Conservative Holding M2 Telecommunications Group Ltd. deserves its reputation for growing through mergers and acquisitions. M2 (ASX: MTU, OTC: MTCZF), which we added to the AE Portfolio in December 2011, spent more than AUD500 million scooping up more than 20 rivals from 2007 to 2013.

It’s now Australia’s fifth-largest provider of fixed-line broadband -services, with brands such as Dodo, iPrimus, Engin and Commander serving business, wholesale and consumer clients.

But M2’s remarkable growth over the past decade was as much internal as it was the result of gobbling up smaller competitors in Australian telecommunications. Mergers and acquisitions remain a central part of M2’s long-term strategy, and the company’s broader horizons now extend beyond telecom to include energy. 

Management has a reputation for cutting costs and reaping big savings from newly acquired businesses before merging them with the rest of the company. That bodes well for M2’s latest venture—offering electricity and natural gas services, thanks to one of its acquisitions.

It’s also a good sign for long-term earnings and dividend growth.

Beyond Telecom

With the Australian market largely consolidated, second-tier telecoms are on the prowl for new sources of revenue and profits. So what’s M2’s solution? Selling its services to its telecom, electricity and natural gas customers.

The May 2013 acquisition of Dodo, a hybrid telecom-energy retailing business, brought with it an electricity customer base of 53,000 that continues to grow. M2 recently rolled out Dodo Electricity in South Australia and last year also launched Commander Energy, which will bundle telecom and energy services for small-business customers in South Australia, Victoria and New South Wales.

Even as it expands into utilities, M2 primarily provides broadband service to businesses and consumers. M2 began its retail broadband service in April 2012, when it acquired Primus Telecommunications and its 165,000 customers for AUD192 million.

Dodo had over 400,000 total customers and some 660,000 active Internet services, in addition to its energy customers. Eftel, acquired along with Dodo in May 2013, had over 130,000 active Internet services.

The acquisitions made M2 one of the largest Internet service providers in Australia, behind Telstra, Singapore Telecommunications Ltd.’s (Singapore: ST, ASX: SGT, OTC: SNGNF, ADR: SGAPY) Optus unit and iiNet Ltd. (ASX: IIN), and nearly as big as TPG Telecom Ltd. (ASX: TPM).

As of the end of last year, M2’s “services in operation” were 1,634,000, an 8.8% year-over-year increase, with internal growth accounting for 3.7%. And average sales per subscriber for the half-year were AUD51 per month, up from AUD50 for fiscal 2014, proof that higher pricing didn’t account for that growth.

M2 also established new distribution channels—Dodo Kiosks, for example—that should beef up earnings in fiscal 2016. For the first half of fiscal 2015, 30% of kiosk sales were to electricity customers, suggesting that both an appetite for the service existed and that the new method for reaching customers was effective.

Turnover for broadband customers should remain low, because most M2 customers, including 95% of consumer and 93% of business customers, have fixed-term agreements of 24 months or more.

And M2 certainly stood out from the competition by launching a full suite of electricity products across all channels in February.

Hitting Its Numbers

Revenue for the six months ended Dec. 31, 2014, rose 7.9% to a company record of AUD546.2 million. That jump in revenue supported growth in earnings before interest, taxation, depreciation and amortization (EBITDA) of 13.6% to AUD86.1 million.

Net profit after tax (NPAT) jumped 24.6% to AUD38.5 million, while underlying NPAT, which excludes one-time expenses, was up 15.5% to AUD50.6 million. Earnings per share (EPS) increased 22.5% to AUD0.212. With an interim dividend of AUD0.15, the payout ratio for the period was 70.7%.

Company policy is to pay a full-year dividend of about 70% percent of NPAT.

Management estimates revenue will grow 8% to 9% and NPAT 15% to 20% in fiscal 2015.

Full-year EPS should come in around AUD0.44, and full-year dividends at approximately AUD0.31, with a final dividend of AUD0.16. That would be about 10% more than the final dividend for fiscal 2014, resulting in year-over-year growth of nearly 20%.

Services should continue growing into the second half of the year, and if Dodo Kiosks attract more new customers, earnings and dividends will be even greater.

M2 could itself become a target for cash-rich telecom hunters because it has attractive current valuations compared with peers such as Amcom Telecommunications Ltd. (ASX: AMM, OTC: ATMUF), which Vocus Communications Ltd. (ASX: VOC, OTC: None) is acquiring. As a result, M2 offers attractive prospects for long-term growth and income as well as good value.

The company is on track to grow thanks to its consistent investment in sales and marketing as well as its considerable cross-selling opportunities. Plus, M2’s strong cash flow bolsters a solid dividend and can be used to invest in future sources of growth.

With a 2015 price-to-earnings ratio of 18.58, M2 is also cheap compared with a telecom sector average of approximately 21.

M2 is now a buy under USD9 on the Australian Securities Exchange using the symbol MTU or on the U.S. over-the-counter (OTC) market using the symbol MTCZF.