Australia | Mar 30 2010
By Chris Shaw
The Australian Government continues to move towards establishing a National Broadband Network and Bank of America Merrill Lynch suggests one implication of the NBN creation will be to commoditise the internet service provider or ISP market.
Assuming this happens, scale will be a key differentiating factor in the market and Australia's number three ISP, iiNet ((IIN)), has recognised this and has set a goal of achieving a market share of 15%.
To help achieve this iiNet has announced the acquisition of Victorian and Tasmanian ISP Netspace for $40 million, in a deal expected to add around 70,000 subscribers to its existing subscriber base of around 450,000. As RBS Australia points out, this means the deal adds to both iiNet's scale and to its East Coast footprint.
RBS estimates the acquisition price implies an EBITDA (earnings before interest, tax, depreciation and amortisation) multiple of around five times in FY11, making it cheaper than the 2008 acquisition of Westnet. When combined with a forecast $5 million in annualised synergies, RBS expects the deal will deliver strong earnings growth for iiNet from FY11 onwards.
Factoring in these synergies makes the deal look even better, Macquarie suggesting the post-synergies price implies a FY11 EBITDA multiple of about four times. This falls to an EBITDA multiple of around three times in FY12 on Macquarie's estimates.
What RBS also likes about the deal is iiNet's management team has a proven track record in delivering on acquisitions, especially in key measures such as integrating customers onto its own infrastructure and reducing the cost per subscriber for backhaul and international bandwidth.
Factoring in the Netspace deal has seen brokers lift earnings forecasts, with RBS increasing its FY11 earnings per share (EPS) by 13.8% to 28.5c and its FY12 forecast by 13.5% to 34.4c. Macquarie has also lifted its forecasts but not as aggressively, its EPS estimates rising by 4.8% in FY11 and by 9.5% in FY12 to 23.6c and 26.3c respectively. BA Merrill Lynch has increased its EPS numbers by 2.2% and 7% respectively to 28.5c and 31.7c in FY11 and FY12.
Across the market FY10 EPS forecasts are relatively unchanged as the deal comes too late in the year to have much impact. Consensus EPS forecasts for iiNet according to the FNArena database now stand at 19.9c for FY10 and 26.6c for FY11.
This suggests solid earnings growth in FY11, but risk to consensus numbers remains to the upside as further acquisitions of smaller ISP's remains likely. As Macquarie points out, iiNet's gearing remains conservative even after the Netspace deal.
Macquarie estimates a net debt to EBITDA ratio of just 0.2 times in FY11, which is well below the 1.0-1.5 times level at which management has previously indicated it would be comfortable. This suggests further acquisitions to strengthen iiNet's footprint, something BA Merrill Lynch expects given there are still a number of sub-scale operators in the sector.
The combination of an already solid earnings profile and the scope to add to this via acquisitions means recommendations on iiNet remain positive, the FNArena database showing the company is rated as Buy four times and Accumulate once.
Aside from the solid earnings growth profile forecast by brokers, another reason to be positive on the stock according to RBS is relative value, as on its numbers iiNet shares are trading on a multiple below that of its peers at current levels.
The increases to earnings forecasts to reflect the Netspace deal have been matched by increases to price targets. Macquarie has increased its target to $2.90 from $2.40 and RBS to $3.14 from $2.50, while the average price target according to the FNArena database has risen to $3.02 from $2.63 previously.
Shares in iiNet today are stronger and as at 11.00am the stock was up 11c or 4.2% at $2.73, which compares to a range over the past year of $1.40 to $2.80. At current levels the stock offers almost 10% upside to the average price target in the database.
