Analyst: PIPE bid is the right price

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Analyst: PIPE bid is the right price

An "audacious, but not inconceivable" bid.

Australia's pre-eminent telco analyst believes SP Telemedia's $373 million bid to acquire PIPE Networks is at the right price for PIPE and is just within reach of SP Telemedia's borrowing capacity.

SP Telemedia ended a week of speculation by announcing its plan to acquire PIPE for $6.30 per share late yesterday afternoon - after PIPE had been trading at just under $6.00.

Mark McDonnell, a financial analyst at BBY with expertise in the telecommunications sector, had already valued PIPE at $6.39 over the next 12 months, based on PIPE's recent profit guidance.

Over the course of the financial year 2010, McDonnell expected PIPE's share price to grow from $5.79 to $6.85.

"At November 11, we are approximately one third of the way there - you come to a figure of around $6.30," he told iTnews, within hours of the merger being announced.

PIPE is trading with a profit to earnings (P/E) ratio of over 30 - which often denotes an over-valued stock. But McDonnell told iTnews that PIPE was a special case.

"You have to see it in the context of PIPE's business," he said. "PIPE has had a significant and sustained compound annual growth rate across the whole business, and has successfully executed on the PPC-1 cable."

McDonnell said PIPE's after-tax profits have grown from $1 million in 2004/05 to $3m in 05/06, then $5m a year later and $7m the following year. It recorded a $10m profit in the last financial year and announced forward looking estimates of $22m for the current fiscal year.

"The rule of thumb for a company with a P/E ratio of over 30 is that you would expect earnings to double every year," he said. "That describes PIPE's business. Their EBITDA (earnings before interest, tax, depreciation and amortisation) margins are better than Telstra, and on current estimates will go north of 50 percent in the current year."

Can Soul afford it?

PIPE's impressive figures calls into question whether SP Telemedia, a company with only $17m cash on hand and $58 million in bank debts, can afford the purchase.

McDonnell believes that at a stretch, it can.

"It is an audacious bid, but by no means inconceivable that they can secure the funding to complete the transaction," he said.

McDonnell's "back of envelope" calculations suggest that when the total debts of both companies are added to the $373 million purchase price, SP Telemedia would "notionally" need to borrow around $458 million.

This represents four times the combined earnings of both companies.

"That is high," he said. "Telstra's net debt to EBITDA ration is 1.3, iiNet is 0.2, and this would be 4."

On hypothetical interest rates of seven percent, SP Telemedia would need to pay $32 million per annum in interest which "prima facie, is manageable," McDonnell said.

But a lender might feel the need to increase the interest rate to reflect the higher risks associated with such a high net debt to EBITDA ratio.

"At ten percent, your annual repayment is more like $46 million, and that would certainly squeeze earnings," he estimated.

McDonnell concluded that if SP Telemedia chief executive David Teoh "pulls this off, he's come a long way from TPG to this."


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