Australia | Oct 25 2017
Vocus Communications has expanded its transformation program and flagged the potential sale of NZ assets and Australian data centres.
-Quantum of expanded transformation program feasible, with provisos
-Seen gaining traction in both consumer and enterprise/wholesale segments
-Integration challenges persist, but flagged asset sales should reduce pressure on balance sheet
By Eva Brocklehurst
Confidence in Vocus Communications ((VOC)) has increased as management appears to be making progress on some of the issues that have beset the business over the past year.
At the company's investor briefing, brokers welcomed the fact there was no downgrade to FY18 guidance. Outside of the reassurances from management, UBS analysis suggests FY18 operating earnings (EBITDA) guidance of $370-390m remains achievable.
The quantum of the company's expanded transformation program, which it estimates could deliver $90m in uplift to operating earnings between FY18 and FY20, is feasible, in the broker's opinion, but only assuming NBN economics per customer do not deteriorate further, and only if there is no meaningful drag from the loss of voice-only revenues and/or loss of Commander profitability.
Importantly, NBN average revenue per user (ARPU) fell to $62.60 in the first quarter from $64.23 in FY17. UBS believes there is some risk that NBN revenue per unit may need to come down in future but this could be offset by the company up-selling NBN products and a higher mix of Primus NBN product.
On the other side of the equation, the implied cost per NBN subscriber fell to $42.65 in the first quarter from $43.97 in FY17. The company did not disclose the drivers of the cost decline.
Citi is stalled on Neutral, with its core concern being the magnitude of the transformation plan and the risk of the timeline slipping for key projects. The broker notes savings from the transformation plan will be partly offset by the impact of lower margins on NBN.
The efforts to fix the business combined with possible divestments may be a positive catalyst if the balance sheet improves, Morgans suggests, and with these factors in mind, upgrades to Hold from Reduce. The company is gaining traction in both its consumer and enterprise/wholesale segments, the broker adds.
Vocus added 53,000 NBN subscribers in the September quarter, and sales targets were met in enterprise/wholesale, with some success in resolving delivery issues. The company continues to progress its Australia-Singapore cable project, on track to go live from the first quarter of FY19.
The most important positive catalyst, Ord Minnett believes, is the anticipated transformation savings and customer contract updates on the Australia-Singapore cable project. The broker does not give the company full credit for the intended cost savings or the contract updates, so envisages a further 50% of potential upside to valuation if management can deliver. The Australia-Singapore cable project is on track to go live from the first quarter of FY19.
Morgan Stanley points out that all Australian telecommunication stocks are confronting higher competition, lower margins and lower returns, but for Vocus the risk is amplified by specific factors such as poor execution, strategic gaps in business mix and high debt.
The broker acknowledges reiterating guidance was important, given the company's mixed recent history, although integration challenges persist and were never going to be a quick fix. Nevertheless, Morgan Stanley suspects a bear case scenario is less likely. One of the main risks the broker envisages is that the company could have to undertake a deeply discounted equity raising, which at current levels would be very dilutive for shareholders.
Asset Sales
The company has now explicitly flagged the sale of its New Zealand assets and the Australian data centres, largely welcome by brokers as this is expected to alleviate the pressures on the balance sheet. Assuming a sale multiple for both assets of 5-7x this would imply net debt in FY18 drops to a range of 1.4-1.9x operating earnings, from current forecasts at UBS of 2.5x.
Morgan Stanley calculates the data centres' enterprise value is $154-180m based on 9-11x estimates of FY18 operating earnings. A sale of 100% of the NZ operations is calculated at $422-542m, based on 7-9x FY18 operating earnings. Successfully achieving both would result in a reduction in net interest expense. While the news is incrementally positive, in the broker's view the risk/reward remains unattractive.
Macquarie expects there will be broad interest in NZ assets, which offer a fixed broadband customer base operating at scale. In regard to the Australian data centres, Macquarie considers the quality is mixed, which needs to be considered in the context of assessing the value of the asset. Morgans views the NZ business as the more palatable purchase and believes there is a reasonable possibility a sale occurs.
For now, the company continues to invest heavily with capital expenditure exceeding operating cash flow in FY17 in FY18, Morgans observes. The broker would prefer that cash flow be used to de-gear and de-risk the business for equity holders.
Janchor
Janchor has lodged substantial shareholder notices disclosing a 6.4% interest in Vocus. Janchor also has an additional interest in cash-settled equity derivatives equivalent to around 8.66% of Vocus shares.
The long-term intentions with respect to Vocus are unknown but UBS highlights the stake, given Janchor's recent involvement in the turnaround at Bellamy's Australia ((BAL)). Since mid 2017, when Bellamy's installed John Ho, a representative of Janchor, as chairman, that company has raised capital, acquired assets and renegotiated supply agreements, along with upgrading guidance.
While UBS acknowledges the turnaround was affected by external factors, the fact remains that Bellamy's is back now near a multi-year high in the share price. Hence, UBS ponders whether these catalysts can be applied to Vocus.
Potential items include regulatory breakthroughs, a capital raising, vertical integration and renegotiating key supply contracts. UBS points out it does not factor any of these potential initiatives and maintains a Neutral rating.
FNArena's database shows seven Hold ratings and one Buy (Ord Minnett). The consensus target is $2.86, suggesting 7.4% upside to the last share price. Targets range from $2.62 (Deutsche Bank) to $3.30 (Ord Minnett).
Disclaimer: The writer has shares in the company.
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