In my previous free cashflow analysis post using Frasers Commercial Trust, I have briefly sidetracked to touch on the problematic nature of Business Trust and that Netlink Trust is another business that actually borrows from the bank to finance its current high dividend distribution of 5.42% (based on 9 Sep 2019 closing price of S$0.90) and that it will most likely not be sustainable in the long run due to a deficit of <S$33Mil>. I will illustrate this using a shortcut methodology below and discuss some of the main technical points:
1. Is interest paid for loans an operating activity or financing activity?
The good thing about Netlink Trust financial statements is that unlike many companies which deemed interest paid as “Net cash used in financing activities”, financing cost paid by Netlink Trust is included under “Net cash from operating activities”. Many of the partners of Big 4 accounting firms argue that interest paid is not an operating activity and chuck it under financing activity. Hence if one based the free cashflow computation using such approach, one will end up with a bias and impractical modelling as REITS and Business Trusts made use of leverage as an essential tool in acquiring yield accretive assets. If one exclude it, then you will end up with a higher operating cashflow that throws you off track.
|Screenshot 1:Extract of Q1 FY2020 Cashflow Statement|
|Screenshot 2:Free Cashflow Stress Testing|
2. Apparent deficit of <S$33Mil> in terms of distribution based on free cashflow computation
Using the most recent quarterly results (Q1) of Netlink Trust to extrapolate the numbers for Free Cashflow modelling, the expected annualized operating cashflow is S$226Mil and yearly recurring CAPEX will be <69.2Mil>. Free cashflow is thus S$156.8Mil per annum. Please refer to screenshot 2 above.
To see whether the recurring CAPEX number of S$69.2Mil is reasonable estimate, I did a further deep dive back into the previous financial year whereby Netlink Trust spent <S$71.1Mil> in FY2019 (pls refer to screenshot 3 below). Hence the current estimation of CAPEX using Q1 extrapolation of <S$17.3Mil> to arrive at <S$69.2Mil> appears to be a reasonable and consistent run rate.
|Screenshot 3: Extracted from FY2019 Annual Report|
This means that we are staring at a gap of <S$33Mil> in annual cashflow deficit for the senior management team of Netlink Trust to resolve, if they wanted to maintain the high dividend distribution rate to shareholders.
3. Where is the money coming from then to pay out dividends? Parallelism to Asian Pay TV Trust- Another creature of the business trust structure in Singapore
Obviously, the money for the distribution thus came from bank borrowings by Netlink Trust. This is similar to Asian Pay TV Trust which used to finance dividends using bank borrowings until a point whereby the dividends is no longer sustainable and a massive cut had to be declared by their senior management which led to the famous collapse in its unit price by half last November.
Of course, from the perspective of Netlink Trust senior management, they are not using bank borrowings to finance the distributions. Rather, they are only using bank borrowings to finance the CAPEX in order to be more efficient in capital management. Hence the dividend distributions are financed from operating cashflow using this argument.
Again, this rationale seems ostensibly purely due to optimizing the use of debt in terms of actively managing the capital structure of Netlink Trust. But problem starts arising when one keeps repeating this year after year in order to keep investors happy.
4. Problems with the Business Trust Structure
The problem with most business trusts is that they are extremely CAPEX intensive in nature. Look at Netlink Trust and Asian Pay TV Trust. Put it this way, the net asset that investors are holding on to will decline due to depreciation of CAPEX.
Some of them such as Keppel Infrastructure Trust (“KIT”) appeared to have very high dividend yield but actually derives most of its earnings from concessionary service agreements which means that net assets value (“NAV”) as aforesaid mentioned will definitely decline over time. My thoughts are that the complex accounting treatment on capitalizing concessionary service agreements makes it hard to understand for many retail investors and that their effective return overtime is actually a lot lesser than what has been received due to the issue of confirmed declining NAV. In KIT’s case, the Axiom acquisition was a much needed M&A to acquire a different form of more sustainable business relative to the current form of concessionary holdings.
The idea that business trusts are less risky investments as they produce very stable and predictable future cashflows is thus fraught with multiple flaws. Hutchison Port Holdings Trust is a perfect analogy. Its prices languished from USD1.01 per unit at IPO in March 2011 to the current USD0.152 per unit- a whopping 85% price plunge.
Hence as a matter of fact, my thoughts are that holding on to Business Trusts are very risky contrary to popular folklore.
5. So is Netlink Trust a stable cash cow or just another time bomb waiting to explode?
With regard to this question, investors should ask themselves and consider the following 4 pertinent points based on their own outlook:
5.1 Whether one thinks that the annual CAPEX run rate will halve itself eventually such that the dividends payout will be sustainable;
5.2 Whether the 5G implementation will lead to a surge in volume from connection fees earnings as per mentioned by Netlink Trust Senior Management;
5.3 As alluded to pt 5.2, 5G technology can also be an imminent threat to the business of Netlink Trust and there are various downside risks and
5.4 Whether the government in 2022 will maintain or raise the controlled fees due to the 5G implementation. Or the government can change the whole game totally and reduce connecting fees prices.
|IMDA regulated pricing for Netlink Trust Services|
For the short-term, I believe that there should not be any major issue. Debt level is only at approximately S$635Mil out of S$2,952Mil of equity and at a very healthy debt equity ratio of only 21.50%. I guess it is more of a musical chair scenario right now, enjoy the dividends paid out using bank borrowings for as long as possible. Just don’t be the last one standing or holding on to Netlink Trust when the music stops.