Vodafone buyers may find 2degrees tempting too

News reports say overseas buyers want Vodafone New Zealand. Rival 2degrees is also a likely take-over target.

Vodafone is the largest mobile carrier in New Zealand. In comparison, 2degrees is an also-ran. Yet, in the right hands, the smaller mobile carrier could prove a better investment.

At The Australian, Bridget Carter and Gretchen Friemann write UBS for the defence as TPG eyes Vodafone.

Carter and Friemann’s story has a lot of informed speculation.

2degrees also in play

The pair write:

“Some believe 2degrees Mobile could also be an acquisition target of Australia’s recently merger between Vocus and M2, despite chequered performance.”

The Australian Financial Review says staff saw senior TPG executives at Vodafone’s Auckland headquarters. TPG billionaire Teoh may soon call Vodafone.

Like most AFR stories, it is behind a paywall. You can read it for free at Stuff.

Stuff’s Tom Pullar-Strecker has a local follow-up Vodafone NZ silent on sale rumour. He says:

“Vodafone NZ has read the rumours but chosen not to comment.”

Pullar-Strecker also mentions a possible tie-up between Vocus and 2degrees.

TPG and Vocus

At NBR Chris Keall didn’t get anyone from Vodafone on the record when he wrote: “TPG in town to buy Vodafone NZ, or is it 2degrees, or …”. (Link is no longer online).

He runs through the sale potential of three telcos. In short:

• Vodafone — possible.
• Chorus — unlikely.
• 2degrees — “Now we’re talking”.

To date most reports name two acquisitive, fast-emerging Australian telco giants as potential buyers. Both TPG and Vocus have run the ruler over New Zealand mobile company assets in recent months.

While most stories are about TPG buying Vodafone, we can assume both companies looked at 2degrees.

China Mobile

It doesn’t end there. I’m told China Mobile has looked at a possible NZ acquisition. And at least one Indonesian telco has investigated the local market.

This means a Vodafone sale could be competitive.

In the NBR story Chris Keall looks at Vodafone’s numbers. He notes:

“Vodafone NZ lost $120 million last year. It blamed complications integrating TelstraClear…”

He goes on to point out the operating earnings were $438 million.

Vodafone getting the books ready

Recently Vodafone embarked on a ruthless cost-out programme. Moving from expensive office space on Fanshaw Street to the cheaper Smales Farm site is part of that. Make no mistake, many staff will choose not to move. That’ll cut costs further.

It’s possible that within a year Vodafone New Zealand could be generating an annual free cash flow that’s the thick end of a billion dollars. Free cash flow, by the way, is what buyers like Vocus and TPG often look for in an acquisition. It gives them money to carry on expanding.

Either way, Vodafone’s profitability is moving in the right direction.

Indigestion

While the NBR doesn’t put a price on Vodafone’s NZ business, Keall notes Spark’s $6.1 billion market cap would “be way too big for TPG to digest”.

Maybe. But the going price for a market-leading mobile phone company with 2.4 million users and $1 billion in free cash flow each year isn’t far short of Keall’s $6.1 billion.

That could well be too much for TPG’s shareholders. China Mobile could find the cash.

Spectrum is red

There’s other value locked in Vodafone New Zealand. The company owns the rights to 320 MHz of spectrum. That asset alone is worth over a billion dollars.

Spark paid $83 million for the last paired 5 MHz block of 700 MHz spectrum. At that price Vodafone is sitting on an asset of more than $2.5 billion. Spark paid a premium, not all blocks sell at such a premium. Let’s take half that price. That values Vodafone’s spectrum at about $1.2 billion.

Vodafone’s physical cellular network, with all the building and consents done is likely to be worth close to another billion dollars. Add in the goodwill, the relationships and so on. It’s clear Vodafone New Zealand has a few billion in assets. Maybe $3 billion.

Free cash flow

If Vodafone’s free cash flow hits a billion a year, then you’re looking at a likely sale price around $5 billion. Maybe more, after all this is a market leader.

Vodafone’s board in the UK would be cock-a-hoop if the company could flick the NZ operation for more than its current book value.

In comparison 2degrees has yet to break-even. The company loses money every month. Its network isn’t extensive and it owns less spectrum than Vodafone. In early May reports said the company was looking at an ASX float. Those stories put 2degrees’ value at around $800 million.

Assessing assets

If we look at 2degree’s spectrum assets, it has about 110 Mhz. On the same basis as our earlier calculation, that is worth around $500 million. It’s complicated because some spectrum is owned by a Maori trust. The value of the network is also complicated. It involves vendor finance. And it isn’t as extensive as Vodafone’s.

2degrees has call centres, shops, a decent brand, an OK reputation and systems in place.

Looking at the assets and the company’s potential, an $800 million valuation looks reasonable.

Imagine you were a cash-rich international telco looking for a New Zealand asset. Your choices are to pay a hefty premium and buy the market leader or to pay under a billion and pick up the number three player.

Fear of missing out

Remember, there are three, maybe four, buyers looking at the market. It’s possible a buyer who misses Vodafone might still want an NZ carrier.

On the face of it Vodafone would be the smartest bet. It’s not risk-free. Spark is snapping hard at Vodafone’s heels.

Managing Director Simon Moutter has taken the fight to his competitor. Today Spark has almost as much usable spectrum as Vodafone. It has access to similar, if not better, technologies.

The recent 4.5G trial in Christchurch illustrates Spark’s capacity to compete. If a Vodafone take-over is messy, Spark will probe every weakness.

Vodafone is also under pressure from Spark’s investment in public wi-fi hotspots serving customers as much as an extra gigabyte of data a day from old telephone boxes.

2degrees more threating than you might think

If anything, the threat to Vodafone from 2degrees is more serious.

Yes, that’s right. It sounds counter-intuitive, but until now 2degrees’ biggest stumbling has been lack of investment capital. It hasn’t had the funds to maximise its opportunity.

Many 2degrees customers roam on the Vodafone network. That means the company has to pay Vodafone when its customers make calls. Guess who makes the most money when that happens? It’s not 2degrees.

And let’s not forget that 2degrees couldn’t find the $20 million or so needed to buy spectrum that other carriers value at $80 million. Nothing shouts “under capitalised” more than that decision.

A billion here, a billion there

What if a cash-rich international telco snapped up 2degrees for say, $1 billion? And then invested another billion filling in the network holes and buying spectrum — assuming there is any still available.

Let’s say the new buyer switched strategy. Rightly or wrongly 2degrees is positioned as a full-service telco. Maybe that’s not the smartest approach when you’re small and undercapitalised. Maybe New Zealand doesn’t need three full-service mobile carriers.

That is another story. For now the key point is that if Vodafone is in play, so is 2degrees. The merger and acquisition activity could come to nothing, but that’s not what people inside the business think will happen.

Blame the regulator?

Australian telecommunications analyst Paul Budde thinks 2degrees’ problems come down to New Zealand regulatory settings.

He may have a case, but he is looking at the market from a country where the government is only too keen to get its hands dirty in the telecommunications market. New Zealand’s more lassez-faire approach precludes that. Regulatory changes are unlikely with the current New Zealand government.

Let’s not forget TPG and Vocus are competitors. If one moves on a New Zealand mobile carrier, the other may feel it has to move in order not to fall too far behind.

If the stories circulating in the market have any validity, it’s likely both Vodafone and 2degrees will have new owners before the end of the year