$15bn rival enters the ring
Telstra faces an even tougher future after the merger between TPG and Vodafone
TPG has turned the Australian mobile market on its head. It was common knowledge that it was building a mobile network and that pricing would be aggressive but not so aggressive as it turned out to be. The first stone thrown in the mobile phone price war offered six months of 4G access – with unlimited data – for free. After that, TPG will charge $10 a month.
By contrast, Telstra generates average revenue per user (ARPU) of $65 a month while amaysim’s $10 plan offers just 1 gigabyte (GB) of data a month.
This is by far the most aggressive pricing the domestic mobile sector has yet seen, making mincemeat of a former Intelligent Investor “buy” recommendation on amaysim.
At the time of the announcement we said: “The rest of the industry must now respond.” Thus far, Optus and Telstra have not, although price competition of this ilk will almost certainly make it happen at some stage.
Instead, TPG has now lobbed a second stone onto the battlefield.
TPG and Vodafone have finally revealed their plan – long rumoured and often denied – to create a new $15 billion competitor in the telco market.
The deal itself is rather conventional. TPG will own 49.9% of the merged entity with Vodafone Hutchison Australia owning the rest. Vodafone’s chief executive, Inaki Berroeta, will lead the new group with the enigmatic David Teoh taking a non-executive chairman role.
Interestingly, the new group – which will retain the TPG Telecom name – will hold just $4 billion in net debt, half of the net debt owed by VHA alone. This implies that VHA’s parent companies will absorb a hefty chunk of debt to leave the group well capitalised.
The Singapore operations, which comprise spectrum and an almost complete mobile rollout, will be distributed to existing TPG shareholders before the merger. They won’t be included in the new company’s asset base.
Instead, the new business will have Vodafone’s rebuilt nationwide mobile network and TPG’s impressive fibre and broadband footprint. Together these assets make for a formidable competitor. You can bet the conversations within the boardrooms of Telstra and Singtel Optus inevitably turn to the potential impact of this new force.
In typical TPG style, the detail around strategy and synergies is scant. But we can make an educated guess about what the new group will do and how it might operate.
A key benefit will be better utilisation of the Vodafone mobile network. Having invested almost $6 billion in the network over the past five years, this isn’t the joke
it once was. In terms of reliability, speed and reach, it should compete very effectively with Optus and Telstra.
Nevertheless, the low utilisation is telling. Vodafone’s mobile network currently generates earnings before interest, tax, depreciation and amortisation (EBITDA) margins of about 27%. Optus makes margins of 30% and Telstra boasts an impressive 40%.
In other words, Vodafone doesn’t have enough customers. The merger with TPG will be of great help in this regard. The company’s remarkable success has been built by harnessing high-quality fixed assets and then using its cost advantage to fill those assets with customers, reaping the benefits of scale.
You can see the value of this approach in TPG’s broadband business. It generates the same margins as Telstra while charging half the retail price.
This kind of operating nous can now be brought to the mobile network to attract customers and boost margins. In time they should exceed 30% on a larger revenue base. This is the first source of value in the deal.
The second lies in the bundling benefits. Cross-selling rightly deserves the derision with which it is sometimes met. But in telco land it’s a proven way of lifting ARPU and lowering churn. For the first time, TPG and Vodafone will be able to offer genuine mobile-broadband bundles, just like the ones that have been so successful for Telstra. We also have high hopes for larger corporate sales. TPG has built an impressive corporate business that now contributes about 40% of its revenues. Until now Telstra has faced little competition in this area but Vodafone should now be able to tap into TPG’s corporate channel and compete in mobile.
These three factors mean there is plenty of room for the merged group to lift revenues and margins. There’s also a good chance that Vodafone’s fatter expense line will look trimmer in a few years, guided by Teoh’s famously stingy approach.
Out of the gate, the merged group will have a 20% market share in mobile and a 22% market share in broadband. Those figures should start to rise after the merger.
What else? Well, an important feature of the new group will be access to shared spectrum. With 5G spectrum auctions kicking off soon, the entire industry will be relieved that three, rather than four, bidders will vie for limited bandwidth.
Telstra’s relief, though, should be temporary. The new TPG will be a far more formidable competitor. The small cell network envisaged by TPG will still go ahead but will now be backed by a full-scale national mobile network and the second largest fibre network in the land.
In terms of cost, aggression and capital allocation, TPG is superior to Telstra. The announcement of the merger does nothing to temper our view that Telstra, although it remains a decent business, will face a more competitive future.
Returns from the mobile sector are likely to fall. Indeed, the success of TPG is predicated on the company bringing about exactly that.
Since our initial upgrade 18 months ago, TPG has been an almost permanent feature on our buy list at between $5 and $7. Those now look like bargain prices, with the stock up anywhere from about 30% to 80%.
We wouldn’t be looking to upgrade it again at these prices just yet but as more details emerge this one will be worth watching.