SPK- Spark NZ (TELCO)

[Snoopy]

The Operating cashflow for Spark has been roughly $800mill for the last four years or .43 cents a share (I understand they may have been buying back shares which would improve per share earnings, buybacks should be made illegal again, if there is excess funds and nothing better to invest in pay out a bigger dividend) at 1,845 mill shares and dividends have been .27cents per share.

Reported earnings include depreciation and amortisation of roughly $500mill which is a non-cash expense.

There are a couple of problems I can see with this explanation. The Spark dividends are fully imputed. Sure you can use cashflow to boost dividends above earnings. But if you did that the portion of the dividend above earnings would not have any imputation credits attached. Given the Spark dividends are fully imputed, this would suggest that they are not being boosted by 'free cashflow' above earnings.

The second point is that all of those electronic gizmos that Spark are putting on mobile towers and in exchanges around the country actually do depreciate. Electronics to physically wear out or become technically superseded. So I don't think you can ignore depreciation. Accounting rules would suggest it is gone in 8-15 years. Then of course you have the mobile transmission spectrum which was bought and has a finite life which must be amortised away, so that Spark can afford the renewal price when the time comes. IOW I don't buy the 'non-cash expense' argument.

SNOOPY

[Snoopy]

this is sparks new div policy

pay-out ratio of ~80%-100% of free cash flow on a long run basis


free cashflow now calculated as


EBITDAI


LESS


Other gains and impairments; Interest; Tax; Lease costs; and
Maintenance capital expenditure


EXCLUDES:
Growth capital expenditure; Spectrum; and Movements in working capital


my rough ball is fcf is 900m odd so there div payout is 50% odd (486 m )

i havnt included maintenance cap exp so figures prob out a little just top of head stuff

If Spark's policy is to pay out 80-100% of 'free cashflow' and you have calculated they are only paying out 50% of free cashflow, this would suggest to me that you calculation of 'free cashflow' cannot be sustainable.

SNOOPY

[JeffW]

The Connexa sale boosted the shareholder equity coffers to $1,940m AND (very importantly) added some deferred tax assets to the books to the extent (see AR2023 balance sheet p90) that a deferred tax liability of $108m from FY2022 turned into a deferred tax asset of $55m in FY2023! Now I am no expert in tax law and I cannot explain how this has occurred. All I can say is that it has occurred, as evidenced by this quote from HYR2023 p10 which explains most of the difference:

"Due to the difference between right of use assets realised at the date of the transaction, a non-tax deferred tax asset of $126m was recognised."

My best explanation of the situation now is that 'deferred tax assets' can be regarded as 'tax already paid' and can therefore be distributed out to Spark shareholders as imputation credits, despite these imputation credits never being earned in any conventional sense (!). If a tax expert is reading this I am happy to be corrected on this point. But I see no reasonable alternative explanation. Reading between the lines, Spark now has enough 'breathing room' (time) to allow new earnings streams (like datacentres and 5G applications) to push underlying earnings to grow to support the increased fully imputed dividends being declared today.
SNOOPY

The deferred tax asset has absolutely nothing to do with Imputation Credits - rather the deferred tax asset is to do with timing differences in tax deductions - in this instance apparently to do with the Right of Use assets

As far as ICA accounts are concerned, they can be in debit (i.e. "Overdrawn") at any point during the year without penalty, EXCEPT 31 March, irrespective of balance date, which for Spark is 30 June. I do not think it is any coincidence that Spark pays its dividends in April & October, and not March & September

[Snoopy]

The deferred tax asset has absolutely nothing to do with Imputation Credits - rather the deferred tax asset is to do with timing differences in tax deductions - in this instance apparently to do with the Right of Use assets

Appreciate the correction JeffW. I know you know your tax stuff. Once the towers were sold, they no longer appear as a towers on the Spark balance sheet, as Spark no longer owns them. Instead Spark gets to report a 'right of use asset' which is depreciated and offset, -not exactly in timing- with a 'lease expense' as Spark now rents the towers from Connexa.

We are talking about IFRS16 here and the accounting reporting requirements around that. Because the IFRS16 depreciation reporting on leases does not align with the IRD depreciation schedule exactly, that means there will be a 'change in timing' of 'IFRS reported tax' and 'actual tax payments' which creates the 'deferred tax asset.' To explain in more detail.....

1/ A deferred tax asset appears in the accounts if reported tax deductions are greater than the actual tax money owed to the IRD (IIRC IFRS16 typically front loads tax deductability in the first few years). Question WHY?
2/ Answer: In any particular year, if reported tax deductability increases, that means the company 'reported after tax profit' decreases.
3/ However the IRD wants none of this. They want the same tax money as before IFRS16 existed, and any company must bow to the IRD's wishes as far as tax is concerned.
4/ The result is that 'our company' (Spark) obeys the IRD and reports paying more tax than the IFRS rules say is due, the extra tax paid being recorded as a 'deferred tax asset' on teh Spark balance sheet. It is deferred because eventually the IFRS16 front loading of the depreciation cycle reverses and depreciation reduces to below the IRD allowable rate. Consequently all the 'deferred tax' turns into 'actual tax paid' by the time the multi-year depreciation cycle ends. This is because the eventual result of using the IFRS16 depreciation schedule for leased assets, and the IRD system is the same. It is only the timing of the deductions that is different.

OK. I hope that shows I know a little bit about the subject of 'deferred tax', even though I don't call myself an expert. I agree with JeffW when he says
"the deferred tax asset is to do with timing differences in tax deductions - in this instance apparently to do with the Right of Use assets"

However, I do not see why "The deferred tax asset has absolutely nothing to do with Imputation Credits." Because the deferred tax is real money that has been paid to the IRD, which the IRD classes under their own alternative set of accounts as income tax paid. So why can actual 'income tax paid' (which is recorded for IFRS accounting purposes only as a 'deferred tax asset') not be reassigned as 'imputation credits for shareholders'? I don't get it?

SNOOPY

[JeffW]

However, I do not see why "The deferred tax asset has absolutely nothing to do with Imputation Credits." Because the deferred tax is real money that has been paid to the IRD, which the IRD classes under their own alternative set of accounts as income tax paid. So why can actual 'income tax paid' (which is recorded for IFRS accounting purposes only as a 'deferred tax asset') not be reassigned as 'imputation credits for shareholders'? I don't get it?

SNOOPY

Hi Snoopy - firstly, you're right - it does have something to do with Imputation Credits, but not CURRENT imputation credits - I should have said the deferred tax asset is absolutely not reflected in the current balance of the ICA Account. Any overpayment or prepayment of tax is reflected in the ICA account, but not in the deferred tax asset, but rather in the current tax asset/liability which is effectively the stuff IRD knows and cares about.

A deferred tax asset is not real money paid to the IRD - It's a future tax benefit, in the same way that a deferred tax liability recognises a future tax liability. I'm not entirely sure in this case, but it probably relates to the tax effect of the future lease payments that have been recognised under IFRS16 as a liability. As you rightly say, IRD don't care about IFRS16, but the discounted value of the future lease payments is seldom if ever the same amount as the capitalised Right of Use asset, so there's always a timing difference.

[bull....]

If Spark's policy is to pay out 80-100% of 'free cashflow' and you have calculated they are only paying out 50% of free cashflow, this would suggest to me that you calculation of 'free cashflow' cannot be sustainable.

SNOOPY

i hadnt taken out maintenance cap so in my calc i had 900m - 468 div's ( 50% fcf at that stage ) - maintenance exp which i had not worked out yet so if take that out probably falls within the 80 - 100% payout of fcf . my calc based on there formula

[bull....]

i forgot to add my figures based on annual report 23 , so considering a downgrade in earnings this yr has occurred thet would reduce fcf calc's there payout ratio's

[Aaron]

There are a couple of problems I can see with this explanation. The Spark dividends are fully imputed. Sure you can use cashflow to boost dividends above earnings. But if you did that the portion of the dividend above earnings would not have any imputation credits attached. Given the Spark dividends are fully imputed, this would suggest that they are not being boosted by 'free cashflow' above earnings.

The second point is that all of those electronic gizmos that Spark are putting on mobile towers and in exchanges around the country actually do depreciate. Electronics to physically wear out or become technically superseded. So I don't think you can ignore depreciation. Accounting rules would suggest it is gone in 8-15 years. Then of course you have the mobile transmission spectrum which was bought and has a finite life which must be amortised away, so that Spark can afford the renewal price when the time comes. IOW I don't buy the 'non-cash expense' argument.

SNOOPY

I can't argue with you Snoopy as the more I read and try to understand the financial statements the more questions I have and the more I appreciate how little I understand.

If dividends have been roughly 100% of taxable earnings over the years then imputation credits would be available.

I agree that depreciation is a real cost to a business over the long term but the Connexa sale resulted in a tax free gain on sale so it would appear the towers appreciated in nominal dollar terms.

I would have thought that there would be a large depreciation recovered in the tax adjustments but I do not understand these enough to comment.

Maybe they wrangled the sale to sell the assets at written down book value with a big goodwill portion in the sale.

More importantly the proceeds of the sale were to benefit the shareholders, which I guess it has with reduced debt and sharebuybacks.

Regarding the share buybacks the share price has gone from just under $5.50 to just under $4.50 over the last couple of years. Wouldn't the share buyback make the remaining shares more valuable?

A great big dividend would have been better, but maybe they did not have the imputation credits to cover it.

[Snoopy]

Hi Snoopy - firstly, you're right - it does have something to do with Imputation Credits, but not CURRENT imputation credits - I should have said the deferred tax asset is absolutely not reflected in the current balance of the ICA Account. Any overpayment or prepayment of tax is reflected in the ICA account, but not in the deferred tax asset, but rather in the current tax asset/liability which is effectively the stuff IRD knows and cares about.

Hi JeffW and thanks for the clarification. I see in AR2023, at the bottom of page 110 we learn
"Spark has a negative 32 million imputation credit account balance as at 30 June 2023."

This is mentioned under the sub header 6.1 'Deferred tax assets and liabilities'. I take it from this that the imputation credit balance is part of the whole wider 'Deferred tax assets and liabilities' picture. But where? I don't see this $32m mentioned anywhere elsewhere on that page. Where is the negative $32m imputation credit balance hiding in the balance sheet? Or have I got this completely wrong and so I am consequently looking in the wrong place? Why is the $32m mentioned in section 6.1 if it is, as you suggest, a current tax asset/liability? In the balance sheet the current tax liability is only $25m.

SNOOPY

[JeffW]

Hi JeffW and thanks for the clarification. I see in AR2023, at the bottom of page 110 we learn
"Spark has a negative 32 million imputation credit account balance as at 30 June 2023."

This is mentioned under the sub header 6.1 'Deferred tax assets and liabilities'. I take it from this that the imputation credit balance is part of the whole wider 'Deferred tax assets and liabilities' picture. But where? I don't see this $32m mentioned anywhere elsewhere on that page. Where is the negative $32m imputation credit balance hiding in the balance sheet? Or have I got this completely wrong and so I am consequently looking in the wrong place? Why is the $32m mentioned in section 6.1 if it is, as you suggest, a current tax asset/liability? In the balance sheet the current tax liability is only $25m.

SNOOPY

The Imputation Credit Account never appears on the balance sheet. It is a notional account effectively made up of NZ Income Tax Paid/Refunded less Imputation Credits Attached to dividends paid. Every time a tax payment is made it reflects on the balance sheet as either a reduction in the current tax liability or an increase in prepaid tax, and the same amount is notionally put to the ICA Account. When a dividend is paid, the amount net of Imputation Credits (but inclusive of RWT credits) is debited against Equity, and any Imputation Credits are notionally debited to the ICA account, but has no effect on the financials

The deferred tax asset or liability is fundamentally a different beast. It represents expected future tax liabilities or benefits, that will in time are expected to increase or decrease income tax payable. For example, accrued Employee Holiday Pay is not deductible for tax purposes at balance date (unless paid within 63 days), but is recognised as wages in the P&L and a lability in the balance sheet. So if a company has say $1m of Holiday Pay liability accrued, it has a deferred tax asset of $280,000 being the future tax benefit (or future deduction if you like) to the company when the holiday is paid out. Conversely, if the company has depreciated an asset by say $1m, but then revalues it by $600,000 then it anticipates a future depreciation recovery of the $600,000 and therefore recognises a Deferred Tax Liability of $168,000 being 28% of the $600k.