Treasure Chest: Fibre Not As Strong As It Might Seem For TPG

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

By Greg Peel

TPG Telecom ((TPM)) last week posted an FY13 result that was in line with broker forecasts. But that’s not why the stock has subsequently rallied 29%. The rally is due to the company’s announced intention of rolling out a fibre-to-the-building (FTTB) network to around half a million apartments in Australia’s major capital cities. The network would compete with the NBN which, even under a new government with a more rational approach, is seen as still being glacial in its arrival at most nodes.

See TPG Triggers Interest in New FTTB Plan.

Whatever stock analysts’ varying views on the FTTB plan might be, the market made up its mind very quickly, hence on an isolated valuation basis TPG suffered two downgrades to Hold (or equivalent) in the FNArena database to meet a Hold, two Sells and a lone Buy. Despite the ratings, analysts were nevertheless net positive on the fibre plan.

Citi (Buy) suggested the FTTB offered “material earnings upside”. Credit Suisse suggested the FTTB offered a “highly competitive offer for consumers”, despite downgrading to Neutral. CIMB (Underperform) saw long term margin growth potential but a significant jump in required capex nearer term. BA-Merrill Lynch (Neutral) saw the FTTB as offering binary risk, implying a $5.00 valuation if they get it right and sub-$4.00 if they get it wrong. Macquarie acknowledged a material investment opportunity before downgrading to Neutral, wishing to see more detail.

JP Morgan (Underweight) was never convinced. Having reported on the result, JPM’s analysts have since had a closer look at the FTTB plan and decided their initial reaction was the right one.

The market has priced TPG post result as if the FTTB is offering a competitive retail alternative to the NBN. While the new Coalition government has always been keen on opening up infrastructure competition with the NBN on a wholesale basis, JP Morgan does not believe the competition policy will stretch to retail. Were a monopoly infrastructure owner, as TPG will be of its FTTB, also to provide a retail service then this would amount to recreating a whole series of “mini Telstras” in each location, the broker suggests.

The Howard government’s Telstra ((TLS)) model was a dud, as anyone, including Malcolm Turnbull, will tell you. Neither free market nor nationalised, the uneasy hybrid of infrastructure and service suffered a form of reverse synergy, no more evident than in the spectacular fall of the share price from the first tranche of “privatising” through to when the Labor government decided to finally split the beast up. The whole point of the government buying back the copper network on behalf of the taxpayer, who actually owned it anyway before Howard came along, was to remove an unfair infrastructure monopoly and level the playing field for retail providers. The planned replacement of copper with fibre is a separate issue of technology update.

So if TPG is allowed to build its own, albeit limited, fibre network and then offer retail packages on top, it’s a step back to the bad old days. And if competition then runs riot, which most brokers warn would likely be the case, it will be bad old days multiplied.

JP Morgan’s thinking is along these lines. The market is pricing in some sort of first mover advantage for a TPG that will become a retailer of fibre broadband speeds long before the lumbering NBN, even under the new government, reaches the building. Certainly TPG can become an infrastructure competitor, as infrastructure competition is part of the government’s policy, but a combined wholesale/retail service? Not so likely.

Mini-Telstras aside, the analysts at RBS Morgans are not even convinced about the infrastructure part.

Extrapolating back from the current share price, RBS calculates the market is pricing in a 35-40% market share win for TPG in the buildings TPG proposes to run fibre to. Given Tesltra already boasts around a 45% market share nationally, this is a stretch. But even if such a share could be achieved, TPG first has to get past anti-cherry-picking legislation.

The broker suspects that given TPG already had an existing pipe network in place before the ACP legislation came into to place in January 2011, the company believes it can call the connection of fibre within these pipes to the buildings within one kilometre away a “network upgrade” rather than a start-from-scratch, thus avoiding ACP implications. RBS would not be so hasty.

And even if this hurdle is overcome, Telstra, Optus ((SGT)), iiNet ((IIN)), M2 Telecoms ((MTU)), Vocus ((VOC)) and AAPT ((TEL)) can all do the same, and each already has a large fibre network.

Thus, suggests RBS, even if TPG can get as far as connecting capital apartments legally and without government interference, the competition could quickly make the market’s assumed 35-40% market share very pie in the sky.

RBS rates TPM as Underperform.

 

 

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