Australia | Dec 10 2013
-TPG price rally excessive
-TPG's risks increase
-Telecom focus now on NZ
-Telecom NZ capital management likely
By Eva Brocklehurst
TPG Telecom ((TPM)) will add another fibre network to its suite with the acquisition of AAPT. TPG has been on the front foot since delivering a strong FY13 result and earlier in the year announcing an intention to build its own Fibre-To-The-Building network. Brokers now think the share price has run too far and company has a lot of expectations to fulfill.
TPG will acquire AAPT from Telecom New Zealand ((TEL)) for $450m, funded by debt. Around 60% of AAPT's revenue comes from the wholesale carriage business and the remainder from corporate customers. Assets include the inter-capital fibre links, an extensive metropolitan and suburban fibre footprint and 15 data centres. The assets should complement TPG's network, which includes fibre, submarine cable and DSLAM. While the AAPT business may be a good fit, and tended to be neglected by Telecom NZ, brokers worry about the extent of the synergies and believe, in the main, that the share price reaction to the deal was over the top.
BA-Merrill Lynch flags cost synergies that the acquisition will allow as the key unknown. The interstate transit market is competitive and savings may be significant, but will be unlikely to have the same impact on the cost base as was seen with TPG's acquisition of PIPE Networks. The limited visibility on this, and the share price reaction, suggest to the broker the market is putting a "degree of faith" in TPG's ability to deliver. An Underperform rating is maintained.
Credit Suisse considers the acquisition opens up meaningful synergies through network duplication and TPG can migrate third party back haul arrangements to AAPT fibre. The challenge for TPG will be absorbing AAPT as well as executing on the proposed FTTB. Credit Suisse is mindful that the FTTB roll out carries political risk, as a number of NBN reviews are underway with the new federal government. If the laws are amended to protect a level playing field objective, ie. against cherry picking, then this may affect TPG's ability to deliver the FTTB plan. AAPT brings execution risk in both managing the revenue decline that's been in evidence in the past two years and delivering cost cuts. All up, the valuation looks fair to Credit Suisse but a Neutral rating is appropriate in the current market conditions.
Macquarie notes the decision regarding depreciation and goodwill will affect the actual accretion or dilution value of the transaction. The broker observes, even with debt funding for the transaction, TPG's net debt will still be comfortable. Macquarie is restricted on providing a recommedantion for both stocks at present. JP Morgan likes the deal but believes TPG's share price reaction was excessive. The stock will struggle to live up to expectations in the broker's opinion. The reaction implies AAPT is worth $445m more in TPG's hands compared with what was paid. While the potential of AAPT may have been neglected by Telecom, such valuation is excessive in the JP Morgan's view. While a lot of cost has been taken out of the business the drivers of synergies are not that clear.
Moreover, JP Morgan thinks the philosophy of using capital to buy out network operations to control as much infrastructure as possible offers no added value for the stock. One reason why TPG may be keen to acquire AAPT and develop competitive infrastructure is because, according to JP Morgan, resellers in an NBN world are likely to earn much lower margins. Still the broker finds it hard to get over the heightened expectations, unless the NBN creates a very large opportunity. Goldman Sachs, meanwhile, believes the acquisition will not only deliver inter-capital fibre but also a greater presence in Perth and Adelaide for TPG, where the broker estimates the company's market share is lower than its national average.
From Telecom's point of view the sale is consistent with an ambition to focus on the NZ business and investors will now be looking at the prospects for capital management. The company has stated it will use the proceeds to pay down debt and will provide an update at the half year results in February. The sale removes a distraction, in JP Morgan's view, and the price achieved was better than expected. Telecom's NZ share price has been flat since June as investors await more evidence of a turnaround. JP Morgan is of the view that it's too early to conclude the core business is turning around. Having said that, the broker does not think a material deterioration in fixed line economics is on the cards.
Merrills also finds limited scope for a near-term re-rating of Telecom as the fixed line competitive environment is difficult, with bundling discounts a relatively new feature. The broker wants top line stability and a more rational competitive stance from Vodafone. That said, while sale proceeds will be used to repay debt, Merrills thinks there's scope for a modest NZ1c per share dividend per annum increase, as well as investment in initiatives to grow the top line.
UBS also believes the exit from Australia removes a distraction at a time when resources are being used to transform the company's fortunes in New Zealand and the cash should underwrite the dividend despite earnings pressure. The broker remains impressed by Telecom's transformation but is cautious about revenues. Drivers of a more positive fundamental outlook from here will be signs of price rationalisation, share gains and short-term wins in the digital division. Credit Suisse considers the sale opens up a buy-back opportunity. The broker thinks Telecom can hold earnings level over the next few years, through cost reductions and some revenue growth from mobile.
On the FNArena database TPG has one Buy rating (Citi, yet to update), one Hold and three Sell. The consensus price target of $4.11 suggests 10.6% downside to the last share price. This target has risen from $4.02 ahead of the announcement. Telecom NZ has no Buy ratings. There are five Hold and two Sell ratings. The dividend yield on FY14 and FY15 consensus earnings forecasts is 6.9%.
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