Telco - Fixed Line. Should I stay or should I go? Neutral (no change)

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1 Neutral (no change) Summary of price target changes We have lowered our price targets on TLS, TPM and VOC as we now set EV/EBITDA valuations based on lower trading multiples. TLS, Hold recommendation; A$5.20 price target VOC, Hold recommendation; A$6.05 price target TPM, Reduce recommendation; A$6.47 price target SDA, Add recommendation; A$4.51 price target Telco - Fixed Line Should I stay or should I go? The easy money has been made in tier 2 telcos over the last 10 years as the sector has had: 1) structural tailwinds (growing market share and the benefits of moving customers on-net, which generates higher margins) and 2) the benefits of many acquisitions (customers and suppliers), which has turbo charged earnings. More diverse companies combined with lower interest rates, safety of earnings and strong earnings growth resulted in trading multiples virtually doubling from their long-term average of 6x to 12x EV/EBITDA, and this is now unwinding. Our view is 7-8x EV/EBITDA is a more appropriate number but history suggests investment markets tend to over shoot then under shoot. Telstra a natural hedge Perversely while Telstra has the most to lose under a National Broadband Network (NBN), it is well hedged due to the A$11bn net present value deal (compensation) it struck with the government back in 2010 (and discounted at 10% pa). TLS has publically said that as a result of the NBN it will lose a net A$2-3bn in EBITDA (after including recurring NBN compensation). At the mid-point that s a A$2.5bn EBITDA loss or 24% of FY16 EBITDA. TLS s capex will decline but they need to replace lost earnings by building or buying new earnings streams, or worst case, buying back their own shares, to maintain the dividend. TPM has the largest degree of earnings risk Unlike TLS, TPM doesn t get compensated for NBN losses. We estimate that today s higher access prices mean, all things being equal, TPM loses 18% of its gross profits. TPM needs to either double their consumer customer numbers, grow corporate market share or reduce costs from iinet to offset this impact. Most likely they will do all of the aforementioned but it will be a challenge and we think the era of easy wins is over. VOC has limited earnings risk but its own operational challenges VOC has immaterial NBN earnings risk as they already pay the higher access prices. However given VOC has undertaken a number of company transforming acquisitions and experienced a number of management changes, we think investors will want to see the businesses integrated and cash flowing before revisiting VOC. We note that the acquired businesses have 2-15 year customer contracts so the core of the business is not at risk, but given the possible distraction organic growth could disappoint. Sector investment view challenging sector for now Earnings aside we have seen a multiple re-rating then de-rating impact the sector. We think TPM could de-rate further, VOC has de-rated and now looks interesting but it needs to deliver track record, and TLS never re-rated so it remains relatively safe. TLS has an NBN hedge and despite challenges is more than holding its own with respect to NBN market share. Our preferred pick is SDA (Add recommendation, A$4.51 price target), which is a global satellite reseller. We liken SDA to iinet 10 years ago when its reputation for high customer service drove impressive organic growth and it undertook numerous acquisitions that created value through economies of scale and cost deduplication. Given SDA is a global business, it has a much larger addressable market and therefore a substantially longer runway for growth, in our view. Figure 1: Fixed line telco trading multiples have been highly volatile Nick Harris T E nick.harris@morgans.com.au SOURCE: COMPANY DATA, MORGANS FORECASTS IMPORTANT DISCLOSURES REGARDING COMPANIES THAT ARE THE SUBJECT OF THIS REPORT AND AN EXPLANATION OF RECOMMENDATIONS CAN BE FOUND AT THE END OF THIS DOCUMENT. MORGANS FINANCIAL LIMITED (ABN ) AFSL A PARTICIPANT OF ASX GROUP Powered by EFA

2 Contents 1. Sector valuations and long-term trading ranges M&A ranges in the sector, what s driven the re-rate and why this isn t maintainable NBN progress to-date and sector look through Comparing NBN plans prices and ADSL plans prices Reminder on SDA our prefered telco Forecast and valuation changes and risk/reward Financial summaries International peer comparison

3 1. Sector valuations and long-term trading ranges Our recommendations and TSR expectations are as follows. Figure 2: Morgans recommendations, price targets and TSR expectations F Total Ticker Recommendation Share price Price Target F Dividend Yield Shareholder TLS Hold $ 5.06 $ % 9.1% TPM Reduce $ 7.46 $ % -11.3% VOC Hold $ 5.87 $ % 6.4% SDA Add $ 3.85 $ % 19.1% SOURCES: MORGANS, COMPANY REPORTS Key trading metrics and growth are as follows. Figure 3: FY1 key metrics Ticker Mkt Cap (A$b) EV/EBITDA EBITDA growth PE EPS growth PEG Yield TLS $ % % % TPM $ % % % VOC $ % % % SDA $ % % % AVERAGE % % % SOURCES: MORGANS, COMPANY REPORTS Key trading metrics and growth are as follows. Figure 4: FY2 key metrics Ticker Mkt Cap (A$b) EV/EBITDA EBITDA growth PE EPS growth PEG Yield TLS $ % % % TPM $ % % % VOC $ % % % SDA $ % % % AVERAGE % % % SOURCES: MORGANS, COMPANY REPORTS 3

4 As figure 5 below illustrates TLS has historically traded on 6.4x EV/EBITDA and at current levels is slightly expensive, albeit much cheaper than peers, and debatably cheap relative to record low interest rates and the relative appeal. Figure 5: TLS EV/EBITDA band over the last 10 years SOURCE: FACTSET; MORGANS RESEARCH, COMPANY TPM has historically traded on 5.8x EV/EBITDA. It got as expensive as 14x and stayed there for a number of years before retreating to current levels where it is still slightly expensive. Given the outlook for weakened EPS (higher NBN access costs erode margins and NBN connected households are expected to double each year for the next few years so the trend becomes more material), we think this multiple has room to continue de-rating. Figure 6: TPM EV/EBITDA band over the last 10 years SOURCE: FACTSET; MORGANS RESEARCH, COMPANY Similar logic as TPM applies to VOC; however, it is a very different business now to a few years ago so it s not really fair to compare its long-term multiple of 7.5x. Although we think just coincidently at 7.5x EV/EBITDA it s a reasonable number going forward. 4

5 Figure 7: VOC EV/EBITDA band over the last 10 years SOURCE: FACTSET; MORGANS RESEARCH, COMPANY 2. M&A ranges in the sector, what s driven the re-rate and why this isn t maintainable The chart below shows the benefits telcos such as TPM (including iinet) have extracted from moving customers onto their own networks and we highlight this positive trend is likely to reverse under the NBN unless telcos are able to charge consumers considerably more. Figure 8: M&A and trading multiple versus current trading multiples (as at 19 October 2016) We use FY2 as it includes 12 months of contributions from acquisitions settled in FY17 like NextGen. We also note that we are now seeing the listed telcos trade at a discount to M&A multiples which makes sense given M&A multiples typically include a change of control premium and factor in some synergies. SOURCE: MORGANS RESEARCH, COMPANY The chart below shows the benefits telcos such as TPM (including iinet) have extracted from moving customers onto their own networks and we highlight this positive trend is likely to reverse under the NBN unless telcos are able to charge consumers considerably more. 5

6 Figure 9: iinet s margin trends from scale and infrastructure ownership created a re-rate which reverses under the NBN SOURCES: MORGANS, COMPANY REPORTS However, this isn t maintainable as gross profit margins will decline under the NBN, and we d argue this realisation has led to the recent de-rating of TPM. We had flagged this risk for a number of years but the investment market appeared to ignore this risk until just recently. The chart below simplistically shows the impact that NBN has on TPM s margins. Currently TPM make a ~74% gross profit margin (and a ~55% EBITDA margin) on its on-network subscribers. This will halve. Figure 10: Working through the NBN margin impact = a de-rate On-net (now) NBN (future) % change % change Average Revenue Per User $58.70 $67.20 $ % Cost Of Goods Sold $15.00 $43.00 $ % Gross Profit $43.70 $24.20 ($19.50) -45% Gross Proft Margin 74% 36% 3. NBN progress to-date and sector look through The NBN rollout to-date SOURCES: MORGANS, COMPANY REPORTS There were 1.1m active NBN customers as at 30 June m premises passed (available). The geographic splits to-date is shown below. 6

7 Figure 11: NBN rollout to-date The NBN rollout and adoption curve SOURCES: MORGANS, COMPANY REPORTS NBN continues to gather pace. There were 1.1m active NBN customers as at 30 June 2016 and this number is expected to virtually double year on year for the next few years as critical mass is hit. The last NBN business plan forecasts 12m NBN enabled households with 8m active NBN households by 2020 (~70% take-up). Figure 12: Overlaying historical and forecast NBN adoption (LHS = million households, RHS is% take-up ) SOURCES: MORGANS, COMPANY REPORTS If we overlay June 2061 ISP market shares against the NBN s business plan for 8m active households by 2020 then subscriber trends would look broadly as follows. 7

8 Premises Declared (000s) Premises Activated (000s) Telecommunications Australia Equity research October 25, 2016 Figure 13: Premises declared (000s) - market share Figure 14: Premises activated (000s) - market share 6, , , , , , , , , , , , , FY16 FY17 FY18 FY19 FY FY16 FY17 FY18 FY19 FY20 VOC TLS IIN TPM Optus Other VOC TLS IIN TPM Optus Other SOURCE: NBN Co Data SOURCES: NBN Co Data Premises declared and activated NBN continues to be rolled out in accordance with the revised Statement of Expectations released by the government post-election Premises are defined as addressable locations which the NBN is required to connect, they are regarded as the basis for measuring the NBN s achievement of the government s coverage objectives. Declared premises are ready to begin connection in that region whereas activated premises already have an active service installed. NBN released their Corporate Plan 2017 in August 2016 revising their expectations for the NBN rollout until FY20. At 30 June FY16 there were 2,893,474 premises declared and 1,098,635 premises activated nationwide on schedule with the government s revised expectations for NBN rollout, outlined in Figure 15: NBN household traction 3,500,000 3,000,000 2,500,000 2,000,000 1,500,000 1,000, ,000 0 Q4 Jun 14 Q1 Q2 Q3 Sep 14 Dec 14 Mar 15 Q4 Jun 15 Q1 Sep 2015 Q2 Dec 2015 Q3 March 16 Q4 June 16 Q1 Sep 16 Premises Declared Premises Activated SOURCE: NBN Co Data NBN market share There are four major players currently competing in the NBN market space: Telstra, Vocus, TPG Telecom (including iinet) and Optus. Telstra is the dominant player in NBN at 45.51% market share and approximately 500,000 units. 8

9 Figure 16: Market Share NBN activated households Jun-15 Dec-15 Jun-16 NBN households activated 485, ,052 1,098,635 TLS (national legacy market share is 48%) 43.5% 44.7% 45.5% TPM & IIN (national legacy market share is 27%) 25.9% 26.4% 25.1% Optus (national legacy market share is 15%) 11.1% 12.0% 10.3% VOC (national legacy market share is 7%) 5.4% 5.6% 6.2% Other (national legacy market share is 3%) 14.1% 11.4% 12.9% SOURCES: MOGANS, COMPANY REPORTS If we overlay the June 2016 market share data with the NBN s business plan and the NBN s forecasts for activated households cumulative NBN subscribers are displayed in Figure 17 below. TPM (including IIN) had a total of 1.87m broadband subscribers as at 31 July In another four years time it s possible they have 2m NBN broadband customers (assuming current market shares hold). Given these replace their existing on-net customers this is not sufficient, in our view, to offset lost earnings as result of margin pressure (on higher access costs). The NBN s business plan also forecasts ARPU (TPM and others last mile access cost) to increase from current levels of A$43 per month to $52 by FY20, which will further exacerbate margin pressure. Figure 17: Cumulative premises activated by FY20 Telcos FY16 FY17 FY18 FY19 FY20 Total Premises (000s) 1, , , , , TLS , , , , TPM & IIN , , , Optus VOC Other , SOURCES: NBN Co Data NBN rollout forecasts and implications NBN premises projection NBN released their Corporate Plan 2017 in August 2016 outlining their expectations for the NBN rollout by FY20. They project that 100% of premises declared will be constructed and ready for connection by FY20 the majority of which will be Fibre to the Node. Key technologies of chose are Fibre To The Premise (FTTP), Fibre To The Node (FTTN), Hybrid Fibre Coaxil / cable TV network (HFC), and Fibre To The Basement (FTTB). Figure 18: Premises activated by FY20 - Market share by distribution type FY16 FY17 FY18 FY19 FY20 FTTP Brownfields 64% 35% 18% 13% 11% FTTP Greenfields 18% 9% 7% 6% 6% FTTN 9% 39% 48% 52% 52% HFC 0% 4% 20% 22% 25% Fixed Wireless 9% 9% 5% 4% 4% Satellite 0% 4% 2% 3% 2% Total 100% 100% 100% 100% 100% SOURCES: NBN Co Data 9

10 Figure 19: Premises declared (passed) by FY20 Premises (millions) FY16 FY17 FY18 FY19 FY20 FTTP Brownfields FTTP Greenfields FTTN HFC Fixed Wireless Satellite Total SOURCES: NBN Co Data Figure 20: Premises activated (paying customers) by FY20 Premises (millions) FY16 FY17 FY18 FY19 FY20 FTTP Brownfields FTTP Greenfields FTTN HFC Fixed Wireless Satellite Total SOURCES: NBN Co Data 4. Comparing NBN plans prices and ADSL plans prices Can telcos raise prices to offset higher access costs? Given access prices go up considerably either telcos margins compress (as we currently expect) or telcos raise prices (and consumers pay more for what is at this stage virtually the same product). We have been closely monitoring the pricing differential between hero plans (NBN vs ADSL). A summary is below and this diverges from last reported ARPU. Websites suggest consumers will pay A$10-A$50 per more per month for an NBN service than an ADSL service. However companies last reported ARPU figures differ greatly from this and suggest that NBN customers are not paying substantially more. We will need further data points to pin point the direction of ARPU but maintain the view that it s a competitive environment so pricing is under pressure as telcos battle to gain the customer. Pricing wars are typically good for consumers but bad for profits and shareholders. Figure 21 overleaf titled last reported data points from company indicates that reported ARPU for NBN is around A$4 than reported ARPU from ADSL and therefore telcos are not passing higher access prices onto consumers (at this stage). However contradicting this the hero pricing on companies website (as advertised to the public) show NBN services as being around A$27 higher than ADSL. These two data points contradict each other and the conclusion we draw is that telcos are probably discounting relative to their recommended retail price and the product mix is most likely also impacting the blended ARPU. 10

11 Figure 21: Plan comparison based on LAST REPORTED DATA POINTS FROM COMPANY Last reported Last reported NBN ARPU ADSL ARPU NBN vs (inc phone) (inc phone) ADSL ($) NBN vs ADSL (%) MORGANS TELCO SHOPPER DATA POINTS Aug 16 NBN Aug 16 NBN vs NBN vs (25Mbps) ADSL ADSL ($) ADSL (%) Telstra $ $ $ $ % TPG $ $ $ % $ $ $ % iinet (TPG) $ $ $ % $ $ $ % Optus (1) $ $ $ $ % Dodo (VOC) n/a $ $ $ $ % MEDIAN $ $ $ (4.15) -2% $ $ $ % AVERAGE $ $ $ (4.15) -2% $ $ $ % Notes on last reported data points * TLS is a blended figure so predominately ADSL * TPG & iinet ARPU for NBN and On Net ADSL include revenues from on-net home phone voice * Optus $52 is a last reported ADSL ARPU and ex phone * Dodo $68.30 is a blended ARPU figure not ADSL SOURCE: MORGANS RESEARCH, COMPANY ; AS AT AUGUST 2016 The key take away from the output above is that ARPU as last reported tends to be lower than ARPU as advertised. It is also worth pointing out that around three quarters of NBN plans are the lower speed plans (i.e. closer to the current ADSL offering) which proves, in our view, that telco is a pricing decision and consumers are not willing to pay more for higher speeds. We include average speeds of existing NBN connections below in Figure 22 as it is more relevant for an apples to apples comparison of NBN vs ADSL. Figure 22: ARPU differentials based on data points above and NBN speeds NBN reported vs advertised ADSL reported vs advertised Speed (Mbps) 31-Dec Dec-15 Telstra $ (25.69) 12/1 38% 33% TPG $ (22.79) $ (1.29) 25/5 38% 45% iinet (TPG) $ (19.49) $ /10 1% 1% Optus (1) /20 4% 5% Dodo (VOC) $ /40 19% 16% MEDIAN $ (21.14) $ (11.69) AVERAGE $ (31.13) $ (1.85) SOURCE: MORGANS RESEARCH, COMPANY ; AS AT AUGUST 2016 We suspect that until the NBN rollout is completed, and the once in a lifetime churn event completed, telcos will continue to compete aggressively on headline prices. Once the churn is stabilised we would expect, in an economically rational world, prices will go up. Ultimately the key point this analysis misses is the return on invested capital equation. Under an NBN the capital intensity of telcos should decline (as they don t need to build as much infrastructure because the NBN is building the most expensive part). Since the capital intensity declines if EBITDA can decline a commensurate amount to the declining capex then the return on capital could be unchanged. We d argue this is a key point that is being overlooked; however, in our experience stock markets tend to focus more on margins than return on capital. For example TPG Telecom traded at a higher multiple than iinet we think because the market looked at its EBITDA margin which was higher and ignored the fact that their return on capital was virtually the same. Details of NBN locations available: 11

12 Figure 23: QLD rollout plans SOURCES:, COMPANY REPORTS Figure 24: QLD services available SOURCES:, COMPANY REPORTS 12

13 Figure 25: NSW rollout plans SOURCES:, COMPANY REPORTS Figure 26: NSW rollout to-date SOURCES: COMPANY REPORTS 13

14 Figure 27: VIC rollout to-date SOURCES: COMPANY REPORTS Figure 28: VIC services available SOURCES: COMPANY REPORTS 14

15 5. Reminder on SDA our prefered telco We expect the NBN to be a challenge for the sector over the coming years and think investors may prefer to steer clear until the dust settles. Those looking for an alternative without the NBN challenges should look more closely at SpeedCast (SDA:ASX). We rate SDA as our preferred telco given: 1) attractive returns on capital; 2) strong growth outlook at attractive prices; 3) US dollar earnings; 4) ongoing opportunities for value creating acquisitions; 5) substantial equity ownership by long servicing CEO Pierre-Jean Beylier; and 6) it s completely unrelated to the NBN. For those not familiar with SDA here is the overview: SDA is a global satellite communications and network service provider. For those familiar with iinet and M2 Group there are many similarities from a high level perspective. However, SDA is global and sells satellite communications, not terrestrial services. SDA is a leading global network and satellite communications service provider offering high-quality managed networks services with 4,000 links in over 60 countries; and a global maritime network serving customers worldwide. SDA is headquartered in Hong Kong, with 42 international sales & support offices and 39 teleport operations. It provides quality services and support of business critical telecommunications services to remote locations across land and sea. SDA do not specifically break down the divisional contribution other than to say that Energy is the smallest division and accounts for ~15% of revenue, Maritime services is the middle division, and enterprise and government the largest. SDA have an aspiration target of being a top three player in the satellite services, maritime and energy in the next three years. They are a global business so subject to currency movements. Their last disclosed currency exposures are as follows. Figure 29: SDA's currency exposures (June 2016 excluding WINS acquisition) USD AUD EUR GBP Revenue 73% 21% 5% 1% Access costs / COGS 93% 3% 3% 1% Opex 32% 44% 14% 10% Depreciation 76% 19% 5% Net finance costs 54% 47% SOURCES: MORGANS, COMPANY REPORTS, SDA FY15 RESULT PRESENTATION 15

16 6. Forecast and valuation changes and risk/reward TLS Hold retained We have made minor changes to our TLS forecast. These are largely around result composition and result in immaterial changes. From a valuation perspective we now apply an EV/EBITDA mythology in conjunction with our DCF. We weight this 75% DCF and 25% EV/EBITDA where formerly this was 100% DCF. Our EV/EBITDA valuation applies 6.4x to TLS 12-month forward EBITDA and uses 6.4x as this is its long term average trading multiple. Figure 30: TLS forecast and valuation changes FY17 old FY17 New FY18 % change old FY18 new % change Revenue 28,727 28, % 29,275 29, % Gross profit 20,828 20, % 21,218 21, % Opex 10,193 10, % 10,141 10, % EBITDA 10,635 10, % 11,077 11, % EBIT 6,340 6, % 6,502 6, % NPAT 3,944 3, % 4,095 4, % EPS % % DPS % % Ops Cash Flow 8,947 8, % 8,897 7, % Capex 5,171 5, % 5,269 5, % Free Cash flow 3,776 3, % 3,628 2, % DCF $5.72 $ % EV/EBITDA n.m. $4.40 n.m. Weighted valuation $5.72 $ % Premium / (discount) 0% 0% n.m. Price target $5.72 $ % SOURCE: MORGANS RESEARCH, COMPANY TLS risk / reward Competition remains intense in the telecommunications sector and operationally this is a challenge for TLS from both a fixed and wireless perspective. The other risk to be aware of is the possibility of the Australian Competition and Consumer Commission (ACCC) declaring mobile roaming. TLS do not disclose the materiality of regional mobile network (EBITDA or capex) so it s impossible to accurately predict any impact. We also note lower interest rates have seen, in our view, peers trading multiples re-rate then derate. As US interest rates increase this may have a detrimental impact on yield stocks. We d argue that TLS did not re-rate on lower interest rates so fundamentally shouldn t de-rate. Upside potential relates to better than expected contract wins from NBN or the potential for TLS to undertake other value creating deals like the Pacnet acquisition in Asia. Poorly executed deals could result in share price weakness; however, we would argue that TLS has, of late, done a commendable job of managing its portfolio. We also highlight that as the NBN continues to gain momentum this will, in the short term, have a positive impact for TLS as A$4bn of the A$11bn NPV is front end loaded (i.e. happens as the NBN rolls in). Once this has completed TLS will need to replace the earnings hole via build, buy or buy-back. For those with a growth bias we acknowledge that TLS is likely to deliver limited earning growth over the next few years and a large part of management s time will be dedicated to replacing lost earnings (or buying back its own shares). However we believe that dividend remains relatively safe and this creates appeal, in our view. 16

17 TPG Telecom Reduce retained We have reduced TPM s EV/EBITDA multiple applied to our valuation from 10x to 7x, which results in our valuation declining from A$7.94 to A$6.47. We have made no other forecast or valuation changes and reiterate our Reduce recommendation. Figure 31: TPM forecast and valuation changes FY17old FY17 New % change FY18 old FY18 New % change Revenue 2, % 2, % EBITDA % % Cash NPAT % % Reported EPS % % DPS % % DCF $7.68 $ % EV/EBITDA $8.21 $ % Weighted valuation $7.94 $ % Premium / (discount) 0.0% 0% n.m. Price target $7.94 $ % TPM risk and reward SOURCE: MORGANS RESEARCH, COMPANY In our view, NBN margin erosion and the ability to offset this through cost reductions, adding more consumer customers, and growing the corporate division at an accelerated rate remains the key upside and downside risk for TPM. TPM has done a commendable job of reducing costs and simplifying the core business from prior acquisitions (Pipe Networks and AAPT) although these were businesses that were vertically integrated (they were TPM s key suppliers) and not predominately consumer facing businesses like iinet. Conversely upside risk relates to the high likelihood that, at least in the short term, TPM will be able to pull more costs from the IIN business than expected and this has the potential to result in higher EBITDA than market expectations. VOC Hold retained We have reduced the EV/EBITDA multiple applied to our valuation from 10x to 7x. In the short term, we believe VOC needs prove they can successfully integrate the business and generate strong operating cash flow then deliver a few periods of solid organic growth before the market regains confidence. Figure 32: VOC forecast and valuation changes 2017 old 2017 new % change 2018 old 2018 new % change Revenue % % EBITDA % % EBIT % % NPAT % % Norm EPS % % DPS % % Shares on issue % EV/EBITDA valuation $8.69 $ % DCF $8.99 $ % Weighted valuation $8.84 $ % Premium / Discount 0% 0% n.m. Price target $8.84 $ % SOURCE: MORGANS RESEARCH, COMPANY VOC risk and reward We cannot entirely rule out the possibility of an earnings downgrade to VOC. We highlight that: 1) our FY17 forecasts are pro-forma (and reported numbers will be lower due to one-off Next Gen costs, which are estimated to be A$28m); 2) VOC acquired Amcom and NextGen which had negative underlying EBITDA trends (these should be reversed under a vertically integrated national network but this remains to be seen); and 3) given the substantial operational changes 17

18 that have taken place within VOC there may be some distractions. Ultimately VOC is a series of strong cash generating businesses with 2-15 year customer contracts so the backbone of the business remains, in our view, solid. It s just the growth that remains to be seen. VOC s share count has increased seven fold in just over two years (from 87m shares on issue in FY14 to 616m now post the NextGen acquisition). VOC s EBITDA has increased even more significantly from A$33m in FY14 to around A$500m now (assuming a 12-month contribution from the NextGen acquisition). This exceptional growth is largely from acquisitions and requires the VOC leadership team to integrate these acquisitions. Cost synergies are expected to take around three years to be fully realised and this gives investors an indication that there is still a long way to go with respect to fully integrating these acquisitions. On 22nd September when VOC announced the ACCC will not oppose its acquisition of NextGen they also informed the market they are working towards an October 2016 completion and that The Vocus Corporate and Wholesale business continues to perform strongly, exceeding new sales targets in Q1 FY17 and will be further strengthened with the ability to target new customer segments and markets following the integration of the NextGen assets. Given there is no guidance in the market from VOC this does not guarantee that earnings are tracking in-line with consensus/ market expectations (as management targets may differ with analyst expectations). However, we think it s safe to assume that VOC s sales targets are based on Q1FY17 doing better than Q4FY16 (when VOC announced underlying EBITDA of A$95-100m for the quarter / A$ m annualised). We need to add to this NextGen s contribution which should be around A$66m annualised EBITDA (guidance is mid to high single digit growth on A$62m normalised cash EBITDA ) which sees VOC s underlying annualised EBITDA base as A$ m. VOC will get ~8 months of NextGen contributions in FY17 and 12 months in FY18. On-top of this we need to add: 1) organic growth (VOC have increased the sales force so it s safe to assume sales should accelerate over time); and 2) synergies from acquisitions less costs to extract these synergies (which have not been specifically disclosed). A$14m from AMM with 100% impact in FY18 A$40m from M2 with 100% impact in FY19 A$28-31m from NextGen with 100% impact from FY20 This should give us an annualised underlying EBITDA base of around A$550m pre organic growth. However VOC is not likely to hit this annualised number until FY20 and it will progressively work its way towards this figure over the next three years. 18

19 SDA forecasts and valuation We have made no changes to our forecasts, valuation or price target. SDA risk and reward In our view the key operational risks for SDA relate primarily to successful integration of acquisitions to pay down debt and create surplus free cash flow. To-date the company has integrated a number of acquisitions successfully and these have delivered value to shareholders. However, acquisitions also come with risk. Failure to successfully integrate acquisitions (to realise synergies and economies of scale) or to extract the expected EBITDA and cashflow could result in disappointment from equity markets and bankers. Management plays a key role in operating the SDA business, integrating the acquisitions already completed, finding ongoing acquisitions and completing SDA s Enterprise Resource Planning upgrade (a key current project). As such, in our view, the CEO (Pierre-Jean Beylier aka PJ) and CFO (Ian Baldwin) represent key management risk. To-date SDA s integration track record has been successful so its formula looks to be repeatable. 19

20 7. Financial summaries Figure 33: TLS financial summary Profit and loss Jun-15A Jun-16A Jun-17E Jun-18E Jun-19E Valuation details TLS Revenue 26,112 27,050 28,689 29,550 30,661 Share Price $5.07 Market Cap A$62.1bn Gross Profit 19,267 19,804 20,834 21,218 21,775 Price Target $5.20 Total Operating Costs -8,734-9,339-10,193-10,141-10,243 Upside 2.6% Rec HOLD EBITDA 10,533 10,465 10,641 11,077 11,532 TSR 8.9% Depreciation -2,915-2,957-3,136-3,422-3,692 WACC Valuation Amortisation & impairments -1,059-1,198-1,157-1,157-1,157 DCF 7.9% $5.46 EBIT 6,559 6,310 6,348 6,499 6,683 EV/EBITDA 6.4 $4.40 Net Interest Income Weighted valuation and Price Target $5.20 Pre-tax Profit 6,051 5,600 5,643 5,838 6,038 Tax -1,746-1,768-1,693-1,751-1,811 Key metrics/ multiples Jun-16A Jun-17E Jun-18E Reported Profit 4,305 5,849 3,950 4,086 4,227 P/E (normalised) Exceptional items , Yield 6.1% 6.2% 6.3% Normalised Profit 4,114 3,832 3,950 4,086 4,227 EV / EBITDA Guidance is mid to high-single digit revenue grow th and mid-single digit EBITDA grow th Price / Book Value Cash flow statement Jun-15A Jun-16A Jun-17E Jun-18E Jun-19E Price / Net Tangible Assets EBITDA 10,533 10,465 10,641 11,077 11,532 Operating cash flow yield 11.6% 14.3% 12.8% Net interest Free cash flow yield 6.7% 6.0% 4.2% Tax -1,755-1,860-1,693-1,751-1,811 Changes in working capital -1, Per share data Jun-16A Jun-17E Jun-18E Operating cash flow 6,852 7,199 8,913 7,940 8,979 Diluted shares on issue 12,202 11,962 11,962 Capex -8,463-3,051-5,164-5,319-5,519 Reported Earnings per share Free Cash Flow -1,611 4,148 3,749 2,621 3,460 Normalised EPS (A$) Acquisitions and divestments othe -1,743-1, Dividends per share (A$) Investing cash flows -10,206-4,194-5,164-5,319-5,519 Payout ratio 65.4% 95.8% 93.7% Increase / decrease in Equity -1,004-1,894-1, Dividend vs FCF 91.2% 100.5% 146.0% Increase / decrease in Debt -1,667 1,033-1, ,650 Dividends paid -3,699-3,787-3,705-3,768-3,708 Result quality Jun-16A Jun-17E Jun-18E Other financing cash flows Cash flow conversion 94.2% 106.6% 93.6% Financing cash flows -5,827-4,869-5,974-3,768-2,058 FCF vs. NPAT 108.2% 94.9% 64.1% Balance Sheet Jun-15A Jun-16A Jun-17E Jun-18E Jun-19E Gearing Jun-16A Jun-17E Jun-18E Assets Net Debt 13,752 14,941 16,076 Cash And Deposits 1,396 3,550 1, ,634 Net Debt / Net Debt + Equity 46.4% 50.1% 51.4% Debtors 4,721 4,737 4,514 5,223 5,411 Net Debt / EBITDA (x) Inventory EBITDA interest cover (x) Total Current Assets 6,970 9,340 7,087 6,677 8,300 Invested Capital 30,269 29,117 31,990 Fixed Assets 21,621 20,581 22,609 24,507 26,334 Enterprise Value 75,555 75,528 76,663 Investments Goodwill & Intangibles 9,332 9,229 8,072 6,916 5,759 Growth ratios Jun-16A Jun-17E Jun-18E Total Non-Current Assets 33,475 33,946 34,817 35,558 36,228 Revenue 3.6% 6.1% 3.0% TOTAL ASSETS 40,445 43,286 41,905 42,236 44,529 EBITDA -0.6% 1.7% 4.1% Liabilities NPAT -6.9% 3.1% 3.4% Short Term Debt 1, , , , ,795.2 Reported EPS 36.0% -30.6% 3.9% Creditors 4, , , , ,727.7 Normalised EPS -5.4% 4.4% 3.9% Total Current Liabilities 7, , , , ,194.9 DPS 1.6% 1.6% 1.6% Long Term Debt 14, , , , ,156.8 Operating cash flow 5.1% 23.8% -10.9% Total Non -Current liabilities 17, , , , ,700.8 TOTAL LIABILITIES 25, , , , ,808.7 Margin analysis Jun-16A Jun-17E Jun-18E Equity EBITDA Margin 38.7% 37.1% 37.5% Issued capital 5, , , , ,979.9 EBIT margin 23.3% 22.1% 22.0% Retained earnings 8, , , , ,642.0 NPAT margin 14.2% 13.8% 13.8% Other reserves and FX ROE 36.8% 26.5% 26.9% TOTAL EQUITY 14, , , , ,719.9 ROIC 20.8% 21.8% 20.3% SOURCE: MORGANS RESEARCH, COMPANY 20

21 Figure 34: TPM financial summary Profit and loss Jul-15A Jul-16A Jul-17E Jul-18E Valuation details TPM Revenue 1, , , ,635.6 Share Price $7.46 Market Cap A$5,779.4m Gross Profit , , ,390.8 Price Target $6.47 Total Operating Costs Total shareholder return -11.3% WACC 8.8% EBITDA * Depreciation Multiple Weighting Valuation Amortisation & impairments DCF n.a. 50.0% $7.65 EBIT EV / EBITDA 7.0 x 50.0% $5.28 Net Interest Income Weight valuation $6.47 Pre-tax Profit Premium / (discount) 0% Tax Price Target $6.47 Reported Profit * Exceptional items Key metrics/ multiples Jul-16A Jul-17E Jul-18E Normalised / Cash profit * Cash P / E Gross dividends Yield 1.9% 2.0% 2.1% * includes on off gains on acquisitions, divestments & IRU's PEG FY17 guidance - Underlying EBITDA of A$ m & capex of A$ m EV / EBITDA Cash flow statement Jul-15A Jul-16A Jul-17E Jul-18E Price / Book Value EBITDA Price / Net Tangible Assets Net interest Operating cash flow yield 7.9% 12.5% 11.1% Tax Free cash flow yield (pre exp 6.4% 10.5% 9.1% Changes in working capital Free cash flow yield 3.7% 5.5% 2.4% Operating cash flow Maintenance capex Per share data Jul-16A Jul-17E Jul-18E Free cash flow (pre expansion) Diluted shares on issue Total capex Reported EPS (A$) Free Cash Flow Normalised EPS (A$) Acquisitions and divestments Dividends per share (A$) Other Investing cash flow , Payout ratio 30.6% 37.5% 41.2% Investing cash flows 0.7 1, Increase / decrease in Equity Result quality Jul-16A Jul-17E Jul-18E Increase / decrease in Debt Cash flow conversion 80.3% 114.3% 103.3% Dividends paid FCF vs. NPAT 115.6% 89.7% 51.4% Other financing cash flows Gross dividends vs FCF 31.5% 39.8% 58.0% Financing cash flows Gearing Jul-16A Jul-17E Jul-18E Balance Sheet Jul-15A Jul-16A Jul-17E Jul-18E Net Debt 1,338 1,212 1,245 Cash And Deposits Net Debt / Equity (x) Debtors Net Debt / EBITDA (x) Inventory EBIT interest cover (x) Other current assets Invested Capital 2,950 3,328 3,459 Total Current Assets Enterprise Value 7,665 7,553 7,587 Fixed Assets , ,418.7 Investments Growth ratios Jul-16A Jul-17E Jul-18E Goodwill & Intangibles , , ,421.8 Revenue 94.6% 1.2% 5.0% Other non-current assets Operating costs 123.0% 16.0% 2.9% Total Non-Current Assets 1, , , ,872.6 EBITDA 75.4% -2.6% 0.7% TOTAL ASSETS 1, , , ,258.3 NPAT 61.2% -7.1% -7.2% Short Term Debt Reported EPS growth 67.8% -15.6% -5.9% Creditors Cash EPS growth 57.6% -11.2% -7.3% Other current liabilities DPS growth 26.1% 3.4% 3.3% Total Current Liabilities Operating cash flow 27.1% 56.8% -10.6% Long Term Debt , , ,212.8 Other Non current liabilities Margin analysis Jul-16A Jul-17E Jul-18E Total Non -Current liabilities , , ,340.3 Gross profit margin 53.1% 54.5% 52.8% TOTAL LIABILITIES , , ,072.0 EBITDA Margin 34.3% 33.0% 31.6% Issued capital , , ,459.0 EBIT margin 24.1% 22.5% 20.2% Retained earnings Cash NPAT margin 16.6% 15.2% 13.5% Other reserves and FX Cash ROE 23.2% 19.2% 16.3% TOTAL EQUITY 1, , , ,186.3 ROIC 20.3% 16.9% 15.4% SOURCE: MORGANS RESEARCH, COMPANY 21

22 Figure 35: VOC financial summary Profit and loss (A$m) Jun-15A Jun-16A Jun-17E Jun-18E Jun-19E Valuation details VOC Revenue , , ,331.4 Share Price A$5.94 Market Cap A$3,661.2m Gross Profit , ,119.6 Total shareholder return 5.0% WACC 8.8% Total Operating Costs EBITDA Multiple Weighting Valuation Depreciation DCF n.a. 50.0% A$7.64 Amortisation & impairments EV/EBITDA multiple 7.0x 50.0% A$4.46 EBIT Weight valuation A$6.05 Net Interest Income Price Target A$6.05 Pre-tax Profit Tax Net Profit after Tax Key metrics/ multiples Jun-16A Jun-17E Jun-18E Non-cash amortisation adjustments P/E (underlying) Underlying NPAT Normalised EPS growth 41.7% 31.1% 3.8% FY17 does not include NextGen transaction costs or non -cash amorisation still to be confirmed on recent acquisitions PEG FY18 onwards does not include non -cash amorisation still to be confirmed on recent acquisitions EV / EBITDA Cash flow statement Jun-15A Jun-16A Jun-17E Jun-18E Jun-19E Dividend yield 2.9% 3.1% 3.2% Operating cash flow Operating cash flow yield 3.7% 10.7% 12.2% Total capex Free cash flow yield 1.9% 6.4% 7.8% Free Cash Flow Acquisitions and divestments Per share data Jun-16A Jun-17E Jun-18E Other Investing cash flow Diluted shares on issue Investing cash flows Normalised EPS Increase / decrease in Equity Ordinary dividends Increase / decrease in Debt Total dividends Divs & other fin cash flows Ordinary div payout ratio 52% 47% 47% Financing cash flows Result quality Jun-16A Jun-17E Jun-18E Balance Sheet Jun-15A Jun-16A Jun-17E Jun-18E Jun-19E Cash flow conversion 77.1% 107.2% 107.7% Cash And Deposits FCF vs. EBITDA 31.7% 48.7% 53.2% Debtors FCF / Book Equity 2.2% 5.5% 6.6% Other current assets Total Current Assets Gearing Jun-16A Jun-17E Jun-18E Fixed Assets ,068.6 Net Debt Goodwill & Intangibles , , , ,807.6 Net Debt / Equity 23.6% 18.7% 14.2% Other non-current assets Net Debt / EBITDA (x) Total Non-Current Assets , , , ,464.4 EBIT interest cover (x) TOTAL ASSETS , , , ,799.4 Invested Capital 3,972 4,970 4,912 Short Term Debt Enterprise Value 4,409 4,448 4,295 Creditors Other current liabilities Growth ratios Jun-16A Jun-17E Jun-18E Total Current Liabilities Revenue 454.6% 154.0% 1.5% Long Term Debt Operating costs 425.7% 143.5% 14.9% Other Non current liabilities EBITDA 315.0% 120.6% 11.9% Total Non -Current liabilities , , EBIT 312.2% 137.9% 11.1% TOTAL LIABILITIES , , , ,314.3 Underlying NPAT 461.9% 120.7% 12.0% Issued capital Underlying EPS 41.7% 31.1% 3.8% Retained earnings Operating cash flow 218.3% 188.6% 13.8% Other reserves and FX , , , ,427.8 Free cash flow 538.8% 239.3% 22.1% TOTAL EQUITY , , , ,485.0 SOURCE: MORGANS RESEARCH, COMPANY 22

23 Figure 36: SDA financial summary Profit and loss (US$m) Dec-14A Dec-15A Dec-16E Dec-17E Dec-18E Valuation details SDA Revenue Share Price A$3.85 Market Cap A$528.2m Gross Profit Share Price US$2.84 Market Cap US$ Total Operating Costs Total shareholder return 19.2% WACC 10.0% EBITDA Multiple Weighting Valuation Depreciation DCF n.a. 50.0% US$4.05 Amortisation & impairments EV/EBITDA multiple % US$2.57 EBIT Weight valuation US$3.31 Net Interest Income USD / AUD conversion rate 0.74 Pre-tax Profit Price Target A$4.51 Tax Reported Profit (ex one-offs) Key metrics/ multiples Dec-15A Dec-16E Dec-17E Amortisation adjustment P/E Normalised Cash Profit Cash EPS growth 17.0% 20.6% 25.0% N.B. Historics are reported while forecasts are underlying PF - we have normalised 1H16 EV / EBITDA Pro-forma normalised FY14 FY15 1H16 FY16 Price / Book Value Pro-forma EBITDA F Equity yield 3.6% 5.5% 4.6% Pro-forma NPATA na Operating cash flow yield 4.6% 3.3% 7.5% NPATA per share na Free cash flow yield 2.8% 0.2% 4.8% Dividend yield 1.7% 2.0% 2.2% Cash flow statement Dec-14A Dec-15A Dec-16E Dec-17E Dec-18E Per share data Dec-15A Dec-16E Dec-17E Operating cash flow Diluted shares on issue Maintenance capex Normalised EPS (US$) Free Cash Flow (pre expansion) Normalised EPS (A$) Total capex (inc expansion) Dividends per share (A$) Free Cash Flow Payout ratio 38% 37% 32% Acquisitions and divestments Result quality Dec-15A Dec-16E Dec-17E Other Investing cash flow Cash flow conversion 102.8% 52.4% 99.8% Investing cash flows FCF vs. EBITDA 48.1% 2.0% 49.2% Increase / decrease in Equity FCF / Equity 40.5% 1.0% 27.2% Increase / decrease in Debt Divs & other fin cash flows Gearing Dec-15A Dec-16E Dec-17E Financing cash flows Net Debt Net Debt / Equity 309.3% 146.8% 115.9% Balance Sheet Dec-14A Dec-15A Dec-16E Dec-17E Dec-18E Net Debt / EBITDA (x) Cash And Deposits EBIT interest cover (x) Debtors Invested Capital Other current assets Enterprise Value Total Current Assets Fixed Assets Growth ratios Dec-15A Dec-16E Dec-17E Investments Revenue 42.4% 42.3% 18.1% Goodwill & Intangibles Operating costs -12.4% 19.9% 23.4% Other non-current assets EBITDA % 81.8% 24.9% Total Non-Current Assets EBIT 158.9% 195.5% 30.3% TOTAL ASSETS NPAT -60.9% 37.7% 24.8% Short Term Debt EPS growth % 491.6% 33.1% Creditors Operating cash flow 63.7% -27.4% 205.1% Other current liabilities Free cash flow 150.9% -92.6% % Total Current Liabilities Long Term Debt & hybrids Margin analysis Dec-15A Dec-16E Dec-17E Other Non current liabilities Gross profit 38.1% 38.1% 40.0% Total Non -Current liabilities EBITDA Margin 13.7% 17.5% 18.5% TOTAL LIABILITIES EBIT margin 4.7% 9.7% 10.7% Issued capital Tax rate 53.4% 23.7% 24.0% Retained earnings NPAT margin 8.8% 8.5% 9.0% Other reserves and FX ROE 54.3% 24.1% 27.0% TOTAL EQUITY ROIC 7.1% 10.1% 14.8% SOURCE: MORGANS RESEARCH, COMPANY 23

24 8. International peer comparison Figure 37: International telco peer comparison part 1 of 2 Mcap Last P/E EV/EBITDA USDm Price Actual FY + 1 FY + 2 FY + 3 Actual FY + 1 FY + 2 FY + 3 INCUMBENTS Vodafone Group Plc 72, x 33.93x 29.53x 23.36x 6.97x 7.05x 6.78x 6.51x Spark New Zealand Limited 4, x 16.94x 16.21x 15.81x 7.43x 7.25x 7.11x 7.04x Orange SA 40, x 13.69x 12.94x 12.22x 5.61x 5.41x 5.29x 5.16x Deutsche Telekom AG 74, x 15.89x 14.99x 13.44x 6.80x 6.29x 5.97x 5.69x BT Group plc 45, x 12.91x 11.80x 10.93x 6.23x 6.26x 6.09x 5.95x China Mobile Limited 239, x 14.95x 13.70x 12.56x 4.63x 4.51x 4.21x 3.98x NTT DoCoMo, Inc. 95, x 14.14x 13.47x 12.87x 7.55x 6.65x 6.31x 6.06x Telefonica SA 49, x 14.99x 12.22x 10.72x 9.52x 7.42x 7.12x 6.83x Telecom Italia S.p.A. 11, x 13.54x 12.83x 10.81x 6.30x 5.97x 5.84x 5.68x INCUMBENTS AVERAGE 70, x 16.78x 15.30x 13.64x 6.78x 6.31x 6.08x 5.88x INCUMBENTS MEDIAN 49, x 14.95x 13.47x 12.56x 6.80x 6.29x 6.09x 5.95x Telstra Corporation Limited 45, x 14.68x 13.89x 13.45x 7.18x 6.84x 6.55x 6.45x SMALL TELCOS Manitoba Telecom Services Inc. 2, x 7.91x 7.63x 8.02x Frontier Communications Corporation 4, x 6.19x 5.51x 5.50x Hellenic Telecommunications Organization SA 4, x 17.99x 14.51x 13.19x 4.00x 3.94x 3.86x 3.82x Level 3 Communications, Inc. 17, x 9.39x 8.88x 8.33x Telecom Plus PLC 1, x 20.68x 19.35x 18.32x 15.84x 17.91x 16.91x 15.28x National Grid plc 48, x 16.56x 16.31x 15.69x 10.18x 11.95x 11.68x 11.21x ecotel communication ag x 21.02x 15.16x 13.21x 4.20x 4.13x 3.74x 3.54x SMALL TELCOS AVERAGE 11, x 19.06x 16.33x 15.11x 8.87x 8.77x 8.31x 7.96x SMALL TELCOS MEDIAN 4, x 19.33x 15.73x 14.45x 9.53x 7.91x 7.63x 8.02x TPG Telecom Limited 4, x 16.12x 14.79x 13.21x 9.59x 8.85x 8.25x 7.70x Vocus Communications Limited 2, x 15.39x 13.09x 11.32x 12.81x 5.90x 5.05x 4.50x SOURCES: FACTSET, MORGANS, COMPANY REPORTS Figure 38: International telco peer comparison part 2 of 2 Mcap Last EPS gth (%) Dividend yield USDm Price FY+1 FY+2 FY+3 Actual FY+1 FY+2 FY+3 INCUMBENTS Vodafone Group Plc 72, % 14.9% 26.4% 6.2% 5.8% 5.8% 5.8% Spark New Zealand Limited 4, % 4.5% 2.5% 7.0% 7.1% 6.7% 6.8% Orange SA 40, % 5.7% 5.9% 4.3% 4.3% 4.7% 5.0% Deutsche Telekom AG 74, % 6.0% 11.5% 3.7% 4.0% 4.5% 4.5% BT Group plc 45, % 9.4% 7.9% 4.5% 4.1% 4.5% 5.0% China Mobile Limited 239, % 9.2% 9.1% 3.0% 2.9% 3.2% 3.6% NTT DoCoMo, Inc. 95, % 5.0% 4.6% 2.4% 3.2% 3.5% 3.8% Telefonica SA 49, % 22.6% 14.0% 8.1% 8.1% 8.0% 7.1% Telecom Italia S.p.A. 11, % 5.6% 18.6% 0.2% 0.2% 0.7% 1.1% INCUMBENTS AVERAGE 70, % 9.2% 11.2% 4.4% 4.4% 4.6% 4.7% INCUMBENTS MEDIAN 49, % 6.0% 9.1% 4.3% 4.1% 4.5% 5.0% Telstra Corporation Limited 45, % 5.7% 3.2% 6.1% 6.3% 6.4% 6.4% SMALL TELCOS Manitoba Telecom Services Inc. 2, NA NA NA 3.7% 1.7% 0.0% 0.0% Frontier Communications Corporation 4, NA NA NA 10.3% 10.2% 10.2% 10.3% Hellenic Telecommunications Organization SA 4, % 24.0% 10.0% 1.3% 1.7% 2.5% 3.5% Level 3 Communications, Inc. 17, NA NA NA 0.0% 0.0% 0.0% 0.0% Telecom Plus PLC 1, % 6.8% 5.6% 4.5% 4.0% 4.3% 4.8% National Grid plc 48, % 1.6% 3.9% 5.0% 4.2% 4.4% 4.5% ecotel communication ag % 38.6% 14.8% 2.5% 2.4% 3.2% 3.8% SMALL TELCOS AVERAGE 11, % 17.8% 8.6% 3.9% 3.5% 3.5% 3.8% SMALL TELCOS MEDIAN 4, % 15.4% 7.8% 3.7% 2.4% 3.2% 3.8% TPG Telecom Limited 4, % 9.0% 11.9% 2.0% 2.2% 2.5% 2.8% Vocus Communications Limited 2, % 17.6% 15.6% 3.0% 3.5% 4.0% 4.5% SOURCES: FACTSET, MORGANS, COMPANY REPORTS 24