Across client accounts that have selected the “Growth” Australian Equity option we have sold TPG Telecom, the Australian based telecommunications company. At the time of purchasing TPG Telecom we noted the attraction of the company’s ownership and operating control of a ‘hard-to-replicate’ fibre network and its push into mobile which would allow it to better combat the potential competitive threat to fixed broadband substitution from improvements in wireless technology.

This view would be further reinforced if the early stage merger talks between TPG Telecom and Vodafone Hutchison Australia (“Vodafone”) were to lead to a deal, as that could deliver the following benefits:

  • capex savings as TPG Telecom avoids some of its planned c$600m mobile network spend;
  • complementary spectrum holdings;
  • TPG Telecom’s fibre & backhaul assets could support Vodafone’s tower assets;
  • cross-selling opportunities of Vodafone’s mobile plans to TPG Telecom’s fixed broadband customers and vice-versa; and
  • potential operational and overhead savings (the quantum is unknown and may be limited given TPG Telecom’s low cost model and Vodafone’s significant cost outs since FY11).

There is however no certainty that a deal will actually materialize. And even if it does, there are still key issues to be resolved including:

  • what conditions or concessions the regulator may require to give it the go ahead;
  • both companies are already highly geared and a merger does not remedy this;
  • ownership structure and management control; and
  • how to proceed with TPG Telecom’s mobile roll-out in Singapore as Vodafone has not previously expressed any interest in this market.

With the share price up around 36% in the past week and 50% since the start of July, the market is seemingly focused primarily on the potential benefits and less on the issues still to be addressed, including the possibility of no actual merger. At current prices the margin of safety (in terms of valuation) is dramatically lower should there be any hiccups or management fail to deliver on expectations in a highly competitive industry, and if this were to occur the share price reaction could be exacerbated by the lack of free float since c.60% of TPG Telecom is owned by its two largest shareholders. As such we believe it prudent to sell TPG Telecom.

With reporting season almost complete we are reviewing some alternative options for the portfolio and expect a decision on a replacement to be made shortly. In the interim the proceeds will remain in cash.

If you have any queries, please contact Elston