STRATEGIC FINANCIAL REVIEW OF DIGI.COM BHD

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

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

P a g e | 2


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

1 Hendrik Clausen (2011), Analyst Briefing, 22 September 2011, DiGi Bhd.. 2 Axiata Group Berhad (2010), 3rd Quarter 2010 Analyst and Investor Briefing, 24th

November 2010, Axiata Group Berhad3 M1, (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)

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)

P a g e | 3

http://www.m1.com.sg/

http://www.xl.co.id/

http://www.digi.com.my/

http://m1.com.sg/M1/CMA/About_Us/Corporate_Information/IR/PDF/Investor%20Presentation%2019%20Jan%202011.pdf



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.

5 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

P a g e | 4


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 Long term sustainable growth does not look promising

2.1.1 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 2006 2007 2008 2009 2010

Revenue growth rate 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) 1,677,4

01

1,502,6

45

1,819,4

22

1,443,7

18

1,268,8

72

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

P a g e | 5


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)

P a g e | 6

http://www.investopedia.com/terms/a/altman.asp#axzz1eKZSDomX


Indicators for DiGi 2006 2007 2008 2009 2010

Dividends per share 0.39 1.65 1.93 1.77 1.74

Dividends paid (RM'000)

288,9

00

1,237,3

51

1,500,6

92

1,376,1

75

1,352,8

50

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

2006 2007 2008 2009 20100.00

50.00

100.00

150.00

200.00

250.00

300.00

DiGiXLM1

Diagram 2.1.3: Comparison of dividend cover between DiGi, XL & M1

P a g e | 7


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

2006 2007 2008 2009 20100.00

0.20

0.40

0.60

0.80

1.00

1.20

1.40

1.60

1.80

DiGiXLM1

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

P a g e | 8


the positive region. The indicators appear low mainly because, as mentioned

earlier, the Singaporean mobile telecommunications market is already mature

and saturated.

Sustainable Growth Rates Comparison

2006 2007 2008 2009 2010

-0.30

-0.20

-0.10

0.00

0.10

0.20

0.30

0.40

0.50

DiGiXLM1

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

P a g e | 9


than rely solely on long term financing in order to finance said expenditure, we

recommend that the current dividend policy be 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


2.2 Net Profit Margins are not growing in tandem with revenue growth

2.2.1 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.

3,702,100

4,407,025

4,851,056 4,932,640

5,459,851

2006 2007 2008 2009 2010

Comparison between revenue growth against margin

Total Revenue79.0% 79.8% 77.5% 76.3% 74.3%

46.3% 48.3%45.0% 42.5% 43.4%

21.8% 24.1% 23.5%20.3% 21.6%

Gross operating marginEBITDA margin

Net Profit margin

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

P a g e | 11


contracting from 2008 to 2010. The important issue that is revealed here is that

both revenue growth and gross operating margin are trending divergently.

Year

2007 2008 2009 2010

Revenue Growth Rates

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


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


Diagram 2.2.4: Revenue & Gross Operating Margin trend of M1

2006 2007 2008 2009 20100.0%

10.0%

20.0%

30.0%

40.0%

50.0%

60.0%

70.0%

OPEX/revenue trend

DigiXL AxiataM1

Perc

enta

ge

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,

P a g e | 14


operates in a market with 85% penetration, which by definition, is still a growing

market.

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.

2007 2008 2009 20100.00%

5.00%

10.00%

15.00%

20.00%

25.00%

30.00%

Revenue Vs. Traffic Charges

RevenueTraffic Charger

Grow

th R

ate

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


13 Insider Asia, 2011, Steady Gains seen for DiGi, available at: http://www.theedgemalaysia.com/in-the-financial-daily/190317-steady-gains-seen-for-digi.html (accessed on 7th November 2011)

P a g e | 15

http://www.theedgemalaysia.com/in-the-financial-daily/190317-steady-gains-seen-for-digi.html



customers are outside DiGi’s network 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.

2006 2007 2008 2009 20100.0%

5.0%

10.0%

15.0%

20.0%

25.0%

30.0%

Traffic Charges as a percentage of revenue

DigiXL AxiataM1

Perc

enta

ge

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 substitution by cheaper services16. In our opinion, traditional

14Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd.15Financial Daily, (2010), DiGi Prepaid Revenue gains traction, available at:

http://www.theedgemalaysia.com/in-the-financial-daily/165458-digi-prepaid-revenue-gains-traction.html (accessed on 7th November 2011)

16MCMC (2007), Trends and Markets in Malaysian Mobile Services, volume 5, Malaysian Communications and Multimedia Commission

P a g e | 16

http://www.theedgemalaysia.com/in-the-financial-daily/165458-digi-prepaid-revenue-gains-traction.html



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.

0

20

40

60

80

100

120

2006 2007 2008 2009 2010

Ring

git

MA

lays

ia (

RM)

DIGI ARPU

Prepaid

Postpaid

Blended

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)

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

P a g e | 17


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

http://biz.thestar.com.my/news/story.asp?file=/2010/6/11/business/6448138&sec=business



2006 2007 2008 2009 20100.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

0.90

Gearing trend

Gearing (Debt/Equity) ratioGearing (Debt/EBIDTA)

Ratio

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 Bhd19DiGi.com Bhd. 2011, Annual Report 2009 – 2010 [online]. Available at

http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=6 (Accessed 15 November 2011)

P a g e | 19


2006 2007 2008 2009 20100

200000400000600000

80000010000001200000

1400000160000018000002000000

DiGi's Debt to Equity Progression

EquityDebt

Axis Title

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.

2006 2007 2008 2009 20100.00

0.50

1.00

1.50

2.00

2.50

3.00

3.50

4.00

Gearing Trends (DEBT/EBIDTA)

DIGIXL AxiataM1

Ratio

Diagram 2.3.3: Gearing (Debt/EBITDA) trend of XL Axiata & M1

P a g e | 20


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.

2006 2007 2008 2009 20100.00

20.00

40.00

60.00

80.00

100.00

120.00

140.00

Interest cover

DIGIXL AxiataM1

Ratio

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:

a) Internally generated funds from increased retained earnings


P a g e | 21


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.

2006 2007 2008 2009 20100.00

0.10

0.20

0.30

0.40

0.50

0.60

0.70

0.80

Acid Test

DigiXL AxiataM1

Acid

test

ratio

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


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.

2006 2007 2008 2009 20100.0%

10.0%20.0%30.0%40.0%50.0%60.0%70.0%80.0%90.0%

100.0%

Measures of return

ROEROAROCE

Perc

enta

ge R

etur

n

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

P a g e | 23


Diagram 2.5.2: Financial leverage coefficients for the year 201

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 2006 2007 2008 2009 2010

Net Profit margin 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

ROE 45.97% 67.35% 60.13% 65.76% 87.48

%

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

21 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)

P a g e | 24

http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=2661&pgPoint=4&year=2006



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).

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


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.

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

22Surin Murugiah, The Edge (2010), Spectrum Refarming in the Works, available at http://www.theedgemalaysia.com/in-the-financial-daily/166717-spectrum-refarming-in-the-works.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-see-telcos-capex-rise.html (accessed 7th November 2011)

24Telenor, 2011, DiGi Business Description, available at: http://www.telenor.com/en/investor-relations/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

http://www.midf.com.my/project/midf/media/2009/05/04/094112-183.pdf

http://www.telenor.com/en/investor-relations/company-facts/business-description/digi

http://www.theedgemalaysia.com/features/168450-corporate-spectrum-refarming-could-see-telcos-capex-rise.html


http://www.theedgemalaysia.com/in-the-financial-daily/166717-spectrum-refarming-in-the-works.html



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.

26 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.

P a g e | 27

http://www.digi.com.my/aboutdigi/media/mr_press_det.do?id=6280&pgPoint=3&year=2011



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


4.0 APPENDIX

4.1 Financial Figures – DiGi Bhd28

Financial Ratios Description Year

2006 2007 2008 20092010

Profitability Analysis

Net Profit marginNet profit after tax /Sales

21.8%24.1

%23.5

%20.3%

21.6%

Gross operating margin

Sales less Cost of sales/sales

79.0%79.8

%77.5

%76.3%

74.3%

Net operating marginNet profit before interest and tax/sales

28.9%32.5

%31.6

%26.9%

28.3%

EBITDA margin EBITDA/sales 46.3%48.3

%45.0

%42.5%

43.4%

Return on equity (ROE)

Net profit after tax/equity

46.0%67.4

%60.1

%65.8%

87.5%

Return on assets (ROA)

Net profit before interest/Total assets

19.4%27.0

%24.2

%20.3%

21.9%

Return on capital employed (ROCE)

Net profit before interest on LT-debt/Equity + LT-debt

38.5%58.9

%56.5

%41.9%

46.5%

Financial leverage coefficient

ROE/ROA 2.4 2.5 2.5 3.2 4.0

Asset Utilisation Analysis Total asset turnover sales/total assets 0.91 1.14 1.04 1.04 1.06

Long-term asset turnover

Sales/non current assets

1.26 1.50 1.25 1.28 1.43

Receivables turnover(Net credit) Sales/Receivables

14.75 12.53 11.53 11.7312.4

9

OPEX (excluding COGS)/Revenue

33% 32% 33% 34% 31%

Traffic charges / revenue

18.8%19.0

%21.5

%22.6%

21.9%

Financial Strength Analysis Long-term solvency risk Analysis

Gearing (Debt/equity ratio)

Debt/equity 0.171 0.190 0.207 0.6060.80

0

Interest coverProfit before interest and tax/Net interest charges

67.61193.92

4124.1

4332.66

529.9

15

Dividend coverEarnings per share/Dividend per share

278.81685.88

976.93

772.71

287.0

69

Debt/EBITDA 0.175 0.141 0.179 0.4390.45

4

Interest/EBITDA 0.009 0.007 0.006 0.0190.02

2Short-term liquidity risk Analysis

Current ratioCurrent assets/Current liabilities

0.69 0.54 0.34 0.43 0.59

Acid test (or quick ratio)

Current assets – Inventories/Current liabilities

0.68 0.21 0.20 0.22 0.21

28 Derived from DiGi Berhad Annual Reports 2006-2010

P a g e | 29


Financial Ratios Description Year

2006 2007 2008 20092010

Days inventory outstanding

(Inventories/Cost of sales)* 365

408.71236.9

8110.8

6134.1

0221.

10

Credit given(Receivables/credit sales)*365

Credit obtained(Trade payables/cost of sales)*365

586.81484.5

7499.8

4445.4

6477.

86Strategic Ratios

Dividend payout ratios

Dividend / Earnings attributable to shareholders

0.359 1.164 1.316 1.3761.14

8

Sustainable growthROE x (1 – Dividend payout ratio)

0.295-

0.111-

0.190-0.247

-0.13

0Financial leverage coefficient

ROE/ROA 2.373 2.494 2.481 3.2423.98

9

Operational Gearing 0.7230970

82

0.7582390

3

0.8325889

7

0.81529712

8

0.740923

3 ROE decomposition

Net Profit marginNet profit for the period/Sales

21.8%24.1

%23.5

%20.3%

21.6%

Asset turnover sales/total assets 0.91 1.14 1.04 1.04 1.06

Financial leverage total Assets/equity2.3260355

36

2.4577715

5

2.4541011

6

3.11044596

4

3.814458

ROE 45.97%67.35

%60.13

%65.76

%87.4

8%Net assets per share (RM)

2.34 2.1 2.44 1.96 1.73

General Ratios

Revenue growth rate 28.35%19.04

%10.08

%1.68%

10.69%

Traffic charges growth rate

20.76

%24.59

%7.28%

7.01%


19% 19% 21% 23% 22%

Cost of material growth rate

-

33.74%

-3.71

%8.76%

250.56%

EBITDA margin growth rate

4.17

%

-6.75

%

-5.50%

2.10%

Gross operating margin growth

1.02

%

-2.90

%

-1.62%

-2.60

% ARPU Prepaid 50 56 54 49 46 Postpaid 96 92 89 84 83 Blended 54 59 59 55 52

P a g e | 30


4.2 Financial Figures – XL Axiata29

Financial Ratios Description Year 2006 2007 2008 2009 2010Profitability Analysis

Net Profit marginNet profit after tax /Sales

10.1% 3.0% -0.1% 12.3% 16.4%


Sales less Cost of sales/sales

72.4% 77.2% 80.3% 84.1% 85.9%

Net operating margin

Net profit before interest and tax/sales

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%


ROE/ROA 1.9 1.2 -0.1 1.8 1.8

Asset Utilisation Analysis

Total asset turnover

sales/total assets 0.51 0.44 0.42 0.51 0.65

Long-term asset turnover

Sales/non current assets

1.07 1.14 0.66 1.10 1.61

Credit given(account receivable/total credit sales)*365

13.14 14.21 28.39 8.85 9.55

Credit obtained(trade payable/cost of sales)*365

226.09 259.90195.2

5102.16 74.15


18.97%

19.15%19.04

%14.80%

13.20%

Financial Strength Analysis

Long-term solvency risk Analysis


Debt/equity 1.72 2.16 4.35 1.53 0.87

Interest coverProfit before interest and tax/Net interest charges

2.82 2.74 1.60 2.04 6.62

Dividend coverEarnings per share/Dividend per share

9.71 1.77 - - 3.18

Debt/EBITA 2.87 2.75 3.65 2.17 1.10 Interest/EBITA 0.14 0.18 0.21 0.19 0.08Short-term liquidity risk Analysis


0.51 0.24 0.60 0.33 0.49



0.51 0.24 0.60 0.33 0.47


35.43 58.91146.0

055.21 50.27

Credit obtained (Trade payables/cost of 226.09 259.90 195.2 102.16 74.15

29 Derived from XL Axiata Financial Statements (2006-2010)

P a g e | 31


Financial Ratios Description Year 2006 2007 2008 2009 2010

sales)*365 5Strategic Ratios

Dividend payout ratios

Dividend / Earnings attributable to shareholders

0.1027607

0.56494024

0 00.315

289

Sustainable growth

Sustainable growth = ROE x (1 – Dividend payout ratio)

13.7% 2.4% -0.3% 19.4% 16.9%

Operating Gearing

–LT assets /Total assets0.9063

0690.9106

43050.871

3640.92669

8320.918

242ROE

Decomposition

Net Profit

marginNet profit for the period/Sales

10.1% 3.0% -0.1% 12.3% 16.4%

Asset turnover sales/total assets 0.51 0.44 0.42 0.51 0.65

Financial

leveragetotal Assets/equity

2.9518804

4.21075028

6.711003

3.110303306

2.326163

ROE15.23

%5.62%

-0.35%

19.41%24.68

%General Ratios

Revenue growth rate

29.37%45.32

%14.18%

27.07%

EBITDA growth rate

71.21%-

0.40%40.56%

109.58%

Gross operating margin growth

6.65% 4.02% 4.75% 2.12%

OPEX(excluding COGS)/revenue

34.38%

37.43%40.99

%42.85%

36.33%

P a g e | 32


4.3 Financial Figures – M130

Financial Ratios Description Year 2006 2007 2008 2009 2010Profitability Analysis Net Profit margin Net profit after tax /Sales 21.3% 21.4% 18.7% 19.2% 16.0%


Sales less Cost of sales/sales 65.0% 63.1% 62.4% 57.8% 49.8%

Net operating margin

Net profit before interest and tax/sales

28.4% 25.4% 24.1% 23.2% 20.0%


Net profit after tax/equity 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%


ROE/ROA 2.6 4.0 3.4 3.1 3.0

Asset Utilisation Analysis

Total Asset Turnover Sales/Total Assets 0.73 0.95 1.00 0.93 1.05

Long-term Asset Turnover

Sales/Non-current Assets 0.99 1.12 1.16 1.12 1.40

Inventory Turnover Cost of sales/inventory 48.64 35.41 35.36 13.00 21.01

Receivables Turnover

(Net credit) Sales/Receivables 9.43 9.94 11.56 8.95 5.49

traffic charges/revenue

-17.3% -20.3% -21.6% -24.2% -19.9%

COGS/revenue -0.35 OPEX (excluding traffic charges)/revenue -55.1% -54.6% -54.5% -52.8% -60.3%Financial Strength Analysis

Long-term solvency risk Analysis


Debt/equity 0.65 1.41 1.12 1.05 1.04

Interest CoverProfit before interest and tax/Net interest charges

21.37 21.53 25.42 28.10 33.59

Dividend per Share 0.261 0.108 0.145 0.134 0.134

Dividend CoverEarnings per share/Dividend per share

63.67 171.00 115.88 125.53 130.28

1.1Gearing (Debt/EBIDTA) 0.75 0.89 0.79 0.87 1.01Short-term liquidity risk Analysis


0.51 0.44 0.48 0.28 0.78



0.50 0.41 0.44 0.23 0.70

Days inventory outstanding

(Inventories/Cost of sales)* 365

-3.63 -5.07 -5.10 -15.39 -10.88


38.70 36.73 31.57 40.76 66.44

Credit obtained(Trade payables/cost of sales)*365

-131.13

-120.02

-93.73 -92.82 -73.62

Strategic Ratios

Dividend payout ratiosDividend / Earnings attributable to shareholders

1.57 0.56 0.86 0.80 0.77

Sustainable growthROE x (1 – Dividend payout ratio)

-0.25 0.37 0.09 0.12 0.12

30 Derived from M1 Financial Statements (2006-2010)

P a g e | 33


Financial Ratios Description Year 2006 2007 2008 2009 2010

Operating GearingTotal Non-Current Assets / Total Assets

0.74 0.85 0.86 0.83 0.75

ROE Decomposition Financial Leverage Total Assets / Total Equity 2.76 4.19 3.60 3.27 3.09 Net Profit margin 21.3% 21.4% 18.7% 19.2% 16.0% Debt to Assets LT Debt / Total Assets 0.00 0.30 0.31 0.00 0.27

2.1ROENet Profit Margin x Total Asset Turnover x Financial Leverage

43.09%

85.09%

67.24%

58.69%

51.85%

P a g e | 34


4.4 References

Axiata Group Berhad (2010), 3rd Quarter 2010 Analyst and Investor Briefing, 24th 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-gains-traction.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-telcos-capex-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/in-the-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

http://www.investopedia.com/terms/a/altman.asp#axzz1eKZSDomX












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/?vgnextoid=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-the-works.html (accessed on 7th November 2011)

Telenor, 2011, DiGi Business Description, available at: http://www.telenor.com/en/investor-relations/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

http://www.m1.com.sg/

http://www.xl.co.id/

http://www.digi.com.my/

http://www.telenor.com/en/investor-relations/company-facts/business-description/digi





http://www.xl.co.id/investor-relation/language/en-GB/CompanyReports/Quarterly

http://www.m1.com.sg/M1/site/M1Corp/menuitem.faca305fb9985217f15a947b3f2000a0/?vgnextoid=ad241b7faba72010VgnVCM100000275a160aRCRD&vgnextfmt=pdate:1111202212:





http://www.midf.com.my/project/midf/media/2009/05/04/094112-183.pdf

Education

STRATEGIC FINANCIAL REVIEW OF DIGI.COM BHD