Telco Transformers

Mint Asset Management – Greg Fraser

The New Zealand capital market is about to get a significant shot in the arm as Vodafone NZ prepares to shed its cloak of invisibility and invite shareholders aboard. Plan B has sprung into action following the stymied merger between Vodafone NZ and Sky Network TV.

 Investors got a quick peep behind the doors of Vodafone NZ earlier this year when it revealed a reasonable amount of detail about itself in the process of trying to merge with Sky TV.  Much of what we saw was no real surprise but as Vodafone NZ moves toward a public listing on the NZ exchange, it will become a fascinating comparison to Spark on all aspects of its business, not just the financial metrics.

 Telecom New Zealand, as it was when it first listed in 1991, was literally part of the furniture of the country. Employing more than 25,000 people, the company did everything from installing rotary dial telephones in your home to building its own office furniture as newly appointed CEO Rod Deane discovered.

 Fast forward to today and Spark has done some skin shedding of its own. The capital-intensive network business was cleaved off as Chorus, the workforce has shrunk to a more nimble 5,000 or so and the historic reliance on copper is beginning to swap over to fibre-optic cable.

 Even telecommunications as an industry is mutating.

 The S&P500 Telecommunications sub-index is in danger of disappearing following years of consolidation in the industry. Telecom was 2.1% of the S&P 500’s overall market capitalisation as of the end of June, according to S&P Dow Jones Indices, down from 8.7% in 1990.

In addition, much of the value once attributed to the industry has migrated to the new technology behemoths at Amazon, Apple, Google and Facebook.

 The telecommunications industry still invests vast amounts of money on network infrastructure, software, spectrum and customer relationship IT that is needed to retain and grow a customer base whose diet is constantly changing.

 Spark will this year spend more than $400 million on an array of projects that are aimed at either taking more cost out of the business or, preferably, adding revenue and profit margin.

Everyone’s hot topic is 5G mobile but this iteration of the technology will not be widespread until at least 2020. In the meantime, there is plenty to be harvested from the current 4G network and its variants.

 Spark and Vodafone NZ need those extra earnings to continue to offset the natural decline in legacy earnings from good ol’ landlines and voice calling. Spark admits it is swimming against a $70 million annual operating earnings tide in this regard.

 At its recent investor day in Auckland, Spark set out a range of aspirational targets across its business that would effectively pump up its earnings by roughly $150 million. The company reported operating earnings just under $1 billion for its 2017 financial year so the increment is large but not unattainable.

 Vodafone NZ will be under the same pressure to demonstrate a robust pathway of earnings. Its mobile business is of a similar magnitude to Spark and generates about 60% of its total revenue. Group revenue is approximately two-thirds of what Spark reports.

 Both companies have strategies that include finding a way to incorporate new revenue streams as the internet permeates every nook and cranny of the economy. From autonomous vehicles to simple monitoring devices (is the milk in your fridge past its use-by date?), there is a tsunami of data on its way that must be collected, carried and analysed.

 It is the analytics factor that seems to be intriguing Spark and it is certain to open up a panorama of opportunities to leverage its inherent expertise in the first two factors. Spark has already invested in some capability to get this moving at pace. It could be a key differentiating factor between Spark and Vodafone NZ.    

For investors, both domestic and international, the current appeal of Spark is unambiguous. CEO Simon Moutter readily admits the company is “an international yield stock” with a net dividend yield comfortably above 6%.

 It will be fascinating to see if Vodafone NZ adopts a more aggressive dividend policy to signal a stronger growth profile.

Telstra’s earnings struggle has resulted in a reduction in its future dividend payout ratio meaning a sizeable dividend cut from this year onward.

From an international investor’s point of view, the relative stability of Spark must be looking quite good in comparison.

Picture from By dooder / Freepik