CDB, MAXIS and TM have entered into conditional agreements to acquire a 20% stake each in DNB via a total consideration of RM420m each. This marks the first step in enabling the transition to 5G dual network from the single wholesale network model. We are neutral on this development given that the final outcome on the mechanics of 5G DN is not revealed yet. Furthermore, the impact on gearing is marginal for the telco players given their large EBITDA base. Hence, this implies that their cashflow prowess and capacity to pay dividends remain intact at this juncture. Therefore, we remain cautiously optimistic, pending further details and clarity. We maintain our OVERWEIGHT stance on the sector.

The transition is finally happening. CDB, MAXIS and TM have each entered into conditional share subscription agreements (SSA) with the Ministry of Finance (MoF) and Digital Nasional Berhad (DNB). This entails: (i) acquisition of a 14% stake in DNB for RM100k, and (ii) cash payment of RM233m to DNB as prepayment for delivery of 5G access services. The other telco players that have entered into this SSA include U Mobile Sdn Bhd and YTLPOWR. Collectively, all 5 telco players will own 70% stake in DNB whilst MoF will retain a reduced stake of 30% (from 100%) and hold a special share.

To recap, in May 2023, the Government announced the implementation of the 5G network in 2 phases. Under Phase 1, DNB will continue its roll-out of 5G to meet 80% Coverage of Populated Area (CoPA) by end 2023 (end-Oct: 73%). Meanwhile, under Phase 2, the Single Wholesale Network (SWN) will transition to a Dual Network (DN). The 5G DN transition shall commence upon issuance of the official 5G DN policy directive from The Ministry of Communications and Digital (KKD). As part of this transition, two entities will be established, namely entities A and B which will each own DNB and the upcoming second 5G network (NW2), respectively. Both entities will be entirely owned by private telcos - but their equity stakes are unknown at this juncture.

Total outlay of circa RM420m for 20% stake in DNB. The prepayment amount of RM233m is regarded as shareholder advances to DNB subject to fulfillment of conditions precedent. This includes satisfactory results on the ongoing due diligence findings on DNB. However, it may revert to being deemed as a prepayment subject to circumstances set out in the upcoming shareholders’ agreement to be executed between the telcos, MoF and DNB. Following completion of the SSAs, and upon DNB having achieved 80% CoPA, the telcos are required to acquire MoF’s remaining 30% stake in DNB for at least RM190m. This exercise is targeted for completion by 1QCY24.

Neutral as details remain scarce. Based on our understanding, post completion of this exercise, each telco will end up with a 20% stake in DNB after having forked out a total consideration of RM420m. The latter is the cumulative total of: (i) RM233m in shareholder advances for an initial 14% stake, and (ii) RM190m for an additional 6% stake to enable the full exit of MoF from DNB. We are neutral on this announcement pending more details, including: (i) the final equity stake for each telco in entity A or B, (ii) key financial information on DNB (e.g. profitability, debt holdings, annual cash flow generation), (iii) entity B’s acquisition price (if any) and mode of payment (e.g. cash, securities), and (iv) revised (if any) access rates charged by DNB to each telco.

Muted impact to gearing. Based on the current configuration, the outlay of RM420m will result in an increase of 0.1x to the net debt/EBITDA for each telco as follows: (i) CDB: 2.1x (from 2.0x), (ii) MAXIS: 2.1x (from 2.2x), and (iii) TM: 0.5x (from 0.4x). Evidently, the impact is marginal given the large FY23F-24F EBITDA base for MAXIS (RM4.2b p.a.), CDB (RM6.2b p.a.) and TM (RM 4.5b p.a.). However, following the formation of entity B, the final outlay may fluctuate as each telco’s shareholdings in DNB may be recalibrated. On a separate note, we understand that for entity B shareholders, the prepayment amount offsets against future access payments to DNB. Therefore, this implies that the cash outlay for shareholder advances are earnings neutral for entity B shareholders.

Expect fair game between Entities A & B. Whilst details remain fluid, we arrive at several assumptions on the potential mechanics of the DN implementation. Recall that it is KKD’s aspiration for healthy wholesale competition to drive enhanced 5G coverage and service quality. Therefore, we postulate that entities A and B will each be spearheaded by a single major telco leading a consortium of other smaller players. Moreover, this will result in comparable total subscriber base between both entities. Hence, one does not have an unfair advantage over the other. Additionally, we believe that operating conditions need to be level – which implies equal ownership of 5G spectrum blocks between A & B. On the same note of achieving fairness, we believe that KKD may structure a financially reasonable exit mechanism from DNB for entity B members.

Does Entity B need to compensate A? Recall that KKD had earlier revealed that entity B has two years to progressively reach 80% CoPA. If this term prevails, we believe that Entity B will continue to purchase wholesale capacity from Entity A during its first few years of operations. As such, it is able to offer 5G services to its customers while building its new network. To recap, DNB imposed target capacity payment of RM360m p.a. on MAXIS, and RM288m p.a. for other access seekers under a long term 10-year agreement. However, when NW2 is finally launched, this agreement will likely be revised or prematurely terminated. Therefore, this gives rise to the possibility that entity A may not be able to recoup its earlier investments used to roll out the first network (NW1). Given these circumstances, we do not discount the possibility that Entity B may need to provide some form of compensation to A.

Dividends intact with potential upside under blue skies scenario. In our view, the best-case scenario is that associate contribution from entity A more than offsets cost from: (i) wholesale network access payments, and (ii) opportunity and/or interest costs on the required outlay for stake acquisition. Hence, this will result in: (i) a leaner balance sheet given that entity A’s debt is not consolidated, (ii) boost to earnings from monetization of 5G and entity A’s contribution, and (iii) absence of profit drag from amortization of 5G spectrum fees, network depreciation and entity A’s interest costs. Correspondingly, this implies enhanced capacity to leverage and potentially afford higher dividends. These same benefits could also apply to Entity B postcompletion of NW2.

Two sides to a coin when it comes to choosing between the entities. In our view, assuming no major outlay for stake acquisition, there are pros and cons to ownership in either entity A or B. For entity B, we believe its advantage lies in better control over costs and timing of network roll-out. This is given autonomy over selection of its key technology provider, suppliers, and vendors. In turn, this results in a better cost structure that enables it to derive higher asset returns. In addition, NW2’s roll-out may also be optimized via: (i) integration with entity B’s existing core network, and (ii) co-location with B’s existing towers. Therefore, this corresponds to greater cost synergies and higher service quality. However, on the flipside, B needs to allocate substantial resources, especially manpower and fundraising efforts, to roll out a new network.

In contrast, ownership in entity A implies immediate cash flow accretion from access payments on the existing NW1. However, its legacy cost structure and fixed design may turn out to be a setback. Hence, this may diminish its competitive edge in securing offtake from price sensitive access seekers. Recall that regulated tariffs offered by entity B cannot exceed that of NW1. Hence, if given a more efficient cost structure, B may potentially offer lower rates and snag wholesale market share from A.

Overweight on dismantling of SWN. In essence, we believe that investors are generally upbeat on 5G DW as it reflects a relatively milder regulatory environment. Recall that the previous administration implemented SWN that was dogged by concerns of: (i) unfair pricing given its monopoly, (ii) network roll-out inefficiencies, and (iii) regulatory intervention that is negative to commercial sustainability. Evidently, the introduction of DN reflects the current government’s more accommodative and libertarian approach. Therefore, we are cautiously optimistic that earnings and dividends for telco players will remain intact. Against this backdrop, we maintain our OVERWEIGHT recommendation on the sector.

Source: Kenanga Research - 4 Dec 2023