NetLink NBN Trust - Maybank Kim Eng 2020-07-27: Underground Shelter To Dividend Downside


NetLink NBN Trust - Underground Shelter To Dividend Downside

NetLink NBN Trust's yields are more stable vs telcos and REITS. BUY

  • Reinitiate coverage of NetLink NBN Trust with BUY and DDM-based (6.3% COE, 1.5% LTG) Target Price of SGD1.08.
  • NetLink NBN Trust is the sole nationwide provider of passive fibre network infrastructure in Singapore. NetLink NBN Trust’s business is less volatile than other yield plays such as certain REITs and telcos amid risks of DPU cut and competition. In addition, NetLink NBN Trust is a domestic-yield play amid COVID-19 re-opening uncertainties.
  • Changes to its regulated returns (based on 7% pre-tax WACC) is the key upside or risk to our outlook.

NetLink NBN Trust - Corporate information

  • NetLink NBN Trust (SGX:CJLU), which owns 100% of the units in Netlink Trust, has a nationwide network that is the foundation of Singapore’s Next Generation Nationwide Broadband Network (NBN). This delivers ultra-high speed internet access throughout Singapore. As of 31 Dec 2018, the trust owns 10 central offices, 76,000km of fibre cables, 16,200km of ducts and 62,000 manholes.

Backbone of Singapore’s digital-nation plan

  • NetLink NBN Trust commenced operations and deployment of Singapore’s Next Generation NBN in 2009 in support of the government’s Intelligent Nation (iN2015) Masterplan. As of Mar 2020, the network is connected to 1.4m residential end-users, 47,681 non-residential end-users and 1,679 NBAPs (locations without postal codes such as traffic lights, lamp posts and bus stops).
  • The trust provides nationwide coverage to Requesting Licensees (RL, also known as OpCos) at regulated rates. The RLs sell fibre services to Retail Service Providers (RSP) that market services to end-users. These end-user segments are:
    1. residential connections;
    2. non-residential (enterprise or commercial) connections; and
    3. NBAP connections.
  • NetLink NBN Trust has a universal service obligation to provide fibre connectivity to all parties based on a set of IMDA-approved service rates. Since Apr 2013, IMDA instituted a requirement for all new homes in Singapore to be pre-wired with an optical fibre termination point within the household. In Nov 2018, IMDA revised its requirement, mandating all new homes to be fitted with an additional fibre termination point given the expected increase in smart devices within a household.
  • 81% of NetLink NBN Trust’s FY20 revenue is under the RAB regime. The RAB regime sets rates based on NetLink NBN Trust’s forecasted revenues, opex and capex. The IMDA has agreed to an overall pre-tax WACC of 7% as NetLink NBN Trust’s return on its asset base. The rates are reviewed every five years, with the current agreed prices ending in Dec 2022.
  • Interconnection offers are prices regulated by IMDA using the RAB framework. The pricing is based on:
    1. Return on capital: based on the value of the asset base and pre-tax WACC of 7% for the current review period.
    2. Operating expenditure
    3. Depreciation.

Residential connections: natural monopoly

  • NetLink NBN Trust operates the only fibre network with nationwide coverage in Singapore. Entry barrier is high for any potential competitor, as it would require significant costs and permits to build coverage of the same scale as NetLink NBN Trust’s.
  • Further, residential fibre penetration is already high at 93.5% as at Jan 2020 so redundancy risk is high for any greenfield network project. On the other hand, high penetration rate also means growth potential for NetLink NBN Trust’s residential fibre business is limited to Singapore’s new home growth.
  • Going forward, Singapore’s housing supply is projected to grow at 25,000 homes per year or a 10-year CAGR of 1.7% through 2029.

Non-residential: aims to grow market share

  • In this segment, NetLink NBN Trust competes for market share in enterprise and commercial segments with telco incumbents that utilise their own network infrastructure to serve enterprise and commercial end-users.
  • As of Dec 2019, NetLink NBN Trust had 37% market share of the corporate fixed broadband subscribers recorded by IMDA, up from 34% in 2018.
  • The growth is driven by SMEs and commercial developments located outside the CBD, where NetLink NBN Trust’s network is a monopoly. NetLink NBN Trust remains a beneficiary of the government’s continuous push to decentralise business activities and commercial centres to outside of the CBD, such as to Jurong East, Woodlands, Tampines, one-north and Paya Lebar.

NBAP and segment: small contribution but growing

  • NBAP and segment connection revenue grew at a 3-year CAGR of 19% to SGD7m between FY18-FY20. This was mainly driven by fourth mobile network operator TPG (TPM AU) building connections for its base station deployment.
  • Based on Media Partner Asia (MPA, source: NetLink prospectus) estimates for FY18 market size, NetLink NBN Trust had 32% share in NBAP, up from 25% a year earlier. MPA estimated industry NBAP connections to grow by a CAGR of 76% from FY16-FY21E to 8,171. This is driven by the expansion of Wireless@SG hotspots and the introduction of Heterogeneous Networks under Singapore’s Smart Nation Plan.
  • Although NBAP has the potential to scale up in volumes, NetLink NBN Trust’s high revenue base should keep NBAP and segment’s revenue share at single-digit levels.

Other regulated revenues –recurring vs project-based

  • Revenues generated by co-location and installation business segments are non-RAB, but IMDA regulated. This accounted for 11% of FY20 revenue. The former involves leasing rooms within central offices for RLs to host active network equipment and servers.
  • Installation involves providing civil works for network-rollout projects and thus is dependent on project awards and timeline.

Non-regulated revenues – stable vs volatile

  • 8% of NetLink NBN Trust’s total revenue is not under the regulated regime. These involve central office and diversion segments.
  • Central office revenue is mainly derived from leases to SingTel (SGX:Z74) for hosting certain equipment and operations. Contracts for such arrangements are long term in nature, thus providing stable top line for NetLink NBN Trust.
  • On the other hand, diversion involves providing re-routing civil works on a project basis. Similar to the installation segment, this segment is more volatile as project pipeline is less predictable.

NetLink NBN Trust - Investment Highlights

Residential and non-fibre businesses to provide stable earnings visibility

  • NetLink NBN Trust is the sole nationwide provider of passive fibre network infrastructure in Singapore. 92% of NetLink NBN Trust’s FY20 revenue was recurring income and predictable cash flow. 81% of NetLink NBN Trust’s FY20 revenue was under the regulated asset base (RAB) regime. The Infocomm Media Development Authority (IMDA) sets NetLink NBN Trust’s pricings and returns for a five-year period based on its asset base and pre-tax WACC. The current five-year period will last until Dec 2022 (FY23), with a 7% pre-tax WACC designated as NetLink NBN Trust’s fixed return on its assets.
  • Residential connection revenue represents the bulk (FY20: 62.5%) of the business and we expect this segment to continue to provide stable earnings for NetLink NBN Trust.
  • With current residential internet access penetration rate already high at 98%, NetLink NBN Trust’s residential connection growth will be driven by Singapore’s new household formation going forward.
  • Based on HDB and URA projections, Singapore’s new household formation is estimated to be 25,000 per year for the next 50 years, in new estate areas such as Tenggah and Punggol.
  • Due to its large exposure in this segment, any downward revision in IMDA’s regulated pricing in residential connection in 2023 will impact earnings and Target Price the most. Every 2% change will lead to a potential 1.5% impact to Target Price.
  • That said, we think a drastic downward revision by IMDA is unlikely, as Singapore’s broadband connection pricing is one of the lowest globally already.
  • Meanwhile, we expect other non-fibre businesses (FY20: 18.5%) such as ducts & manholes, co-location and central office segments to remain stable due to long-term contracts with its customers.

Non-residential: office decentralisation, data centres

  • Non-residential connections (RAB revenue) made up 8.4% of FY20 revenue. As of Dec 2019, NetLink NBN Trust had 37% market share of corporate fixed broadband subscribers recorded by IMDA, up from 34% last year.
  • This is driven by connections by SMEs and commercial developments located outside of the CBD, where NetLink NBN Trust’s network is a monopoly. Currently, competitors’ (incumbent telcos) network deployment is largely concentrated within the CBD and business parks.
  • As such, NetLink NBN Trust should continue to benefit from the government’s drive to decentralise business activities and commercial centres to outside of the CBD, such as to Jurong East, the Woodlands, Tampines, one-north and Paya Lebar Central.
  • Decentralisation of commercial activities to outside of the CBD could potentially push the incumbents to expand their coverage beyond the CBD and business park areas, thus competing with NetLink NBN Trust and each other.
  • However, the probability of this happening is low as the incumbent telco service providers, unlike NetLink NBN Trust, do not have any guaranteed returns on such capex and are subject to market forces.
  • Going forward, NetLink NBN Trust will also aim to improve its presence in major data centre sites.
  • Based on a market research report by ReportLinker, while Singapore is one of the mature data centre markets in APAC, it is likely to remain a major connectivity hub in the region as global cloud service providers continue to expand their presence. As such, Singapore’s data centre market size is projected to grow at a CAGR of 4% to SGD2.5b from 2020-2025. Further, growth in Internet of Things and 5G network generate demand for edge computing data centres in Singapore.

5G not a threat but an opportunity

  • 5G wireless network uses higher frequency millimetre (mm) wave spectrum to provide higher bandwidth with virtually no latency. As such, 5G wireless network will provide nearly 100% network availability with less than 1 millisecond latency.
  • This implies that 5G technology could provide 1,000 times the current bandwidth and 10 gigabit-per second (Gbps) speed, up from the current maximum speed of 1Gbps. To put things in perspective, this enables one to download a two-hour movie in 3.6 seconds. The same task would take about six minutes on 4G.
  • The key benefit of 5G technology spans far beyond speed. It allows a massive increase in connected devices at lower latency and it’s the key enabler for industrial automation and autonomous driving.
  • High frequency mm waves can travel only about 250 feet so this means telco players have to set up denser 5G base stations on streetlamps and buildings to power 5G network.
  • According to RCR Wireless News, successful 5G rollout would require existing fibre infrastructure, and both networks will never be mutually exclusive. 5G base stations have to be linked to Singapore’s fibre backhaul. It is helpful to imagine that 5G will function as capillaries (mobile fronthaul), but most of the internet traffic is carried by arteries (fibre backhaul).
  • Based on an US case study by Deloitte, only 10% of internet traffic is carried by wireless networks (5G), while the remaining 90% is supported by wireline network (fibre backhaul). Without fibre, telcos will not be able to support the projected four-fold increase in mobile data traffic between 2016 and 2021.
  • In other words, the quality and reliability of 5G technology is dependent on fibre network transmitting data traffic to and fro 5G base stations.
  • As such, 5G deployment will not pose a threat to NetLink NBN Trust’s business but rather an opportunity to grow its Non-Building Address Points (NBAP) segment.
  • We have captured this to a small degree. Our base case assumes NBAP connections to grow at 10% per year through FY23, up from FY20’s growth rate of 6%.
  • Areas of growth clusters include the following trial sites:
    • Smart Estates: Singapore Science Park by CapitaLand (SGX:C31), TPG Telecom and Navinfo Datatech.
    • Industry 4.0: Changi Business Park by ARTC, Singapore and JTC.
    • Urban Mobility: NTU Smart Campus by M1 and NTU.
    • Maritime Operations: Singapore Maritime Drone Estate (near Marina South Pier) by SingTel, M1 and PSA
    • Cloud Gaming: Shaw Centre and Ngee Ann City (Orchard) and one-north by Razer and SingTel
  • By 2025, Singapore will have two nationwide full-fledged 5G coverage. The telcos will have to achieve at least 50% coverage by end-2022. Currently, incumbent telco players such as SingTel, StarHub (SGX:CC3) and M1 do have their own fibre infrastructure, but those are only concentrated within CBD and business park areas.
  • In order to achieve nationwide coverage, incumbents are likely to rent from NetLink NBN Trust’s fibre infrastructure, rather than expanding their current fibre coverage to reduce capex spent on 5G development.
  • In fact, NetLink NBN Trust’s NBAP growth in recent years was mainly led by new telco entrant TPG’s (TPM AU) 5G trial network deployment across Singapore Science Park 1 and 2. See Business Times report. As such, we believe it’s likely that incumbents would rent from NetLink NBN Trust’s infrastructure instead of building up their own fibre network for 5G deployment.
  • The approach is similar in China, as its two large mobile telcos are trying to build out their 5G capability at low cost through co-sharing 5G mobile network with rivals to reduce capex and maintain stable dividend. See Nikkei report. For instance, China Telecom (728 HK) and rival China Unicom (762 HK) have agreed to jointly build a 5G network and they will share part of the infrastructure.
  • 5G base-station linkage by fibre will be a boon for NBAP connection and installation revenue. That said, NetLink NBN Trust’s NBAP and segment business made up only 2% of FY20 revenue and will remain a small revenue contributor to the trust.

Defensive yield play

  • We believe our DDM methodology is best suited for NetLink NBN Trust as its business trust structure returns 100% of its free cashflow to unit holders. This mimics the payout and valuation methodology for REITs.
  • At current levels, NetLink NBN Trust's FY21E (end-Mar) yield of 5.2% for FY21E is comparable to Singapore’s REITs’ FY20E average yield of 5.6%. We favour NetLink NBN Trust over certain REITs with lower yields and higher risk of DPU downside as some are looking at dividend reduction to preserve capital amid the COVID-19 outbreak.
  • Our REITs analyst Chua Su Tye remains selective on retail REITs due to downward rent pressure and lower occupancies, as well as hospitality REITs with declining RevPARs. See report Singapore REITs - Maybank Kim Eng 2020-05-19: In Conservation Mode.
  • Against Singapore telco players’ average yield of 5.5%, NetLink NBN Trust also provides comparable yield, while offering shelter to dividend downside and persistently weak ARPUs.
  • For 1QCY20 results, both SingTel and StarHub’s earnings were hit by the COVID-19 pandemic as travel and movement restrictions led to lower prepaid and roaming revenue. Meanwhile, equipment sales also saw a decline due to supply chain disruptions.
  • As a result, SingTel cut MarFY20 dividend by 30% to SGD0.1225 (dividend yield: 4.8%), while StarHub did not declare any quarterly dividend for 1Q20. Both groups withdrew their forward-dividend guidance.
  • NetLink NBN Trust’s FY20E net gearing of 18% is low compared to infrastructure fund’s average of 123%. The trust has significant room to fund its future capex with debt to maintain its DPU. Given the low interest rate environment, NetLink NBN Trust’s FY21E/FY22E dividend yield of 5.2%/5.3% may benefit from yield compression in the near term.

NetLink NBN Trust - Valuation

DDM methodology

  • We use dividend discount model methodology to determine our Target Price. We believe this is appropriate as NetLink NBN Trust’s business trust structure declares its free cash flow as cash available for distribution. We discount its cash distribution by its cost of equity of 6%. We derive a Target Price of SGD1.08.
  • We have assumed that rates and regulated returns to remain unchanged following the review period in FY23E and capex stays at between SGD70-80m per year.
  • Based on the current share price, the stock is yielding 5.2% and 5.3% for FY21E and FY22E.

NetLink NBN Trust - Financial analysis


  • We project NetLink NBN Trust's revenue CAGR of 1% in FY21-23E on the back of continued growth in the residential connection segments. This is underpinned by annual new household formation of 25,000 and the assumption of household broadband penetration rate of 94% through FY21-FY23E, up from the current 93% as households continue to connect on fibre via government-subsidised initiatives such as IMDA’s Home Access programme for low-income households. There are currently 100,000 of such households which are not connected to fibre broadband. Tele-commuting trend should help accelerate broadband penetration rate.
  • We assume NetLink NBN Trust's EBITDA margin to expand to 71.7% and 71.4% in FY21E/FY22E. This is higher than FY20’s 68.2% due to cost savings from COVID-19 Job Support Scheme (est SGD4.9m in CY20), property tax rebates (est SGD 4.9m), as well as the absence of one-time write-off of capitalised project cost of SGD15.4m relating to discontinuation of contract.

Balance sheet and cash flow

  • With interest coverage estimated at 13x for FY21E-23E and net gearing at 18%over the period, we believe NetLink NBN Trust’s balance sheet is capable of sustaining its 100% cash distribution policy. In order to maintain an optimal capital structure, we assume it will be refinancing its existing debts in FY21E.
  • We assume capex of SGD73m per year for FY21-23E, at the lower range of FY19-20’s capex, as NetLink NBN Trust aims to keep its capex stable.

NetLink NBN Trust - Opportunities, risks and sensitivity analysis

  • Under the RAB framework, NetLink NBN Trust is subject to pricing revision by regulator IMDA every five years. The adoption of this framework has led to rate reductions (-8% in Residential/ +10% in non-residential/ -60% in NBAP/ -29% in inter-Central Office connections) in the last review in 2017. As such, a change in its regulatory set return of pre-tax WACC of 7% and approved capex would impact its tariff structure.
  • If the IMDA were ever to rule that NetLink NBN Trust had generated excess returns within the review period, there is no claw back/refund required but rather an adjustment to future capex that would translate to tariff cuts. The lack of claw back lessens the risk of significant one-time earnings and cashflow swings in the event of any negative decisions.
  • We illustrate in Fig32 in the PDF report attached below the sensitivity of profit and target price to potential swings in revenues and connection rates.
  • As residential revenue is the largest revenue component of NetLink NBN Trust, it is the most significant as every 5% change would lead to a 4% to Target Price.
  • At the other end of the spectrum is NBAP and segment revenue, which would need a substantial deviation to move the needle.
  • From the standpoint of the stock being a dividend-yielding investment, the direction of interest rates is likely to influence share price performance. This is also the case with REITs and dividend-yielding telcos.
  • The stock’s low 3-year beta of 0.59 against the STI has exhibited low volatility to market movements. As such, it could underperform during an up-cycle but it’s relatively defensive during a downturn. Every 0.5% change in COE impacts our Target Price by 8%. While every 0.5% change in long-term growth (LTG) impacts our Target Price by 9%.
  • See NetLink Trust Share Price; NetLink Trust Target Price; NetLink Trust Analyst Reports; NetLink Trust Dividend History; NetLink Trust Announcements; NetLink Trust Latest News.

See 30-page PDF report attached below for complete analysis on NetLink NBN Trust,

Kareen Chan Maybank Kim Eng Research | https://www.maybank-ke.com.sg/ 2020-07-27
SGX Stock Analyst Report BUY INITIATE BUY 1.08 SAME 1.08