We downgrade our recommendation for P.T. Telekomunikasi Indonesia Tbk. (TLK) to Neutral following the company’s current valuation and increasing competition in the Indonesian telecom market.

Deregulation of telecom segment by the Indonesian Government has enabled several competitors to provide similar services at lower costs to subscribers. That country’s wireless service providers slashed prices in 2008 in order to capture market share. As a result, ARPU (average revenue per user) reduced across the industry. Major competitors of Telekomunikasi are P.T. Indosat Tbk. (IIT), and P.T. Excelcomindo Pratama.

Indonesia’s wireless users often switch service providers to take advantage of low promotional rates and available credit. About 10% of Telkomsel’s reported prepaid subscriptions still remain inactive. Moreover, in November 2009, Excelcom and Axis Telecom have signed an agreement for Indonesia’s first roaming network. The deal will allow Axis customers to use Excelcom’s network. Telekomunikasi may lose its market share if Axis further expands its operations in the country.

Telekomunikasi has decided to spread out its radio access network infrastructure throughout Indonesia. The company’s wireless division Telkomsel has decided to raise its capital expenditure to $1.4 billion in fiscal 2009, an increase of 25% over previous fiscal. This may put further pressure on the company’s leveraged balance sheet.

At the same time, current stock price is at the high end of its 52-week price range and moved up more than 53% in 2009. Despite facing competition, the company is exhibiting solid growth in cellular services and data & Internet revenue. Telekomunikasi commands 45% market share for both mobile and fixed-line telecom services in Indonesia. However, we believe these positive factors are already reflected in the current valuation leaving little room for above market gain.

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