Operators ringing the changes

David O'Brien, Jakarta

The telecommunications market has been the first major infrastructure business in Indonesia to experience significant change. Although market participants continue to argue about access arrangements and interconnection pricing the results cannot be argued against.

Prior to deregulation the country had eight million wireline subscribers and a lengthy waiting list. Today they have been joined by almost 45 million wireless subscribers, forecast to grow by the same number again over the next five years.

A second stage of industry rationalization is now occurring. The smaller Indonesian operators are cashing out to investors at a time when the wireless business (whilst still highly profitable) may have peaked in terms of profitability per customer.

Telekom Malaysia purchased 27.3 percent of Excelcomindo for US$314 million earlier in the year. As such the implied value of 100 percent is in the region of $1.15 billion. Based on market share, its comparable profitability and its medium term trend, it seems a full priced acquisition.

As the smallest player, with the highest foreign currency debt, Excelcomindo has struggled in relation to its larger incumbent competitors. In the period from December 2003 to July 2005, Excelcomindo has seen a decline in market share from around 16 percent to 11.2 percent of the GSM market. In the last six months its competitors have continued customer growth at a little over 30 percent, whilst Excelcomindo has grown at 13 percent.

Where one may have expected a more nimble footed and innovative competitor relative to the state owned monoliths, past ownership has failed to articulate a clear market position and make in roads.

As at the end of June 2005 Telkomsel has 21 million subscribers, Indosat 13 million and XL 4.5 million. In the CDMA market Telkom is a clear leader with 75 percent of the market and 3.7 million customers, followed by Mobile 8 with 0.8 million, Bakrie 350,000 and Star One 70,000.

Under the Excelcomindo acquisition agreement, Telekom Malaysia is required to arrange an IPO as a step to gaining majority control from Peter Sondakh's Rajawali Group. Latest reeports from the Jakarta stock exchange said that Khazanah Nasional Bhd (Malaysian state investment company),which owns part of Telekom Malaysia had acquired 16.82 percent of Excelmindo for $234 million.

Closely following the Telkom Malaysia acquisition, Maxis, Malaysia's second largest telecommunications company announced its own Indonesian telecommunications investments. Indonesia's Lippo Group managed to obtain $100 Million and a commitment of $150 million of capital expenditure for 51 percent of its shell entity that holds the rights to 3G bandwidth. This same bandwidth the government now wishes to retender in November this year.

Maxis' associated Pay TV arm Astro also bought Lippo physical assets in the form of the Lippo owned Kabelvision cable network. For 51 percent of these assets Astro paid an initial $65 million in equity and loans and committed up to $200 million over five years for pay TV.

This valuation seems to be based on some heady penetration rate projections. Astro's stated target sees the potential to grow up to some 10 million homes, representing about 25 percent of the total market, within the next five years.

There are obvious synergies that Astro brings with its economies of scale; however expanding the market to the extent forecast could prove a little more difficult. In the more than five year period pay TV has been operating in Indonesia the subscriber base has only managed to reach around 250,000 households between the Indovision and Kabelvision.

The future in Indonesia is likely to be wireless for the so called last mile which will then be switched to fiber optic backbone carried on IP (Internet Protocol) for both broadband and regular communication. Some of the valuations being developed for these plays are seemingly predicated on this bold new future of the triple play of internet, television and voice.

The ability to have a content base is seen to potentially confer a comparative advantage in bundling a service offering. However, many technical and regulatory unknowns remain to make such a bet reality. Questions remain also about the role of 3G relative to the new wireless broadband technology of Wi Max.

The Maxis play is seemingly predicated on leveraging the cable and also being able to offer content on 3G. Excelcomindo will have contemplated a similar scenario to leverage the national fiber optic network which is currently under utilized.

Mobile 8 also appears to have such a broader media play in mind via their mix of media assets and CDMA 2001 network. To date Mobile 8 have primarily leveraged the cost savings of the more modern network to attract lower end subscribers rather than promote high speed data capabilities.

Although strong customer growth continues, it is now predominately amongst lower value customers. The measure of such used in the industry is ARPU (Average Revenue per User). In the case of XL this has declined from nearly Rp200,000 (US$20) per month in 2000, to just Rp70,000 per month in 2004. For Telkomsel the fall has been from Rp179,000 to Rp102,000 over the same period. The current ARPU for Indosat is at Rp89,500 per month. All these amounts are the blended or weighted average of pre and post paid users.

In a small minority of high end customers there may be a demand for 3G services. In Indonesia the total post paid customer base at end December 2004 was only 1.85m (Telkomsel 1.3m, Indosat 0.5m and XL 0.05m). This number has increased greatly in the past year as margins on post paid have been cut. The ARPU on these customers still sits at just Rp 300,000 rupiah/month for Indosat and Telkomsel and 500,000 on the XL small subscriber base.

The future is likely to be one where 3G is rolled out and for a smaller proportion of the population, value added services are taken up. The number of competitors in this field is likely to keep pressure on the fat margins currently enjoyed. At the lower end of the market competitive pressures will grow to pressure margins through pricing and greater customer acquisition and retention costs.

The writer is a Technical Advisor at CSA Strategic Advisory. CSA helps businesses through a combination of "soft" behavioral and "hard" financial advice. He can be reached at dobrien@csadvisory.com.