Singtel Sank nearly 10% in Two Days, What’s Going On?

Singtel (SGX: Z74) fell from a high of $2.64 to a low of $2.41 last week before recovering to $2.44. The main reason was likely due to a Citi Research analyst report which was since corrected by the analyst.

The report announced a negative watch on Singtel downside due to a significant earnings miss by Telkomsel in Indonesia, one of Singtel’s major associates.

A correction was subsequently added to the report to explain that the operational earnings miss was not as significant once the valuation losses of Telkomsel’s investment in GoTo (formed from the merger of Gojek and Tokopedia) was excluded from the bottom line.

Analyst made an error but…

However, the analyst still stood by the original view of a potentially softening of earnings in the short term. Looking at the longer term, the analyst opined that the move to merge Telkomsel with Indihome should help reduce operational expenses and drive cross selling synergies.

Singtel’s management was quick to clarify

Singtel quickly provided a clarification on the Citi Research Report saying that the analyst report may have caused unnecessary confusion. Singtel also clarified that Telkomsel’s 21% YoY decline in their net profit was driven mainly by fair value revaluation of its investment in GoTo.

Excluding the fair value of investment in GoTo, Telkomsel would have instead reported a 1% YoY increase to net profit.

Singtel also explains that fair value revaluations are non-cash in nature and are also not taken into account when Telkomsel determines its dividend payouts to shareholders. Consequently, this does not impact Singtel’s original guidance of dividends expected from its associates including Telkomsel. Singtel further affirmed its dividend policy to pay ordinary dividends at 60% to 80% of underlying net profit.

Due to Singtel’s large investor base which comprise of a lot of Singaporeans especially those from the older generation, the management has gone the extra mile in reiterating its dividend policy and commitment for their FY2024.

Disappointing share price performance

Singtel’s shares recovered by 3 cents after the clarification was made, less than 20% of the loss.

However, before this happened, Singtel’s share price performance had already been disappointing. It is down more than 20% in 5 years from a share price of $3.14 then and even more if compared to previous highs.

What is the management doing about the share price?

In April 2023, Singtel announced a reorganisation of its structure saying it would drive growth, synergies and productivity at the country level. The moves are part of Singtel’s strategic reset and ongoing efforts to restructure and reposition the company.

This reorganisation consolidates consumer and enterprise businesses in Singapore into a single operating company and forms an infrastructure arm.

Singtel has lots of assets – what are potential spinoffs?

The standalone infrastructure arm is called Digital InfraCo and this includes Singtel’s regional data centre business, subsea cable and satellite carrier businesses as well as Paragon (not the shopping mall), Singtel’s all-in-one platform for 5G multi-access edge computing (MEC) and cloud orchestration.

In 2021, Singtel spun off its ICT arm, NCS, as an autonomous business unit. This was a reversal of the initial plan to integrate NCS with Singtel’s enterprise unit some years back in the hope of extracting synergies.

Singtel hoped the spin-off would accelerate NCS’s expansion into Asia Pacific as an autonomous business unit. In July 2022, Singtel further decentralised its organisational structure by transferring the management of Optus Enterprise to Australia, effectively giving Optus more operational autonomy and direct accountability.

This means that Singtel has three segments that could potentially be spun off;

1. NCS
2. Digital Infraco and
3. Optus.

The snapshots below show the revenue and EBITDA of NCS is $2.7 billion and $0.25 million respectively. Optus generates $7.6 billion and $2.0 billion respectively.

The Digital Infraco was not a separate segment, but we do know that it was part of the Singapore Consumer entity.

At a share price of $2.45, Singtel carries a market valuation of $40.5 billion, which represents a valuation of about 2.8x revenue and 11x EBITDA multiple.

At such valuation, I think the Digital Infraco segment would be the only segment that can list at a higher valuation, should it convert into a tax transparent structure (i.e., REIT/Trust).

For reference, NetLink Trust is trading at a 12.4x EBITDA multiple while Keppel DC REIT trades at 15.5x multiple. Keppel DC REIT also disclosed in a study from Danseb that the valuation of colocation assets in mergers and acquisitions rose from an average of 18-20X EBITDA in 2018, to 25-30X EBITDA in 2022, reflecting the popularity and potential of data centers.

I think the two other segments would not necessarily re-rate higher in a spin off, unless they can demonstrate strong growth or increased profits. To this, you should note that NCS recorded a YoY revenue growth of 15.5%, but a profit decline of 15.7%.

Summarily, I don’t think we should view spinoffs as unlocking value for Singtel but rather to secure headroom for future capital expenditure and investments.

How did NetLink Trust perform for Singtel shareholders?

NetLink Trust listed in July 2017 at $0.81 and currently trades at $0.86 with an all time high of $1.03 and a trough of $0.74. With the share price is close to the IPO price, this showed that Singtel had sold its stake in NetLink at a price that benefitted existing shareholders.

This IPO was due to Singtel’s undertaking to the regulator to divest its 100% stake in NetLink Trust to less than 25%, in order to maintain neutrality of NetLink Trust.

A special dividend of 3 cents amounting to $500 million or 22% of proceeds was distributed to shareholders. The balance in proceeds was kept by Singtel for future spectrum acquisitions and growth investments.

The proceeds also allowed Singtel to immediately reduce its debt and maintained its credit rating. At the point of IPO, there was a risk of Singtel losing its credit rating which would have led to higher interest costs and a lowered net profit.

With the benefit of hindsight, it is quite clear that Singtel was fortunate to be in a position to carry out this divestment, use the funds for capital expenditure and maintain its credit rating.

Is Singtel a buy hold or sell?

A long time ago, Warren Buffett leaned towards investing in industries that did not require much capital as companies in such industries were able to return a lot more of its profits to investors rather than retain and invest it in fixed assets. He even singled out the Airline industry as one to avoid.

A notable development since then has been the transition away from low capital intensity businesses into high capital intensity businesses such as railroads and utilities. Buffett has even taken a position in Airlines once before.

The reason for him was that he needed a way to deploy significant amount of funding and benefited from the compounding gains of this investment.

Tech companies such as Amazon, Tesla and Meta Platforms also invested heavily in assets such as warehouses, charging stations and data centres respectively.

The key point is that these companies first started off with a core product and then tried to secure its position with capital investments.

Applying Buffett’s reasoning, I would have to say that Singtel is a buy because it is investing to keep up with times. But first, we would need to see Singtel deliver compounding gains (higher profits).

However, if we look at Singtel’s five-year financial summary, their underlying profits declined for 3 consecutive years before marking a slight recovery in 2023. Hence, Singtel is currently only a Hold, until underlying profit reflects the investments made by Singtel.