Telecommunications

Not Out of the Woods Yet

Currently, the Malaysian Government is considering the viable options for Malaysia’s 5G network rollout, deliberating whether to adopt a Single Wholesale Network (SWN), Dual Wholesale Network (DWN), or other options. We opine that the government will most likely adopt the SWN model. In our view, the SWN model (via supply-led 5G rollout) presents downside risks to MNO’s profitability mainly as MNOs may have to pay upfront wholesale costs to Digital Nasional Berhad (DNB), even if MNOs are slow to monetize 5G services. The MNOs’ potentially less valuable 4G assets and sticky 4G capex further adds salt to the wound. However, we maintain our NEUTRAL call on the sector, as we have factored in said risks in our estimates/valuations. Our top pick for the sector is AXIATA, as its regional and digital businesses provide a hedge against said developments, which mostly impact domestic-only MNOs (i.e. DIGI, MAXIS).

Latest situation. Currently, while DNB continues to roll out the 5G single wholesale network, the government is considering the options for Malaysia's 5G network rollout, deliberating over whether to adopt a SWN, DWN, or other options, including scrapping the SWN plan. From a Reuters report and our channel checks, we gathered that there has been a group of unidentified telcos which proposed a DWN alongside DNB’s SWN to prevent risks of a single point of failure and to encourage some infrastructure competition. However, from our recent discussion with DNB and from DNB CEO Ralph Marshall's response to YB Dr. Ong Kian Ming's questions (as reported by The Edge), we opine that the government will most likely opt for the SWN model. There is no clear guidance on when the government's final decision will be announced, but we expect it to be in Feb/March.

SWN the most likely scenario. We share DNB's view that the cancellation of the SWN could bring severe risks and repercussions to the sector, government and nation. DNB pointed out that the premature termination of SWN could, among others: (i) bring early termination payments, (ii) adversely impact FDI inflow into Malaysia due to a loss of confidence, (iii) cause a delay in 5G network rollout, and (iv) widen the urban-rural digital divide. Furthermore, in DNB's view, a DWN would spell the end of DNB's wholesale network, likely due to wholesale competition, which would in turn, turn the once-secondary telco-led wholesale network into a private SWN monopoly. While DNB opines that the government is open to reducing its stake in SWN in 3 years, DNB is of the view that it must have the initial ownership of SWN to lead the cost recovery and supply-led approach of the rollout, mainly to expedite the rollout and narrow the urban-rural digital divide. Taking these factors into consideration, we believe the government will most likely opt for the SWN model, with DNB owning the SWN for the initial 3-5 years.

SWN model presents downside risks to MNOs' profitability. We foresee numerous factors that pose downside risks to MNOs' near/medium term (3~5 years) profitability. 1. MNOs have limited room to raise ARPU on 5G services, in our view. We predict that the MNOs' 5G services will not meaningfully lift service revenue, as the telcos are unlikely to raise 5G plan prices, due to: (i) stiff competition, and (ii) it going against the government's desire for affordable 5G mobile services. 2. Upfront wholesale costs. Because the SWN is supply-driven, we foresee that in the initial years of the rollout, MNOs may have to pay upfront wholesale fees while not earning much from 5G services due to: (i) potentially slow 5G adoption due to limited adoption of 5G handsets, and (ii) continued price competition from smaller MNOs/MVNOs. This puts the MNOs in a position where the incremental costs could potentially exceed incremental revenue. 3. Risk of accelerated D&A. We gathered that the MNOs' networks are currently 5G ready, as they have been procuring 4G/5G compatible equipment and preparing their networks for 5G. While we believe meaningful portions of their current networks will be merged with DNB's multi-operator core network (MOCN), there's a risk that the MNOs will see continued accelerated D&A (thus higher D&A expenses) on existing assets, such as existing spectrum, if they cannot be repurposed for 5G, or if their useful life is shortened in light of the SWN approach. 4. Continued 4G capex. In the coming 4-5 years, we foresee MNOs spending their current levels of capex (RM800m~RM1.2b per annum) on: (i) continued 4G expansion and network modernization, especially as 4G traffic continues to grow, and (ii) JENDELA initiatives to bridge the rural urban digital divide. Together, we believe these factors pose downside risks to the MNO's profitability in the near/medium term.

Factored in TPs, maintain NEUTRAL. We maintain our neutral view, as we have largely factored in the downside risks into our lower valuations. However, that said, should these risks turn out to be worse-than-expected, that poses further estimates/valuation downside risks to the domestic-only MNOs, namely DIGI and MAXIS, and to a limited extent AXIATA. Key upside risks to our call include earlier-than-expected ownership stake transfer of SWN to MNOs, and the cancellation of SWN, both of which we think are highly unlikely. Our top pick for the sector is AXIATA, as its regional exposure and digital businesses provide investors a hedge against said developments in the domestic mobile-broadband space.

Source: Kenanga Research - 14 Feb 2022