The looming margin crunch from the NBN

Morgans Financial Limited

TPG Telecom (TPM) have made significant progress in reducing iiNet costs and trying, where practically possible, to offset the looming margin crunch of NBN. That said we expect it's difficult to avoid and 2H17 will show this. Consequently we have decreased our share price target and we retain our Reduce recommendation

1H17 result at a glance

On an underlying basis TPG Telecom (TPM) reported 8% revenue growth and 13% underlying EBITDA growth year on year (yoy), including a big improvement from iiNet. Given the substantial uplift in capex, it was surprising that depreciation and amortisation were lower in 1H17 than 1H16 but this appears to be largely a timing issue and will step up in future years. TPM's normalised EPS was up 25% yoy to 24.5c and the dividend was up 14% yoy to 8.0c. Both were ahead of expectations.

TPM noted that in 1H17 Fibre To The Building (FTTB) helped offset NBN margin pressure but they do not expect this to continue into 2H17. TPM's FY17 guidance was reiterated and shows that underlying EBITDA will decline 1% to 4% from 1H17 to 2H17 as headwinds increase.

Noteworthy items

We estimate TPG's standalone EBITDA growth was 3.9% (excluding the A$34m EBITDA improvement from iiNet and the A$47m profit from selling TPM's VOC/AMM shares). Over the half 98% of operating cashflow was poured into capex (including purchasing Singaporean Spectrum, the Vodaphone fibre rollout and TPM's Fire To The Basement rollout). TPM netted A$124.5m in cash including a A$47m profit from selling non-core VOC stock (originally AMM stock). This windfall allowed TPM to reduce net debt by A$54m in the last six months.

TPM disclosed 25,000 FTTB subscribers, including 10,000 which were acquired from a wholesale customer and 14,000 which were organically added (from either new NBN customers or legacy migrations). TPM added 112,000 NBN subscribers from 2H16 to 1H17 with FTTB take-up looking to be best case around 12.5% (although we do not know how many NBN subscribers were in FTTB catchments).

iiNet the star of the show

Most noteworthy was a 32% increase in iiNet's EBITDA (+A$34m on 1H16) with EBITDA margins expanding from 22% to 26%. iiNet's revenue was up an impressive 8.9% (+A$44m) through customer wins and higher broadband pricing (more sales of higher ARPU NBN plus ARPU increases on the legacy ADSL). Given iiNet's operating costs were broadly flat yoy, EBITDA margin expansion was mostly a function of putting internet traffic (existing and new) onto TPG's own network. iiNet's gross profit increased by A$35m and gross profit margins expanded from 44% to 46% over the period.

Investment view

Contributed by Nick Harris Senior Analyst Telecommunications, Technology and Financial Services. Original blog here: (VIEW LINK)


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