Rakuten Mobile merger with KDDI looms, says analyst

Try as he might, Hiroshi Mikitani simply cannot persuade large numbers of Japanese consumers to buy a mobile-phone service from his company.

Mikitani, who goes by the nickname Mickey, founded Rakuten in the late nineties, before NTT Docomo, Japan's biggest operator, had even launched 3G. For most of its life it was known as an ecommerce player, often characterized as a small, Japanese version of Amazon. But it decided to make a bold splash on telecom in its early twenties and launched a mobile service about three-and-a-half years ago. Across a country of about 126 million people, Rakuten today serves 5 million. In mobile, Mickey looks mouse-like.

Company losses do not, however. At group level, they have climbed to about $5.4 billion since 2019, when Rakuten began building a network it claims can be operated at lower cost with fewer people. Despite the colossal investments it has made, signals remain weak in Japan's subways and skyscrapers, where city dwellers spend most of their waking lives, due to Rakuten's lack of lowband spectrum, ideal for indoor and wide-area coverage. As a fix, it has extended a roaming deal with KDDI, one of the Japanese incumbents. Analysts at New Street Research now think it could be a precursor to a formal merger.

They are unimpressed with the progress Rakuten has made and in a research note issued a few days ago say it is "no longer a material competitive threat." Heavy losses have prompted Rakuten to embark on a major cost-cutting drive, slashing monthly network costs from 39 billion Japanese yen (US$260 million) in September last year to about JPY26 billion ($170 million) in June. Its target is JPY24 billion ($160 million). And the new lowband roaming deal with KDDI has been linked to a massive JPY300 billion cut to capital expenditure over the 2023-to-2025 period. All this could render it ineffectual, according to New Street Research.

Its calculations show annual capex dropping to as little as JPY37 billion ($250 million), down from nearly JPY300 billion ($2 billion) in 2022. "Rather than gaining share, we think this means Rakuten is set to build capacity so slowly that there is a case that they may lose share going forward," said New Street Research.

Wreckuten

The question is whether Rakuten's recent application to the Japanese government for some sub-1GHz spectrum of its own – dubbed the "platinum band" in Japan – would alter its capex projections. To make use of that spectrum, Rakuten would probably have to invest in new radio equipment, besides carrying out software updates. Funding all this would be tough given the scale of its losses. Rakuten has estimated it needs between 8 and 10 million customers just to break even, and reaching these numbers could take around three years at the current rate of growth.

Of course, Rakuten already boasts extensive coverage of Japan, claiming its own network featured 57,358 macro sites in April and covered 98.7% of the population at the end of June. Its signal-boosting arrangement with KDDI should allow it to avoid big capital investments, provided it is happy to continue paying a rival.

What's missing from recent updates by Rakuten Mobile is any reference to 5G. When it last disclosed a figure in its financial reports, it had as few as 6,440 5G basestations in September last year, having previously said it would install 10,000 of them in 2022 alone. And all those, of course, will have been using the higher-spectrum bands where signals do not travel as well.

Since then, it has stopped providing updates. But it's hard to believe that Rakuten is anywhere near its rivals on 5G rollout. Softbank, for instance, had been aiming to install 50,000 5G basestations by the end of last year. And Rakuten Mobile's annual capex budget of JPY37 billion ($250 million) sounds insufficient to close the gap that probably exists.

Price-insensitive

What's more, competitors no longer seem worried about the pricing challenge from Rakuten, judging by New Street Research's update. After noting Rakuten's budget constraints, it goes on to say that "the incumbents are now lifting prices on a like-for-like basis and as a result we are confident that ARPU [average revenue per user] is set to inflect sharply, for NTT and KDDI."

Long dubious about Rakuten's chances, analysts now see a merger with KDDI as the most probable scenario, even if it does not happen soon. "We think the likely outcome is a formal four-to-three consolidation deal with KDDI and we think that by signing an extension to the roaming deal recently, KDDI is putting itself in a strong negotiating position to get what it wants when that deal comes up for renewal," the analysts said.

Rakuten's entry into the telecom sector has for some time looked like a huge miscalculation by Mikitani, who has been under growing pressure on earnings calls to show that Rakuten Mobile can still succeed. Unfortunately, Japanese consumers seem unmoved by talk of lower prices and favorable access to Rakuten's portfolio of online services. This is one market that was evidently not ripe for disruption.