Australia | Jul 08 2013
This story features TELSTRA CORPORATION LIMITED. For more info SHARE ANALYSIS: TLS
-Advantage in owning fibre networks
-Key JV with Cisco
-Incremental margin and recurring revenue
By Eva Brocklehurst
As the adoption of cloud computing grows at a healthy pace, a company such as Amcom Telecommunications ((AMM)), which has its own fibre network, can improve market share. The company has triggered keen interest on this basis and Citi has initiated coverage of the stock.
Amcom provides IT and telecom services to government and enterprises over fibre. The company built its own fibre optic network in 1998 and delivers a broad range of data, internet and managed services nationally. The proprietary fibre network spans 2,200 kilometres in Perth, Darwin and Adelaide and leverages third-party networks in capital cities where Amcom does not own the fibre. The company's Amnet Broadband provides internet and VoIP to customers across Western Australia.
Citi is watching out for strong free cash flow that will be fuelled by organic growth in data networks. This has grown over the last 18-24 months and now represents 93% of Amcom's underlying net profit. Data network sales for FY12 were 43% ahead of the previous financial year. Citi's Buy recommendation joins two others covering Amcom with Buy ratings on the FNArena database. They are Macquarie and CIMB. The present consensus target on the database is $1.86, albeit Macquarie and CIMB have not updated since February. The dividend yield is 3.0% based on FY13 forecasts and 3.6% for FY14.
Post the first half results, CIMB considered the company's new divisions were gaining traction and was confident double-digit earnings growth would continue. Macquarie expected fibre sales and margin would maintain earnings per share growth above 20%, driven by growing demand for cloud-based services. Cloud computing is company-specific services delivered via the internet which do not require special applications or infrastructure. Shifting to the cloud provides businesses with cost savings, operational flexibility and faster market response times and reflects a convergence of IT and telecommunications.
Telcos are seen partnering with software companies and acting as software aggregators. This benefits Amcom's L7 Solutions software business. L7 has been offering cloud-managed services and IT in a partnership with Cisco. Cloud services require a strong, diversified network and growth in this respect will be material for Amcom, in Citi's view. Amcom is exploiting a first mover advantage via its hosted collaboration with Cisco. Amcom is currently one of only three accredited Cisco providers, gaining access to the enterprise market where Cisco has around 60% market share emanating from a strong brand. In turn, Amcom has made Cisco more visible in government sectors locally. These two features – the cloud and the Cisco JV – can be leveraged by Amcom via its proprietary fibre network to gain economies of scale and recurring revenue.
Another advantage is in the roll out of the National Broadband Network (NBN). All fixed line service providers will become retail providers, which provides an opportunity for newcomers such as Amcom to obtain customers from the incumbents such as Telstra ((TLS)). Competition abounds of course. Second tier telcos are looking for scale ahead of the ramp up of the NBN. The networks are fairly saturated as NBN is being offered both in the wholesale channel as well as via resellers. Telstra and Optus ((SGT)) provide connectivity for retail, SME and wholesale services and the smaller ISPs such as iiNet ((IIN)) and TPG Telecom ((TPM)) rely on these for final delivery.
Where Amcom differs from the smaller telcos is that it has its own fibre network to provide services to SMEs. The risks lie in the potential increase in new players in this area. Here, Citi believes execution will be vital in deciding winners and in the first half of 2014 it is critical for Amcom to leverage the connection with Cisco. Amcom may not be encumbered by a large existing network, such as Telstra and Optus, but it may be challenged if price becomes the critical differentiating point for clients. Profit growth could be affected if Amcom's value and service offering is undermined by price wars.
FY13 profit growth is expected to be over 20%. Citi notes Amcom is trading on a FY14 price/earnings multiple of 20.3 times, equating to a conservative price/earnings growth ratio of 1.4 times FY14 expectations and 1.3 times FY15. Moreover, there is growing annuity revenue from the fibre network. Of the expected $100m in annuity based revenue in FY13 Citi estimates data networks constitute 70%, with the remainder split between IP telephony and Amnet. As customers usually sign long-term contracts of three to five years the greater the traffic that passes through Amcom's network the greater the incremental margin that can be generated. Amcom also expects to generate $1.8 million in annualised network revenue per month from new customers and its ability to leverage this recurring relationship is what makes it appealing.
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