Brian Gaynor: Trustpower changes may be too radical

The Trustpower TECT Rescue Helicopter. Photo / File

A brief release to the NZX at 8.30am on Thursday, January 25, signalled a major change in the structure of the Tauranga Energy Consumer Trust, which owns 26.8 per cent of NZX-listed Trustpower.

Under this proposal, the assets of the Tauranga Energy Consumer Trust will be transferred to TECT Charitable Trust and Trustpower customers will no longer receive an annual distribution from their electricity supplier.

Approximately 56,000 eligible Trustpower customers will receive a one-off lump sum payment of $2500 this year and a further $360 per annum in the five years between 2018 and 2022.

After that there will be no more customer payments, the Tauranga Energy Consumer Trust will be wound up and its Trustpower dividends will be "distributed exclusively into Tauranga and Western Bay of Plenty community and charitable organisations".

Investors' response to the proposal has been negative, and Trustpower's share price has fallen 10.0 per cent, from $5.92 to $5.33, since the announcement.

Why has the Consumer Trust proposed these changes, particularly as trustees gave no public indication that they would support this scheme when they stood for election?

Is it because Trustpower is looking to acquire the Vocus or 2degrees broadband operations and the Consumer Trust is concerned that this could have a negative impact on dividend payments?

Why has Trustpower's share price reacted negatively and should Trustpower consumers accept or reject the proposal?

Trustpower, which has its origins in Tauranga's first power station established in 1915, was incorporated in October 1992 in response to the deregulation of the electricity sector.

It listed on the NZX in April 1994 following the distribution of 42.7 million free shares to nearly 30,000 eligible Trustpower customers.

In addition, the company also issued free shares to the Consumer Trust and shares at 92.5c each to Infratil, the Wellington investment company.

The newly-listed company had a subdued start, with only 552,000 shares trading on the NZX on day one when it closed at 97c, giving it a sharemarket value of just $96m.

The figures in the accompanying table show how the market value, net profit after tax and dividend distributions increased dramatically over the following 10 to 15 years, when Trustpower was one of the best performing NZX companies.

However, Trustpower has stalled in recent years for a number of reasons including increased competition in the electricity industry and costs associated with its expansion into the broadband sector.

The latest Commerce Commission Annual Telecommunications Monitoring Report, published in December 2017, shows that Trustpower is the fourth largest broadband retailer by connections, with a 5 per cent market share, behind Spark with a 44 per cent share, Vodafone 27 per cent and Vocus 13 per cent. 2degrees is in fifth position with a 4 per cent market share.

In 2016, Trustpower shareholders approved the demerger of the company into two separate listed companies as follows:

• Tilt Renewables acquired the company's Australian and New Zealand wind generation assets and its wind and solar development projects
• Trustpower continues to operate the company's remaining Australian and New Zealand hydro generation assets and its New Zealand retail business.

The demerger was executed through the issue of one free Tilt Renewables share for every existing Trustpower share. No additional capital was raised and the Tauranga Energy Consumer Trust owned 26.8 per cent of both companies.

Trustpower chairman Paul Ridley-Smith wrote that directors had decided the best way to take advantage of the renewable energy opportunities, particularly in Australia, was the proposed demerger.

The demerger has been a limited success at best, as the combined value of the two companies is currently $2300m, compared with $3045m in mid-2017 and $2431m at the end of June 2016.

The 2017 net profit and dividend figures in the accompanying table are the combined Trustpower and Tilt Renewables figures.

It is worth noting that Trustpower shareholder numbers have fallen more than 50 per cent over the past two decades as original holders, who received free shares, have sold their holdings.

It is also worth noting that Tilt Renewables had 11,835 shareholders, compared with Trustpower's 12,655 shareholders, in May 2017, whereas they had the same number of shareholders when Tilt Renewables listed in October 2016.

The Consumer Trust announced on January 25 that it is putting forward its proposal because there "are a number of questions for Trustees about inevitable future changes in the energy industry which could impact on the long-term interests of the Trust".

The Trust has distributed $338m to consumers and $101m to community organisations since 1993 and in 2017 consumers received 80 per cent of the distribution, or an average of $497 per customer, while community groups received 20 per cent, or $7.7m.

The Trustees would like to increase this $7.7m to around $23m a year. This is a worthy gesture, but it effectively means a transfer of income from electricity consumers to community and charitable groups.

Trustpower has a loyal customer base, partly because of this annual distribution, which has allowed it to charge above average prices to customers.

Investors are concerned that the removal of the annual distribution will have a negative impact on customer loyalty and losing customers.

Trustpower could respond by lowering prices but this would have a negative impact on profitability and dividend distributions.
This would not be in the best interest of shareholders, particularly Infratil which owns 51.0 per cent of Trustpower.

There are several other options available to the Consumer Trust, including the sale of its 26.8 per cent Tilt Renewables stake, which could realise around $160m. It could also reduce its Trustpower stake from 26.4 per cent to 20 per cent, realising a further $100m.

This additional $260m could be added to the Trust's current investment portfolio of nearly $170m, which was mainly funded through the sale of $150m worth of Trustpower shares in 2015.

The maths from these share sales would be as follows:

• The Consumer Trust would have an investment portfolio of $430m which would generate annual returns in excess of $25m, assuming an investment return of 6 per cent The Trust would still receive Trustpower dividends, estimated to be around $22m per annum, with around $18m — or 80 per cent — distributable to consumers and the remaining $4m available for community and charitable projects
• This $4m, plus the $25m of investment returns, would enable the Trust to meet its annual $23m distribution target for community and charity projects. Trustpower consumers would continue to receive an annual distribution, albeit more like $320 than the $497 average paid in 2017.

It is unfortunate that the Consumer Trust has not offered a number of alternatives because the current proposal may be too radical for Trustpower customers.

If the proposal proceeds, the Trust will probably have to sell Tilt Renewables and/or Trustpower shares as it will require nearly $145m to fund the $2500 payment to consumers later this year.

The new proposal has led to speculation that Trustpower may be looking to purchase the broadband retailing operations of either Vocus or 2degrees and the Consumer Trust is concerned that this could have a negative impact on Trustpower's profitability and dividends in the short term.

Trustpower's share price has reacted negatively to the proposal because it has created a great deal of uncertainty about the ability of the company to retain its customer base, and profitability, once the annual distribution is removed.

Several public meetings will be held in Te Puke, Katikati and Tauranga late next week to discuss the proposed changes. Consumers should try to attend these meetings before making any final decision.

The proposal will be the subject of a vote by consumers with the result announced in late April 2018.

- Brian Gaynor is an executive director of Milford Asset Management.