Is TPG Telecom Ltd a better bet than Telstra Corporation Ltd? 

When TPG Telecom Ltd (ASX: TPM) completed the takeover of iiNet last year it overtook Optus to become Australia’s second-largest broadband provider behind only Telstra Corporation Ltd (ASX: TLS).

This takeover gave TPG Telecom control of a portfolio of brands including iiNet, Internode, Westnet, and Agile Communications, as well as the infrastructure that comes with them. The company plans to continue to operate the brands more or less independently of one another, and with each of the brands marketed at different demographics it should put TPG Telecom in a great position to continue its growth without risk of cannibalisation.

In fiscal year 2015 TPG Telecom grew both revenue and earnings by 31% year over year. This figure excludes the iiNet acquisition which completed after the end of its fiscal 2015. So things are clearly looking very positive for the company.

The growth of the company’s corporate segment has been impressive. Six years ago it accounted for around 10% of its earnings, whereas today it accounts for approximately half of its earnings. With iiNet having a strong business, government and corporate segment (in 2014 iiNet’s business segment was bringing in revenue of $204 million) this should further cement its growth in the future.

The shares don’t come cheap though it must be said.

Trading at a forward PE ratio of 24 puts it well above the telecommunication industry average forward PE ratio of around 17. But subscribers are growing at a high rate, most recently at just short of 10% year over year, and the roll out of the NBN is potentially going to open up opportunities to accelerate this growth rate, which I believe goes some way to supporting the high PE ratio. Because of this analysts are expecting the company to grow earnings by 27% per annum for the next two years.

There is also a massive opportunity for the company in the mobile segment. At the moment it has been lagging the other segments posting year-over-year declines in subscribers. In August The Sydney Morning Herald reported that Telstra had grown its mobile subscriptions to 16.7 million. In its last annual report TPG Telecom lists its mobile subscriptions as just 320,000.

Customer service has been a huge selling point for iiNet over the years. Its net promoter scores were often the highest in the industry. The same can’t really be said for TPG Telecom, which tended to score a little on the low side to say the least. I feel there is a danger that if overall customer service dropped on the iiNet side after this acquisition then subscribers could look elsewhere. This would not be good for the company’s top and bottom lines. The good news is that management stated in its most recent annual report that it plans to maintain the iiNet call centres in order to ensure the strong customer service reputation is upheld.

Foolish takeaway

Because the shares have fallen 13% from their November highs, I feel it does make this a good time to look at them as an alternative investment to Telstra shares. The growth that the company has ahead of it, and the healthy balance sheet and strong levels of free cash flow, should more than make up for the high price to earnings ratio.

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Motley Fool contributor James Mickleboro has no position in any stocks mentioned. Unless otherwise noted, the author does not have a position in any stocks mentioned by the author in the comments below. The Motley Fool Australia has no position in any of the stocks mentioned. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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