Is iiNet worth two Bob?
iiNet’s full-year results have been released. I have taken particular interest because communications and data is one sector of the marketplace I believe is relatively less affected, in terms of share-of-wallet, by the ructions in the US Europe.
The results released today (15 August 2011) were marginally below the expectations of several analysts we correspond daily with. Underlying EBITDA was up just shy of 30 per cent to $104.8 million (some analysts were expecting $106 million and a little more).
With DSL (Digital Subscriber Line) – the technology that significantly increases the digital capacity of ordinary telephone lines, and excluding HFC (Hybrid Fiber-Coax network – CABLE) – iiNet is now the number two competitor and the leading “challenger “in the Australian residential telecommunications market. As an investor, I am always interested in the number 1 or 2 player in town. However the gap between number 1 (Telstra) and iiNet (#2) is enormous. iiNet have 641,000 paid DSL subscribers (up 19 per cent). Telstra has 2.4 million.
The company reported its underlying Net Profit After Tax was $39.0m, up 12.4 per cent on FY10, while reported NAPT fell 3.7 per cent to $33.4m (FY10 $34.7m). On a quick glance, I reckon underlying profit was $37 million (you have to add back $3.9 million in deal costs, redundancy costs of $1.2 million and legal costs of $1.4 million but tax effect it). Stripping out the impact of the acquisition, I also estimate cash flow was close to $40 million.
The reason for the less than stellar growth in reported net profit was because iiNet’s tax bill was much higher than last year. The increase in tax wiped out all of the increase in the net profit before tax.
Whilst many analysts will look at the growth in operating profit (EBITDA), I’d look at the net profit before tax. If I add the legal costs in 2010 back to that year’s profit-before-tax and then add the one-offs for 2011, I get a jump in net profit before tax from $43.85 to $53.4 million and a reduction in margins from 9.25 per cent to 7.6 per cent. Hopefully the company’s expected ‘synergies’ (an extra $10 million from porting AAPT customers across to the iiNet billing system?) raise this to 8.5 per cent.
Net debt increased to $96.4m from $56.3m as a result of the AAPT Consumer division. This has had an impact on our Quality Score (the A1-C5 system), which was B2 previously. Gearing will be 40 per cent. And the the balance sheet? It now contains $302 million of goodwill compared to $242 million of equity.
Revenue and operating cash flow was up significantly with the full year’s benefit of the Netspace acquisition and a nine month benefit of the AAPT consumer division. What really would be interesting however is an estimate of what like-for-like revenue and operating cash flow is. Sure iiNet has no ‘stores’, but acquisitions and synergy extraction doesn’t have the same whiff of sustainability as a business that can grow organically. I would like to see how the old business (excluding the acquisitions) is travelling. Value.able Graduates – would you?
And when I hear company say that it is “Ideally positioned for the future“, I want answers as to whether they were previously ideally positioned for ‘now’.
The 19 per cent growth in DSL subscribers includes AAPT’s consumer division, so it doesn’t give us much insight into the organic growth of the company. With ARPU (Average Revenue Per User) largely unchanged, yet network and carrier costs up 56 per cent – above the 47 per cent increase in revenue – some insights into organic growth would be helpful. I suspect subscriber growth will reflect slow organic growth in FY12, and any margin/profit improvement will come from ‘synergies’. While these may be significant ($9 – $12 million from migrating AAPT customers onto iinet billing system), they are not a long-term delivery platform for profit growth.
It is clear that management’s confidence is high. They have significantly increased the dividend from $12.1 million last year to $16.7 million this year and have announced separately a share buy-back of up to 7.6 million shares, or about 5 per cent of the issued capital (about $17 million at current prices), despite the fact that debt has risen substantially by a net $52 million. Perhaps when you have $766 million coming through the door you can afford to be a bit fancy-free with your capital allocation? Thoughts anyone?
I hear whispers in the background… Roger, how do you know all this? Yes, I do listen to company presentations and we do read investor briefings. But nothing compares to the clarity that comes from using our A1 service. It is, quite literally, extaordinary. And we can’t wait to share it with you. Value.able Graduates – expect to receive your invitation very soon. Now, back to the program…
If organic growth is slow and acquisitions begin to thin out, one would expect debt repayment followed by an increase in the payout ratio. Or perhaps the other way around, if share price support is contemplated?
The prices paid for acquisitions does not immediately cause concern for me, because the returns on equity being reported aren’t poor. But they aren’t A1 either.
Investors have tipped in $223 million and left in $15 million. On those amounts, iiNet’s Return on Equity is about 16 per cent.That’s not bad, but are there better opportunities out there. Before you suggest Telstra, keep in mind it is 140 per cent geared and profits are boosted by the failure of the company to recognise software development expenses in the year they are incurred.
The old fashioned Value.able investor in me doesn’t like looking at a balance sheet that reveals the debt-funded acquisition of goodwill. I have witnessed far too many examples of this turning out poorly. Sure, some of you may say that MMS did the same thing? But while debt rose significantly there, the corresponding asset was PP&E, not goodwill. You may instead point out that interest cover is still high at 9 times (20 times last year). That, I accept.
Finally, the NBN. What does it mean for iiNet?
First, some background. An ‘Off-net’ customer is provided a DSL service through another network – usually Telstra wholesale. An ‘On-net’ customer is one that is provided a DSL service through the iiNetwork (iiNet’s own broadband network). The NBN is expected to reduce the average monthly cost of broadband + Voice bundling to $33, which compares favourably to the current off-net cost of $57. This is a potentially major saving, but the reason I am not as excited about this as the company is because as the transition is made, there will be some leakage. It will occur over an unexciting period of time and any number of offsetting factors could adversely impact revenues, costs and profits during that time.
I am more excited about other companies at the moment. A growth by acquisition strategy may offer wonderful potential in the short-term, but it can also be used to mask slow organic growth. The buy-back can be a sign that cashflow will be strong, but it can also be used to merely ‘display’ confidence and support the share price. At Montgomery HQ, we reckon the shares are very close to their Value.able intrinsic value, but iiNet’s fall in quality, from A3 to B2, suggests shifting your attention to other opportunities.
You should be practising your own Value.able valuations. So what do you get for iiNet for 2011, 2012 and 2013?
Posted by Roger Montgomery and his A1 team, fund managers and creators of the next-generation A1 service for stock market investors, 15 August 2011.
Roger Montgomery is the Founder and Chairman of Montgomery Investment Management. Roger has over three decades of experience in funds management and related activities, including equities analysis, equity and derivatives strategy, trading and stockbroking. Prior to establishing Montgomery, Roger held positions at Ord Minnett Jardine Fleming, BT (Australia) Limited and Merrill Lynch.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Greg
:
Hi Roger,
Previously on this blog I ask what HVLM (could be the other way round LMHV) stood for.
I think the fixed line DSL business is HVLM (high volume low margin), with very little product differentiation between suppliers, hence the need to bundle.
Customers will simply buy on price and suppliers compete on price alone. It will suite tier 1 carriers who have better (cheaper) access to the internet and the low cost companies like DoDo. Companies in the middle will be squeezed.
This is only going to get worse under the NBN, to the point when it will be like buy electricity, its all the same at the power point.
What I think maybe happening now is a land grab, secure as many customers (at any price?) before the NBN arrives, sign the up and hope they don’t jump ship latter.
Regards Greg
Leon
:
A few months ago Roger M mentioned investing in the US market on the back of the improved exchange rate. I think he said the best way to do it is
through ETF’s (I think) and nominated – IV* IJ* IV* IE* IX* and IO* (moderators note: This is factually incorrect. securities listed are not known by author and incorrectly attributed).
All of these are now cheaper to buy than before. Is it still Roger’s
view that these are the best options for investing in the US market rather than direct investing in US shares? If not, which other funds / shares would be recommended?
Roger Montgomery
:
Hi Leon,
A classic case of mistaken identity. You are attributing to me that which I did not say.
Graeme
:
Using a RR of 12% I calculated the IVs as
2011 – $2.18
2012 – $2.29
Thanks
Prasad
:
Value.able TV #4 is ‘disappeared’, glad I watched it. Absolutely fantastic! Thanks Roger
Roger Montgomery
:
Technical issue I am told. Who knows…Team is working to get it back up.
Peter Robinson
:
Not on IIN, but I’m excited having calculated my first set of IVs for three upcoming gold miners. I figure they’ve been handed an additional $200-300 an ounce over what most analysts seem to have factored in. That should go straight to the bottom line, everything else being equal.
RR=12% Gold price=AUD$1,600
TAM 2012 IV=$1.97, 2013 IV=$9.80
NMG 2012 IV=$4.50, 2013 IV=$11.90 (which I hold from my pre-Value.able days)
SLR 2012 IV=$9.80, 2013 IV=$10.70
Now I appreciate that those figures are significantly above the current share prices. I fear I may be off track given 1) my rookie status at performing the IV calculations; 2) I have relied on broker reports for asset valuations (adjusting where applicable for my higher gold price); and 3) I’ve used company presentations for gold production numbers – which look very aggressive to me based on 2010/11 figures.
Are there other graduates out there who can advise on whether I’m around the mark or way off track here?
Ash Little
:
Good post Peter,
I think some of the Goldie are very good value but I am using rr much high and given mine life issues your implied growth rate may be too high.
I think Roger would agree that it is very difficult to value gold stocks using the formulae in value.able.
Lots of issues to consider here.
Roger Montgomery
:
with the exception of the one we own of course!
Duncan
:
In iiNet’s own investor presentation covering the acquisition of AAPT, they stated:
“iiNet broadband subscribers to increase by 113,000 to more than 652,000.”
So if they’ve now ended the year with 641,000 subscribers, I’d say something has gone bad with organic growth or with maintaining those acquired customers.
Roger Montgomery
:
Very nice throw back Duncan. Good reminder and a question for the analyst briefing.
AlexS
:
They lost me as a customer this month. I’ve been with IINET for over 5 years, and at the time I started with them, they were quite competitive, but they are less competitive (in terms of pricing) now, specially since both Telstra and Optus have reduced their plan prices.
They have to either reduce their plan prices or face the prospect of losing more customers.
Anthony K
:
Hi All,
I can relate to Scotty G’s story and although I bought and read Value.able in the first run, I failed to find the time to apply Rodger’s Intrinsic Value and cash profit techniques. In last couple of weeks as panic set in I sold a number of my shares at prices well below the current value.
Finally, I admitted that I had no idea how to value shares. Since then I have completed the Easter homework. My intrinsic values where slightly different to Rodger’s probably because the revised forecast EPS and DPS.
So I was looking forward to more homework to check my calculations. Once again my results are different to the others. I have provide 2 calcs, one for actual EPS and one for underlying EPS both using a 10% RR and shares on issue 152m.
EPS $0.219
2011 – 1.88
2012 – 4.27
2013 – 4.11
EPS $0.257
2011 – 2.72
2012 – 4.12
2013 – 3.32
Any comments will be appreciated.
Cheers
Anthony K
Scotty G
:
I got the following using a 13% RR and a slight downgrading of analysts future expectations.
2011 – $1.71
2012 – $2.07
2013 – $2.81
Andrew
:
On a 10% RR for 2011 i get $2.13
2012 i get $2.62
2013 i get $2.84
I would personally use 13% which means $1.50, $1.83 and $2.00 although i wouldn’t actually invest in this myself. Just felt like doing the exercise. Look forward to seeing what others come up with.
Simon Anthony
:
Insurance Australia Group
There has been a few whispers going around after CBA retiring CEO answered some questions regarding future M&A activity of Australia’s largest bank. One popular view is the takeover of Insurance Australia Group (IAG) which could perhaps explain why Insurance Australia Group CEO Mike Wilkins has now turned his attention to China, with the insurer buying a 20 per cent stake in Bohai Property Insurance for $A100 million. It’s quite possible that this is a defensive manoeuvre to ward off would be takeover offers but an extra 100 million isn’t much compared to CBA mammoth cash holdings. So perhaps the rumours are misplaced ? Well for one thing IAG has been trying to break into the Chinese market since 2007, furthermore IAG can only pay ($100 million) out for a 20 per cent strategic interest in Bohai, which under Chinese law is the maximum holding possible for a single foreign investor in a single general insurance company. So that leaves room for the strategic defensive policy of IAG establishing itself into a series of general insurance companies in South-East Asia. These moves will help ensure IAG shall meet its target of generating 10 per cent of its income from Asia before 2015.
After forging a passage to India in 2009, IAG also owns 26 per cent of an Indian joint venture with State Bank of India, where it hopes to get $1 billion in gross written premium in five years. “Once the partnership is complete, IAG will have a foothold in the two fastest-growing economies in Asia and most populous countries in the world – China and India.”,” the chief executive of IAG, Mike Wilkins, has been yesterday quoted.
With additional businesses in Thailand and Malaysia it’s obvious that IAG management has set its eyes on South East Asia for future growth.
Considering QBE, IAG, and Suncorp, have saturated the Australian market we now have a scenario where these limited opportunitys for domestic growth and the arrival of Coles into motor insurance market has forced IAG to go down this path for growth.
Justin Breheny, the chief executive of IAG’s Asian operations, said in a recent interview regarding the question of whether continuing economic growth in China supported a growing insurance industry. ”A good measure of that is the number of vehicles sold each year. In 2010 sales exceeded 18 million cars, which makes China, for the first time, the largest individual market worldwide for new car sales, now exceeding the United States. Such high levels of domestic consumption, of course, are underpinning demand for insurance,” Mr Breheny said.
So we can now speculate and say that on the one hand it’s business as usual for IAG and nothing overtly defensive is being undertaken by IAG, or as I see it, that CBA could launch a takeover bid for IAG and if/when successful continue on with the boards plans for expansion into Asia. It also assumed that the ACCC would have no reason to oppose the Commonwealth Bank of Australia’s proposed acquisition of IAG. Either way whatever happens watch this space!
Roger Montgomery
:
Very interesting Simon. And a bid for Qantas too….watch that space…
Simon Anthony
:
Caught your comments last night on Lateline Business ABCTV. Agreed! They are both in the same boat and rowing in the same direction.
Brad
:
I agree Roger IIN fully valued.
RFG looks on the cheap side, anyone had a look in detail ?
PaulS
:
Hi all,
Using RR = 10%
BV = 1.59
EPS = 0.22
ROE = 13.8%
2011 IV – $2.70
2012 IV – $4.05 (ROE = 17.1%, EPS = 0.302, BV = 1.762 )
2013 IV – $3.61 (ROE = 16.4%, EPS = 0.317, BV = 1.93 )
using RR = 12%
2011 IV – $2.08
2012 IV – $3.06
2013 IV – $2.77
Cheers,
PaulS
Michael
:
2011 – $2.18
2012 – $2.63
2013 – $2.84
Using 12% RR
Not exactly what you’d call A1 cashflows….company cashflows negative so they’re effectively funding the dividend via increased debt.
Clearly management are positive about the future…but then again try and find a management team not optimistic about the future prospects for their company!
Ash Little
:
Hey Michael,
Nice last line about opptomistist management
Thank
kingsley
:
Roger you are certainly doing a lot of teasing with your new A1 software coming. Are you brave enough to give us a tentative date?
Peter Ralph
:
Hi Roger,
I spent many years of my business life as a “supposed” expert witness testifying as to whether companies were solvent or not.
One quick glance at IIN’s balance sheet hardly fills me with warmth… current assets $60 mil (cash $5.5m) against current liabilities of $106 million and this is a company about to enter into a $17m share buy back as a “capital management incentive?” Forgive me for being old-fashioned (which I am) but the norm for share buybacks has usually been surplus cash that the directors can’t put to good use. In IIN’s case there is no surplus cash so the buy back is going to be paid for out of:
a) future income
b) borrowings
c) a capital raising sometime later in the year.
Many companies have significant working capital deficits (e.g WOW) that result from favourable terms of trades but I can’t find another company in the same business as IIN that in % terms has even a remotely similiar sized deficit.
The other thing that hardly fills me cheer about IIN is that after a successful year its net tangible asset backing increased from negative 10 cents to negative 41 cents…..and I think the comment below it in the Accounts says an awful lot…..”The decrease in Net Tangible Asset Backing is attributable to the increase in total Interest Bearing Loans and Borrowings used to fund the acquisition of the AAPT Consumer Division subscriber base and goodwill.”
This is a company where the preliminary report does not disclose enough detail particularly regarding the treatment of intangibles and I don’t think a proper analysis can be undertaken until after the statutory Accounts are published.
I don’t know whether Buffet would buy IIN but I do know that Ben Graham most certainly would not.
Cheers,
Peter
Roger Montgomery
:
….amid drumroll please….that’s spot on Peter! I expect the quality score could continue deteriorating in the absence of a capital raising (unlikely given it would appear bipolar after a buy back) or significant improvement in cash flows from synergies, which the company has indicated it will be focusing on.
Andrew
:
Great post Peter. i found it really informative. i didn’t put the rubber gloves on for IIN as i am not particularly interested in them but everyone can learn a little bit from your analysis and how to look at all companys.
Nic Arena
:
Hi Guys,
Iinet gets my 3rd highest rating (not bad out of 15 but not 1st or 2nd which I look at very carefully). Below are my IVs.
$2.19 IV after annual report
$2.41 – 2012
$2.66 – 2013
Nic Arena
:
Actually updated some numbers (oops)
2011 – $1.87
2012 – $1.98
2013 – $2.24
Slide
:
To me, a company like MAQ offers a more compelling investment case in the telecommunications sector. It has a higher ROE, and is investing in organic growth through its new data centre, and on my reckoning currently trades below I.V of $12.32 for FY11 on an 11% RRR. More clarity on growing profits in the year’s ahead – in a nutshell.
Will
:
2.95 for 2011 with 10% Mos
Uni
:
Hi Roger,
I admit that I have just finished Part 1 of your book during the weekend. Great to read (I’ll send you photo I’m reading it as my bedtime story).
Since I knew about investing a couple months ago, I gained access to a University Library and read most of the (readable) investment books in there (mostly just finish glancing in an hour and put back on the shelves, you know why). So, Valua.able is the second that I buy and keep. Love it. The first one gave me general ideas of financial control & value investing. But Value.able is the one I have been looking for. I believe I will be able to value the businesses I want to buy after finishing it. Much more insights and details.
So far, I manage to find my own way to calculate IV which might be so so different from Value.able. So let’s see how far I am. I’m very happy that I’m far away from reality though.
Just a rough calculation:
2010 – IV $2.15
2011 – IV $2.52
2012 – IV $3.18
2013 – IV $2.90
Please correct me.
Bedtime story now.
Roger Montgomery
:
Good stuff Uni.
Lets see how it compares to the other valuations thrown up.
Here’s an extract from a broker report that hit my desk today:
· IIN’s FY11 result was on balance a clean result, however was slightly below our forecasts. Improving cash flow generation and higher than anticipated dividends were the highlights. The announcement of a share buyback by IIN confirms our view that IIN is currently significantly undervalued. At 3.5x FY12 EBITDA IIN is priced circa 40.0% below peers. We maintain our BUY recommendation; our price target is lower at $3.20 (from $3.41).
· FY11 result key points:
o Reported EBITDA of $98.3m, up 27.9% on FY10. Underlying EBITDA of $104.8m vs PSL forecast for $106.1m
o 2H EBITDA of $56.9m vs 1H EBITDA of $41.5m
o Underlying NPAT of $39.0m, up 12.1% on FY10. One offs include AAPT acquisition costs, redundancy and court costs
o Full year dividend of 12.0cps compared to FY10 9.0cps
o Free cash flow of $50.2m compared to FY10 $28.8m
· Subscriber growth slowing. Core on-net growth remains strong (50,900 adds) however continuing competitive pressures in regional areas (43,100 losses) is hampering IIN’s subscriber growth. We believe this trend will continue in FY12 and forecast minimal subscriber growth. However, the continuing process of migrating off-net subscriber’s on-net is likely to drive incremental growth.
· FY12 / 13 forecasts reduced by circa 2.5%. Our forecasts are marginally lower with growth largely premised on margin improvement. The drivers to generate a stronger FY12 include: organic growth from current products and increased bundling levels; growth of the small business division; full period of synergies from Netspace; full period contribution from AAPT; and part period of synergies from AAPT.
· IIN best acquisition in market? While IIN continues to seek out appropriate acquisitions, management view its own shares are their best opportunity. The debt funded buyback of up to 5.0% of shares will likely support the share price in light of any selling pressure post the Amcom in-specie distribution of its 20.1% shareholding.
MPORTANT DISCLAIMER:
This document is intended to provide general securities advice only, and has been prepared without taking account of your objectives, financial situation or needs and therefore before acting on advice contained in this document you should consider its appropriateness having regard to your objectives, financial situation and needs. If any advice in this document relates to the acquisition or possible acquisition of a particular financial product, you should obtain a copy of and consider the Product Disclosure Statement for that product before making any decision
Ash Little
:
Thanks Roger,
Lots of EBITDA’s in that Analyst report trying to put a cherry view on sometime that was not really that great…..Lipstick on a pig comes to mind.
The key words though are.
Subscriber growth slowing. Core on-net growth remains strong (50,900 adds) however continuing competitive pressures in regional areas (43,100 losses) is hampering IIN’s subscriber growth. We believe this trend will continue in FY12 and forecast minimal subscriber growth.
Through to the keeper for me
Craig B
:
2011 – $2.54
2012 – $2.68
2013 – $2.91
12% RR
Roger Montgomery
:
Thanks Craig.
Paul Eagle
:
Roger,
I think you may be mistaken with the TLS gearing, on my calculation net debt to equity is less than 100%.
If software can be used over more than 1year do you think it should be expensed over more than 1year?
Cheers,
Paul
Roger Montgomery
:
Thanks for the heads up on the typo on the debt/equity. I can see a few others as well. Re: Capitalisation of software development expenses under ‘Other’ in the balance sheet; will not be amortised until the software is ‘used’?