Morningstar Item

Item dated 3 May 2017

Vocus Hit by Hocus Pocus Systems and Processes; FVE Cut to AUD 4.80
We cut our fair value estimate for narrow-moat Vocus by 25% to AUD 4.80 per share, following a distressing trading update. Management's 16%, or AUD 70 million, downgrade to its previous fiscal 2017 EBITDA guidance is not only startling in its magnitude, but raises serious doubts about the group's financial controls and systems. While steps are being taken to improve in these areas, it is abundantly clear Vocus has bitten off more than it can chew with its recent spate of mergers and acquisitions. Reporting and technology systems are woefully inadequate for what is a major player in the telecom big leagues.

The silver lining amid the current mess is that most of the factors behind the downgrade appear fixable. The AUD 33 million EBITDA impact from a delayed recognition of expected project revenue reflects aggressive initial accounting treatment, while the AUD 10 million reduction in EBITDA forecast for the Enterprise and Wholesale division is also a product of haphazard budgeting. These shortfalls, combined with the AUD 12 million extra costs for technology investment, can all arguably be traced back to Vocus' subpar finance and reporting systems—an issue that should be resolved over time.

We have cut our fiscal 2017 to 2019 underlying EPS forecasts by between 20% and 24%, reflecting the guidance downgrade, as well as a revision of revenue growth and sustainable margin estimates longer term. Our DPS forecasts have similarly been reduced.

Our investment thesis for Vocus remains anchored to the long-term upside from lifting market share in corporate (from current 5% level) and mass market broadband (from the current 7% level). Unfortunately, the company's credibility is at a low, with the stock at a depressed 8.2 times price/earnings and 5.9 times enterprise value/EBITDA on our fiscal 2018 estimates. It will take time for market confidence to return and for shares in Vocus to close the 51% discount gap to our fair value estimate.