SPK- Spark NZ (TELCO)

[Snoopy]

https://investors.sparknz.co.nz/Form...gy%20FINAL.pdf

Slide 71 suggests that revenue from 'Other Revenue' (that is the revenue category that includes the three hot growth prospects) will grow by $80-$90m (from $130m) by EOFY2023. That represents a compounding annual growth rate 'g' of:

$130m(1+g)^3=($210m to $220m) => g= 17% to 19%

<snip>

P61 of AR2020 is where the true calculation of profitability starts

	Operating Revenues	less Product Costs	less Labour Costs	less Other Operating Expenses	equals EBITDA
'Other Operating Revenues'	$130m	$82m	$19m	$15m	$14m

Notes

1/ 'Labour Costs' and 'Other Operating Expenses' are estimated in fractional proportion (f) to the percentage of revenue turned over by the 'Other Operating Revenues' business unit.

f= 130/3588 = 3.623%; Labour Cost = 0.03623 x $511m = $19m, 'Other Operating Expenses' = 0.03623 x $402m = $15m

-------------------

EBITDA is a good proxy for cashflow. But barring some trunk transmission assets, most of the equipment at Spark is not long lived. Indeed there is significant investment now replacing the old PSTN telephone system and continuing the 5G mobile roll out. In my assessment, this means EBIT is the more important measure.

Depreciation & Amortisation ('Other Revenue') = 0.03623 x $479m = $17m

EBIT= EBITDA - DA = $14m - $17m = -$3m

The interest charge against 'Other Revenue' = 0.03623 x [ $36m - $94m ] = -$2m. With a loss there is no tax due. So underlying Net Profit After Tax is:

NPAT = EBIT - I = -$3m-$2m= -$5m

These growth initiatives at Spark sound good and no doubt have future promise. But at this stage in the business cycle, the future growth initiatives are loss making.

FY2021 results are out. So time to try and find how the exciting new growth divisions are shaping up.

P68 of AR2021 is where the true calculation of profitability starts:

	Operating Revenues	less Product Costs	less Labour Costs	less Other Operating Expenses	equals EBITDA
'Other Operating Revenues'	$137m	$67m	$19m	$15m	$36m

Notes

1/ 'Labour Costs' and 'Other Operating Expenses' are estimated in fractional proportion (f) to the percentage of revenue turned over by the 'Other Operating Revenues' business unit.

f= 137/3565 = 3.843%; Labour Cost = 0.03843 x $491m = $19m, 'Other Operating Expenses' = 0.03843 x $385m = $15m

-------------------


EBITDA is a good proxy for cashflow. But barring some trunk transmission assets, most of the equipment at Spark is not long lived. Indeed there is significant investment now replacing the old PSTN telephone system and continuing the 5G mobile roll out. In my assessment, this means EBIT is the more important measure.

Depreciation & Amortisation ('Other Revenue') = 0.03843 x $523m = $20m

EBIT= EBITDA - DA = $36m - $20m = $16m

The interest charge against 'Other Revenue' = 0.03843 x [$34m - $81m] = -$2m. With a loss there is no tax due. So underlying Net Profit After Tax is:

NPAT = 0.72(EBIT - I) = $16m-$2m= $10m

On page 68 of AR2021 we learn "Other operating revenues include revenue from Qrious, Internet of Things, Spark Sport, and exchange building sharing arrangements." I had previously assumed this category included 'Spark Health' as well. But it could be the Spark Health referred to as a promising potential future revenue business unit has yet to start from a zero base.

Whatever, the NPAT estimate for all those promising future growth initiatives looks to have turned the corner from loss making, and is now a small positive number. Albeit in overall terms, that profit is not significant.

SNOOPY

[Snoopy]

It looks pretty clear to me Snoopy. They work hard just to stay where they are, they will never go bust but there is no growth there. I hold for diversification and they have been a better investment than Telstra which I also hold.

The bare earnings numbers and history as a default necessary service provider lead to the impression of a 'steady as she goes' giant - I agree. But look at what has happened to the revenue break down over the five reporting years under review.

Product Category	Operating Revenue (FY2021)	Operating Revenue (FY2017)	Change	Change Percentage
Mobile	$1,311m	$1,197m	+$114m	+9.5%
Voice	$308m	$655m	-$347m	-47%
Broadband	$670m	$689m	-$19m	-2.8%
Cloud, Security & Service Management	$443m	$324m	+$119m	+36.7%
Procurement and partners	$414m	$345m	+$69m	+20.0%
Managed Data, Networks & Services	$282m	$207m	+$75m	+36.2%
Other Operating Revenues	$137m	$116m	+$21m	+18.1%
Total External Revenues	$3,565m	$3,533m
Total Absolute Value of Changes			$764m

Something that struck me about this table was the broadband revenue decreasing! This is partly explained by the reclassification of some earnings. From p9 of "Updates to External Reporting" document issued in December 2018.

"To provide a clearer view of broadband and managed data performance, revenues associated with managed internet services have been moved from broadband revenue to managed data revenue."

For the FY2018, year this policy change reduced broadband revenue from $685m to $665m. Concomitant with that, Managed Data, Networks & Services revenue increased from $190m to $207m. Yet even with that adjustment broadband revenue was flat. An example of customers expecting more and more for the same price?

$764m/$3,565m = 21%

That is a measure of how much the business has changed in five years. Although overall revenue has barely changed, more than one in five dollars taken in has shifted to a different product category. I would suggest that is rather a large operational change. In fact I would struggle to think of any other NZ business that has transformed this much over the last five years (bar some start ups). Sometimes what you think you see, a boring steady dividend payer, is not a boring as you think it is.

SNOOPY

[Ferg]

Thanks for the analysis Snoopy. Interesting reading.

[Biscuit]

The bare earnings numbers and history as a default necessary service provider lead to the impression of a 'steady as she goes' giant - I agree. But look at what has happened to the revenue break down over the five reporting years under review.

Product Category	Operating Revenue (FY2021)	Operating Revenue (FY2017)
Mobile	$1,271m	$1,237m
Voice	$486m	$573m
Broadband	$685m	$665m
Cloud, Security & Service Management	$400m	$370m
Procurement and partners	$365m	$357m
Managed Data, Networks & Services	$197m	$207m
Other Operating Revenues	$114m	$114m

I really appreciate the fact you share your figures Snoopy. But what's really changed over those 5 years? There's been a significant drop back in "voice" and a pick up in a few other things. They are not a provider of a commodity service like power, they are a technology service and have to keep changing as the technology changes. There should be opportunities for growth in there but are there?

[Snoopy]

I really appreciate the fact you share your figures Snoopy. But what's really changed over those 5 years? There's been a significant drop back in "voice" and a pick up in a few other things. They are not a provider of a commodity service like power, they are a technology service and have to keep changing as the technology changes. There should be opportunities for growth in there but are there?

There are opportunities for growth for sure. The cloud data centres look promising. But looking a bit further into the future, where is the next bout of growth to come from? It seems not from the pool of new business ideas that I covered in my post 1812. No doubt if management were doing the same analysis, then they would report things slightly differently.

"It seems future profit growth is not yet coming from the pool of new business ideas covered in Snoopy's post 1812."

SNOOPY

[FatTed]

Thanks for your work Snoopy, is this at current SP in your opinion a buy hold or sell? Spark make up 10% of my holdings

[Snoopy]

Thanks for your work Snoopy, is this at current SP in your opinion a buy hold or sell? Spark make up 10% of my holdings

Stay tuned FatTed. I am not sitting on a valuation thesis for SPK that I am feeding to Sharetrader page by page. It's all going out live.

SNOOPY

[Snoopy]

Continuing my reviews of these Spark podcasts

https://sparkiot.buzzsprout.com/3898...-ep-6-security

This one is about risks associated with the IoT. The general risk is similar to a person connected to the internet, trading data for convenience. In the case of the person, an example of this would be you handing over your credit card details for the convenience of buying an item. Just like a laptop computer, access to your IoT devices must be controlled and the software involved in running them must be patched.

Mass market makers of IoT devices are concentrating on getting as many products out to the market as they can without thinking about security or whether a device can even be patched. Government regulations seem almost inevitable to get some level of security around these IoT devices. The EU has since banned hard coded default passwords. In the USA, the California Act demands that IoT devices have some kind of security features, without specifying what those security features are.

IoT security divides up into:

1/ Data privacy
2/ The Security of Devices

As an IoT device owner there are two ways to lose:

1/ You can lose your data that your device is transmitting OR
2/ Your device can be used to attack others.

Spark are going to use a technique called 'network slicing'. A 'sliced network' connects and exceeds the emerging requirements from a wide range of enterprises. Thus there is network space that allows a user to isolate untrusted IoT from trusted IoT. Slices are defined as end-to-end self-contained logical networks, which can be controlled and managed in an independent way by the slices’ owner. The 'ultimate owners' are Over-The-Top (OTT) service providers and Mobile Virtual Network Operators (MVNOs), like Spark.

Another issue is 'telematics' (GPS location) , and the control of privacy devices in cars. Could an internet connected vehicle be taken over? You have to carefully control how firmware is updated. With vehicles, the consequences of the risk involved is higher.

Currently there are no specific security standards for IoT beyond specific legislation. Should you as an operator take responsibility for voluntary user initiated updates? Or rely on over the air updates? Or forced updates? Some updates can force a reboot. You don't want that to happen with a critical device, like when a car is speeding down a twisting back road. The best way to check if a company is taking IoT seriously is to web-search the words 'company name' and 'security' and see what comes up. People are very vocal on social media about security.

For any IoT capable device, always ask yourself if you need to connect it to the internet. Don't feel obligated to trade off your personal information for internet enacted convenience you don't need. Always factor in 'use' verses 'risk'. Despite the flood of insecure cheap devices from manufacturers, there is public and government pressure to make security on the IoT better.

SNOOPY

[Snoopy]

Happy with the annual dividend but really disappointed with the SP...finally hit $5 earlier but didn't last long at all

Spark certainly is one for the 'dividend hounds'. I haven't yet written the summary conclusion to my Buffett tests. But it is clear the background conditions to run the so called "Buffett Spreadsheet' to value Spark will not be fulfilled. This means we need to apply alternative valuation techniques. My standard 'go to' alternative method is 'capitalised dividend valuation'. This is capitalising the average dividend paid over the last five years.

To reprise, -because I haven't done this for a while- 'capitalising the dividend' is actually a fairly crude method of valuation. Implicit is the assumption that the company is 'no growth', and that the performance of the last five years will be reflective of company performance in the current year. Of special mention in this case is that Spark dividends have been consistently greater than underlying earnings. One way to think of this is that directors, who have more up to date and comprehensive knowledge of Spark than we shareholders do, are optimistic that underlying business will improve. IOW we shareholders are benefitting from director 'insider knowledge'. Another benefit of capitalised dividend valuation is that it does not require anyone to forecast any dividend payouts from the company. So there is no forecasting error. All the figures I use in the valuation are based on dividends actually paid

Gross Dividend Calculations

FY2017 P2:
11.0c (Ordinary, 100% imputed) + 1.5c (Special, 80.6% imputed):
= 11.0c (FI) + 1.209c (FI) + 0.291c (NI) = 11.0c/0.72 + 1.209c/0.72 +0.291c = 17.25c (gross dividend)

FY2018 P1:
11.0c (Ordinary, 100% imputed) + 1.5c (Special, 75% imputed):
= 11.0c (FI) + 1.125c (FI) + 0.375c (NI) = 11.0c/0.72 + 1.125c/0.72 + 0.375c = 17.22c (gross dividend)

FY2018 P2, FY2019 P1, FY2019 P2, and FY2020 P1 (All 75% imputed): 11.0c (ordinary) + 1.5c (ordinary) = 12.5c (total)
12.5c (Ordinary, 75% imputed) = 9.375c (FI) + 3.125c (NI) = 9.375c/0.72 +3.125c = 13.021c +3.125c = 16.15c (gross dividend)

FY2020 P2:
12.5c (Ordinary, 75% imputed) = 9.375c (FI) + 3.125c (NI) = 9.375c/0.72 +3.125c = 13.021c +3.125c = 16.15c (gross dividend)

FY2021 P1, FY2021 P2, FY2022 P1:
12.5c (Ordinary, 100% imputed) = 12.5c (FI) = 12.5c/0.72 = 17.36c = 17.36c (gross dividend)

Year	Dividends as Declared	Gross Dividends	Gross Dividend Total
FY2017	12.5c+12.5c	N/Ac + 17.25c	17.25c
FY2018	12.5c+12.5c	17.22c + 16.15c	33.37c
FY2019	12.5c +12.5c	16.15c +16.15c	32.30c
FY2020	12.5c + 12.5c	16.15c + 16.15c	32.30c
FY2021	12.5c + 12.5c	17.36c + 17.36c	34.72c
FY2022	12.5c + ?c	17.36c + ?c	17.36c
Total			167.3c

Now we come to selecting the capitalisation rate in this ultra low interest rate environment. I have selected a figure of 5% for Chorus. But Chorus is a regulated monopoly. I think Spark shareholders need a greater implied return than that, to compensate for the risks of competition and technological change. I think a 6% gross interest return on your shares bought would be fair. The five year historical average gross dividend received by shareholders from Spark was:

167.3 / 5 = 33.46c

The capitalised dividend value of Spark (fair value) is therefore: 33.46c/0.06 = $5.58

Of course no self respecting value investor would target 'fair value' as a price purchase target. Value investors want a discount! For a utility type investment like Spark I think a discount of 10% is reasonable target. So I am setting my target purchase price at $5.58 x 0.9 = $5.02.

I have been buying SPK cum that 12.5c fully imputed dividend today!

SNOOPY

[Snoopy]

A fall in the 'under 3 month' NZD Commercial debt ($228m-$155m=$73m), both in capital being borrowed and interest paid on that capital, looks like the explanation for interest payments saved over FY2021 (see AR2021 p89). There are $100m in domestic notes maturing in each of FY2022 and FY2023 too. Refinancing those at lower interest rates should take the pressure off the interest bill in the next two or three years.

This is a little exercise I like to run on all my companies just to check they are not overloaded with debt. MDRT is the answer to the question:

"How many years would it take to repay your borrowing debt if you decided to repay that debt by pouring all this years net profit into debt repayment, and continued to do the same in subsequent years?"

In other calculations I have been concerned with 'normalised profit', as I am concerned with sustainable earnings trends. However in this case I need the recognised profit from all sources, as determined by current accounting standards. For FY2021 that was $384m.

The total long and short term debt at Spark at EOFY2021 balance date was $1,403m (p89 AR2021). From that figure I like to take off the balance sheet cash balance of $72m. So at EOFY2021, for Spark:

MDRT = ($1,403m-$72m) / $384m = 3.47

My 'rule of thumb' is that any MDRT between 2 and 5 represents a 'medium level' of debt. 3.47 is right in the middle of that range. Whether that is a good result depends on the kind of company being assessed. Generally if you have a stable cashflows that are not affected too much by business cycles, it becomes more 'capital efficient' for shareholders if you crank the debt up a bit This is exactly the situation that I see Spark in. That means I am quite happy with Sparks debt position.

Conclusion: Pass Debt Test

SNOOPY