Over the next few months Telstra will make some important capital allocation decisions, including what to do with billions of dollars in payments from NBN Co. Naturally, investors are eagerly awaiting the announcements. So, what can they expect to see?
There has been some speculation that it might well make sense for TLS to crystallise the value of these payments, possibly by packaging them up and selling them to infrastructure investors. Some readers have asked what we would make of this, so here is our two cents worth.
In looking at a transaction like this, the fundamental question is whether it creates value, and, if so, for whom? Generally speaking, there are two ways in which a corporate transaction can “create” value:
It can give rise to cashflows that would otherwise not exist. This typically happens where a transaction creates synergies such that the asset in question becomes more profitable in the hands of a different owner; or
It can allow a higher multiple to be ascribed to the same cashflows.
We are fans of the former. In our view, there is little doubt that genuine value is being created where additional cashflows are generated. However, this is unlikely to be the case for a securitisation of TLS’ NBN payments; those payments will be the same regardless of whether it is TLS or some other owner who is entitled to receive them.
So in this example, it becomes a question of whether these cashflows are worth more to an alternative owner than they are to TLS shareholders. If that is the case, we might expect to see a rise in the TLS share price if the payment stream is replaced by sale proceeds that correspond to the “full” value of the income stream.
Clearly, this type of value “creation” is a bit harder to pin down than the first type. However, we can make some relevant observations as follows:
If TLS keeps the NBN Co. payments, shareholders who hold TLS long-term will ultimately receive the “full” value of these payments, even though they may not realise it. The highly certain nature of these payments means lower overall risk for TLS investors, which is worth something, even to an investor who is ignorant of the counter-factual.
Investors who don’t hold their shares long term are more likely to benefit from a sale, assuming the sale does give rise to a lift in the share price in the near term. These investors stand to receive a higher price for their shares on sale.
Offsetting this, there will inevitably be costs associated with the transaction, including things like adviser fees, management distraction, and possibly tax implications. This means that the long-term holders may be disadvantaged by the sale, and if the costs are large enough, all shareholders may be disadvantaged.
It is possible that TLS can persuade itself that the buyer is overpaying for the NBN Co. payments, and its shareholders overall will therefore be better off. However, if the buyer is a sophisticated infrastructure investor who feels that they got a good deal, they may well be the ones who have got it right.
Finally, there is one group who unambiguously benefit from the transaction – the investment bankers who stand to receive a large completion fee if it proceeds. These same investment bankers may be the ones advising TLS on whether they are getting a good deal, and whether TLS shareholders will be better off overall.
Putting all of that together, we expect that long-term investors who think carefully about what they are investing in may see less virtue in a securitisation transaction than those with a shorter-term orientation.
You can probably guess which side we lean to.
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Tim is the Portfolio Manager of The Montgomery Fund – a concentrated, All-cap Australian equity fund that aims to generate capital growth and income. Montgomery focuses on owning high quality businesses and generating superior returns.