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Vodafone Hutchison Australia (VHA) has registered a scheme booklet for the merger with TPG Telecom, which provided firm projections on the combined entity’s (‘MergeCo’) financial starting point and a clearer picture of VHA’s operational trajectory.


The scheme booklet finally gave us a look at the capital intensity and cash flow position of VHA. The numbers reveal a business that is past a period of heavy investment into the network and is now generating significant cash flow. Capital expenditure has stepped down considerably from 35% of revenue in FY17 to just 17.5% in FY19 (including spectrum payments), which is lower than our 20% forecast. We estimate VHA’s capital expenditure will drop to 13.8% of revenue from FY21, once the one-off spectrum payments are made.


Tuas, TPG’s Singapore entity which is to be spun off, had a total of 412,000 trial subscribers sign up over 15 months, although only 186,000 subscribers were still on the network at the end of the trial period and only 7,000 paid customers had signed up within the first month of commercial launch. This is far shy of the 400,000 additions we were estimating for the first 2.5 years for the company to reach operating earnings breakeven. We now estimate Tuas will reach the breakeven point of 400,000 subscribers at the end of FY24 and will require at least $110m of capital to sustain itself until that time, versus our previous $100m estimate. This is in line with the $130m it will receive as part of the separation, which likely allows for a 20% cushion.


It is now clear that VHA is coming to the end of a period of significant investment in the business and will begin generating substantial free cash flow (FCF). This gives MergeCo the optionality to reinvest and compete more aggressively to win market share, and eliminates one of our major concerns.


The financial position of MergeCo is better than we had anticipated due to the larger tax loss asset, lower capital expenditure at VHA and lower interest cost on the new debt facilities.


These factors have driven our FCF yield estimate to more than 10% by FY23, leading us to increase our target price for TPG Telecom to $8.65 from $8.25. We have upgraded our recommendation to Accumulate from Hold, noting further upside could come from potential revenue benefits.

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