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Morningstar | Not Marrying Vocus, Even at Third Sight

We restore our fair value estimate for Vocus to its prior stand-alone intrinsic assessment of AUD 3.00 per share. This follows EQT Infrastructure's decision to withdraw its AUD 5.25 per share Indicative Proposal, one that was announced just last week while this author was on leave, in the middle of a shocking 8th hole of an even more shocking round of golf.

The development is disconcerting. This is the third time a private equity suitor has snubbed the narrow-moat-rated group, after Kohlberg Kravis Roberts and Affinity Equity Partners both withdrew their separate AUD 3.50 per share proposals back in August 2017. While we may never know the real reasons, these suitors' decision to walk away after extensive due diligence points to the likelihood they may have overestimated Vocus' sustainable earnings power. They also perhaps were not sufficiently confident the current efforts to fix Vocus' systems and controls could be done within the typical timeframe for private equity before existing at an acceptable internal rate of return.

In fairness, newish CEO Kevin Russell (who began in May 2018) has resolutely maintained Vocus is in the early stages of a three-year turnaround program. It is not Vocus' fault private equity (and the public market) has been overexuberant with respect to the pace/magnitude of the group's recovery potential. In any case, we expect Vocus' group EBITDA to reach AUD 412 million in fiscal 2021, up 15% from our forecast fiscal 2019 base of AUD 358 million (effectively flat over the last three years). We believe this adequately factors in the recovery potential under the rejuvenated senior management team.

Despite the "hot money" exiting the register post the withdrawal of EQT's interest, shares in Vocus are still trading 25% above our AUD 3.00 fair value estimate on a stand-alone basis. Some speculative attention may still be lingering, with AGL Energy having previously shown its interest in Vocus.

We will cross that bridge if or when we come to it, especially as AGL Energy only recently terminated its discussions with Vocus. However, the energy company's investment banking advisors may want to point out that over 40% of Vocus' revenue (consumer, business) remains hostage to adverse external factors (NBN, structural headwinds facing legacy sales). While the network services division is the crown jewel, it does not operate in a competitive vacuum as evidenced by continuing industry price erosion. Vocus' New Zealand unit exhibits dependable earnings but it accounts for just 10% of Vocus group EBITDA before unallocated costs, and is in a market where AGL Energy has no presence.

There may be ostensible "synergy" between energy and data in this increasingly convergent world. But surely there is an easier way to realise this synergy for an energy company than buying a whole telecom entity for a hefty premium, taking on considerable integration and execution risks in a highly competitive industry in which AGL lacks any superior knowledge, and assuming the resale risk of any unwanted businesses. One would have thought data-energy synergy could be more easily pursued by way of joint venture with a telecom, purchasing just the consumer broadband business of a telecom, or simply just becoming a reseller on the National Broadband Network, or NBN. Then again, stranger things have happened in the trigger-happy corporate world where the "need for action" can be overwhelming.

Finally, Vocus reiterated its fiscal 2019 earnings guidance as stated on 27 February 2019, with underlying EBITDA expected to be between AUD 350 million and 370 million. We currently forecast AUD 358 million. In the meantime, we look forward to management's strategy update in the last week of June. It will be a chance for us to assess the details of its three-year turnaround program and get an insight into whether the NBN-dependent consumer broadband business will remain a core part of Vocus longer term.