PAC Partners note

Received this PAC Partners note - it's hella positive and well worth a read.

COMPANY Macquarie Telecom	MCAP $418m	$19.69/share	Date: 29th April 2019
RECOMMENDATION BUY and PT $33.14/share 68% upside, Medium Risk
EVENT:Initiating Coverage – Time to get set.
KEY POINTS
1.Macquarie Telecom (MAQ) operates in attractive SME and Government markets, and a multi-year growth story well placed to benefit from ongoing structural tailwinds: the move to digital business models, IT Hybrid-Cloud, data usage, Hosting, Private Data Exchange, Colocation, &Cyber Security.
2.The build of Intellicentre 3 (IC3) is a transformational asset (33MW of capacity) for the company, already owning the land (purchased for $10m several years ago), and being adjacent to the existing IC2 facility at Macquarie park, the ‘lead-ins’ from carriers are already in place, and the location is one of the last availability zones around the CBD which means it is well sought after by Hyper-Scalers looking for capacity. Due to its location adjacent IC2 incremental OPEX is light - Thinking like a commodity analyst IC3 will be at the bottom of the ‘cost curve’ in the opaque world of Data Centre capacity, meaning a higher ROIC than peers, and should competitive tensions arise, be in a position to undercut rivals. MAQ has forecast earning $4.8m revenue per MW in the existing IC2 facility, if applied to the new IC3 facility implies and additional ~$160m in revenue at ~50% EBITDA margins.
3.The NBN wholesale agreement signed last year will expand the addressable market for MAQ’s telco products and services, and importantly we expect gross margin expansion of 10% to come from that as customers are migrated away from the existing wholesale carrier deals. 4.The introduction of SD-WAN is a disrupter for the industry, as it decouples carriage from network management, implying that networks can be controlled by software and agnostic to the owner of the infrastructure. MAQ are a leading player in that marketplace. We see the opportunity for MAQ to pursue a materially larger portion of the circa $4.6bn pa Corporate/SME network market in Australia. 5.We see the opportunity for MAQ to convert existing Colocation customers to Hybrid/Private Cloud and increase the revenue per MW (currently $4.8m per MW in IC2). Within the corporate market for hosting this has been core to the value proposition. 6.MAQ operate in 42 Government agencies, they are accredited, on the panels, and being the largest Australian owned Private Cloud provider are well placed, particularly as Huawei (banned) and others under foreign ownership cannot easily compete. We see this as a strong source of barriers to entry.
1.FY’20F METRICS EV/EBITDA 7.6x | PER 28.6x 2.FY’21F METRICS EV/EBITDA 7.1x | PER 26.3x
LINK TO initiation: MAQ_Initiation_25_04_2019.03.pdf30 pages
INVESTMENT VIEW
We initiate with a BUY and a positive view on: 7.Management. Hold significant amount of ordinary equity (55%) and decisions are aligned with external holders interests. Evidence is clear, from the high returns on equity achieved, cutting dividends and using debt to fund DC expansion, rather than ‘tapping’ shareholders for funding, Management are good capital allocators and this as important in an industry that by its very nature is capital intensive. 8.Markets. We see the SME/SMB markets that MAQ operates within as having a higher growth profile than the mass market consumer/retail sector and from a sector stock selection perspective see MAQ well placed versus consumer-focused peers. 9.Upside and room to upgrade. A Fortune 100 customer has contracted for up to 2.5MW of capacity in IC2, which we see as a solid foundation for demand in IC3 – a faster ramp-up than our projections would see upside to cashflow forecast in DCF, and we realistically envisage a scenario where we upgrade our numbers. Global ICT Market Revenues and Growth Source: Monitor Deloitte: “B2B: igniting the new telco value engine” Valuation:We derive a DCF valuation of $33.14, based on a progressive 2MW ramp-up per annum for IC3. Funding: MAQ have a $100m syndicated debt facilities and have entered into a sale and leaseback with Keppel DC REIT, there is no funding risk for MAQ and have a healthy cash balance.
company Background
Listed in September 1999, MAQ has been a ‘quiet achiever’ progressively expanding its customer base and the services it offers. In an industry that has a high degree of rivalry and intense competition, MAQ have differentiated through a consistent and unrelenting focus on customer satisfaction which has culminated in MAQ achieving a peer leading Net Promoter Score of +75. (the likelihood a customer is to recommend your products and services). Macquarie Telecom (MAQ) is a $233m (FY’18A) revenue generating business delivering integrated cloud and telco full-service provider with two external revenue generating business units, Hosting which delivered $91m in revenue and, Telecoms which contributed $142m. Notwithstanding recent earnings pressures across the industry, While Hosting represents 39% of the revenue, it generates 56% of the EBITDA, and consists of two sub-sectors, Cloud-Services and Government, and a product mix including: Hybrid IT, Co-Location, Application Hosting, Data Centre for both private/public cloud within Cloud Services, and cyber-security, secure cloud and col-location for Federal Government. Competitors are many, and include, NEXTDC, Public Cloud, rack-space, Verizon and HP, Equinix. MAQ operates, three data centres (DC) called “Intellicentre” labelled (IC1, IC2, IC4) and IC3 (East and West) which is under construction. MAQ achieves a high revenue per MW (~$4.8m per MW) and this is down to the additional services that are layered on top from private-cloud/hybrid cloud hosting that MAQ undertakes. Macquarie does offer vanilla IaaS and co-location, but it continues to position itself as a higher-touch, premium player compared with low-cost public cloud providers like AWS. With MAQ having a large Government client base, we see secure hosted services continuing to command a premium per MW.
key drivers Modest ramp-up profile at 2MW per annum…
EBITDA profile becomes more weighted towards recurring hosting revenue over time…
Milestones
10.Mid CY’20 – The practical completion of IC3 at Macquarie Park. 11.Over the next two years the migration of SME customers from existing wholesale carrier arrangements to the NBN. RISKS
1.Delay to IC3, slower ramp-up, cost overrun.