2015 was a banner year for global M & A (merger and acquisition) activity.  Here in Australia TPG Telecom Limited (TPM) and Vocus Group Limited (VOC) emerged from a flurry of bids and bidding wars, with TPG gobbling up rival iiNet and Vocus acquiring Amcom and Nextgen and then merging with M2 Communications. 
In many cases investor reaction to mergers and acquisitions is positive in expectation of future growth.  That enthusiasm can be overridden or tempered by concerns over the initial cost of the acquisition as well as the costs of merging operational activities that sometime overlap.  Most large acquisitions are funded via two sources – debt financing or equity offerings.  Many investors take a dim view of some capital raises as they initially lower the value of the stocks they hold.  Adding debt raises concerns of weak balance sheets into the future.
Investor response to the moves made by TPM and VOC were generally positive as stock prices rose going into 2016.  The following chart shows the price movement of the two companies over the past two years.

The tipping point began in early September of 2016 with TPM now down 44% year over year with VOC dropping 61%. While moving from the status of “market darling” to “market dog” is not an uncommon phenomenon, given the share price and dividend history of TPM and VOC, the shift in investor sentiment comes as something of a surprise.  The following table compares the historical performance of Vocus and TPG against industry behemoth Telstra Limited (TLS), also down year over year with a 24% decline in stock price.

The share price declines stand as stark evidence of an investment maxim that says past performance is no guarantee of future results.  Investors already concerned about the impact of the NBN (National Broadband Network) were nonetheless shocked to hear TPG Management acknowledge in the FY 2016 Full Year Results released in September that resulting lower margins expected put a damper on the company’s FY 2017 guidance.  
To add to the misery, the company announced substantial increases in capital expenditures for expansion, including higher network access fees with the NBN.  
Investors used to the company shattering expectations were sorely disappointed with positive performance results across the board that fell far short of TPG’s historical habit of crushing its numbers. Shares of Vocus fell in the rout, with the loss of key members of its management team adding to the downward slide; as did shares of Telstra, but to a lesser degree, as you can see in the following price movement chart.

In a sense comparing Telstra to its two smaller rivals is akin to the classic tale of the tortoise and the hare.  Not to imply that Telstra the tortoise is winning the race but the company’s business model and global reach far surpasses TPG and Vocus.  The company has four business segments operating in 22 countries with primary focus on the Asia-Pacific region.  Telstra’s sheer size suggests it hardly could be considered a growth stock while both Vocus and TPG piqued investor interest due to growth potential, which now appears limited, at least in the eyes of many investors.
The consensus analyst forecast on all three companies is HOLD.  With diminishing opportunities for M & A expansion and the spectre of the NBN looming on the horizon, what might the future hold for the Big Three ASX Telco stocks?
Based strictly on the numbers, the slower growth scenario may have merit.  First, let’s look at some current growth forecasts.

While respectable it should be noted only Telstra’s analyst earnings forecasts have gone up since mid-November of 2016, when Earnings Growth was forecasted -1.7%. At that time analysts expected earnings at TPG to rise 10.1% over two years and 48% at Vocus, with both stocks featuring an OUTPERFORM rating.
At the core of the newly arisen skepticism is the NBN, expected to be fully completed by 2020.  The current iteration of this long and hotly debated project calls for running Fibre Optic cable to a network node (FTTN) in a neighborhood, allowing Internet Service Providers to connect individual households and businesses to the node for a hefty fee – reportedly considerably higher than current fees – up to four times higher. 
Perhaps of greater concern is the fact when completed the NBN will represent a regulatory monopoly eager to recoup the reported $40 billion-dollar price tag for the network.
While there is no limit to current discussions of the impact NBN will have on suppliers, little attention is paid to the potential demand increases, not just in current subscribers, but in data usage. The following graph from the ABS suggests the possibility of more growth in data usage post NBN.

The CEO of the NBN stirred the passions of super-fast (1 gigabyte) broadband enthusiasts when he stated the following:
• ‘In our opinion, there is still minimal consumer demand for ultra-fast speeds…’
With all due respect, this comment deserves a place in a list of prognostications of future demand for products not yet widely available to consumers.
Consider the following:
• When General Motors in the US began development of its Chevrolet Volt Electric Vehicle (EV) skeptics rushed in to proclaim the public had no wide interest in EVs.
• When US based Tesla Motors announced plans to develop an EV roadster priced above US$100k, skeptics scoffed at the notion few beyond the uber-rich would be attracted to a pricey vehicle.
• Management at one of the world’s most successful corporations in its day, Canada’s Research in Motion, considered the 2007 release of the first iPhone to represent nothing more than a basic communications and entertainment device.  
As you may know, EV demand around the world is driving the demand for lithium used in the batteries that power these vehicles.  The explosion of applications – apps – for iPhone and now Android mobile devices is literally changing the world.  Here’s what analyst firm Deloitte had to say in the 2016 version of Predictions for the TMT (Technology, Media, and Telecommunications) Sector:
• ‘A Gbit/s Internet connection might appear frivolous, but a decade ago some commentators may have questioned the need for a touchscreen-based device capable of transmitting data at 150Mbit/s, with storage for tens of thousands of HD photos, video quality sufficient for broadcast…, secure fingerprint reader, and billions of transistors within a 64-bit eight core processor. Yet modern smartphones with these specifications are likely to sell in the hundreds of millions of units this year. While a Gbit/s connection for a single device or a single application may be overkill, consumers are likely to continue accumulating connected devices in the long term.’
Certainly, there is an abundance of uncertainty and risk as the Telecommunications Sector goes forward with the NBN.  However, if you believe advances in technology have a way of defying the odds, the current share prices of the Big Three make them at least worthy of consideration.
Telstra last traded around $4.25 in December of 2012.  TLS has a Trailing Twelve Month P/E of 9.44 with a Forward P/E of 12.14.  Despite its size the company is not immune to market competition.  Shareholders are holding their collective breath in anticipation of an upcoming ACCC (Australian Competition and Consumer Commission) ruling on allowing smaller rivals roaming access to Tesla’s mobile network – the largest in Australia.
To add to the woes of Telstra shareholders, on 12 April pesky rival TPG made yet another move to measure up to Telstra, announcing it would spend $1.9 billion to build its own mobile network.  The price tag included $1.26 billion securing premium spectrum in the 700-megahertz band from the government.  Completing the network will cost another $600 million. TPG was trading around $6.66 when it went into a trading halt pending completion of a $400 million-dollar capital raise to go towards funding the expansion.
Given the fact investors have concerns about future growth potential in the Telco Sector, one would expect a positive reaction to this news.  In this case, one would be wrong.  The following price movement chart shows how investors reacted to the news.

The share price quickly rebounded in response to an analyst at UBS issuing a BUY recommendation on the beleaguered stock with a price target of $6.70.  In addition, renewed speculation that TPG is casting a covetous eye on Vodaphone Australia has dreams of TPG eroding Telstra’s economic moat dancing in investors’ heads.  TPM has a trailing P/E of 12.54 and a Forward P/E of 14.46.
The merger of M2 Communications and Vocus came with less cost and hassle of combining similar operations, since M2 ‘s primary focus is the business market while Vocus goes after the retail segment. In theory, this should produce a bigger earnings boost since the combined entity will generate revenues from heretofore untapped sources.  The company is somewhat unique in the sector as it offers services beyond what one might expect from a traditional Telco.  Vocus operates globally, using the Southern Cross Cable Network (SCCN) to the United States in addition to its own cables connecting Australia to Hong Kong and Singapore.  The company also offers cloud services and data centres to its clients. 
On 21 February, the company announced outstanding Half Year 2017 Results.  Aided by close to $70 million in revenues combined from M2 and another recent acquisition, Nextgen, Vocus reported a 404% increase in revenue.  Statutory NPAT (net profit after tax), which adds one-time acquisition costs and other items such as asset sales, was up 95%.   Underlying NPAT, which excludes one time charges thus showing a truer measure of what the company actually made over the period, rose 236%.
Vocus began paying dividends in 2007 and has increased its payout every year.  For FY 2014 the company paid a dividend of $0.018 per share, growing to $0.173 per share in FY 2016, an 860% increase.  VOC has a trailing P/E of 20.43 and a Forward P/E of 9.31.  The current Price to Book Ratio is 0.54, translating into a per share book value of $6.21 against a trading price at $3.34.  The Price to Earnings Growth (P/EG) ratio is equally attractive at 0.67.  Although the P/E is by far the favored measure of most investors, the P/EG provides a more accurate picture of a company’s worth since it factors future growth into the calculation.  A P/EG under 1 is considered to be an indication the stock is undervalued.

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