TPG Telecom has gone into a trading halt to conduct a capital raising to pay for a slab of mobile spectrum it has purchased in a Government auction.
TPG will spend $1.26bn on the licence for 2x10 MHz of spectrum in the 700 MHz band and a further $600m over three years to build the network. The business has agreed to pay licence costs in instalments so it can mobilise operating cash flow to help pay for them, but it is also raising $400m via a 1-for-11.13 non-renounceable rights issue at $5.25. More debt will also be required.
Early verdicts on the deal suggest concern about the price paid for spectrum which, at $2.75 per MHz per head of population covered, is a global record for a 4G licence. We aren't as concerned. As a new entrant, TPG can avoid building and maintaining outdated legacy infrastructure that peers must maintain – such as 3G, 3.5G towers – and, by utilising its existing backhaul and infrastructure, it can lower start-up costs usually borne by new entrants. It can afford to pay up for spectrum because it will save a lot of money on building costs. In aggregate, the announced capital expenditure is slightly lower than we'd expect.
Despite this, TPG has its hands full. With a Singapore network, metro fibre and a mobile business to build, capital expenditure over the next few years will be considerable, so the free cash flows envisioned in Opportunity calls at TPG won't appear. As we said then, this recommendation implies a high degree of faith in management, so it's pleasing to see that the two largest shareholders, executive chairman David Teoh and Washington H Soul Pattinson, are taking up their rights.
We recommend doing the same since, with the rights issue being non-renounceable, shareholders that don't take up their rights will be diluted. The retail component of the rights issue will open on Friday 21 April, when a booklet will be sent out, and will close on Friday 12 May.
Buying shares at $5.25 is an easy decision; buying them at market prices is a harder choice. When they resume trading on Tuesday, the shares will lose around 11 cents due to dilution from the rights issue and a further 8 cents after losing entitlement to the interim dividend, but they will probably fall by more due to investor concerns about the move. As things stand, the implied valuation (an EV/EBITDA multiple of about 8) is mildly cheap but this is a better than average business.
Our concern is that TPG is now focused on building a scale business – mobile – without any scale. Irrational pricing, deep discounting and a short-term disregard for profit could follow. The other question is a longer-term one: the success of the mobile network will depend on the ACCC's pending decision on allowing access to Telstra's regional network. In short, the risks have just gone up.
While we remain positive about TPG and agree this is the right long-term move, we still need to do more work to assess the right price to pay for the stock. We're downgrading to HOLD and temporarily removing our price guide pending a more detailed review.
Note: The Intelligent Investor Growth Portfolio owns shares in TPG and intends to take up its rights. Find out how you can invest directly in this and other Intelligent Investor and InvestSMART portfolios by clicking here.