Investor Wag Informal Investment Insights

Software will bite at Telcos

Megaport Limited (ASX:MP1) is tech entrepreneur Bevan Slattery's 4th and latest IPO. Its ASX listing occurred on 16th December 2015, raising $25m in the process to fund a global expansion.

It's a company that helps organisations connect data centres with private high-speed fibre network links. The value they add for customers include process simplification, speed, flexibility and an open API. Megaport is currently established on the Australian east coast, parts of the Asia Pacific region and right now it's busily expanding to the United States and Europe.

Unlike Slattery's other ventures (PIPE, NextDC, Superloop) which are infrastructure heavy companies, Megaport is more likened to a Software-as-a-Service play. Once the company is established and of critical mass, it should be able to operate with relatively low levels of capital expenditure. It's a company that's all about domain knowledge, software and network infrastructure relationships.

I came across a question recently: "Why wouldn't the established telcos squeeze Megaport out with a similar offering?" When I began structuring the reasoning I impulsively started drawing comparisons with OzForex (ASX:OFX) and the question: "Why doesn't the big banks just squeeze them out?" Strangely enough, although completely different companies in different industries, both OzForex and Megaport have very similar structural advantages over the incumbents in their respective industries.

In essence the primary competitive advantage for both companies can be distilled down to possessing a global perspective.

The incumbents in the International Money Transfer (IMT) space are banks that are generally very nationally focused. OFX with an international presence is able to route money locally and net transaction flows. In turn delivering superior customer outcomes in simplicity, cost and speed. More details are available in my previous post on OFX.

Telcos are also very nationally or regionally focused. The value they deliver are bound to the network infrastructure they own and manage. If Megaport is able to execute on its global vision, it will translate to its own set of competitive advantages:

  1. Simplification and Abstraction. Connecting two Megaport enabled data centres works the same way every time. No need to work with different parties with different processes.
  2. (Aspiring) Global Presence. No doubt the aspiration is to be the one-stop-shop to connect any multiple locations in the world. Your office in Adelaide to your data centre in Melbourne to Amazon Web Services in Sydney to Google Cloud Platform on the US West Coast to Azure in Western Europe. An aspiration that will be extremely difficult for any one telco to compete with.
  3. Speed and Flexibility. A link is provisioned within 59 seconds. Altering bandwidth thereafter is just as fast. Pay-as-you-go billing rather than big upfront capital expenditure and long-term contracts. Having such agility will allow customers with greater flexibility in their specific use case. For example, expanding bandwidth temporary in the evenings for off-site backups. Much of this is achieved by using a Software Defined Networking (SDN) approach to the management of network links.
  4. Open API. An API allows other organisations to extend and integrate with Megaport's services. When international companies begin to investigate the orchestration of their global networks - partnering with a global company with a well maintained API will be key to the decision making. This will also apply to software developers/vendors in this space. The overhead of writing software to integrate with a heap of different national/regional network providers using different technologies/processes would be tremendous.

Due to these key advantages, it's likely to be other small SDN players, such as VC backed IIX, that will be the primary competitors to Megaport rather than large telcos. None of the current financials will make sense from a value investing perspective. It's a long-term bet on execution and significant market disruption. It's unlikely to be cashflow positive for some time so the ride will likely be a bumpy one.

MP1 last traded at $2.79.

Disclosure: At the time of publishing I own shares in MP1 and OFX.