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TPG: time to get back in on the Teoh Telco Express

Richard Hemming

Take some profits in TPG but it could be more profitable to hold on for the David & Vicki Teoh ride.

This is a stock has climbed from below 10 cents almost exactly 10 years ago during the height of the financial crisis and at a current price of $8.53 is approaching $10. The key factor in why I think it will eclipse $10 is the Teoh factor.

DON’T BE SHY TO TAKE A PROFIT, BUT IT CAN OFTEN BE GOOD TO HANG ON FOR THE RIDE

One thing we always say at Under the Radar is not to be shy to take a profit, but in the case of TPG, whose stock has climbed 50% rise in the past month after some of the short-selling squeeze dust has settled on its merger with Vodafone Hutchison Australia, I would argue that it’s eminently sensible to keep a stake in the David & Vicki Teoh game.

An image of a roller coaster

 

THE GAME CHANGER

The potential merger with VHA should have revenues of about $6bn and gives the company a 20% share in mobile phones and 30% share in fixed line. Although the equity division is close to 50:50 and the debt will be equalised, because VHA is contributing 20% more earnings in theory it seems TPG is getting a better deal. Effectively TPG is paying $7.5bn for $6bn of sunk costs, which is approximately what Vodafone Hutchison invested over five years to create a mobile phone network in Australia. This is a great deal by any measure.

You cannot compare this potential merger to TPG, prior to the deal being announced. Then you had a company that had poured some $1.2bn into spectrum and was on the hook for another $600m to build a subscale mobile phone network. Plus the company was intending to spend another $400m on the Singapore market. The company was looking down the barrel of (again) raising equity, this time to fund its participation in the upcoming auction of 5G spectrum.

THE TEOH BUSINESS MODEL MAKES MONEY

The merger should give Teoh full reign to enhance on an unprecedented scale, his track record of being the low cost operator in the commoditised world of telecommunications. Because of this there is the big possibility that the Vodafone deal will lead this company overtaking Telstra in mobile over the next decade.

Even if it doesn’t there is big money to be made. Of course there are synergies (mainly revenue from cross selling) which could well be a case of one plus one equals three. But this is dwarfed by the industry structure going from four to three, which means instead of a shrinking industry, rational pricing is resuming, which leads to growth. Even if this is one or two percentage points, this is a big deal for an aggressive marketeer like TPG (which is what the merger will be called).

WHAT THE DEAL MEANS

Vodafone’s mobile phone towers will be combined with TPG’s fibre network, which means that the voluminous data being pumped through this system will cost almost nothing, and go straight to the bottom line. The gross profit margins in this business are huge, because of the sunk costs. The combined group will have control where the traffic goes and the ability to keep those customers in its own network.

A SMALL FREE FLOAT THAT WILL BE HIGHLY SOUGHT AFTER

The combined company should have an enterprise value of about $20bn, comprising $16bn of equity and $4bn in debt. The free float is small at $2.5bn, and should be sought after, especially among large cap funds who are desperate to be underweight banks and want exposure to a business whose earnings are resistant to the cyclical ebbs and flows of the Australian economy.

Using rough industry measures for the Lifetime Value of the customer base, such a 25% churn rate and conservative average revenue per user assumptions, suggest that the VHA component could be valued at $10.4bn, which is almost 40% more than TPG effectively paid. This is before you factor in cross selling, although this figure is not discounted back.

THE DAVID AND VICKY TEOH FACTOR

The Malaysian born entrepreneur formed Total Peripherals Group after he and wife Vicky migrated to Australia in 1986. The business imported cables for memory chips and PCs and then moved into being a cut price broadband supplier. It subsequently stepped up into the big league, becoming what we now know as TPG Telecom, after a reverse takeover of the Washington H Soul Pattison owned SP Telemedia.

At the time there were big question marks about Teoh’s ability to turn around SP Telemedia, which had been subscale and going nowhere fast. The merger provided the Teoh with the critical mass to be able to be a national player, or at least closer to one than either group had been.

The strategy after that was to be the low cost player in the broadband and ISP market, which remains the case. This enables TPG to charge lower prices and quickly gain market share.

He has been particularly good at reducing the debt that came with the merger, then making another debt funded acquisition PIPE Networks, paying that debt down and then making other acquisitions AAPT and iiNet, and doing the same thing.

A BOX SEAT IN AUSTRALIA’S TECHNOLOGY FUTURE

Now we come to Vodafone Hutchison Australia. Teoh’s stake in the combined entity will be diluted through the deal from 35% to 17.1%, but the 20% market share in mobile phones gives this company a box seat in Australia’s telecommunications future.

About the Author

Richard Hemming

Investment analyst and Editor of Under the Radar Report

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