Description

Thesis

Amaysim is a mobile virtual network operator (MVNO) in Australia whose stock presents what I believe to be a special situation investment opportunity that could return 50% in a matter of months with minimal downside risk. Within the next 9 months, amaysim will either a) be acquired or b) continue operating independently with significantly improved economics as a result of an upcoming contract renegotiation with its mobile network operator (MNO) partner. The opportunity largely exists because of the small size of the company and the significant competition in the Australian mobile sector.

History and management

Amaysim was founded in 2010 by Peter O’Connell, Rolf Hansen, Thomas Enge, Christian Magel, and Andreas Perreiter. The latter four were already experienced in the business, having originally launched Simyo in 2005, a company that pioneered the online MVNO business model in Germany. In 2007, Simyo was sold to E-Plus, a subsidiary of KPN that later became Telefonica. Along with Peter O’Connell (the current CEO), the four believed that Australia, like Germany, presented an attractive opportunity for a new low-cost entrant in the form of an MVNO.

MVNOs do not own the wireless infrastructure but instead purchase access to spectrum from MNOs and resell it to their own customers while typically performing their own marketing, billing, and customer care. In the US, the analogy would be Verizon/ATT/T-Mobile/Sprint as the MNOs and MetroPCS/Boost Mobile as the MVNOs.

Amaysim performed very well in its initial years by operating a low-cost, customer-friendly online model that did not require long-term contracts – in contrast to the existing MNOs. Customers could bring their own device (BYO) and sign up for a low-cost monthly plan with amaysim on the Optus network (a Singtel subsidiary). Until the IPO in 2015, customer numbers and average revenue per user (ARPU) increased consistently, and amaysim’s market cap achieved a peak value of $560 million (AUD).

Shortly after the IPO, the company’s difficulties began to surface. The mobile market became incredibly competitive, as not only MVNOs but also the MNOs themselves introduced low-priced plans (in particular Telstra with their Belong brand). The vicious competition resulted in ARPU declines falling directly to the bottom line and inevitably a horrendous stock price performance for amaysim as the stock declined 90% from its peak in 2015 through March when COVID-19 hit.

In 2016 and 2017 respectively, the company diversified into reselling broadband and energy. However, these services lacked the scale that the company had in its mobile division and were later divested – broadband in 2018 and energy in August 2020. Today, the company is back to its roots purely in mobile.

In 2018, co-founder Peter O’Connell (approximate age 67) – who had been on the board – rejoined the company as CEO.

Market

Australia has a population of nearly 25 million people and approximately 36 million mobile services in operation (SIOs) (1.4 per person).

Telstra has around 45% market share of the market, followed by Optus (30%), and TPG Telecom (15%) – the merged entity of Vodafone Hutchinson and TPG. The remaining 10% is held by MVNOs, of which amaysim holds around 3% (percentage points) and therefore has a leading 30% market share among MVNOs.

Special situation

Last week, amaysim announced the divestiture of its energy division, Click Energy, for $115 million in cash. Amaysim originally acquired Click for $120 million in 2017 and generated approximately $60m of FCF during the time it was held. The recently announced sale was a good result given the regulatory uncertainty in the industry as well as the increase in bad debt as a result of COVID-19.

Most importantly, the company has once again become simplified and is back to its roots as a pure MVNO. While this is a mediocre business at best, I believe that the current share price does not account for a large value creation event that will occur within a matter of months.

As an MVNO, amaysim purchases capacity from Optus, which it markets, re-sells, and services for its own customers. The benefit for Optus is that it generates a high margin (90-100%) revenue stream by selling off excess capacity available on its network, while the benefit for amaysim is that it buys capacity at wholesale prices and sells it at retail prices.

Amaysim’s current network services agreement (NSA) with Optus expires in June 2022, which will be the event that crystallizes the value of the amaysim business. Although the expiration is not for another 22 months, amaysim has already begun tendering this contract with the aim of a conclusion by June 2021. Practically, the result will likely manifest itself in the coming months as management has just sold the energy business (the only other division) during a strategic review.

Why is this contract so important? In its annual year ended March 31, 2020, Optus generated around $1bn (AUD) of FCF, of which close to $100m came from amaysim. This payment represents around 85% of amaysim’s cost of sales and has very little associated cost for Optus. After all, Optus is merely granting access to its unused spectrum to amaysim (for which the majority of the capex is already sunk and requires little human support).

As amaysim approaches the re-contracting event, the company has invested aggressively in growth – both organic and via M&A – to maximize its leverage in the negotiation with Optus. I believe that the following are the possible scenarios over the coming months:

1)      Sale of amaysim

a.     Optus: Optus likely enjoys the status quo, but the status quo may be disrupted if a rival makes an outright bid to acquire amaysim or offers amaysim a more attractive NSA. Optus has the most to lose from losing amaysim as an MVNO partner given that it would lose >10% of its customers and not only forgo the ~$100m of FCF it receives annually from amaysim, but also that one of its competitors would begin to receive this cash flow (hence creating a $200m shift in cash flows to the benefit of the competitor). If Optus were to acquire amaysim, its annual earnings would reflect amaysim’s existing FCF + the COGS amaysim pays to Optus (as Optus wouldn’t need to pay itself for access to its own network). The FCF already factors in the marketing investment required from amaysim to at least maintain its subscriber base (which is actually growing by >10% per year). Combining the FCF and COGS to Optus results in ~120m, and it is up to Optus how valuable that income stream is to it. Should it pay 2x, 3x, or 4x that amount to acquire amaysim, avoid the loss of the income stream, and prevent its competitors from accessing the income stream? The math Optus will do likely compares this payback period to the customer acquisition cost and payback period of organic growth as well as the time required to acquire ~1 million subscribers.

b.     TPG Telecom: TPG is the result of a merger between TPG and Vodafone Hutchison, which recently received approval from the Australian Competition and Consumer Commission (ACCC). The company has the third largest market share in the mobile market and may be eager to acquire amaysim to increase its subscriber numbers. If it were to acquire amaysim, just as in the Optus acquisition scenario, TPG would not have to pay the COGS to itself to run on its network, and therefore its earnings from the acquisition would be close to amaysim’s FCF + the COGS amaysim is paying to Optus. However, there would be some churn as some subscribers would not be happy moving from the Optus network to the TPG network, so a haircut to the overall figures should be assumed; accordingly, TPG likely cannot pay as high a price as Optus. Nevertheless, TPG would love to generate a significant earnings stream while depriving Optus of the same.

c.     Vocus, et al.: A player like Vocus which may have previously had ambitions to acquire amaysim in order to increase its MVNO strength could be a potential acquirer. Vocus also utilizes the Optus network and a transition could be seamless. By increasing its subscriber base, Vocus could improve its network services agreement (NSA) with Optus and generate higher margins. It is unlikely the company could pay as high a price as Optus or TPG, however. There could also be interest from energy players although that may be less likely given the recent sale of the energy division to AGL that did not include the mobile division (an energy company could not pay as high a price as a mobile player).

d.     Private equity: private equity firms might be attracted to the low-cost mobile operator with significant cash on its balance sheet and a bloated cost structure. They will not be able to bid as high as a strategic player, however.

2)      NSA re-negotiation

a.     Optus: in lieu of a sale to Optus, amaysim could re-negotiate the NSA. There have been two previous re-negotiations to the original 2010 NSA, the first in 2014 and the second in 2019; as a result of the latter, amaysim’s gross margins increased from 30%+ to 40%. Assuming the mobile market remains rational, an increasing subscriber base along with improved terms would result in materially higher profitability for the company.

b.     Telstra or TPG: it is unlikely that Telstra could outright purchase amaysim given that it is already the largest player in the market and anti-trust considerations may come into play. In lieu of an acquisition, Telstra could tender for the amaysim contract. In fact, amaysim nearly departed Optus for a Telstra agreement during the 2014 NSA renegotiation, but ultimately received an improved offer from Optus and continued the partnership. A renegotiation of the NSA could result in materially improved economics for amaysim, whether it comes from Telstra or TPG – both of whom would love to deprive their rival of 100m of annual FCF while generating a similar amount.

3)      Status quo: it is possible that neither scenario (acquisition or NSA renegotiation) occurs but this is highly unlikely as explained below. In such a case though, amaysim would reduce opex significantly (among other expenses, management costs and marketing are high for the company as it pursues growth in advance of the NSA contracting event).

I believe that a value crystallizing event is on the horizon for amaysim. The following reasons increase my confidence level:

1)      The Australian mobile market is mature as evidenced by the lack of growth in the MNO subscriber numbers; the only way to move the needle is via an acquisition, and the only material acquisition available is amaysim given its 1m subscribers

2)      Optus has a lot to lose by losing the NSA with amaysim, and TPG or Telstra have a lot to gain by winning it; this means there is more than 1 bidder at the table

3)      Amaysim has just sold its energy division after announcing a “review of strategic alternatives” and has returned to its original life as a pure mobile operator

4)      The company has announced the re-tendering of the NSA agreement with Optus (earlier than originally planned around Christmas 2020) and expects a resolution “in the near term” according to their latest release

5)      One of the five founders of the business (Peter O’Connell) re-joined the company in 2018 and was awarded 4m shares that vest based on the achievement of a board-approved minimum “cumulative underlying EBITDA” target to FY2021. O’Connell was formerly part of the formation of Optus and is now sitting on the opposite end of the table in the negotiation.

6)      The other three key management personnel (COO Isaac Ward, CFO Gareth Turner, and Head of Strategy Alex Feldman) have been granted 4.25 million shares that vest based on underlying EBITDA targets but also an increase in the recurring mobile subscriber base as well as a “strategic objective to unlock additional value from the mobile business through its wholesale arrangements”

7)      The company’s largest shareholder (Langfristige Investoren TGV) has board representation in a setup similar to its investment in another recurring revenue business - AlarmForce in Canada - where it was also the largest shareholder and had board representation. AlarmForce had a dominant Canadian business but prior management had led an expensive foray into America which negatively affected the company’s valuation. Under the purview of the German shareholders, the division was sold (similar here to energy) and the company was shortly thereafter acquired by Bell, a major Canadian telco.

8)      The company’s shareholder base and management are united in their quest for a sale or re-tendering of the NSA. All incentives are now aligned after shareholders voted against a previous management remuneration proposal (in Australia, two strikes and you’re out).

9)      The company is small and illiquid and therefore less likely to be efficiently valued outside of an event that crystallizes its value. Given management’s significant share awards, they are incentivized to achieve a proper valuation.

Valuation

The current valuation of amaysim is as follows (in AUD):

Share price: 0.75

Shares out: 295m

Market cap: 220m

LTIP plan: 19.4 (assuming targets achieved)

Treasury shares: 5.6 (purchased below 40 cents)

Diluted shares outstanding: 314m

Diluted market cap: 236m

Net cash (after Click sale): 83

EV: 153

Amaysim’s earnings currently appear to be minimal, but the company is investing to grow its subscriber base in order to maximize its strategic value over the upcoming months. If the company wished only to replace its churn (a little more than 2% per month), it could reduce marketing, much of the management overhead could be removed, and several other costs could be eliminated. FCF in such a scenario would likely be close to $15m, resulting in a valuation of 10x EV/earnings – a reasonable multiple for a mediocre business. If the next 9 months result not in a sale of the company but rather a re-negotiation of the NSA, amaysim would receive a greater portion of the cash flow that it generates for itself and Optus and the true multiple would be far lower. (Consider that five percentage points more gross margin would result in nearly 7m more FCF and the multiple would decline to 7x).

If amaysim is indeed acquired, the upside could be even higher. The EV of 153m is very similar to the annual earnings either Optus or TPG would generate by acquiring the company (~120m for Optus or ~100m for TPG as described above – existing FCF + COGS paid to Optus that would not need to be paid to the MNO itself). In other words, their payback periods of 1-1.5 years ought to imply a higher price for the business than the current EV (though exactly what price is difficult to predict).

Whether in a renegotiation of the NSA or an outright sale of the company, it appears amaysim will realize a value creation event in the very near future that is not currently priced into its shares.

The biggest risk is that one or more parties is uninterested in owning or partnering with amaysim, which will result in a lower valuation of the company as a result of decreased competition for the asset. I believe this is unlikely and that the upside/downside at these prices heavily favors the upside.

Catalyst

Sale of the company

Re-negotiation of the NSA