Margin squeeze affects Indonesia's mobile momentum - Price pressures hit world's sixth-largest mobile market despite strong growth

Indonesia is the sixth-largest country in the world in terms of mobile connections. By end of second-quarter 2008, the country had over 116 million connections and was growing by 50% a year. With mobile penetration still at only 50% of the population, connections growth is not expected to slow for the foreseeable future. Pakistan is the only market of a similar size with similar room for growth.

The country's current growth trajectory is typified by the recent revelation by mobile market-leader, Telkomsel, which claimed it had reached its full-year 2008 target of 60 million subscribers by the end of September. It has set itself a target of 10 million new subscribers next year.

Second-placed Indosat and third-placed Exelcom have grown at an even faster rate with annual second-quarter connections growth of 62% and 125%, respectively, according to our calculations. In the case of all three of the largest mobile operators, growth has been maintained despite strong progress by some of Indonesia's smaller players and new entrants. For example, Hutchison 3 Indonesia, which launched services in first-quarter 2007, was the eighth-fastest growing operator in Asia-Pacific in terms of annual connections growth in the second-quarter and already has over 3 million mobile connections.

However, increasing competition in the market has lowered prices and is putting pressure on margins. Telkomsel noted in its 1H 2008 financial report that strong customer additions and usage growth had failed to translate into operating revenue growth due to a significant drop in effective price per minute. ARPU at the operator stood at IDR63,000 (US$6.6) by the end of second-quarter 2008, down from IDR78,000 (US$8.2) in the year-earlier period. It is a similar situation at Indosat, which noted recently that its own margin growth is slowing due to aggressive competition, leading to higher subscriber acquisition and retention costs. Indosat's ARPU declined from IDR54,000 (US$5.7) in second-quarter 2007 to IDR41,000 (US$4.3) a year later. Recent interconnection regulations have also negatively impacted voice and non-voice revenue at some of the larger operators.

These margin pressures reflect the still developing nature of the market. The vast majority of Indonesia's mobile connections are prepaid, while high-speed networks and mobile data services are currently limited. According to our calculations, the three largest operators only had around 1 million WCDMA (including HSPA) connections each by the end of second-quarter 2008, despite launching high-speed networks over two years ago.

Matt Ablott, Analyst, GSMA Intelligence:

Strong mobile subscriber growth in Indonesia is set to continue for the foreseeable future and - as Telkomsel admitted recently - this will be vital for offsetting declining prices. High-speed networks and data services are still in their infancy but are already becoming a key contributor to profitability and margins. Indosat, for example, said that by the end of the second-quarter, revenue from non- SMS data services already accounted for 5% of ARPU. To date, capital expenditure at most Indonesian operators is concentrated on expanding network capacity to meet the growing subscriber base, but high-speed network build- out may be the key to sustaining profitability in the longer-term.