ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTD

DIALOG PLC (DIAL) July, 2017 Accelerating Sri Lanka’s Digital Future, Today!

SRI LANKA | | INITIATING COVERAGE BUY

Amid facing the challenges of diminishing growth in mobile voice operations, CMP RS 12 we believe DIAL would continue to take the market leadership position in TARGET RS 14 (+21%) domestic mobile telecommunications industry with the aid of healthy COMPANY DATA growth potential in Data operations. Strong growth in subscriber base BLOOMBERG TICKER : DIAL:SL stemming from both industry expansion and acquisition of market shares of O/S SHARES (MN) : 8144 MARKET CAP (LKR BN) : 96.91 other small players would strengthen DIAL against the risks of industry MARKET CAP (USD BN) : 0.63 consolidation without the involvement of DIAL. Besides witnessing a slight 52 - WK HI/LO (LKR) : 12.3/ 10.1 LIQUIDITY 1Yr (USD MN) : 0.14 decline in EBITDA margins and Free Cash Flows over FY17-mid 18E, we believe DIAL’s “Build” strategies for data operations would eventually result SHARE HOLDING PATTERN, % in “Cash Cows” generating increased cash inflows. Our base case Dec 16 AXIATA INVESTMENTS ( LABUAN): 83.30 assumptions estimate LKR 14.3 per share value for DIAL (compared with the OTHER STRATEGIC HOLDERS : 0.02 current market price of c.LKR 11.8) considering the average of DCF and PUBLIC & OTHERS : 16.68 COMPOSITION OF PUBLIC FLOAT EV/EBITDA evaluations subject to bull and bear cases. FOREIGN INVESTORS : 63 We expect DIAL to grab 9% income CAGR over FY17-19E LOCAL INSTITUTIONAL : 32 LOCAL RETAIL : 5 Enhancing smartphone usage of the country together with Dual-SIM enabled facilities would drive industry penetration to reach 140% levels by FY19E. We believe DIAL PRICE PERFORMANCE, % would further penetrate in to the Sri Lankan mobile telecommunications market 3MTH 1YR DIAL 6.4 2.7 (currently holding c.45%) given its large scale operations and continuously being able ASPI 8.4 -0.2 to bypass its small competitors. Growing corporate sector of the country together S&P SL20 8.2 9.3

Source: APSL Research with increasing per capita income (above USD 5,100 by FY19E) would help DIAL’s fixed business (especially LTE) to post above industry average growth by PRICE VS. ASPI/S&P SL20 strategically challenging domestic Fixed Operations leader SLT. 120% EBITDA margins would bounce to 33% levels by FY19E following a slight DIAL ASPI S&P SL20 decline over FY17-18E 110% We expect c.1pp decline in EBITDA margins over FY17E given higher marketing and networking expenses, Depreciating LKR against USD (worse case we expect a further 100% 4% LKR decline during FY17E) causing substantial Forex losses on USD denominated 90% borrowings. Further there is an increased likelihood of increase in taxes on Data

(Increased to c.32% from c.12% during 1Q17) which would cause a severe hit on 80% 16-May-16 13-Aug-16 10-Nov-16 7-Feb-17 7-May-17 EBITDA margins of the industry as a whole.

Ongoing large scale CAPEX cycle to end by mid FY18E easing pressures on KEY FINANCIALS Free Cash Flows LKR MN FY17E FY18E FY19E We expect DIAL would reach 30% levels of capital intensity over FY17-mid 18E which Revenue 99,935 108,708 119,064 would result in an estimated base case CAPEX figure of c.LKR 62b. We believe DIAL EBIDTA 32,503 36,280 39,887 would be able to generate improved Free-Cash Flows to compensate ongoing higher Net Profit 8,887 9,648 10,585 CAPEX from FY18E onwards. However, we forecast DIAL would continue to operate EPS/LKR 1.09 1.18 1.30 with above 50% levels of Debt-to-Equity ratios enabling progressive dividend pay- PER, x 13.01 11.98 10.92 outs (c.35% for FY16) and necessary investments in data business. P/BV, x 1.95 1.77 1.62

We establish a valuation range of LKR 11-15 for DIAL shares. ROE, % 16% 15% 15% Our base case DCF analysis assuming a post-tax WACC of 10.3% and a conservative Debt/Equity (%) 60% 56% 54% terminal growth of 3% results LKR 14.5 per share intrinsic value. Our alternative base Source: APSL Research case EV/EBITDA evaluation assuming an EV/EBITDA multiple of 5.16x estimates LKR Analysts: Sandun Kulathunga 14.2 per share. Adjusting our base case assumptions for potential upsides and [email protected] declines results in a valuation range of LKR11-15 DIAL shares. Nishani Ruwanpathirana [email protected] ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

This page intentionally left blank. The detailed report begins from next page.

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

TABLE OF CONTENTS

DIAL to post 9% revenue CAGR owing to increasing trend of DATA consumption over 17-19E

 Mobile business to grow at 8% CAGR over FY17-19E 1  Fixed Business to record exponential growth 3  DTV revenue to fluctuate around LKR 6b levels over FY17- 19E 5

Overall EBITDA margins to settle in 33% levels over FY17-21E  Improving Mobile Data ARPU to offset declining Voice business 8  Rising marketing and networking costs limit upside potential of EBITDA 9  Relatively low margins of Pay-TV operations (DTV) deteriorate overall profitability 10

DIAL to run with increased CAPEX; Ongoing cycle to end by mid-18  DIAL would stick into progressive dividend policy amid substantial CAPEX cycles 12  Continuous CAPEX requirements would urge to maintain higher levels of debt 13

We establish a valuation range of LKR 11-15 for DIAL shares  DCF analysis based on Free-Cash Flows estimates a valuation range of LKR 10.5-14.7 per DIAL share 15  EV/EBITDA valuation arrives at LKR 13.24-15.07 for DIAL shares 17

Appendix 1: COMPANY REVIEW  Segmental Analysis 20  Group Structure 21  Governance 22  Shareholding structure 23  Internal Environment Analysis: SWOT 24

Appendix 02: Sri Lankan Industry

 Sri Lanka: Government and the Telco industry 27  Michael Porter’s Five Forces application 28

Appendix 3: Global Telecommunication Industry Outlook 29 Appendix 4: Indications for Portfolio Construction 30 Appendix 5: Comparison: DIAL vs SLT: Key financial parameters 31 Appendix 6: Financial Statements & Ratios 33

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

DIAL to post 9% revenue CAGR owing to increasing trend of DATA consumption over 17-19E DIAL income breakdown: We expect DIAL would continue to grab the fast growing data market both in Mobile segment continues to dominate revenue generation. terms of Mobile and Fixed categories. Rising smartphone penetration of the country would support DIAL to record volume based growth while improving Segment 2017E 2018E 2019E per capita income levels would expand average data consumption levels and Mobile 85% 85% 84% demand for Dialog TV (DTV) connections. We believe DIAL would secure its Fixed 9% 10% 10% current market leadership position in “Saturated Red-Ocean” mobile voice DTV 6% 6% 6% business through offering a blend of unique value added services. Further we Total 100% 100% 100% believe fixed business (especially data) would gradually increase their income Source: DIAL AR’s, APSL Research contribution with the aid of rising demand for 4G and Wi-Fi facilities by the Note: Reported Mobile Segment includes fast growing business sector of the country. Voice, Data, Digital services, VAS, International Revenue and other income sources DIAL to post 9% revenue CAGR over 17-19E

Income/LKR m YoY growth/RHS LKR m 140,000 20%

120,000 100,000 15% 80,000 10% 60,000

40,000 5%

20,000

- 0% 2014 2015 2016 2017E 2018E 2019E

Source: DIAL AR’s, APSL Research

Mobile business to grow at 8% CAGR over FY17-19E DIAL total revenue breakdown Income contribution of Data reflects an We expect DIAL’s mobile business to post c.8% revenue CAGR over FY17-19E upward trend to reach c.45% of total backed by established voice operations and the high growth trajectory of data revenue by FY19E income. We expect DIAL’s mobile business to post c.6.4% subscriber CAGR Source/LKR Bn 2017E 2018E 2019E over FY17-19E in both pre-paid and post-paid lines supported by growing 35 44 54 smartphone penetration and increasing usage of handheld devices. Further, Data* we believe DIAL would be able to slightly increase its mobile segment market Voice & Others 64 65 65 share (in subscriber basis) from 44.6% (in 2015) to 45.3% levels by FY19E. This Data % 35% 40% 45% is backed by effective initiation of attractive additional services while offering customers, the “early mover” advantage. We expect mobile data ARPU to Source: DIAL AR’s, APSL Research match the long term per capita growth of the country while expecting a shift *Data includes both mobile and fixed data income of revenue generation from voice to data causing a slight decline in voice ARPU.

DIAL to record a slight increase on mobile market share from c.44.6% in FY15 to c.45.3% in FY19E (Subscriber basis)

Year 2012 2013 2014 2015 2016 2017E 2018E 2019E Market 20.32 20.45 22.12 24.38 26.36 28.14 30.01 31.91 DIAL 7.727 8.714 9.539 10.87 11.83 12.72 13.57 14.47 Market Share 38.0% 42.6% 43.1% 44.6% 44.9% 45.2% 45.2% 45.3%

Source: DIAL AR’s, TRCSL statistics, APSL Research

Page | 1

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Mobile segment to contribute for more than 80% of group total revenue securing the leadership position in domestic mobile services industry.

LKR m Income/LKR m YoY growth/RHS 120,000 18% 16% 100,000 14% 80,000 12% 10% 60,000 8% 40,000 6% 4% 20,000 2% 0 0% 2014 2015 2016 2017E 2018E 2019E

Source: DIAL AR’s, APSL Research

Higher cellular penetration and income levels to support voice & VAS business growth Industry wide total local outgoing calls shows a slight incease Amid data being the key driver of growth, we believe voice income (together over 2012-2016 by recording c.2% CAGR. with additional products such as eZ cash and VAS’s) would dominate revenue Noticeably, international calls witnessed a substantial decline at c.13% negative CAGR generation by accounting for the majority of mobile business income in FY17E. over the same period. Despite a gradual decline in mobile segment voice ARPU, the increasing population and cellular penetration would support DIAL to record YoY growth Local International/RHS in number of subscribtions while securing the existing market share. The 46,000 800 Value Added Services (VAS) would play a major role here in retaining existing 45,000 700 customers. However, considering the clear shift from voice to data, we expect 44,000 600 500 voice ARPU to witness a gradual declining trend over FY 17-21E. This is further 43,000 400 evident by intence competition in voice market and saturating nature of 42,000 Minutes Of Usage-MOU. We believe Sri Lankan mobile industry penetration 300 41,000 200 would reach 140% levels over FY19E given the countries such as Singapore 40,000 100 and Malaysia has already reached 150 and 145 levels as of 2016. Further we 39,000 - believe there is potential for subscriber growth for DIAL due to technological 2012 2013 2014 2015 2016 trend setting innovations together with early mover advantage, established *Minutes of Usage (MoU) /Mn’s brand name, customer service quality, nationwide coverage and its Source: TRCSL statistics widespread service center network, together with increasing affordability of hardware devices.

However, industry wide subscriber adjusted

We believe DIAL would reach 66% mobile penetration level by FY19E whilst MoU per user for both local (-4% CAGR) and industry penetration marks above 140% levels. international (-17% CAGR) sectors shows a clear decline over 2012-2016

200% Local International/RHS

2,100 40 150% 35 2,000 30 100% 1,900 25 50% 20 1,800 15 10 0% 1,700 2012 2013 2014 2015 2016 2017E 2018E 2019E 5 1,600 - Penetration rate/DIAL Penetration rate/Industry 2012 2013 2014 2015 2016 *MoU per subscriber Source: DIAL AR’s, APSL Research Source: TRCSL statistics, APSL Research

Page | 2

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Exploiting CAPEX and increased per capita income would boost data Singer Sri Lanka sells Huawei & Sony income smartphones in Sri Lanka. Combined annual sales has grown from 380 units in 2011 to DIAL continues to invest more and more in upgrading and initiating 490,000 units in 2016 Broadband/4G facilities with the state-of-art technology giving them a competitive edge over rivals such as Mobitel, and Airtel. DIAL spent Smartphone Sales : SINS c.LKR 23.2Bn as CAPEX in FY16 and majority (c.70%) of the investments 600,000 forcussed towards Broadband and Data services (4G). Further reflecting the 500,000 room for value creation, the incremental return on new investments recorded 400,000 above 15% levles in FY16 cf. assumed cost of capital (WACC) of c.10.3%. We 300,000 believe the increasing adoption of smartphones/Handheld devices and 200,000 increasing data consumption will contribute positively towards higher mobile 100,000 data subscriber numbers and data ARPU. This is further supported by 0 relatively lower smartphone penetration of Sri Lanka compared with regional 2011 2012 2013 2014 2015 2016 peers such as Singapore and Malaysia. Number of devices

DIAL to post c.24% Mobile data income CAGR over FY17-19E supported by Source: SINS AR’s 10% and 6% expected average growth in Per Capita GDP and number of internet users in Sri Lanka

LKR m 45,000 8,000 40,000 7,000 35,000 6,000 30,000 5,000 25,000 4,000 20,000 3,000 15,000 10,000 2,000 5,000 1,000 - 0 2015 2016 2017E 2018E 2019E

DIAL/Mobile data income Per Capita GDP/USD (RHS) Internet users/000" (RHS)

Source: DIAL AR’s, APSL Research

Fixed Business to record exponential growth

DIAL enjoys technologically early mover advantage when it comes to adapting the newest technology. DIAL serves as the strategic testing centre for its parent, Axiata group based on Burhad, Malaysia. DIAL successfully launched commercialy viable 4G service in 2012 which has now passed 50% fixed penetration rate. DIAL forcuses on telco infrastructure including spectrum DIAL records relatively high performance in terms of speed allocation. DIAL gained access to the 2,300MHz spectrum band for 4G home Service Avg.Speed Max.Speed broad band service with TD-LTE technology. DIAL 4G LTE 19.02 41.97 Further, DIAL being a contributing partner of Bay of Bengal (BB) consortium SLT 4G LTE 12.53 24.84 with an initial investment over LKR 5b would substantialy enhance Bell 4G LTE 5.51 9.70 international connectivity through high speed state of art fibre optic cables. *Speeds in Mbps as per TRCSL 14 June 4MBPS 4G LTE test results as of June 2014: DIAL ahead of peers report 4MBPS Speed Test Results Test counts as a % of advertised speed Percentage of test counts >70% 70-50% 50-30% <30% DIAL 4G LTE 98.24% 0.30% 0.24% 1.22% SLT ADSL 4M 82.91% 3.24% 1.62% 12.23% 4G LTE 94.46% 2.74% 0.96% 1.84%

Source: TRCSL

Page | 3

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Fixed business to be driven by increased demand for fixed broadband connections (4G)

LKR m 14,000 25%

12,000 20% 10,000

8,000 15%

6,000 10% 4,000 5% 2,000

0 0% 2014 2015 2016 2017E 2018E 2019E Income/LKR m YoY growth (RHS)

Source: DIAL AR’s, APSL Research

4G enabled data to lead DIAL’s fixed operations

We expect DIAL’s fixed data income to contribute for almost all the segment income by FY19E. This is further evident by the increasing usage of 4G facilities nationwide. DIAL held c.20% market share in fixed internet market in FY15 and we believe this would reach 37% by FY19E. Current underutilization of capital assets caused the segment to report net losses whilst higher CAPEX aimed at 4G and fibre infrasture results in higher depreciation costs. However, we believe DIAL would be able to compete effectively with its major peer “SLT” and gradually increase the market share to pull the segment from loss making status to the winning stream.

DIAL to increase its share of Fixed Internet market from c.20% in FY15 to c.40% in FY21E

Subscriber wise market share 2015 2016 2017E 2018E 2019E 2020E 2021E Industry 100% 100% 100% 100% 100% 100% 100% Market Leader: SLT 78% 72% 67% 63% 60% 59% 58% Nicher: Lanka Bell 2% 2% 2% 2% 2% 2% 2% DIAL share 20% 26% 31% 34% 37% 39% 40%

DIAL accounted for c.20% of Fixed Data market in FY15 We expect DIAL would capitalize on higher CAPEX to result in c.37% market share by FY19E

2% 2% 20% FY15 FY19E

37%

60%

78%

DIAL SLT Lanka Bell DIAL SLT Lanka Bell

Page | 4

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

DTV revenue to fluctuate around LKR 6b levels over FY17- 19E Amid considerable growth in prepaid subscriptions, the decline of ARPU would weigh on overall revenue stream to lie around LKR 6Bn levels over FY17-19E. DIAL held c. 70% share of pay-tv market in FY15 with a subscriber A relatively lower Pay-TV penetration in base of c.650, 000 cf. SLT’s subscriber base of c.174, 000 which accounted for Sri Lanka reflects a higher growth c.19% of total market. Meanwhile, other operators including Dish TV potential for the industry as a whole successfully secured c.11% share of Sri Lankan pay TV market by the end of Regional Pay-Tv penetration FY15. However, Blended ARPU showed c.18% decline over FY15-16. Sri Lankan Pay-TV penetration rate stands below 10% levels as of FY16 Country Penetration reflecting room for further expansions amid the local TV entertainment Sri Lanka <10% industry is comprised by 18 analog private and state-owned ‘-to-air’ India 80%+ channels. Pay-TV industry faces the risk of substitution by close and low cost Malaysia 48%+ alternatives such as YouTube etc. Singapore 77%+ Source: contentasia, TRCSL Statistics, APSL Research Further, illegal TV connections through tracking frequencies of other service providers (especially in northern area of the country receiving signals from Indian frequencies) continue to put extra pressure on Sri Lankan Pay-TV business. DTV revenue to report slower growth with declining ARPU and higher competition from substitutes.

LKR/m 7,000 35% 6,000 30% Try to find out some stats for 25% 5,000 local analog TV related things 20% 4,000 15% 3,000 10% 2,000 5%

1,000 0%

0 -5% 2014 2015 2016 2017E 2018E 2019E Income/LKR m YoY growth (RHS)

Source: DIAL AR’s, APSL Research

However, Industry growth potential would help DIAL to post YoY increase in revenue

LKR Subscribers 12,000 1,500 10,000 8,000 1,000 6,000 4,000 500 2,000 - - 2014 2015 2016 2017E 2018E 2019E ARPU/LKR Subscribers (000's)

Source: DIAL AR’s, APSL Research *ARPU is in annual terms

Page | 5

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Device Sales, Digital services and VAS

Device sales income accounted for c.3% mobile segment income in FY16. DIAL continued to create affordable smart devices in the market for customers through ‘Lesi Pay” and over 13,000 customers have benefited from this scheme in FY16. DIAL’s eZ Cash network supported a subscriber base in excess of 2.8m as of FY16 and transacted a total of LKR 18b. The digital services business grew by 103% in FY16. FY16 proved to be a remarkable year for Value Added Services business where it was able to drive usage via Video, Music, Gaming, Sports, Education offered from various apps and websites. VAS would be a handy strategy in retaining existing customers in highly competitive mobile telecommunication market in Sri Lanka.

Upside potential to revenue growth

Increased taxes would further open up the odds of industry consolidation Sri Lankan mobile Telco market is at its near maturity levels with intense competition between five operators. The two smaller/unprofitable operators, Hutchison Lanka and Airtel Lanka may leave the industry given extra burden generated in the forms of tax increases. Effective from May 2016, the government imposed a value added tax (VAT) of 15 percent and nation building tax (NBT) of 2 percent on telecom services, which will increase tax on voice and data services to 50 percent and 32 percent, respectively from 28 percent and 12 percent, earlier. Hence, we believe still there is room for few more strategic consolidations, which would result in two or three large companies to dominate the market. Here, the underutilized debt capacity of DIAL would be useful to finance such acquisitions around LKR 10-12Bn.

Increased usage of handheld devices beating consensus Smartphone penetration attributable for DIAL subscribers stands at 44% as of FY16 cf. 33% as of FY15. Further, we expect the smartphone penetration within Capital would reach 70% levels while nationwide penetration is likely to reach 50% levels in the near term. This is further backed by existing government’s plans to increase the utilization of internet and handheld devices for educational purposes. This would support both device sales as well as subscriber growth. (DIAL sells smartphones at prices starting from LKR 9,900 and Handheld tablets at prices starting from LKR 19,900)

Downside Risks for revenue expansion

Increasing usage of over the top (OTT) applications would deteriorate voice income. Increased usage of OTT applications such as WhatsApp, Skype, Viber, WeChat etc. is causing a net decrease for the Telco companies. Therefore, decline of local and international voice income due to increased usage of OTT applications would not perfectly have covered by respective increase in Data revenue since majority of such OTT applications consume relatively lesser amount of Data.

Page | 6

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Lower than expected economic growth affecting both subscriptions and usage of services negatively. We assume the Sri Lankan economy would record 5.5-6.5% GDP growth in the medium term. (CBSL Road Map for 2017: “Cautiously Optimistic”) This would result in a medium term Per Capita GDP of USD 5180 by FY19 supporting both usage and volume based growth. However, situational macroeconomic vulnerabilities such as adverse BOP and Depreciating LKR would affect the ability to achieve medium to long-term GDP targets and in turn affecting topline growth of DIAL. This is further evident from the strong co-relation between DIAL’s performance and Per Capita GDP of Sri Lanka.

Increased government intervention in terms of price limits, increased taxes and charges. Telecommunications Regulatory Commission of Sri Lanka (TRCSL) acts as the major regulator in the domestic Telco industry. The TRCSL involves in Spectrum management, Licensing, Telco Levy Management etc. Hence, offering new licenses for new entrants while Government increasing charges such as VAT, NBT and special Telco levies can significantly affect DIAL’s topline in the current Red Ocean Telco market space. DIAL operates with higher effective taxes compared to Mobitel. (DIAL per second package “off net” tariff amounted to LKR 2.50 per minute cf. Mobitel’s LKR 1.50 per minute as of early 2016). Hence, increase in charges would be an extra burden on DIAL hindering competitive advantage over peers.

Industry consolidation without the involvement of DIAL would affect DIAL’s topline Even though there is a high chance of DIAL acquiring and or Airtel, there may be legal restrictions since that will result in DIAL to own more than 50% market share, which reflects dominance. Hence, other possible consolidations without involving DIAL are, Mobitel acquiring Hutch, Mobitel acquiring Airtel or Etisalat. This would create a more powerful market challenger for DIAL. Further, there may be size wise economies for a merged firm (Ex: shared channels and CAPEX) which would cause DIAL to lose its market share.

Page | 7

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Overall EBITDA margins to settle in 33% levels over

FY17-19E During FY14-16, DIAL incurred c.LKR 58b as CAPEX and c.LKR 39b as depreciation We expect a slight drop in DIAL’s overall EBITDA margin over FY17-19E to LKR m c.33% in FY21E cf. 34% in FY16. This is mainly due to increased marketing and 40,000 networking expenses caused by aggressive subscriber acquisition in mobile and fixed broadband segments together with gradual shift of voice call income 30,000 towards OTT applications which usually generate relatively lower average 20,000 income streams. However, we believe the currently loss making DTV business would reach breakeven levels over FY17-19E given the increasing trend of 10,000 demand for Pay-TV services and DIAL has already completed necessary CAPEX requirements for the business. 0 2014 2015 2016 CAPEX Depreciation We expect c.100bps decline in DIAL’s EBITDA margin by FY19E Source: DIAL AR’s, APSL Research

LKR m 50,000 25%

40,000 20%

30,000 15%

20,000 10%

10,000 5%

- 0% 2014 2015 2016 2017E 2018E 2019E EBITDA/LHS YoY growth/RHS Source: DIAL AR’s, APSL Research

Improving Mobile Data ARPU to offset declining Voice business

Considering the fast growth of OTT applications, we expect Mobile Voice ARPU to decline over FY17-21E despite increasing mobile phone penetration over and above 100% levels. However, we believe DIAL would be able to capture majority of revenue loss of voice business through the expansion of Data operations. Besides potential increases in data charges (Currently, Sri Lanka offers one of the lowest data charges in the South Asian region) we assume the data consumption of customers would increase significantly supporting Data ARPU to grow effectively recovering majority of lost revenue elsewhere in the voice business.

Growing data business to compensate for voice business decline

LKR Blended ARPU Data ARPU Voice&Others 7,000 6,000 5,000 4,000 3,000 2,000 1,000 - 2012 2013 2014 2015 2016 2017E 2018E 2019E Source: DIAL AR’s, APSL Research *ARPU is in annual terms Page | 8

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Healthy growth of post-paid subscriber base with relatively higher ARPU would help DIAL to defend against cost increases. DIAL enjoys relatively higher ARPU & EAT margins compared to its major DIAL’s pre-paid to post-paid mix as of FY16 is c.89/11 where the subscriber competitor Mobitel CAGR over FY12-16 stood at c.12% for pre-paid and c.6% for post-paid As of FY16 DIAL Mobitel connections. However, during FY16, Post-Paid subscriber growth overtook its Subscribers*/m 11.83 6.40 past five year CAGR of c. 6% and Pre-paid subscriber growth of c.9% YoY to post c.10% YoY growth. We conservatively assume c. 3% CAGR for post-paid Blended ARPU** 6,127 5,613 subscribers over FY17-21E. DIAL’s Post-paid ARPU is more than three times EAT Margin 14.20% 11.40% larger than Pre-paid ARPU and hence a higher growth in Post-Paid subscribers *include mobile subscribers only would benefit DIAL’s profit margins. **estimated considering DIAL’s revenue

other than Fixed and DTV.

Source: DIAL/SLT AR’s, APSL Research We expect DAIL to post c.3% and c.7% Post-Paid and Pre-Paid subscriber growth respectively.

Subscribers/m Prepaid/LHS Post Paid/RHS Subscribers/m 16.00 1.60

14.00 1.40

12.00 1.20

10.00 1.00

8.00 0.80

6.00 0.60

4.00 0.40

2.00 0.20

- - 2012 2013 2014 2015 2016 2017E 2018E 2019E 2020E 2021E

Source: DIAL AR’s, APSL Research

Rising marketing and networking costs limits upside potential of EBITDA

Aggressive subscriber acquisition strategies would necessarily require effective marketing campaigns which in turn would increase marketing costs. Sales & Marketing costs accounted for c.15.2% as a percentage of revenue in 1Q17, up 20 basis points from 15% in 4Q16. Further, networking costs including interconnection/international origination costs and Telco charges increased significantly during 1Q17 to 13.5% of revenue cf.12.9% in 4Q16. However, we do not expect a radical increase in interconnection and international origination costs given declining Voice business caused by the substitution of Data.

We expect a slight increase in DIAL’s Marketing costs over FY17-21E

Total Cost Break Down 1Q17 4Q16 Change Direct Expenses 26.6% 27.8% -1.2% Sales & Marketing 15.2% 15.0% 0.2% Network Cost 13.5% 12.9% 0.6% Staff Cost 8.3% 8.1% 0.2% Overheads 3.1% 2.2% 0.9% Bad Debt 0.7% 1.4% -0.7% Total 67.4% 67.4% 0.0%

Source: DIAL earnings call transcript 1Q17

Page | 9

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Relatively low margins of Pay-TV operations (DTV) deteriorate overall profitability.

Besides posting a healthy growth in subscriber base with c.29% YoY growth in FY16, DTV operations continued to witness EBITDA contractions. EBITDA fell by 15 percentage points over FY12-16 period to mark a single digit 6.3% in FY16 cf.21.2% in FY12. This is majorly caused by the market entry of Dish TV into Sri Lanka and LKR depreciation especially against USD. Majority of DTV’s costs are USD denominated and hence LKR depreciation against USD would heavily affect DTV margins negatively. We expect LKR may continue to depreciate at least in the short run given the series of US Fed rate hikes over 2016-2018 would increase interest rate differentials between Sri Lanka and US. Increasing imports compared to exports would further worsen the FX position of the country.

LKR depreciation and Dish TV introduction weigh on DTV profitability

LKR m LKR depreciated by c.4% in FY16 Dish TV introduction in 2015 7000

6000

5000

4000

3000

2000

1000

0

-1000 2012 2013 2014 2015 2016 EAT Revenue EBITDA

DIAL’s overall EBITDA margins are largely driven by Mobile segment performance. However, margin decline of DTV caused overall margins to settle bellow standalone mobile segment performance. EBITDA Margins 60.0%

50.0%

40.0%

30.0%

20.0%

10.0%

0.0% 2012 2013 2014 2015 2016 Mobile Fixed Pay TV (DTV) DIAL Overall Source: DIAL earnings call transcripts, DIAL AR’s

Page | 10

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

DIAL to run with increased CAPEX; Ongoing cycle to end by mid-18

We expect DIAL would increase capital expenses during FY17-mid FY18E given However telecommunication industry the necessary investments in 4G/Fibre Optic Infrastructure developments and faces a challenge of shortening Internet Data Centre projects. DIAL incurred c.LKR 98b CAPEX over FY12-16 investment cycles. For example in the mobile segment, 4G migration from reflecting c.28% average capital intensity over the same period. We expect took a faster stride compared to the DIAL would reach 30% levels of capital intensity over FY17-mid 18E resulting previous development of 3G from an estimated base case CAPEX figure of c.LKR 62b over the same period. We services. This delivers challenges and believe DIAL would be able to fund the investments through internally investment pressure as the time generated earnings as well as debt capital without rising financial risks available to yield a return is getting substantially. shorter

DIAL to mark increased levels of CAPEX intensity over FY17-mid 18

LKR m CAPEX Intensity CAPEX CAPEX intensity 35,000 40.0% 30,000 35.0% 25,000 30.0% 25.0% 20,000 20.0% 15,000 15.0% 10,000 10.0% 5,000 5.0% - 0.0% 2012 2013 2014 2015 2016 2017E 2018E Source: DIAL AR’s, APSL Research

Mobile segment absorbed c.71% of total CAPEX in FY12 c. 1/3 of CAPEX were directed to Fixed Operations in FY16 5% 5% 24% 32%

63% 71%

Mobile Fixed operations DTV Mobile Fixed operations DTV

DIAL extensively invests in 4G LTE/Fibre optics developments and hence the CAPEX intensity of fixed operations continued to mark above 50% levels over FY12-16 while the major, mobile segment average CAPEX intensity recorded c.24% over the same period.

Segmental CAPEX intensity Mobile Fixed operations DTV 140% 120% 100% 80% 60% 40% 20% 0% 2012 2013 2014 2015 2016

Source: DIAL AR’s

Page | 11

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

DIAL would stick into progressive dividend policy amid substantial CAPEX cycles

DIAL maintained a progressive dividend scheme over the years and we expect dividend payout to remain at 40% levels in over FY17-19E. However, we expect a slight increase in payout to reach 45% levels from FY20E given most of the ongoing investments in 4G LTE and Fiber optics together with BB project would generate substantial positive net cash inflows for DIAL.

DIAL would continue to pay progressive dividends over FY17-19E

LKR Payout 1.40 60%

1.20 50% 1.00 40% 0.80 30% 0.60 20% 0.40

0.20 10%

- 0% 2012 2013 2014 2015 2016 2017E 2018E 2019E EPS Payout/RHS DPS Source: DIAL AR’s, APSL Research

DIAL’s dividend policy substantially in line with regional long term pay-out patterns

DIAL’s past 5-year average payout ratio over FY12-16 is c.38% subject to a minimum of c.17% in FY14 and maximum of c.50% in FY15. Average median payout ratio of selected local and regional peers for the same period recorded as c.39%. Since industry moves with CAPEX cycles, we believe DIAL would continue to be in line with the regional peer average payout ratios on long-term basis.

Payout ratio FY12 FY13 FY14 FY15 FY16 DIAL 44% 45% 17% 50% 35% SLT 39% 28% 27% 43% 34% Axiata Group 79% 73% 81% 69% 133% Bharti Airtel 17% 26% 30% 9% 11% Reliance Communications 8% - - - - Globe Telecom 126% 180% 75% 69% 76% China Mobile 44% 44% 43% 42% 46% Peer Median Payout 41% 36% 36% 42% 40%

Source: marketsft.com, APSL Research

Page | 12

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Continuous CAPEX requirements would urge to maintain higher levels of debt

We expect DIAL would continue to operate with more than 50% levels of gearing (Debt-to-Equity) in order to facilitate increasing CAPEX requirements. USD denominated borrowings showing DIAL’s total borrowings include both LKR and USD loans exposing DIAL to both a substantial decline during FY16 interest rate and exchange rate risks. following US Fed rate hikes.

USD denominated borrowings accounted for c.66% of DIAL’s total Year LKR USD USD % borrowings as of FY16 FY12 4,784 20,142 81% FY13 4,204 25,154 86%

34% FY14 5,719 24,193 81% FY15 2,577 22,830 90% FY16 11,785 22,400 66% *LKR&USD m Source: DIAL AR FY16 66%

Sri Lankan rupees United States dollars

Source: DIAL AR’s FY16

Total USD denominated borrowings comprise syndicated term loan of USD Debt repayment schedule*/FY16 92m at interest rate of USD 3 Months LIBOR+1.450% p.a. and USD 56m at an 3 months or less 3,339 interest rate of USD 3 Months LIBOR+1.225% p.a. 3-6 months 1,510 LKR denominated borrowing of LKR 10b carries a fixed interest rate of 8.75% 6-12 months 3,024 p.a for a period of 2 years (till FY18) and thereafter a floating rate. 1-5 years 26,313 Total 34,186 We assume the US Federal Reserve (Fed) would raise the rates (Fed funds *LKR m rate) as per initial announcements at least till FY18E. Hence this would Source: DIAL AR FY16 increase USD 3 month LIBOR’s resulting increased effective borrowing costs for DIAL. Further, Sri Lankan basic interest rates are unlikely to increase in the short run considering the contradiction between economic growth and interest rates. This would cause LKR to depreciate against USD which would result in substantial translation and transaction losses for DIAL.

Series of US Fed fund rate increases would cause USD LIBOR to raise resulting increased interest costs for DIAL on variable rate borrowings.

3.50%

3.00%

2.50%

2.00%

1.50%

1.00%

0.50%

0.00% FY17 June FY17 Dec FY18 Mar FY18 June FY18 Dec FY19 Mar FY19 June FY19 Dec

Fed Funds Rate USD 3 Month LIBOR

Source: globalrates.com, APSL Research

Page | 13

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Additionally, Fed rate hikes would cause LKR to depreciate against USD which in turn would cause Foreign exchange losses for DIAL. LKR depreciated by c.3.9% during FY16 which caused c.LKR 0.8b translational forex loss for DIAL. Further, DIAL estimates if LKR fluctuates by 1% against USD as at FY16, with all other variables held constant, it will result in a net foreign exchange difference of LKR 231m. During 1Q17, LKR depreciated by c.2.0% and as the worst case we believe LKR would further depreciate by c.4.0% during FY17E totalling to c.6% total depreciation for the year. This may cause c.LKR 1.4b forex loss for FY17E.

Estimated LKR/USD rates under different inflation rate scenarios assuming purchasing power parity holds.

Possible Inflation Rates in the US 158.67 1.00% 1.25% 1.50% 1.75% 2.00% 2.25% 2.00% 154.19 153.81 153.43 153.06 152.68 152.31 2.50% 154.95 154.56 154.18 153.81 153.43 153.05 3.00% 155.70 155.32 154.94 154.56 154.18 153.80 3.50% 156.46 156.07 155.69 155.31 154.93 154.55 4.00% 157.22 156.83 156.44 156.06 155.67 155.29 Possible 4.50% 157.97 157.58 157.19 156.81 156.42 156.04 Inflation 5.00% 158.73 158.33 157.94 157.56 157.17 156.79 Rates in 5.50% 159.48 159.09 158.70 158.31 157.92 157.53 Sri Lanka 6.00% 160.24 159.84 159.45 159.06 158.67 158.28 6.50% 160.99 160.60 160.20 159.81 159.42 159.03 7.00% 161.75 161.35 160.95 160.56 160.16 159.77 7.50% 162.51 162.10 161.71 161.31 160.91 160.52 8.00% 163.26 162.86 162.46 162.06 161.66 161.27

*Assumed average spot rate=152.68 Source: CBSL, APSL Research

However, DIAL has arranged an interest rate SWAP with HSBC (notional DIAL’s current financial leverage is amount c.USD 70m) to hedge the interest rate risks with at an agreed fixed slightly less than its past 5 year average Debt-to-Equity ratio of c.68% rate of 2.6075% p.a cf. 3 months LIBOR+1.45% which is initial rate on USD Year Debt-to-Equity denominated borrowings. FY12 67% DIAL consumes relatively lower level of external debt by recording c.63% FY13 74% Debt-to-Equity ratio as of FY16 cf.81% Median Debt-to-Equity ratio of regional FY14 67% peers. However, domestic peer SLT records a lower financial leverage than FY15 54% DIAL. FY16 63%

Source: DIAL AR’s, APSL Research DIAL operates with relatively lower level of financial leverage compared with regional peers.

D/E Ratio 200%

150%

100%

50%

0% DIAL SLT Axiata Group Bharti Airtel Reliance Communications Globe Telecom

Source: investing.com, SLT/DIAL AR’s, APSL Research

Page | 14

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

We establish a valuation range of LKR 11-15 for DIAL shares.

We establish LKR 11-15 per share valuation range for DIAL, based on our current performance outlook of the telecom provider. We have used Discounted Cash Flow (DCF) as the basic valuation methodology to value DIAL equity shares since the drivers of future cash flows are fairly identifiable.

Hence we have considered the arithmetic average of base case DCF and EV/EBITDA based valuation methodologies to arrive at an average price target of LKR 14 per share.

Our valuation range analysis establishes LKR 11-15 value range for DIAL shares

DCF Analysis

EV/EBITDA

52 Week L/H

10.1 10.5 12.3 13.24 14 14.7 15.07

Source: DIAL AR’s, CSE, APSL Research

DCF analysis based on Free-Cash Flows estimates a valuation range of LKR 10.5-14.7 per DIAL share

Our base case DCF analysis assuming a risk free rate of 10% and a market risk premium of 5% results a c.LKR 14 per share value. Further, adjusting base case value drivers for bull and bear cases sets a range of LKR 10.5-14.7 per share value.

DIAL’s current capital structure comprises 63% debt and 47% equity. We have assumed a target debt to equity ratio of 55/45. Our base-case valuation assumes a terminal growth of 3.0% applicable for levered free cash flows after the explicit forecasting period.

Finally, we have assumed 28% corporate tax rate for cash flow and cost of capital calculations. We arrived at our Enterprise Value (EV) by discounting the leveraged FCF values throughout the explicit period together with terminal value as of FY21E by the estimated Weighted Average Cost of Capital (WACC).

DCF assumptions of base case analysis are as follows;

After Tax WACC 10% FY17E/LKR m Cost of equity 14% EBIT 12,942 After tax cost of debt 7% FCFF 174 Target capital structure Undiscounted Terminal Value 168,626 Equity 45% Enterprise Value 152,239 Debt 55%

Page | 15

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Scenario Analysis for DCF based valuation

We introduce the upside and downside potentials for revenue growth as discussed in pages 9-10 for valuation purposes in the means of two additional scenarios: Bull Case and Bear Case. This scenario analysis results in a price range of LKR 10.5-14.7 for DIAL shares.

Bull-case scenario: Here, we assume that DIAL performs better than our estimates and mobile segment achieves a 7.1 % CAGR in net subscribers over FY17-21E, 70 basis points over and above our base-case assumptions of a 6.4% CAGR. This scenario also assumes mobile data ARPU CAGR to be one percentage point higher than base-case assumption of 5%. Further we assume an aggressive 33% CAGR for fixed segment net subscriber additions over FY17-21E. This leads to a group revenue CAGR of c. 12% over FY17-21E cf.10% assumed CAGR for Base Case analysis. Here we also expect a slight decline in EBITDA margins from existing 34% to c.33-32% levels by FY19E assuming increased marketing and capital depreciation expenses.

Bear-case scenario: Our conservative Bear-case assumes a net subscriber CAGR of 5.9% for mobile segment over FY17-21E, 50 basis points decline compared to our Base-case assumption of 6.4%. Further we assume a conservative CAGR of 4% for mobile data ARPU. We also assume a CAGR of 21% for fixed segment net subscriber additions over FY17-21E. These assumptions would translate to c.7% overall revenue CAGR over 17-21E. Additionally we assume EBITDA margins to settle at c.33% levels over FY17-19E.

Scenario Analysis for DCF Following tableau summarizes important case-wise valuation assumptions;

Case-wise Scenario Analysis ** Over FY17-21E Bear Case Base Case Bull Case Mobile Segment Subscriber CAGR 5.9% 6.4% 7.1% Data ARPU* CAGR 4.5% 4.7% 6.5% Revenue CAGR 6.8% 9.5% 12.2%

Fixed Segment Fixed subscriber CAGR 18.6% 20.5% 33.2% Revenue CAGR 11.0% 12.8% 24.6%

DTV Segment Subscriber CAGR 10.5% 11.5% 12.4% Revenue CAGR 8.7% 9.7% 10.6%

EBITDA Margins (FY17-19E) 33% 34-33% 33-32%

*Mobile Data ARPU is calculated and estimated considering DIAL’s smartphone penetration within the customer base and upside potential of smartphone sales during FY17-21E

Page | 16

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

EV/EBITDA valuation arrives at LKR 13.24-15.07 for DIAL shares Historically DIAL has traded at discounted multiples cf. SLTL DIAL recorded c.3.8x EV/EBITDA as of FY16 end cf.SLT’s approximated EV/EBITDA of 5.0x reflecting c.32% discount. DIAL’s past four-year average EV/EBITDA (x) EV/EBITDA stands at c.5.0x over FY12-15 where SLT stands at c.5.5x marking Company 2012 2013 2014 2015 2016 c.10% discount to SLT multiple. DIAL 4.5 5 6.1 4.4 3.8 However, DIAL has overtaken SLT during FY12-16 in terms of Revenue, SLT 5.3 5.0 6.2 5.5 5.0 EBITDA, EAT, Total Assets and Total Equity growth by recording 11%, 14%, However, DIAL posted superior 11%, 10% and 10% CAGR’s cf. 7%, 4%, 5%, 8% and 5% of SLT over the same performance cf. SLT over FY12-16 period. Further, DIAL has invested c.LKR 97b as CAPEX over FY12-16 cf. SLT’s reported CAPEX of c.LKR 87b. 4 Yr CAGRs (FY12-16) Company Revenue EBITDA Assets Equity Hence as the base case, we conservatively believe DIAL should at least trade DIAL 11% 14% 10% 10% at an EV/EBITDA multiple of 5.16x which is its historical EV/EBITDA multiple SLT 7% 4% 8% 5% adjusted for EBITDA CAGR over FY12-16. This results in c.LKR 149.47b Source: CSE, DIAL AR’s, SLTL AR’s, APSL Research enterprise value for DIAL which converts to c.LKR 14.16 per share value.

DIAL has been traded within the range of 6.1-3.8x EV/EBITDA over FY12-16. However, EV/EBITDA has shown a sharp decline since FY14.

LKR/m EV/EBITDA 45,000 7.0 40,000 6.0 35,000 5.0 30,000 25,000 4.0 20,000 3.0 15,000 2.0 10,000 5,000 1.0 - - 2014 2015 2016 2017E 2018E 2019E EBITDA/LHS EV/EBITDA (x) Source: DIAL AR’s, APSL Research

We apply a scenario analysis for EV/EBITDA based valuation range

Optimistic scenario: Here we assume a 5% premium to DIAL’s adjusted base case EV/EBITDA multiple of 5.16x. Our optimistic assumptions result in an EV/EBITDA multiple of 5.39x which translates in to c.LKR 15.07 per share value. Industry consolidation through possible acquisitions while increased smartphone and hand held device penetration would fairly defend 5% premium on DIAL. Further, change of debt mix from foreign to local sources would effectively minimize foreign exchange related losses making a positive impact on EBITDA margins.

Pessimistic scenario: Here we assume a 5% discount to DIAL’s adjusted base case EV/EBITDA multiple of 5.16x. Our pessimistic assumptions result in an EV/EBITDA multiple of 4.87x which translates in to c.LKR 13.24 per share value. We believe c.5% discount is justifiable to account for possible industry consolidations without involving DIAL and negatives such as further increases of government taxes and levies causing sharp declines in data and voice consumption.

Page | 17

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

DIAL Share price performance Total average annual return of DIAL

2013 2014 2015 2016 DIAL shares closed at LKR 11.6 on 15 May 2017, LKR 0.30 higher than 12 months earlier, an increase of 3%, compared to a 1% decrease in All Share Capital Gain 27% 21% 6% -6% Price Index (ASPI) and a 9% increase in the S&P SL 20 Historical performance. Dividend yield 3% 1% 3% 4%

Total Return 30% 22% 9% -2%

DIAL marginally outperformed the broad ASPI during past 12 months. Source: CSE, APSL Research However, DIAL’s performance against S&P SL20 was relatively weaker.

120% DIAL ASPI S&P SL20 115% 110% 105% 100% 95% 90% 85% 80% 16-May-16 15-Jul-16 13-Sep-16 12-Nov-16 11-Jan-17 12-Mar-17 11-May-17

Source: CSE, APSL Research DIAL vs major local & global indices

Further, DIAL has outperformed major global indices such as UK’s FTSE 100, 3M 6M 3Yrs 5Yrs Dow Jones Industrial Average of US, Japanese Nikkei 225 and Australian DIAL 6% 5% 22% 115% S&P/ASX during last 3 months’ period. However, DIAL recorded relatively ASPI SL 8% 5% 6% 31% weak performance in the medium term during FY15-16. Over the long term, DJIA 2% 11% 27% 67% DIAL showed a significant rate of return over 100%. Additionally, DIAL is a FTSE 100 2% 10% 9% 38% relatively attractive share among both local and foreign investors marking an Stoxx Europe 7% 17% 17% 42% average daily volume of c.1874 (In 000’s) shares and average daily turnover of Nikkei 225 3% 12% 41% 124% c.20, 898 (In LKR 000’s) over the past 12 months. S&P/ASX 1% 10% 7% 37%

Source: CSE, APSL Research DIAL & ASPI performance against major global indices over FY12-17

130%

110%

90%

70%

50%

30%

10%

-10% 3M 6M 1 Yr 2 Yrs 3 Yrs 5 Yrs DIAL ASPI SL DJIA FTSE 100 Stoxx Europe Nikkie 225 S&P/ASX

Source: CSE, investing.com, APSL Research

Page | 18

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Appendix 1: COMPANY REVIEW

Dialog Axiata PLC (DIAL) (subsidiary of Axiata Group Berhad through its DIAL subsidiary Axiata Investments [Labuan] Limited) entered into the Sri Lankan 1st in South Asia to Launch: mobile telecommunications market in the year 1995 was able to capture the market leadership position by the year 2000. Since then they were able to  International  Short Messaging Service maintain its market leadership position in the Mobile Telecommunications  Introduce WAP, GPRS & MMS sector with a strong presence in Sri Lanka’s Fixed Telecommunications and  Introduce 3G Digital markets through its fully-owned subsidiaries Dialog  Receive ISO Certification Broadband Networks (Private) Ltd (DBN) and Dialog Television (Private) Ltd  Mobile 4G FD-LTE services (DTV). DIAL currently holds c.45% (subscriber basis) market share in mobile  4. TDD LTE network operations while closing to 12m mark of mobile subscribers. DIAL being one of the largest listed companies on the (CSE) in terms of market capitalization (c.LKR 97b as of 21st June 2017, the fifth largest company by market cap) is also Sri Lanka’s largest Foreign Direct Investor (FDI) with investments adding over USD 2.1Bn.

DIAL posted c.LKR 87b total income in FY16, the highest recorded income figure since the beginning of its operations in FY95. Besides increased completion and intense price wars, DIAL generated c.11.4% total income CAGR during FY12-16 while posting an YoY income growth as high as 17% in FY16.

DIAL recorded c.11% revenue CAGR during FY12-16

LKR m Income/LKR m YoY growth/RHS 100,000 30%

80,000 25% 20% 60,000 15% 40,000 10%

20,000 5%

- 0% 2012 2013 2014 2015 2016 Source: DIAL AR’s, APSL Research

Mobile operations business continued to be the major income generator for DIAL since its inception in FY95.

DIAL’s mobile segment consistently accounted for more than 80% of total revenue

100%

80%

60%

40%

20%

0% 2012 2013 2014 2015 2016 Mobile Fixed DTV Source: DIAL AR’s, APSL Research

Page | 19

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Segmental Analysis

Mobile operations

DIAL’s mobile segment accounted for c.84% of group total income and c.85% of EBITDA in FY16. Mobile business includes mobile voice, mobile data, Value Added Services (VAS), International services, Device sales, Digital services and other operations. DIAL provides 2G, 3G and 4G coverage throughout the country and currently testing 4.5G technology. DIAL is the market leader in Sri Lankan mobile telco industry with a subscriber base of c.11.8m as of FY16 reflecting an approximated market share of 45%. Majority of DIAL’s mobile subscribers are “Prepaid” and it accounted for c. 89% of total subscriber base in FY16. In terms of international services, DIAL has signed roaming agreements with 15 GSM operators, added 2 destinations to its roaming footprint during the year 2016, and expanded its roaming footprint on GPRS, 3G, and CAMEL to 205,176 and 186 destinations respectively. Further, they expanded its LTE roaming footprint and coverage to 160 operators and 75 destinations. However, voice business reflects a much weaker growth with the substitution of data related OTT applications. Ability to curb the declining voice income through increased data business is a major challenge faced by DIAL.

Fixed operations

DIAL’s fixed business serves over 250,000 individuals and corporates by providing multiple services including fixed telephony, Hosted PABX offerings, broadband, and internet leased lines, data communication, Internet Data Centre (IDC), converged ICT solutions, telecommunication infrastructure, and transmission and backbone services.

Dialog Broadband Network (DBN) was the first in Sri Lanka to launch 4G-LTE high-speed broadband services in 2012. Further, DIAL acquired Suntel Limited in 2012 to strengthen its Fixed-voice business. However, business growth is majorly generated by increased demand for data services including 4G LTE facilities. Fixed business accounted for c. 9% of total group income and c.14% for group total EBITDA in FY16.

Television operations

DIAL Operates a Direct-to- Home (DTH) Digital Satellite Pay TV service and supports a broad array of international and local content in both Standard Definition (SD) and High Definition (HD) formats together with a wide portfolio of Sri Lankan television channels and delivers high quality infotainment to a viewer base of 838,000 Sri Lankan households. The DTV business accounted for c.7% of group total income and c.1% of group total EBITDA in FY16. However, the segment continued to post net losses since FY15 while witnessing c.56% decline in EBITDA over FY14-16

Page | 20

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Group Structure

DIAL has formulated separate business units for its different types of operations reflecting the room for employing a mix/unique strategy for each operation. Most of the business units are wholly owned subsidiaries of DIAL.

Sri Lanka’s second largest Fixed Telecommunications service Dialog Broadband provider, serving residential and enterprise customers with voice, Networks broadband, lease lines and customized telecommunication (Private) Limited services. DBN is also a leading provider of Radio and Optical Fibre- (DBN)/100% based transmission infrastructure facilities

Operates a Direct-to- Home Digital Satellite Pay TV service which Dialog Television supports a broad array of international and local content in both (Private) Limited Standard Definition and High Definition formats together with a (DTV)/100% wide portfolio of Sri Lankan television channels.

Dialog Business Services (Private) Business process outsourcing services Limited (DBS)/100%

Digital Commerce Lanka (Private) eCommerce and digital marketing services. Limited (DCL)/100%

Digital Holdings Lanka (Private) Investment holding company for new e-commerce businesses of Subsidiaries Limited Dialog Group. Eg: wow.lk,Guru.lk,Doc.lk etc. (DHL)/100%

Dialog Television Trading (Private) Selling information technology enabled equipment Limited (DTT)/100%

Communiq Broadband Network (Private) Information technology enabled services Limited (CBN)/100% DIAL

Digital Health Developing and operating a state-of-the-art electronic commerce (Private) Limited infrastructure for the healthcare sector. (DH)/70%

Telecard (Private) International telecommunication services Limited/100%

Joint venture between Firstsource Solutions (a leading global BPO services Firstsource-Dialog provider), Firstsource-Dialog Solutions (Pvt) Ltd is the leading BPO service Associates Solutions (Pvt) provider in Sri Lanka offering services across Mobile, Fixed Line, DTH & Ltd/26% amp; Broadband across inbound voice,back-office processes and insurance processes.

Source: DIAL AR’s, APSL Research

Page | 21

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Governance

Well renowned and experienced Board of Directors from both Sri Lanka and Malaysia governs DIAL:

Name Position Description Appointed to the Board on 21 July 2008,Senior Independent Non-Executive Director of Axiata Group Bhd, and is a partner in the law firm of Azzat and (Chairman / Non-Independent, Non- Izzat, Malaysia. He graduated from the Mr. Datuk Azzat Kamaludin Executive Director) University of Cambridge, , with degrees in Law and in International Law, and was admitted as a Barristerat- Law of the Middle Temple, London in 1970. Appointed to the Board on 19 January 2001, and functioned as the Group Chief Executive of the company during the period 01 September 1997 to 31 (Non-Independent, Non-Executive December 2016. In 2016, the worldwide Dr. Hans Wijayasuriya Director (Immediate Past) Group Chief association governing the Global Mobile Executive - FY 2016) Industry, honoured Dr. Wijayasuriya with the ‘Outstanding Contribution to Asian Mobile Industry’ Award - the highest honour at the Asia Mobile Awards. Appointed as the Group CEO and as a Member of the Board of on 01 January 2017. He commenced his career in Telecommunications at Dialog Axiata in 1999 and held multiple roles, such as Head of Strategy, CEO of the (Group Chief Executive/Non- Mr. Supun Weerasinghe Mobile Business before and Group COO Independent, Executive Director) of Dialog Axiata.He is a fellow member of the Chartered Institute of Management Accountants, UK and holds a Bsc in Accountancy and Financial Management from the University of Sri Jayewardenepura, Sri Lanka. Appointed to the Board on 15 September 2004. He is currently the Chairman of the Capital Trust Group of companies, a Mr. Moksevi Prelis (Independent, Non-Executive Director) Director of the Colombo Stock Exchange Limited and Sinwa Holdings Limited. He is also a Director of the National Research Council of Sri Lanka. Appointed to the Board on 14 June 2006. His experience includes working as a Strategic Management Consultant and Director on international corporate and Mr. Mohamed Muhsin (Independent, Non-Executive Director) Foundation Boards. He successfully implemented major reforms in global telecommunications, video conferencing, information management and enterprise business systems.

Source: DIAL AR’s

Page | 22

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Shareholding structure

Axiata Investments (Labuan) Limited (83.3% stake) continues to be the major shareholder of DIAL since its inception in 1995. Public float recorded as c.16.68% as of FY16. Further, c.63% of public float is held by foreign investors making the total foreign stake of DIAL to c.94%.

Foreign investors held c.94% of the total stake of DIAL as of FY16 Approximated local and foreign retail stake stands at c.3% as of FY16 6% 3%

94% 97% Retail Institutional Domestic investors Foreign investors

Top 20 shareholders of DIAL as of 1Q17:

Shareholding Number of Position Shareholder % shares 1 Axiata Investments (Labuan) Limited 83.32 6,785,252,765 2 Employees Provident Fund 2.22 180,787,158 3 CITI Bank New York S/A Norgens Bank Account 2 1.27 103,661,281 4 HSBC INTL Nominees Limited - JPMCB Scottish ORL SML TR GTI 6018 1.02 83,426,021 5 HSBC International Nom Limited - SSBT - Stewart_ Subcontinent Fund 0.91 74,511,200 6 CB NY S/A International Finance Corporation 0.79 64,086,800 7 BNYMSANV RE - CF Ruffer Investment Funds: CF Ruffer Pacific Fund 0.7 57,314,300 8 HSBC International Nom Limited - MSIP - Saga Tree Asia Master fund 0.63 51,624,144 9 HSBC International Nom Limited - SSBT - First State Stewart Asia 0.58 47,270,000 Pacific Fund 10 HSBC International Nom Limited - MSIP - Vittoria Fund - ST, L.P. 0.57 46,193,749 11 Deutsche Bank AG Singapore - DSS A/C Navis Yield Fund 0.47 37,883,584 12 HSBC International Nom Limited - SSBT - Stewart Investors Asia Pacific 0.46 37,613,700 Fund 13 Northern Trust Company S/A Hosking Global Fund PLC 0.43 35,074,720 14 HSBC International Nom Ltd - JPMCB - Pacific Assets Trust PLC 0.42 33,865,700 15 Rubber Investment Trust Limited A/C # 01 0.4 32,168,830 16 HSBC International Nom Ltd -Luxembourg - Next 50 Emerging 0.27 22,148,248 Markets Fund 17 Mellon Bank N.A Parametric Structured Emerging Market Equity Fund 0.24 19,392,086 18 Mellon Bank N.A. - Ups Group Trust 0.23 18,880,000 19 HSBC International Nom Ltd - SSBT – Parametric Emerging Markets 0.23 18,848,970 Fund 20 The Ceylon Investment PLC A/C # 02 0.23 18,797,647 Subtotal 95.39 7,768,800,903

Source: DIAL AR’s/Interim FS

Page | 23

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Internal Environment Analysis: SWOT

STRENGTHS WEAKNESSES

 Market leader in Sri Lanka’s mobile  Diminishing tradeoff between lower interest telecommunication sector: DIAL held c.45% costs and FX losses: The low interest cost market share (subscribe basis) as of FY16 and advantage of observing USD denominated funds continued to attract customers from other is partially absorbed by the continuous players especially from Etisalat. This increasing depreciation of LKR against USD resulting customer base would help DIAL to minimize substantial FX losses. Hence, the effectiveness of average fixed costs in the long-run opening up the IR Swaps is questionable and improved attention room for economies of scale. is needed for hedging DTV operations since  Strong brand recognition & strong network majority of the costs are denominated in USD. coverage throughout the country: DIAL is  Higher Combined leverage: Increasing renowned to provide clear signals throughout the workforce, towers and rent expenses together country and expected to put up another 900 with the depreciation of increased CAPEX towers in the next two years to increase capacity necessarily increases the variability of operating and coverage of its GSM, 3G and CDMA networks, profits (EBIT). DIAL’s high debt consumption (D/E taking its tower network to approximately 2,000. ratio c.63% as of FY16) leads DIAL to record a  Availability of low cost funding sources: DIAL magnified total leverage, which would affect uses both local and foreign debt in financing its DIAL’s EPS negatively when a decline in topline major investments. Ability to obtain low cost USD occurs. denominated funds gives DIAL the vital advantage of interest cost savings.

OPPORTUNITIES THREATS

 One of the largest listed companies on the  Increasing trend of smartphone adaption  Potential imposition of various indirect and Colombo Stock Exchange in terms of market throughout the country: Smartphones consumes direct taxes by the government: Re- Introduction capitalization. (LKR 85.5Bn – as at 31st December relatively higher amount of data compared to of 15% VAT has already caused significant 2016) traditional Symbian platforms. Hence, data revenue loss for DIAL. Given the current data

business would be the major growth contributor charges in Sri Lanka is relatively lower comparted

in time to come. with regional peers, there is the risk of tax

 Room for higher mobile phone penetration in Sri increases for Data services which is considered to

Lanka (124% in 2016): Increasing trend of be the major driver of future growth.

demand for Dual SIM mobiles is a leading  Industry consolidation without the involvement indicator of subscriber growth. Hence, mobile of DIAL: Since DIAL already holds c.45% of market penetration would increase further over and share, it is unlikely to expect TRCSL giving above 100% levels given the countries such as permission for DIAL to acquire small players such Singapore has already passed 150% levels of as Etisalat and Airtel. Hence, there is the risk of mobile penetration. the rise of a clear challenger for DIAL if Mobitel  Losing business focus of other small players: acquires Etisalat and /or Airtel. Currently the local players, Etisalat, Hutch and  Continuous and Rapid shift of fundamental Airtel does not make a clear challenge for DIAL technologies: The risk of recovering the initial which opens up DIAL the opportunity to attract investment and a fair return increases where the customers and increase the market share even fundamental platforms are subject to without going for industry consolidation directly. unavoidable rapid change in order to protect the market share. Ex: Shift from 3G to 4G is much quicker than from 2G to 3G.

 Page | 24 Higher inflation and increasing exchange rates.

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Appendix 02: Sri Lankan Telecommunication Industry

Sri Lankan mobile market competition is relatively high with 5 operators (DIAL, Mobitel, Etisalat, Hutch & Airtel) catering to a 26.36 Million (End 2016) mobile subscribers. This overcrowded mobile phone industry has led ICT Development Index operators to charge low data and voice charges from customers in order to Country 2016 Change 2015 capture market share leading Sri Lanka to be one of the lowest data prices and Rank Value to 2016 Sri Lanka 116 3.77 mobile voice prices in the South Asian Countries. India 138 2.69

Sri Lanka’s Monthly phone usage is the lowest among the South Asian Pakistan 146 2.35 Malaysia 61 6.22 Countries Singapore 20 7.95

Monthly Phone Usage in US$ (2014) Networked Readiness Index Country Rank Rank Change Bhutan 2.95 Sri Lanka 63 65 India 2.80 India 91 89 Pakistan 110 112 Nepal 2.49 Malaysia 31 32 Singapore 1 1 Source : itu,world economic forum Pakistan 2.12

Bangladesh 1.42

Sri Lanka 0.97

Source: World Bank

We believe DIAL would continue to capture the market from Etisalat, Hutch and Airtel.

50

40

30

Market Share(%) Market 20

10 2014 2015 2016 2017E 2018E 2019E DIAL Mobitel Others (Etisalat,Hutch & Airtel) Source: DIAL AR’s & APSL Research

Sri Lanka witnessed a rapid evolution in the telecommunication industry in In order to increase the data the recent past with focus diverting away from the traditional connectivity prices and to realize an increase means to diverse areas such as data connectivity and digitization. The market in average revenue per user we expect a consolidation in the for mobile broadband is in a growth phase of the cycle and therefore growing market, existence two to three more strongly, driven by 3G and 4G adoption and increased smartphone large players in the market. penetration.

Page | 25

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Sri Lanka’s Mobile Phone Subscription is on a growing trend along with the Future of the World Telecommunication Industry in Sri Lanka… Mobile Phone Penetration (Defined as connections per 100 persons) 140 Mobile broadband/data will be the 130 main revenue driver in the telecom 120 sector due to increase in household income, in increase in smartphone 110 adoption and as major part of the 100 country is covered by 3G or 4G. 90 80 70 In Sri Lanka’s western province 60 Megapolis project, government is 2012 2013 2014 2015 2016 planning to create Smart City, Smart Home, National Data Cloud, National Sri Lanka Developing Countries Data Centre and International Data Connectivity. Developed Countries World

Source: ITU

Sri Lanka’s internet penetration grew at a steady rate in the past; hence, we expect the same would reach 35% by 2019. Internet Penetration % 60 50 40 30 20 10 - 2012 2013 2014 2015 2016 2017E 2018E 2019E

Sri Lanka World Asia Pacific

Source: ITU & APSL Research

Relatively lower internet penetration in Sri Lanka reflects the potential for future growth % 80 72 It is estimated that by 2020, 5 70 Billion of World population will 60 use the internet (that’s over 52% of the world’s population) and that 50 41 37 the developing countries will 40 34 32 witness the biggest growth. 30 22 18 20 12 10 -

Internet Penetration (% of Country's Total Population as at 31st March 2017)

Source: internetworldstats.com

Page | 26

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Sri Lanka: Government and the Telco industry

Telecommunication Levy represents nearly 2% to 2.5% of total government revenue. In 2016 revenue from telecommunication levy increased by 7.5% due to expansion in telecommunication related activities and the rate, increase in both Telecommunications, levy on internet services and International Telecommunication Operators’ Levy.

We anticipate that in the short-term, increased indirect taxation on telecommunication services will constrain consumption and demand for such services.

Telecommunication Levy as a % Government Revenue % of Government Revenue Government % of ) 45 3.00 40 2.50 35 30 2.00 25 1.50 20 15 1.00 10 0.50 5 0 - Telecommunication Telecommunication Levy (LKR Bn 2012 2013 2014 2015 2016 2017E

Telecommunication Levy (LKR Bn) % of Government Revenue

Source: CBSL AR/ APSL Research

Budget 2017 proposals that would have a potential impact on Telco industry

 The telecommunication levy on internet services was increased to 25%  SIM Card Activation Levy of LKR 200 per SIM card was imposed.  Annual Spectrum Licensee Fee increased by 25%  The services provided by the external gateway operators to local operators exempted from VAT and NBT.  Government instructed all mobile telephone operators to convert their infrastructure to provide 3G coverage to all metro areas of the country by end June 2017. Any operator who fails to provide 3G coverage within the first six months of 2017 will be liable for a surcharge of LKR 100m per district.  Mobile telephone service providers are requested to provide 4G coverage to all metro areas of the country by end June 2018.

Page | 27

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

PORTER’S FIVE FORCES ANALYSIS ON THE SRI LANKA’S TELECOMMUNICATION INDUSTRY

Five forces methodology analyses the attractiveness of the Sri Lankan Telco industry as a whole

Barriers to entry  Highly regulated by the Telecommunications Regulatory Commission of Sri Lanka (TRCSL)

 Capital Intensive – Industry require continuous large scale High investments on technology

 Strong Brand Recognition – New companies will have to improve their brand value in order to compete effectively

Bargaining power of customers  Switching cost is minimal. Therefore, customers can easily switch between telecom providers. High  Customers can exert pressure on companies to bring down the prices or to improve the quality of service for the same price, which will bring down the profits of the company.

Bargaining power of suppliers

 Number of vendors providing standardized products – (ex: Infrastructure, fiber optic cables, SIM cards etc.) Low

 Lack of talented sector specialist

Threat of Substitutes  Over the Top players such as viber, skype and WhatsApp are a threat to the telecom providers Medium  Companies are deprived of charging a higher price for the services that they offer as that will give space for customers to easily switch to another service provider who provide the same service at a lower price

Industry Rivalry  Sri Lanka’s mobile market is over crowded with 5 players offering services to 26.36 subscribers. High  In the telecom industry, choice is determined by price and service, which leads to increased competition among players.

Page | 28

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Appendix 3: Global Telecommunication Industry Outlook

The improving telecommunications infrastructure of a country is essential as it plays an important role in the fundamental operations of the society and thus connects people in rural areas or developing countries with the urban community or of developed nations. In this era of globalization, increasing numbers of businesses compete globally and every company assesses them with advanced nations to remain globally competitive.

It is estimated by the year 2020, 50Bn devices around the globe will be connected to the Internet and possibly one third of them will be computers, smartphones, tablets, and TVs and remaining two thirds will be sensors, newly invented intelligent devices that monitor, control, analyze, and optimize the world. Emerging of ‘Internet of Things’ (the interconnection via the Internet of computing devices embedded in everyday objects, enabling them to send and receive data) represents a transformative shift for the economies and opens new business opportunities for a variety of players. It is estimated that ‘Internet of Things’ would have a potential economic impact range from about US$2 trillion to more than $14 trillion by 2020. However, this will result in price of connecting with devices declining and the enabling devices, such as smartphones and tablets, becoming less expensive and more commanding.

Rapidly changing smartphones, tablets and devices have revolutionized OTT services (over-the-top). The OTT service providers deliver audio, video and other media over the internet and bypass the traditional operator’s network. An OTT service, “VoIP (Voice over IP) technology” has led smartphone users with underlying network to make free calls and send free text messages both locally and internationally. Internet TV (IPTV) is another OTT service, which is permitted to distribute videos and television content over the Internet. Hence, OTT services have invaded the traditional revenue field of telecom operators. According to Informa’s World Cellular Revenue Forecasts 2018, To combat the challenges telecom global annual SMS revenues will fall down from US$120 Bn in 2013 to US$96.7 operators face with the emerging OTT Bn by 2018, due to increasing adoption and use of Over-The-Top (OTT) services, operators should develop messaging applications. Therefore, it is important that telecom companies advanced connectivity services in order to defend their core networking find profit pools where their strengths can be utilized to face challenges and infrastructure business and created by OTT providers. To combat these challenges telecom operators can develop new applications and other services and offer them directly to develop advanced connectivity services in order to defend their core consumers. networking and infrastructure business and develop new applications and other services and offer them directly to consumers. Further consumers are rapidly learning the value of digitization through their experience in more advanced industries (e.g. Financial industry, healthcare, retail etc.) and they expect the same from their telecom operators. Therefore, it is important that telecom operators prove to their customers that they provide high quality, state-of-the-art, reliable communication services with expertise in security system.

Page | 29

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Appendix 4: Indications for Portfolio Construction

Correlation coefficient of monthly returns between DIAL and SLT over past 12 months is estimated as c.0.6

Monthly returns SLT DIAL 8% 6% 4% 2% 0% -2% 0 2 4 6 8 10 12 -4% -6% -8% -10% -12% Month Number

*Time period: June 2016-May 2017 Source: CSE, APSL Research

Reflecting room for efficient portfolio diversification, DIAL shows negative correlation with monthly returns of Dow Jones Industrial Average (DJIA) of US and relatively small positive correlation with the Nikkei Stock Average of Japan over past 12 months.

Correlation analysis of selected global indices:

Correlations DIAL ASPI DOW NIKKIE AUS ASX DIAL 1.0000 0.6076 (0.2344) 0.1637 0.608 ASPI 0.608 1.000 (0.0640) 0.380 0.192 DOW (0.234) (0.064) 1.000 0.312 0.577 NIKKEI 0.164 0.380 0.312 1.000 0.488 AUS ASX 0.608 0.192 0.577 0.488 1.000

*DOW: Dow Jones Industrial Average of US *NIKKEI: Nikkei 225 Stock Average of Japan *AUS ASX: The S&P/ASX of Australia

Source: investing.com, APSL Research

Page | 30

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Appendix 5: Comparison DIAL vs SLT: Key financial parameters

Revenue (LKR Bn) 100 DIAL records a substantially 80 higher income CAGR of c.11% cf.7% of SLT over FY12-16 60 40

20

- 2012 2013 2014 2015 2016

DIAL SLT

EBITDA (LKR Bn) 35 DIAL outperformed 30 SLT in EBITDA growth by 25 recording c.14% CAGR cf.4% of 20 SLT over FY12-16 15 10 5 - 2012 2013 2014 2015 2016

DIAL SLT

EAT (LKR Bn) 10.00 DIAL posted c.11% EAT CAGR over FY12-16, which is more than 8.00 twice of SLT’s EAT CAGR of c.5% 6.00

4.00

2.00

- 2012 2013 2014 2015 2016 DIAL SLT

Source: DIAL, SLT AR’s

Page | 31

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

20% ROE & ROA (%) Both DIAL and SLT shows a 18% strong relationship in terms 16% of ROE. However, SLT’s ROA 14% has declined substantially 12% over FY16. 10% 8% 6% 4% 2% 0% 2013 2014 2015 2016 ROE of DIAL ROE of SLT ROA of DIAL ROA of SLT

Both companies (DIAL vs Mobitel) recorded +8% YoY growths in mobile subscribers

14

12

10

8 10.9 11.8 6

4 5.9 6.4 2

0 2015 2016 Dialog Mobile Subscribers (Mn) SLT Mobitel Mobile Subscribers (Mn)

SLT (+55% YoY growth) outperformed DIAL (+29% YoY growth) in terms of DTV subscriber acquisition over FY15-16. However, DTV continues to manage the market leadership position in domestic Pay TV industry

900,000 800,000 700,000 600,000 838,000 500,000 650,000 400,000 300,000 200,000 100,000 174,278 269,458 - 2015 2016 SLT Peo TV Subscribers (No.s) Dialog TV Subscribers (No.s)

Source: DIAL, SLT AR’s

Page | 32

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Appendix 6: Financial Statements & Ratios

Summarized Statements of Comprehensive income

Re-stated/Pro forma SCI/LKR m 2015 2016 2017E 2018E 2019E Revenue 73,930 86,745 99,935 108,708 119,064 Direct costs excluding D&A (28,930) (32,978) (37,992) (40,765) (44,649) Gross profit 45,000 53,767 61,942 67,942 74,415 Distribution costs (10,838) (13,534) (15,990) (17,393) (19,050) Administrative costs (10,442) (11,097) (13,450) (14,269) (15,478) EBITDA 23,719 29,136 32,503 36,280 39,887 Depreciation & Amortization (14,255) (16,293) (19,561) (22,193) (24,538) EBIT 9,464 12,843 12,942 14,087 15,349 Finance income 485 367 359 216 177 Finance costs (3,244) (2,730) (3,133) (3,263) (3,369) Finance costs - net (2,759) (2,363) (2,773) (3,046) (3,192) EBT 6,705 10,480 10,169 11,041 12,157 Income tax expense (1,518) (1,517) (1,282) (1,393) (1,572) EAT 5,187 8,962 8,887 9,648 10,585

Summarized Statements of Cash Flows

Company Format SCF/LKR m 2017E 2018E 2019E Cash flows from operating activities Cash generated from operations 30,091 37,020 40,606 Tax paid (1,464) (1,327) (1,463) Employee benefits paid (79) (63) (63) Net cash generated from operating activities 28,548 35,630 39,080 Cash flows from investing activities Purchase of property, plant and equipment (29,253) (32,652) (27,921) Purchase of intangible assets (885) (973) (1,073) Net cash used in investing activities (30,138) (33,625) (28,994) Cash flows from financing activities Repayment of borrowings (7,872) (7,121) (7,352) Proceeds from borrowings 9,292 8,277 9,226 Dividends paid to ordinary shareholders (3,555) (3,859) (4,234) Net cash generated from/(used in) financing activities (2,135) (2,703) (2,360) Movement in cash and cash equivalents At start of the year 8,045 4,320 3,622 Increase/(decrease) (3,725) (698) 7,726 At end of the year 4,320 3,622 11,348

Page | 33

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Summarized Statements of Financial Position

Company format SFP/LKR m 2015 2016 2017E 2018E 2019E ASSETS Non-current assets Intangible assets 17,341 16,434 15,225 13,799 12,138 Property, plant and equipment 79,060 89,944 101,509 113,903 119,287 Investment in subsidiaries Investment in associates 80 72 72 72 72 Amount due from related companies - - Financial assets 40 40 40 40 40 96,522 106,490 116,846 127,814 131,537 Current assets Inventories 556 677 659 726 790 Trade and other receivables 12,780 17,142 23,172 25,207 27,608 Cash and cash equivalents 6,993 8,045 4,320 3,622 11,348 20,329 25,864 28,151 29,555 39,746 Total assets 116,851 132,354 144,997 157,369 171,283 EQUITY Capital and reserves attributable to equity holders Stated capital 28,104 28,104 28,104 28,104 28,104 Reserves 19,214 25,903 31,235 37,023 43,375 Non-controlling interest (0.70) 14.42 14 14 14 Total equity 47,317 54,021 59,353 65,142 71,493 LIABILITIES Non-current liabilities Borrowings 15,943 26,313 28,485 29,409 30,909 Derivative financial instruments 25 15 15 15 15 Deferred revenue 1,723 1,658 1,658 1,658 1,658 Deferred income tax liabilities 53 0 - - - Employee benefit payables 1,509 1,373 1,528 1,720 1,941 Provision for other liabilities 1,147 1,310 1,310 1,310 1,310 20,400 30,668 32,994 34,111 35,831 Current liabilities Trade and other payables 38,891 38,920 44,838 50,005 55,365 Borrowings 9,464 7,872 7,121 7,352 7,727 Derivative financial instruments 12 16 16 16 16 Current income tax liabilities 766 858 675 742 851 49,134 47,666 52,650 58,115 63,959 Total liabilities 69,534 78,333 85,644 92,227 99,790 Total equity and liabilities 116,851 132,354 144,997 157,369 171,283 NAVPS LKR 5.81 6.63 7.29 8.00 8.78

Page | 34

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Key Summary Ratios

FY 2015 2016 2017E 2018E 2019E Market Market price LKR 11.38 10.75 14.33 14.33 14.33 EPS LKR 0.64 1.11 1.09 1.18 1.30 DPS LKR 0.32 0.39 0.44 0.47 0.52 Net assets value per share LKR 5.81 6.63 7.29 8.00 8.78 Capital Gain 6.5% -5.5% 33.3% 0.0% 0.0% Dividend yield 2.8% 3.6% 3.0% 3.3% 3.6% Earnings yield 5.6% 10.3% 7.6% 8.3% 9.1% Total Annualized Return 9.3% -1.9% 36.3% 3.3% 3.6% Price Earnings (x) 17.78 9.68 13.13 12.09 11.02 Price-to-book value (x) 1.96 1.62 1.97 1.79 1.63 Payout 50% 35% 0.4 0.4 0.4 EV/EBITDA (x) 4.4 3.8 4.7 4.2 3.8 Business Risk Degree of operating leverage 199% 206% 5% 101% 94% Profitability ROE 11% 18% 16% 15% 15% ROA 6% 9% 8% 8% 8% GP margin 61% 62% 62% 63% 63% Expenses ratio 29% 28% 29% 29% 29% EBITDA margin 32% 34% 33% 33% 34% EBIT Margin 13% 15% 13% 13% 13% Net profit margin 7% 10% 9% 9% 9% Liquidity Current (x) 0.41 0.54 0.53 0.51 0.62 Quick assets (x) 0.40 0.53 0.52 0.50 0.61 Solvency Debt-to-Equity 54% 63% 60% 56% 54% Debt-to-assets 22% 26% 25% 23% 23% Equity multiplier (x) 2.47 2.45 2.44 2.42 2.40 Interest cover(x) 2.92 4.70 4.13 4.32 4.56 Dividend cover (x) 2.00 2.85 2.50 2.50 2.50 Financial Risk Degree of financial leverage -80% 206% -218% 97% 109% Combined leverage -160% 424% -11% 97% 102% Efficiency Total asset turnover (x) 0.65 0.70 0.72 0.72 0.72 Debtors' turnover (x) 5.68 5.80 4.96 4.49 4.51 Debtors' collection period (days) 62.95 73.62 81.22 80.95 Creditors' turnover (x) 0.81 0.85 0.91 0.86 0.85 Creditors' payment period (days) 430.61 402.34 424.60 430.69

Page | 35

ASHA PHILLIP INSTITUTIONAL EQUITY RESEARCH SECURITIES LTDSRI LANKA

Contact Information

Head Office

Sales Thakshila Hulangamuwa [email protected] +94 11 2429108 Upul Priyantha [email protected] +94 11 2429106 Shanmugam Sudhagar [email protected] +94 11 2429107 Vasantha Wicramasinghe [email protected] +94 11 2429114

Research Visahan Arumainayaham [email protected] +94112429139 Nishani Ruwanpathirana [email protected] +94 112429137 Sandun Kulathunga [email protected] +94 112429129

Regional Offices

Colombo (H/O) Matara Jaffna # 321, Lakshmans Building, 2nd Floor, #24-1/3A, #147, 2/3 Galle Road, Colombo 03. E.H. Cooray Tower, 2nd K.K.S. Road, Tel - 94 112429100 Floor, Jaffna. Fax - 94 112429199 Anagarika Dharmapala Tel: 021 2221614 www.ashaphillip.net Mw, Email - [email protected] Matara. Tel: 041 2235191-5

Kiribathgoda Embilipitiya Kandy

#94, Udeshi City Shopping Complex, #62, # 88, Ceybank House,

2nd Floor, #2/12, Makola Road, Building, Dalada Vidiya,

Kiribathgoda. Main Street, Kandy. Tel. 011 2908511 Embilipitiya. Tel. 081 2204750 Tel. 047 2261950 Anuradhapura Negombo Gampaha # 2nd floor,488/8/2, #72 A 2/1, #107, Town hall place, Old Chilaw Road, Sanasa Ideal Complex, Maithreepala senanayaka mawatha, Negombo. Bauddhaloka Mawatha, Anuradhapura Tel. 031 2227474 Gampaha. Tel. 025 2234705 Tel. 033 2234888

Important Information This document has been prepared and issued by Asha Phillip Securities Ltd, on the basis of publicly available information, internally developed data and other sources, believed to be reliable. Whilst all responsible care has been taken to ensure that the facts stated are accurate and the opinions given are fair and reasonable neither Asha Phillip Securities Ltd, nor any Director Officer or employee, shall in any way be responsible for any decisions made on its contents. Asha Phillip Securities Ltd may act as a Broker in the investments which are the subject of this document or related investments and may have acted upon or used the information contained in this document, or the research or analysis on which it is based, before its publication. Asha Phillip Securities Ltd., Its Directors, Officers or Employees may also have a position or be otherwise interested in the investments referred to in this document. This is not an offer to sell or buy the investments referred to in this document.

Page | 36