Revisiting: TPG Telecom

Revisiting: TPG Telecom

As an update to our last post on TPG Telecom (TPM:ASX) in December last year, the read-through from the business’ continued growth (as reported in accounts that were released on Tuesday) is that the future continues to shape up in a promising way. In short? TPG will be a major player in the Australian telecommunications sector – regulatory change notwithstanding.

Followers of this blog will be aware that we are a part-owner of this business, and to see the share price increase by 7 per cent following the release of their half-year results is a very pleasing, but not completely unexpected, development for investors in our funds. We recap some of our early thoughts on their report, below:

The business largely reports underlying earnings before interest, tax, depreciation and amortisation (EBITDA) to allow comparison between periods. Even though Warren Buffett considers these ‘nonsense’ earnings, while this may be true for many businesses – for TPG and indeed other telecom companies it seems to be an applicable measure. Given their fibre-optic cables can last underground for 30 years if not dug-up and damaged, TPG actually has very little in the way of actual depreciation and amortisation expenses. EBITDA therefore proves to be a reliable way to measure business growth from period to period, and we agree with management that it more closely reflects the underlying profitability and cash flows.

With that in mind, for the first half there was plenty of growth in the underlying TPG business. So much so that reported EBITDA was up 19 per cent to $158.1m. This level of growth was again in excess of consensus estimates of $141.9m, and feedback from all of our channels confirmed that this was a very strong result.

Given AAPT was a recent acquisition and had no time to contribute to the result; the uplift in performance was largely organic and driven by strong performances in TPG’s consumer and corporate divisions.

TPG’s consumer segment – which includes broadband and bundled products – reported 17 per cent EBITDA growth to $100.2m over the PCP. Their corporate segment reported 25 per cent EBITDA growth to $64.5m

This strong performance in the consumer space was aided by broadband subscription growth of 36,000; 61,000 in bundled product offerings (broadband with home phones) and industry-low ‘churn’ rates.

All said, TPG now have 707,000 broadband and 370,000 mobile subscribers, and average revenue per unit (ARPU) has lifted as cost control has remained tight. This has led to expanding EBITDA margins, which we expect to be an ongoing feature of this business, given the huge economies of scale afforded to them during this growth by their extremely valuable fibre-optic infrastructure.

As a further positive to future growth, AAPT will now begin to add revenue to the business, and earnings in the full-year report will include five months’ contribution, given the acquisition was formally completed on 28 February 2014.

Given management upgraded their EBITDA guidance from $290-$300m to $340m-$355m in this half-year result, AAPT appears to be contributing more, and earlier, than expected. AAPT guidance of $15-$25m, after $7-$12m integration (or one-off) expenses, implies the annualised run-rate exceeds $70m EBITDA – which was the profitability of APPT when it was purchased. Hence once again, TPG’s latest add-on follows a not dissimilar path of prior acquisitions, with the market underestimating integration benefits from a shrewd operator.

At a minimum, we currently expect upgrades to consensus forecasts in the order of 10-15 per cent are likely to flow through in the coming weeks. As another positive, given the amount of free-cash flow this business is now generating (in the half-year, free cash flow was approximately $100m), the circa $400m+ debt incurred from the APPT acquisition will be brought down extremely quickly giving the balance sheet flexibility for future market share growth initiatives.