Small Caps | Apr 15 2013
By Shuo Yang, Equity investment analyst at Microequities
The telecommunications sector has been a favourite hunting ground for investors looking for yield and defensive earnings. The ASX 300 telecommunications index is up almost 34% over the last 12 months with companies like iiNet ((IIN)), TPG Telecom ((TPM)), Amcom ((AMM)) and BigAir ((BGL)) leading the way with share price gains of more than 50% in the same period. Even former dog of the market, Telstra is up more than 34% as investors salivate over its 28c per share fully franked dividends.
One company that has been a poor performer in the sector is Vocus Communications ((VOC)) with the shares down 7% in the last 12 months. The company operates an IP transit division, several data centres, a fibre network and voice services. Vocus deals purely with direct corporate and wholesale clients and does not have a retail ISP arm, which has become increasingly competitive. The company has in the past 3 years as a listed company transformed itself into a multiple product telco by adding on data centres and fibre network to its IP Transit and voice services offering.
Figure 1: 12-month share price performance of ASX telecommunication companies (as of 10th April 2013)
Source: Bloomberg, Microequities
One reason potentially for the share price underperformance is that the company raised around $23m of equity in early July 2012, around 22% of its issued capital at the time. As most of these funds are yet to be deployed, EPS in FY13 is expected to decline.
A second reason for the underperformance is the timing of recent data centre and fibre network acquisitions, Maxnet and Ipera Communications. Ipera will only make a partial contribution to FY13 earnings and cost synergies from both acquisitions are not expected to be fully extracted until FY14. We believe the market has failed to price in the earnings growth potential in FY14 from these two acquisitions.
Thirdly, the market is failing to see the earnings potential of the 325km fibre network that Vocus has rolled out in the past two years. The fibre division delivered revenue growth of 152% in 1H13 to $5.8m (1H12: $2.3m). The utilisation rate on the network is currently just over 5% and with potential long term EBITDA margins of 60-70%, this provides explosive earnings momentum for Vocus over the next 3-5 years. Interestingly, 60% of new monthly sales are from fibre/ethernet and Vocus is signing up some large direct corporate customers in the IT and financial services sectors. Importantly, Vocus operates this business in the eastern seaboard which has more expensive competitors in the form of Telstra and Optus. The main price competitor to Vocus is TPG with its Pipe Networks subsidiary.
Another key takeaway from the most recent result is management’s guidance for capital expenditure to peak in FY13. As Vocus’ infrastructure network is nearing completion and the shifting focus from investment to marketing and signing up customers to its suite of products, we expect the company to deliver strong free cash flow, supporting further acquisitions at low multiples and grow dividend payments.
Investors and the market in general is often myopic in the sense they focus on the next period’s earnings forecasts and fail to account for the earnings potentials of the company 3-5 years out. Whilst EPS is expected to fall in FY13, we expect 50%+ EPS growth in FY14 with the culmination of recent acquisitions, cost synergies and explosive growth from its fibre division. Based on consensus and our internal forecasts, Vocus is trading on an undemanding 10.6x FY14 PE compared to its peer average of 15.5x and even higher multiples currently commanded by the likes of Amcom (17.2x) and TPG (17.8x). This discount is unwarranted and could lead to a significant re-rating once the market understands the potentials of Vocus.
Figure 1: FY14 PE comparison of ASX telecommunication companies (as of 10th April 2013)
Source: Microequities
Microequities Asset Management is a value investor specialised in Australian microcaps. Its flagship fund –the Deep Value Microcap Fund– has a 5 star Morningstar rating. For further information visit microequities.com.au. Content included in this article is not by association necessarily the view of FNArena (see our disclaimer).
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