Is iiNet Limited now a takeover target for TPG Telecom Ltd?

With CEO departing, is iiNet open to being bought out?

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Telecommunications provider iiNet Limited (ASX: IIN) could be a takeover target now that founder and long-time CEO Michael Malone has announced he is leaving.

And the company with its eye on iiNet could be one of its largest current shareholders, TPG Telecom (ASX: TPM).

Mr Malone still holds more than 9 million shares (5.6%) in iiNet through his company Perth Internet, but TPG owns more than 10.1 million shares, giving it a 6.3% share. But given he sold 5 million shares in August 2013, he may be willing to sell his complete shareholding, now he is leaving.

Consolidation in the telecoms sector has continued over the past few years, with iiNet acquiring Adam Internet, after the Australian Competieiton and Consumer Commission (ACCC) knocked back Telstra Corporation's (ASX: TLS) bid for the company on competition grounds.

Similarly M2 Telecommunications (ASX: MTU) recently acquired smaller telcos iPrimus and Dodo, giving it over 450,000 broadband services. By contrast, TPG had 671,000 broadband subscribers at the end of July 2013, while iiNet has 926,000 subscribers.

TPG could also be eying iiNet's 25% market share in NBN contracts, with over 30,000 active subscribers to the super-fast internet service. A combined TPG/iiNet would give the company greater scale with around 1.5 million broadband subscribers, putting it on a comparable scale with Optus, and not far behind Telstra. The combined company would also have a large number of mobile device subscribers.

The one issue TPG may have is the amount of debt iiNet currently sports on its balance sheet. With around $237 million in debt, a takeover could be risky with TPG recently acquiring AAPT for $450 million funded by debt.

Still, a combined TPG/iiNet would have a market cap in excess of $5.6 billion should be easily able to pay the interest costs, as well as pay down the debt. Of course TPG would not want to over-pay for iiNet and could use an equity raising to buy iiNet.

Foolish takeaway

After a series of acquisitions, M2 is focused on consolidating its new businesses, while Optus's strategy is to drive earnings from its existing user base. Telstra is unlikely to get ACCC approval to acquire iiNet, which leaves open the potential for a TPG/iiNet tieup.

Motley Fool writer/analyst Mike King owns shares in M2 Telecoms, Telstra and TPG Telecom. You can follow Mike on Twitter @TMFKinga

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