In mid-October 2024, TPG Telecom (ASX:TPG) announced a proposal to sell its Fibre network infrastructure assets and Enterprise, Government and Wholesale (EGW) fixed business. The transaction delivers significant net cash proceeds of A$4.65b to A$4.75b on completion. However, several aspects pertaining to the proposed transaction, as well as the performance of the underlying business, have recently weighed on the shares. Accordingly, we recently researched the Company in The Dynamic Investor to assess whether current levels present an entry opportunity.
About TPG Telecom
TPG Telecom is an Australian based integrated telecommunications company (‘telco’). TPG is the result of a 2020 merger combining TPG’s fixed line assets with the Mobile assets of Vodafone. The merged entity resulted in TPG becoming Australia’s number 3 full-service telecommunications operator. Key brands include Vodafone and Lebara (mobile); TPG, iinet and Internode (consumer fixed line) and AAPT (enterprise and government fixed line).
Key Fundamental Drivers
Sale Proceeds to Reduce Elevated Debt Levels
The gearing level (on a net debt to EBITDA basis) of 3.2x as at 30 June 2024 is elevated relative to the covenant level of 3.75x. Gearing is also elevated in comparison to many of its global telco peers (where average gearing is ~2x). In addition, interest cover of 1.8x (on an EBIT/interest cover basis) is well below the average for global telco peers. Prior to the announced asset sale, the elevated gearing level had increased the likelihood of TPG cutting the dividend to zero in order to reduce the debt burden.
Potential for Special Dividend
Reducing the debt balance is a key priority. However, this is likely to be undertaken in combination with the payment of a special dividend. Using the entire sale proceeds for debt reduction will likely reduce the gearing level to ~1.5x, which is below the global telco average and also below TPG’s target gearing of 2.0-3.0x.
It is also plausible that TPG uses the sale proceeds to pay a special dividend in combination with debt reduction. A special dividend is likely to be unfranked, given the limited free float of TPG’s shareholder structure and immaterial franking credits. In addition, assuming no material gain on the asset sale (although there could be), then paying out a sizable special dividend would reward shareholders and lower TPG’s shareholder equity. This would lift TPG’s currently-low Return on Equity (ROE).
We estimate that reducing the gearing level to the midpoint of the target gearing range (which assumes a special dividend payment of ~$1.4b) could result in a cash return to shareholders of ~76 cents per share.
Further, the payment of a special dividend results in a higher implied Enterprise Value (EV)/EBITDA multiple, compared to debt reduction only. This is important from the viewpoint that there is considerable investor debate on where the shares will ultimately trade.
Mixed Performance for Underlying Business
The key negative surprise from TPG’s result for the six months to 30 June 2024 (1H24) was the soft performance in postpaid mobile. Postpaid subscribers fell -47k to 2,920k, compared with Telstra and Optus reporting +53k and +13k in the June 2024 half. TPG’s reported growth in postpaid subscribers also compared negative to the industry’s +19k gain. Mobile prepaid subscribers also grew modestly and below the rate of growth reported Telstra and Optus.
The Company highlighted three contributing factors to the 1H24 weakness that also point to continued weakness in 2H24: i) A reduction in international arrivals, ii) A shift towards prepaid with cost-of-living pressures and iii) Competition in the handset market.
In response to the challenging revenue trends is offset by several initiatives. These include cost savings, a Mobile Virtual Network Operator (MVNO) contract win (Lyca Mobile) and phasing of back-book postpaid price increases (implemented in April and May).
Fundamental View
We take a cautious view on TPG at current levels for several reasons.
i. The proposed transaction not without risk. ACCC rejection is likely to present to biggest risk given that ACCC has attempted to block a number of TPG-related deals over the past few years. In addition, the current deal appears once again to be combining the number three and number four players (in Fibre).
ii. Following sale of the Fibre assets, TPG will have future earnings (and dividends) that are more acutely dependent on a continuing rational mobile pricing market, as well as fluctuations in consumer spending. As such, any cuts in industry mobile pricing will likely prove to be materially negative for TPG’s earnings (and dividend) outlook.
iii. There is considerable investor debate on where the shares will ultimately trade. This is unlikely to become clear for another ~12 months, given the targeted completion in the 2nd half the 2025 financial year. In addition, underperformance in postpaid mobile, regulatory risk (ACCC) are factors acting as an overhang for the shares in the near term.
iv. While the announced asset sale would likely improve gearing, there is potential for investors to downgrade the EV/EBITDA multiple for the residual business. This is because the “new” TPG will have an earnings base that is more sensitive to mobile pricing (given less infrastructure earnings). In turn, this means that TPG is likely to rely on cost efficiency to a greater extent in order to support earnings growth.
Charting View
TPG remains in a long-term downtrend. Whilst it is oversold in the short-term and could be at risk of a bounce, the overall path is still to the downside for now. This means that we would be looking for a retest of support near $4.20.
Michael Gable is managing director of Fairmont Equities.
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