Netlink Trust

[weijian]

SIAS has asked some really good questions with regards to the coming AGM for NLT. Interesting to see that NLT is changing its trust deed to give them the flexibility to invest overseas. Any investment will probably be huge in nature and since NLT does not retain any cash, will have to raise equity to eventually pay for it.

RESPONSES TO QUESTIONS FROM SECURITIES INVESTORS ASSOCIATION

https://links.sgx.com/FileOpen/NetLink_N...eID=631830

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eAGM to be held on Monday 4pm.
Attached QnA for the session:
https://links.sgx.com/FileOpen/NetLink_N...eID=632702

Stay home and stay healthy, everyone.

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1H Result ended 30 Sep 2020 will be release on 6th Nov 2020 after trading.
https://links.sgx.com/FileOpen/NetLink_N...eID=636164

Stay home and stay safe, everyone.

[BlackCat]

NLT has held up well in the past 2 years.

But 80+% of their revenues are undergoing regulatory review end 2022. Don't think the mkt is pricing this in yet.

What will the new WACC be?

1) The Fed has said "lower for longer" even if inflation occurs. https://www.ft.com/content/3d7704d3-a312...233f469ccd . So interest rates are expected lower in the next 5 years than the previous.
2) Telecom service prices always drop. My home broadband bill could drop 35% in the past 2 years! (when I renew). Telcos are squeezed.

Can anyone see any way that the WACC (and netlink's prices) will be increased? I can't. I can only see them going down.

What would be the effect on NLT's earnings? (rough calculations)

The only growth opportunity I see for NLT is increased NBAP revenue if 5G becomes more widely adopted. Probably by govt or specialised industries first.

[Shrivathsa]

Hopefully this helps in some way to estimate the WACC.

Netlink Trust's WACC is determined by IMDA.

In 2018, IMDA had set a rate of 7% WACC i.e. Netlink would earn 7% pre-tax return on its capex investments.

The Long Term US treasury rate (10 year) was between 2.71 to 3% in 2018.

Currently, the long term treasury is between 1.5 to 2% in 2021.

However, there was and is no indication that the WACC would be set based on US Treasury.

If one were to use the 30 year rate of SGS securities yield, it was 2.44% in 2018 and 1.85% in 2021.

Potentially, at best there may be a 50-75 basis point compression in WACC.

On a side note, NBAP revenue falls under the regulated revenue based on the 7% return, so while it may grow, it is likely to be regulated.

[BlackCat]

Thanks Shrivathsa for your reply.

I'm trying to put all the pieces together.

Does this look roughly correct?

1) The formula is:

Nominal Pre-tax WACC =

  a) 'Cost of equity' X (1 – gearing)
        +
  b) 'Cost of debt' X gearing (1 – tax)

  From p5 of https://internetfileserver.phillip.com.s...190327.pdf

2) From NLT's 2020 balance sheet, its 1/4 funded by debt (1 trillion) and 3/4 equity (2.9 trillion).  So 'gearing' above is 0.25. 

So the WACC is roughly 3 parts of 1a) plus 1 part of 1b).  Ignoring the tax.

3) Interest rates have dropped 25% (from 2.44% to 1.85%) from 2018 till now based on your 30 year SGS rate.

You could get up to a 40% drop depending on what tenure you use and how you eyeball the numbers (eg: take average rate over the past 5 years).

https://tradingeconomics.com/singapore/g...bond-yield

4) So cost of debt (1b) , which is roughly 1/4 of the WACC, drops 25% to 40%

5) The Cost of equity (1a) is hard to calculate.  I make a blind guess that 2/3rd of it is from the risk free rate.  The other 1/3rd is from the market risk premium (compensate holders for risk/volatility of holding these equities).

So a X% drop in risk free rate leads to a 2/3rds drop in 1a). 

6) So for 1a) and 1b) together:
    - A 25% drop in risk free rate drops the WACC by (0.25 * 1/4) + (0.25 * 2/3 * 3/4)  = 0.1875 or 18.75%,make it 19%.  The new WACC is the old one (7%), minus this 19%, which gives 5.7%.
    - A 40% drop lowers the WACC by 30%.  New WACC is 4.9%.

7) In the real world, the old 7% WACC is really high!  This is a mandatory utility (like water/electricity) not a discretionary one (like airport).  Who gets a 7% return on capital these days?

Even 4.9% to 5.7% is pretty high.

8) Most important: I think "Nominal Pre-tax WACC" in the formula is earnings *after* depreciation, is that correct?  Around 3/4ths of NLT's 2020 dividends are from D&A (ie: a return of capital, not a payout of earnings).

If PBT drops 19%-30%, thats a 14m-21m drop.
Cutting the distribution paid by this amount only cuts dividends by 7%-11%.

[Shrivathsa]

Hi Blackcat,

I am trying to answer your points as best as I can

1) Yes, the philip securities link does mention that, the first caveat is we do not know whether IMDA uses that formula, the second caveat is that in the same philip securities link, there is mention of a 10.5% p.a fixed perpetual securities note of 1 billion as QLDS (wonder who owns that, would be a great note to own as the return is 10.5%). In addition NBN, has 500 million of bonds coming due in 2022, which presumably will need a fresh bond by when they will have visibility on the IMDA WACC. The point is that there seems to 'wiggle' room in calculating the debt cost and related to that, with potential to increased bond issuance, gearing and therefore WACC

2) Addressing your points 2 to 7, DBS has estimated that the 'new' WACC will be 5.5%. The link for that is below. https://researchwise.dbsvresearch.com/Re...=fbedjkhaa . All your points are perfectly valid.

3) Addressing your point 8, I am not really sure, as all that NLT have said is the WACC is set by IMDA. However, it does not look like it is Earnings after depreciation, as FY 21 Earnings after Depreciation before finance charge is 102, 445,00, that for FY 20 is 90,643,000. When looking at Gross debt of 666 million, that translates to finance charge of between 13 to 15%

4) Purely as an aside, in one of NLT's reports, they have indicated the wholesale price of residential fibre broadband is around 13-15 SGD a month, so in case WACC drops, wholesale price to telcos may also reduce, hopefully that is passed on to end consumers by Telcos, which though, will compress the margins of the telcos further.

I hope that is helpful

[tanjm]

I'm no expert, but I doubt if the regulated WACC is based on Netlink's existing debt/equity structure. More likely, it is based on some "industry average". What is that average? I don't know. But the likelihood is that the "industry average" uses a higher leverage than what Netlink currently has.

The interest rate portion of the WACC would not be based on risk free rates either. It should be based on what a equivalent corporate can get on the market.

All in all, I would not be surprised if the 5.4% WACC by DBS is derived in the "typical" way. Decide on the "target price" first, then reverse engineer the WACC (with a bit of hand waving justification).

Last, if the WACC changes in any significant way, it should be because the inflation environment has changed. At the end of the day, the RAB model (as I understand it) targets a reasonable real return on capital for infrastructure investors.

[Shrivathsa]

Hi Tanjm

You are right that it is based on industry average.

This is not exactly based on the Netlink WACC, but in 2000, IMDA did outline how they calculated WACC for Singtel and it was based on industry average.

https://www.imda.gov.sg/news-and-events/...1120093400

Relevant portion on WACC in quotes
"In calculating the WACC, a capital structure appropriate for a basic services company operating in Singapore has been used; this may differ from the actual capital structure of each of the two companies. The actual capital structure may reflect factors other than those applicable to the basic services business in Singapore.

The appropriate capital structure that minimises WACC is a function of market requirements and is best estimated by what capital markets require for similar types of companies. It is not possible to directly determine what capital markets require; however, it is likely that actual capital structures will tend to reflect those requirements. As a result, an average of actual capital structures for selected telecommunications companies was used to estimate the appropriate capital structure with appropriate adjustments for each company to reflect their circumstances."

Hi Blackcat,

What that means is that if you look at Telco Infrastructure assets and average their capital structure, you will get the WACC. Having said that, since the proxy method of say 4.9 to 5.7 which you have derived and the 5.4 which DBS seems to have derived are not too far off, you could use that range rather than spend more time in calculating WACC.

For what it is worth, I think the market may be blase about the pricing review and focused on the yield.

However, that may or may not create a shock i.e. if the review is that WACC does not drop much and the dividend is maintained the price may actually increase due to certainty, hell breaks loose in varying levels if dividend is cut (depending on the cut), hard to predict the outcome or even estimate probability for each potential outcome, in a way, too difficult (at least for me) to think of a way to invest on this.

[BlackCat]

Thanks Shrivathsa and tanjm, 

For point 8, yes, the 2020 "earnings-before-tax-and-D&A" (~239m) matches the 7% target: 7% of (debt 700m + equity 2.9b) is 252m.  "Earnings-before-tax" (of 72m) is nowhere close.  So the WACC is probably a target for CashFlow from Ops.

I'm no expert, but I doubt if the regulated WACC is based on Netlink's existing debt/equity structure. More likely, it is based on some "industry average". What is that average? I don't know. But the likelihood is that the "industry average" uses a higher leverage than what Netlink currently has.

Taking 50% debt and 50% equity,  a 25-40% drop in interest rates reduces WACC by 18-30%.

The interest rate portion of the WACC would not be based on risk free rates either. It should be based on what a equivalent corporate can get on the market.

Good point.  Since corporate loans are SIBOR + x, my 25-40% drop from 2018 to 2023 would be a lower percentage (maybe 15-30%).

Some may think that NLT is a halfway between a govt agency (like HDB) and a corporation.  

All in all, I would not be surprised if the 5.4% WACC by DBS is derived in the "typical" way. Decide on the "target price" first, then reverse engineer the WACC (with a bit of hand waving justification).

Yeah, this WACC calculation looks simple in concept but is impossible to work out the details.  There are so many assumptions and moving parts, you can justify whatever needed.

In the end its a guess.  I estimate an 18-30% drop in WACC.  From 7%... to 4.4% to 5.7%.