In this series of articles, I am taking a look at the history of some of the ASX's best performing stocks. In particular, I hope to address the following questions.
- What did these companies look like at the start of their rise?
- Is it possible to identify tomorrow's 10 baggers?
TPG Telecom Ltd (ASX: TPM) is one of the largest telecoms providers in Australia today and services both the consumer and enterprise markets. If you had bought $10,000 of stock in TPG back in March 2009, it would be worth over $970,000 today plus you would have received almost $40,000 in dividends.
TPG was a private business until April 2008 when it merged with ASX-listed SP Telemedia Limited which was backed by Washington H. Soul Pattinson and Co. Ltd (ASX: SOL). Soul Patts is a highly regarded diversified investment company and has paid a dividend every year since it listed in 1903.
David Teoh founded TPG in 1984 and he was appointed CEO and chairman of the combined group following the merger. He still runs the company today and has been widely credited for its success.
Unsurprisingly given Soul Patts' involvement, the acquisition of TPG in 2008 was a fantastic deal for SP Telemedia shareholders. SP Telemedia paid $150 million in cash and issued 270 million shares in return for a business generating $29 million of net profit after tax (NPAT). Based on SP Telemedia's share price of 35 cents at the time, this represented a price-to-earnings ratio (PER) of 8.5.
However, TPG exceeded expectations delivering $38.3 million NPAT in 2008 and so effectively SP Telemedia paid an enterprise value-to-earnings ratio (EV/E) of just 6 for the business. Furthermore, TPG came with an extremely valuable broadband network which would improve profit margins of the combined entity and reduce its reliance on third party networks.
The cash component of the deal was financed with debt and it is impressive that a small company like SP Telemedia was able to get access to lending during the GFC. Use of debt was a sound move as it limited share dilution at a time when it was very expensive to issue equity.
Despite the transformational merger, shares in the group were trading at 13 cents by March 2009 implying an enterprise value of $234.7 million. In other words, you could buy both TPG and SP Telemedia for the same price that SP Telemedia had paid for TPG just under a year earlier.
This fact wasn't lost on the chairman of Soul Patts, Robert Millner, who was a non-executive director of SP Telemedia at the time. He bought 600,000 shares in SP Telemedia that are worth over $7,500,000 today for less than $100,000 in December 2008.
SP Telemedia reported headline losses in 2008 and perhaps this was one of the reasons for the low share price at the time. However, excluding write-offs of bad debts and commissions related to discontinued operations, the group delivered earnings before interest, tax, depreciation and amortisation (EBITDA) of $46.6 million for the year.
This included only a couple of months' contribution from TPG and so guided EBITDA for 2009 was much higher at $93 million. Forecast NPAT was just $16 million but included large non cash amortisation charges related to acquired customers hiding the true level of free cash generated of the business which was closer to $45 million.
In early 2009 it was possible to buy shares in TPG for an EV/E of about 5. This was extremely cheap for a company that owned valuable broadband infrastructure at a time when demand for bandwidth was growing rapidly year on year. Furthermore, it was and still is a highly scalable defensive business with sticky recurring revenues and an astute board of directors.
