Spark New Zealand's (NZTCF) CEO Simon Moutter on Q2 2017 Results - Earnings Call Transcript

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Spark New Zealand Limited (OTCPK:NZTCF) Q2 2017 Results Earnings Conference Call February 15, 2017 4:00 PM ET


Simon Moutter - Managing Director

David Chalmers - Chief Financial Officer


Arie Dekker - FNZC

Adrian Albon - Craigs

Blair Galpin - Forsyth Barr

Brian Han - Morningstar

Ian Martin - New Street Research

Shane Minogue - IDC

Simon Moutter

Good morning, everyone. And welcome this briefing on Spark New Zealand Limited’s results for the first half of the financial year FY 2017. I’m Simon Moutter, the Managing Director and I'm joined by David Chalmers, our Chief Financial Officer, who joined the company last October.

I describe our result this time as a solid, if not spectacular result. It's a good solid performance and really does demonstrate, I think, continuing execution and continuing delivery on plan and within the guidance that we had set out.

I think the EBITDA performance slightly up, but when you remove the one-off elements, I think you can see that it’s supported by strong mobile connection growth performance, still doing very well in connection numbers, continuing upgrade from copper to fiber and wireless broadband. It’s a very important strategy for us given the performance concerns we had on the copper network last year and our new wireless broadband product has been very well received by the market at over 40,000 connections at the half year.

We’ve seen sustained revenue growth in platform and cloud IT services business. And everyone on the call, I’m sure, understands the importance of that to us and the significance of that business in our big business and government sector and continuing at 25% revenue growth there as a strong performance.

We’re continuing to invest in digital self-service capabilities and you can see in the cost growth in our business, we hope, which will be temporary, some very substantial additional human resource into our call centers to help pull the service back to where we would like it to be, which we have successfully done in the half year.

We’re working now to expand the presence and positioning of Spark’s products and brands and in particular emphasizing the continuing focus on digital inclusions and premium products under the Spark brand and elevating the significance of our flanking brand in Skinny by moving it now also into the fixed and wireless broadband space from where it was firmly in mobile a year or so ago.

So, we’re looking to use the brands and the positions we’ve got to elevate our share of broadband revenue, particularly moving forward.

That said, we do see continuing price pressure across mobile broadband and IT services and it does require us to continue to think about the tight management of cost and CapEx, if we’re going to sustain long-term shareholder returns and profit growth.

On the key results, revenue growth at 4.1% is a strong performance, a little ahead of where we thought it would be in our plan. That is contributing to EBITDA growth at 3.5% and that growth, I think, is primarily coming from mobile revenue growth at 4.4% and IT services revenue growth at 19%.

On market performance, mobile share has slipped slightly there. That is the continuing share gain of 2degrees. I think we’d be holding our own relative to our major competitor, Vodafone. But 2degrees continues to grow revenue and we would see some impact from that.

Mobile customer growth continues to be strong and we’re very pleased to be well over the 2.3 million customer mark now. Broadband share, this continues to be a battleground and a decline of two share points continues to disappoint us and we are gearing our business up now to compete much more strongly in the price seeker segments in that market, accepting that a lot of customer decision on broadband is based on price. And the sort of stronger point there, and we don't have a good measure of it, but we’re confident in our market share of revenue in broadband would be materially higher than that as we do tend to focus on the higher value segments.

Broadband customers flat, reflecting that performance, and we continue to grow our position in IT services.

So just moving across to the detailed numbers, let me introduce David.

David Chalmers

So, slide four gives us a snapshot of the financials and you can see the revenue there, as Simon mentioned, up by 4.1% and operating expenses up by 4.3%. [indiscernible] the drivers of each of these, but it did want a note in terms of the translation of EBITDA down to NPAT growth. So, we note EBITDA growth here over the period of 3.5% as against an NPAT increase of 12.7%. And what’s been driving that is our decrease in depreciation as our CapEx from two years ago, which was circa 600 million, has come down to around about $400 million. And so, we’re seeing that reduced profile come through.

In addition, while net debt increased over the period, our average cost to debt fell, meaning that we have a constant net finance expense over the period. And that's the reason why you see that 3.5% EBITDA growth line translate into a much higher NPAT impact.

Turning over to the next slide where we talk about the revenue waterfall and the key drivers there are IT services and IT services of NZ$ 62 million including the CCL acquisition which we’ve noted there of 29 million. CCL acquisition was made on 1 December, 2015, so there’s one month in the previous comparative period versus the full six this year.

Mobile grew by $25 million. That’s a combination of $4 million of service revenue where we saw the increased base offset some declines in ARPU, given those challenges we’re seeing in the market and the price competition. And we’ve seen a big improvement there has been in the CPE area of our business, and this is not just consumers choosing expensive handsets, it's also the move away from subsidized handsets to interest free models.

Broadband is the other contributor there and you can see also that the decline in some of our traditional businesses continues at about the same trajectory as we’ve seen in previous periods.

Moving to the operating expenses line, the IT services cost of sale has increased and that’s principally to fund that revenue growth that I have mentioned on the previous slide, and we’ve also noted there the CCL impact.

The labor costs of $26 million, think of that as being roughly 50% again to support the topline growth we’re seeing in IT services and roughly 50% in terms of dealing with some of those customer service pain points that we talked about previously in HMB. So, we’ll talk again about that, that sort of $13 million cost that we’ve incurred there, but that is certainly driving the result.

The increase in broadband, baseband and excess cost is a result partly of the mandated price increases in December 2015 coming through and it's also the migration that we've had as customers choose higher speed UFB programs.

The net result of those two on the next slide translates directly through the EBITDA. And again there, we’ve split out the timing of the Southern Cross dividend. Southern Cross dividend was NZ$35 million for the half, up from NZ$26 million previous year. And we do expect that difficult to be timing. And so, that's why we’ve called it out there getting to the NZ$471 million.

Some comments on Spark HMB on the next slide. Mobile, we’ve talked about, but what we’re really seeing there is some pleasing changes in terms of customers moving both up into high value-add plans with digital inclusions as well as growth with Skinny.

On the broadband side, there is some – well, the base has been constant. Again, there is some migration up in terms of the selection of plans and the main story there being as our base is evolving with our upgrade New Zealand program away from copper based to wireless broadband and fiber.

In terms of the cost increases of NZ$19 million that we’ve called out in HMB, again, NZ$13 million of that relates to those call center increases I mentioned earlier and approximately NZ$7 million for those regulatory price increases, and that’s what’s driving the cost differential.

Across on Spark Digital, the headline of 19% on IT services, and IT services comprises both our traditional IT services, which is principally professional services, platform IT services which are some of our newer cloud businesses and managed services and also procurement. And those are really where we’re very pleased to see the growth that we’ve been deliver through those acquisitions over time.

Simon Moutter

Let me pick up on where we’re at with customer experience and this was an issue we called out that we were very dissatisfied with our performance at the end of the full year last year, but I can now confidently say we have brought our call center performance bank to the sort of levels of service that we would expect the market leader to provide. So, very substantial improvements in call wait times and a marked improvement in marketing piece as a result of that.

So, that has been achieved by a significant lift in human resourcing in the call centers which was the fastest way to make a difference and that is now being backed up by a series of programs to digitize and to bring to bear the big investment we made in the IT stack now to provide more digitized service options, more proactive service assurance and to simplify some of the issues that cause to come in. So, we’re making good solid progress on the longer-term sustainable corrections as well.

Another contributor to the improving performance, our success in moving customers off the copper network, our fixed copper network is the source of a large number of our issues in the call center, be they for calling or broadband customers on DSL products, and so we’re now at 25% of our base removed from the copper network and shifted to either fiber or wireless, so pleasing progress, and that does help de-load the call centers.

The other big program we have underway is the migration away from Yahoo! to a new mail platform as a provider for our Xtra mail service. New Zealand members on the call will know the trouble we’ve had with the service over the last few years. Yahoo! had been a very poor performing service provider in recent times, so we’re very pleased to be moving away from them. And while it's a very complex migration and will cause us a few hiccups in the process, we are looking forward by the end of March to being away from them as a service provider.

Moving to broadband, we are going well in broadband, but it is a struggle to maintain connection share in a market which has all the effects of commoditization showing up in the business. Competition is essentially price based across most of the market, really only are Spark and Vodafone make any attempt to bundle other services with it. The rest of the market plays price.

And we’re privileged, I think, therefore to have a multi-brand approach to that to help our performance with Skinny working across the low-price basic broadband service. We really bought Skinny into broadband very recently, so we’re hoping to see an improvement in our position in that market.

We also have Bigpipe for the tech savvy customer and Spark for the customers who prefer a full-service model and a lot of value packed in with things like Lightbox bundled into the service.

The Upgrade New Zealand program is the driver away from copper. We’re very committed to this program and going hard with it. We want to de-load our network from copper and we’re trying hard to get as far as we can with it before the rain comes in May, which when the rain comes, the copper network performance degrades materially. We’re pushing the lower volume customers across to wireless and the high-volume customers across to fiber and going well in both.

So, swept up 43% of the market growth in fiber in the first half and we’re going to aim to do even better than that in the second half and we’ll continue to proactively push customers toward wireless broadband where it's a great service for them.

Digital service inclusions with Spark Broadband are driving clear retention benefits now and we’re pleased to see churn on our core Spark broadband product right down to 15%. That’s the lowest it’s been in quite some time and the key driver of that, the Lightbox, the integrated service now progressing very well toward the 250,000 subscriber network and we’re underway with the replatforming of Lightbox to give it more capability and more options to support the marketplace strategy we outlined in February last year.

Moving to mobile, pleasingly, pushing further and further away from subsidized contracts and have now flipped through the 80% level in home, mobile and business division on pay monthly customers are reverting to no contract, open-term plans, and effectively bring your own device. Where the customer can’t afford the device up front, we provide a time payment option and essentially a financed arrangement. That does impact ARPUs and some of the dynamics you’ll see in the overall ARPU figures, but it's extremely good business at a margin level, and so this is something we set out to achieve two or three years ago and it really is a very successful strategy.

Lightbox and Spotify are now included and are pay monthly and with very clear benefit on churn. HMB’s churn in postpaid mobile is the lowest it's been in over three years. We work hard to proactively re-sign our business customer base.

Skinny Direct, a new service we launched in the first half which is online only, bring your device mobile is proving that a digital-only sales and service model can work and deliver improved margins even with very aggressively priced deals. So, very pleased with the progress there.

And we continue to belt along with our network investment and have commenced the 4.5G overlay which does give us some significant advantage with five times increase in data capacity when we apply 4.5G to a 4G site. So, we’re starting to make that really work for us and it's a key part of our wireless broadband program.

Platform IT going very well. We have an extremely strong leadership position in this market and New Zealand revenue – a CAGR of 26% revenue performance over the last two years and strengthening margins on the back of a large number of significant customer wins. We’ve had a of transition work going on in the first half and David did draw your attention to some of the cost of that, but we will see the revenue and margin benefits from that show up. From the second half onwards, we had a very significant program of large customers coming into our Revera data centers over the first half.

Acquisition of CCL Limited has been a very good and complementary business and we’ve scaled that up by acquiring into it some of our regional operators in the South Island, so that’s already a significantly bigger business and delivering a strong revenue performance as well.

Ultimately, of course, and we’re seeing the first signs of – this is a product that we understand will commoditize over time too. We’re seeing some signs of that, but we do have a differentiated and unique position in the market and we’re backing ourselves to manage that and to provide a string of value-added services which fight against the forces of commoditization, things like managed security [indiscernible] and things that are very difficult for the globals to provide down here.

And we will continue, of course, to drive for more efficient and leverage the progress we're making across our multiple cloud propositions and with our own big core data center business as well.

Looking forward to the future and the investment in that, we signaled in August that we are keen to move to an owned CBD fiber model, just integrating fiber where we have the right dynamics and seeking sort of more a fixed input model there and more control of the customer experience, better network economics given our large market share and much more agility on speed to market. We’re progressing that and are in dialogue with parties around how we might achieve that. Of course, one of those is the filing of the notice of intention for a takeover of TeamTalk. TeamTalk own a CBD fiber network in Wellington and that’s of interest to us as a part of that strategy, along with some of the other businesses that TeamTalk are involved in and where we think there’s some synergy.

Connect 8 is a small business that we already owned a half of. We have just taken the other half of that fiber installation and management experts and again just goes to the point that we are looking to have more control over our fiber assets, be they core transport, backhaul or access network. We are interested in playing more of a role in all of that.

Digitization investment continues apace. We’re about to launch a new Spark app, which will be a world-class app and does have conductivity into the banking systems and will enable a lot more customer self-service and automation. That launch is imminent. It's been in beta trial and getting very strong feedback.

We moved last year to implement proactive fault assurance where we notified customers when there are faults rather than wait for them to call us and offer options around switching between their mobile and broadband proactively in an automated way and over 5,000 fault events have already benefited from that. So, they’re good examples. A lot of our online buy and change journeys have been materially upgraded as well with very good improvements in interaction promoter scores and uptake.

And as I said before, we’re continuing to focus on improving our network economics and unlocking that with a 4.5G program, but also have commenced the retirement now of the PSTN and have begun removing switches and we've approved and are underway with the big investment in the IMS core which replaces the intelligent network, which is the centerpiece of the PSTN and provides a lot of the control logic for that. So, that’s something we intend to share a lot more information with the stakeholders in the coming few weeks with a detailed presentation on where we’re headed with the retirement of PSTN.

David Chalmers

Back to you, David, on CapEx. In relation to CapEx, a few comments I wanted to make, in particular the impact of the November 2016 Kaikoura earthquakes. As a result of that, we forecast to spend across FY 2017 approximately NZ$15 million and that’s both remedying some of the damage that was caused by the earthquake, in particular, on the eastern fiber route in the South Island. And in addition to that, improving resilience by – with increased backhaul capacity and also adding a third fiber route as well. So, that impact of NZ$15 million does impact our guidance around CapEx. However, it still falls within the range we’ve given, which is 11% to 12% of revenues.

Turning over capital structure, it’s worth I guess noting that the strategy around capital structure has been to use, in particular, the special dividend to reset our capital base. And so, part of what you see over the period is net debt increasing as I flagged earlier from NZ$758 to NZ$950 million, so an increase of just under NZ$200 million. And some of the key drivers of that is the dividend and again that we’re using to reset the capital structure. Some of those investments effectively in working capital around IT services, so to fuel a lot of those managed services contracts and growth, this is a typically a large investment that’s led up front and that’s the impact there.

Simon mentioned earlier how pleased we were with the switching in handsets and that movement away from subsidies towards financed plans. That does have an impact in terms of the cost, but given the increasing gross margin, again, we’re very pleased with that progressing. And that's about NZ$40 million impact.

So, that's what's happening on the net debt side of things. In terms of the impact on dividends, we’ve declared a first half FY 2017 dividend of NZ$0.11 fully imputed and a special dividend of NZ$0.015 cents, 75% imputed.

When we look out across the second half, we’re anticipating to mirror that again with NZ$0.11 per share and again a special dividend of NZ$0.015 with no change in terms of our view on imputation, being fully imputed on the ordinary and at least 75% on the special.

So, moving to guidance on the next slide on 17, just to give an overview of what has changed from previous guidance and we note that we’ve had no change in terms of our outlook on total revenues or reported EBITDA. The CapEx line there, we would note, that’s the increase specifically due to the earthquakes that we’ve called out and that's really the only change to guidance, so no change in terms of earnings-per-share or dividend per share guidance.

Simon Moutter

Thanks, David. Let me comment on the indicators of success slide we publish in August what we thought and this should hold us to and deliver this year, and I think the report card would reflect good amount of progress, some significant achievement, but the odd thing not going as well as we would hope at the half year point, but we do have our team very focused on getting all of these key indicators to where we need them to be. So, going well on call answer times, first call resolution, we’ve made some progress, but nowhere near enough and continue to work hard on that. That’s a very important part of getting call center performance to where we really want it to be out.

We've had a good lift in our market net promoter score, so we’re on track for that five-point lift across the year. Call volume reduction has been a bit modest to date and I think that's fueled by, in particular, the one-off exercise we’re dealing with at the moment in the migration of Yahoo!, which is extremely complex and it does require a lot of assistance to customers. So, we’re very much hoping that when we’re clear of that by the end of March we should see a volume – material volume reduction, but time will tell.

We’re going well – Spark app, as I mentioned before, about to be taken fully to market. We’ve delivered on proactive fault management. We’re scaling our dev ops model very quickly now. Spark logins to the app, of course, that won't really move until we’ve got the app out there, so we’ll just hold that performance until later in the year.

Skinny certainly achieving that 10% target on digital channel sales. Wireless broadband uptake, we set a target for the full year of 50,000. I think it’s very clear that given that we had 40,000 at the half here and we really only started actively selling and promoting it in November that we’re going to scoop well past that target. So, I've adjusted the internal target up to 70,000 for the year-end. And next, we will be aiming to be ahead of that number.

I mentioned before, we’re in progress around the CBD fiber program. We’re rapidly expanding our 4G coverage footprint. We’re sort of close on UFB orders. As I said, we’re at 43. So, we’re slightly behind, but we’re backing ourselves to get there on that.

Mobile total revenue growth slightly behind at 4.4, I think, the number was. It might be hard to close that to 5% in the second half, but we be there or thereabouts, going very well on IT and broadband inclusions.

Still considering options on entering any adjacent high-growth markets. And I’ll just emphasize to investors, if we can't find something that looks good enough, we won't – we certainly won't be pushing ourselves to do something we’re not very confident about the benefit.

All that said, I think – as I said at the opening, a solid result, but not a spectacular one. And it feels like we – this is a good time now to start to rethink some of our strategic positioning. A lot of the strategy we’ve been executing were set in 2013. And while we’ll give it a very big tick and a mark of success, it does feel like we’re at a point where we need to make some material adjustments and we’re reflecting on that the sort of the learnings from the last three years of execution.

And we would note that I think that customers are very strongly preferring wireless connectivity and digital self-service everywhere we’re offering that. The net promoter scores are materially higher than anything to do – anything we can achieve on the fixed network. So, that is very compelling steer to us to up the emphasis on wireless and mobile capability and investment.

It’s very clear that a growing portion of the market is choosing to buy primarily on price, and we’d see that really across all our telco portfolios irrespective of whether it's consumer, SME, or big business. And so, we can't continue to try to steer our whole proposition only to the high-value market. We are going to play now an increasing role in completing in the more price seeker markets.

We await the decision on Vodafone Sky, which we expect to hear later this month. If approved, clearly that will have a profound impact on the industry structuring and the competitive playing field and will warrant a response that we wait to see where that lands. And if it comes about, we’ll need to make some adjustments.

And I have a new leadership team now in place and of course we’re working hard. Therefore, to respond to those changes, we’re working on the next evolution of our market strategies and working out how we will address those new trends and the future risk. And what you've seen in the recent times from us, the significant expansion in Skinny into the fixed broadband market and a wider portfolio of assets across wireless broadband and Skinny direct as the first indicator of a significant move to address the markets where we we've been a little bit – where we formerly have been choosing not to play too hard on those.

So, that will all result, I think, in the next few months the creation of a refreshed strategic plan. And given the last one was set in 2013, it does feel like time to do that refresh and we’ll be in a position by the middle of the year to publish that plan and share it with investors at an investor day, hopefully, before the end of this financial year.

So, sort of overall, we’re in good shape, but it is time to make some adjustments and we’re working hard to make those and look forward to addressing the issues that are in front of us.

So, let me hand now back to the operator and have the operator manage the Q&A.

Question-and-Answer Session


Thank you very much. [Operator Instructions] Your first question comes from the line of Arie Dekker from FNZC.

Simon Moutter

Good morning, Arie.

Arie Dekker

Good morning, Simon, David. Two questions just on CapEx and Southern Cross in particular. I see the investment in a second cable as being as sort of bought forward potentially. You’re about to do the survey. How should we to think about the CapEx associated with that or whether that will see dividend suspended for a period when that investment is made, what the timing and quantum might be?

Simon Moutter

Too early to say. It’s very preliminary at this point. The Southern Cross – it’s not a full cable all the way to the US. It’s the first stage of that expansion, but at this point we don't really have enough advice from Southern Cross Limited, who are a separate entity to give us much help with answering that question, Arie.

Arie Dekker

Okay. No, it’s fine. Just on the regulatory review, clearly, fixed has been the focus of that and continues to be. It does it appear that it's wrapping up and almost complete. Mobile is still open and there is some talk that they’re going to come back with something on that shortly. Do you perceive there being any material changes in the regulatory framework and settings?

Simon Moutter

Yeah. So, I think your conclusion is right that the focus of the review so far has been on the fixed line issues. And, broadly, we’re very aligned to the thinking that’s emerged from that and we support the government's position. The consultation paper that was published last week makes a lot of sense. So, they have Spark’s backing generally. If there is one issue we have in the outcome from the government’s process to date on fixed, it would simply be what are the reference products that are going to be applied for those price path decisions in 2020. And on a fast evolving market, it feels like a they’re a little bit low spec-ed. So, we’d prefer some higher spec-ed products as the reference points. But broadly, other than that, we’re very positive about the approach to giving price certainty on the inputs in fixed.

When you look at mobile, it is very difficult to imagine what the problem is that could be solved in mobile. All the mobile market indicators at this point – at this state in New Zealand point to a market that is delivering prices that benchmark extremely well internationally. There’s a huge amount of investment going in and world-class technology across three nationwide networks in a small population. So, really don't understand what the problem might be. And if you think about what the biggest challenge in mobile is today, it’s really solving the expansion and coverage into highly uneconomic areas, which is the point of the mobile blank spot in extension program the government are leading and regulation of mobile operators just make that harder to affect. So, look, we certainly can't see the case for regulating mobile and would note that there are multiple MVNOs. So even if you come at it from that angle, there doesn't appear to be a problem when there’s a dozen MVNOs successfully operating across all three of the core mobile networks.

Arie Dekker

Great. RBI 2, presumably, you’re keen to participate on that on fixed wireless.

Simon Moutter

Look, on RBI 2, we are keen to support the government's initiative. Our ambition statement at Spark is to unlock the potential in all New Zealanders and that includes our rural citizens and the people who do the hard work out there for us. But it is a very, very challenging economic. So, we agree that if you’ve got to solve some of these issues, you’ve got to bring every conceivable technology to the table. You’ve got to get a public-private partnership going to solve the numbers. There is no simple business case to make. And we're interested in playing an effective part of that, but we think is pretty challenging. But you're right, fixed wireless ought to play a pretty significant role in solving for those markets.

Arie Dekker

And then just quickly, last question, adjustments if Vodafone-Sky is approved, is there anything you can elaborate on that?

Simon Moutter

Look, our position on Voda/Sky, just to let me start with a bit of background and just reassert where we are because there’s been a little bit of action on that in the media today. But we've been absolutely consistent on this and that our objection – we do object to the Vodafone/Sky merger as its proposed today, essentially noting that in the absence of an effective wholesale market for a key bottleneck asset, that bundle of core sports that New Zealanders want, that approving the merger just will continue – will transfer that dominant monopoly position into another market. And with the merger approved, we think New Zealanders will have fewer choices on how to consume the sport they want available from one company. If the merger is not approved, then Sky will be highly incented to work with all broadband companies to produce a range of sporting products and bundles that can be delivered in a new way across everyone's broadband services and New Zealanders will be far better off, and so will Sky in our view – and having everyone work with them to head to the future. And so, we continue to be opposed to that merger and that Sky have made no meaningful offer to us or we are not sure – we don't think anyone else on an effective wholesale regime that would be about the future, not the past. We’ve walked away from our box bundling stuff deals with them several years ago because they weren’t effective, and that’s telling you customers don't want to buy the past. They do want to buy bundles of sport delivered in a modern online à la carte consumable way on-demand. So, that's our position on the merger. We sent them a letter yesterday requesting that they provide a short stay of a few days on the back of a nine-month process if the commission grants approval next week just to allow us and others who have an interest in the process some time to consume the decision and make a determination on whether we have any issues with it. They rejected that this morning, so we will be considering our options and will make a decision on what to do next on that later today.

In terms of our response, clearly, if the merger is approved, it will require a response and a meaningful one, but there’s no way I'm sharing that with anyone externally. And we will – it’s very commercially important that we do that and that whatever we do we do with committed strength and that we approach our customers first without thinking – not signal our intentions to competitors. So, I’m not going to answer the question you asked, Arie.

Operator, next question.


Your next question comes from the line of Adrian Albon from Craigs.

Adrian Albon

Good morning, guys. Just three kind of questions from me. First one, on the gap between effectively the EBITDA to operating cash flow conversion, which I think if you have back the interest and the tax, it’s around NZ$80 million and has been a feature of the last couple of reporting windows. Look, I understand the drivers in terms of the IT services and mobile. Are you expecting that – how long do you think we should sort a model a gap on that? Should we expect it to close within the next 12 months? Or is it more of a permanent feature for two to three years before they really comes back into an alignment?

David Chalmers

If you look at the pathway of what’s been driving that, around about half of that comes from those deferred costs and prepayments in terms of establishing those longer-term IT services contracts. So, that, we do expect to be a feature going forward. The difference, I guess, we would see is in the second element, which is about $20 million, which relates to deferred handset commissions. And if you look at the pathway, about 12 months ago, we were 72% of the way into open term plans. We’re now about 82% of the way with growth rates slowing. So, that is the one area that we would expect to moderate over time. We wouldn’t expect the rate of growth in that that we’ve seen in the past few years continue. The balance of the other drivers of that difference really are timing. So, timing in relation to receipt of dividends, or sort of working capital movements. So, probably, as I said, we would see the deferred cost element of that continuing and we’d see a moderation over time as there has been over the last 12 months of the handset contribution to that gap.

Adrian Albon

And just to be clear, that deferred cost element is roughly about – is about NZ$40 million, isn’t it, there or thereabouts?

A - David Chalmers

Yeah, yeah.

Adrian Albon

Okay. Just second question, just in the broadband market, just really thinking about [indiscernible] on the fixed wireless, which has obviously been going quite strongly, are you able to firstly give us an indication of how much of, if you like, the adds are coming through the Skinny versus the Spark brand? Just as a sort of a way of us kind of trying to understand what the margin differential might be, given obviously one of the motivations is avoiding [indiscernible] with those connections.

Simon Moutter

Look, commercially, that's valuable information to us, Adrian, but you can consider the majority coming from Spark. The selling capability and machinery around Spark is much bigger than Skinny.

Adrian Albon

Okay. And then to the fixed broadband part, are you able to give us an indication of – firstly, at the last report, about 40-odd-percentage of bases had already moved to unlimited. Can you give us an update on that? And then, probably of more interest, just how much of the base is effectively on the Xtra email?

Simon Moutter

Again, we wouldn’t share the detail on Xtra email. That’s commercially sensitive, but it’s the hundreds of thousands. And, Dean, do we have an update on the latest number on the percent that are on unlimited. I'm sorry, I don’t have that. We’ll have to pick that one up offline. Sorry, Adrian, I don't have that one with me, I’m afraid.

Adrian Albon

Okay, that's fine. And just, I guess, more broadly, I guess, what we’re seeing in broadband, I guess, some of the price points now becoming more sticky, but it's really the acquisition cost, which is rising. Like, just noting that your own and Voda is at sort of like almost three months free for a 12-month contract and then you’re starting to see some of the other players [indiscernible] offering free TVs and stuff like that.

Simon Moutter

[indiscernible 0:44:50] split off into two, which these – low price for a year, high price for second year, which we think are flawed. They’re very flawed. You win on price, you lose on price. And so, that’s a significant part of the price pedal. So, you’re correct to observe that, Adrian. I think a lot of acquisition, if in a market which is saturating, there’s not a lot of organic growth today. Most people who want broadband have got it. I think it generally is an industry flawed logic to be applying so much effort to acquisition when there’s such a huge job to do on migration to fiber where customers get a material benefit and much stickier. So, it is something that frustrates us, the degree of price competition that’s driven by acquisition effort, which is just driving market share. I don't think it's obvious that anyone's particularly gaining on that. But that is the state of the market today and we have play in it and over time I guess it will become a bit more orderly.

I think, operator, we better take another question. Thanks, Adrian.


Certainly. Your next question comes from the line of Blair Galpin. Please go ahead.

Blair Galpin

Good morning, David and Simon. Thank you for the call today. Look, a few quick questions. Firstly, great fixed wireless result. And in terms of your baseband charges, it’s fallen quite a bit over the last half. So, this is 2016, is that really driven by that fixed wireless number or is there sort of other pieces in the puzzle as well?

David Chalmers

Yeah. The two main elements there are the regulatory price increases from December 15. So, that’s obviously pushed the number up and that’s the line we do start to see some of the impact of the wireless broadband moving across and those charges coming down. So, there’s obviously a timing element there in terms of when those customers came on in the half, but that's the line that we expect to see move with wireless broadband.

Simon Moutter

Blair, just if I’d add, I think we started the year at 12 or so. I think we had around 12, we signaled. The majority of that uplift to 40 came late in the half. We really – remember, we were having some challenges getting the customer journeys, right, particularly where a calling service was involved with the product. It took us a while to polish those up and give them rights. So, we really market launched late October, and so the uplift in sales occurred late in the half. My point being you won’t see a huge impact yet on those costs, but we should see a material improvement in the cost position because we’ll get a flow through into the second half.

Blair Galpin

Definitely. And a couple of CapEx related questions. First, [indiscernible] upgrade, obviously, you’ll give an update at some point. In terms of that upgrade, is that really going to remove again that focus on the copper network? Is it really only a fiber focused, mobile focused upgrade?

Simon Moutter

Very much so. The IME score is the key element – central element that enables the retirement of the services that run on a PSTN world. It replaces the intelligent network which is what runs everything from 111 calling to 0800 and conferencing. These are – it’s the intelligence that allows us to then shift to modern software voice and data applications and integrate them with international services and all the other things that are required across the multiple axes platform. So, that’s a big build program. I think it delivers that first major phase release about a year from now. But it's a board approved program and underway. And so, as I indicated before, we will be conducting a substantive stakeholder briefing to which investors will be welcome within the next four to six weeks on the whole program around IME score and the migration away from the PSTN over the next few years because we’re well and truly underway on that. So, if you could hold off on that, we’ll give you a lot more information about that very shortly.

Blair Galpin

Definitely. [indiscernible] the whole strategy around pushing fiber versus copper and so forth.

Simon Moutter

Absolutely, yeah.

Blair Galpin

[indiscernible]. Platform IT, you mentioned potential commoditization with some parts of platform IT, looking at how you can mitigate at that. Are you foreseeing the international guys proactively – is it more that corporates are looking overseas for those sort of services?

Simon Moutter

Look, no, how we’re viewing it is – if you move to an all software world with quality of service management and policy control rules and these sort of thing that there’s an ability to shift even the data connectivity which today we would describe as a fat dump pipe service and evolve it into a fat smart pipe service. So, business and large consumers in particular will be attracted to buying inputs that have more capability built into those data connectivity layers in terms of policy control and prioritization of traffic and services and much more flexibility to switch between access products. So just builds a much more flexible, manageable, software defined, automatable infrastructure that we can build full-service products on that some customers want or we can sell inputs to that other sophisticated end user customers who just really want inputs for that advanced capability and they can do their own development on. So, that was our API strategy. We're intending to make these networks very open, so that depending on customer capabilities, they can buy at any layer in the service. So, we’re excited about the future, but it’s several years to deliver it in that core networking technology, obviously.

Blair Galpin

Okay, thank you.

Simon Moutter

Next question, operator. Thank you.


Your next question comes from the line of Brian Han from Morningstar.

Brian Han

Good morning, gentlemen. Just two short questions. Firstly, how much higher do you think your share of the broadband revenue market is compared to your connection share?

Simon Moutter

Look, it’s very hard. We can only get revenue share if we see some IDC attempts to deliver, but it's pretty ropey analysis. So, why don’t we call it something like 3 to 5 percentage points, I think, would be where we would estimate it. It’s very difficult to substantiate that given we’re the only meaningful publisher of any information about broadband revenues in New Zealand. All our competitors are unlisted companies and we don't see much from them. That might change obviously over time, now that we have 2degrees listing on the Toronto Exchange and if the Voda/Sky proceeds they’ll become a listed company too. So, that might help get a bit firmer on there in due course. But that would be our broad estimate.

Brian Han

Okay. Great, Simon. And also secondly, your customer experience metrics have clearly improved. Does that mean the incremental investments you’re making in call centers done or is there another step up to come?

Simon Moutter

No, they’re done. And in fact, we expect to abate. I think – so, we've started now to believe that we can start to reduce that investment in people and will back that by some very compelling service – digital service capability, including a new app, which I mentioned before. We have a very rudimentary app on Spark and have for several years because it's been very difficult to wire the app into the system. But having completed the big rebuild of IT last year, we are in the process – as I said, we have in beta test today a new app which is much more capable and is a much more sophisticated platform for digital self-service. So, in particular, using that capability, we’d expect to see customers able to do much more with us online through their app and through the websites.

Brian Han

Okay, great.

Simon Moutter

Thank you.


Your next question comes from the line of Ian Martin from New Street Research. Please go ahead.

Ian Martin

Yes, thanks. Look, I think you've largely dealt with those RAN CapEx issues. And I just note, you talk about the benefits of owning CBD fiber, being network economics, customer experience, and so on. But, really, those kind of benefits extend beyond the CBD, don't they? And that's going to have some implications for capital spending in the longer term?

Simon Moutter

Ian, once you move beyond CBD, the economics of density are very strong in the CBD areas. So, I think it would be – and in the context, the industry structure that’s been in New Zealand with several natural monopolies having been created around, call it, non-CBD fiber access, it would be very challenging to make a business case to move into the – to overlaying non-CBD fiber and there are no other networks. Whereas in the CBDs of New Zealand today, there are already several fiber networks. So, as we mentioned when we announced this initiative in August, we put owned in quote mark. We don't necessarily have to actually own it to achieve the benefits of ownership because we can do that in a structured deal with one of the parties who has a CBD asset. So, our ambitions longer term in non-CBD access are much more linked to the wireless future. We’re big believers in the pathway on mobile. We strongly believe that in a 5G world, a very material portion of the market will prefer untethered connectivity and will not need a fixed access, be it fiber or wireless because in these next generation wireless technologies, they’re going to meet a lot of the demand and the service benefits are very – and customer experience benefits are very strong. So, we’re backing that pathway and our aspirations for the longer-term future in, say, the suburbs.

Ian Martin

Excellent. Thanks, Simon.

Simon Moutter

Thank you. Thank you. Operator?


Yes. Your next question comes from the line of Shane Minogue from IDC. Please go ahead.

Shane Minogue

Good morning, Simon. I was hoping you could provide a little more color on fixed wireless performance. Currently, at 40,000 subscribers, first, what impact is this having on mobile capacity constraints, if any, and how are you managing this? And second, just looking ahead, is there a limit to the total subscriber numbers you can expect on fixed wireless before it starts to impact our mobile performance and your mobile subscriber performance of mobile customers?

Simon Moutter

Look, great questions. And this is sort of the art of managing – fixed wireless broadband is all about managing network capacity. Because we've been believers for some years we invested heavily in the last few years around single RAN technology and the software upgrades that allows to integrate carriers. And, of course, we spent up large on 700 MHz spectrum to have the largest slice of that, which has helped us in the less dense areas of New Zealand, less densely populated, and we went quickly into a deal to acquire 75 MHz of 2300 spectrum recently, which we’re also deploying. So, we have acquired a lot of spectrum assets. We integrate those spectrum assets through the network with these 4.5G carrier aggregation technologies and we have – we spec the modems that we can drive the modem to the various spectrum bands in each area where we have capacity. So, we work extremely hard to steer the fixed wireless network on to the alternate spectra, the stuff that’s not used by mobile devices as much on each tower. We control the availability by residential address. So, these fixed wireless broadband modems are not movable. They’re only allowed on the site they’re spec-ed to. If you pick them up and take them with you to your beach house, they won’t work. We will shut them down. So, we control very carefully the sale where we have capacity. And we run with about a six-week lead. As soon as we see capacity getting tight in area where we want to continue with fixed wireless, our mobile team only needs six weeks before they can complete the enhancements. So, we’re running very carefully and we move immediately to stop-sell wherever we get any concern about our capacity problems. So, as yet today, I've not had reported a single issue with mobile performance that could have anything to do with the presence of fixed wireless broadband. So, consider it extremely carefully managed.

On where it can get to, I think that's more determined by the customers’ utilization patterns on broadband. So, as broadband services grow and more and more people stream video, I think, realistically, it would be hard to imagine our current capability of fixed wireless broadband serving any more than half of our market and probably quite a bit less than that. But at the moment, I’d be cautious to put a limiter on it, given that our fixed wireless technologies are going to continue to improve. And I note, since we launched this product, we've upgraded the available gigabyte allowances twice already in a year and that’s the continuing fast improvements that we’re getting and the capability of wireless for data delivery and also the economics of it.

Shane Minogue

Thanks, Simon. That covers it in great detail. On the point you made about control sale where you have the capacity, so at current point, is fixed wireless available country-wide, or what percentage of kiwis can actually get fixed wireless broadband today?

Simon Moutter

Do we know that number? Look, I’m sorry, I can't answer that, but it's pretty extensive. We’ll have to think about whether we're willing to share that information or not. And if so, we’ll share it in a way that everyone can see it. But I don't have it to hand.

Operator, we’ve probably got time for one more question.


Certainly. Your final question today comes from the line of Arie Dekker from FNZC. Please go ahead.

Arie Dekker

Hi, guys. Got a second chance, given some of your Aussie colleagues are obviously focused on Telstra. So, just a couple ones on the numbers. The depreciation and amortization, David, you called that out in terms of stepping down with the CapEx coming down around that NZ$400 million mark. Can you just give a little bit of color on where you see that sort of leveling out and how quickly it will get there?

David Chalmers

Over time, we would see that moderating, so that effectively CapEx and depreciation start to line up. And so, if you look at the pathway over that that’s where we’re heading down towards. So, that’s probably going to be the best assumption, I think, across the medium term. But what we wouldn't do is call out a specific number. And the reason I’d say that also, this relates back to Simon's earlier comment. Given the refresh on the strategy, that may well impact different elements of our strategic plan moving forward. But based on today, we would see it moderating, so that those two lineup.

Arie Dekker

Yeah. No, I understand that and that sort of steady-state asset base. The other part of the question, though, it was NZ$9 million down on first half 2016. Do you sort of – the phasing for this asset base to get to that sort of circa NZ$400 million, are we sort of – is it done in 18 months or will it take a little bit longer to get there?

David Chalmers

I think most of what you see in terms of that timing differential, there’s just some timing differential in terms of CapEx spend. There’ll be an increase of the – NZ$15 million is predominantly weighted to the second half. So, you’re going to see a little bit of an impact there. But around about that sort of timeframe probably is about right based on the current outlook.

Arie Dekker

Okay, great. And then just with regards CapEx, is there anything notable to call out in terms of phasing? And there, I note the reasons for very slightly increasing the envelope for this year, but as you've gone through the year, are there any things that have sort of been brought forward and which might impact where that sort of guidance sits the next year out and FY 2018?

David Chalmers

It really is just the impact of the earthquake that we called out. And as I said, that spend of NZ$15 million will be predominantly weighted to the second half, given that the earthquake was November. So, there was an immediate remedial work. But as I said, the balance of that will be in the – majority of that will be in the second half.

Arie Dekker

Yeah. So, no reason for not thinking that FY 2018 would be in that 11% to 12% of revenues range?

David Chalmers

No, that’s right.

Simon Moutter

The only thing we would say is just with the strategy refresh, let’s not be closed minded to a powerful investment case tuning up. But don’t read that as a hint either that we plan to have a lump [ph]. But just – we’re going to do quite a bit of rework on strategy, particularly as it relates to this wireless pathway. But later this financial year, we’ll be in a position to share a bit more. I think that's – given your interest in where this CapEx profile, the depreciation profile goes, we’ll try and pick that up as something to provide more guidance on at that point, if that’s okay.

Arie Dekker

No, that's wonderful. And actually, that just reminds me of one other thing that sort of just in the Q&A came up. I know you're going to share more detail on the potential retirement pathway for PSTN. Just in terms of the stakeholders, do you envisage that requiring and do you intend to talk to the government around the TSO date as part of that?

Simon Moutter

Look, it will throw up a number of issues because there are a lot of services today that are reliant on PSTN technology and the intelligent network. So, hence the reason for a stakeholder briefing. It’s a multiyear program, but we want everyone across it. And whether it requires changes in TSOs or regulatory sittings or just a number parties to take action to ensure that they are on a new technology platform for something that they currently rely on in the air [ph], I think all of those questions are open. And what we’ll do in the next four to six weeks is open the kimono, say this is where we’re heeded, the PSTN is going. It's no longer a question around whether it is or not. We’ll set out the timeline and invite everyone to the table to say let’s help solve for the issues that that’s going to create. So, I don't know what they all are yet.

Simon Moutter

Great. Well, thank you, Arie. And thank you everyone for being on the call. Really appreciate the continuing interest in the company and look forward to updating you with the full-year results in August. And for any follow-on conversations, you know to approach Dean and Sean Tay [ph] and the investor relations team and we're happy to provide some more information where it's appropriate. Thank you all.

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