Seven years ago, Western Australia's poster boy for entrepreneurship had a wake-up call – shares in the company Michael Malone had created from a standing start in his parents' garage were tumbling and he had to devise a strategy to save iiNet.
Even the GFC did not hit iiNet as hard as the catastrophic accounting mistake in 2006 and profit downgrades that shattered investors' confidence.
Part of the saviour was his family selling everything to buy $4 million worth of shares. And now they, and other early investors, are reaping rewards from their confidence in the internet service provider, ranked Australia's second largest.
iiNet's past few years demonstrate the progress made in turning its fortunes around. It has achieved a total shareholder return (TSR) of 39 per cent over the past five years.
In the past financial year alone, iiNet's share price doubled and the company has achieved a ranking of second-best performer among the state's top 100 stocks, with a TSR of 109 per cent.
But it has not been an easy road.
Baring all
At the start of 2005, iiNet's outlook was relatively positive. It had survived the dot.com crash in 2001 and the company was again growing and regaining market confidence.
Then a major accounting error was discovered, two successive profit downgrades were issued, and the stock's value plummeted from a high of $3.50 to a mere 56 cents.
"We will never be burnt like that again," Mr Malone told Business News.
"It was down to our systems; our billing system was correctly billing everybody and accurately reporting revenue but the financial system on the other side was incorrectly booking it.
"For example, the billing system was saying we've got $16 million in revenue, whereas the finance guys were saying it should be $18 million," Mr Malone said.
That oversight, coupled with Telstra having just increased wholesale prices, created the perfect storm for iiNet.
Mr Malone's response was to bare all to the market. He believes it was that immediate warts-and-all declaration which has given iiNet investors confidence over the long term.
"The feedback we got from investors was that we handled it pretty well; we went through a tough time but we went through every possible issue that we could find with the business and we disclosed it," Mr Malone said.
Telecommunications peer Amcom was one of iiNet's rescuers at that time when it leapt on iiNet's misfortunes and bought $18.3 million worth of shares on market, giving it a 20 per cent stake.
Amcom increased its shareholding to 23 per cent until it sold part of its stake to institutional investors and distributed the remainder to Amcom shareholders in 2011.
The value Amcom received during that period gives a clear indication of how iiNet has returned value to shareholders; in the five years that Amcom held iiNet shares it received dividends amounting to $11 million and overall value of $53 million.
Through thick and thin
The 2006 incident was not the last of iiNet's worries, however, as it had to battle for attention with WA resources companies.
"The sector was pretty down in 2010 because everybody was piling money into resources, which (people thought) could never possibly lose any money," Mr Malone said.
"In times when people think the stock market can't fail people move their money into things that take a bit more risk."
For telecommunications companies, which are typically low growth but relatively safe, that left iiNet and its peers out in the cold.
"At the time a lot of money moved away from telcos – Telstra was by far the most stable in the industry and they were bottoming, so we were all doing pretty poorly," Mr Malone said.
Both iiNet's and Amcom's share prices over that period indicate stagnant appetite for telecommunications stocks but the major shareholders stuck by the company.
"Our investors didn't desert the company; the substantial shareholders that were in there stayed in," Mr Malone said.
Safe bet
In contrast, investor interest has grown rapidly over the past two years, focusing on iiNet's building of revenues and its increasing profits.
The ISP is now pushing $1 billion in revenue and reported net profit after tax of $31.9 million for the first half of the 2013 financial year – a whopping 122 per cent increase on the previous corresponding period.
iiNet has passed on those results to shareholders through higher dividends. The interim dividend for the 2012 financial year was 6 cents a share, which increased to 8 cents a share for the first half of the latest year.
The increase in revenues has been aided by the strategic acquisitions of Internode and TransACT, which Mr Malone said had sparked investor confidence.
"We've done this time after time and I think the market believes we can integrate ISPs," he said.
The acquisitions have analysts backing iiNet for more gains, with many highlighting cost savings as a positive for future financial growth.
But Mr Malone believes a lot of the growing confidence needs to be attributed to the good performance of the telecommunications sector.
"When you look at the resources sector, which has been knocked about by commodity prices and retail, which is getting some real shocks, companies like iiNet look safe in that context – so the entire telco sector has approximately doubled in the last two years," he said.
Mr Malone's analysis also rings true for Amcom, the share share price of which has skyrocketed – increasing about 80 per cent since July last year to trades of $2 a share this month.
That's translated into total shareholder returns of 91 per cent for the 2013 financial year.
Certainty in uncertain market
Looking ahead, iiNet's prospects look bright. Analysts are advocating the stock as a buy and Bank of America Merrill Lynch anticipates a target stock price of $6.35 a share from the current $5.97.
Merrill Lynch based its positive outlook on the roll-out of the National Broadband Network, which will put iiNet on a level playing field with Telstra in regional areas.
Analysts said iiNet was likely to benefit from the NBN regardless of the outcome of the federal election.
Merrill Lynch has taken a conservative view of the NBN on internet service providers' profit margins - estimating gross profit margins under Labor's fibre to the home plant at $15 per subscriber per month.
For iiNet, the profit margins could be much higher, as it already earns about $48 profit in metro areas and $21 in regional areas for broadband and phone bundles.
If the coalition were to succeed at the poll and its proposed fibre to the node plan implemented, the outlook is even more positive for iiNet because wholesale charges on ISPs would be much lower.
Analysts are also optimistic the Australian Competition and Consumer Commission's regulation of wholsesale fixed-line prices will swing in iiNet's favour and be reduced when current prices expire in June 2014.
While frustrated with progress made on the roll-out of the NBN, Mr Malone said it would give iiNet an opportunity to tap into Telstra's latent subscriber base.
"There's a decision point for customers in that they have to actually decide who they're going to go with, whereas up until now it's just been easier to stay with Telstra," he said.
The same can be said for any further dips in the WA economy.
"[iiNet] tends to be pretty recession proof because ... if you're unemployed, you need the internet to find a job, or if you haven't got a job then for $10 a week it's an extremely cheap form of entertainment," he said.
But iiNet is also tackling new frontiers with the launch of its business-to-business, mobile and hardware offerings already bolstering revenue.
Mr Malone admits he "dithered" on entering the mobile services market as he failed to see what iiNet's unique proposition was.
But after realising the 1 million households with an iiNet internet connection may also want their mobile phone service catered to by the same provider, it set the ball rolling. The company now has 120,000 mobile customers.
The introduction of in-home hardware is also making small but significant additions to the iiNet revenue pool while business-to-business contracts now account for about $200 million annually.
For TSR data on 700-plus WA companies, visit http://www.businessnews.com.au/total-shareholder-returns
