Low-cost carrier Amaysim and data centre provider NextDC are the two stocks earmarked by fund manager and former telco boss James Spenceley as the biggest winners from the NBN, which has levelled the playing field at the expense of bigger providers.
In Mr Spenceley’s first investment letter to MHOR Asset Management clients, obtained by The Australian Financial Review, he argues that the NBN’s structure offers no advantages for size or scale, and it is the most efficient operators that will reap the biggest rewards.
“It’s very rare for a sector to have an external event of such scale as NBN, and unheard of for that event to level the pricing playing field for all industry participants; this is unchartered waters for any industry,” he said.
Mr Spenceley established MHOR with fund manager Gary Rollo in August, starting out in small cap stocks. He resigned from the board of Vocus in October in a highly public exit and disclosures suggest he no longer holds any shares in the telco business he founded in 2007.
Now as a stockpicker, Mr Spenceley favours a challenger brand and a listed data centre business as the best ways to play the NBN.
Amaysim is a mobile virtual network operator (MVNO) which means it leases its wireless infrastructure and “has no NBN downside compared to its fixed listed telco peers,” the fund manager says.
Trading at 14 times earnings, which are estimated to grow by 25 per cent, he argues the stock’s comparatively low multiple “implies a free option on NBN upside success”.
“That gets even more interesting given it is entirely possible [Amaysim] could earn more in absolute dollar margin per subscriber from NBN than from their MVNO business.”
Amaysim stock plunged in February after rallying strongly following its 2015 float. The stock is trading at $2.14 compared with its low of $1.55 nine months ago and $1.80 offer price.
“Since leaving Vocus I’ve been inundated with calls from people asking about the future of retail telecommunications and NBN,” the fund manager said in the first of his regular MHOR investment letters.
“The rally in telco stocks over the past seven years has been largely fuelled by consolidation, he says. “What was the M&A raison d’etre? As always, the macro drives individual events and it was the prospect (and then reality) of the NBN which was the root cause of consolidation.
“The view was, that to survive in retail telco in the post-NBN world you have to have scale and he who has the most scale, would have the most benefit.”
Room for competition
The NBN pricing model does not discount for volume. “A reseller does however require a minimum amount of scale to operate in an NBN service area but once that scale is reached it can operate with a gross margin not too distant from that of the larger four incumbent telcos,” Mr Spenceley, whose wealth was estimated at $51 million by BRW Young Rich, said.
“Scale via acquisition has led to complexity which implies a greater cost to serve. Size, age and incumbency means the larger and older businesses have more overhead and structure which makes them all less efficient than the new entrants.”
About four new providers including Amaysim, MyRepublic, Foxtel and Vodafone have entered the NBN market, joining the established players which face customer transfer costs by getting users off older ADSL technology (except for Telstra) and lower margins for NBN services.
“The conclusion we can draw from the above is that three of the incumbents will either have no strong desire to actively migrate their users, which leaves the door well ajar for the new entrants or will force them to bring cost and margin reduction forward to attempt to protect the existing user base.”
These fears were confirmed by a shock profit downgrade from TPG Telecom back in September.
NextDC is not a telco or internet provider but the data centre operator is poised to cash-in on the faster speeds and improved stability of the NBN which will support cloud-based activity.
“We are at the early stages of the growth cycle of cloud adoption and faster, better and cheaper residential broadband will only drive demand from cloud providers for NextDC’s assets,” Mr Spenceley writes.
Earnings are growing up to 85 per cent in 2016-17 and it is the dominant player.
“This is a business growing at 2.5 [to] 3 times faster than the listed US peers while trading on [one-third] the price to book. The growth outlook for the business with its second facilities in Sydney, Melbourne and Brisbane is very strong and the business is now largely funded.”
NextDC shares last traded at $3.07; they have fallen from as high as $4.46 since the company raised $150 million in September.
Both stocks are owned by the MHOR Australian Small Cap Fund which went into last week’s United States election fully invested, anticipating a rally in markets.