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Saturday, July 14, 2007

Tiscali and Pipex: A Bleak Future

I am not surprised that Tiscali has bought the broadband and voice division of Pipex, but I am extremely surprised at the price - £210m. Tiscali annonced the acquisition yesterday, (3 page pdf) along with a new debt facility of €650m. I consider this a huge premium basically for a business which has at best stalled and needs a lot of work to integrate into Tiscali existing business.

In 2005, the Pipex division had a turnover of £76.5m, in 2006 this had grew to £231.8m and Tiscali forecast that the standalone business would have a £300m turnover in 2007 with £20m EBITDA. This looks quite healthy apart from the fact that nearly all of the growth comes from the big three acquisitions in 2006 of Homecall (Mar), Bulldog (Sept) and Toucan (Oct). It has not been divulged how much of the growth in 2007 is from the effect of full year contribution from these businesses.

In its 2006 Annual Reports, Pipex reported 570k broadband customers; in the Tiscali press release they revealed they had acquired 570k broadband customers. In other words, there has been no net growth in the first six months of 2007 in a market that is still exhibiting good growth rates – Pipex has been losing market share. We could do a similar calculation on the voice base, but the figures are even more opaque.

Even worse is the effort required to integrate the Pipex base onto the Tiscali network and back office systems. Mary Turner, the Tiscali Uk head honcho claims:
Over a four-year period, we estimate cumulated synergies in the region of £150 million at EBITDA level ca £50 million to secure the synergies and efficiencies.
Personally, I think £50m is slightly optimistic and also certainly doesn’t include the porting cost of moving the customers onto Tiscali’s ULL network. There is a huge integration risk and churn point for the Pipex base. Even the normally indefatigable Charles Dunstone of Carphone Warehouse described the potential acquisition of Pipex as a step too far in terms of integration effort.

Tiscali itself seems to be slowing down in its organic growth. Tiscali reported its customer numbers of 1.54m at the end of Q2 compared to 1.48m at the end of Q1 and 1.42m at the end of 2006. This is despite offering some of the most aggressive prices on the market for double play unbundled customers. Either nobody is taking up the offer or Tiscali is experiencing a lot of churn on its legacy base, neither of which is a good sign for Tiscali. In terms of the unbundled base, Tiscali is reporting 500k compared to 437k a quarter ago or about 10% of the net adds and only 32% of the total base. Tiscali currently has 800 exchanges unbundled and is targeting 1,000 in total.

In the 1H07 Tiscali UK revenues stood at EUR 253 million, + 23% YoY. EBITDA stood at
EUR 36 million (14% of revenues), +21% YoY. The equivalent revenue growth rate in 2006 was 39%. In 1H2006 Tiscali added 266k ADSL customers wheras in 1H2007 the growth rate is around 120k.

I think this slowdown in the Tiscali growth rate is the real rationale for the deal. I cannot see in the short term the competitive threat lessening and I can’t figure any “unique selling point” for the Tiscali services compared to the competition. BT and Sky are going to prove formidable competitors with strong brands and a decent reputation. I suspect that Carphone/TalkTalk will never be beaten on price. All this is before the scale and cost advantages of Virgin Media.

The future looks bleak for Tiscali UK. The only real hope for Tiscali investors is that LLU Company valuations will increase in the future as they become scarcer.