AE Portfolio Conservative Holding M2 Telecommunications Group Ltd (ASX: MTU, OTC: MTCZF) reported a 47 percent increase in fiscal 2013 first-half net profit after tax to AUD24.7 million, a surge largely attributable to the online and mobile phone service provider’s June 2012 acquisition of Primus Telecom Holdings Ltd.

When the Primus deal was first announced, in April 2012, M2 CEO Geoff Horth described it as potentially “transformational,” and that forecast has, at least to this point, proven to be on point. The deal also positioned M2 for the move to a new fiber access regime Down Under, with the broader technical and National Broadband Network (NBN) expertise provided by Primus.

When the NBN launches all telecommunication providers will be required to largely operate as “resellers” of broadband services, which is essentially the business model M2 operates now and clearly well understands.

In mid-March Mr. Horth announced a set of deals that he described as “significant” in terms of the scale it will allow M2 to achieve and “material” in terms of how it will impact shareholders: the AUD203.9 million acquisition of Dodo Australia Holdings Ltd on a debt-free and cash-free basis and the off-market takeover offer for Eftel Ltd at AUD0.3581 per share in cash or shares, implying a total enterprise value of AUD44.1 million, including AUD5.6 million of net debt.

Management expects the acquisitions to contribute in excess of AUD400 million of revenue and AUD50 million of earnings before interest, taxation, depreciation and amortization (EBITDA) in fiscal 2014.

Based on a median broker fiscal 2014 earnings per share (EPS) estimate of AUD0.41 for M2 and assuming the acquisitions contribute in excess of AUD50 million of EBITDA, Dodo and Eftel are expected to result in underlying fiscal 2014 EPS accretion of approximately 20 percent.

M2 will fund the acquisitions and refinance existing debt through a combination of new, fully underwritten three-year, AUD400 million loan facilities and the issue of approximately 19.2 million ordinary shares of M2 to Dodo and Eftel shareholders.

Upon completion of the acquisitions, M2 expects its pro forma leverage to be approximately 1.8 times, or net debt divided by forecast fiscal 2014 EBITDA.

The Dodo acquisition is expected to close in early May. On April 10 Eftel announced that its directors–among which are two who controlled 71 percent of Dodo–had accepted the “all shares” option in respect to the 88.5 percent of Eftel that they controlled. This effectively seals the deal, as at 90 percent of shares tendered M2’s offer becomes “compulsory” according to Australian securities law.

Neither Dodo nor Eftel is a capital-intensive business, and both generate significant cash, so the added debt should be very manageable and will likely be paid down in short order.

What this deal is about for M2, as Mr. Horth noted, is scale. With the acquisitions M2 is on track to generate more than AUD1 billion of revenue in fiscal 2014. That’ll make it the fourth-biggest telecom in Australia.

Scale–or building more of it–has been the defining factor for M2 over the past several years. In fiscal 2010 EBITDA margin was 7.7 percent. By fiscal 2012 that figure pushed out to 15.3 percent, and for the first half of fiscal 2013 it was 18 percent, all because M2 became a bigger business, with the ability to buy more network access at better rates and more efficiency through the consolidation of operations.

Additional revenue will only allow it to save more and squeeze out even better margins. M2 is “quite confident” it can see AUD42 million from Dodo and AUD8 million from Eftel of EBITDA in fiscal 2014.

Shareholders are clearly benefitting from the Primus deal, as M2 boosted its interim dividend, a 15.3 percent increase from AUD0.086732 for the first half of fiscal 2012 to AUD0.10 per share for the first half of fiscal 2013.

Management stated during its call with analysts to discuss the recent acquisitions that it intends to maintain its policy of paying out approximately 70 percent of net profit after tax to shareholders as dividends.

M2 reported in February that revenue for the six months ended Dec. 31, 2012, surged by 65 percent to AUD305.2 million, while EBITDA for the period was up 99 percent to AUD55.1 million. Earnings per share (EPS) were up 16 percent to AUD0.157, while underlying EPS grew by 32 percent to AUD0.20.

As of Dec. 31, 2012, M2 had cash on hand of AUD29.6 million, up from AUD16.7 million a year ago. Net debt declined to AUD116.2 million from AUD125.3 million as of June 30, 2012.

In its press release announcing the Dodo and Eftel deals management noted that on a stand-along basis and without reference to the acquisitions M2 “is on track to report underlying earnings at or above the midpoint of previously released earnings guidance.”

The nominal contribution to earnings in fiscal 2013 from Dodo and Eftel is expected to be more than offset by stamp-duty and other transaction costs incurred by M2 before the end of the financial year. As a result, pro forma for the acquisitions, M2 expects to report FY13 underlying earnings toward the lower end of its previous guidance range.

Guidance announced with first-half results in February was for full-year revenue of AUD610 million to AUD650 million versus AUD393.5 million in fiscal 2012. The midpoint-growth figure is 60 percent.

Management forecast EBITDA to expand by approximately 88 percent to AUD108 to AUD118 million and EBITDA margin to be 17.9 percent versus 15.3 percent in fiscal 2012.

NPAT and underlying NPAT are forecast to grow by 32 percent and 52 percent, respectively, while EPS and underlying EPS are on track to increase by 13 percent and 24 percent, respectively.

M2 plans capital expenditures in fiscal 2013 equal to 3 percent of revenue, a 131 percent increase over fiscal 2012. Free cash flow is forecast to surge by 53 percent over fiscal 2012 levels to AUD51 million to AUD56 million.

Dodo, in Mr. Horth’s words, is a company that’s been “flying below the radar” recently, not only because it’s not publicly listed. It’s also suffering a bit of a public relations problem, something Mr. Horth acknowledged during the company’s conference call to discuss the deal, having earned a “worst brand” label from one entity that tracks such things in Australia.

Mr. Horth noted too that part of M2’s due diligence included “secret shopper” exercises that revealed the customer service problems that plagued Dodo six years have been addressed and that the “worst brand” designation was likely a lingering effect of experiences that are part of its customers’ past.

Dodo, in fact, has seen significant growth over the last several years and now has more than 400,000 customers signed up for a total of more than 650,000 active services. About 150,000 are pre-paid.

Dodo offers services across the whole range of telecommunications products, including broadband, mobile, home phone and wireless broadband. During the last two years the company entered the power and gas business and also offers car, home and home-contents insurance.

These latter services were added as Dodo sought to leverage its marketing and customer service prowess to make it “a single point retailer of essential services to residential customers.” The company brings 45,000 power and gas customers to M2, which represents an “interesting” opportunity for M2.

Dodo’s power and gas business was launched in 2011, offering electricity mainly to residential customers in Victoria. Since then the business has expanded its electricity offering into New South Wales and Queensland and more recently has started offering gas to customers in Victoria. Dodo has obtained licenses to retail both electricity and gas in Victoria, New South Wales, Queensland, South Australia and the Australia Capital Territory.

Dodo offers its insurance product as an authorized representative of A&G Insurance Services and arranges the issue of policies on behalf of AGIS.

What’s intriguing to M2 is Dodo’s demonstrated ability to cross-sell telecommunication and energy products, as approximately 25 percent of Dodo’s current energy customers have also purchased a Dodo telecommunications service.

It’s a low-cost brand that will sit nicely alongside M2’s existing iPrimus brand and give it more “shelf space,” as it were, for a wider range of consumers seeking telecommunications services. In other words, Dodo will help M2 build market share.

Dodo also brings well-developed, low-cost customer service and network support operations and associated systems and technologies on the telecom side. It also brings established capability, systems, licenses and a customer base in power and gas, which offers considerable cross-sell opportunity as well as new customer organic growth opportunity for M2.

Dodo’s revenue has grown from AUD151 million in fiscal 2011 to AUD174 million in fiscal 2012 and is on track to AUD263 million for fiscal 2013. EBITDA has climbed from AUD5 million for fiscal 2011 to AUD21 million for fiscal 2012 and is heading toward AUD29 million for fiscal 2013.

Eftel, meanwhile, generates about AUD80 million of revenue from about 130,000 active services; it offers a full suite of telecommunications services to consumers as well as corporate and government customers and also the wholesale market.

Seen as a whole, the Dodo/Eftel acquisition provides a profitable and organically growing consumer-focused business highly complementary to M2’s existing consumer division.

It brings a proven management team experienced in the consumer segment, including expertise in delivering low-cost new customer acquisition through highly targeted marketing and sales campaigns.

And it brings significant additional scale to M2’s business and corresponding opportunities for both short- and long-term cost savings and operational efficiency.

When we last profiled M2 as a Sector Spotlight–in the September 2012 issue, when the stock was trading at around AUD3.50 per share on the Australian Securities Exchange–we opened by referencing our very first writeup of the stock.

As we noted on Dec. 16, 2011,“It’s almost implicit in its strategic focus that [M2] is on constant lookout for opportunities to add services that it can include in tailored packages for its small and medium-sized businesses in Australia and New Zealand.”

It’s clear now that M2 is working both sides of the scale equation, adding services and now customers as well in combinations that will help it build and sustain market share in a competitive landscape.

Based on the estimated impact on earnings of the Dodo/Eftel acquisition–including consideration of management’s ability to execute post-deal on plans articulated during talk in the immediate aftermath of previous deals–we’re boosting our buy-under target for M2.

If the Primus experience is any indication of what we’re likely to see, shareholders will be rewarded soon, maybe not when the final dividend for fiscal 2013 is announced, but surely in fiscal 2014.

M2 Telecommunications is now a buy on dips below USD5.25 on the ASX using the symbol MTU and on the US OTC market using the symbol MTCZF.

M2’s fiscal year runs from Jul. 1 to Jun. 30. The company reports full financial and operating results twice a year; it typically posts first-half results in late February, with full fiscal year numbers out in late August.

The board approved and management declared an interim dividend of AUD0.10 per share on Feb. 25, 2013. It will be paid April 16, 2013, to shareholders of record as of March 22. The shares traded ex-dividend on this declaration on March 18.

A final dividend of AUD0.09 was declared Aug. 27, 2012. It was paid Oct. 26, 2012, to shareholders of record as of Oct. 5, 2012. Shares traded ex-dividend on this declaration as of Sept. 28, 2012.

Dividends paid by M2 are “qualified” for US tax purposes. Based on the “fiscal cliff” compromise reached in Washington, DC, in early January dividends will be taxed at Bush-era rates of 5 percent to 15 percent for investors’ first USD450,000 a year of income for couples and USD400,000 for single filers. Above that the maximum tax rate is 20 percent.

Among the analysts who cover the stock, five rate it a “buy” according to Bloomberg’s standardization of brokerage house recommendation terminology. There are five “hold” and one “sell” ratings on the stock at present. The “best consensus” 12-month target price among the six analysts that provide such a number is AUD5.18, with a high of AUD5.95 and a low of AUD3.75.