Themes we like: Junior Telcos

Last week we briefly talked about three themes that we like. Over the coming weeks we will talk in a bit more detail about each of those themes.

This week, let’s discuss junior telecommunications companies and why we like them.

Problem Being Solved

Australia has a poor reputation globally for internet speed. We ranked 68th in global internet speed ranking, making us the fourth slowest country for broadband in Organisation for Economic Co-operation and Development (OECD). Despite spending $51 billion to roll out the National Broadband Network, we are just ahead of Mexico, Turkey and Greece. It is a serious problem in the current Internet Age when everything is moving online.

Australian telecommunications companies have problems servicing small businesses. The Telecommunications Industry Ombudsman reported in June 2020 that the proportion of complaints from small businesses has steadily increased since 2016. Now the proportion is 14.7%, more than 19,000 complaints are from small businesses.

Telecommunication companies are investing a significant amount of money trying to solve these problems. For example, 5G Networks (5GN), Uniti Group (UWL) and Spirit Telecom (ST1) have built fast and affordable internet connections to residential, SME and enterprise customers in suburban and metropolitan areas. Since these companies are smaller than the top tier companies, they are more willing to devote resources to serve small businesses. Some of them offer 24/7 customer services and 24-hour installation services, which aim at assisting their customers efficiently, this is significantly better that anything Telstra can offer!

Opportunity: Industry Consolidation The telecommunications industry is mainly dominated by four players, NBN (11%), TPG (16%), Optus (21%) and Telstra (44%). The remaining 8% is shared by lower-tier companies. We have historically seen a lot of M&A activity in this sector and we believe this is a good source of return when the bigger players look to grow through acquisitions.

The benefits of consolidation are twofold.

Through acquisitions, junior telcos can get cost and network volume synergies. Telecommunication companies usually have similar direct and overhead costs. Merging two telco companies can achieve cost synergies by reducing operational overheads and shifting users to the one network and billing platform. In addition to this, the acquired companies are usually underutilised in terms of network volumes and data center volumes. After acquisitions, the combined group can utilise the increased volumes over the same infrastructure as well as cross-selling to the expanded client base.

So the thematic provides:

• Cost synergies

• Revenue synergies (cross sell)

So investing in the sector is attractive on a fundamental basis along with the potential for an acquisition premium when the industry consolidates.

Instead of synergies from acquisitions, junior telcos investors can also enjoy the benefit from industry consolidation in another way. Undervalued junior telco companies are attractive takeover targets. Acquirer is likely to pay a premium to settle the deal and investors can profit from the takeover. This is another way investors can benefit from industry consolidation.

Conclusion

We like the junior telecommunications companies because of the opportunity arisen from the telco industry consolidation. At the same time, we are cautious to examine each company. The debt level, the rationale behind every acquisition and the valuation are crucial factors to consider before investing in it.

Till next week happy investing.

Michael and Kenny