Rethinking amaysim

The hardest thing in investing isn't losing money; it is revisiting a stock after losing money. If emotion is the enemy of the investor, then this exercise more than any other is doomed to appease the enemy.

So why do it? Chances are, if you're feeling uneasy about revisiting a stock after it has fallen, so might other investors and a mispricing may be present. Mispricings are more likely in stocks that dim the spirit than those that raise the pulse. 

In that vein, we return to amaysim, the cause of considerable grief. 

We first recommended the stock back in 2016 (see Unlocking value in amaysim). We were enthused by a capital-light model that was able to benefit from billions of dollars of network spending while lowering its own rental costs. 

Margins were thin but amaysim was the only mobile virtual network operator (MVNO, a business that resells spectrum) that made a profit.

amaysim had built unprecedented scale as the fourth largest mobile provider and boasted costs to acquire and serve customers that were fractions of the large network operators.

With a cost advantage and scale that allowed it to increase margins, we figured this was a better business than it appeared. And at first, that's how it played out. Operating margins doubled as customer numbers and average revenue per user (ARPU) grew. Then it all came crashing down.

Fight club

The mobile market got more competitive faster than expected. When handsets ceased adding new features, operators started to fight on price. Across the industry, average revenue per user (ARPU) has been scorched as fixed cost operators fought for customers. 

amaysim's ARPU has fallen from nearly $30 per customer per month to $15 and the business couldn't capture enough customers to offset lower prices. This is the dark side of operating leverage; when high fixed costs meet lower revenues, profits crumble.

Mobile profitability collapsed from operating profits of $43m in 2017 to just $23m last year. The fall can be entirely explained by lower ARPUs due to intense competition that appears unlikely to ease. The business has offset mobile decline with a successful move into energy which now accounts for the bulk of profits.

We were slow to recognise that falling ARPUs pointed to a significant industry change rather than something temporary. That error was costly. We belatedly issued a Sell call on the stock losing almost 47% on our purchase price. 

Lessons

Investing isn't a pursuit for those who insist on certainty; even the best investors will be wrong 40% of the time. Yet the biggest problem here wasn't being wrong. Our mistake here was sloth; we were too slow to recognise change even when the signs of it were abundant. 

The share price has fallen a further 35% since our Sell and operating conditions in the mobile business have deteriorated. Customer growth has stalled, ARPU has fallen and profitability has plunged. Yet there is still a case for the optimistic. 

amaysim's key asset is its 1 million strong mobile customer base, along with 194,000 energy customers. In fiercely competitive markets these are worthy prizes, particularly the mobile customer base.

That customer base generates EBITDA of $24m for amaysim. In a business with a market capitalisation of about $200m that may not sound out of the ordinary yet recall that amaysim captures and reports only a resellers' margin. 

That same customer base is, however, worth much more to a mobile network operator that captures both wholesale and retail margins. Let's dig into that in more detail.

Two profit pies

Last year amaysim generated mobile revenue of $240m. Optus receives roughly 70% of that revenue in network charges, or about $170m. From the remaining 30%, amaysim pays all its non-network costs and generates a profit margin. 

To amaysim, 1 million customers are worth only a small margin; to Optus, or another mobile network, that same asset base is worth a lot more. 

Investors currently pay for the value customers generate to amaysim alone, ignoring the value generated for mobile networks who could, in time, pay for what the market ignores.     

amaysim, in other words, generates far more value than it captures. 

There is a decent case that amaysim should be judged not by its own profit but by the value it generates from its customers, most of which accrues to network operators. That opportunity was present when we first upgraded the stock and it remains present today. 

There are two big differences between then and now: value and time.

Value and time

Heavy share price declines mean the option of realising value from the customer base is cheaper now than it was and the numbers look enticing. 

For $200m, one can buy a mobile customer base that puts at least $150m of revenue per year into the hands of networks. And that ignores decent profits from energy. The fixed cost economics of mobile networks mean that revenue comes with high margins and, by improving utilisation, every additional customer makes the network more profitable.

Optus, Telstra and TPG-VHA should all be looking at amaysim as the last chance to buy 1 million customers in one go.

We note also that amaysim's network agreement with Optus expires in 2021 and a renegotiation of that contract should be well under way by 2020 if it hasn't already commenced. 

When amaysim first negotiated that contract it was a fledgling, profitless reseller completely dependent on the Optus network. Today, it is the largest MVNO on the market with 10% of Optus's customer base and a large chunk of its growth. 

The relative balance of power has shifted and amaysim is in a position to cut a better deal. Any decline in network costs flows straight to the bottom line and could significantly increase earnings.

Alternatively, amaysim could shop its customer base around to other networks. The inclusion of energy opens up other potential partnerships. Both AGL and Origin, for example, have started telco subsidiaries and could be potential suitors.

amaysim itself appears to have recognised the strategic value of its customers. It has raised $50m of fresh capital to repay debt and to ramp up marketing. 

It appears the business will seek to raise customer numbers and then either sell itself to the highest bidder or switch its service to the lowest priced network. The status quo is unlikely to remain. 

Re-engage?

There are good reasons why amaysim could be worth more than today's price suggests, and a genuine mispricing may be present. So should you buy? 

That decision is harder because, unlike a conventional investment, value here won't be realised by internally generated cash flow. We are dependent on other parties to realise value and that introduces significant risk. Takeovers usually make for a poor investment case.

Another potential outcome may simply be that amaysim's contract renegotiations don't yield any gains. Or that continuing competition erodes any value it can generate. 

These uncertainties are probably why, for the optimistic and risk tolerant, an opportunity may be present. However, it also ensures that the range of outcomes is wide and risks are high. 

amaysim remains an interesting idea but one we aren't prepared to put cash into at this stage. We'll keep an eye on it from a distance and, for now, we're CEASING COVERAGE.