How to value the Vocus/Nextgen deal

How to value the Vocus/Nextgen deal

Last week’s takeover by Vocus Communications of Nextgen was the latest chapter in the consolidation of our telecommunications sector. On paper, it looks like a good deal. Do the numbers stack up?

Let’s start with a brief overview:

• Price: Vocus Communications Limited to pay $700m for Nextgen Networks, plus two development projects from the Nextgen Group for an upfront consideration of $107m and deferred consideration of up to $54m

• Revenue & EBITDA: $193m revenue (excluding $33m deferred revenue) and $62m in EBITDA
• What is Nextgen?: Nextgen operates a national backhaul (fibre) network. It provides wholesale services to other telecommunications companies

So is the deal bad or good? Using a quick ‘back-of-the-envelope’ approach, we estimate that this deal adds about $70m in free cash flow (before interest, including immediate and forecast synergies) to the firm’s cash flow. With a circa $700m purchase price (leaving the deferred consideration/projects acquisition aside), this is a yield of about 10 per cent.

The cost of capital for Vocus is perhaps a little below 10 per cent, so the value of the deal appears slightly higher than what the firm has paid (perhaps $800m-$900m). So far, on the present information, there’s nothing to get too excited about. Perhaps there’s $100-$200m of additional value for Vocus on top of what it’s paid, but for a $4.5b company, this doesn’t really move the needle.

But as we look through the potential for the Nextgen fibre network, its prospects become more interesting. The Nextgen network stretches 17,000 km around Australia and provides access to thousands of buildings which house many small and medium enterprises as well as large corporates and government offices. Hence the real opportunity here for Vocus is to sell broadband/fibre services to as many business and government clients across its new network.

One problem remains – it’s not currently known how many extra buildings Vocus now has access to (i.e. buildings near the Nextgen network that are not currently Nextgen customers). Therefore it’s very difficult to quantify the upside since we don’t know how many customers could be put onto the network.

It is clear that the corporate telecommunications market is worth several billion dollars and hence the opportunity is large, but how large is not currently answerable, and hence it can’t be valued.

Overall the deal appears reasonable, the asset is clearly worth a tad more than the company paid for it and there appears to be a ‘free option’ on top from SME and corporate/government revenues – which could potentially be worth a considerable amount.

The Montgomery [Private] Fund owns shares in Vocus Communications Limited.

Scott Shuttleworth is an analyst at Montgomery Investment Management. To invest with Montgomery domestically and globally, find out more.