Smaller base, larger returns
CNVRG is a high-speed fixed broadband operator in the Philippines. Its customer base, divided into Residential and Enterprise subscribers, is confined to Luzon. Nonetheless, it said it had commenced expanding its network beyond Luzon to the rest of the Philippines in 2019 and is on track to substantially complete its primary nationwide backbone loop, which will connect Luzon, Visayas, and Mindanao by 2021.
In 2019, CNVRG managed to grow its net income by +53.43% year-on-year (y/y) to PHP 1.90 billion. This, as topline spiked +80.82% y/y to PHP 9.14 billion on the back of the more than tripling of revenues from its FTTH (Fiber to the home) business from PHP 1.15 billion in 2018 to PHP 3.88 billion in 2019. This accounted for roughly 70% of its total revenues for the period.
This above-average profitability spilled over into 1H20, with bottomline growing +52.63% y/y to PHP 1.26 billion in the semester. Total revenues, meanwhile, climbed +64.62% y/y to PHP 6.59 billion. Growth was largely fueled, again, by the triple-digit growth momentum of its FTTH business.
If CNVRG’s performance in the 1st Half of 2020 is any indication, it is highly likely that the firm will be able to grow its profits by more than half this year. Our conservative estimates see net income hovering around the PHP 3 billion mark, give or take.
Market trends in favor of CNVRG
The Philippine broadband market is one of the most underdeveloped in Asia. As of December 2019, fixed broadband penetration of total households stood at just 14.1% in the country. This lags behind compared to the 58.5% in Vietnam, 44.0% in Thailand, and 38.0% in Malaysia.
As such, we expect that CNVRG will easily be able to sustain the growth trajectory of its subscriber base—for both its Residential and Enterprise business. Do note that the expansions may cause some contraction in margins—therefore lower ARPU—as CNVRG will be competing with TEL and GLO to gain more market share.
If anything, the pandemic has only accelerated the expansion of the Philippine fixed broadband segment. The COVID-19 crisis is expected to increase the demand for these services, as a chunk of the population continues to work and study from home.
Also a contributor to the growth is the rapid digitalization of day-to-day utility, social, and entertainment activities. This, as people try to minimize unnecessary physical transactions amid the health crisis. Case in point, CNVRG recorded its highest single-month gross subscriber additions in three consecutive months in 2020, with 49,421 in May, 60,608 in June, and approximately 65,000 in July.
It expects additions of about 65,000 to 70,000 in August. Churn is also expected to remain at significantly low levels, barring a slight pickup in 2H20 as the full impact of the expiration of government-mandated payment extensions will be felt during the period.
Throughout the years, CNVRG’s Residential business contributed to about 57% of total revenues. The rest was accounted for by its Enterprise business. While this segment has a relatively smaller subscriber base, we expect that its growth trajectory will nevertheless be sustained at least until 2021E, backed by the country’s growing IT-BPM and Financial Services industries.
CNVRG vs. GLO and TEL
Given that CNVRG’s network is still confined to Luzon, it naturally has a smaller broadband subscriber base compared to the country’s two telco giants. While we do not foresee it being able to completely catch up with TEL’s and GLO’s networks, it will be able to accelerate its growth trajectory on the back of stable and increasing demand.
In our view, GLO and TEL only recently started focusing on expanding their broadband base. GLO, for its part, operates a predominantly mobile business. Meanwhile, the past few years, TEL was only just starting to increase the share of data-related services to its revenues.
Contrast this with CNVRG, whose operations are solely composed of data-related services. Since it is purely a broadband provider, it is the only one (of the 3 covered stocks) that will not incur losses from an expected decline in personal spending on mobile—as was the case for GLO in 1H 2020—or the declining revenues from legacy operations—in the case of TEL.
Assuming a market price of PHP 16.80 per share, CNVRG’s Price-Earnings (P/E) ratio in 2020E is estimated to be around 37x.
After CNVRG’s stock-split and preceding IPO, its earnings per share (EPS) will range from PHP 0.45 to PHP 0.70.
The increased equity base stemming from CNVRG’s IPO will lead to a slight slip in Return on Equity (ROE) to 18.46% this year. We expect it to normalize around these levels in the coming years as CNVRG continues to expand its operations.
CNVRG does not plan to declare dividends in the near-term since it will be focusing on reinvesting its profits to further its network expansions.
Key Financial Data
Summary and Recommendation
All things considered, we think Converge ICT Solutions Inc. (CNVRG) will outperform PLDT (TEL)’s and Globe Telecom (GLO)’s profit growth in the near-term because of the following:
- its smaller network base calls for larger marginal returns upon expansion
- services offered are purely fixed broadband — the telco segment seeing the largest spike in demand amid the pandemic; and
- majority of revenues come from FTTH services, which has higher Average Revenue per User (ARPU) than HFC.
The only downward pressure we’re seeing right now is on CNVRG’s EBITDA margins, which could see some contractions as it competes against TEL’s fiber offerings in more areas in the Philippines.
Based on our Discounted Cash Flow (DCF) valuation model, CNVRG’S IPO offer price of PHP 16.80 would be at a significant discount to the estimated fair value.