Macquarie Telecom Growing Hybrid IT

This story features MACQUARIE TECHNOLOGY GROUP LIMITED, and other companies. For more info SHARE ANALYSIS: MAQ

Macquarie Telecom is growing its hosting service at a fast rate, with a focus on hybrid IT that includes dedicated servers and data centre co-location. Canaccord Genuity initiates coverage.

-Increasing evidence that hybrid IT services can work better
-Telecom business returns to modest growth after several years of declines
-Trading materially below the rating of telco peers in Australia
 

By Eva Brocklehurst

Macquarie Telecom ((MAQ)) is growing its hosting service at a much faster rate than its telecom business, providing hybrid IT and data centre co-location. The market for private cloud (or managed hosting services) is forecast by Cisco to grow at 17% per annum over the next five years. This may be lower than the public cloud at 26% but still offers an attractive profile, Canaccord Genuity asserts.

Hosting, with a focus on hybrid IT services and data centre co-location, addresses the shift in business IT off-site to data centres and Macquarie Telecom can offer both private and public cloud services.

Canaccord Genuity notes the business has been growing revenue at 13% per annum over the last three years, which may be less than the higher rates achieved by peer NextDC ((NXT)) but operating leverage means that earnings should grow much faster. NextDC does not offer private cloud.

Migration Back To Private

Growth in public cloud adoption is exceptionally strong but there are some signs, the broker notes, that companies are finding a hybrid approach works better. There are several areas where some functions are being returned to private servers for economies of scale, such as where "bill shock" has occurred, and where network constraints make delivering high-quality video and streaming services particularly problematic, such as in regional and rural areas.

Evidence is cited where companies had to migrate some applications back to equipment on-site to improve performance, while some have found that migrating work to cloud environments merely swapped one problem for another, such as in the case of power outages.

Meanwhile, the company's telecom business has returned to modest growth after several years of decline. The broker highlights the telecom sector in Australia is highly competitive and aggregate revenue from the business/enterprise segment is, at best, flat. While recent growth is distinctly positive, in order to maintain revenues, the broker emphasises gaining customers is essential.

Canaccord Genuity expects revenue growth of 7% per annum between FY17-20, of which hosting offers 16% and telecoms 2%. Operating earnings (EBITDA) are expected to outstrip revenue, growing by 13% per annum.

The broker points out that the company's conservative depreciation policy will mean a significant uplift in charges in FY18. Net profit and earnings per share may actually decline in FY18. Meanwhile, the telecom business will benefit from investment in a new SD-WAN (software-defined wide area network) platform while there are preparations to in-source the network operations centre.

Build Or Buy Option

The company is in the process of deciding between building or buying new data centre capacity to accommodate growth in its hosting business. The broker's forecasts are based on the build option, as this is consistent with its business model to date. Renting wholesale space would be less capital intensive but at the cost of profit margins and, the broker suspects, some of the uniqueness of the company's proposition for investors.

The broker's modelling of the new data centre comprises a mixture of debt and new equity and, longer term, a second sale and lease-back to pay down debt. Canaccord Genuity considers the shares extremely good value and, adjusting for illiquidity, calculates a price target of $18 and initiates coverage with a Buy rating.

The broker observes, generally, telcos have de-rated materially over the last few years in Australia because of modest business growth and concerns about earnings from residential customers, as they battle with NBN access charges and the consequent effect on profit margins. On the broker's estimates, Macquarie Telecom trades on in FY18 enterprise value/operating earnings of 6.3, materially below the rating of telco peers in Australia.

Macquarie Telecom provides telco, managed IT, private cloud and co-location services in Australia. It operates data centres in Sydney (Intellicentres 1 and 2) and Canberra (Intellicentre 4), which will have a combined capacity of 14.5MW when the fit-out of Intellicentre 2 is completed. In FY17 telecommunications represented 65% of revenue but 46% of operating earnings. In contrast, hosting delivered 35% of revenue and 54% of operating earnings.
 

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