M2 Group Ltd (ASX:MTU) is currently the fifth-largest Internet Service Provider in Australia and operates under familiar brands such as Dodo, Commander and iPrimus. M2 also derives significant revenue from fixed line voice services, mobiles and reselling gas and electricity. M2 has been in the headlines lately for its $1.57 billion bid for iiNet Limited (ASX:IIN). M2 has since been trumped by a higher offer from TPG Telecom Ltd (ASX:TPM).
If this offer succeeds, as looks likely, investors will want to know how the company will perform in an environment where it only has half as many subscribers as each of the top three broadband providers?
Growth Drivers
Despite missing out on the iiNet acquisition, M2 has several key growth drivers that should propel the company's earnings over the coming years. M2 has made a number of significant acquisitions over the years and its scale has now enabled the company to lower its cost to serve.
This should allow the company to increase its market share in its core telecommunications market in the near term. M2 recently announced the acquisition of New Zealand's third largest Internet Service Provider – Call Plus Group. Acquiring Call Plus provides M2 with an entry into the New Zealand market and may be the vehicle for further product offerings, replicating the success of Dodo domestically.
M2 also continues to expand its product offerings in Australia, recently adding insurance and electricity for businesses to its portfolio. Again using its low cost model and extensive marketing to attract customers, M2 will be hoping these products have the success it has had in other products.
M2, which has previously relied on the online and telephone sales channels, has recently begun to roll out a physical sales channel with its Dodo connect kiosks in shopping centres throughout Australia. Customers at the kiosks can purchase all of Dodo's products as well as mobile and computer accessories and pay per use internet browsing facilities.
M2 will hope that the continued rollout of the NBN will prompt customers to review their providers and find value in Dodo & Commander's offerings. It's believed that M2 has signed a deal with Telstra Corporation Ltd (ASX:TLS) that provides M2 with access to Telstra's 'backhaul' network that carries data between NBN Co's points of interconnect. This allows M2 to offer NBN products without having to build its own interconnect network and enables the company to focus on what it does best – reselling infrastructure services with an efficient, low cost model.
Recent Performance and Guidance
In its most recent half yearly results, M2 reported an 8% increase in revenue to $546 million and a 25% increase in net profit after tax to $38.5 million. Given the company's guidance for the full 2015 financial year was for a 8-9% increase in revenue and 15-20% increase in NPAT, the company is in a strong position to beat its forecasts.
For FY16, the company has already stated that the Call Plus acquisition is forecast to add NZ$250 million in revenue and NZ$45 million in EBITDA, representing around 20% growth in total M2 revenue and 23% growth in EBITDA. If the growth drivers mentioned above can successfully increase earnings and the integration of Call Plus goes well, the platform is set for M2 to have a bumper FY2016.
Risks and Competitive Threats
As mentioned above, M2 has recently been caught up in a bidding war with TPG for iiNet which will shake up the domestic broadband market. Although the acquisition may have been beneficial for M2 in the long term, there are some benefits of missing out, including savings of up to $50 million in finance and advisory fees and forcing its competitor to pay a higher premium for its acquisition.
As it will be by far the smallest of the top-four broadband providers, M2 will now have to work harder to gain market share by providing plans that offer customers great value for money, improving their reputation for customer service and ensuring potential customers are aware of their offerings through quality marketing & advertising. Investors should monitor the impact that this may have on profit margins.
As an acquisitive company, debt loads can become an issue. This has not been a problem thus far for M2 and they actually reduced their total liabilities in the first half of FY2015. Since then, however, the company has made the Call Plus acquisition, so investors should keep an eye on the company's ability to meet its debt repayments and ensure that interest payments do not further reduce margins.
Foolish takeaway
M2 may not end up as the owner of iiNet but the company has substantial growth drivers and a history of making smart acquisitions that can add value to shareholders. Despite impressive share price growth over the past couple of years, the growth trajectory of the company's profits should see justification of its current valuation and provide value to investors at current prices.
