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Morningstar | A Curious Case of ACCC Calling TPG Telecom’s Bluff that May Not Be; Time to Call in the Lawyers

Australian Competition and Consumer Commission's, or ACCC's, rejection of TPG Telecom's proposed merger with Vodafone Australia is a curious one. Despite pronouncements to the contrary since January 2019, the competition regulator appears adamant TPG will resurrect its ambitions to become a new entrant in the Australian mobile network space, if it cannot find a way to tie up with Vodafone.

However, this could be a case of the ACCC calling a bluff that may not be. We have consistently been sceptical of the economics of TPG's plans to roll out a national mobile network for just AUD 600 million, after forking out a ritzy AUD 1.3 billion for the spectrum. Just as this was dawning on management, the government banned the use of Huawei's 5G equipment—an elimination of a cost-effective vendor who was critical to the group's next-generation mobile strategy. Against this backdrop, the ACCC's insistence that TPG will still go ahead with a mobile rollout, sans Vodafone, is a bold one.

Shares in narrow-moat-rated TPG reacted sharply to the news and are trading 13% below our AUD 7.00 fair value estimate on a standalone basis. This is understandable, given the amount of hot money in the stock as expectations of an ACCC approval was building ahead of the surprise decision. But investors should be mindful of the healthy baby that they are throwing out with the bath water. TPG generates around AUD 360 million EBITDA from a solidly-growing corporate unit that is largely immune to the margin-crunching National Broadband Network, or NBN. And even the consumer broadband unit bearing the brunt of the NBN impact is still producing over AUD 450 million in EBITDA and faring better than peers.

The issue is whether TPG is content with this portfolio. Or is ownership of a mobile network paramount to securing its future in a mobile-centric world, especially in the face of crippling NBN economics? TPG's (with Vodafone) decision to take the ACCC to court unequivocally points to the latter.

The ball now moves to the Federal court and we await the next chapter of this saga. In the meantime, the mobile industry dynamics are stabilising. A potential fourth player (TPG) is looking unlikely and management of the third player (Vodafone) is likely to be much-distracted with the legal process and, if the TPG merger goes ahead, with the complex integration exercise. And Vodafone must do all this while trying to manage the transition to 5G, against an incumbent that is hellbent on defending its turf, even if it means a hit to near-term margins, as reflected in our forecasts for Telstra.

As for the ACCC decision, we appreciate its desire to foster greater competition, especially in a concentrated sector such as mobile, dominated by just three players. However, in presuming that TPG will resurrect its mobile network ambitions by preventing the TPG-Vodafone merger, the regulator appears to have completely bought into TPG's initial mobile plans. Those plans consisted of outlaying a jaw-dropping AUD 1.3 billion for spectrum, budgeting AUD 600 million to roll out a national mobile network (when the incumbents each spend AUD 800 million to AUD 1 billion-plus a year just to maintain their networks) and counting on Huawei to cost-effectively upgrade to 5G over time. In a way, the ACCC is paying TPG the ultimate compliment and declaring that TPG management will somehow find a way to build a vibrant mobile network because of its track record in building its existing successful businesses.

Finally, we witnessed a rare instance of an ACCC procedural mishap. We understand the ACCC was scheduled to hand down its decision on May 9. In anticipation of a favourable decision, shares in TPG traded up as high as 3% to AUD 7.26 on May 8. Then, the ACCC inadvertently posted its surprise decision on its website at around 3.24pm on May 8, catching everyone by surprise and promptly pushing the stock price down to AUD 6.07 by the close. Guess fat fingers are not confined to trading rooms in financial markets!