Telecom plus today put tech stock mania firmly behind it as its shares soared to an all-time high. The discount telecoms, gas and electricity provider more than met expectations for the year to March. The shares may, however, be due a breather after a giddying run, argues Magnus Grimond.

It will come as no surprise to those new to Telcom plus that shares in this "virtual" supplier of telephone, gas and electricity services hit a low of 64.5p in the autumn of 2001. The technology bubble had just burst and few needed to look beyond the company's name to see that this was just another telecoms failure in the making.

Anyone who had taken the trouble to look a little further would have seen that this was a very different animal than the blue sky no-hopers that populated the stock market at the turn of the millennium. Indeed, by not splurging millions sinking pointless cables into streets up and down the country, Telecom plus has made a virtue of its "virtuality". Without the burden of lighting its own "dark fibres", the company is able to take advantage of the rock bottom prices generated by the huge surplus of telecoms and, to a lesser extent, electricity capacity in the UK.

By allowing its customers to take advantage of this surplus, it claims to be able to offer some of the lowest-priced telecoms and the lowest-priced electricity and gas in Britain. And because chief executive Charles Wigoder has already made one fortune in a similar business - founding and selling Peoples Phone to Vodafone for £77m - he knows the value of software.

This means that Widgoder and the team he took over to Telecom plus from Peoples Phone in 1998 have sliced costs to the bone by running all the company's operations on one system. This allows functions like billing and customer service to be combined however many services a customer takes. This is not the case, says Wigoder, at Centrica, a major rival. Here brands like British Gas, British Gas Electricity and One.Tel duplicate overheads with each service offered.

The third unusual feature of Telecom plus is the way it sells its wares. Unlike Peoples Phone, there is no chain of shops, rather a team of 10,000 independent "distributors" earn commission selling the company's products. This may be just a housewife telling her friends up to a few who make being a salesman for Telecom plus into a full-time job from which they can earn thousands of pounds a month.

And the results speak for themselves. Losses reduced steadily as turnover ratcheted up in the company's early years. The 12 months to March 2001 saw maiden profits of £2.51m on turnover of £28.1m - 21 times the level of just three years before. Inevitably, that level of growth could not be maintained, but the group has still been able to announce a phenomenal 78% rise in 2002-2003 turnover to £58m today. That was good for a 38% rise in pre-tax profits to £5.59m, feeding through to basic earnings per share up 26% at 6.8p.

One final unusual attribute of Telecom plus, particularly stark on the day that Cable & Wireless has announced it is abandoning any payment to shareholders for a year, is that this is one telecoms group that pays a substantial dividend. At 5.75p, the total tally for the last 12 months was ahead of expectations and represents a 28% improvement on the year before.

The main beneficiary of this largesse will be Wigoder himself, who is the largest shareholder with a 28% stake. Another investor who will be celebrating is Nigel Wray, the celebrated company backer and share dealer, who has 4.8%.

According to Wigoder, organic growth has rarely been higher. The subscriber base is up 40% on the year to 134,000, well ahead of the half-year forecast and a "significant improvement" on the previous year. Then the company was still running with a telecoms-only service for the first six months. Now around half the customer base also takes a second service from Telecom plus, mostly mobile telephony, but around 15% buy gas or electricity.

The increasing contribution from these lower margin services, plus the maiden contribution from Telecommunications Management (TML), acquired during the year, served to dilute returns on sales. Gross margins dropped from 37.4% to 31.5%, but Wigoder points out that people tend to spend double the amount on either gas or electricity that they do on using the telephone. Thus the absolute annual contribution from an individual customer may still end up being similar.

In the mean time, the growing economies of scale being created by Telecom plus were reflected in operating margins which remained broadly flat at 11.2% during the last year.

Working capital remains reasonable for a fast-growing company. With few fixed assets, there is little depreciation, so operating cash flow is roughly eqivalent to operating profit. Debtors have risen, but this reflects the business customers that came aboard with TML, which tend to be tardier in paying bills. Net cash fell by £3.67m to £5.68m, less than the £5.6m cost of the TML acquisition and another investment.

The company's broker, KBC Peel Hunt, has substantially jacked up its forecasts in the light of these figures. It is now looking for £8.6m before tax, followed by £10.8m, feeding through to earnings per share of 9.6p and 12.1p. That puts Telecom plus on a rolling forward multiple of 21, with the shares jumping 11p to an all-time high of 215p today.

Originally tipped at 117.5p in our subscription-only Hemscott Analyst e-mail newsletter, we were perhaps a little premature selling the shares at 193.5p last month. On fundamental grounds, they look a tad undervalued, but may be due a breather after such a good run. Hold.

Share prices can go down as well as up. The past is not necessarily a guide to future performance and the marketability of some shares can make them difficult to sell.

posted by Jeremy Tromans at 6/04/2003 11:48:00 PM