On a list of strange acquisitions, you might find a mobile business buying an energy retailer. Odd as it may at first appear, though, there are many similarities that amaysim shares with its most recently acquired business, Click Energy.
Click is a retailer of energy. It locks in fixed price electricity from a generator and then sells it to retail customers at a margin. The business earns a gross margin of around 25% from which it pays non-electricity operating expenses and makes its profit. To do that, it needs both scale and low costs.
With just 150,000 customers, Click is profitable and generates earnings before interest, tax, depreciation and amortisation (EBITDA) margins of about 7% and, with an online only model that mirrors amaysim’s own, costs are low and customer growth has been swift.
Acquires online energy retailer, Click
Aims to offer multiple services from a common platform
The business model – reselling via an online platform – isn’t too far removed from amaysim's. Electricity, like mobile services, is a capital-intensive business where it can make sense to resell rather than own assets outright.
Ok, so they are similar. But why buy Click? The ultimate aim for amaysim would be to have three products – mobile, NBN and electricity – on a single platform with shared technology to market to a shared user base.
Combining electricity and telecoms isn’t unheard of in Australia (M2 did it) and is becoming more common in overseas markets where telcos have crept into power retailing.
The energy retail market is dominated by three participants who hold an 80% market share. AGL, Origin and EnergyAustralia run ‘gentailer’ models, that is operating generators as well as retailing electricity.
For a long time these businesses have delivered superior returns, but each is facing difficulties as electricity demand falls, rooftop solar flattens power peaks and coal generators become unprofitable. We described these challenges a couple of years ago in Electricity disrupted.
The energy retail market, which is being examined by competition authorities, is ripe for disruption, looking a lot like telecoms did a few years ago with healthy incumbent margins, lots of complexity and a reputation for poor service.
There's room for new competitors that operate with lower costs and aren’t burdened with legacy assets. But a case for Click Energy isn’t necessarily a case for amaysim buying it.
The deal is, for a start, expensive. Click says it has about 155,000 customers, which means amaysim is paying about $775 for each one. Origin has acquired customers in past transactions at about half this cost and more recent transactions have come to about $500 per customer.
Click does boast a relatively high ARPU at $115 a month, and it is growing its customer base swiftly. It has grown from 20,000 to 155,000 customers in about three years. This isn’t a bargain buy but one could argue that it isn’t a crazy price.
Amaysim itself has targeted just $5m a year in cost savings by sharing technology, suggesting this isn’t an acquisition driven by huge cost savings. The only way to justify the purchase is to assume the two businesses can cross-sell products.
Hot cross sell
Generally we are sceptical of cross-selling strategies. For years, the banks have hoped to cross-sell all sorts of financial products to their customers and failed.
Cross-selling mobile and NBN services, though, has history and makes sense. Does adding power retailing do the same?
It has been tried before. Both Vocus and its predecessor M2 have offered energy albeit without obvious success. That might be changing. Internationally, plenty of telcos are adding energy retail products to their offerings.
For amaysim specifically, there should be more overlap with Click than Vocus or M2 had ever managed. Both amaysim and Click offer simple products without contracts on website-only platforms that are largely self-service. It isn’t heroic to assume that a customer who has deliberately chosen amaysim would also look at Click.
That had better be the case because, in the absence of cross-selling successfully, it’s hard to see this acquisition succeed. Amaysim believes the acquisition will boost earnings per share (EPS) by 27% by 2018 but all this benefit comes because of the financing of the deal rather than the substance of it.
Amaysim will pay $40m in equity and another $80m in cash, which will increase its debt. If the deal had been wholly financed with shares at $1.75 a share, it would raise EPS less than 5%.
While we aren’t overly enthused by the purchase there is a logic to combining these businesses and amaysim still appears inexpensive.
The energy addition is one we would prefer not to have but, given it is here, what do we do with it?
Energy will account for about half of revenues and about a quarter of earnings. If it works, it would be hugely beneficial. Sharing technology platforms and lifting average revenue per user (ARPU) will raise margins without forcing higher prices. If it doesn’t work, the base business should be able to repay the debt and the gambit would have failed without existential consequences.
In two years, amaysim could be generating about $500m in revenues and about $60m in EBITDA. With an adjusted enterprise value of about $480m, an EV/EBITDA of about 8 times appears marginally cheap rather than an outright bargain considering this is now riskier than it was.
The market disagrees with our caution and has pushed the share price higher. It is now just below our $2 Buy price. More conservative investors might wait as this has become a riskier buisiness, but we'll keep it as a BUY.
Note: The Intelligent Investor Growth and Equity Income portfolios own shares in amaysim. You can find out about investing directly in Intelligent Investor and InvestSMART portfolios by clicking here.
Disclosure: The author owns shares in amaysim.