“If you have a KiwiSaver account, there is a high chance that the MSCI All Country World Index (ACWI) has a bearing on the composition of your global equity exposure.

“If your KiwiSaver provider takes a passive approach to allocating your savings, there is a high chance that the ACWI determines exactly which global shares you own and in what proportion,” Castle Point Funds Management’s Stephen Bennie told financial adviser site Good Returns.

To rub salt into the wound, the industry chatter is that Infratil (100% owner of One NZ and 48% owner of CDC Data Centres) will be added to the influential index, Solly adds.

Is the well-telegraphed MSCI news already priced into Spark’s depressed shares?

Jarden told clients more than a month ago that it expected the telco to be dropped from the index.

If it is announced that Spark has been dropped from the MSCI, that could impact investor sentiment on Thursday, Solly says. But in practical terms, passive funds would not sell until the MSCI changes are implemented on November 25 (November 26 NZT). It’s possible several days of pain will follow as various funds unload.

Jarden director Jeremy Ashworth wrote that the telco being dropped from the MSCI “is expected to result in the sale of 90 million Spark shares.” That represents 4.9% of the telco’s stock. On the average trading day, fewer than 500,000 shares change hands; its highest volume day this year saw 18.4m shares trade hands.

The situation has been shaded by an apparent spike in short-selling, and the string of bad news, which has also included the abrupt departure of long-time CFO Stefan Knight, and an October 30 Forsyth Barr downgrade to “under-perform” with its 12-month target price chipped down to $2.80 (Spark closed at $2.94 on Thursday).

In a note titled “No spark”, analysts Aaron Ibbotson and Benjamin Crozer said that with the telco’s announcement around its downgrade, “We learnt little new about the headwinds in Cloud, but the weakness in mobile suggests the emergence of cracks in the historically disciplined NZ mobile market.”

And they added a fresh critique, writing: “We suspect that 2degrees has found that Spark and One NZ are not willing to defend their market shares aggressively, leaving it with a value maximising option to undercut price and take share.” 2degrees recently won a huge education contract – covering broadband for nearly every school in the country – from Spark in a deal running through to 2031.

Spark trading at a 30% discount

“It is jarring for income-focused investors to see a defensive company in an earnings and dividend downgrade cycle,” Morningstar director of equity research Brian Han said.

And he sees the telco as being in far from perfect shape. “Structural shifts in cloud have starkly exposed Spark’s bloated cost base in the IT units and the enterprise and government side,” he wrote in an October 30 research note.

But Han also sees Spark addressing costs with a drive to save $50m – or 10% of its wage and salary bill this financial year as hundreds of jobs are axed, while $30m (or 7%) has been cut from op-ex by deferring spending – although he also describes the cuts as “just the start”. And he says the recession clouds will lift.

That means, “Shares in Spark remain attractive, trading at a 30% discount to our revised intrinsic assessment [trimmed by 7% to $4.30],” he wrote.

He told the Herald late on Wednesday,“The dividend guidance downgrade is likely to weigh on sentiment for a while, especially coming from a prototype defensive company whose register is filled with yield-minded shareholders.

“The souring sentiment is likely to linger, but the 8% [dividend] yield at current prices provides support. As cyclical pressures subside, we see benefits from the expanded cost-out initiatives and non-core asset reviews restoring investor confidence.”

While the market might have reacted negatively to Spark lowering its profit guidance by 4% and lowering its FY2025 dividend guidance from 27.5 to 25 cents per share, Solly says investors have to revise their expectations around profit payouts.

“Companies paying out a disproportionate share of earnings as dividends may struggle to maintain these levels during economic downturns or periods of reduced profitability. Some investors have an unfortunate track record of paying up for regular dividends that may be based on a very full payout of unsustainable underlying company earnings or dividends from capital rather than earnings,” he says.

“These dividend distributions eventually get exposed as a dividend chimera – an unrealistic, unreliable mythical investment monster – and the share price tends to fall back to levels that the market thinks truly reflect sustainable dividend income.”

In Spark’s case, Solly noted the revised-down 25cps dividend forecast for FY2025 would only be 75% imputed (the FY2024 first-half and full-year installments were fully-imputed) – leaving shareholders with a higher tax bill if they’re in the top income bracket.

Dividend ‘chimera’

Spark has mooted further asset sales, including its remaining stake in Connexa, the company formed when it sold 70% of its passive mobile network assets to the Ontario Teachers Pension Plan Board.

Solly sees the potential for some of the proceeds going toward Spark’s data centre push (the telco has said it is also weighing various capital and partnership options for its plan to spend up to $1 billion over the next half-decade on data centre expansion).

Forsyth Barr recently noted that much of the $583m that Spark netted from the 70% sale of its cell towers went to “unfunded” payouts to investors via a special dividend and share buybacks.

On one level, that seems to gel with Solly’s “dividend chimera” thesis.

Would the telco have been better to keep the money from the mid-2022 celltower sale in kitty for its data centre push, positioning it better for the AI boom?

He cuts the board some slack. At the time, it could not have anticipated that the economic slowdown would reach deep into 2024. At the time, it would have been an inefficient use of the telco’s balance sheet.

Solly said there was a groundswell of chatter that “governance changes are needed at Spark.”

Did he think change was needed at the top, where Jolie Hodson has been CEO since 2019 and Justine Smyth chairwoman since 2017?

“There should always be pressure for governance renewal,” he said.

He agreed Hodson had got the short stick in terms of external challenges, facing Covid then recession – as well as having to deal with clean-up of the Spark Sport mess and other issues inherited from her predecessors.

A big part of Spark’s FY2024 revenue and profit tumble was down to the fact the telco’s FY2023 result benefited, to the tune of $583m, from the sale of 70% of the passive assets of its cell tower network (there was also a negative one-off, with $54m in costs associated with the closure of Spark Sport).

On an adjusted basis, revenue was down 1.2% to $3.861b, net profit fell 21% to $342m and earnings before interest expense, tax, share-based payments, defined benefit expense, depreciation, amortisation and impairment (ebitdai) dropped 2.5% to a below-forecast $1.163b.

Chris Keall is an Auckland-based member of the Herald’s business team. He joined the Herald in 2018 and is the technology editor and a senior business writer.