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Dean Mico
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I manage a private investment fund in Australia known as The Edge Fund. I invest in the best Australian stocks using a value investing methodology. I overlay this with technical analysis to buy low and sell high. My website is www.edgeseven.com.au
My company:
Edge Seven Pty Ltd
My blog:
Edge Seven Value Investing
  • ASX: MTU - M2 Telecommunications Group Limited 0 comments
    Apr 19, 2012 12:44 AM

    M2 is now jumping bigger hurdles - perhaps it is appropriate in an Olympic year.

    M2 Telecommunications Group Limited (ASX:MTU) is a provider of retail fixed-line, mobile and data telecommunications services, specifically tailored towards Small to Medium Businesses (SMBs) in Australia and New Zealand.

    Is this business easy to understand?

    M2 Telecommunications Group Limited 'M2 Telecom' was established in 1999 and has become Australia's largest network independent provider of telecommunications services to SMBs in Australia and New Zealand.

    Over the past 10 years, M2 Telecom has grown both organically and via a number of acquisitions. M2 Telecom now boasts seven key brands:

    • Commander
    • People Telecom
    • M2 Telecom
    • M2 Wholesale
    • Southern Cross Telco
    • Green Mobiles
    • Simply Mobiles

    Does this business have a sustainable competitive advantage?

    M2 Telecom have grown to become the leading provider in the SMB telecommunications market due to a few key points of difference which largely evolve around their 'can do' attitude which has created ongoing positive morale amongst their staff .

    M2 Telecom proudly boast that the energy and capability of their team is what makes M2 telecom successful.

    The M2 team has grown significantly over recent years, however M2 Telecom reports that is enjoys near non-existent turnover of core staff members which is the envy of any organization anywhere in the world.

    M2 Telecom developed a sales model of being innovative in comparison to their peers. M2 Telecom does not sell on price and instead focuses on understanding the needs of their potential customers. M2 Telecom provide solutions to customers' problems in order to create greater benefits for their customers.

    What are the risks facing this business?

    The very recent risk (announced 16 April, 2012) to M2 Telecom's business is their latest acquisition of Primus Telecom. With strong knowledge of their industry, the company has presented some very prescient information which does make the acquisition look attractive. These attractive points include:

    • Growing revenue and earnings as a result of the acquisition
    • Primus has a strong presence in the residential telecommunications market which compliments M2 Telecom's market share in the business market
    • Increased cross selling benefits across the two businesses
    • $5 million of potential cost saving synergies per annum via operational efficiencies, possible consolidation of premises and potential savings in buying bandwidth with enhanced buying power
    • M2 Telecom is preparing for the National Broadband Network with greater market scale and reach

    On the flip side, the negatives in making this acquisition include:

    • M2 Telecom is taking on a significant level of debt. They are increasing their debt level by $135 million dollars. The interest on this increased debt will cost more than $5 million per annum which is the forecast saving from 'synergies'
    • In these situations, I am skeptical that the proposed $5 million per annum of cost savings via synergies will materialize
    • The risk to the corporate culture can have an impact on the business. Staff in these situations typically become inwardly focused and naturally concerned about their jobs, particularly when the company considers reducing costs by consolidating premises
    • Change predominantly faced by the employees of the acquired business, in this case Primus employees, can easily become negative, leading to contagion of reduced staff morale

    Is it run by able and trustworthy management?

    M2 Telecom has delivered consistent growth in both revenues and profit, year-on-year for each of the last seven years. In recognition of this significant and consistent growth, M2 was named by Business Review Weekly as one of Australia's fastest growing companies in 2003, 2004, 2005, 2006, and 2008.

    M2 Telecom's corporate culture no doubt created from the top of the organization is very impressive.

    M2 Telecom present that they take a particularly strict approach to corporate governance and responsible financial management, for the benefit of customers and shareholders alike. They have demonstrated in the past that this is the case with the acquisitions they have made up until now. I do however question if the Primus acquisition is as responsible.

    Is it trading at a bargain price?

    2011 Actual Valuation = $2.91

    Today's Share Price = $3.27

    2011 Forecast Valuation = $3.48

    Prior to the acquisition the average return on equity for 2012, 2013 and 2014 was forecast to be 38.8%.

    Prior to the acquistion their current net debt to equity was a low 9.8%.

    2013 Forecast Valuation (prior to acqusition) = $4.80

    2014 Forecast Valuation (prior to acquistion) = $5.53

    M2 Telecom has changed the look of their company with this acquisition.

    After the acquisition, average return on equity to 2014 is forecast to be a lower 32.3%.

    After the acquisition, the net debt to equity position becomes an uncomfortable 78%.

    2013 Forecast Valuation (after the acqusition) = $3.76

    2014 Forecast Valuation (afte the acquistion) = $4.10

    *Please note that this estimate of intrinsic value is subject to change on a daily/weekly basis.

    For me, M2 Telecom has taken a very successful business that was running along only needing to jump one foot hurdles. With this Primus acquisition, they are now jumping three and a half foot hurdles. As good as Sally Pearson is at running the high hurdles (three and a half footers), the reality is that Sally would be able to run faster if they were only one foot high. M2 Telecom has given themselves the challenge of running the same speed over higher hurdles which is an ambitious task.

    Summary

    In summary, M2 Telecom is a profitable business with positive cash flow and experienced management. The Primus acquisition significantly increases their debt level and makes the business bigger. Bigger is not always better. I will watch M2 Telecom's progress with interest hoping that the positive attributes of their acquisition shine through in the long run. Go M2 and go Sally!!!

    Disclosure: Dean Mico sold his shares in M2 Telecom on Monday morning, 16th April after digesting the information presented in the acquisition. Dean Mico purchased his M2 Telecom shares on the afternoon of 25 November, 2011 and had considered this business a long term holding until this announcement. Please do your own research and do not make a buy or sell investment decision based solely on the information provided in this article.

    This article is published by Dean Mico.

    The information provided in this article is intended for general use only. The article is intended to provide educational information only. Please be aware that investing involves the risk of capital loss. The information presented does not take into account the investment objectives, financial situation and advisory needs of any particular person nor does the information provided constitute investment advice. Under no circumstances should investments be based solely on the information herein.

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