Spirit Telecom – ST1

The telco business model is one I like because it’s easy to understand.  Your network costs are semi-fixed – the only incremental costs are the connection cost and sometimes a small network extension to connect to the customer site (which is usually paid for as part of the connection fee)

 

The incremental profitability of new customers, once you have covered your current network cost, is therefore very high, so that once you break even, you should see significant profit growth, even if revenue is growing at a more moderate rate.

 

The introduction of NBN has hampered the profitability of most consumer internet providers, because most of the network is “off-net” (Leased from NBNCo), which levels the playing field but also limits the ability for service providers to achieve scale and better profitability.  Spirit generate most of their revenue from “on-net” services (as they operate their own infrastructure), increasing their profitability and allowing them to successfully compete against service providers who are using NBN infrastructure.

 

As of HY17, ST1’s gross margins are 61%.   They offer services up to 200/200Mbps, faster than NBN can provide, for $169 per month.  A 100/100Mbps option is also available for $96 per month, as well as several lower cost plans. The high margins are achievable because Spirit focus on high-rise apartments, which need a single physical link to service dozens of customers.  They also connect many sites using WiMax technology, which has a lower connection cost than fibre, but still provides an acceptable amount of bandwidth.

 

A case study which Spirit refer to is the Eureka Tower in South Melbourne, which was an NBN incumbent site before Spirit delivered connectivity in early 2017.  They now have over 100 customers connected in this building alone, and will repay their $70k capex within 11 months.

 

So, in effect, Spirit are delivering a double whammy of benefit – not only do they have a regular stream of high-quality revenue, but they have a reliable pipeline of high-density buildings they can deploy capital to connect, growing their revenue base and subsequent profits.

 

Current connected building penetration is around 18%, leaving huge upside if those customers coming out of contract decide to switch to Spirit.

 

The June 2017 quarterly cashflow report showed operating cashflow of $1m, good going for a $20M market cap organisation.  The share price has fallen over the last couple of days (last traded at 10.5c) but I intend to add to my position.  The company’s finances are now on a solid footing and they have plenty of upside as they connect more buildings and increase building penetration.

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