SPK- Spark NZ (TELCO)

[Snoopy]

Sometimes tax credits can materialise out of thin air, as a result of selling assets to a new entity in which you become a shareholder. Of course I am describing the Connexa transaction. I have used this 'fact' to explain where a lot of imputation credits paid out over and above what might be expected from 'normalised' income came from. But this doesn't explain where the money for extra imputation credits came from, before the Connexa separation agreement. It is worth keeping tabs on these alternative cash sources, which is the point of this post.

Two sources worth looking at are:
i/ Existing shareholder equity AND
ii/ Net cash gains from derivative transactions.

So what were the changes in shareholder funds on the balance sheet of Spark at EOFY2021, EOFY2022, EOFY2023 and EOHY2024?

Available Drawdown Capital	FY2020	FY2021	FY2022	Summed Incremental Change to EOFY2022	FY2023	HY2024	Summed Incremental Change to EOHY2024
Shareholder Funds	$1,474m	$1,503m	$1,475m	$1m	$1,357m (1)	$1,085m (1)	($389m)
Short Term Derivative Assets	$1m	$12m	$5m	$4m	$1m	$0m	($1m)
Long Term Derivative Assets	$60m	$24m	$13m	($47m)	$27m	$12m	($48m)
Short Term Derivative Liabilities	($5m)	($4m)	($1m)	$4m	($4m)	($4m)	$1m
Long Term Derivative Liabilities	($156m)	($91m)	($77m)	$79m	($94m)	($75m)	$81m
Total Derivative Assets Only				$40m			$33m
Overall Total				$41m			($356m)

Notes

1/ Net earnings for FY2023 are quoted as $1,135m. This the figure that flows through to the increase in shareholder equity. But that figure
includes a $583m contribution from the Connexa transaction. The object of this exercise is to follow the change in equity excluding that transaction. This will allow us to determine the equity flow in the underlying business, assuming that transaction did not take place. Thus we are removing any effect of the Connexa transaction 'papering over' any leakage of shareholder capital were it not for this one off event.

The adjusted shareholder equity for FY2023 and HY2024 is therefore recorded as follows:
FY2023: $1,940m - $583m = $1,357m
HY2014: $1,668m - $583m = $1,085m

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SNOOPY

[Snoopy]

This is the discussion post for the numbers I have calculated and put down in the table in post 4a above.

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We are discussing two particular points of time, and how Spark managed to pay for their 'fully imputed dividends' at each of those points of time:
a/ The EOFY2022 before the Connexa transaction.
b/ The EOHY2024 after the Connexa transaction.

EOFY2022

Post 2124 shows an underlying $53m shortfall in the tax payments required to maintain the dividends as fully imputed up to this date. But post 2125 shows a positive summed incremental shareholder equity change of $41m at this time point. Strictly, that means there is still an $8m shortfall of cash to fund those fully imputed dividends. But as far as the tax department is concerned, Spark would have until 31st March the following year to make up this difference. Also remember we are talking about Spark here. By the time CEO Jolie Hodson has finished her morning latte on a Monday, that $8m would've already flowed into Spark's bank account in the allotted fifteen minute coffee break. $8m is not big money in Spark corporate terms.

I therefore conclude that Spark would have no problem pumping up their imputation credit account with the IRD by $53m, to allow those dividends paid up from EOFY2020 to EOFY2022 to be fully imputed. I remain conscious that it is just one way of looking at this is to say that most of the extra capital needed to do the 'dividend prop up' has come from revaluations in derivatives at the EOFY2022 time point. And Spark is not a 'derivative trader'. So Spark would have taken out those derivative positions to hedge against known future payments, such as the $500m in foreign domiciled medium term notes that form part of Spark's debt funding package. In my judgement, it would be highly irregular to use these transient changes in the supporting underlying derivative values to fund operational activities. Of course, no doubt Spark would disagree with by interpretation of where this extra capital to fund dividend payments came from. Spark would just say that it was instead funded through pre-approved increases in operational borrowings. This is what happens when you have a 'big balance sheet'. It almost becomes a matter of opinion as to where a particular rise in capital available for deployment comes from. But given any derivative value volatility would be expected to 'net out to zero' by eventual payback time, I am sticking to my view.


EOHY2024

We now move on to the most current declared balance sheet position. This is showing a massive drawdown in shareholder capital of $356m, just to maintain the rate of fully imputed dividends above underlying earnings levels. Of course the real position is not as dire as this, because I have removed the $583m gain booked from the Connexa transaction from the table. So the actual capital position of Spark is entirely healthy. But the Connexa transaction was a one off. The point of my table is that it shows that operationally, in my view, Spark are unable to sustain the fully imputed level of dividend payment that we see today.

Of particular note at the EOHY2024 balance date, is the snapshot valuation of the derivatives at $33m. It is still positive, and some might say on track to zero as we might eventually expect. But it is now very much 'out of the money' in being able to cover the accumulated imputation credit shortfall of $98m (see post 2124) on that date. This means that the increasing imputed dividend is not being covered by an operational increase in EBITDA as management have alluded to (post 2118, bullet point 2), but has instead been funded by the one off Connexa sale. Once again no doubt management would disagree with my interpretation of events. They would point to the big CAPEX spend in data centres, with the future associated contractual demand, and the big spend on 5G to enable future as yet unimagined sources of cashflow for the future supporting the ever increasing EBITDA comment. IOW they are looking through today's operating earnings, using the time the Connexa sale has given them for improving underlying operating earnings and they are seeing only the blue skies ahead. I am actually very respectful of current management, and I believe they have a very good chance of delivering on their dreams. BUT predictions can be notoriously uncertain - especially about the future.

To me what is happening is akin to a New Zealand Cricket test match, where Kane Williamson is due to take up his position at the crease for NZ, when he drops the comment:
"Actually I am New Zealand's greatest ever batsman. My record stands for itself. So actually I do not need to go out and bat, because statistically we know what the result will be."

To which I would say, "Actually Kane you do need to bat. You can't just rely on yesterday's projections to accumulate your score in present day time." Likewise Spark has to get their own 'runs on the board' to make their earnings projections come true. And Microsoft and AWS in datacentres, and OneNZ and 2degrees in mobile, are there to make getting those incremental 'runs on the board' as awkward as possible.



Summary Position

I believe that since 2020, Spark have been massaging their cashflows in a way that creates the impression of gently increasing fully imputed dividends. There have been some deft moves with capital, and a well thought one off transaction that have allowed Spark to present this very favourable dividend picture to shareholders. But current operational earnings do not support this dividend flow picture. Capex initiatives have put Spark in a position where this favourable dividend position could realistically become reality. But hope, in itself, is not a successful sharemarket strategy, without the execution to 'back it up'. And execution has to be earned, not assumed. A fully imputed dividend at today's levels should not be taken as a given going forwards. Any investor chasing yield, should allow a suitable discount factor on their share price purchase to reflect the reality of future dividend uncertainty.

SNOOPY

discl: hold SPK