TPG results strong after recent iinet acquisition

TPG key statistics: ASX: TPM

Closing share price 28.03.17: $6.870

52-week high: $12.930

52-week low: $6.050

Most recent dividend:8 c

Annual dividend yield: 2.26%

Franking: 100%

What's new?

TPG's recent interim result showed that broadband margins are shrinking, as expected, but the acquisition of iinet, build-out of independent fibre, growth in the corporate business and potential ventures in mobile all go some way towards offsetting the decline.

In aggregate, revenue grew 9% while earnings before interest, tax, depreciation and amortisation (EBITDA) grew 28%. Some of this increase was due to expanding margins from bringing iinet customers onto TPG infrastructure, but cost-cutting was also significant. iinet now generates an EBITDA margin of 26%; before being bought by TPG it made just 18%.

By contrast, TPG's consumer business generates an EBITDA margin of 38%. With lower levels of service, we expect that TPG's margin will always outstrip iinet's, but the two should continue to converge.

The corporate business continues to perform strongly, increasing revenue by 4%, EBITDA by 7% and expanding the EBITDA margin from 40.6% to 41.8%.

The corporate business enjoys high incremental margins because of the low marginal cost of signing customers on to existing fibre services.

It has helped that customers are choosing to leave low-margin voice services and signing on to higher-margin fibre services. As a reminder, the corporate business, which accounts for about a third of EBITDA, won't be impacted by the NBN.

The same can't be said of TPG's consumer business. Although NBN subscriber numbers are currently just 15% of total broadband customers, that will grow as NBN access increases. ADSL margins of 40% will be replaced by NBN reseller margins that are much lower.

TPG is growing its fibre to the basement business (FTTB) product, a clever idea that bypasses the NBN and earns splendid margins, but that opportunity is limited to about 500,000 households.

To date, FTTB has successfully offset margin decline and TPG reported surprisingly high broadband EBITDA margins of 40%. That will fall as the take-up of NBN accelerates. We expect margins to eventually fall towards the mid-20% range.

High reinvestment rates combined with uncertain rates of returns mean this recommendation relies to a degree on our faith in management. A splendid track record helps in that regard and, with an enterprise value to EBITDA multiple of less than 9, TPG is attractive enough to start building a position. BUY.

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