Macquarie Telecom (MAQ) is a company that jumps off the page across a whole host of attributes we look for. Despite a sustained rally that has seen its share price triple in just 3 years, we believe there is still opportunity in MAQ – it remains a prominent holding within the Clime Smaller Companies Fund (CSCF).
We’ll get into these attributes in a moment, however we ought to start with the company’s somewhat outdated name as a descriptor.
The business was founded in 1992 by brothers David and Aidan Tudehope, who are CEO and Managing Director respectively, and listed in 1999. MAQ initially focused on providing telecom services (data, voice, mobile and colocation) to government and medium to large enterprises.
Between 2001 and 2013 MAQ established three data centres, including two in Sydney and one in Canberra, to support Hosting operations (provided by Macquarie Cloud and Macquarie Government divisions). Benefiting from the the trend of businesses moving IT resources offsite, Hosting has become MAQ’s primary earnings driver, contributing around two thirds of Group earnings before tax, depreciation and amortisation (EBITDA) and a higher share of incremental growth.
So, despite the ‘Telecom’ in its name, it is more accurate to associate MAQ with hybrid cloud services than telecommunications.
In terms of investment attributes, MAQ screens well across value, balance sheet capacity, management quality and alignment, as well as growth prospects.
Starting with value, at first glance MAQ is interesting because its $362m enterprise value is only 11 times owner earnings of $33m (EBITDA less maintenance capex), or around 15 times adjusted for tax. This implies an option over returns on growth capex, which MAQ splits between Customer Growth capex (provisioning customers with equipment and systems within existing datacentres) and Growth capex (mainly extensions to datacentre capacity). MAQ historically generated strong returns on capex of approximately 30%.
 

Figure 1. MAQ FY18 EBITDA and capex guidance
Source: MAQ 1H18 presentation
 
In the near-term MAQ plans to increase the capacity of its three datacentres by 17% from 12.5MW to 14.5MW. In addition to this, subject to demand, MAQ is set to announce a decision on whether to build or buy a fourth datacentre.
We believe MAQ’s team led by the Tudehope’s is first class, which is reflected in MAQ’s industry leading Net Promoter Score of +66, which represents ‘excellent’ customer loyalty, and position within the hosting market as a specialist in cyber security and customised hybrid cloud.
Although the Telecom’s division faces strong competition and likely (gradual) price deflation, we believe MAQ should hold share and divisional earnings. Most recently, the Macquarie Telecom division was first-to-market with SD WAN (software defined wide area network) capability, which should significantly improve service to corporates – particularly in the area of unified communications.
Macquarie Hosting is the primary provider of cyber security and secure cloud and colocation to the Australian government with 42% of government agencies contracted. The company also designed and delivered the Lead Agency Secure Internet Gateway, which protects government departments from cyber threats.
Of course, the profitability of future additions to datacentre capacity is dependent on industry supply and demand. On the demand side, increasing bandwidth is a long-term tailwind. However, over 100 datacentres in Australia currently supply the market. We are confident in MAQ’s long-term profitability due to its differentiated offering and as well as the fact that David and Aidan Tudehope collectively own 61% of the company. Given dividends are the Tudehope’s main income source, we believe strategic decisions will be tightly aligned with shareholder interests.
It’s also worth pointing out the criss-crossing trajectories of Telecom and Hosting divisional EBITDA. Previously, Hosting growth was masked by the decline of Telecoms earnings. This may in part explain why MAQ remains undervalued. However, as Hosting earnings growth more potently impacts the Group bottom line, we’ll likely see increasing interest from a wider group of investors.
 

Figure 2: Telcom and Hosting divisional EBITDA
Source: MAQ, Clime
 
As shown below, the current share price of $18.16 is a modest discount to our FY19 valuation of $19.26. Overall, we believe MAQ is undervalued relative to its long-term growth potential.
 

Figure 3: MAQ valuation summary
Source: StocksInValue
 
The Clime Group owns shares in MAQ for and on behalf of various mandates for which it acts as investment manager.