We maintain NEUTRAL on the sector following our recent downgrade due to the lingering overhang on the 5G dual network (5GDN) policy, exacerbated by U Mobile's surprise win in leading the second 5G network (NW2). This development has introduced additional layers of complexity, and raised uncertainty surrounding 5GDN's outcome, further clouding long-term visibility on earnings, capex, and dividends for mobile network operators (MNO). On the bright side, while service revenue growth in the mobile and home fibre segments is expected to remain moderate, the wholesale bandwidth segment presents more compelling growth prospects. This is primarily driven by: (i) robust growth in terrestrial fibre backhaul demand fuelled by soaring internet traffic, and (ii) accelerated demand for global bandwidth capacity driven by the influx of data centres (DC), as Malaysia is experiencing a DC boom. Our sector top pick is TM (OP; TP: RM7.53).

1. Mobile

The plot thickens with U Mobile's win. The formal announcement of the 5GDN policy is eagerly awaited, as U Mobile's surprise win in leading NW2 has added new layers of complexity. Key issues requiring clarification have broadened to include: (i) specific MNOs that will partner with U Mobile and their partnership terms, (ii) final ownership structure of Digital Nasional Berhad (DNB), (iii) possible revisions to DNB's 10-year 5G access agreement with other MNOs once NW2 is operational, (iv) coverage and deployment targets for NW2, and (v) the financial and operational health of the first 5G network (NW1).

Outlook remains uncertain. Lingering uncertainty surrounding the outcome of 5GDN continues to cloud long-term visibility on earnings, capex, and dividends for the MNOs. While the award of NW2 to U Mobile marks progress, its rollout could face delays as the company must first finalize additional MNO partnerships, appoint a 5G-advanced technology vendor, and secure financing, among other preparatory steps. Hence, we believe that stock valuations and sentiment for MNOs will only recover upon resolution of these uncertainties, possibly after the policy directive is finally unveiled.

Official policy directive needed for guidance. The directive will likely clarify the extent of the MNOs and TM's involvement in either NW1 or NW2. At present, four MNOs, namely CDB (OP; TP: RM3.82), MAXIS (MP; TP: RM3.80), YTLPOWR (OP; TP: RM5.00), and U Mobile collectively hold 65.1% stake in DNB. With U Mobile now leading NW2, it is anticipated that DNB's ownership shall be restructured to reflect the divestment of shares by U Mobile and its partners. The restructuring is expected to follow one of two mechanisms: (i) put option: allowing NW2 shareholders to sell their stakes to NW1 within a month of MCMC authorizing NW2, or (ii) call option: enabling NW1 shareholders to acquire those stakes if the put option remains unexercised. Upon completion of this restructuring, we believe it will provide the market with clear visibility on which MNO will operate on which network (between NW1 and NW2). In turn, this is expected to largely bring closure to the 5GDN saga, allowing investors to form definitive views and confidently formulate their investment strategies.

Who is U Mobile's lucky suitor? U Mobile announced that it is excited to collaborate with various stakeholders, including the Malaysian Communications and Multimedia Commission (MCMC) and other telco companies such as CDB and TM to deliver world-class 5G-Advanced services to consumers. Notably, U Mobile highlighted partnerships with CDB and TM, while excluding any mention of MAXIS. Thus, we do not rule out the possibility that this may fuel market speculation that U Mobile would likely select CDB and TM as partners. This possibility is further supported by U Mobile's history of collaboration with CDB. In July 2024, the two companies, alongside ZTE Corporation, conducted Malaysia's first live broadcast powered by 5G-Advanced technology. Moreover, U Mobile and CDB share a Multi-Operator Core Network (MOCN) agreement, which encompasses 100 MOCN sites across Malaysia, with each party contributing 50 sites each.

Nevertheless, we do not completely rule out the possibility that U Mobile may still rope in MAXIS as its partner. This is given our understanding that there should not be a significant disparity between the collective subscriber bases of the telco owners in each entity. Hence, one does not have an unfair advantage over the other and 5G traffic would be evenly distributed between both networks. Given U Mobile's subscriber base of approximately 9.0m and MAXIS' 12.7m, their combined total of roughly 21.7m aligns more closely with CDB's base of 18.5m subscribers. This closer parity in subscriber numbers could potentially mitigate concerns about unequal 5G traffic distribution and render a MAXIS-U Mobile partnership a more viable option.

Mixed mobile APRU and subscriber trends. Mobile service revenue growth is expected to remain moderate in the near-to- medium term (9MFY24: +1.4% YoY), reflecting a mild expansion in market size amidst lingering competition. In the prepaid segment, we foresee sequential ARPUs stabilizing, as they appear to have reached a floor following the strategic pivot by major MNOs towards postpaid customer acquisition. While prepaid-to-postpaid migration is likely to continue, it is expected to occur at a slower pace, contributing to reduced prepaid subscriber churn. Specifically, for CDB, we anticipate a more stable prepaid subscriber base, driven by its recent efforts to streamline the segment by eliminating casual subscribers and focusing on acquiring loyal users.

In the case of postpaid ARPUs for the major MNOs, it is expected to face slight sequential pressure, due to: (i) users down trading to more affordable plans and handsets amid inflationary pressures, and (ii) onboarding of new users on lower priced entry level plans. On a positive note, we anticipate sustained traction in subscriber net adds, supported by market expansion driven by these affordable entry-level offerings.

2. Fixed

Competition for home fibre will likely remain intense. For fixed-line players, we anticipate that competition in the retail segment will remain intense as MNOs persist in their efforts to attract and retain convergence customers. These strategies are aimed at fostering greater customer stickiness through bundled postpaid plans. Consequently, we foresee the continued likelihood of below-the-line promotional activities, such as monthly rebates, free router upgrades, and other incentives, as players vie to capture market share. This competitive landscape is expected to create downward pressure and volatility on ARPU and net additions. The extent of this impact will largely depend on each operator's appetite for sustaining aggressive discounting measures to maintain or grow their customer base.

Gen AI DCs will drive demand for bandwidth. While service revenue growths in the mobile and home fibre segments are expected to remain steady, the wholesale bandwidth segment presents more compelling growth prospects. This is primarily driven by:

(1) robust growth in terrestrial fibre backhaul demand - fuelled by soaring internet data traffic stemming from: (i) 5G adoption, (ii) proliferation of Internet-of-Things (IoT) devices (e.g. security cameras, drones, & smartwatches), and (iii) growth in online activities (e.g. streaming, social media, online gaming, remote working, e-commerce, digital banking & cloud computing).

(2) accelerated demand for global bandwidth capacity - driven by the influx of data centres (DC), as Malaysia is experiencing a DC boom. According to DC Byte, total DC capacity in Malaysia is projected to increase by more than 11-fold by 2028, reaching c.3.2GW from 280MW in 1QCY24.

Gen AI will drive the next stage of growth. The surge in Malaysia’s DC capacity is primarily driven by investments exceeding USD16.5b by hyperscalers (i.e. Amazon Web Services, Microsoft, Google, and Oracle) to expand DC, cloud, and AI infrastructure in Malaysia. Additionally, international co-location operators (eg. AirTrunk, Princeton Digital Group, & Equinix) have announced new DC projects in Malaysia, particularly in Johor. These investments are made in anticipation of an expected surge in adoption of generative artificial intelligence (Gen AI) tools hosted in the cloud. For instance, full stack AI platforms such as Amazon SageMaker and Microsoft Azure Machine Learning rely on robust AI and cloud infrastructure to process vast datasets, driving demand for advanced servers and hardware housed in global DCs.

High demand for fibre cabling. The influx of DC capacity in expected to catalyze demand for global and terrestrial bandwidth services in Malaysia. Specifically, we anticipate growing demand for managed wavelength and wholesale bandwidth services, including hot standby bandwidth allocation (HSBA) and indefeasible right of use (IRU) contracts. These services, provided by fixed line operators, facilitate data transmission globally, connecting hyperscale DCs, DCs to public/private cloud infrastructures, and DCs to end users. As such, TM and TIMECOM (OP; TP: RM5.91) are poised to benefit, as they own and operate critical DC connectivity infrastructure, including: (i) international submarine cables and their landing stations, (ii) terrestrial fiber optics network, and (iii) global points of presence. See our recent initiation note on TIMECOM dated 18 Dec 2024 titled “Leveraged Data Play”.

3. Summary

Prefer fixed players for growth. We prefer fixed line operators due to the ongoing uncertainty surrounding MNOs as we await the unveiling of the 5GDN policy. In the near-to-medium term, our focus is on assessing earnings momentum from the delivery of global and terrestrial bandwidth services, particularly to cater to existing and upcoming DCs in Malaysia. Key indicators of demand growth for these services include: (i) news flow on fresh capital commitments for DC projects in Malaysia, (ii) commercial launches of completed DCs, and (iii) growing and healthy DC occupancy rates.

5GDN is the key to unlock valuations. Looking ahead, we anticipate sentiment on MNOs will improve if the 5GDN policy delivers outcomes that surpass expectations. Key areas include: (i) fair 5G access fees for NW1, (ii) appropriate compensation for early termination of NW1 access agreements, (iii) reasonable rollout timeline and coverage targets for NW2, and (iv) NW1 is profitable and cash generating, with a healthy balance sheet.

Remain neutral. We maintain our NEUTRAL recommendation on the sector with TM as our top pick, followed by TIMECOM. 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), cloud services powered by generative AI, etc, (ii) it benefitting from upcoming JENDELA phase 2 projects via roll-out and monetization opportunities, and (iii) earnings accretion from its upcoming hyperscale DC, and (iv) higher demand for data transmission via its network of submarine cables and landings, as well as terrestrial fiber optics backhaul.

Source: Kenanga Research - 15 Jan 2025