TPG Telecom appears to have its merger with Vodafone Australia in the bag, sending brokers scurrying to re-evaluate the combined entity.

-Special dividend likely to result from the merger
-Significant cost savings forecast over two years from FY21
-TPG Telecom the main beneficiary of NBN entry-level bundles
 

TPG Telecom ((TPM)) has been bolstered by a green light for its planned merger with Vodafone Australia and also upgraded earnings guidance after a strong first half. News the Australian Competition and Consumer Commission will not appeal the Federal Court decision to approve the merger has sent brokers scurrying to re-evaluate a merged entity.

UBS points out the merger comprises two highly complementary businesses from customer, asset and cost perspectives. The merger is expected to be completed mid year, subject to some lower-risk approvals, and UBS has a base case special dividend of $0.60.

Under the merger scheme, if net debt is less than $2.37bn, the difference will be paid out to shareholders as a special dividend, after allowing for the capitalisation of Singapore operations. In Singapore TPG Telecom has reached 99.89% outdoor coverage and paid services are to commence this month. Net debt as of January 31 was $1.74bn. 

Ord Minnett's valuation of the combined company assumes $200m in cost savings over two years from FY21 and -$2.4bn in net operating losses plus 100,000 in annual mobile subscriptions. The broker assesses the stock is now trading at fair value and downgrades to Hold. No revenue upside from fixed wireless is incorporated into estimates.

Credit Suisse increases its valuation based on the merger proceeding, driven by higher earnings estimates for TPG Telecom on a stand-alone basis and lower capital expenditure for Vodafone Australia.

The company has provided no guidance on current financials for the merger or the potential for cost savings, although Morgans points out TPG Telecom has a history of delivering significant cost savings.

Morgans increases its price target to $8.37 from $5.89 based on valuation of the merged entity but highlights there are many moving parts, including final clearance from authorities, and this valuation is likely to move around as details become clearer in coming months.

First Half

TPG's first half results were robust in the broker's opinion, given cost pressures from NBN and the distraction of the merger. The company declared a 3c fully franked interim dividend, the first time in three years it has edged up. Mobile subscribers did drop in the first half and the company aims to correct this with new plans that include generous data allocations and cheaper excess data versus competitors.

FY20 operating earnings (EBITDA) guidance has been increased by 5% to $775-785m. Of the upgrade, Macquarie notes $7m is from better-than-expected NBN pricing on entry-level products. On a preliminary view, Morgan Stanley found the first half results incrementally positive and together with the ACCC decision expects the shares will now trade towards its bull case of $8.70.

UBS assesses guidance implies a second-half that looks reasonably achievable, as the company appears to be factoring in a continuation of the first half trends. The broker also notes subscriber numbers are growing again, benefiting from a benign competitive environment. This is also supported by the current skew of the roll-out to areas where the TPG brand is strong.

Meanwhile corporate business is enjoying improving margins on the back of on-net sales. Morgans points out corporate did the heavy lifting in the first half, not because of revenue growth but rather because of the company's expertise in the arbitrage between off-net and on-net.

Substantial value has been created with vertical integration, removing third-party carrier costs and putting traffic onto its own network where margins are substantially higher.

NBN

Macquarie notes the company is working its way through NBN headwinds and will have only 13% of its base on copper by the end of the year. Despite rising NBN input costs, broadband earnings should stabilise and improve.

TPG Telecom was the main beneficiary of NBN introducing entry-level bundles. While management has indicated any incremental benefit from reduced NBN access costs for lower speed tiers is already factored into guidance, Credit Suisse envisages scope for some pricing changes that could provide a meaningful benefit.

FNArena's database has five Hold ratings. The consensus target is $7.93, signalling -2.2% downside to the last share price. Targets range from $6.85 (Morgan Stanley) to $8.40 (UBS).

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