- iiNet is the third largest internet service provider (ISP) in Australia with over 900,000 broadband subscribers.
- iiNet should be able to compete and potentially gain market share in regional areas largely thanks to the NBN.
- Management has grown the company significantly over a long period of time, delivering solutions to its subscribers.
How long have you held iiNet (IIN)?
We have held iiNet in excess of two years. However, we have monitored the company for some time prior to investment.
What do you like about it?
iiNet is the third largest internet service provider (ISP) in Australia with over 900,000 broadband subscribers. Over the years, iiNet has grown, via both acquisitions and organically, to become a national internet service provider with a broadened product suite that includes mobile and TV subscription services.
iiNet (IIN)
Source: Yahoo!7 Finance, 18 December 2014
Our investment in iiNet is representative of our view that the demand for connectivity, improved connection speeds and data will continue to rise. iiNet provides a compelling exposure to the telecommunications theme through its consumer broadband products, particularly as an alternative to the incumbent telecommunication providers.
As the third largest ISP, iiNet is well positioned to extend its products into longer-term prospects in the market. The small and medium-sized companies and regional consumer markets are potentially attractive segments given similar demands for more competitive products and service.
In the past, management have been able to utilise scale to gain operating efficiencies and improve profit margins. However, iiNet’s cost base is still high compared to its peers. We expect management to continue to focus on improving profitability that will lead to future efficiency improvements.
How is it better than its competitors?
Competition in the ISP segment is extremely high. Incumbent ISPs, such as Telstra, have strong competitive advantages due to their network coverage and high capital expenditure plans. It is therefore quite instructive that providers such as iiNet have been able to gain new customers despite the challenges faced by these companies. We believe the customer experience has been positive for iiNet and has led to net gains in subscriber numbers. Keener pricing is another contributory factor.
iiNet’s subscriber gains have largely been in urban areas. We expect iiNet to compete and potentially gain market share in regional areas largely thanks to the NBN, which has opened up the total addressable market for iiNet and other providers. There are an estimated 1.5 million premises in regional areas. We believe the majority of these new regional customers would have been uneconomical for iiNet to enter if not for the level playing field provided by the NBN.
What do you like about its management?
Management has grown the company significantly over a long period of time, delivering solutions to its subscribers. For shareholders, management has created value in three ways: First, acquiring complementary business to enlarge its footprint and gain scale. Second, by acquiring new subscribers organically through brand management, excellent customer service and competitive products. Third, expanding its margins through more efficient operations and by bringing more subscribers on to its own network, which is a more profitable enterprise.
What is your target price on the company?
The stock is trading on a share price of $7.61 putting the company on 14.6 times next year’s earnings, which is estimated to grow by 16%. We have a target price of $9.45.
At what point would you sell?
iiNet competes in an extremely competitive segment. We are very conscious of the fact that in a competitive industry, any excessive profits earned by any company will eventually be competed away. Therefore, the pricing regime has the potential to alter our view of the industry structure and iiNet’s profitability. Signs of a deteriorating industry structure include declines in customer numbers and falling average revenue per user.
How much has it added to your overall portfolio over the last 12 months?
iiNet has been a strong contributor to our fund performance in the past 12 months, both on a relative and absolute basis. Our investment in iiNet has contributed 118 basis points to portfolio performance in the 12 months to end November 2014.
Is it a liquid stock?
Yes, iiNet is a liquid stock.
Where do you see the value?
We believe iiNet’s growth prospects are robust over the medium term. We expect iiNet to continue gaining net new subscribers in both urban and regional areas, backed by a low churn rate of 1 to 2% per annum. We further expect iiNet to leverage its scale into the business segment where the company has a small national market share of about 5%. The iiNet brand has grown in credibility, increasing the likelihood of business customer acquisitions. Opportunities for acquisitions have declined due to the lack of suitable and sizeable targets, but should not be discounted.
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