ACCC blocks TPG's merger

In a previous life, I worked with the ACCC on water regulation and have always been impressed by the commitment and intellect of the economists working there. 

What follows is said with no malice and some remorse: the ACCC's decision to block the merger between TPG and Vodafone Hutchinson Australia (VHA) is one of the worst decisions in the regulator's history and illustrates a total lack of understanding of the Australian mobile market.

It is possible to call the mobile market uncompetitive because one firm charges hefty retail prices, earns the highest operating margins in the world and commands a 50% market share. 

The real monopolist

The monopolist is Telstra, and the merger was the single best way to break its grip on the market.

Rather than serve consumers, the ACCC has damned them by blocking the most aggressive, effective competitor to Telstra's monopoly from emerging.

TPG shares dived 14% just before yesterday's close as the news leaked unintentionally online, although they have recovered 3% this morning. Without the merger, TPG's grand strategy of combining quality fixed assets with its aggressive, cost-focused operating nous is in tatters. We don't know if there is a Plan B.

The ACCC has argued that the merger would have prevented the emergence of a fourth network operator yet no market - certainly none as small as Australia - has been able to sustain four networks. 

In fact, the ACCC has blocked the emergence of a third competitor capable of offering bundled services. Currently, only Optus and Telstra can bundle effectively and Optus, to put it mildly, has proved a weak competitor.

Contest

A combination of VHA's decent mobile network with TPG's excellent fibre network and ruthless disposition would have, in our view, eventually dethroned the Telstra monopoly. For the moment, that opportunity is gone.

The decision is being contested. VHA announced within hours that it would appeal to the Federal Court and they have a strong case. It wouldn't be the first time the court has overturned an ACCC decision and this decision looks worse than any that have come before it. 

What should TPG shareholders do from here? Action is hard to recommend because the outcome from here is binary. An appeal is underway: if it succeeds, TPG's share price will soar and we think the combined business could be worth about $10 a share (see our valuation breakdown here); if it fails, then TPG may be worth less than $4 a share. 

The odds must surely favour a reversal of the decision from the courts but that is no certainty. For now, we're removing the price guide, but increasing our risk ratings to High and reducing our recommended maximum portfolio weighting to 5%. HOLD.