PT XLSMART Telecom Sejahtera Tbk

Good morning, ladies and gentlemen. Welcome to XL Axiata's earnings conference call for the first half of the 2019 financial year. My name is Albert and I will be your coordinator today. During the presentation, all participants are in a listen-only mode. Instructions will be given on how to register your questions when we get to the question and answer session. As a reminder, this conference is being recorded for replay purposes. We would like to turn the conference over to our host, Mr. Indar. Please proceed.

Thank you, Albert. Good morning, everyone, and welcome to the call. On behalf of the Excel Management Team, I would like to thank all of you for taking the time to join us today. With us on the call today, we have Pak Adlan, our Chief Financial Officer, Pak Allen, our Chief Commercial Officer, and Pak Budi, Finance Group Head. Ibu Dian extends her apologies for not being able to join the call today. Now, Pak Adlan will share the highlights of the first half of 2019, which will then be followed by a question and answer session. I will now hand the call over to Pak Adlan.

Thank you, Inder, and good afternoon, everyone. I think we are pleased to announce that our first half performance, where we continue to see good traction in the market. This is the fourth consecutive quarter. where we have recorded a sequential increase in service revenue. And we are also seeing very strong growth across all financial metrics, as well as growing profitability. The continued positive momentum is a direct result of the consistent execution and implementation of our strategy, which aims to position us as the mobile provider of choice in Indonesia. Our strategy is focused on three main trusts, being our dual brand strategy, where Excel and Access serve different market segments with attractive data-focused products, continued network investment in building our 4G network across Indonesia, and focus on growing our X-Java market share. In the first half of 2019, our revenue increased 11% year on year, mainly due to service revenue, which rose 15% year-on-year. And driving this is data revenue, which increased 29% year-on-year. Strong customer traction across both the Access and the Excel brands and the success of our upselling exercise to our customers, coupled with the monetization of data, actually has led to the strong growth in data revenue. Data revenue in the latest quarter now accounts 88% of service revenue and continues to be higher than our peers, enabling us to weather the effects of declining legacy services better. Profitability growth has also been strong with EBITDA rising faster than revenue at 19% year-on-year due to our focus on cost efficiency with margin increasing 2.7% year-on-year to 38.7% in the first half year of 2019. The growth of EBITDA coupled with savings of our depreciation expense meant that we have seen a return to sustainable profits. A donation data-savvy customer has continued to respond well to our improved network as we are increasingly being recognized as the brand of choice for smartphone users. As our first half to 2019, our smartphone customer stands at 48.9 million, a 24% growth compared to the same period last year. These make up approximately 86% of our subscriber base, which is significantly higher than the industry average. And we also continue to see fast rate of migration of subs to 4G, where 4G subs now account more than 65% of our total subscriber base. We are pleased to report that our customer numbers continue to increase post the prepaid registration implementation in a healthy and sustainable manner. This is due to our focus on sustainable customer acquisition and thus we have seen our base of registered customer increase to more than 56 million this quarter. Importantly, Our ARPU has also increased 3% this quarter, which is evident by the success of our efforts in upselling our customers and monetizing data. This quarter, the Excel brand saw the launch of several packages in conjunction with the Lebaran festive season, including the Extra Rezeki package, which offers attractive cashback benefits. The Axis brand also expanded its product portfolio with the launch of Awesome and Booster package catering to the youth segment. As a result, we enjoyed a very good Abaran season this year. Both Excel and Axis maintain their strong NPS within each of the brand's target segments. In parallel, we continue to ensure a high-quality data experience to our customers through the ongoing rollout and upgrade of our network. Thus, our total BTS count is now above 127,000 BTS and 4G eNodeB totaling more than 37,000 covering 408 cities across Indonesia. Our network investment continues not only within Java, but also focus in X Java. And these have actually started for the last three years, which have translated to better coverage and network performance in these areas. This has also led to a stronger revenue performance outside Java, which continues to grow at an exponentially faster rate than Java and increased overall contribution to revenue. In particular, awareness of our brand, improved network quality, Coverage as well as innovative products have significantly increased outside Java and we are now increasingly known as a nationwide operator. We intend to build on this strong first half of 2019 with continued focus on executing our strategy to become the preferred mobile internet operator in Indonesia. We will also continue to monitor competition in the market with the hope of competition remains rational. Our guidance for 2019 is maintained, where we expect revenue to grow better than or at least in line with the market. EBITDA margin guidance of high 30s and CapEx plan guidance for 2019 of around 7.5 trillion, which will remain focused on data network investment in 4G and continuous network improvement and modernization in and outside Java. Thank you, and let us now proceed to question and answers.

Hi, Albert. Can we have the Q&A, please?

Ladies and gentlemen, we will now begin the question and answer session. If you wish to ask a question, please press star 1 on your telephone keypad. If you wish to cancel your request, please press star 2 from the telephone keypad. Please kindly limit your questions to only 2 to allow other participants to raise their questions. Should you need to ask more questions, you can go back to the queue by pressing star 1 again. We shall end the conference call sharp at 10 a.m. Jakarta time. Your first question comes from the line of Piyush Choudhary from HSBC. Your line is now open.

Hi, good morning. Thanks for the presentation and congrats for the results. Two questions. Firstly, could you talk about the current competitive environment and outlook for ARPU? Secondly, in the X Java business, could you elaborate how has been the revenue growth in the first half? and what proportion of subscribers and revenues come from xJava right now? Thank you.

Good morning, Piers. Let me take the first question regarding the current situation. As you can see from the results, yes, we had a pretty good first half and especially the second quarter of 2019. But I can hear from your question that there's a little bit of a change in the market at the moment. And you're absolutely right. So what we have seen, we started from Smartfront, we introduced some months ago, they introduced an unlimited product in Indonesia. And unfortunately, we see that Intustat as well have followed up and as well have introduced an unlimited value proposition in Indonesia. Not saying that we are going this way or this route, but at least we see there are some changes in the market which could take down the RQ in the future. We are monitoring at the moment, we are not panicking and we are not reacting, but we are seeing this a little bit of change in the market at the moment.

Okay, on X-Java, I think since our investment for the last two to three years, I think we have seen significant performance outside Java, right? So today, X-Java accounts for, now it's already slightly more than 20%, right? of our total revenue. And I think if you look at queue on queue, I think you probably see that Xjava is actually growing at double digit, and I would probably say high teams. So on the first half, the number is actually quite significant. So we will probably not be able to disclose the number, but suffice to say that we believe that we will probably gain some market share outside Java.

Sure, thank you. Just on these unlimited plans, are there speed limits on these plans and what price points are these launched? If you can elaborate on that.

Not to go into too much detail, but you're right. It's not real unlimited. There's some FUP and there's some throttle on it, but the starting point is around 80,000 rupees in Indonesia for the unlimited plans.

Okay, thank you. Come back in the queue.

Your next question comes from the line of Colin McCallum from Credit Suisse. Your line is now open.

Thanks, and congrats on the results. Two questions for me. First of all, just on... I know you'd pushed up the pricing a little bit into LeBaron as usual. Am I right in saying that you've tried to maintain... those higher price points in some areas, is that still being able to be maintained? That's my first question. Then my second question is I guess for Adlan, just obviously the monetization is getting a bit better now, but obviously your profitability overall is still a little bit low. What are you guys thinking on CapEx? I see you've maintained the CapEx guidance for this year. What are you thinking as we go forward a little bit? Is it worth investing more into the Indonesian market or you think these levels are about right? What's your view? Thank you.

Thank you. Let me take the first question regarding the price point in Indonesia. If I compare the previous year with this year in terms of LeBaron, I think we see a significant change in price increase in the market. We haven't changed the price a lot. Yes, we have done a little bit here and there, but it's not as it's been the previous year. What has been successful this year is mainly the upselling part. So our architectural marketing machinery has worked fantastic, meaning that we can upsell each of our customers, we can actually approach each of our customers with new value proposition, upselling what they have today. And we know that during the labor run, they are more data savvy, they are more hungry for data, so we were able to upsell a lot. The prices will continue what we have done so far, and we continue the upselling part as well, because it has been pretty successful during the labor run. And we actually see that continue into the Q3.

So on your second question, I think on the Capex side, yes, we are spending around $7.5 trillion this year. I think the way we look at Capex moving forward, I think what we definitely see, there's definitely opportunity outside Java, right? Because if we look at the revenue growth, what we're seeing today, it's actually growing faster than what we initially anticipated, right? Definitely there's opportunity there. So whether we're probably going to accelerate the investment on new coverage area, there's a potential. Having said that, I think the other part that we're probably going to be a bit more tighter in our investment case is on the capacity expansion. So we probably set a higher hurdle rate, for example, for any additional capacity expansion. In that case, I think we will probably try and monetize more in some of the investments that we have done before. On a net-net basis, I think the actual CAPEX can only come once we finalize the business plan. But in any case, I think there will be some compensation between coverage and capacity And I think moving forward, maybe at least at this point in time, the numbers that we're seeing that probably at this level is probably the right level of investment. Nevertheless, I think if there are opportunities, obviously we'll probably not hesitate to put in the investment.

Fair enough. Very clear. Thank you.

Your next question comes from the line of Chung Chen Fong from CIMB. Your line is now open.

Hi, thanks for the call and congrats on a good set of results. Two questions from me. Firstly, on the revenue growth for mobile, you talked about XJava, but could I also get a sense of the growth in Java? And especially if you compare it to peers, do we know whether we are outpacing our peers in terms of Java growth? And what do you think in terms of the notion that has been put forth that there may be some underinvestment in the Java region for Excel, even the focus in XJava these last two to three years? Second question, I wanted to ask about the EBITDA margin gap. outlook going to the second half. You've done very well in the first half despite the fact that you've got this network managed services contract renewal. Going to the second half, do you see further improvements in the EBITDA margin or do you see any sort of cost pressures coming in? Those are my two questions. Thank you.

Yeah, I think generally if you look at Java revenue, I think if you look at first half, I think both regions are actually growing, right? Whether we are growing the competitors or not, we don't have a split. But I think what we can see definitely in some of the big clusters, we are maintaining or if not growing our market share in some of these big clusters. Nevertheless, there are some of our strong clusters are probably also under attack, right? But on a net-net basis, I would say that if relative to competitors, we believe that we have either maintained or have actually grown slightly within Java. Obviously, I think the rate of growth is probably less than what we see at Java. But I think as we align with our strategy, Java is all about defending our market position and monetizing existing customers. So we are probably staying true to that strategy. And as Java is all about growing market share. So that's on your first question. Second question, I think on EBITDA, if you look at EBITDA margin growth in the first half, it's actually primarily driven by also the growth in revenue. As you can see in our numbers, our operating leverage is quite high, given the good growth that we see on the top line, it has translated into a higher EBITDA as well as a higher EBITDA margin. So I think the key driver to our EBITDA growth would definitely be revenue growth. If you are able to maintain the sort of revenue growth that we see in the first half, I think there is a good chance that margins will continue to improve. But having said that, I think you probably have heard from Alan as well, the market is also getting more competitive as we speak today, right? So I would expect that second half would probably be, competition would probably intensify as compared to the first half. At least that's the indication that we're seeing today.

Okay, thank you very much, Adelaide.

Your next question comes from the line of Prem Jayara Jazingam from Macquarie. Your line is now open.

Hi, thank you for the opportunity and congratulations on a good set of numbers. Two questions from me. First of all, Padhlan, when you talked about how well you're doing outside of Java, could you remind us on the profitability of the ex-Java business? I recall at the beginning we were planning towards a three-year break even, if I'm not mistaken. How are you faring in terms of that breakeven process? Are we also ahead on that, or are we just ahead on a revenue front? That's one. And secondly, I know a bit further out looking, but with regards to the Telenor-Axiata proposed merger... What do you think the implications are for Excel in terms of your growth trajectory? Do you think it will accelerate or do you think it's going to be life as usual, business as usual going forward? Thank you.

Yeah, on your first question, XJava, I think... what we are actually seeing now in terms of revenue growth has actually exceeded our expectation, our initial plan, right? So I think especially in areas where we go with Takomcell as a monopoly, I think the traction that we see in those markets are quite significant. So on the revenue front, we are probably ahead, right? On profitability, yes. I think XJava, as we speak today, probably still not profitable. Nevertheless, I think what we are also doing in XJava as well today, we are also looking at the cost aspect of it, right? How do we also operate this in a more efficient manner, right? And I think we are not just looking at network, but also all the other cost line items, right? So if you look at overall, I think from a profitability perspective, I think we are still probably on track as what we have probably planned for before. Just going back to what you said in terms of return and all that, today as part of the shifting year, we probably have a higher hurdle rate in terms of return that we are probably looking at X Java. So I think we are also setting ourselves a higher bar now, given the shift and focus on profits and returns. And I think in whatever we do, we'll probably be focusing more on smart investment outside Java. Yeah, so Telenor, I think at this point in time, I think for us it's business as usual. I cannot comment much in terms of how that's going to be moving forward. But in any case, I think as far as we are concerned, at least from some initial discussion, I think as much as the merge entity are also very excited looking at the opportunity there is in Indonesia. And I believe that I think the strategy would also be similar to what we actually have and looking at opportunity to grow in areas, especially in outside Java. What that means for us, I think it's still too early to comment at this point in time and until probably the deal is actually concluded. So I'll probably just leave it at that at this point in time.

All right. Thank you. I appreciate your thoughts.

Your next question comes from the line of Ranjan Sharma from JP Morgan. Your line is now open.

Hi, good morning, and thank you for the presentation. A couple of questions from my side, more on the balance sheet and cash flows perspective. I see that your lease liabilities have increased further, but your depreciation and interest expenses have come down quarter on quarter. Have you seen any change in your interest rate assumptions or your WAC assumptions which allows you to record a lower depreciation and interest expense? That's the first question. The second question is, again, coming from lease liabilities. We've seen a significant increase from second quarter last year to second quarter this year. I think it's to the tune of seven, eight trillion. How much of that explains the margin expansion from 36% to 39%? Thank you.

A quick question. If I look at our interest expense, the number has actually grown. It has not come down, right? No, QAnon.

QAnon. QAnon. QAnon. QAnon. QAnon. QAnon.

Yeah, and I think partly contributed by the fact as well, right? I mean, if you look at on quarter to quarter, interest has also come down as well. And I think in the end of the first quarter as well, we have paid down some debts as well, right? So that's probably partly contributed to the reduction on the Q1Q. But if you compare to last year, I think it has probably increased, right? So... So on the lease liability, obviously, I think as we continue to build our fiber, and that's where we capitalize it as finance lease, and that's what you probably see why our finance lease numbers are probably growing. And I think as we go end of this year, we are hoping to fiberize close to about a third of our sites. and probably by next year, probably extend it more to close to 50%. So, this financial lease liability will continue to go up as we continue to expand and fiberize our sites. In any case, I think in 2020, I think Indonesia will adopt the IFRS 16. So, I think there will be a complete change in terms of how you probably see the margins and the balance sheet structure. So that will probably take effect in 1st January 2020. But in any case, I think that financial lease liability will continue to grow as we continue to fiberize more and more of our sites.

Okay, thank you. On the margin expansion part, you've seen 36% has gone to 39%. How much of that is explained by the lease liabilities, or rather if I have to ask the other way around, let's say you want to normalize all your liabilities as operating leases, what would be the margin be? Thank you.

No, as I explained, the margin expansion is driven primarily by the operating leverage, the high operating leverage, right? given that revenue have actually grown quite significant and the majority translate back to EBITDA line and profitability. So if you were to see on the lease liability, I think the impact will not be that significant, but I think the expansion in margin primarily is actually driven by the high operating leverage because of the higher revenues. Just to put in perspective, if you were to look at in quarter two, we have also seen quite a significant increase as a result of the new managed service as well. Despite that fact, I think you probably have seen as well our expansion in our EBITDA margin. Hence, that proves the point that our operating leverage number is quite high and other cost efficiency that we are doing are probably starting to show results.

Okay, thank you.

Once again, if you wish to ask a question, please press star 1 on your telephone keypad. If you wish to cancel your request, please press star 2 from your telephone keypad. Please kindly limit your questions to only 2 to allow other participants to raise their questions. Again, it's star 1 to ask a question. Your next question comes from the line of Siward Ludin from Goldman Sachs. Your line is now open.

Hi, and congrats again on the good set of results. First question for me is that you mentioned earlier that the xJava business is still not profitable, and how long do you think that this business would actually reach a profitable state? And the second question is more of a housekeeping question. I saw that there is salaries expense increase. I know that employee count has increased, but the cost for employees has actually increased even more. Is there any one-off this quarter? Because in last quarter, you mentioned there are some provisions for annual bonuses. So could you give some color on why the number is still pretty high? Okay, those are my two questions. Thanks.

Yeah, okay. On XJava, yes. I think XJava is all about growing scale, right? I think at this point in time, I think we are growing market share, we are growing scale in those areas. Obviously, I think one of the key drivers is probably to gain more subscribers and subscriber share in those markets. And I think that's what we have been doing at this point in time and we are seeing good traction on that. So on profitability, I think when we set the cost initially, I think we are looking at a payback period of slightly more longer payback, right, between four to five years. However, having seen some of the success on our expansion XJava, I think we have tightened up in terms of our expectation on returns and payback coming from XJava. And that's why we are probably looking at a slightly shorter period between three to four. And if you look at overall RxJava, obviously it's not profitable, but there are certain areas which we have probably built three years earlier that we have actually moved into profits already. So as we continue to expand, I think you probably would expect that that would probably need some time before it moves into profit areas. But in any case, I think you've probably seen in certain areas that we've invested the last three to four years have started to turn into profitability, right? So the way we look at Java is as Java is not in total, but we probably evaluate from a cluster to cluster basis, right? So overall still not profitable, but certain clusters have definitely turned around. Oh, labor costs. The second one, I think in quarter two, The increase in labour, if you look at our performance today, we are probably striving for an exit expectation in terms of performance. Last year we did an accrual on the bonus side, but this year I think in this quarter we actually accrued for our long-term incentives, given that I think we are not only going to meet, but we are probably going to exceed this year's number. And hence, I think we are topping up in terms of our LTI for the reward to employees. And that probably explains the increase that you probably see in this current quarter.

Okay, got it. Should we expect this to be the current base, or is it actually going to come down in the next quarter as there's no more one-offs like this?

It's probably coming down slightly, but you should expect that it's probably higher, slightly higher than what we saw before, given the higher payout.

Okay, got it. Thank you.

Once again, if you wish to ask a question, please press star 1 from your telephone keypad. Again, it's star 1 to ask a question. Your next question comes from the line of Piyush Chaudhry from HSBC. Your line is now open.

Hi, thanks. Just as a follow-up on your comment when you were saying few clusters in XJava have become profitable, are we talking about EBITDA breakeven or we have already started seeing EBITDA breakeven of few clusters? Secondly, with an infrastructure expense, You used to disclose the managed services expense for Huawei. Can you comment how much was that figure in the first half of 2019? Thank you.

I think in most of the clusters that we have built for the last three years or so, at EBITDA definitely we are already at a positive territory. But there are clusters, especially in some of the major cities that we've managed to gain quite significant market share. We are also EBIT positive, right? So I wouldn't say at this point in time, let's say clusters are three years. There are many, but there are clusters that's really started to turn. Second one is on managed service.

Biyush, we'll come back to you on that, Biyush.

Sure.

The second question.

Sure. Thanks a lot.

Your next question comes from the line of a C. Ward Liddin from Goldman Sachs. Your line is now open.

Okay, another two questions from me. So in the last call, you mentioned that there's some aggressive competition from telecom within Java. Are you still seeing that trend or is it actually come down a bit? And second one is another housekeeping question. So your GNA has been quite volatile since fourth quarter 2018. So is there any reason for the volatility and especially for the drop in the second quarter, the Q and Q drop in the second quarter 2019? And also what level should we expect it to go going forward? Thanks.

Let me take the first one regarding the competition from Telkomsel. So you're right, they were pretty aggressive in defending in Java for the last couple of quarters. And we have not seen Telkomsel ease down in Java. They're defending whatever they have in Java. We have even seen Telkomsel introducing low package, meaning they are attacking our Axis brand, which is the value for the money brand, and the used brand. So they are introducing low package packet in this market. So we have not seen telecoms down in Java. They're defending.

On the overhead, I think one of the big expenses sitting in overhead is probably on professional fee, right? So that variation is probably due to some projects With consultants, that's probably driving those numbers.

So is that actually one-off or is it still going to continue in the second half of 2019?

No, it will move up and down depending on the project that we run over the years, right? Throughout the year, right? Because if consulting fee is basically you pay per project basis, right?

Okay, got it.

Thank you. Your next question comes from the line of Chun Shansong from CIMB. Your line is now open.

Hi, thanks. One follow-up question on the network managed contract with Huawei. I just wanted to find out whether the network management fee is a fixed percentage of revenue or if not, how is it structured? And also on the duration of the contract, I noticed that it's a three-year contract compared to a seven-year contract previously. So why the shorter duration? Is there a specific project that we are working on and thereafter that contract will then be renewed on a different term? Those are my questions. Thank you.

So the managed service contract, the new one, I think we have changed the business model a little bit, right? I think the previous one was more on an adjusted revenue sharing. However, now I think the contract is based on a fixed amount, not a fixed amount. But it's a variable amount depending on the various scopes that we are probably drawing, right? But it's not no variation to revenue, right? So it's not a cost base. And I think the contract that is not three years, it's actually five years.

Okay, got it. Thank you, Alan. Thank you.

Once again, if you wish to ask a question, please press star 1 from your telephone keypad. Again, it's star 1 to ask a question.

Okay, as there are no further questions, I would like to thank everybody for their participation in today's call. As always, do get back to us if you need further information, and we'll speak again next quarter. Thank you very much.

Ladies and gentlemen, that does conclude our conference call for today. Thank you for participating. You may all disconnect.