Celcom and Digi have inked a transaction agreement to merge together (Source)
Big news coming from the telecommunication industry in Malaysia, Axiata Celcom and Digi are planning to merge together after signing the transaction agreement. This deal is expected to result in a pre-synergy equity value of RM50bn and a combined market capitalisation of RM70bn. Pre-synergy here means that it's just the sum of the equity value of the companies without realising any benefits from the merger. The merger is expected to generate about cost and CAPEX synergies of around RM8bn on a net present value basis. Now, net present value basis here just means that the merger will generate those improvements in the years after the merger and thus is discounted back. This can be illustrated in the following way in terms of the reduction in cost in the next 5 years. You just discount the future savings with the discount rate which is usually the weighted average cost of capital but to minimise the complexity of this, we will just take this discount rate as 8% and you can treat it like if I have RM100 today to invest, I expect to generate 8% in returns next year. So the RM108 that you received next year will be the same value now if you discount it by 8%.
Now, since I am a numbers guy… well at least I think I am, how does the merger stack up in the market? Well, it will effectively become a monopoly since it will consist of more than 50% of the market capitalization of the telecommunications market. Taking 7 telecommunications providers as the whole market, it came up to about RM138.2bn in total market capitalization, where the merger will result in RM70bn in market capitalization. Maxis comes in next at RM35.3bn, with Telekom Malaysia at RM22.9bn.
Though, my big question is how is this not anti-competition? Malaysia does have laws exactly for this kind of thing. Then, it hit me, you know this is just the merger of the Malaysian operations of Axiata (Celcom) with Digi. So technically, it doesn’t hit the anti-competition laws like it's stated here and it isn’t a merger of Axiata with Digi. But if you think about it, I mean this is just a technicality cause Celcom has 9.1 million customers and Digi has 10.7 million mobile subscribers with total mobile subscribers of 44.6 million in Malaysia. Simple mathematics tells me that Celcom and Digi combined will have 44.4% of the total market in Malaysia. I mean like they definitely have monopoly pricing power in the market with that. So, I guess GLCs do get some “preference” in terms of regulations.
How does this translate to the financial performance of both companies? For one, it needs to be noted that Axiata is way more inefficient compared to Digi. Axiata made about RM24.2bn in revenue last year, but only generating RM365m, resulting in a profit margin of 1.5%. Digi on the other hand generates about RM6.2bn in revenue last year, with profits of RM1.2bn, resulting in a profit margin of 19.8%. Even in 2019 where Axiata made RM1.5bn in profits, its profit margin was only 5.9%.
However, just looking at the historical financial performance, it is interesting to see possibly what are the main motivations for each company in this merger. If you take a look at the profit profile of Axiata, you can see that it is very volatile with 2018 incurring a huge loss of RM4.8bn. This was due to its big non-operating income/expense item of RM3.0bn which was related to the derecognition of its stake in its associate in Idea which leads to a reclassification of its stake to non-current asset. In a nutshell, an investment in an associate has lost value and is now recognized as a non-current asset for sale. Though, it can be seen also that its revenue growth hasn’t been particularly strong. Axiata probably wants to address this volatility in its profits and also chase for more revenue growth.
For Digi, its profits are very stable while its revenue has actually started to shown signs of not growing anymore throughout the years. It does however have reasonably high-profit margins, so it’s probably looking at Axiata being government-backed and having trouble generating efficient profits as a way to tap a much bigger market. Axiata after all has exposure to other countries in the region so Digi will have an outlet to expand overseas.
So I do see the rationale of doing this merger but I am worried about the potential monopoly that will come out of it. After all, a monopoly will definitely try to kill off the existing competition in the market now (Maxis mainly and the smaller players) and in turn charge higher prices and lower quality. Great as an investment but potentially horrible for clients.
