Tuas still growing at a strong clip in Singapore

Back in June we provided an executive summary and results update for Tuas Ltd (ASX: TUA), the David Teoh-led Singapore mobile phone service provider spun out of the merger between TPG and Vodafone in 2020 and formerly known as TPG Telecom Pte Ltd (TPG Singapore).

At that time, we wrote, “The success of TPG Australia, whose equity rose five-fold between 2010 and 2020 under Teoh’s leadership, offers investors a possible blueprint for TUA. As the Executive Chairman and a major stakeholder in TUA, Teoh is expected to bring the same disruptive strategy, aggressive pricing, vertical integration, and cost control as was seen at TPG.”

Back then, TUA had captured 8 per cent of the Singapore mobile market, and the company reported a 55 per cent increase in revenue for the first half of the 2023 financial year compared to the prior corresponding period. Along with the then average revenue per user of $9.38 and operating leverage, earnings before interest, tax, depreciation, and amortization (EBITDA) had jumped 126 per cent compared to the first half of the financial year ending 2022.

More recently, the company reported its full-year results for the 2023 financial year. Thanks to rising subscriber numbers and operating leverage, revenue rose 50 per cent to S$86.1 million. TUA’s mobile network costs are incurred irrespective of whether the company has one subscriber or a million. More subscribers mean more profit net of variable costs drops to the bottom line, improving profitability.

Meanwhile, mobile phone subscriptions rose 40 per cent to 819,000, and EBITDA was S$31.1 million, which beat analyst estimates, as did the EBITDA margin of 36.1 per cent. Moreover, TUA ended the 2023 financial year with S$44 million of net cash, which despite S$45 million of capital expenditures (capex), was aided by an attractive cashflow conversion of over 120 per cent.

While discussing its financial results, the company announced a transformation, or perhaps an evolution, from a consumer mobile business to a full-service telecommunications company, targeting the launch of broadband services in the first half of the 2024 financial year launch (i.e., by Jan-24). In an echo of the successful development path of TPG, the company plans to follow broadband with the launch of business and enterprise services.

For those of you who have been following our coverage of TUA, you may recall we last wrote: “Regarding unit economics for the broadband sector, brokers estimate a potential EBITDA margin of 15-20 per cent or up to S$4.00 per subscriber. Analysts have arrived at this figure by assuming an average revenue per user (ARPU) of S$20 per month, an NBN wholesale cost of S$14 per month, and operating expenses of S$2 per month. Importantly, TUA should be able to leverage existing call centre staff and backhaul fiber capacity, which would mean incremental operating costs are minimized or negligible. And given that low-hanging sales and initial market share gains can be achieved through word-of-mouth, hefty marketing expenses won’t be required for some time”.

Despite some analysts expecting a deceleration in the rate of subscriber growth as the company nears 10 per cent market share, the opposite might be occurring. Indeed, mobile subscriber growth is accelerating notably. In the second half of 2023 (2H23), the company reported an additional 128,000 subscribers, marking its best performance since early 2021. A rerating of the stock may yet be on the cards if analyst expectations of total addressable market (TAM) increases.

Here are some of the highlights from the 12 months to 31 July 2023 ($S):

· Revenue up 50 per cent to $86.1 million

· EBITDA up circa 100 per cent to $31.1 million

· Net loss improved $11.4 million to a net loss of $15.3 million

· Subscribers increased 40 per cent to 819,000

· Subscribers up 18.5 per cent over six months

· Operating cash flow of $40 million

· ARPU up from $9.19 per month to $9.37 per month.

Another growth driver will eventually be price increases and the migration of customers to premium plans. There has been only marginal, low single-digit growth in ARPU, but it appears the company has not pulled this lever in any meaningful way. It may not do so until it becomes a more significant player in Singapore’s mobile market, capturing a greater share of people who might first require a superior service experience before being willing to pay higher prices.

A reason for optimism is the belief that TUA will replicate TPG's success. David Teoh’s leadership and the absence of legacy profit pools enable a disruptive start-up culture and pricing strategy, which should ensure the capture of meaningful initial market share.

Of course, as with any investment, there are risks that could impact TUA's growth. These include increased competition from incumbents, lower spectrum holdings that could affect network performance or increased future capex, possible delays, or increased costs for the 5G roll-out, and unanticipated increases in subscriber acquisition costs and marketing spending once the low-hanging fruit is won.

TUA's guidance for the 2024 financial year is that capex stands between S$45-50 million. This is admittedly higher than analyst estimates of circa S$30 million however most analysts believe the company will produce positive cash flow by the 2025 financial year. For what it’s worth I believe the company’s ambitions are greater than achieving positive free cash flow in the short term and David Teoh is not a Chief Executive Officer (CEO) that kowtows to analysts or the market. Expanded mobile infrastructure and additional spectrum required to accommodate rapid growth and market share gains may delay the achievement of positive free cash flow. In any event, this is unlikely to adversely impact the market’s estimation of success and growth prospects.

And keep in mind TUA is already earning a reputation for outperforming analyst earnings forecasts.

The one ever-present question for any fast-growing company is valuation, and the long-horizon nature of the opportunity and profitability means the stock will be sensitive to both general market and idiosyncratic sentiment. It is also worth keeping in mind TUA has a market cap of almost A$1 billion, which is more than 10 times their 2023 financial year revenue. Of course, if revenue grows by 50 per cent again in 2024’s financial year, the multiple of revenue will drop to seven times.

To some extent the downside might be mitigated by a demonstration of high double-digit EBITDA growth but 2022 and the surge in interest rates that year showed that even the fastest-growing businesses can be de-rated heavily.

On balance, if forced to decide one way or the other, I am inclined to bet with David Teoh rather than against him. If the company can achieve 20 per cent EBITDA growth for at least a few years, while not certain, it is probable the share price will rise, even if the price earnings (P/E) ratio doesn’t change. Of course, we cannot predict sentiment and so cannot predict what the P/E will do next, but assuming no change to the P/E ratio, the share price and investor returns should follow operating earnings growth.