Turkey of the week: poorly positioned telecoms provider

Despite a recent successful acquisition, this telecommunications provider should struggle to meet expectations in an increasingly tough corporate environment.

Turkey of the week: Thus Group (THUS), tipped as a buy by Blue Oar

Thus is a fixed-line telecommunication provider for large firms, public-sector bodies and small and mid-sized businesses, with around a 7% share of the UK market. In February 2006 it added mobile-phone services to its portfolio when it bought Your Communications (YC) from United Utilities for £74m.

Although the integration of Your Communications has beaten hopes in terms of cost savings, there is still no respite in this cut-throat sector. Most of Thus's major rivals are slashing prices and offering bundled quadruple-play services to win and retain customers. For Thus, being a low-cost provider is no longer just a unique differentiating factor, but a necessity if it is to protect its margins.

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Thus is moving in the right direction by offering more and more internet-based products, such as hosting and network outsourcing. But the company is playing catch-up, while older operations, such as narrowband internet access, still precariously account for about half of the group's turnover and probably generate an even greater proportion of profits.

In financial terms, the City expects sales and EPS of £560m and 1.1p for this year, rising to £582m and 7.0p next, putting the shares on challenging p/e ratings of over 100 and 21 respectively. Due to its lack of scale, I believe Thus will struggle to achieve the City's expected 6% a year organic growth rates going forward especially given a tough corporate climate in which price deflation is rampant.

Even the board is "cautious on pricing and the structure of the UK telecoms market", which historically has been plagued by overcapacity. Given its poor competitive position compared to much larger peers, such as BT and Sky, I could see Thus losing, rather than gaining market share.

So why is the stock rated on such a racy valuation? As with many other mid-caps, there have been rumours flying around about takeover interest. AT&T has been named as a potential suitor, but if a bid doesn't transpire then the shares could fall back dramatically. Given that all of its core markets, even for "new wave" internet products, will remain extremely fierce for the foreseeable future, I wouldn't be surprised to see Thus becoming marginalised in this dog-eat-dog environment. My advice to shareholders would be to follow the lead of United Utilities, which jettisoned its 22.6% stake in June at 183p.

Recommendation: Sell at 149p greater downside risk than upside potential

Paul Hill also writes a weekly share-tipping newsletter, Precision Guided Investments