LONDON (Reuters Breakingviews) - TalkTalk’s focus on cheap may not be cheerful. The UK broadband provider’s founder and largest shareholder Charles Dunstone wants to grow the business by focusing on value for money. That’s risky in a competitive market, and endangers profitability. The alternative – finding a buyer – could be tricky given the company’s rich valuation.
Dunstone’s growth-at-all-costs plan is bold but is arguably the only option for the 1.8 billion pound telecoms operator after losing a net 49,000 broadband customers in the full year ending March 31 2017. Low margins, intense competition and a recent dividend cut mean there’s little else to tempt investors. Markets are giving Dunstone some credit for this, with TalkTalk’s forward price-earnings ratio rising from around 13 at the start of May to more than 15 now.
Growing amid increasing competitive pressures, however, could prove an impossible task. Peers such as BT offer their own low-cost brands like Plusnet, and TalkTalk’s price-sensitive customers could be lured away if rivals offer similarly pitched packages. A recent survey of broadband customers by Berenberg analysts ranked TalkTalk ninth out of nine providers, scoring it poorly for risk of subscriber loss, network quality, customer service and endorsements.
Dunstone has so far opted for greater pricing certainty for customers rather than an outright cut, but even on this strategy the EBITDA margin looks set to suffer. Analysts polled by Reuters expect it to fall to 15.4 percent next year from 17 percent, partly because of a step-up in efforts to win subscribers.
As a backup plan, TalkTalk could seek a buyer, although that looks difficult at the current price. Add in TalkTalk’s 782 million pounds of net debt and the purchase price would be 2.6 billion pounds. Even without a takeover premium, that values each TalkTalk customer at 660 pounds, which seems hard to justify given high churn rates.
Even if a buyer found cost savings equal to half of TalkTalk’s forecast 2018 operating profit, the return on investment would be below 7 percent, according to Breakingviews calculations assuming a 20 percent tax rate. Dunstone’s broadband may be good value for money; his company currently isn’t.
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