Internet Service Providers (ISP) is a mature industry with entrenched telecommunications leader ASX Telstra. Industry growth is single digit at best with smaller competitors focusing on taking market share from each other or from acquisitions.
TPG following the acquisition of iinet, is the 2nd largest provider of DSL and National Broadband Network (NBN) internet service in Australia. NBN is a wholesale service where retailers like iinet and TPG provide retailing service al a comparable to utility model.
TPG now has combined subscribers of 1.7 million and 40k NBN customers (estm 26% of market). It is pure Australian telecom company which there are no US to AUS currency risks.
We do not own TPM at this stage however given the new scale and reach post iinet transaction, it has shown up on our radar. It is just the start of the research process and on our watchlist.
TPG FTTB Network
Ostensibly TPG looks like a mini Telstra but given the scale, more nimble in grabbing market share and product development. The large share from iinet in NBN customers is a key part in reaching scale. Additionally, TPG is building its own fibre network in competition with NBN.
Background for NBN: It is a national fibre network created by the government to ensure broadband infrastructure is available for all Australians. Fiber aim to cover 93% of population with rest serviced by satellite and wireless.
TPG through subsidiary Wondercom is building a competing fiber network. Instead of fiber to each premises, FTTB is Fiber to basement. This means that TPG is building a fiber network with a focus on high density areas in contrast to the NBN which by mandate has to cover everyone.
Building list of FTTB service shows the initial rollout is across east coast CBD locations. TPG FTTB network is required to provide wholesale service for other ISP retailers.
The ambition means that cashflow will be used to fund the rollout process or debt services charges.
Related: see why most need income protection insurance Australia wide.
The value is a competing network where high value customers is captured and ability to offer cheaper products verses NBN retailers. Once this gets scale, we feel it will propel TPG to a series contender for number 2 position in the telecom industry. This is our primary thesis for TPG. iinet acquisition is complement the wholesale service by allowing TPG to reach total customer scale but with a key eye on NBN retail.
As a customer of iinet products over the last 10 years. It has a great brand power driven by price competitive products. It was the first major ISP starting to resell NBN service and hence one of the major players in the NBN retail sector.
Transaction was completed with a mix of cash and stock. Transaction multiple of EV/EBITDA 10x and P/E of 23.8x. One of the major valuation metrics to use for telecom stocks is the the EV/EBITDA (similar to EBIT ratio used for, see: wow share price). It is a proxy for operating cashflow.
- Management noted it is immediately EPS accretive. Hard not to given it was primarily funded with debt. Debt to EBITDA immediately post acquisition sat at 3.4:1 (pre 300mil capital raise)
- Increase in scale allows for synergy across the larger business. No number given however independent expert report repeated broker estimates typically around $60mil over 3 years.
On face value it looks pricey and thats because it is. iinet and TPG both grew through a mix of organic and bolt on acquisition. TPG through the acquisition of iinet jumped from 4th largest position to 2nd in the industry with greater emphasis on retail customers.
Table above shows the EV/EBITDA multiple in the industry going back few years. the iinet transaction is the largest and also most expensive deal going back to 2008.
One risk for TPG is it paid peak multiples with cash rather than with equity. Maybe the best way to pay for it was equity rather debt given the price.
Largest 2 shareholders in TPG accounts for more than 50% of shares on issue and most likely did not want to dilute ownership. Total share issued to iinet shareholder in the combined group was sub 5%, non material given the price tag.
TPG structure post acquisition
The group position acquisition will have greater reach across retail, small/medium enterprise and corporate customers. TPG original strength has always been in corporate services while iinet is strong in retail and SME market. Strong iinet customer focus is also a key differentiator. Management has stated that the strategy will be maintained however business review is underway.
The proof as they say is in the pudding and the management need to show ability to execute the integration of iinet within TPG group while minimizing customer facing services and no change service quality.
Below were the management guidance for the FY15 forward EBITDA
- iinet EBITDA: $196 mil to $202 mil
- TPG Telecom: $480 mil
- Merged group: $735 mil estm (Independent valuation report pre synergy)
- Total debt $2043 mil (pre $300 mil capital raise)
Total debt to EBTIDA decreased following the $300 mil capital raise in late 2015. However given where the stock is trading today, it looks very expensive compared to industry and transaction average. While we appreciate the growth story, we are patiently waiting for a pull back before adding any position.
Dividend for TPM is relative low (unlike the bank dividend yields). Most of the cash is used in capital expenditure.
TPG has always traded at a premium to the industry but we are happy to wait patiently will pull the trigger if there is a pullback. Keep this on the watchlist for now.