The arrival of the NBN is forcing smaller telcos such as M2, TPG and iiNet to consider scaling up through consolidation.
Photo: Rob Homer
M2 Telecommunications’ planned acquisition of consumer brand Dodo and business provider Eftel highlights the need for consolidation among Australia’s second-tier telcos that includes rivals TPG and iiNet.
M2, which will spend $248 million buying the companies founded by entrepreneur Larry Kestleman and Michael Slepoy, intends to expand further – after the 12 months or so it needs to digest its current targets – chief executive Geoff Horth says.
“This market is moving to maturity,” Horth tells BRW. “When you get to maturity you need to have scale. People have been asking us for the past two to three years: ‘Have you run out of targets to buy?’ We haven’t and probably still haven’t. In Tier 2 there’s some potential for consolidation in the next three to five years.”
In an industry led by Telstra and Optus, the advent of the National Broadband Network is causing the three next-largest providers, M2, TPG and iiNet, to look at consolidation. The gains they have made from falling prices for ULL, the so-called unconditional local loop deals they made for wholesale lease of Telstra’s copper line – which allow them to reach individual residences and business customers – have come to an end and they need to drive up numbers to keep increasing profit levels.
Smaller players need to build backhaul muscle
In addition, the smaller players also need to build up their customer bases so they are large enough to justify investment in their own backhaul infrastructure that will connect their servers to the NBN’s so-called interconnection points or, alternatively, become large enough to bargain with Telstra and Optus to provide wholesale backhaul infrastructure services.
None of M2, TPG or iiNet are big enough to achieve this by themselves, says CIMB Securities analyst Ian Martin.
“They’ve got to get together,” Martin says. “That’s why we’ve seen iiNet’s price go up. They’re seen as the most likely target for TPG. That leaves M2 as a big question mark. Would someone buy it or would it buy others, like a Macquarie Telecom or Amcom?”
Another name in the mix is wireless access provider Big Air. However, like fibre-based provider Amcom and hosting- and cloud-service provider Macquarie, Big Air operates at the expensive end of the niche it occupies – making all three expensive acquisitions. M2, which has already seen its net debt rise to $300 million this week from $17 million a year ago, needs to generate cash, Martin says.
“They’ve got their work cut out for them over the next 12 months,” he says.
Perhaps it is understandable that Horth says M2 is sticking to its game for now.
“For the moment we’re going to focus on these to make sure we come out at the end of next year meeting profit expectations,” he says.
iiNet shares, which have risen 70 per cent over the past 12 months, fell 1 per cent on Monday. TPG shares rose 1.5 per cent, bringing their gain over the same period to 60 per cent. Neither company could immediately be contacted for comment.
Problems with pairing up
Joining rival providers together is not a simple business, however. While iiNet and TPG may be seen as a likely pair, they have differences.
“The management styles are very different,” Martin says. “TPG is notoriously lean and parsimonious in its cost structure, whereas iiNet is prepared to spend more to build up the quality of its service.”
Speaking to BRW on Monday, Horth said Kestleman was a good businessman – “as good a business operator as I’ve every encountered, bar none” – but added there was no decision yet as to whether he would become a director of M2, after the transactions from which he and partner Slepoy would hold just under 10 per cent of the company.
“It’s not something either party has made a firm commitment to at this time,” Horth said.
He hinted that the acquisition of Eftel, for a price of $44.1 million, had a strategic angle to it.
“It makes sense not to have Larry with a major interest in a competitor.”
He hastened to say, however, that was not the main reason behind the purchase.
“It was a very good business itself, well run.”
M2 shares rose 4.5 per cent on Monday to $4.85. They have gained 50 per cent over the past 12 months.