Another potential reunion
In last week’s report we covered off Vocus Group as a traffic light, with the stock having been one of our more satisfying recommendations in recent years, getting exposure around the bottom, and selling out close to what has proved to be a top. We discussed how a significant loss in shareholder value, more appealing investment metrics, along with the prospect of new management, and a lower debt load, gave cause to put the company back on our watch-list, with a view to potentially re-entering the stock.
This week we cover off another telecom, in bedfellow TPG Telecom (ASX:TPG), with which we have also experienced strong success. Indeed, the stock rates as one of our best performing recommendations in recent years, with the final exit yielding a return of more than 1100% on our original recommendation.
There are certainly some similarities with Vocus, but also some notable differences. The fall in shareholder value has not been as great with TPG since its top, but has certainly been significant nonetheless. From a peak in July 2016, the shares lost 60% of their value to the low point last October. A recovery has been seen since, but the shares remain more than 50% below their all-time highs.
We originally gained exposure to TPG through SP Telemedia, which traded under the Soul brand. The company was swallowed up by TPG and was the first of many deals. Our original buy entry into TPG was 92 cents, and we were happy staying with them for a number of years, as the company pursued acquisitive growth as well as organic gains.
We did make a number of take profit recommendations along the way, and finally called time on TPG in September 2015 for a gain of 1142% including dividends. As with Vocus, we were impressed with the overall performance of the company and the stock, but there were some warnings bells on the horizon in our view, which could lead things to turn south.
A key concern of ours (again as with Vocus) was a burgeoning debt load. TPG bought AAPT (off Spark New Zealand) and iiNet in quick succession, and total debt ballooned to close to $2 billion, which in our view would significantly weaken the company’s free cash flow and liquidity position over the next few years.
Also again as with Vocus, we became concerned that TPG had gone from being a value play to a high priced growth stock (and more vulnerable to disappointment). At the time of our sell call, TPG was trading on 33 times the next year’s earnings with a low dividend yield of just 1.1%.
We also noted that ironically, following the merger between Vocus and M2 Group, TPG would soon have a somewhat bigger rival to look over its shoulder at. We were also concerned that TPG may look to ‘trump’ this by buying more growth through further deal making which would add to an already sizeable debt mountain. These concerns also started to be priced in by the market, as the company delivered some reasonable earnings results, but not as strong as needed given the company’s valuation.
Also as it turned out, TPG (ASX:TPG) went a step further on pursuing growth, and a year ago announced that it was looking to take on even bigger rivals, buying up 4G spectrum, and announcing plans to invest $1.4 billion in a new network. The company launched a $400 million entitlement offer and the market not surprisingly surmised that TPG was biting off more than it could chew.
The shares were re-rated downwards accordingly, with the shares dipping below $5 late September/early October. The bottom though now looks to have come in not long after the company’s full year results, which offered some encouragement on a number of levels. Certainly looking back the trends were impressive, with 2017 delivering the eighth consecutive year of revenue and profit growth.
Source: TPG Telecom (ASX:TPG) AGM Presentation
The company saw full-year profit rise 9% to $413.8 million in the 12 months to December 31 2017, on a 4% rise in revenues to $2.5 billion. Turnover was boosted by iiNet, and divisional performance was generally strong. Underlying earnings rose 8% to $835 million which was ahead of the company’s $820 million to $830 million guidance range issued in April.
Source: TPG Telecom (ASX:TPG) AGM Presentation
There was however a ‘but’ coming, and (similar to Vocus) management slashed the dividend from 7.5 cents to 2 cents a share. The company warned that it faced mounting costs in the year ahead as customers migrate to the national broadband network.
Executive chairman David Teoh went onto say that shareholders would ‘benefit’ in the long-term from a “fiscally prudent” decision to put cash into the new mobile phone network it had previously announced. Robbing Paul to pay Peter anyone?
Unlike Vocus though, the market, post the result, seemed to acclimatise to the prospect of lower (and not nil) dividends, and indeed lower near-term earnings. The company has forecast that 2017/8 earnings will come in between $800 million and $815 million, with around 400,000 to 500,000 fixed line subscribers expected to shift to the NBN.
The company though expects its mobile network to be up and running in parts of Sydney, Melbourne, Adelaide, Brisbane, and Canberra by the middle of this year. Management also stuck to an initial capex guidance of $600 million over the next two to three years for the mobile network, covering 80% of the population. This is also on top of the $1.26 billion TPG paid for a slice of the 4G mobile spectrum.
TPG (ASX:TPG) has over 21,000 kilometres of fibre optic cables installed across the country, with an expected 2500 mobile sites at $240,000 a site. Although significant, management didn’t say when the project was expected to break even. The company also has its eye longer term on the evolution of 5G.
The problem though, as we see it, is the margin attrition that the company will have to wear in enticing customers to move to a new network. Arguably this is a commodity, but branding and known reliability are also relevant. We suspect that free trial periods, unlimited data and bundling discounts will be in heavy use. Indeed, the company has already said that it will offer six months of free mobile services to people in Canberra that migrate, which is the first city on the rollout.
TPG (ASX:TPG) is also not content with targeting growth at home, and also has a major mobile network rollout planned in Singapore. Nationwide, outdoor service coverage is targeted for December 2018. The company is targeting a capex spend of SG$200 – SG$300 million (SG$1 = 0.97A$) and has spent SG$125 million on spectrum there. TPG is looking to become the fourth provider in the Singaporean mobile market alongside operators Singtel, StarHub, and M1.
There is no free-lunch as they say, and while TPG’s cash flows are strong, they are not strong enough to meet its investment plans. Free cash flows last year came in at $119 million. Group debt had declined to $900 million, but this downward trend is set to reverse. This is a differentiating point as opposed to Vocus.
Source: TPG Telecom (ASX:TPG) AGM Presentation
Post the year-end, the company has increased its total facilities by some $750 million to $2.385 billion. Management made much of the fact that ‘improved pricing and terms’ had been secured, but the reality is TPG’s debt mountain is about to get somewhat steeper.
Another key point with respect to TPG relative to Vocus is that new management is not on the table as a re-rating catalyst. Indeed at the company’s AGM, CEO Teoh highlighted the “remarkable stability of [our] senior management team” with an average tenure of 17 years.
Turning to the daily chart, prices are in flirtation-mode with the 50-day moving average (red line) of $6.18. A decisive break above this indicator would lift short-term upward momentum, and thus give rise to an eventual ascent towards the next band of resistance sighted between $6.41 and $6.52. This is made up of the 50% and 61.8% Fibonacci retracement respectively. From a medium-term momentum perspective, this remains in favour of the bull-camp, as backed by the bullish moving average crossover present since December 2017. This is when the 50-day moving average (red line) crosses above the 200-day moving average (green line).
With reference to the monthly chart, support is located at the September 2017 low of $4.86 as marked by the horizontal solid-blue line if the bears were to maintain downward pressure over the near term. In order for the long-term technical outlook to improve, a sustained break above the March 2017 high of $7.03 as shown by the horizontal red line is required. Should this occur, then medium-term momentum would shift in favour of the bull-camp. However, it should be noted that technical damage has been done, and therefore, any rise in the share price will likely be slow-coming.
Summary
In considering the case of TPG Telecom (ASX:TPG) there are certainly some similarities with Vocus. TPG is a stock we did very well on, and the final exit proved to be not too far off the top. The shares have lost significant value since as many of our fears proved to be well founded.
However, our original concern over the company becoming too big for its boots, and the debt load a large one, has not changed – if anything the risks are much greater. Technically the shares are displaying positive signs but the valuation is also going up rather than down. The FY18 earnings multiple is 15 times, rising to 20 times in FY19 on rising costs.
There is some cause for interest though, and we will certainly be following the company’s interim results which are released next week. We are putting TPG Telecom (ASX:TPG) on a traffic light alert.
