Tag Archives: Telecom/Technology

article 3 months old

Technology One Defies The Downturn

-Resilience in the face of spending cuts
-Capital management potential
-Major cloud initiatives key to growth
 

By Eva Brocklehurst

Software developer Technology One ((TNE)) stands out. The economic doldrums have affected a wide range of companies, not just retailers and resources, and IT is one area which has felt the impact of reduced spending. So brokers greeted the first half results tentatively and were positively surprised.

Technology One is one of the few software companies to almost entirely undertake research and development domestically. There is a small offshore facility, in Bali, which is used to support back-office functions. There are no plans to increase the scale of this in the near term, because of concerns about compromising product and service quality. CIMB expects Technology One to expense around $36 million in R&D this year, which gives rise to tax breaks, and lowers the tax rate to the low 20% levels. This means shareholders are not able to receive fully franked dividends at this stage.TNE raised the interim dividend by 10%, to 1.77c, partly franked at 85%.

The company has extended its R&D tax concession review to include 2008-10 and expects to see franking below 100% in FY13.  UBS notes there's no special dividend or capital return mentioned but TNE is reviewing potential capital management options. It will not make a special dividend payment until dividends can be fully franked. An update on the most tax efficient way to return cash is expected in the next six months.

The balance sheet is strong. Operating cash flow was ahead of profit and cash conversion was 103%. The company is intent on improving profit margins and these have finally started to rise. The company aim to lift margins back towards 25% over the next five years and managing the cost base will be critical to this outcome. BA-Merrill Lynch has described the company's cost control as stellar and the cash generation the highlight of the results. Macquarie hails the annual licence fees, which grew very strongly at 18% and reflect good customer retention.

The second half looks to be very strong across local councils and the education sector, with no signs of any slowing in conversion to date. Macquarie observes there are no state or federal government contracts coming though and the upcoming election is probably having an impact there, but there are a number of contracts which should drive growth in the second half as opposed to a heavy reliance on one or to lumpy ones. The company's guidance is for 10-15% profit growth in FY13 and the brokers seem happy with that. Of course it does assume no further deterioration in the economic climate.

Major initiatives are new products, such as Mobile Solutions, as well as continued investment in the Ci2 cloud and the UK investment. In order to demonstrate the cost efficiencies of moving to the cloud with Ci2, TNE will operate its own corporate head office on the cloud. The initiative requires less IT staff on the premises. Hardware/software will be hosted in the cloud utilising Amazon's data centres and there is no more need for an off-site disaster recovery centre, given back-ups are at multiple data centres. Management estimates around $1-2m of cost savings in 2014. Given the scalability of the model derived from wholesale cloud hosting and the fixed cost of Ci2 development there is ample longer-term margin upside, in UBS' view.

At issue is the pace of the adoption of cloud computing by business and government agencies. For customers the adoption is a transformational and capital budget decision. They can reduce IT and business risks, avoid up-front capex, but lose control of hardware and perhaps accept limited customisation. Cost savings result from reduced head count, lower servicing costs and capex for self-maintained IT infrastructure with improved system stability and recovery capability. Moelis suspects R&D expense growth will now decelerate because the initial building of the cloud enterprise suite is now complete and a level of critical mass has been achieved. R&D expense should grow at an average compound rate of 8% or less per annum over the next five years versus the historical compound growth rate of 15% per annum.

The UK business continues to feel the effects of the GFC and Technology One is a relatively new player, competing against the entrenched multinational contingent. Moelis is yet to be convinced of the long-term sustainability of TNE's operation in that region. In contrast, there is a good pipeline of contract opportunity in Australia and New Zealand, despite the subdued environment and this, in Moelis' view, reflects the company's exposure to the more resilient segments of the market, such as health and local government. TNE benefits from minimal exposure to the more pressured sectors such as manufacturing and retail. The UK's drag on profits is also the one area of concern for Macquarie. There is a significant turnaround required before this can turn a profit. Nevertheless, the sheer size of the UK market and the limited losses to date means, in Macquarie's view, the company can afford to be patient.

BA-Merrill Lynch has decided, after having a Buy rating for three years that a Neutral rating is now more appropriate. This is largely because the valuation has expanded to 17 times the 2-year forward price/earnings ratio and there are a lack of catalysts, so the stock is likely to be range-bound. This does not take away from the fact that the stock is supported by strong margin leverage, cost controls and cash generation. The move to Neutral is also based on the fact that the second half has more weighting and risk to the software licence outlook, and this could be a challenge in an election year.

On the FNArena database Technology One has two Buy and two Hold ratings. The consensus target is $1.76, having risen from $1.64 yesterday, and suggesting 6.8% upside to the last share price. The dividend yield on consensus FY13 earnings is 3.5% and for FY14 it is 4.0%.

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article 3 months old

Weekly Broker Wrap: FY14 Outlook May Be Overly Optimistic

-FY14 outlook appears optimistic
-Budget impact minimal for health stocks
-Rise of self managed super funds
-Valuing Telstra's fixed asset base
-Drought rears again
 

By Eva Brocklehurst

The market's outlook for FY14 might be a bit optimistic in terms of stock performances. BA-Merrill Lynch finds there is an over-reliance on second half improvement when it comes to Computershare ((CPU)), Harvey Norman ((HVN)), UGL ((UGL)), Ansell ((ANN)) and Toll Holdings ((TOL)). Margin expansion is also optimistic for the likes of Metcash ((MTS)), Echo Entertainment ((EGP)) and Toll. The broker has looked at the earnings risk for two key sectors, domestic cyclicals and mining.

Recent economic data and company updates suggest the rally in domestic cyclicals could be unsustainable. Merrills finds retail, media and building stocks are not covering the cost of capital. Moreover, they operate in industries with poor pricing power. What's of concern is that some retail stocks have rallied while inventory turnover has deteriorated. In terms of resource stocks, the big caps offer attractive valuations, in Merrills' view. While sizeable earnings risks exist for small cap miners, the broker likes the bigger names, such as Rio Tinto ((RIO)). What is surprising is the amount investors are willing to pay for low-growth yield stocks, particularly banks. While struggling to see value in the sector, the broker thinks a catalyst for de-rating is unlikely near term. Material upside for the Australian market will be driven by miners.

Credit Suisse has reviewed government spending in health care, ahead of the federal budget being brought down on Tuesday. Pathology and the Pharmaceutical Benefits Scheme have borne the brunt of funding pressure. Cuts to drugs that treat Alzheimer's, diabetes and atrial fibrillation are likely but the impact on companies like Australian Pharmaceutical Industries ((API)) and Sigma Pharmaceuticals ((SIP)) is considered minimal. Both are large and can reduce trade discounts to pharmacists to offset revenue. Pharmacists will take the hit. Offsetting this cut is likely to be funding for additions to the PBS. The private health insurance rebate is not expected to undergo further drastic changes, after previous announcements, while GP practice incentives are a perennial target where cuts can be expected. Neither of these are expected to affect the health care sector in any significant way.

The rise of self-managed superannuation funds (SMSF) has gone relatively unnoticed despite a large amount of asset transfer. CIMB notes, between June 2001 and June 2012 the assets in these funds grew at a compound annual 17%, to reach $440 billion. This makes it the fastest growing, and largest segment, of Australia's $1.5 trillion superannuation industry. Market share gains for the funds over the last 15 years netted an additional $180bn over and above system growth. The portfolios tend to be concentrated in Australian shares (32%) and cash or term deposits (29%).

CIMB finds, as a result of the high allocation to Australian equities and rapid growth of market share, the direct ownership of Australian market capitalisation has risen to over 11% in 2012 from 4.7% in 2004. It appears, moreover, that the typical SMSF is less concerned about diversification. Large cap stocks are the beneficiary of increased market participation because of their blue-chip status. The S&P/ASX 200 still looks attractive with the market paying a post-tax gross yield of 5.2%, compared with 3.4% in term deposits. This yield gap is one percentage point wider than the 10-year historical average.

Casinos in Australia are being challenged by the weaker economy, particularly at a time when many of the properties are finishing major capex investment. UBS thinks it's not just economic data that heralds caution in this regard, but also the various industrial companies that have commented on the tough consumer environment. Victorian gaming revenue is also weak. The state government's statistics for non-casino slot machines shows softness and, while there are reasons specific to non-casino slot markets that may account for this, there is likely to be some impact on Crown's ((CWN)) earnings, in the broker's view.

The ACCC has raised the prospect of further changes to valuing Telstra Corp's ((TLS)) customer access network in the 2013 fixed services review. An access price rise seems likely. In CIMB's view, the Telstra economic model shows a divergence between the internal costs for use of the access network and the external regulated access charge. As values fall, average costs will increase relative to regulated prices. The decline in copper fixed services and the implied cross subsidy from retail to wholesale is expected to grow. CIMB thinks the trend of fixed volumes falling faster than expenses leaves the ACCC with little choice but to reduce the value of the regulated asset base.

The current value of the regulated asset base (RAB) is likely to produce an increase in regulated prices for a range of services. The ACCC may adjust the RAB down further to maintain current prices or manage price increases at a lower rate. The analysts do not see a workable price that would allow the RAB to be maintained at current levels. This is of concern to CIMB. The approach adopted in 2011 led to significant access price reductions, which are unlikely to see the reduced value of RAB recover before migration from copper to NBN fibre. This leaves Telstra shareholders holding part of the cost for the endorsement of the government's high-cost FTTP (fibre to the premises) NBN. CIMB notes that the review in 2013 will likely be done in the context of a reversion to the Coalition's FTTN (fibre to the node) NBN.

Drought is the word being bandied about again and the prevalence of herbicide spray rates has been subdued, lagging levels seen last year. CIMB surveyed the agricultural chemical sector and finds the lack of rain has also affected the distributor outlook for fertiliser application rates. Expectations for fertiliser demand were based on a reasonable winter and moisture levels. Incitec Pivot ((IPL)) is likely to experience more of the subdued conditions that persisted in the summer. As an aside, CIMB notes Incitec Pivot has reduced of of the volume risk following efforts to secure volume commitment from distributors, although acceptance has not been uniform. Dry conditions also pose obstacles for Nufarm ((NUF)). The company said in March the domestic backdrop was challenging because of the dry conditions and this, according to CIMB's feedback, has continued in April. The prevalence of weeds has been below average, according to 64% of respondents to the survey.
 

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article 3 months old

What Is TPG Doing In 4G?

-TPG surprises with spectrum buy
-Telstra scores the bigger slice
-What will TPG do?
 

By Eva Brocklehurst

The latest Australian auction for 4G spectrum produced some surprises. On offer was spectrum in the 700Mhz and 2.5Ghz bands. Telstra ((TLS)) and Optus ((SGT)) were obvious bidders, but TPG Telecom ((TPM)) put its oar in and scooped up two 10Mhz tranches of the 2.5Ghz spectrum. Vodafone ((HTA)) had indicated it would not bid in the 700Mhz band, saying it had enough to meet needs, and withdrew from the auction. Telstra gained most of the offering, spending $1.3 billion to acquire spectrum in the 700Mhz and 2.5Ghz band. Optus spent $649m and TPG spent $13.5m. The 700Mhz was sold at the reserve price and 2.5Ghz sold marginally above reserve.

Now brokers are asking what TPG is planning. Higher frequency spectrum is likely to be used for mobile broadband. Credit Suisse does not see the acquisition as a strategic fit for the junior telco, quoting the experience of VividWireless and the trouble building a standalone mobile broadband network in Australia, particularly in high frequency bands where in-building coverage is weaker. The broker thinks building a mobile network is a risky strategy and is curious to see what TPG does with its purchase.

BA-Merrill Lynch thinks there could be a risk of a return to a four-player market, noting TPG has around 300,000 mobile subscribers, wholesaled by Optus, or 1% of the market share. Any aggressive network roll-out could lead to revenue compression for the entire industry, although the capex outlay would be substantial and, therefore, this is not a number one option in the broker's view. Citi holds a suspicion that TPG could be just camping on the spectrum as "option value".

JP Morgan does not think TPG, on its own, is considering a role as a fourth wireless player. Therefore, the most logical option is to joint venture with one of the others. TPG could offer a fixed wireless broadband focused on niche markets, perhaps student accommodation. High frequency spectrum would work for this but it's unlikely to be of high enough worth. Rolling out fixed wireless broadband from scratch is also risky in JP Morgan's view. The NBN will, in due course, provide similar or higher speeds and there is not much evidence of a customer base for TPG in this regard.

So, this leads back to contemplating a full wireless network in joint venture. JP Morgan rules out Telstra and thinks the player with most to gain would be Vodafone. Vodafone is constrained by a lack of fibre backhaul to cell sites. JP Morgan understands only about 30-40% of its sites have fibre, compared with 93% for Telstra. While emphasising it's all speculation, the broker does observe that Vodafone has track record of pursuing joint ventures in fixed line assets, while fixed-line players such as TPG face a more competitive landscape as the NBN rolls out. JP Morgan also considers the same possibility that Citi has flagged, citing examples of potential new entrants buying spectrum and then thinking better of it and selling it down the track. Committing just $13.5m suggests TPG's plans are not yet concrete.

Optus bought as expected. Credit Suisse thinks its strategy of buying less low frequency spectrum than Telstra carries risk. The broker queries the longer-term network coverage disadvantage that Optus may suffer in not holding low frequency to the same extent and the potential capital inefficiency that comes form deploying a more high frequency network. Merrill Lynch thinks the spending on spectrum could constrain Telstra's dividend growth. The outlay was slightly ahead of the broker's assumption of a $1.1bn spend.

JP Morgan does not think it confirms the dominance of Telstra in mobile. Dominating the 700Mhz spectrum is a mixed blessing in metro areas where cell density is set to grow. It could simply be that Telstra has 50% more customers than Optus and therefore needs more spectrum. The argument that Optus' holding in that band is light on is too simplistic, in JP Morgan's view. The broker thinks the high reserve price altered the economic trade-off between spectrum and other capacity solutions.

Unsold spectrum is likely to be returned to the market in the next two or three years. ACMA has stated it should not be assumed it will come back to market at lower price in the near term. The spectrum is worth $1 billion to the government so it's likely to be sold as soon as possible and where it ends up could have important implications for competition in the longer term. Brokers are watching with interest.
 

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article 3 months old

M2 Telecommunications: For And Against

-CIMB doesn’t like recent acquisitions
-Macquarie isn’t sure
-Citi has some reservations
-Moelis sees share price upside


By Andrew Nelson

M2 Telecommunications ((MTU)) looks like a real puzzler as far as analyst perception goes. The stock is covered by three major Australian brokers and each one has a different recommendation. Boutique broker Moelis, on the other hand, has a very clear opinion and it is positive.

Looking at broker positions from least favourable to most favourable will give us a good picture as to what analysts have to say about the stock. CIMB Securities sits at Sell and one of the main issues the broker has is the recent acquisitions undertaken and the difficult job it sees in these being brought effectively into the company.

MTU advised last month it is buying Dodo Australia and Eftel, both resellers in the telecommunications marketplace. CIMB thought the announced acquisition prices were reasonable, but suspects the company will have its work cut out consolidating these acquisitions. CIMB believes the deals will add to costs in FY13 and may add a risky $50m to earnings in FY14.

The crunch for CIMB in terms of valuation is whether the expanded scale and scope of the company has become sufficient to add more value than the amounts paid by M2. It’s this unanswered valuation question and the uncertainty it causes that keeps the broker at Sell.

Macquarie admitted it was surprised by the deal for these two consumer companies and is torn by between the opportunistic upside offered by these acquisitions and the need to develop a more sustainable business.

The broker explains the company's traditional focus has been on the small-medium business market. That being said, Macquarie does admit the deals provide an extra stream in the growth strategy over the next two years. But longer term, the broker believes the company will need to become more focused on delivering what is more meaningful organic growth. Torn between earnings upside and longer term potential, the broker sits at Hold.

Citi, on the other hand, saw the move as a good way to provide some nice diversification and a good entry into low-cost retail via Dodo. Between the two, the broker thinks the company should see about a $50m uplift in operating earnings by FY14. The other nice thing is that there is barely an impact on gearing.

Yet while Citi point outs the diversification does lower risk, it also detracts from management's focus on the higher margin, core SME business. The broker really hasn't come to an opinion as to whether this is a good move or not and intends to reserve its judgment until it understands the Dodo and Eftel businesses a little better. In the meantime, the broker sticks with its Buy call

That brings us to Moelis, who chimed in on the stock yesterday. The Eftel deal has reached better than 90% acceptance and with the Dodo sale subject to a binding arrangement, both are now pretty much done deals, reports the broker.

Moelis sees a pretty good return, noting the $248m spent will deliver better than $400m in revenue, add better than $50m in operating earnings and add 20% to FY14 EPS. While, like Citi, the broker hasn’t come to a conclusion about the strategic shift from a pure SME business focus, it is happy to wait and see given the near term upside that has been acquired.

The broker also sees plenty of potential for better than expected integration savings, noting management’s solid track record in generating scale-driven savings in data costs. The broker sees this delivering some robust margin expansion.

Much like Macquarie, Moelis is concerned about the company’s ability to maintain organic growth as it beds these acquisition down. The difference is, Moelis thinks there will really be no change in the company’s general direction, with the SME sector performance underpinned by the company’s Commander brand which continues to chip away at Telstra ((TLS)).

All up, Moelis thinks the company boasts the least demanding metrics amongst its peers and with integration savings more than offsetting consumer competitive pressures, we should be seeing share price upside soon. This should be driven both by EPS growth and incremental PER expansion as the upside from these two acquisitions start to flow though, predicts the broker.

Moelis has set a target price of $6.40 on MTU while the consensus target in the FNArena database sits at $4.77 between the three brokers covering the stock. The spread is significant, from CIMB at $3.87 to Citi at $5.53. On the wide spread of forecasts, the database shows an average forecast yield of 4.1% for FY13 and 4.9% for FY14.
 

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article 3 months old

Don’t Lose Focus On Vocus

By Shuo Yang, Equity investment analyst at Microequities

The telecommunications sector has been a favourite hunting ground for investors looking for yield and defensive earnings. The ASX 300 telecommunications index is up almost 34% over the last 12 months with companies like iiNet ((IIN)), TPG Telecom ((TPM)), Amcom ((AMM)) and BigAir ((BGL)) leading the way with share price gains of more than 50% in the same period. Even former dog of the market, Telstra is up more than 34% as investors salivate over its 28c per share fully franked dividends.

One company that has been a poor performer in the sector is Vocus Communications ((VOC)) with the shares down 7% in the last 12 months. The company operates an IP transit division, several data centres, a fibre network and voice services. Vocus deals purely with direct corporate and wholesale clients and does not have a retail ISP arm, which has become increasingly competitive.  The company has in the past 3 years as a listed company transformed itself into a multiple product telco by adding on data centres and fibre network to its IP Transit and voice services offering.

Figure 1: 12-month share price performance of ASX telecommunication companies (as of 10th April 2013)

Source: Bloomberg, Microequities

One reason potentially for the share price underperformance is that the company raised around $23m of equity in early July 2012, around 22% of its issued capital at the time. As most of these funds are yet to be deployed, EPS in FY13 is expected to decline.

A second reason for the underperformance is the timing of recent data centre and fibre network acquisitions, Maxnet and Ipera Communications. Ipera will only make a partial contribution to FY13 earnings and cost synergies from both acquisitions are not expected to be fully extracted until FY14. We believe the market has failed to price in the earnings growth potential in FY14 from these two acquisitions.  

Thirdly, the market is failing to see the earnings potential of the 325km fibre network that Vocus has rolled out in the past two years. The fibre division delivered revenue growth of 152% in 1H13 to $5.8m (1H12: $2.3m). The utilisation rate on the network is currently just over 5% and with potential long term EBITDA margins of 60-70%, this provides explosive earnings momentum for Vocus over the next 3-5 years. Interestingly, 60% of new monthly sales are from fibre/ethernet and Vocus is signing up some large direct corporate customers in the IT and financial services sectors. Importantly, Vocus operates this business in the eastern seaboard which has more expensive competitors in the form of Telstra and Optus. The main price competitor to Vocus is TPG with its Pipe Networks subsidiary.

Another key takeaway from the most recent result is management’s guidance for capital expenditure to peak in FY13. As Vocus’ infrastructure network is nearing completion and the shifting focus from investment to marketing and signing up customers to its suite of products, we expect the company to deliver strong free cash flow, supporting further acquisitions at low multiples and grow dividend payments.

Investors and the market in general is often myopic in the sense they focus on the next period’s earnings forecasts and fail to account for the earnings potentials of the company 3-5 years out. Whilst EPS is expected to fall in FY13, we expect 50%+ EPS growth in FY14 with the culmination of recent acquisitions, cost synergies and explosive growth from its fibre division. Based on consensus and our internal forecasts, Vocus is trading on an undemanding 10.6x FY14 PE compared to its peer average of 15.5x and even higher multiples currently commanded by the likes of Amcom (17.2x) and TPG (17.8x). This discount is unwarranted and could lead to a significant re-rating once the market understands the potentials of Vocus.

Figure 1: FY14 PE comparison of ASX telecommunication companies (as of 10th April 2013)

Source: Microequities
 

Microequities Asset Management is a value investor specialised in Australian microcaps. Its flagship fund –the Deep Value Microcap Fund-- has a 5 star Morningstar rating. For further information visit microequities.com.au. Content included in this article is not by association necessarily the view of FNArena (see our disclaimer).

DISCLAIMER: This article contains general information only and should not be construed or relied upon as legal, financial or professional advice. Accordingly the recipient should note that a) the advice has been prepared without taking into account the recipients objectives, financial situation or need; and b) because of that, the recipient should, before acting on the advice, consider the appropriateness of the advice, having regard to the recipients objectives, financial situation and needs, and obtain individual professional advice on this matter.

article 3 months old

Weekly Broker Wrap: Australia To Grow, Modestly

-Oz business, consumer confidence diverge
-Economic growth below trend
-Modest improvement in housing, building
-Coalition broadband policy positive for small telcos
-Coalition win could benefit miners, industrials
 

By Eva Brocklehurst

We're blaming a lot on a high Australian dollar these days. One thing it could explain is the divergence between business and consumer confidence. Citi analysts think so. They note improvement in consumer sentiment usually translates quickly into business confidence. This time it hasn't. Consumers are benefiting from the high Australian dollar through lower prices for imported goods and travel expenses but business profitability is being squeezed. With the recent quantitative easing announced by the Bank of Japan, Citi analysts believe the stubbornness of the Australian dollar will stay a problem for many Australian businesses. The analysts point to production cuts and job losses recently flagged by General Motors Holden and suspect manufacturing prospects are unlikely to improve in the near future.

St George Bank economists find the Australian economic outlook is patchy and suspect that the economy, after 3.7% growth in 2012, will grow below trend at just under 3.0% in 2013. Housing is one area that is positioned for moderate growth, the economists maintain. Over the past decade a lack of new supply has underpinned house prices and residential building has been running at below average levels for some time. At the same time population growth has picked up.

All this sets the stage for more growth in house prices and an improvement in residential construction. The economists suspect it will be uneven across the country. Over the next year they expect modest house prices increases of 5-10% per annum. Forget about any return to 20% growth in house prices that was witnessed in the early 2000s. Housing finance is growing and auction clearance rates are picking up and the economists think this heralds improvement in home buyer sentiment. The key word is modest, whether it be house prices, housing construction or housing finance.

JP Morgan asks whether the shortage of housing in Australia is real or just perceived. On the back of the 2011 census population data the analysts pose the question of whether a shortage exists. The figures suggest the number of heads per household is 2.51, 4% lower than previously thought. Crunching the numbers, for the analysts this implies there are around 370,000 fewer houses needed than was previously considered to be the case and eliminates the widely perceived shortage figure of 150-200,000. So, based on expected average population growth of 1.4% and average head per new dwelling of 2.05, there are around 150,000 housing starts needed. While the figures do not definitively prove the shortfall is more perceived than real, they suggest a less acute shortfall. Hence, the prospect of a sharp rise in residential construction appears remote.

Domestic building construction activity appears to have found a floor, in CIMB's view. Potential capacity constraints in better performing states and Victoria are likely to remain subdued for some time. The housing recovery is also expected to be more gradual than in prior cyclical rebounds. The analysts note a lack of confidence is the most commonly cited obstacle for broad based improvement in housing sales and, therefore, construction activity. Responses to CIMB's survey were the most positive the analysts have seen for some time but this was not surprising considering the gloom that has abounded for some time. The analysts believe FY12 was a cycle trough and there will be... here's that word again... modest (2%) growth in housing starts in FY13. The analysts expect Victoria and Queensland will remain a net drain on national housing activity. The recovery should gather pace again in FY14 and the analysts are forecasting 6% growth.

An now for something completely different. The government has announced changes to the tax treatment of deferred Lifetime Annuities (DLAs), to provide a potential source of new growth for the life insurance industry. Analysts at JP Morgan believe the changes could be worth an incremental $800 million in annual profits by 2020 if DLAs capture 5% of post retirement assets. This is achievable, they maintain, given the lack of retirement products that provide income certainty.

If DLAs were to gain popularity it would be against the trend in the retirement income market, which has seen the annuity market share fall from around 40% of assets in 2000 to 9% in 2012. Instead, allocated pension products gained popularity because of flexible drawdown and as tax advantages of annuities were neutralised. The analysts note lifetime annuity sales virtually disappeared after 2007. Nevertheless, it will be a hard sell. The analysts believe DLAs will appeal to those with retirement savings of $300-700,000. At present, the median of super saved is still below $100,000 so DLAs are not a mass market product.The key for life insurers will be dealing with investment and longevity risks.

Citi has taken a look at the Coalition's broadband policy. The broker believes Internet Service Providers (ISP) stand to benefit from the prioritisation of regional areas in the network roll-out and the scope for lower wholesale access pricing. Those in the spotlight for this include iiNet ((IIN)) and TPG Telecom ((TPM)). The broker warns there is potential for a broadband price war in the quest to gain market share. The Coalition NBN plan includes a 5-year network roll-out, a move to FTTN architecture and lower wholesale access price because of the lower network building cost. The Coalition will amend the network roll-out in order to prioritise areas deemed inadequately served by broadband. This would enable iiNet and TPG to expand regional presence sooner under an access regime that is independent of Telstra ((TLS)).

At present Telstra holds a 75% retail subscriber share in non-metro exchanges and iiNet has 8% while TPG has 5%, in Citi's estimation. What concerns the broker is that retail pricing is the only lever for iiNet and TPG to stimulate growth in the broadband subscriber base. The broker acknowledges the potential for lower wholesale access pricing to increase growth margins but thinks the more likely outcome is the partial offset in gains via retail price cuts. Nevertheless, the Coalition's policy presents potential valuation upside for ISPs, adjusting for market share gains and lower access costs. iiNet is seen benefiting the most against TPG because of the accelerated migration of a larger off-net customer base to the NBN.

CIMB suspects the ALP government could lose 18 seats in the House of Representatives after September's poll. Most of the lost seats would be in NSW and Queensland. Sentiment should also pick up with an end to minority government. A robust Coalition victory is expected to improve sentiment, although CIMB analysts note the unpopularity of Tony Abbott as a leader. There is also a lack of clarity on how the Coalition would balance popular promises at the same time committing to budget sustainability. Confidence is not expected to make a step change higher on election day. The implications of a Coalition win mean the unwinding of the mining and carbon taxes. This would benefit miners and the broad industrial sector. Telstra is expected to be insulated by the shift in Coalition policy on the NBN. Qube Logistics ((QUB)) is one stock the broker thinks might benefit from a private sector approach to the development of the Moorebank intermodal.
 

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article 3 months old

TPG Rings Up Strong Subscriber Growth

-Strong subscriber growth
-Margin risk but earnings compensate
-Potential growth in acquisitions
-Potential capital management


By Eva Brocklehurst

TPG Telecom ((TPM)) pleased the market with first half results showing strong subscriber growth in broadband and mobile. What brokers are really seeking is as to how the company can differentiate itself in the hotly contested telecommunications sector. Dividends and capital management are important too, of course.

Management provided no guidance on dividends but CIMB expects the payout ratio to be similar to FY12, at 37%. The broker previously forecast a payout ratio of 45% but notes management plans to focus on paying down debt. The first half dividend payment was 3.5c.

Going forward, CIMB finds risks in the increased price competition in the fixed broadband market. TPG is up against M2 Telecommunications ((MTU)) and that company's recent acquisition of Dodo Australia, another player in the lower value end. Other risks include those of continued margin pressure in the corporate division and slower revenue growth. Mobile margins declined during the half because of lower pricing. CIMB notes TPG is in the process of negotiating the mobile reselling agreement and there could be a risk to margins as Optus ((SGT)) is reviewing channel partner agreements to improve profitability. Having taken note of risks, the broker still believes TPG has ample balance sheet capability to pursue strategic acquisitions. Nevertheless, at current levels, growth is largely priced in. The broker prefers iiNet ((IIN)) given the higher free cash flow yield, scope for cost cutting and corporate activity.

Goldman Sachs hailed TPG's ability to win share in the consumer and corporate segments without sacrificing profitability. The key issue ahead is capital allocation. Will it be acquisitions? TPG has announced a $10m investment in Cocoon data to develop cloud-based applications. Will it be capital management? Goldman notes the balance sheet potential for such but accepts the company is focused on paying debt. Morgan Stanley finds strong free cash flow places the company in a position to increase the dividend, make a small strategic investment and pay down debt.

The big event ahead, the laying out of the National Broadband Network (NBN), presents both risks and opportunities for TPG in Goldman's opinion. The opportunity exists in the increasing ability to tap into the market with the structural separation of Telstra ((TLS)) and an improved regulatory environment. The risks are in increased competition and margin erosion from higher costs. For Morgan Stanley there is more opportunity for TPG if the NBN is delayed by 18 months. The broker estimates TPG's value could be 7% higher. Why? Extended increases in organic market share of over 1% per annum for an additional two years, with construction delays pushing cost increases down the track.

Morgan Stanley views TPG as a winner in the NBN space but does not factor this into the base case. Still, the broker likes the stock and rates it a Buy for three reasons. These include on-net subscriber migration and organic market share growth as well as the attraction in any delay in the NBN. The third reason is the potential to participate in industry consolidation, i.e. acquisitions. Morgan Stanley believes up to $477m in aggregate value can be achieved in the industry with further consolidation in the small telecom space. This is the broker's point of differentiation for TPG against iiNet.

Macquarie notes the company has something up its sleeve. TPG previously was going strong on internet protocol television (IPTV), flagging delivery of linear channels and video on demand. A year later that's not the priority. Instead there's an important project in the wings with further details to come over the next three to six months. The broker is waiting. Meanwhile, Macquarie likes the free cash flow generation, ongoing consumer broadband growth and scope for acquisitions. Gearing has fallen to $75m and the broker expects the company to be in a net cash position by the end of the year. While management has stayed mum on returning excess capital, the broker notes the possibility of further network investment or acquisition.

TPG offers value for Credit Suisse. The broker likes the defensive 12% earnings growth for the next three years and is looking for management to use the balance sheet potential to unlock significant shareholder value. The broker would not be surprised if the payout ratio was increased. Credit Suisse views the 15% stake in Cocoon as an investment to fund a start-up company and at the same time acquire product development for the core business. TPG has indicated it does not intend to increase its stake. TPG is the broker's preferred stock in the sector.

For Citi, the subscribers are the key and there's healthy growth there. Citi has upgraded the stock to a Buy, viewing earnings growth as outweighing margin risk. Citi believes the business deserves to trade at a premium to its peers. On the FNArena database there are three Buy recommendations and two Hold. The consensus target price is a neat $3.00, suggesting 3.9% upside to the latest share price. The dividend yield on FY13 earnings estimates is 2.7%.


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article 3 months old

M2 Telecom Acquires Businesses And Risk

-Acquisitions ahead of wholesale renewal
-Gains more bargaining power
-Risks heightened
-Is there too much debt involved?
 

By Eva Brocklehurst

In a previous story (Doubts over M2 Telecom's Growth Rate) we noted broker views that M2 Telecommunications ((MTU)) needed to deliver better organic growth or pursue more acquisitions. Well, the company has obliged. M2 has acquired Dodo Australia and made an offer for Eftel ((EFT)). Eftel is a telecommunications reseller as is Dodo. Dodo also resells other services, such as gas and electricity.

CIMB finds the new acquisitions a bit of a mouthful, coming just nine months after Primus was acquired. The broker's key concern is whether the amount being paid for Dodo ($204m) and Eftel ($44m) will adequately add value. The company expects the acquisitions to be 20% accretive to earnings in FY14. The acquisitions will take net debt to around $302m in June 2013, nearing three times the broker's earnings forecasts for FY13. The company expects to pay this down to 1.8 times in FY14 and still maintain a dividend payout of 70% of net profit after acquisition.

As an aside, the FNArena database shows consensus dividend yield based on FY13 forecasts of 4.5% with 5.4% for FY14. For CIMB, reducing debt, improving earnings and maintaining payout is the risky bit and means M2 has to rely on a good relationship and wholesale agreement with Telstra ((TLS)). The broker pointedly remarks that these acquisitions could make or break the company.

The company's growth projections from the acquisition would take FY14 earnings to around $165 million. To CIMB this appears unrealistic, given organic growth has been flat. The broker believes it would require about 6% organic revenue growth post-acquisition and about 30% incremental earnings margin, supported by acquisition synergies. To achieve this would require a smooth transition in operations and high customer retention rates as well as a lift in bundled sales. Despite the acquisitions, Macquarie believes that share price outperformance in the longer-term will be reliant on the company's ability to achieve better organic growth.

Macquarie was surprised by the acquisition of a consumer business, given the company's focus on the small-medium enterprise market and the intense competition for the consumer dollar. The broker notes that, unlike M2's iPrimus consumer business, which is positioned at the top end of the market, Dodo is low cost and only differentiates from competitors on price. The business has posted very strong organic revenue and earnings growth over the past few years but does not provide any infrastructure and has established wholesale agreements with Telstra and Optus ((SGT)). So there's little prospect to move customers to the Primus network. The positive for Macquarie is the enhanced buying power that may be possible once wholesale agreements come up for renewal in 2014.

For Citi, the diversification in the business model should lower risk, but then it also dilutes the focus on the higher margin business. Citi noted that peak debt was 2.1 times FY12 earnings following the Primus acquisition, so paying that down to 1.8 times in FY14 takes it off the peak in historical terms. The broker just wants to see more of what Dodo and Eftel are about before judging the merits of the acquisitions. Citi currently rates M2 a Buy, the only Buy of the three rating the stock on the FNArena database. Macquarie has a Hold rating and CIMB has a Sell. CIMB believes the stock is overpriced, given the aforementioned risks. The consensus price target is $4.73, revealing 4.7% downside to the last traded share price.

It's just that the debt is being loaded up at a time when the company is vulnerable to negotiations with Telstra, CIMB maintains. In mobile, M2 resells Optus and the broker understands that arrangement is also under review. M2 may be planning to switch this customer base to Telstra, CIMB surmises. Regardless, the additional customers and traffic should give the company more bargaining power. Maybe Telstra will value the arrangement enough to consider offering good terms. Time will tell.


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article 3 months old

Status Quo Plays In Broadband

-ACCC drafts final ADSL pricing
-Seen defending regional status quo
-Little improvement for small telcos
-Lost opportunity to improve competition
 

By Eva Brocklehurst

The ACCC has published the draft final access determination for pricing of wholesale asymmetric digital subscriber line (ADSL). There's not much change except in the methodology the regulator is using to establish final prices. The ACCC plans to finalise the determination by August 13. The final decision reduces port prices but increases bandwidth charges. In doing so, there's an improvement in earnings outlook for the likes of iiNet ((IIN)) but not as much as the market had hoped for. For the wholesaler and retailer, Telstra ((TLS)), the earnings implications are small. Wholesale broadband is, for Telstra, around just 1% of revenue.

For Citi this is a lost opportunity to stimulate competition in rural areas. The pricing has minimal impact on the broker's earnings view for IIN, or TPG Telecom ((TPM)) for that matter, but what it does is extinguish any upside surprise for the stocks. Citi notes the non-Telstra ISPs viewed pricing of $15-20 a month as appropriate to stimulate competition, not the $20-30 a month in the draft pricing. Citi estimates Telstra holds a 75% subscriber share in regional areas and expects, with the current decision, the telco's grip on the regions will continue.

BA-Merrill Lynch finds two major surprises to the final draft. The shift to cost-based methodology has come without a meaningful change in the final prices and there is no change to the zone structure, despite the ACCC finding inconsistency with other declared services. Also, the ACCC appears to see no reason to mandate unbundling. For the broker this is of little benefit and will reinforce Telstra's competitive advantage and bundling strategy. UBS notes, despite draft prices being lower than average prices pre-declaration, many internet service providers (ISP) may not necessarily apply for regulated pricing, given existing commercial agreements. The broker believes lower pricing will have a second order impact of stimulating more off-net competition.

Credit Suisse notes the financial decisions made by the ACCC have been kept in confidence and it is quite difficult to critically assess the determination. Safe to say that Telstra earnings forecasts will increase by about 0.35% as the broker had previously assumed a bigger cut to pricing. The flow on benefits to Telstra's retail business is an added positive and the Hold rating is retained. The Hold ratings number six on the FNArena database.

The other two are Sell ratings, recommended by BA-Merrill Lynch and CIMB. Neither broker finds their view on Telstra's stretched valuation impeded by the latest ACCC news and believe more catalysts are needed to spark dividend growth. The consensus FY13 forecasts show a dividend yield currently at 6.3%. For BA-Merrill Lynch the decision will support the status quo and allow Telstra to shore up it competitive position in regional Australia over the coming year or so. While the direct earnings impact is negligible it should allow Telstra, in the broker's view, to win broadband share.

BA-Merrill Lynch had anticipated a re-alignment of the zone structure and a pass-through of the savings to retail from the decision. This has not eventuated and the broker has cut earnings estimates for iiNet, expecting subscription trends will be slightly negative over the next two years. A potential catalyst for an upgrade has been pushed back and a Buy rating is retained. There are four Buy ratings on the database. Citi has one. Despite reservations about the ACCC decision, Citi has a strong outlook for IIN, given the near-term impact of access pricing and, long-term, in the transfer to national broadband network (NBN) from copper wire. Nevertheless, the broker suspects there remain a number of risks which could make it difficult for the stock to achieve targets.

Credit Suisse has lowered earnings estimates for iiNet which are partly offset by a review of cost savings assumptions. This just takes the broker's forecasts closer to consensus. Again, a Hold rating is maintained. For JP Morgan the news has sparked an upgrade in earnings estimates but a Hold rating is maintained. These are two of the three Hold recommendations on the FNArena database. Price targets range from $4.50 to $5.50. The consensus target price of $5.13 implies 5.5% upside to the last share price.

Credit Suisse has not adjusted forecasts for TPG Telecom as the earnings sensitivity was immaterial, given the company's small off-net broadband subscriber base. TPG still is the broker's number one telco pick, with the attractive organic growth profile, ownership of infrastructure and under-leveraged balance sheet. On that score, the broker has a Buy rating and raised the target to $3.00, which stands at the top of the range on the FNArena database. The lowest is $2.15, which is held by Macquarie, which also, by the way, has the other Buy rating. The other three brokers covering the stock have a Hold rating. The consensus target of $2.59 shows just 2.1% upside to the last share price. The stock also has a 3% dividend yield for FY13 consensus forecasts. 

Meanwhile, Citi has had a look at mobile operator results for 2012 and found the slowdown in subscriber growth continues. Earnings margins are edging up as operators focus on profitability in a maturing market, but ongoing investment is required. Wireless broadband services grew 10% year on year but this is slower than the 20% plus seen previously. Telstra now holds a 47% subscriber share with Singapore Telecom's ((SGT)) Optus at 31% and Hutchison Telecoms' ((HTA)) Vodafone at 22%. Here too, Telstra dominates and looks like continuing to do so. 
 

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article 3 months old

BigAir: Looking Beyond The FY13 Results

By Shuo Yang and Carlos Gil of Microequities Asset Management

Investing is about looking ahead, it is about looking at how a business will evolve in the future, but how much into the future should investors be looking into? The answer is that a year ahead is not far enough. Some investors overact to short term earnings and lose sight of the bigger long term picture. They tend to overact and trade profit announcements before they delve into the detail and understand what is actually happening in the business itself.

This was the case when microwave broadband provider BigAir Group ((BGL)) recently reported its first half numbers. The share price fell from a high of $0.61 before the announcement to a low of $0.455 in the ensuing days, despite the company reporting a 36% rise in revenue and 20% increase in operating profit (EBITDA) for the half compared to the previous period. Admittedly we were disappointed by the slowing organic growth, which we estimate was around 9.6% for the first half. This is short of the double digit organic growth rates we had come to expect from BigAir. The market reacted negatively to this, and to the lower headline EPS figure, which was due to the timing of shares issued for the two most recent acquisitions and timing of revenue and cost synergies which are yet to be gained from those two acquired businesses. Although we thought the result was poor, it did not warrant such a severe reaction in the share price and we are not about to sever our relationship with BigAir.

So looking behind the set of numbers, we felt organic growth was below par in the fixed wireless division with some wholesale channel partners reporting patchy results and potentially increased competition in metro regions. The student broadband side of the business continues to show solid organic growth despite pressures from the high Australian Dollar. Going forward, we are watching for signs of improved organic growth levels in both divisions. Underpinning this will be a higher proportion of direct corporate customers following the Link and Allegro acquisitions, leverage into the regional growth centres in Queensland and New South Wales, increased penetration into existing BigAir student sites and rollout into new sites.

What interests us more are the two most recent acquisitions made by BigAir, Allegro and Link. On the surface it would appear BigAir paid too much for Allegro, if you just look at the short term financial metrics and the dilutive effect it has to overall group margins. But FY14 is when Allegro will really hit its straps. Transition off third party networks onto BigAir’s own backhaul takes time and will continue to progress as these contracts expire. Allegro also adds an additional 8,000 beds serviceable under the student broadband division with penetration rates half that of BigAir’s existing sites. We think improved marketing and customer service should see penetration rates improve dramatically over the next 12-24 months. Another key benefit of the acquisition is the exclusive agreements with Student Housing Australia and Unilodge who are looking to rollout new sites.

The Link acquisition, whilst it also dilutes margins in the short term, provides BigAir with access to faster growth regional centres and increased direct corporate relationships. We think investors need to look past the headline numbers for FY13 and see that the acquisitions will make a meaningful contribution in FY14.

At Microequities, we are long term business partners with our invested companies and we tend to look beyond the short term financial results. We are more interested in whether the company will continue to grow its profits and free cash flows over five year plus horizon, instead of reacting to half year and yearly profit reports. Only when the investment case significantly deviates from when we first invested in the company, or when the market places an overly optimistic view on the company’s prospects, do we consider reducing our position. With BigAir, we are looking for a pickup in organic growth and expect that FY14 will see the full benefits of the Allegro and Link businesses. Good things, sometimes take time.


Disclosure: Microequities Asset Management is a substantial shareholder in BigAir Group Ltd.

Microequities Asset Management is a value investor specialised in Australian microcaps. Its flagship fund –the Deep Value Microcap Fund-- has a 5 star Morningstar rating. For further information visit microequities.com.au. Content included in this article is not by association necessarily the view of FNArena (see our disclaimer).

DISCLAIMER: This article contains general information only and should not be construed or relied upon as legal, financial or professional advice. Accordingly the recipient should note that a) the advice has been prepared without taking into account the recipients objectives, financial situation or need; and b) because of that, the recipient should, before acting on the advice, consider the appropriateness of the advice, having regard to the recipients objectives, financial situation and needs, and obtain individual professional advice on this matter.