TPG Telecom due for rerating as shares released
TPG, the third biggest telecommunications operator in Australia, is about to be recreated – and quite likely rerated.
It’s a listed company with $7bn worth of shares currently locked up in escrow soon to be freely traded; it’s announced a game-changing part-merger with the market giant; and it’s sitting on $13bn-plus worth of attractive core-plus assets. Is it time to start caring about TPG Telecom?
TPG, the third biggest telecommunications operator in Australia, is about to be recreated – and quite likely rerated. Despite the bloodbath on the stockmarket, a number of analysts and investors think TPG’s share price should be at least 40 per cent higher this year if it pulls off even some of its plans.
The game-changers for TPG are threefold. It has been largely forgotten because its low free float has led to its exclusion from the ASX/S&P 100 and MSCI World Index. That may change next month when 64 per cent of the company’s shares – held in escrow since the merger with Vodafone Hutchinson Australia – become available for sale.
On top of that 64 per cent, Washington H Soul Pattinson owns 12.6 per cent, and managing director Todd Barlow is one of those expecting a strong share price rise as soon as this year.
“There is currently an issue with the perceived overhang of shares that could come to the market,” he said. “The conundrum is that the very fact these shares are coming out of escrow is depressing the share price, and because it’s depressing the shares, they won’t actually come to the market because the price isn’t right to sell.”
As soon as liquidity increases TPG will be back in the indexes. Vodafone has said it will exit its non-core assets, and it’s believed Hutchinson would like to as well. The reclusive billionaire David Teoh, who started TPG, is also a likely a seller. But all at the right price.
When this is all done, TPG’s market capitalisation is expected to rise significantly from its current $10.9bn.
But timing is everything, and investors are right to be cautious in the short-term. When Teoh sold 3 per cent of the combined TPG last December, the most he could offload as part of the deal with Vodafone, the company shed $1bn in market value.
So while the likes of WHSP and Evans & Partners believe the shares could rise more than 40 per cent this year, others including Morgan Stanley think if all three major shareholders sell their shares in escrow at once, TPG may drop as much as 20 per cent.
It’s certainly one reason TPG trades at a discount to Telstra. Other reasons have included its high debt levels, which will be significantly reduced through the sale of its towers to OMERS for $950m, and its confusing mishmash of brands and strategies acquired through the merger. The merged entity’s brands include Vodafone, TPG, iiNet, AAPT, Internode, Lebara and felix.
TPG chief financial officer Grant Dempsey will this week host the company’s first investor day since its merger two years ago.
There’s no doubt this timing is deliberate – to beat the July 13 date when a majority of shares in TPG come out of escrow. The company will no doubt be doing what it can to give analysts and investors the tools they need to make a decision if a liquidity event does occur.
He is likely to speak of the need to simplify the business.
“We’re going to proudly be a low-cost value provider to consumer and enterprise, connecting people and businesses,” said Mr Dempsey. “A telco doesn’t have to be front and centre. It just needs to be reliable, low-cost, and work. And that’s where we’re going to get to,” he added. “We will evolve from being seen just as low-priced to providing greater value, but you can only do that and get your returns if you are low-cost. We keep ourselves simple by not doing frivolous things.”
This strategy ties into the second potential game-changer for TPG, which is its proposed regional network-sharing deal with Telstra.
This controversial play, if allowed by the Australian Competition & Consumer Commission, will see TPG shut 725 mobile sites and use Telstra towers instead, making it a bigger player in the regions than Optus, and in return lease valuable low-band spectrum to Telstra.
Optus has come out against the deal, saying it would leave regional Australia worse off.
TPG and Telstra believe it will do exactly the opposite. TPG will have a genuine regional offering, giving regional customers more choice, and making TPG a consideration for city-dwellers who want a mobile phone that also works in the bush.
The ACCC will rule on the proposed regional merger in October and has given Optus an extension to its June 14 deadline to submit objections.
The third and arguably most fundamental factor that could impact TPG is its potential to be rerated as what private capital players call a core-plus asset.
While TPG might be best known for its mobile phone plans and internet, the company has significant quantities of fibre cable covering Australia’s key cities and in-between.
This is what the likes of Brookfield Asset Management, KKR and others are champing at the bit to get their hands on around the world. In New Zealand, Brookfield was part of a consortium that bought Vodafone’s assets three years ago for $3bn. Brookfield and its rivals like the growth in data usage and see it as a recession-proof sector – particularly infrastructure investments such as towers and cables that support data transportation and storage.
Brookfield owns the largest tower operator in France with 7000 towers and active rooftop sites, 5500km of fibre in France, and 41 data centres globally.
Core-plus investments are slightly more risky than traditional core infrastructure investments and garner a higher return of 12-16 per cent compared to 7-9 per cent for core, or an even lower 3-6 per cent for a new asset class known as super-core.
Telstra is already down the path of splitting its business into a ServeCo/InfraCo, and is likely to get a higher valuation for its InfraCo business if the ACCC allows TPG to share its towers.
TPG doesn’t have scale or maturity in its key phone business to consider any kind of split yet. In its better known phone business, there are still eight brands after the merger, plus a myriad of customer IT platforms that need to be streamlined.
The company is also likely to want to grow its infrastructure business further – though clearly not through towers – before such a deal would make sense.
When the time comes, the valuation of its infra business is not insignificant.
Mr Barlow believes it’s important that TPG has sold its mobile towers for 32 times earnings before interest, tax, depreciation and amortisation.
Fibre optic network builder Uniti has just sold at 26 times EBITDA to a Brookfield/ HRL Morrison consortium.
“TPG owns extensive fibre optic cable so why should it eventually not have a Uniti multiple?” asks Mr Barlow. “It currently trades at about seven or eight times, but its fibre optic assets are definitely core-plus infrastructure assets. It’s irreplaceable technology. It’s future-proof. It’s the backbone of mobile phone infrastructure. The Internet of Things will rely on this.”
Ultimately Mr Barlow believes TPG is due for a rerating and should, over time, be valued like core-plus. “We think the share price should be over $8 without even considering TPG and its infrastructure as a core-plus asset.”
It means, of course, that WHSP may have to continue to remain patient with their investment. Whether or not a private equity player sees opportunity is another matter entirely.
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