M2 Crosses The Ditch

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-Provides second growth stream
-Potential to add product to CallPlus
-Is the valuation now stretched?
 

By Eva Brocklehurst

M2 Telecommunications ((MTU)) is expanding its New Zealand operations with the proposed acquisition of CallPlus and related entity, 2Talk, for $245m. The transaction is subject to approval from the NZ Overseas Investment Office.

CallPlus is the number three fixed internet service provider in New Zealand and Goldman Sachs observes it provides a good opportunity to increase market share, given M2 Telecom's backing and the roll-out of New Zealand's Ultra Fast Broadband (UFB) network. CallPlus is expected to contribute around NZ$270m in revenue in FY16 and expected to be 15% earnings accretive in FY16. M2 will fund the transaction via debt and expects pro forma leverage to be around 2.0 times net debt/FY16 earnings. The broker notes the company's net debt peaked at 2.6 times in FY13, following the acquisitions of iPrimus and Dodo/Eftel.

The company has made a good purchase, in Credit Suisse's view, for a business with reasonable organic growth and a strong management team. The acquisitions also deploy excess balance sheet capacity and provide a solid return to shareholders. In addition, the broker notes M2 has the potential to add strategic value by expanding products to CallPlus where it has expertise, such as in electricity and mobile, as well via bolt-on acquisitions in the NZ market. The one uncertainty Credit Suisse observes is centred on FY16 earnings for CallPlus, with a final decision expected from the authorities on wholesale copper pricing towards the end of 2015.

CallPlus operates five brands – Slingshot, Orcon and Flip, which target the consumer segment, and CallPlus Business and 2Talk, which target small-medium enterprises. With this acquisition M2 will become the third largest ISP in New Zealand with 18% market share in broadband, behind Spark and Vodafone. Citi believes the CallPlus business is similar to the M2 business in Australia as it is light on infrastructure and covers the same residential and SME segments. M2 also knows the business, as CallPlus was a wholesale supplier in NZ to M2's Black and White.

Nevertheless, there are acquisition risks. Citi notes this acquisition will reduce the focus on the larger Australian business and increase the foreign exchange risk. Also, the increased internal competition for capital needs to be acknowledged, as M2 continues to expand both organically and acquisitively and each business now faces incremental challenges in winning its share of growth capex.

Macquarie observes the expansion provides a two-pronged growth strategy for M2 over the next couple of years. Outperformance will be reliant on M2's ability to sustain meaningful organic growth from both domestic and NZ operations. Longer term, the broker believes the trans Tasman expansion could increase M2's appeal with fibre-heavy operators like TPG Telecom ((TPM)), and Vocus ((VOC))/Amcom ((AMM)) where a merger deal is pending.

Morgans welcomes the deal as after a period of growing organically, M2 has acquired a peer that fits well culturally. The broker also notes that New Zealand is a number of years ahead of Australia with respect to its national broadband network and the acquisition gives M2 operational insight into the migration from copper to fibre and the complexities and opportunities that come with the migration. Given a larger portion of CallPlus revenue comes from data – 58% versus 34% — Morgans envisages a significant opportunity to up-sell voice services to the customer base.

The acquisition may be accretive but Morgan Stanley considers the valuation of the stock already reflects this. The broker takes the view that, as the NZ broadband market is more mature and consolidated than Australia's, it reduces scope for further consolidation. On this point, the broker highlights the fact that the NZ UFB project – similar to Australia's NBN – provides a reduced catalyst for the consumer to change internet providers. In Australia, the NBN will turn off a consumer's connection if they have not moved across to the NBN in 18 months. This is not the case in New Zealand. Consequently, this reduces the ability to take market share. Morgan Stanley retains an Equal-weight rating.

UBS believes the growth premium to telco peers is more than priced into the stock. Acknowledging the market share wins, new products and sales channels the broker still considers the valuation is stretched and moves to a Sell rating from Neutral. The size of further M&A would now need to be much larger to deliver meaningful accretion, in UBS' view, and such opportunities among Australian telcos are now reduced.

FNArena's database has two Buy, three Hold and one Sell rating. The consensus target is $11.06, suggesting 2.2% downside to the last share price. Targets range from $9.51 to $13.00.
 

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