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Morningstar | TPG Telecom Trying to Go Around NBN Any Which Way It Can. See Updated Analyst Note from 18 Mar 2019

TPG Telecom is the latest telecom player to join the public chorus, denouncing National Broadband Network's, or NBN's, uneconomic pricing model and threatening to cease selling the NBN AUD 60 per month basic entry plan. The 5% (AUD 12 million) fall in fiscal 2019 first-half consumer EBITDA to AUD 243 million shows why, and could have been a lot worse had cost efficiency not been realised to drive down overhead by 9% (AUD 13 million).

This was more than offset by the 15% (AUD 24 million) rise in corporate EBITDA to AUD 183 million, buoyed by a step-up in contributions from the Vodafone fibre contract, as well as product mix shifting to TPG's on-net business offerings. This helped first-half group underlying EBITDA lift by 3% to AUD 424 million, and remain on track to meet our AUD 807 million full-year EBITDA forecast and management's reaffirmed guidance of AUD 800 to 820 million (all figures exclude Singapore losses).

Unfortunately, TPG's other audacious strategy to diversify away from NBN was recently abandoned, with the cessation of the mobile network rollout resulting in an AUD 159 million aftertax impairment charge (as announced last month). However, it has increased the probability of the TPG-Vodafone merger getting the green light from the competition regulator, thereby, keeping alive the NBN-bypass-via-mobile strategic option.

In the meantime, we maintain our AUD 7.00 fair value estimate on TPG, and shares in the narrow-moat-rated group are trading in line with this stand-alone intrinsic assessment. Management is best-in-breed when it comes to extracting cost efficiencies and limiting NBN's margin-crunching impact (for example, via corporate, fibre-to-the-buildings, or FTTB). However, near-term stock price movement will hinge on whether TPG has a mobile/5G path to circumvent the NBN. And the pending ACCC decision (expected in May 2019) on the proposed Vodafone merger will go a long way towards clarifying that issue.

Another plank of TPG's diversification strategy involves rolling out a mobile network in Singapore. The progress on this front is good, with 99%-plus national outdoor service coverage achieved and indoor coverage steadily expanding. The service is still in a trial mode and commercialisation is not expected until the end of 2019 calendar year. We are currently forecasting this venture to incur an operating loss of AUD 14 million in fiscal 2019.

TPG Telecom reported fiscal 2019 first-half net profit after tax, or NPAT, of AUD 47 million, down from AUD 199 million a year ago. This was impacted by AUD 159 million in impairment charges relating to the mobile spectrum and the mobile network assets rolled out to-date, having recently abandoned its ambitions to become the fourth mobile network player. On an underlying basis excluding this write-down, amortisation of acquired intangibles and one-off transaction costs relating to the Vodafone merger, underlying NPAT increased 4% to AUD 225 million.

The group ended the first half with a net debt of AUD 1.6 billion. This equated to net debt-to-trailing 12-month EBITDA of 1.9. The board declared an interim DPS of AUD 0.02 fully franked, and we maintain our full-year dividend forecast of AUD 0.05.

TPG finished the first half ended January 2019 with 1.9 million total broadband subscribers, a decline of 9,000 from six months ago. While low-margin NBN subscribers increased by 127,000, this was more than offset by 142,00 decline in legacy subscribers, with the 115,000 fall in super high-margin on-net ADSL subscribers especially hurting profitability.

The 5,000 increase in on-net FTTB subscribers to 112,000 is noteworthy because it was achieved while staff resources were focused on the mobile network rollout venture in Australia. With the mobile ambition now abandoned, reallocation of resources back to higher-margin FTTB should increase its penetration. Granted, FTTB competes against a myriad of NBN resellers marketing into these multidwelling apartment buildings. However, TPG's FTTB product has speed and relative price advantages to these NBN resale products and presents yet another way TPG can limit NBN's margin-crunching impact.