We reiterate our Buy call on XL Axiata (EXCL). EXCL share price has declined from the high of ~IDR2,600 (13^th May 2024) to IDR2,270 whereas the JCI gained 3.7% during the same period. While at the moment it is not clear when the planned merger with SmartFren (FREN IJ, Not rated) would be completed, we see improving operational trend for EXCL. We think the stock deserves a re-rating, due to the following:

EXCL has the potential to deliver strong revenue from its fixed broadband (FBB) division, in our view. As noted in our previous report (report), under the business transfer agreement between EXCL and LINK (LINK IJ, Not rated), LINK will transfer 750k FBB subscribers to EXCL. Hence, EXCL’s total FBB subscribers will reach 1mn users, and will have an average ARPU of IDR351k (based on 4Q23 number). This will make EXCL the second-largest FBB player after IndiHome (unlisted), a subsidary of Telkomse (lTSEL; unlisted). Moreover, amongst major telcos, EXCL has the highest convergence ratio of ~81%, which suggests that the majority of its FBB customers are using EXCL’s cellular services.

Within the FBB businesses, while IndiHome is the market leader by market share, its ARPU is much lower at IDR240k. Moreover, despite amassing 10.6mn subcriptions in 1H24 (+27.7% y-y), IndiHome’s revenue declined to IDR13.0tn (-9.7% y-y) during the period, suggesting customer churn and that it had a lower quality subscriber base than EXCL. On the other hand, ISAT’s (ISAT IJ, Buy) FBB services are small compared to EXCL or TSEL.  We believe that EXCL’s fixed to mobile convergence has been successful. With a convergence penetration rate of ~81% and relative high ARPU, we conclude that EXCL has been successful in capturing high quality non-churning customers.  Yet, currently its FBB revenue contribution is still very low at 2-3% of total revenue (from 1-2% in 2023).

In the near term, we believe EXCL has the opportunity to continue and improve its revenue base through its FTTH (fiber to the home) initiative. The company has initiated deals with TOWR (TOWR IJ, Buy) and LINK to establish home passes. As its FTTH utilization picks up (through more home connections being made), the costs borne by EXCL will fall, as fiber rental uses trenches; this means that above a certain utilization ratio, the company will pay less in rental fees for each additional home connect (while the infrastructure company may be compensated by other means such as profit sharing). For example, in EXCL’s deal with LINK, for the first 25% of home connections EXCL will pay LINK IDR120,000 per month per home connect for its fiber asset rental. Once the 25% home connection threshold is passed, EXCL will only have to pay IDR80 per month to LINK for each additional home connection. We believe that it is very likely for EXCL to exceed the threshold as FBB is still in infancy in Indonesia. We estimate FBB traffic will rise to approximately 5x those of mobile broadband (MBB). Considering the prospects of FBB and MBB, we believe fibre optic (FO) capacity will become increasingly important. As of 2021, the average US household consumed over 11 times more data over fixed network (fixed broadband) versus mobile access (mobile broadband/cellular) (link). For Indonesia households, the number is only 5 times more data over fixed network versus mobile access, according to our estimates, suggesting a significant potential upside for Indonesia’s fiber business and therefore EXCL.

Meanwhile, in the cellular space (see Figure 1), EXCL has demonstrated a consistent rising ARPU trend since 4Q21, which signifies that EXCL is able to capture high quality customers. Thus, combined with the ongoing trend of FBB, we think EXCL could see improving FCF in the medium term.

Valuations and risks

With that, we maintain our Buy call on EXCL. We derive our TP of IDR2,600 based on a DCF analysis, using a risk-free rate of 6.2%, an equity risk premium of 7.4%, and a terminal growth rate of 2.5%. This results in a WACC of 9.4%. At our TP, the stock would trade at 2024F EV/EBITDA of 4.7x (compared to 4.1x at the current price). Downside risks include adverse macro conditions, lower customer spending, less service price hikes leading to lower data prices, irrational competition behavior, and/or higher opex.

Fig. 1: Operator ARPU & Subs