Networks, business ambitions line up for Vodafone, TPG

The strength of the strategic rationale for the proposed "merger of equals’’ between Vodafone Hutchison Australia (VHA) and TPG Telecom was laid bare in the detail of its announcement, helping to explain why the telcos were able to put aside their individual ambitions and work through the daunting complexities to agree a deal.

It is a compelling combination, hence the willingness of TPG’s entrepreneurial David Teoh to surrender control of the business he built from scratch, and VHA owners Vodafone Group and Hutchison Telecommunications (Australia)’s acceptance of the need to absorb a big slab of their business’ debt to make the numbers work.

It is compelling at a number of levels.

Their networks are complementary, as are their business ambitions.

Vodafone has a mature mobile network, in which it has been investing more than $1 billion a year, a customer base of 6 million mobile subscribers and nascent fixed-line NBN resale ambitions. It has a mobile market share approaching 20 per cent.

TPG has a first-rate fixed-line broadband network with 1.9 million subscribers and market share of about 22 per cent. It has a small mobile customer base, re-selling Vodafone capacity, and had embarked on building a $600 million mobile network of its own.

Both are metro-centric and pitch their products at value-conscious consumers, so the combination will create an enormous cross-selling opportunity across their existing technology platforms, while conserving capital on what would otherwise be duplicated infrastructure and access costs.

While there will inevitably be conventional and probably significant cost synergies from bringing the two telcos together, it is the more efficient use of capital, the complementarity of the networks and customer bases, and the big increase in the scale of the business and its balance sheet and cash flows that make sense in such a capital-intensive sector - one in which the accelerating roll-out of the NBN is crunching fixed-line margins.

Illustrating the potential benefits of the merger is an agreement to form a joint venture, regardless of whether the merger is implemented, to bid for 5G spectrum in the auction of 3.6 GHz spectrum scheduled for November and to jointly acquire spectrum in future. The joint venture may also oversee future spectrum and network sharing.

Under the terms, Vodafone Group and Hutchison Telecommunications (Australia) will each emerge with 25.05 per cent of the merged entity, David Teoh 17.12 per cent, his backer Washington H. Soul Pattinson 12.61 per cent and other TPG shareholders 20.17 per cent. All the major shareholders have agreed to two-year escrow arrangements for their shares.

Vodafone’s Inaki Berroeta will be chief executive and Teoh chairman.

The reclusive TPG chief executive David Teoh will be chairman of the merged group.

Photo: Daniel Munoz

The combination will have an enterprise value of $15 billion, an equity base of about $10.9 billion and free cash flows of about $900 million, with net debt of about $4 billion.

Apart from the debt the Vodafone and Hutchison groups appear to be taking onto their own balance sheets to create the near-equality of interests between the Vodafone and TPG shareholders, TPG will spin out its relatively recently created Singapore mobile business to its shareholders.

With a scheduled $352 million spectrum payment in January, TPG is expected to have net debt of about $1.673 million at the point of merger. Depending on how it capitalises the Singapore entity, its cash flows between now and then, and the final transaction costs, anything less than that will be distributed to TPG shareholders via a special dividend.

The merger will create a much stronger integrated competitor for Telstra and Optus but will also mean the long-standing status quo of three mobile competitors, which had been threatened by TPG’s mobile network build, will be preserved and the threat of disruptive infrastructure overcapacity dispelled.

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