AnalysisSGX

10 things I learned from the 2021 Netlink Trust AGM

Netlink NBN Trust is the sole owner of Singapore’s fibre network infrastructure. It’s responsible for maintaining and operating any infrastructure related to the fibre network including ducts, manholes, fibre cables, and central offices.

A large part of its income is derived from a Regulatory Asset Base (RAB) model. Under the RAB model, Netlink is promised a pre-tax return that is equal to its pre-tax weighted average cost of capital (WACC). The WACC measures the company’s net cost of borrowing money, weighted by the company’s total debt and equity.

During the Infocomm Media Development Authority’s last round of price revisions in 2017, Netlink’s pre-tax WACC was 7%. As such, IMDA has set fibre connection prices such that Netlink will make a 7% pre-tax return on its past capital investments. Given that the IMDA revises prices once every five years, current prices will be retained until the next review in 2022. So, while Netlink trust enjoys a great position, it is unable to have one of the core advantages of being a monopoly: pricing power.

However, while Netlink doesn’t enjoy true pricing power, the company is able to stay in a dominant position that only entrenches itself further every year as it lays out millions of dollars of cable over time, effectively forcing competitors to either to do the same (getting half or less of the profits at full cost is a bad idea) or buy them out (expensive). This means its income stream, which itself is recurring in nature, is highly durable and stable, making it a favourite for dividend investors in Singapore.

As a business trust, Netlink distributes 100% of its cash flows after company expenses such as management costs and interest payments. This enabled the company to pay shareholders a healthy distribution per share of 5.08 cents for FY2021. This translates into an attractive yield of 5.1% based on its closing price of S$0.98 on 31 July 2021.

While the dividend yield is enticing, it is important to find out whether the dividend can be maintained (or increased) going forward. I attended Netlink Trust’s 2021 virtual AGM to find out more.

Here are 10 things I learned from the 2021 Netlink Trust’s AGM:

1. Netlink NBN Trust’s business is as stable as ever for 2021. Revenue maintained at S$368.5 million and EDBITDA grew 4.6% to S$270.2 million. As of 31 Mar 2021, Netlink reported S$171m of cash left on its balance sheet, gross Debt/EBITDA of 2.5, EBITDA interest cover of 14.8, while sporting 5.08 cents of FY21 distribution per unit against a share price of 98 cents (as at 31 July 2021), which results in a yield of 5.1%.

2. A shareholder raised the questions about management’s view on rising inflation and impact on business expenses. The management replied that Netlink is a business with a stable stream of income, and they know exactly what their expenses are to keep it running. He added that they would keeping a tight control on expenses to ensure that it does not exceed revenue.

3. Another shareholder asked what management the expects of the upcoming revision for tariffs and borrowing in 2022. CEO Tong Yew Heng replied that the RAB framework will review the prices every five years. A lowered cost of borrowing will allow Netlink to earn more profits, but it is not the only factor that affects WACC; for example, market risk premium and debt premiums will also affect rates of return. There will also be many more months of discussions with the regulators, and they are expecting authorities to consider all factors moving forward.

The chairman added that the formula accounts for all future capex raises at the next revision of rates. In short, all future rates of return will be adjusted in accordance with the rise and fall of expected WACC, which means that Netlink should not be negatively or positively affected in one way or another.

4. A shareholder asked about the possibility of Elon Musk’s Starlink rendering Netlink’s fibre broadband business obsolete, as well as possible diversification that the management is considering. The chairman replied that they have studied the area extensively and, based on engaging researchers and universities, nothing can disrupt fibre broadband for now. The concept of satellites beaming the internet back to landmasses is interesting but fails to work in cities with high building densities since large buildings would block signal transmission. A Starlink network would probably work better for countries with large land masses and low building densities. He added that the cost of such an internet provider would be significantly higher than fibre broadband, and, if there is a difference in price, Netlink will likely maintain an edge.

With regards to diversification beyond towers and fibre broadband, the chairman revealed that Netlink has started to look at other countries for related telco infrastructure. The management is currently looking at assets that have come onto the market — some in Australia — and have also considered starting consultancies, leveraging its knowledge as a critical fibre broadband infrastructure operator.

5. A shareholder asked if there was ever a likelihood of a competing company rendering the environment an effective duopoly. The chairman mentioned that Netlink has 1.45 million residential connections, which represent a 95% residential penetration rate for the Singapore market. He also mentioned that they are focused on converting the remaining 5%, which, unfortunately, is part of the low-income group and will need assistance to establish a fibre connection.

Beyond that, 20,000 new homes are being built on average annually in Singapore. Netlink enjoys new business from redevelopments and new buildings. Netlink also enjoys a growth tailwind for IoT as Singapore is starting to roll out fibre broadband nationwide with more fibre requirements for the Smart Nation strategy. He added that they would continue to look for more income-producing assets from overseas opportunistically.

6. Another shareholder asked about the risks of a change in operators for the critical infrastructure are, and what the cost and income related to low-income households would be like. The chairman confirmed that (a) it would not be feasible to outlay Netlink’s time and capital in fibre broadband networks and (b) the only remaining option would be to buy them out. Both remain unlikely. He further added that the cost of adding low-income housing to the fibre broadband networks would likely be insignificant.

7. Is there a strategy to diversify from non-tariff sources? The CEO commented they are under no pressure to do so, but as mentioned above, will continue to monitor the markets for opportunistic investments that will be accretive to Netlink’s distribution per unit.

8. Will significant increases in capital expenditures expected for future developments affect dividends? Management replied that the company will continue to spend as needed in order to support Singapore’s Smart Nation plan and future fibre developments. They further commented they are not afraid of spending the capex required, since any of it spent is included in the RAB formula for WACC. It might affect some of Netlink’s cash on hand, but management will continue to maintain the trend of distributions that they have been able to deliver the last few years. 

9. What acquisition sizes will Netlink find comfortable acquiring? The management replied that some assets have come onto the table in the past few months that come at billions of dollars. While the company has the capacity to borrow, they don’t want to borrow too much to fund an acquisition. Future acquisitions may be done through a combination of debt/shareholder fund raises. More likely, however, are joint partnerships where Netlink will aim to own part of an income producing asset.

10. To what extent will the rollout of 5G impact the company? The management said that the question has been asked many times and the underlying assumption is that 5G ends Netlink’s competitive position (since if you have reliable 5G, you no longer require reliable fibre broadband). The chairman replied that 5G also requires lots of micro-cells to transfer and ping signals. So 5G will inherently raise fibre demand which improves Netlink’s business. Further, fibre broadband’s relative attractiveness remains its price to speed ratio – it is likely to be cheaper per gigabyte to use versus 5G.

The fifth perspective

Netlink Trust is the epitome of a business that has durable, recurrent cash flow streams in a near monopolistic environment. Its business will likely remain stable until 5G is broadly distributed around the world at a cost that is cheaper or equal to fibre broadband. At 5% yields, Netlink is an investment more suited to larger portfolios looking for passive income where growth is no longer an active need.

Liked our analysis of this AGM? Click here to view a complete list of AGMs we’ve attended »

Irving Soh

Irving is a microcap/compounder focused investor with a large interest in business strategy and base unit economics. He believes that psychology, discipline, and focusing on long-term strategies will result in the best investing outcomes over a long period of time.

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