There has been a lot of activity in the telecommunications sector recently. The takeover of iiNet Limited (ASX: IIN) by TPG Telecom Ltd. (ASX: TPM) as well as the proposed merger between Vocus Communications Limited (ASX: VOC) and Amcom Telecommunications Limited (ASX: AMM) make a period of uncertainty in the sector likely for some time to come.
Looking further afield to the New Zealand market and Spark New Zealand Ltd (ASX: SPK) may offer an opportunity for investment with a dominant business in its market.
Spark New Zealand Limited (formerly Telecom Corporation of New Zealand Limited) is a telecommunications service provider, offering a range of services and products to consumers and businesses in New Zealand. It is the largest internet service provider and second-largest mobile provider behind Vodafone.
Spark New Zealand has gone through a period of restructuring, including divesting its holding in AAPT Limited and winding down its IT business in Australia. It has also announced an intention to sell its interest in Telecom Cook Islands.
Trading at around $2.70, Spark New Zealand is well down from its high of nearly $3.50 in January. Its price-to-earnings ratio of 16.5 is not expensive considering the forecasts for earnings growth over the next three years.
Because Spark operates outside of Australia, the dividends are unfranked, but at a yield of 6.3% the return is still very healthy in the current climate of low interest rates for fixed income investments.
Spark New Zealand enjoys a strong operating margin of over 26%. The return on invested capital and return on equity are both satisfactory at 16 and 19 respectively.
The equity valuation-to-earnings ratio is 16.5, which suggests the current price has upside given that the market average is 20.
One aspect of Spark New Zealand's financial situation that is a cause for concern is free cash flow. It is much lower than the reported earnings per share and as a result, my calculations for intrinsic value based on cash flow are significantly lower than the current price. This is largely a result of the high capital expenditure required to maintain and develop infrastructure in the telecommunications sector.
By my calculations, Spark New Zealand is trading above fair value. It would need to be priced closer to $2.00 per share before I would buy.
Nonetheless, I will keep it in my watch list as the potential for further benefits from the restructuring may lead to an improvement in the free cash flow and therefore an adjustment in my assessment of fair price.
