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Morningstar | TPG Telecom's Punctured Mobile Dream a Blessing in Disguise

We increase our fair value estimate on TPG Telecom by 15% to AUD 7.00 per share, following the decision to abandon the Australian mobile network rollout. The uplift reflects the financial impact of the AUD 704 million savings on the balance owing on the 700MHz spectrum acquired in April 2017 and the elimination of assumed AUD 100 million in operating losses and AUD 670 million future capital expenditure associated with the venture.

Critically, the bursting of the narrow-moat rated group's aspirations to become the fourth mobile network operator Down Under may be a blessing in disguise. The federal government's ban on the use of Huawei equipment for 5G may have thwarted management's strategy to own and operate its own mobile network, one that could have bypassed the crippling economics of being a fixed-line reseller on the National Broadband Network.

However, abandoning the mobile network has significantly increased the chances of gaining the Australian Competition and Consumer Commission's, or ACCC, approval for the proposed merger with Vodafone. The competition regulator's primary concern about the TPG-Vodafone tie-up is that the deal will ensure the mobile industry remains a three-player market that would be prima facie negative for competition. Now that the potential fourth player has decided not to play, the ACCC's argument has lost much of its cogency. The timing of TPG's announcement (six weeks after the ACCC raised preliminary concerns about the merger) makes one wonder whether the decision to abandon the rollout was more than just Huawei related.

Shares in TPG are trading broadly in line with our revised intrinsic assessment for TPG as a stand-alone entity. While implications of management's mobile network ambitions will no longer occupy investors' minds, stock price volatility is likely to remain elevated, as market attention turns to second-guessing ACCC's decision on the Vodafone merger (mid-April 2019) and the implications from the tie-up.

Sector implication-wise, TPG's retreat from the mobile network arena is an unequivocal positive. We recognise that a combined Vodafone-TPG will be a formidable entity for the incumbent operators in Telstra and Optus. However, the status quo of just three mobile operators is still better for competitive dynamics than having an aggressive, price-led challenger such as TPG invading the market with its own network. And the market could certainly do with such a reprieve, given the unprecedented current competitive intensity in the mobile space, even before the entry of a new challenger.

As for the changes to our earnings estimates for TPG, we have increased our EPS by an average of 45% for the next three years. This reflects the positive impact of eliminating assumed operating losses from the Australian mobile network venture in its initial years as well as the financial impact of not having to spend another AUD 670 million in rollout capital expenditure (AUD 130 million already spent or committed out of management's AUD 600 million budget versus our previous forecast of AUD 800 million) and AUD 704 million in balance owing on the spectrum purchases.

A key point of interest is TPG's plans for the this 700MHz spectrum that it acquired in April 2017 for AUD 1.3 billion, with AUD 605 million already paid (which we have for the time being treated as sunk cost). Management has admitted it has made no decision on TPG's current spectrum holdings. For modelling purposes, we have assumed TPG will not pay, or will eventually be reimbursed for, the AUD 704 million balance owing on the 700MHz spectrum--premium properties that would attract material interest if reallocated.

Finally, the capitulation by TPG on its mobile network ambition highlights the concentrated telecom equipment supplier market in Australia. There are effectively only three such vendors Down Under, namely, Ericsson, Nokia, and Huawei. And Huawei is by far the lowest cost provider--the very reason why it was chosen to partner TPG in its 5G upgrade ambition. The ban on Huawei has now made the supplier concentration so great that it has ostensibly knocked a major telecom entity from pursuing its mobile ambition, and likely to now push network construction costs even higher in the future. It goes without saying that both TPG and Vodafone are likely to use this as another reason to convince the ACCC that they should be allowed to merge, so as get bigger, defray these costs of upgrading to 5G, and compete more effectively with Telstra and Optus.