The Isle of Man may be a small island in the Irish Sea, but it is a self-governing British Crown Dependency with its own government and upper and lower houses. Contrary to what many people mistakenly believe, it is not part of the United Kingdom and is not a member of the European Union or European Economic Area. That is unlikely to change as the island is doing rather well on its own which is very good news for Manx Telecom.
Cash flow to fund bumper dividends
There were three key points I noted at the time of the flotation: the company’s dividend policy; cash generation; and above average growth prospects given the robust economic growth of the Isle of Mann.
Firstly, Manx Telecom’s board intend to declare a dividend of 10p a share in the current financial year based on a 7 per cent dividend yield on February’s 142p float price. That dividend will cost £11m to fund, a sum easily covered by last year’s free cash flow of £16m. As one would expect from a telecoms company, cash generation is pretty robust with cash inflow from operations just over £28m last year, or 103 per cent of cash profits of £27.4m. In turn, this allowed the company to invest almost £10m in capital expenditure as well as paying £2.7m into the group pension scheme.
The difference between last year’s cash profits of £27.4m and operating profit of £18.1m is the non-cash depreciation charge of £9.2m and a tiny amortisation charge for intangibles of £137,000. So in effect, the bumper cash generation is enabling the board of Manx to make capital investments in-line with the depreciation charge. It also means that there is ample cashflow left over to fund that chunky dividend payment even though cover is slim at 1.2 times based on 2014 forecast EPS of 11.9p. In my view, a prospective yield of 6 per cent is not only attractive, but there is every reason to expect the board to be able to adopt a progressive dividend policy too. That’s because Manx Telecom looks well set for the future.
Understand the business drivers
As the only operator of a fixed-line copper network providing local access on the Island, the company is in a strong position, serving almost all of the existing available residential and business customers for fixed line, and providing a substantial proportion of the Island's existing available customers with broadband and mobile services. In terms of the revenue split, fixed-line services account for 40 per cent of Manx Telecom’s annual turnover of £76m, mobile contributes around 25 per cent, data centres just under 9 per cent, and the off-island business around 18 per cent.
Off-Island primarily relates to the mobile technology platform, enabling wholesale and corporate customers to offer a variety of mobile products using Manx Telecom SIMs. There are six key areas including wholesale text messaging, strongest signal roaming, inbound services, wholesale voice termination, a service management platform, and UK Mobile Virtual Network Enabler (MVNE) which is sold via wholesale partners who offer low cost roaming for international travellers via distributors.
It’s a valuable source of revenue too as the Off-Island business posted 26 per cent growth in 2013 buoyed by an accelerated development of the product range. For instance, Manx Telecom has developed technologies that allow both wireless and wired systems to communicate with other devices. Examples here include vehicle tracking, alarms and metering.
Data centres are likely to prove another significant revenue generator for Manx Telecom in the years ahead as the company makes its move into the small and medium enterprises market with the provision of Cloud services. The provision of additional data centre facilities this year should underpin growth in this area. The aim is to target high value managed service contracts and aim to be the Island's leading, quality data centre operation.
For instance, Manx Telecom’s new Greenhill data centre opened at the end of March at a cost of £3.5m to add to capacity offered by its existing facilities in Douglas North and Douglas Central. Greenhill added 100 racks of storage space to take the total storage space to 385 racks. Phases two and three, which are due for completion in 2015 and 2016, will add a further 120 and 320 racks and cost £1.5m and £5m respectively, making Greenhill the biggest data centre on the Island in terms of rack space.
There are opportunities in the mobile business too by targeting growth in the high value post-paid customer base and by leveraging off the mobile launch of a 4G network this summer to boost mobile data traffic.
Affluent customer base
Importantly, Manx Telecom operates in a growing, relatively affluent, local market, with a population of approximately 85,000 people. In fact, the Isle of Man has seen 29 years of unbroken economic growth, including throughout the last recession, and has posted average annual growth in GDP of 6 per cent over the past decade. It has a high GDP per capita (21 per cent higher than the UK) and low unemployment levels of just 2.4 per cent. Financial services accounted for 35 per cent of GDP in 2011/12 which helps explains why GDP per capita was almost £45,000 that fiscal year.
So the combination of a strong market position delivering high quality services into a growing and resilient market place should underpin Manx Telecom’s prospects and profits in the years ahead. And unlike its listed rivals, the company also benefits from a zero per cent corporate tax rate (applies to the vast majority of Manx Telecom's businesses) which means it currently pays no corporation tax on both on and off-Island profits. That should ensure more cash is returned to shareholders through dividends.
Funded for growth
At the time of the flotation in February, the company entered a new £80m banking facility with a consortium of banks which matures in June 2018. Of this sum, £70m was drawn down and when netted off against cash on the balance sheet net borrowings were £65m, or around 72 per cent of pro-forma shareholders funds. So with shares currently trading on a bid-offer spread of 161p to 164p, the company has a market value of £183m and an enterprise value of around £250m. That’s a very reasonable nine times annual cash profits.
Add to that an enticing 6 per cent dividend yield, and promising growth prospects in the off-island, mobile and data centre businesses, and I feel Manx Telecom's shares are worth buying now before investors cotton onto this Irish Sea gem. My year-end target price is 210p based on an enterprise value to cash profits multiple of 11 times.
Finally, I have published seven other articles so far this week all of which can be viewed on my home page. I am currently working my way through a list of companies on my watchlist including: Inland (INL), API (API), Taylor Wimpey (TW.), Barratt Developments (BDEV) and Bovis (BVS).
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