Spark New Zealand Limited (SPK) Earnings Call Transcript & Summary

Thank you for standing by, and welcome to the Spark New Zealand Limited Investor Update. [Operator Instructions] I would now like to hand the conference over to Jolie Hodson, CEO. Please go ahead.

[Foreign Language] Good morning, and thank you for joining us. This morning, we've announced we are reducing our FY '25 guidance to the market. And the purpose of this call is to step through that announcement and then we'll allow some time at the end for questions. We've announced today that we will be updating EBITDAI guidance to $1.12 billion to $1.18 billion, excluding gains on sales and transformation costs that are greater than $25 million. CapEx guidance to $415 million to $435 million and dividend guidance of $0.25 per share, 75% computed. Clearly, this is not where we wanted to be, and we acknowledge that our current financial performance falls short of what is acceptable to our shareholders. To that end, I will spend some time today outlining how we plan to reset performance, but first, I'll speak to the key drivers of the guidance change. So starting with our economic context, we experienced a tough economic environment during FY '24, and these challenges have persisted in the first quarter of FY '25. And in some areas, further deteriorated. Since the completion of FY '24, we've seen multiple OCR movements, which is a welcome change that will put more money into the pockets of Kiwi and improve confidence over time. But I guess the key words there are over time, the rationale for the most recent 50 basis point drop was telling point to subdued economic activity, weak business investment, weak consumer spending and low productivity growth. That is the economic environment we are experiencing, and these challenging conditions have impacted our markets of mobile and IT. With that context, the key drivers of our updated EBITDAI guidance can be summarized as follows: Starting with mobile. The mobile service revenue is now expected to be largely flat year-on-year compared to our original FY '25 ambition of 3% growth, driven by lower anticipated growth in overall mobile connections and pressure on ARPU. Breaking that down by area. During Q1, consumer and SME pay monthly connections continue to grow, but at a slower rate than forecast, while there was a sharper decline in prepaid connections in a highly competitive market. Pay monthly and prepaid ARPU has also been impacted by lower spend on extras and casual usage as customers continue to reduce spending. In Enterprise and Government connections remained stable during the quarter but this was offset by an acceleration in ARPU decline with increased price erosion at contracts resigning and aggressive competitive pricing activity. If I move now to IT, our original FY '25 guidance assumed stabilization in the rate of decline of IT services in the second half and based on the first quarter trading this remains on track. However, in IT products, the mix shift between private and public cloud has accelerated, negatively impacting margins. Over time, we anticipate an ongoing structural shift from private to public, recognizing this path is not linear and customers will choose to have a combination of both to serve different needs for some time still. Turning to costs and our SPK-26 operate program. We have made strong progress on our new Enterprise and Government operating model changes, which went live on the 1st of October, integrating our subsidiaries into Spark and improving efficiency. As a result, we're on track to deliver our net labor cost reduction target of $50 million in the year. Continuing to work towards a $30 million net OpEx target and to support this, we intend to expand the program to deliver materially higher cost reductions, but realizing these benefits and associated transformation costs collectively over FY '25 and FY '26. With this context that we've updated EBITDAI guidance to reflect the softer trading conditions we're experiencing, while rightsizing our CapEx guidance to this new earnings profile. The Board has then made the decision to reduce the FY '25 dividend guidance to $0.25 per share, reflecting the updated EBITDAI guidance and balanced against a focus on shareholder returns. The reduction in EBITDA guidance broadly being offset by a reduction in CapEx guidance, our free flow -- sorry, our free cash flow ambition of $400 million to $444 million remains unchanged. We remain committed to bringing net debt back to targeted levels. So in line with this ambition, as we pursue our data center strategy, we recognize the need to secure alternative long-term funding options outside of the core business' free cash flow to support our development pipeline. We're currently exploring capital partnerships to achieve this. Now turning to the actions we are taking to reset performance. The challenges we are facing are both cyclical and structural. As such, our focus is on building momentum in our core business and significantly reducing our cost base to offset market headwinds, while addressing structural segment challenges in our Enterprise and Government division and simplifying our portfolio. As we shared in our market announcement this morning, we are reviewing all noncore assets to support our focus on the core business. Through this review, we will determine if Spark remains the best owner, or if divestment or partnership will deliver greater value to shareholders while further strengthening our balance sheet. We have confirmed that we've made the decision to divest our shareholding in mobile towers business Connexa, while a transaction is not yet certain, the strong levels of interest we've received is reflective of the high quality of the Connexa business. We'll provide a further update on this review at our interim results in February or earlier in the case of any material developments. As I mentioned earlier, we intend to expand our SPK-26 Operate Program to become a broader multiyear transformation. This expanded scope would include our technology delivery model, which includes the costs attached to managing our network and IT infrastructure, which is labor, support and maintenance, licensing, infrastructure and other costs. The 2-year time line will enable considered execution that accelerates our strategic focus on automation, simplification and resilience while delivering materially higher value over FY '25 and '26 collectively. Finally, I'd like to touch on Mobile, we were firmly focused on stimulating demand into the second half. While we're navigating a subdued economic environment and increased competitive pricing pressure in the business market, the long-term value drivers of mobile remain. Demand for data continues to grow. Our brand health is strong, and we have a significant pipeline of activity landing now and into the second half including pricing, new campaigns and a new Endless plan lineup that will deliver our customers higher data allowances than ever before. So when combined with easing monetary policy, we're confident that these tailwinds will continue to support a strong growing mobile business into the future. So to finish, I wanted to recognize that we have work ahead of us to win back the confidence of our shareholders, and we're committed to that work. We're firmly focused on our core telco business and building momentum in key markets and resetting our cost base. At our interim results, we will provide an update on our review of noncore assets as well as a more detailed summary of our intended extension of the Operate program and the benefits and associated transformation costs that can be expected collectively over FY '25 and '26. So with that, I'll now open the line for questions.

[Operator Instructions] The first question today comes from Arie Dekker from Jarden.

Just first, a couple of points of clarity on the Operate Program. You haven't increased the target for labor savings of $50 million this year. But are you signaling that in labor as well that we should expect materially higher labor cost reductions in FY '26 and if that's the case in what areas?

We will update further, Arie, on the Operate Program at the interim results, but we would expect that the impact of the changes we've made this year and the ones that we are looking further to expand and would have an impact into '26 and beyond.

Yes. On LIBOR and OpEx?

Yes.

Yes. Okay. No, great. And then those OpEx savings -- and you sort of talked to expanding the scope of that and then the time horizon as well. Is that largely centered around the network support and computer cost categories? And can you just talk a little bit about -- because there has been growth in those costs in the last sort of 4 or 5 years. Can you just sort of talk about how meaningful any rebasing there could be and what the key risks around execution are?

I think, Arie, we're able to provide more detail at the half 1 in terms of the full depth of that program, both the benefits and the associated costs. I think within the territories of area that you're talking about are the right areas that we'd be looking at, and they have a meaningful impact into not only '26 but beyond that.

Great. There was a footnote to the guidance just around the potential for one-off transformation costs and also gains on sale greater than $25 million that would be excluded. Could you just sort of confirm that within the guidance, the updated guidance you've provided that the other gains line item, which was elevated in FY '24, your assumptions still at this point is that that's at around more normal levels around $30 million?

That is correct.

Great. Just on working capital. Is there a more favorable tailwind in FY '25 coming from working capital release? Or what are you seeing on the working capital front in FY '25?

Arie, it's Stefan here. Look, so in terms of working capital, as you'd expected a business like this there is quite a few different moving parts. And some of it does once again tie back to the cyclical nature of the economy. So think about things like device receivables where our customers are looking to use interest-free payments. That's still a big part of the driver of working capital. So that keeps -- that's increased a little bit. Otherwise, I would say you'd expect kind of the trends to continue broadly as planned, but there is work for us to do around managing prepayments, which would help kind of offset. So we're looking, I guess, to drive some level of improvement into FY '25, but it is an ongoing work in progress. The only other thing I'd call out is around inventory levels. We continue to manage them as tightly as possible. And really, we have been thinking about the optimal way to rightsize holdings of things like modem inventory and CPE mobile devices. So there's quite a lot of work going on in that space as well, which will help.

Yes. And then just any color you can give on sort of where you're at in the process associated with capital partnering on data centers. And your reference with regards to Connect's high levels of sort of interest. Have you had high levels of inbound interest on the data center since the results as well?

On the capital partnerships we're exploring at the moment. But again, it's clearly to provide any more detail on that, but that is certainly the focus for us in terms of the data center expansion plans around the funding and working with a partner. We don't have anything more to share right now.

Okay. And then just last question on mobile. Would it be fair to say that if you excluded the prepaid and enterprise offsets that in the key consumer SME segment for postpaid, but you're still getting sort of low to mid-single-digit revenue growth in this year, but that is being offset by those factors you pointed to in prepaid in Enterprise and Government?

I think, Arie, the way to think about it is we're still seeing connection growth in pay monthly. At the start of the year, we had some assumptions around how fast the market would grow. We're seeing the growth being slower than what we had anticipated, but it is still growing. And then I guess when you look at kind of ARPU, there's a little bit pressure on some of the casual usage and extras. But ultimately, we're still seeing positive signs in this consumer pay monthly market.

The next question comes from Entcho Raykovski from E&P.

My first question is around Connexa. And I appreciate that you have some uncertainty around the process. But if you were to sell your holding in Connexa, will there be any impact on your lease liabilities just trying to work out whether any additional lease liabilities crystallize? Or if it's just a matter of losing...

No.

Okay. So it's just a matter of losing associate income?

Yes. That's right.

Okay. And I don't think it's in your accounts, I don't think you break it down, but the -- what was the contribution in '24 from Connexa to associate income? Any number you can give us?

We don't give that level of detail.

And so secondly, sorry if I missed this, but are you still assuming the DRP is operational in FY '25. And if so, did the Board as part of their process, consider cutting the dividend further and not having the DRP in place given -- I mean it looks highly dilutive at current trading levels.

Obviously, we've had the DRP in place for the last dividend and we will provide an update at the interim results around any future thinking around the DRP going forward, but we're not providing any update on that today.

Okay. And sorry, the risk of just harping on about the stuff you spoke about at the FY '24 results, the hybrid note issuances is kind of in the context of exploring the sale of noncore assets. Is that something you're still exploring? Or does the potential to sell noncore assets mean that, that requirement is now reduced?

So I guess if you lift it back up the overarching goal here is to get back to a normalized debt level, which is currently sitting at as we measure at 1.7x net debt to EBITDA. We've indicated there's a number of different ways in which we can get there. And at the full year, we said hybrid was our most likely outcome. With the announcement of the portfolio review of noncore assets, the decision by the Board to investigate the Connexa Holding and the divestment of that, that's obviously additional information. So we'll be putting all of those factors together and continuing to assess the options and then we'll give an update as things progress in that space.

Okay. So it sounds like you're still exploring, but no specific announcement to that.

Yes. That's right.

Okay. And just one last question. In mobile, are you able to tell us where mobile service revenue tracked in the first quarter versus the new guidance for flat year-on-year growth for '25. Just trying to work out if you're assuming an improvement over the course of FY '25 from current levels?

I get it. But I guess the important thing to remember is today -- the purpose of today is a trading update to give some trends around market performance. We're not going to go into quarterly numbers. So you'll see, obviously, service revenues when we report at the half year.

Okay. I suppose, can you give us color as to whether you think it will improve over the course of the year or is that not something you can go into?

Look, I think there's a focus on the activity that we've got in place. And certainly, in payments, we've launched new plans today, we've got further pricing coming, other campaigns associated with that. We've also got to see the flow out of what happens in the economic environment as we see the impacts of lower OCR, but there's a lot of pieces still to roll through. So there is significant amount of activity planned for the year ahead, particularly into the second half.

The next question comes from Kane Hannan from Goldman Sachs.

I think back in August, you guys were talking about a return to top line growth through FY '25. I think it's only really the mobile service revenue target that I can see has changed today. So I mean, are we still thinking about potentially being able to return to growth? Or is it more aspiring for a to flat to declining outcome at the group level?

Look, I think clearly, our ambition remains to have growth. But given the current trading environment, there is pressure out there and with mobile service revenue trading towards flat, that will obviously make that more difficult. That said, we are still looking to target growth in areas around data center and high tech. So we still have those aspirations and there's a lot of work going on really to kind of improve the trajectory in the mobile space.

Yes. And just the mobile space. I think as a result, you're talking about holding share in the market growing 3%. I mean some of the other comments you made referenced competition a lot. Is that still how we think about your outlook this year? Or do you think you potentially see a little bit of share with those price rises going through? Just hope to talk a bit more about that, please.

We can sort of tell you what we've seen in terms of large connection growth and pressure on ARPU. We're still to receive the market information. It's released quarterly, so we haven't had that yet. There is heightened pressure in enterprise. However, what I'd say is our base, we've retained our base, just the pressure is on the ARPU. So it's that lower -- more aggressive pricing within that. And then prepaid until we really see the broader market, it's hard to determine, but I imagine there's an element of competition at that low end of the market.

And just lastly, the reduced CapEx. Talk about where you've been pulling back spend and how that impacts your capital budgets into FY '26, whether it's just sort of deferring numbers a little bit?

Yes, sure. So I guess first point is if you think about the revised guidance of $415 million to $435 million, the way I think about it is it's actually returning us back to what I'd call more normalized levels. In the past, we've typically run at more like $410 million to $420 million. So we're kind of coming back into that more normalized zone. Within that spend, we're still looking to have data center spend of around $70 million to $90 million. And so the pullback has been in the maintenance CapEx, and there's a few areas that we have prioritized to make sure that we're not impacted. So we are very committed to maintaining the resilience of our networks, and we continue to spend in that space. The reduction is more in areas like the fit-out of stores or some of the transformation of our IT systems that support our business segments and they're more around deferrals rather than cuts that we'll think about them over a longer period of time.

The next question comes from Aaron Ibbotson from Forsyth Barr.

So maybe if I could start with you, Jolie. Just trying to understand a little bit better what goes behind the thoughts from the Board when it comes to dividends. So you mentioned that you cut the dividend, reflecting the updated EBITDAI guidance. I have to admit that I understood that your dividend was primarily or exclusively a function of your free cash flow or adjusted free cash flow estimate. So is that a change of policy? Or is it reflecting concerns around leverage? Or how does the follow-through go basically?

So you're right in terms of free cash flow is how we consider our dividend again. But if you look at where we set our previous dividend guidance of $0.275, it is what we've seen in terms of the overall context of the trading environment, the EBITDAI guidance reduction is sort of the range of around $45 million when the Board said and considered that and against all of those factors, the decision was made to reduce the dividend to $0.25 to reflect that, the $0.025 shift.

So the Board considers the relationship between the dividend and the EBITDAI?

If you look at the overall context of performance, I think that would be the better way to consider it. And when you look at the overall context of 4 months and where we are, the implications while free cash flow is maintained, we're also looking at balance sheet and all those components that go with that.

Just staying on cash flow and maybe this is just timing of taxes or something that I haven't got fully right, but you cut your EBITDAI and your CapEx by about the same amount. But in my book, that should have increased your free cash flow a little bit because CapEx is sort of 100% drop-through, but EBITDAI is not. Is that some of the working capital? Or is it cash taxes paid or something that's slightly higher or that...

Cash tax, ultimately it's -- so the EBITDAI will obviously impact -- will impact tax expense or cash tax is what we put into the free cash flow calculation. Also just remembering that there are ranges here and there's a number of moving parts with them. So at the end of day, what we're calling out is we remain comfortable with that free cash flow aspiration of the $400 million to $440 million.

Okay. And finally, just on this accelerated private to public cloud that you called out earlier on. I'm just curious to know sort of you've laid out quite clearly that public cloud has lower margins, obviously. I'm curious to understand if you're also seeing pressure within private cloud sort of on a like-for-like or private cloud staying private cloud, if you're seeing any price pressure within your private cloud business as well? Or if it's just this shift to public that's causing that?

It's majorly the shift, Aaron, in terms of from the private to public and the implication that has on mix. We see customers. So if you recall for '24, we actually saw a growth in our private cloud workloads are shifting. And if we look at a long-term basis, we believe structurally that will continue to head in that direction, but it's not a linear relationship necessarily and customers will choose what they want to do and some will have a hybrid component of all of that. So it's not necessarily price pressure within private cloud. It's actually the workload move.

Okay. That's clear. And then finally, and maybe I misunderstood fully your answer to Arie's question on restructuring charges. So did you -- did we understand it correctly that up to $25 million or something like that of restructuring charges would be included in the EBITDAI i.e., that you would sort of -- it's reflected in the new EBITDAI guidance, but if your restructuring charges would be higher, that would be outside of it, similar to other gains? Or what exactly did you say there?

So there was 2 points to clarify. One is other gains we would expect to come in at similar levels to prior year, which we've kind of said is typically runs around that $13 million. Then secondly, in terms of the restructuring costs, what we're saying there is, if they were to exceed $25 million, it would be on the basis that there would be much bigger benefits because of the additional size of the transformation program and that those in aggregate would be adjusted out of EBITDA.

And how does that compare to your guidance in August? Did you have any adjusted out of EBITDAI guidance then and...

We had a small allowance for restructuring costs within FY '25 guidance, but it wouldn't have met the $25 million threshold. What we're saying is as we're working through the transformation program, the larger benefits and we're sizing that up, if the aggregate amount of those restructuring costs was to now exceed the $25 million then in line with our common practice, what we do every year, we would adjust those out of the results. In the same way that we do with any gains. So we're consistent we do both costs and gains that would both be adjusted.

Sorry to dwell on that, but if the cumulative restructuring charges is higher than 25%. Would you then exclude all of it? Or would you leave 25% into your EBITDAI? I'm just trying to understand the sort of underlying business.

All of it.

You would then exclude all of it?

Yes.

Okay. So in your new guidance that you provided today on EBITDAI, have you assumed that these restructuring charges are going to be higher than $25 million and therefore excluded? Or have you assumed that there is a $25 million restructuring charge in this guidance?

It's too early to say, well, we're still working through the size and timing of that transformation program, and that's the kind of thing we'll be able to give greater clarity on at the half year result when we had the time to really work through it in the proper level of detail.

Sorry, I didn't mean that you should say what it was going to be, just what you've assumed for your new updated EBITDAI guidance.

So just to clarify, we've assumed that if it goes above $25 million, it will be adjusted out.

The next question comes from Brian Han from Morningstar.

Thanks. Just a couple of simple ones. When you say you're looking to simplify your portfolio, would that include reviewing the scope or the magnitude of your ambitions in data centers? .

No. What we're talking about there in relation to there's 2 different things. There's a noncore asset review underway, and that talks about a range of anything outside the core telco assets. The data center strategy is separate to that, and it is funded by the long-term capital partnerships that we're exploring. And the actual simplification of portfolio or product portfolio, we're actually talking about at the Enterprise and Government business in terms of the further work we announced at the FY '24 results around what we were doing around both operational structure there, but also the range of products and the number of products we had in each of those categories.

Okay. So the data center strategy is setting stone. We're just looking for capital partners on that front?

Yes, that's correct.

Okay. And -- does Southern Cross play in important strategic role for Spark? Or do you consider that noncore?

That would sit in the noncore asset review that we're doing, and we'll give an update at the interim results around our progress against that review.

The next question comes from Phil Campbell from UBS.

Just a few questions from me. In terms of the asset sales with the Connexa deal, can you give us some guidance on timing for that? It did talk about the release possibly February but could be earlier. So is that -- we're talking kind of the next 3 months for that type of deal?

We will be able to provide an update at February or earlier if there were material developments within that. We have confirmed that we are divesting our shareholding in that, and we have had strong interest in that. We're not in a position to tell you any more around exact timing.

You might not be able to answer this question, but in terms of the process, is that stake being marketed in conjunction with Ontario Partners as well? Or is it kind of -- they both be marketed as separate stakes?

We can't answer on behalf of Ontario, that would be a question for them.

Okay. In terms of the data center partnering, obviously, a number of different structures you could look at there. What would be the time frame realistically on trying to get a partner for that business?

Yes. I think we -- we look to provide an update in February in relation to it. But in terms of that broadly, it's more like a 6-month type process, I would say, is approximate.

Yes. Again, it might be a bit hard given this is quite a big announcement today, but the last couple of years, we've seen the first half, second half EBITDAI splits be a bit different from what it normally is historically. Like is there any color you can give us in terms of what you expect the first half, second half split to be this year?

Yes, Phil. So we've outlined the trading conditions that we're seeing, particularly around mobile and IT. We're not going to go into any more details on that for today. So we'll pick up further detail obviously at the half year.

And maybe just a last question is kind of, I suppose, in the past, like an A- credit rating has been seen as quite conservative and quite good I suppose what that's allowed Spark to do is to invest in some other smaller projects and stuff like that. And now obviously, with the core coming into more pressure, and obviously, now you're being a bit more focused in on the businesses, but kind of shifting more into kind of a quasi-founder mode. So cutting CapEx, looking at the portfolio in a much more focused company. So a little most like the business is transitioning into a kind of a mobile and data center business over time. Is that the right way to kind of think about it?

Yes, I think that's a good summary, a much clearer focus on the core in terms of mobile and what sits within that and data center in terms of that medium-term growth for us.

I suppose at the Strategy Day last year, you did spend quite a lot of time talking about MATTR. Is MATTR an asset that will be under noncore?

Yes, it is.

The next question comes from Andrew Hodge from ACC.

I have 2 questions. The first is one of the independent data providers saying that in Q3, you guys have continued to lose market share? And I guess, just given the fact that you're now guiding to flat revenue in mobile from being 3% up, 2 months later from giving guidance, do you feel that you've lost touch with like where your competitors are and that you just didn't appreciate the competitive environment? Or why do you think it's been such a material change in 2 months?

I think what we've seen is in Enterprise we saw the pressure or the competition in the earlier part of the year, and we talked about that at the full year results. What we've seen is an acceleration of that. And what we're seeing is retaining our customers, but at a lower price. In terms of prepaid, I think there is more competition at the bottom end of that market. So I think that's fair within that. But in pay monthly, we continue to grow that base and our churn remains consistent as it has with prior periods.

Okay. And then second question would be on data centers. Given the challenges you guys are facing, partners would realize you guys are essentially -- you guys need partners here. You don't have the capital to develop it. Why would someone partner with you guys to develop a data center as opposed to partnering with someone that's in a more financially strong position or that has -- that doesn't be essentially a foreseller?

Well, we're not a foreseller. We have a strong land base. We have resource consents, we operate these assets and have done for a period of time. We have a strong customer base that sits around that with most contracts with hyperscalers and we have options around how we fund this. So our focus is on a capital partner and the opportunity to grow this business together, and that's the approach that we're taking. So it's not selling of assets. Yes.

I mean shrinking to greatness by selling off noncore assets and like data centers obviously are going to be great, but I just -- I struggle to see why it to find someone to sign up with you guys for a data center as opposed to going with other guys directly?

Well, capital and reviewing noncore assets, that's always part of a process that you do and you look to recycle capital as we have done over many periods of time, whether that's offshore investments, whether that was for the towers, and we continue to do that and look at ways of creating that investment to reinvest and continue to return to our shareholders and our return on invested capital does set up at that 15%. So making choices around where our investments are and making sure that they can provide an appropriate return as part of managing our business at any point of time.

At this time, we're showing no further questions. I'll hand the conference back to Jolie for any closing remarks.

Thank you for the questions, and we'll look to conclude the call now.

Thank you. That does conclude our conference for today. Thank you for participating. You may now disconnect.