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Teoh's brave mobile play: Is TPG a buy?

Andrew Main
18 April 2017

By Andrew Main

If the analysts have been mostly underwhelmed by TPG Telecom’s brave move to become Australia’s fourth mobile network, it’s probably because there’s an element of necessity in entrepreneur David Teoh’s decision.

Of the eight houses surveyed by FNArena, only two have the stock as a buy or an overweight.

And two of them – Citi and Ord Minnett – have dropped their recommendation. Citi to Neutral from Buy, and Ord down from Hold to Lighten.

To summarise, last week TPG announced it would raise $400 million via a one-for-11.3 shares issue at $5.25, to help back the $1.9 billion expenditure, of which $600 million would finance a mobile network rollout to reach 80% of Australia’s population.

The Malaysian-born entrepreneur wasn’t up against the wall with his company’s decision, announced last week, that it had bought a swag of 700 megahertz domestic spectrum for $1.2 billion, because it already has a raft of broadband infrastructure that will facilitate the expansion.

To give you an idea of how cheap and cheerful that $600 million total rollout figure is, both Telstra and Singtel Optus lay out more than $1 billion a year on mobile infrastructure in Australia while the third player, Vodafone Hutchison, spends $600 million a year on filling in the holes in its network.

The bulk of the outlay will be $1.26 billion for two chunks of prime bandwidth, for which TPG bid the government a post-2008 world record price of $2.75 per Megahertz per population. (There was some craziness in the US in 2008 when the rate went up to almost $US4 per head, but since then, it’s seldom exceeded $US1.)

That had the expected effect yesterday, the first day of trading since the trading halt was lifted, of lopping almost 18% off the TPG share price, from $6.70 to $5.50.

Clearly, TPG is chasing a meaningful “back of the bus” bundled retail broadband-phone offering. The big selling point for any putative telco titan is to offer a clutch of services at an attractive monthly price, say around $40.

But even with its platform of 2 million broadband customers already, thanks in part to the $1.56 billion acquisition of iiNet in 2015, TPG was until now basically a broadband company. It had a tiny mobile presence courtesy of the iiNet deal, and even that was a headache because TPG had to migrate those customers from Optus to Vodafone at a significant inconvenience because it didn’t yet have its own mobile infrastructure.

Clearly, the carrot for TPG now is to grow a low-cost mobile network thanks to the big amounts of “dark” or unused optic fibre it lays claim to.

They’re talking about how if they merely pick up 500,000 subscribers or 2% of the market, they’ll hit EBITDA breakeven.

And if they can get to 6 or 7% market share (around 2.3 million out of the 33 million phones there are out there), they will be EBIT positive. Bear in mind that even if that 33 million number looks like a pretty full market penetration, Australia’s population is creeping up at around 2.6% a year and every new migrant needs a phone service.

But the stick is that the much derided NBN network has been eating into TPG’s profit margins at a rate which has caused the share price to slip from almost $13 in August of last year to less than $7. That must focus the mind wonderfully.

To digress, there’s been a fair bit of muttering in the ranks of broadband users about the fact that the NBN won’t offer a lot of urban users much of an advantage, if any, on speed.

But like death, taxes, and Christmas, it’s with us and what’s more a lot of people will be compelled to migrate to it as ADSL services are shut down.

But why did Telstra shares fall out of bed (8% in a day) just after the TPG announcement? Clearly, there’s concern about the biggest player losing market share in the all-important mobile space but the other issue out there is that a new entrant may persuade the ACCC – the Australian Competition and Consumer commission – to “declare” roaming facilities on Telstra’s mobile network.

It’s due to hand down a decision by the end of this month.

As with iron ore railways, declaration means the big player has to allow access to smaller players for whom it would be uneconomic to set up in parallel.

Neither Telstra nor Optus, who have spent the most, want to see a declaration by the ACCC. So, it’s inevitably the smaller players who are seeking it, and the more numerous they are (Vodafone Hutchison and now TPG), the more likely a decision in their favour.

The normally very private Mr Teoh hit the phone on Monday to tell the AFR that a declaration would help break the sector’s “monopolistic culture”.

The former computer shop owner, who’s now worth several billion dollars, said there was plenty of opportunity for TPG to capitalise on Australia’s mobile phone market. “I think roaming would help tremendously,’’ he said.

So: is TPG a buy? It’s a tightly run company in a sector that has a great deal of promise but is also subject to regulation, even potentially helpful regulation. That’s one hard-to-control factor and the clear negative is that Australia’s a lousy place to be the fourth biggest player in anything. If you think TPG can avoid the problem that forced Hutchison and Vodafone to have to merge, and TPG’s existing infrastructure should help, it’s worth a look.

But there will probably be a fair few shares floating around looking for an owner until the $400 million issue is bedded down, so there’s almost certainly no rush.

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