Friday, February 24th, 2017
Donald Trump has raised the term “fake news” to prominence. Prior to the US Presidential Election campaign it was not a common term. However, it may well be the case that the reporting of news has always been to some extent infected by both deliberate mis-statement and misrepresentation of facts. It may not be widespread, but any small and deliberate factual error can have a pernicious effect on the credibility of the publisher or the presenter of a false statement. It leads the listener or reader to ask this question – What else is false?
It is not true, as President Trump consistently presents, that the media is mainly responsible for creating fake news. Rather, fake news often has a covert source and traditional media merely reports it after it has already been aired on social media. The checks and balances of social media have yet to be fully developed, and still rely heavily on human integrity – and we all know there is a declining level of that.
As fake news is a relatively new term, its definition is not settled. Wikipedia says “fake news is a type of hoax or deliberate spread of misinformation, be it via the traditional news media or via social media, with the intent to mislead in order to gain financially or politically“. The reference to both financial and political by Wikipedia is interesting when we reflect a little later on the flow of information surrounding the arrangements between the NBN (Australian Government) and Telstra (public listed company).
In politics, the colouring of statements by politicians fed by highly paid political spin doctors is widespread. Spin has now reached such nauseating levels that politicians are widely regarded as untrustworthy. It is hard to determine when or if politicians actually say what they truly believe. Further, the setting of policies is not always determined by what is right or fair but rather by what generates a vote. Arguably this is leading to the worldwide backlash against incumbent governments. Social or online media is the communication link that creates a powerful vote for change. However, social media can also be abused in terms of factual reporting so that the audience is bombarded with information and has no way of discerning the truthfulness of what is being communicated.
This preamble has a purpose – and it is not a defence of the press, or a justification for the anti-media rants of President Trump. However, it is our view that a form of “fake news” is observable in the information flow through the Australian stock market. Financial spin and the colouring of facts do occur in ASX announcements and it is perpetuated by the media’s reporting of the statements by Australian listed companies. While we do not blame listed company boards and their CEOs for putting a positive spin on disappointing trading results, this should be distinguished from the making of excessively optimistic or fanciful profit outlook statements in the face of evidence to the contrary. It is important because most equity analysts and self-directed investors rely to some extent on the board-sanctioned outlook statements made by authorised company representatives. Optimistic forecasts that are widely reported and relied upon can cause the mispricing of securities in the market and this is both an unsavoury and unfair outcome.
TELSTRA, NBN CO. AND THE COMMONWEALTH
While it is sometimes true that listed company boards are not required to divulge confidential information, it is rare that information relating to the financial position or the financial outlook of a publicly listed company can remain confidential for a sustained period. “Public” companies are so called because they are widely owned and their shares trade on the stock market based on publicly available information. Financial information is essential for the valuation and pricing of their securities. If the financial information of a company remains confidential, then arguably that company should not be publicly listed because its shares will not trade in a fully informed market as required by securities law. Further, inside information must exist because it is not publicly disclosed and such information will flow to some “inside” market participants over time, as it simply cannot be securely quarantined.
This brings us to review the history of public statements concerning the commercial and financial relationship that exists between Telstra and NBN Co. Our interest to do so was stimulated by the reporting last week by senior business writers in the AFR and The Australian that the Australian Government and/or NBN Co. have a 30 plus year arrangement. The term of the agreement was not new information, but there were some interesting revelations that flowed from a Q&A of Telstra’s company executives after the interim result. It was stated that NBN Co. has an obligation to pay Telstra $1 billion per annum from 2020, and that this obligation will be indexed for inflation. Indexing is important; this benefit was not explicitly stated by Telstra in prior announcements. It is noteworthy that if Australia’s inflation rate averaged at 3% pa, then the payments would reach $2 billion a year by 2042. The disclosure of the $1 billion pa indexed payment helped Alan Kohler deduce in The Australian on the weekend that NBN Co. is a dog that will never achieve a decent return on investment. A billion dollars pa liability to Telstra would suck the NBN’s free cash flows.
The issue with the media reporting NBN Co.’s obligation was that they revealed facts that had not previously been announced to the stock market by Telstra. Further, the Australian Government through NBN Co. had never properly disclosed it to Australian taxpayers. While there were many public statements regarding the financial arrangements and many opportunities to clarify the position, both sides meticulously avoided the truth. So was it commercially sensitive, or simply politically embarrassing? Is there a covert reason for the lack of transparency? What else don’t we, or the market, know?
A financial heads of agreement between Telstra and NBN Co. was documented in 2010 and a year later (on 23 June 2011) a full agreement was signed that “was estimated to be worth $11 billion post-tax net present value” by Telstra in its ASX and shareholder announcements through to 2014. The following extract is from December 2014 when Telstra heralded revised contracts with NBN Co.
The above statement is remarkable for its understatement of the future indexed cash flows to Telstra. The infrastructure access payments that we now know extend for over 30 years and are indexed are valued at a mere $5 billion. The discount rate of 10% is nonsense and the omission of an annual compounding inflation adjustment is appalling.
In October 2015, Telstra provided to shareholders via the ASX a bit more information when it outlined “Definitive Agreement Receipts” pursuant to the Revised Agreements. Yet again, there was no mention of $1 billion pa indexed from 2020.
The extracts from Telstra’s presentation explains their ongoing role and relationship with NBN Co. The “infrastructure access receipts” and the Commonwealth payments for the equipment and the maintenance of the Universal Service Obligation (USO) is noted, but the forward disclosure is underwhelming.
This brings us to the revelations made by Telstra over the last few months. However, even these statements are lacking in positive transparency and abound in negativities.
CEO Andrew Penn November 2106:
Now $2 to $3 billion is one large range of outcomes … just a mere $1 billion! However, the downside may be bigger because presumably it is after the annual indexed billion dollars from NBN Co. – or is it? Are you confused? We certainly are. In passing, we note that the NBN could have a 30% profit impact on Telstra … if we can join the dots created by Telstra announcements, but even that is not clear.
However, don’t panic shareholders because things are not that bad. In fact, they are so good that the Telstra board instigated a $1.5 billion buy-back of ordinary shares. “And while we have $13 billion of net debt, that is not an issue because we have surplus cash.”
The following is an extract from the Telstra 2016 Annual report that refers to the outlook with NBN Co.
This was followed up by Andrew Penn at Telstra 2016 AGM:
The above statement was reiterated at the investor briefing in November 2016, but the following chart was produced with a crucial bit of information: from nowhere, a reference to the $1 billion pa payment indexed to inflation is disclosed. Remember that this was not in an AGM address, not in a letter to shareholders, nor mentioned in an Annual Report to shareholders – but in a reference to long term payments compressed in a chart for analysts.
It was easy to miss the significance of this disclosure in a world where information flies endlessly over the internet. But Telstra will claim that the disclosure was made. This point was picked up in a strange way in the Q&A after Telstra’s interim report.
The following exchange between a Telstra analyst and Andrew Penn is noteworthy.
So Mr Penn at some point disclosed the $1 billion pa indexed payments. He may have also hinted that the payments go for thirty years or so, but it appears to us that this is the first time that either he or Telstra have put most of the facts in one sentence. Even then, it is unclear what it actually means and how Telstra could possibly value those indexed cash flows at just $5 billion. Would Telstra today be willing to sell those future cash flows for $5 billion? In our view, they clearly would not as this cash flow would contribute (on an after tax basis) some $700 million of franked dividends per annum, and these could rise to well above $1.5 billion per annum in 25 years. In our view the real value is much greater than $5 billion and could be valued as high as $20 billion.
Think about it this way. If you could buy the NBN Co. payments for $5 billion, you would receive a 14% franked dividend and your pre-tax cash flow would pay back the $5 billion cost inside five years. There would then be a further 25 years of pre-tax cash flows of over a billion dollars per annum or alternatively huge franked dividends.
The true value of these cash flows could be significant and unlocked if Telstra buys the NBN Co. from the Commonwealth and distributes the NBN to its shareholders. NBN and/or the future cash flows from the NBN Co. are equivalent to about $1.75 per Telstra share.
WHERE WILL THE NBN Co. END UP?
We believe that Alan Kohler’s assessment of NBN Co. may well be correct. It seems to us that the Commonwealth Government intends to sell off the NBN at some point. However, the thirty year obligation to pay Telstra massive payments suggests to us that there is really only one possible buyer – Telstra. This sale could be achieved by Telstra giving up its right to the NBN payments in return for the NBN asset.
The next problem is that Telstra cannot own the NBN under current Commonwealth Law and we suspect that this will not be changed to facilitate a deal. The Commonwealth forced Telstra to decouple when it conceptualised and created the NBN and it is not likely that a monopoly distribution will be handed back to it. So a transaction may be contemplated whereby the net present value of the NBN payments gets magically revalued to something like $20 billion and the NBN is magically valued at $20 billion to facilitate a transaction with Telstra which then distributes the NBN business to its shareholders.
The above may be wild speculation, but we are drawn to it by the “cloak and dagger” disclosures by Telstra. On the other side, NBN Co. and the Commonwealth have been mute in their disclosures.
In a world of fake news, we should be alert and conscious of the risk that we are not always told the truth. Fake news is another inhibitor to our ability to make proper value based investments, and a good reason to be conservative in our investment approach.
As for Telstra, we are watching closely and with great scepticism. Indeed, we are pondering whether a $20 billion NBN capital return is possible, or is it just speculation based on another bit of fake news?