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Morningstar | Solid Progress Toward 5G Spark

The recent 5G spectrum auction in Australia has prompted us to assess Spark New Zealand's plans for the next-generation wireless upgrade.

5G spectrum allocation in New Zealand is not expected to occur until late 2020. However, using the Australian experience as a broad guide (AUD 853 million at AUD 0.29/MHz/pop), our preliminary view is that narrow-moat rated Spark will need to outlay less than NZD 100 million for its share of the 5G spectrum allocation. This is an amount that can be easily accommodated by the group's balance sheet, with equity base of NZD 1.5 billion and net debt/EBITDA of just 1.2 (versus 1.4 to 1.5 to maintain A-minus credit rating, implying headroom of around NZD 250 million).

Excluding the spectrum cost, the 5G-related network spend is likely to be within Spark's current capital expenditure range of 11% to 12% of operating revenue, or just over NZD 400 million per year. This is because current spending on 4G capacity increase will be redirected to 5G upgrade, with any significant incremental expenditure only dictated by needs to build new cell sites in certain frequency bands.

In the meantime, Spark appears to be making good progress on the 5G rollout, with due diligence on the number and locations of required new cell sites ongoing, augmented by existing cell densification efforts that are also serving to meet increasing current capacity demand.

Shares in Spark are trading at a 15% premium to our unchanged NZD 3.70 fair value estimate (or AUD 3.50 at the current exchange rate). Rather than the solid 5G upgrade progress, we believe the premium is more a reflection of the relatively benign regulatory and competitive environment in New Zealand, at least compared with the bun-fight going on in the Australian telecom industry. However, we urge against investor complacency, particularly as Spark shares are now trading at enterprise value/EBITDA of 8.5, notably higher than the global telecom industry average of around 7.5.

Proactive planning and work on 5G are understandable given cost advantages of the upgrade. This is because mobile data usage in New Zealand has grown at a CAGR of 80% since fiscal 2010 and data traffic on Spark's 4G network has been growing in line with the industry, close to doubling every year, at a time when average revenue per user, ARPU, is showing little growth. As such, the group's investment in 5G is likely to stand on its own in terms of lowering operating costs (operating cost per gigabyte likely to be less than half of current levels), reducing network maintenance expenditure and boosting capacity.

Beyond that cost efficiency, the incremental revenue opportunities associated with 5G are too early to call. Most telecom executives appear to be of the view that the next-generation wireless boost ARPU, as customers pay more to access the technology, in order enjoy the benefits of greater speed, features and functionalities. We concur but the picture longer term is a little fuzzier.

For instance, gamers apparently will be willing to pay telecom operators more per month for 5G's superior latency (in layman's terms, speed and responsiveness when you are playing heavy-graphic, multi-player, online games). The argument extends to the automotive, healthcare, mining industries, and even robotics and virtual reality spheres, where millisecond response rate is critical. However, concrete overseas evidence of these customers willing to pay more per month for these 5G benefits is hard to find. Having said that, we recognise that it is still early days in the 5G evolution, and quantifying the revenue opportunities is difficult at present. We are merely making the point that, with every previous wireless generation upgrade, the ARPU uplift was temporary and most value in the chain accrued to exploiters of the improved network (think Netflix, Facebook, Youtube, and other application or services providers).