Telco Vocus Communications Limited (ASX: VOC) was hit hard by the market this morning, diving 13% at the open to $5.03 after the company released its Annual General Meeting (AGM) presentation to the market. This was up from lows of $4.89 early in trading.
What's going on?
There are a number of potential issues with Vocus. Executive resignations and the search for replacements are a key source of uncertainty, with the market also concerned about the company's messy accounts. The rapid pace of acquisitions has resulted in a number of one-off costs and integration issues that has made the company's accounts difficult to follow.
Probably the biggest issue was the underperformance at the recently acquired Nextgen Networks. Underlying earnings are likely to come in below management's expectations, due to higher customer cancellations and re-signing of contracts at lower margins. Given the recent-ness of the acquisition, this suggests that Vocus overpaid or misjudged the benefits from the business. Management remains optimistic they can turn it around.
Management also reported that new National Broadband Network (NBN) connections came in below expectations, due to network outages and poor customer experience. NBN customers have a longer lifetime than ordinary broadband customers, however Vocus incurs fairly hefty costs to transition customers from copper networks to the NBN.
Combined, the fear is that due to costs of customer transition, investment in Singaporean fibre, costs of improving customer service, integration costs, and so on, the recent acquisitions aren't likely to benefit Vocus as much as investors would have hoped.
Shares in fellow telco TPG Telecom Ltd (ASX: TPM) are also being sold off today, probably due to concerns that market issues like customer switching costs and slow migration to NBN will also hit TPG.
What's a shareholder to do?
It's challenging to decipher Vocus' accounts, particularly considering the market's concerns all relate to the current year's future earnings. All that investors have to go off is the company's estimates of capital expenditure and investment costs, as well as a forecast of underlying Earnings Before Interest, Tax, Depreciation and Amortisation (EBITDA) of between $430 million to $450 million and underlying Net Profit After Tax (NPAT) of between $205 million and $215 million.
These forecasts depend on a number of assumptions including $41 million in EBITDA from Nextgen, as well as successfully achieving $57 million in synergies from acquisitions.
If those assumptions don't come true, the final result could fall short. Bearing in mind that earnings from Nextgen have already fallen below management's expectations, investors are probably thinking that the expected synergies might be similarly difficult to forecast.
That aside, Vocus is still in its growth phase. It's investing heavily for growth and has plenty of opportunity to lift its customer service game.
The NBN migration might be taking longer than expected, but that doesn't mean it isn't going to occur. In an increasingly data-intensive world, copper connections just aren't going to cut it. Plus, if underlying NPAT forecasts are accurate, Vocus at $5 is trading on just 15 times its underlying earnings.
It wasn't a great update, but given the way the company is valued and its outlook for the next couple of years, I'd be more inclined to buy than sell at today's prices.
