Australia | Sep 24 2014
-Strong subscriber growth
-Impressive AAPT synergies
-Valuation full, upside questioned
By Eva Brocklehurst
TPG Telecom ((TPM)) had a lot of promises to fulfill with its FY14 results, and did. Not only did the headline beat forecasts but FY15 estimates have been raised, stemming from accelerated subscriber growth and further synergies from the recent acquisition of AAPT. Looking further ahead, several brokers question the sustainability of the company's growth rates and the implications inherent in the current share price.
Macquarie found the result hard to fault. Organic subscriber growth is robust in broadband, while margins expanded in the corporate segment and the company made earlier-than-expected synergy gains from the AAPT acquisition. The broker likes the company's unique position, given its infrastructure assets and cost base, and believes this should underpin further earnings growth from both the consumer and corporate segments. Credit Suisse was impressed with the synergies from AAPT, as a result of head count reductions, given the business has only been owned for five months. More gains are expected in FY15. That said, the broker believes the stock is fair value and retains a Neutral rating, looking to take a more positive view with any pullback in the share price.
Moreover, Credit Suisse continues to believe that TPG's roll out of FTTB – fibre-to-the-basement – will ultimately be stopped by a change to legislation, or a prohibitive cross subsidy tariff being imposed on superfast broadband networks that compete with NBN.
CIMB observes TPG is now adding 500-600 new NBN re-sale subscribers per week, around 13-15% of NBN's current activations, although there may be an initial "opening the floodgates" effect which will likely moderate. The stock appears to boast the best growth prospects in the fixed telco market on a three-year view, in the broker's opinion. Moreover, the company has stated that its extensive infrastructure holding allows it scope to leverage that which is profitable and focus on high market, on-net traffic. This strategy deserves praise, in CIMB's view, but longer term the outlook is not so buoyant.
As an indication, CIMB's valuation of TPG is $5.00, which includes a number of factors coming into play beyond FY17. TPG's share price of $7.00 is well beyond this figure and any extra value the broker can ascribe to the FTTB build-up. CIMB also suspects expectations for FTTB are unlikely to be realised in full, while the market appears to have overly optimistic assumptions about the potential for full service carrier consolidation. CIMB concedes the stock's small free float – relatively fewer shares available for public investment – tends to magnify the share price impact of key developments and operating performance.
Citi expects subscriber growth will accelerate amid further synergies from AAPT and this should drive earnings growth rates of over 22% for the next three years. Citi forecasts TPG to hit 1m subscribers in FY17 and move to a 15% share of fixed retail broadband. Nevertheless, the broker believes the share price already reflects option value from FTTB and NBN. To BA-Merrill Lynch subscriber growth seems to be the main driver of revenue while mobile growth has been lacklustre, raising concerns about whether the company will be willing to sacrifice margins to win subscribers in an NBN environment. The broker is not convinced. An Underperform rating is retained.
JP Morgan also has doubts. The business is good, but the valuation is a concern. The broker cannot argue with the trajectory of earnings but has a problem with calculating a fair price to pay for it. Half of the revenue comes from the corporate sector and it is harder for the market to establish where the company has the edge. Moreover, corporate pricing is competitive. Meanwhile, retail fixed line is mature and the incumbents, of which TPG is one, earn high returns, although entry barriers are being lowered by the NBN. Current multiples imply that high margins continue indefinitely, while JP Morgan assumes they fade.
Morgan Stanley looks at the stock's price from the perspective that TPG and AAPT currently control 7% market share in the Australian corporate telco market and every percentage point gain represents up to 26c per TPG unit. Hence, any market share gain delivers pure upside to the broker's forecasts and valuation. The company's competitive advantage in the retail broadband market is its lean cost structure and with the recent acquisition of AAPT this means TPG is a fully vertically integrated telco for corporates. It all ads up to market share, earnings and valuation upside for Morgan Stanley. The broker also believes TPG's pricing strategies are sustainable.
FNArena's database contains one Buy, two Hold and three Sell ratings for TPG. The consensus target price is $6.22, signalling 11.5% downside to the last share price. This compares with $5.32 ahead of the results. Targets range from $4.90 to $7.60.
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