by: Tam Ging Wien
- Paying a Premium for a Stable and Predictable Business
This is the second of a 2 part series analysing the upcoming NetLink Trust IPO. In the first part, we will discuss the history, summarise the offer and make a preliminary assessment of the offer. You may access Part 1 here.
The second part will discuss in detail the business model, revenue generators, risk factors, assess the qualitative and quantitative aspects of the trust and finally reveal our valuation of the unit price.
[2017-Jul-11, Update]: According to recent media reports, NetLink Trust is set to price the IPO at $0.81 per share at the lower end of the spectrum. The relevant sections below have been updated to reflect this new information.
[2017-Jul-22, Update]: Based on NetLink NBN Trust announcements made on 20-Jul and 21-Jul, Morgan Stanley Asia as stabilizing manager had made purchases of approximately 55mil and 12mil units respectively between 80.5c and 81c. Does that mean that there was significant selling pressure which required the stabilization manager to kick in their obligations? Morgan Stanley's has obligations of up to 123.456mil units and in 2 days already fulfilled more than half their obligations. This is perhaps something to watch out for going into next week as it may give us indication of price direction. Announcements can be seen here:
The Intelligent Nation 2015 (iN2015) is a decade long masterplan by the Singapore Government to modernise and step-up its infocomm infrastructure and transform Singapore into an intelligent nation and global city. The iN2015 is led by IDA with the follow broad based objectives to:
The Next Gen NBN was a project birth as part of Singapore’s iN2015 ambitions. It forms the backbone to interconnect all homes, offices, schools and commercial centres on the main island of Singapore and its surrounding islands with ultra-high-speed broadband. The network is fully fibre-optic and is capable of delivering over 1Gbps throughput.
Fibre-optic cables are thin and lightweight glass fibres which allow light signals to pass through at high speeds. Instead of data being encoded on electrical signals, data is instead encoded in light signals and are carried through these fibre-optic cables.
Figure 4: Next Gen NBN Tiers
The Next Gen NBN comprises of 4 tiers, 3 which are industry tiers while the 4th are the consumers. The consumers of the service can be classified into Residential and Non-Residential consumers.
NetLink Trust is the sole appointed network company that designs, builds, owns and operates the passive infrastructure the passive infrastructure that operates in Tier-1. The passive infrastructure includes the fibre-optic cables, ducts, manholes, central offices and co-location room space. NetLink Trust generates revenue from leasing of these passive infrastructure to operators in Tier-2 which in-turn sells bandwidth connectivity to Tier-3 retailers.
Central offices and co-location spaces are spaces which NetLink Trust leases out to Tier-2 operators to house their network equipment and operate their ancillary services such as maintenance and administration.
The key passive infrastructure assets owned and operated by NetLink Trust includes approximately 76,000km of fibre-optic cable, 16,200km if ducts, 62,000 manholes and over 3,300sqm of co-location spaces.
Figure 5: NetLink Trust Network Assets
NetLink Trust provides consumers with the following types of connections:
For each connection type, NetLink Trust collects a one-off installation charge per termination point and a monthly connection charge. As shown in the figures below, NetLink Trust has already connected up the majority of the connections. Therefore the profits from the one-off installations are likely to be tapering off and the monthly connection charge is where the business will secure majority of its revenue in the future.
Figure 6: Residential Connectivity
Figure 7: Non-Residential and Non-Building Address Points Connectivity
Non-building address points (NBAP) are devices sprawled across Singapore requiring internet access but are not inside buildings. Examples are traffic lights, bus stops, security cameras, street laps, digital signages and weather sensors.
Based on the revenue breakdown, it is clear that NetLink Trust derives majority of its revenue from the residential connections comprising 61.3%. Together with other major revenue sources such as servicing of ducts and manholes, non-residential connections and installation revenue make up nearly 85% of NetLink Trust total revenue.
Figure 8: Breakdown of Revenue
Figure 9: Statistics on Fibre End User Connections
At 81.7% of end-user fibre connections for residential, the room for growth in this segment is likely to stabilise. However for the non-residential segment, the end-user fibre connections currently stands at 31.7%. This is the segment that is likely to provide the growth in revenue in the coming years. On top of that, the NBAP connections are expected to grow rapidly as more connected devices and Internet-of-Things (IOTs) leverage on the network and become mainstream.
Figure 10: Fibre Connection Projections
NetLink Trust is the sole appointed network company that designs, builds, owns and operates the passive infrastructure the passive infrastructure for Singapore's ultra-high-speed Next Generation Nationwide Broadband Network (Next Gen NBN) optical fibre network. In other words, they are a monopoly and other operators must lease the passive infrastructure and assets from NetLink Trust. Their business is guaranteed as long as Singapore continues to utilise fibre-optic broadband network.
Of course, despite being a monopoly, they operate in a highly regulated environment. The rules and regulations set out by the Singapore Government ensures that NetLink Trust prices it leases in a non-discriminatory and non-exclusive way so that all operators have a access to fair pricing of passive infrastructure and compete on a level playing field. This negate the traditional benefit of a monopoly.
With the Singapore Government’s Intelligent Nation and Smart Nation initiatives, high-speed broadband is evolving from a good-to-have to a necessity. Following from the earlier point regarding NetLink Trust as the sole network company, they would be a directly beneficiary of these initiatives.
The majority of its revenue is derived from leasing of passive infrastructure. It records sales for each connection and charges a monthly recurrent fee to maintain that connection. The pricing for each connection type is also clearly stated and known making their business very transparent and predictable.
As mentioned before, nearly 81.7% of the residential already have end-user fibre connections. Growth in this connection is expected to stabilise over the coming years. However, the revenue growth opportunity for NetLink Trust is in the non-residential and NBAP segment.
Figure 11: Projected Subscription Growth Rates – Residential
The NetLink Trust offers a 9.9% and 86.2% CAGR for the non-residential and NBAP segment. This is a promising growth area in anticipation of the IoT revolution. IoTs are smart devices which are all interconnected with each other and require access to the network. The Singapore Government’s Smart Nation initiative will no doubt spur the growth of IoTs which could take the form of drones, digital signages, sensors, smart vehicles, wearables, embedded sensors…etc. NetLink Trust is certainly well positioned to capitalise on growth in the IoT, connected devices and Smart Nation revolution.
Figure 12: Projected Subscription Growth Rates – Non-Residential
Figure 13: Projected Subscription Growth Rates – Non-Building Address Points
The chart below shows the plot of revenue, various profits and the operating and free cash flow of NetLink Trust.
We have used the projected figures for FY2018 and FY2019 based on the income statements provided in the NetLink Trust prospectus. As the figures assume listing on 01-Aug-2017 and the financial year closes in March, we annualised the 8 month figures by dividing all figures by 8 and multiplying by 12.
Where pro-forma figures were provided, we used them. If neither the projected figures nor pro-former figures were provided, we used the audited figures.
Figure 14: Revenue, Profit & Cash Flow Trends
Based on the charts, it is clear that NetLink Trust shows a clear and consistent upward trend for all figures except the Free Cash Flow. The free cash flow figures which appears rather lumpy despite fairly consistent operating cash flows and can only be explained by the CAPEX expense. Therefore, the CAPEX deserves more detailed analysis and monitoring as it could potentially bring risk to the dividend payouts.
Interestingly, NetLink Trust has a “Capex Reserve Requirement” to set aside $8mil annually for 5 years 2018 to 2022. The purpose of this reserve is to meet regulatory requirements from IMDA or for any new network infrastructure projects that improve the capacity, technology, capability or resilience of NLT’s network infrastructure. This fund is a good practice as it ensures that the CAPEX will be paid out from a separate fund and doesn’t affect the cash flows for unitholders. The amount in reserve needs to be monitored annually against the actual CAPEX to detect risk that the capital expenses are running higher than what was budgeted in the reserves.
Figure 15: Debt Ratios
The debt levels of NetLink trust is rather high pre-IPO. As laid out in the “Use of Proceeds”, NetLink Trust will use ~41 to 47% of the amount raised through this IPO to repay the principal amount due and owing under the ST Facility Agreement. This will bring down their gearing and total debt-to-asset ratio to a fairly comfortable level.
Again, while NetLink Trust currently operates as the sole network company, there is no guarantee this will remain the case forever. While we view this risk as low, it certainly is worth mentioning.
While NetLink Trust operates as the sole network company, it is also quite unlike a traditional monopoly as it operates in a highly regulated environment. Similar to financial services sector, heavy regulations and compliance will weight down a business through high operating cost and unpredictable changes. Should regulations change which adversely affects NetLink Trust, it is likely to affect is operating structure and increase is operating cost reducing the cash flows available for dividend distributions. This risk is mitigated by the fact that the Singapore Government has shown to be fairly consultative when it comes to policy making and is likely to have open discussions involving NetLink Trust before making any firm policy moves. This will likely give time to NetLink Trust react to any changes in regulation or compliance requirements.
The same regulatory requirements dictate that NetLink Trust is required to deliver a minimum Quality of Service (QoS) standards. Failing to meet these standards will expose NetLink Trust to potential loss of revenue or even worse fines from the regulator. Rectification of these issues may lead to an unpredictably high CAPEX. This situation is somewhat mitigated by the capital reserves which NetLink Trust is required to put in place for 5 years. Of course, there is a possibility that the capital expenditure may exceed the reserves and lead to reduction in payouts to the unitholders.
NetLink Trust free cash flow has historically been unpredictable due to capital expenditure. These expenses might be necessary to upgrade the infrastructure due to technology replacement cycles and maintenance of its sophisticated assets. Therefore there is a risk that the CAPEX could be well above the forecasted range, leading to reduction in the payout to the unitholders. Similar to the previous risk, this risk is somewhat mitigated by the reserves.
Technology develops at a very rapid pace. Copper wire cables use to form the backbone of broadband networks and are now being displaced by fibre-optic cables. Could there be a newer technology which allows higher speeds and bandwidth of data transfers in the future displacing the need for fibre-optic cables? Could satellite communications or perhaps peer-to-peer connectivity one day supersede the need for fibre-optic cables? Investors would need to keep up-to-date with the telecommunications technologies to be able to spot a potential new substitutes. If such a situation occurs, there is likely going to be a new tender to replace the passive network infrastructure again. Would NetLink Trust be the frontrunner for this tender?
NetLink Trust has a concentration risk which investors need to be aware of. As its business operations is solely in Singapore and solely reliant on the Singapore economy. It is therefore exposed to any direct risk to the Singapore economy. Should there be any adverse impact of the Singapore economy, there is very little that NetLink Trust can do to defend its revenue. It is also not able to expand overseas to seek growth.
Due to the high concentration nature of the passive assets, NetLink Trust is also exposed to unexpected black swan events which may disrupt the functioning of their infrastructure. For example, a natural disaster (eg storms, flooding, earthquakes) or a terrorist attack may permanently damage the infrastructure, leading to a loss of function and a loss in revenue will follow. The expenses required to repair or replace such infrastructure may be expensive.
We have chosen to a value NetLink Trust based on Discounted Dividend Model as the projected growth rates of 5.5% is provided by the prospectus for FY2017 to FY2018. We assume this projected growth rate of 5.5% will continue.
We have also chosen a discount rate of between 3 to 4% as this represents the premium that we demand over the risk free rate of the CPF ordinary account interest rate of 2.5% or the SSB rate of ~2.75%.
We have also chosen to a flat 15-year period to sum with no terminal value. We believe that these assumptions account for both the benefits and stability that NetLink Trust brings as well as the risk that investors take on.
Using the dividend discount modal, we get a range between $0.74 and $0.80.
While there is no trust that we are aware of with the similar characteristics of NetLink Trust, we have chosen to take trust which some “distant” resemblance. We have chosen Keppel Infrastructure Trust, RHT Health Trust and HKT Trust for comparison.
We have also chosen to derive a market price for NetLink Trust based on the average dividend yield offered by these “distant” peers. We obtain a 6.09% average yield giving a $0.72 unit price.
In other words, based on “distant” peer comparisons, $0.72 is a price which offers similar average yield of a portfolio with containing all 3 peers in equal weightage.
We have also recalculated the price assuming that NetLink Trust followed the “distant” peer with the lowest dividend yield. We find a price of $0.79. In other words, NetLink Trust needs to trade at $0.79 or lower in order to match the dividend yield of its lowest “distant” peer which is RHT Health Trust.
Using the peer comparison method, we get a range between $0.72 and $0.79.
Interestingly, both the dividend discount method and the peer comparison method gives a similar range of valuation. Using 2 different methods, we come to the same conclusion that the offer price of NetLink Trust at $0.81 has a slight premium built in.
We are particularly optimistic on the long term prospects of NetLink Trust as the sole appointed network company but we definitely do not want to overpay for the stock.
What we like about NetLink Trust:
What we see as risk factors to NetLink Trust’s investors:
We had performed various methods of valuation for NetLink Trust and we summarised our entry price based on the different methods below:
What we don’t like about the offer is that majority of the proceeds raised will go directly to either SingTel or paying off the debts. There is very little from the proceeds left for the business. Perhaps SingTel is the biggest beneficiary of this IPO?
We think that NetLink Trust exclusivity in Singapore’s Next Gen NBN and is well positioned to ride the growth in connected devices and IoTs revolution is an excellent reason to be invested in the business.
However, is the slight premium demanded in its offering price of $0.81 something investors are willing to pay?
1 – NetLink Trust Website
2 – NetLink NBN Trust Preliminary Prospectus, 27-Jun-2017
3 – Singapore Telecommunications Ltd. Annual Report 2017
4 – “Award of Network Company for Next Generation National Broadband Network”, 26-Sep-2008
5 – “City Telecom leaves Infinity Consortium, QIA to invest”, 20-Aug-2008
6 – “OpenNet consortium has been selected as NetCo”, 26-Sep-2008
7 – “Long Form Consolidation Application Submitted by Opennet, NetLink Trust, CityNet and SingTel”, 25-Sep-2013
8 – “IDA has approved the proposed CityNet's acquisition of OpenNet with conditions”, 21-Nov-2013
9 – “Next Gen NBN”, 28-Nov-2016
10 – “Long Form Consolidation Application”, 28-Aug-2013
11 – “Explanatory memorandum on the decision of IDA in relation to the long form consolidation application”, 21-Nov-2013
12 – “NetLink NBN Trust set to be biggest IPO in Singapore in six years with pricing at 81 cents”, 07-Jul-2017
The views and opinions expressed herein are those of Tam Ging Wien (“the author”) and do not necessarily reflect the official policy, position or view of the author’s employer, organization, committee or other group(s) or individual(s).
The author does not intend to subscribe to the Singapore Public Offer of NetLink NBN Trust during the period of 10 to 17 July 2017.
The author at time of writing does not hold any stake in Singapore Telecommunications Ltd.
The COVID-19 crisis has brought about an unprecedented economic shock to many sectors, and yet it has also generated opportunities in others.
The tech sector has been a major beneficiary and along with that, S-REITs exposed to the Data Centre sector such as Keppel DC REIT and Mapletree Industrial Trust gained phenomenally.
But are the investment opportunities in REITs now gone? Personally, we do not think so. There are still many REITs below their pre-COVID-19 levels poise to recover strongly in the coming quarters – and now it is the best time to prepare to capture the post-COVID recovery.
Join us as we discuss the opportunities and risk in the S-REIT space sector-by-sector as we try to uncover recovery opportunities for FY2021 and beyond. Real estate sectors that we will be covering include the Retail, Hospitality, Offices, Healthcare, Industrial and Data Centres.
Our speaker Tam Ging Wien will be sharing his knowledge and experience including:
Some key highlights that will be covered includes:
During the sharing session, various Singapore-listed REIT examples will be used.
There will also be a Q&A so that members of the investing community may engage in open dialog and discussions in order to deepen their understanding of REITs. Do prepare your writing materials for note taking.
Please note that the duration of the on-site seminar is 7pm to 9:45pm Singapore Time (GMT +8).
The details of the event are as follows:
To learn more about REITs, we recommend the article: What are REITs?
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