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NetLink NBN Trust Biggest Risk

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On 10 July 2017, NetLink NBN Trust registered its final prospectus with Monetary Authority of Singapore, paving the way for the biggest IPO of the year. The offering price is $0.81. Initially, the offering price was estimated by analysts to be between $0.81 and $0.93. The low-end of the offering price could be indication of weak demand from the big boys.

With net asset of $3.07 billion and total units of 3.02 billion, the Net Asset Value (NAV) is about $1.01. Given that the offering price is only $0.81, NetLink NBN Trust IPO is considered surprisingly under-valued. It should be noted that the majority of the assets is the network infrastructure, which are recognised initially at their fair value at the date of acquisition and then depreciated over their remaining useful lives. The estimated remaining useful life for the purposes of calculating depreciation for NLT’s network assets is between 25 and 50 years, depending on the type of assets.

As cited by several local investment bloggers. there are a few risks that investors need to note for NetLink NBN Trust.

NetLink NBN Trust

First, a few bloggers had mentioned that although NetLink NBN Trust has a monopoly in the residential fibre network, it is tightly regulated by IMDA. Hence, its ability to set price is curtailed by the regulators. But I don’t see this as a major concern because Singapore government is known to be business-friendly and it will not be in the government’s interest if NetLink Trust is making annual losses.

In any case, the Trust’s distribution is based on cash flows available for distribution and not on whether the Trust makes an accounting profit or loss. This type of structure is different from a typical listed company which issues dividends to shareholders based on annual profits or losses. In fact, NetLink is highly cash generative as the net cash from operating activities was $196 million for the year ended 31 March 2017. Previous year was $133 million.

Investors may point out that although NetLink has cornered the fibre network for the residential market, it may face competition in the non-residential segment. This is because retail service providers can choose to set up their own fibre networks in industrial parks and Central Business District (CBD).

For areas where the Requesting Licensees have their own fibre networks, demand for use of the Trust Group’s network is likely to be lower. However, I don’t see this as a risk because NetLink NBN Trust is currently also leading in this segment with a market share of 32% of the estimated 121,3004 corporate wired broadband connections.

Furthermore, NetLink NBN Trust’s network is very extensive across Singapore island. It takes a large amount of investment to install the fibre, meters, sensors and other connecting devices. Because of this, the entry barrier is very high and without substantial government’s backing, it is almost impossible to develop a network infrastructure like NetLink’s.

Fundamentally, there are three significant risks for this stock. NetLink’s existing business activities are located solely in Singapore and demand for use of its network is dependent, among other things, on economic conditions in Singapore. Going forward, I don’t foresee NetLink NBN Trust penetrating foreign markets because of the high capital requirements and foreign regulatory barriers. So, the growth will be limited only to Singapore market and the risks may be very concentrated to a single market.

Secondly, the license does not permit NetLink to have direct material relationship with the end users of the network and is largely dependent on Requesting Licensees or Retail Service Providers for marketing activities and growth in demand for the use of the network.

As a Business-to-Business (B2B) service provider, NetLink’s destiny does not rest in its hands although the end-users are the residential and non-residential users. I don’t like the fact that NetLink has to rely solely on the Retail Service Providers like SingTel, M1 and StarHub to grow demand. The risk could be high as it is not within NetLink NBN Trust’s control to expand its customer base.

The biggest risk of NetLink Trust NBN Trust stems not from its business model nor its financial performance, but from the very technology which the whole business is built upon. NetLink currently uses Optical Fibre network technology to transmit large amounts of data and at high speeds from country to country, through undersea submarine cables. Optical Fibre cables are thin strands of glass, about the thickness of a strand of human hair, that permit the transmission of data using light over longer distances and at connection speeds of 1 Gbps and above.

Like every technology, the Optical Fibre network technology is susceptible to disruptions, thereby making NetLink NBN Trust’s network obsolete in the future. When it comes to technology, it is always a wildcard. The advancements made in recent years had been very disruptive and pervasive.

Take for example in Singapore, cab booking applications like Grab and Uber led to the advent of private car hiring and disrupt the taxi industry. Taxi flagging by the roadside may become a thing of the past within the next few years. Just imagine the impact of technology in our daily lives.

Group chat applications like Whatsapp has also pushed Short Messaging System (SMS) to the brink of extinction. Nowadays, most Singaporeans only use SMS for secured electronic transactions involving 2 Factor Authentication. In the past, SMS used to be a cash cow for telco operators which package it in their data plan subscriptions. Ask yourself how many SMS you have sent for the past month. I am pretty sure it is less than 20 as most people use chat apps to communicate.

The problem with NetLink is that its business is built upon a single technology and once it becomes obsolete, the whole empire will collapse. Thankfully, current technology has not advanced to the point of making fibre optical network obsolete. But in five years, things may change.

In the product sheet of NetLink NBN Trust, it is also stated “NetLink NBN Trust faces substitution risk from alternative means of data transmission. While the Trust Group’s network currently offers the highest potential speeds for data transmission among commercially available options, customers and applications that do not require higher speed data connections may choose to rely on these alternative technologies for data connectivity.”

As a business trust, NetLink NBN Trust may appeal to investors looking for dividend pay-outs. For Forecast Period 2018, the Trust is expected to pay an annualised distribution yield of 5.43% based on the Offering Price. The distribution yields are expected to grow by approximately 5.50% to a distribution yield of 5.73% in Projection Year 2019 based on the Offering Price. These are respectable returns for the short-term.

For the long-term, investors need to take into consideration the three key risks mentioned in this article. The way I see it, the NetLink Trust IPO is more like an exercise for parent company, Singtel, to raise capital. In fact, the IPO would raise cash consideration of S$1,095 million and an approximately 24.99% stake in NetLink NBN Trust. The 24.99% stake in NetLink NBN Trust will be held through a wholly-owned subsidiary of Singtel, Singtel Interactive Pte. Ltd., upon divestment.

Singtel intends to use the net proceeds from the divestment of its stake in NetLink Trust for debt repayment, re-investments into its existing businesses, acquisitions and other capital management initiatives. On this note, Singtel investors may be disappointed that the cash windfall from the NetLink IPO would not result in a special dividend for them.

It seems that Singtel may be plotting something special. In the next article, I would write an analysis into Singtel’s next move. Till then, enjoy the ride.

Read my other articles on NetLink NBN Trust:

  1. Three things about NetLink Trust
  2. Singtel’s NetLink Trust IPO application approved
  3. Singtel’s shares to rocket on NetLink Trust IPO?
  4. Can Singtel fight gravity?
  5. Singtel at a cross-road

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4 Comments

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  1. while accounting profit&loss isn’t ‘real’ in income statement, hard cash flow is the king, still i cannot comprehend a few bloggers’ opinions on the similar statement here “In any case, the Trust’s distribution is based on cash flows available for distribution and not on whether the Trust makes an accounting profit or loss. This type of structure is different from a typical listed company which issues dividends to shareholders based on annual profits or losses. ”

    in fact, i don’t understand this part, whether trust or company, is just a form of holding structure, governed by different acts/regulations, but the underlying biz is the same for NLT, that is a operating CF generating biz w/ an enormous infrastructure outlay(read depreciation here), what is the true return of such biz? if every time we just talk about EBITDA, but not real cash return, then something is missing.

    on the other hand, singtel choose to float it only after these many years, is an indication that is the best time to milk it. chinese idiom: “sellers are aways smarter than buyers.” (买的没有卖的精)

    where is the growth story? leave us only a dividend play, whether 5% is maintainable and good enough, every player has one’s own take.

  2. Hi Bruce,

    Thank you for your comments. You are right to point out that NetLink Trust’s asset depreciation is huge – minimum of $100 million for the past few years. Probably due to this, Singtel is cashing out now and plotting to reinvest the cash.
    After reviewing the prospectus, I don’t think I would be participating in the IPO. There are other more interesting counters to grow my wealth.

    Regards,
    Gerald
    http://www.sgwealthbuilder.com

  3. Excellent analysis. Obviously this divestment does a lot of good things for Singtel’s balance sheet. Imho, the ‘kicker’ is the possible technology disruption to the business. That risk just got unloaded onto the investing public. Instinctively I don’t have good vibes about a business if the owner (Singtel) is pricing the business less than its ‘fair value’ and then proceeds to sell shares to the public. Throw in the DPU lure and the trap is set. It’s a telling sign about the owner’s future view of the prospects for the business. I’m sure Singtel already knows what’s around the corner in terms of disruptive technology.

  4. Hi Justin,

    Thank you for your comments. I share your sentiments after reading the prospectus.
    I think SingTel could be aware of the next generation technology for network connection.
    Lets be vigilant against the big boys.

    Regards,
    Gerald
    http://www.sgwealthbuilder.com

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