I. Sector Landscape and Outlook
The Communication Services and Technology sector encompasses telecommunications and digital technologies that connect remote communities and simplifies business operations. Australians scored high in the digital skillset, and the government spot fifth place in The United Nations E-Government Development Index for seamless centralized online services such as myGov, etc. It is worth noting, Australia is a world leader in silicon-based quantum computing research.
In terms of output, the Information Media and Telecommunications industry posted strong decadal growth of 5.1% in the 1990-2020 period, far exceeding the all-industry average growth of 2.9%, according to the Australian Trade and Investment Commission. Due to the large pool of tech-savvy population and favourable government policies, the Information and Telecommunication sector is the sixth-largest recipient of foreign direct investment (FDI), totalling $30.5 billion in 2019, according to the Department of Foreign Affairs and Trade.
Access to high-internet data speeds and mobile networks becomes the centre stage for economic growth and job creation. With the government spearheading infrastructure spend, Australia took the podium with high data download speeds over the mobile 5G network as compared to advanced economies such as the US, Germany, the UK, and Canada.
Figure 1. Australia Topped the Chart with High Mobile Data Download Speed:
Data Source: Australian Trade and Investment Commission, Chart Created by Kalkine Group
With an increasing share of millennials and wide internet adoption, the nation has the highest internet penetration at 89.0%, in-line with major economies such as North America (90%), Southern Europe (86%), Western Europe (93%). Australians use the internet extensively for e-commerce and online bill payments, according to a centralized data portal, DataRePortal. Digital advertising has taken a new shape, with ads in search engine becomes a familiar mode for brand discovery. Total digital ad spends in Australia stood at $7.45 billion in 2020, with ~$3.12 billion in search engines. Listed out below are few facts related to The Communication Services and Technology sector.
Figure 2. Australia Boast the Highest Internet Penetration:
Data Source: DataRePortal, Chart Created by Kalkine Group
The rollout of the 5G network in Australia is progressing with limited connectivity. Mobile Network Operators (MNO) able to offer 5G home broadband services on their mobile networks in limited circles. Optus is the first to roll out the 5G home broadband product, followed by Telstra and TPG Telecom recently. As more spectrum gets allotted over time, MNOs will be able to widen their 5G plans and services.
During the pandemic, daytime data downloads peaked with 81% higher than pre-COVID levels, led by distance learning and remote working trends. The government, through National Broadband Network Co Limited (NBN), added extra capacity to meet the demand. The rollout of NBN, although completed in 2019-20, migration of few legacy services is expected to get over within the next two years.
NBN forecasts that it will have 12.5 million premises ready to connect by June 2024. Australians favour mobile phones over fixed-line services for voice calls, but over 90% of data downloaded was through fixed-line networks, according to the Australian Competition Consumer Commission (ACCC). While NBN dominated the wholesale market, the retail segment is dominated by Telstra with a 47% market share in the fixed-line broadband services, as captured in the below chart.
Figure 3. Retail Services Providers and Market Share:
Data Source: Australian Competition Consumer Commission, Chart Created by Kalkine Group
The pandemic saw accelerated use of online collaborative tools. High levels of remote working fastened digitization progress in Australia. In a report by Infrastructure Australia, about 9 in 10 firms adopted new technologies during the pandemic. Cloud adoption had taken the top priority even before the onset of the pandemic, with ~69% of organizations were migrated data from enterprise resources planning (ERP) to cloud applications. In a survey by Gartner, a research firm, about one-third of organizations have expressed that they deployed distributed cloud. About 27% of respondents implemented robotic automation, and about 40% have expressed to do it so in the next two years. As detailed below, business intelligence and data analytics will be a game-changer in 2021.
Figure 4. Ranking of Technologies for 2021:
Data Source: Gartner, Chart Created by Kalkine Group
Microsoft teams saw a surge in active users by 43 million in just one month, reaching 75 million in April 2020. Adoption of Zoom video conference also rose by 85% during the pandemic. Revenue from online collaboration tools has shown a steady growth globally with +9.2% in 2020. Growth is expected to soften by +6.5% over the next five years to 2025. Increase in VPN users may push the cloud services with revenues expected to grow 23.1% from 2019 to 2024, according to Infrastructure Australia.
Index Performance:
The ASX 200 Information Technology (AXIJ) and ASX All Technology Index (AXTX) has generated 5-year returns of ~24.12% and ~24.22%, respectively, as compared to ~0.58% by the ASX 200 Index. Increasing NBN rollout by the government, promising growth in 5G, fostering artificial intelligence, and business intelligence and analytics by businesses, and implementation of blockchain technology roadmap provides a cornerstone for uptick in sector gains.
Figure 5: The ASX 200 Information Technology (AXIJ) and ASX All Technology Index (AXTX) outperformed ASX 200 Index in the past five years:
Source: Refinitiv (Thomson Reuters) as on the close of 13 May 2021
Key Risks and Challenges:
The telecommunications sector has a high entry barrier with substantial investment in building network infrastructure and getting spectrum license. Further, the dominant position by NBN in the fixed-line broadband has put pricing pressure on Mobile Network Operators. Low switching costs in both retail and wholesale operations alter the plan offerings, bundling of services, and pricing. Investment in data centre construction projects was affected by the pandemic. In a report by Infrastructure Australia, data centre investments grew by a paltry 3.0% in 2020. But the hyperscale data centre market is expected to show a rebound in 2021.
Figure 6. Key Risks in The Communication Services and Technology sector:
Sources: Analysis by Kalkine Group
Outlook:
The Morrison government has recently laid out a National Blockchain Roadmap in Australia. The initiative will likely to implement blockchain technology in supply chain and logistics, agriculture, trusted credentials, and smart contracts. Blockchain technology has the potential to generate annual business values of over US $175 billion by 2025 and more than US $3 trillion by 2030.
The federal government has allotted $1.2 billion in 2021-22 budget for investment in Information and Communication Technology (ICT). These investments were aimed to embrace the existing systems in artificial intelligence, digital skills, cybersecurity, and digital payment for small and medium businesses. Gartner is expecting Australia’s IT spend to grow 3.6%, reaching $95.8 billion in 2021. Spending on technology by utilities, government, education, and healthcare sectors remain unaffected by the pandemic. In a survey by Gartner, cybersecurity took centre stage ushered by increasing remote working trends. About 67% of respondents expressed increased investment in cybersecurity.
II. Investment theme and stocks under discussion (TPG, CNU, APX, MP1)
After understanding the sector, let us now look at four companies listed on the ASX. The price potential of the companies under discussion has been analysed based on the ‘EV/Sales’ method.
1. ASX: TPG (TPG Telecom Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$9.68 Billion)
TPG provides mobile and fixed broadband telecommunication services to residential, government, corporate enterprises, and wholesale market.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 22.42% on 13 May 2021. We believe that the stock might trade at a slight premium as compared to its peer average EV/Sales (NTM Trading multiple) given the accelerated 5G rollout plans with recent 400 and 600 MHZ fixed wireless 5G spectrum licenses covering major cities in Australia. TPG is expecting to kick-start 5G fixed wireless services in H1 FY21. For the said purposes, we have taken peers such as Macquarie Telecom Group Ltd. (ASX: MAQ), Telstra Corporation Ltd. (ASX: TLS), Vocus Group Ltd. (ASX: VOC), to name a few. Considering the merger synergies, strong progression in the 5G roll out, valuation, and trading levels, we give a “Buy” recommendation on the stock at the current market price of $5.160, down by 0.960% on 13 May 2021.
2. ASX: CNU (Chorus Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$2.63 Billion)
CNU operate as a fixed line communications infrastructure provider. The company owns majority of telephone lines and exchange equipment in New Zealand.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 21.57% on 13 May 2021. We believe that the stock might trade at a slight premium as compared to its peer average EV/Sales (NTM Trading multiple) given the upsurge in fibre broadband connection by 29,000 in Q3 FY21 with 1Gbps connection reached 17% of total connections. Fibre reached about 82% of total broadband connections. For the said purposes, we have taken peers such as Macquarie Telecom Group Ltd. (ASX: MAQ), Uniti Group Ltd. (ASX: UWL), Superloop Ltd. (ASX: SLC), to name a few. The stock has delivered an annualized dividend of 3.91%. Considering the fibre roll out plans, elevated projections, dividend forecasts, we give a “Buy” recommendation on the stock at the current market price of $5.790, down by 1.698% on 13 May 2021.
3. ASX: APX (Appen Limited)
(Recommendation: Buy, Potential Upside: Low Double-Digit, Mcap: A$1.39 Billion)
APX is Australian technology company providing solutions to improve data management through machine learning and artificial intelligence.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 20.97% on 13 May 2021. We believe that the stock might trade at some discount as compared to its peer median EV/Sales (NTM Trading multiple) as the pandemic saw a freeze in budgetary spend by corporates which may hamper new order flows. The company’s Speech & Image revenues may continue to be affected by project deferrals and reprioritization of projects. For the said purposes, we have taken peers such as rhipe Ltd. (ASX: RHP), NEXTDC Ltd. (ASX: NXT), EML Payments Ltd. (ASX: EML), to name a few. The stock has delivered an annualized dividend of 0.90%. Considering the traction in sales, healthy customer addition, profitability projections, we give a “Buy” recommendation on the stock at the current market price of $11.110, down by 1.682% on 13 May 2021.
4. ASX: MP1 (Megaport Limited)
(Recommendation: Hold, Potential Upside: Low Double-Digit, Mcap: A$2.07 Billion)
MP1 is a software company providing a platform for secure and on-demand connections between enterprises, networks, and services.
Valuation
Our illustrative valuation model suggests that stock has a potential upside of 16.70% on 13 May 2021. We believe that the stock might trade at some discount as compared to its peer median EV/Sales (NTM Trading multiple) due to series of historical losses with negative EBITDA. Besides, the scalability is low when compared to peer companies in cloud operations. For the said purposes, we have taken peers such as NEXTDC Ltd. (ASX: NXT), Afterpay Ltd. (ASX: APT), Firstwave Cloud Technology Ltd. (ASX: FCT), to name a few. Considering the growth strategies for cloud platform, accelerated customer base, solid cash balance, we give a “Hold” recommendation on the stock at the current market price of $13.110, down by 1.355% on 13 May 2021.
Note: All the recommendations and the calculations are based on the closing price of 13 May 2021. The financial information has been retrieved from the respective company’s website and Refinitiv (Thomson Reuters).
Investment decision should be made depending on the investors’ appetite on upside potential, risks, holding duration, and any previous holdings. Investors can consider exiting from the stock if the Target Price mentioned as per the Valuation has been achieved and subject to the factors discussed above.
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