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Long rumoured and often denied, TPG and Vodafone have finally revealed their plan to create a new $15bn competitor in the Australian telco market.
The deal itself is rather conventional. TPG will own 49.9% of the merged entity with Vodafone Hutchinson Australia (VHA) owning the rest. Vodafone’s chief executive Inaki Berroeta will lead the new group with the enigmatic David Teoh taking a non-executive Chairman role.
Interestingly, the new group – which will retain the TPG Telecom name – will hold just $4bn in net debt, which is half of the net debt owed by VHA alone. This implies that VHA’s parent companies will absorb a hefty chunk of debt to leave the group well capitalised.
The Singapore operations, which comprise spectrum and an almost complete mobile rollout, will be distributed to existing TPG shareholders before the merger. They won’t be included in the new company’s asset base.
The new business will have Vodafone’s rebuilt, nationwide mobile network and TPG’s impressive fibre and broadband footprint. Together, these will make a formidable combination.
In typical TPG style, the detail around strategy and synergies was incomplete, but we can infer a bit about what the new group will do and how it might operate.
A key benefit will be better utilisation of the Vodafone mobile network. Having spent almost $6bn on the network over the past five years, this isn’t the joke it once was and it now competes effectively with Optus and Telstra in terms of reliability, speed and reach.
The mobile network currently generates earnings before interest, tax, depreciation and amortisation (EBITDA) margins of about 27%. Considering Optus generates 30% margins and Telstra boasts 40%, this is low, explained by low utilisation on a high fixed cost asset base.
In other words, Vodafone doesn’t have enough customers. TPG will no doubt help in that regard.
TPG’s remarkable success has been built by harnessing quality fixed assets and then using its cost advantage to fill those assets with customers and reap the benefits of scale.
As we like to point out, TPG’s broadband business generates the same margins as Telstra while charging half the retail price. That kind of operating nous can now be focused on the mobile network to attract customers and boost margins which should, in time, exceed 30% on a larger revenue base.
Then there are the bundling benefits. Cross-selling often deserves derision but, in telco land, it’s a proven way of lifting average revenue per user (ARPU) and lowering churn. For the first time, TPG and Vodafone will be able to offer genuine mobile-broadband bundles, like the ones that have been so successful for Telstra.
We also have high hopes for larger corporate sales. TPG has built an impressive corporate business from nothing and it now contributes about 40% of its revenues. Until now, Telstra has faced little competition to its corporate sales but Vodafone should now be able to tap into TPG’s corporate channel and compete in mobile.
There is plenty of room for the merged group to lift revenue and lift margin. We note Vodafone’s fatter expense line and suggest it may look trimmer in a few years.
The merged group will have a 20% market share of mobile and a 22% market share in broadband and we expect those shares to increase following the merger.
An important feature of the new group will be access to shared spectrum and, with 5G spectrum auctions kicking off soon, the entire industry will be relieved that three, rather than four, bidders will vie for limited bandwidth.
Telstra’s relief should be temporary. The new TPG will be a far more formidable competitor. The small cell network envisaged by TPG will still go ahead. It will now be backed by a full scale national mobile network and the second largest fibre network in the land. In terms of cost, aggression and capital allocation, TPG is far superior to Telstra.
Today’s news does nothing to temper our view that Telstra, although it remains a decent business, will face a more competitive future. The potential for the merged TPG and Vodafone needs to be examined in more detail and we'll do that following reporting season.
Since our initial upgrade eighteen months ago, TPG has been an almost permanent feature on our Buy list at between $5 and $7. Those now look like bargain prices, with the stock up anywhere from about 30% to 80%.
We're removing our price guide pending a more detailed review but, depending on when you bought, you may be bumping up against our maximum recommended portfolio weighting of 6%, in which case we'd recommend taking some profit. Otherwise, TPG remains a comfortable HOLD.
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