Highly competitive: Quality will likely improve as the sector undergoes consolidation

With one of the most competitive telecommunications markets in the world, prices have been dropping year after year as Indonesian operators fight for customers. The result has been the rapid growth in user numbers and especially high penetration rates in major cities such as Jakarta. The intense competition and falling prices have also led to under-investment in some parts of the network, inconsistent service quality, and a lack of commitment to research and development. The market has grown, but in the lower end. “They [the operators] have to think about how to improve their business,” Triono Soedirdjo, a partner at PwC Indonesia, told OBG.

THE MARKET: Three competitors dominate the business with an estimated 83% market share. They are: Telkomsel, owned by Telekomunikasi Indonesia and Singapore Telecommunications, with an estimated 42% market share; Indosat, 65% owned by Qatar Telecom and with a market share of about 22%; and XL Axiata, owned by Malaysia’s Axiata Group with a 19% market share. The other providers are: Hutchinson CP Telecommunications Indonesia, a joint venture between Hong Kong’s Hutchison Telecommunications International (with 60%) and Thailand’s Charoen Pokphand (with 40%); Axis, 80% owned by Saudi Telecom Company; Bakrie Telecom, a code division multiple access (CDMA) operator; and Smartfren, another CDMA operator.

The market had nine players just two years ago. In March 2012 Bakrie Telecom merged with Sampoerna Telekomunikasi Indonesia, another CDMA operator, and Smart Telecom acquired Mobile 8 Telecom in March 2010 to become Smartfren. Both were CDMA operators. In 2010 Telkomsel considered acquiring Bakrie Telecom and merging its TelecomFlexi CDMA unit with it, but the deal never went through.

The stiff competition can be seen in the numbers. Indonesia had 259m mobile subscribers in 2011 and an estimated 300m in 2012, making the wireless penetration rate 107% and 122%, respectively. Growth in 2011 was about 18%. The average revenue per user (ARPU), meanwhile, is low and falling. It dropped from $4.65 per month in 2008 to an estimated $3.68 in 2011 and $3.54 in 2012, according to Frost & Sullivan. That is still higher than India’s $1.60, but far lower than the near $50.00 ARPU in the US and the $11.00 ARPU at China Mobile. “It is one of the freest telecom markets in the world,” Danny Wijaya, an analyst at financial news website Indonesia Finance Today, told OBG.

LOW INVESTMENT: The negative consequences of the intense competition are primarily anecdotal and subjective and come in the form of dropped calls, poor call quality and low data speeds. But it is clear from the statistics that the country has been committing less than others to its network. As the price war took hold, investment plummeted. Investment in telecoms as a percentage of fixed capital formation dropped from 3.4% in 2007 to 1.1% in 2010, according to the International Telecommunications Union (ITU). That compares with 3.0% in the Philippines, 3.6% in Malaysia and 2.0% in Russia. “How can operators live with less than a few dollars a month and still make a profit?” Setyanto Santosa, chairman of the Indonesian Telecommunications Society, said to OBG.

It is also worth noting that some of the more impressive statistics may not give the full picture. True mobile penetration rates are far less than the headline rate of 100%-plus. According to Wireless Intelligence, each Indonesian consumer has an average of 2.62 SIM cards and in some segments of the market consumers will use 10-12 SIM cards a year. Because of multi-SIM card use and churning, Frost & Sullivan estimates that actual wireless penetration is more like 50%.

NEW USERS: A recent Gallup survey is somewhat more optimistic. Conducted in July and August 2012, it puts the number of Indonesians with their own mobile phone at 63% and the number of households with a mobile phone sat 81%. The survey indicated that 97% of 15-24 years olds have their own phones, as do almost all Indonesians with a university education. According to the International Data Corporation (IDC), the mobile phone market in the country grew 25% year-on-year in the second quarter of 2012. Some analysts believe the market may in fact be getting close to the natural limits of straight-line growth, that in terms of voice and SMS it may just be as big as it gets. “2011 was the saturation point,” Wijaya told OBG. “Maybe people talk about low penetration and growing consumer class, but the industry could be facing slower growth.”

At the same time, the Indonesian telecoms market is beginning to advance, raising the possibility that growth will be achieved not so much through the acquisition of subscribers but through the sale of data and value-added services. This part of the market has been relatively slow in developing and significant opportunity remains. As late as the summer of 2012 only 20% of mobile users had a smartphone, according to Gallup. As of September 2012 about 54% of all smartphones in the country were BlackBerrys. The popularity of the device is puzzling as it is facing serious competition. Some credit the company’s aggressive promotion of the handset, hiring local stars for ads and allowing customers to buy the product on instalment.

ANDROID INVASION: But BlackBerry mania is beginning to cool. Android-enabled devices, some of the no-brand, made-in-China models retailing for as little as $50, are beginning to attract customers. The BlackBerry’s strength has become its weakness, as its messaging system is closed, groups of friends and colleagues were locked into it. But now open systems solutions offer the same functionality without being hardware dependent. They work on many devices, so once one person in a group leaves, they all tend to follow.

While BlackBerry is still number one in the smartphone category, the BlackBerry OS lost its position in the second quarter of 2012 when the Android OS claimed 52% of the market. Data from mobile advertising firm InMobi suggests that Android is the fastest-growing OS for mobile devices, rising 8.3% in terms of ad impressions in the first quarter of 2012 compared with the same quarter in 2011. According to the IDC, the country will have 8m BlackBerry OS devices, 10m Android-powered units, 500,000 iPhones and 5m Windows-based handsets by 2015. Whatever the future of BlackBerry, it is certain that the market is advancing. According to market research group GfK, Indonesia is South-east Asia’s largest smartphone market, with 54m units as of June 2012. It also noted that smartphone sales were up 56% in the year to June 2012, though 78% of all units sold are still feature phones. According to some unofficial estimates, future trends indicate Samsung will continue to grow from its 33% market share, BlackBerry will fall from its 39% share, LG will grow from its 1.5% share, Sony will remain flat at 6%, STC will grow from its 8% share and Apple stay flat at around some 3% of market share.

DATA IS THE FUTURE: Data is seen as the key to the future of the telecoms market. Indeed, Indonesia is regarded as one of the best markets for mobile data. Because the country is relatively poor, its infrastructure underdeveloped and mobile phones so cheap, very few access the internet via PCs or tablets; most Indonesians access the web via feature phones and increasingly their smartphones. Fewer than 20m people use personal computers in the country, while 10 times that number have handsets. More than 60% of all internet usage is via mobile devices, while an estimated 87% of the country’s 1.3m tweets a day are initiated on handsets. According to mobile advertising firm InMobi, ad impressions in the country almost doubled to 26.9bn in the first quarter of 2012 over the same quarter a year earlier. Impressions on smartphones rose from 19% of the total to 22% of the total.

Data is the best way to raise ARPU and fatten margins, but that may not be easy. Bottlenecks are already cropping up and capacity may not keep pace with demand, as 2G and 3G networks are under strain as more customers transition to smartphones and higher-powered feature phones. Efforts to bridge the gaps have so far been less than successful. A total of eight WiMAX licences were granted for 15 zones in 2009, but four were rescinded and as of August 2012 only two services were deployed. Long-term evolution technology will probably not be available for a few years because most suitable bands are currently occupied.

Most significantly, the third 3G licence auction has been cancelled because of the bankruptcy of Telkomsel. The telecom giant was declared technically bankrupt on September 14, 2012 after Prima Jaya, a pre-paid voucher company, claimed an unpaid debt of $550,000. Under Indonesian law, it is very easy to force a company into bankruptcy. Despite the action being merely a technicality, and one that hardly affected the share price, Telkomsel was not allowed to bid and the auction, originally scheduled for June 2012, was scrapped. The fear was that with too few bidders, the final price would not be competitive.

SPECTRUM CONSTRAINTS: At this point, many places outside the main cities are restricted to sub-3G technology. Without additional capacity through the allocation of bandwidth or the deployment of better technology, Indonesia’s future as the next China of mobile technology is in jeopardy. One solution proposed is to allow the use of the 700-MHz band for 3G, a band currently allocated to analogue television. But digital conversion, which would free up the spectrum, is not set to come in until 2018, and broadcasters are not interested in rushing the process because of the costs involved.

The current state of the market is taking its toll on the operators. Performance has been decidedly mixed. For the nine months from January to September of 2012 Bakrie Telecom reported operating revenues of Rp1.7trn ($17m), down 9.7% from the same period a year earlier. It also recorded an operating loss of Rp329.5bn ($32.95m). But in the same period, XL Axiata reported earnings before interest, tax, depreciation and amortisation up 6% year-on-year. Data revenue was up 60% and data traffic more than doubled, while voice revenue rose only 7%.

Telkomsel’s subscriber numbers more than doubled from 2007-11 – and jumped 17% in the third quarter of 2012 – and chargeable minutes grew sixfold in that five-year period, but its profits have been stagnant and its ARPU dropped almost 50%. And while Indosat reported 55% growth in net income in the third quarter of 2012, the strong result was mainly from a one-time gain on the sale of base stations. Its operating profit only rose 7.6%. Also, operating profit fell between 2010 and 2011, declining from Rp3.44trn ($344m) to Rp2.83trn ($283m). “The growth is not like it was before,” said Leonardo Henry Gavaza, a research analyst at Bahana Securities.

BRIGHT SIDE: Another promising area is the base transceiver station (BTS) business. A number of the major telecoms operators are selling their towers to raise money and pay down debts. This is a capital intensive, though profitable, part of the industry and can be a problem for companies facing pricing pressures, declining margins and the need for additional expenditures on new technologies. IndoPremier Research estimates that 60-70% of the cost of establishing a wireless network goes toward base stations.

Indosat sold 2500 towers to Tower Bersama for $406m in August 2012. As of September 30, 2012 the company (controlled by Saratoga Capital and Provident Capital) reported the ownership of 6714 telecoms towers. The firm has also said it will build 560 new towers in the second half of 2012 and is considering the acquisition of another 12,000 from Indosat. In November 2012 the company reported that it was considering the purchase of the tower assets of CamGSM (Mobitel) in Cambodia. Tower Bersama has grown consistently through aggressive acquisition after its founding in 2004, when it also acquired Telenet Internusa. In 2006 it bought Mobile-8’s towers, and the following year it acquired Bali Telekom, then Prima Media Selaras in 2008. In 2010 it bought Solu Sindo Kreasi Pratama, bringing it total sites up from 551 in 2007 to 3104.

Profesional Telekomunikasi Indonesia is another player, with 7585 towers as of third quarter 2012. The company bought 200 towers from Central Investindo CI and Mitra Karya Propertindo for Rp376bn ($37.6m) in July 2012. It also signed a deal in 2010 to acquire 1000 towers from Hutchison CP Telecommunication, and as of mid-2012 all but 300 towers had been transferred. The company is extending its reach overseas as well, buying the Dutch assets of Royal KPN for €75m in cash. The parent company Sarana Menara Nusantara trades as TOWR on the exchange.

TOWER ECONOMICS: In October 2012 it was reported that XL Axiata was interested in unloading 8000 of its 10,000 towers for Rp14trn ($1.45bn). According to the company, it would save money if it sold and then leased back the assets. Currently, it is spending Rp392.6bn ($39.26m) a year on repairs and maintenance. Leasing back the 8000 towers would cost about Rp120bn ($12m) a year. Possible purchasers named were Tower Joint Infrastructure, Tunas Solutions Pratama and Sarana Menara Nusantara.

But the trend toward asset sales is not as clear as it once was. While towers may be seen as a balance sheet burden, some operators are reconsidering their tower strategies. The assets are certainly expensive, and an argument can be made to offload them and concentrate on the core business, but in some cases it may make sense to build a BTS portfolio for both strategic and financial reasons. Base stations after all provide steady and predictable cash flow and can act as a natural hedge to the more volatile and at times less profitable side of the business. Telkomsel, for example, keeps adding towers despite the tendency for its competitors to do the opposite. In 2011 the market leader built 6000 new stations, bringing its total to 42,623. “Some operators want to focus on the core business,” Chrisna Wardhana, a partner at PwC Indonesia, told OBG. “But some operators think if they have control over the towers, they will have an advantage.”

CONSOLIDATION: The obvious trend, and one that would help considerably in terms of ARPU and network investment, is consolidation. While Indonesia is not as bad as India in terms of total players, which has about 15, it still has far more than the two to four common in other regional markets, such as Hong Kong, China, Mongolia and Thailand. But much stands in the way of the trend. All the players have backers with deep pockets, and it is likely that these backers will hang in there. For some, analysts say, it is just ego. For others, especially regional players with long-term strategic goals in the ASEAN, the market is just too attractive. Indonesia is the most populous country in the ASEAN Economic Community and has perhaps the greatest growth potential. For Singapore Telecommunications and Axiata, that is reason enough to stay on.

The case of Bakrie Telecom is instructive. The company is having significant problems and seems to be losing the price war. In the first six months of 2012 it experienced a 20.4% fall in gross revenue and an 18.8% drop in service revenue. Voice turnover was down 23.8% on year, while non-voice revenues fell 15.4%. The company lost 18.5% of its subscribers from June 2011 to June 2012. For a while, it seemed to have serious balance sheet issues too. In June, it appeared as though Bakrie did not have enough cash to repay Rp650bn ($65m) due in August. It ended up coming through with the money, a day late and only after selling Rp557bn ($55.7m) in shares to a related company.

With the Bakrie Group standing behind Bakrie Telecom, Sinar Mas backstopping Smartfren and major international partners supporting the others, all players have the wherewithal to stick it out. The foreign ownership issue muddies the waters a bit. In 2007 the government limited non-Indonesian entities to 65% of mobile telecommunications companies and 49% of fixed-line operators after a period in which restrictions were ambiguous. In 2008 foreign ownership of base station towers was completely prohibited. Indonesia remains one of the most open telecommunications markets in the region, if the not the world, but the trend is definitely towards more local control and further restrictions. The country has found that while its markets are liberalised, others in the region remain relatively closed. In Malaysia and Thailand, foreign investors are effectively limited to 49% ownership in telecommunications. Indonesians increasingly see that as unfair.

ONSHORING TREND: So far, talk of further control has centred on pulling more telecoms infrastructure onshore. Since the middle of 2011, the Ministry of Communications and Information Technology has been discussing the need for foreign telecoms firms operating in Indonesia to place their data centres within the country. In fact, in October 2012 the government approved a new regulation to control electronic systems and transactions. The regulation stated operators of electronic system-based public services must build the data centre and disaster recovery centre in Indonesia. Freddy Tulung, the director-general of information and public communication at MCIT, told OBG, “This regulation will allow law enforcers to access data centres if an investigation requires so. By forcing companies to have their data centres in the country we can guarantee a higher level of security in all kinds of electronic transaction in sectors like insurance, banking, ticket selling, mobile operations, and the like.”

The Emirates Telecommunications Corporation, 60% owned by the UAE government, did sell 9.1% of its 13.29% stake in XL Axiata in September 2012 for $509.1m. But it appears to have reduced its stake to focus on its core business and home market, not because of concerns about the Indonesian telecoms sector.

OUTLOOK: However, economic realities are taking hold, and as pricing stabilises, the market consolidates and leadership emerges, quality will improve, margins will widen and significant investments will be made. While it is not clear exactly who will win in the end and what they will be offering, it is all but certain that many of the weaknesses in the market will be addressed as the business becomes more profitable and as the players start to compete on quality.

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The Report: Indonesia 2013

Telecoms & IT chapter from The Report: Indonesia 2013

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