Trustpower Retail Acquisition Transcript

Mercury NZ Update 21 June 2021 Start of Transcript Operator: Thank you for standing by and welcome to the Mercury update. At this time, all participants are in a listen only mode. After the speaker’s presentation, there’ll be a question-and-answer session. To ask a question during the session, you will need to press star one on your telephone. Please be advised that today’s conference is being recorded.

If you require any further assistance, please press star zero.

I would now like to hand the conference over to your speaker today, Mr Vince Hawksworth, Chief Executive, please go ahead.

Vince Hawksworth: Thank you, good morning everyone and thanks for coming online so that we can talk a little bit about the transaction that you have obviously heard about this morning, and you will have seen our presentation slides. I’m going to talk reasonably briefly to those, because I think the value will probably come in the conversation and the questions that no doubt you have.

So, I’m on this transaction overview slide now, and you can see that we have acquired the Trustpower retail business for $441 million, including working capital. That comes with a 10-year hedge arrangement with some declining volume shape to it. It obviously also comes with all of the assets associated with the ISP network and the restructured tech processes.

So, settlement will occur following Commerce Commission approval, which obviously needs to be worked through, and implementation of the TECT Deed structure and Trustpower shareholder approval. You’ve got the EBITDAF at multiples there and obviously some information about transition costs and synergies, and William can touch on banking and stuff to the extent you want to know more about that.

Slide 3 in the pack is the Trustpower retail business at a glance, it gives some indication of what we are acquiring, and you will note at the bottom of that page that it includes staff in Tauranga and Oamaru, and our intention is that the two brands will operate as in the marketplace beyond the completion of the transaction such that we continue to support customers whilst we consider working through the synergies.

This isn’t a crunch together of the capabilities, we see this as a growth of the capabilities under both brand headings for the foreseeable future.

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Mercury NZ Update 21 June 2021 On slide 4, this is a one slide about the strategic rationale around this acquisition. I know there will be those on the call that may feel that this is me putting the band back together, I guess we have thought about that very, very hard as we went through that process, to make sure that our rationale is sensible.

I think this slide indicates that the concept of the bundle is one that consumers have valued, they value convenience, they value being connected, they value the ability to deal with one party in what is an ever-complicated world. You can also see that that’s becoming increasingly the case other than in New Zealand. So, that’s an underlying rationale.

Then of course scale does matter in these types of businesses. If you’ve got the investment to make in underlying systems and automation and so forth, if you’re doing that at a larger scale, that helps defray costs.

Slide 5 talks to the bringing together the two complementary businesses. We do see the businesses as complementary, Trustpower obviously having been leading in the multiproduct space and having a strong platform for its ISP. Mercury having strong brand presence and obviously being more North Island centric, Trustpower having more consumers outside of the metros, albeit that the metro areas have increased over recent times. As I just said, this idea that scale will allow efficiency and leverage of technology.

Slide 6 really just gives high-level key financial information and I might just ask William to talk to this slide and call out the key points before we go to questions.

William Meek: Thanks, Vince. Just step in there quickly, consideration of $441 million for the Trustpower retail business. EBITDAF metrics there are on an IFRS basis and for a full year, so that won’t reflect what would happen in say FY21, assuming this deal completes before the end of this calendar year, so we can pro rata those and then some high-level multiples based on those numbers above.

So, certainly in terms of the way we’ve seen the transaction, we do see some reasonably substantial cost synergies between the two businesses which are quite similar, and certainly looking at the complementary nature of the multiproduct offering from Trustpower to Mercury, it’s the cost synergies of circa $35 million per annum once we complete the full integration.

So, that’s expected at the end of the three-year period, and transition costs of circa $50 million split 60% OpEx and 40% CapEx. Some metrics on dollars per customer or Page 2 of 10

Mercury NZ Update 21 June 2021 connection, again Trustpower business particularly given it has both broadband and mobile connections, thinking about it in the context of just ICPs is probably old world thinking when it’s showing products that aren’t related to power.

Gearing, we certainly see ourselves in a good position, committed to our current credit rating of BBB+, and we have secured a commitment for a new bank line so as to fund this acquisition, and certainly as we look forward in terms of other DCM options, certainly we’ve enjoyed a lot of success in green retail bonds and wholesale. There’s options there around treasury stock or also hybrid instruments, so we’ll work through those, which obviously we won’t do anything until this deal was confirmed and those three CPs are fully satisfied.

Vince Hawksworth: Thanks very much for listening. I think we’ll throw open for questions.

Operator: Thank you, as a reminder to ask a question, you will need to press star one on your telephone and wait for your name to be announced. To withdraw your question, please press the pound or hash key. Please stand by while questions queue. Once again it is star one. We have multiple question in queue. The first question is from Andrew Harvey-Green from Forsyth Barr, please ask your question, Andrew.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Morning guys, a couple of questions from me. First of all in terms of a synergy number that you’ve talked about there, do you have any revenue synergies in there, or is it all cost out? I’m just thinking about cross-selling of telco across the Mercury customer base.

William Meek: That number is virtually all cost synergy, not revenue.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Second question is just around the gearing and outlooks for dividends going forward. Obviously, you guys have put in a huge amount of investment into the business over the last little while, I guess a couple of transactions to complete but once that’s been done and you can have a big step up and earning some cashflows. In terms of where gearing gets to, it goes, it gets relatively high in the shortterm and then comes down pretty quickly. But from a dividend growth perspective, what should we be expecting and how are you thinking about that at the moment?

William Meek: Thanks, Andrew. Our dividend policy remains unchanged, 70% to 85% of free cashflow average payout, so that policy accommodates changes to your earnings through time. Gearing absolutely does step up on the back of particularly this transaction but also the funding, the remaining funding for Turitea and obviously the Tilt acquisition, Page 3 of 10

Mercury NZ Update 21 June 2021 which we expect to complete in August. So, we’re happy with that, we’ll certainly as our practice, would expect to issue ordinary dividend guidance for FY22 with our end of year results. But at this stage our dividend policy remains unchanged.

Andrew Harvey-Green: (Forsyth Barr, Analyst) There’s no plan to change to gearing targets or dividend policies at this point?

William Meek: Again our BBB+ credit rating gives you quite a - is a fairly broad range in terms of where you are. We’re at the low end of that band, clearly these transactions will push us higher up that band. But as you’ve already said, you’ve got essentially debt peaking and then falling back as those earnings essentially generate free cash to repay debt.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Last question from me at this point, in terms of transaction costs, are there any - is that in addition to the $50 million you have disclosed there? Or are there additional transaction costs we should be building in?

William Meek: The transaction costs aren’t large, they’re in single millions.

Andrew Harvey-Green: (Forsyth Barr, Analyst) Okay, great thanks.

Operator: Just a reminder it is star one to ask a question. Our next telephone question is from [Grant Swanepoel from Jarden], please ask your question, Grant.

Grant Swanepoel: (Jarden, Analyst) Morning team, first question just on your IT systems, are you guys going to be transferring your Mercury customers onto the Trustpower system, or is it going to be the other way around?

Vince Hawksworth: Thanks, Grant. Look the part of the process we will go through is to fully understand the options around that. As I said, this does give us scale to make an investment and it might be that we don’t go onto either of those platforms in the future.

But the foreseeable future, the two platforms will - for delivery to customers will operate quite separately.

So, much of the synergies we see in that space are what I would describe as more corporate synergies than customer delivery ones. But we’ve made no assumption about which platform we might be on in this process.

Grant Swanepoel: (Jarden, Analyst) Thank you, next question on when you guys split out the $266 million for the existing business, can you give some colour on what you assume the TECT deal adds to the EBITDAF? Page 4 of 10

Mercury NZ Update 21 June 2021 William Meek: The TECT construct’s a pretty interesting one, so for people on the call that aren’t familiar, TECT is going through a restructure of its trust deed, which will see some changes to the way that operates. Essentially it guarantees a dividend stream to the customers that were with Trustpower I think at the end of February, and if those customers leave the business from that point, essentially would no longer be eligible for the dividend.

So, that’s largely independent of the supply arrangements from Trustpower to those customers, but obviously it is a benefit they receive, it is reflected in longer tenure, the pricing is slightly favourable also. So, that’s the benefit. I’m not going to break down the quantum of what TECT’s worth, but it’s certainly a valuable construct, and I don’t think this transaction would have occurred if that TECT arrangement hadn’t been changed.

Grant Swanepoel: (Jarden, Analyst) Okay, so it’s a big chunk of $174 million that you guys point out as not being part of the core. Next question, well my final question actually, is on the EBITDAF numbers that you put in your pro forma of mid $50 million that obviously assumes around about $101 per megawatt hour transfer price on the CFD similar to what Trustpower had in their numbers for FY21.

Going forward, is there any escalation in that number, because the ASX hedge curve is indicating that it’s a lot higher than that in FY23/24, or should we see that as a more consistent type of earnings we see from this company ex your synergies?

William Meek: Yes, I’m not going to go into the nitty gritty of the contract, but yes there is an escalator for a period of time in that contract.

Grant Swanepoel: (Jarden, Analyst) Thanks, that’s it from me.

Operator: Once again it is star one. Our next telephone question is from Jeremy Kincaid from UBS, please ask your question, Jeremy.

Jeremy Kincaid: (UBS, Analyst) Morning Vince and William. First question from me is just around synergies, could you talk a bit more about where those cost synergies will arise from? Obviously Trustpower are talking to the fact that the vast majority of employees will remain within their generation business or the retail business, and also following on from that can you talk to whether or not the $20 million or $30 million of cost optimisation benefits you talked to at the last result included in that number?

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Mercury NZ Update 21 June 2021 Vince Hawksworth: I’ll deal with the second bit first, that project that we called Thrive at the last discussion, was effectively a Mercury standalone project, so it was what we believed we could do within the Mercury business had both cost and revenue opportunities in it, that stands separate from this deal. Looking at the Trustpower Mercury base, as I said to Grant’s question, in the immediate future we see the customer facing issues as being the most important things.

In other words, if you said well what things would you least like to see occur? You wouldn’t want to see escalated churn, so we’re very focused on both brands being able to continue to deliver for customers.

Where the first opportunities come in synergies are those sorts of shared processes, which we would have across both businesses and you could look at that as things like payroll, accounting systems, et cetera, where there is a whole bunch of stuff that we would be able to do what I would call those more corporate type activities. Then we will build towards looking for the cost synergies that come from some more standardisation of systems, and we would be looking for the revenue synergies that come by being able to apply some of the products and services that Trustpower brings, namely the ISP mobile et cetera to a wider customer base.

So, with this whole idea that ultimately we move towards one platform over time, but I think anybody that’s been involved in anything like this before knows that these sorts of things are about what it costs you, what the quality is and time. I think what’s really important is getting the quality right, and that’s why we are very excited about also getting the capability and having the Trustpower retail team able to continue to deliver for their customers, whilst the Mercury team can deliver for its customers.

This is, as I said at the start, not a question of transferring a whole bunch of customers onto one platform and thinking that that’s the way to be successful in these types of processes.

Jeremy Kincaid: (UBS, Analyst) Okay, thank you, and two more quick ones from me, somewhat related. Does your view around your existing Mercury retail position change?

Obviously, you’ve been ceding a bit of market share there, and I suppose longer term would you like to remain longer generation, or a bit shorter now? What’s your thinking around that?

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Mercury NZ Update 21 June 2021 Vince Hawksworth: Well I don’t think - we have seeded some market share in the mass market, but of course we have also gained, if you want to put it that way, or we have sold product into the commercial market. We’ve seen that as economically responsible. That said, we’re well aware that you don’t want to be continually sliding loss of customers. So, we have been taking some action to slow down those losses, and at least over the last month or two that appears to be working.

I think in terms of length, ultimately as we all see today, being short on your obligations to sell in a market that’s highly volatile, is not a great place to be. But that’s not just about generation, that’s also about your risk management processes. But of course in the near term we have had the Kawerau challenge, which we continue to hedge out that risk because we don’t really want to be exposed as being short in the market.

Jeremy Kincaid: (UBS, Analyst) Sure, okay thank you very much.

Operator: Once again, if you wish to ask a question, it is star one. We have a question from Cameron Parker from Craigs Investment Partners, please ask your question, Cameron.

Cameron Parker: (Craigs Investment Partners, Analyst) Hi guys, well done on the transaction or the pending transaction. Just one question on your build program, so does the acquisition or potential acquisition of Trustpower and then the retail base being backed by a reducing volume in terms of PPAs or hedge agreements, does that impact your decision making around new builds going forward and over the timeframe through to the late 20s?

Vince Hawksworth: Well I think, Cameron, the view that we had around the pipeline that we are acquiring from Tilt is that they’re good projects. But as we have said consistently, we’re prepared to do PPAs on some of those projects with other players, because we think that supports the decarbonisation story. As we all know at the moment, we are heavily reliant on the thermal generation, and I think everybody knows that Genesis are doing a lot of heavy lifting.

But they’ve got a strategy that they want to execute on and so we’ll continue to talk to them and anybody else that wants to talk to us about our pipeline and seeing that develop.

I think in terms of having this bigger retail book with this transaction, that kind of supports the same overall story which is deployment of these projects. So, as the CFD

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Mercury NZ Update 21 June 2021 arrangements with Trustpower do step down over time, we have got time to do those investments and make those choices, so, we don’t face any cliff edges.

We can do things in a considered and sensible way, dependent on what the market looks like, and I don’t think any of us know what post 2024/25 will bring. I think we’re well positioned, irrespective of a decision by a larger industrial at the bottom of the South Island, we’re well positioned to invest or not and we’re also well positioned to invest as a consequence of people wanting to change their thermal fuel mix. I feel confident we can adapt both of those scenarios.

Cameron Parker: (Craigs Investment Partners, Analyst) Great, okay thanks, Vince. One last question is just where can we see the C&I book in terms of volume going over the next probably 18 months to two years?

Vince Hawksworth: Our starting place has always been that we should make economically rational decisions. Obviously, the C&I book has been very good for us, we continue to be a supplier into that space. I don’t think you should read into this that we would somehow start exiting it. Because I think your reputation in the market is really important and our job is to manage price and volume risks.

Most customers, their job is to manage that risk in the context of the industry that they’re in. So, we’ll still play in that book.

Cameron Parker: (Craigs Investment Partners, Analyst) Okay, right thanks guys.

Operator: Once again it is star one. Once again it is star one. We have some questions from Eamon Rood from Energy News, please ask your question.

Eamon Rood: (Energy News, Media) Good morning, my question was about what will happen to the Trustpower brand once it’s transferred over? Will it be continued to be a separate offering or be rolled into the Mercury brand?

Vince Hawksworth: So, the brand comes with the transaction, so Trustpower customers will on day one see no change to what they experience today. In fact, we very much hope that we will be supporting the Tauranga and Oamaru based teams that service Trustpower’s customers to continue to provide a high level of service and access to the products that Trustpower provide.

Similarly, for Mercury, our Auckland and Hamilton based teams will continue to provide the service. We will be looking for opportunities to cross sell products over time, and like all Page 8 of 10

Mercury NZ Update 21 June 2021 things where the brands end up some point down the track, I’m not even going to speculate. You can all speculate whatever you want but we’ve made no decisions.

Certainly we value the way that both brands are regarded by their relative customers and where they stand in the market.

Eamon Rood: (Energy News, Media) Okay, thank you.

Operator: Our next telephone question is from Stephen Hudson from Macquarie Securities, please ask your question.

Stephen Hudson: (Macquarie Securities, Analyst) Morning Vince and Will, just a couple from me. I just wondered if you had factored in any dis-synergies into your thinking? I know you talked about synergies being achieved over three years, but if it’s only lost market share or anything you factored into your thinking in the next few years for instance?

Secondly, just on Genco, would you be the natural owner of those assets should they come up for sale following this transaction? Then maybe one for Will, just on the $420 per connection adjustment that you’ve given, whether or not you can break down particularly the TECT construct adjustment that you’ve made, how you’ve gone about constructing that adjustment in particular?

Vince Hawksworth: Thanks Stephen, I’ll start off. So, with Genco, I think we’ve got a bit of digesting to do with both Tilt and Trustpower retail. I have no idea, you’re far better to ask the current Trustpower team and their shareholders what their plans are with Genco.

I guess we will see what happens there. No, I don’t necessarily think we’re the natural owner of those assets, they’re quite distributed, small hydros with a particular way of operating.

I don’t necessarily think that Mercury brings a type of capability for those, so I think it would be a big leap to say that we are the natural owner. But who knows? In terms of dis-synergies, well obviously we’ve tried to be very careful about the transition costs and make sure we haven’t underestimated those for starters.

Then the second point you make, which is the one of elevated churn, well we did have a very good, hard look at what the implications of that would be in our business case and in landing where we landed. We are very aware of that issue, and that’s one of the reasons why we’ve been very clear, we want to run the two brands as standalone, we want the nature of the service levels that customers get to remain unchanged.

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Mercury NZ Update 21 June 2021 We want the people in the two sets of businesses to be very focused on looking after the customers, not looking over their shoulders.

William Meek: Steve, on your last question around just the breakout again, I think Grant asked the question earlier, I mean the price paid reflects the all-encompassing value of PPAs, the TECT arrangement, the ISP, the customers, we’re acquiring the synergies, the transition costs and assumptions around churn. So, they’re all obviously embedded in that.

We were just acutely aware that there’s a tendency in the industry to go consideration paid divided by number customers equals dollars per customer. So, we were keen to avoid that comparison, particularly given Trustpower is more complex with broadband and a mobile offering. So, I think that old world calc has less relevance when you move into a multiproduct environment.

There’s no doubt that the PPA construct right here right now has good value, given where wholesale prices are trending. We think the ISP capability is good in terms of the ability to cross sell and help us expand that multiproduct offering across Mercury’s customer base and to other New Zealanders also. I’ll leave it at that.

Stephen Hudson: (Macquarie Securities, Analyst) Cheers, thanks guys.

Operator: Once again it is star one. Once again it is star one. Pardon me speakers, there’s no further questions at this time. I would now like to hand the call back you for closing remarks, thank you.

Vince Hawksworth: Okay, thank you, look thanks everyone, thanks for the questions, thanks for listening. I’m sure there’ll be plenty to discuss around this topic as we go forward over the next few months and years. So, thanks for calling in, we’ll call it a day, cheers.

Operator: This concludes today’s conference call, thank you for all participating, you may all disconnect, have a great day.

End of Transcript

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