Maintain NEUTRAL on sector with BUY on StarHub and M1 unchanged. M1 preferred for likelihood of special dividend.

Lower handset subsidies for popular models such as Samsung Galaxy S5 and HTC One M8 should see telco margins benefit.

Government cut on SIM cards from 10 to three per sub could hurt prepaid mobile revenue.

What’s New

The higher prices of three new major handsets launched last week confirmed our view that handset subsidies would decline this year. For basic plans, the Samsung Galaxy S5, for example, received the lowest level of subsidies yet, ie, SGD369-380, down by 21-22% from SGD469-490 for the S4 (in 2013), and lower still from the S3, when the subsidy was as high as SGD550 (in 2012). Similarly, subsidies for the just-launched HTC One M8 fell by 24-28% to SGD320-360 from SGD420-499 for the original HTC One, launched in 2013.

What’s Our View

We think there could be upside to EBITDA margins from the trend towards lower subsidies. Subsidies had already been reduced last year for the Galaxy S4 and even the most premium of handsets, the iPhone 5S, saw a slight reduction of 1-5%, down to SGD471-483 from SGD475-508.

We estimate that 2013’s subsidy reduction benefited SingTel and StarHub’s EBITDA margins by 2ppts. For both telcos, it was quite clear that margins improved in the quarters the Galaxy S4 and the original HTC One were launched compared to previous models. For M1, the picture was not so clear, perhaps due to its accounting treatment for iPhone subsidies, but we believe its underlying profitability should also have improved.

This year’s subsidy reduction is the highest yet in recent years. We therefore maintain that margin guidance by the telcos, in particular StarHub, is conservative and anticipate further upside.

On a less positive note, the government’s cut in the number of prepaid SIM cards allowed to be purchased from 10 to three per subscriber could have a negative impact on prepaid revenue, as many foreign worker agencies buy up to 10 cards each time for their workers. Prepaid revenue accounts for 13%, 19% and 25% of M1, StarHub and SingTel’s Singapore mobile revenue, respectively.

We maintain BUY on StarHub and M1, with a preference for M1 as we think there could be another special dividend this year. Usually, M1’s special dividends would equal the final dividend

Source: Maybank Kim Eng Research - 9 Apr 2014