The telco sector has taken a battering over the last few years thanks to the government backed 'National Broadband Network' slashing the profit margins of home internet broadband providers.
For example shares in former blue-chip dividend payer Telstra Corporation Ltd (ASX: TLS) have lost half their value since trading at $5.85 in July 2016 to sell for just $2.92 today.
That's not a surprise since the giant telco has been forced to cut its dividend from 31 cents per share to 22 cents per share largely due to the profits taken out of its bottom line by the effects of the transition to the NBN.
Over the past 3 year shares in TPG Telecom Ltd (ASX: TPM) are also down 30% for similar reasons, however it might have a better growth outlook than Telstra. Let's take a look at some reasons why.
- Vodafone merger – this is due for approval or rejection by the ACCC on December 13, and assuming it goes ahead the combined group will have mobile market share around 20% and home internet market share around 22%. The larger scale gives it more opportunity to invest in price and bundle mobile and home broadband products for example. The bundling of products is a key profit driver and enabler of market share gains for large telcos.
- 5G – TPG's founder David Teoh has a long-term approach to investing and it seems his focus is on capitalising on the upcoming super-fast next generation 5G mobile networks. This mobile space will be highly profitable for whoever wins market share. The combined group will have an established fibre network and long-term infrastructure assets.
- Fibre-to-the-basement – TPG is building its own fibre optic internet network to connect residential properties and undercut the NBN. As TPG owns this network it will produce strong profit margins for investors.
- Management – TPG appears to have a more effective management team in terms of capital and investment expenditure allocations and cost controls than Telstra under Andy Penn. Optus under CEO Allen Lew has built its strategy around investing heavily in English soccer broadcast rights to attract customers to its mobile and broadband offerings.
- Dividends – The combined group's larger scale, strong cash flows and expanded balance sheet are expected to support "attractive" dividends as is traditionally expected from a telco business. If dividends rise over time investors will bid the shares higher.
Of course there are plenty of risks in this space including the possibility that the ACCC rejects the proposed Vodafone merger on December 13. The 'national broadband network' and rapid pace of technological change are other risks. The group's initial proposed debt burden at 2.2x net debt to EBITDA is also high and magnifies the downside risk if the business does not perform as planned.
