Is an acquisition frenzy creating a telco bubble?

Questions about whether Singapore Telecommunications Ltd's (ASX:SGT) latest $1.1bn acquisition will hurt more than help its earnings is a warnings shot across the bow for the sector.

Brendon Lau

Brendon’s passion for shares started by accident in 2003 and he has worked in various roles around capital markets ever since as a trader, stock analyst and markets reporter with the Australian Financial Review. Most of his wealth has come from share investing than any other asset class, and that has given him the financial freedom not to work full-time, if he chooses to. Brendon is a medium to long-term investor who aims to hold positions for a year or longer and is focused on fundamental analysis, although he will occasionally use technical indicators to time his entries and exits. Brendon has an MBA from Melbourne Business School and is RG 146 certified. He lives in Melbourne with his wife, three kids and two dogs.

Published April 9, 2015 1:53 pm AEST

ASX-listed telecommunications companies are searching for new growth opportunities after their stellar run on the market but Singapore Telecommunications Ltd's (CHESS) (ASX: SGT) latest billion dollar acquisition has raised doubts about its strategy.

Merger and acquisition activity in the sector has been rife as there isn't enough organic growth left in the industry at a time when most telecom stocks are trading at big premiums to the market.

Singapore Telecommunications, or SingTel, announced yesterday that it was paying around $US810 million ($1.1 billion) for a 98% stake in the largest independent managed security services provider in North America, Trustwave.

Trustwave has three million business subscribers across 26 countries and it provides protection to IT infrastructure and applications from cyberattacks.

SingTel, which owns the Optus Network, isn't the only one trying to buy growth. Sector star Telstra Corporation Ltd (ASX: TLS) is expanding into eHealth via acquisitions, while TPG Telecom Ltd (ASX: TPM) is trying to consummate its $1.4 billion takeover proposal for iiNet Limited (ASX: IIN).

M2 Group Ltd (ASX: MTU) could also see some corporate action, as my colleague Mike King wrote yesterday.

Interestingly, Telstra has been dominating shareholders' attention even though SingTel is outperforming Australia's largest telco by 10 percentage points over the past year.

However, Singtel could soon give up some of this outperformance with at least one broker warning that the Trustwave acquisition will hurt group earnings for the next two financial years.

JPMorgan has cut its earnings forecast by 0.5% to 2% for 2015-16 and 2016-17 in the wake of the deal and is expecting higher losses in Singtel's digital business.

The broker said it is worried about margin pressure from the group's enterprise division and it has a price target of $3.85 on the stock, which is about 10% below Singtel's current share price of $4.23.

But this is perhaps a warning shot across the bow for the sector with investors rubbing their hands in glee whenever a corporate deal is announced.

Using acquisitions for growth is a far riskier endeavour than pursuing organic growth, and investors should not underestimate how value destructive a poorly executed deal can be for the bidder's share price.

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