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Kordia

EQUITY RESEARCH – New Zealand ANALYST FIRST NZ CAPITAL SECURITIES LIMITED IS A NZX FIRM Gregory Main CFA +64 4 474 4061 [email protected]

31 October 2011 A valuation perspective

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TABLE OF CONTENTS TABLE OF CONTENTS ...... 2 EXECUTIVE SUMMARY...... 3 Recent Performance...... 3 Earnings Outlook ...... 3 Base Case Valuation ...... 3 Comparison to Listed Market Peers ...... 3 COMPANY BACKGROUND ...... 4 Kordia Networks...... 5 Kordia Solutions ...... 5 KS Australia...... 5 KS New Zealand (KS NZ) ...... 6 Orcon ...... 6 Kordia Corporate ...... 6 COMPANY PERFORMANCE ...... 7 Kordia Outlook – From Broadcast to Broadband and up the value chain...... 8 Earnings Model ...... 9 Earnings Estimates...... 9 Cash Flow Estimates ...... 11 Balance Sheet ...... 12 Valuation ASSUMPTIONS ADOPTED ...... 13 General Assumptions...... 13 DISCOUNTED CASH FLOW VALUATION ...... 13 Cost of Capital Assumptions - Rf, Beta ...... 13 Summary of DCF Valuation ...... 14 COMPARISON OF DCF VALUATION WITH MARKET BASED MULTIPLES ...... 14 Peer Company Analysis ...... 14 Kordia Solutions ...... 15 Orcon ...... 16 Kordia Networks...... 17 Kordia Group ...... 17 Valuation Conclusion ...... 18

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EXECUTIVE SUMMARY Recent Performance Kordia increased FY11 revenue by 14% to $294.5mn but EBITDA declined by 1% to $51.5m as Kordia’s transition from a broadcast transmission centric business to a company focused on broadband, communications and transmission moves is nearly complete and moves to the next phase. Kordia recognised an impairment charge of $21m post tax as it reduced the value of its broadcast assets due to the earlier switchover to digital transmission of television services than previously planned. This impending change has been the catalyst for Kordia to diversify its business over the past 5 to 6 years and expand into telecommunication and network consulting services. Earnings Outlook The impact of the digital switchover, expected to impact Kordia’s operating earnings by circa $10m, negatively weighs on Kordia’s operating earnings outlook to FY14. To offset this earnings impact, Kordia Solutions Australia is experiencing good demand for its services, Orcon continues to expand its revenue and Kordia is expanding its telecommunications offering. Thus while we forecast relatively flat EBITDA to FY13 and a decline in FY14 to $47mn from $53mn in FY13, we expect earnings to recover relatively quickly thereafter as the growth momentum in other parts of the business continues. We expect some compression in the EBITDA margin to occur over this period given the change in business mix. Base Case Valuation Given the different divisions which Kordia operates we have valued Kordia using a sum of the parts approach. While Kordia discloses divisional revenues in its result and Statement of Corporate Intent (SCI) it does not disclose any other divisional details. As such we have had to assume a breakdown between the divisions that has increased the subjectivity of the valuation. We have derived an enterprise valuation for Kordia Group of $215mn and an equity valuation of $137mn.

Figure 1: Kordia Group DCF valuation summary $m WACC applied Valuation of Kordia Networks 76 9.9% Valuation of Kordia Solutions Aust 79 10.5% Valuation of Kordia Solutions NZ 11 10.6% Valuation of Orcon 59 12.6% Corporate Overhead adjustment (9) Enterprise valuation 215

Net Debt 78 Equity valuation 137 Source: Company data, FNZC estimates

Our assessed valuation is toward the upper end of the range as stated in Kordia’s SCI for an enterprise valuation of $165mn to $221mn. The Board concluded that given current economic conditions a valuation range of $185mn to $200mn was reasonable. We note any payment Kordia may have received from Telecom NZ as part of a recent regulatory settlement would increase our valuation. Comparison to Listed Market Peers We have used listed industry peers to benchmark our divisional forecasts and as a basis to assessing how Kordia could be valued if it were a listed entity to provide a comparative value to our DCF assessed valuation. We believe it is likely Kordia would trade at a discount to our DCF assessed value if it were a listed entity. This discount would reflect current market conditions and where industry peers are currently trading. Further we expect a discount to our DCF valuation would apply until there is evidence of Kordia’s ability to execute with regard to growing its telecommunications earnings and managing its DSO decline and historic transmission business.

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COMPANY BACKGROUND Kordia has its origins as the transmission operation for TVNZ which was put into a separate company in 2002 with the business focused around broadcast transmission services and the maintenance of this and other networks. At a public presentation of its FY11 Annual Result, Kordia CEO Geoff Hunt, disclosed the situation Kordia faced in 2006 as the business was heavily exposed to its legacy business of analogue TV transmission given the pending switch over to Digital transmission, a maintenance contract with Broadcasting Corporation of Australia and a contract to supply certain services to Telecom NZ. We note that Kordia’s specific issues were set against a backdrop of the continued convergence between the broadcast and communication markets. Figure 2, recreates a slide presented by Kordia at this meeting, highlighting how each of the above items would impact Kordia’s EBIT over time if the business did not evolve. The dramatic decline forecast for Kordia’s earnings provided the impetus to diversify Kordia and develop new earnings streams. Over the past six years Kordia has been executing its “Broadcast to Broadband” strategy. This strategy, represented by the green line in Figure 1, highlights how Kordia has developed alternate earnings streams from what was relied on in FY06 and as evidenced by Kordia generating an adjusted FY11 EBIT of $19.8m.

Figure 2: Kordia’s Broadcast to Broadband EBIT transformation ASO (10) 28

24 THLA (6) 20 New products New businesses

TNZ 16 Extend 24 (6) EBIT 12

ASO 8 (10)

4

0 FY06 FY10 FY14 FY06 FY07 FY08 FY09 FY10 FY11 FY12 FY13 FY14

Source: Company data, FNZC estimates

The Broadcast to Broadband strategy resulted in Kordia acquiring new businesses and investing in new services and products to diversify prior to the DSO.

Figure 3: Acquisition history Acquisition Date Cost Comment

Assets of Business Online Limited, a provider of 30/11/2010 $2.5m Contributed $3.3m to FY11 rev, annualised revenue managed business telecommunication services contribution would have been circa $5.5m. Genesis Power Customer List 1/10/2009 $0.3m Presumably related to Orcon Quality Managed Design FY10 Likely small Acquired by Kordia Solutions Australia to strengthen NBN rollout capability Orcon Limited 2/07/2007 $24.5m In FY08 Orcon contributed a loss of $3,578. Acquired 49% of shares in AAP Communications 12/12/2006 $0.04m Services (Thailand) Co Ltd AAP Communications Services Pty Ltd 11/07/2005 $24.7m Source: Company data, FNZC estimates

Kordia now consists of three core operating divisions with a corporate division sitting over the top.

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Figure 4: Kordia structure Kordia Group

Kordia Networks Kordia Solutions Orcon

FY11 Gross Revenue $66.8m $159.1m $73.4m

NZ Australia Source: Company data, FNZC estimates

Kordia Networks Kordia Networks (KN) has revenue of circa $67m and circa 100 staff. This is an asset intensive business and as such is likely to have a relatively high fixed cost structure and operating leverage with the transmission business having higher margins than the telecoms business. KN itself consists of two parts:  the traditional broadcast business with assets focused around transmission towers and network; and  a telecoms operation revolving around Kordia’s control of national backhaul fibre but also utilising spectrum capacity and transmission towers. Increasingly this part of the business will become more about the service layer rather than the infrastructure. Kordia does not disclose separate revenue, earnings or cash flow for broadcast activities or telecoms. The KN broadcast business is the traditional heart of the business. This business leverages the traditional assets of transmission towers and broadcast capacity to deliver a range of services to its clients. Revenue and cash flow (given sunk investment) is dominated by the traditional TV transmission services but KN also provides radio transmission and a range of other services. A key issue facing this business is the switch from analogue to digital transmission. The digital switchover (DSO) is phased in over four stages with Hawkes Bay and the West Coast occurring in September 2012, the balance of the South Island in April 2013, the Lower North Island and East Cape in September 2013 and lastly the upper North Island by November 2013. This will result in a large number and significant percentage of transmission sites (many of which are very minor) no longer being required and will need to be dismantled. Kordia will retain most of the larger key sites but will reduce the size of the present towers. KN’s telecommunications business levers Kordia’s ownership of key transmission towers and its digital microwave network but also its interest in the TelstraClear fibre optic cable and capacity on FX Networks’ national backhaul network. This means KN has backhaul capacity around NZ, can offer redundancy and is able to offer services by leveraging these assets. Going forward the service layer will become an increasing part of this business. Kordia markets its telecommunication services to wholesale and corporate customers while its Orcon division targets residential and SME services. Kordia Solutions Kordia Solutions (KS) is an engineering, contracting and consulting business which provides design, project deployment and management, maintenance and field services. As such this is a people intensive business, which typically involves lower capital investment requirements and operating margins.

KS can itself be divided into two parts: KS Australia The Australian arm of this business was formed by combining Kordia’s existing Australian operations with the $24.7m acquisition of AACPS on 11 July 2005. At Kordia’s FY10 Public Meeting, CEO Geoff Hunt disclosed that KS Australia had circa NZ$120m in revenue in FY10 and circa 600 staff and we assume it was the main driver of KS’ 12% FY11 revenue growth. A key aspect of KS Australia has been to diversify its customer base and revenue sources. KS Australia has expanded its targeted markets to now supply services to a range of telecommunication companies (key

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customers include Telstra, Vodafone Hutchison Australia, Optus, Vivid Wireless); Mining companies and more latterly Australia’s NBN project through supporting suppliers to the NBN. Exposure to these sectors of Australia’s economy, which continue to invest and perform, means that KS Australia has not been materially impacted by the slowing economic conditions and is experiencing strong growth. In addition, KS Australia has a contract with the Australian Maritime Safety Authority out to 30 June 2012 (2006 annual Report pg 8) to monitor the waterways for mayday signals. It utilises three towers it owns in Australia. It is difficult to assess how material this contract is but we assume it is an immaterial part of KS Australia’s overall revenues. KS New Zealand (KS NZ) KS New Zealand had FY10 Revenue of $21.5m and we assume only modest revenue growth in FY11. This business helps maintain and run the transmission network as well as providing support services to telecommunication companies. KS NZ has a number of contracts around the Pacific providing services ranging from assisting with deploying mobile networks to digital microwave links to tower expertise and consulting services. It is unclear what proportion of KS NZ’s revenue is derived from servicing KN’s transmission and communications network and what if any exposure it has around DSO. We assume this makes up the bulk of the inter-company eliminations. In addition, KS NZ has a similar contract for monitoring mayday signals for NZ. Combined Kordia covers approximately one-quarter of the world’s oceans. Orcon Orcon is an internet focused broadband and communications company offering retail and business (primarily SME) broadband, fixed and mobile reseller telecommunication services. In addition, it offers a range of other services ranging from hosting, domain names, local loop unbundling, and supporting SKY TV’s iSKY service with a nationwide content delivery network. Kordia does not disclose a breakdown of Orcon’s revenues, any operating metrics (such as broadband connection numbers, fixed line services, mobile customers, hosting revenues, etc) or other financials such as operating earnings or capital investment. At the FY10 public briefing Kordia CEO Geoff Hunt stated that Orcon generated a $7.5m profit turnaround in FY10. We interpreted this as Orcon earning circa $2m - $3m FY10 EBIT. At the presentation of its FY11 result Kordia said Orcon increased operating earnings by 33% in FY11, from what we assume is a low base, on revenue growth of 31% ($17.4m revenue growth). Kordia Corporate We understand this is essentially the CEO’s office, finance and IT. Corporate oversees the operating divisions and provide services to these divisions. The cost of the corporate function isn’t disclosed and presumably it is fully allocated to the operating divisions. A key function of Kordia Corporate is presumably the allocation of capital within the group and to drive the overall broadcast to broadband strategy as evidenced by Kordia’s acquisitions over recent years and the reshaping of the business. The investment in new businesses and products has had to be balanced against Kordia’s debt profile, which peaked in November 2008 at $123.7m. Kordia has been successful at lowering its debt to $77.9m by June 2011 and at present the only major covenant on Kordia appears to be that it maintains minimum shareholder funds of $70m (FY10 $80m). This compares to FY11 shareholder funds of $81.6m. We understand Orcon operates as a largely stand alone entity but presumably it contracts with Kordia Networks to access its national back-haul. It is unclear what if any corporate charges may be allocated to Orcon with reference to Orcon’s FY10 EBIT turnaround and earnings level noted above. For the purposes of this valuation we have assumed Kordia Corporate is allocated to the individual divisions and that this represents the cost that these divisions would otherwise incur on a stand alone basis. However, we have assumed that corporate does undertake an IT platform upgrade every five to six years and along with a little unallocated capital expenditure this contributes a negative value to our Kordia Group valuation.

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COMPANY PERFORMANCE

Figure 5: Kordia Result Summary Trend Year to 30 Jun $m FY08 FY09 FY10 FY11 3 year CAGR

Kordia Networks 210.0 67.8 66.4 66.8 Kordia Solutions 0.0 171.1 141.5 159.1 Orcon 28.6 39.2 56.0 73.4 Other 0.2 0.0 0.0 0.0 Corporate eliminations 0.0 (24.4) (5.6) (4.8) Total revenue 238.9 253.7 258.3 294.5 7.2%

EBITDAF 41.5 41.3 52.2 51.5 7.5% EBITDAF margin 17.4% 16.3% 20.2% 17.5% Depreciation & Amortisation 28.9 33.4 36.1 31.7 3.2% EBITF 12.6 7.9 16.2 19.8 EBITF margin 5.3% 3.1% 6.3% 6.7% Impairment charges 0.0 0.2 1.5 30.6 EBIT 12.6 7.7 14.7 (10.8) Net finance costs 7.9 9.2 9.7 8.0 Pre tax 4.7 (1.4) 5.0 (18.8) Tax 3.8 (0.3) 6.0 (4.1) Reported profit 0.9 (1.1) (1.0) (14.7) Equity Earnings (0.1) 0.0 0.0 0.0 Reported Net Profit 0.8 (1.1) (1.0) (14.7) Adjusted Net Profit 2.7 1.3 3.0 7.4

Net debt 110.5 109.8 93.4 77.9 -11.0% Capex 38.9 27.0 20.6 15.1 Acquisitions 24.2 5.4 1.8 9.4 SHF 101.5 97.0 96.0 81.6 -7.0% Total Assets 263.0 280.1 257.1 238.6 -3.2% Source: Company data, FNZC estimates

FY11 – result review Strong revenue growth from Orcon (31%) was a key highlight and Kordia noted that Orcon’s EBIT increased 33%, albeit we believe this is from a low base (circa $2m to $3m). We assume the drivers of the improved Orcon result will have been the benefit of the acquisition of Business Online Limited assets, which contributed revenue of $3.3m, and a full year’s benefit from Orcon’s enlarged LLU footprint and the introduction of a number of new products (including the content distribution network). While Orcon increased revenue by $17.4m, we believe continued operational investment limited EBIT growth to just $1m to $2m. Kordia Solutions grew revenue 12% with EBIT (not disclosed) jumping 34%. Again we believe the strong EBIT growth was from a relatively low base. Kordia noted that most of the EBIT growth was driven by KS Australia. Kordia noted the KS NZ business was “back in the black”, with significant new lines of business in fibre deployment as well as contracts throughout the South Pacific. Kordia Networks’ revenue was flat with revenue growth from new products offsetting declines in legacy services. FY11 EBITDAF was flat with the margin falling as there was a greater mix from lower margin businesses. Notable is the growth in employee and contractor costs, increasing 18.5% ($16.9m) over the pcp. We believe a lot of this would have been driven by Kordia Solutions Australia and Orcon as both businesses scaled up for potential growth. Direct network costs increased by $9m (+19%) and project material and subcontractor costs increased by 22% or $8.1m. Below the EBITDAF line, depreciation and amortisation declined to $31.7m from $36.1m. The decline was driven by a lower carrying value of the Network Broadcast assets. Kordia recognised an impairment charge of $21m post tax as it reduced the carrying value of its Network broadcast assets due to the earlier switch over to digital television with completion by late 2013 compared to Kordia’s previous assumption of circa 2015.

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FY11 operating cash flow of $39.7m compares to $39.8m in FY10. Capex of $15.1m was down from $20.6m in FY10. Net debt (including derivatives) has decreased from a peak of $126.6m in December 2008 (1H09) to $77.9m by June 2011. Net debt to EBITDA is circa 1.4x and we believe Kordia’s financial position appears sustainable. Kordia Outlook – From Broadcast to Broadband and up the value chain DSO dominates medium term earnings forecasts Kordia’s 2012 Statement of Corporate Intent (SCI) sets out key financial and operating performance targets, a summary of which is contained in Figure 6. Projected revenues by division have been disclosed but Kordia has not provided any other divisional information. The impact of the DSO will negatively weigh on Kordia’s earnings between FY12 and FY14 with this most evident in the later stages because of the scheduling for the DSO. Kordia’s FY14 earnings projection should fully reflect the impact of the DSO on its earnings offset by growth in other areas. Kordia appears to be expecting earnings growth from other divisions to more than offset any decline from the DSO impact in FY13. We assume the decline in FY14 EBITDA projected by Kordia is the net impact of the DSO decline offset by growth in other areas. Since Kordia published its 2012 SCI, Orcon has launched its Genius product. At its FY11 result briefing Kordia noted that Orcon achieved its FY12 full year sales target related to the Genius product in the first two months of the new financial year. While the greater than expected demand resulted in some teething issues, this implies the performance targets for Orcon in the 2012 SCI are likely to prove conservative.

Figure 6: Key performance targets FY12 FY13 FY14 FY11 Tgt FY11 Actual Kordia Networks 73.1 77.7 70.0 72.5 66.8 Kordia Solutions 147.0 152.0 156.5 143.0 159.1 Orcon 89.3 102.7 115.6 74.2 73.4 Corporate elimination -3.8 -5.8 -5.8 -6.3 -4.8 Total Revenue $m 305.6 326.6 336.3 283.4 294.5 Revenue per FTE $000 321 327 336 312 325

EBITDA 48.9 52.2 44.5 50.0 51.3 EBIT 16.2 20.1 11.8 -10.5 -10.8 NPAT 6.1 9.7 4.1 -13.8 -14.7

SHF $m 86 94 98 82 82 SHF to Total Assets % 39 43.9 45.9 36 34 Gearing (net debt/ net debt + equity) % 46 39 36 49 48 Interest cover (EBITDAF/interest paid) 7.0 8.5 7.9 6.9 6.4

Return on Capital employed (EBIT/Avg capital) % 10 12 7 -6 -6 Return on Equity (NPAT / Avg SHF) % 7.2 10.8 4.3 -16 -17 Dividend payout (dividends paid / net CFO less depr) % 40 23 0

Implied $m Depreciation and amortisation 33 32 33 Total Assets 221 214 214 Net debt 73 62 55 Interest and tax 10 10 8 Source: Company data, FNZC estimates

Kordia’s dividend policy is that the dividend be the surplus of funds after taking into account banking covenants; medium term capital expenditure requirements, investment in new opportunities and working capital requirements. Kordia expects to pay a dividend of $2m in FY12 and FY13 with no dividend in FY14. However, Kordia expects to resume dividends in FY15 with a projected dividend of $6.5m, implying a strong FY15 earnings rebound is expected and gearing levels are comfortable.

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At its FY11 result briefing Kordia disclosed its five year revenue target of increasing revenue to circa $380m by FY17 (refer Figure 7). Kordia’s “Broadcast to Broadband” strategy will evolve from its focus on developing the physical infrastructure and gaining market positions to delivering more services and looking to leverage its existing investments.

Figure 7: Kordia’s revenue growth expectations

Source: Company data, FNZC estimates Earnings Model Earnings Estimates Given the distinct and diverse operating divisions within Kordia, we have assessed the business on a sum of the parts basis. This has involved forming revenue, earnings and capex forecasts for each division. However, this process is complicated by the lack of divisional disclosure and we have had to make assumptions as to the mix between legacy and new revenues, revenue growth, margin and capex profiles. Kordia provided some indication of the mix of revenues at its FY11 result presentation as depicted in Figure 8. The grey and white areas depict historic/legacy revenues while the coloured areas show new revenue streams. This highlights the key growth drivers between FY10 and FY13 are expected to be Orcon, KS Australia and KN new revenues (which we assume is a mix of new transmission revenues and telecommunication revenues). We have used a combination of Kordia’s Statement of Corporate Intent (SCI), the FY11 result and the presentation to the FY11 result to provide a basis of assessing our near term forecasts.  Revenue – Revenue is expected to grow relatively strongly over the next three years driven by Orcon and KS. We expect KN revenue to be down marginally in line with Kordia’s SCI. Compared to Kordia’s SCI we have assumed a higher uplift in Orcon’s near term revenue but it doesn’t flow through to substantially higher earnings for Orcon because of upfront costs. KS Australia revenue is also assumed to be higher than the SCI due to the good FY11 result and positive Kordia commentary. Kordia noted the pressure on staff costs given strong demand for the particular skill set in the Australian market.  Earnings – The key is the impact of the DSO offset by growth in other areas. We expect this to result in a margin contraction. Also we have assumed a small decline in depreciation and amortisation in FY14 which results in our NPAT forecast exceeding Kordia’s SCI projections.

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Figure 8: Kordia’s Revenue Transformation

Source: Company data, FNZC estimates

Figure 9: Kordia P&L Summary Year to 30 Jun $m FY09a FY10a FY11a FY12F FY13F FY14F

Kordia Networks 67.8 66.4 66.8 70.0 74.0 68.0 Kordia Solutions 171.1 141.5 159.1 163.0 169.1 172.9 Orcon 39.2 56.0 73.4 92.5 109.2 124.5 Corporate eliminations (24.4) (5.6) (4.8) (5.8) (5.8) (6.0) Total revenue 253.7 258.3 294.5 319.7 346.5 359.5

Operating costs 212.5 206.1 243.0 269.7 293.5 312.5 EBITDAF 41.3 52.2 51.5 50.0 53.0 47.0 Depreciation & Amortisation 33.4 36.1 31.7 32.8 32.3 30.7 EBITF 7.9 16.2 19.8 17.2 20.7 16.3 Impairment charges 0.2 1.5 30.6 0.0 0.0 0.0 EBIT 7.7 14.7 (10.8) 17.2 20.7 16.3 Net finance costs (9.2) (9.7) (8.0) (6.5) (5.5) (4.6) Pre tax (1.4) 5.0 (18.8) 10.7 15.2 11.7 Tax (0.3) 6.0 (4.1) 3.0 4.3 3.3 Reported profit (1.1) (1.0) (14.7) 7.7 11.0 8.4 Dividend Paid 2.0 2.0 0.0 Retained earnings (14.7) 5.7 9.0 8.4 Normalised NPAT 1.3 3.0 7.4 7.7 11.0 8.4

Revenue growth 6.2% 1.8% 14.0% 8.6% 8.4% 3.7% EBITDAF growth -0.5% 26.6% -1.4% -2.9% 6.0% -11.3% EBITDAF margin 16.3% 20.2% 17.5% 15.6% 15.3% 13.1% EBITF margin 3.1% 6.3% 6.7% 5.4% 6.0% 4.5% Interest cover (EBITF/Net Interest) 0.9 1.7 2.5 2.6 3.8 3.5 Dividend payout ratio 26.0% 18.2% Source: Company data, FNZC estimates

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Cash Flow Estimates There are several key influences on Kordia’s cash flows in coming periods. These are primarily focused around the earnings profile, working capital requirements and capex profile of Kordia.  Operating cash flow – Operating cash flow is expected to closely mirror operating earnings. A key assumption to operating cash flows is how working capital will vary as the business moves away from the steady cash flows of the transmission business to having more working capital invested in Orcon and Kordia Solutions.  Capital expenditure (capex) and investment programme –Kordia does not provide capex guidance. We have assumed in the long run that capex aligns with industry norms.

Figure 10: Kordia Summary Cash Flow Year ending June $m FY09a FY10a FY11a FY12F FY13F FY14F EBITDA 41.3 52.2 51.5 50.0 53.0 47.0 Other Cash Income 0.0 0.0 0.0 0.0 0.0 0.0 Interest Paid -8.7 -8.9 -7.5 -6.5 -5.5 -4.6 Tax Paid 2.2 -5.4 -2.7 -3.0 -4.3 -3.3 Working Capital 3.1 1.9 -1.6 -4.4 -4.6 -5.2 Other (e.g. cash abnormal) 0.0 0.0 0.0 0.0 0.0 0.0 Operating Cash flow 38.0 39.8 39.7 36.1 38.6 33.9 Capex (net forecasts) -27.0 -20.6 -15.1 -23.3 -26.4 -26.3 Expansion Capex 0.0 0.0 0.0 0.0 0.0 0.0 Acquisitions -5.4 -1.8 -9.4 0.0 0.0 0.0 Dividends Paid 0.0 0.0 0.0 -2.0 -2.0 0.0 Other 0.0 0.0 0.8 0.0 0.0 0.0 Funding Required 5.6 17.4 15.9 10.8 10.3 7.6

Increase (decrease) of Net Debt -6.2 -17.5 -16.0 -10.8 -10.3 -7.6 Proceeds from sale of assets 0.5 0.1 0.1 0.0 0.0 0.0 Equity raised 0.0 0.0 0.0 0.0 0.0 0.0 Other 0.0 0.0 0.0 0.0 0.0 0.0 Total funding provided -5.6 -17.4 -15.9 -10.8 -10.3 -7.6

Capex trends Capex to D&A 87% 64% 56% 83% 95% 100% Capex to Revenue 11% 8% 5% 7% 8% 7% Capex to EBITDAF 65% 39% 29% 47% 50% 56% Source: Company data, FNZC estimates

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Balance Sheet  Total assets – We forecast a decline in Kordia’s fixed asset base offset by higher working capital requirements.  Net debt and gearing – Net debt is projected to decrease by 39% by FY14 resulting in improved gearing ratios.

Figure 11: Kordia Summary Balance Sheet Year ending 30 June $m FY09a FY10a FY11a FY12F FY13F FY14F Current Assets: Cash & S/T Deposits 11.8 3.9 5.6 5.6 5.6 5.6 Derivatives 0.0 0.0 0.0 0.0 0.0 0.0 Other financial assets 1.8 1.1 0.3 0.3 0.3 0.3 Receivables 42.3 42.2 60.1 65.2 70.6 73.2 Investments 0.0 0.0 0.0 0.0 0.0 0.0 Inventory 1.9 1.6 1.2 1.3 0.9 1.0 Other 0.0 0.0 0.0 0.0 0.0 0.0 Total Current Assets 57.8 48.8 67.2 72.4 77.5 80.1 Non Current Assets: Fixed Assets 165.1 148.8 109.3 101.7 97.1 93.9 Derivatives 0.0 0.0 0.1 0.1 0.1 0.1 Intangible Assets 52.1 54.5 58.0 56.0 54.7 53.5 Future Income Tax Benefit 4.1 4.3 4.1 4.1 4.1 4.1 Other financial assets 1.0 0.6 0.0 0.0 0.0 0.0 Other 0.0 0.0 0.0 0.0 0.0 0.0 Total Non-Current Assets 222.2 208.2 171.4 161.8 155.9 151.5 Total Assets 280.1 257.1 238.6 234.3 233.4 231.6

Current Liabilities: Bank Overdraft 1.0 12.7 10.2 10.2 10.2 10.2 Derivatives 0.2 0.0 0.3 0.3 0.3 0.3 Accounts Payable 43.3 43.5 60.8 61.6 62.0 59.4 Provisions 1.8 1.1 1.8 1.8 1.8 1.8 Income tax payable 4.1 1.3 1.1 1.1 1.1 1.1 Other 0.0 0.0 0.0 0.0 0.0 0.0 Total Current Liabilities 50.4 58.7 74.2 75.0 75.4 72.8 Non-Current Liabilities Interest Bearing Debt 116.2 80.3 69.2 58.4 48.1 40.5 Derivatives 4.3 4.3 3.9 3.9 3.9 3.9 Provisions 3.7 5.7 5.5 5.5 5.5 5.5 Deferred tax 5.0 8.0 0.4 0.4 0.4 0.4 Other 3.5 4.1 3.8 3.8 3.8 3.8 Total Non-Current Liabilities 132.7 102.4 82.8 72.0 61.7 54.1 Total Liabilities 183.1 161.1 157.0 146.9 137.1 126.9 Shareholders Funds 87.7 87.7 87.7 87.7 87.7 87.7 Retained earnings 11.1 10.2 -4.5 1.2 10.1 18.5 Other (Non-controlling Interest) -1.9 -1.9 -1.5 -1.5 -1.5 -1.5 Minority Interests 0.0 0.0 0.0 0.0 0.0 0.0 Total Capital Funds 97.0 96.0 81.6 87.3 96.2 104.6

Average Invested Capital (IC, $mn)) 207.2 193.7 170.3 152.9 149.7 149.4 Group ROE (average equity) -0.9% 0.5% 17.9% 9.1% 11.9% 8.4% Net debt (excl derivatives) 105.4 89.1 73.8 63.0 52.8 45.2 Debt / Debt + Equity 52.1% 48.1% 47.5% 41.9% 35.4% 30.2% Net Debt / EBITDA 2.6 1.7 1.4 1.3 1.0 1.0 Equity / Total Assets 34.6% 37.3% 34.2% 37.3% 41.2% 45.2% Source: Company data, FNZC estimates

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VALUATION ASSUMPTIONS ADOPTED General Assumptions

Figure 12: Economic forecasts Actual Forecasts June Years 2007 2008 2009 2010 2011F 2012F 2013F 2014F 2015F

GDP (Production) (1) 1.3 2.5 -2.4 0.5 1.5 2.2 3.1 2.7 2.7 Consumer Price Inflation (2) 2.0 4.0 1.9 1.7 5.3 2.8 2.6 2.6 2.6

90-Day Bank Bill Rate (3) 7.8 8.7 5.3 2.8 3.0 2.8 3.9 4.3 4.5 10-Year Government Bond Rate (3) 6.0 6.4 5.4 5.8 5.4 4.7 5.0 5.2 5.3

(1) Annual average % change (2) Annual % change (3) Average level for June years Source: FNZC estimates DISCOUNTED CASH FLOW VALUATION Cost of Capital Assumptions - Rf, Beta Estimates of future unlevered cash flows are discounted by the estimated Weighted Cost of Capital (WACC). WACC represents the assessed returns required by providers of debt and equity capital weighted by their respective contributions of capital. WACC is derived using the following formula:

Re * (1-L) + Rd *(1-Tc) * L

where:

Re = Cost of equity derived by using the simplified Brennan - Lally version of the Capital Asset Pricing Model

= Rf * (1- Ti) + B* TAMRP

L = Leverage employed (i.e. the proportion of debt to debt plus equity)

Rd = Cost of debt

Tc = Corporate tax rate = 28%

Ti = Individual investor tax rate = 28%

Rf = Sustainable long term bond = 5.25%

B = Estimated equity beta

TAMRP = Tax adjusted market risk premium = 7.25%

Notes:

 The methodology used above is consistent with that being adopted by the Commerce Commission in assessing returns on infrastructure and utilities. The only modification relates to estimation of Rf.  We use 5.25% as a suitable proxy for the risk free rate as we take the view that current interest rates are cyclical and will normalise when international market conditions normalise. Our valuation sensitivity analysis should capture a range in WACC which should accommodate variation in Rf.

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 The tax adjusted MRP converts to a MRP used internationally by using the formula MRP = TAMRP - Rf* Ti (i.e. 5.75%)  Equity beta is estimated by de-leveraging the equity betas of comparative companies (local and overseas) to calculate an average asset beta for the compcos. The average asset beta is then converted to an equity beta using the firm’s leverage.

Summary of DCF Valuation1 We have prepared a DCF valuation for each operating division of Kordia to reflect the different nature and cost of capital of these operations. This derives an enterprise valuation for Kordia Group of $215mn and an equity value of $137mn. This assumes the net debt position inclusive of derivatives is used to derive the equity value. We note that Telecom NZ has recently (14 October 2011) paid out to the Commerce Commission and some of its wholesale customers $31.6mn related to the resolution of some regulatory issues. Kordia had claimed $74m in damages as part of the Commerce Commission’s investigation. Any amount Kordia has received should be added to our valuation.

Figure 13: Kordia Group DCF valuation summary $m WACC applied Valuation of Kordia Networks 76 9.9% Valuation of Kordia Solutions Aust 79 10.5% Valuation of Kordia Solutions NZ 11 10.6% Valuation of Orcon 59 12.6% Corporate Overhead adjustment (9) Enterprise valuation 215

Net Debt 78 Equity valuation 137 Source: Company data, FNZC estimates

Kordia’s 2012 Statement of Corporate Intent stated that based on assumptions made by management as at May 2011, an estimate of current commercial value of the Group was between $165mn and $221mn and the commercial value of the Crown’s investment being between $85mn and $141mn. Given the current economic conditions, including the impact on cost of capital, Kordia’s Board considered a valuation range of $185m to $200mn for the FY11 commercial value of Kordia to be reasonable (implying an EV/EBITDA range of circa 3.7x to 4.0x). COMPARISON OF DCF VALUATION WITH MARKET BASED MULTIPLES Peer Company Analysis There are a number of reasons why a company may be valued by the market differently from the value implied by a DCF valuation. In our experience, near and medium term earnings and free cash flow momentum, return on invested capital trends, dividend yield, execution risk on major projects, overall risk profile including reliance on a key revenue source or contract and the relative value proposition to peers or the wider market are a few of the many variables that can impact market value. In addition, given current market conditions many companies are trading below analyst DCF valuations and as such it is likely that if it were publicly listed that Kordia could be valued by the market at less than our assessed DCF valuation.

1 DCF Valuation - Important Note and Risk Warning Your attention is drawn to the fact that the above DCF valuation and projections of the future performance of Kordia reflect various assumptions by the author of this report, which may or may not prove correct. Some assumptions inevitably will not materialise and unanticipated events, unknown risks, uncertainties and other circumstances will likely occur. Therefore, the actual results achieved during the period of the projections shown will vary from those projected, the valuation will also vary from that presented, and such variations may be material. Such factors include, amongst other things, the following: general economic and business conditions; competition; regulatory or administrative changes affecting the business; the timing and amount of the company's capital expenses; general sector industry trends and pricing; cost of capital considerations; unexpected operations difficulties and other factors, many of which will be beyond the control of Kordia. First NZ Capital Securities Limited makes no representation or warranty, express or implied, as to the accuracy or completeness of the DCF valuation or the information or assumptions on which such valuation is based or derived from, and nothing in this report shall be deemed to constitute such a representation or warranty. Recipients of this report must carry out their own analysis and are cautioned not to place undue reliance on such forward-looking information.

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Assessing the performance and value of Kordia’s business divisions relative to industry peers is impacted by the lack of disclosure around the different business divisions. In the absence of detailed divisional disclosure we have examined industry peers to benchmark profitability and ascribed appropriate capitalisation multiples to estimated earnings. Kordia Solutions Listed consulting type companies are few and dependent on both the market in which they operate, their industry exposure and nature of operations. We have selected as peers Opus, Cardno, Worley Parsons, UGL, Coffey and we have also included Atkins from the UK. The current economic climate and outlook is generally weighing on the sector and the market. Given KS Australia may be less exposed to the economic climate than the comparative group, we believe a multiple of circa 5.5x to 6.0x forward EV/EBITDA could be applied to KS Australia. The main issues are around how its revenue is structured (guaranteed price vs cost plus reimbursement model, length of contracts, etc) and how exposed it is perceived to be post the current investment cycle in Australia’s mobile and NBN networks (i.e. what longer term earnings base could the business be capitalised at). A multiple for the NZ business could potentially be distorted by it only recently moving “back into the black” and the unknown impact that it could experience as part of the DSO. For the consulting based companies, we note the following general observations:  We expect KS to earn a long term EBITDA margin of between 8% and 12% with the main issue being the structure of contracts and the Maritime Service potentially providing a small upward bias compared to a pure consulting service.  We would expect D&A and capex to closely align over time and that it sit circa 1.0% to 2.0% of revenue. Our assessed enterprise value for KS Australia of $78m and for KS NZ of $11m relates to an FY12 EV/EBITDA multiple of 6.0x for KS Australia and 5.3x for KS NZ. There is the potential for other entities to look to acquire either KS Australia or KS NZ, the later requiring some form of long term contract related to its existing servicing of Kordia’s transmission and communication networks. Under a consolidation scenario it is quite possible that efficiencies could be achieved in areas such as IT costs and licences and general overheads that could see a price paid in excess of our valuation. Under such a scenario it would not be unreasonable to expect a difference of at least $5m to $10m be added to the valuation of KS Australia with the upside for KS NZ dependent on the nature of any contract to continue to service the NZ transmission towers and network.

Figure 14: KS Peer Group Valuation Multiples Market PE EV/EBITDA Cap 2011 2012 2013 2011 2012 2013 ATKW.L Atkins WS 573.6 7.8 7.2 7.0 4.8 3.8 3.7 CDD.AX Cardno 583.5 9.6 9.8 9.1 6.2 6.0 5.5 COF.AX Coffey International 70.8 21.5 3.5 3.2 6.5 4.0 3.5 WOR.AX WorleyParsons 6,707.3 22.8 17.8 15.3 13.8 12.8 10.9 UGL.AX UGL Limited 2,143.7 13.5 12.6 11.5 8.4 7.4 6.7 OIC.NZ Opus 274.6 11.6 11.2 9.8 6.6 5.9 5.1 Source: Credit Suisse, FNZC estimates

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Figure 15: Projected Margin Profile comparative 14%

13%

12%

11%

10%

9%

8%

7%

6%

5%

4% 2011 2012 2013

Atkins WS Cardno Cof f ey WorleyParsons UGL Opus KS Australia KS NZ

Source: Credit Suisse, FNZC estimates

Orcon Comparing Orcon to industry peers is complicated by the disclosure around Orcon. Also peers and the industry may be at different points of evolution. We believe Orcon is probably earning a low single digit EBIT margin and a low to mid teen EBITDA margin at present with free cash flow around breakeven or a bit below. This compares to IIN earning a mid to high teen EBITDA margin and TPG earns an EBITDA margin of circa 40%. We believe Orcon is more closely aligned with the IIN business model than it is with TPG. Orcon has the potential to improve earnings over the next few years prior to UFB being widely available and as it levers its existing LLU investment and product suite and expands market share. The rate of growth is probably at least partly dependent on how much capital it is willing to invest and it capacity to absorb initial losses on new services and/or customers. As such we would expect Orcon’s value to rise over the next few years as it moves along its path to profitability. However, once UFB is up and running profitability will depend on customer demand for the new service and how the retail market evolves (especially with regard to customer costs and retail offers around fibre uptake). This could mean telco service companies operate on broadly similar margins with similar retail offerings with differentiating factors being dependent on backhaul assets, other services to include in a bundle (mobile, content), operating efficiency and cost structure and ability to target different niches. Under this scenario Orcon could earn a lower margin than it does currently from its LLU customers. Using a DCF valuation we estimate Orcon’s value at $59m. We estimate this valuation would place Orcon on circa 4.6x FY12 EV/EBITDA. However, given current financial market conditions and our belief that Orcon is probably operating around breakeven cash flow at present, if it were independently listed it would likely trade at a discount to our DCF valuation until investors attached a high confidence level to its earnings and cash flow profile. Orcon appears relatively well positioned in the NZ market with a recognised and respected brand and appears to have attained a critical level of market share. This should support Orcon either being an industry survivor and successful or being a potential consolidation play. The most recent example of this was in Australia with iiNet’s acquisition of the AAPT Consumer Division in July 2010 for 3x post-synergy EBITDA in the first full year after acquisition.

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Figure 16: Orcon peer multiples Market PE EV/EBITDA Cap 2011 2012 2013 2011 2012 2013 IIN.AX iiNet 380.5 9.9 9.6 9.6 4.7 4.1 3.9 TPM.AX TPG Telecom 1,113.1 14.1 10.1 8.5 5.9 4.8 4.1 Source: Credit Suisse, FNZC estimates

Kordia Networks Kordia Networks doesn’t have many listed peers. KN focuses on transmission towers and has telecommunications infrastructure and service capability. The listed tower operators generally have long term arrangements around wireless/mobile towers and cell sites with various degrees of exposure to television transmission towers. The value of these types of assets is usually dependent on the certainty of cash flow streams they generate. In its FY11 result briefing Kordia noted it had $200m of contracted revenue related to its broadcast customers, with long term contracts with a high level of certainty. The revenue and earnings outlook for Kordia’s telecommunications services is harder to forecast given Kordia is coming from a low base, is moving more into the service layer and there is a large amount of change occurring in the industry, including an increasing level of competition. As such revenue, margin and capex forecasts for this business are very uncertain. The combination of a degree of uncertainty about the earnings profile of the transmission business and the market wanting to see greater evidence of the success or not of Kordia’s telecommunications strategy would likely see KN trade at a discount to our assessed DCF value if it were listed. We derived a DCF value for KN of $76mn, with the value biased toward the next few years as Kordia benefits from legacy revenues. This implies a FY12 EV/EBITDA multiple of 3.4x. Although this appears low this reflects the decline in EBITDA projected for this business given the DSO as discussed above. Kordia Group Our DCF valuation of Kordia’s enterprise and equity valuations imply the following multiples for Kordia Group as shown in Figure 17. Although Kordia Group appears undervalued relative to the market on an EV/EBITDA basis we note that Telecoms companies generally trade at lower than market average EV/EBITDA profiles. On a PE basis Kordia would be trading on a relatively high PE although we note this is partly distorted by its high deprecation and amortisation rate, which we assume is greater than capex over the next few years so a cash PE would be slightly lower. Kordia’s dividend yield is well below the market over the next few years. We have not allowed for any size/liquidity factors when assessing multiples nor applied a holding company discount.

Figure 17: Implied valuation multiples for Kordia based on DCF derived valuation Implied valuation for equity FY10a* FY11a FY12F FY13F

Equity value from DCF 137 137 137 137 Average net debt 102 86 73 62 Enterprise value 238 223 209 199

Implied PE 45.6 18.5 17.9 12.5 Implied EV/EBITDA 4.6 4.3 4.2 3.8 Implied EV/EBIT 14.7 11.2 12.2 9.6 Net Debt / EBITDA 1.8 1.5 1.3 1.1 Adj EPS growth 147% 3% 43% Dividend yield (cash yield) 1.5% 1.5%

NZ market PE 15.8 14.1 12.4 NZ market EV/EBITDA 7.7 7.1 6.5 NZ market EV/EBIT 11.8 10.8 9.5 NZ market EPS growth 5% 12% 14% NZ market Dividend yield (gross) 7.3% 7.4% 8.1% Source: FNZC estimates

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Valuation Conclusion Based on a DCF analysis we have assessed an enterprise valuation for Kordia Group of $215mn and an equity value of $137mn. However, we note that this valuation is very sensitive to key assumptions made and the lack of divisional earnings and capital breakdown has increased the subjectivity of the valuation. In addition, Kordia’s growth to offset the decline due to the DSO is predicated on it successfully expanding its telecommunication revenue and earnings in NZ. This is an industry that is expected to evolving rapidly as it moves toward the UFB initiative becoming reality. We believe it is likely Kordia would trade at a discount to our DCF assessed value if it were a listed entity. This discount would reflect current market conditions, where industry peers are currently trading and the market probably awaiting further evidence of Kordia’s ability to execute with regard to growing its telecommunications earnings and managing its DSO decline and historic transmission business. As mentioned above, given Kordia’s different operating divisions, it is possible that one or more of these divisions could be attractive to an acquirer. If this is the case, the value realised could be greater than our assessed value given the potential synergies.

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Limitations and Disclaimer

This research report (the “Report”) has been prepared by First NZ Capital Securities Limited (“FNZCS”) and is addressed to the Crown solely for the purpose of providing the Crown with an independent view on the relevant State Owned Enterprise also having regard to relevant industry and other factors. This Report is furnished by FNZCS solely for the purposes described and neither this Report nor any copy or extract of or from the Report may be further distributed, reproduced, published, quoted or disclosed except where agreed.

This Report is unsuitable for any purpose other than the specific purpose described above and should not be relied upon by any other person or for any other purpose. The Report does not, and does not attempt to, contain everything material there is to be said about the State Owned Enterprise, its business or the industry in which it operates. The information in this Report is given in good faith and has been obtained from published information and other sources believed to be reliable, accurate and complete at the time of preparation, but its accuracy and completeness is not guaranteed. FNZCS is under no obligation if it becomes aware of any change or inaccuracy. Although reasonable care has been taken to ensure that the facts stated and any opinions, estimates, forecasts and projections contained in this Report are fair and accurate, we have not independently verified the information contained in the Report and assume no responsibility for the independent verification thereof. To the fullest extent permitted by law, no liability or responsibility is accepted for any loss or damage or other consequence arising out of the use of or reliance on the Report or its contents or otherwise arising in connection therewith. Information, analysis, opinions and estimates contained herein reflect a judgement at the date of provision of the Report and are subject to change without notice.

This Report may include certain statements, estimates, forecasts, and projections about anticipated future performance of the State Owned Enterprise and/or the relevant industry. Such information will reflect various assumptions concerning anticipated performance which may or may not prove correct. Accordingly, there can be no assurance that such statements, estimates, forecasts or projections will be realised and variations may be material. Undue reliance must not be placed on such forward looking information.

FNZCS, its employees and persons associated with FNZCS may (i) hold securities mentioned in this publication (or related securities) as principal for their own account, (ii) may have provided investment advice or investment services in relation to such securities within the last twelve months, and (iii) may have other financial interests, including as a shareholder of FNZCS, in the matters mentioned herein. The Crown should assume that FNZCS, its related companies and Credit Suisse Group, with whom First NZ Capital has a strategic alliance, does and seeks to do investment banking business with the Crown and State Owned Enterprises.

A Disclosure Statement is available from First NZ Capital Securities Limited on request, free of charge.

Copyright: First NZ Capital Securities Limited and its related companies, 2011. All rights reserved.

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