Anticipation wanes slightly

By Dene Mackenzie

Anticipation of Spark New Zealand’s investor day on June 30 may have waned a little following recent events, Morningstar analyst Brian Han says.

The group’s successful lobby against the Sky Network TV-Vodafone New Zealand merger had, at the very least, substantially delayed the threat of a convergent juggernaut for Spark to grapple with, he said in a research note.

The benign final details of the New Zealand Telecommunications Act review had provided some certainty with respect to the fixed-line pricing regime after 2020.

"Still, we are looking forward to management addressing a number of key issues at the investor day. Having undergone a three-year turnaround programme, and with the operating earnings base stabilised at the $1 billion a year level, the group’s vision for reigniting growth will be closely scrutinised."

Spark would undoubtedly continue the strategy of differentiating its services in an increasingly competitive environment, Mr Han said.

Some of that was evident in the Spotify music-streaming partnership for mobile and the recently-struck Netflix video-streaming partnership for fixed-line broadband.

Those products, in addition to Lightbox, presented consumers with more compelling reasons to bundle Spark products — a churn-reducing advantage in New Zealand where nearly 60% of households bought a bundle of telecom services in the 2016 financial year, up from about 30% in 2014.

Insight into future bundling and convergence plans would be useful, especially if the Sky-Vodafone merger was resurrected through the High Court, he said.

There were two other areas management would hopefully shed light on. First was Spark’s cashflow outlook, having reported a below 80% conversion rate of operating profit to cash in each of the past three years.

Second was the outlook for the fixed wireless unit and its potential to stem the decline in Spark’s fixed-line broadband share.

Spark’s share of the fixed-line broadband connection had been falling consistently, from 47.5% in June 2013 to 42.3% in December 2016, Mr Han said.

"This is not a surprise given the dominant legacy position it is starting from and aggressive competition from the likes of Vocus, Trustpower and 2degrees in recent periods."

However, within Spark’s 675,000 broadband customers, more than 40,000, or 6%, were fixed wireless broadband customers, who were provided broadband wirelessly to a modem plugged into their mains power supply. That growth had been achieved in less than a year, demonstrating its popularity in the below $60 per month broadband market, especially those in areas underserviced by fixed-line fibre.

The future progress of the fixed wireless broadband service could have a key bearing on whether Spark achieved Morningstar’s 39.1% broadband connection share forecast in five years time.

Regarding cashflow, Mr Han understood the below 80% profit to cash conversion in recent years had been partly caused by the timing of corporate clients going on to IT service contracts and mobile customers switching to deferred handset payment options.

A cogent plan on sustainably improving the measure would provide investor comfort and add to Spark’s strong balance sheet.

Spark’s IT service business now accounted for 19%, up from 14% three years ago, and the trend was expected to continue, he said.

IT services were forecast to make up 23% of Spark’s revenue base in five years time, driven by increasing penetration into IT and expansion into value-added services such as manager security.

An insight into how management planned to combat the margin pressure now emerging would be useful, Mr Han said.