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TPG - executing on strategy, but out of favour

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By Paul Rickard

Listed telco TPG Telecom delivered a very solid first-half result on Tuesday that beat expectations, but that wasn’t enough for brokers Ord Minnett or Credit Suisse, who immediately downgraded TPG to “lighten” and “underperform” respectively. While the telco business is a tough game at the moment, the downgrades and negativity about the sector are a reminder about how quickly market sentiment changes, and potentially, creates opportunities for contrarian investors. 

Notwithstanding the broker downgrades, the share market was a bit more positive, with TPG’s shares closing yesterday at $6.79, up 2.6% since the result was announced. But the share price is still down more than 47% on the high of $12.93 achieved just last July!

TPG Telecom (TPM) - March 2016-March 2016 


Source: Nabtrade

TPG’s share price woes aren’t unique, with other telcos under pressure due to concerns about pressure on margins. The ASX telecommunications sector, which is largely Telstra plus Vocus and TPG, had a horrid start to 2017. After being the worst performing sector on the ASX in 2016 with a return of minus 7.1%, it is already down another 6.9% (including dividends) this year.

So, is there any light at the end of the tunnel for TPG, and is it a “contrarian” buy?

First half result

TPG reported underlying EBITDA growth of 13% to $417.6m for the first half. This was achieved on revenue growth of 7% to $1,235m.

Each of TPG’s three Australian divisions grew revenue and increased EBITDA. The consumer business, which is largely a broadband business under the TPG brand, increased EBITDA by 8%, while iiNet, which TPG acquired in late 2015 and is mainly broadband and fixed voice, grew EBITDA by 26% to $141.7m. The corporate division, which includes the old AAPT business and provides data/internet and voice services to corporate customers, grew EBITDA by 8%.  

Highlights of the result included:

  • The contribution from iiNet (organic EBITDA up by $14.7m);
  • Group broadband subscribers growing in total to 1.9m (up 69,000 on 31/1/16 and 43,000 on 31/7/16). There are now 388,000 subscribers on the NBN, up 112,000 over the last 6 months;
  • TPG’s new FTTB (fibre to the basement) service, which attracted 24,000 customers;
  • Broadband ARPU (average revenue per user) remaining relatively stable. For example, TPG  ARPU for NBN fell from $67.40 to $67.10 compared to the corresponding half in 2016, while iiNet ARPU for NBN rose from $70.90 to $72.80 over this period; and
  • Strong sales of on-net data and internet services driving growth in the Corporate Division.

The company re-affirmed guidance of underlying EBITDA for the full year of $820m to $830m.

The Brokers

The Brokers see potential upside in the stock, with the current consensus target price at $7.89 representing a 16.1% premium to the current share price. However, their recommendations are quite varied, with three buys, three sells and two neutrals. According to FNArena, individual recommendations and target prices from the major brokers are as follows:

Many brokers think that the guidance is conservative, and although it will be more challenging to extract synergies and cost reductions from the iiNet business in the second half, TPG should come in at the top side of the range.

Another upside are spectrum auctions and a decision on mobile roaming by the ACCC, which brokers say may be a catalyst for TPG to build a mobile business. Currently, TPG has a small mobile business, effectively reselling and rebadging services from Optus (and moving to Vodafone). While this could be a long-term opportunity, the brokers are worried about the capital expenditure to develop and roll-out a metro centric mobile business. TPG has also recently acquired spectrum in Singapore and plans to build a network in that market.

The major concern for the brokers is the potential for a margin crunch, as broadband subscribers are migrated off TPG’s and iiNet’s ADSL networks to the NBN. With Telstra, Optus, Vodafone and TPG becoming retailers and NBN the monopoly wholesale supplier, brokers fear that ARPU will decrease as the four major providers and new entrants compete for subscribers. While the wholesale margin will also not be available on customers who switch to the NBN (TPG’s new FTTB service will compete head on with the NBN), there will be an opportunity to “upsell” customers to a higher margin plan that provides higher download speeds. 

My view

The risk with margin crunch is real and it is unlikely that the market is going to stop worrying about this in the short term. It is not really “new news” and I am not sure why the market wasn’t concerned when the share price got close to $13.00, but “group think” prevails and the telco sector is on the nose. Time will tell how this plays out.

That said, TPG is executing well and the almost halving of the share price is an incredible re-assessment of value for a company that is meeting its targets.

TPG is reasonably priced, trading on a forecast multiple of 14.0 times FY17 earnings and 14.3 times FY18 earnings (the brokers are forecasting earnings to fall marginally in FY18). But I am a believer in management track record and TPG boasts a strong record. Although growth has been partly driven by acquisition, the following charts are quite impressive. 

And while the opportunities for mobile networks in Singapore and/or Australia are likely to require capital and may take some years to show fruition, David Teoh and his team at TPG are very competent operators.

A contrarian buy.

ImportantThis content has been prepared without taking account of the objectives, financial situation or needs of any particular individual. It does not constitute formal advice. Consider the appropriateness of the information in regards to your circumstances.

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Published: Thursday, March 23, 2017

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