Telco watch: Will Turnbull block TPG's fibre plans and could iiNet Limited team up with Vodafone?

The Australian telecommunications industry is constantly changing. How does it impact your portfolio?

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I first became interested in TPG Telecom Ltd (ASX: TPM) in early 2012, because I noticed the company was buying shares in Australia's second largest ISP, iiNet Limited (ASX: IIN). Since the start of 2012, iiNet shares are up almost 150% and TPG shares are up 300%.

Peter Lynch famously suggested good investment ideas can come from one's own life experiences, and that was the case for me. Having moved house quite a lot since 2008, I've had a broad range of ISPs. Currently, I'm with Primus, owned by M2 Group Ltd (ASX: MTU), and it is by far the worst internet service I've ever had. I sometimes have to tether my phone to my computer, even when I'm at home. We were suckered in by the low prices.

Meanwhile, I found TPG Telecom to be fairly bad, especially with customer service, although at the time the company was offering the best rates. If it had been up to me, I would have reopened my account with iiNet – by far the best internet provider, for customer service and connection speed, if not price. The company thoroughly deserves its excellent reputation.

That's why it could be a terrible error for iiNet to team up with Vodafone, as Amcom Telecommunications Limited (ASX: AMM) chairman Tony Grist has suggested. In my opinion, unless the deal compensated iiNet for the inevitable brand damage that would ensue, a merger with "Vodafail" could be a catastrophe for iiNet. It's certainly an unnecessary risk.

Although the Vodafone network has supposedly improved, the company has perhaps shown that it cannot be trusted to maintain service quality, and there is no guarantee that network problems won't arise again. You can be sure that customers are only just beginning to forget the terrible reputation Vodafone earned for itself a few years ago.

The beauty of iiNet, as a company, is that its reputation allows it to launch new products more easily, and charge a little more, than other ISPs such as Primus. For example, Primus advertises unlimited DSL for $69.95 but for the same price, iiNet will limit customers to 250GB, which is more than enough for most of us anyway.

Regular readers will know that I opted to buy shares in TPG Telecom over iiNet because of its superior fibre network, among other reasons. iiNet recently sold off its super fast Canberra fibre network to NBN Co. This makes sense, because much of that network is still under construction and therefore required to provide open and equivalent access under current legislation.

As I've said in the past: "As part of the NBN package, the Telecommunications Act 1997 was amended to require that any fibre networks provide open and equivalent access to the network. This was designed to prevent companies like TPG from building a fibre network to high-density areas before NBN Co. However, the Act provides a few exceptions, including for networks that do not extend more than one kilometre beyond fibre that was in existence prior to 2011."

In 2010 the then CEO of AAPT lambasted the foolishness of the NBN plan. "I cannot find any way they'll make any money and I find it absolutely unbelievable to think they're going to run fibre where I've got fibre today," he said. "We've got 24 strands of fibre running Sydney, Melbourne, Brisbane. Do you know how many of those I use? Three."

TPG Telecom now owns that fibre, so has plenty of scope to connect buildings to a fibre optic network, as long as the grandfathering clause, regarding fibre built prior to 2011, remains in place. Speaking to the Australian Financial Review, Malcolm Turnbull said: "There are some grandfathering provisions and we haven't got any plans to change those."

TPG Telecom's plans will, in my opinion, seriously undermine the business model of the poorly executed NBN (Stephen Conroy, why didn't you build to high-density areas first?). This would be a good thing for all of us, as it means we'll get faster internet sooner. The main risk is that the government puts a stop to TPG's plans, as they threaten to turn the NBN Co into a budgetary expense.

Foolish takeaway

Raymond Tong from Goldman Sachs has said, "TPG's current FTTB plans will not have a material impact on the profitability of NBN Co," and downgraded the company to a price target of $4. Morgans analyst Nick Harris gave TPG a price target of $4.44, arguing: "We see TPG is now priced for success … and this seems very optimistic." These opinions are legitimate, and I wouldn't buy TPG shares at current prices. However, if the government doesn't allow TPG to go ahead with its plans, then it is completely hypocritical, championing as it does, the efficiency of private enterprise. Given the current uncertainty facing TPG, there are clearly safer investments available on the market.

Motley Fool contributor Claude Walker (@claudedwalker) owns shares in TPG Telecom.

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