TPG wires 'next-phase' growth trajectory to iiNet takeover

Recent revelations that competition regulator (the ACCC) finally approved its $1.56 billion takeover of Perth-based iiNet, adds to myriad reasons – none the least of which is its quality balance sheet – why investors are attracted to the growth story of rising telco star TPG Telecom Ltd (ASX: TMP). TPG has some pretty deep pockets for further expansion, and the cash alternative it made to counter an all-scrip offer by rival M2 ultimately found favour with the iiNet board and shareholders.

The share price has bounced 20 cents higher since the ACCC verdict, and should do likewise following the pending announcement of its full year results – which following on from the net income increase of 18% at half year to $106.7 million – shouldn't reveal too many surprises.

By all accounts, TPG's full year result on 22 September – as good as it might be – is likely to be over overshadowed by the enormity of the ACCC announcement. TPG is now poised to become a telecommunications heavyweight and with over 1.7 million customers – compared to the 3.1 million at Telstra and 1 million at Optus – will be Australia's second-biggest provider of fixed-line broadband.

If that wasn't enough to smile about, shareholders also received extra jollies from ACCC's admission that further consolidation by the Big 4 – which in addition to TPG/iiNet, include Telstra, Optus and M2 Group – would be 'extremely difficult'. Yet another kicker came from the release of iiNet's full year result 21 August which revealed a $70 million in net profit, and 989,000 broadband customers.

Beyond the numbers full year numbers on the 22 September, watch the commentary from TPG management very closely. Given its capacity for growth, it's unlikely that iiNet is at the end of the acquisition trial. Watch out for any hints from management that an enlarged TPG has ambitions of becoming a 'fully integrated telco' – in which case mobile networks could be on it next its takeover radar.

In the few weeks since taking full control of iiNet, TPG boss David Teoh has wasted no time in trimming costs and offloading executives superfluous to requirements.

The combined TPG/iiNet entity is expected to have revenues of around $2.3 billion, EBITDA in the vicinity of $654 million – plus more than 60,000 NBN subscribers. At some point, TPG/iiNet can expect to be re-rated once the 14 analysts covering the stock have greater clarity on its future upside, and the scope for future synergies.

Take particular note of what the iiNet acquisition does to TPG's existing $419 million funding gap.

TPG's long-term cash flow relative to profits is strong, and iiNet will add positively to this future sustainable cash flow. While TPG's return on equity (ROE) has averaged 10.58% since 2005, it recently generated ROE of 22.17%, and even without factoring in recent developments, ROE is expected to remain at this level out to 2017. Similarly, while earnings per share (EPS) has been exceptional over the last five years, it's expected to remain so, and is expected to jump from $0.22 in 2014, to $0.30, $0.35 and $0.41 in 2015, 2016 and 2017 respectively.

Based on any measure, TPG is by no means cheap. It's currently trading at 36% premium to its intrinsic value, and on a 2016 P/E ratio of 26.79 which is expensive relative to its peers. However, with much of the blue sky from iiNet yet to be fully priced-in, investors who like the growth story need to question whether it's going to get cheaper any time soon. Future share market volatility may make for a more opportune entry point.