Margin pressure stemming from the NBN will step up for TPG Telecom ((TPM)) as promotional discounts unwind and migration to the NBN increases. Hence, Citi believes it will be strong growth in the company’s corporate division that will stand out from FY20 and offset the NBN impact. This is the main attribute that TPG Telecom brings to the proposed merger with Vodafone Australia.
NBN margins are set to narrow because of rising CVC (network capacity) charges, although Macquarie suggests there is scope for a better outcome if either NBN wholesale pricing changes or TPG Telecom increases its prices. The company has indicated that it may become uneconomic to sell a $60 NBN product if there is no change to pricing.
Guidance for operating earnings (EBITDA) of $800-820m in FY19 is maintained, largely because of an expected increase in NBN access costs in the second half. Excluding $22m in revenue from the Vodafone Australia backhaul contract, corporate data and internet revenue grew by less than 1% in the first half, as management decided to exit the NBN wholesale business.
Ord Minnett calculates this poses a -5% headwind to the growth rate. Meanwhile, corporate margins have benefited from the uplift in revenue from the Vodafone Australia fibre contract as well as the winding back of NBN low-margin wholesale business.
Morgan Stanley welcomes further cost reductions and better-than-expected corporate earnings. Revenue and operating earnings grew by 2.5% and 15.0%, respectively, in the first half, the primary impetus being the scaling up of revenue from Vodafone. The broker estimates the company now needs second half operating earnings of $376-396m to achieve its full year guidance.
First half results were supported by a benign Singapore mobile division, as the company has reached 99% outdoor coverage, amid lower finance costs. Commercial launch in Singapore is expected in December and the company continues to run free trial services.
Ord Minnett pushes out its commercial estimates for Singapore to the second half of FY20. The broker forecasts break-even by FY20 in operating earnings and calculates the venture will require $180m in capital to become positive on free cash flow.
Morgan Stanley acknowledges downside risks include the new business launches in Australia and Singapore mobile, if they fail to attract sufficient consumer interest and remain unprofitable.
Merger
The ACCC (Australian Competition and Consumer Commission) review of the merger with Vodafone Australia is in train, with a decision now expected in May. Several brokers envisage significant downside potential if the merger does not eventuate.
Citi’s earnings forecasts currently assume the merger is blocked and that the company’s Australian mobile network roll-out ceases. Even if the merger does not proceed, UBS suspects TPG Telecom has a Plan B. The broker asserts the cessation of the company’s mobile network roll-out adds complexity and may have created an impasse, as the ACCC will need to form a view on what a stand-alone entity would do with its mobile spectrum and network assets.
UBS values a merged business at $7.50 and TPG Telecom at $5.00 on a stand-alone basis. Morgans believes the deal should be allowed to proceed, as having a stronger and better-funded third operator is better for consumers in the medium term. This remains key to the share price and an investment driver going forward. The broker suggests the share price will rally if approval is granted.
Mobile Network Future
Credit Suisse assesses any upside is more than factored into current trading prices. The broker includes higher depreciation & amortisation in its forecasts, to reflect spectrum not previously factored in, given the decision by TPG Telecom to cease its Australian mobile network roll out following the ban on the use of Huawei equipment in 5G mobile networks.
Morgans suggests, if the merger does not proceed, TPG Telecom will need to liquidate its spectrum or find another use by possibly working out how to reinstate the mobile network. Selling the spectrum to a third party would presumably be at a loss as the company paid a very full price for 4G. Building out a 4G/5G network would also be difficult and more costly than originally expected because of the Huawei ban.
FNArena’s database has one Buy (Morgan Stanley), two Hold and three Sell ratings. The consensus target is $6.50, signalling -10.1% downside to the last share price. Targets range from $5.60 (Credit Suisse) to $7.15 (Morgan Stanley).
