 Investopedia, Altman Z-scores, available at: http://www.investopedia.com/terms/a/altman.asp#axzz1eKZSDomX (accessed on14th November 2011) Page |6
  7. 7. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad Indicators for DiGi 2006 Dividends per share 2007 0.39 Dividends paid (RM'000) 2008 1.65 2009 1.93 2010 1.77 1.74 288,900 1,237,351 1,500,692 1,376,175 1,352,850 Dividend Payout Ratio 0.36 1.16 1.32 1.38 1.15 Diagram 2.1.2: Key financial ratios related to dividend payout 2.1.3 Comparisons with XL and M1 The following graph shows the ability of each company to pay dividends to its shareholders based on a factor of its earnings vis-à-vis their internal dividend policy during a particular year. It appears that both DiGi and M1 are in a very good position to carry out its targeted dividend payouts to its shareholders. In XL’s case, their performance, especially in 2008 is simply not good enough to justify high dividend returns. Dividend Cover Comparison 300.00 250.00 200.00 DiGi 150.00 XL 100.00 M1 50.00 0.00 2006 2007 2008 2009 2010 Diagram 2.1.3: Comparison of dividend cover between DiGi, XL & M1 Page |7
  8. 8. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad The following graphs compare the sustainable growth rate and dividend payout ratios between DiGi, M1 and XL. It is apparent that the sustainable growth rates for XL and M1 are fairly volatile, quite possibly reflecting the dynamism of their respective mobile telecommunications market. DiGi, in comparison with XL and M1 appears to be the worst off among the three in terms of this indicator, even though it is the only one among the three that has consistently recorded an average of more than 10% revenue growth year-on-year. This is supported by the fact that DiGi appears to have the highest dividend payout ratio among the three telcos, and is the only one among the three that is consistently paying out more dividends than their net profits. Dividend Payout Comparison 1.80 1.60 1.40 1.20 1.00 0.80 0.60 0.40 0.20 0.00 DiGi XL M1 2006 2007 2008 2009 2010 Diagram 2.1.4: Comparison of dividend payout ratio between DiGi, XL Axiata & M1 M1 appears to have the most sensible dividend payout plan where the dividend payout ratio is less than 1, which implies that they retain some earnings for possible use in the future, while at the same time delivering value to their shareholders. This is reflected in their sustainable growth indicators which are in the positive region. The indicators appear low Page |8
  9. 9. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad mainly because, as mentioned earlier, the Singaporean mobile telecommunications market is already mature and saturated. Sustainable Growth Rates Comparison 0.50 0.40 0.30 0.20 DiGi 0.10 XL 0.00 M1 -0.10 2006 2007 2008 2009 2010 -0.20 -0.30 Diagram 2.1.5: Comparison of Sustainable growth rate between DiGi, XL & M1 Having not made any dividend payments in 2008 and 2009 (despite a rapid recovery from net loss in 2008 to net profit in 2009), XL’s low dividend return policy is helping it achieve significant numbers in sustainable growth, as compared with the other 2 telcos. 2.1.4 Recommendations The current rate of dividend payouts is not conducive to long term growth. Cash reserves will continue to dwindle, and it will place DiGi in a difficult position should there be cash flow problems or a large purchase consideration. In the light of the challenges that face DiGi in the medium term (e.g. spectrum auction bidding, LTE rollout), DiGi should consider being more conservative in managing it’s retained earnings in order to be better equipped to deal with the capital expenditure and operational expenses that will be incurred as a result of these challenges. Rather than rely solely on long term financing in order to finance said expenditure, we recommend that the current dividend policy be Page |9
  10. 10. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad amended and revised to a much lower rate to increase the amount of internally generated funds that will be available to finance the required capital expenditure. The maximum dividend payout rate should be set as a percentage of net profit and be significantly below 100%. This will help arrest and reverse the decline in shareholder equity, and help reduce financing costs in the annual income statement. DiGi’s strong cash flow position should not be taken for granted to be the main engine for servicing loans, especially when the global economic climate is still uncertain ever since the global financial crisis of 2009. P a g e | 10
  11. 11. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 2.2 2.2.1 Net Profit Margins are not growing in tandem with revenue growth Indicators DiGi has seen consistent revenue growth from 2006 to 2010, during which revenue has increased almost 50% from RM3.6 Billion in 2006 to 5.5 Billion in 2010. Over the same period however, this growth did not translate into a parallel increase in profit margin growth. In fact, gross operating margin has been decreasing since 2008 to 2010. Diagram 2.2.1 illustrates the general trend between Gross Revenue, Gross Operating Margin, EBITDA Margin and Net Profit Margin. Comparison between revenue growth against margin 5,459,851 4,851,056 4,932,640 4,407,025 3,702,100 79.0% 79.8% 46.3% 48.3% 21.8% 24.1% 77.5% 76.3% 74.3% 45.0% 42.5% 43.4% 20.3% 21.6% 23.5% Total Revenue Gross operating margin EBITDA margin Net Profit margin 2006 2007 2008 2009 2010 Diagram 2.2.1: Comparison between revenue against margins Table 2.2.2 illustrates the growth rates for revenue, Gross Operating Margin and EBITDA margin. From Table 1.1 it is clear that revenue has had a consistent positive growth where as gross operating margin has been consistently contracting from 2008 to 2010. The important issue that is revealed here is that both revenue growth and gross operating margin are trending divergently. P a g e | 11
  12. 12. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad Year 2007 Revenue Growth Rates 2008 2009 2010 19.04% 10.08% 1.68% 10.69% Gross Operating Margin Growth Rate 1.12% -2.86% -1.54% -2.79% EBITDA Margin Growth Rate 4.17% -6.75% -5.50% 2.10% Diagram 2.2.2: Growth rate for revenue, gross operating margin & EBITDA margin The positive growth in DiGi’s EBIDTA for the year 2010 (refer to Table 2.2.2) was due largely to internal cost savings initiatives10. OPEX (excluding traffic charges) only grew a marginal 1.25% from 2009 to 2010. These internal cost reductions also helped to offset the large increase in material cost in 2010. These internal cost saving efforts even though effective in the short term will be hard to maintain over an extended time frame. At present DiGi has already reached a high level of efficiency relative to XL and M1 (refer to Diagram 2.2.5 below). 10 Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd. P a g e | 12
  13. 13. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 2.2.2 Comparison with XL Axiata and M1 XL Axiata shows a strong correlation between revenue growth and gross operating margin growth. Diagram 2.2.3: Revenue & Gross Operating Margin trend of XL Axiata In contrast with XL, M1 displays a similar trend as DiGi where gross operating margin is declining even though revenue is growing. According to a CIMB Research Report11, the margin erosion of Telcos in Singapore is due to increased smartphone subsidies and high startup cost of next generation broadband network. 11Kelvin Goh (2011), “Telecommunication, Muffled by regulation and competition”, CIMB Research Reports (17 Feb 2011). CIMB Bhd. P a g e | 13
  14. 14. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad Diagram 2.2.4: Revenue & Gross Operating Margin trend of M1 OPEX/revenue trend 70.0% 60.0% Percentage 50.0% 40.0% Digi 30.0% XL Axiata 20.0% M1 10.0% 0.0% 2006 2007 2008 2009 2010 Diagram 2.2.5: Comparison of OPEX/Revenue between DiGi, XL Axiata & M1. The similar profit margin trends of DiGi and M1 can possibly be attributed to the fact that they are operating in markets where mobile penetration is above 100%, and therefore we can infer that they are subject to keener competition to acquire more subscribers and reduce subscriber churn. XL Axiata, on the other hand, operates in a market with 85% penetration, which by definition, is still a growing market. P a g e | 14
  15. 15. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 2.2.3 Root cause analysis The two major components of gross operating margin are revenue and cost of service (COS) consists of traffic charges and material costs12. The traffic cost has had a higher growth rate compared to revenue from the year 2007 to 2009. This results in a decreasing gross operating margin. Revenue Vs. Traffic Charges 30.00% Growth Rate 25.00% 20.00% 15.00% Revenue 10.00% Traffic Charger 5.00% 0.00% 2007 2008 2009 2010 Diagram 2.2.6: Growth rate of revenue and traffic charges DiGi has relatively smaller network coverage in Malaysia in comparison with Maxis and Celcom13, thus DiGi has had to be reliant on Celcom & Maxis networks for coverage via inter-connection agreements. Traffic charges refer to interconnect charges and domestic roaming charges. When DiGi customers make calls to a non-DiGi number, DiGi will have to pay interconnect charges to the other mobile network operator. When DiGi customers are outside DiGi’s network 12 Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd. 13 Insider Asia, 2011, Steady Gains seen for DiGi, available at: http://www.theedgemalaysia.com/inthe-financial-daily/190317-steady-gains-seen-for-digi.html (accessed on 7th November 2011) P a g e | 15
  16. 16. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad coverage area, they are able to utilise other Malaysian mobile operators’ network infrastructure to make calls. DiGi will incur “Domestic roaming” charges when such calls are made. Traffic Charges as a percentage of revenue 30.0% Percentage 25.0% 20.0% Digi 15.0% XL Axiata 10.0% M1 5.0% 0.0% 2006 2007 2008 2009 2010 Diagram 2.2.7: Traffic charges as a percentage of revenue A recent trend contributing to service cost is the cost of material which jumped from 62 million in 2009 to 217 million in 2010. This 250% increase is due to the high cost of subsidy of mobile devices14. DiGi has started promoting mobile broadband services bundled with mobile devices. These devices such as iPhone, BlackBerry and Galaxy Tabs are heavily subsidised to encourage take up. It is expected that in the long run, monthly subscription charges will help offset these subsidies. Smartphone subsidies are usually intended to accelerate the take-up rate of mobile internet services15. The revenue growth rate is slowing due to a steady decline in ARPU, despite a continuous growth in subscriber base. The trend in decreasing ARPU is driven by price reduction and 14Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd. Daily, (2010), DiGi Prepaid Revenue gains traction, available http://www.theedgemalaysia.com/in-the-financial-daily/165458-digi-prepaid-revenue-gainstraction.html (accessed on 7th November 2011) 15Financial at: P a g e | 16
  17. 17. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad substitution by cheaper services16. In our opinion, traditional services, such as voice & SMS (short messaging service), will continue to experience extensive pricing pressures because of they are considered a commodity, and are subject to the vagaries of price competition. In addition, online services such as instant messaging and VOIP calls tend to cannibalise SMS and voice services revenue, resulting in overall lower ARPU. DIGI ARPU 120 Ringgit MAlaysia (RM) 100 80 Prepaid 60 Postpaid Blended 40 20 0 2006 2007 2008 2009 2010 Diagram 2.2.8: DiGi’s ARPU trend from 2006 to 2010 2.2.4 Recommendations Increase ARPU Although the industry trend is towards lower ARPU, clear strategies can be adopted to improve ARPU: a) Grow customer segment with higher ARPU b) Encourage use of Value Added Services (VAS) 16MCMC (2007), Trends and Markets in Malaysian Mobile Services, volume 5, Malaysian Communications and Multimedia Commission P a g e | 17
  18. 18. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad High ARPU customer segments are postpaid customers and especially corporate postpaid customers. As illustrated in Diagram 2.2.8, postpaid ARPU is almost twice that of prepaid ARPU. Currently, prepaid users form 80% of DiGi's customer base. A higher percentage of postpaid customers will help increase the blended ARPU. VAS such as ring tones, Mobile Application sales can help to increase ARPU. More marketing effort should be focused on popularising VAS among the customer base. DiGi should also look into identifying “killer” apps/services that can be used to spearhead the growth in VAS. Reduce Cost of Traffic Cost of traffic can be addressed via an expansion of DiGi’s network infrastructure or via strategic partnerships with a local telco operator. The option to expand DiGi’s network will be a very capital intensive option and would take a considerable amount of time to realise its financial benefit. As such we recommend a strategy to enter in a strategic alliance with Celcom to share network infrastructure for 2G & 3G services. DiGi and Celcom are already collaborating to share transmission towers17. Further detailed study on the structure/framework of the network sharing will need to be conducted. DiGi should focus CAPEX expenditure on developing 4G (LTE) network infrastructure. 2.3 Gearing is increasing DiGi’s gearing has been increasing dramatically since 2008, (refer to Diagram 2.3.1). The steep rise in gearing in 2009 was due to long term borrowings jumping from RM 100 million in 2008 to RM 772 million in 2009. 17Sidhu B.K. (11 Jun 2010). Celcom and DiGi to collaborate, The Star[Online]. Available at: http://biz.thestar.com.my/news/story.asp?file=/2010/6/11/business/6448138&sec=business [accessed on 22 November 2011] P a g e | 18
  19. 19. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad Gearing trend 0.90 0.80 0.70 Ratio 0.60 Gearing (Debt/Equity) ratio 0.50 0.40 Gearing (Debt/EBIDTA) 0.30 0.20 0.10 0.00 2006 2007 2008 2009 2010 Diagram 2.3.1: DiGi’s gearing is trending upwards This increase can be attributed to the implementation of DiGi’s plans to modernise its infrastructure to improve the quality of its service as well as to drive cost efficiency18. DiGi has invested a total of RM720 million in capital expenditure, of which a substantial portion was allocated for expanding its mobile broadband and mobile internet footprint. It also enhanced the capacity and quality of its 2G network to serve its growing number of customers19. 18Hendrik Clausen (2011) , Analyst Briefing, 22 September 2011, DiGi Bhd Bhd. 2011, Annual Report 2009 – 2010 [online]. Available http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=6 (Accessed 15 November 2011) 19DiGi.com at P a g e | 19
  20. 20. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad Axis Title DiGi's Debt to Equity Progression 2000000 1800000 1600000 1400000 1200000 1000000 800000 600000 400000 200000 0 Equity Debt 2006 2007 2008 2009 2010 Chart 2.3.2: DiGi’s Debt-to-Equity progression over five years In comparison to XL Axiata and M1, DiGi still has a relatively low gearing rate as measured by debt/EBITDA. However, DiGi’s debt level looks large when measured by debt/equity due to DiGi’s small and shrinking equity. Gearing Trends (DEBT/EBIDTA) 4.00 3.50 3.00 Ratio 2.50 DIGI 2.00 XL Axiata 1.50 M1 1.00 0.50 0.00 2006 2007 2008 2009 2010 Diagram 2.3.3: Gearing (Debt/EBITDA) trend of XL Axiata & M1 P a g e | 20
  21. 21. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad DiGi has strong cash flow from operations that allows us to easily cover our interest obligations20. The figure below compares the interest cover between DiGi, XL Axiata & M1. Prior to 2009, DiGi had a far superior interest cover rate to the other two telcos. However, DiGi’s interest cover has since been trending downwards and in 2010 was below that of M1. Interest cover 140.00 120.00 100.00 DIGI 60.00 XL Axiata 40.00 Ratio 80.00 M1 20.00 0.00 2006 2007 2008 2009 2010 Diagram 2.3.4: Comparison of Interest cover trend between DiGi, XL & M1 Historically speaking, DiGi’s debt levels and ability to service those debts appears more favourable in comparison with M1 and XL. However, DiGi’s debt levels seem to be increasing, and although interest cover is still very much in the positive, it has dropped dramatically since 2008 and is now slightly below that of M1. Steps should be taken to reverse this declining trend. Our recommendation is not to take on further debt unless absolutely necessary. Instead of the debt market, we recommend the following two sources for additional cash: 20 Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd. P a g e | 21
  22. 22. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad a) Internally generated funds from increased retained earnings b) Additional capital from shareholders 2.4 Short term liquidity is of concern Diagram 2.4.1 illustrates the overall trend of the acid test ratios for DiGi, XL Axiata & M1. DiGi has the lowest relative short term liquidity as measured by the acid test ratio from 2007 to 2010. Between 2007 and 2010, the short term liquidity levels have been holding steady. Acid Test 0.80 0.70 Acid test ratio 0.60 0.50 Digi 0.40 XL Axiata 0.30 M1 0.20 0.10 0.00 2006 2007 2008 2009 2010 Diagram 2.4.1: Acid test ratios as a measure of short term liquidity Given that DiGi has consistently had these low levels of short term liquidity in the last 5 years and yet have still been able to grow in terms of revenue and subscriber base, as well as being able to invest in infrastructure, we see no reason to be overly alarmed over the results of the acid test. However, to be on the safe side, short term financing should be arranged and kept as a back-up in order to mitigate short-term liquidity risks. P a g e | 22
  23. 23. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 2.5 Special Note: ROE is distorted by capital structure While the following indicators do not impact on our study of DiGi’s growth potential, the anomalies presented by these indicators are worth noting. ROE has shown a strong growth since 2006 to 2010. In the same time period, ROA and ROCE have been relatively flat. Percentage Return Measures of return 100.0% 90.0% 80.0% 70.0% 60.0% 50.0% 40.0% 30.0% 20.0% 10.0% 0.0% ROE ROA ROCE 2006 2007 2008 2009 2010 Diagram 2.5.1: ROE is diverging from other measures of return such as ROA & ROCE Diagram 2.5.1 compares the Financial Leverage Coefficient (ROE/ROA) between DiGi, XL Axiata and M1. DiGi has the highest coefficient among the three telcos. This indicates that DiGi has a high debt to equity ratios (gearing) as compared to the other telcos. Telco 2010 DiGi 3.99 XL Axiata 1.83 M1 2.97 Diagram 2.5.2: Financial leverage coefficients for the year 201 P a g e | 23
  24. 24. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad The diagram below illustrates the three key drivers of ROE and their values from 2006 to 2010. It is clear that financial leverage has grown significantly where net profit margin has declined and asset turnover only grew marginally. As such we can confidently conclude that the growth in ROE is primarily driven by the growth in financial leverage. ROE decomposition Net Profit margin 2006 2007 2008 2009 2010 21.8% 24.1% 23.5% 20.3% 21.6% Asset turnover 0.91 1.14 1.04 1.04 1.06 Financial leverage 2.32 2.45 2.45 3.11 3.81 45.97% 67.35% 60.13% 65.76% 87.48% ROE Diagram 2.5.3: Key drivers of ROE Financial leverage is growing due to increase in borrowing and a reduction in shareholder equity due to reduction in retained earnings. Retained earnings have been declining due to dividend payouts exceeding net profit for the last several years. DiGi conducted two capital repayment exercise in 2005 and 2006 respectively21. More than RM1 billion was paid out in these two capital repayments exercises resulting in a large drop in shareholder capital. Shareholder capital experienced a 90% drop from the year 2005 (RM 750 million) to the year 2006 (RM 75 million). 21 DiGi, 2006, Press Release, available at: http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=2661&pgPoint=4&yea r=2006 (accessed on 5th November 2011) P a g e | 24
  25. 25. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad As the ROE figures are not a good reflection of DiGi’s performance, we recommend that it not be used as the critical measure to evaluate true performance. We recommend to utilise ROA & ROCE as a more realistic measure of the company’s performance. We also recommend that for future cash needs that we consider raising new capital. This could be done via rights issues to all current shareholders or sales of new shares to strategic partners. P a g e | 25
  26. 26. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 3.0 CONCLUSION 3.1 Approaching Milestones There are several challenges that await DiGi in the medium to long term that will have significant financial implications. 3.1.1 Telecommunications Spectrum Re-farming22 The next few years will see the expiry of various blocks of spectrum currently held and utilized by the local telecommunications providers. This will lead to a bidding war between the major players for the spectrum blocks, as the incumbents (such as Maxis and Celcom) will strive to protect their currently held spectrum and other players, such as DiGi will attempt to acquire more spectrum blocks. This means that DiGi will incur a large capital expenditure in the next couple of years23. 3.1.2 3G License Expiry DiGi’s current 3G license is sub-leased from Time Dot Com Berhad and is due to expire in 201824. DiGi will need to be able to finance the renewal of the lease, which will cost at least another RM695 million25. 22Surin Murugiah, The Edge (2010), Spectrum Refarming in the Works, available at http://www.theedgemalaysia.com/in-the-financial-daily/166717-spectrum-refarming-in-theworks.html (accessed on 7th November 2011) 23Fong Min Hun, The Edge (2010), Spectrum Refarming could see Telcos Capex Rise, available at: http://www.theedgemalaysia.com/features/168450-corporate-spectrum-refarming-could-seetelcos-capex-rise.html (accessed 7th November 2011) 24Telenor, 2011, DiGi Business Description, available at: http://www.telenor.com/en/investorrelations/company-facts/business-description/DiGi (accessed on 7th November 2011) 25MIDF Research, 2009, Equity Beat (DiGi.com Bhd), available at: http://www.midf.com.my/project/midf/media/2009/05/04/094112-183.pdf (7th November 2011) P a g e | 26
  27. 27. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 3.1.3 Long Term Evolution Rollout In order to maintain its’ positioning in the mobile broadband space, DiGi will need to invest a lot of capital expenditure in LTE technology that will further enhance its’ mobile data offerings which is 4 times faster than the current HSPA+ technology26. LTE is widely considered as 4G technology and is the next logical step in the technological evolution of the mobile telecommunications industry27. DiGi, 2011, Press Release, available at: http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=6280&pgPoint=3&year=2011 (accessed on 7th November 2011) 27Ayvazian. B, (March 2011), Heavy Reading, LTE Operator Business Case and Adoption Forecast, pp. 3-5. 26 P a g e | 27
  28. 28. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 3.2 Summary of Recommendations The milestones mentioned above poses a significant financial challenge on future cash flow for DiGi, and DiGi needs to be financially prepared to meet these challenges. Over the past 3 years, the strategy to ensure high short term returns to the shareholders has diminished the net assets of the company. In order to arrest this development, DiGi shareholders must be persuaded to take a long term view of the business, especially in the light of today’s uncertain economic climate, both globally and locally. The following is a recap our key recommendations to address the highlighted concerns. Maximum dividend payout policy to be set at well below 100% of net profit Implement strategies to grow net profit margins via increased ARPU and reduced traffic costs Future funding needs should be fulfilled via internally generated funds or capital market rather than the debt market. Short term debt facility should be arranged to mitigate short-term liquidity risks. P a g e | 28
  29. 29. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 4.0APPENDIX 4.1 Financial Figures – DiGi Bhd28 Financial Ratios Description 2006 Profitability Analysis Net Profit margin Gross operating margin Net operating margin EBITDA margin Return on equity (ROE) Return on assets (ROA) Return on capital employed (ROCE) Financial leverage coefficient Asset Utilisation Analysis Total asset turnover Long-term asset turnover Receivables turnover OPEX (excluding COGS)/Revenue Traffic charges / revenue Financial Strength Analysis Long-term solvency risk Analysis Gearing (Debt/equity ratio) Interest cover Dividend cover Net profit after tax /Sales Sales less Cost of sales/sales Net profit before interest and tax/sales EBITDA/sales Net profit after tax/equity Net profit before interest/Total assets Net profit before interest on LT-debt/Equity + LTdebt Acid test (or quick ratio) Days inventory outstanding Credit given 28 Year 2008 2009 2010 Profit before interest and tax/Net interest charges Earnings per share/Dividend per share Current assets/Current liabilities Current assets – Inventories/Current liabilities (Inventories/Cost of sales)* 365 (Receivables/credit 23.5% 20.3% 21.6% 79.0% 79.8% 77.5% 76.3% 74.3% 28.9% 32.5% 31.6% 26.9% 28.3% 46.3% 48.3% 45.0% 42.5% 43.4% 46.0% 67.4% 60.1% 65.8% 87.5% 19.4% 27.0% 24.2% 20.3% 21.9% 38.5% 58.9% 56.5% 41.9% 46.5% 2.4 2.5 2.5 3.2 4.0 0.91 1.26 1.14 1.50 1.04 1.25 1.04 1.28 1.06 1.43 14.75 12.53 11.53 11.73 12.49 32% 33% 34% 31% 19.0% 21.5% 22.6% 21.9% 0.171 0.190 0.207 0.606 0.800 67.611 93.924 124.14 3 32.665 29.91 5 278.816 85.889 76.937 72.712 87.06 9 0.175 0.009 Debt/equity 24.1% 18.8% sales/total assets Sales/non current assets (Net credit) Sales/Receivables 21.8% 33% ROE/ROA Debt/EBITDA Interest/EBITDA Short-term liquidity risk Analysis Current ratio 2007 0.141 0.007 0.179 0.006 0.439 0.019 0.454 0.022 0.69 0.54 0.34 0.43 0.59 0.68 0.21 0.20 0.22 0.21 408.71 236.98 110.86 134.10 221.1 0 Derived from DiGi Berhad Annual Reports 2006-2010 P a g e | 29
  30. 30. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad Financial Ratios Description 2006 Credit obtained sales)*365 (Trade payables/cost of sales)*365 2007 Year 2008 2009 2010 586.81 484.57 499.84 445.46 477.8 6 0.359 1.164 1.316 1.376 1.148 0.295 -0.111 -0.190 -0.247 -0.130 2.373 2.494 2.481 3.242 3.989 0.723097082 0.7582 3903 0.8325 8897 0.81529 7128 0.740 9233 21.8% 24.1% 23.5% 20.3% 21.6% 0.91 1.14 2.4577 7155 67.35 % 1.04 2.4541 0116 60.13 % 1.04 3.11044 5964 1.06 3.814 458 87.48 % 2.1 2.44 1.96 1.73 19.04 % 20.76 % 19% 33.74 % 10.08 % 24.59 % 21% 1.68% 10.69 % 7.28% 7.01% 23% 22% -3.71% 8.76% 250.5 6% 4.17% -6.75% -5.50% 2.10% 1.02% -2.90% -1.62% 56 92 59 54 89 59 49 84 55 Strategic Ratios Dividend payout ratios Sustainable growth Financial leverage coefficient Dividend / Earnings attributable to shareholders ROE x (1 – Dividend payout ratio) ROE/ROA Operational Gearing ROE decomposition Asset turnover Net profit for the period/Sales sales/total assets Financial leverage total Assets/equity Net Profit margin ROE 2.326035536 45.97% Net assets per share (RM) General Ratios 2.34 Revenue growth rate 28.35% Traffic charges growth rate Traffic charges / revenue 19% Cost of material growth rate EBITDA margin growth rate Gross operating margin growth ARPU Prepaid Postpaid Blended 50 96 54 65.76% 2.60% 46 83 52 P a g e | 30
  31. 31. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 4.2 Financial Figures – XL Axiata29 Financial Ratios Description 2006 Profitability Analysis Net Profit margin Gross operating margin Net operating margin Return on equity (ROE) Return on assets (ROA) Return on capital employed (ROCE) Financial leverage coefficient Asset Utilisation Analysis Total asset turnover Long-term asset turnover Credit given Credit obtained Interest cover Dividend cover Acid test (or quick ratio) Credit given Credit obtained 29 2009 2010 10.1% 3.0% -0.1% 12.3% 16.4% 72.4% 77.2% 80.3% 84.1% 85.9% 15.9% 21.0% 14.4% 17.8% 29.3% Net profit after tax/equity 15.23% 5.62% -0.35% 19.41% 24.68% 8.0% 4.8% 3.7% 10.6% 13.5% 9.8% 7.6% 4.8% 13.6% 16.2% 1.9 1.2 -0.1 1.8 1.8 sales/total assets 0.51 0.44 0.42 0.51 0.65 Sales/non current assets 1.07 1.14 0.66 1.10 1.61 13.14 14.21 28.39 8.85 9.55 226.09 259.90 195.25 102.16 74.15 18.97% 19.15% 19.04% 14.80% 13.20% 1.72 2.16 4.35 1.53 0.87 2.82 2.74 1.60 2.04 6.62 9.71 1.77 - 2.87 0.14 2.75 0.18 3.65 0.21 2.17 0.19 1.10 0.08 0.51 0.24 0.60 0.33 0.49 0.51 0.24 0.60 0.33 0.47 35.43 58.91 146.00 55.21 50.27 226.09 259.90 195.25 102.16 74.15 Net profit before interest/Total assets Net profit before interest on LT-debt/Equity + LTdebt ROE/ROA (account receivable/total credit sales)*365 (trade payable/cost of sales)*365 Debt/equity Profit before interest and tax/Net interest charges Earnings per share/Dividend per share Debt/EBITA Interest/EBITA Short-term liquidity risk Analysis Current ratio Year 2008 Net profit after tax /Sales Sales less Cost of sales/sales Net profit before interest and tax/sales Traffic charges / revenue Financial Strength Analysis Long-term solvency risk Analysis Gearing (Debt/equity ratio) 2007 Current assets/Current liabilities Current assets – Inventories/Current liabilities (Receivables/credit sales)*365 (Trade payables/cost of sales)*365 - 3.18 Derived from XL Axiata Financial Statements (2006-2010) P a g e | 31
  32. 32. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad Financial Ratios Description Year 2008 2006 Strategic Ratios Dividend payout ratios Sustainable growth Operating Gearing Dividend / Earnings attributable to shareholders Sustainable growth = ROE x (1 – Dividend payout ratio) –LT assets /Total assets 2007 2009 2010 0.10276 07 0.564940 24 0 0 0.3152 89 13.7% 2.4% -0.3% 19.4% 16.9% 0.90630 69 0.910643 05 0.8713 64 0.9266983 2 0.9182 42 10.1% 3.0% -0.1% 12.3% 16.4% 0.51 2.95188 04 15.23% 0.44 4.210750 28 5.62% 0.42 6.7110 03 -0.35% 0.51 3.1103033 06 19.41% 0.65 2.3261 63 24.68% 29.37% 45.32% 14.18% 71.21% -0.40% 40.56% 27.07% 109.58 % 6.65% 4.02% 4.75% 2.12% 37.43% 40.99% 42.85% 36.33% ROE Decomposition Asset turnover Net profit for the period/Sales sales/total assets Financial leverage total Assets/equity Net Profit margin ROE General Ratios Revenue growth rate EBITDA growth rate Gross operating margin growth OPEX(excluding COGS)/revenue 34.38% P a g e | 32
  33. 33. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 4.3 Financial Figures – M130 Financial Ratios Description 2006 Profitability Analysis Net Profit margin Gross operating margin Net operating margin Return on equity (ROE) Return on assets (ROA) Net profit after tax /Sales Sales less Cost of sales/sales Net profit before interest and tax/sales Net profit after tax/equity Net profit before interest/Total assets Net profit before interest on LTdebt/Equity + LT-debt Return on capital employed (ROCE) Financial leverage ROE/ROA coefficient Asset Utilisation Analysis Total Asset Turnover Sales/Total Assets Long-term Asset Sales/Non-current Assets Turnover Inventory Turnover Cost of sales/inventory Receivables Turnover (Net credit) Sales/Receivables traffic charges/revenue COGS/revenue OPEX (excluding traffic charges)/revenue Financial Strength Analysis Long-term solvency risk Analysis Gearing (Debt/equity Debt/equity ratio) Profit before interest and Interest Cover tax/Net interest charges Dividend per Share Earnings per share/Dividend Dividend Cover per share 1.1 Gearing (Debt/EBIDTA) Short-term liquidity risk Analysis Current assets/Current Current ratio liabilities Current assets – Acid test (or quick ratio) Inventories/Current liabilities Days inventory (Inventories/Cost of sales)* 365 outstanding Credit given (Receivables/credit sales)*365 (Trade payables/cost of Credit obtained sales)*365 Strategic Ratios Dividend / Earnings Dividend payout ratios attributable to shareholders ROE x (1 – Dividend payout Sustainable growth ratio) Total Non-Current Assets / Operating Gearing Total Assets 30 2007 21.3% 65.0% 21.4% 63.1% 28.4% Year 2008 2009 2010 18.7% 62.4% 19.2% 57.8% 16.0% 49.8% 25.4% 24.1% 23.2% 20.0% 43.1% 85.1% 67.2% 58.7% 51.9% 16.6% 21.4% 19.6% 18.7% 17.4% 40.4% 35.9% 30.1% 56.2% 29.5% 2.6 4.0 3.4 3.1 3.0 0.73 0.95 1.00 0.93 1.05 0.99 1.12 1.16 1.12 1.40 48.64 9.43 -17.3% -0.35 -55.1% 35.41 9.94 -20.3% 35.36 11.56 -21.6% 13.00 8.95 -24.2% 21.01 5.49 -19.9% -54.6% -54.5% -52.8% -60.3% 0.65 1.41 1.12 1.05 1.04 21.37 21.53 25.42 28.10 33.59 0.261 0.108 0.145 0.134 0.134 63.67 171.00 115.88 125.53 130.28 0.75 0.89 0.79 0.87 1.01 0.51 0.44 0.48 0.28 0.78 0.50 0.41 0.44 0.23 0.70 -3.63 -5.07 -5.10 -15.39 -10.88 38.70 36.73 31.57 40.76 66.44 -131.13 -120.02 -93.73 -92.82 -73.62 1.57 0.56 0.86 0.80 0.77 -0.25 0.37 0.09 0.12 0.12 0.74 0.85 0.86 0.83 0.75 Derived from M1 Financial Statements (2006-2010) P a g e | 33
  34. 34. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad Financial Ratios Description 2006 ROE Decomposition Financial Leverage Net Profit margin Debt to Assets 2.1 ROE Total Assets / Total Equity LT Debt / Total Assets Net Profit Margin x Total Asset Turnover x Financial Leverage 2007 2.76 21.3% 0.00 4.19 21.4% 0.30 43.09% 85.09% Year 2008 2009 2010 3.60 18.7% 0.31 3.27 19.2% 0.00 3.09 16.0% 0.27 67.24% 58.69% 51.85% P a g e | 34
  35. 35. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad 4.4 References Axiata Group Berhad (2010), 3rd Quarter 2010 Analyst and Investor Briefing, 24 th November 2010, Axiata Group Berhad Ayvazian. B, (March 2011), Heavy Reading, LTE Operator Business Case and Adoption Forecast, pp. 3-5. Central Intelligence Agency, World Factbook, available at: https://www.cia.gov/library/publications/the-world-factbook/index.html (accessed on 9th November 2011) DiGi.com Bhd. 2011, Annual Report 2005 – 2010 [online]. Available at http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=6 (Accessed 15 November 2011) DiGi.com Bhd. 2011, Quarterly Financial Report Q1 2006 – Q4 2010 [online]. Available at http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=3 (Accessed 15 November 2011) DiGi.com Bhd. 2011, Quarterly Analyst Breifing Q1 2006 – Q4 2010 [online]. Available at http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=3 (Accessed 15 November 2011) DiGi, 2006, Press Release, available at: http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=2661&pgPoint=4&year=2006 (accessed on 5th November 2011) DiGi, 2011, Press Release, available at: http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=6280&pgPoint=3&year=2011 (accessed on 7th November 2011) Financial Daily, (2010), DiGi Prepaid Revenue gains traction, available at: http://www.theedgemalaysia.com/in-the-financial-daily/165458-digi-prepaid-revenue-gainstraction.html (accessed on 7th November 2011) Fong Min Hun, The Edge (2010), Spectrum Refarming could see Telcos Capex Rise, available at: http://www.theedgemalaysia.com/features/168450-corporate-spectrum-refarming-could-see-telcoscapex-rise.html (accessed 7th November 2011) Hendrik Clausen (2011), Analyst Briefing, 22 September 2011, DiGi Bhd. Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd. Insider Asia, 2011, Steady Gains seen for DiGi, available at: http://www.theedgemalaysia.com/inthe-financial-daily/190317-steady-gains-seen-for-digi.html (accessed on 7th November 2011) Investopedia, Altman Z-scores, available at: http://www.investopedia.com/terms/a/altman.asp#axzz1eKZSDomX (accessed on14th November 2011) Kelvin Goh (2011), “Telecommunication, Muffled by regulation and competition”, CIMB Research Reports (17 Feb 2011). CIMB Bhd. MCMC (2007), Trends and Markets in Malaysian Mobile Services, volume 5, Malaysian Communications and Multimedia Commission P a g e | 35
  36. 36. Accounting & Finance (N14M01) Strategic Financial Review of DiGi.Com Berhad MIDF Research, 2009, Equity Beat (DiGi.com Bhd), available at: http://www.midf.com.my/project/midf/media/2009/05/04/094112-183.pdf (7th November 2011) MobileOne Ltd, (2011) Investor Presentation Jan 2011, available at: http://m1.com.sg/M1/CMA/About_Us/Corporate_Information/IR/PDF/Investor%20Presentation %2019%20Jan%202011.pdf (accessed on 7th November 2011) MobileOne Ltd. (2011), Annual Report 2006 – 2010 [online]. Available at http://www.m1.com.sg/M1/site/M1Corp/menuitem.faca305fb9985217f15a947b3f2000a0/?vgnextoi d=ad241b7faba72010VgnVCM100000275a160aRCRD&vgnextfmt=pdate:1111202212: (Accessed 15 November 2011) PT XL Axiata Tbk. 2011, Annual Report 2006 – 2010 [online]. Available at http://www.xl.co.id/investor-relation/language/en-GB/CompanyReports/Annual (Accessed 15 November 2011) PT XL Axiata Tbk. 2011, Quarterly Report Q1 2006 – Q4 2010 [online]. Available at http://www.xl.co.id/investor-relation/language/en-GB/CompanyReports/Quarterly (Accessed 15 November 2011) Sidhu B.K. (11 Jun 2010). Celcom and DiGi to collaborate, The Star[Online]. Available at: http://biz.thestar.com.my/news/story.asp?file=/2010/6/11/business/6448138&sec=business [accessed on 22 November 2011] Surin Murugiah, The Edge (2010), Spectrum Refarming in the Works, available at http://www.theedgemalaysia.com/in-the-financial-daily/166717-spectrum-refarming-in-theworks.html (accessed on 7th November 2011) Telenor, 2011, DiGi Business Description, available at: http://www.telenor.com/en/investorrelations/company-facts/business-description/DiGi (accessed on 7th November 2011) Websites: DiGi Berhad, www.digi.com.my XL Axiata, www.xl.co.id MobileOne, www.m1.com.sg P a g e | 36

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