M2 Telecommunications Group (MTU) M2 has a strong model and owns the territory Buy $0.54
Event Yesterday we visited M2 Telecommunications Group in its new offices in Southbank, Melbourne. Taking advantage of favourable leasing opportunities, M2 has combined its 60-odd local staff from several locations into one office. This heightens staff synergies and momentum and creates an appropriate base for M2's next leg-up into corporate telecommunications wholesaling without departing from its 'lean and mean' approach to costs and overheads.
We last reviewed M2 in Morning Notes on 9 October - Buy at 37¢. With the price now 54¢, do we maintain this recommendation? Definitely!
M2 has an agreement to wholesale Optus mobile services to existing and emerging telcos, adding strong upside to its profitable marketing of telecommunications services to small and medium enterprises (SMEs). M2 offers strong cash flow and good franked dividends.
As we have covered in more detail previously, the Optus agreement was struck on 30 May 2006 after an already close relationship between M2 and Optus in mobile, fixed voice and data services. By 9 October, after just three months of effective operations, M2 as exclusive arranger or 'enabler' of Optus mobile services to the wholesale market had signed up Dodo Australia, Australia's fifth largest ISP, together with Telecom One, Smartcharge Australia and Edirect and was working on several other agreements. We understand that the business has been developing well and above expectations and believe it is likely that other deals will be announced in the near term.
Telstra has been very obviously 'dog in the manger' over cooperating with other telcos. Its new 3G mobile network is not being made available to wholesalers. Optus has a top quality 3G network which will be available, together with hardware, for wholesale deployment within the next month and before Christmas. This gives Optus and M2 and its counterparties added momentum.
M2 has been putting considerable emphasis on its role as effectively the 'wholesaling department' of Optus. There are close and daily contacts between a number of staff at each company who are apparently working well together – not surprisingly as Optus has apparently recently generated more wholesale mobile business than in previous years. We expect M2 to perform well and continue to be positive on the growth story for M2 in the Optus telecoms wholesale field.
In New Zealand M2 is attempting to build its relationship with Vodafone into a similar opportunity. There Telecom New Zealand operates a CDMA service which will be progressively sidelined by Vodafone which has the only GSM network. The NZ CDMA service offers few international roaming possibilities and, for instance, Motorola is no longer supplying handsets. M2 is being appointed as one of two MVNOs – mobile virtual network operator – for Vodafone and is currently setting up all the arrangements and infrastructure, essentially duplicating its Australian experience. Vodafone is appointing as the other MVNO a data company. Their operations will begin in the first half of 2007 when number portability is permitted in NZ. After that and with its Optus experience, M2 is well placed to move to the broader role of enabler for Vodafone, creating another important opportunity although of course smaller than that in Australia.
Meanwhile M2's original core SME business provides the underlying profits as in previous years and continues to grow. M2's focus there is to support the direct 'rifle shot' marketing of its 'franchised' nationwide agent and dealer structure in selecting, training, motivating and rewarding, while minimising costs and monitoring and controlling the flow of sales and debts using its proprietary IP systems. M2's expertise is focused on sales and marketing rather than IT, but it has effective customer and agent maintenance and billing systems that it developed in-house with outsourced code writing that remains its own intellectual property. M2's alliances with partners such as Travelscene American Express, Virgin Blue or Bartercard enhance the loyalty program results.
We see a successful 1H07 leading to greater revenues and profits in H2 from M2's wholesale enabling role for Optus amongst the smaller telcos. FY08 will see the full impact of this development, in New Zealand with Vodafone as well as with Optus in Australia. But the real FY08 growth story depends on M2 catching a 'whale' or two.
The first stage with Optus is to build out Optus' mobile penetration into the smaller telcos. The second step is to move the model into the corporate arena, offering a compelling proposition to major corporates to enable them to provide telco services to their large customer bases.
In the USA there are probably fifty MVNOs servicing customers of Disney, Walmart and others. In the UK, supermarket leader Tesco is building such a business. As arguably the most experienced mobile virtual network operator in Australia and offering the leading Optus mobile brand, M2 is building plans for offering a complete service to institutions with large customer bases. These might include major banks, insurance companies, retailers, motoring and health institutions and others. M2 We had expected M2's next moves to be a combination of smilar telecommunications offerings in Asia and service offerings to utilities other than telcos, such as electricity, gas and water. However, we understand that while M2's experience and IP give it long suits in these other utility areas, it is better off at present playing out all its trumps with its Optus relationship, particularly while Telstra has opted out of the game (at least not working with telcos!).
While M2 does not have the infrastructure and capacity to handle in-house the total provision of telco services to the potentially numerous clients of a major corporate, it already knows how to do it and would never intend to do it all in-house. It has already licensed and worked with specialists in customer service, debt collection and IT in Australia, India and the Philippines and would contract support as appropriate, while it would project manage the entire package for the client.
Impact We have repeated in the table the projections for base ('B') and probable ('P') earnings and dividends in FY07 as in our 9 October review, updated for the current price. We see a strong likelihood of M2 catching at least one 'whale' to add to earnings in FY08, which could push NPAT close to $4.0m and generate EPS of some 6.6¢. With the 70% expected payout continuing this could give a P/E of 8.2 times and a franked yield of 8.5% on the 54¢ current price. We will firm up the prospects for this projection in the light of announcements of more wholesale agreements this year and the 1H07 results early in 2007.
We maintain our recommendation on a company with a sound track record and a market capitalisation of $32m in a telecoms market of over $4bn. M2 appears to have both a strong and scaleable model for profitable growth and ownership of a prime piece of territory in the market. Buy.
