Telcos: Thinking outside of the box

This week, as a follow up to a recent telco article, Guy Carson takes a look at Inabox.

Recently we wrote an article looking at the Telecommunications industry in Australia. Our main premise was the introduction of TPG Telecom into the mobile space would cause problems for the existing players and lead to lower margins across the industry. We received a lot of feedback on that article and the most interesting aspect was the amount of readers who had started to move on from the large Telcos and look elsewhere for cheaper alternatives. As a result of this, our belief that the smaller players will continue to rise has been strengthened. These players are typically large non-Telco companies that wish to cross-sell to existing customers and it creates an interesting dynamic in this market. Access to customers is a crucial element that these new competitors have over the incumbents and could lead to a substantial shift in consumer behaviour.

One company that will potentially benefit from this trend is Inabox (IAB.ASX). Whilst the company only has a market cap of $20m, it has a surprising amount going on under the service. The core competency of the business is its Telco-in-a-box platform. This platform allows anyone to become a Telco reseller and they currently have approximately 450 out of the current 1,200 National Broadband Network providers as customers. This means they are exposed firstly to new entrants wanting to setup a Telco capability, and secondly to the growth in subscribers amongst those non-mainstream brands. They also have exposure to the top end of town, as their platform is used by Belong which is Telstra’s low cost brand.
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One of the keys for the company is their ability to white label a Telco offering. This means they can partner with non-Telco retailers to enable them to provide these services. The potential here is large. When we look experience offshore we find that retailers have had significant success. For example in the UK, Tesco is now the 2nd biggest Telco provider. The possibility here is that Woolworths, Coles, Aldi and other major retailers can use a platform such as this to add an additional revenue stream from existing customers and capture more of their wallet. The nature of the Telco market hence has the potential to change dramatically over the coming years. Whilst Inabox has a number of strong and significant clients already, the announcement of a blue chip retail client could be a real turning point for the company and its profile.

Source: Company filings

Inabox is largely unknown at the moment and their financials appear messy at first glance. They have been consistently profitable since listing but despite that they have struggled to gain any significant momentum. The acquisition of Hostworks this year could potentially change that. Hostworks was acquired for $7m from Broadcast Australia, who paid $69m for the same business back in 2008. The acquisition adds a cloud services capability to the business in addition to its Telco operations; as a result the company is able to service firms across the entire spectrum of communications and technology. When we add in the runrate EBITDA of the acquisition to the Inabox business we can expect a meaningful step-up in FY18.

The acquisition though did bring some one-off costs and as a result EBITDA and NPAT fell this year. Stripping out those costs, underlying EBITDA rose to $6.1m on flat revenues as low margin operations were exited. As mentioned above, the full year contribution from Hostworks is set to boost this number further in FY18. The company has spent a significant amount of capital building out its platform capabilities and potentially has one more year of circa $4m spend ahead of it. Post this spend a majority of the EBITDA will fall to the bottom line, after some tax of course. Recent guidance is for $100m revenue in the next year, up from $90.1m this year. If EBITDA margins are maintained (and in fact we believe there is the potential that they expand), the company will achieve EBITDA in the order of $6.8m. With a current market capitalisation of $20.1m, the shares are currently trading on a very undemanding multiple. 
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It must be pointed out that this is a very small company with a little bit of debt so an investment is certainly not without risk. However, given the nature of their platform and the fact that 76% of their revenue is recurring we believe the company is significantly less risky than most other microcap companies. In addition, it operates in the area of connectivity which is a growing sector and has structural tailwinds that should support it over the coming years. Whilst it may not be our largest position, we believe it is worthy investment for part of our capital.