Does MTU Offer Value?

Does MTU Offer Value?

Telecommunications supplier M2 Group (ASX: MTU) is a business we have previously owned in The Montgomery Fund, and it was a rewarding experience. MTU shares rose from around $3.50 when TMF was launched in August 2012, to over $6.00 in August 2013. We parted ways with MTU at that time, as the full-year results announcement showed that MTU’s debt-fuelled acquisition strategy had stretched its balance sheet beyond the limits we consider to be investment grade.

The share price has weakened slightly since then, so we missed nothing by sticking to our process. Nevertheless, we continue to monitor MTU so that when it recovers its investment-grade ranking, we will be up to speed on its investment merits. MTU is aiming for 30 per cent EPS growth this year, so it certainly shows strong growth potential, and it’s strong growth that will help bring its balance sheet back into shape.

When we caught up with MTU recently, the commentary seemed fairly positive. Some recent product initiatives have been well-received in the market, including a self-install cloud offering aimed at small business, and an energy resale offering which MTU bundles with telecommunications services and sells to small businesses under the well-regarded Commander brand. In the case of this latter product, MTU claims to have a significant structural cost advantage over the large incumbent energy retailers.

Combined with healthy organic growth delivered in its consumer business, these sorts of initiatives look to be driving MTU towards another good result for FY14. The company has issued guidance for underlying NPAT of $85-$95m for the year, but here is where it gets a bit interesting. Underlying NPAT excludes $15m of amortisation of customer contracts acquired through M&A. If you include this amortisation, NPAT falls to $60-70m, so it’s important to be clear on which number is the “right” one. At $85-$95m, MTU looks cheap; at $60-$70m – it doesn’t.

According to Bloomberg, broker consensus has FY14 NPAT at around $80m – somewhere between the two. It appears the broking community may be divided as to whether to include or exclude the amortisation.

For us, amortisation of customer contracts is a non-cash accounting charge that would not be there if the customers had been acquired organically. Accordingly, we see a strong case for ignoring it provided MTU does a reasonable job of integrating the acquired businesses. On this basis, there may be good value currently on offer in MTU, but don’t forget – that debt still needs to be reduced to bring the quality of the company up to scratch.

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Tim joined Montgomery in July 2012 and is a senior member of the investment team. Prior to this, Tim was an Executive Director in the corporate advisory division of Gresham Partners, where he worked for 17 years. Tim focuses on quant investing and market-neutral strategies.

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