By Paul Rickard

Investors in Australia’s leading second tier telco, TPG Telecom (ASX Code TPM), must be starting to believe that TPG is now in the “too pricey for growth” category, as the market has smashed TPG’s share price from a high of $12.93 on 29 July to yesterday’s $7.14. That’s a fall of over 45%!

TPG Telecom Share Price - Last 12 months

 

TPG’s share price slide stems from disappointing the market with its profit guidance for the FY17 year. Although TPG’s FY16 results broadly met expectations, TPG said that it expected an underlying EBITDA of $820m to $830m in FY17 compared to $775m in FY16. This represents a growth rate of 6% to 7%, which is interesting, but hardly inspiring for a company trading on a high multiple.

The forecast also acted to support concerns that competition is intensifying in the telecommunications industry, pressuring margins. Competitor Vocus’s fall from grace has also hurt, with TPG losing 9% on Tuesday following Vocus’s profit warning.

The TPG business

TPG, which is 34% owned by David Teoh and his family, has three major business units. iiNet, which was acquired in August 2015, TPG Consumer and TPG Corporate. Earnings are split evenly, with iiNet earning $242.6m, Consumer $255.7m and Corporate $269.3m.

Composition of EBITDA Growth

 

TPG Consumer has 885,000 broadband subscribers and 304,000 mobile subscribers. With iiNet, this gives the group 1,868,000 broadband subscribers and 475,000 mobile subscribers. Despite these impressive numbers, growth is slowing - with broadband subscribers growing by 1.4% over the half year, and mobile subscribers by 2,000, or just 0.4%.

Group Broadband Subscribers

Revenue per subscriber has plateaued, with ARPU (average revenue per user) from NBN customers falling from $67.40 per month in the first half to $67.20 in the second half. There were similar falls for on net ADSL bundles. With subscriber numbers also stalling, revenue growth in the second half was almost flat compared to the first half, and second half EBITDA in TPG Consumer of $130.6m was up by just 4% (or $5m) on the first half.

TPG’s Corporate division includes the old AAPT business, and provides services to business and wholesale customers. Its infrastructure includes overseas submarine cables and a national core network of fibre connecting the major capital cities. It grew underlying EBITDA by 11.1% in FY16. 

With a view to long term growth, TPG is participating in a mobile spectrum auction in Singapore, where it is one of two remaining bidders. It says that should it win the auction, it will move quickly to establish a substantial operation in Singapore, which it will fund from existing debt facilities and cash generated from Australian operations.

The Brokers view

On valuation grounds, the brokers are largely positive on TPG. The current price of $7.14 sits well below the current consensus price of $9.40, implying potential upside of 32%. Many see the price fall as excessive. That said, several brokers reduced their target price following the FY17 profit guidance.

The main concerns centre on intensifying competition in the consumer business, in particular margin compression as the NBN rolls out, and trading multiples given the (now) single digit EBITDA growth rate.

Individual recommendations and targets (source: FNArena) are:

On a forecast basis, TPG is trading on a multiple of 15.6 times FY17 earnings, and 14.3 times FY18 earnings. The dividend is forecast to be 15.5c in FY17, putting the stock on a yield of 2.2%.

My view

Any stock that falls 45% must be interesting, particularly when it has largely delivered on its targets. The only thing that has changed is that the market’s growth expectations were way too high, and perhaps a growing realisation that competitive pressures in the telco industry are intensifying.

However, unless management is being very conservative about their forecast, the lack of EBITDA growth does surprise and I am struggling to get that excited about it. A swing factor that could go either way is that according to the latest ASIC figures, 3.74% of the company’s shares (or 31.7m) are sold short. While this is not that high, almost 60% of the company’s shares are under the control of two shareholders - the Teoh family and listed company, Soul Pattinson (ASX: SOL). While the shorters more often than not get it right, a short squeeze on some good news could see a very sharp appreciation in price.

One to watch and perhaps put on the buy list if it gets hit again.