Today I’m going to do a first pass on three growth Telcos; M2 Telecommunications Group Limited (ASX:MTU), Pipe Networks Limited (ASX:PWK) and iiNet Limited (ASX:IIN). Two of them rank in the top ten Austalian Telcos, the third’s growth could see it in that group within a few years.

Why these three?

• Hunter Hall disclosed a large position in MTU back in April, topped up in May and again in June taking their holding to 12.3%.
• A telco lawyer friend mentioned Pipe Networks to me when the price was around $1.80. I’ve checked my notes and my cursory look was encouraging, but Pipe slipped through to the keeper. The stock in now up 200%, so I’m hoping it’s better late than never.
• iiNet is my ISP so I’ll call this a Lynchian idea. In reality is was this analysis at PazzoMundo that made me consider iiNet as an investment opportunity.
• All three have high growth rates, outstanding management and excellent growth prospects.

By the numbers

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Diving Deeper

M2 Telecommunications Group Limited (ASX:MTU)

M2 is a provider of a full suite of telecommunication services to small and medium enterprises and wholesale customers in Australia and New Zealand. Founded Dec 1999, listed on ASX in 2004 it has grown quickly to become the seventh largest Australian telco.

The MD Vaughan Bowen sold 19% of his holdings in early September for $2.5M. With the share price rising so quickly this year, from mid 40c to over $1.20 it’s not surprising that the MD has decided to take some play money.

This investor presentation of the full year results is a good starting point.

• Excellent year on year growth, though with NPAT up 45% and EPS only up 37% there must have been some heavy dilution, that’s worth looking at. Strong balance sheet with modest debt. Strong and growing cash flows, thought they only grew 13% YoY, so need to check why.
• Eight consecutive years growth in EPS and DPS.
• Ont the retail side MTU has $250M recurring revenues (I like those) from 100,00 customers. From wholesale $110M recurring revenues from 250 customers.
• Acquired People Telcom and Commander in April and June 2009 respectively. People Telcom $2M + 28.6M MTU shares (hence the aforementioned dilution), Commander $19M cash plus inventories.
• 2010 guidance: EPS growth 55% to range of 13.3-14.3cents, while NPAT up 100%. The difference is due to shares issues to People Telecom this year.
• Dividend policy is 70% of NPAT, which is forecasted in range of 14.5-15.5cents. Consequently dividend should be around 10.5 cents giving MTU a tasty forward yield of 8.5%

BRR Presentation

• Good organic growth in wholesale business and slightly positive on retail.
• Good integration of recent acquisitions.

2009 Annual Report

• Acquired Orion Telecommunications in October 2007 and Unitel Australia in Feb 2008. The 86% revenue growth came from combination of organic growth in wholesale and those acquisitions. Anyone know the breakdown?
• 3 cent franked final dividend record date 15 October 2009.
• Revenue run rate now $360M
• $70.3M intangibles and goodwill from their acquisition strategy. Backing those out, net assets fall from $48.5M to -$21.8M. I must check if M2 are actually creating value.

While the P/E ratio is overused by investors and of questionable merit it does provide a quick snapshot of the prices investors have been willing to pay. In the above example, if we take the mid point of FY10 forecasts, 13.8 cents we can multiple that by 20 for a quick and dirty one year upper target price of $2.8, the current P/E will see a price of around $2. Those rough figures point to potential capital gains of 60-125%. I stress these are rough figures and only intended as part of  a super quick impression for how much analysis effort I should put in.

The other reason I like this chart is it quickly tells me whether the share is likely to have ratio expansion on top of the growth opportunity. It is the double bang of expanding multiples and growth that most often leads to significant outperformance over one to two years.

M2 Telecommunications Analysis Part Two: Acqusitions and Valuation

iiNet Limited (ASX:IIN)

iiNet is a fast growing ISP and pips M2 by one place in the Telco league, coming in at sixth largest behind Telstra, Optus, Vodafone Hutchison, AAPT and SP Telemedia.

iiNet’s 2009 Results Presentation

• Strong balance sheet, gearing at 7% and 18x interest cover
• Growing customer base, up 10% YoY, naked customers up 123%.
• Access to lower cost bandwidth from FY10
• Churn down 25 bps to 1.83% per month. As an existing customer I am very happy with their service and new products.
• $20.9M in FCF
• Broadband market share now 8%

The major growth in 2009 came from the acquisition of Westnet. Though like all acquisitive companies they are quick to promote their organic growth. iiNet have began marketing in more states, Victoria and Queensland, and with the business processes in place to support growth they should be able to leverage their model. They should profit from the NBN.

iiNet are an innovative company and I have only heard glowing comments about the MD, Michael Malone. Interestingly he too has been selling shares; the release highlights the good reason behind the share sale.  iiNet were buying shares back early this year and with the share price up over 80%  they have been suitably rewarded for their capital management acumen. They regularly launch cool new services and products like BoB, the all in one doodacky for your communication needs.

Pipe Networks Limited (ASX:PWK)

PWK is all about the pipe. In their case 1,300km of the ‘thickest’ domestic network in Australia and their new Sydney to Guam cable, PPC-1, which will be operational in October. An investment in Pipe is an investment in the growth of the internet. I don’t even need to dig into their numbers to know they have huge growth ahead, the question is, as always, the price.

Let’s start with Pipe’s 2009 Results Presentation

• Stack of industry awards.
• Good growth across the board. Fibre utilisation up from 22% to 25%.
• Since 2005 they have achieved the following CAGRs; revenue 81%, NPAT 88%, EPS 62%, DPS 59%. According to them that “growth is underpinned by a diverse set of long term annuity customers”.
• Over 370 customers across Telco/ISP, corporate and government. Top 20 account for less than half revenues.
• Domestic network expanded 18%, now 1,300km
• PPC-1 will generate FCF in FY10 and be operation 8 October.
• Guidance. Revenue $92 – 96M an 86% increase, NPAT $20.5 – 21.5M a 100% increase, maintain current dividend level while investing in PPC-1.
• Self funded PPc-1 increased debt to $35.2M and gearing to 38%. They say interest cover is 33.7, which greatly differs from my other figures, need to check that.

2009 Preliminary Annual Report

2008 Annual Report

Mo-mo is in the house. I wouldn’t have been surprised to find Pipe’s MD Bevan Slattery selling shares at these prices, but it appears he still hold his 8M shares, around 14% of PWK.

Conclusion

Pipe Networks looks like a fantastic story, but the price is a tad rich for me. iiNet and M2 look attractive at current prices and I will be digging deeper into their stories and valuation. The current yield of MTU and their growth send them to the top of the pack. I did email M2’s MD Vaughan Bowen about his large share sale and why EPS growth will be considerably lower than NPAT in FY10, but as yet have had no reply. I’ve been told Mr Bowen is well respected in the industry and a nice guy who is smart with a fair amount of vision. I’ll stick with that impression for now, but if he’s not polite enough to reply to my email I’ll be scrubbing nice off the list . His $2.5M sale is the sort of figure he’d need if he was buying a new house, so maybe the story is as simple as that. [Update: I have now received a reply from My Bowen and I'm very happy to leave nice guy on the list, due to limited time I'll share his comments in another post.]

All three companies should continue to show impressive growth over many years. Owning the physical network asset gives Pipe the widest moat and if I get a better value point I’ll be interested in buying. iiNet and M2 are building large satisfied customer bases, which should provide them some price strength in what is sure to become an even more competitive market.

Finally here’s the comparative performance of IIN, MTU and PWK since the start of 2008, FWIW.

Disclosure: I currently have no positions in any of the above highlighted stocks, but may have by the time you read this. I do have a position in Telstra.

As always do your on research and don’t rely on anything posted here as it is for entertainment purposes only. Admittedly I’m confused about who is meant to be entertained. While I try to ensure all the facts and figures are correct they might not be etc etc etc.

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3. M2 Telecommunications Analysis and Valuation
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