Nottingham University Business School
MBA Programmes
ACCOUNTING AND FINANCE (N14M01)
STRATEGIC FINANCIAL REVIEW OF DIGI.COM BHD
GROUP MEMBERS:
SHANMUGA PILLAIYAN (010194)
KEVIN CHOO (010226)
GURMEET SINGH (002967)
ORIGINAL
Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
TABLE OF CONTENTS
1.0 EXECUTIVE SUMMARY.......................................................................................................................3
2.0 KEY ISSUES.............................................................................................................................................5
2.1 LONG TERM SUSTAINABLE GROWTH DOES NOT LOOK PROMISING..........................................................5
2.2 NET PROFIT MARGINS ARE NOT GROWING IN TANDEM WITH REVENUE GROWTH................................11
2.3 GEARING IS INCREASING.......................................................................................................................18
2.4 SHORT TERM LIQUIDITY IS OF CONCERN...............................................................................................22
2.5 SPECIAL NOTE: ROE IS DISTORTED BY CAPITAL STRUCTURE..............................................................23
3.0 CONCLUSION........................................................................................................................................26
3.1 APPROACHING MILESTONES.................................................................................................................26
3.2 SUMMARY OF RECOMMENDATIONS......................................................................................................28
4.0 APPENDIX..............................................................................................................................................29
4.1 FINANCIAL FIGURES – DIGI BHD..........................................................................................................29
4.2 FINANCIAL FIGURES – XL AXIATA.......................................................................................................31
4.3 FINANCIAL FIGURES – M1....................................................................................................................33
4.4 REFERENCES..........................................................................................................................................35
Word Count: 4171
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1.0 EXECUTIVE SUMMARY
DiGi has performed admirably over the last five years, in terms of operational
efficiency, growth and share holder value, culminating in the highest gross
revenue level in its corporate history at approximately RM 5.5 billion in 2010
(refer to Appendix 1).
However, a closer look at our financials have revealed several trends that may
have long term repercussions on our ability to successfully surmount the
challenges that lay ahead over the next few years.
Long term sustainable growth does not look promising
Net profit margin is not growing in tandem with revenue growth
Gearing is increasing
Short-term liquidity position is precarious
In order to derive further insights into our performance, we have also
benchmarked our performance with 2 other players based in different markets,
namely XL Axiata in Indonesia and M1 in Singapore. These companies were
selected on the following basis:
DiGi1, XL2 Axiata and M13 are currently the third ranked telcos in
their respective markets.
All 3 telcos deploy similar telecommunication technologies
(GSM, GPRS,
UMTS, HSPA) and have similar product offerings4
1 Hendrik Clausen (2011), Analyst Briefing, 22 September 2011, DiGi Bhd.. 2 Axiata Group Berhad (2010), 3rd Quarter 2010 Analyst and Investor Briefing, 24th
November 2010, Axiata Group Berhad3 M1, (2011) Investor Presentation Jan 2011, available at:
http://m1.com.sg/M1/CMA/About_Us/Corporate_Information/IR/PDF/Investor%20Presentation%2019%20Jan%202011.pdf (accessed on 7th November 2011)
4 1. DiGi Berhad, www.digi.com.my (accessed on 5th November 2011). 2. XL Axiata, www.xl.co.id (accessed on 6th November 2011). 3. M1, www.m1.com.sg (accessed on 5th November 2011)
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To have a comparison with markets that have different mobile
penetration rates. XL Axiata is from Indonesia a growth market
(around 85% mobile penetration) and M1 is in Singapore which is a
mature market (around 155% mobile penetration). Malaysia is
between these two markets as a maturing market5 (around 120%
mobile penetration)
Over the long term, we need to be financially prepared for the milestones such
as the Telco Spectrum Auction6, DiGi’s 3G license expiry in 20187 and the Long
Term Evolution (LTE) roll-out to enhance mobile data services8
The following are our key recommendations to address both the highlighted
issues and the financial challenges presented by these milestones.
Dividend payout policy to be set at a maximum of below 100% of
net profit
To focus on improving net profit margins by increasing monthly
Average Revenue Per User (ARPU), and reducing 3rd party mobile
traffic charges.
Use more internally generated funds to fuel future growth.
Short term debt facility should be arranged to mitigate short-term
liquidity risks.
5 Central Intelligence Agency, World Factbook, available at: https://www.cia.gov/library/publications/the-world-factbook/index.html (accessed on 9th November 2011)
6 Kelvin Goh (2011), “Telecommunication, Muffled by regulation and competition”, CIMB Research Reports (17 Feb 2011). CIMB Bhd.
7 Kelvin Goh (2011), “Telecommunication, Muffled by regulation and competition”, CIMB Research Reports (17 Feb 2011). CIMB Bhd.
8 Hendrik Clausen (2011) , Analyst Briefing, 22 September 2011, DiGi Bhd
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
2.0 KEY ISSUES
Despite DiGi’s many successes over the years, we have noticed several trends
arising from our analysis of several financial indicators that do not appear to be
benign. These issues will be detailed in the following sections.
2.1 Long term sustainable growth does not look promising
2.1.1 Indicators
Although DiGi’s financial performance is looking very healthy in the light of its
balance sheet and income statement reflecting asset growth and year-on-year
growth of topline revenue (refer to Appendix 1), we are concerned about its
prospects for future growth.
The following is a table showing some of the major financial indicators that have
raised our concerns over DiGi’s long term growth.
Indicators for DiGi 2006 2007 2008 2009 2010
Revenue growth rate 28.35% 19.04% 10.08% 1.68% 10.69%
Sustainable Growth Ratio 0.29 -0.11 -0.19 -0.25 -0.13
Equity Reserves (RM’000) 1,677,4
01
1,502,6
45
1,819,4
22
1,443,7
18
1,268,8
72
Altman Z-score 1.15 1.53 1.32 1.17 1.19
Dividend Cover 278.82 85.89 76.94 72.71 87.07
Diagram 2.1.1: Key financial indicators of DiGi related to long term growth
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
All of the Z-scores between 2006 and 2010 are below the 1.8 watermark, which
theoretically signals that the company is in distress9. While the z-scores do not
indicate that DiGi is in immediate danger of bankruptcy (especially when all
these indicators are taken in conjunction with DiGi’s strong cash flow and
balance sheet), it does however indicate that DiGi is in a grey zone that is fairly
worrying in terms of long term business sustainability should this trend continue
on.
As presented in the table above, it can clearly be seen that equity reserves have
also been declining steadily since 2008, even though overall revenue growth and
market share has been on the rise during the same period. Such divergent
trends warrant a closer look.
Also, one can see that DiGi’s dividend cover is substantially lower from 2007
onwards, and it appears to be trending downwards. Some improvement is seen
in 2010 which can be attributed to DiGi achieving its highest gross revenue
levels ever.
2.1.2 Root Cause
It appears that the biggest culprit causing the negative trend in the sustainable
growth ratio is the fact that DiGi has been aggressively and excessively
delivering more dividends back to the shareholders every year since 2007.
Looking at the dividend payout ratios listed in the table below, DiGi has been
paying out between 15% - 40% more than its net earnings as dividends every
year since 2007. This has had a detrimental effect on DiGi’s equity reserves and
has severely diminished retained earnings.
9 Investopedia, Altman Z-scores, available at: http://www.investopedia.com/terms/a/altman.asp#axzz1eKZSDomX (accessed on14th November 2011)
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
Indicators for DiGi 2006 2007 2008 2009 2010
Dividends per share 0.39 1.65 1.93 1.77 1.74
Dividends paid (RM'000)
288,9
00
1,237,3
51
1,500,6
92
1,376,1
75
1,352,8
50
Dividend Payout Ratio 0.36 1.16 1.32 1.38 1.15
Diagram 2.1.2: Key financial ratios related to dividend payout
2.1.3 Comparisons with XL and M1
The following graph shows the ability of each company to pay dividends to its
shareholders based on a factor of its earnings vis-à-vis their internal dividend
policy during a particular year. It appears that both DiGi and M1 are in a very
good position to carry out its targeted dividend payouts to its shareholders. In
XL’s case, their performance, especially in 2008 is simply not good enough to
justify high dividend returns.
Dividend Cover Comparison
2006 2007 2008 2009 20100.00
50.00
100.00
150.00
200.00
250.00
300.00
DiGiXLM1
Diagram 2.1.3: Comparison of dividend cover between DiGi, XL & M1
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The following graphs compare the sustainable growth rate and dividend payout
ratios between DiGi, M1 and XL. It is apparent that the sustainable growth rates
for XL and M1 are fairly volatile, quite possibly reflecting the dynamism of their
respective mobile telecommunications market.
DiGi, in comparison with XL and M1 appears to be the worst off among the three
in terms of this indicator, even though it is the only one among the three that
has consistently recorded an average of more than 10% revenue growth year-on-
year.
This is supported by the fact that DiGi appears to have the highest dividend
payout ratio among the three telcos, and is the only one among the three that is
consistently paying out more dividends than their net profits.
Dividend Payout Comparison
2006 2007 2008 2009 20100.00
0.20
0.40
0.60
0.80
1.00
1.20
1.40
1.60
1.80
DiGiXLM1
Diagram 2.1.4: Comparison of dividend payout ratio between DiGi, XL
Axiata & M1
M1 appears to have the most sensible dividend payout plan where the dividend
payout ratio is less than 1, which implies that they retain some earnings for
possible use in the future, while at the same time delivering value to their
shareholders. This is reflected in their sustainable growth indicators which are in
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
the positive region. The indicators appear low mainly because, as mentioned
earlier, the Singaporean mobile telecommunications market is already mature
and saturated.
Sustainable Growth Rates Comparison
2006 2007 2008 2009 2010
-0.30
-0.20
-0.10
0.00
0.10
0.20
0.30
0.40
0.50
DiGiXLM1
Diagram 2.1.5: Comparison of Sustainable growth rate between DiGi, XL &
M1
Having not made any dividend payments in 2008 and 2009 (despite a rapid
recovery from net loss in 2008 to net profit in 2009), XL’s low dividend return
policy is helping it achieve significant numbers in sustainable growth, as
compared with the other 2 telcos.
2.1.4 Recommendations
The current rate of dividend payouts is not conducive to long term growth. Cash
reserves will continue to dwindle, and it will place DiGi in a difficult position
should there be cash flow problems or a large purchase consideration. In the
light of the challenges that face DiGi in the medium term (e.g. spectrum auction
bidding, LTE rollout),
DiGi should consider being more conservative in managing it’s retained earnings
in order to be better equipped to deal with the capital expenditure and
operational expenses that will be incurred as a result of these challenges. Rather
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
than rely solely on long term financing in order to finance said expenditure, we
recommend that the current dividend policy be amended and revised to a much
lower rate to increase the amount of internally generated funds that will be
available to finance the required capital expenditure.
The maximum dividend payout rate should be set as a percentage of net profit
and be significantly below 100%. This will help arrest and reverse the decline in
shareholder equity, and help reduce financing costs in the annual income
statement. DiGi’s strong cash flow position should not be taken for granted to be
the main engine for servicing loans, especially when the global economic climate
is still uncertain ever since the global financial crisis of 2009.
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
2.2 Net Profit Margins are not growing in tandem with revenue growth
2.2.1 Indicators
DiGi has seen consistent revenue growth from 2006 to 2010, during which
revenue has increased almost 50% from RM3.6 Billion in 2006 to 5.5 Billion in
2010. Over the same period however, this growth did not translate into a parallel
increase in profit margin growth. In fact, gross operating margin has been
decreasing since 2008 to 2010.
Diagram 2.2.1 illustrates the general trend between Gross Revenue, Gross
Operating Margin, EBITDA Margin and Net Profit Margin.
3,702,100
4,407,025
4,851,056 4,932,640
5,459,851
2006 2007 2008 2009 2010
Comparison between revenue growth against margin
Total Revenue79.0% 79.8% 77.5% 76.3% 74.3%
46.3% 48.3%45.0% 42.5% 43.4%
21.8% 24.1% 23.5%20.3% 21.6%
Gross operating marginEBITDA margin
Net Profit margin
Diagram 2.2.1: Comparison between revenue against margins
Table 2.2.2 illustrates the growth rates for revenue, Gross Operating Margin and
EBITDA margin. From Table 1.1 it is clear that revenue has had a consistent
positive growth where as gross operating margin has been consistently
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
contracting from 2008 to 2010. The important issue that is revealed here is that
both revenue growth and gross operating margin are trending divergently.
Year
2007 2008 2009 2010
Revenue Growth Rates
19.04
% 10.08% 1.68%
10.69
%
Gross Operating Margin Growth
Rate 1.12% -2.86% -1.54%
-
2.79%
EBITDA Margin Growth Rate 4.17% -6.75% -5.50% 2.10%
Diagram 2.2.2: Growth rate for revenue, gross operating margin & EBITDA
margin
The positive growth in DiGi’s EBIDTA for the year 2010 (refer to Table 2.2.2) was
due largely to internal cost savings initiatives10. OPEX (excluding traffic charges)
only grew a marginal 1.25% from 2009 to 2010. These internal cost reductions
also helped to offset the large increase in material cost in 2010.
These internal cost saving efforts even though effective in the short term will be
hard to maintain over an extended time frame. At present DiGi has already
reached a high level of efficiency relative to XL and M1 (refer to Diagram 2.2.5
below).
10 Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd.
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2.2.2 Comparison with XL Axiata and M1
XL Axiata shows a strong correlation between revenue growth and gross
operating margin growth.
Diagram 2.2.3: Revenue & Gross Operating Margin trend of XL Axiata
In contrast with XL, M1 displays a similar trend as DiGi where gross operating
margin is declining even though revenue is growing. According to a CIMB
Research Report11, the margin erosion of Telcos in Singapore is due to increased
smartphone subsidies and high startup cost of next generation broadband
network.
11Kelvin Goh (2011), “Telecommunication, Muffled by regulation and competition”, CIMB Research Reports (17 Feb 2011). CIMB Bhd.
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Diagram 2.2.4: Revenue & Gross Operating Margin trend of M1
2006 2007 2008 2009 20100.0%
10.0%
20.0%
30.0%
40.0%
50.0%
60.0%
70.0%
OPEX/revenue trend
DigiXL AxiataM1
Perc
enta
ge
Diagram 2.2.5: Comparison of OPEX/Revenue between DiGi, XL Axiata & M1.
The similar profit margin trends of DiGi and M1 can possibly be attributed to the
fact that they are operating in markets where mobile penetration is above 100%,
and therefore we can infer that they are subject to keener competition to acquire
more subscribers and reduce subscriber churn. XL Axiata, on the other hand,
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
operates in a market with 85% penetration, which by definition, is still a growing
market.
2.2.3 Root cause analysis
The two major components of gross operating margin are revenue and cost of
service (COS) consists of traffic charges and material costs12. The traffic cost has
had a higher growth rate compared to revenue from the year 2007 to 2009. This
results in a decreasing gross operating margin.
2007 2008 2009 20100.00%
5.00%
10.00%
15.00%
20.00%
25.00%
30.00%
Revenue Vs. Traffic Charges
RevenueTraffic Charger
Grow
th R
ate
Diagram 2.2.6: Growth rate of revenue and traffic charges
DiGi has relatively smaller network coverage in Malaysia in comparison with
Maxis and Celcom13, thus DiGi has had to be reliant on Celcom & Maxis networks
for coverage via inter-connection agreements.
Traffic charges refer to interconnect charges and domestic roaming charges.
When DiGi customers make calls to a non-DiGi number, DiGi will have to pay
interconnect charges to the other mobile network operator. When DiGi
12 Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd.
13 Insider Asia, 2011, Steady Gains seen for DiGi, available at: http://www.theedgemalaysia.com/in-the-financial-daily/190317-steady-gains-seen-for-digi.html (accessed on 7th November 2011)
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
customers are outside DiGi’s network coverage area, they are able to utilise
other Malaysian mobile operators’ network infrastructure to make calls. DiGi will
incur “Domestic roaming” charges when such calls are made.
2006 2007 2008 2009 20100.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
Traffic Charges as a percentage of revenue
DigiXL AxiataM1
Perc
enta
ge
Diagram 2.2.7: Traffic charges as a percentage of revenue
A recent trend contributing to service cost is the cost of material which jumped
from 62 million in 2009 to 217 million in 2010. This 250% increase is due to the
high cost of subsidy of mobile devices14. DiGi has started promoting mobile
broadband services bundled with mobile devices. These devices such as iPhone,
BlackBerry and Galaxy Tabs are heavily subsidised to encourage take up. It is
expected that in the long run, monthly subscription charges will help offset these
subsidies. Smartphone subsidies are usually intended to accelerate the take-up
rate of mobile internet services15.
The revenue growth rate is slowing due to a steady decline in ARPU, despite a
continuous growth in subscriber base. The trend in decreasing ARPU is driven by
price reduction and substitution by cheaper services16. In our opinion, traditional
14Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd.15Financial Daily, (2010), DiGi Prepaid Revenue gains traction, available at:
http://www.theedgemalaysia.com/in-the-financial-daily/165458-digi-prepaid-revenue-gains-traction.html (accessed on 7th November 2011)
16MCMC (2007), Trends and Markets in Malaysian Mobile Services, volume 5, Malaysian Communications and Multimedia Commission
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services, such as voice & SMS (short messaging service), will continue to
experience extensive pricing pressures because of they are considered a
commodity, and are subject to the vagaries of price competition. In addition,
online services such as instant messaging and VOIP calls tend to cannibalise SMS
and voice services revenue, resulting in overall lower ARPU.
0
20
40
60
80
100
120
2006 2007 2008 2009 2010
Ring
git
MA
lays
ia (
RM)
DIGI ARPU
Prepaid
Postpaid
Blended
Diagram 2.2.8: DiGi’s ARPU trend from 2006 to 2010
2.2.4 Recommendations
Increase ARPU
Although the industry trend is towards lower ARPU, clear strategies can be
adopted to improve ARPU:
a) Grow customer segment with higher ARPU
b) Encourage use of Value Added Services (VAS)
High ARPU customer segments are postpaid customers and especially corporate
postpaid customers. As illustrated in Diagram 2.2.8, postpaid ARPU is almost
twice that of prepaid ARPU. Currently, prepaid users form 80% of DiGi's customer
base. A higher percentage of postpaid customers will help increase the blended
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
ARPU. VAS such as ring tones, Mobile Application sales can help to increase
ARPU. More marketing effort should be focused on popularising VAS among the
customer base. DiGi should also look into identifying “killer” apps/services that
can be used to spearhead the growth in VAS.
Reduce Cost of Traffic
Cost of traffic can be addressed via an expansion of DiGi’s network infrastructure
or via strategic partnerships with a local telco operator. The option to expand
DiGi’s network will be a very capital intensive option and would take a
considerable amount of time to realise its financial benefit. As such we
recommend a strategy to enter in a strategic alliance with Celcom to share
network infrastructure for 2G & 3G services. DiGi and Celcom are already
collaborating to share transmission towers17. Further detailed study on the
structure/framework of the network sharing will need to be conducted. DiGi
should focus CAPEX expenditure on developing 4G (LTE) network infrastructure.
2.3 Gearing is increasing
DiGi’s gearing has been increasing dramatically since 2008, (refer to Diagram
2.3.1). The steep rise in gearing in 2009 was due to long term borrowings
jumping from RM 100 million in 2008 to RM 772 million in 2009.
17Sidhu B.K. (11 Jun 2010). Celcom and DiGi to collaborate, The Star[Online]. Available at: http://biz.thestar.com.my/news/story.asp?file=/2010/6/11/business/6448138&sec=business [accessed on 22 November 2011]
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2006 2007 2008 2009 20100.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
0.90
Gearing trend
Gearing (Debt/Equity) ratioGearing (Debt/EBIDTA)
Ratio
Diagram 2.3.1: DiGi’s gearing is trending upwards
This increase can be attributed to the implementation of DiGi’s plans to
modernise its infrastructure to improve the quality of its service as well as to
drive cost efficiency18. DiGi has invested a total of RM720 million in capital
expenditure, of which a substantial portion was allocated for expanding its
mobile broadband and mobile internet footprint. It also enhanced the capacity
and quality of its 2G network to serve its growing number of customers19.
18Hendrik Clausen (2011) , Analyst Briefing, 22 September 2011, DiGi Bhd19DiGi.com Bhd. 2011, Annual Report 2009 – 2010 [online]. Available at
http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=6 (Accessed 15 November 2011)
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
2006 2007 2008 2009 20100
200000400000600000
80000010000001200000
1400000160000018000002000000
DiGi's Debt to Equity Progression
EquityDebt
Axis Title
Chart 2.3.2: DiGi’s Debt-to-Equity progression over five years
In comparison to XL Axiata and M1, DiGi still has a relatively low gearing rate as
measured by debt/EBITDA. However, DiGi’s debt level looks large when
measured by debt/equity due to DiGi’s small and shrinking equity.
2006 2007 2008 2009 20100.00
0.50
1.00
1.50
2.00
2.50
3.00
3.50
4.00
Gearing Trends (DEBT/EBIDTA)
DIGIXL AxiataM1
Ratio
Diagram 2.3.3: Gearing (Debt/EBITDA) trend of XL Axiata & M1
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
DiGi has strong cash flow from operations that allows us to easily cover our
interest obligations20. The figure below compares the interest cover between
DiGi, XL Axiata & M1. Prior to 2009, DiGi had a far superior interest cover rate to
the other two telcos. However, DiGi’s interest cover has since been trending
downwards and in 2010 was below that of M1.
2006 2007 2008 2009 20100.00
20.00
40.00
60.00
80.00
100.00
120.00
140.00
Interest cover
DIGIXL AxiataM1
Ratio
Diagram 2.3.4: Comparison of Interest cover trend between DiGi, XL & M1
Historically speaking, DiGi’s debt levels and ability to service those debts
appears more favourable in comparison with M1 and XL. However, DiGi’s debt
levels seem to be increasing, and although interest cover is still very much in the
positive, it has dropped dramatically since 2008 and is now slightly below that of
M1.
Steps should be taken to reverse this declining trend. Our recommendation is not
to take on further debt unless absolutely necessary. Instead of the debt market,
we recommend the following two sources for additional cash:
a) Internally generated funds from increased retained earnings
20 Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd.
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
b) Additional capital from shareholders
2.4 Short term liquidity is of concern
Diagram 2.4.1 illustrates the overall trend of the acid test ratios for DiGi, XL
Axiata & M1. DiGi has the lowest relative short term liquidity as measured by the
acid test ratio from 2007 to 2010. Between 2007 and 2010, the short term
liquidity levels have been holding steady.
2006 2007 2008 2009 20100.00
0.10
0.20
0.30
0.40
0.50
0.60
0.70
0.80
Acid Test
DigiXL AxiataM1
Acid
test
ratio
Diagram 2.4.1: Acid test ratios as a measure of short term liquidity
Given that DiGi has consistently had these low levels of short term liquidity in the
last 5 years and yet have still been able to grow in terms of revenue and
subscriber base, as well as being able to invest in infrastructure, we see no
reason to be overly alarmed over the results of the acid test. However, to be on
the safe side, short term financing should be arranged and kept as a back-up in
order to mitigate short-term liquidity risks.
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
2.5 Special Note: ROE is distorted by capital structure
While the following indicators do not impact on our study of DiGi’s growth
potential, the anomalies presented by these indicators are worth noting.
ROE has shown a strong growth since 2006 to 2010. In the same time period,
ROA and ROCE have been relatively flat.
2006 2007 2008 2009 20100.0%
10.0%20.0%30.0%40.0%50.0%60.0%70.0%80.0%90.0%
100.0%
Measures of return
ROEROAROCE
Perc
enta
ge R
etur
n
Diagram 2.5.1: ROE is diverging from other measures of return such as ROA &
ROCE
Diagram 2.5.1 compares the Financial Leverage Coefficient (ROE/ROA) between
DiGi, XL Axiata and M1. DiGi has the highest coefficient among the three telcos.
This indicates that DiGi has a high debt to equity ratios (gearing) as compared to
the other telcos.
Telco 2010
DiGi 3.99
XL Axiata 1.83
M1 2.97
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
Diagram 2.5.2: Financial leverage coefficients for the year 201
The diagram below illustrates the three key drivers of ROE and their values from
2006 to 2010. It is clear that financial leverage has grown significantly where net
profit margin has declined and asset turnover only grew marginally. As such we
can confidently conclude that the growth in ROE is primarily driven by the growth
in financial leverage.
ROE decomposition 2006 2007 2008 2009 2010
Net Profit margin 21.8% 24.1% 23.5% 20.3% 21.6%
Asset turnover 0.91 1.14 1.04 1.04 1.06
Financial leverage 2.32 2.45 2.45 3.11 3.81
ROE 45.97% 67.35% 60.13% 65.76% 87.48
%
Diagram 2.5.3: Key drivers of ROE
Financial leverage is growing due to increase in borrowing and a reduction in
shareholder equity due to reduction in retained earnings. Retained earnings have
been declining due to dividend payouts exceeding net profit for the last several
years.
DiGi conducted two capital repayment exercise in 2005 and 2006 respectively21.
More than RM1 billion was paid out in these two capital repayments exercises
21 DiGi, 2006, Press Release, available at: http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=2661&pgPoint=4&year=2006 (accessed on 5th November 2011)
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
resulting in a large drop in shareholder capital. Shareholder capital experienced
a 90% drop from the year 2005 (RM 750 million) to the year 2006 (RM 75
million).
As the ROE figures are not a good reflection of DiGi’s performance, we
recommend that it not be used as the critical measure to evaluate true
performance. We recommend to utilise ROA & ROCE as a more realistic measure
of the company’s performance.
We also recommend that for future cash needs that we consider raising new
capital. This could be done via rights issues to all current shareholders or sales of
new shares to strategic partners.
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
3.0 CONCLUSION
3.1 Approaching Milestones
There are several challenges that await DiGi in the medium to long term
that will have significant financial implications.
3.1.1 Telecommunications Spectrum Re-farming22
The next few years will see the expiry of various blocks of spectrum
currently held and utilized by the local telecommunications providers. This
will lead to a bidding war between the major players for the spectrum
blocks, as the incumbents (such as Maxis and Celcom) will strive to
protect their currently held spectrum and other players, such as DiGi will
attempt to acquire more spectrum blocks. This means that DiGi will incur a
large capital expenditure in the next couple of years23.
3.1.2 3G License Expiry
DiGi’s current 3G license is sub-leased from Time Dot Com Berhad and is
due to expire in 201824. DiGi will need to be able to finance the renewal of
the lease, which will cost at least another RM695 million25.
3.1.3 Long Term Evolution Rollout
In order to maintain its’ positioning in the mobile broadband space, DiGi
will need to invest a lot of capital expenditure in LTE technology that will
22Surin Murugiah, The Edge (2010), Spectrum Refarming in the Works, available at http://www.theedgemalaysia.com/in-the-financial-daily/166717-spectrum-refarming-in-the-works.html (accessed on 7th November 2011)
23Fong Min Hun, The Edge (2010), Spectrum Refarming could see Telcos Capex Rise, available at: http://www.theedgemalaysia.com/features/168450-corporate-spectrum-refarming-could-see-telcos-capex-rise.html (accessed 7th November 2011)
24Telenor, 2011, DiGi Business Description, available at: http://www.telenor.com/en/investor-relations/company-facts/business-description/DiGi (accessed on 7th November 2011)
25MIDF Research, 2009, Equity Beat (DiGi.com Bhd), available at: http://www.midf.com.my/project/midf/media/2009/05/04/094112-183.pdf (7th November 2011)
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
further enhance its’ mobile data offerings which is 4 times faster than the
current HSPA+ technology26. LTE is widely considered as 4G technology
and is the next logical step in the technological evolution of the mobile
telecommunications industry27.
26 DiGi, 2011, Press Release, available at: http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=6280&pgPoint=3&year=2011 (accessed on 7th November 2011)
27Ayvazian. B, (March 2011), Heavy Reading, LTE Operator Business Case and Adoption Forecast, pp. 3-5.
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
3.2 Summary of Recommendations
The milestones mentioned above poses a significant financial challenge on future
cash flow for DiGi, and DiGi needs to be financially prepared to meet these
challenges. Over the past 3 years, the strategy to ensure high short term returns
to the shareholders has diminished the net assets of the company. In order to
arrest this development, DiGi shareholders must be persuaded to take a long
term view of the business, especially in the light of today’s uncertain economic
climate, both globally and locally.
The following is a recap our key recommendations to address the highlighted
concerns.
Maximum dividend payout policy to be set at well below 100% of
net profit
Implement strategies to grow net profit margins via increased ARPU
and reduced traffic costs
Future funding needs should be fulfilled via internally generated
funds or capital market rather than the debt market.
Short term debt facility should be arranged to mitigate short-term
liquidity risks.
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
4.0 APPENDIX
4.1 Financial Figures – DiGi Bhd28
Financial Ratios Description Year
2006 2007 2008 20092010
Profitability Analysis
Net Profit marginNet profit after tax /Sales
21.8%24.1
%23.5
%20.3%
21.6%
Gross operating margin
Sales less Cost of sales/sales
79.0%79.8
%77.5
%76.3%
74.3%
Net operating marginNet profit before interest and tax/sales
28.9%32.5
%31.6
%26.9%
28.3%
EBITDA margin EBITDA/sales 46.3%48.3
%45.0
%42.5%
43.4%
Return on equity (ROE)
Net profit after tax/equity
46.0%67.4
%60.1
%65.8%
87.5%
Return on assets (ROA)
Net profit before interest/Total assets
19.4%27.0
%24.2
%20.3%
21.9%
Return on capital employed (ROCE)
Net profit before interest on LT-debt/Equity + LT-debt
38.5%58.9
%56.5
%41.9%
46.5%
Financial leverage coefficient
ROE/ROA 2.4 2.5 2.5 3.2 4.0
Asset Utilisation Analysis Total asset turnover sales/total assets 0.91 1.14 1.04 1.04 1.06
Long-term asset turnover
Sales/non current assets
1.26 1.50 1.25 1.28 1.43
Receivables turnover(Net credit) Sales/Receivables
14.75 12.53 11.53 11.7312.4
9
OPEX (excluding COGS)/Revenue
33% 32% 33% 34% 31%
Traffic charges / revenue
18.8%19.0
%21.5
%22.6%
21.9%
Financial Strength Analysis Long-term solvency risk Analysis
Gearing (Debt/equity ratio)
Debt/equity 0.171 0.190 0.207 0.6060.80
0
Interest coverProfit before interest and tax/Net interest charges
67.61193.92
4124.1
4332.66
529.9
15
Dividend coverEarnings per share/Dividend per share
278.81685.88
976.93
772.71
287.0
69
Debt/EBITDA 0.175 0.141 0.179 0.4390.45
4
Interest/EBITDA 0.009 0.007 0.006 0.0190.02
2Short-term liquidity risk Analysis
Current ratioCurrent assets/Current liabilities
0.69 0.54 0.34 0.43 0.59
Acid test (or quick ratio)
Current assets – Inventories/Current liabilities
0.68 0.21 0.20 0.22 0.21
28 Derived from DiGi Berhad Annual Reports 2006-2010
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
Financial Ratios Description Year
2006 2007 2008 20092010
Days inventory outstanding
(Inventories/Cost of sales)* 365
408.71236.9
8110.8
6134.1
0221.
10
Credit given(Receivables/credit sales)*365
Credit obtained(Trade payables/cost of sales)*365
586.81484.5
7499.8
4445.4
6477.
86Strategic Ratios
Dividend payout ratios
Dividend / Earnings attributable to shareholders
0.359 1.164 1.316 1.3761.14
8
Sustainable growthROE x (1 – Dividend payout ratio)
0.295-
0.111-
0.190-0.247
-0.13
0Financial leverage coefficient
ROE/ROA 2.373 2.494 2.481 3.2423.98
9
Operational Gearing 0.7230970
82
0.7582390
3
0.8325889
7
0.81529712
8
0.740923
3 ROE decomposition
Net Profit marginNet profit for the period/Sales
21.8%24.1
%23.5
%20.3%
21.6%
Asset turnover sales/total assets 0.91 1.14 1.04 1.04 1.06
Financial leverage total Assets/equity2.3260355
36
2.4577715
5
2.4541011
6
3.11044596
4
3.814458
ROE 45.97%67.35
%60.13
%65.76
%87.4
8%Net assets per share (RM)
2.34 2.1 2.44 1.96 1.73
General Ratios
Revenue growth rate 28.35%19.04
%10.08
%1.68%
10.69%
Traffic charges growth rate
20.76
%24.59
%7.28%
7.01%
Traffic charges / revenue
19% 19% 21% 23% 22%
Cost of material growth rate
-
33.74%
-3.71
%8.76%
250.56%
EBITDA margin growth rate
4.17
%
-6.75
%
-5.50%
2.10%
Gross operating margin growth
1.02
%
-2.90
%
-1.62%
-2.60
% ARPU Prepaid 50 56 54 49 46 Postpaid 96 92 89 84 83 Blended 54 59 59 55 52
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
4.2 Financial Figures – XL Axiata29
Financial Ratios Description Year 2006 2007 2008 2009 2010Profitability Analysis
Net Profit marginNet profit after tax /Sales
10.1% 3.0% -0.1% 12.3% 16.4%
Gross operating margin
Sales less Cost of sales/sales
72.4% 77.2% 80.3% 84.1% 85.9%
Net operating margin
Net profit before interest and tax/sales
15.9% 21.0% 14.4% 17.8% 29.3%
Return on equity (ROE)
Net profit after tax/equity
15.23%
5.62%-
0.35%19.41%
24.68%
Return on assets (ROA)
Net profit before interest/Total assets
8.0% 4.8% 3.7% 10.6% 13.5%
Return on capital employed (ROCE)
Net profit before interest on LT-debt/Equity + LT-debt
9.8% 7.6% 4.8% 13.6% 16.2%
Financial leverage coefficient
ROE/ROA 1.9 1.2 -0.1 1.8 1.8
Asset Utilisation Analysis
Total asset turnover
sales/total assets 0.51 0.44 0.42 0.51 0.65
Long-term asset turnover
Sales/non current assets
1.07 1.14 0.66 1.10 1.61
Credit given(account receivable/total credit sales)*365
13.14 14.21 28.39 8.85 9.55
Credit obtained(trade payable/cost of sales)*365
226.09 259.90195.2
5102.16 74.15
Traffic charges / revenue
18.97%
19.15%19.04
%14.80%
13.20%
Financial Strength Analysis
Long-term solvency risk Analysis
Gearing (Debt/equity ratio)
Debt/equity 1.72 2.16 4.35 1.53 0.87
Interest coverProfit before interest and tax/Net interest charges
2.82 2.74 1.60 2.04 6.62
Dividend coverEarnings per share/Dividend per share
9.71 1.77 - - 3.18
Debt/EBITA 2.87 2.75 3.65 2.17 1.10 Interest/EBITA 0.14 0.18 0.21 0.19 0.08Short-term liquidity risk Analysis
Current ratioCurrent assets/Current liabilities
0.51 0.24 0.60 0.33 0.49
Acid test (or quick ratio)
Current assets – Inventories/Current liabilities
0.51 0.24 0.60 0.33 0.47
Credit given(Receivables/credit sales)*365
35.43 58.91146.0
055.21 50.27
Credit obtained (Trade payables/cost of 226.09 259.90 195.2 102.16 74.15
29 Derived from XL Axiata Financial Statements (2006-2010)
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
Financial Ratios Description Year 2006 2007 2008 2009 2010
sales)*365 5Strategic Ratios
Dividend payout ratios
Dividend / Earnings attributable to shareholders
0.1027607
0.56494024
0 00.315
289
Sustainable growth
Sustainable growth = ROE x (1 – Dividend payout ratio)
13.7% 2.4% -0.3% 19.4% 16.9%
Operating Gearing
–LT assets /Total assets0.9063
0690.9106
43050.871
3640.92669
8320.918
242ROE
Decomposition
Net Profit
marginNet profit for the period/Sales
10.1% 3.0% -0.1% 12.3% 16.4%
Asset turnover sales/total assets 0.51 0.44 0.42 0.51 0.65
Financial
leveragetotal Assets/equity
2.9518804
4.21075028
6.711003
3.110303306
2.326163
ROE15.23
%5.62%
-0.35%
19.41%24.68
%General Ratios
Revenue growth rate
29.37%45.32
%14.18%
27.07%
EBITDA growth rate
71.21%-
0.40%40.56%
109.58%
Gross operating margin growth
6.65% 4.02% 4.75% 2.12%
OPEX(excluding COGS)/revenue
34.38%
37.43%40.99
%42.85%
36.33%
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
4.3 Financial Figures – M130
Financial Ratios Description Year 2006 2007 2008 2009 2010Profitability Analysis Net Profit margin Net profit after tax /Sales 21.3% 21.4% 18.7% 19.2% 16.0%
Gross operating margin
Sales less Cost of sales/sales 65.0% 63.1% 62.4% 57.8% 49.8%
Net operating margin
Net profit before interest and tax/sales
28.4% 25.4% 24.1% 23.2% 20.0%
Return on equity (ROE)
Net profit after tax/equity 43.1% 85.1% 67.2% 58.7% 51.9%
Return on assets (ROA)
Net profit before interest/Total assets
16.6% 21.4% 19.6% 18.7% 17.4%
Return on capital employed (ROCE)
Net profit before interest on LT-debt/Equity + LT-debt
40.4% 35.9% 30.1% 56.2% 29.5%
Financial leverage coefficient
ROE/ROA 2.6 4.0 3.4 3.1 3.0
Asset Utilisation Analysis
Total Asset Turnover Sales/Total Assets 0.73 0.95 1.00 0.93 1.05
Long-term Asset Turnover
Sales/Non-current Assets 0.99 1.12 1.16 1.12 1.40
Inventory Turnover Cost of sales/inventory 48.64 35.41 35.36 13.00 21.01
Receivables Turnover
(Net credit) Sales/Receivables 9.43 9.94 11.56 8.95 5.49
traffic charges/revenue
-17.3% -20.3% -21.6% -24.2% -19.9%
COGS/revenue -0.35 OPEX (excluding traffic charges)/revenue -55.1% -54.6% -54.5% -52.8% -60.3%Financial Strength Analysis
Long-term solvency risk Analysis
Gearing (Debt/equity ratio)
Debt/equity 0.65 1.41 1.12 1.05 1.04
Interest CoverProfit before interest and tax/Net interest charges
21.37 21.53 25.42 28.10 33.59
Dividend per Share 0.261 0.108 0.145 0.134 0.134
Dividend CoverEarnings per share/Dividend per share
63.67 171.00 115.88 125.53 130.28
1.1Gearing (Debt/EBIDTA) 0.75 0.89 0.79 0.87 1.01Short-term liquidity risk Analysis
Current ratioCurrent assets/Current liabilities
0.51 0.44 0.48 0.28 0.78
Acid test (or quick ratio)
Current assets – Inventories/Current liabilities
0.50 0.41 0.44 0.23 0.70
Days inventory outstanding
(Inventories/Cost of sales)* 365
-3.63 -5.07 -5.10 -15.39 -10.88
Credit given(Receivables/credit sales)*365
38.70 36.73 31.57 40.76 66.44
Credit obtained(Trade payables/cost of sales)*365
-131.13
-120.02
-93.73 -92.82 -73.62
Strategic Ratios
Dividend payout ratiosDividend / Earnings attributable to shareholders
1.57 0.56 0.86 0.80 0.77
Sustainable growthROE x (1 – Dividend payout ratio)
-0.25 0.37 0.09 0.12 0.12
30 Derived from M1 Financial Statements (2006-2010)
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
Financial Ratios Description Year 2006 2007 2008 2009 2010
Operating GearingTotal Non-Current Assets / Total Assets
0.74 0.85 0.86 0.83 0.75
ROE Decomposition Financial Leverage Total Assets / Total Equity 2.76 4.19 3.60 3.27 3.09 Net Profit margin 21.3% 21.4% 18.7% 19.2% 16.0% Debt to Assets LT Debt / Total Assets 0.00 0.30 0.31 0.00 0.27
2.1ROENet Profit Margin x Total Asset Turnover x Financial Leverage
43.09%
85.09%
67.24%
58.69%
51.85%
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
4.4 References
Axiata Group Berhad (2010), 3rd Quarter 2010 Analyst and Investor Briefing, 24th November 2010, Axiata Group Berhad
Ayvazian. B, (March 2011), Heavy Reading, LTE Operator Business Case and Adoption Forecast, pp. 3-5.
Central Intelligence Agency, World Factbook, available at: https://www.cia.gov/library/publications/the-world-factbook/index.html (accessed on 9th November 2011)
DiGi.com Bhd. 2011, Annual Report 2005 – 2010 [online]. Available at http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=6 (Accessed 15 November 2011)
DiGi.com Bhd. 2011, Quarterly Financial Report Q1 2006 – Q4 2010 [online]. Available at http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=3 (Accessed 15 November 2011)
DiGi.com Bhd. 2011, Quarterly Analyst Breifing Q1 2006 – Q4 2010 [online]. Available at http://www.DiGi.com.my/aboutDiGi/investor/index.do?sec=3 (Accessed 15 November 2011)
DiGi, 2006, Press Release, available at: http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=2661&pgPoint=4&year=2006 (accessed on 5th November 2011)
DiGi, 2011, Press Release, available at: http://www.DiGi.com.my/aboutDiGi/media/mr_press_det.do?id=6280&pgPoint=3&year=2011 (accessed on 7th November 2011)
Financial Daily, (2010), DiGi Prepaid Revenue gains traction, available at: http://www.theedgemalaysia.com/in-the-financial-daily/165458-digi-prepaid-revenue-gains-traction.html (accessed on 7th November 2011)
Fong Min Hun, The Edge (2010), Spectrum Refarming could see Telcos Capex Rise, available at: http://www.theedgemalaysia.com/features/168450-corporate-spectrum-refarming-could-see-telcos-capex-rise.html (accessed 7th November 2011)
Hendrik Clausen (2011), Analyst Briefing, 22 September 2011, DiGi Bhd.
Hendrik Clausen and Terje Borge (2011), Results Briefing Q4 2010, DiGi Bhd.
Insider Asia, 2011, Steady Gains seen for DiGi, available at: http://www.theedgemalaysia.com/in-the-financial-daily/190317-steady-gains-seen-for-digi.html (accessed on 7th November 2011)
Investopedia, Altman Z-scores, available at: http://www.investopedia.com/terms/a/altman.asp#axzz1eKZSDomX (accessed on14th November 2011)
Kelvin Goh (2011), “Telecommunication, Muffled by regulation and competition”, CIMB Research Reports (17 Feb 2011). CIMB Bhd.
MCMC (2007), Trends and Markets in Malaysian Mobile Services, volume 5, Malaysian Communications and Multimedia Commission
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Accounting & Finance (N14M01)Strategic Financial Review of DiGi.Com Berhad
MIDF Research, 2009, Equity Beat (DiGi.com Bhd), available at: http://www.midf.com.my/project/midf/media/2009/05/04/094112-183.pdf (7th November 2011)
MobileOne Ltd, (2011) Investor Presentation Jan 2011, available at: http://m1.com.sg/M1/CMA/About_Us/Corporate_Information/IR/PDF/Investor%20Presentation%2019%20Jan%202011.pdf (accessed on 7th November 2011)
MobileOne Ltd. (2011), Annual Report 2006 – 2010 [online]. Available at http://www.m1.com.sg/M1/site/M1Corp/menuitem.faca305fb9985217f15a947b3f2000a0/?vgnextoid=ad241b7faba72010VgnVCM100000275a160aRCRD&vgnextfmt=pdate:1111202212: (Accessed 15 November 2011)
PT XL Axiata Tbk. 2011, Annual Report 2006 – 2010 [online]. Available at http://www.xl.co.id/investor-relation/language/en-GB/CompanyReports/Annual (Accessed 15 November 2011)
PT XL Axiata Tbk. 2011, Quarterly Report Q1 2006 – Q4 2010 [online]. Available at http://www.xl.co.id/investor-relation/language/en-GB/CompanyReports/Quarterly (Accessed 15 November 2011)
Sidhu B.K. (11 Jun 2010). Celcom and DiGi to collaborate, The Star[Online]. Available at: http://biz.thestar.com.my/news/story.asp?file=/2010/6/11/business/6448138&sec=business [accessed on 22 November 2011]
Surin Murugiah, The Edge (2010), Spectrum Refarming in the Works, available at http://www.theedgemalaysia.com/in-the-financial-daily/166717-spectrum-refarming-in-the-works.html (accessed on 7th November 2011)
Telenor, 2011, DiGi Business Description, available at: http://www.telenor.com/en/investor-relations/company-facts/business-description/DiGi (accessed on 7th November 2011)
Websites:
DiGi Berhad, www.digi.com.my
XL Axiata, www.xl.co.id
MobileOne, www.m1.com.sg
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