NetLink NBN Trust ("Netlink Trust" or "NLT" or "Trust") is set to be the biggest IPO in Singapore in the last 6 years where it will raise around S$2.3 billion. The last mega IPO was when Hutchison Port Holdings Trust raised US$5.5 billion in 2011. According to various sources, NLT is set to priced its IPO at 81 cents. This is at the low end of its book building range of 80 to 93 Singapore cents, indicating lacklustre demand from investors. This is one of the widest book building range i have ever seen and it probably reflected the manager's inability to gauge the demand for its units.
According to this article, "Pricing is done to ensure that there is a diverse base of investors ranging from long-only asset managers, insurance companies and high net-worth individuals," one person with knowledge of the matter told The Straits Times. This probably means that the manager see different demand level from different types of investors and the pricing was to accommodate the demand from the lowest denominator.
The number of units on offer will be 2,898,000,001 under the Placement and Public Offer and subject to over-allotment. More details will be available when the public tranche is launched this coming Monday, 10 July 2017. The IPO will close on 17 July 2017 at 12pm.
Coming back to Netlink Trust. If you haven't heard about this Company, you should probably know OpenNet. In simple words, OpenNet is the company that installs high speed fiber network into your home as part of the government's initiative to enable high speed connections across the nation. I upgraded from ADSL 100mbps to highspeed fiber 1Gbps in April this year and i have to tell you that my experience with OpenNet was horrible (given its monopoly status) but once i "tasted" surfing the net with fiber optics speed, i can't imagine moving back to the stone age speed anymore unless it is replaced by better technology.
Anyway, long story short, if you want the history of how eventually this company ended up on Singtel's books and why it is mandated to divest more than 75% of its holdings by April 2018, you can read the history from The Motley Fool here. Singtel will continue to hold 24.99% of the Company post IPO. Actually www.fool.sg has a series of simpler to understand articles on Netlink Trust, i would encourage you to read them (going through the preliminary prospectus was a torture - boringly written, somewhat similar to its business)
According to the prospectus, Netlink Trust owns and deploys all the fibre optic cables and offers wholesale dark fibre services to qualifying clients (Singtel, Starhub, M1, My Republic and ViewQuest) as well as install connectivity to homes, offices and buildings. With respect to each residential end-user connection, the Trust receives a "one-time" connection fee and a recurring monthly connection charge. Most of the internet users subscribed through one of the ISP providers and the business will be pretty stable as most of the contracts are contracted for 12-24 months and in the event end consumers switched providers, it doesn't really affect NLT as it will still be on its network.
Why Business Trust?
NLT has to use a business trust structure as it was capital intensive to build the network. Under a Company structure, it would be weigh down by the depreciation charge and would have difficulty paying out high dividends. As such, a business trust structure allows the stable cashflows to be "extracted" and be paid to investors in the form of distributions.
The structure diagram is below for your information:
It is good that the Trust is able to provide financial forecasts given the stability of its business
In terms of financial performance, the Company provided forecasts for FP2018 and FY2019. The profit after tax is expected to be $44m and $66m respectively. Frankly the profit before tax is not "as important" as the cashflows as this is a business trust and it is allowed to distribute cash that is generated by the business.
As you can tell from the cashflow statement above, the Trust is highly cash generative. The cash generated from operations continue to be healthy at $140.4m in FP 2018 and $217.6m in FY 2019.
A more important measure is the EBITDA (which stands for Earnings Before Income Tax Depreciation and Amortisation). This reflects better the financial position of NLT, which has high depreciation charges but doesn't impact the Trust has they have been incurred. EBITDA stands at $153m and $240m for FP2018 and FY2019 respectively.
Enterprise Value ("EV") = market value of common stock + market value of preferred equity + market value of debt + minority interest - cash and investments.
In our case, using the pro forma balance sheet as of 31 March 2017, EV = $3,130m + $507m - $15m = $3,622m (ball park). Assuming EBITDA of $200 to 240m for FY 2018 is used (most optimistic), the EV/EBITDA is between 15-18x. This is not "cheap" as according to PitchBook, the median EV/EBITDA buyout multiple is around 8-9x. Singtel is probably better off "divesting" the assets at this valuation as it should be accretive to its balance sheet.
The pro-forma balance sheet (see Appendix B) was prepared based on the assumption that the IPO price was $0.88. Assuming the IPO price is 81 cents, that would imply that the IPO is issued at a discount to its book value and the price-to-book ratio is around 0.92x. While this is good, frankly, there is no real market for the value for the assets given the tight regulatory regime.
The Trust intends to distribute around $113m for FP2018 and $179m for FY2019 as indicated in the prospectus above.
Use of Proceeds
The use of proceeds is as above and the issuance expenses is around $58m. It is a good year for local investment banks this year.
With such a large issuance of 2.89b shares, you will need an army of underwriters and placement agents and the key players are below. I am offered placement shares but i am seriously contemplating whether to pay that 1% or get it from the ATM given the large issuance. I will decide on that when the number of shares available for public offering is released.
Every investors (be it insurance companies, asset managers, family offices, private banking clients etc) should be able to get what they "demand" for. As such, don't expect much fireworks on its debut. as there isn't any scarcity premium and everyone will get at least some shares. The pricing at the lower end of its book building range probably meant that the demand was lacklustre.
What i like about the Company
- Resilient business with predictable SGD income stream - The Trust enjoys a recurring revenue from each connection it made. As such, the revenue stream is pretty stable as internet connectivity at home is now an "essential" item with the proliferation of smart devices. Even the fridge in the kitchen needs a connection! It is also not affected by and could actually benefit from a "war" among the ISPs (Internet Service Providers), who usually subsidize the installations to boost subscribers' base. There is also not much "forex risk" to worry about.
- Monopoly business in residential - The Trust is the sole provider of residential fibre network in Singapore, which is a maturing market with high demand for fibre broadband services. It is unlikely that the government will allow a competitor to provide similar service due to the high capex, hence pricing has to be highly regulated.
- Room for growth - As of 31 March 2017, there were approximately 1.1m residential end-user connections supported by the NLT's network, representing 76.3% of all residential homes in Singapore. As such, there is still some room for growth as more homes become wired to the fiber network. According to MPA, the broadband penetration in Singapore is around 88%. In addition, MPA believes ADSL subscribers will migrate to fibre by 2021 and HFC-based services will cease the same year. 2021 probably represent the D-date for NLT. Based on the few diagrams below, it seemed like the Trust can still benefit from some growth
- Fibre optics remained the preferred network with long usage life - According to the prospectus, fibre optics continue to support advanced technological applications and meet the requirements of sophisticated end-users with high bandwidth requirements. As such, there will be limited substitution risk. Wireless broadband connection such as 4G and 5G is unlikely to replace fibre as it is less reliable. The Trust-Manager also believes the cables last much longer than the 25 years of accounting lives as large components of the fibre network infrastructure is buried underground, resulting in less wear and tear
- Reasonable Manager Fee - The $900,000 Manager Fee seemed reasonable although maybe there isn't much to do for them.
Some of my concerns
- Highly regulated environment - The Company operates in highly regulated environment and that includes the pricing it can charge for its network and the pricing is reviewed every 5 years. Any change to the pricing or regulations will have a material impact on the Trust even though my view is that it should remain stable. The highly regulated environment also means that any non-compliance or services lapse will result in hefty penalties for NLT
- Highly competitive non-residential business - The Trust competes against the Telcos for the non-residential business. Nothing is stopping the Telcos from laying their own network to these buildings.
- Arrangement with Singtel cease after listing - Following the listing, some of the existing arrangement with Singtel (such as access to Singtel's existing ducts and manholes) as well as collaboration with Singtel to jointly undertake projects to construct ducts and manholes and cost-sharing will be on a case-by-case basis. This may result in higher capital expenditure to NLT
- Huge public float and lacklustre demand at book building - The huge float may result in downward pricing pressure during debut as investors demand should be easily fulfilled. It was a good thing that pricing was at lower end and below book value
Assuming the IPO price is 81 cents, the projected yield is 5.43% for FP 2018 (annualised) and 5.73% for FY2019.
As of Dec 2016, there is an estimated 1m fibre broadband subscriptions and this is expected to grow by 40% to 1.4m subscriptions by Dec 2021 (according to MPA). This will provide the catalyst for "DPU growth" for the coming years.
Distributions will be made on a semi-annual basis with the amount calculated as of 31 March and 30 September each year and the Trust will pay out the distributions within 90 days of the end of each distribution period.
My Chilli Ratings
This is a huge IPO where 75% of the Company will be sold to the public. This whopping IPO is going to suck up much of the liquidity in the market place and probably signals the end of our IPO market. hahaha ok pardon my pessimism.
Given its criticality as the backbone of Singapore's IT infrastructure, this is one asset that probably will never be sold to foreign hands. As such, if you want to invest in this IPO, you should be looking at this IPO from the yield perspective as it is not intended for a short term punt. Ask yourself if the income stream is sustainable and whether it will grow over time. I like the fact that it has a monopoly over the residential connection and that its DPU should improve over time. My gut feel is the Manager will try to outperform its forecast as they will try to be conservative in a prospectus.
If you are happy with a 5.43% yield that is growing to 5.73% , then this stock should form part of your retirement portfolio for the long term. However, given the huge float and lacklustre demand at book-building, my view is that the debut will be muted and i don't expect much fireworks as most demand should be fulfilled. The pricing for the book building was within my expectation as i wouldn't be buying if it is not yielding at least 5%. Assuming investors demand a floor yield of between 5.2% to 5.8%, the share price should be range bound between 76 cents to 85 cents in the near term.
If you are considering buying some for the retirement pot, you might want to subscribe to some shares at the IPO and then consider whether to add on to the position post IPO.