Reuters recently claimed that "none of Malaysia's major mobile carriers have agreed to use the government's 5G network yet due to transparency and pricing issues". Contrary to DNB's rejection of the claim, our finding shows that the MNOs have indeed yet to sign any agreements with DNB, citing unfavorable terms and lack of clarity. The heightened uncertainty may delay MNOs’ investment decisions and risks forgone services, potentially hurting revenue growth. It is also becoming increasingly clear that MNOs’ enterprise services risk facing reduced differentiation from using a single wholesale network. Together, the uncertain costs and potential adverse impacts to revenue presents downside risks to the MNOs’ margins. While disagreements can reasonably be expected at early stages of a complex negotiation, we fear the prolonged negotiations and delayed 5G rollout could raise the risk of unfavorable outcomes for the large MNOs. On these de-rating catalysts, we have downgraded MAXIS from MP to UP (TP: RM4.00); DIGI from MP to UP (TP: RM3.80) and AXIATA from OP to MP (TP: RM4.20).

Negotiations hitting a wall. Last Wednesday, Reuters, in an exclusive article, reported that "none of Malaysia's major mobile carriers have agreed to use the government's 5G network yet due to transparency and pricing issues". The very next day, DNB refuted Reuter's claim and said that negotiations with MNOs are still ongoing. From our channel checks, we found that Reuters' claim has some element of truth - thus far, the MNOs have yet to sign any agreements with DNB and requested for "extensive revisions" to DNB's pricing proposal. Furthermore, the timeline for commercial agreements to be struck has been postponed to early-2022, as opposed to market's expectations for end-2021. The prolonged negotiations signal that there are still large gaps between DNB's existing proposals and what the MNOs are willing to accept. In our view, these are early signs that final terms may be unfavorable to the MNOs, which have no autonomy to build, own and operate their own 5G networks.

Heightened uncertainty delays business decisions. The current disagreements and lack of clarity on commercial terms and technical capabilities present great uncertainties, especially for the MNOs’ enterprise segment. As MNOs lack autonomy over the 5G network on which they will be offering their enterprise services, they do not have certainty and control over the network's capabilities and quality of service (QoS), and thus may be unable to (i) provide certain services and (ii) guarantee a certain QoS, losing potential revenue. Furthermore, the MNOs fear that DNB may take longer-than-expected to deliver certain technical capabilities, especially when run by an entity with no competition. The lack of a clear pricing mechanism is causing further confusion, as the MNOs do not know if they would be able to pay a premium for DNB to expedite the development of certain network capabilities, of which MNOs would have likely been able to promptly develop due to the profit incentive. As a result, we think the MNOs are not only withholding investment decisions, but may also forgo certain enterprise services. In turn, these could potentially hurt the MNOs’ revenue growth from 5G use cases.

Risk of reduced differentiation of enterprise services. Due to the aforementioned uncertainties and potentially delayed investments on innovative enterprise solutions, the MNOs’ enterprise segment risk facing reduced differentiation. There are concerns within the industry that by riding on a SWN, where technical capabilities are equally accessibly by all, MNOs are all able to offer similar services (in terms of technical capabilities) to their enterprise customers. In the traditional model where a MNO would be able to customize its network to meet the specific needs of an enterprise, there would have been: (i) synergies between the MNO’s own network and any value-added services, and (ii) differentiation on the MNO’s network based on technical capabilities. With DNB ensuring “fair and equal access to full 5G capabilities”, the MNOs could lose said differentiation by using DNB’s SWN.

While we maintain NEUTRAL on the sector, the recent events have clouded our view on the sector, especially on the MNOs. The prolonged negotiations and MNOs’ pronounced defiance show that there are not only real risks of further delays of Malaysia's 5G network, but also that the SWN model could be disrupting the free-market mechanism, as it appears that MNOs are left in the dark regarding their future services and pricing, and thus margins and earnings. The continued uncertainties about the MNOs' future operating environment, risks of unfavorable terms for the MNOs, lack of cooperation between the MNOs and DNB, and real risks of delays and inefficiencies have dampened the MNOs’ prospects. We believe any negative sentiment from concerns about the SWN will likely impact DIGI and MAXIS, as these uncertainties adversely affects them the most, and to a lesser extent AXIATA, for its holdings in Celcom (and eventually Celcom Digi). Due to these de-rating catalysts, we:

i. Downgrade MAXIS from MP to UP; lower our TP from RM4.55 to RM4.00 (increase WACC from 6.7% to 7.4%),
ii. Downgrade DIGI from MP to UP; lower TP from RM4.25 to RM3.80 (lowered CDB EV/EBITDA from 10.5x to 9.5x),
iii. Downgrade AXIATA from OP to MP; lower TP from RM4.45 to RM4.20 (on lower Celcom Digi value).

Downside risks to MNOs' margins. DNB and the Ministry of Communications and Multimedia are of the view, as reported by TheEdgeMarkets, that the SWN model is financially beneficial to the MNOs, namely through lower capex, which should result in higher cash flows and earnings (from lower D&A expenses). While the MNOs may have improved cash flows in the near-term from network rollout capex savings, unforeseen costs and revenue pressures could weigh on margins over the long-run. As an example of higher-than-expected costs, we turn to DNB’s estimated cost for its 5G rollout. When DNB chose Ericsson as the sole vendor to roll out the network, the estimated cost stood at RM11b, lower than the initially budgeted RM15b. Of the RM11b, RM4b was allocated for Ericsson's network equipment, and RM7b was allocated to network infrastructure costs from other parties. However, as reported by TheStar, the figure was later revised upwards to RM12.5b, with the network cost estimate rising to RM8.5b. Later on, DNB pointed out that there will be an additional RM4b for corporate costs, of which RM2.5b would be for labor cost. This totals to RM16.5b, which DNB has said could swell up to RM20b between 2025 to 2030. Due to the cost-pass-through model (refer to section below) and DNB’s uncertain costs, we believe there are upside risks to wholesale prices, and thus, downside risks to MNO's margins. To make matters worse, the lack of network differentiation on the consumer segment and the potentially reduced service differentiation on the enterprise segment translate into risks of lower-margin MNO revenues.

DNB's wholesale pricing model (what we know so far). Fundamentally, DNB's pricing models are optimized for recovery of costs incurred for providing the wholesale services. DNB has proposed a 3-step approach to pricing.

1. Coverage capacity. Where telcos have to commit to a minimum capacity to provide coverage across all commissioned units built. This is a prerequisite for Steps 2 and 3. 
2. Additional capacity. Telcos have the option to add capacity for specific areas 
3. Buffer capacity. Telcos have the additional further capacity catered for peak seasons. However, we gathered that there is still confusion among telcos regarding their ability to pay premiums for certain higher requirement capabilities, which may not be readily available on the SWN at inception.

Source: Kenanga Research - 15 Nov 2021