TPG expanding its reach

TPG expanding its reach

TPG Telecom (TPM) is set to become a major player in the Australian Telecommunications sector after announcing the acquisition of Telecom New Zealand Australia Pty Ltd and its subsidiaries, which include AAPT and PowerTel.
The acquisition, to be consummated on 28 February 2014, is highly complementary given it will add 11,000km of optical fibre, 254 Mid Band Ethernet exchanges, 1,500 directly connected premises and 15 data centres, servicing 300 wholesale customers and ~5,000 business customers, to TPG’s current infrastructure base.

TPG’s existing infrastructure includes 3,800km of optical fibre, 411 DSLAM Exchanges (ADSL 2+ broadband infrastructure), 1,600 buildings directly connected to the group’s fibre network and its own 6900km carrier-neutral submarine cable (PPC-1) which services 671k broadband, 358k home phone and 360k mobile subscribers.

Therefore, not only does TPG secure an expanded customer base to cross-sell products and services, the acquisition also represents the final piece in the puzzle for TPG given their largely metro focus has now been significantly expanded to include a fibre network that literally runs from Cairns to Perth.

It’s worth noting that both TPG’s existing infrastructure (through their acquisition of Pipe Networks), and now APPT’s fibre networks, largely pre-date the government’s anti-cherry picking legislation. With the acquisition, TPG now has an Australia-wide, metro and regional network that dovetails into the business’s Fibre to the Business (FTTB) roll out plan perfectly.

A competitive advantage?

TPG is now uniquely placed (for a limited time) to offer an unmatched, low cost, high-speed product range to consumers, businesses, and even their competitors. In our opinion, TPG will take market share as the ‘internet of everything’ gathers pace.

TPG’s significantly expanded infrastructure comes at a (wholly debt funded) cost of $450m, which seems, at first blush, to be a hefty price tag. If, however, one believes the company can repeat the success of its acquisition of Pipe Networks, large amounts of free cash should flow from the fixed cost base of its low cost model.

It’s worth also remembering that Telstra has a $62.3b market capitalisation and the NBN build cost is estimated at $43m billion. TPG’s fibre network effectively covers more than 50 per cent of the NBN’s points of interconnection and 70 per cent of third party data centres, and its market capitalisation is just $3.7billion. One way or another we would expect the relevant gap to be arbitraged away.

TPG had previously forecast FY14 EBITDA (Earnings Before Interest Tax Depreciation and Amortisation) between $290m and $300m. Adding AAPT’s pro-forma $70m EBITDA and an estimated 10 per cent in synergies, we estimate TPG’s 2015 numbers as follows:

As an aside, this puts the acquisition on a multiple of just ten times NPAT. With TPG’s 793.8m shares on issue, we estimate the business will likely generate earnings of 29.8c per share.

At the current share price of $4.80, this equates to a price to earnings ratio (PE) of 16.1x which compares the average industrial company (including Telstra) currently trading on ~16x forward earnings.

As we all know, over time, share prices tend to follow the earnings profile of a business. TLS’s earnings profile over the past five years looks like this:

And TPG’s like this:

If you were offered the option to invest in TLS or TPG today, which one would you choose?

We think it’s a relatively easy task to identify which business at 16x forward earnings is more attractive and which warrants a place in your portfolio. Our time and money is therefore invested in TPG.
In time we believe the market will begin to agree with us and begin switching from Telstra to TPG. Before you go doing likewise however be sure to seek and take personal professional advice and read our warnings and disclaimers.