MNF Group (ASX:MNF)

Taking from the box

Leading VoIP provider, MNF Group (ASX:MNF) has announced it will buy the wholesale and enablement business of Inabox Group. The deal would be immediately accretive as it will bolster MNF’s wholesale telecom services to the retail service provider market while also complementing its mobile offerings. We are pleased with this development considering that MNF has, over the years, done a great job in growing its business via acquisitions and the proposed deal looks to be another good one.

What’s New?

In our previous coverage of MNF Group (ASX:MNF) back in September (FAT-AUS-889), we reviewed the company’s FY18 results. They showed decent revenue growth, with the top line up a healthy double-digit pace of 15%, however net profits saw a disappointing 1.7% drop to $11.9 million, largely due to a higher tax impact and increased investment in Pennytel for future growth.

Consequently, the share price took an 18% drop following the release. The shares did eventually stage a minor recovery and we took the opportunity to take profits off the table.

Since then and as we pointed out in the Daily correspondence last week, the company has announced that it entered into an agreement with Inabox (ASX.IAB) to acquire certain businesses and specifically IAB’s Wholesale and Enablement assets.

IAB Acquisition

The terms of the arrangement focus on IAB selling all its operating subsidiaries which covers its ‘indirect’ wholesale telecommunications (telecom) business and its enablement services business, along with the Telco-In-A-Box, iVox, Neural Networks, Mobile Services Solutions and Symmetry Networks brands to MNF Group for a consideration of $30.5 million and up to $33.5 million, all in cash with the upper limits based on earn out conditions being met and the working capital needed.

IAB’s exit was based on its issues stemming from the failed Hostworks acquisition, a hosting provider, which caused it to post a $13 million net loss and retrench 10% of its staff. MNF’s acquisition, however, won’t involve the ‘direct businesses’ Hostworks or Anittel which IAB already sold to 5G Networks in early August for a $5.7 million consideration.

Source: 10 October 2018 Company Presentation

The $3.0 million ‘Earn Out’ bonus will be paid in 3 tranches and is based on a successful commercialisation of the enablement services, Octane, which provides a full operational outsourcing system for voice, data and mobile for other retail brands. The operational system also includes networks, operational support and billing services and, last year, generated $7.9 million.

The ‘indirect’ wholesale business which mainly provides telecom services to the channel brings in the lion’s share of revenues, at $45 million last year. The ‘indirect’ business currently services about 500 wholesale customers across varying regions in Australia. We are also pleased to note that there is barely any overlap with MNF’s ASX filing indicating that both companies have only 21 customers in common. This may impact revenues by around $1.6 million when consolidated.

Source: 10 October 2018 Company Presentation

The acquisition will also involve IAB’s 84 remaining staff in Australia but will not include IAB CEO Damian Kay and CFO Deborah Zimmer.

Though MNF management didn’t provide a timeline or target date for completion of the acquisition, IAB management did mention that they expect it to be completed around 30 November, following their next General Meeting sometime next month and provided shareholders agree.

We believe this transaction will likely push through, considering that the IAB Board voted unanimously in the deal’s favour and with IAB shareholders expected to receive up to A80 cents, which is a substantial 70.2% premium to its 3-month volume weighted average price of A47 cents if it includes the ‘earn out’ bonus.

Moving on and according to a separate filing by IAB, the current deal includes MNF paying $28.0 million upon the deal’s completion and another $2.5 million will be in escrow until 30 June 2019.

The $2.5 million figure held in escrow will be reduced if a higher working capital figure is needed while there is also a relatively small reserve for any possible liabilities arising from legacy “Indirect Business Liabilities”. According to IAB’s filing, they expect some $1.5 million up to $1.7 million will not be paid out of the escrow due to these issues.

MNF management also noted that the acquisition will be funded from the company’s existing revolving debt facility which currently has a $27 million limit but will be raised to $51 million upon completion of the deal. Management estimates Net Debt to expand from the current $4.9 million to $33.9 million and Gearing to more than double, although it will remain moderate at 1.7 times.

MNF (ASX:MNF) expects the acquisition to boost revenues by $55 million and generate some $4.2 million in EBITDA for the entire FY19. However, since the timing of the deal will fall within FY19, management expects a smaller, though still accretive, contribution, covering only 7 months as indicated in the graphic below:

Source: 10 October 2018 Company Presentation

We believe that this deal will ultimately benefit the company as it will make MNF the largest provider of wholesale telecom services to the retail service provider market in Australia and will also complement its long-term relationship with mobile players like Telstra’s Belong (~260k subs) and ALDIMobile which has circa 1 million subscribers thanks to its bulked-up telecom enablement portfolio.

Guidance update

Management also updated its guidance estimates for FY19 and onwards to include the impact of the IAB deal. As noted above, the FY19 forecast includes 7 months’ contribution from the deal and includes funding costs and estimated amortisation expense.

Source: 10 October 2018 Company Presentation

It seems that EPS growth for FY19 is slated for a muted 7.3% increase on FY18’s A16.3 cents result though before a much larger 28% increase in FY20. The market reacted negatively to the guidance.

Turning to the charts, and the technical picture has weakened. On the daily chart, prices have entered a corrective phase of the overall technical cycle after printing a high of $6.90 earlier in the year, as marked by the horizontal red line. Support has also given way at the $4.89 region. Dynamic resistance at the 50-day moving average (red line) at $4.98 has also failed to hold. The 2018 low of $4.51 stands as the next buttress.

With reference to the monthly chart, structural support was recently breached at the $5.03 region as shown by the horizontal blue dashed-line. In the grand scheme of things, a solid long-term uptrend remains intact as evident from the series of higher lows and higher highs since 2012. This however will need to be watched.

Summary

MNF Group (ASX:MNF) has, over the years, done a great job in growing the business via acquisitions and the upcoming deal with Inabox seems to be another good one in our view. The deal covers Inabox’s ‘indirect’ wholesale business which includes up to 500 wholesale customers and this will grow MNF’s market share in the wholesale telecom services to retail service providers. The deal is expected to be immediately accretive and complement MNF’s mobile offerings.

The market seemed underwhelmed with initial guidance and the technical strength is tepid, so we there may be some more room for retracement in the months ahead.

Nevertheless, having already taken some profits earlier and still viewing MNF’s potential as solid over the longer term, we recommend HOLDING MNF Group (ASX:MNF) at this juncture.