TPG Telecom Ltd (TPM)

Transcription

1 21 October 2011 Analyst Daniel Blair Associate Analyst Sam Thornton Authorisation TS Lim TPG Telecom Ltd (TPM) TPM makes a "strategic investment" in IIN Recommendation Hold (Reduce) Price $1.39 Target (12 months) $1.61 (unchanged) Expected Return Capital growth 16.3% Dividend yield 4.6% Total expected return 20.9% Company Data & Ratios Enterprise value Market cap Issued capital $1,374m $1,085m 784m Free float 38% Avg. daily vol. (52wk) 0.78m 12 month price range $1.23-$1.83 GICS sector Telecommunication Services Price Performance (1m) (3m) (12m) Price (A$) Absolute (%) Rel market (%) With TPM becoming a substantial shareholder in IIN (5.14%) a full bid looks increasingly likely but such a bid has limited rationale in our view. We continue to maintain our concerns with TPM s strategy including its lack of preparation for a NBN world. With the share-price having declined >20% since our initiation (Reduce rating), we now move to a Hold given our $1.61 Target Price. Rationale doesn t stack up... We view scale, customer service and product innovation as key differentiators in a NBN world. This is likely to drive industry consolidation. That said we don t believe a takeover of IIN by TPM makes sense due to the differences in culture and brand proposition. We view IIN as better positioned than TPM for the NBN and merging IIN into TPM could dilute IIN s comparative advantage of service and product innovation. A better strategy may be to run two separate brands; albeit this may reduce the strategic flexibility of the combined group given a decision in one brand could impact the value of the other brand. That said there are plenty of examples of this approach globally. Synergies are unlikely to be material given IIN and TPM have a similar DSLAM footprint. Potential opex (non COS) synergies in IIN might be illusory given they could dilute IIN s comparative advantage (ie customer service and brand). But at the end of the day it comes down to price Key IIN shareholders (including CEO Michael Malone) together own >30% of the company and this limits a hostile bid in our opinion. IIN is cheap relative to TPM at 9.3x PER vs. 10.4x for TPM, but we believe a bid price would need to contain a $3+ handle to sway key shareholders and the IIN board. Investment view Hold with $1.61 Target Price We continue to have a differentiated view to the market as we see key risks to TPM s business model, including a lower focus on customer service relative to its peers, price leadership cannibalising the existing returns and risks at PIPE. Absolute Price $ Oct 09 Apr 10 Oct 10 Apr 11 Oct 11 Earnings Forecast Year end 31 July 2010a 2011a 2012e 2013e Sales (A$m) EBITDA (A$m) NPAT (reported) (A$m) NPAT (adjusted) (A$m) EPS (adjusted) ( ps) EPS growth (%) 194.4% 33.2% 31.5% 6.3% PER (x) FCF Yield (%) 9.1% 9.4% 15.6% 13.9% EV/EBITDA (x) Dividend ( ps) Yield (%) 2.9% 3.2% 4.6% 4.9% ROE (%) 12.5% 15.2% 17.3% 16.3% SOURCE: IRESS BELL POTTER SECURITIES LIMITED ACN AFSL SOURCE: BELL POTTER SECURITIES ESTIMATES DISCLAIMER AND DISCLOSURES THIS REPORT MUST BE READ WITH THE DISCLAIMER AND DISCLOSURES ON PAGE 8 THAT FORM PART OF IT. Page 1

2 TPM s opportunistic play on IIN Market leading ISP but market growth continues to slow Thesis recap TPM operates across a broad spectrum of the Telco market. Whilst we acknowledge growth prospects from its fibre business, we believe this is offset by risks to TPM s broadband strategy coupled with key business risks across the group. We also believe the NBN will reduce TPM s comparative cost advantage. We have a Hold rating with a $1.61 Target Price. TPM is not positioned with the NBN in mind We view TPM s price leader strategy as risky given the mature broadband market coupled with a reduction in its cost advantage as the NBN starts. We believe customer service and product innovation will be NBN differentiators and we see limited evidence that TPM has positioned for this. Scale, including network scale, will also be important and TPM is better positioned in this regard. As a result we believe that TPM is not properly positioned ahead of the NBN. Rationale of deal doesn t stack up... History shows that TPM has been an active acquirer, having recently bought InterPower (IPX) and before that Pipe Networks (PWK) and SP Telemedia (SOT) via a reverse takeover. TPM has not been a buyer and holder of minority stakes thus a full bid for IIN is becoming increasingly likely as it creeps on the register. We believe scale will be important in a NBN world which will likely result in consolidation of the 2nd/3rd tier Telco s. In saying that we don t believe a takeover by TPM makes sense as the companies are too different in terms of culture, brand and product positioning. As we have previously discussed, we believe TPM is poorly positioned for a NBN world given its current comparative advantage is premised on price leadership. Whilst we believe IIN is much better positioned than TPM in a NBN world, turning IIN into a mini TPM could dilute IIN s comparative advantage of service and product innovation. In that respect it would be a poor outcome. Whilst TPM needs to improve its capability ahead of the NBN, we believe there are more effective ways of achieving this than buying IIN. We believe running separate brands (price leader vs. high end) may be a better strategy as it could limit our above concerns. The drawback is this may reduce the strategic flexibility of the combined group given a decision in one brand could impact the value of the other brand. Synergies are unlikely to be material given IIN and TPM have a similar DSLAM footprint. Potential opex (non COS) synergies in IIN might be illusory given they could dilute IIN s comparative advantage (ie customer service and brand). Page 2

3 But at the end of the day it comes down to price Key IIN shareholders (including CEO Michael Malone) together own >30% of the company and this limits a hostile bid in our opinion. IIN is cheap relative to TPM at 9.3x PER vs. 10.4x for TPM, but we believe a bid price would need to contain a $3+ handle to sway key shareholders and the IIN board. Separately given the recent AMM in-specie distribution of 30m IIN shares, we believe there could be new IIN shareholders (you never intended to own IIN stock) who might entertain a bid. A takeover by TPM at $3.00ps would require ~$450m in debt or equity funding. Given TPM has limited headroom in its existing debt facilities; we believe TPM would need to raise debt or equity or offer scrip to IIN shareholders. We are not convinced a takeover makes sense Whilst we ve argued that TPM does need to do something significant to reposition for the NBN, we would be wary of an IIN move if it sought to change the fabric of IIN. That said we continue to believe consolidation of the tier two Telco s will continue albeit for the reasons above we are not convinced a takeover makes sense. If IIN s share price does move towards our target price of $2.93 we would recommend shareholders take profits. Hold and $1.61 Target Price Move to Hold with a $1.61 Target Price With the share-price having declined >20% since our initiation (Reduce rating), we now move to a Hold given our $1.61 Target Price. Our $1.61 DCF valuation forms the basis of our Target Price. From a relative valuation basis TPM is trading on 10.4x FY12e EPS vs. a peer average at ~9.9x. Page 3

4 M&A in advance of the NBN We believe the NBN will level the playing field for access, which will result in operators seeking to differentiate their propositions. We therefore believe operators will seek to position in advance of the NBN. The following below is an extract from our 11 March 2010 note M&A could deliver material upside which looked at the ISP market structure and described the six possible transactions that could occur. ISP market ripe for consolidation Figure 1 - ISP overview Fragmented market still exists The Telco market is very fragmented with 107 ISPs 1. We see significant opportunities for consolidation, particularly as operators seek scale and capability. TMT (Telco, Media & Technology) convergence may also factor. Whilst there are likely to be willing buyers, willing sellers may depend on whether they believe they can compete in a NBN world what is the likely access price? Does size matter? Figure 2 - ISP overview ISP Telstra (Broadband) Optus (Broadband) FY Revenue ($m) SIO's (k's) DSLAM's (ADSL2+) FY10 1,572 2,255 1,891 Full integrated telco offer 2Q Full integrated telco offer iinet (Broadband) FY10^ TPG (Broadband) FY Internode est Primus est Dodo est Adam est Exetel est EFTel FY Customer proposition with voice and content with voice and content with voice with voice with voice, moving into mobile (incl. WBB) with VoIP with VoIP with voice Broadband Subscriber's (k's) DSLAM's iinet (Broadband) TPG (Broadband) Internode Primus Adam Exetel Dodo EFTel SOURCE: BELL POTTER SECURITIE ESTIMATES SOURCE: BELL POTTER SECURITIE ESTIMATES M&A strategies positioning ahead of the NBN Whilst there are many permutations of possible M&A strategies, we have focused on those that have the most direct reference to IIN (and ISPs generally). IIN well positioned to play a leading role Given we view IIN as the leading ISP in terms of customer service; we believe any possible transaction is likely to be driven by: Product innovation where intention is to enhance IIN s product offering (ie content, wireless); Network reach where intention is to extend IIN s core network capability (ie domestic or international capacity and reach); Scale where intention to generate scale (and to move from current 12% 2 market share to target of 15%-20%) and deliver synergies. 1 Source: ABS Internet Activity Survey Jun-11 reported 107 ISPs of which 23 ISPs had >10k subs with 12 ISPs >100k subs. This just measures ISPs with subs >1k, therefore the number of ISPs is likely to be much higher. 2 IIN estimates it currently has 12% of the fixed broadband market. Page 4

5 POSSIBLE TRANSACTIONS WE HIGHLIGHTED IN MARCH 2010 ISP consolidation likely to drive synergies IIN faces risk from a hostile takeover The core network could become the bottleneck in a NBN world We believe there is greater value for TEL in splitting AAPT and retaining a smaller stake in divested units 1 Tier 3 consolidation (continuing) to acquire scale and generate synergies. We view: Netspace; Internode; and Adam Internet as likely candidates due to the similarities in customer profile. Since we first published IIN has acquired Netspace and AAPT Consumer. Outside of obvious synergies (operations, back-office, and network), the acquisition of Internode and/or Adam would give IIN an entrance into fortress Adelaide. TPM is the other likely acquirer, given its low price proposition, it may target Dodo and/or Primus; 2 Secure IIN s share register (completed) we had previously proposed IIN either acquire AMM s previous 23.4% stake in IIN or buy it back to ensure the holding does not fall into the wrong hands. Since that time, AMM has distributed its stake through an in-specie distribution while TEL has sold its 18% stake in IIIN; 3 Buy network reach (continuing) driven by our contention that the NBN will be limited in geographical scope (with limited back-haul) we believe core network reach and capability will be a point of differentiation. We also view international capacity as increasingly important given the growth in submarine data traffic (part rationale for TPM s proposed acquisition of PWK). Possible acquisition for IIN s could include buying NextGen; 4 Merged ISP/Mobile operator (yet to play out) intention being to create a full service alternative by combining IIN (or TPM) with VHA. This could be combined with the acquisition of AAPT wholesale deliver network reach; 5 Merged ISP/Content operator (yet to play out) with end goal to deliver converged Telco and content offer. Whilst a STV operator is unlikely to use fibre (or DSL) as its linear broadcast platform, they may use IPTV (over broadband) to target the 70% of the market that STV operators have not penetrated to-date; 6 AAPT breakup (partially played out) we had previously highlighted the rationale for TEL in breaking up AAPT, selling individual businesses, and TEL taking a smaller stake in the divested businesses: a. Wholesale is AAPT s strongest business unit. It would logically fit with VHA as they are APPT s biggest customer and there would likely be strong synergies in combining them. VHA would have the most to gain from AAPT s backhaul network (particularly if NBN is limited in backhaul reach and does not pass VHA s tower network); b. Retail 120k broadband and 227k voice customers which tend to be at the price conscious end of market. IIN acquired AAPT Consumer in July 2010 for $60m; c. Corporate largely medium enterprise customers that may best fit with MTU or MAQ. As can be seen by the comments made in the parenthesis, the change in the ISP market is playing out as we expected over 18 months ago. Page 5

6 TPG Telecom Ltd (TPM) Company description TPM is a full service carrier to both the Australian residential and corporate markets. In residential, TPG Telecom is the fourth largest ISP with a focus on price leadership. In the corporate market TPM operates through the SOUL and Pipe Networks brands. Pipe was acquired in 2010 and provides dark fibre, Ethernet, peering, telehousing as well as owning the PPC-1 submarine cable system between Sydney and Guam. TPM is 36.3% owned by David and Vicky Teoh and 26.8% by Washington H Soul Pattinson. We have concerns on the strategy and direction of TPM Investment thesis Our investment thesis is based on our view of risk within the TPM business. This view is based on: Concerns over strategy we believe a strategy of price leadership is risky in a maturing market; NBN we believe customer service and product innovation will be NBN differentiators and we see limited evidence that TPM has positioned for this. Scale, including network scale, will also be important and TPM is better positioned in this regard; Key business risks we are concerned with respect to key business processes and systems. There is some evidence that customer churn is increasing and that some processes are strained. It also appears that there is some risk to Pipe s (PWK) sales and product culture; Investor transparency given the size of key shareholdings there is a risk that TPM is managed as if it were a private company. Our DCF valuation for TPM is $1.61 and this forms the basis for our $1.61 Target Price. We estimate a terminal growth rate of 2.5% with a WACC of 11.0% based on a Beta of 1.20x, a risk free rate of 5.5% and a market risk premium of 5.5%. Where might we be wrong? Key risks to our call may include: Historic performance continues TPM has experienced strong growth driven by its broadband business. Whilst we expect this growth to slow considerably, if TPM can sustain a higher growth rate then TPM s outlook may improve to that to which we have assumed; Coupled with fibre prospects we see strong prospects for fibre growth in Australia. Recent contract wins by PWK suggest it may enjoy some of this growth. If TPM can manage the aforementioned risks and capture this growth then its outlook may exceed that to which we have assumed. If TPM could deliver the above then this would result in stronger; earnings, free cashflow (FCF) and ROE than our forecasts assume. Under these circumstances we would revisit our rating. Page 6

7 TPG Telecom Ltd Recommendation Hold as at 21 October 2011 Price $1.39 TPG Telecom Ltd (TPM) 21 October 2011 Target (12 months) $1.61 Table 1 - Financial summary PROFIT AND LOSS VALUATION DATA Y/e July 31 ($m) 2010a 2011a 2012e 2013e 2014e Y/e July 31 ($m) 2010a 2011a 2012e 2013e 2014e Total income Reported EPS (c) Operating expenses (337) (341) (375) (394) (407) Adjusted EPS (c) EBITDA Adj. EPS growth (%) 194.4% 33.2% 31.5% 6.3% 3.0% Depreciation & Amort. (80) (93) (82) (81) (73) DPS (c) EBIT Dividend Yield (%) 2.9% 3.2% 4.6% 4.9% 5.1% Associate income EV/EBITDA Net interest expense (13) (27) (15) (3) - EV/EBIT Pre-tax profit P/E ratio (x) Income tax expense (22) (35) (45) (49) (53) DCF Valuation Adjusted net profit WACC (%) 11.0% One-off items Debt/(Debt+Equity) 17% Reported net profit PV of cash flows 1,472 less: Net debt (289) CASHFLOW Equity valuation 1,263 Y/e July 31 ($m) 2010a 2011a 2012e 2013e 2014e DCF - Price per share $ 1.61 EBITDA Price Target $ 1.61 Working capital / provisions 23 (18) Net interest paid (12) (23) (15) (3) - PROFITABILITY RATIOS Tax paid (17) (48) (35) (45) (49) Y/e July 31 ($m) 2010a 2011a 2012e 2013e 2014e Other (5) (1) Sales revenue growth (%) 5.6% 13.0% 8.5% 3.3% 1.9% Operating cashflow (1) EBITDA/sales (%) 33.7% 40.7% 39.9% 38.8% 38.1% Capex (2) (68) (43) (44) (45) (46) EBITDA growth (%) 41.5% 36.8% 5.9% 0.6% 0.0% Disposals EBIT/sales (%) 17.9% 24.5% 26.6% 26.2% 26.9% Other (383) 1 (17) (8) - Capex/sales (%) 13.4% 7.5% 7.0% 7.0% 7.0% Investing cashflow (445) (43) (60) (53) (46) Return on assets (%) 9.5% 15.4% 18.6% 19.5% 21.1% Dividends paid (5) (9) (11) (14) (15) Return on equity (%) 12.5% 15.2% 17.3% 16.3% 15.1% Equity issued 66 (0) ROIC (%) (post tax) 8.0% 12.7% 14.9% 15.3% 16.4% Borrowings incurred/(repaid) 223 (100) Dividend payout (%) 52.8% 44.6% 48.2% 48.2% 48.1% Other (8) (0) Effective tax rate (%) 28.4% 31.0% 29.9% 29.9% 29.9% Financing cashflow 276 (109) (11) (14) (15) Free cash-flow yield (%) 9.1% 9.4% 15.6% 13.9% 13.2% Increase in cash/(debt) (9) (8) LIQUIDITY AND LEVERAGE RATIOS Free cash flow (1+2) Y/e July 31 ($m) 2010a 2011a 2012e 2013e 2014e Net debt/(cash) ($m) BALANCE SHEET Net debt/equity (%) 70.8% 43.2% 16.7% -4.4% -20.4% Y/e July 31 ($m) 2010a 2011a 2012e 2013e 2014e EBIT net interest cover (x) nmf Cash Net debt/ebitda (x) Receivables Current ratio (x) Inventories Receivables turnover (x) Other Payables turnover (x) Current assets INTERIMS PPE Half end Jan 31 ($m) 1H10a 1H11a 1H12e 1H13e 1H14e Intangibles Total revenue Other EBITDA Non-current assets EBIT Total assets Net profit after tax (adj) Current payables Adjusted EPS (c) Short term debt Interim DPS (c) Provisions Revenue rec'd in advance DIVISIONAL EBITDA Long term debt (98) (234) Y/e July 31 ($m) 2010a 2011a 2012e 2013e 2014e Other Broadband Total liabilities Mobile Shareholders equity Other Consumer Total shareholders funds Corporate Total funds employed Pipe Networks Unallocated (6) (0) W/A shares on issue - basic (m) Total EBITDA SOURCE: BELL POTTER SECURITIES ESTIMATES Page 7

8 Recommendation structure Spec Buy: Expect >30% total return on a 12 month view but carries significantly higher risk than its sector Buy: Expect >15% total return on a 12 month view Accumulate: Expect total return between 5% and 15% on a 12 month view Hold: Expect total return between -5% and 5% on a 12 month view Reduce: Expect total return between - 15% and -5% on a 12 month view Sell: Expect <-15% total return on a 12 month view Bell Potter Securities Limited ACN Level 32, Aurora Place 88 Phillip Street, Sydney 2000 Telephone Facsimile Quant Team Mathan Somasundaram Quantitative Analyst Head of Quant & Data Services T E mathan@bellpotter.com.au Janice Tai Quantitative & System Analyst T E jtai@bellpotter.com.au Karen So Associate Analyst Quant & Production T E kso@bellpotter.com.au Research Team Steve Goldberg Head of Research T E sgoldberg@bellpotter.com.au Trent Allen T E tcallen@bellpotter.com.au Daniel Blair Telco/Media T E dblair@bellpotter.com.au David George Diversifieds T E dgeorge@bellpotter.com.au Fleur Grose Iron Ore T E fgrose@bellpotter.com.au Johan Hedstrom Energy T E jhedstrom@bellpotter.com.au Stuart Howe Coal & Base Metals T E showe@bellpotter.com.au Tanushree Jain Associate Healthcare/Biotech T E tnjain@bellpotter.com.au Judith Kan Energy T E jkan@bellpotter.com.au TS Lim Financials Analyst Banks/Regionals T E tslim@bellpotter.com.au Michael Lovesey T E mlovesey@bellpotter.com.au Toby Molineaux Associate Retail T E tmolineaux@bellpotter.com.au John O Shea T E joshea@bellpotter.com.au Paresh Patel Retail/Beverages T E ppatel@bellpotter.com.au Stuart Roberts Healthcare/Biotech T E sroberts@bellpotter.com.au Emma Sellen Executive Assistant T E esellen@bellpotter.com.au Jonathan Snape T E jsnape@bellpotter.com.au Lafitani Sotiriou Financials Analyst Diversified Financials T E lsotiriou@bellpotter.com.au Stephen Thomas T E sthomas@bellpotter.com.au Sam Thornton Associate Telco/Media T E sthornton@bellpotter.com.au Fred Truong Associate Resources T E ftruong@bellpotter.com.au James Tsinidis Associate Financials Analyst Financials T E jtsinidis@bellpotter.com.au Chris Whitehead T E cwhitehead@bellpotter.com.au Damien Williamson Fixed Income T E dwilliamson@bellpotter.com.au Barry Ziegler Fixed Income T E bziegler@bellpotter.com.au The following may affect your legal rights. Important Disclaimer: This document is a private communication to clients and is not intended for public circulation or for the use of any third party, without the prior approval of Bell Potter Securities Limited. This is general investment advice only and does not constitute personal advice to any person. Because this document has been prepared without consideration of any specific client s financial situation, particular needs and investment objectives ( relevant personal circumstances ), a Bell Potter Securities Limited investment adviser (or the financial services licensee, or the representative of such licensee, who has provided you with this report by arraignment with Bell Potter Securities Limited) should be made aware of your relevant personal circumstances and consulted before any investment decision is made on the basis of this document. While this document is based on information from sources which are considered reliable, Bell Potter Securities Limited has not verified independently the information contained in the document and Bell Potter Securities Limited and its directors, employees and consultants do not represent, warrant or guarantee, expressly or impliedly, that the information contained in this document is complete or accurate. Nor does Bell Potter Securities Limited accept any responsibility for updating any advice, views opinions, or recommendations contained in this document or for correcting any error or omission which may become apparent after the document has been issued. Except insofar as liability under any statute cannot be excluded. Bell Potter Limited and its directors, employees and consultants do not accept any liability (whether arising in contract, in tort or negligence or otherwise) for any error or omission in this document or for any resulting loss or damage (whether direct, indirect, consequential or otherwise) suffered by the recipient of this document or any other person. Disclosure of interest: Bell Potter Limited, its employees, consultants and its associates within the meaning of Chapter 7 of the Corporations Law may receive commissions, underwriting and management fees from transactions involving securities referred to in this document (which its representatives may directly share) and may from time to time hold interests in the securities referred to in this document. Page 8