We did a deep dive into Microsoft’s recently announced USD2.2b (RM10.4b) investment in Malaysia in cloud computing and related advanced technologies, including Generative AI (GenAI). We identified TM as a key beneficiary as this will result in a surge in data transmission for data centres (DC) that host public and private clouds. Acknowledging that the earnings impact may not be immediate, we keep our forecasts and TP of RM7.22. Maintain OUTPERFORM.

Multibillion cloud and AI investments. Microsoft’s investments include: (i) building cloud and AI infrastructure in Malaysia, (ii) establishing the national AI Centre of Excellence to drive AI adoption across key industries, (iii) collaboration with the government via the Perisai Siber initiative to enhance cybersecurity, and (iv) supporting the growth of Malaysia’s developer community. This is coherent with Microsoft’s earlier plans back in 2021 to establish its first DC region in Malaysia under its Bersama Malaysia initiative.

Hot on the heels of Amazon’s outlay. Meanwhile, Amazon Web Services (AWS) announced last month that it plans to invest USD6b over 14 years (until 2037) to build the AWS Infrastructure Region in Malaysia.

This is in-line with Amazon’s plans to spend almost USD150b in the coming 15 years on DCs globally, according to Bloomberg. We believe this recent stream of multi-billion investments by hyperscalers are in anticipation of strong take-up of new cloud offerings powered by GenAI.

GenAI cloud services are hungry for storage. To recap, with the dawn of GenAI, organizations are accumulating and archiving vast amounts of data. GenAI-powered applications are able to analyze large data sets to generate outputs that enhance business, operational and research processes. Malaysian enterprises that have subscribed for cloud-based Gen AI solutions include:

(i) Petronas - Adopted Copilot for Microsoft 365 to enhance employee productivity and creativity. It has also leveraged on Azure OpenAI Service to boost operational efficiency, reliability, and employee safety.

(ii) Prudential Malaysia - Embedded an in-house AI tool in its call center via Azure OpenAI Service. Following this, the time required by the servicing team to gather product information for agents was reduced to less than 30 seconds (from 4 minutes previously).

Ramp up in DC capacity to cater to GenAI cloud. Nevertheless, even before the onset of GenAI, the proliferation of DCs in Malaysia to host private or public clouds has been ongoing since before 2020. This was after the Singapore government imposed a moratorium on new DC builds in 2019, in our view. Evidently, according to Structure Research, there is a substantial pipeline of new DC capacity in Johor and Cyberjaya in 2023-28, amounting to 331MW and 255MW, respectively. This translates to a multi-fold expansion from total current live capacity of 141MW for both regions.

High demand for submarine cables. Against this backdrop, we anticipate sustained strong demand for submarine cables and landings that connect DCs to global networks. Therefore, TM is able to capitalize on this via its established network of digital infrastructure. This includes: (i) 32 submarine cable systems covering 340k km with over 80 Tbps capacity, (ii) 29 global Points of Presence (PoPs), (iii) 90 in-country cache nodes, and (iv) 690k km of domestic fiber optics backhaul.

As a prelude to this, recall that in FY23, TM Global’s 9% YoY topline growth was mainly driven by increased managed wavelength services for hyperscalers. Key mega deliveries in FY23 by this segment include the provision of 35 Tbps of long-term leased connectivity for a US-based hyperscaler.

DC capacity expected to play catch-up. As illustrated above, hyperscalers are investing in DCs to cater to the surge in storage capacity requirements required by GenAI cloud offerings. Therefore, we believe this largely mitigates concerns of DC oversupply in Malaysia. Moreover, according to Cushman & Wakefield, co-location vacancy rates for DCs at Malaysia remain well below its regional peers at 17% currently. This is relatively healthy in comparison to Manila (55%), Ho Chi Minh (49%), Greater Jakarta (34%) and Bangkok (23%).

Timely to expand into hyperscale DC. Given the above, we believe the timing is ripe for TM is to embark on a significant expansion of its DC business. This is because new hyperscale DCs could leverage on TM Global’s extensive network of digital infrastructure assets. To recap, TM One’s existing portfolio comprises eight tier-3 DCs in Malaysia and one in Hong Kong. This translates to total capacity of 46MW over total white space of 269k sqft. The key centers include: (i) Klang Valley Core Data Centre (20MW) in Cyberjaya, and (ii) Iskandar Puteri Core Data Centre (20MW) in Johor.

Expect double-digit project IRR. For TM’s potential new hyperscale DC, we estimate project IRR of 12.6%, project payback period of circa 8 years and project NPV of 13 sen/share. This is underpinned by the following key assumptions:- (i) Tier-3 with 50MW capacity, (ii) capex per MW: USD7m, (iii) 90% leased out capacity based on co-location model, (iv) 80% debt financing over 10 years, (v) lease rate at 20% discount to Singapore market rates, (vi) lease tenure: 8-years (fixed) + 5 years (3 extensions each), (vii) 10% step-down in rental rates during each 5-year contract extension period, (ix) 18 month construction period, and (x) asset useful life: 20 years.

Forecasts. Maintained as the earnings impact from these recent opportunities is not immediate.

Valuations. We also keep our TP of RM7.22 based on 5.5x FY24F EV/EBITDA. There is no adjustment to our TP based on ESG given a 3-star rating as appraised by us (see Page 4).

Investment case. We like TM on account of: (i) it being leveraged towards secular data growth on the back of current trends such as digital transformation, proliferation of internet of things (IoT), Gen AI etc, (ii) it benefitting from JENDELA phase 2 projects via roll-out and monetization opportunities, and (iii) sustained traction in its cost optimisation initiatives. Maintain OUTPERFORM.

Risks to our call include: (i) higher-than-expected erosion in wholesale revenues from new Reference Access Offer prices, (ii) pricing pressures at the retail segment arising from policy-led directives, and (iii) irrational competition in the retail fiber broadband space.

Source: Kenanga Research - 9 May 2024