The ambitious $1.6 billion takeover offer for iiNet launched by M2 Group is a superior offer to TPG Telecom's original proposal, say fund managers, but the battle for the Perth-based internet service provider is far from over.
On Monday, M2 launched a competing offer against TPG's $8.60 per share all-cash bid, in an attempt to acquire what investors and analysts have labelled one of the last prized assets in the telecommunications sector.
Under M2's proposal, iiNet shareholders would receive 0.803 of an M2 share per iiNet share, as well as 75¢ per share by way of a special dividend.
Details surrounding the offer are still being negotiated and the iiNet board of directors has not yet come to a decision on whether it believes the M2 offer is superior.
Should it recommend M2's offer, iiNet is required to inform TPG who will have three days to match, or better, the bid.
On Tuesday, M2 was forced to clarify the value of its offer, after some confusion surrounding its $11.37 per share headline valuation, which included $1.37 per share value of estimated synergies in the proposed new entity.
"Whilst that value was determined based on considerable work undertaken by M2, M2 recognises that there may be differing views on the appropriate value to be ascribed to such synergies and risks in achieving such synergies," M2 said in a statement to the Australia Securities Exchange.
"In assessing M2's Competing Proposal, the iiNet board will ultimately need to form its own view on the estimated value of synergies."
The implied value of M2's bid is $10 per share.
Beulah Capital chief investment officer Peter Mavromatis, who holds iiNet in his takeover fund, said that in his view the M2 bid was an improved offer.
"Overall, we think it's a superior bid to the initial TPG cash bid. We're interested to see what TPG's response is going to be and we're also going to be interested to see if Optus comes into the fray," Mr Mavromatis said.
"Because this is probably the last really important asset in the sector, I suspect there will be more interest."
BT Investment Management's head of smaller companies Paul Hannan said the winner of the battle for iiNet would be catapulted into a clear no. 2 position. BT holds more than 5 per cent of iiNet.
"I'm not surprised there is a competing offer. These are strategic assets; that's the one thing we've been pointing out – this is probably the last significant player in the broadband space," Mr Hannan said.
"The market is telling you it is a superior offer. Anything that gets a better outcome for our unit holders we're happy with."
"I don't think this game is over yet. TPG has everything to lose. They realise what's at stake here."
M2 chief executive Geoff Horth said that some of the concerns expressed by iiNet shareholders about the TPG bid factored into the competing bid.
Around 14 per cent of shareholders expressed disappointment in the $1.4 billion TPG valuation and offer and indicated they may not vote in favour of it.
One of the leading figures against the TPG has been iiNet founder and former chief executive Michael Malone.
The negative reaction from shareholders was driven by the fact that there is fundamental value in getting scrip, Mr Horth said.
"That includes the CGT rollover relieved, it includes the opportunity to share in synergies, and obviously to just keep money invested in the sector – it's a very well regarded sector and this would be a pretty big business in that sector," he said.
"There were a couple of shareholders who made it pretty obvious that they would be interested in a scrip offer and that, to some extent, encouraged us to enter the fray."
It is possible that there will be a bidding war, Morgans analyst Nick Harris said.
"iiNet's key assets are a strong brand, strong net promoter score and 16 per cent share of the household broadband market. These provide sticky customers and economics of scale, which create competitive advantage under the NBN," Mr Harris said.
"We rate M2 more favourable than TPG, both for iiNet shareholders and as an investment, but, given the potential for a bidding war, we think investors are best places owning iiNet in the short-term."
Credit Suisse analyst Bradley Clibborn said that an increased TPG offer at around $10.20 per share would only reduce earnings per share accretion from 21 per cent to 17 per cent.
"We assume the $8.60 per share cash offer remains and TPG adds around $1.60 scrip consideration into the deal. The certainty of consideration in a TPG offer of this nature would likely give iiNet directors sufficient certainty on value to recommend a revised TPG offer over the M2 proposal," Mr Clibborn said.
Mr Clibborn said he did not believe M2 could raise its bid for iiNet.
"We estimate M2's EPS accretion under the proposal of 7 per cent in year two and 9 per cent in year three," Mr Clibborn said.
"For M2 to add another $1 per share to its proposal this would alleviate around 5 per cent of our estimated EPS accretion, making the deal challenging for M2."
Deutsche Bank's Craig WongPan suggested that M2 could raise its cash offer by $1.60 per iiNet share above their initial competing bid.
"[This] would reduce the EPS accretion to 5 per cent and increase leverage to 3.0x. Therefore, we conclude there is potential for increased offers by both TPG and M2," Mr WongPan said.
TPG could increase its cash offer, but the more likely scenario would be offering scrip on top of the offer already on the table, Mr WongPan said.
"We calculate TPG would need to raise its initial cash offer by 26 per cent to provide a similar level of value as M2's current offer," he said.
"While the increased TPG offer is still EPS accretive, assuming $60 million of synergies, it would increase TPG's leverage ratio to 3.54x, which we believe would be above the company's comfort level."
