BigAir finds its wireless tailwind

PORTFOLIO POINT: Telco group BigAir is cruising in the fixed wireless and broadband space, with acquisitions boosting its revenue and earnings. It is in a good position to soar higher.

Several small telecommunication stocks have had stellar gains in the past few years as demand for internet connectivity booms and newer players eat into the market share of larger ones.

Returns have been especially strong over 12 months. TPG Telecom’s one-year total shareholder return (including dividends) is 42%. iiNet has delivered 52% over that period; Amcom Telecommunications has returned 47%; and M2 Telecommunications Group has rewarded shareholders with a 36% total return.

BigAir provides ‘fixed wireless’ (no not a misprint) internet services to businesses in capital and some regional cities. The fixed wireless division contributes three-quarters of revenue, while its community broadband division, which provides internet services in the student accommodation market, provides the rest.

BigAir says it owns and operates Australia’s largest metropolitan business fixed wireless broadband network. Companies use it for direct high-speed internet access and to extend their local area networks to wide area networks, and connect their outlets, employees, customers and suppliers nationwide.

Like many small telcos, BigAir is busily buying smaller competitors as bolt-on acquisitions. In June it bought fixed wireless network operator Link Innovations for between $1.75 million and $2.75 million (there are performance incentives).

Acquisition of Link’s high-speed fixed wireless network extended BigAir’s footprint in key regional markets and was earnings-per-share accretive. Importantly, the acquisition was funded mostly from cash flow.

In May, BigAir expanded its fixed wireless reach when it acquired Allegro Networks for $7.5 million (plus an additional $3 million if it meets revenue targets) through a mix of cash and shares.

The acquisition boosted its share of the fast-growing tertiary student market for internet services. BigAir now provides pre-paid internet services at 120 student accommodation sites, servicing more than 27,000 students.

BigAir’s strategy is paying off. Revenue rose 47% to $22.9 million in FY12 and earnings before interest, tax, depreciation and amortisation (EBITDA) rose 80% to $9.75 million. Earnings per share rose from 1.2 cents to 2.8c, and BigAir delivered a maiden 1c dividend.

A good sign was BigAir’s underlying EBITDA margin rising from 35% to 42.6% in FY12. Management has done a good job integrating acquisitions, reducing duplication and extracting synergies and quickly exploiting economies of scale to boost margins and earnings. It also is building a reputation for over-delivering on company earnings guidance.

BigAir has other characteristics that score highly in Skaffold.com. There is no debt, and strong growth in operating cash flow gives it scope to buy smaller competitors without excessive and dilutive share issuance.

Although better than several small telco stocks, BigAir’s ROE trails its peers. BigAir needs to get ROE well above 20%, and consistently improve it over the next few years, so that growth in intrinsic value accelerates. Skaffold forecasts BigAir’s intrinsic value to increase 26.5% from 33c a share to 42c over the next year. With its shares trading at 43c, that leaves no margin of safety for investors who buy BigAir today.

Figure 1. Intrinsic value rising at a solid clip, but share price currently no bargain

BigAir is still worth watching. It could grow faster than the market expects and boost earnings per share (EPS) from 2.8c to above 4c at its current trajectory. And the company has good tailwinds. More businesses are demanding wired and wireless internet services to ensure uninterrupted web access as they take advantage of cloud computing, and acceptance of fixed wireless as a reliable, high-speed service is rising. It is a large market for BigAir to grow into.

BigAir’s expanding reach in regional markets offers new opportunities, as does student accommodation internet services. These could grow faster than the market expects as international student enrolments recover. Perhaps the real upside is exploiting synergies from acquisitions and using strong operating cash flow to buy other companies.

Small telcos can hit an earnings sweet spot when they leverage capital investment in their network across a much larger customer base, to spread fixed costs and bolster margins. BigAir’s capital expenditure as a percentage of revenue has fallen from 31.9% in FY10, to 18.1% in FY12.

A key risk is how both the 4G and the National Broadband networks affect demand for BigAir’s offer as well as those of other emerging telcos. BigAir believes the NBN will create opportunities and there will be pent-up demand for super high-speed broadband as NBN hype builds. BigAir says its network is already delivering NBN speeds today.

Given already strong gains BigAir is no bargain today, however the company should be on your watch list and deserves a thorough review.

Note: Montgomery Investment Management owns Big Air through the funds it manages.

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Roger Montgomery is an analyst at Montgomery Investment Management and author of Value.able, available exclusively at rogermontgomery.com.