Popular junior Telco plans even more acquisitions
Hard on the heels of its Primus purchase mid last year, M2 Telecommunications recently announced two further transformative acquisitions. It plans to outlay $204 million for Dodo, a privately-owned telecommunications player in the residential retail market, and also announced a $38 million offer for Eftel, an ASX-listed entity that provides a full suite of telecommunications services to consumers, corporate and government entities.
M2 Telecommunications plans to pay for the combined $260 million cost (inclusive of $18 million in transaction expenses) by issuing $84 million in new equity to the stockholders of the two companies, with the remaining $176 million to be funded by debt.
Management has projected that the two businesses will contribute more than $50 million in Earnings before Interest, Tax, Depreciation and Amortisation (EBITDA) in fiscal 2014, amounting to over 40 per cent of M2 Telecommunications existing earnings base.
If these earnings come through, it means the two companies would have been acquired on a EBITDA multiple of just five times.
The company has estimated an earnings accretion from the acquisitions of about 20 per cent for fiscal 2014, and that its net debt-to-EBITDA ratio will increase from 1.1 times to 1.8 times in fiscal 2014.
The projected $50 million EBITDA contribution from Dodo and Eftel in fiscal 2014 is a significant step up, given that the two companies currently produce a combined EBITDA of $37 million. However, even assuming a more conservative $42 million in contributions, our analysis shows the acquisitions are still accretive to the tune of 13 per cent.
One reservation we have is the higher debt load (almost $300 million) that M2 Telecommunications will be carrying post the acquisitions. We note, however, management's implicit confidence in servicing this debt, reiterating its intention to keep the dividend payout at 70 per cent.
The market continues to embrace M2 Telecommunications' growth story, pushing its stock up 34 per cent and 39 per cent in the past six and 12 months, respectively. The latest acquisitions are likely to further ignite interest in this fast-growing junior telco, particularly among larger-cap fund managers, as the company's market value approaches $800 million.
While management's track record in bedding down acquisitions and delivering accretive growth for shareholders is undoubted, we will monitor earnings from the acquisitions.
Even without the earnings accretion expected from the two purchases, as it stands M2 Telecommunications boasts a strong double-digit EPS growth outlook, is financially sound and generates significant free cash flows. Despite this, the stock trades at just over 14 times consensus fiscal 2013 EPS estimates, reducing to less than 13 times the following year, and with a dividend yield of above 4 per cent. With further potential upside from a successful integration of Dodo and Eftel longer term, we believe the stock is worth buying at current levels.
Brian Han is senior research analyst at Fat Prophets sharemarket research. To receive a recent Fat Prophets Report, call 1300 881 177 or email firstname.lastname@example.org.