We maintain OVERWEIGHT on the sector. In the mobile space, we believe investors are generally upbeat on the implementation of the DWN (Dual Wholesale Network) model as it reflects a more moderate regulatory environment. Conceptually, DWN should result in: (i) removal of the government’s monopoly on 5G capacity, and (ii) efficient roll-out of the second 5G network by private telcos with minimal intervention. However, we are cautiously optimistic as the devil is in the details. Meanwhile, for fixed services, we expect sentiment to improve as clarity emerges on the repricing of retail broadband packages. Our sector top picks are CDB (OP; TP: RM5.07) and MAXIS (OP; TP: RM5.13).
Mild market environment. Competition in the mobile space remains benign, as evident from the 2%-3% YoY growth (QoQ: flat to +1%) in total subscriber base for the major telcos in 2QCY23. Nevertheless, ARPU pressure is expected to persist on expectations of weakness in the prepaid segment. This is due to the continuous launch of affordable plans to cater for the B40 market segment. This includes Pakej 5G Rahmah which was introduced to align with the government’s Madani economy framework. Evidently, blended ARPUs were lower by 1%-3% for the telcos in 2QCY23 (QoQ: flat to -2%). Nevertheless, profit erosion is partially mitigated by upselling of entry level postpaid packages to prepaid users (e.g. Hotlink postpaid plans).
Muted 5G adoption for now. Moving forward, over the longer term, we expect ARPUs to receive a boost from monetization of 5G services. Currently, it is still early days as reflected in the small 5G subscriber base of 1m in Malaysia (4G: 43m). Evidently, out of the 15% of CDB subscribers that signed up for 5G, merely 11% are active users. Moreover, according to OpenSignal, 5G availability in Malaysia was just 21% during the May-July period. Therefore, this implies significant room for expansion in 5G offerings as awareness, capacity and usage ramp up.
DWN is a game changer. Meanwhile, we are cautiously optimistic on the implementation of the dual wholesale network (DWN) model. To recap, the government announced the transition of the current single wholesale network (SWN) model to DWN by end CY23. This will take place after the existing 5G network owned by Digital Nasional Berhad (DNB) achieves 80% coverage of populated areas (COPA). To kick start 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 early juncture.
According to Communications and Digital (KKMM) Minister Fahmi Fadzil, the telco players (i.e. CDB, MAXIS, TM, U-Mobile and YTL Communications) will execute a share sale subscription agreement soon to finalise their shareholdings in DNB. Following this, entity A will take over DNB, and the government will cease to be a shareholder. Whilst entity A will resume DNB’s operations and network implementation, entity B will start from “scratch”. Nevertheless, entity B has two years to progressively reach 80% COPA.
Entity A likely in the green. We believe that entity A will likely be profitable given that access prices for wholesale 5G is determined based on the long-run incremental cost model. This incorporates a reasonable profit margin on top of cost recovery for access providers. Furthermore, recall that DNB imposed chunky target capacity payment of RM360m p.a. on MAXIS, and RM288m p.a. for other access seekers under a long term 10-year agreement. Nevertheless, the full amount of these payments will only be realized after DNB’s network (NW1) achieves 80% COPA (end-Aug: 69%). In the meanwhile, wholesale payments for NW1 will commensurate with network availability. However, this pricing arrangement will likely be revised or terminated following NW2’s launch.
Enhanced dividends if all is well. In our view, the best-case scenario is that associate contribution from entity A more than offsets expenses from: (i) wholesale network payments, and (ii) opportunity and/or interest costs on the cash outlay for stake acquisition. This scenario 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, depreciation of NW1 and interest costs from entity A’s debt. Correspondingly, this implies enhanced capacity to leverage up and also afford higher dividends.
Both entities may compete. However, moving forward, we surmise that shareholdings in entity A may be recalibrated to enable entity B’s formation. This is based on our expectations that: (i) all major telcos will initially own stakes in entity A as alluded by KKMM, and (ii) the telco that emerges as the largest shareholder in entity B may need to surrender its existing stake in entity A (if any). Under this scenario, it is imperative that the exit terms, including disposal price for entity A is reasonable to facilitate a smooth transition and reinforce investor confidence. Recall that the government’s aspiration is that healthy wholesale competition results in comprehensive coverage and enhanced service quality. Therefore, we postulate that it is KKMM’s ultimate aim for entities A and B to each be spearheaded by a single major telco.
Entity B starts on a clean slate. In our view, assuming no major cash outlay for stake acquisition, there are pros and cons to ownership in either entity A or B. We believe that entity B’s 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, network roll-out may be optimized to integrate with the existing core network and towers of the telco that controls entity B. Therefore, this corresponds to greater cost synergies and higher service quality if the latter offtakes capacity from NW2. However, on the flipside, entity 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 wholesale payments on the existing NW1. However, its legacy cost structure and fixed design may be a potential 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, entity B may potentially offer lower rates and snag market share from NW1.
Moderate regulatory environment. Against this backdrop, we believe that investors are generally upbeat on DWN and believe that the regulatory environment is relatively more accommodative. Recall that the previous government implemented SWN that encountered opposition due to concerns of: (i) price monopoly on wholesale 5G by a government entity, (ii) financial leakages during network roll-out, and (iii) regulatory intervention that is detrimental to commercial sustainability. Evidently, the introduction of DWN as a counter reflects the current administration’s milder and more libertarian approach. Therefore, future regulatory actions will likely strike a balance between populist and economic interests. However, we highlight our cautious stance depending on the actual outcome of DWN’s implementation.
Dissipating price headwinds on fixed broadband. We expect sentiment to finally improve as clarity emerges on the repricing of retail fiber broadband packages. Currently, TM (OP; TP: RM6.57) is seeking agreement from access seekers on new wholesale prices under its new reference access offer (RAO). Upon acceptance of the RAO, we expect the introduction of fixed broadband packages with lower pricing. This corresponds to reduced wholesale prices and the government’s upcoming policy of “where there is a road, there will be internet".
Actual cuts may be milder. Based on our observations, new wholesale tariffs for HSBB Layer 3 service gateway under the new RAO are lower by 9%-60%. This is in comparison to rates offered under TM’s previous RAO published in 2018. Under the new tiered pricing structure, we gauge merely 9% savings for 3 Tbps of subscribed bandwidth. However, the savings spike up to 60% for 9 Tbps of wholesale bandwidth. Nevertheless, we believe that the latter, which is the highest tier bandwidth, will likely not benefit service providers that have a small subscriber base. To recap, TM has the largest broadband subscriber base with 3m customers followed by MAXIS (622k), Celcom (73k) and Digi (41k).
In contrast, price reductions between the Mandatory Standard on Access Pricing (MSAP) in 2020 (which is still applicable currently) and 2023 are significantly higher at 51% across the board. To recap, regulated tariffs offered by access providers may not exceed maximum prices prescribed by MSAP. Additionally, note that MSAP does not have prescriptions for tiered pricing based on varying bandwidth capacities. Nevertheless, media sources reported that MCMC will review TM’s RAO to seek clarification and understand the basis of its tiered pricing approach.
In essence, actual wholesale price cuts under the RAO that was published recently in end-July appear to be lower when benchmarked against MSAP. Correspondingly, we believe there will be a milder cut in retail prices vis-a-vis earlier expectations when MSAP was published back in Feb 2023. Hence, this should quell concerns of intense pressure on retail ARPUs and wholesale earnings.
Sector Recommendation: With the exception of CDB and AXIATA (OP; TP: RM3.45), we leave our TP and forecasts largely unchanged for telco companies under our coverage. For CDB, we assume lower accelerated depreciation charges in FY24F based on the company’s refreshed guidance. As a result, our FY24F earnings for CDB and AXIATA (which owns 33% stake in CDB) are raised by 37% and 6%, respectively.
Additionally, for AXIATA, our TP is lowered to RM3.45 (from RM3.60) as we effect the following key changes to our Sum-of-Parts valuation: (i) applied 1.0x EV/Sales (previous: 20x EV/EBITDA) for the digital businesses as we assume ADA and Boost to report LBITDA in FY23-24 (1HFY23: RM88m LBITDA), (ii) recalibrated EV/EBITDA multiples for Robi to 5.0x/2.0x (from 8.0x/3.0x) to correspond to their current historical average valuations, and (iii) lowered EV/EBITDA multiples for NCell and Smart to 3.0x (from 5.0x/6.0x) based on a 20% discount to its listed regional peers’ historical average.
Against the backdrop above, we retain our OVERWEIGHT stance on the sector. In essence, the investment community will likely appreciate the current government’s approach that is relatively more commercial driven. Therefore, sentiment remains optimistic although the implementation of DWN, particularly the set-up of entity B, will likely unfold over a prolonged period. Our sector top picks are CDB and MAXIS.
We like CDB for the following reasons: (i) merger synergies are expected to amount to NPV of RM8b over 5 years – emanating from network (RM5.5b), IT (RM1.1b) and others (RM1.4b), (ii) robust FCF yield of more than 6% in FY23-34 implies capacity to pay steady dividends, and (iii) leading subscriber base share of 39% and 20% in the postpaid and prepaid segments, respectively, translating to pricing power.
We favour MAXIS due to: (i) its convergence strategy that have so far enabled the group to approximately double its home connectivity customers over the past three years and defend its mobile subscriber base, (ii) ramp-up in business from its enterprise customers as they intensify digitalization measures, and (iii) it is leveraged towards monetization of 5G given that service revenue (1HFY23: 49%) mainly emanates from high-ARPU mobile subscribers in the postpaid and enterprise segments.
Source: Kenanga Research - 27 Sept 2023