challenging year ahead

THIS REPORT WAS PREPARED BY MICHAEL TANJUNG, A MASTERS IN FINANCE STUDENT OF THE NOVA SCHOOL OF BUSINESS AND

ECONOMICS, EXCLUSIVELY FOR ACADEMIC PURPOSES. THIS REPORT WAS SUPERVISED BY ROSÁRIO ANDRÉ WHO REVIEWED THE

VALUATION METHODOLOGY AND THE FINANCIAL MODEL. (SEE DISCLOSURES AND DISCLAIMERS AT END OF DOCUMENT)

See more information at WWW.NOVASBE.PT /36

MASTERS IN FINANCE

EQUITY RESEARCH

We initiate coverage of Telkom with BUY

recommendation and a price target of 2,550 IDR, offering an

upside potential of 20%. The stock currently trades at a P/E ratio of

14.15 – a 30% discount to the telecommunication sector.

Risk factors. Firstly, we foresee XL-AXIS merger and

acquisition to be the game changer for the Indonesian cellular market.

Ultimately, by retaining Axis’ spectrum, XL’s network bandwidth is now

on par with Telkomsel. Secondly, inevitable pricing compression

caused by fierce competition in the cellular market would eventually

result in Telkomsel lower margin.

Segments development. We expect the continuingly fixed-to-

mobile substitution effect to further penalize fixed-line voice sector. As

for the fixed-broadband segment, rapidly growing middle class

population, rising household consumption and incremental number of

new enterprises created every year would provide a solid platform for

robust growth. Mobile broadband will be the new growth engine

fuelled by Indonesian young population, and growing urban

population, which subsequently promotes higher penetration of

advance telecommunication gadget such as smartphone and tablet.

In spite of fierce competition in the cellular market,

Telkomsel’s persistently strong cash flow derived from its large

business scale and superior operational efficiency will enable the

company to preserve its superior network quality and market share.

Company description

Telkom is the largest and most integrated telecommunication service provider in Indonesia, providing fixed wireline, fixed wireless, cellular, data and Internet services to over 90% of Indonesian population.

PT. TELEKOMUNIKASI INDONESIA COMPANY REPORT

TELECOM 06 JANUARY 2014

STUDENT: MICHAEL TANJUNG [email protected]

Challenging Year Ahead

…yet to be conquered

Recommendation: BUY

Price Target FY11: 2,550 IDR

Price (as of 6-Jan-14) 2,125 IDR

Reuters: TLKM.JK, Bloomberg: TLKM IJ

52-week range (IDR) 1,751-2,566 IDR

Market Cap (trillion IDR) 214.2

Outstanding Shares (B) 100.8

Free float (B) 49.2

Source: Bloomberg

Source: Bloomberg

(Values in Rp billions) 2012A 2013E 2014F

Revenues 77,143 83,145 89,027

EBITDA 39,757 42,987 45,742

Net Profit 12,850 14,172 15,137

EPS 127 141 150

EV/Sales 3.4 3.1 2.9

EV/EBITDA 6.2 5.8 5.5

EV/Subscribers 1.7 1.7 1.7

Net (Debt)Cash/EV -1.6% 0.6% -0.1%

ROIC 30% 30% 28%

Source: Analyst’s Estimates, Company Reports

speralta

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PAGE 2/36

Table of Content

COMPANY OVERVIEW ............................................................................ 3

VALUATION METHODOLOGY................................................................. 4

MACROECONOMIC OUTLOOK ............................................................... 5

FIXED LINE BUSINESS ............................................................................ 6

FIXED-LINE VOICE – THE INEVITABLE DECLINE ..................................................... 6 FIXED WIRELESS ACCESS VOICE – THE END IS NEAR............................................. 8 FIXED BROADBAND – DECENT GROWTH POTENTIAL .............................................. 9

CELLULAR BUSINESS .......................................................................... 11

VOICE USAGE AND TARIFF .................................................................................. 16 SMS .................................................................................................................... 16 MOBILE BROADBAND “FLASH” – THE FUTURE GROWTH ENGINE ......................... 17 INTERCONNECTION .............................................................................................. 21

OPERATING COST MARGIN AND INVESTMENTS .............................. 21

FIXED BUSINESS MARGIN ................................................................................... 22 CELLULAR BUSINESS MARGIN ............................................................................ 23 FIXED LINE INVESTMENTS ................................................................................... 24 CELLULAR INVESTMENTS .................................................................................... 24 FOREX RISKS ON INVESTMENTS ........................................................................ 25

CAPITAL STRUCTURE AND COST OF CAPITAL ................................. 26

FINAL VALUATION CONSIDERATIONS ............................................... 27

APPENDIX I – FINANCIALS ................................................................... 28

APPENDIX II – ADDITIONAL SCENARIO ANALYSIS ........................... 29

APPENDIX III – INDONESIAN MOBILE OPERATORS .......................... 31

APPENDIX IV – BROADBAND TARIFF COMPARISON ........................ 31

APPENDIX V – SPECTRUM AND 3G BAND PLAN ............................... 32

APPENDIX VI – BTS FORECAST .......................................................... 33

APPENDIX VII – FOREX RISK ON INVESTMENTS ............................... 34

APPENDIX VII – COMPARABLES ......................................................... 34

DISCLOSURES AND DISCLAIMER .......................................................................... 35 RESEARCH RECOMMENDATIONS ....................................................................... 36


PAGE 3/36

Source: Bloomberg

Graph 2 – 2012 Shareholder Structure

Graph 1 – 2012 Telkom Revenues Contribution by Segments

Company overview

PT. Telekomunikasi Indonesia (Telkom) is the largest and most integrated

telecommunication company (telco) in Indonesia. Telkom’s source of value creation

is wholly derived from its domestic telecommunication businesses including fixed

line and fixed wireless telephone connections, mobile cellular communications,

network and interconnection services, and data communication services. Telkom still

enjoys monopoly in the fixed line telephone segment; notwithstanding, we see an

inevitable declining demand for fixed-based voice services due to continuing fixed-

to-mobile substitution effect. Telkom is currently a leading player in the fixed-

broadband sector with 78% market share; fixed-broadband market has been

growing significantly with rising middle class population; we see a tremendous

growth opportunity for the upcoming terms. Through its subsidiary, Telkomsel1,

Telkom provides cellular connectivity that covers more than 97% of the Indonesian

population. Telkomsel has the largest subscribers’ base amounted to 44% market

share in 2012; nevertheless, a recently merged XL-Axis (XL:IJ) would definitely

challenge its dominance. As of December 2012, Telkomsel revenues contribution

totalled to 71%.

Still a State Owned Enterprise

Telkom is a State-Owned Enterprise (SOE) as government owns more than 50% of

all shares outstanding. The remaining shares are listed on the Indonesia Stock

Exchange, NYSE and LSE. Bank of New York Mello Corporation serves as the

Depository of registered American Depository Shares (ADS) holders for the

Company’s ADSs2. Table 1 below presents other top holders;

Table 1 - Institutional Shareholders as of December 2013

Top 10 Holders % ownership

Vanguard Group Inc 1.44%

Blackrock Fund Advisors 0.85% JPM 0.76%

Invesco LTD 0.65%

Fidelity International 0.57%

Norges Bank 0.56%

Matthews International Capital 0.47%

Pictet Asset Management Ltd 0.46%

Grantham Mayo van Otterloo & Co 0.35%

SchroderInvestment Management Ltd 0.32% Total 6.43%

1 Telkom assumes control of Telkomsel with 65% ownership, the remaining 35% belonged to Singapore Telecom (ST:SP)

2 As of September 30, 2013, 45,765,152 ADS shares were listed on the NYSE and LSE. Following the 1-for-5 stock split

(approved on April 19, 2013), each ADS represented 200 common shares.

Source: 2012 Annual Report

Source: 2012 Annual Report


PAGE 4/36

Unit: billion IDR, unless stated otherwise | Source: Analyst’s Estimates, Bloomberg, Company Reports

Valuation Methodology

We used a sum of parts (SOP) approach to arrive at the final equity value. Fixed and

cellular business segments were valued separately using Discounted Cash Flow

(DCF) model. Net debt/cash was derived by deducting excess cash (book value)

from market value (MV) of debt. Obligations to employee and other non-equity items

were obtained from their book value (BV). We have reached a price target of 2,586

IDR, implying an upside potential of 19%.

We have incorporated various scenarios that could impact our initial cash flow

forecast, and the respective price target. The probability attributed to each scenario

analysis is solely our view on current market situation.

Following table summarizes our valuation;

Table 2 - Summary of Telkom Valuation

Stake Method Base Case Scenarios

Best Case Scenarios

Indonesia Economy to Erode Further

Weighted Value

p = 50% p = 30% p = 20%

Cellular business value 65% DCF 206,907 267,374 121,627

Fixed business value 100% DCF 52,575 58,860 36,204

Enterprise Value 259,482 326,234 157,831

Net cash (debt) - MV (167) 53 (2,526)

Obligations to employee - BV (2,314) (2,314) (2,314)

Non-equity items - BV 480 480 480

Equity Value - - 257,481 324,453 153,471 256,771

# Oustanding Shares (B) - - 100.8 100.8 100.8 100.8

Price Target - - 2,554 3,219 1,523 2,547

Current Price - - 2,125 2,125 2,125 2,125

Implied Upside Potential - - 20% 51% -28% 20%


PAGE 5/36

Units: trillion IDR | Source: IMF

Graph 4 – Indonesia GDP Growth YoY Graph 5 – Indonesia Domestic Interest Rate and Inflation

Macroeconomic Outlook

Indonesian economy has been contracting recently; IMF revised GDP growth down

to 5.3% in September 2013 from previously 6.3% in April 2013, but expecting slight

recovery to happen in 2014.

Table 3 – Indonesia GDP Forecast (Constant Price)

2008 2009 2010 2011 2012 2013E 2014F 2015F 2016F 2017F 2018F

GDP 2,082 2,179 2,314 2,465 2,618 2,757 2,908 3,083 3,268 3,464 3,672

% growth 6.0% 4.6% 6.2% 6.5% 6.2% 5.3% 5.5% 6.0% 6.0% 6.0% 6.0%

We are informed that the revision was triggered by recently high inflation3 that forced

Bank Indonesia (BI) to continuingly raising interest rate, which in turn had slowed the

overall economy growth due to higher borrowing cost (reduces economic activity)

and higher saving rate (reduces consumption as people tend to save instead).

Furthermore, BI rate is expected to be escalating further4 until the inflation rate ease

back to the target level of 4%-5%, which means growth would continue being

penalized in 2014, at the very least.

Other various macroeconomic and demographic indicators will certainly steer our

cash flow forecast; nevertheless, their relevance may differ per business segment,

as such we will cover them specifically and separately for each business segment.

3 As seen in graph 5, Indonesian inflation rate has been very volatile which was mostly caused by large amount of

government subsidy on basic needs like food, fuel and electricity. Early this year government reduced subsidy on fuel and let the price of gasoline and diesel inflated by 44% and 22% respectively (to 6,500 IDR and 5,500 IDR per litre); this had directly and swiftly caused a huge jump in inflation rate, as basic needs such as transportation, for instance, became more expensive and led to higher end-products or services (due to higher logistic costs). World Bank estimates that raw and core inflation would rise approximately by 300bps and 100 bps respectively when fuel prices increased by 2,000 IDR. 4 We are also informed that Indonesia’s large current account deficit has caused loss of confidence from foreign investors

who started pulling their money out of the country in anticipation of the approaching FED tapering. Besides to control inflation, higher interest rate is also perceived as an incentive for foreign funds to remain intact. Additionally, Rupiah would remain vulnerable as account deficit has showed no meaningful improvement lately, and thus high inflation would likely to persist longer; we see this as a downside risk to our initial earnings estimates; we discuss this further under Additional Scenario Analysis section.

Source: Badan Pusat Statistik Indonesia

Source: Bank Indonesia (BI)


PAGE 6/36

Graph 6 – Total Minutes Productions from Fixed-Line Voice (LHS) Vs. Cellular Voice (RHS) Services

Graph 7 – 2012 Fixed-line Voice Penetration Rates per 100 Households

(Average: 33)

Units: # households | Source: ITU, Analyst’s Estimates

Fixed Line Business

Fixed-line Voice – the inevitable decline

Telkom fixed-line telephone service is no other than the plain old telephone service.

This fixed-line telephone service includes local, direct long-distance (DLD) and

international call service. Telkom still enjoys monopoly in this segment with 99%

market share; because of an inevitable decline of the sector growth and

subsequently low potential of value creation, fixed-line telephone segment seems to

attract no new entrants. For the last 5 years, this sector has suffered from fixed-to-

mobile substitution effect. The overall decreased in total minutes production implies

that minutes production per lines in service (LIS)5 has decreased by roughly 1,700

minutes in 2008 to only 755 minutes in 2012. As seen in table 4, fixed-line voice

revenue contribution has shrunk considerably;

Table 4 – Telkom Fixed-line Voice Subscribers and Revenues Evolution

2007 A 2008 A 2009 A 2010 A 2011 A 2012 A 2013 E 5y-CAGR

Lines in service (millions lines) 8.7 8.6 8.4 8.3 8.6 9.0 9.4 2%

Fixed-line voice revenues 18,021 15,878 10,289 9,453 9,833 8,818 9,016 -11%

growth -12% -35% -8% 4% -10% 2%

Voice ARPU6 (thousand IDR) 173 152 102 95 95 81 79 -12%

Note that ARPU includes fixed monthly subscription charges and usage charges,

which the latter contributes disproportionately larger. Persistently declining ARPU is

in fact a result of lower usage per LIS, conversely the implied price per minute7 has

actually increased from 1,119 IDR in 2008 to 1,297 IDR in 2012. At this rate, fixed

voice service is actually charging much higher than cellular voice service (of only

166 IDR8 per minute), adding another reason why people tend to use their cell-

phones nowadays.

Despite the substitution effect aforementioned, we believe that low penetration rate

in the fixed-line telephone sector (refer to graph 7) would still provide little room for

growth, and that the essentialness of basic telephony would drive penetration higher

in the future. In fact, we see a slight pickup in LIS in 2011 after the cellular

penetration rate surpassed 100% mark in late 2010, whilst utilization rate has been

rising from 78% to 81% and 82% in 2012 and 2013 respectively (refer to graph 8).

5 We refer subscribers in the fixed-line telephone sector as LIS

6 Average revenue per user (ARPU) is calculated based on total voice revenues per month divided by total LIS

7 Price per minute is calculated by dividing voice revenues by total minutes production

8 This amount is calculated based on 2012 cellular voice revenues and total cellular minutes production (including free

minutes). Lower price per minute seen in cellular voice services is due to excessive promotions (free calls) caused by intense competition in the mobile market. We discuss further under Cellular Business section.

Units (revenues): billion IDR | Source: Company Reports

Units: billion minutes | Source: Company reports


PAGE 7/36

Graph 8 – Number of Lines in Service, Installed Lines (LHS) and Utilization Rate (RHS)

Units: million lines | Source: Company Reports, Analyst’s’ Estimates

Graph 9 – Voice ARPU Forecast

Units: trillion IDR and thousand IDR (ARPU) | Source: Analyst’s estimates

Since the fixed-line telephone penetration is still concentrated in big cities and urban

area9, we assume that Telkom would continue adding new lines with intention to

drive penetration in the sub-urban or rural area higher. Nevertheless, we foresee the

additional lines to grow at a slower pace than 3% CAGR verified from 2004-2013,

with priority set to utilize lines back to 90% level10

.

Provided the expected additional installed lines for the upcoming terms, we could

then infer the incremental LIS by estimating utilization rate in the future of which is to

converge towards 90% rate. The following table presents our forecast summary for

the next 5 years;

Table 5 – Fixed-line Telephone Forecast

2012A 2013 E 2014 F 2015 F 2016 F 2017 F 2018 F CAGR

Installed lines 11,109 11,498 11,555 11,613 11,671 11,810 11,956 1%

Lines in service 9,034 9,474 9,712 9,956 10,206 10,534 10,808 3%

Utilization rate 81% 82% 84% 86% 87% 89% 90%

Our estimation implies a growing subscribers’ base (LIS) at CAGR of 3%11

, still

lower than 4.5% CAGR yielded during 2010-2013.

In what regards the ARPU, we expect the downtrend would continue in near

future12

as we are still convinced that the fixed-line usage will decline further due to

voice-to-data substitution effect. Over the top VoIP application such as Skype has

become more popular and been used globally, not only for home-personal use, but

also professionally, such as on-line meeting, job interview and university admission

interview. Moreover, currently low penetration in the broadband sector coupled with

substantial growth potential would surely affect Telkom

legacy business including local, DLD and international call

services; as such we believe that the fixed-line usage would

still plummet in the foreseeable future.

As for the longer timeframe, we expect fixed-mobile/voice-

data substitution effect to start lessening, and the respective

usage per LIS to find the equilibrium and stop decreasing;

and therefore ARPU would rise due to a higher unit price13

.

9 Yet we could not infer precisely how many cities are currently covered by Telkom and which cities are still to be covered, as

the information in that regards is not disclosed. 10

Telkom has indicated that CAPEX related to fixed-line business would be mostly allocated to the fixed-broadband network

development, thus it would be reasonable to assume slower expansion in the fixed-line telephone. 11

At this rate, we implicitly expect fixed-line telephone penetration rate to reach 33% mark (or equal to current APAC

average) in the next 20 years. 12

We are still convinced that fixed-line usage would still decline in near future due to voice-data substitution (we discuss this

issue in greater detail under Cellular Business section). 13

Bear in mind that ARPU is a function of usage (minutes production/user) and unit prices (price per minute). Though usage

is presumed to be constant over time, a rising unit price would still result in higher ARPU. We use expected inflation as proxy.

Source: Company reports, Analysts’ estimates | Units: thousand lines


PAGE 8/36

Graph 13 – Flexi Revenues Contribution

Graph 10 – FWA Telephone Market Share Evolution over the Last 7 Years

Source: Company reports, Analysts’ estimates

Graph 11 – Indonesia FWA Subscribers’ Base Trend

Graph 12 – 2013 Flexi Subscribers Base

Contraction

Units: million users | Source: Telkom Q3 2013 info memo

Graph 14 – ARPU Trend of Flexi and Esia

Fixed Wireless Access Voice – the end is near

Telkom’s fixed wireless access (FWA) voice service is managed by the Wireless

Broadband Division under the trademarks “Telkom Flexi” or “Flexi” and uses CDMA-

base network technology.

As of December 2012, Flexi and Esia14

are the main operators in the sector with the

subscribers’ base totalled to more than 97% market

share when combined, see graph 10.

As also seen in the fixed-line telephone, threat of

substitute is even greater in the FWA voice sector.

New tariff regulation15

has turned the differences

between FWA and GSM mobile cellular tariff

immaterial. Moreover, the ever-fiercer competition in

the GSM cellular market has provoked lower tariff

charged by the GSM-based operators16

. Apparently

with similar cost of usage, customers would rather

have GSM-based mobile phone as it provides more

features and richer application experiences. Altogether these circumstances

promote migration to a full mobile GSM service. As seen in graph 11, the FWA voice

market has finally taken a massive hit this year after peaked earlier in 2010; the

overall subscribers’ base plummeted by more than 40%.

Flexi has suffered the worst from pricing compression, as it has been giving

excessive promotions17

in order to maintain its

subscribers’ base size, see graph 14 and 10; Esia on

the other side has kept ARPU above 20 thousand

IDR, yet lost more than 20% of subscribers in 2012

alone. Flexi’s revenue contribution has shrunk

remarkably since 2009; and we estimate its revenues

to be just under 1,000 billion IDR for FY13 following

the 9M-2013 results released. In that same period,

Flexi lost more than 30% of its subscribers, refer to

graph 12.

14

Esia is another FWA voice services provider operated by Bakrie Telecom (BTEL) 15

The government altered the regulation relating to the calculation of right-of-use tariff in December 2010, resulting in a

significantly smaller gap between GSM and CDMA tariff. 16

As of December 2013, average price of voice service charged by FWA provider is 1,666 IDR per minute, which is very

close to GSM-based operators’ average tariff per minute of less than 1,799 IDR. Price already includes interconnection cost. Source: Operators’ website. 17

Free minutes derived from promotions surely put pressure on ARPU, as unit price decreases while usage is not necessarily

increased.

Units: billion IDR | Source: Company reports, Analysts’ estimates

Units: million users | Source: ITU, Analyst’s estimates

Units: thousand IDR | Source: Company reports


PAGE 9/36

Graph 15 – Flexi Subscribers and ARPU Forecast

Graph 16 – 2012 Asia Pacific GDP per Capita PPP constant US$

Graph 17 – Fixed Broadband Penetration per 100 Households

Graph 18 – Speedy Market Share Evolution

According to the CFO, Mr Honesti Basyir, Telkom intends to gradually withdraw

FWA voice services over the next two or three years. We see this as an appropriate

move by the management; as spectrum becomes a scarce national resource, 10

MHz spectrum blocks on 850 MHz18

frequency used by Flexi can be returned and

re-used by Telkomsel to provide a lower-end and cheaper data service19

.

To conclude, we forecast Flexi’s subscriber to continue declining sharply for the next

2-3 years, afterwards the service is presumed terminated. ARPU is expected to rise

as we assume Flexi would start reducing promotions (free calls), and thus unit price

would eventually converge to market price.

Fixed Broadband – decent growth potential

Telkom provides fixed-line based broadband internet access using ADSL and fiber

optic technology under the brand “Speedy”. Fixed broadband is still perceived as a

premium need in Indonesia, and rather explains

low broadband penetration in the country that has

lower GDP per capita than most of its Asia Pacific

(APAC) peers. Looking further into the penetration

rate, we are left with more questions; as seen in

graph 16 and 17 consecutively, Vietnam, India,

and Phillipines has higher broadband penetration

rate than Indonesia despite their lower production

per capita. What might be the setback for

Indonesia, besides its rather challenging

geography condition? Following is our best guess;

Indonesian customers have fewer fixed-broadband service choices and incur higher

prices as the fixed-broadband sector is lack of operators and therefore experiences

less efficient competition; in fact, Speedy holds 78% market share in Indonesia (as

per December 2012). Unit price for 1 Megabit per second (Mbps) is comparatively

much higher in Indonesia, yet the average speed of fixed-broadband internet

connection is not truly superior to the available connection speed provided by the

mobile broadband services, of which is accessible with a lower cost, see graph 1920

.

Thus, it is no surprise that fixed-broadband penetration is rather limited in Indonesia.

18

CDMA-base operators currently use 850 MHz frequency band to provide voice and data services, whilst GSM-3G use

2,100 MHz frequency. 19

Spectrum license for providing telecommunication services through 850 MHz frequency is priced much cheaper than the

2,100 MHz used for 3G, the associate radio usage charges are also lower, thus allowing Telkomsel to provide cheaper data-service for the lower-end market. This way Telkomsel would have more flexibility to maintain its premium services and prices without putting more pressure on its operating margin. If executed rightfully, Telkom would be able to create additional value in the long run through its more efficient spectrum management. 20

The data presented is the actual speed. In practice, operators claim 7.2 Mbps for their 3G connection download speed.

Moreover, the average mobile broadband cost per Mbps is lower than 5 US$. Notwithstanding, fixed broadband still has an advantage of higher capacity of usage and a more reliable internet connection. See appendix IV for tariff comparison.

Units: million users (Subs.) and thousand IDR (ARPU) | Source: Company Reports, Analyst’s Estimates

Units: # households | Source: ITU, Analyst’s estimates

Source: World Bank

Source: ITU, Company Reports


PAGE 10/36

Graph 19 –Indonesia Broadband Speed Comparison

Units: Megabit per second (Mbps) | Source: ITU, Ookla

Graph 20 –Fixed Broadband Subscriptions in Indonesia

Graph 23 – Decreasing cost to start a business, and increasing number of new

business registered every year

Graph 21 – Indonesia Households Consumption Expenditure

Table 6 - 2013 Fixed Broadband Comparison Matrix

Vietnam India Indonesia Thailand China APAC Europe

# Operators21

6 9 3 20 5 - -

Cost per Mbps (US$)22

13.72 11.00 25.72 2.48 2.25 9.29 3.60

Cost of Broadband (US$) - 19.49 42.50 30.25 27.03 - -

As % GDP/capita - 23% 22.7% 8.98% 9.93% - -

Household Download Index (Mbps)23

13.18 4.22 3.36 12.96 15.99 17.23 22.11

Despite the aforementioned hindrance, we believe that

low penetration rate would still provide decent growth

opportunity for Telkom Speedy in the future.

We expect the subscribers’ base to grow at slightly

lower rate in 2014 than seen in 2012-2013 amid

recent economy contraction aforementioned under

Macroeconomic Outlook section24

. As for the longer

run, it would be reasonable to forecast stronger growth

provided a solid platform formed by rapidly growing

middle class population, firm economy growth and

growing number of new enterprises created every year (refer to graph 22 and 23).

Additionally, household consumption has also been increasing exponentially, which

signals growing demands for premium products/services.

21

This indicator aims to explain bargaining power of buyer, more number of operators implies that customers have more

choices and that competition is presumably more efficient resulting in generally lower prices. Though may be not entirely true, but the fact that Speedy holds more than 75% market share, which results in high market concentration, customers are therefore inferred low bargaining power. 22

Cost per Mbps measures the median cost charged by the provider for 1 Mbps. Indonesia is among the highest by a far

margin. 23

Household download index measures average download speed per broadband connection. Additional information,

European countries’ average download speed is above 20Mbps. 24

Recently high inflation that is expected to persist until mid-2014 would really penalize customers’ purchasing power; as

such we expect their spending behavior would be shifted towards premier needs, such as food, transportation, etc.; thus available income for premium needs would be reduced, and premium products or services, including fixed-broadband service would surely be less attractive.

Source: ITU, Ookla, Companies’ Websites

Units: thousand subscribers | Source: ITU

Graph 22 – Percentage of Household with Disposable Income Larger than 15,000 USD

and 25,000 USD

Source: Euromonitor Source: World Bank Units: billion USD | Source: World Bank

CAGR 32.5%


PAGE 11/36

Units: billion IDR (revenues) and thousands IDR (ARPU) | Source: Company Reports, Bloomberg

Graph 24 – Speedy Subscribers and ARPU Forecast

Units: thousand subscribers and thousand IDR (ARPU) | Source: Analyst’s estimates

Table 7 - Speedy Subscribers and Monthly ARPU (last 5 years)

2009 2010 2011 2012 2013 E CAGR

Subscribers (000) 1,145 1,649 1,789 2,341 3,114 28%

% growth 78% 44% 8% 31% 33%

Broadband Revenues 5,339 7,069 7,484 7,980 8,382 12%

Broadband ARPU 389 357 349 284 224 -13%

Telkom had introduced “Speedy Instant” or pre-paid subscription25

that provides

more flexibility to subscribers, which explains significant ARPU declined in 2012 and

2013, yet the impact on the overall revenue was being offset by the strong growth of

the subscribers’ base, refer to table 7 - Broadband ARPU.

Telkom has recently engaged in fiber network roll-out26

, and we foresee the better

technology27

would facilitate the demand for larger data capacity and faster

connection; we shall later see a clear distinction between mobile and fixed

broadband in terms of speed and capacity.

We forecast Speedy subscribers’ base to continue growing at CAGR of 30% for the

next 2-3 years, and of 10% thereafter. Our perpetuity growth estimation implies that

fixed broadband subscriptions in Indonesia would reach 50% penetration rate in

approximately 2028

years from today.

In what concerns ARPU, we expect the declining trend to continue in the future due

to increasingly growing number of pre-paid subscribers29

and the fact that Telkom is

already charging higher unit price than its APAC peers average, we foresee a

gradually declining tariff30

.

25

Pre-paid subscribers are being charged the same initial amount for equipment (including modem) installation. The monthly

charge will be then accumulated according to their monthly usage. 26

We could not infer how many households were actually under FTTH subscriptions. Telkom only disclosed in its reports that

it had roughly 5 million homepass capacity in 2012 and aimed to reach 15 million by 2015. 27

Telkom is upgrading their old copper network with fiber to the home (FTTH), thus we expect higher speed and capacity to

be delivered in the future. 28

We assume that the average persons of approximately 4 per household will not change in the future, and the population

will continue growing at CAGR of around 1% in the long run-as projected by the IMF. 29

Pre-paid subscribers tend to have control over their own expenditure by simply limiting the usages, hence implying a rather

lower ARPU. 30

It would be reasonable to see lower tariff in the future driven by the regulator (as was seen in cellular market couple years

ago), assuming lower tariff would induce higher broadband penetration.


PAGE 12/36

Source: Analyst’s estimates, Company reports

Graph 27 – 2012 Asia Pacific Cellular Penetration per 100 Inhabitants

Units: million users | Source: ITU

Graph 28 – Average Price for a Prepaid Starter Pack

Units: US$ | Source: Company Websites

Cellular Business

Over the past years, mobile cellular market has overshadowed other

telecommunication services sectors in Indonesia; and with subscribers’ base totalled

to more than 280 million in 2012, it has become the fourth largest cellular market in

the world31

.

According to the Indonesian Telecommunications Regulatory Authority (BRTI), it is

common that a single user owns more than one mobile phone and holds 2-3 active

SIM cards with reason to get the best network quality (higher-end user) or cheapest

price (lower-end user) available. We see this as an opportunity for continuing growth

being sustained in near terms. As such, we forecast Indonesian cellular subscribers’

base to continue increasing at CAGR of 4% (lower than 6% yielded in 2012-2013)

for the next 3 years, and of 1% in perpetuity32

.

Indonesian cellular market is characterised with high churn rate and highly

disproportionate number of prepaid subscribers (refer to graph 30). In fact, we also

see a correlation between low GDP per capita and high number of pre-paid

subscribers. We believe that a cheap prepaid-starter-pack (refer to graph 28)

coupled with limited financial means to commit for a post-paid plan explains why

Indonesian cellular market is flooded by pre-paid subscribers. This also partly

explicates low cellular average revenue per user (ARPU)33

seen in Indonesian

cellular market.

Graph 29 displays ARPU evolution relatives to GDP per capita, which seems, has

reached the equilibrium (of around 2%-2.5%). We assume similar pattern to hold in

31

Top 5 global mobile markets by number of subscribers (2012); China (1,112 million users), India (865 million users), USA

(303 million users), Indonesia (282 million users), Brazil (248 million users). Source: ITU 32

We look into Bloomberg (Bloomberg Industry – Telco Asia Pacific) forecast for Asia Pacific mobile sector growth of 7%

CAGR as proxy; since the forecast made by Bloomberg includes China and India – of which their cellular penetration rate is still below average, it would be reasonable to forecast a slower growth for Indonesia. As for perpetuity, we expect the subscribers base to increase with population; population is projected to grow at CAGR of 1% by World Bank.s 33

Bear in mind that pre-paid subscribers have greater control over their own cellular service expenditure by limiting usage.

Generally pre-paid ARPU will be much lower than post-paid ARPU.

Graph 25 – Cellular Revenues Contribution throughout the Years

Units: # users | Source: ITU

Graph 26 – Cellular Subscriptions in Indonesia

CAGR 16%


PAGE 13/36

Graph 31 – Indonesian Cellular

Market Share Evolution

Graph 29 – ARPU to GDP per Capita Comparison Graph 30 – Churn Rate vs. Prepaid Subscribers (as % of

total cellular subscribers)

Graph 32 – HHI of Indonesian Cellular Market

Source: Company reports, Analyst’s estimate

the long run, meaning that cellular ARPU is to increase consistently with GDP per

capita34

.

In 2001, the government liberalized the cellular market; and since then there have

been three big players namely Telkomsel (TLKM:IJ), Indosat (ISAT:IJ), and XL

Axiata (EXCL:IJ) that control more than 80% market share (as of December 2012,

see graph 30). The other operators are briefly described in the appendix III.

Using Herfindahl-Hirschman Index (HHI)35

-that measures industry concentration

level we see that competition has been escalating sharply (measured by a

decreasing HHI index – showing of a less concentrated market). Smaller operators

namely, Axis (not listed) and Hutchison Indonesia (not listed) have been significantly

re-establishing their position in the market for the last 3 years36

. As seen in graph 31,

XL was the one mostly affected37

by their stronger presence.

In early 2013, XL proposed an acquisition of Axis, which was recently approved38

in

the beginning of December 2013 by the Ministry of Communication and Information

(KOMINFO) with a certain term that obliges them to return spectrum blocks of 10

MHz in 2,100 MHz frequency band used for 3G network. Even after returning 10

MHz frequency blocks, XL-Axis now has spectrum capacity as large as Telkomsel;

34

Note that we only use this additional information to triangulate our ARPU estimation, not to actually forecast the ARPU. 35

HHI is calculated by summing of the squares of the market shares of all cellular operators. The value ranges from 0 to

10,000. HHI Index of 10,000 indicates market-monopoly while 0 implies a nearly perfect competition. For example, market of 8 participants (as in the case of Indonesia cellular market) with perfectly equal market share would have a HHI index of 1,250. 36

Axis and Hutchison market share were estimated around 5% and 8% in 2012 respectively, which increased to 7% and 12%

in 2013. 37

XL lost 3% of its market share in 2012 38

According to the Indonesian Supervising Committe for Business Competition (KPPU), XL-Axis merger and acquisition

would not harm the market competition, and will not cause monopolistic industry. KPPU estimates an increase of 200 points in HHI post-merger.

Source: Analyst’s estimates

Source: World Bank, Bloomberg, Analyst’s Estimates Source: Bloomberg, Analyst’s estimates


PAGE 14/36

Source: Ministry of Communication and Information Technology, Company reports, Analyst’s estimates

Graph 33 – 2013 Total BTS Comparison Table 8 – 2013 Spectrum Blocks (MHz) and BTS Comparison Matrix

39

900 Mhz 1,800 Mhz 2,100 Mhz # BTS40

Telkomsel 7.5 22.5 15 65,65341

Indosat 10 20 10 23,207

XL Axiata 7.5 7.5 15 42,796

Hutchison 0 10 10 ~13,000

AXIS 0 15 10 ~10,000

XL-Axis 7.5 22.5 1542

~53,000

In order to understand the implication of those figures presented above, we run

some spectrum efficiency calculation that reveals their importance, please consult

appendix V. We foresee XL-Axis to become a more formidable player in the future;

by retaining Axis’ spectrums and infrastructures, XL would be able to cut its

investment budget and save considerable amount in capital expenditure43

, and to

focus more on rebranding and gaining more market share. Nevertheless, we expect

the impact on the industry dynamic and especially on Telkomsel to be more

apparent in medium to long term timeframe, considering an integration process44

that XL-Axis has to endure. Furthermore, XL-Axis merger and acquisition will

promote industry consolidation as also supported by the regulator who thinks that

the cellular market is currently too crowded45

. Should the consolidation happen in

the future, Telkomsel would most likely be forced out of consolidation to avoid high

market concentration46

. We expect Telkomsel’s market share to eventually shrink to

40% over the long run.

Best case Scenario – market share remains intact

Notwithstanding the aforementioned concern, we see a likely scenario that

Telkomsel would be able to maintain its market share through aggressive customer

39

Telkomsel and XL acquired additional 5 MHz in 2,100 MHz band in February 2013. See appendix V for the 2,100 MHz

Band Plan by the Ministry of Communication and Information Technology. 40

Base tranceiver station (BTS) is a telecommunication equipment that transmits and receives radio telephony signals to and

from other user equipment devices, such as mobile phone. 41

Currently Telkomsel has the most BTS employed and spread throughout the country and claims to cover more than 97% of

the population. In 2013, it has added 11,356 new BTS of which 71% are 3G BTS. We estimate the BTS deployed by Telkomsel in 2018 will consist of more than 75% 3G/4G BTS, as the company intends to stop deploying 2G-BTS in near future. 42

XL-Axis is obliged to return 10 MHz spectrum blocks in 2,100 MHz. 43

Looking at our spectrum efficiency calculation, XL-Axis would have enough capacity to accommodate its potentially growing subscribers’ base without incurring any significant investment for additional BTS and/or spectrum in near future. 44

Integration process would involve network integration, business process re-engineering, streamlining distribution networks,

redefining cost-structures, rebranding, etc. 45

According to the regulator, it will be hard to obtain additional spectrum in the future without consolidation as spectrum is a

scarce national resource. It is expected that Indonesian telecommunication sector will face spectrum crunch in the next 2-3 years where there are insufficient bandwidth to accommodate excessively growing data demand. 46

Regulator uses HHI index-where level of concentration is divided into 4 spectrum; spectrum 1 is associated with HHI Index

that ranges from 0-1800 (low concentration), spectrum 2 with HHI Index ranges from 1801-3000 (moderate concentration); spectrum 3 with HHI Index ranges from 3001-4000 (high concentration); spectrum 4 with HHI Index above 4000 (monoplistic industry tendency)- to assess any potential merger and acquisition. We expect that Telkomsel will not be granted any acquisition proposal as it will cause high industry concentration (referring to HHI Index that might jump to above 4000 level).

Source: Company reports


PAGE 15/36

Graph 34 – 2013 Subscribers’ base

Evolution

Graph 35 – 9M 2013 YoY Revenues

Comparison

loyalty program and by continuously maintaining its superior network quality and

expanding its coverage as seen in the last 3 years. Telkomsel has the capacity to do

so given its strongest operating cash flow resulted from its largest scale business

and superior operating efficiency; moreover, it also has the strongest financial

position among the three, as summarized in the following table;

Table 9 – 2012 Operational and Financial Highlight Comparison

Telkomsel Indosat XL

Revenues 54,531 22,419 20,970

EBITDA Margin 57% 47% 46%

Operating Cash Flow 25,573 6,989 8,985

OCF/Sales 47% 31% 43%

Interest coverage 11.7 1.54 5.6

Total Debt/EBITDA 0.16 2.23 1.4

Secondly, Indosat recent network roll-out issue has resulted in incremental

subscribers’ base of both Telkomsel and XL, and their respective cellular revenues

(refer to graph 34 and 35). Indosat weakest financial position would also limit its

ability to engage in decent network upgrade that leads to continuing poor network

quality, falling operating revenues, worsening operating cash flow and thus limiting

investments and having tenacious network issues47

. This on-going concern over

Indosat would give Telkomsel opportunity to maintain, if not enlarge its subscribers’

base.

Lastly, Telkomsel’s solid network existence and strong brand awareness outside

Java may persist and its market share would likely remain intact48

.

Following table summarizes our Indonesian cellular subscribers’ growth and

Telkomsel market share forecast;

Table 10 – Indonesian Cellular Subscribers and Telkomsel Market Share Forecast

2012 A 2013 E 2014 F 2015 F 2016 F 2017 F 2018 F

Indonesian Population 247 248 252 255 259 262 266 # Cellular Penetration 282 299 318 334 348 351 354

Penetration rate 114% 121% 127% 131% 133% 134% 133% Best Case -Market Share 44% 43% 43% 43% 44% 43% 43%

Base Case -Market Share 44% 43% 43% 42% 41% 40% 40%

47

Indosat has netted -1.8 trillion IDR lost in 9M-2013 caused by slumping revenues, higher financial cost and excessive forex

lost. This worsening condition would limit its ability to recover its network issue. 48

Although Telkom was required to share its network infrastructure by the regulator (under network sharing regulation

introduced in 2008), we are convinced that smaller operators are rather lacking of scale than lacking of access to infrastructure. The fact that they already have access to third party infrastructure provider (with similar capacity with Telkom’s tower subsidiary), we foresee insignificant changes in the industry dynamic for the upcoming terms.

Units: millions users | Source: World Bank, Analyst’s estimates

Units: billion IDR (unless stated) | Source: Company Reports, Analyst’s Estimates




PAGE 16/36

Graph 36 – Telkomsel MoU/user/month

Source: Company reports, Analyst’s estimates | Units: minutes/user

Graph 38 – Telkomsel Historical Trend of

SMS per Users (LHS) and RPS (RHS)

Source: Company reports, Analyst’s estimates | Units: IDR/minute

Units (voice revenues): billion IDR | Source: Analyst’s estimates

Voice Usage and Tariff

We see voice to data substitution effect has started accumulating through voice over

internet protocol (VoIP) applications like Skype, Google Talk, FaceTime, Viber, etc.

Minutes of usage (MoU) per user has been declining, whilst operators has been

inducing usage through promotions (free calls, for instance) that subsequently, has

put pressure on the average revenue per minute (ARPM). Given the fact that

smartphone penetration in Indonesia is still relatively low, yet showing significant

growth potential49

, voice to data substitution effect would only be amplified in near

future (refer to Mobile Broadband section for greater detail about m-broadband).

The fact that Telkomsel’s has consistently charged higher price per minute (as seen

in graph 37) whilst being able to preserve its market share is evidence of economies

of scale it has created through its superior network quality that has persisted over

the previous years. Moving forward, we expect Telkomsel’s unit price to be

maintained above market price, yet we believe that price compression is

unavoidable and the ARPM will continue declining due to excessive promotions

resulted from fierce competition. As for the longer run (perpetuity); considering that

the industry consolidation were to happen, market would reach competitive

equilibrium eventually; as such unit price would stop being penalized, and start rising

with inflation. Below is our forecast summary;

Table 11 – MoU/User/Month and ARPM Forecast

2011 A 2012 A 2013 E 2014 E 2015 E 2016 E 2017 E 2018 E

MoU (minutes) 129 123 128 127 126 125 124 123 ARPM (IDR) 172 166 163 154 149 146 145 151 Voice Revenue 28,598 30,731 32,455 31,785 31,406 30,866 30,457 31,593 Implied Voice-ARPU 22 20 21 20 19 18 18 19

SMS

We expect that SMS per user will also resume its down trend following increased

popularity of on-line messaging through Blackberry messenger (BBM), WhatsApp,

Facebook messenger, Lines, etc. Nevertheless, we see that the substitution effect

had peaked in 2010; where average SMS/user stumbled from 285 in 2008 to 177 in

2010 and has been rather slowly decreasing (see graph 38); we forecast SMS

volume to continue declining yet to a lesser degree.

In what regards revenue/SMS (RPS), we see a similar pattern that happened in

2009 being held currently; RPS seems to be resilient not to drop further below 50

IDR mark as the operators must cover for the SMS interconnect expense about 35

49

Smartphone penetration in Indonesia has doubled from 12% in March 2012 to 24% in March 2013, source: Emarketer,

retrieve (December 2013) from: http://www.emarketer.com/Article/Smartphone-Penetration-Doubles-Indonesia/1010102

Units: # SMSs and IDR/SMS (RPS) | Source: Company reports

Graph 37 – ARPM Evolution

http://www.emarketer.com/Article/Smartphone-Penetration-Doubles-Indonesia/1010102


PAGE 17/36

Graph 39 – Mobile Broadband Subscribers (LHS) and Total Data Traffic production

(RHS)

Units: billion IDR (revenues) | Source: Company Reports, Analyst’s Estimates

Graph 40 – 2012 Broadband Penetration by Age Group

Source: Telkom Presentation 2011

IDR. This in fact implies 30% net-interconnect margin for SMS, which is expected to

be the minimum margin. However, we anticipate the pricing compression resulted

from lower demand were to persist for the foreseeable future. We assume that

Telkomsel would maintain RPS at a similar rate as competitors.

Table 12 - SMS Production and Revenues Forecast

2011 A 2012 A 2013 E 2014 F 2015 F 2016 F 2017 F 2018 F

SMS/user (#) 174 168 163 159 156 153 152 152 RPS

50 (IDR) 58 50 51 51 51 52 52 53

Competitors’ RPS (average)

51 - - - - - -

SMS Revenue 13,093 12,631 12,921 13,202 13,370 13,348 13,354 13,557

Mobile broadband “Flash” – the future growth engine

Over the past 5 years, we have seen enormous growth of data usage; as seen in

graph 39, Telkomsel’s mobile broadband subscribers’ base has increased massively

from 1.8 million in 2009 to 22.7 million in 2013, whilst data traffic production increased

immensely from 12 petabyte51

(PB) to 96 PB.

In order to forecast revenues contribution from mobile-broadband properly, we break-

down the key drivers as follow;

Young Population and Growing Urbanization

First and foremost, Indonesian young population would provide an economic

advantage for the telecommunication carriers as they are more technology savvy,

social and connected; which also becomes even more relevant as we see broadband

penetration in Indonesia, unlike global broadband penetration, is skewed heavily

towards age group of 14-34 years old, see graph 40.

Table 13 - Portion of Indonesian Population by Age Group

2015 F 2025 F 2035 F

Age 0-13 26% 24% 22%

Age 14-24 17% 17% 16%

Age 25-34 17% 17% 17%

Age 35-44 15% 16% 16%

Age 45-54 12% 14% 16%

Age 55+ 13% 19% 26%

Furthermore, urban population has been increasing and its respective poverty

headcount has been consistently decreasing since 2006. Though we could not

quantify urban population by age group due to lack of data, we assume that growing

urbanization in general will promote higher penetration of advance

50

Note that revenue per sms (RPS) is associated with total SMS productions thus including free SMSs 51

1 Petabyte = 1,000,000,000 MB

Units: million users and Petabyte (Data traffic) | Source: Company reports

Source: World Bank


PAGE 18/36

Graph 43 – 2012 Facebook users globally (excluding USA)

Graph 44 – 2013 Global Twitter Users

(% of Total, excluding USA)

Units: million users |Source: Facebook Annual Report 2012

Source: PeerReach statistics, October 2013

Graph 42 – Urban Population (% of Total)

Graph 46 – Global Mobile Data Traffic Monthly Forecast

Graph 45 – Monthly Data Traffic Production by Region

Graph 47 – Global Mobile Data Traffic by Device Type

telecommunication gadget, such as smart-phones and tablets, which in turn will drive

data traffic higher. Altogether, those indicators aforementioned above will provide a

solid platform for robust growth in the mobile-broadband sector.

Smartphone + Social Media = the Next Big Thing

It is undeniable that a changing lifestyle within Indonesian society promotes higher

usage of smartphone and other large screen devices, such as iPad, Android Tablet,

etc. Indonesians are more modernized and seek more sophisticated way to

communicate through on-line messaging platform, on-line news portal, on-line social

media and video streaming platforms, etc. This argument is supported by the large

number of Facebook and Twitter (the most recognized social media platforms

globally) users in Indonesia, which is currently the fourth and the third largest market

for Facebook and Twitter respectively. Furthermore, smartphone users grew

substantially from 11 million in 2011 to 42 million in 2013, which also explains huge

jump in data-traffic between the years (refer back to graph 39). Nowadays,

smartphone can leverage and deliver those aforementioned needs in a more

sophisticated fashion. This is why they are the key value driver to mobile carrier

operators of which will surely benefit from this fast growing advance technology

gadget. As shown in graph 47 reported by Cisco, data traffic produced by

smartphone users has grown substantially and surpassed data traffic produced by

notebooks in 2013, whereas graph 45 and 56 shows that Asia Pacific (will) have a

high share of the total mobile traffic.

Graph 41 – Poverty Headcount Ratio at Urban Poverty line (% of urban population)

Source: World Bank Source: World Bank

Units: Petabyte | Source: Cisco Visual Networking Index 2013

Units: Terabytes | Source: Cisco Visual Networking Index 2013

Units: Exabytes | Source: Ericsson Mobility Report, November 2013


PAGE 19/36

Graph 48 – Connection Speed Threshold

Units: Kbps | Source: Ericsson Mobility Report, November 2013

Graph 51 – 2013 Price/MB, Average Download Speed, and Average Capacity (Advertised) Comparison

750

8,366 1,000

7,200 1,000

7,200 1,000

7,200 750

6,104

1500

154 500

MB

Graph 49 – 2013 Global Smartphone Penetration

Source: Nielsen report, September 2013

Graph 50 – %population has

broadband connection

Source: ITU

Graph 48 describes the minimum speed of internet connection required to utilize the

respective usages. As of today, mobile cellular broadband has the capacity to

accommodate those needs effortlessly with an average connection speed that is

faster than 1,000 Kbps. The fact that nowadays, Indonesian can go online by

spending as low as 15,000 IDR (less than

2 US$) (which was a decrease from

50,000 IDR (4 US$) 2 years ago52

), would

only boost mobile broadband penetration

higher. Moreover, smartphone penetration

rate in Indonesia is still comparatively low,

signalling tremendous growth that is yet to

be seen.

Flash Market Share, Unit Price and Data Volume

Forecast

Following 9M-2013 results released, Telkomsel Flash has approximately 55% of

mobile broadband market share, which is a decline from 74% in 2011. For the last

two years competition in mobile broadband has been fiercer than ever, and has led

to enormous data pricing compression. Nowadays a single operator provides more

than 3 different packages with diverse choices in capacity and speed. Several

smaller operator charges much lower tariff which compete purely on value-

destroying pricing strategy. Graph 51 summarizes mobile broadband price, speed

and capacity comparison between operators;

Telkomsel biggest threat now comes from XL-Axis considering its stronger

infrastructures (more BTS-wider coverage) and larger capacity (larger spectrum

bandwidth), and its low-cost strategy. As such, we foresee Flash subscribers’ base

to deteriorate further to 40% in the long run and in the perpetuity (or at similar level

of its cell-phones market share).

52

Average tariff for a mobile broadband prepaid starter pack in Indonesia as of December 2013. Source: Company websites

5,400

Units: IDR/MB | Source: Company reports, Company websites, Analyst’s estimates

Mbps

Implied Price/MB Advertised Speed and Capacity


PAGE 20/36

Graph 52 – Substantial Data-Pricing Compression

(cost/MB) started in 2012

Source: Company reports, Analysts’ estimates | Units: IDR/MB

Units: million users | Source: Emarketer, Company reports, Analyst’s Estimates

Units: (revenues) billion IDR | Source: Company reports, Analyst’s Estimates

Graph 53 – Monthly Data

Traffic per User Forecast

Source: Ericsson Mobility Report, November 2013

Table 14 - Broadband Subscribers' Base and Flash Market Share Forecast

2011 A 2012 A 2013 E 2014 F 2015 F 2016 F 2017 F 2018 F

Indonesian M-Broadband users53

12 26 42 61 75 90 104 114

Penetration rate (% population) 5% 11% 17% 24% 29% 35% 40% 43%

Flash and Blackberry subsccribers 9 17 23 32 37 41 45 45

Market Share 74% 64% 55% 52% 49% 46% 43% 40%

Furthermore, we expect data pricing compression to continue in the

future; Telkomsel current price per megabyte (MB) is currently at premium

103 IDR54

, whilst the market average is just 6455

IDR. We forecast

Telkomsel price to be driven by the market price in the future, especially

by XL-Axis, considering business scale they just created.

We foresee data usage (traffic) will increase substantially

in the future with enhanced network capacity, namely 4G-

LTE technology56

. Nevertheless, we forecast Indonesia’s

data traffic production to be less than the Ericsson’s

projection since the implementation of the LTE network in Indonesia

is quite lagging compared to the global average5758

.

Table 15 - Mobile Broadband Revenue Forecast

2012 A 2013 E 2014 F 2015 F 2016 F 2017 F 2018 F CAGR

Data/user/month (MB) 258 353 472 619 779 961 1,160 27%

Cost/MB (IDR) 121 109 92 81 72 67 62 -11%

Broadband Revenue 6,273 10,442 16,501 22,168 27,992 34,592 38,879 30%

Implied ARPU (000 IDR) 31 38 43 50 56 65 72 14%

53

We expect Indonesian broadband users to grow substantially at CAGR 26% for the next 4 years (using indication from

Ericsson for Asia Pacific mobile broadband sector and Emarketer), and 10% over the longer run. Our estimation infers that penetration rate will be close to 100% in approximately 10 years-time. We assume that multiple subscriptions per user will be more apparent in mobile broadband sector as people generally own tablet and smartphone at the same time (as they provide rather different features). Considering that technology in general always grows swiftly and exponentially, our implicit timeframe should be then reasonable. 54

Global average is at 0.50-1.00 US$ cent (60-120 IDR). Source: international operators websites, analyst’s research

estimates. 55

Please note that this is the offered price on competitors websites, therefore we might overestimate (underestimate) the true

price charged per MB due to less (more) actual usage. As for Telkomsel, Indosat and XL we used the actual revenue per MB derived from total data revenues divided by total data traffic production. 56

Last October 2013, Telkomsel conducted 4G-LTE network trial, of which the actual (not advertised) 4G internet connection

speed reaches approximately 15 Mbps or about 7-8 times faster than average normal 3G connections. 57

South Korea was the first to commercially deploy 4G technology in 2006, followed by Northern European countries in 2009,

and rest of the world (developed countries) in 2010-2011. 58

There are two important factors in estimating data traffic production per user; first is the device being used, 4G enabled and

3G enabled devices apparently have different output. We assume that Indonesians, being less wealthy on average than its international peers, would prefer cheaper product (Indonesia has been flooded by smartphone shipped from China targeting lower-end users) that obviously has technical limitation (most of them are still 2G-3G only devices) when compared with higher end products such as iPhone or Samsung Galaxy (of which are made ready for 4G network), thus limiting their broadband usage. Second is the 4G-LTE network availability; as aforementioned, Indonesian cellular operators have not yet conducted 4G-LTE network roll-out, indication is that they might start as soon as next year. Regulator (BRTI) is still arranging and assessing 4G LTE frequency band. As frequency band is limited, there is speculation that 4G will be operated in 1,800 MHz band, which is currently being used for 2G network, and reaffirming network might take some time, if not years.

CAGR 25%


PAGE 21/36

Graph 54 – Net-interconnect Margin Comparison

Graph 55 – On-Net vs. Off-Net Tariff per second


Source: Company reports, Analysts’ estimates | Units: IDR/second Graph 56 – Net Interconnect Margin Forecast


Interconnection

Economies of scale are more apparent in what regards net-interconnect margin59

.

Given its largest market share, Telkomsel has been able to yield significantly higher

net-interconnect margin, as seen in graph 54.

In 2006, the Ministry of Communication and Informatics Republic

Indonesia (KOMINFO) mandated a cost-based interconnection tariff

scheme60

; where the interconnection charges are determined by the

network operator on which a call terminates based on a long-run

incremental cost formula. As of today, all network operators charge

similar on/off net tariff as presented in graph 55. Regulator has altered

the tariff in 2008 that reduced off-net charged per minute by 10% to approximately

30 IDR, which implies termination rate of 5 IDR per second that is equivalent to

approximately 0.025 USD/minute. At this rate, interconnection tariff in Indonesia is in

fact relatively low compared to its International peers61

. We could then argue that

cellular market in Indonesia should not be heavily affected by the network effect62

;

nevertheless, market share would still be the important factor in gaining net-

interconnect margin; as larger market share implies higher interconnection revenues

and lower interconnection expenses. As we expect Telkomsel’s market share to

eventually contracting in the future, we suppose the respective net-interconnect

margin to shrink too. Graph 56 recaps our interconnection expense and revenue per

minutes relative to ARPM forecast.

59

Net-interconnect margin is calculated by deducting interconnection revenues received from other operators by the

interconnection expenses paid to other operators. 60

KOMINFO issued Regulation No.8/PER/M.KOMINFO/02/2006 on interconection on February 8, 2006. (retrieved from:

Telkom annual report 2012, ) 61

Average termination rates around the world; Europe (0.07 USD), Africa (0.19 USD), Asia Pacific (0.04 USD), USA (0.16

USD). Source: ITU World Tariff Policies Database 2012 62

The fact that smaller operators like Hutchison and Axis has been able to reinforce their position lately is evidence that

network effect is rather insignificant in Indonesian cellular market. Additionally, as we foresee data-voice to take charge in near future, interconnection cost would be less relevant.


PAGE 22/36

Graph 57 – Fixed-line Business EBITDA Margin Forecast

Source: Company reports, Analysts’ estimates, Bloomberg

Graph 59 – 2012 Revenues per Employee

Source: Analysts’ estimates, Bloomberg | Units: billion IDR

Graph 58 – Fixed Business Operational Expense Contribution by Segments


Operating Cost Margin and Investments

Fixed Business Margin

As discussed previously, broadband tariff in Indonesia is relatively more expensive

than its International peers; we believe that the regulator would likely to drive price

lower, considering currently low broadband penetration rate could be propelled by a

decreasing unit price; consequently lowering Telkom operating

margin. Moreover, although regulator has not required Telkom to

share its fixed-broadband infrastructure, in the future where demand

for fixed-broadband is presumed to be increasingly growing, we

foresee threat of new entrants and a likely scenario that Telkom

would have to share its infrastructure thus decreasing its competitive

advantage. It would be then most reasonable to expect a rather

contracting margin in the future. Nevertheless, we are still convinced

that Telkom’s fixed-business margin would be higher than

comparables due to following reasons; firstly, Telkom’s operation and

maintenance expense contributes by relatively low portion to the

overall operating expenses, this means that even if unit price margin

were to shrink, it would not affect Telkom’s overall margin greatly. In

fact the company was able to reduce costs related to the operation

and maintenance in 2012, which shows its superb operational

efficiency. Secondly, Telkom’s most expensive bill comes from

personnel expense63

, which consistently contributes around 50% of

total operating expense, whereas comparables’ average is within 20-30% range;

Moreover, Telkom’s workforce efficiency in which reflected by the amount of

revenue generated per employee is relatively low, suggesting that the company still

has some extra space in the trunk for the workforce efficiency enhancement. Lastly,

which we consider as best case scenario; though we could not quantify precisely as

for Telkom fibre roll-out case64

, according to FTTH Council Europe65

, “fiber access

networks are lower cost to build than copper and much lower cost to operate”; total

operational cost reductions were estimated of around 15%-30%; as such we

presume higher margin to be sustained.

As for the worst case scenario (Indonesia economy to erode further, appendix II), it

is common that companies including Telkom would not be able to adjust its fixed

cost instantly, such as personnel cost, SG&A expense, etc. and therefore sudden

63

Being an SOE, Telkom rather assumes responsibility in creating job field. 64

Telkom did not disclose specifically its investments and operational cost related to FTTH, and revenues gained from the

investment. 65

Stanislawski, S., & Kauze, J. (2012). Financing Stimulus for FTTH. Retrieved from

http://www.ftthcouncil.eu/documents/Reports/FTTH_Finance_Report.pdf

http://www.ftthcouncil.eu/documents/Reports/FTTH_Finance_Report.pdf


PAGE 23/36

Graph 60 – Prepaid Subscribers (% of Total)


Graph 61 – 2013 Unit Price Comparison

(Telkomsel Prepaid vs. Post-paid) as advertised

Units: IDR | Source: Company websites, Analyst’s estimates

Graph 62 – 2012 Prepaid Subscribers (% of Total)

Graph 63 – 2012 Margin Comparison

Source: Bloomberg, Analyst’s estimates Source: Bloomberg, Analyst’s estimates

Graph 64 – EBITDA Margin vs. Market Share

Source: Company report, Analyst’s estimates

drop in revenues – in response to the slumping demand, would result in significantly

lower margin. We use comparables margin (of 40%) as proxy in determining margin

contraction for the worst case scenario.

Cellular Business Margin

As aforementioned, Indonesian cellular market is characterized by its highly

disproportionate amount of pre-paid subscribers; as of December 2012, only 1 in

100 cellular subscribers is a post-paid subscriber. Though pre-paid ARPU is much

lower than post-paid ARPU, the profit margin associated with pre-paid subscription

is arguably higher as pre-paid subscribers pay higher unit prices (price per minute

and per SMS, for instance), and operator need not deal with bad-credit customer

which may incur additional operating cost (under SG&A expense). We believe that

is one of the main reasons why Indonesian cellular operators have been able to

sustain EBITDA margin above 45% whilst international median margin is around

38%66

. We see a correlation between high revenue contribution from prepaid

subscribers and high operating margin as shown in graph 62 and 63.

Notwithstanding the aforementioned fact, we see that market share (competition)

has a substantial impact on margin. As seen in graph 64, Telkomsel EBITDA margin

has been shrinking consistently with a decreasing market share. Moving forward, we

see continuously contracting margin to be in line with our declining-market share

forecast. Additionally, heavy pricing

compression that is caused by vicious

competition would continue putting pressure

on margin too67

. Subsequently, we forecast

margin to be gradually declining towards

competitors’ margin.

We are aware that our initial estimate involves

66

Source: Bloomberg 67

Telkomsel’s expense related to network activity is significant, contributing to about 65% of total operating expense,

therefore, unit price margin really does matter for it.

Graph 65 – Cellular EBITDA Margin Forecast



PAGE 24/36

Graph 67 – 2012 CAPEX per Fixed-Line Connection

Units: thousand IDR | Source: Bloomberg, Analyst’s estimates

Units: trillion IDR | Source: Bloomberg, Analyst’s estimates

Graph 66 – Customer Survey Results


upside risk where Telkomsel would in fact be able to sustain higher margin as if the

company were to succeed in preserving its market share; as such we incorporated

this likely scenario into our best-case scenario analysis.

Fixed Line Investments

Fixed network business investments mostly utilized for deploying access and

backbone infrastructure to support the broadband services. As part of the IDN

project aforementioned, we foresee intensive capital expenditure (CAPEX) relative

to sales to last until 2015.

In order to have the notion of recent investment intensity committed by Telkom, we

conducted comparable analysis focusing on capital expenditure per fixed-line

subscription as shown in graph 67, which we expect similar intensity to hold in near

future as we believe that relatively more expensive investment made by Telkom per

fixed-line subscribers was largely due to a more challenging Indonesia’s geography

condition, and the fact that Telkom has just began its fiber roll-out whereas its peers

had started couple years ago. As for the longer run, Telkom’s fixed network CAPEX

budget should be closer to the comparable CAPEX.

In what regards extraordinary maintenance, we foresee no additional CAPEX

required as Customer Satisfaction Index68

has showed continuing improvement,

which implies that the existing infrastructure has served the customers well.

Cellular Investments

We see that Telkomsel capital expenditure per incremental data traffic69

and per

subscribers has been much lower than its competitors. It would therefore be

reasonable to anticipate higher investments made by Telkomsel in the future in

order to keep up with competitors, especially in response to XL-Axis’ stronger

infrastructure.

68

Telkom routinely engage independent market analysts to conduct survey and market research on their customers’ levels of

satisfaction and loyalty. (avaliable on annual report 2012,2011,2010) 69

CAPEX/incremental data as the company has to keep up with its peers in accommodating higher data-demand.

Graph 68 – Fixed Network CAPEX Forecast


PAGE 25/36

Graph 69 – Cellular CAPEX Comparison Graph 70 – CAPEX to Revenues Graph 71 – CAPEX per Subscriber Graph 72 – CAPEX per Incremental Data

Units: billion IDR | Source: Company reports

Source: Company reports Units: thousand IDR/subs | Source: Company reports, Analyst’s estimates

Units: IDR/MB | Source: Company reports, Analyst’s estimates

Graph 73 – Cellular CAPEX Forecast

Units: trillion IDR | Source: Analyst’s estimates

Graph 74 – Mobile Broadband Revenue Contribution

Units: billion IDR | Source: Analyst’s estimates

Since Telkomsel’s CAPEX has been largely, if not all, devoted to BTS deployment, it

is of utmost importance to properly estimate the additional BTS of which is installed

to accommodate excessively growing data-demand. Considering limited spectrum

availability operators could only meet data traffic through deploying more BTS.

Please see appendix VI for our BTS forecast.

Our BTS forecast implies that Telkomsel’s capital expenditure would be

continuously larger than its current level. Notwithstanding, provided our mobile

broadband revenues forecast, Telkomsel would break even in 2015, and would

continue generating good returns from the emergence of the mobile broadband

usage.

FOREX Risks on Investments

We also take into account FOREX risk associated with Telkom capital expenditure

committed under foreign currency contractual agreement70

. As provided in the

appendix VII, higher CAPEX was somehow associated with weaker Rupiah in that

respective year. Hence, it is also important to understand what might be the

additional amount derived from the FOREX risk. By assuming that in the future,

Telkom would commit to 40% USD denominated CAPEX, we could then infer

additional amount of CAPEX associated with increased in USD/IDR.

70

More than 90% of the foreign currency contractual agreement was denominated in USD


PAGE 26/36

Graph 75 – Target Debt/EV

Source: Analyst’s estimates, Bloomberg

Source: Analyst’s estimates, Bloomberg

Capital Structure and Cost of Capital

Target D/EV

Management has been rather conservative in its use of debt. As seen in graph 74,

Telkom has engaged in comparatively low leverage than its peers. Strong operating

cash flow has allowed Telkom to finance its investments without relying too much on

debt. Yet we assume that the company would seek an optimal capital structure (by

increasing leverage) in order to minimize the cost of capital over the long run. We

infer 14%71

debt to enterprise value to be maintained in the future.

Cost of Capital

Table 16 – WACC

We used CAPM pricing model to estimate the cost of equity. Firstly, we inferred

that the US 10-year government bond is the most applicable risk-free asset and

thus its yield would give us the most appropriate risk-free rate proxy. Next, we

obtained Indonesia risk-free rate by adjusting the differential in the expected

long term inflation73

. Secondly, in order to get a fair estimation on

telecommunication sector systematic risk, we regressed 63 global

telecommunication companies’ stock returns on the MSCI World Index returns;

we then unlevered each company beta using their respective capital structure

and statutory tax rate. Subsequently, we derived a median of unlevered beta of

0.85. Finally by using Telkom capital structure and statutory tax rate, we could

obtain the appropriate levered beta for Telkom.

Although CAPM infers that investors are well diversified and implies that sector

beta should be an adequate measure of the investment risk associated with

Telkom, we believe it does not sufficiently capture specific country risks such as

political instability, social unrest, natural disaster, etc. Therefore we incorporate

country beta in our cost of equity estimation to reflect this additional risk. To

obtain the country beta, we regressed Jakarta Composite Index (JCI) returns on the

MSCI World Index returns (using monthly data of the last 5 years). Lastly, by

assuming risk-premium of 5.5% we derived the cost of equity of 11.6%.

In what regards cost of debt, we incorporated Moody’s probability of default and

historical recovery rate for similar rated companies (BBB-) into our calculation74

.

Taking into account the specific tax rate for Telkom and Telkomsel, we estimated

their respective weighted average cost of capital of 10.9% and 10.8%.

71

We use mean-reversion approach; adding 2/3 of Telkom current weight to 1/3 of sector average 72

US expected inflation was obtained by deducting US 10Y bond yield with US 10Y TIPS 73

Risk free Indonesia = (1 + Risk free US) * (1 + Indo Inflation) /(1 + US Inflation) - 1 74

The cost of debt was calculated as follow; (1+yield) * (1- probability of default) + recovery rate * probability of default -1

US 10Y TIPS 0.8%

US 10Y Govt. bond 3.0%

US inflation72

2.2%

Indo inflation 4.5%

Rf 5.3%

Market risk premium 5.5%

β sector 0.95

β country 1.22

Cost of equity 11.6%

Probability of default 1.9% Recovery rate 49.6%

Yield 9.0%

Cost of debt 7.9%

Target D/EV 14%

Tax rate Telkom 20%

WACC Telkom 10.9%

Tax rate Telkomsel 25%

WACC Telkomsel 10.8%


PAGE 27/36

Graph 76 – ROIC


Table 17 – Terminal Growth Rates Sensitivity Analysis Table 18 – Price target sensitivity to changes in cellular ROIC and RR

Source: Analyst’s estimates Source: Analyst’s estimates

Cellular Growth

6.50% 6.75% 7.00% 7.25% 7.50%

4.00% 2,318 2,417 2,529 2,657 2,803

4.25% 2,332 2,431 2,543 2,670 2,817

4.50% 2,347 2,446 2,547 2,686 2,832

4.75% 2,362 2,461 2,573 2,700 2,847

5.00% 2,379 2,478 2,590 2,717 2,864

Fix

ed-lin

e

Gro

wth

Reinvestment Rate

20.9% 21.9% 22.9% 23.9% 24.9%

28.5% 2,172 2,262 2,364 2,481 2,615

29.5% 2,237 2,339 2,457 2,592 2,750

30.5% 2,308 2,425 2,547 2,718 2,907

31.5% 2,386 2,520 2,676 2,863 3,089

32.5% 2,473 2,626 2,809 3,030 3,305

RO

IC

Final Valuation Considerations

ROIC

Our valuation implies a declining ROIC75

for the cellular business due

to expectedly lower margin and higher investments for the upcoming

terms discussed previously. Notwithstanding, we believe that

relatively high excess return generated by Telkomsel is reasonable

given its persistently strong operational and financial position that

would enable the company to maintain its large-scale business, which

also being supported by the cellular market size and structure in

Indonesia aforementioned previously. As for the fixed-line business,

we believe that the emergence of the growing demand for fixed-

broadband service, despite the unavoidable decline of the fixed-voice service, would

avoid value destruction. Nevertheless, we would not see significant excess returns

generated from the fixed network business as we foresee broadband price

compression would penalize the margin and NOPLAT consecutively.

Terminal growth rate

We derived terminal growth rate for both cellular and fixed-line business from the

reinvestment rate and the ROIC associated with their respective perpetuity cash

flow. As for our base case scenario, we obtained 7% and 4.5% nominal growth rate

for the cellular and fixed-line business respectively. Considering the expected long-

term inflation rate of 4.5%, cellular and fixed-line business is then respectively

presumed to grow by approximately 2.4% and 0% in real term and in perpetuity.

Since the cellular business terminal value contributes by disproportionately large

amount to the enterprise value, impact on the fair value caused by changes in the

implicit cellular growth rates is considerably larger. We then performed another

sensitivity analysis in regards to the final price target that is affected by the implicit

cellular growth rate derived from reinvestment rate and ROIC, refer to table 20.

75

ROIC presented here is obtained from the base-case scenario.


PAGE 28/36

Units: billion IDR | Source: Company Reports, Analyst’s Estimates

Appendix I – Financials

Table 17 - Financial Statements

2011 A 2012 A 2013 E 2014 F 2015 F 2016 F 2017 F 2018 F

Summary of P&L forecast

Revenue 71,238 77,143 83,145 89,027 96,109 103,729 111,252 119,006

EBITDA 37,016 40,343 42,987 45,742 48,357 50,707 53,590 56,242

EBIT 22,153 25,887 27,978 29,284 30,189 30,913 32,222 33,519

Net financial income (expense) -1,091 -1,459 -806 -658 -546 -778 -694 -662

Other income (expense) -220 -200 -363 0 0 0 0 0

EBT 20,842 24,228 26,809 28,626 29,643 30,135 31,529 32,856

Taxation -5,387 -5,866 -6,563 -7,002 -7,222 -7,327 -7,670 -7,990

Minorities -4,505 -5,512 -6,074 -6,487 -6,726 -6,843 -7,158 -7,460

Net Profit 10,950 12,850 14,172 15,137 15,695 15,966 16,701 17,406

Summary of Cash Flow forecast

NOPLAT 17,881 21,532 23,223 23,708 24,019 24,689 25,661 26,600

Depreciation 14,863 14,456 15,008 16,458 18,168 19,794 21,368 22,724

Operating Cash Flow 32,744 35,988 38,231 40,166 42,187 44,483 47,029 49,324

Net CAPEX 13,932 16,260 22,389 25,525 26,452 27,595 28,333 29,794

∆ in net working capital 423 -2,075 -616 -1,593 -337 -162 -63 -189

∆ in other operating assets-liabilities -139 964 -965 -78 -454 -312 -354 -168

Others 138 427 -514 -474 -354 -331 -472 -341

Investing Cash Flow 14,355 15,576 20,295 23,380 25,307 26,790 27,443 29,097

Core Business FCF 18,390 20,412 17,936 16,786 16,880 17,693 19,585 20,227

Non-core FCF -844 -2,054 -1,467 -1,868 -1,802 -1,192 -1,201 -1,226

FCF to the Firm 17,546 18,359 16,470 14,918 15,078 16,502 18,385 19,001

Change in excess cash -122 -7,080 -5,985 2,394 -948 -1,592 -3,420 -3,373

Interest paid (received) -1,091 -1,459 -806 -658 -546 -778 -694 -662

Interest tax shield 242 293 173 117 96 140 116 101

Change in debt -4,143 1,404 291 -2,599 1,457 1,423 1,579 1,633

Change in equity -10,889 -12,365 -9,839 -14,172 -15,137 -15,695 -15,966 -16,700

FINANCING CF -16,003 -19,207 -16,167 -14,918 -15,078 -16,502 -18,385 -19,001

Summary of Balance Sheet Forecast

Cash and cash equivalents 9,634 13,118 22,695 19,650 20,668 22,336 25,831 29,282

Accounts Receivable 5,250 5,409 5,536 5,342 5,767 6,224 6,675 7,140

Inventories 758 579 667 714 771 832 892 955

Other current asets 5,616 8,867 5,400 5,700 6,041 6,339 6,837 7,262

Fixed assets 74,897 77,047 84,462 93,268 101,416 109,176 116,096 122,993

Intangible assets 1,789 1,443 1,408 1,669 1,805 1,845 1,891 2,064

Other non-current assets 5,043 4,817 5,389 5,897 6,293 6,446 6,971 7,382

Total Assets 102,987 111,280 125,557 132,240 142,760 153,198 165,193 177,078

Trade payables 8,355 7,456 9,268 9,951 10,727 11,345 12,442 13,136

Taxes payables 1,039 1,844 1,497 1,515 1,724 1,851 1,817 1,911

Other current liabilities 7,882 9,149 10,334 11,316 12,409 13,185 14,150 15,159

Provisions/other non-current liabilities 6,859 6,578 7,508 7,654 7,354 7,736 8,232 8,520

Total debts 17,871 19,275 19,566 16,967 18,424 19,847 21,425 23,059

Total Liabilities 42,006 44,302 48,172 47,403 50,640 53,964 58,066 61,785

Minority interest 13,471 15,437 17,012 18,539 19,967 21,317 22,886 24,501

Equity attributable to owners 47,510 51,541 60,373 66,297 72,153 77,918 84,241 90,792 Total Liabilitieis and Equity 102,987 111,280 125,557 132,240 142,760 153,198 165,193 177,078


PAGE 29/36

Graph 77 – China GDP Growth Rate

Source: National Bureau of Statistics of China Source: Bank Indonesia Source: Badan Pusat Statistik Indonesia

Graph 78 – Indonesia Current Account Deficit Graph 79 – Indonesia Unemployment Rate

Appendix II – Additional Scenario Analysis

Indonesia economy were to erode further

Sluggish global economy recovery especially China has continued putting pressure

on commodity prices due to significantly lower demand. Indonesia whose export

derives mostly from commodity, such as coal, petroleum gases, palm oil, etc. has

suffered continuously from this global economy contraction. On the other side,

Indonesia has been massively importing services and products to support rapid

growth and to meet demand of growing consumption; altogether this creates great

imbalances in the current account and causes large deficit. In Q2 2013 Indonesia

current account deficit hit at an all-time high of nearly 10 billion USD (4.4% of GDP)

and had showed no meaningful recovery76

(in spite of remarkably cheaper Rupiah,

export showed little improvement) in the third quarter77

. If export were to continue

slumping in the future, overall country production may continue declining,

unemployment and thus poverty would then inflate higher. Consequently,

disposable income available to households and respective consumption in general

would shrink significantly; companies including Telkom would be greatly affected.

This growing concern may only worsen market sentiment, and foreign capital

outflow would continue even more severely as foreign investors hardly gain their

confidence back. In turn, we might see Rupiah being penalized further78

, and

subsequently inflation would continue rising. Additionally, there is a possibility that

the government would cut its budget on subsidy expenditure – especially on fuel

next year as it is running over budget largely this year of which the amount becomes

76

In contrary, India was able to recover noticeable as its account deficit improve to 1.2% GDP in third quarter from 4.8% GDP

in second quarter. 77

Account deficit narrowed to only 3.8% of GDP in the third quarter. 78

Rupiah along with Indian Rupee were the most depreciated currencies against other foreign currency including the USD; as

both countries endures the highest account deficit among other APAC countries, they are most vulnerable to the approaching FED tapering.


PAGE 30/36

unsustainable (cutting budget may also be a necessary mean to restore Rupiah

value). If subsidy on food, fuel and electricity were to be reduced again next year,

prices and thus inflation would remain high (higher transportation cost would lead to

higher end-products and or services, for instance). As consequence, domestic

interest rates would be higher and very likely to remain high until inflation meets the

target, in which may penalize growth and reduce consumption much further. In what

regards additional risk associated with largely depreciated Rupiah, as also

expressed by Telkom, slumping Rupiah may trigger modification of the current

floating exchange rate policy in order to stabilize, maintain, or increase the Rupiah’s

value; this modification may result in “substantially higher interest rates, liquidity

shortages, and the withholding of additional financial assistance by multinational

lenders” (Telkom annual report 2012 - Risk Factors)79

. Lastly, next year presidential

election may only bring another uncertainty; this additional political risk would not do

any favour to Indonesian economy.

To conclude; reduced consumption would adversely impact Telkom’s revenue

through limited growth of its subscribers’ base and the reduction of the amount of

telecommunication service used. Subsequently, unit price would have to adjust;

indirectly, by giving more promotions as a mean to induce usage, or directly, by

cutting unit price (per minute, SMS, etc.) as competition would become more

irrational (assuming operators would fight harder to gain incremental subscribers

from competitors due to limited growth in general). Collectively, ARPU would decline

and revenue would be penalized.

Lower unit price also implies lower operating margin and cash flow, which

consequently would affect Telkom’s capability to expand its network capacity as

cash available for CAPEX would be then limited. Historically, Telkom has been able

to fund most of its investments using cash from operation, and has not relied heavily

on debts. Decreasing cash available for investment would force Telkom to rely more

on debt of which its associated cost would be presumably higher than it is today,

hence Telkom would incur significantly higher financial expense, which in turn,

lessen the net profit and/or dividend available for shareholder. As for the case of

limited financial assistance, which implies difficulties in funding CAPEX, Telkom

would suffer from network constraint which could result in increasing complaints and

declining market share that leads to decreasing revenues. As such, we predict

Telkom overall growth rate to be slower in the perpetuity.

79

Available on sub-section Macro Economic Risks, page 60, Telkom annual report 2012.


PAGE 31/36

Appendix III – Indonesian Mobile Operators

Table 20 - 2012 Mobile Operators in Indonesia

Total

subscribers

Ownership

Telkomsel 125 Telkom (65%), SingTel (35%)

Indosat 59 Qatar Telecom (65%), State-owned (14%), Public (21%)

XL-Axiata 46 Axiata Group (67%), Emirates Telco (13%), Public (20%)

Axis 16 Saudi Telecom (80%), Maxis Communication (20%)

Hutchison 22 Hutchison HK (60%), TPG-private equity (40%)

Bakrie Telecom 12 Bakrie (23%), Raiffeisen Bank International AG (7%), Public (70%)

Smartfren 11 Sinarmas (82%), Public (18%)

Sampoerna Telkom 3 Sampoerna

Appendix IV – Broadband Tariff Comparison

Table 21 - Speedy Postpaid Tariff

Activation

Fee (Rp)

Monthly

Charge (Rp)

Monthly Usage

Allowance

Excess Usage

Charge

Limited Home 75,000 200,000 1.0 GB 175/MB

Limited Professional 75,000 400,000 3.0 GB 175/MB

Unlimited Office 75,000 750,000 Unlimited -

Unlimited Internet Café 75,000 1,750,000 Unlimited -

Table 18 - Telkomsel Flash Tariff

Telkomsel Flash Quota Tariff (Rp)

Basic 3 GB 125,000

Advance 8 GB 225,000

Pro 10 GB 400,000

Units: million users |Source: Companies’ Reports, Analyst’s Estimates

Source: Company Reports

Source: Company Websites


PAGE 32/36

Graph 80 – 3G Band Plan

Appendix V – Spectrum Efficiency

Calculation and 3G Band Plan

Table 19 - Spectrum Efficiency Calculation

Telkomsel Indosat XL-Axis

Bit efficiency 1.29 1.29 1.29

Busy hour average loading - Lbh 50% 50% 50%

Required user data rate (Mbps) - Rsub 0.256 0.256 0.256

Overbooking factor 20 20 20

No of sector per site - Nsec 3 3 3

No of site 3G-BTS 23635 4993 19722

Market Share 3G 44.00% 18.75% 26.40%

Required Bandwidth (BW) 14.19 28.62 10.20

Available BW - 3G 15.00 10.00 15.00

Surplus/Deficit- Bandwidht 0.81 -18.62 4.80

Source: KOMINFO, Analyst’s estimates

Source: BRTI

Source: KOMINFO


PAGE 33/36


Appendix VI – BTS Forecast

By estimating BTS utilization rate and total data traffic production we could infer how

many additional BTS required each year. In our CAPEX estimation, we incorporate

several assumptions due to lack of information. Firstly, we assume that BTS

utilization rate wouldn’t run for more than 90% (very efficient) swiftly in the near

future. Since there are BTSs deployed in more rural or less populated area

throughout the country that are less utilized, the overall average utilization rate must

less than optimal; but for the longer run, we may expect utilization rate be higher

than 90% by assuming that wealth and public infrastructure would be well dispersed

thus promoting higher utilization in the suburban area. Furthermore, gradually

increasing data capacity per BTS should be reasonable as 2G BTS would be fully

replaced by 3G/4G BTS with higher capacity in the future80

. Following table

summarized our BTS forecast;

Table 20 - BTS Forecast

2012 A 2013 E 2014 F 2015 F 2016 F 2017 F 2018 F

Total Capacity (TB) 109,572 157,474 240,239 316,189 429,018 558,208 666,535

Expected Data Traffic (TB) 51,938 96,059 180,179 272,067 386,117 513,551 626,543

Utilization Rate 47% 61% 75% 86% 90% 92% 94%

Total BTS 54,297 70,940 90,187 107,909 122,012 132,295 142,314

Secondly, we assume that “transmission equipment” net book value reported under

the fixed assets caption, consist of simply BTS to provide cellular network services.

In practice, transmission equipment may consist of other base station namely base

station controller, base station subsystems, etc. But since the company only

disclose the number of BTS deployed, we assume BTSs to already include all other

related communication equipment. We could then estimate net book value for each

BTS. The net book value is presumed to already reflect depreciation and deduction.

Subsequently, we could estimate the value of BTS in the future by taking into

account the upcoming depreciation expense.

80

Management indicates that Telkomsel will stop deploying 2G-BTS in the next 1-2 years.


PAGE 34/36

Source: Company reports, Bloomberg, Analyst’s estimates

Source: Bloomberg, Analyst’s estimates

Appendix VII – FOREX Risk on Investments

Table 21 - Historical FOREX Impact on CAPEX

2007 2008 2009 2010 2011 2012 2013 E

USD/IDR 9,125 9,661 10,147 9,059 8,725 9,328 10,249

Total CAPEX (billion IDR) 15,481 21,356 17,270 13,380 13,932 16,260 22,399

% CAPEX in foreign currency 32% 55% 64% 54% 54% 35% 39%

as % revenue 26% 35% 26% 19% 20% 21% 27%

Table 22 - Implicit FOREX Impact on Future CAPEX

Dates IDR/USD % different

Impact on CAPEX

Spot 12/27/2013 12,259

1Y Forward 12/29/2014 13,230 8% 3%

2Y Forward 12/28/2015 14,186 7% 3%

3Y Forward 12/27/2016 15,144 7% 3%

4Y Forward 12/27/2017 15,546 3% 1%

5Y Forward 12/27/2018 15,841 2% 1%


PAGE 35/36

Graph 81 – ROIC (last filing) vs. PE (TTM)

Source: Bloomberg

Source: Bloomberg

Appendix VIII – Comparables

Table 23 - Comparables

Name Country Mkt Cap (billionUSD)

EV/EBITDA TTM

P/E D/EV

CHINA TELECOM CORP LTD-H China 39.8 4.07 14.54 0.35

CHINA MOBILE LTD Hong Kong 207.1 3.25 9.65 0.04

CHINA UNICOM HONG KONG LTD Hong Kong 35.1 2.85 21.21 0.41

BHARTI AIRTEL LTD India 21.2 7.96 63.4 0.37

RELIANCE COMMUNICATIONS LTD India 4.4 10.4 22.88 0.6

TELEKOMUNIKASI INDONESIA PER Indonesia 17.4 5.44 13.91 0.09

INDOSAT TBK PT Indonesia 1.8 3.89 81.28 0.53

XL AXIATA TBK PT Indonesia 3.6 6.84 29.26 0.3

SOFTBANK CORP Japan 102.9 11.18 20.42 0.49

NTT DOCOMO INC Japan 70.8 4.54 13.71 0.03

KDDI CORP Japan 53.3 6.03 14.73 0.13

MAXIS BHD Malaysia 16.6 13.64 29.51 0.12

DIGI.COM BHD Malaysia 11.4 12.81 26.7 0.03

AXIATA GROUP BERHAD Malaysia 17.6 8.66 22.64 0.2

PHILIPPINE LONG DISTANCE TEL Philippines 12.8 7.72 17.37 0.17

GLOBE TELECOM INC Philippines 4.8 7.49 60.89 0.25

STARHUB LTD Singapore 5.7 10.22 19.15 0.09

SINGAPORE TELECOM Singapore 44.9 12.23 15.9 0.13

SK TELECOM South Korea 17.8 6.11 9.15 0.28

KT CORP South Korea 7.6 4.25 14.42 0.64

CHUNGHWA TELECOM CO LTD Taiwan 24.0 8.61 18.22 0

THAICOM PCL Thailand 1.3 11.41 28.22 0.18

SHIN CORP PCL Thailand 7.1 62.26 15.38 0.03

ADVANCED INFO SERVICE PCL Thailand 19.2 10.12 17.47 0.03

Average 31.2 7.8181 20.8182 0.23

Median 17.5 7.84 18.69 0.18

81

Excluding Shin Corp 82

Excluding Indosat and Globe Telecom


PAGE 36/36

Disclosures and Disclaimer

Research Recommendations

Buy Expected total return (including dividends) of more than 15% over a 12-month period.

Hold Expected total return (including dividends) between 0% and 15% over a 12-month period.

Sell Expected negative total return (including dividends) over a 12-month period.

This report was prepared by Michael Tanjung, a student of the NOVA School of Business and Economics, following the Masters in Finance Equity Research – Field Lab Work Project, exclusively for academic purposes. Thus, the author, which is a Masters in Finance student, is the sole responsible for the information and estimates contained herein and for the opinions expressed, which reflect exclusively his/her own personal judgement. This report was supervised by Professor Rosário André (registered with Comissão do Mercado de Valores Mobiliários as financial analyst) who revised the valuation methodology and the financial model. All opinions and estimates are subject to change without notice. NOVA SBE or its faculty accepts no responsibility whatsoever for the content of this report nor for any consequences of its use. The information contained herein has been compiled by students from public sources believed to be reliable, but NOVA SBE or the students make no representation that it is accurate or complete, and accept no liability whatsoever for any direct or indirect loss resulting from the use of this report or its content. The author hereby certifies that the views expressed in this report accurately reflect his/her personal opinion about the subject company and its securities. He/she has not received or been promised any direct or indirect compensation for expressing the opinions or recommendation included in this report. The author of this report may have a position, or otherwise be interested, in transactions in securities which are directly or indirectly the subject of this report. NOVA SBE may have received compensation from the subject company during the last 12 months related to its fund raising program. Nevertheless, no compensation eventually received by NOVA SBE is in any way related to or dependent on the opinions expressed in this report. The Nova School of Business and Economics, though registered with Comissão do Mercado de Valores Mobiliários, does not deal for or otherwise offers any investment or intermediation services to market counterparties, private or intermediate customers. This report may not be reproduced, distributed or published without the explicit previous consent of its author, unless when used by NOVA SBE for academic purposes only. At any time, NOVA SBE may decide to suspend this report reproduction or distribution without further notice.

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