TPG Telecom Ltd & Vodafone to rival Telstra Corporation Ltd

In a major deal that would transform the future of Australia’s internet services and mobile phone sector TPG Telecom Ltd (ASX: TPM) and Vodafone Hutchinson Australia (VHA) today announced an agreement to a merger of equals that would combine the two companies.

If the deal is approved by the Australian Competition and Consumer Commission (ACCC) the merged group would be 49.9% owned by TPG shareholders and 50.1% owned by VHA’s existing shareholders, who are its parent companies the Vodafone Group and Hutchinson Telecommunications.

If combined the group would have a market value around $15 billion with EBITDA of $1.8 billion on revenue of $6 billion. It’ll also have a combined net debt to EBITDA of 2.2x, which represents a whopping $3,616 million in debt, with TPG contributing $1,672 on top of VHA’s $1,944 million plus upcoming debt-funded 5G spectrum payments.

The combined entity will also aim to pay out at least 50% of net profit in dividends with the strong free cash flow generation (associated with the telco sector) likely to prove popular with dividend-hungry institutional investors that recently abandoned TPG on the back of its dividend-demolishing capital investment plans.

TPG also announced plans to “separate” its nascent Singapore mobile services business as part of the deal, with the deal to be completed via an “in specie distribution” presumably of cash or scrip in the Singapore business.

In addition existing TPG shareholders may be in line for a one-off special fully franked dividend if the deal goes ahead and TPG’s net debt position is within certain special covenants.

The glue behind the merger is the coming of next generation 5G super-fast mobile network technologies that could offer an alternative to nbn broadband to cost conscious consumers looking to pick up a single household and mobile internet services bill.

The merger will also bring substantial cost savings for both businesses in the terms of cutting call centre support costs, sharing backhaul networks, and existing mobile infrastructure that TPG was in the middle of a costly process of investing in.

Moreover, there’s also the potential both companies can cross-sell products to consumers with the “bundling” of mobile and home internet services (at a relative discount for the consumer) a key sales strategy in the fight for market share of telco giants like Optus, Telstra, TPG and Vodafone.

After news of the deal officially hit the market Telstra’s share price rose strongly as investors bet that a new triumvirate of Optus, Telstra and TPG would refrain from engaging in a mobile price war given the market would be large enough to sustain profitable pickings for three major players.

This may true to an extent and a short-term benefit to Telstra, but over the medium term I expect the deal will prove another negative to Telstra investors as TPG’s superior management and operational performance see it attack Telstra’s margins and take its market share.

As such I’d use strength in the Telstra share price to exit a position in a business that looks likely to keep shrinking over the long term.

For TPG shareholders the significant obstacle ahead is the ACCC’s approval, which is likely to rest on the argument that the merger diminishes a duopoly rather than creates an oligopoly.

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Motley Fool contributor Tom Richardson owns shares of TPG Telecom Limited.

You can find Tom on Twitter @tommyr345

The Motley Fool Australia owns shares of and has recommended TPG Telecom Limited. 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 Scott Phillips.

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