PT Telkom - More talk, action unlikely - Macquarie

Event
§ A Singtel spokesperson was quoted in this morning's Kontan, a local newspaper, as saying "Singtel is looking to be a long term strategic investor in Indonesia" in response to ongoing talk from TLKM management in relation to purchasing Singtel’s 35% stake in Telkomsel. We maintain our view a deal is unlikely to arise and ongoing talk remains a distraction for management from more crucial operational matters. We maintain our Neutral recommendation.

Impact
§ TLKM distracted by Singtel's stake. We view TLKM's ongoing attention to purchasing Singtel's stake as a source of distraction and potential friction with Singtel's management team. Singtel remains intent on being a "strategic" investor in Telkomsel, and is therefore averse to short term fluctuations in operational performance as witnessed recently. We therefore place a low probability on a deal materialising between TLKM and Singtel and believe attention on Singtel's stake as a misallocation of resources.
§ More corporate activity in pipeline? TLKM was quoted in Kontan (12th July), as assessing ISAT's CDMA business Starone as a potential partner for its own CDMA division - Flexi. We believe a merger of these businesses offers limited upside to TLKM given both are underperforming assets within a highly competitive segment with a challenging growth profile. Flexi represents ~5% of TLKM's revenue, whose revenue also declined by 15% YoY in 2010.
§ Operational performance the key driver of value. TLKM’s operational performance within Telkomsel is the key to driving its share price, in our view, with greater clarity needed on its portfolio of brands and their respective pricing points. Telkomsel’s aggressive approach to pricing more recently is unsustainable, in our view, attracting the less profitable high churn segment which is likely to impact performance once its price-led promotions ease.

Earnings and target price revision
§ No change.

Price catalyst
§ 12-month price target: Rp7,350 based on a DCF methodology.
§ Catalyst: 2Q results by the end of July 2011.

Action and recommendation
§ Neutral recommendation maintained. The catalyst for a re-rating remains improved operating momentum in relation to both revenue growth and profitability which have missed investor expectations recently. We expect TLKM to remain range-bound given its flat earnings profile despite trading on a relatively undemanding valuation of 11.4x FY11e PER. EXCL (Outperform, Rp6,700 PT) remains our preferred sector exposure, trading on 6.2x FY11e EV/EBITDA. EXCL is the prime beneficiary of strong growth in mobile internet, with ~50% penetration in this segment and no fixed line exposure.