M2 Telecommunications: For And Against

This story features TELSTRA GROUP LIMITED. For more info SHARE ANALYSIS: TLS

-CIMB doesn’t like recent acquisitions
-Macquarie isn’t sure
-Citi has some reservations
-Moelis sees share price upside

By Andrew Nelson

M2 Telecommunications ((MTU)) looks like a real puzzler as far as analyst perception goes. The stock is covered by three major Australian brokers and each one has a different recommendation. Boutique broker Moelis, on the other hand, has a very clear opinion and it is positive.

Looking at broker positions from least favourable to most favourable will give us a good picture as to what analysts have to say about the stock. CIMB Securities sits at Sell and one of the main issues the broker has is the recent acquisitions undertaken and the difficult job it sees in these being brought effectively into the company.

MTU advised last month it is buying Dodo Australia and Eftel, both resellers in the telecommunications marketplace. CIMB thought the announced acquisition prices were reasonable, but suspects the company will have its work cut out consolidating these acquisitions. CIMB believes the deals will add to costs in FY13 and may add a risky $50m to earnings in FY14.

The crunch for CIMB in terms of valuation is whether the expanded scale and scope of the company has become sufficient to add more value than the amounts paid by M2. It’s this unanswered valuation question and the uncertainty it causes that keeps the broker at Sell.

Macquarie admitted it was surprised by the deal for these two consumer companies and is torn by between the opportunistic upside offered by these acquisitions and the need to develop a more sustainable business.

The broker explains the company's traditional focus has been on the small-medium business market. That being said, Macquarie does admit the deals provide an extra stream in the growth strategy over the next two years. But longer term, the broker believes the company will need to become more focused on delivering what is more meaningful organic growth. Torn between earnings upside and longer term potential, the broker sits at Hold.

Citi, on the other hand, saw the move as a good way to provide some nice diversification and a good entry into low-cost retail via Dodo. Between the two, the broker thinks the company should see about a $50m uplift in operating earnings by FY14. The other nice thing is that there is barely an impact on gearing.

Yet while Citi point outs the diversification does lower risk, it also detracts from management's focus on the higher margin, core SME business. The broker really hasn't come to an opinion as to whether this is a good move or not and intends to reserve its judgment until it understands the Dodo and Eftel businesses a little better. In the meantime, the broker sticks with its Buy call

That brings us to Moelis, who chimed in on the stock yesterday. The Eftel deal has reached better than 90% acceptance and with the Dodo sale subject to a binding arrangement, both are now pretty much done deals, reports the broker.

Moelis sees a pretty good return, noting the $248m spent will deliver better than $400m in revenue, add better than $50m in operating earnings and add 20% to FY14 EPS. While, like Citi, the broker hasn’t come to a conclusion about the strategic shift from a pure SME business focus, it is happy to wait and see given the near term upside that has been acquired.

The broker also sees plenty of potential for better than expected integration savings, noting management’s solid track record in generating scale-driven savings in data costs. The broker sees this delivering some robust margin expansion.

Much like Macquarie, Moelis is concerned about the company’s ability to maintain organic growth as it beds these acquisition down. The difference is, Moelis thinks there will really be no change in the company’s general direction, with the SME sector performance underpinned by the company’s Commander brand which continues to chip away at Telstra ((TLS)).

All up, Moelis thinks the company boasts the least demanding metrics amongst its peers and with integration savings more than offsetting consumer competitive pressures, we should be seeing share price upside soon. This should be driven both by EPS growth and incremental PER expansion as the upside from these two acquisitions start to flow though, predicts the broker.

Moelis has set a target price of $6.40 on MTU while the consensus target in the FNArena database sits at $4.77 between the three brokers covering the stock. The spread is significant, from CIMB at $3.87 to Citi at $5.53. On the wide spread of forecasts, the database shows an average forecast yield of 4.1% for FY13 and 4.9% for FY14.
 

Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.

Click to view our Glossary of Financial Terms