The Malaysian Communications and Multimedia Commission (MCMC) has decided that Malaysia's second 5G network (NW2) shall be implemented by U Mobile Sdn. Bhd. Additionally, subject to MCMC's approval, U Mobile is allowed to collaborate with other mobile network operators (MNO) in implementing NW2. While this development signifies progress, we are neutral on this announcement until further details emerge to address ongoing uncertainties. Key areas requiring clarifications include: (i) specific MNOs that will collaborate with U Mobile and the partnership terms, (ii) final ownership structure of Digital Nasional Berhad (DNB), which owns the first 5G network (NW1), (iii) coverage and timeline targets for NW2, and (iv) state of NW1's financial and operational health. On the positive side, as neither CDB (OP; TP: RM5.59) nor MAXIS (MP; TP: RM3.74) will lead NW2, we expect muted commitments in terms of capex and resources associated with building a new network. However, this is dependent upon the specific stake the MNO will hold in NW2, and their level of involvement. In summary, while U Mobile's win marks a key milestone, many uncertainties linger (as outlined above), making it premature to assess whether this development will ultimately benefit or negatively impact other MNOs. Therefore, we continue to favour fixed-line operators, which are less exposed to these uncertainties. Maintain OVERWEIGHT on the sector.

Surprise as dark horse wins the race. To recap, in Aug 2024, TM (OP; TP: RM7.53), CDB, MAXIS and YTLPOWR (OP: TP: RM5.20), submitted their tenders to develop the second network. U Mobile's win comes as a surprise, as we had postulated that the development of NW2 will be spearheaded by a single major telco leading a consortium of smaller players. This is based on our understanding that the collective subscriber base count of NW1 and NW2 should be comparable. Hence, one network does not have an unfair advantage over the other, and 5G traffic would be evenly distributed. As of end-2022, U Mobile reported a subscriber base of over 8.6m, which is notably smaller than CDB (20.1m) and MAXIS (12.6m) as of 2QCY24. This disparity suggests that U Mobile might need to partner with one of the larger MNOs (i.e. MAXIS or CDB) to ensure sufficient scale.

Will U Mobile and CDB's 5G partnerships continue? According to U Mobile, it is excited to collaborate with various stakeholders, including MCMC and other telco companies such as CDB and TM to deliver world-class 5G-Advanced services to consumers. We believe this initiative may extend upon U Mobile's prior collaborations with CDB. Recall that in July 2024, the two companies, along with ZTE Corporation, successfully achieved Malaysia's first live broadcast powered by 5G-Advanced technology. Additionally, U Mobile and CDB share a Multi-Operator Core Network (MOCN) partnership agreement, which includes 100 MOCN sites across Malaysia, with each party contributing 50 sites.

A lot of question marks remain. While this development signifies progress, we remain neutral until further details emerge that will address ongoing uncertainties. Key areas requiring clarifications include: (i) specific MNOs that will collaborate with U Mobile and terms of their partnerships, (ii) final ownership structure of DNB, (iii) revised terms of DNB's 10-year 5G access agreement with other MNOs after NW2 launches, (iv) coverage and timeline targets for NW2, and (v) state of NW1's financial and operational health. Nevertheless, this advancement implies the looming award of NW2 roll-out contracts by U Mobile, that is positive for contractors and tower operators such as OCK (MP; TP: RM0.60), AXIATA (OP; TP: RM2.75), and REDTONE (NOT RATED).

Could be blessing in disguise. On the positive side, given that neither CDB nor MAXIS will lead NW2, we expect reduced commitments in terms of capex and resources (e.g. manpower and fundraising efforts) associated with building and maintaining a new network. However, this capex light model is dependent upon the specific stake the MNO will hold in NW2, and their level of involvement. Conversely, there are potential advantages in leading NW2, including: (i) enhanced user experience as NW2 could be optimized to integrate seamlessly with the MNO's existing 4G network, and (ii) accelerated deployment of 5G services for enterprise clients without needing additional approvals.

Neutral as nothing much has changed. To recap, Malaysia's transition from the 5G Single Wholesale Network model to a dual-network approach will involve the establishment of two entities: (i) entity A will assume control of NW1 via DNB, and (ii) entity B, led by U Mobile, will develop NW2. Both entities will be fully owned by private telcos, including CDB, MAXIS, YTLPOWR and TM alongside U Mobile. These four players (except for TM) hold a cumulative stake of 65.1% in DNB after finalizing a share sale agreement (SSA) and a conditional SSA with the Ministry of Finance (MoF) and DNB in June 2024. The remaining 34.9% stake as well as a redeemable preference share in DNB is held by MOF.

With U Mobile now responsible for NW2, we anticipate a restructuring of DNB's ownership to reflect the divestment of shares by entity B shareholders. This restructuring will likely occur either via a put option (allowing entity B shareholders to sell their shares to entity A within a month of MCMC authorizing NW2), or a call option (enabling entity A shareholders to acquire the shares within the following month if the put option is not exercised).

Uncertainties on first network linger. Recall that under a 10-year agreement, DNB imposed target capacity payment of RM360m p.a. on MAXIS, and RM288m p.a. for other 5G access seekers Additionally, the government stated that entity B has two years to progressively reach 80% population coverage. If this term prevails, we believe B's shareholders will continue to pay for 5G access from A until B's network achieves sufficient capacity. However, once B's network is operational, this access agreement may be revised or prematurely terminated. Therefore, this raises the possibility that A may not be able to fully recoup its investments on NW1, hence requiring B to provide financial compensation.

Benefits and risks remain. In our view, assuming no major transactional cash outlay, there are pros and cons to participating in either entity A or B. The best-case scenario for A's shareholders is if A's associate contribution more than offsets costs for: (i) network access payments, and (ii) opportunity and/or interest costs on the initial cash outlay. These same benefits also apply to Entity B post completion of NW2. Conversely, the worst-case scenario for A's owners may manifest as: (i) significant associate losses from A, and (ii) substantial 5G access payments drag on opex. In turn, this would lead to contraction in EBITDA and cash flow, resulting in lowered dividend payout.

Waiting for clarity to sink in. We believe stock valuations and sentiment for MNOs will recover once the government announces the 5G Dual Network policy. This will finally alleviate concerns around earnings, capex, and dividends which have weighed on the sector. While U Mobile's win marks a key milestone, many uncertainties remain (as outlined above), making it premature to assess whether this development will ultimately benefit or negatively impact other MNOs. Therefore, we continue to favour fixed-line operators, which are less exposed to these uncertainties.

Prefer fixed players for wholesale bandwidth growth. Additionally, for fixed line players, we anticipate growing demand for managed wavelength and wholesale bandwidth services. This is underpinned by the surge in investments by global tech giants that have collectively pledged over USD16.5b in DC, cloud, and AI infrastructure investment in Malaysia. Digital assets owned by fixed line operators (eg. terrestrial fiber optics backhaul, network hubs, and submarine cables with landing stations) are essential to facilitate data transmission across this expanding infrastructure. We maintain our OVERWEIGHT recommendation on the sector, with TM as our top pick.

Source: Kenanga Research - 4 Nov 2024