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Weekly Update: M2, Telstra and One ‘Integrated’ Play On The Cashless Megatrend

Dear Motley Fool Share Advisor Subscriber,

We’re just putting the finishing touches to our special biotechnology issue of Share Advisor. It will hit your in-box this Thursday April 26th after the market closes.

Last week saw the telecommunications industry take centre stage, with M2 Telecommunications (ASX: MTU) acquiring Primus Telecom Holding from its US parent for $192.4 million, and Telstra (ASX: TLS) unveiling its latest capital management plans. Both provided further evidence that you can’t please all the people all the time!

More, much more, on M2’s acquisition and rights issue below, but first a great quote from our U.S. colleague Alex Scherer…

“Trust talented leadership to succeed … that’s what they’re there for.”

Both M2 and Telstra have strong management teams; they have proven themselves to be excellent leaders in turbulent times. Since replacing Sol Trujillo at the head of Telstra three years ago, David Thodey has snatched victory from the jaws of defeat. His leadership team has earned the right to keep making the big calls and I applaud their decision not to engage in a share buyback. Long-term investors will be better off waiting for an increase in fully franked dividends as share buybacks seldom create lasting value.

Telstra still has many challenges ahead. The telecommunications and information technology (IT) landscape is rapidly evolving, so maintaining financial strength and flexibility is a smart move.
The optionality of cash – the value of investment opportunities as a result of holding cash – is under-appreciated by most people, but Thodey and new CFO Andrew Penn appear to understand the value of cash.

There’s a parallel there for investors – if you’re fully invested and don’t have even a little cash on the sidelines, you might rue that fact if an unexpected opportunity presents itself and you can’t capitalise on it.

As an aside, we hope by now you’re getting a sense of how we think about investing. Some live and die by the numbers and others are happy to trade in and out of a stock for a couple of percentage points here and there, hoping to get lucky by guessing whether the market is going to zig or zag.

At The Motley Fool, we’re business focused investors. We focus on understanding what a company does and how it makes money, and on the management and culture of the business. We think that gives us an edge – an edge we’ll use to pick companies we expect to beat the market.

It’s only early days, but we’re pleased to see our companies performing well. We hope you’re enjoying the journey so far, and we’re looking forward to bringing you more great stock selections, starting this Thursday via our special biotechnology issue of Share Advisor.

In this week’s update:

  • Our play on the cashless megatrend, Integrated Research.
  • More on M2 Telecommunications‘ acquisition of Primus Telecom and accompanying entitlement / rights offer.

Company Updates

Integrated Research (ASX: IRI) is our play on the cashless megatrend.

It’s Foolish (with a capital F) to always be mindful of confirmation bias — our tendency to seek out information that confirms beliefs we already have — but when one of the best investors I know highlights the global move to cashless transactions as a major trend he’s following, I pay attention. That investor is The Motley Fool’s own Jeff Fischer.

Jeff is both a brilliant investor and lead advisor of one of our parent company’s most successful services. The following is a paraphrased excerpt from a recent interview with Jeff, in which he highlighted his thinking behind an investment in MasterCard. I’ve taken the liberty of replacing MasterCard with Integrated Research.

One trend that has been playing out, and is I think going to play out for a long time to come is that of cashless transactions replacing cash, and one way to invest in it is Integrated Research. About 85% of worldwide commerce transactions are still cash based, which is pretty hard to believe when you think about it. In the USA, around 60% of transactions are still cash. So Integrated Research and its competitors are really not up against each other so much as they are up against cash. That’s a pretty good competitor to be able to pick off year by year. And so year by year, their volume is growing and their profits right alongside of it.

One megatrend wave is great, but it’s even better if there is a set of waves forming for us to ride! Integrated Research is riding multiple trends. It’s not simply riding the cashless megatrend, IR is also aboard the VoIP tidal wave and the surging ‘consumerisation’ of information technology or BYOD (Bring Your Own Device) wave. We hope to ride those waves for many years to come.

As we highlighted in our first ever weekly update, subscribers interested in Integrated Research or technology more broadly, will enjoy this Foolish podcast. Thirty minutes in, Venture capitalist Paul Holland discusses the future of technology. His first pick, Sunnyvale California company MobileIron, is based on its BYOD  software.

While IR is not cheap on a near-term valuation basis and is officially a hold on our scorecard, members who have not started a position should take another look at IR, and consider buying an initial third in this exciting company that is riding multiple megatrends. Click here to read more on buying in thirds.

M2 Telecommunications‘ is being taken to the woodshed by investors; its share price continues to fall.

The market is clearly less than impressed with the company’s acquisition of Primus. Not only does the deal appear expensive on most multiples, it is a significant change of strategy for this once asset light reseller of telecommunication services to small and medium businesses. While most company announcements are full of hubris and words such as ‘transformational’ are overused, in this case CEO Geoff Horth was on the money. This deal is certainly transformational for M2.

It’s times like this that Alex’s sage advice bears repeating – “Trust talented leadership to succeed … that’s what they’re there for.

M2 has done a sensational job of acquiring telecommunications assets, integrating them and growing its business, so while I’m yet to get my head fully around the long-term implications of this deal, I am prepared to give management the benefit of the doubt. I think M2 will over-deliver, and the combined company will be stronger than the sum of the parts.

However, I can certainly see how selling makes sense for investors who are not prepared to trust management. In short, the deal has significantly increased the risks faced by M2 investors without an obvious increase in the potential reward. M2 certainly had to add next generation telecommunications services to their product line and this deal has ticked all those boxes. But did it need to spend $192.4 million to achieve that?

As for my advice for shareholders, M2 is now a completely different company with different risks and opportunities. I’m yet to come to grips with it, and as such am sitting on the fence. If investors do want to increase their exposure to M2, they should buy more shares at the entitlement price of $2.66. If not, they should simply sell the rights via their broker. More below…

What now? If you bought M2 shares prior to Wednesday April 18, you will automatically be given one entitlement right for every four share you own. If you don’t wish to purchase further shares at the entitlement price of $2.66 you can sell your right on the market.

The rights started trading on the 18th under the ticker MTUR. You won’t receive the rights in your broker account until after the record date (April 24), so trading of these is currently done on a deferred basis, i.e. you can buy and sell them now, but the rights can’t be exchanged until after the record date (April 24).

You should either sell your rights by 4pm on May 4 or buy the shares prior to 5pm on May 11. If you do nothing your rights will expire and you would have lost all their value. So whatever you do, DO SOMETHING!

In summary M2 holders get 1 right for every 4 shares they own. You should either sell the right or buy more shares at the $2.66 entitlement price. One right buys one new share.

Scorecard

There are no changes to our current recommendations, with eight of our ten recommendations remaining as buys (highlighted in green), the other two being holds (highlighted in yellow).

Rec Date Australian Aus Returns Market Returns Int. Returns International
22-Mar-12 Industrea (ASX:IDL) buy 1.0% 1.9% 2.6% WisdomTree Investments (Nasdaq: WETF) buy
23-Feb-12 Vocus Communications (ASX:VOC) buy 8.8% 2.6% 8.5% Amazon.com (Nasdaq: AMZN) buy
26-Jan-12 QBE Insurance Group (ASX:QBE) buy 18.5% 4.1% 6.9% Dolby Laboratories, Inc. (NYSE: DLB) buy
22-Dec-11 Thorn Group (ASX: TGA) buy -4.8% 8.8% 41.1% Apple (Nasdaq: AAPL) hold
5-Dec-11 Integrated Research (ASX: IRI) hold 56.0% 3.1% 21.1% Coach (NYSE: COH) buy

For an explanation of the scorecard, see this recent update.

Coming soon – Our Special Biotechnology Issue, and a MAD update

The next issue of Share Advisor will be published this Thursday April 26th. As a reminder we publish Share Advisor on the 4th Thursday of the month after the market closes. This month’s issue will feature our top biotechnology pick and six other biotech and medical device companies that are on our radar.

As you’ll appreciate, Dean has been spending most of his time focusing on biotechnology. But he hasn’t forgotten about watchlist stock Maverick Drilling & Exploration (ASX: MAD). He’ll update Share Advisor members next week, plus Maverick executive director Brad Simmons has promised us another email interview. If you missed the last one, grab a cup of coffee and click here to get the Maverick story, in all its glory.

As ever, we thank you for your support.

Yours Foolishly,

Bruce Jackson and Dean Morel

Motley Fool Share Advisor

Disclosure: Bruce Jackson shares in Thorn Group, Vocus Communications and Apple. Dean owns shares in Integrated Research. Click here to view The Motley Fool’s disclosure policy.

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