Just a quick follow upon yesterday’s post about change and churn at TPG.
In a perfectly-competitive Adam Smith inspired world, no company earns an above average return on its capital. They all compete and innovate like crazy, but the benefits of efficiency and innovation flow through to the wider population in the form of lower prices and better products.
Of course the real world doesn’t work like that. Many thousands of companies earn high rates of returns and many don’t use much capital at all. Finding these companies and investing in them at attractive prices is the holy grail of investing.
Profit seeking motive
But never forget the principle. For all of its shortcomings, we do live in an economy full of profit seekers. And if you own a honey pot, you can bet your bottom dollar someone somewhere is trying to dip their paw in it.
TPG’s honey pot is a large one.
You could replicate the company’s physical assets for less than $1 billion ($980 million of net property plant and equipment and negative net working capital). Yet is enterprise value (market capitalisation plus net debt) is $6.8 billion. It was once more than double that.
So there is roughly $6 billion of intangible value attributed to the company at today’s market price. There is nothing at all wrong with that. As I said above, the best businesses all have value well in excess of their tangible assets. The excess represents the worth of their competitive moat.
But if you are going to invest in a business like this, you need to be sure of two things. Why does the moat exist? And how sustainable is it? (The Livewire interview below with Dr Philipp Hofflin from Lazard is an excellent summary of this concept.)
You probably know TPG better than me and I would be interested in hearing your thoughts. But TPG’s brands don’t seem to be strong enough to suggest pricing power. Most of us are not particularly loyal to our internet service provider. There are not really any network effects as most providers are using the same infrastructure. There are certainly some economies of scale, but I’m not sure how significant they would be relative to the other large players.
Value in the customer base
The main intangible asset here seems to be TPG’s 1.9 million strong customer base. I love database assets. The cost of acquiring all of those customers has been expensed in previous periods and the value doesn’t show up on the balance sheet. It has been a source of hidden value in some of Forager’s most successful investments.
What’s it worth? Once again, the world is not perfect and there are many benefits of incumbency. In a perfect world, however, the value TPG’s database would be what it costs someone else to replicate it. The point of yesterday’s blog is that the cost of building that database is a lot less in a market where people are actively looking than one in which they aren’t.
Imagine if MyRepublic tried to acquire me last year. Firstly, they would have had to make me aware of them. That requires a lot of brand advertising. Then, incentivised me, motivated me to register and finally to sign up. That’s a lot of marketing dollars.
Market change impairs TPG’s value
Because I am out there looking for an alternative, though, all of those costs fall away. All they have to do is offer the best price and I am theirs for the taking. Because of the NBN we all have a reason to look, and that means the cost per lead has fallen dramatically.
It is my theory that this impairs the value of TPG’s database. It is only that – a theory. The stock price has already fallen a long way and I don’t have a view as to whether today’s price is cheap or expensive. All I know is that there is still a huge amount of competitive moat in the current valuation. I can’t get confident the moat is that defensible. And that means it’s in the too-hard basket for now.
I’ve been with TPG since 2006 and have never once thought about churning. They have an excellent customer support system that can quickly diagnose problems with ADSL internet connections – I once rang to complain about slow internet throughput and they identified the problem (a degraded Telstra line into the property) and had a service call booked to Telstra, all in a 15 minute conversation with somebody who sounded like they were in a Philippines call centre. Compared to the searing hate generated by the big Oz telcos (worse than banks by a long country mile) TPG looks very good. I don’t know whether that means I should own shares in them; I just know that goodwill comes from customer loyalty. Just my $0.02 worth.
Hi Steve,
As an investment manager, on searching for the best deal on annual contract renewals for broadband/energy/mobile etc, you probably aren’t representative of the broader population.
At the moment, the majority of people can’t be bothered to search/switch. I think the proportion of regular- and maybe-switchers is likely to increase over time as comparison websites/apps and technology facilitates an easier process to do so, but for now, insurers, telcos and banks can rely on a decent chunk of their customer base being pretty ‘sticky’.
It’s a hassle (in the UK at least) to switch broadband. You can rely on having 3-4 days offline, and maybe longer if you’re unlucky. For most it’s a PITA they can’t be bothered with. Appreciate it may be different for Oz at present, and then different again with NBN.
Increased competition (new entrants) and associated marketing spend can be expected to increase churn to some extent, but will players be able to sustain that heavy initial marketing spend over the longer term? Will they need to? Not sure.
Cheers for the blog
Not sure you could replicate TPG’s assets for <$1bn – as disclosed on page 12 of their equity raise presentation of 12 April, they've sunk a cumulative $1.9bn into their fibre network. That $1.9bn figure is admittedly a little cheeky as they have included the entirety of the acquisition EV in respect of PIPE and AAPT in there, but i still think it'd be rather difficult to build from scratch today what they have for <$1bn – for example, TPG owns a 21,000km fibre network, which they are currently extending in partnership with Vodafone at a cost of $400m for an additional 4,000km of fibre (as announced – back-of-the-envelope suggests it is costing ~$1m per 10km of fibre laid (at cost), so a finger-in-the-air estimate of cost to replicate from scratch TPG's 21,000km fibre network alone might be in in the order of $2bn.
And then there's the $1.3bn of spectrum licence they've just bought, submarine cables, wireless networks etc., which they also own.
PP&E is much lower than replacement value of TPG’s assets so you should rethink that assumption. It is true that in a period of churn and higher competition, prices will (or atleast should) decline to marginal cost of the marginal operator. TPG’s margin for now is opportunity for likes of VOC, Myrepublic. Fortunately for then OZ is one of the most consolidated telco markets which is why prices are comparitively higher than anywhere else. It remains to be seen if NBN driven churn causes a permanent breakdown in industry pricing discipline. If it doesn’t then forward looking yields are now reasonable.
Nice follow up Steve.
I personally see TPG as too risky atm, especially after the Vodafone experience of yesteryear.
Too much risk of having to spend a lot more capital than forecast on the Mobile ambitions.
Competition on an infrastructure level can be difficult on a large scale in my opinion. Can a new player really get a suitable return replicating these networks.
You do raise a good point about customer loyalty and the transition to the NBN being a big risk to the incumbents.
Still amazes me how many people still stick with Telstra.
https://www.accc.gov.au/system/files/Copy%20of%20NBN%20Wholesale%20Market%20Indicators%20Report%2031%20March%202017.pdf
https://www.accc.gov.au/regulated-infrastructure/communications/national-broadband-network-nbn/nbn-wholesale-market-indicators-report/reports
Looks like they still have a lot of pull in the regions according to the report.
I think MyRepublic are doing a bit of loss leading to try to quickly build scale and a customer base and banking on people’s laziness, etc. to keep them as prices rise.
They are ultimately still dependant on your Telstra’s, Optus’s, TPG’s & Vocus’s for the backbone networks.
Personally I am backing Vocus, bit managements been an issue with them.
My thoughts – don’t know if they support or challenge your thesis ;o)
NBN is one initiator of change – another is the growth in online video streaming requiring a massive increase in data. For me the NBN is still not available but I bought a smart TV and found that the 10GB quota on my existing plan only lasted a few days!
I am with Internode – bought by iiNet & bought, in turn, by TPG – and have always been VERY happy with their customer service. I did look around but eventually moved my Telstra landline to Internode, which involved moving my connection to their infrastructure at the exchange, and ended up with a bundled plan which I’m very happy with. I get 250GB/month (which I never come close to using) so now i have 25x the data, better speed and pay around $20/month LESS.
The changeover was seamless and the support was really good so, when I eventually need to change to the NBN, there would have to be a compelling reason to make me want to change ISP.
Of course, others will have different requirements and experiences.
I should add that my original plan was a very old one & I had looked at other plans before but, at that time, the Internode DSLAMs were not available in my exchange.
I think a decent chunk of the intangible value could be on management quality in Teoh and backed by SOL giving a very stable share register, the ability to think long-term, stay the course, better execution, etc. Management quality is always critical but even more so in an industry shake-up. In my opinion, TPM is some way ahead of TLS and VOC in this regard.
I think you underestimate the value of inertia. Whilst there may be 15% of Australians who actively look for deals, the majority do not. They stick with with their providers year after year, until some disaster or a particularly poor piece of customer service occurs. This occurs with phone companies, insurance companies, utility providers, banks, superannuation providers, accountants and car servicing providers.
The majority of us are creatures of habit, and unless something changes to upset us, e.g. significant price increases or poor customer service, most of us are too busy getting on with life to bother changing.
There will be churn with NBN but it may not be as high as you may think.
That’s true. Given TPG and the companies it acquired were all new entrants when ADSL rolled out, though, you would have to think their clients are less sticky than Telstra’s?
I’m pretty sure that last comment is not going to be valid re Churn, based on the following evidence:
Amaysim – latest churn stats I could find (seem to have stopped reporting them) = 3% per month (36% per year)… which then got restated (how?/why?) to 2% per month / 24% per year.
These guys claim the lowest number of complaints per number of user services vs Optus, Telstra etc.
Optus claims about 17% churn last year.
Telstra’s Post Paid churn was 12%.
The above is mobile churn (just had those numbers to hand), where there are less barriers to switching… but it’s also a very mature market.
So whilst it may be right that 15% of subscribers LOOK for deals, that is very different to the situation where they are FORCED to switch to a new provider – as will be the case in the HFC/Copper to NBN switch.
Looking at my current circumstance – I myself am not that price sensitive… I need good quality connect…. but my ONLY realistic option is Optus HFC because it is the only decent cable running past my house. So I’m with Optus and I pay whatever they charge.
Post NBN I will care
I think Steve’s framework for thinking about the impact of NBN on let’s call it “apparent loyalty” is correct…. it will provide a decision point for people to switch.
So, is churn likely to go DOWN from the current levels when people have NBN (i.e. the SAME product at the back end) being marketed to them by multiple groups, meaning they therefore have a choice between the same product/similar packages at different prices?
Interesting – a year ago i changed TO telstra because my bundle within internode included mobiles, and the coverage on their mobile network was terrible. Telstra were happy to do deals and have provided better mobile coverage, more data, more minutes, and the whole package costs the same. Clearly telstra want to compete when challenged.
Before that – we’d been with Internode for a decade, even though no cheapest, because their customer service was first rate. The change to telstra was reasonably straightforward with the biggest issue being porting mobiles over. The prompt to change was only due to a cold-call be telstra sales wanting to do a deal.
For me the reasons to churn are always there but the motivation and aggravation just never makes it worthwhile.
I agree that the NBN changes everything – but it is a one-off change. Even then, anecdotally, I hear that many customers simple remain with their existing providers – the physical equipment changeover happens, the bills keep coming in, and the motivation to change just isn’t there.
For those that do change, the opportunity presented is a one-off because as you rightly point out, there are very low costs to the providers to incentivise a change by a customer. Once the NBN transition is made though, as far as costs to a provider to get a change – the situation will revert to that which prevailed before. The providers cost base may be different due to their payments to NBNCo – but in a way this is not a lot different to when most ISP’s had to pay fees to use Telstra DSLAMs.
I therefore see the NBN disruption as a one-off hit that will allow ISPs to try and grab market share from one another – and this could be quite disruptive. But after that the situation will be much as it was before – customers will move most likely because poor service incentivises a move rather than anything else.