Netlink Trust in the Pocket

Was there ever a stock that you’ve wanted to buy and you’ve waited for months on end to enter a position on the said stock?  

Well, Netlink NBN was such a stock to me.  

I first took notice of Netlink sometime in May last year when the price was hovering around $0.85.  I didn’t take action on Netlink then, hoping that the price would go down below $0.80.  Well, too bad for me then, the share price of Netlink kept going up from that time all the way to about $1.00 … an almost 25% increase over my desired purchase price.  

Will I ever have Netlink in my portfolio, I wondered then?

Well, I finally have Netlink in my pocket. The opportunity finally came during the market meltdown in March.  I didn’t get it at a price below $0.80.  I settled at $0.88, and I considered it a fair purchase.

Why was I so insistent on purchasing Netlink stocks?  Simply because it is a company with a wide and sustainable economic moat.

Introduction

Netlink, constituted as a business trust and listed on the SGX Main Board on 19 July 2017, delivers ultra-high speed internet access to residential homes and non-residential premises throughout mainland Singapore and its connected islands.  Netlink designs, builds, owns and operates the passive fibre network infrastructure (comprising ducts, manholes, fibre cables and central offices) of Singapore’s Next Generation Nationwide Broadband Network (NGNBN). 

Netlink’s fibre network (about 93000 km of fibre cable, 16,200 km of ducts, and 62,000 manholes) supports approximately 1.43 million residential end-user connections and roughly 47000 non-residential end-user connections, and deploys fibre to 1,679 non-building address point (“NBAP”) connections across Singapore. 

What are NBAPs?  NBAPs are basically your roadside points, bus stops, traffic lights, multi-storey car parks etc.  These NBAPs support infrastructure for telecommunications operators, cameras, sensors, signage and outdoor kiosks.  In this segment of its operations, Netlink is the lead partner in the development of Singapore’s new fibre-based initiatives (including the Singapore government’s Smart Nation programme).

Highlight

The NetLink Group is the only telco regulated by the IMDA under the Regulated Asset Base (“RAB”) regime which allows it to recover the cost of investment, operating expenditure and earn a regulated rate of return for its fibre network assets.  Netlink derives 80% of its revenue from the RAB regime.  The remaining 20% of its revenue comes from the provision of other services and rental of space.

Results and Ratios

In the latest annual report (1 Apr 2019 to 31 Mar 2020), Netlink reported the following:

1. Revenue rose 4.7% from S$353 million to S$370 million, mainly due to higher residential connections and diversion revenue.  However, installation-related and ducts and manholes services saw a reduction in revenue.

2. Profit before tax rose 3% from S$69.75 million to S$71.87 million.

3. EBITDA rose 4.3% from S$247.87 million to S$258.43 million.

4. Netlink reports a gross debt/EBITDA ratio of 2.60 (similar to financial year 2019), which is reasonable.  A ratio of 4 or 5 would be considered high.  It is interesting to note that other infrastructure and utility players with a structure similar to Netlink’s RAB model have debt/EBITA ratio above 5.  The debt/EBITDA ratio expresses Netlink’s ability to use its available cash to pay back its debts which currently is S$666 million, and does not reflect its earning ability.  Debt is not necessary a bad thing, especially if it helps to grow the business and leaves the business better off in the long-term.  What is important is that the business has a realistic and sustainable way to repay the debt, which Netlink is well capable of doing.

5. Netlink also reports an EBITDA interest cover of 13.4 (13.5 for financial year 2018).  How capable is Netlink in servicing its short-term debt obligations?  Very capable!  A ratio greater than 1 indicates that a business has more than enough interest coverage to pay off its interest expenses, and Netlink has a EBITDA interest cover ratio of 13.4!

7. Free Cash Flow

2020: Free Cash Flow of S$186.983 million (Cash from Operations S$262.518 million less CAPEX S$75535) is less than dividend payout of S$196.797 million.  FCF shortfall: -S$9.814 million.

This mirrors the same in the previous financial year.

2019: Free Cash Flow of S$158.542 million (Cash from Operations S$229.642 million less CAPEX S$71100) is less than dividend payout of S$190.172 million. FCF shortfall: -S$31.63 million.

As a result of Netlink’s CAPEX cost and high payouts (80-85%), it consequently pays out more dividends than its FCF.  Netlink has been funding its CAPEX cost from a combination of cash and debt to increase the efficiency of its balance sheet.  It is encouraging to note that due to increased revenue and a payout amount consistent with the previous year, the cash holdings of Netlink has gone up by 20%.  

It is worth mentioning that Netlink’s asset has a long life (for instance, fibre and related infrastructure has a useful life-time of 25 years) and therefore incurs CAPEX to replenish its depreciated asset base annually.  On average, Netlink incurs an annual CAPEX cost ranging from S$40 to 60 million.

8. Cash Balance: 

2020: 168.624 million

2019: 148.621 million

2018: 166.449 million

9. PB ratio was 1.08 when I made my purchase so it was a relatively fair purchase of a good stock.

Why did I buy Netlink NBN Trust?

Resilient Business & Recurring Revenue: Netlink, being the only fibre network provider with nation-wide residential coverage, is a business with a very substantial economic moat.  As of 31 March 2020, there were approximately 1.43 million residential connections supported by the network, representing  more than 90% of all residential homes in Singapore.  As such, its business is resilient and its earnings are assured.  With 90% penetration in Singapore already in the grasp of Netlink, it makes no sense for another business to enter and build another fibre network for residential homes.

In addition, much of its revenue is of a recurring nature.  For the past financial year, more than 90% of Netlink’s revenue was recurring, and came mainly from the provision of fibre broadband services to residential customers (62.5%: $13.80/connection/month), non-residential customers (8.4%: $55/connection/month), and non-building access points (2%: $73.80/connection/month).  Such prices, however, will be up for review by IMDA come end of 2022, although a provision has been made for a possible review in 2020 should IMDA or Netlink deem that necessary.

Of the 8 sources of income, only installation-related revenue and diversion revenue are non-recurring in nature.

Given the importance and indispensability of internet connectivity in present day and age (especially with current WFH measures which will continue into the near future), it is not difficult to understand just how Netlink is able to hold on to its customer base (e,g, Singtel and Starhub which lease Netlink’s spaces to provide their telecommunication services).

Netlink’s residential business will grow with the creation of new housing development projects across the island in the years ahead and in its participation in IMDA’s Home Access programme for low-income households (IMDA will bear the 2-year subsidy for these households and Netlink’s pricing will not be affected).

Netlink plans to grow its non-residential and NBAP and segment connections by customising offerings to SMEs, deepening penetration on data centres’ point-to-point connections, making NBAP easier and faster to deploy, and preparing to support 5G infrastructure.  However, ducts and manhole services (8.2% of revenue) will see a decline in revenue as fewer copper cables are installed by Singtel.  During this time of the outbreak, the installation and diversion revenue (8.6% of revenue) has been at risk given the shutdown and consequent project delays.

5G, a Substitute for Fibre Network?: Netlink operates in a technology realm.  Any changes in technology, something more efficient and more cost-effective than fibre-optic cables perhaps, might spell the eventual demise of Netlink’s fibre-optic network.  What is relevant today might be rendered obsolete in the fast-changing world of technology.  So what new technology will ascend on the horizon in the future? Is 5G a substitute for fibre connection?

5G connection is complementary and not a substitute for fibre connection.  In Singapore’s heavily built-up environment, it is expected that wireless broadband service might suffer from network congestion as well as signal degradation and speed reduction.  Consider the following concerning the essential relationship between fibre optics and 5G wireless networks:

“5G wireless small cells and their fiber wireline networks will never be mutually exclusive. To understand the relationship between wireless and wireline networks, it’s helpful to think of a city’s network in physiological terms: 5G will function splendidly as the capillaries (mobile fronthaul) of a city’s networking system — but internet traffic will travel nearly its entire journey in the veins or arteries (fiber backhaul). In fact, much like the human bloodstream, only about 11% of traffic is carried by wireless networks.  The other 90% of internet traffic is supported and carried by the wireline network.  So in a 5G world, the customer experience will be improved by better small cell wireless access points. But ultimately, the quality and reliability of the wireless network will depend on the wireline (fiber) network carrying traffic to and from the 5G small cells.”*

So, put simply, 5G’s formidable network performance is heavily dependent on the availability of a reliable fibre network.

Supporting 5G infrastructure will be a major growth engine for Netlink.  With the nationwise 5G rollout, more base stations will be added to Netlink’s NBAP connections to facilitate optimal performance, thus allowing Netlink to monetize these stations through monthly recurring charges.  

Netlink also stands to benefit from Singapore’s Smart Nation initiatives which seek to harness infocomm technologies, big data and a network of sensors and monitoring equipment all across Singapore to create and support tech-enabled solutions (autonomous vehicles, HD surveillance cameras, weather data collection, etc).

Unsustainable Future Distribution?: Will Netlink be able to sustain its dividend payouts given that its dividend payouts exceed its FCF? On this scenario, my mind immediately thinks of Starhub and Asian Pay TV which had to borrow extensively to sustain their distributions as they were unable to support their dividend payouts based on their FCF alone. 

The last thing I want to see is Netlink cutting its distribution. 

Netlink’s gearing is pretty low at 16%, as compared to Singapore Reits’s gearing at 35-40%. That means Netlink still has lots of headroom for debt.  Thus, Netlink is able to borrow to boost its cash flow and meet its distribution as well as CAPEX needs.

The difference between Netlink’s FCF and dividend payouts is quite insignificant at about -S$31.63 million in FY2019 and -S$9.814 million in FY2020.  That Netlink is able to narrow the FCF and distribution difference in FY2020 is commendable.  

Honestly, I’m not very concerned about this right now.  I’m confident Netlink will be able to sustain its distribution in the future.  That said, I will still be on the qui vive for any adverse development on this.

Netlink operates in an environment heavily regulated by IMDA.  IMDA sets the pricing terms and dictates the quality of service Netlink must meet.  NetLink is required to deliver a minimum Quality of Service (QoS) standards.  The pricing terms are subjected to review by IMDA every 5 years (end of 2022), and a mid-term review might be imposed by IMDA in 2020.  IMDA might revise the pricing terms upward or downward either this year or end 2020, and this is something that I will take note of.  Apart of changes to the pricing terms, I will be mindful to watch for any changes in regulations that might impact Netlink’s operations, financial status, and distribution ability. 

Competition from SP Telecom?: That Netlink does not have any single competitor will not remain true come this year.  Netlink might have a competitor in SP Telecom, a joint venture between ST Electronics and Temasek’s Singapore Power, which also owns, builds and powers communications and infrastructure services.  SP Telecom consults with PCCW Solutions, the IT services arm of Hong Kong telecoms giant PCCW Group.

Fortunately for Netlink, SP Telecom, thus far, is only concentrated in the non-residential area catering to a small group of customers in the CBD, one-north area, some major data centres and government sites.  SP Telecom’s aggressive entry into the fibre broadband services providing comprehensive coverage (inclusive of cybersecurity and cloud network) to the Government and businesses in the CBD area poses a potential threat only to Netlink’s non-residential revenue (8.4% of Netlink’s revenue). Netlink still has no challenger in its residential business.

However, will SP Telecom eventually challenge Netlink’s dominant position in the residential segment?  Unlikely. 

Netlink’s fibre network is still the only network with nationwide residential coverage in Singapore (more than 90%).  Netlink runs the Next Generation Nationwide Broadband Network (NGNBN), while SP Telecom runs the Software-Defined Network with Network Functions Virtualisation (SDN-NFV).  Will SP Telecom build the SDN-NFV infrastructure which is laid alongside the Singapore power grid throughout Singapore?  Quite unlikely, I would say.  But again, how things will shake up in the future is anybody’s guess.  I’ll be watching the development in SP Telecom’s business in this area.

Netlink is a resilient dividend play with a formidable moat and I should be keeping it in my Forever Portfolio for the long term.

For a small amount of perspective at this moment, imagine you were born in 1900. When you are 14, World War I starts and ends on your 18th birthday with 22 million people killed. Later in the year, a Spanish Flu epidemic hits the planet and runs until you are 20. Fifty million people die from it in those two years. Yes, 50 million. When you’re 29, the Great Depression begins. Unemployment hits 25%, global GDP drops 27%. That runs until you are 33. The country nearly collapses along with the world economy. When you turn 39, World War II starts. You aren’t even over the hill yet. When you’re 41, the United States is fully pulled into WWII. Between your 39th and 45th birthday, 75 million people perish in the war and the Holocaust kills six million. At 52, the Korean War starts and five million perish. At 64 the Vietnam War begins, and it doesn’t end for many years. Four million people die in that conflict. Approaching your 62nd birthday you have the Cuban Missile Crisis, a tipping point in the Cold War. Life on our planet, as we know it, could well have ended. Great leaders prevented that from happening. As you turn 75, the Vietnam War finally ends. Think of everyone on the planet born in 1900. How do you survive all of that? A kid in 1985 didn’t think their 85-year-old grandparents understood how hard school was. Yet those grandparents (and now great grandparents) survived through everything listed above. Perspective is an amazing art. Let’s try and keep things in perspective. Let’s be smart, help each other out, and we will get through all of this.” In the history of the world, there has never been a storm that lasted. This too shall pass.

Anonymous

Disclaimer: I am only an amateur investor and nothing you read here on my blog constitutes financial advice.  I write here to detail my investments, strategies, and analyses.  Feel free to read at your own risk.  Should you need financial advice, consult a licensed financial advisor.

* https://www.rcrwireless.com/20190220/opinion/readerforum/fiber-optic-5g-reader-forum