Beruflich Dokumente
Kultur Dokumente
VITO MOLLICA
STUDENTS:
LJILJIANA CELLIC 43594417
PAUL BAWEJA
41477871
IINET
Table of Contents
Executive Summary....................................................................................................................................................................... 2
1. Company History and Performance.......................................................................................................................................... 3
1.1 Business Description........................................................................................................................................................... 3
1.2 Source of Revenue.............................................................................................................................................................. 3
1.3 Company Strategy............................................................................................................................................................... 5
2. Macroeconomic Environment.................................................................................................................................................... 6
2.1 Political Factors................................................................................................................................................................... 6
2.2 Social Factors...................................................................................................................................................................... 6
2.3 Economic Factors................................................................................................................................................................ 6
2.4 Technological Factors.......................................................................................................................................................... 7
3. Industry Analysis....................................................................................................................................................................... 8
3.1 The NBN, the potential game changer, if and when its built...........................................................................................8
3.2 Industry Outlook.................................................................................................................................................................. 9
3.3 Porters Five Forces.......................................................................................................................................................... 10
4. Historical Financial Performance............................................................................................................................................. 11
4.1 DuPont Analysis................................................................................................................................................................. 11
4.2 Liquidity............................................................................................................................................................................. 12
4.3 Debt to Equity.................................................................................................................................................................... 12
4.4 Dividend Payout Ratio....................................................................................................................................................... 13
4.5 P/E Ratio........................................................................................................................................................................... 13
4.6 Working Capital Management........................................................................................................................................... 14
5. Valuation Analyses.................................................................................................................................................................. 15
5.1 Valuation Scenarios........................................................................................................................................................... 15
5.2 Key Assumptions for Scenarios......................................................................................................................................... 17
5.3 Scenario 1 Steady growth without acquisitions..............................................................................................................19
5.4 Scenario 2 Growth with acquisition................................................................................................................................ 20
5.5 Scenario 3- Declining growth (acquisition by TPG)...........................................................................................................21
5.6 Scenarios Comparison...................................................................................................................................................... 22
5.6.1 Free cash flows to equity........................................................................................................................................... 22
5.6.2 Sustainable Growth Rate........................................................................................................................................... 23
5.6.3 Revenue Growth........................................................................................................................................................ 24
5.6.4 Debt to Equity............................................................................................................................................................ 25
6. Conclusion............................................................................................................................................................................... 25
Bibliography................................................................................................................................................................................. 26
Appendix A iiNET SWOT Analysis............................................................................................................................................ 29
Appendix B Scenario 1, Steady Growth................................................................................................................................... 30
Appendix C - Scenario 2, Accelerated Growth............................................................................................................................ 31
Appendix D - Scenario 3, Declining Growth................................................................................................................................ 32
1|Page
Executive Summary
This report covers the valuation of iiNET, an Australian telecommunications company. iiNET is Australias second
largest Internet Services Provider. It also provides telephony services.
iiNET is listed on the Australian Stock Exchange (ASX Code IIN). Since its inception over 20 years ago, the
company has undergone above-average growth by industry standards. This growth stems mostly from an
acquisition of over 30 Internet Service Providers (ISP), and from the acquisition of new iiNET customers and
increased sales to existing customers. The latter was achieved through improved service and product innovation,
very high levels of customer service evidenced by an international award for customer service in 2014.
In 2014 iiNET revenues were AUD1,005 million, up from AUD 940 million in 2013. Revenue growth was 13.2% in
2013, and 7.0% in 2014, with reports of 10% for 2015.
The Australian telecommunications industry is highly concentrated with a few major players having the majority of
the market. The proposed merger of iiNET with TPG may affect the competition in the industry if the prices
become high relative to the level of innovation and customer service.
In our analysis we identified several drivers and took into account historical financial data to build a financial
valuation model for the next five years. We used the Discounted Cash Flow Model to calculate the share value
and the CAPM for calculation of cost of equity. The key drivers of iiNET value have been identified as Revenue
and Cost of Goods Sold (COGS) and debt. iiNET growth strategy of strategic acquisitions, geographical
expansion and bundling of innovative services such as television, XBOX gaming, and innovative mobile bundles
are all contributing to the revenue growth.
As a result of risk analysis, we concluded iiNET growth is expected to slow beyond 2015 due to market factors
such as the introduction of Broadband NBN and resulting lower capital intensity inviting increasing competition,
through the entry of more numerous resellers of services in the industry. This may reverse the current trend
towards increasing industry concentration and prevent near- oligopoly pricing being established. We have also
taken onto consideration a possibility of a merger resulting in the loss of iiNETs competitive advantage in
customer service and innovation, which until now has set it apart from its competitors.
We analysed three scenarios: high growth through continuing acquisitions, stable growth and low growth due to
lack of synergies post takeover by TPG.
The first scenario assumes iiNET operating as a provider of higher value, higher cost services and continuing with
their acquisition strategy for growth, with an acquisition of a new company in Year 3 and 5. The second scenario
assumes stabilising growth in light of greater price and product competition through the roll out of the NBN and
entry of multiple smaller ISP providers. The third scenario assumes low growth as a subsidiary of TPG due to
corporate cultural incompatibilities and dilution of iiNETs competitive advantage as a provider of high value
adding services. Our analysis has led us to make the recommendation for the sale of iiNET shares as a currently
overvalued equity under all three scenarios.
Scenario
High growth with acquisitions
Average growth
Low growth- takeover by TPG
Figure 1Scenario outcomes share price
2|Page
Internet access - broadband, naked DSL, Wi-Fi hotspots, virtual private networks access
Phone - home phone service, business landlines, VOIP plans
Domain, web hosting & email hosting
Hardware & Software - modems, routers, handsets, software, cards & adapters
Fetchtv 2 - an IPTV service
Additional services - computer support, static IP, Cloud computing.
The companys competitive advantage comes from the provision of exceptional customer service by Australian
and international standards, as well as value- adding in the product and service offerings through enabling
entertainment content delivery in new and competitively priced ways, such as Xbox unlimited download plans and
Fetchy TV.
3|Page
iiNET main source of revenue is from internet related services such as VoIP, XBOX, Netflix and business internet
connectivity.
The majority of the revenue for iiNET is generated by two categories of customers: residential and business.
Products- non-business:
Products- business:
4|Page
residential customer base, where customer service is of international standard and key to their core business
success.
In 2008, iiNET changed their target market to business/corporate customers. This came with the acquisitions of
TransACt and Internode in 2011 and Adams Internet in 2013, which came with a significant business consumer
base. iiNET recognizes its business clientele as a profitable source of revenue, and has since expanded their
service offerings to account management, cloud storage and set up support/assistance for small, medium and
corporate sized businesses.
Second to high level customer service, iiNET is developing its reputation in innovation and entertainment.
Product extensions have included Fetch TV in 2010, gamers.net.au, unmetered content data for Xbox live, ABC
iView and streamed radio stations and most recently the launch of JIVA broadband offering unlimited downloads.
Driving the entertainment in iiNET, the marketing approach is now infiltrating the national sports arena, signing
up as a major sponsor for AFL club, Hawthorn and the Sydney Sixers in 2013. iiNET Chairman, Michael Smith,
explains the marketing platform has significantly increased brand awareness, which is assisting them in
expanding their market share prior to the introduction of the NBN.
The NBN threatens to place all ISPs on a level playing field. Hence iiNET is gearing up to expand its current
occupation of 25% of the NBN customer base, including the conversion of Telstra customers, as a prime strategy
to increase revenue. Acquisition based growth is not likely to continue given the minimal privately owned ISP
companies remaining as a result of the aggressive acquisitions by iiNET, M2 and other telecommunication
companies such as TPG. Thus consolidation and product extension and technological changes will lead iiNET
revenue production into their next three years.
The challenge for iiNET will be to explore other revenue sources upon the introduction of the NBN, or indeed
other technological advances in data access, such as the potential of Google net. Revenue prospects are moving
with the industry into online communications such as Google, Facebook and Whats App and away from traditional
telecommunications. Business clients will have a greater longevity in their reliance on traditional communications.
While iiNET has vouched a focus on this area, in addition to growing acquisitions such as Internode, Adam
Internet and TransACT, their marketing strategies and service extension lines are all geared toward retail
customers and are not consistent with corporate clientele.
5|Page
2. Macroeconomic Environment
2.1 Political Factors
The
major
political
factor
influencing
Australian
6|Page
Figure 5
Australias
inflation rate;
Annual
source:
RBA
7|Page
3. Industry Analysis
3.1 The NBN, the potential game changer, if and when its built
Several concerns were identified during the privatization of Telstra, the monopoly tier 1 provider in the Australian
Telecommunication industry:
benchmark;
End-user and whole sale prices where above
8|Page
9|Page
BUYER POWER M
Tendency to switch
Unidentified product
Backwards integration
Buyer independence
Buyer size
Financial muscles
Low cost switching
Oligopoly threat
Price sensitivity
Product dispensability
SUPPLIER POWER H
NEW ENTRANTS M
Supplier accessible
Undifferentiated product
Week brands
Little regulation
Little IP involved
Low cost switching
Market growth
Scale unimportant
THREAT OF SUBSTITUTES - L
10 | P a g e
Switching cost
Differential input
Forward integration
Importance of quality/cost
No substitute inputs
Player independence
Supplier size
Oligopoly threat
Player dispensability
DEGREE OF RIVALRY M
Undifferentiated product
Competitor size
Easy to expand
Lack of diversity
Low fixed cost
Low cost switching
Similarity of players
The above data confirms that the ROE is primarily driven by the aggressive acquisition strategy. Through the
utilisation of leverage and the purchasing smaller companies for low multiples the company managed to continue
to drive ROE growth. This increase in leverage from 2012 onwards indicates iiNETs increased reliance on debt
financing. Non-current liabilities increased two-fold mainly due to increase in non-current borrowings. These noncurrent borrowings have tripled over the same period of time as they have been used to finance iiNET aggressive
acquisition program.
Also the Return on Assets (ROA) movements do not correspond to changes in total equity increase over the past
five years. This indicates that increase in equity is a result of increased retained earnings which iiNET is using to
support their growth plans and opportunities.
11 | P a g e
4.2 Liquidity
The Acid test ratio does not include inventory on hand and prepayments as these cannot be converted to cash
quickly. It determines whether a firm has sufficient short-term assets to cover its immediate liabilities without
selling inventory.
iiNET has a liquidity level that has been quite stable over the last 7 years and it averages around 0.5. Such
liquidity indicates that company is over-leveraged and it would find having difficulties in meeting current
obligations using liquid assets. This lines up with their cash flow position.
2006
2007
2008
2009
2010
2011
2012
2013
2014
Debt/Equity Ratio
1.80
1.60
1.40
1.20
1.00
0.80
0.60
0.40
0.20
0.00
2005
2006
2007
2008
12 | P a g e
2009
2010
2011
2012
2013
2014
13 | P a g e
100
50
0
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
14 | P a g e
P/E Ratio
80
70
60
50
40
30
20
10
0
2005
-10
2006
2007
2008
2009
2010
2011
2012
2013
2014
15 | P a g e
Working Capital
20
0
2005
-20
2006
2007
2008
2009
2010
2011
2012
2013
2014
-40
-60
-80
-100
Looking at iiNET the cash conversion cycle is important for two reasons. First, it's an indicator of iiNETs efficiency
in managing its important working capital assets and second, it provides a clear view of a company's ability to pay
off its current liabilities.
iiNET Cash Conversion Cycle (CCC) historically has been low which is indicating that they have been using their
cash reserves to streamline operational activities and finance further acquisitions by being reliant on this indirect
source of financing from their creditors to offset the need for short term loans. From 2011 onwards their CCC is
sharply moving upwards and although is still negative it indicates that increase in their current liabilities is driven
by aggressive growth initiatives.
5. Valuation Analyses
5.1 Valuation Scenarios
We have chosen to perform an analysis of three possible future scenarios. The first scenario is for stable growth.
In this scenario iiNET pursues average growth through increases in sales. It does not undertake any acquisitions
or divestments.
The second scenario assumes iiNET continues its growth trajectory, through an acquisition strategy in two out of
the five years of forecast cash flows.
16 | P a g e
DRIVERS
2014
VALU
E
EXPLANATION
REFERENCE
Sales Growth
4.80%
BuddeComm - global
independent
telecommunications
research company.
Australia Telecoms
Industry: Statistics and
Forecasts.
12.00%
Current liabilities/
sales
20.40%
74.50%
78.00%
17 | P a g e
4.30%
Amortization
10.03%
10.00%
2.80%
Tax rate
30.00%
50.00%
Debt / Sales
20.00%
18 | P a g e
These assumptions rest on iiNET continuing to be a significant player in the Internet Service Provider (ISP)
segment (currently with a 14.20% market share) and maintaining its number two position in the market as well as
maintaining its competitive advantage in customer service.
Further it was assumed that any technological advances will be taken up equally by all ISP providers and will not
advantage iiNET more or less than any other market player.
19 | P a g e
Also it was assumed that iiNET will not become involved in:
Resale of telecommunications,
Where
rf
rm
is the expected
market return. For the purposes of this report, the broader market was defined as the telecommunications market
and the risk-free rate as the Australian Government 10-year bond yield. As at 28 May 2015, the Australian 10year bond yield is 2.92 %(Bloomberg, 2015 & RBA, 2015) with long term average between 3% - 4%.For this
report the risk premium rate was considered to be 4.0% With calculated re-levered beta and an equity risk
premium of 7.9% we calculated cost of equity for each scenario. Explanation follows below.
5.2.3 Beta
The Morningstar database provides the levered beta for iiNET of 0.5 which is higher than industry beta of 0.37.
This indicates slightly higher level of risk (according to the market) associated to iiNET, compared to similar
market players. Unlevered beta was calculated based on average debt to equity in the period 20052014 and an
average tax rate of 30%. This unlevered beta was then re-levered based on forecasted debt to equity ratio for
2015 2020 and forecasted tax rate of 30%. The re-levered beta is 0.508 for scenario 1 (steady growth), 0.529
for scenario 2 (growth with acquisition) and 0.502 for scenario 3 (acquisition of iiNET by TPG).
With a cost of equity of 8.92%, the implied growth rate was calculated by taking the cost of equity and
subtracting the expected dividend yield.
2. It is assumed that the iiNET share price is trading at a premium due to the speculation on the takeover
bid through the announced potential sell out and that the price will fall once the decision is made about
company future.
3. M2 Group in their Competing proposal for iiNET indicated median broker terminal growth rate of 3.0%
4. RBA forecast for the growth in GDP over the next decade at around 2.5% per year (a little slower than
over past decades), within the economy there will be a shift towards services and away from primary and
secondary industries (like agriculture and manufacturing).
Although calculated terminal growth rate of 4.8% is based on real numbers, it is considered unrealistic based on
the additional factors listed above. Even though the recommended terminal rate of 3% is higher than long term
average GDP growth, the decision was made based on assumption that, on average, the service sector will grow
more than other industries.
In this scenario the primary drivers affecting the value of the firm are sales growth, cost of goods sold and the
debt to equity ratio. The underlying reason for the historical growth of iiNET has been two-fold: acquisitions of
smaller ISP providers occurring frequently almost yearly and oftentimes of more than one company in any given
year.
According to IBISWorld report on iiNET (IBISWorld, 2015) the companys revenue is forecast to grow by 16.9%
per annum over the next 5 years if it were to follow a similar growth scenario through continuing aggressive
acquisitions. We believe that acquisitions will become harder for iiNET as it is now one of the top 4 companies in
the telecommunications market. Competitive pressures from other companies in respect of pricing will lead to the
stabilization of revenue growth at more conservative levels which in turn will affect the profitability and free cash
of iiNET. In addition the ACCC will step in to prevent further market concentration in the industry in order to
mitigate oligopolistic tendencies from emerging.
Our estimate of the share price is AUD 7.76 which compared to the current market price of AUD 9.58. The stock
is overvalued and does not present a good investment opportunity at this time.
21 | P a g e
Figure 13 Value projections for iiNET 2015-2019 : steady growth without acquisitions by iiNET
In our second scenario we have assumed that iiNET will continue its current strategy of growth through
acquisitions. Whilst the company will not be pursuing acquisitions as aggressively as in the past, we have
assumed that an acquisition will occur in 2016 and 2018. These acquisitions will lead to increases of sales growth
from 4.8% in 2016 to 7 % in 2017 and 9% in 2018-19. At the same time, the debt ratio will increase to from the
current value of 20% to 30% and further to 35% of the turnover. We assume ROE increases over18% evidenced
in 2014 and is maintained at this high level.
This will lead to a decrease in cash available to equity and lead to in a drop in the share price to AUD 8.45.
22 | P a g e
23 | P a g e
The projected free cash flow to equity as shown by Figure 23 indicates that the free cash flows to equity for
scenario one (steady growth) and scenario three (acquisition of iiNET by TPG) are very similar with the steady
growth scenario being slightly better than being acquired by TPG. The financial model also projects more
available free cash flows with scenario two (growth with acquisition). However, this decreases significantly one
year after each acquisition. This is due to the assumption of iiNET repaying some of its increased debts following
the acquisition to reduce the risk its carrying from a very high leverage (debt to equity ratio).
24 | P a g e
2015
2016
Steady Growth
2017
2018
2019
Declining Growth
Figure 23 Free cash flows to equity- comparison of 3 scenarios for iiNET 2015-2019 valuation
2011
2012
SGR
2013
2014
Actual Growth
There are limitations to the usefulness of the sustainable growth analysis as it assumes that debt to equity ratio
remains stable. This is rarely the case in real life. In scenario with accelerated growth through acquisitions this
analysis is affected further as the debt to equity ratio fluctuates.
Future sustainable growth rates are similar for the decreasing and stable growth scenarios. The medium term
SGR for the scenario with accelerated growth is increasing, pointing to the ability of the firm to generate increased
25 | P a g e
2011
2012
Steady Growth
2013
2014
2015
2016
2017
2018
2019
Declining Growth
26 | P a g e
Revenue Growth
1600000
1400000
1200000
1000000
800000
600000
400000
200000
0
2014
2015
Steady Growth
2016
2017
2018
2019
Declining Growth
Debt to Equity
2.00
1.60
1.20
0.80
0.40
0.00
2014
2015
2016
2017
6. Conclusion
27 | P a g e
2018
2019
28 | P a g e
Bibliography
NBN Co, How the NBN (NBN) works, [ONLINE]
Available at:
http://www.nbnco.com.au/nbn-for-home/how-it-works.html?icid=pub:hme:about-nbn:hro:img
[Accessed 30 May 2015]
ABS (ABS) (2014).Population clock.[ONLINE]
Available at:
http://www.abs.gov.au/ausstats/abs@.nsf/0/1647509ef7e25faaca2568a900154b63?OpenDocument
[[Accessed 30 May 2015]
Connolly, E Norman, D. & West, T. (2012). Small business: An economic overview. Reserve Bank of Australia,
Small Business Finance Round Table.[ONLINE]
Available
at:http://www.abs.gov.au/websitedbs/d3310114.nsf/4a256353001af3ed4b2562bb00121564/d291d673c4c5aab4ca
257a330014dda2/$FILE/RBA%20Small%20Business%20An%20economic%20Overview%202012.pdf
[Accessed 30 May 2015]
Stiglitz, J, September 213, Australia, you don't know how good you've got it,[ONLINE]
Available at:
http://www.smh.com.au/comment/australia-you-dont-know-how-good-youve-got-it-201309012sytb.html#ixzz327h8u5To
[Accessed 30 May 2015]
BuddeComm (2013). Australia - Telecoms Industry - Statistics and Forecasts, [ONLINE]
Available at:
http://www.budde.com.au/Research/Australia-Telecoms-Industry-Statistics-and-Forecasts.html
[Accessed 30 May 2015]
BuddeComm (2013). Australia The Telecom Market in 2014,[ONLINE]
Available at:
http://www.budde.com.au/Research/Australia-The-Telecoms-market-in-2014.html#sthash.G7lD47r8.dpuf
[Accessed 30 May 2015]
Deloitte Access Economics, February 2013, Mobile Nation Brochure,
Mobile nation - The economic and social impacts of mobile technology, [ONLINE]
Available at:
http://www.deloitte.com/assets/Dcom-Australia/Local%20Assets/Documents/Services/Corporate
%20Finance/Access%20Economics/Deloitte_Mobile_nation_brochure_Feb2013.pdf
[Accessed 30 May 2015]
Telsyte, March 2014, Australian media tablet sales double in 2013 as low cost units flood the market, [ONLINE]
Available at:
https://www.telsyte.com.au/?p=2228
[Accessed 30 May 2015]
29 | P a g e
Fulton B., Where is Australia headed? Some future projections - Posted March 2013[ON LINE]
Available at:
31 | P a g e
32 | P a g e
WEAKNESSES
share volume
Limited revenue avenues that are reliant on data
contracts. Major revenue opportunity trending in
online communication enablers, such as Whats
App, Facebook, imessage
OPPORTUNITIES
Bundling options
Competition edge
Increase national coverage with Perth deal
THREATS
TPG acquisition
Expense of consolidation/back office integration
NB and associated political climate
Technological advance in data usage that may
threaten traditional ISP business model
33 | P a g e
34 | P a g e
35 | P a g e
36 | P a g e